The Final Rule
On June 22, 2011, the Securities and Exchange Commission (SEC) adopted rules implementing the exemption from registration for venture capital funds that was established in July, 2010 by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).  A final rule that defines “venture capital fund” under Section 203(l)-1 of the Investment Advisers Act of 1940 (the Act) was also implemented (The Final Rule).  An investment adviser that provides advice to venture capital funds as defined by the Act will not be required to register as an investment adviser, but will be required to file certain reports as set forth in the recently adopted rules.

Requirements for Claiming an Exemption from Registration
The Final Rule sets forth five basic requirements in its definition of “venture capital fund.”

• The fund must hold only qualifying investments and short term holdings subject to a 20% basket.
  • Qualifying investments consist primarily of equity securities, including instruments convertible into equity securities; cash; short- term US treasury securities; and money market funds.
  • The fund can hold non qualifying investments not to exceed 20% of the fund’s capital contributions and uncalled capital.  Assets within the basket are permitted to be valued at historical cost for purposes of determining the 20% limitation.
• The fund shall not borrow or incur leverage in excess of 15% of the fund’s aggregate capital contributions and uncalled capital. 
  
  • The term of any leverage incurred can be no longer than 120 days
  • The 120 day term does not apply to individual company guarantees up to the value of the fund’s investment in each qualifying portfolio company
• The fund cannot provide for early redemptions of the interests of its own equity holders.
  • Pro rata distributions are allowed, but the SEC has not discussed the meaning of “pro rata” and if it includes preferred returns or carried interest splits.
• The fund must have represented itself to its investors in its offering documents as pursuing a venture capital strategy.
• The fund must not be registered under Section 8 of the Investment Company Act of 1940.

Grandfathering Exemption
The Final Rule also includes a grandfathering exemption, which incorporates certain private funds into the venture capital fund exemption. Three conditions must be met to qualify for the exemption:

1. The funds must have issued interests to one or more investors not related to the adviser before December 31, 2010;
2. The funds did not issue interests after July 21, 2011; and
3. The funds represented to investors and potential investors at the time of the offering that it pursues a venture capital strategy. 

Reporting Requirements and SEC Examination
Advisers meeting the requirements for the venture capital fund exemption will not need to register as an investment adviser, but it will be subject to a lesser level of regulation under the Act as an “Exempt Reporting Adviser”.  Exempt Reporting Advisers are required annually to file and update parts of Form ADV Part 1.  Exempt Reporting Advisers must file their initial Form ADV within 60 days of relying on the exemption from registration.  Existing advisers claiming the exemption for the first time under the Act must file their first reports on Form ADV between January 1, 2012 and March 30, 2012.  The SEC is recommending that these advisers submit their Form ADV filings by February 14, 2012 to assure registration by the deadline.   Exempt Reporting Advisers are subject to examination by the SEC, but the SEC has stated that it does not intend to conduct routine compliance examinations of Exempt Reporting Advisers.

Contact the Decosimo Financial Services Leadership Team
Decosimo is a PCAOB-registered firm, and our Investment Partnership team provides tax, audit and advisory services to hundreds of investment companies both in the U.S. and offshore. Our financial services professionals can provide additional information and guidance.

Karl Jordan, CPA | Domestic and International Principal

Marshall Harvey, CPA•CFE | Assurance Principal

Brad East, CPA•ABV | Assurance Principal

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