Determining the Right Regulatory Authority: SEC or State for Exempt Reporting Advisers

Investment fund organizers, when acting as investment advisers, must navigate the intricacies of registration with the appropriate regulatory body. The choice between SEC registration and state registration hinges on a meticulous analysis of Assets Under Management (AUM) and their alignment with specific registration thresholds.

Deciphering the Realm of Investment Adviser Registration

Investment advisers aspiring to become Exempt Reporting Advisers (ERAs) typically opt for registration through one of two avenues:

SEC Registration with State Notice Filing: The adviser registers with the SEC and submits a notice filing to the relevant state securities regulator(s).

State Registration: The adviser chooses state security regulator(s) for registration.

The primary regulatory authority for an investment adviser is determined by evaluating their total regulatory AUM and comparing it against the prescribed registration thresholds.

Calculating Regulatory Assets Under Management (AUM)

The SEC defines regulatory AUM as securities portfolios for which you provide continuous and regular supervisory or management services as of the date of filing. It deems an account a securities portfolio if at least 50% of its total value comprises securities. This classification extends to all assets within a private fund, including uncalled capital commitments.

An investment adviser is considered to provide continuous and regular supervisory or management services if they either:

• Exercise discretionary authority over the account and provide ongoing supervisory or management services
• Lack discretionary authority but bear the responsibility of selecting or recommending specific securities or investments for the account based on client needs

Fair Market or Fair Value: Two Valuation Approaches

Determining regulatory AUM requires establishing the value of the securities portfolio using either the fair market or fair value standard.

Fair Market Value

According to the Internal Revenue Service, fair market value is the price at which the property would change hands between a willing buyer and a willing seller when neither is under compulsion to buy or sell. It incorporates factors such as business nature, economic outlook, book value, earning capacity, and market prices of comparable assets.

Fair Value

Under Generally Accepted Accounting Principles (GAAP), fair value is defined as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. It focuses on a shareholder's proportionate share without accounting for market or control discounts.

Navigating State and Federal Adviser Registration Thresholds

Small Advisers

Advisers with less than $25M in AUM are prohibited from SEC registration and must register with the state regulator in their principal place of business.

Mid-Sized Advisers

Advisers with AUM between $25M and $100M must register with the SEC if required by the state where they operate.

Large Advisers

Firms with $100M or more in AUM are required to register with the SEC, with preemption of state law. However, Large Adviser ERAs must file notice with state regulators in their principal place(s) of business as a condition of the exemption.

Conclusion

Fund organizers serving as investment advisers must calculate their AUM carefully as part of the overarching determination regarding their regulatory registration authority.