Thank you, Chairman Schapiro.
I, too, join my colleagues in thanking the staff – particularly those from the Division of Investment Management – for your dedicated efforts on these rulemakings.
The recommendations before us would implement certain provisions of the Dodd-Frank Act that amend the Investment Advisers Act of 1940.
The “Exemptions Adopting Release” adopts final rule changes that implement the provisions of Dodd-Frank providing for new exemptions from registration for foreign private advisers; for advisers to venture capital (VC) funds; and for advisers to private funds with assets under management of less than $150 million.
The “Implementing Adopting Release” adopts final rule changes that, among other things, implement the provisions of Dodd-Frank that raise the assets-under-management threshold for an investment adviser to register with the SEC and that eliminate the exemption from registration that Section 203(b)(3) of the Advisers Act had afforded advisers with fewer than 15 clients. The final rule would impose public reporting obligations on certain investment advisers, including managers of venture capital funds, even though they would be exempt from registration as investment advisers.
In my remarks this morning, I am going to focus on one aspect of the recommendations: the implications for venture capital.
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Before Dodd-Frank amended the Advisers Act, VC fund managers could avail themselves of Section 203(b)(3) of the Advisers Act, which provided an exemption from registration for an adviser with fewer than 15 clients. This private adviser exemption no longer exists. Instead, Dodd-Frank amended the Advisers Act to add new Section 203(l). Section 203(l) exempts managers of VC funds from having to register with the Commission, although VC fund managers may be subjected to reporting and recordkeeping requirements.
Among other things, the Exemptions Adopting Release responds to Dodd-Frank’s directive to the Commission to define “venture capital fund” for purposes of the new Section 203(l) VC registration exemption.
I want to compliment the staff for the thoughtful approach to the definition of “venture capital fund” that the final rule takes. I especially welcome the 20% basket – to be calculated as a percentage of a fund’s capital commitments – which permits funds to make non-qualifying investments, up to a limit, and for the adviser to still fit within the VC registration exemption. The 20% basket reflects the Commission’s effort to accommodate the diversity of the venture capital industry by affording a VC fund manager flexibility in making investments and managing a fund. Because the 20% basket is of sufficient size and predictability to be consequential to a fund manager in practice, incorporating the basket into the final rule should be of significant benefit to the VC industry. That said, I should note that I would have been pleased had the final rule afforded even more flexibility by allowing a “venture capital fund” to invest in a broader range of “qualifying investments.” Nonetheless, I support the recommendation as a result that meaningfully improves the rule as compared to the initial proposal and other possible outcomes of this rulemaking .
Thank you again to the staff for your diligence in navigating through the range of choices we faced in determining what is and what is not a “venture capital fund.”
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Let me now turn to the Implementing Adopting Release. I supported the implementing rulemaking at the proposing stage, although I did so with hesitation. Now that we are at the adopting stage, having received the benefit of commenters’ input, I find myself unable to support the Implementing Adopting Release recommendation and respectfully dissent.
My overarching objection to the Implementing Adopting Release is this: The extent of the mandatory public disclosure that the final rule imposes on VC fund managers, even though they are exempt from registration, coupled with the rationales that animate the release in requiring such disclosure, goes too far toward collapsing the distinction between what it means to be unregistered versus registered as an investment adviser. I am troubled that the release charts an increasingly regulatory course forward such that the Advisers Act regime that applies to exempt advisers will end up closely resembling the regime that regulates registered advisers; that as their reporting and recordkeeping obligations mount, exempt advisers will find themselves subject to what in substance is registration. * It is simply too easy to see how VC fund managers will likely be obligated to disclose more and more information over time, steadily thwarting the purpose behind the VC registration exemption that Congress enacted.
More to the point, VC funds, which by definition cannot be sold to the public, already provide meaningful disclosure to their investors because investors demand information, and fund investors perform their own diligence in evaluating whether to invest in a fund. Indeed, VC fund investors qualify as at least accredited investors and in many instances are large institutions. Accordingly, to my mind, it is difficult to identify any appreciable marginal investor protection benefit from the public disclosure that the final rule dictates. To the contrary, there is reason to worry that at least some of the information might be competitively sensitive and that mandating its public disclosure could harm VC funds and the very investors that the rule purports to protect. Consequently, I am not persuaded that the cost-benefit tradeoff cuts in favor of the public disclosure that the final rule mandates from exempt VC fund managers.
In addition, it is important to keep in mind that because Congress put the new VC registration exemption in Section 203(l) of the Advisers Act instead of Section 203(b), where the former private adviser exemption was found, the SEC would appear to have the authority to examine VC fund managers that are exempt from registration, meaning that exempt VC fund managers may be subject to still more regulatory burdens than the new public reporting obligations. This, of course, is something that Congress could address by relocating the VC registration exemption from Section 203(l) to 203(b).
Stated more concretely, my concern is that the Commission is shaping a regulatory regime that ultimately will come at the expense of capital formation, innovation, entrepreneurism, and jobs. As the VC fund industry is required to bear more regulatory burdens and demands, the risk is that capital formation will be unduly hindered. And when capital formation is frustrated, it becomes increasingly difficult for startups and other small businesses to finance the research and development of new ideas; to commercialize cutting-edge technologies that make us all better off; and to create jobs. If the VC industry is hampered and discouraged, not only is it bad for business and our economy, but the interests of VC fund investors are also undercut.
We need to ensure that the regulatory regime does not compromise the vibrant entrepreneurism that characterizes venture capital. In my view, the Implementing Adopting Release does not pass this test. Therefore, I am unable to support it and the recommendation it reflects.
* A corresponding analysis would apply to the Section 203(m) exemption from registration.