What is an "excluded adviser"?

General context:

Any person (individual or entity) engaging in advisory services for compensation is typically considered an “investment adviser,” which means they are subject to a variety of regulatory considerations from both the state they are based in as well as from the SEC.  In most commonly understood investment advisory related contexts, advisers must become “registered investment advisers” (aka an “RIA“), which in most states entails, amongst other things, holding certain FINRA licenses such as the Series 65 and a costly registration process that must be worked on with legal counsel.   However, in many states, there is an “exemption framework,” where, if certain criteria is met, an investment adviser that would otherwise need to register can be exempt from registration (commonly referred to as being an “exempt reporting adviser” or “ERA“).   This is often considered desirable, as it generally means less administrative, licensure, and cost related consideration.  For a more detailed understanding about ERAs, check out our guide about exempt reporting advisers.

Not every state has an exemption framework, which means that in those states, registration is required in all cases for any form of advisory activity.  However, most states do.  Of the states that do, in most cases, the exemption is specific to advisers only to certain private funds.  In other words, the concept of being an ERA is very rarely something that occurs other than for private fund managers (it would, for example, be exceedingly uncommon to run into a general wealth advisor that is exempt).

A handful of states, alongside or instead of having an exemption framework, provide for the ability to simply not be considered an investment adviser at all (we’ll call such an otherwise-would-be-investment-adviser an “excluded adviser“) where other states and/or the SEC would consider the same person an investment adviser.

Following this section, we’ll first discuss the most common exemption framework for private fund advisers, the “NASAA model rule,” to establish context on what an example of an exemption framework looks like as well as some of the implications of being exempt.  After, we’ll discuss being excluded.  If you already understand exemption well, you can simply skip ahead.

The NASAA Model Rule for exempt advisers:

The NASAA model rule is an exemption framework created by the North American Securities Adminstrator’s Association in collaboration with state-level legislators.  Of the states with exemption frameworks for private fund managers, many have elected to adopt the NASAA model rule essentially outright and/or on a modified basis, although a number of states have their own, unrelated framework.

In the NASAA model rule, advisers exclusively to private funds are able to be exempt from being required to become RIAs with their state subject to certain criteria.  There are a variety of criteria, much of which is important but likely a non-issue for most emerging managers (e.g. it is not available to certain “bad actors” or folks with certain prior securities violations, standard filings need to be completed, disclosures need to be given to investors, etc).

The two most subjectively notable requirements are:

1. Investors in exempt manager-managed private funds must be “qualified clients,” ($2.2m+ net worth) and not merely accredited investors.
2. An annual audit is required per each fund (generally within 120 days of calendar year close) and the results must be distributed to investors.

Finally, in most of these states, certain filings (such as Form ADV) are required.

As you can see, although an ERA is exempt from registration, by no means is does that mean that they are exempt from regulation entirely.

Now that we have an understanding of a common exemption framework and some of its restrictions, let’s discuss and compare that to being an excluded adviser.

Excluded advisers:

If you aren’t considered to be an investment adviser at all by a given state, then you don’t need to register or be exempt from registration in that state; those are requirements for investment advisers, and, well, you aren’t one, so they don’t apply!   (Note, though, that SEC jurisdiction still kicks in at $25m of assets under management (“AUM“), and the SEC will still generally consider any adviser to private funds to be an investment adviser, even if the state doesn’t.  We know – a bit confusing!  More on that later.)

Thinking about the previous section, if rules around getting annual fund audits and restrictions around the types of investors that may come into a private fund are derived from restrictions for investment advisers, then an excluded adviser does not have the same restrictions.  There is no audit requirement for funds managed by an excluded adviser (and even when SEC jurisdiction kicks in, the SEC doesn’t use the NASAA model rule and the SEC’s exemption framework doesn’t require an audit either), for example, nor is an excluded adviser-managed fund limited to qualified clients.

However, before you get ahead of yourself and assume that it’s all free game, there are still other regulatory frameworks that will kick in for private fund managers from the perspective of the fund and the sale of securities to fund investors, even if there is no regulation for the adviser, such as the Investment Company Act of 1940 and the Securities Act of 1933.  For example, even though an excluded adviser is technically unrestricted in what kind of investors it may take on, the Securities Act of 1933 imposes a requirement that a “safe harbor private placement of securities” (essentially, the means by which hedge funds bring on investors) essentially be limited to accredited investors.  In other words, one set of laws might say nothing about a particular thing that another set of laws that concurrently applies does.  Still, though, an excluded adviser generally has less to be concerned about than an exempt or registered investment adviser.

As a final note on the matter, for an exclued adviser that has AUM exceeding $25m, they will be in the fascinating and uncommon circumstance of simultaneously:

– Not being considered an investment adviser at all by PA, but
– Still being considered an investment adviser by the SEC.

At $150m, though, most advisers must become federally registered with the SEC, so the above is not an indefinite state of affairs.

Do note that an excluded adviser is not an ERA, since ERA standards for exempt reporting adviser.  However, it is, for whatever reason, fairly common to hear folks (and even lawyers) refer to advisers that are excluded as ERAs, even though this is not technically correct.

States with exclusion frameworks:

There are only a few states with an exclusion framework.  Sometimes, such a state only has an exclusion framework, but no exemption framework, while other times, a state may have both.  If a state has both, they are mutually exclusive; an adviser either decides to declare that is exempt, or it declares that it is an investment adviser but does not have to register.

Three prominent examples of states with exclusion frameworks are:

• New York (exclusion framework only; no exemption framework)
• Pennsylvania (both)
• Florida (historically, exclusion only; recently both)

Conclusion:

Exemption vs exclusion vs registration may seem like a complicated subject – and it is.  It varies state-to-state in availability and then requirement.  However, it is extremely useful and important for a prospective fund manager to understand its registration requirements (or lack thereof).  It is also critical to work with service providers that specifically understand the regulatory frameworks that apply to advisers in your specific state.  It is shockingly common to encounter the following:

• Law firms that have expertise in one or a few states launching a manager in another state and not being aware of that other state’s exemption framework and its requirements;
• Law firms that focus on registered managers and rarely work with exempt or excluded advisers and similarly launch incorrectly; and
• Service providers that don’t understand these concepts for their clients, and therefore fail to enforce restrictions correctly.

And unfortunately, the cost of mistakes in this area will fall to the adviser, not its service providers, so fund managers should operate with care around these matters.

If you are a potential emerging manager, Repool provides state-specific exemption/exclusion guides that go into further state-specific detail here.  Additionally, Repool’s focus as the de facto launch platform for emerging managers, careful work with leading investment management counsel, and robust programmatically enforced state-specific launch rules to ensure compliant launches is a strong fit for any U.S. emerging manager seeking to operate as exempt or excluded.  If that’s you, and you are thinking about fund launch, we’d love to hear about your fund here and see if we can help.