What is an "exempt reporting 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.

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 specifically scoped for 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.  Although in some philosophical sense, this is very different than being an ERA, the practical considerations are largely similar; if you meet the criteria to be an excluded adviser, you naturally don’t need to register as an RIA and aren’t subject to RIA requirements.  This article will not contemplate excluded advisers in great deal; for more on that topic, check out our guide to excluded advisers.

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.  Then we’ll talk at a high level about some of the variations and how exemptions criteria varies state to state.  If you are already deeply familiar with what an ERA is and simply want to understand the ERA framework for a specific state, you can explore our state-by-state guide to ERA frameworks.  However, we strongly suggest finishing this article first to help contextualize some of the concepts in the state-specific articles.

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, let’s discuss some of the ways states adopt and adapt the NASAA framework as their own.

State-specific NASAA variations:

Although some states that have an exempt framework have modeled their framework after the NASAA model rule, many clone it outright or as substantially similar for all practical purposes.  However, other states make modifications ranging from minor to major.  Without contemplating specific states, here are some examples of variations on the NASAA model rule:

• Lowering the qualified client threshold requirement for investors to mere accreditation only
• Additional state-specific filings, reporting, and/or recordkeeping requirements
• Modifications to the definition of a “qualifying private fund” or “private fund adviser” that must be met to be eligible to be exempt
• Dropping the audit requirement

Non-NASAA model rule exemption frameworks:

As previously mentioned, a number of states have an exemption framework that is theoretically unrelated to the NASAA model rule, although even in those such cases, the concepts are still generally quite similar (e.g. there isn’t a state where the ERA needs FINRA licensure or where its funds need to receive two audits a year or something fairly different); the restrictions are still generally around definitional criteria, investor qualification thresholds, bookkeeping and reporting, and audits.

In any case, NASAA model rule or otherwise, understanding state specific requirements is very important and can make or break a potential manager’s launch, especially for emerging managers who wish to take on accredited investors that are not qualified clients, since that is only allowable in a handful of states.

To assist, Repool has painstakingly created the most comprehensive public guide on detailed state-by-state guide to ERA frameworks.

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)

Click into the links above to read about exclusion/exemption criteria specific to the state.

SEC ERA jurisdiction and registrations:

A commonly misunderstood or simply unknown concept is that of concurrent SEC jurisdiction for emerging managers.  Many managers think that being an ERA is exclusively a state-specific consideration.

On the contary, the SEC co-claims jurisdiction over private fund managers in most cases at $25m+ in AUM.  Beginning at $25m+ AUM, an investment adviser must also notice file with the SEC alongside the state.

As an example, if an investment adviser starts as an ERA with its state and initially manages $10m, it will initially only need to notice file as an ERA with its state and consider state-level ERA requirements.

However, once that same investment adviser ahs $25m+ under advisement, it must not only continue to meet its state requirements but also meet the SEC criteria for being an exempt reporting adviser, which is different than that of the state and different than that of the model rule, and also notice file on Form ADV with the SEC!

This can be a confusing concept, and this article won’t delve into its complexities.  However, at a high level, the good news is that in almost all cases, a manager that is able to be an ERA with its state will also meet the SEC’s ERA standards, so it would be exceedingly uncommon (possibly impossible?) to be an ERA with a state, hit $25m, and then implicitly run afoul of the SEC.

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Registration:

Also note that once a manager hits $150m in net regulatory AUM across its funds, it must register with the SEC as a registered investment adviser (aka a “federally covered investment adviser“).

At this point, the federally covered investment adviser status supersedes state-level considerations, and the manager is only really concerned with its SEC-related RIA requirements, so in some sense it becomes more straightforward but certainly not adminsitratively or compliance-wise less complex.

(There are some exemptions on SEC registration for certain qualifying private fund advisers exclusively to certain venture capital funds, but this article does not contemplate that and for any adviser to typical hedge funds and other non-VC funds, the definition is strict and this is not useful to consider).

Conclusion:

Exemption, exclusion, registration, and state vs federal related adviser considerations are a complicated regime of intersecting concepts and ideas, and they aren’t even close to being the only regulatory considerations for an emerging manager.

Therefore, it is extremely important for a prospective fund manager to understand its registration requirements (or lack thereof) to avoid running afoul of regulators.  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’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.