Exempt Reporting Adviser Status for US Managers of a Cayman Fund

A US-based manager that advises only private funds, such as a Cayman fund relying on section 3(c)(1) or 3(c)(7) of the Investment Company Act, and manages less than US$150 million of private fund assets can rely on the private fund adviser exemption in section 203(m) of the Investment Advisers Act and Rule 203(m)-1 instead of registering with the SEC. An adviser relying on that exemption is an exempt reporting adviser. It does not register, but it files a public report on Form ADV, remains subject to the Act's antifraud provisions, the pay-to-play rule and SEC examination of its records, and must deal separately with state investment adviser law. The exemption ends when an annual updating amendment reports private fund assets of US$150 million or more, or immediately if the adviser takes on a client that is not a private fund.

Exempt reporting status is a sensible starting point for a new US manager, but it is a status with a filing calendar and a ceiling, not an absence of regulation. The managers who handle it well calculate their regulatory assets properly from the first filing, keep their client list to private funds, and treat the move to registration as a project that starts a year before the threshold, not a filing made in the month they cross it.

David Lloyd, Chief Executive Officer at CV5 Capital

Executive Summary

For a US manager launching a Cayman fund, the first regulatory question concerns the manager rather than the fund: SEC registration, an exemption, or state registration.

• Rule 203(m)-1(a) exempts a US adviser that acts solely for qualifying private funds with less than US$150 million of private fund assets, counted wherever the funds are organised.
• The threshold uses gross regulatory assets under management under the Form ADV instructions, with no deduction for borrowing.
• An exempt reporting adviser files a public subset of Form ADV Part 1A within 60 days and updates it within 90 days of each fiscal year end.
• The Marketing Rule, compliance rule, custody rule and Form PF do not apply; section 206, Rule 206(4)-8 and the pay-to-play rule do.
• Federal pre-emption of state registration does not cover exempt reporting advisers.

What Exempt Reporting Adviser Status Is

Section 203(m) of the Advisers Act directs the SEC to exempt any adviser that acts solely as an adviser to private funds and has assets under management in the United States of less than US$150 million. The SEC implemented it through Rule 203(m)-1, adopted in Release IA-3222 in 2011. Paragraph (a) of the rule applies to an adviser whose principal office and place of business is in the United States; paragraph (b) applies to a non-US adviser and counts only private fund assets managed at a US place of business.

The term exempt reporting adviser comes from Rule 204-4, which requires an adviser relying on section 203(l) or 203(m) to file reports on Form ADV. Section 203(l) is the separate exemption for advisers solely to venture capital funds, as defined in Rule 203(l)-1. An adviser relying on it must advise solely funds meeting that definition, so it does not fit a hedge fund strategy.

The foreign private adviser exemption in section 203(b)(3) is not available to a US-based manager. The statutory definition in section 202(a)(30) requires, among other conditions, that the adviser has no place of business in the United States. Our wider guide to the full Advisers Act decision sequence for a US manager of a Cayman fund sets these exemptions side by side. This article concentrates on operating as an exempt reporting adviser.

The Two Conditions for a US Manager

A US manager relying on Rule 203(m)-1(a) must act solely as an investment adviser to one or more qualifying private funds and manage private fund assets of less than US$150 million.

A qualifying private fund is a private fund that is not registered under section 8 of the Investment Company Act and has not elected business development company status. A private fund, under section 202(a)(29) of the Advisers Act, is an issuer that would be an investment company but for section 3(c)(1) or 3(c)(7) of the Investment Company Act. A Cayman fund offered to US investors is commonly structured to rely on one of those two exclusions, which in turn determines who may invest; our article on accredited investor and qualified purchaser tests for Cayman funds explains the difference.

The solely condition is the easier of the two to breach. In Release IA-3222, the SEC stated that an adviser with one or more clients that are not private funds is not eligible for the exemption. A single separately managed account breaks it, and the Form ADV instructions state that the loss is immediate. The release also notes that the SEC may, depending on the facts, treat two or more separately formed advisory entities, each below US$150 million, as a single adviser when assessing whether an exemption is available.

For a US adviser, the fund's domicile does not matter. The release states that all private fund assets of an adviser with its principal office and place of business in the United States are assets under management in the United States. The Cayman fund's assets count in full.

How Regulatory Assets Under Management Are Calculated

Rule 203(m)-1 defines assets under management as regulatory assets under management determined under Item 5.F of Form ADV, and private fund assets as the portion attributable to qualifying private funds. Those instructions produce a larger number than NAV for any fund that uses leverage.

Release IA-3222 explains that private fund assets are calculated in connection with the annual updating amendment, and that changes between annual amendments do not affect the exemption. The test date is predictable, but a strong year can take the adviser over the threshold at a single measurement point.

The release adds that advisers, as fiduciaries, may not alter investment behaviour against clients' interests to stay below the threshold.

What an Exempt Reporting Adviser Must Still Do

Exempt reporting status removes registration, not the Advisers Act.

Reporting comes first. Under Rule 204-4 and General Instruction 13, the initial Form ADV is filed through the Investment Adviser Registration Depository within 60 days of first relying on the exemption. An exempt reporting adviser that is not registering with any state completes only Items 1, 2, 3, 6, 7, 10 and 11 of Part 1A, with the corresponding schedules. These cover identifying information, the exemption relied on and the private fund assets figure, organisation, other business activities, affiliations and private funds, control persons and disciplinary history. A Section 7.B.(1) of Schedule D is completed for each private fund, including its gross assets. The SEC makes the information publicly available. Part 2 brochures and brochure supplements do not apply.

General Instruction 4 requires an annual updating amendment within 90 days after fiscal year end, and prompt amendments when specified items become inaccurate. For the complete timetable, our guide sets out every US filing deadline in one calendar.

Two items in that table are often missed. Section 204A requires every adviser subject to section 204 to establish, maintain and enforce written policies reasonably designed to prevent the misuse of material non-public information. Section 204(a) excludes only advisers specifically exempted under section 203(b), and the SEC explained in Release IA-3222 that advisers relying on section 203(m) are not specifically exempted in that sense. The same reasoning gives the SEC authority to require records from, and to examine the records of, an exempt reporting adviser.

Antifraud, Marketing and Pay-to-Play

The Marketing Rule, Rule 206(4)-1, applies by its terms to an adviser registered or required to be registered under section 203. An exempt reporting adviser is outside it. Fund marketing is still regulated: section 206 prohibits any investment adviser from defrauding clients or prospective clients, and Rule 206(4)-8 makes it unlawful for any adviser to a pooled investment vehicle to make an untrue statement of a material fact, or omit a material fact, to any investor or prospective investor in that vehicle. A Cayman fund relying on section 3(c)(1) or 3(c)(7) is a pooled investment vehicle for that purpose. Our article on the SEC Marketing Rule for offshore fund managers covers the rule itself, which applies on registration.

The pay-to-play rule, Rule 206(4)-5, expressly applies to exempt reporting advisers as well as registered advisers and foreign private advisers. It restricts compensated advisory services to a government entity for two years after a contribution to one of its officials by the adviser or a covered associate. A manager expecting public pension money needs a contributions policy from launch.

The State Layer

The federal exemption answers the SEC question only. Section 203A(b) of the Advisers Act pre-empts state laws requiring registration, licensing or qualification of an adviser that is registered with the SEC, and of certain other categories, but an adviser relying on section 203(m) is not within those categories. State investment adviser law therefore continues to apply to an exempt reporting adviser in the ordinary way.

General Instruction 14 to Form ADV confirms that an exempt reporting adviser may be required to register with, or submit a report to, one or more state securities authorities, and that its investment adviser representatives may also be subject to registration. The answer depends on the state of the principal office and any other state where the adviser does business, and requirements differ between states. Settle it alongside the federal analysis before launch: an adviser required to register with a state completes all of Form ADV, not the exempt reporting subset.

Crossing US$150 Million: The Move to Registration

General Instruction 15 to Form ADV sets out what happens when an adviser relying on Rule 203(m)-1 reports in Section 2.B of Schedule D to its annual updating amendment that it has private fund assets of US$150 million or more. Unless another exemption applies, it must register with the SEC. If it has complied with all SEC reporting requirements applicable to an exempt reporting adviser, it has up to 90 days after filing that annual updating amendment to apply for registration, and may continue to do business as a private fund adviser in the meantime. The final exempt reporting adviser report and the application for registration are submitted in the same filing.

The transition period is conditional. If the adviser has not complied with its exempt reporting obligations, the 90 days are not available, and its registration must be approved before it reaches the threshold. The transition period also does not cover new clients: unless another exemption applies, accepting a client that is not a private fund before registration is approved breaches the registration requirement.

A practical sequence:

1. Project gross regulatory assets under management at each fiscal year end.
2. Where it crosses US$150 million, start a year ahead: Form ADV Part 2, a compliance programme and chief compliance officer, a code of ethics, and Rule 204-2 records.
3. Review marketing materials against the Marketing Rule.
4. Confirm custody and audit arrangements satisfy the custody rule.
5. Keep every exempt reporting filing current to preserve the 90-day period.
6. File the final report and registration application together within 90 days.
7. Prepare for Form PF, which applies to registered advisers with at least US$150 million of private fund assets; our guide to Form PF obligations for Cayman fund managers sets out the filing categories.

Registration also changes the state position. Once registered with the SEC, the adviser falls within the federal pre-emption of state registration, although General Instruction 15 notes that it may be subject to state notice filing requirements.

How the Cayman Structure Fits

Exempt reporting status is a matter of US law for the adviser. It does not change the regulatory status of the Cayman fund, which is determined by Cayman law and, where the fund is registered, by CIMA.

The two analyses meet in three places. The fund's reliance on section 3(c)(1) or 3(c)(7) is what makes it a private fund for section 203(m) purposes, linking investor eligibility to the adviser exemption. US taxable investors in a corporate Cayman fund raise a tax question that is separate from the adviser question; our article on PFIC rules for US investors in Cayman funds explains why. And the adviser's entity choice matters less than managers expect: because the Advisers Act analysis looks at where the adviser and its people actually conduct the advisory business, interposing a Cayman management entity is unlikely on its own to take a US-based manager outside it. Our analysis of whether a Cayman investment management company is needed covers that decision.

Common Mistakes

• Measuring the US$150 million threshold against NAV rather than gross regulatory assets under management.
• Accepting a separately managed account, which ends the exemption immediately.
• Assuming that federal exemption settles the state question, or that the state report is the same as state registration.
• Filing the initial Form ADV late, or missing amendments, and so losing the 90-day transition period when the threshold is crossed.
• Treating the absence of the Marketing Rule as permission to use performance material that would not survive section 206 and Rule 206(4)-8.
• Having no written policy on material non-public information or political contributions.

The CV5 Implementation Perspective

CV5 Capital is the Cayman-headquartered institutional fund infrastructure platform for hedge fund and digital asset managers who need to launch quickly, operate properly and satisfy serious investors from day one. It operates CV5 SPC for traditional strategies and CV5 Digital SPC for digital asset strategies, both registered with CIMA under the Mutual Funds Act. Each manager receives a segregated portfolio with an independent board and coordinated fund administration, audit, banking, custody and compliance arrangements. CV5 Capital is not the investment manager of the strategies on its platforms.

For a US manager, the adviser's regulatory status remains the manager's own responsibility, and the platform does not change it. What a Cayman hedge fund platform for third-party managers provides is a fund whose governance, administration, audit and reporting already operate to an institutional standard. The administrator's valuations support the gross asset figure the adviser reports, and the audit and reporting framework is already in place when registration brings the custody rule with it.

Key Takeaways

• Confirm the adviser advises only qualifying private funds before relying on Rule 203(m)-1, and decline separately managed accounts while exempt.
• Calculate private fund assets on the gross Form ADV basis, including leverage and uncalled commitments, at each annual updating amendment.
• File the initial Form ADV within 60 days of relying on the exemption and keep every amendment current.
• Adopt written policies on material non-public information and political contributions from launch.
• Settle state registration or reporting in the same exercise as the federal analysis.
• Start registration work a year before projected assets reach US$150 million.

Frequently Asked Questions

What is an exempt reporting adviser?

An exempt reporting adviser is an investment adviser that relies on the venture capital adviser exemption in section 203(l) or the private fund adviser exemption in section 203(m) of the Advisers Act. It is exempt from SEC registration but must file and update a public report on Form ADV under Rule 204-4, and it remains subject to the Act's antifraud provisions, the pay-to-play rule and SEC examination of its records.

Can a US manager of a Cayman fund be an exempt reporting adviser?

Yes, if it acts solely as an adviser to qualifying private funds and manages private fund assets of less than US$150 million. A Cayman fund relying on section 3(c)(1) or 3(c)(7) of the Investment Company Act is a private fund. For a US adviser, the Cayman fund's assets count in full towards the threshold, because all private fund assets of a US adviser are counted.

Does the US$150 million threshold use net asset value?

No. The threshold uses regulatory assets under management under the Form ADV instructions. All assets of a private fund are counted at market or fair value, borrowing and other liabilities are not deducted, and uncalled capital commitments are included. A leveraged fund can therefore exceed the threshold while its net asset value is well below US$150 million.

Does the SEC Marketing Rule apply to exempt reporting advisers?

No. Rule 206(4)-1 applies to advisers registered or required to be registered with the SEC. An exempt reporting adviser remains subject to section 206 of the Advisers Act and to Rule 206(4)-8, which prohibits untrue or misleading statements of material fact to investors and prospective investors in a pooled investment vehicle, so fund marketing still has to be accurate and complete.

Do exempt reporting advisers file Form PF?

No. Rule 204(b)-1 requires Form PF from advisers registered or required to be registered with the SEC that manage at least US$150 million of private fund assets. An exempt reporting adviser that crosses the threshold and registers will then become subject to Form PF, so the reporting data should be prepared before registration takes effect.

What happens when an exempt reporting adviser reaches US$150 million?

If its annual updating amendment reports private fund assets of US$150 million or more, it must register with the SEC unless another exemption applies. Where it has complied with all exempt reporting requirements, it has up to 90 days after that amendment to apply, filing its final exempt reporting adviser report and registration application together, and may keep advising private funds in the meantime.