In the past six months, the Securities and Exchange Commission has settled a number of enforcement actions against venture capital advisers who are exempt reporting advisers (ERAs) and not registered investment advisers (RIAs). In the years since the implementation of Dodd-Frank Act rules in 2011 – when large private equity and hedge fund advisers that were not eligible for the venture capital or private fund adviser exemptions had to register as RIAs – we saw the brunt of the SEC's regulatory focus fall on these newly registered RIAs, with relatively little enforcement action against ERAs. In fact, it was through these enforcement actions, particularly against private equity advisers, that the venture industry learned to become hypervigilant regarding disclosures around conflicts, as well as fees and expenses.
The landscape appears to be changing under Gary Gensler's leadership of the SEC. With five new settled enforcement actions against venture capital advisers in September alone, we are reminded that VC advisers are not outside the SEC's ambit of scrutiny. Since March, the SEC has announced the following categories of settled enforcement actions against venture capital advisers:
- Pay to play: These four enforcement actions involved political contributions made by employees of fund managers to certain public officials occupying positions within government entities that were already invested in the managers' funds.
- Interfund loans and commingling: These two enforcement actions involved loans and cash transfers between the sponsors' various funds that the SEC alleged were unauthorized and undisclosed.
- Miscalculation of management fees: These two enforcement actions involved disclosures around management fees that the SEC alleged were misleading and calculation of management fees that the SEC alleged resulted in overpayment to the managers.
The SEC's focus on private fund advisers has been clear for some time, as evidenced by the Division of Examinations' Risk Alerts and Exam Priorities. Moreover, as the industry is keenly aware, the SEC proposed sweeping new rules earlier this year that would drastically impact private fund advisers, including ERAs. The enforcement actions listed above do not include the charges that the SEC has recently brought against other types of private fund advisers (just last week, 12 settlements were announced involving registered private fund advisers and alleged custody rule violations). As the SEC continues to focus on private fund advisers, it's likely that we'll see more venture capital advisers operating under the ERA exemption being caught by the SEC's scrutiny.
So, what to do? This is a time to clearly understand the obligations that ERAs are bound to, adhere to them, and follow elements of your agreements (such as the determination of management fees) with extreme precision.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.