What is an Exempt Reporting Advisor?

In the United States, investment advisers who solely manage qualifying venture capital funds or solely manage private fund assets of less than $150 million are exempt from registration with the SEC and from many of the regulations applicable to registered investment advisers (RIAs). They are, however, required to make certain filings and report certain information annually to the SEC and are therefore referred to as exempt reporting advisers (ERAs).

Since the creation of the designation in 2010, thousands of investment advisers to qualifying venture capital funds have become ERAs. Today there are over 5k ERAs.

In this guide, we’ll provide an overview of ERAs for VCs: including what they are, how to become an ERA, and why VC fund managers choose to be an ERA.

What is an Exempt Reporting Advisor?

Under the Investment Advisers Act of 1940 (Advisers Act), an investment adviser is defined as “an individual or entity that, for compensation, is engaged in the business of providing advice, making recommendations, issuing reports, or furnishing analyses on securities—either directly or through publications.”

Managers of venture capital funds and other private funds generally meet this definition and either have to register with the SEC or one or more states, or qualify for an exemption from registration. Registration is a relatively onerous process and subjects an investment adviser to all of the substantive provisions of the Advisers Act and related rules.

For this reason, venture capital fund advisers and private fund advisers will typically rely on exemption from registration to the extent they qualify. It’s important to note though that ERAs still must make certain initial filings and annually report certain information to regulators, are still subject to some provisions of the Advisers Act or analogous state regulatory regimes, and are subject to examination by the SEC staff or state regulators.

How to Qualify as an ERA

The two primary exemptions from registration are:

1. The Private Fund Adviser Exemption

This exemption is available to U.S.-based investment advisers that:

• Solely manage private funds, and
• Have less than $150 million in assets under management (AUM) across all funds managed by the investment adviser.

‍2. The Venture Capital Adviser Exemption:

This exemption is available to investment advisers that solely advise venture capital funds (as specifically defined in the Advisers Act).

To qualify as a venture capital fund and entitle the fund’s investment adviser to rely on the venture capital advisor exemption, a fund must meet the following criteria:

• Representation. A fund must represent itself as pursuing a “venture capital strategy,” including in investor and marketing materials,
• Leverage limitations. A fund must meet the strict limitations imposed on the use of leverage at the portfolio company and fund levels,
• Redemptions. A fund must prohibit redemptions by investors (having their shares repurchased by the fund) except in extraordinary circumstances, and
• Qualifying investments. At least 80% of a fund’s investments must be direct equity investments into private companies, or other “qualifying” investments (including options to purchase such direct equity investments or notes convertible into such equity).

Non-qualifying investments include investments in other funds (e.g., “fund of funds”), public companies, and secondary investments.

Violation of these requirements could result in loss of an investment adviser’s ability to rely on an exemption from registration .

How to File as an ERA

An investment adviser seeking ERA status must complete an exempt reporting adviser (ERA) filing with the SEC within 60 days of claiming the exemption. This is typically the date of the fund manager’s first fund’s initial close. Additionally, an ERA must update its filing annually. The filing must contain the following information:

• Basic identifying information about the ERA (e.g. legal name, principal place of business, etc.),
• Details about any private funds it advises,
• Other business interests of the ERA and its affiliates,
• Disciplinary history of the ERA and its employees, and
• Any “control persons” who directly or indirectly own or control the entity.

ERA Compliance Requirements

While ERAs are not subject to all of the requirements under the Advisers Act or state regulatory regimes, they are generally subject to the following requirements:

• Fiduciary obligations
• Pay-to-play practices
• Anti-money laundering (AML) rules

Fiduciary Obligations

A fiduciary relationship means that the investment adviser is legally bound to put clients’ interests above its own. An ERA should eliminate (or at least plainly disclose) any material conflicts of interest and avoid making misleading statements or omissions (e.g. cherry-picking results or over-exaggerating a potential investment).

Pay-to-Play Practices

ERAs are prohibited from engaging in “pay-to-play practices” (i.e. providing advisory services for compensation to a government entity after making political contributions to an official of that entity ). The rule imposes a two-year “cooling-off” period: after making a contribution to an official of a government entity, you must wait two years before you can receive compensation for providing investment advice to that official or entity. This includes soliciting or coordinating campaign contributions in addition to direct contributions.

AML Rules

Investment advisers (both RIAs and ERAs) are not required to implement anti-money laundering (AML) programs required by the USA PATRIOT Act, the Money Laundering Control Act of 1986, or the Bank Secrecy Act of 1970. However, investment funds and banks often refuse to do business with advisers that do not have AML programs, so it would behoove an investment adviser to have one in place.

ERA Compliance Best Practices

In addition to the above rules, the following widely-accepted best practices can help an ERA maintain compliance and protect itself and its clients.

Code of Ethics

While required for RIAs under the Advisers Act, ERAs would do well to implement a code of ethics that sets forth a standard of business conduct required of all its supervised persons. This Code should include, at a minimum, the following provisions:

• All supervised persons must comply with applicable federal securities laws;
• Policies to monitor for and prevent insider trading;
• Supervised persons must report any code of ethics violations promptly to the appropriate person;
• Each supervised person should be provided with a copy of the code of ethics and any amendments;
• The adviser should obtain the written acknowledgement of each supervised person's receipt of such code and any amendments.

Recordkeeping

While the SEC has not specifically required ERAs to keep certain records, ERAs should still maintain generally the same records as those required of RIAs including:

• Transaction ledgers
• Communications
• Financial records
• Purchases and sales
• Bank and custodial statements
• Evidence of political contributions
• Disciplinary records
• Policies and procedures
• Supervisory or operational procedures

Investment advisers should retain records for at least five years, and keep them easily accessible for at least the first two years.

Note that the SEC has the legal authority to examine an ERA's books and records. In the past, the SEC limited these examinations to those in which there was reason to believe there was wrongdoing; however, as of November 2016, the SEC has begun examining ERAs as part of its routine examination program.

ERA Compliance Costs

ERA status is generally cheaper to maintain than RIA status. In 2016, The NVCA compared the annual compliance costs of ERAs vs. RIAs:

ERAs on AngelList

AngelList helps fund managers (GPs) on the platform make required filings and continue to meet exemption requirements for the life of their fund. ERA services offered to GPs include:

• ERA initial Form ADV filing
• Annual Form ADV population and filing support
• Support for Non-AL Investment Reporting on Form ADV
• Compliance Materials & Best Practices Overview

To learn more about operating a fund on AngelList, visit our website.

ERAs in Summary

While ERAs aren’t exactly “exempt” from all rules and regulations applicable to investment advisors, maintaining ERA status makes operating simpler and cheaper. Adopting practices to comply with the rules governing ERAs will help promote investor confidence while ensuring the fund complies with the SEC and state regulators.