Some private fund managers in California face potentially dire consequences if they fail to properly register with the state and the U.S. Securities and Exchange Commission (SEC). Failing to adhere to relevant securities laws could lead to fines and other monetary penalties, as well as reputational damage.

As such, it is critical for corporate investors to know if under existing regulations they are considered an investment advisor subject to reporting obligations, and if so, what those obligations are.

How is an Investment Advisor Defined?

An investment adviser is defined broadly under California Corporations Code § 25009 as any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing or selling securities, or who, for compensation and as a part of a regular business, publishes analyses or reports concerning securities, with limited exceptions.

California has long been a hub for private fund activity, from venture capital to real estate and hedge funds, that are usually subject to such registration. For fund managers operating in or from the state, compliance with the Investment Advisers Act of 1940 (Advisers Act) and California’s Corporate Securities Law of 1968, a comprehensive securities compliance framework embodied in California Corporate Code Sections 25000-25707, is essential. One key exemption from registration as an investment adviser available to many is registration as an Exempt Reporting Adviser (ERA).

What Is an Exempt Reporting Adviser?

An ERA is an investment adviser who qualifies for an exemption from full registration under the Advisers Act but is still required to provide some information by filing a truncated Form ADV (only Part 1A and applicable schedules) with the SEC and the California Department of Financial Protection and Innovation (DFPI). Typically, ERAs manage certain “qualifying private funds,” which are private funds where an issuer qualifies for the exclusion from the definition of an investment company under one or more of sections 3(c)(1), 3(c)(5), and 3(c)(7) of the Investment Company Act of 1940.

California’s ERA Filing Requirement: Who Must File?

Under California Corporations Code § 25230.1, an adviser providing investment advice may qualify for exemption from registration as an Investment Adviser but may file as an ERA with California if they:

1. manage or advise primarily qualifying private funds;
2. are not be subject to statutory disqualifications or “bad boy” provisions;
2. have a place of business in California; and
3. are not otherwise registered with the SEC.

Additional requirements pertain to “retail buyer funds” which is a qualifying private fund that (i) is not a “venture capital company”, and (ii) qualifies for the exclusion from the definition of an investment company under one or both Sections of 3(c)(1) and 3(c)(5) of the Investment Company of 1940.

An ERA filing must be made within 60 days of commencing advisory activity in California. Thereafter, an ERA is required to update its Form ADV at least annually, or within 30 days of any material change, pay applicable fees, and ensure compliance with California’s rules regarding antifraud, custody, audit and recordkeeping.

Failure to properly register as an ERA can lead to penalties, fines and potential legal action by the DFPI.

Conclusion

Fund advisers operating in California who manage qualifying private funds must carefully assess whether they meet the criteria for filing as an Exempt Reporting Adviser. While the ERA designation offers a streamlined compliance path, it comes with specific eligibility requirements, filing obligations, and ongoing duties under both federal and California law which may be complicated to navigate.

Prompt and accurate registration with the SEC and DFPI, along with diligent maintenance of Form ADV and adherence to applicable rules, is essential to avoid regulatory scrutiny. By understanding and meeting these obligations, with the help of legal counsel, private fund managers can maintain good standing and continue operating in California’s dynamic investment landscape.