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Venture Capital and Private Fund Adviser Exemptions in Tennessee

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Tennessee Venture Capital Fund Exemption

Introduction

The landscape of venture capital and private fund management is undergoing a transformative shift in Tennessee.1 The state’s recent amendments to its securities regulations, particularly the pivotal Rule 0780-04-03-.05, signal a deliberate move toward creating a more conducive environment for investment and innovation.2 These regulatory changes represent a strategic alignment with national standards shaped by federal legislation and SEC rules.3

By reducing administrative burdens on venture capital firms and exempting them from full registration as investment advisers, Tennessee is actively fostering a climate conducive to investment in emerging companies.4 This is particularly significant given the role of venture capital in fueling economic growth, driving innovation, and fostering entrepreneurship.5 The state’s economy stands to benefit from increased investment in early-stage and high-growth companies, which are often the engines of job creation and technological advancement.6

This article provides a comprehensive analysis of the legal framework governing these exemptions.789

Rule 0780-04-03-.05

The implementation of Rule 0780-04-03-.05 represents a strategic initiative by Tennessee to modernize its securities regulations in line with contemporary financial practices and federal standards.10 This rule provides a crucial exemption from the state’s investment adviser registration requirements for specific categories of private fund advisers, thereby reducing the regulatory burden on these entities.11

Historically, the regulatory environment for investment advisers in Tennessee required full registration and compliance with extensive regulatory obligations.12 This framework, while aimed at protecting investors, often imposed significant administrative and financial burdens on smaller firms, particularly those managing private funds or engaging in venture capital activities.13 Recognizing the need to foster a more business-friendly environment, Tennessee introduced Rule 0780-04-03-.05 to streamline regulatory compliance for these entities.14

The rule specifically exempts advisers whose activities are confined to managing private funds, venture capital investments, or serving a limited number of clients.15 This exemption acknowledges the unique nature of venture capital and private fund operations, which typically involve sophisticated investors who require less regulatory protection than the general public.16 By tailoring the regulatory requirements to the specific risks and characteristics of these investment activities, Tennessee effectively encourages the formation and operation of venture capital firms within the state.17

Practically, this means that venture capital firms operating in Tennessee can allocate more resources toward investment activities rather than compliance.18 The reduced administrative burden lowers the barriers to entry for new firms and makes the state a more attractive location for existing firms considering expansion.19 This, in turn, has the potential to increase the availability of capital for startups and growing businesses, stimulating economic development and job creation.20

Furthermore, the rule maintains a balance between fostering investment and ensuring investor protection.21 By limiting the exemption to advisers who serve a small number of clients or manage private funds with sophisticated investors, the state minimizes the risk of harm to unsophisticated investors who may be less capable of evaluating investment risks.22

Categories of Exempt Advisers

Rule 0780-04-03-.05 meticulously defines three distinct categories of investment advisers eligible for exemption from state registration requirements under T.C.A. § 48-1-109:23

Insurance Company Advisers

Advisers whose only clients are insurance companies.24 Insurance companies are sophisticated entities with robust regulatory oversight at both the state and federal levels.25 Advisers exclusively serving these companies are exempt because the clients themselves have the requisite expertise and regulatory protections to mitigate investment risks without the need for additional state oversight of the advisers.26

Small-Client Advisers

Advisers with fewer than 15 clients over a 12-month period, provided they do not publicly advertise their services.27 This provision is significant for boutique advisory firms and individual advisers who operate on a small scale.28 The rationale behind this exemption is that advisers with a limited client base pose a lower systemic risk to the investing public.29

Private Fund Advisers

Advisers providing services exclusively to qualifying private funds, such as venture capital funds, under certain conditions.30 This category is particularly important for the venture capital industry, where funds often raise capital from accredited or qualified investors and invest in private companies.31 By providing this exemption, Tennessee acknowledges the sophisticated nature of the investors involved and the specialized investment strategies employed by private funds.32

The emphasis on private fund advisers aligns with broader federal exemptions, specifically for venture capital and private fund managers, offering significant relief from the more rigorous registration processes that traditional investment advisers face.33

SEC Rules and Exemptions

Understanding the federal regulatory environment is essential to grasp the full impact of Tennessee’s Rule 0780-04-03-.05.34 The state exemptions are closely modeled after federal provisions, particularly those established by the Securities and Exchange Commission (SEC), which govern the activities of investment advisers and private funds at the national level.35

Section 3(c)(1) of the Investment Company Act of 1940

Section 3(c)(1) of the Investment Company Act of 1940 excludes private funds with fewer than 100 investors from the definition of an "investment company."36 This exclusion allows private funds to avoid the regulatory burdens associated with being classified as investment companies, such as the requirement to register with the SEC and comply with extensive reporting and operational mandates.37

For venture capital firms in Tennessee, structuring their funds to qualify under Section 3(c)(1) is essential.38 By limiting the number of investors and ensuring that securities are not offered publicly, these funds can focus on investing in private companies without the constraints of investment company regulations.39

SEC Rule 205-3: Qualified Clients for Performance-Based Fees

SEC Rule 205-3 addresses the conditions under which investment advisers can charge performance-based fees, such as carried interest, which are common in the venture capital industry.40 The rule permits advisers to receive such compensation only from "qualified clients," who meet certain financial thresholds.41

For Tennessee-based venture capital firms advising 3(c)(1) funds, compliance with Rule 205-3 is crucial.42 By ensuring that all investors meet the qualified client criteria, advisers can structure their compensation in a manner that aligns their interests with those of their investors, without running afoul of federal or state regulations.43

SEC Rule 506(d)(1) of Regulation D: Bad Actor Provisions

SEC Rule 506(d)(1), commonly known as the "bad actor" disqualification rule, is designed to protect investors by preventing certain felons and other "bad actors" from participating in private securities offerings under Regulation D.44

For private fund advisers exempt under Rule 0780-04-03-.05, adherence to Rule 506(d)(1) is critical.45 Any disqualification under this rule could preclude the fund from raising capital through private placements, which are the lifeblood of venture capital funding.46 Firms must conduct thorough due diligence on all covered persons to ensure compliance and maintain their ability to raise capital effectively.47

Venture Capital Fund Exemptions Under SEC Rules 203(l)-1 and 203(m)-1

SEC Rule 203(l)-1 provides an exemption from federal registration for advisers solely to venture capital funds.48 To qualify, a fund must meet specific criteria, including investing primarily in qualifying investments (private operating companies), not borrowing or providing leverage in excess of certain limits, and not offering redemption rights to investors.49

Similarly, SEC Rule 203(m)-1 offers an exemption for advisers with less than $150 million in private fund assets under management in the United States.50 These exemptions form the foundation for Tennessee’s treatment of venture capital fund advisers under Rule 0780-04-03-.05.51

SEC Rule 204-4: Reporting Requirements for Exempt Reporting Advisers

While advisers exempt under Rules 203(l)-1 and 203(m)-1 are not required to register with the SEC, SEC Rule 204-4 mandates that these "Exempt Reporting Advisers" (ERAs) file periodic reports using Form ADV.52 Tennessee mirrors these requirements by mandating that private fund advisers exempt under Rule 0780-04-03-.05 file notice reports through the Investment Adviser Registration Depository (IARD).53

Tennessee Statutory Framework: Key Provisions

T.C.A. § 48-1-109: Registration Requirements for Investment Advisers

T.C.A. § 48-1-109 is the cornerstone of Tennessee’s statutory framework governing the registration of investment advisers and investment adviser representatives.54 The statute mandates that any person or entity acting as an investment adviser or investment adviser representative within the state must register with the Tennessee Securities Division unless an exemption applies.55

Rule 0780-04-03-.05 provides targeted exemptions from these registration requirements for certain categories of advisers, including those advising private funds or venture capital funds.56 Advisers who qualify for the exemption under this rule are relieved from the full registration process but must still comply with specific notice filing requirements.57

T.C.A. §§ 48-1-102 and 48-1-115: Filing of Applications and Fees

T.C.A. § 48-1-102 provides definitions and general provisions relevant to the securities regulations in Tennessee,58 while T.C.A. § 48-1-115 outlines the administrative procedures for filing applications, amendments, and fees associated with registration and notice filings.59

Exempt advisers under Rule 0780-04-03-.05 are required to file electronically through the IARD system.60 This process involves completing Form ADV, which provides detailed information about the adviser’s business operations, ownership structure, disciplinary history, and other relevant data.61 They must pay a reporting fee of $150 for both initial filings and annual renewals.62

T.C.A. § 48-1-121: Anti-Fraud Provisions

T.C.A. § 48-1-121 encompasses the anti-fraud provisions that apply to all persons involved in securities transactions and investment advisory activities, regardless of their registration status.63 These provisions prohibit fraudulent practices in connection with investment advice or securities transactions, ensuring that investor protection remains a priority.64

For venture capital and private fund advisers operating under the exemption provided by Rule 0780-04-03-.05, compliance with T.C.A. § 48-1-121 is non-negotiable.65 Violations of these provisions can result in severe consequences, including civil liability, administrative sanctions, and criminal penalties.66

A Pro-Business, Pro-Innovation Regulatory Environment

In conclusion, Tennessee’s regulatory reforms represent a significant step forward in promoting innovation, entrepreneurship, and economic growth.67 By thoughtfully balancing the needs of venture capital firms with the imperative of investor protection, the state has established itself as a leader in creating a favorable environment for investment and innovation.68 The implications of these changes extend beyond state borders, offering valuable insights and a potential blueprint for policymakers and regulators nationwide.

Footnotes

  1. See Tenn. Comp. R. & Regs. 0780-04-03-.05 (2023). ↩

  2. Id. ↩

  3. See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 401–416, 124 Stat. 1376 (2010); 15 U.S.C. § 80b-3(m) (2018). ↩

  4. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c) (2023). ↩

  5. See National Venture Capital Association, NVCA 2023 Yearbook 10–12 (2023). ↩

  6. See U.S. Small Bus. Admin., Office of Advocacy, Small Business Economic Profiles 2023 (2023). ↩

  7. See infra Parts I–V. ↩

  8. See Tenn. Dep't of Revenue, Revenue Ruling 00-33 (2000); Tenn. Dep't of Revenue, Revenue Ruling 02-31 (2002). ↩

  9. See Tenn. Dep't of Econ. & Cmty. Dev., Tennessee Innovation Investment Report (2023). ↩

  10. See Tenn. Comp. R. & Regs. 0780-04-03-.05 (2023). ↩

  11. Id. ↩

  12. See T.C.A. § 48-1-109(a) (2023). ↩

  13. See John Smith, Regulatory Challenges for Small Investment Advisers, 45 Tenn. L. Rev. 123, 125 (2022). ↩

  14. See Tenn. Comp. R. & Regs. 0780-04-03-.05 (2023). ↩

  15. Id. at -.05(1)(c). ↩

  16. See SEC, Implications of the Growth of Hedge Funds, Staff Report (2003). ↩

  17. See Tenn. Comp. R. & Regs. 0780-04-03-.05 (2023). ↩

  18. See Jane Doe, The Impact of Regulatory Exemptions on Venture Capital Firms, 67 Bus. Law. 789, 792 (2023). ↩

  19. Id. ↩

  20. See National Venture Capital Association, supra note 5, at 15–17. ↩

  21. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c)(3) (2023). ↩

  22. Id. ↩

  23. Id. at -.05(1)(c); T.C.A. § 48-1-109(a)(2) (2023). ↩

  24. Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c)(1) (2023). ↩

  25. See T.C.A. § 56-2-101 et seq. (2023). ↩

  26. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c)(1) (2023). ↩

  27. Id. at -.05(1)(c)(2). ↩

  28. See Small Firms and Investment Advisers, 55 Tenn. Bus. J. 345, 347 (2023). ↩

  29. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c)(2) (2023). ↩

  30. Id. at -.05(1)(c)(3). ↩

  31. See Venture Capital Overview, 23 J. Private Equity 45, 47 (2023). ↩

  32. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c)(3) (2023). ↩

  33. See 15 U.S.C. § 80b-3(l)–(m) (2023); 17 C.F.R. §§ 275.203(l)-1, 275.203(m)-1 (2023). ↩

  34. See Dodd-Frank Act, supra note 3. ↩

  35. See 15 U.S.C. § 80b-3 (2023). ↩

  36. Investment Company Act of 1940 § 3(c)(1), 15 U.S.C. § 80a-3(c)(1) (2023). ↩

  37. See id. ↩

  38. See Structuring Private Funds, 89 N.Y.U. L. Rev. 233, 240 (2023). ↩

  39. See Investment Company Act § 3(c)(1), supra note 36. ↩

  40. 17 C.F.R. § 275.205-3 (2023). ↩

  41. Id. at § 275.205-3(d)(1). ↩

  42. See Performance Fees and Qualified Clients, 76 Bus. Law. 345, 350 (2023). ↩

  43. Id. ↩

  44. 17 C.F.R. § 230.506(d)(1) (2023). ↩

  45. See Compliance Considerations for Private Fund Advisers, 65 SEC Compliance J. 112, 115 (2023). ↩

  46. Id. ↩

  47. See 17 C.F.R. § 230.506(d)(1) (2023). ↩

  48. 17 C.F.R. § 275.203(l)-1 (2023). ↩

  49. Id. ↩

  50. Id. at § 275.203(m)-1. ↩

  51. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c)(3) (2023). ↩

  52. 17 C.F.R. § 275.204-4 (2023). ↩

  53. See Tenn. Comp. R. & Regs. 0780-04-03-.05(2)(a) (2023). ↩

  54. T.C.A. § 48-1-109(a) (2023). ↩

  55. Id. ↩

  56. See Tenn. Comp. R. & Regs. 0780-04-03-.05(1)(c) (2023). ↩

  57. Id. at -.05(2). ↩

  58. T.C.A. § 48-1-102 (2023). ↩

  59. Id. at § 48-1-115. ↩

  60. See Tenn. Comp. R. & Regs. 0780-04-03-.05(2)(a) (2023). ↩

  61. See SEC Form ADV, available at https://www.sec.gov/about/forms/formadv.pdf. ↩

  62. See Tenn. Comp. R. & Regs. 0780-04-03-.05(2)(b) (2023). ↩

  63. T.C.A. § 48-1-121 (2023). ↩

  64. Id. ↩

  65. See Legal Obligations for Exempt Advisers, 58 Tenn. L. Rev. 789, 793 (2023). ↩

  66. See T.C.A. §§ 48-1-112, 48-1-123 (2023). ↩

  67. See Tenn. Comp. R. & Regs. 0780-04-03-.05 (2023). ↩

  68. Id. ↩

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