“The left hand never knows what the right hand is doing!” is a common metaphor used to describe policies, procedures, or actions that conflict with each other inside the same organization.
With the Corporate Transparency Act (CTA) becoming effective around the same time as the Securities and Exchange Commission (SEC) implements a new enforcement regime around exempt reporting advisers (ERA), those in the venture capital field have a front-row seat to the left hand and right hand playing different tunes on the same legislative piano.
On the left hand, we have the Corporate Transparency Act.
On January 1, 2024, the CTA went into effect, aiming “to curb illicit finance” by forcing government registration of businesses of a certain size and criteria. The CTA seeks to accomplish its goal by requiring companies to report who their beneficial owners are, as well as other structural details. The logic is clear: If companies must report their beneficial owners, illicit financiers cannot hide their dealings behind multiple corporate layers. Those hiding millions of dollars will have their metaphorical rocks uplifted and searched under.
Perhaps because the government understood that requiring every single entity to report such information put an unfair weight on certain businesses, the CTA exempts 23 types of companies from reporting their beneficial owners, including those operating in fields that are already highly regulated.
One exempted business type includes venture capital fund advisers (and their funds), provided they register with the SEC via FINRA.
Enter the right hand, where we have the SEC’s new exempt reporting adviser enforcement regime.
Exempt reporting advisers exist at two levels: State and Federal. Currently, ERAs may only file as Federal (SEC) ERAs if their funds have over $25 million in assets under management (AUM). Funds with less than $25 million in AUM may only register as State ERAs unless they have investors from more than 15 states.
Previously, the SEC by and large allowed advisers with less than $25 million in AUM to file as Federal ERAs regardless of not meeting the $25 million minimum. A few months ago, however, the SEC started emailing ERAs that did not meet the threshold some version of the following:
Based on your latest Form ADV filing, it does not appear your firm is eligible to report as an SEC exempt reporting adviser (ERA) because you are not eligible to register with the SEC, primarily because … you report that you are managing less than $25 million in private fund gross assets/regulatory assets under management. You further do not qualify for registration under specific exemptions that would allow you to operate without SEC registration, such as being a multi-state adviser or a related adviser under certain SEC rules. Please submit a final report with the SEC to terminate your reporting as an SEC ERA.[1]
This message effectively states that if an adviser does not meet the threshold, the SEC will no longer let it register as a Federal ERA.
How the “Hands” Conflict and Who Is Affected
As mentioned above, the architects of the CTA did not see the value of having businesses in highly regulated industries (like venture capital) be subject to further reporting requirements. However, for a venture capital fund adviser to be relieved of the burden of CTA reporting, they must be registered with the SEC as an ERA. But, with the new enforcement regime, those with under $25 million in AUM, absent very limited exceptions, cannot register with the SEC as an ERA.
This conflict creates a paradox that is the opposite result of that intended by the CTA. The funds that can least afford the additional cost burden of CTA reporting may be the only size venture capital funds required to do so, while the large funds have no such burden. Instead of “curbing illicit finance” in the venture capital field, the CTA and the SEC’s hands are pushing down on the little funds and combining to curb the very financing that creates jobs, new industry and tax dollars for the country.
Moving Forward
As emerging and smaller funds fight to keep traditional administrative costs low, the New Ventures team at Thompson Hine is in constant contact with the SEC regarding its interpretation of the ERA rules and their interplay with the CTA. Similarly, our CTA Task Force is keeping an eye on the recent rulings out of state and federal district courts challenging the constitutionality of the CTA in the first place. We will provide updates as more clarity surrounding these issues emerges.
[1] Credit to Chris Harvey for the simplified version of this email on his blog, Law of VC.
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