The Securities and Exchange Commission (SEC) recently brought to light a significant enforcement action that raises concerns for fund managers aiming to set up separate entities in hopes of avoiding registration requirements. The move has become a focal point for fund managers considering a spinout from an existing investment adviser or forming new entities that share management teams or operational functions with another adviser. The SEC has reiterated its long-standing view: if two or more affiliated advisers, even though legally separate entities, are deemed operationally integrated, they may be considered a single adviser under the Investment Advisers Act of 1940 (Advisers Act). It could compel one or more of these advisers to register, with substantial implications for the fund's operations and compliance.
The Advisers Act prohibits advisers from indirectly engaging in actions that would be unlawful if performed directly. This principle means that investment advisers and their affiliates cannot bypass registration requirements by forming separate entities if they are ultimately “operationally integrated.” Operational integration is a term used by the SEC to describe scenarios where separate legal entities are, in effect, functioning as one integrated operation.
For example, a fund manager relying on the venture capital adviser exemption (VC exemption) may wonder if forming a separate legal entity to manage funds outside the VC scope — such as secondary funds, continuation vehicles, or crypto funds — can avoid violating the Advisers Act. Unfortunately, the SEC views this strategy as a potential workaround that undermines the intent of the law.
Similarly, a fund manager applying the private fund adviser exemption (PF exemption) might be tempted to set up a new adviser entity each time regulatory assets under management approach $150 million to avoid registration. This too would be scrutinized as an improper attempt to circumvent the requirements.
The Venture Capital (VC) Exemption allows advisers to avoid SEC registration if they exclusively manage venture capital funds and do not handle any other types of investment vehicles. The exemption is important for advisers operating within this specific niche, as it provides a way to circumvent the regulatory complexities tied to registration. However, if a venture capital fund adviser forms a separate entity to manage other types of funds — such as continuation vehicles, secondary funds, or funds of funds — it risks losing its exemption status if the SEC determines that these entities are operationally integrated. It would mean that the adviser is, in effect, managing both VC funds and other types of funds through a single integrated business, which would trigger a registration requirement under the Advisers Act.
The Private Fund (PF) Exemption allows advisers to avoid SEC registration if they exclusively advise private funds and have less than $150 million in regulatory assets under management. Fund managers using this exemption face a significant compliance challenge: they cannot exceed the $150 million cap without triggering a registration requirement. The recent enforcement action underscores the risks for advisers who attempt to sidestep this rule by creating new entities as their assets approach the $150 million threshold. If the SEC considers these entities operationally integrated — due to shared management, personnel, or resources — the adviser may be required to register because it would be treated as a single entity with assets exceeding $150 million, violating the PF exemption.
The SEC’s scrutiny of operational integration extends beyond traditional fund types to include more specialized vehicles such as crypto funds, fund of funds, secondary funds, and continuation vehicles. Advisers looking to rely on the VC or PF exemptions but seeking to expand their offerings to these kinds of funds must be cautious. If these new entities share management teams, investment advice, or operational functions with other affiliated advisers, they could be deemed operationally integrated and lose their exemption status. The SEC’s enforcement actions indicate that it is less about the fund’s specific type and more about how it is managed and operated within the broader advisory framework. It ensures that all types of funds adhere to the regulatory requirements designed to prevent circumventing registration obligations through organizational complexity or fragmented structures.
The SEC's determination of whether advisers are operationally integrated depends on a five-factor test, originally established in a no-action letter to Richard Ellis, a financial services firm. The test evaluates whether an adviser has a distinct, independent existence from its affiliated adviser based on the following criteria:
While these factors are straightforward in theory, in practice, particularly for smaller organizations, achieving operational independence can be challenging. The costs and complexities associated with maintaining separate operations, personnel, and information flow are often prohibitive, and such separation may be inconsistent with commercial objectives.
Since the Richard Ellis no-action letter, the SEC has brought several enforcement actions involving operational integration. Notably:
In all these cases, the advisers were found to be operating as a single integrated entity, thus invalidating their exemption claims under the Advisers Act. These actions underscore that it is not just the formal ownership or governance structure that matters, but also how the advisers conduct their day-to-day operations.
Below are necessary considerations and strategies fund managers should implement to align their marketing practices with regulatory expectations:
To mitigate the risks associated with operational integration and maintain exemption status, fund marketers should focus on the following strategies:
The SEC’s recent enforcement actions serve as a critical reminder: fund managers should avoid trying to structure around registration requirements using separate entities if those entities are not genuinely independent. Even where there is no complete overlap in ownership, if two entities share key personnel, office space, systems, or other operational aspects, they could still be considered operationally integrated.
Fund managers relying on exemptions like the VC exemption or PF exemption must carefully evaluate their operational arrangements and ensure they maintain clear separation from affiliated entities. This evaluation should include a thorough analysis of the five-factor test as well as the broader operational realities of how business is conducted.
For fund managers contemplating the setup of a new entity or a spinout, it’s advisable to engage specialized legal counsel early in the process. The stakes are high — missteps could result in SEC enforcement, invalidation of exemption status, and significant penalties. Legal advisors can help design organizational structures and implement policies that support the independence of adviser entities, thereby reducing the risk of being considered operationally integrated.
When it comes to fund marketing, it is essential for fund managers to collaborate with specialized fund marketers. Engaging professionals with a deep understanding of fund marketing strategies ensures that marketing efforts are tailored to the unique needs and regulations of the fund industry. These specialized marketers will communicate the fund's value proposition, optimize outreach strategies, and optimize brand visibility using regulatory-savvy marketing tactics. For fund managers considering their marketing options, reaching out to us will provide practical guidance and concrete action plans.
In conclusion, the SEC’s stance on operational integration is clear: even seemingly minor overlaps or shared functions between affiliated advisers can trigger registration requirements. Fund managers should therefore approach entity structuring and exemption reliance with caution and, where necessary, seek legal guidance and speak with specialized fund marketers to lead through these complex regulations effectively.
