Must a Hedge Fund Register as an Investment Advisor?
Not all hedge fund managers are subject to investment adviser registration. To determine whether a fund manager needs to register, we ask our clients the following five questions:
1. Will the fund invest in "securities?"
2. Will the manager advise separately managed accounts?
3. What will be the size of the fund?
4. In what state is the fund manager physically located?
5. In what states are the investors located?
Does the Fund Invest in “Securities?”
Only funds that invest in securities are required to register as an investment adviser. For example, funds that invest solely in commodities, futures, currencies, or certain real estate investments would not be subject to investment adviser registration.
The definition of "security" is expansive and covers many investment instruments, schemes, and structures. It is rare for a manager's portfolio to be devoid of any securities, as even nominal positions will bring the fund under the jurisdiction of securities regulators. Fund managers should consult with experienced securities counsel before concluding that a fund does not invest in securities.
Will the Manager also Advise Separately Managed Accounts?
In addition to managing pooled investment vehicles, fund managers often also advise individual clients as separately managed accounts (SMAs). Advising SMAs will trigger the requirement for RIA registration for fund managers that would otherwise be exempt. Additionally, advising SMAs lowers the Securities and Exchange Commission (SEC) registration threshold for assets under management from $150 million (for funds that solely advise private funds) to $100 million.
What will be the Size of the Fund?
A securities hedge fund manager that manages over $150 million, including leverage, calculated as Regulatory Assets Under Management (RAUM) automatically requires registration as an investment adviser with the SEC. If the manager also advises clients in separately managed accounts, the RAUM threshold for SEC registration drops to $100 million. All others are subject to state regulation and, depending on the state, may be subject to registration.
States that have adopted registration exemptions for private fund advisers allow a much lighter disclosure than full registration, known as the exempt reporting adviser (ERA) filing. However, many states still require state-level investment adviser registration.
In what State is the Fund Manager Physically Located?
In most states, hedge funds investing in securities with less than $150 million in assets under management must register as state investment advisers in the state where the manager's primary operations occur. Establishing an entity in a jurisdiction to avoid higher regulatory obligations will be disregarded if this differs from the jurisdiction where most of the manager's primary advisory operations occur.
States that recognize a private fund exemption exempt the manager from investment adviser registration if the manager solely advises private funds. At the outset, hedge funds in these jurisdictions are exempt from investment adviser registration at the SEC and state levels.
As discussed in our blog post, Who Can Invest in Hedge Funds?, managers subject to SEC or state investment adviser registration or the ERA filing can only accept performance compensation from "Qualified Clients."
Managers in jurisdictions not initially subject to these adviser registrations at launch may (subject to limitations) accept investments and charge performance compensation from "accredited investors." Once a manager's assets under management in one of these jurisdictions pass the $25 million threshold, they will require an ERA filing and be subject to that jurisdiction's investor standard requirements.
In what States are the Investors Located?
Unless there is an available exemption, most states require a private fund manager with a place of business in that state to register as an investment adviser, regardless of the number of investors in the fund. There is a private fund adviser exemption (ERA) in many states for managers who solely advise private funds.
However, all states also have an offering exemption for managers of private funds without a place of business in that state that exempt them from registration until they reach a certain threshold of clients (typically no more than five clients during a period of twelve months).
For a fund manager advising private funds, most states consider the fund entity as one client for purposes of these exemptions, regardless of the number of investors within that fund entity.
Additionally, most states require fund managers to file a state Form D notice, also called a blue sky filing, within fourteen days of the first investor from their respective state investing in the fund.
Managers Advising Separately Managed Accounts
Similar to private funds, regardless of the number of managed SMA clients, most states require investment adviser registration for a manager advising SMAs with a place of business in that state unless there is an available exemption.
Different from managers of private funds, they do not generally have a widely available exemption (excluding registration with the SEC as an investment adviser).
However, all states have an exemption from registration for managers of SMAs without a place of business in that state. Such managers will be exempt from registration until a certain threshold of investors has been reached (typically no more than five clients during a period of twelve months). Once a manager surpasses all state-based investment adviser exemptions, the manager becomes subject to investment adviser registration regardless of whether it has a business place in that state.
Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund.