Of the several hundred digital asset funds with managers or investors domiciled within the United States, only a minuscule portion have become fully registered investment advisers with the SEC. Instead, most of these digital asset funds have thus far avoided SEC adviser registration in one of three ways:
- by investing solely in digital assets that do not constitute securities under the Howey Test, such as Bitcoin, Ethereum, and true utility tokens;
- by avoiding liquid token investments entirely in reliance on venture capital adviser exemption by investing in the equity of blockchain and DLT related companies;
- by keeping total regulatory assets under management under $150 million (counting all assets for US managers, or solely assets managed from a US place of business for non-US managers) in satisfaction of the private fund adviser exemption.
- Hedge Funds Investing Solely in Non-Securities Assets
Virtual currency tokens, properly designated utility tokens, and other digital assets that do not meet the definition of an investment contract under the Howey Test are deemed non-securities assets. Unlike the CFTC, which has available exemptions for funds holding insignificant percentages of qualifying assets within the manager’s portfolio, funds holding even nominal amounts of assets that constitute securities are subject to the SEC’s registration requirements if not otherwise exempt. Furthermore, even if none of the underlying assets within the portfolio are securities assets, managers may subject themselves to SEC advisory jurisdiction by investing via transactions that could establish a securities transaction. For example, this can be done by holding an asset jointly with another investor, or investing in digital tokens through mechanisms relying on the “efforts of others,” and other factors under the Howey Test. Given the current state of uncertainty, and with so little SEC guidance, fund managers that determine that they are not advising on securities assets or transactions should exercise due caution.
- Venture Capital Private Adviser Exemption
Venture capital investment into illiquid blockchain and distributed ledger technology-related companies, technology, and infrastructure is a growing trend, outpacing the growth of hedge funds that invest directly into liquid funds. This is, in part, because venture capital transactions do not face the degree of regulatory uncertainty posed by open-end hedge funds and do not rely on custodial intermediaries. As such, venture capital funds are able to immediately access a base of institutional investors.
Section 203(l) of the Investment Advisers Act—known as the venture capital adviser exemption—exempts advisers that solely advise venture capital funds from investment adviser registration if the adviser invests 80% of the fund’s AUM in “qualified investments.” Qualified investments are limited to direct investments in equity positions of privately held companies that meet certain structural requirements. Various restrictions apply to exempt venture capital advisers, including a prohibition against allowing investment redemptions (except in specified circumstances), a prohibition against investing in other investment funds, and they must stay within a 15% leverage AUM threshold. Venture capital advisers that exceed $25 million in AUM must register as exempt reporting advisers, discussed below. Unlike the Private Fund Adviser Exemption, discussed below, the venture capital exemption is applied uniformly in most respects to US fund managers and non-US fund managers alike.
- Keeping Assets Under $150 Million - the Private Fund Adviser Exemption
Hedge fund managers holding liquid tokens other than commodity tokens, such as Bitcoin, Ethereum, and true utility tokens, must either register with the SEC or satisfy the private fund adviser exemption by keeping its regulatory assets under management for all funds (even non-security holdings) under $150 million, as described below.
The private fund adviser exemption exempts advisers from SEC registration that:
have regulated assets under management of no more than $150 million; and
- solely advise private funds.
i. $150 Million Regulated Assets Under Management
To satisfy the Private Fund Adviser Exemption, a manager must have no more than $150 million in regulated assets under management. The SEC’s definition of “regulated Assets Under Management” (RAUM) encompasses not only securities assets, but all commodities, assets and other non-securities assets, as well as all leverage on the assets. For US fund managers, this threshold must include investments by both US investors and non-US investors, such that the assets under management from investors investing through offshore tax-neutral jurisdictions are included in the $150 million RAUM calculation.
For non-US advisers, on the other hand, only assets managed from a place of business within the United States are counted toward the $150 million threshold. The term “place of business” is interpreted broadly, and includes any location that a fund manager holds out to the public as a location where it provides advisory-related services, including capital raising activities. Even temporary offices, such as a hotel or auditorium, can be considered a place of business, depending on the activities conducted.
ii. Solely Advising Private Funds
The Private Fund Adviser Exemption is available only to fund managers that only advise private pooled investment vehicles, i.e. funds exempt from the Investment Company Act under Sections 3(c)(1) and 3(c)(7) for private equity funds and hedge funds, as well as under 3(c)(5) for real estate funds.
For US fund managers, meaning that the adviser’s principal place of business is in the United States, the requirement to solely advise private funds means that the adviser cannot also advise public funds or separately managed accounts anywhere in the world. Under the Advisers Act, “principal place of business” refers to the location from which directors, managers, and officers with ultimate responsibility for the fund advisory activities are located.
For non-US fund managers, the requirement to solely advise private funds applies only to US clients, allowing a manager to rely on of the exemption without regard to advisory services provided to public funds and separately managed accounts outside the United States, so long as it solely advises private funds within the United States. Note that this provision disregarding non-US advisory clients under the Private Adviser Exemption contrasts with the requirements under the Venture Capital Exemption, which requires venture capital fund managers to solely advise venture capital funds, regardless of client location.
For additional discussion on investment advisor registration, please see our blog post, “Must a Hedge Fund Register as an Investment Advisor?” Likewise, for more information on potential liability as a startup hedge fund manager, please see our blog post here.