When starting a hedge fund there are a number of investment adviser consideration that the fund manager should consider. For example, does the “boutique” manager starting the hedge fund need to register with the SEC? Does the manager starting the hedge fund need to register with the state as an investment adviser? Are there exemptions from registration that might apply to the manager starting the hedge fund? When reviewing the sources of potential initial investment, does the kind of investors have an impact on manager’s registration? If the start up hedge fund manager accepts investment from nonaccredited how does this impact investment adviser registration?
The Private Adviser Exemption at the SEC level provides for exemptions from registration for advisers to “private funds.” This exemption applies to an issuer fund that would be an investment company under the Investment Company Act, but for section 3(c)(1) or section 3(c)(7) of the Act. Hedge fund managers intending to utilize the Private Fund Adviser exemption from registration as an SEC investment adviser may not have more than $150 million of assets under management.
A number of states have adopted similar legislation. California, for example, adopted an exemption from the California investment adviser licensing requirements that is similar to that of the Venture Capital Fund Exemption and the Private Fund Adviser Fund Exemption, which applies to an issuer hedge fund that would be an investment company under the Investment Company Act, but for section 3(c)(1) or section 3(c)(7) of the Act.
For example, the California exemption is only available to “private fund advisers,” which means those advisers who provide advice solely to one or more “qualifying private funds.”
Generally, the California Exemption available to advisers requires that:
- The Adviser not be subject to statutory disqualifications;
- The Adviser file periodic informational notices regarding the characteristics of the adviser and associated qualifying private funds;
- The Adviser pay the standard investment adviser annual registration fee;
- The Adviser provide advisory services only to Retail Buyer Funds whose outstanding securities are beneficially owned entirely by: (a) persons who, at the time the securities were sold, either (i) met the definition of “accredited investor” in Rule 501(a) of Regulation D adopted by the SEC under the Securities Act of 1933, as amended, or (ii) were managers, directors, officers, or employees of the private fund adviser; or (b) any person that obtains the securities through a transfer not involving a sale of that security; and
- Comply with heightened safeguards including the requirement that it is audited by an independent certified public accountant that is registered with, and subject to regular examination by, the Public Company Accounting Oversight Board, and that a copy of such audited financial statements is delivered to each beneficial owner of the fund within 120 days after the end of each fiscal year (or within 180 days if the fund is a fund of funds).
In addition to the forgoing, the private fund adviser may not enter into, perform, renew or extend an investment advisory contract that provides for compensation to the investment adviser on the basis of a share of the capital gains upon, or the capital appreciation of, the funds, or any portion of the funds of an investor that is not a “qualified client” as defined in Rule 205-3 under the Advisers Act.
One of the more unusual situations encountered by a hedge fund manger concerned the potential investment by an investor that was a “qualified client” but was not an “accredited investor.” The fund manager could not accept investment from the potential investor because it was a trust and even though it was making a capital contribution of more than $1 million (therefore meeting the “qualified client” threshold permitting performance fee) the trust had less than $5 million in assets and therefore did not meet the accredited investor threshold.
For more information on how to start a hedge fund, contact us via E-mail firstname.lastname@example.org or (888) 263-4774.
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