Question: What licenses do you need to start or manage a hedge fund?
Answer: This is a question that comes up quite often. Many people wonder whether they need a series 7 license or the series 65 license or the series 3 to manage a hedge fund. First, a potential hedge fund manager does not need to have a series 7 license in order to manager a hedge fund. The series 7 license is the general securities representative licese which allows an individual to be a representative (broker) of a FINRA registered member firm (brokerage firm or broker-dealer). The series 7 allows a representative to take and place trades for a customer. It is also a prerequisite for many of the other FINRA exams (such as the series 24). Because the hedge fund in not regulated as a broker, a hedge fund manager does not need to have a series 7 license (assuming that the manager is also concurrently acting as a broker-dealer representative).
Second, a start up hedge fund manager may need to have a series 65 license in order to become registered as an investment adviser. There are two potential ways a hedge fund manager would be required to register as an investment adviser – under the federal rules (the Investment Advisers Act of 1940) or under the various state rules (commonly referred to as the state blue sky laws). If a manager is required to register with the SEC under the Advisers Act* then, for federal purposes, the manager will not need to have taken the Series 65. However, the Advisers Act allows states to impose certain requirements on all federally registered investment advisers with a place of business in their state. Generally the states will require all federally registered investment advisers to “notice file” in their state which entails paying a fee to the state. The state can also require that all investment adviser representatives have the series 65 license. This means that anyone who talks to clients/investors or makes any trading decisions or analysis will need to have this license. The definition of investment adviser representative basically encompasses every employee or owner of the investment adviser other than secretary type employees. If you are a federally registered investment adviser you should discuss whether members of your team need to be licensed as representatives at the state level.
If you are not a federally registered investment adviser (generally all managers with less than 30 million of assets under management) then you will need to determine whether your management firm needs to be registered as an investment adviser at the state level. Many states require investment advisers with a place of business** in the state to register. Some popular states that require investment adviser registration are California, Texas, Washington and Colorado. However, there are many states which have exemptions from the registration requirements. Some popular states that have exemptions (through regulation or special order) from investment adviser registration for hedge fund managers are New York, Connecticut, Florida and Georgia. Again, you should speak with your legal counsel or compliance professional to determine whether your hedge fund management firm will need to be licensed as an investment adviser in the state.
Finally, if the hedge fund trades futures or commodities then the manager may need to be registered as a commodity pool operator with the National Futures Association. In order to register as a commodity pool operator at least one person at the management company will need to take the Series 3 exam. For more information on the Series 3 exam and this part of the registration process please read how to register as a CPO or CTA.
* Many potential hedge fund managers are confused with whether a management company will need to be registered as an investment adviser with the SEC. The answer is that in most cases a hedge fund manager will not have to be registered as an investment adviser with the SEC because of an exemption provision within the investment advisers act. Section 203(b)(3) of the Advisers Act specifically exempts from the registration provisions “any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser …” The term “client” in the hedge fund context means a “corporation, general partnership, limited partnership, limited liability company, trust …, or other legal organization … to which you provide investment advice based on its investment objectives rather than the individual investment objectives of its shareholders, partners, limited partners, members, or beneficiaries…”
This means that as long as a hedge fund manager will not need to count the investors in the hedge fund as his “client” and that the hedge fund itself is the only “client.” You will probably recall that a couple of years ago the SEC proposed a change to the rules under the Advisers Act that required a manager to count all of the investors in the hedge fund as clients. Under the proposed rule hedge fund managers would have been required register with the SEC (if they had at least $30 million under management), but Phillip Goldstein successfully challenged the SEC in court. His successful challenge to the rule change allows hedge fund managers to escape SEC regulation.
** “Place of business” of an investment adviser means: (1) An office at which the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and (2) Any other location that is held out to the general public as a location at which the investment adviser provides investment advisory services, solicits, meets with, or otherwise communicates with clients.