Hedge Fund Law – Summary of Hedge Fund Laws and Regulations

he following is a summary of the major laws which affect the hedge fund industry.  If you have any questions on how these laws impact hedge funds in general or your specific situation, please contact us.


Securities Act of 1933 – the 1933 Act was enacted on May 27, 1933 as a reaction to the market crash of 1929. The overarching purpose of the act was to require that all “securities” be registered with the government (at the time the FTC). The Act provides some exemptions from this general requirement; for hedge fund managers, the most important exemption from registration is found in Section 4(2) which provides that securities will not need to be registered is they are sold in a transaction which does not involving any public offering.

Rules under the 1933 Act – one set of rules common to all hedge funds, whether small or large, are the Reg D rules. The Reg D rules provide a “safe harbor” under Section 4(2) of the 1933 Act. This means that if a hedge fund complies with the Reg D rules, such manager does not have to worry about Section 4(2) – they would already be deemed to comply with 4(2). Another common rule which is important to hedge funds is Rule 144 which allows the sale of certain restricted securities without registration.

Securities Exchange Act of 1934 – the 1934 Act was enacted on [date] to regulate the secondary trading of securities which were issued under the 1933 Act. The 1934 Act allowed for the establishment of the securities exchanges (the NYSE, the ASE, etc) and securities brokers. Probably the most important provision of the 1934 Act is section 10(b) which makes it unlawful for a person to engage in fraud with regard to a securities transaction.

Rules under the 1934 Act – the rules under the 1934 act are of less consequence to hedge fund managers. The most important rule, maybe in the whole securities arena, is Rule 10b-5. This famous rule, which is designed to broadly forbade misconduct with regard to securities transactions, has been central to many securities litigation cases, including the insider trading scandals of the 1980’s.

Investment Advisers Act – the Investment Adviser’s Act is one of the most important set of laws that relate to investment managers. Generally hedge fund managers fall under the definition of “investment adviser” under the terms of the act. Those firms or persons who are “investment advisers” generally have to register unless they fall within an exemption or exclusion from the definition. The advisers act provides the manner in which investment advisers will register with the SEC, provides the laws that must be followed as an investment adviser, and makes it illegal for both registered and unregistered investment advisers to act fraudulently toward any investors.

Rules under the Investment Advisers Act – the rules under the Advisers Act further give flesh to the congressional statutes. The most important rules are the anti-fraud rules which apply to all investment advisers, whether registered or not. For registered investment advisers, of special concern are the books and records rules, the performance fee rules and Rule 222.

Investment Company Act – the investment company act, (often referred to as the Company Act, the ICA, or the 1940 act) was adopted as a mean s to regulate the burgeoning mutual fund industry. The ICA places strict guidelines on companies which fall within the definition of “ “ . Probably two of the more famous provisions within the hedge fund world are the “3(c)(1) emeption” and the “3(c)(7) exemption.” Both of these exemptions allow companies which would otherwise be subject to onerous regulations, to operate (without SEC oversight) in a relatively unregulated manner.

Rules under the Investment Company Act – there are really very few rules under the ICA which are of significant consequence to hedge fund managers.

Signficant Securities Laws Cases – cases provide practitioners with further guidance on the securities laws. Depending on the jurisdiction, some cases will be more important than other cases. For all jurisdictions, the cases decided by the U.S. Supreme Court are functionally the law. Some of the most important securities law cases include:

SEC v. Howey – probably the most important securities law case. Provides the test which answers the question – “what is a security?”

No-action letters – no-action letters are not law, they represent positions taken by the SEC which state whether or not the SEC will take enforcement action against a company under a specific set of facts. While these letters do not carry the same weight in a court of law as the statutes or the rules, they are very persuasive. There have been instances where the SEC has however, reversed its stance on certain positions or withdrawn these no-action letters. Significant no-action letters span the acts. With regard to hedge fund managers, some well know no-action letters include:

Clover Capital – discussing the appropriate way for all investment advisers to report performance.

Thompson Financial Inc. – non-SEC registered investment advisers will not be considered to be “holding out” in certain circumstances.

Lamp Technologies Inc. – hedge funds relying on Regulation D can post information ons a password-protected website.

Lamp Technologies Inc. II – the original no-action relief granted in Lamp is clarified and expanded.

Interpretive Releases – the SEC occasionally provides guidance on topics of general interest to the business and investment communities by issuing “interpretive” releases, in which the SEC publishes its views and interprets the federal securities laws and SEC regulations. Below are brief descriptions of and links to well known “interpretive” releases”:

Regulation D Interpretive Release – questions and answers on Regulation D.

Commodities Exchange Act – the Commodities Exchange Act (or CEA) is important to hedge fund managers who trade commodities or futures. Generally managers who trade these types of instruments will need to register with the Commodities Futures Trading Commission (CFTC) as a commodity pool operator (CPO) or as a commodity trading adviser (CTA). There are a couple of statutory exemptions from these rules. Additionally the CEA provides the framework under which CTAs and CPOs must operate. Click here for laws

Rules under the CEA – the rules under the CEA further [] the CEA. Especially important to hedge fund managers are the exemptions from registration provided under Rule 4.7 and rule 4.13.

Signficant Commodities, Futures and Forex Cases – cases provide practitioners with further guidance on the commodities, futures and forex laws. Depending on the jurisdiction, some cases will be more important than other cases. For all jurisdictions, the cases decided by the U.S. Supreme Court are functionally the law. Some of the most important cases include:

CFTC v. Zelener – probably the most important forex case. This is the case which the CFTC has asked congress to legislatively overturn.

CFTC v. Erskine

CFTC Exemption Letter 04-17

CFTC Letter 04-13

NSMIA – the National Securiites Modernization Act was passed by congress in [] in order to [] the rules of the different acts. While it did bring many needed improvements to the acts, the acts are still needlessly complicated, reliant on definitions and cross-references and antiquated – the acts just do not speak to the needs and risks of the current financial markets.

USA – the uniform securities act is a set of model rules/ legislation passed by the Nationl Association of Securites… This model act has been adopted by numerous states in whole or in parts. Many of the underlying principals of the USA are seen in the securities laws of practiallyevery state. While the USA itself if influenced by the federal acts, and it is focused on:

CFMA – the commodities futures modernization action

ERISA – the Employee Retirement Investment Security Act of 1974 is one of the most feared pieces of legislation in the hedge fund world. Many managers will not accept money which is ERISA moneyecause of the extra responsibilities which come with being a manger of ERISA mney. To escape the reach of the law many mangers will ensurethey d not have more tan25% fo thefunds asses as ERISA money.

Department of Treasury Regulations – the department of treasury is the government body which is in charge of enforcing ERISA. The department enforces the provisions of ERISA in much the same way that the SEC enforces the provisisions under the securities acts, one of the most important treasury regulations is the “plan assets regulation.”

IRC – the Internal Revenue Code of 1984 is the tax laws which govern U.S. citizens and aliens who derive income from the United States. The tax code provides taxes on income (wages, salary, fees, etc), dividends and capital gains. Currently income and dividends are taxed at different rates and so there is an incentive to have compensation treated as a dividend rather than income. Short term capital gains are taxed at [] rate. Long term capital gains are taxed at lower rates []; accordingly, there is incentive to have compensation taxed as capital gain and not as income or dividends. Savy accountants and tax attorneys will generally help hedge fund managers sort out these issues. In many circumstances the structure of hedge funds (especially offshore hedge funds) are dictated by certain tax laws. Treasury regulations are similar to SEC rules. However, you will never want to go near treasury regulations – you will ruin your eyesight.

Blue Sky laws – [Forthcoming]

List of Regulatory Bodies

  • SEC – the U.S. Securities and Exchange Commission
  • FINRA – the Financial Industry Regulatory Authority (formerly the NASD and NYSE regulatory bodies); this self regulatory organization’s mandate is to police the brokers and dealers in the securities industry
  • CFTC – the Commodities Futures Trading Commission
  • NFA – the National Futures Association