A common criticism or complaint about hedge funds is that they lack transparency.  While many funds provide transparency to their investors through monthly or quarterly account statements, oftentimes these account statements do not detail the actual positions of the hedge fund.  Because of this some investors who desire more transparency, generally large institutional investors and hedge fund of funds, will ask managers to manage money through a separately managed account structure (also known as a SMA structure or arrangement).

In the separately managed account structure the investor establishes a brokerage account and gives the hedge fund manager power of attorney over the trading account (also known as a “POA account”).  Because the investor is the ultimate owner of the account the investor can see the exact positions in the account, although the manager will have the ability to trade the account.  The POA can be as broad or as narrow as the parties agree and will be memorialized through two different documents: (i) a POA authorization with the brokerage firm and (ii) an investment advisory contract.  The investment advisory contact will be drafted by the hedge fund lawyer and will include the business and legal terms which will govern the relationship.

The separately managed account structure is generally not common, however the need does arise from time to time when a side letter cannot address the concerns of an investor.  For instance, some investors cannot invest in pooled investment vehicles which are not regulated under the Investment Company Act of 1940.  A hedge fund manager who is not registered as an investment adviser will need to take care when entering into these arrangements as it will increase the number of clients that the manager has.  Additionally, if a manager is registered as an investment advisor with the SEC or the state securities commission, the advisory contract may need to include certain state-specific items and the advisor’s Form ADV and Form ADV Part II will need to be amended within two weeks of entering the relationship.

Please feel free to contact us if you have any questions on the separately managed account structure.