Qualified Eligible Person (QEP) Definition

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The securities laws can be written obtusely and the definition of a qualified eligible person (QEP) may be one of the best examples of this.  There is no quick and easy definition of a what a QEP is so we are trying to make it as easy as possible to understand.  This post discusses the importance of the classification, provides the overview of the definition and then provides a link to the actual statutory language.

Why QEP Definition is Important for CPOs

The definition of QEP is important for commodity pool operators (CPOs) in a couple of situations.  The first is the 4.13(a)(4) exemption from the registration provisions for a CPO that provides advice to a commodity pool with only QEPs.  The second situation where a CPO will need to make sure the investors are QEPs is if they want to take advantage of the Rule 4.7 exemption.  The Rule 4.7 exemption allows CPOs to follow less-strict reporting requirements with regard to the commodity pool they manage.  These two exemptions essentially provide for reduced regulatory oversight of a CPO who provides advisory services to these class of investors.

Definition of QEP

A qualified eligible person is an investor who fits into one of two distinct groups: (1) investors who do not need to meet the portfolio requirement and (2) investors who need to meet the portfolio requirement.

1.  Investors who do not need to meet the portfolio requirement:

The following are considered to be QEPs regardless of whether or not they meet the portfolio requirement:

  • registered futures commission merchants
  • registered broker or dealers
  • registered commodity pool operators (under certain conditions, see rule for more details)
  • registered commodity trading advisors (under certain conditions, see rule for more details)
  • state or SEC registered investment advisers (under certain conditions, see rule for more details)
  • qualified purchasers
  • knowledgeable employee of the CPOs
  • certain persons related to advisers to exempt from registration as a CPO or CTA
  • trusts (under certain conditions, see rule for more details)
  • 501(c)(3) organizations (under certain conditions, see rule for more details)
  • non-United States persons
  • certain entities in which all of the owners/participants are QEPs

2.  Investors who need to meet the portfolio requirement:

The following will be considered to be QEPs only if they meet the portfolio requirement described below:

  • investment companies registered under the Investment Company Act (i.e. mutual funds)
  • certain business development companies (defined under both the Investment Company Act and Investment Advisers Act)
  • banks, savings and loan associations, and other like institutions acting for their own accounts or for the account of a QEP
  • insurance companies acting for their own account or for the account of a qualified eligible person
  • plans established and maintained by various governments and related bodies for the benefit of their employees, if such plan has total assets in excess of $5,000,000
  • employee benefit plans within the meaning of the ERISA (under certain conditions, see rule for more details)
  • 501(c)(3) organizations with total assets in excess of $5,000,000
  • corporations, business trusts, partnerships, LLCs or similar business ventures with total assets in excess of $5,000,000 and not formed for the specific purpose of participating in the exempt investment program
  • a natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of either his purchase in the exempt pool or his opening of an exempt account exceeds $1,000,000 [HFLB note: this is one part of the accredited investor definition]
  • a natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year [HFLB note: this is one part of the accredited investor definition]
  • pools, trusts, insurance company separate accounts or bank collective trusts, with total assets in excess of $5,000,000 (under certain conditions, see below)
  • other entities authorized by law to engage in such transactions (under certain conditions, see rule for more details)

3.  Portfolio Requirement

If an investor is one of the entities described in (2) above, it will also need to meet the portfolio requirement.  The portfolio requirement can be met in one of three ways:

  • Owns securities and other investments with an aggregate market value of at least $2MM;
  • Has had on deposit with a FCM at least $200K in exchange-specified initial margin and option premiums for commodity interest transactions in the 6 months prior to the investment; or
  • Has a combination of the two above.  For example, has $1MM in securities/investments and $100K in exchange-specified initial margin in the 6 months prior to the investment

The above definitions have been shortened for the purpose of providing a general overview.  When determining whether an investor meets the qualified eligible person definition the CPO should take special care to make sure that the investor meets the full definition which can be found here.  Generally the investor will make these representations in the subscription documents which are drafted by the hedge fund attorney.

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Bart Mallon, Esq. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.