Exemption from the Registration Provisions of the Investment Advisors Act
We have discussed the SEC hedge fund registration exemption many times before, but we have not addressed it directly.For most management companies with a single hedge fund client, registration is actually a relatively easy and straightforward process. Once hedge fund managers are registered as investment advisors with the SEC there are certain recordkeeping requirements for the hedge fund manager, but the requirements are not onerous (for more information, please see ).
Notwithstanding the above, many managers will choose to remain unregistered for a variety of different reasons and those managers will typically rely on the hedge fund registration exemption found in Section 203(b)(3) of the Investment Advisors Act of 1940. The exemption and the rule underlying the exemption is detailed in full below.
Investment Advisors Act Section 203(b)(3)
Section 203(b)(3) provides that:
The provisions of subsection (a) [the general investment advisor registration requirement] shall not apply to … 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 to any investment company registered under title I of this Act, or a company which has elected to be a business development company pursuant to section 54 of title I of this Act and has not withdrawn its election. For purposes of determining the number of clients of an investment adviser under this paragraph, no shareholder, partner, or beneficial owner of a business development company, as defined in this title, shall be deemed to be a client of such investment adviser unless such person is a client of such investment adviser separate and apart from his status as a shareholder, partner, or beneficial owner;
Investment Advisors Act Rule 203(b)(3)-1
Rule 203(b)(3)-1 — Definition of “client” of an Investment Adviser
Preliminary Note to Rule 203(b)(3)-1: This section is a safe harbor and is not intended to specify the exclusive method for determining who may be deemed a single client for purposes of section 203(b)(3) of the Act.
(a) General. You may deem the following to be a single client for purposes of section 203(b)(3) of the Act:
(1) A natural person, and:
i. Any minor child of the natural person;
ii. Any relative, spouse, or relative of the spouse of the natural person who has the same principal residence;
iii. All accounts of which the natural person and/or the persons referred to in this paragraph (a)(1) are the only primary beneficiaries; and
iv. All trusts of which the natural person and/or the persons referred to in this paragraph (a)(1) are the only primary beneficiaries;
i. A corporation, general partnership, limited partnership, limited liability company, trust (other than a trust referred to in paragraph (a)(1)(iv) of this section), or other legal organization (any of which are referred to hereinafter as a “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 (any of which are referred to hereinafter as an “owner”); and
ii. Two or more legal organizations referred to in paragraph (a)(2)(i) of this section that have identical owners.
(b) Special Rules. For purposes of this section:
(1) You must count an owner as a client if you provide investment advisory services to the owner separate and apart from the investment advisory services you provide to the legal organization, provided, however, that the determination that an owner is a client will not affect the applicability of this section with regard to any other owner;
(2) You are not required to count an owner as a client solely because you, on behalf of the legal organization, offer, promote, or sell interests in the legal organization to the owner, or report periodically to the owners as a group solely with respect to the performance of or plans for the legal organization’s assets or similar matters;
(3) A limited partnership or limited liability company is a client of any general partner, managing member or other person acting as investment adviser to the partnership or limited liability company;
(4) Any person for whom an investment adviser provides investment advisory services without compensation need not be counted as a client; and
(5) If you have your principal office and place of business outside the United States, you are not required to count clients that are not United States residents, but if your principal office and place of business is in the United States, you must count all clients;
(c) Holding out. If you are relying on this section, you shall not be deemed to be holding yourself out generally to the public as an investment adviser, within the meaning of section 203(b)(3) of the Act, solely because you participate in a non-public offering of interests in a limited partnership under the Securities Act of 1933.
Discussion of the Hedge Fund Registration Exemption
There are two important items to note here. First, the investment adviser cannot have more than 15 clients over a 12 month rolling period. Second, according to Rule 203(b)(3)-1(a)(2)(i) a hedge fund counts as a single client for these purposes. For hedge fund managers to avail themselves to this exemption from the registration provisions, they must make sure that they are not holding themselves out generally to the public as investment advisors.
If you have any questions on whether your hedge fund falls within the exemption provisions of Section 203(b)(3) or if you have any other hedge fund questions, please contact us for a free consultation. Other related hedge fund law articles include: