Recently I have received a few good hedge fund law questions.  Please remember that these answers are general discussions of the law and should not be a substitute for actual legal advice.  This discussion does not form an attorney-client relationship, please see our disclaimer.

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Question: [with reference to the new Hedge Fund Registration article] So what’s to say a hedge fund can’t just become the outside advisor to a series of managed accounts?  If so, does the fund still need to register?

Answer:  Many hedge fund management companies do provide individual account management outside of the hedge fund.  Typically this is described as hedge fund separately managed accounts. There are many reasons why a manager may have such accounts, including the fact that many large institutional investors require that their assets be managed in this way.

With regard to registration, yes a manager may have to register as an investment advisor if he manages separately managed accounts outside of the hedge fund.  There are two separate levels of registration – State and SEC.  Generally the SEC does not require a manager to register unless the manager has 14 or less clients over the last 12 months.  This generally means that a hedge fund manager can have 13 separately managed account clients (in addition to the hedge fund) without implicating the SEC registration requirements (see Hedge Fund Registration Exemption).  However, states are free to adopt their own registration laws and many would require a manager with 5 separately managed account clients (in addition to the hedge fund) to register as an investment advisor with the state securities commission.

Each manager’s situation is unique and if the manager has specific questions regarding his legal or registration status he should discuss with legal counsel.  Additionally, if the Hedge Fund Transparency Act is passed, it is likely that hedge fund managers with $50 million or more of AUM will need to register as investment advisors with the SEC.

Question:  Regarding the 3c7 Funds, does the counting of investors require a ‘look through’?  I.e. If an qualified investor was a Fund of Funds, would the counting up to the limit of 500 investors require counting the underlying investor of the Fund of Funds?

Answer: If the investing fund was also a Section 3(c)(7) hedge fund then there would be no “look through.”  If the investing fund was a Section 3(c)(1) hedge fund then there would be certain issues which the Section 3(c)(1) would need to take into consideration.  We will be writing a post about this issue shortly.

Question: What happens if you are NOT an accredited investor, but you have already been allowed to invest into a hedge fund that requires you to be an accredited investor?

Answer: I am not quite sure how this would happen but I believe there might be two separate ways.  First, the investor may have lied in the hedge fund subscription documents.  The subscription documents require the investor to make certain representations regarding the investor’s net worth.  Generally hedge fund managers have no duty to inquire further about the representations made in the subscription documents.  If this happens then generally the investor will not receive the protections under the law for non-accredited investors.

Second, the investor may have been an accredited investor at the time the subscription documents were signed and, because of outside circumstances, the investor later becomes a non-accredited investor.  In this instance the newly non-accredited investor should immediately contact the hedge fund manager and inform him of the new circumstances.

Question: Can you recommend a cost-effective (cheap) administrator for a hedge fund start up?

Answer: Yes.  It is common for me to provide clients with recommendations for all service providers including hedge fund administrators.  There are many hedge fund administration firms and there are many low cost providers which I can put you in touch with.  Usually I will want to get to know you and your firm before I make recommendations.  If you are interested, please contact us now.