Tag Archives: accredited investor

What is a qualified purchaser?

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We have previously discussed the difference between a 3(c)(1) hedge fund and a 3(c)(7) hedge fund. Unlike a 3(c)(1) hedge fund where investors only generally need to be accredited investors and potentially qualified clients, all investors in a 3(c)(7) hedge fund must be “qualified purchasers.” A qualified purchaser is a greater requirement than an accredited investor and a qualified client. Generally only super high net worth individuals and institutional investors will fit within the definition of qualified purchaser. Because of this fact, there are fewer 3(c)(7) hedge funds than 3(c)(1) hedge funds. Also, most 3(c)(7) funds are going to be funds with greater intial investment requirements and will be marketed towards the institutional market. Because of this, 3(c)(7) hedge funds will tend to have greater assets than many 3(c)(1) hedge funds.

The definition of “qualified purchaser” is found in the Investment Company Act of 1940. The definition includes:

i. any natural person (including any person who holds a joint, community property, or other similar shared ownership interest in an issuer that is excepted under section 3(c)(7) with that person’s qualified purchaser spouse) who owns not less than $ 5,000,000 in investments, as defined below;

ii. any company that owns not less than $ 5,000,000 in investments and that is owned directly or indirectly by or for 2 or more natural persons who are related as siblings or spouse (including former spouses), or direct lineal descendants by birth or adoption, spouses of such persons, the estates of such persons, or foundations, charitable organizations, or trusts established by or for the benefit of such persons;

iii. any trust that is not covered by clause (ii) and that was not formed for the specific purpose of acquiring the securities offered, as to which the trustee or other person authorized to make decisions with respect to the trust, and each settlor or other person who has contributed assets to the trust, is a person described in clause (i), (ii), or (iv); or

iv. any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $ 25,000,000 in investments.

v. any qualified institutional buyer as defined in Rule 144A under the Securities Act, acting for its own account, the account of another qualified institutional buyer, or the account of a qualified purchaser, provided that (i) a dealer described in paragraph (a)(1)(ii) of Rule 144A shall own and invest on a discretionary basis at least $25,000,000 in securities of issuers that are not affiliated persons of the dealer; and (ii) a plan referred to in paragraph (a)(1)(D) or (a)(1)(E) of Rule 144A, or a trust fund referred to in paragraph (a)(1)(F) of Rule 144A that holds the assets of such a plan, will not be deemed to be acting for its own account if investment decisions with respect to the plan are made by the beneficiaries of the plan, except with respect to investment decisions made solely by the fiduciary, trustee or sponsor of such plan;

vi. any company that, but for the exceptions provided for in Sections 3(c)(1) or 3(c)(7) under the ICA, would be an investment company (hereafter in this paragraph referred to as an “excepted investment company”), provided that all beneficial owners of its outstanding securities (other than short-term paper), determined in accordance with Section 3(c)(1)(A) thereunder, that acquired such securities on or before April 30, 1996 (hereafter in this paragraph referred to as “pre-amendment beneficial owners”), and all pre-amendment beneficial owners of the outstanding securities (other than short-term paper) or any excepted investment company that, directly or indirectly, owns any outstanding securities of such excepted investment company, have consented to its treatment as a qualified purchaser.

vii. any natural person who is deemed to be a “knowledgeable employee” of the [fund], as such term is defined in Rule 3c-5(4) of the ICA; or

viii. any person (“Transferee”) who acquires Interests from a person (“Transferor”) that is (or was) a qualified purchaser other than the [fund], provided that the Transferee is: (i) the estate of the Transferor; (ii) a person who acquires the Interests as a gift or bequest pursuant to an agreement relating to a legal separation or divorce; or (iii) a company established by the Transferor exclusively for the benefit of (or owned exclusively by) the Transferor and the persons specified in this paragraph.

ix. any company, if each beneficial owner of the company’s securities is a qualified purchaser.
For the purpsoes of above, the term Investments means:

(1) securities (as defined by section 2(a)(1)of the Securities Act of 1933), other than securities of an issuer that controls, is controlled by, or is under common control with, the prospective qualified purchaser that owns such securities, unless the issuer of such securities is: (i) an investment vehicle; (ii) a public company; or (iii) a company with shareholders’ equity of not less than $50 million (determined in accordance with generally accepted accounting principles) as reflected on the company’s most recent financial statements, provided that such financial statements present the information as of a date within 16 months preceding the date on which the prospective qualified purchaser acquires the securities of a Section 3(c)(7) Company;

(2) real estate held for investment purposes;

(3) commodity interests held for investment purposes;

(4) physical commodities held for investment purposes;

(5) to the extent not securities, financial contracts (as such term is defined in section 3(c)(2)(B)(ii) of the ICA entered into for investment purposes;

(6) in the case of a prospective qualified purchaser that is a Section 3(c)(7) Company, a company that would be an investment company but for the exclusion provided by section 3(c)(1) of the ICA, or a commodity pool, any amounts payable to such prospective qualified purchaser pursuant to a firm agreement or similar binding commitment pursuant to which a person has agreed to acquire an interest in, or make capital contributions to, the prospective qualified purchaser upon the demand of the prospective qualified purchaser; and

(7) cash and cash equivalents (including foreign currencies) held for investment purposes. For purposes of this section, cash and cash equivalents include: (i) bank deposits, certificates of deposit, bankers acceptances and similar bank instruments held for investment purposes; and (ii) the net cash surrender value of an insurance policy.

What is a qualified client? Qualified client definition

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UPDATE: the below article is based on the old “qualified client” definition.  The new “qualified client” definition can be found in full here, and the SEC order increase the asset thresholds can be found here.  As a gross summary, the new definition of a qualified client is:

  • entity or natural person with at least $1,000,000 under management of the advisor, OR
  • entity or natural person who has a net worth of more than $2,100,000

For the second test above, natural persons exclude the value of (and debt with respect to) their primary residence (assuming the primary residence is not under water).

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Certain hedge fund managers need to be registered as investment advisors with the SEC or with the state securities commission of the state which they reside in.  For SEC-registered investment advisors, and most state registered advisors, the investors in their hedge fund will need to be “qualified clients” in addition to the requirement that such investors are also accredited investors.  While many accredited investors will also be qualified clients, this might not always be the case because the qualified client defintion requires a higher net worth than the accredited investor definition.  Hedge fund managers who are required to have investors who are both accredited investors and qualified clients cannot charge performance fees to those investors who do not meet the qualified client definition.  Individual investors will generally need to have a $1.5 million net worth in order to be considered a “qualified client.”

The definition of “qualified client” comes from rules promulgated by the SEC under the Investment Advisors Act of 1940, specifically Rule 205-3.  That rule provides:

The term qualified client means:

1. A natural person who or a company that immediately after entering into the contract has at least $750,000 under the management of the investment adviser;

2. A natural person who or a company that the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, either:

a. Has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $1,500,000 at the time the contract is entered into; or

b. Is a qualified purchaser as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 at the time the contract is entered into; or

3. A natural person who immediately prior to entering into the contract is:

a. An executive officer, director, trustee, general partner, or person serving in a similar capacity, of the investment adviser; or

b. An employee of the investment adviser (other than an employee performing solely clerical, secretarial or administrative functions with regard to the investment adviser) who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser, provided that such employee has been performing such functions and duties for or on behalf of the investment adviser, or substantially similar functions or duties for or on behalf of another company for at least 12 months.

What is an accredited investor? Accredited investor definition

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[2017 EDITORS NOTE: this article will be updated shortly.  Please note that the definition has changed and that the net worth requirement now carves out any equity or debt of a personal residence.]

Hedge fund managers can only admit certain investors into their hedge funds.  Most hedge funds are structured as private placements relying on the Regulation D 506 offering rules.  Under the Reg D rules, investors must generally be “accredited investors.”  Many hedge funds have additional requirements.

With regard to individual investors, the most common of the below requirements is the $1 million net worth (which does include assets such as a personal residence).   With regard to institutional investors, the most commonly used category is probably #3 below, an entity with at least $5 million in assets.  Please note that there may be additional requirements for your individual hedge fund so you should discuss any questions you have with your attorney.

The accredited investor definition can be found in the Securities Act of 1933.  The definition is:

Accredited investor shall mean any person who comes within any of the following categories, or who the issuer [the hedge fund] reasonably believes comes within any of the following categories, at the time of the sale of the securities [the interests in the hedge fund] to that person:

1. Any bank as defined in section 3(a)(2) of the [Securities] Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

2. Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;

3. Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;

4. Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;

5. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000;

6. Any 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;

7. Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) and

8. Any entity in which all of the equity owners are accredited investors.

Hedge Fund Websites – How to Run a Hedge Fund Website

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A common question from start-up hedge fund managers is what kind of a website can I have and how do I go about getting investors through an internet solicitation? The unfortunate answer is that hedge fund managers must be very careful when they are designing their website. In general, websites for a hedge fund or a hedge fund manager need to be very low key and potentially password protected. This is especially important in the current regulatory enviornment because securities officials, at both the federal and state level, are becoming more and more vigilant about enforcing the website solicitation rules. This article will briefly detail the legal background and some website best practices.

Regulation D – no “public offering”

Most hedge funds are offered to investors through a Regulation D private placement offering. One of the requirements of the Reg. D offering is that the sale of securities (interests in the hedge fund) is not done through a “public offering.” While there is no exact definition of “public offering,” it will generally mean that the hedge fund is not allowed to offer or sell interests through general solicitation or general advertising. According to the SEC, the analysis can be broken down into two main questions: (i) is a communication a general solicitation or advertisement, and, if so, (ii) is it being used to offer or sell securities? If the answer to either of these questions is negative, the fund is not in violation of public offering rules.

Regulation D – the “pre-existing” relationship

If a private placement is offered to potential investors with whom the hedge fund manager has no pre-existing relationship, the SEC may conclude that there was a general solicitation in violation of the Reg D rules.

Frequently, an issuer can satisfy the pre-existing relationship requirement through prior investment or other business dealings with the potential purchaser. The pre-existing relationship generally involves at least some degree of contact between the issuer and the prospective purchaser prior to the offering – generally 30 days from a “first contact.”

[HFLB note: there are a couple of very important no-action letters on this subject. I will be posting these in the next couple of days.]

Website Best Practices

We will generally recommend that all web presence be minimized. The two most important principles with regard to web presence and web communications are (1) do not name the hedge fund and (2) do not personally, or by fiat, write that you manage a hedge fund. Besides those two overriding items, we recommend that the web presence is minimal at all times. However, we are aware that from a business standpoint, the manager would like to have a web presence.

There are five important parts to a hedge fund website:

The Splash Page

The hedge fund manager should have an initial “splash page” which might include the name of the management company (do not say you are an “investment advisor” unless registered as such in your state of residence or with the SEC). The splash page should include very minimal information.

Note: you should not include your phone number or contact information on this splash page.

Registration Page

This page should have questions to determine if a viewer is qualified to be viewing the fund’s information over the internet. Generally this will include the accredited investor qualifications; it may also mean that the qualified client qualifications are also included.

Login Page (may be on the splash page)

This page will be for viewers who are either currently invested in your fund or who have met the qualifications of registration.

Password protected content

All identifying information of the fund and management company should be password protected. You should never post the fund’s offering documents on the internet unless there are stringent controls in place to make sure that the offering documents can only be viewed by the one investor they are intended for – even if there are these stringent controls, we would normally recommend against this practice.

General disclaimer

The site should have a general disclaimer which should be prepared by an attorney. Additionally, all performance information within the password protected portion of your website should have all appropriate disclaimers.

Note: it is recommended that once you have an almost final draft of the website, you should have your lawyer review before it goes live.

Legal Developments and Conclusion

The regulators are very sensitve about website solicitations. For example,the State of Massachusetts is trying to fine activist hedge fund manager Phillip Goldstein, of Bulldog Investors, because of how he designed his fund’s website. The famed investment adviser is under prosecution by Massachusetts for allowing potential investors unrestricted access to Bulldog’s website. [HFLB to insert the complaint.]

Because of this and other activity it is extremely important that you have your hedge fund attorney discuss the website rules with you. Please contact us if you have further questions or if you would like help launching your hedge fund website.