Exclusion From Definition of Investment Adviser
Generally Massachusetts will require hedge fund managers with a place of business in Massachusetts to register as an investment adviser with the Massachusetts Securities Division. However, there is an exemption from registration for some hedge fund managers located in Massachusetts. [Note: to be more accurate, the “exemption” really is an exclusion from the definition of investment adviser under the Massachusetts Securities Act.]
Definition of Investment Adviser
Under Section 401(m) of the Massachusetts Securities Act, the term investment adviser means:
any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities. …“Investment adviser” shall not include: … a person whose only clients in this state are federal covered advisers, other investment advisers, broker-dealers, banks, savings institutions, trust companies, insurance companies, investment companies as defined in the Investment Company Act of 1940, employee benefit plans with assets of not less than $5,000,000, governmental agencies or instrumentalities, or other financial institutions or institutional buyers, whether acting for themselves or as trustees with investment control; (emphasis added)
This definition is similar for most states and is based on the Uniform Securities Act which was designed to help standardize state securities laws. Normally the definition of “other financial institutions or institutional buyers” is not defined under state law or division regulations and will normally be understood to mean large institutions.
Massachusetts has specifically defined “Institutional Buyer”.
Definition of “Institutional Buyer” for Section 401(m)
Under Massachusetts regulations,
Institutional Buyer shall include any of the following:
a. An organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $ 25 million.
b. An investing entity whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $ 50,000.
c. An entity whose only investors are financial institutions and institutional buyers as set forth in M.G.L. c. 110A, § 401(m) and 950 CMR 12.205(1)(a)6.a. and b.
See 950 CMR Section 12.205(1)(a)(6)
For hedge fund managers, section (b) above is important. A hedge fund would be considered to be an “institutional buyer” if (i) the fund only accepts accredited investors and if (ii) each investor has contributed at least $50,000 to the fund. If the fund does not meet both parts of the test, the fund will not be an “institutional buyer” and the fund manager would not be excluded from the definition of investment adviser and would need to register as such with the Massachussetts Securities Division.
Consequences for Not Registering
If a fund manager does not meet the two tests above, the manager will need to be registered or face certain consequences. These consequences may include:
- An order to cease and desist conducting business
- A requirement to register with the division
- Administrative fines
- Offer of rescission of fund interests to investors
- Further division scrutiny
Some managers may be tempted to not register but as we can see from a previous Massachussetts Securities Division Complaint against an unregistered hedge fund manager, the consequences and the time/money/effort spent with a formal division complaint will be far more cumbersome than simply registering with the division in the first place.
Conclusion
Many states have intricate laws with respect to hedge fund manager registration. These laws will become even more important to understand if/when the Wall Street Reform bill passes in which case many SEC registered advisers will need to switch to state registration.
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Cole-Frieman & Mallon LLP provides comprehensive hedge fund formation and regulatory support. Bart Mallon, Esq. can be reached directly at 415-868-5345.