Tag Archives: RIA

Massachusetts RIA Net Worth Reminder

Today we received an email reminder from the Massachusetts Securities Division with respect to investment adviser minimum financial requirements.  Essentially hedge fund managers registered as investment advisers with Massachusetts will either need to (i) post a $10,000 surety bond or (ii) establish a separate account with $10,000 and maintain a positve net worth.  Managers who choose to establish the separate account need to provide the Securities Division with a balance sheet on an annual basis.

The email stated:

Please see the attached reminder of the Division’s policy regarding minimum financial requirements for certain Massachusetts-based registered investment advisers.  Please call the Division if you have any questions.

The attachment stated:



The Massachusetts Securities Division (the “Division”) hereby provides this reminder to certain investment advisers described as follows:  those (1) who are required to be registered with the Division; and (2) whose principal place of business is in Massachusetts; and (3) who (i) exercise investment or brokerage discretion, (ii) have custody of clients’ funds or securities, or (iii) require the payment of more than $500 in advisory fees more than 6 months in advance.  The regulation found at 950 CMR 12.205(5) requires such investment advisers to either (a) post a $10,000 surety bond, or (b) establish a separate, segregated account of $5,000 [for (i) above] or $10,000 [for (ii) and/or (iii) above] and maintain at all times a positive net worth.  The Division requires that those investment advisers who choose option (b) demonstrate, on an annual basis, their positive net worth with a certified balance sheet prepared in accordance with generally accepted accounting principles applied on a consistent basis.  See 950 CMR 14.412(C).

If you are registered as an investment adviser in Massachusetts and have any questions, please feel free to contact us at Mallon P.C.


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Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for managers and registered investment advisers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Performance Fee Issues for State Registered Investment Advisors

One of the problems with the securities laws in the United States is that there are two levels of rules to be cognizant of at any single time – the federal rules and the state level rules.

For hedge fund managers that are registered as investment advisors with the SEC, there is a simple rule regarding performance fees – performance based fees can only be charged to those investors in the hedge fund who are “qualified clients” (the $1.5 million net worth requirement).  For hedge fund managers that are registered as investment advisors with the state, however, the manager may need to be aware of the performance fee rules of states other than their own state because each state has different securities laws.  (HFLB note: we will be discussing the issue of different state securities laws in an upcoming article on the Uniform Securities Act.)


There are three issues for a state-registered investment advisor to be aware of with regard to a hedge fund:

1.  Are performance fees allowed at the state level?  If so, what are the state’s investor qualification requirements?

2.  Does an investment advisor need to “look through” the hedge fund to the individual investors to determine if a performance fee can be charged?

3.  In the situation where a hedge fund investor resides in a state other than the state where the manager is registered, and with regard to the performance fee and “look through” rules, does the manager need to adopt the laws of the investor’s state or the laws of the state in which it is registered?


First, generally all states will allow performance fees, but each state has different investor qualification requirements.  Some states track the federal rules and require that performance fees be charged only to qualified clients, some states require that the performance fees be charged only to accredited investors, and some states do not allow state-registered investment advisors to charge performance fees (whether a state can legally have such a requirement is another issue).

With regard to the second issue, most all of the states which allow performance fees will “look through” the hedge fund to the individual investor for the purpose of determining who can take the performance fees; this means that each investor in the hedge fund will need to meet the qualification requirements.  However, some states interpret their securities laws to mean that the performance fee can be taken at the fund level and that there is no “look through.”  In these cases, if the hedge fund itself meets the qualification standards (say $1.5 million dollar net worth), then presumably the performance fee can be taken on all of the hedge funds assets, even if no single investor in the hedge fund is a qualified client.  The central reason that anomalies like this exist is poor drafting on the part of the state legislatures.

Finally, we come to the third issue which is essentially a conflict of laws question.  There are a couple of situations where this would apply.

Situation 1: Manager is registered as an investment advisor in State X which allows performance fees to be charged only to “accredited investors” ($1 million net worth) and “look through” rules apply.  Investor from State Y wishes to invest in the hedge fund, but State Y has laws which prohibit performance fees except to those people who are qualified clients.

Situation 2: Same facts as above, but State X provides that there is no “look through” at the fund level and only the fund needs to be an “accredited investor” in order to charge a performance fee at the fund level (which would ultimately be paid by the investor through a diminished capital account).

While we believe that in both situations above the manager should be able to charge performance fees based on its own state laws and without regard to the laws of other states, there have been some state securities commissions that have stated informally to me over the phone that they believe the manager should charge performance fees to investors from their state pursuant to their state rules.  We have never heard of a state instituting a proceeding against a hedge fund manager in this situation, but it is one potential issue and it has not been clearly resolved.

To try to bring a little bit of resolution to this issue, we did a conflicts of law analysis and found that it would probably be ok for a hedge fund manager to charge performance fees to its investors pursuant to the manager’s state law and without regard to the state law of the investors.  However, I do not think a law firm would provide any sort of legal opinion on this issue because it is definitely still within the grey area of the law (HFLB note: this discussion should not be taken as any sort of legal advice, pursuant to our standard website disclaimer).

Generally I would recommend that state registered hedge fund managers only charge performance fees to qualified clients even if the manager’s state had lower requirements.  If the manager wanted to charge performance fees to non-qualified clients, then the manager should consider charging performance fees pursuant to the state laws of each investor in the fund.  The issue with this of course is that it would present additional work for the administrator and create additional costs for the fund.  Additionally, the subscription documents would need to be redrafted to address the state law issues.

In any event, if this situation applies to a state-registered investment advisor who manages a hedge fund, the hedge fund manager should discuss this issue with their legal counsel.

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DOL Sues Investment Adviser for Receiving Undisclosed Fees from Hedge Fund

The case below provides a great example of why registered investment advisors and hedge funds need to have competent legal counsel advising them on all aspects and arrangements of their business.  Basically a registered investment advisor (RIA) had a selling arrangement with a hedge fund where the RIA would receive a portion of the performance fees earned by the fund on those assets which the RIA directed to the fund.  The RIA directed ERISA assets and did not disclose the arrangement with the hedge fund.  The DOL is seeking remedial action on many fronts and is asking that the RIA be banned from acting as a fiduciary to ERISA assets in the future.  The SEC has also frozen the hedge fund’s asset.

I am actually shocked by this story.  Not because of what the RIA or the fund did, but because it actually happened.  I would assume that an RIA with over $500 million in assets (including ERISA assets) would have an attorney review all of the transactions which it contemplated.  I am also in disbelief that the hedge fund manager did not run the proposed transaction through its own attorney.  If an attorney had seen this transaction in proposed form, it would not have gone through.  In addition to the potential ERISA issues, there are potential broker-dealer issues for the RIA as it is essentially acting as a broker in this transaction and if the firm is not registered as a broker, there may be more issues the RIA will have to face with the SEC.

This case highlights the importance of having competent legal counsel and discussing all issues and proposed transactions with counsel on a regular basis.  The consequences are real and severe – the fund’s assets are frozen and now both of these firms have sullied names.  The press release can be found here.

Release Date: October 24, 2008
Release Number: 08-1536-SAN
Contact Name: Gloria Della/Richard Manning
Phone Number: 202.693.8664/202.693.4676

U.S. Labor Department sues California investment advisor and executives to recover losses and hidden fees charged to employee benefit plans

San Francisco – The U.S. Department of Labor has sued Zenith Capital LLC of Santa Rosa, California, and its executives for allegedly investing the assets of 13 retirement plan clients in the hedge fund Global Money Management LP while receiving undisclosed incentive fees from the hedge fund’s sponsor and manager.
The lawsuit alleges that Zenith Capital and executives Rick Lane Tasker, Michael Gregory Smith and Martel Jed Cooper violated their fiduciary obligations under the Employee Retirement Income Security Act (ERISA). The defendants allegedly made investment decisions for their ERISA plan clients. From April 1999 to September 2003, the defendants caused the plans to invest in Global Money Management and received undisclosed incentive fees from LF Global Investments LLC, the general partner and manager of Global Money Management.

In 2004, Zenith Capital LLC was a registered investment advisor with 1,214 clients and approximately $538 million in assets under management. In addition to paying Zenith incentive fees not disclosed to the 13 ERISA plan clients, LF Global held an ownership interest in Zenith. The U.S. Securities and Exchange Commission has frozen the remaining assets of Global Money Management and secured the appointment of a receiver.

The Labor Department’s suit seeks a court order requiring the defendants to restore all losses owed to the plans, requiring them to undo any transactions prohibited by law and permanently barring them from serving in a fiduciary or service provider capacity to any employee benefit plan governed by ERISA. The suit was filed in the U.S. District Court for the Northern District of California.

“We will vigorously pursue investment advisors who try to line their own pockets by illegally steering pension investments. Fiduciaries must invest solely in the interests of the workers to whom these funds ultimately belong,” said Bradford P. Campbell, assistant secretary for the Labor Department’s Employee Benefits Security Administration (EBSA).

The suit resulted from an investigation conducted by the San Francisco Regional Office of EBSA as part of EBSA’s Consultant Adviser Project. Employers and workers may contact EBSA’s San Francisco office at 415.625.2481 or toll-free at 866.444.3272 for help with problems relating to private sector pension and health plans. In fiscal year 2007, EBSA achieved monetary results of $1.5 billion related to pension, 401(k), health and other benefits for millions of American workers and their families.

Zenith Capital LLC, Civil Action Number C-08-4854 (EMC)

U.S. Department of Labor news releases are accessible on the Department’s Newsroom page. The information in this news release will be made available in alternate format (large print, Braille, audio tape or disc) from the COAST office upon request. Please specify which news release when placing your request at 202.693.7828 or TTY 202.693.7755. The Labor Department is committed to providing America’s employers and employees with easy access to understandable information on how to comply with its laws and regulations. For more information, please visit the Department’s Compliance Assistance page.

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