Monthly Archives: May 2011

California Extends IA Exemption for Hedge Fund Managers

Will Wait for SEC Final Registration Regulations to Propose New Rules

California currently has an exemption from the registration requirements for certain fund managers with more than $25M of AUM (Rule 260.204.9).  Back in March California requested input from the investment management community on how they might change the registration requirements when the SEC finalizes its IA registration rules as a result of the Dodd-Frank act.  At that time it was expected that the SEC would finalize its IA registration rules in time for managers to register before the July 21, 2011 registration deadline.  However, the SEC subsequently indicated that it would likely extend the registration deadline until the first quarter of 2012.  From this story by IA Watch, it looks like the Division of Investment Management is moving closer to officially moving the registration deadline to next year.

Because of the uncertaintly of rulemaking at the federal level, the states are left in limbo as to how to proceed with respect to fund managers who may or may not fit under certain exemptions after the federal laws

become effective (even if new federal rules are not yet effective).  California is addressing this exact scenario in a letter it addressed the investment management community on May 13, 2011.  The letter states:

“some uncertainty may exist about the need to become registered after July 21, 2011, for California IAs who are currently unregistered, in reliace on the existing exemption set forth in Rule 260.204.9.”

The letter goes on to state:

“The Department will soon issue emergency regulations to address this potential uncertainty.  These emergency regulations will amend Rule 260.204.9, but have the effect of preserving the status quo.  Therefore, California IAs who currently rely on the exemption from registration for private advisers, will be able to continue to rely on that exemption until such time as the Deparment adopts final rules related to private fund advisers.”

This is good news for current managers located in California and relying on the exemption from registration in California.  We believe that other states (such as Connecticut which has a similar exemption) will soon follow California and release emergency regulations to deal with issues related to the failure of the SEC to finalize the IA registration regulations.  Until the SEC does issue final regulations, it would seem that states would (or probably should) stop proposing changes to state regulations (see previous post on Massachusetts proposed changes).

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Cole-Frieman & Mallon LLP is a law firm focused on the investment management industry.  The firm provides investment adviser registration services to hedge funds and other investment managers.  Bart Mallon can be reached directly at 415-868-5345.

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SEC Proposes Change to Qualified Client Definition

Higher Threshold for Performance Fee Proposed

Under current SEC Rule 205-3, an SEC registered investment adviser can charge a performance fee (also called a performance allocation, incentive fee or incentive allocation) only to those investors who either has:

  • a $1.5M net worth or
  • at least $750,000 in assets with the manager

Many states have the same rules for state registered advisers or they explicitly make reference to the SEC regulation.

As a result of the Dodd-Frank act, the SEC is now proposing to increase the threshold for managers to be able to charge these performance fees.  The proposal declares that clients or investors of an SEC registered investment adviser can be charged a performance fee only if the client has:

  • a $2M net worth (excluding a primary residence) or
  • at least $1M in assets with the manager

What this means for SEC Registered Managers

While there will likely be a grandfathering provision for current fund managers with current investors who are “qualified clients”, when the new regulations go into effect, SEC registered managers (and potentially state registered managers) will likely need to make sure new investors meet the new threshold in order to charge these investors a performance fee.  Additionally, managers will need to update their offering documents to reflect the new definition (reprinted in full as proposed below).

The new regulation is likely to affect smaller funds disproportionally.  Many times smaller funds have investors who may just meet the qualified client threshold.  [Note: for some managers, they may allow non-qualified clients into the fund, but then just charge them a higher management fee in lieu of a performance allocation.]

Managers are urged to send comments to the SEC.  The comment period is open until July 11, 2011.

The SEC notice can be found here.

The full proposed rule can be found here: Performance Fee Rule Proposal.

Current comments on the proposal can be found here.

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Proposed Changes to Rule 205-3

Section 275.205-3 is amended by:

a.  Revising paragraph (c);

b.  Revising paragraphs (d)(1)(i) and (ii); and

c.  Adding paragraph (e).

The revisions and addition read as follows.

§ 275.205-3  Exemption from the compensation prohibition of section 205(a)(1) for investment advisers.

* * * * *

(c)  Transition rules.

(1)  Registered investment advisers.  If a registered investment adviser entered into a contract and satisfied the conditions of this section that were in effect when the contract was entered into, the adviser will be considered to satisfy the conditions of this section; Provided, however, that if a natural person or company who was not a party to the contract becomes a party (including an equity owner of a private investment company advised by the adviser), the conditions of this section in effect at that time will apply with regar

d to that person or company.

(2)  Registered investment advisers that were previously exempt from registration. If an investment adviser was exempt from registration with the Commission pursuant to section 203 of the Act (15 U.S.C. 80b-3), section 205(a)(1) of the Act will not apply to an advisory contract entered into when the adviser was exempt, or to an account of an equity owner of a private investment company advised by the adviser if the account was established when the adviser was exempt; Provided, however, that section 205(a)(1) of the Act will apply with regard to a natural person or company who was not a party to the contract and becomes a party (including an equity owner of a private investment company advised by the adviser) when the adviser is no longer exempt.

(d)  Definitions. For the purposes of this section:

(1)  The term qualified client means:

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

(ii)  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 $2,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property; or

(B)  Is a qualified purchaser as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(51)(A)) at the time the contract is entered into; or

* * * * *

(e)  Inflation adjustments. Pursuant to section 205(e) of the Act, the dollar amounts specified in paragraphs (d)(1)(i) and (d)(1)(ii)(A) of this section shall be adjusted by order of the Commission, effective on or about May 1, 2016 and issued approximately every five years thereafter. The adjusted dollar amounts established in such orders shall be computed by:

(1)  Dividing the year-end value of the Personal Consumption

Expenditures Chain-Type Price Index (or any successor index thereto), as published by the United States Department of Commerce, for the calendar year preceding the calendar year in which the order is being issued, by the year-end value of such index (or successor) for the calendar year 1997;

(2)  For the dollar amount in paragraph (d)(1)(i) of this section, multiplying $750,000 times the quotient obtained in paragraph (e)(1) of this section and rounding the product to the nearest multiple of $100,000; and

(3)  For the dollar amount in paragraph (d)(1)(ii)(A) of this section, multiplying $1,500,000 times the quotient obtained in paragraph (e)(1) of this section and rounding the product to the nearest multiple of $100,000.

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Cole-Frieman & Mallon LLP is a hedge fund law firm focused on the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

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SALT Conference 2011

Hedge Fund Conference Judged a Success

I had the opportunity to make it to one day of the SALT conference in Las Vegas this week.  As I talked to managers, investors and service

providers, it became clear that the attendees were excited about the speakers, the panels and the networking opportunities.  For the most part, it seemed to me that most people were at the conference for the following reasons:

  • to hear what is going on in areas outside of their expertise
  • promotion – many service providers were there
  • to have in-person meetings with investors
  • to have in-person meetings with managers
  • general networking

I found it to be a great opportunity to have conversations and meetings with fellow service providers as well as potential clients and I certainly look forward to going back next year.

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Cole-Frieman & Mallon LLP is a hedge fund law firm focused on the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

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Hedge Fund Events May 2011

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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May 1-3

May 3-4

May 3-4

May 3-4

May 5

May 10

May 10-11

May 11-13

May 17

May 18

  • Sponsor: HedgeAnswer
  • Event: HEDGEAnswers
  • Location: Conference Call

May 19

May 24

May 26

May 26

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Cole-Frieman & Mallon LLP is a hedge fund law firm focused on the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

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