Hedge funds with regulatory assets under management in excess of $100 million are required to register with the U.S. Securities and Exchange Commission (SEC). Advisors who have regulatory capital under management less than $150 million and qualify for the private fund advisor exemption do not have to register with the SEC.
Even so, hedge funds remain far more opaque and more lightly regulated than traditional investment vehicles that often accumulate ordinary investor money such as mutual funds, exchange-traded funds (ETFs), and financial advisory firms.
- Hedge funds are typically required to register with the SEC if they maintain investor assets of more than $100 million.
- If the entirety of assets managed are from private accredited investors then that limit is raised to $150 million.
- New legislations pertaining to the regulation and registration of hedge funds was enacted through the 2010 Dodd-Frank Act and implemented in the Investment Advisors Act of 1940.
Hedge Fund Registration
After 2010, the Dodd-Frank Act's changes to the Investment Advisors Act of 1940 raised the lower limit for hedge fund advisors to register with the SEC from $25 million to $100 million. This change was implemented in Section 203(A)(II) of the Investment Advisors Act of 1940.
Dodd-Frank legislation also defined a new category of advisors, called mid-sized advisors, who have regulatory assets under management between $25 million and $100 million. An advisor of a mid-sized hedge fund does not have to register with the SEC but should be registered with the state where his principal office is located. If an advisor of a mid-sized hedge fund does not have adequate state regulation then that advisor would be required to register with the SEC.
The registration process began its implementation in 2012, the same year the SEC created a special unit to oversee the industry. Under the new legislation, hedge funds are also required to report information covering their size, services offered, investors, and employees, as well as potential conflicts of interest to their clients in appropriately communicated disclosures.
Private Fund Advisor Exemption
Hedge funds are not immediately accessible to the majority of investors. Instead, hedge funds are geared toward accredited high net-worth investors and institutional entities, as these types of investors need less SEC oversight than others. An accredited investor is a person or a business entity with a defined high net worth who is allowed to deal in securities that may not be registered with financial authorities.
Prior to Dodd-Frank, general partners in a hedge fund had exempted themselves from the Investment Advisors Act of 1940, which sought to protect investors by monitoring the professionals who offer advice on investment matters. These hedge funds (primarily family offices) were able to be excluded from the legislation by restricting their number of investors and meeting other requirements. However, Title IV of Dodd-Frank erased the exemptions that had allowed any investment advisor with less than 15 clients to avoid registration with the SEC.
Nevertheless, a hedge fund advisor may avoid registration with the SEC if they qualify for the private fund advisor exemption legislated in the Dodd-Frank Act and communicated in Section 203(m)(1) of the Investment Advisors Act of 1940. This exemption is applicable to an advisor of a hedge fund who has principal offices located in the United States, has regulatory assets under management below $150 million, and only has private fund clients. If a hedge fund advisor has at least one non-private fund client, he is not eligible for the private fund advisor exemption. Also, all assets count towards the $150 million threshold, including assets managed outside of the United States.
(For related reading, see Evaluating Hedge Fund Performance)