The term 'hedge fund' is commonly used to describe a variety of different types of investment vehicles that share some common characteristics and invests in a variety of asset classes, such as securities, futures contracts, options, bonds, and currencies. The term encompasses any pooled investment vehicle that is privately organized, administered by professional money managers and generally caters to sophisticated investors.
A hedge fund can be broadly described as a privately offered fund that is administered by a professional investment management firm (or 'hedge fund manager'). The word 'hedge' refers to a hedge fund's ability to hedge the value of the assets it holds (e.g., through the use of options or the simultaneous use of long positions and short sales). However, some hedge funds engage only in 'buy and hold' strategies or other strategies that do not involve hedging in the traditional sense.
In the US a hedge Capital Fund is a pooled investment vehicle generally formed as a Limited Partnership. A Limited Partnership generally has two entities, 1) the General Partner who holds control and makes all investment decisions, and 2) the Limited Partners who are the investors and cede power to make investment choices to the General Partner.
You may also have a Master Feeder Structure to accommodate investors from non-US jurisdictions. In this case, you would have the pooled investment vehicle mentioned above as well additional structures formed in an off-shore or EU jurisdiction. In this case you would generally form a Company that would allocate shares to the investors, however there would be a separate category for management shares issued to the General Partner or Management Company. Then you would form the Master Fund, which would accept the assets of the Domestic US Limited Partnership as well as the assets of the off-shore or EU Company. The Master Fund enters into the brokerage agreement with the Prime Broker and makes the investment decisions, then it allocates the profits or losses back to each of the sub feeder funds.
Private funds are pooled investment vehicles that are excluded from the definition of investment company under the Investment Company Act of 1940 by section 3(c)(1) or 3(c)(7) of that Act. The term private fund generally includes funds commonly known as hedge funds and private equity funds.
Historically, many of the investment advisers to private funds had been exempt from registration with the SEC under the so-called “private adviser” exemption. The Dodd-Frank Act replaced the old “private adviser” exemption with narrower exemptions for advisers that advise exclusively venture capital funds and advisers solely to private funds with less than $150 million in assets under management in the United States. As a result of the Dodd-Frank Act, many previously unregistered advisers to private funds were required to register with the SEC or the states.
Investment advisers that are registered with the SEC have an obligation to comply with all of the applicable provisions of the Investment Advisers Act of 1940 and the related rules that have been adopted by the SEC.
Investment advisers to private funds use Form ADV to register with the SEC and/or certain state securities authorities. Investment advisers to private funds must report on Form ADV general information about private funds that they manage, including basic organizational and operational information as well as information about the fund’s key service providers.
SEC-registered investment advisers with at least $150 million in private funds assets under management use Form PF to report, on a non-public basis, information about the private funds that they manage. Most advisers file Form PF annually to report general information such as the types of private funds advised (e.g., hedge funds or private equity), each fund’s size, leverage, liquidity and types of investors. Certain larger advisers provide more information on a more frequent basis (including more detailed information on certain larger funds).
Investment Advisers Are Fiduciaries
As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations. You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients.
Generally, facts are “material” if a reasonable investor would consider them to be important. You must eliminate, or at least disclose, all conflicts of interest that might incline you — consciously or unconsciously — to render advice that is not disinterested. If you do not avoid a conflict of interest that could impact the impartiality of your advice, you must make full and frank disclosure of the conflict. You cannot use your clients’ assets for your own benefit or the benefit of other clients, at least without client consent. Departure from this fiduciary standard may constitute “fraud” upon your clients (under Section 206 of the Advisers Act).
Investment Advisers Are Required to Prepare Certain Reports and to File Certain Reports with the SEC
As a registered investment adviser, you are required to file an annual update of Part 1A of your registration form (Form ADV) through the Investment Advisers Registration Depository (IARD). You must file an annual updating amendment to your Form ADV within 90 days after the end of your fiscal year. In addition to making annual filings, you must promptly file an amendment to your Form ADV whenever certain information contained in your Form ADV becomes inaccurate (the Form ADV filing requirements are contained in Rule 204-1 of the Advisers Act, and in the instructions to the Form).
Make sure your Form ADV is complete and current. Inaccurate, misleading, or omitted Form ADV disclosure is the most frequently cited finding from our examinations of investment advisers.
Please keep the e-mail address of your contact person current (Form ADV, Part 1A, Item 1J). We use this e-mail address to keep you apprised of important developments (including when it’s time to file an amendment to your Form ADV).
Accurately report the amount of assets that you have under management (Form ADV, Part 1A, Item 5F(2)). Advisers who have less than $25 million of assets under management, who are not otherwise eligible to maintain their registration with the SEC, or who stop doing business as an investment adviser, should file a Form ADV-W through IARD to withdraw their registration.
With respect to Part 2A of your Form ADV, you are required to file it electronically through IARD. As with Part 1A, you must update Part 2 annually within 90 days of the end of your fiscal year and whenever it becomes materially inaccurate. Part 2B brochure supplements, are not required to be uploaded to IARD.
You may also be subject to other reporting obligations. For example, an adviser that exercises investment discretion (or that shares investment discretion with others) over certain equity securities (including convertible debt and options), which have a fair market value in the aggregate of $100 million or more, must file a Form 13F each quarter that discloses these holdings. “Discretionary authority” means that you have the authority to decide which securities to purchase, sell, and/or retain for your clients.
You should also be aware that it is unlawful to make any untrue statement or omit any material facts in an application or a report filed with the SEC (under Section 207 of the Advisers Act), including in Form ADV and Form ADV-W.
Investment Advisers Must Provide Clients and Prospective Clients with a Written Disclosure Statement
Registered investment advisers are required to provide their advisory clients and prospective clients with a written disclosure document (these requirements, and a few exceptions, are set forth in Rule 204-3 under the Advisers Act). As a registered adviser, you comply with this requirement by providing advisory clients and prospective clients with Part 2 of your Form ADV. This written disclosure document should be delivered to your prospective clients before or at the time of entering into an advisory contract (under certain conditions, you may comply with the delivery requirements through electronic media).
Each year, you also need to deliver Part 2 or summary of material changes to each client, without charge. You are required to maintain a copy of each disclosure document and each amendment or revision to it that was given or sent to clients or prospective clients, along with a record reflecting the dates on which such disclosure was given or offered to be given to any client or prospective client who subsequently became a client (under Rule 204-2(a)(14)).
Investment Advisers Must Seek to Obtain the Best Price and Execution for Their Clients’ Securities Transactions
As a fiduciary, you are required to act in the best interests of your advisory clients, and to seek to obtain the best price and execution for their securities transactions. The term “best execution” means seeking the best price for a security in the marketplace as well as ensuring that, in executing client transactions, clients do not incur unnecessary brokerage costs and charges. You are not obligated to get the lowest possible commission cost, but rather, you should determine whether the transaction represents the best qualitative execution for your clients. In addition, whenever trading may create a conflicting interest between you and your clients, you have an obligation, before engaging in the activity, to obtain the informed consent from your clients after providing full and fair disclosure of all material facts.
The Commission has described the requirement for advisers to seek best execution in various situations.
In selecting a broker-dealer, you should consider the full range and quality of the services offered by the broker-dealer, including the value of the research provided, the execution capability, the commission rate charged, the broker-dealer’s financial responsibility, and its responsiveness to you. To seek to ensure that you are obtaining the best execution for your clients’ securities trades, you must periodically evaluate the execution performance of the broker-dealers you use to execute clients’ transactions.
You may determine that it is reasonable for your clients to pay commission rates that are higher than the lowest commission rate available in order to obtain certain products or services from a broker-dealer (i.e., soft dollar arrangement). To qualify for a “safe harbor” from possible charges that you have breached your fiduciary duty by causing your clients to pay more than the lowest commission rate, you must use clients’ brokerage commissions to pay for certain defined “brokerage or research” products and services, use such products and services in making investment decisions, make a good faith determination that the commissions that clients will pay are reasonable in relation to the value of the products and services received, and disclose these arrangements.
The SEC staff has stated that, in directing orders for the purchase or sale of securities, you may aggregate or “bunch” orders on behalf of two or more client accounts, so long as the bunching is done for the purpose of achieving best execution, and no client is systematically advantaged or disadvantaged by the bunching. The SEC staff has also said that, if you decide not to aggregate orders for client accounts, you should disclose to your clients that you will not aggregate and the potential consequences of not aggregating orders.
If your clients impose limitations on how you will execute securities transactions on their behalf, such as by directing you to exclusively use a specific broker-dealer to execute their securities transactions, you have an obligation to fully disclose the effects of these limitations to the client. For example, if you negotiate volume commission discounts on bunched orders, a client that has directed you to use a specific broker should be informed that he/she will forego any benefit from savings on execution costs that you might obtain for your other clients through this practice.
You should also seek to obtain the best price and execution when you enter into transactions for clients on a “principal” or “agency cross” basis. If you have acted as a principal for your own account by buying securities from, or selling securities to, a client, you must disclose the arrangement and the conflicts of interest in this practice (in writing) and also obtain the client’s consent for each transaction prior to the time that the trade settles. There are also explicit conditions under which you may cross your advisory clients’ transactions in securities with securities transactions of others on an agency basis (under Rule 206(3)-2). For example, you must obtain advance written authorization from the client to execute such transactions, and also provide clients with specific written disclosures. Compliance with Rule 206(3)-2 is generally not required for transactions internally crossed or effected between two or more clients you advise and for which you receive no additional compensation (i.e., commissions or transaction-based compensation); however, full disclosure regarding this practice should be made to your clients.
For more information see:
Information for Newly-Registered Investment Advisers (sec.gov)
As a registered investment adviser, you are required to adopt and implement written policies and procedures that are reasonably designed to prevent violations of the Advisers Act. The Commission has said that it expects that these policies and procedures would be designed to prevent, detect, and correct violations of the Advisers Act. You must review those policies and procedures at least annually for their adequacy and the effectiveness of their implementation, and designate a chief compliance officer (“CCO”) to be responsible for administering your policies and procedures (under the “Compliance Rule” — Rule 206(4)-7).
We note that your policies and procedures are not required to contain specific elements. Rather, you should analyze your individual operations and identify conflicts and other compliance factors that create risks for your firm and then design policies and procedures that address those risks. The Commission has stated that it expects your policies and procedures, at a minimum, to address the following issues to the extent that they are relevant to your business:
Portfolio management processes, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, your disclosures to clients, and applicable regulatory restrictions;
The accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements;
Proprietary trading by you and the personal trading activities of your supervised persons;
Safeguarding of client assets from conversion or inappropriate use by your personnel;
The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
Safeguards for the privacy protection of client records and information;
Trading practices, including procedures by which you satisfy your best execution obligation, use client brokerage to obtain research and other services (referred to as “soft dollar arrangements”), and allocate aggregated trades among clients;
Marketing advisory services, including the use of solicitors;
Processes to value client holdings and assess fees based on those valuations; and
Business continuity plans.
Investment Advisers Must Have a Code of Ethics Governing their Employees and Enforce Certain Insider Trading Procedures
As a registered investment adviser, you are required to adopt a code of ethics (under the “Code of Ethics Rule” — Rule 204A-1 under the Advisers Act). Your code of ethics should set forth the standards of business conduct expected of your “supervised persons” (i.e., your employees, officers, directors and other people that you are required to supervise), and it must address personal securities trading by these people.
We note that you are not required to adopt a particular standard of business ethics. Rather, the standard that you choose should reflect your fiduciary obligations to your advisory clients and the fiduciary obligations of the people you supervise, and require compliance with the federal securities laws. In adopting a code of ethics, investment advisers may set higher ethical standards than the requirements under the law.
In order to prevent unlawful trading and promote ethical conduct by advisory employees, advisers’ codes of ethics should include certain provisions relating to personal securities trading by advisory personnel. Your code of ethics must include the following requirements:
Also, as a registered investment adviser, you are required to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the misuse of material non-public information (under Section 204A of the Advisers Act). These policies and procedures must encompass your activities and those of your supervised persons. Advisers often include this prohibition on insider trading in their code of ethics.
Provide each of the people that you supervise with a copy of your code of ethics (and any amendments that you subsequently make to it), and also obtain a written acknowledgement from the supervised person that he/she has received it. In addition, you must describe your code of ethics in your Form ADV, Part 2, Item 11 and provide a copy to your advisory clients, if they request it.
Investment Advisers are Required to Maintain Certain Books and Records
As a registered adviser, you must make and keep true, accurate and current certain books and records relating to your investment advisory business (under “the Books and Records Rule” — Rule 204-2). The books and records that you must make and keep are quite specific, and are described below in part:
Some advisers are required to maintain additional records. For example, advisers that have custody and possession of clients’ funds and/or securities must make and keep additional records that are described in the Books and Records Rule (Rule 204-2, paragraph (b)), and advisers who provide investment supervisory or management services to any client must also make and keep specific additional records (which are described in Rule 204-2, paragraph (c)).
You must keep these records for specified periods of time. Generally, most books and records must be kept for five years from the last day of the fiscal year in which the last entry was made on the document or the document was disseminated. You may be required to keep certain records for longer periods, such as records that support performance calculations used in advertisements (as described in Rule 204-2, paragraph (e)).
You are required to keep your records in an easily accessible location. In addition, for the first two of these years, you must keep your records in your office(s). If you maintain some of your original books and records somewhere other than your principal office and place of business, you must note this practice and identify the alternative location on your Form ADV (in Section 1K of Schedule D). Many advisers store duplicate copies of their advisory records in a location separate from their principal office in order to ensure the continuity of their business in the case of a disaster.
You may store your original books and records by using either micrographic media or electronic media. These media generally include microfilm or digital formats (e.g., electronic text, digital images, proprietary and off-the-shelf software, and email). If you use email or instant messaging to make and keep the records that are required under the Advisers Act, you should keep the email, including all attachments that are required records, as examiners may request a copy of the complete record. In dealing with electronic records, you must also take precautions to ensure that they are secure from unauthorized access and theft or unintended destruction (similar safeguarding provisions regarding client information obtained by you is required by Regulation S-P under the Gramm-Leach-Bliley Act). In general, you should be able to promptly (generally within 24 hours) produce required electronic records that may be requested by the SEC staff, including email. In order to do so, the Advisers Act requires that you arrange and index required electronic records in a way that permits easy location, access, and retrieval of any particular electronic record.
The following informational sources may be helpful.
Investment Advisers Are Fiduciaries
Investment Advisers Are Must Have Compliance Programs
Investment Advisers Are Required to Prepare Certain Reports and to File Certain Reports with the SEC
Investment Advisers Must Provide Clients and Prospective Clients with a Written Disclosure Statement
Investment Advisers Must Have a Code of Ethics Governing their Employees and Enforce Certain Insider Trading Procedures
Investment Advisers are Required to Maintain Certain Books and Records
Investment Advisers Must Seek to Obtain Best Price Execution for Their Clients' Securities Transactions
Investment Advisers Requirements for Contracts with Clients
Investment Advisers Requirements for Proxy Voting
Requirements for Investment Advisers that Advertise their Services
Copyright © 2024 SGA - All Rights Reserved.