Hedge funds in the United States have traditionally operated under two exemptions from registration prior to the implementation of the Dodd Frank Act registration requirements which came into force on 30 March 2012 . These exemptions were found in the Investment Company Act 1940.
The first of these exemptions was found in section 3(c)(1) which exempted a fund from registering if its outstanding securities were owned by not more than 100 persons who were accredited persons (having a net worth of more than $1m). This basic exemption was not as simple as it first sounded as there were a number of permutations that could be applied to it.
The second of the exemptions was found in section 3(c)(7) which exempted a fund from registering if its shareholders belonged to a category of investors referred to as Qualified Purchasers which was defined by reference to their wealth whether held individually or through entities. There were also some exceptions to this rule such as knowledgeable employees of the manager. Although section 3(c)(7) does not limit the number of investors the practical effect of SEC regulations and the Exchange Act has meant that the number of investors in such funds was limited to 500 investors in order to avoid more onerous reporting requirements i.e. having more than 500 shareholders would require the fund to register as a public company and provide quarterly reporting.
There was also another relevant exemption in 203 (b) 3 which exempted a manager from making certain reports if they had less than 15 clients – a hedge fund being treated as a single client.
In 2001 the SEC tried to bring in a registration requirement for hedge funds by interpreting the requirements for the definition of what constituted a client. This was overturned when the SEC was challenged in Court (Goldstein v SEC).
The Dodd Frank Act following the credit crisis of 2008 brought back registration for advisers to hedge funds exempting only three categories of advisers: advisers that acted solely to venture capital funds, advisers to private funds with less than $150m in assets under management in the United States and certain foreign advisers without a place of business in the United States. Advisers depending on the assets they manage will be subject to either state registration or registration with the SEC.
Recently another Act the Jumpstart our Business Startups Act is expected to affect the way hedge funds are organised and operate in the United States. This is because the threshold requirement to register as a public company has been increased from 500 to 2,000 shareholders (Title V) which is likely to mean that hedge funds can become much larger than they have been historically. Observers have also noted that Title II of the JOBS Act requires the SEC to adopt rules to eliminate the ban on general solicitation and general advertising when issuers are selling securities to “accredited investors”. Note that this requirement to eliminate the ban does not however appear to extend to the CFTC. It is expected therefore that there will be some more self generated publicity for hedge funds than has historically been the case in the United States.
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