General Hedge Fund Structure & Regulation
`
` A hedge fund is an entity that holds capital contributed by investors to be
`
`allocated among one or more investment opportunities pursuant to a management
`
`or advisory agreement with another entity, which may or may not be an affiliate1 of
`
`the hedge fund itself. Hedge funds traditionally invest in or against publicly held
`
`entities, but their investment activity continues to broaden.
`
`A. The Hedge Fund Itself
`
` 1. The Hedge
`
` Fund Structure
`
`Generally, a hedge fund is structured as a limited liability entity, such as a
`
`limited partnership or limited liability company (an “LLC”), whose assets are used
`
`to make various types of investments. A limited partnership fund typically has
`
`1 Under securities laws, an “affiliate” is “a person that directly, or indirectly
`
`through one or more intermediaries, controls or is controlled by, or is under
`
`common control with, the person specified.” 17 C.F.R. § 230.405; 17 C.F.R. §
`
`230.501(b). “Control” means “the possession, direct or indirect, of the power to
`
`direct or cause the direction of the management and policies of a person, whether
`
`through the ownership of voting securities, by contract, or otherwise.” 17 C.F.R. §
`
`230.405. Thus, affiliates can include partners, members, shareholders, directors,
`
`officers, or contract parties, and affiliates can be entities that are subsidiaries of the
`
`same parent entity.
`
`1
`
`NPS EX. 2004
`CFAD v. NPS
`IPR2015-00990
`
`
`
` A hedge fund is an entity that holds capital contributed by investors to be
`
`allocated among one or more investment opportunities pursuant to a management
`
`or advisory agreement with another entity, which may or may not be an affiliate1 of
`
`the hedge fund itself. Hedge funds traditionally invest in or against publicly held
`
`entities, but their investment activity continues to broaden.
`
`A. The Hedge Fund Itself
`
` 1. The Hedge
`
` Fund Structure
`
`Generally, a hedge fund is structured as a limited liability entity, such as a
`
`limited partnership or limited liability company (an “LLC”), whose assets are used
`
`to make various types of investments. A limited partnership fund typically has
`
`1 Under securities laws, an “affiliate” is “a person that directly, or indirectly
`
`through one or more intermediaries, controls or is controlled by, or is under
`
`common control with, the person specified.” 17 C.F.R. § 230.405; 17 C.F.R. §
`
`230.501(b). “Control” means “the possession, direct or indirect, of the power to
`
`direct or cause the direction of the management and policies of a person, whether
`
`through the ownership of voting securities, by contract, or otherwise.” 17 C.F.R. §
`
`230.405. Thus, affiliates can include partners, members, shareholders, directors,
`
`officers, or contract parties, and affiliates can be entities that are subsidiaries of the
`
`same parent entity.
`
`1
`
`NPS EX. 2004
`CFAD v. NPS
`IPR2015-00990
`
`
`
`“general partner(s)” responsible for certain business decisions and “limited
`
`partner” investors with varying rights and activities. See Brown & Max, R AISING
`
`CAPITAL: PRIVATE PLACEMENT FORMS & TECHNIQUES § 4(A) (Mar. 2015). An
`
`LLC fund typically has “manager(s)” responsible for certain business decisions for
`
`the fund and “member” investors with varying rights and activities.
`
`General partners and managers may, but need not, own an interest in the
`
`partnership or LLC. Each person involved in the fund—whether a general partner,
`
`limited partner, manager, or member—can be another limited liability entity or an
`
`individual. However, due to securities law restrictions, limited partners and
`
`members are typically funds-of-funds, institutions, family offices, and high net-
`
`worth individuals.
`
`a. Master Feeder Structures
`
`
`
`One particular hedge fund structure pertinent to the present Petition is the
`
`“master feeder” structure. Master feeder structures have tax and administrative
`
`advantages. The most common master feeder structure is one in which affiliates set
`
`up a “master fund” in an offshore jurisdiction—often the Cayman Islands—and at
`
`least two “feeder funds”, one a U.S. entity and one a non-U.S. entity. The feeder
`
`funds are each separate legal entities that raise two pools of money from investors.
`
`The U.S. entity raises capital from U.S.-domiciled investors, and the non-U.S.
`
`entity raises capital from non-U.S.-domiciled investors. This assures that the tax
`
`2
`
`
`
`status of the U.S. investors will have limited impact on the tax situations of the
`
`non-U.S. investors and that the ultimate hedge fund sponsors can avoid the costs of
`
`setting up and running two completely separate hedge funds. The feeder funds
`
`become limited partners in the master fund, contributing the capital they raise for
`
`the master fund to allocate among its investments.
`
` 2. Registration/Exemption under Securities Laws
`
`
`
`a. The Registration Statement and Prospectus
`
`
`
`Generally, the Securities Act of 1933 (“the ’33 Act”) regulates hedge funds’
`
`offerings because hedge funds are “issuers” of “securities” as defined in the ’33
`
`Act. See 15 U.S.C. §§ 77b, 77e. The ’33 Act prohibits the offer or sale of a security
`
`unless the issuer of the security either (i) files a “registration statement” with the
`
`U.S. Securities and Exchange Commission (“SEC”) or (ii) is exempt due to the
`
`nature of the security, the nature of the transaction, or the nature of the issuer. 15
`
`U.S.C. §§ 77c-e.
`
`The registration statement will include information about the manner in
`
`which the offering is made, the securities to be issued, investment risks, and
`
`information about the issuer and its business. 15 U.S.C. §§ 77f-g; 17 C.F.R. §§
`
`230.404, 230.408; Brown § 19.01(A). Unlike the Form D filings discussed below,
`
`the registration statement “is not a ‘check the boxes’ exercise”; rather, its
`
`“objective is to achieve a full and fair disclosure that will enable an investor to
`
`3
`
`
`
`make an intelligent investment decision.” Johnson, McLaughlin & Haueter,
`
`CORPORATE FINANCE AND THE SECURITIES LAWS § 1.06(C)(2)(a) (Dec. 2014).
`
`A “prospectus” is also filed by the issuer. 17 C.F.R. § 230.404. This
`
`document contains similar information to the registration statement but in narrative
`
`form. 17 C.F.R. § 230.421.
`
`The registration statement and prospectus are documents that most
`
`individuals unfamiliar with securities investments turn to when confronted with
`
`investment questions.
`
`b. Exemptions and Hedge Funds
`
`
`
`The bulk of U.S. filings are not by a registration statement and prospectus.
`
`Rather, most filings are accomplished through exemptions in the ’33 Act and
`
`associated regulations. Johnson, et al., § 7.04. Hedge fund offerings are conducted
`
`through these exemptions.
`
`Regulation D of the ’33 Act (“Reg D”) provides three exemptions from
`
`filing a registration statement under the ’33 Act. 17 C.F.R. § 230.500
`
`et seq. The
`
`exemption used most often is 17 C.F.R. § 230.506 (“Rule 506”), which is
`
`estimated to account for 90% to 95% of all Reg D offerings and an overwhelming
`
`majority of capital raised in accompanying transactions. Johnson,
`
`et al ., § 7.04.
`
`Other Reg D exemptions impose limits on the amount of capital that may be raised
`
`in an offering (namely $1 million or $5 million raised, depending upon the
`
`4
`
`
`
`exemption). See 17 C.F.R. §§ 230.504-05. However, Rule 506 does not impose a
`
`capital limit when the offering is made to “accredited investors,” as defined in the
`
`’33 Act and discussed in the next section. See Rule 506. Rule 506 offerings may
`
`also be made to unaccredited investors, but unaccredited investors are less likely to
`
`be involved in hedge funds. See 17 C.F.R. § 230.501(e); Rule 506. Year to year,
`
`Rule 506 exempted offerings raise almost as much capital as all public offerings.
`
`Brown, § 19.04(C)(1).
`
`When an issuer offers securities under the Rule 506 exemption, the issuer
`
`must still file a Form D with the SEC, which becomes publicly available on the
`
`SEC’s Electronic Data Gathering, Analysis, and Retrieval system (“EDGAR”) at
`
`http://www.sec.gov/edgar/searchedgar/companysearch.html. See 17 C.F.R. §
`
`230.503(a).
`
`A Form D requires disclosure of,
`
`inter alia : (i) “related persons” of the
`
`issuer, which are directors, executive officers, or persons who perform similar
`
`functions, and promoters of the issuer; (ii) whether the filing is for an offer of
`
`equity securities; (iii) the minimum investment that will be accepted; (iv) the
`
`amounts of the offering and resulting sales of securities; and (v) the number of
`
`investors. See, e.g. Ex. 2011. Form D is a check-the-box exercise, with brief, less-
`
`descriptive information. Johnson,
`
` § 1.06(C)(2)(a). Form D disclosures are not
`
`5
`
`
`
`provided for determining whether the fund would be a good investment; that
`
`information is provided through a private placement memorandum (“PPM”).
`
`A PPM is not filed with the SEC and, thus, is not publicly available.
`
`However, a PPM is necessary because of the anti-fraud requirements of the
`
`securities laws and performs an analogous function to the prospectus of a public
`
`company. See 15 U.S.C. § 77q(a); 17 C.F.R. § 240.10b-5. Consequently, a PPM
`
`typically includes information regarding the control, finances and business
`
`strategies of the issuer.2
`
`B. Management of the Hedge Fund
`
` 1. General Partners, Managers, or Investment Managers
`
`
`
`General partners and managers of a hedge fund are often a separate legal
`
`entity such as a limited partnership or LLC, and can be structured similarly to the
`
`hedge fund itself. Like the fund itself, the general partner or manager may have its
`
`own limited partners and members as well. The same would be true of any other
`
`entities further up the chain.
`
`2 State agencies also regulate the offering of securities, but such regulation is
`
`largely preempted. See 15 U.S.C. §§ 77r(a)(1)-(2), (b)(4)(E), (c)(2). If a state
`
`requires a filing for an offering, the filing requirement is typically satisfied by
`
`paying a fee and providing the state agency with a copy of the offering’s federal
`
`Form D. Johnson, et al., § 7.04(H).
`
`6
`
`
`
`The general partner, manager or, more typically, a separately contracting
`
`party that is an affiliate of the general partner or the manager or is a third party (the
`
`“Investment Manager”) will have employees who perform investment management
`
`services for the hedge fund pursuant to an investment advisory agreement. The
`
`Investment Manager is an investment advisor with authority either to execute
`
`investments for the fund in a discretionary manner, recommend investments that
`
`must be approved by the fund investors before they are executed, or some
`
`combination of the two.
`
` 2. Registration as an Investment Adviser
`
`
`
`If an investment advisor has assets under management totaling $110 million
`
`or more, it is required to register with the SEC as a “Registered Investment
`
`Adviser” (“RIA”). See 17 C.F.R. § 275.203A-1. Registration as a RIA requires the
`
`filing of a Form ADV, which is publicly available on the SEC’s Investment
`
`Adviser Public Disclosure (“IAPD”),
`
`www.adviserinfo.sec.gov. 17 C.F.R. §
`
`275.203-1(a).
`
`Form ADV has two parts. Part 1 is a check-the-box and fill-in-the-blank
`
`form with information about the RIA’s business, ownership, clients, employees,
`
`business practices, affiliations, and any disciplinary events.
`
`See generally Ex.
`
`2007. It also discloses “control persons” of the RIA, which are entities or
`
`individuals with the direct or indirect power to direct the management or policies
`
`7
`
`
`
`of the RIA, whether through ownership of securities, by contract or otherwise, and
`
`which include the officers of the RIA and owners of more than 25% of the RIA.
`
`3
`
`See, e.g., Ex. 2007, 49, 55-58.
`
`Part 2 of Form ADV requires RIAs to prepare narrative brochures that
`
`contain information such as the types of advisory services offered, the RIA’s fee
`
`schedule, disciplinary information, and conflicts of interest.
`
`See generally Ex.
`
`2006. The brochures are publicly available on the IAPD website.
`
` C. Limited Partners, Members, and Accredited Investors
`
`
`
` 1. Role of Limited Partners and Members
`
`
`
`Limited partners and members of a hedge fund are legal entities and
`
`individuals separate from the hedge fund itself. They can be U.S. or non-U.S.
`
`entities and individuals. See Brown, § 4(B). They are typically funds-of-funds,
`
`institutions, family offices, and high net-worth individuals. They can be created to
`
`invest in multiple hedge funds or other investment vehicles, and they can be
`
`3 “Control person” is not defined in securities laws. However, securities laws draw
`
`the phrase from the definition of “control”, which SEC Rule 405 describes as “the
`
`possession, direct or indirect, of the power to direct or cause the direction of the
`
`management and policies of a person, whether through the ownership of voting
`
`securities, by contract, or otherwise.” 17 C.F.R. § 230.405. The question of control
`
`is highly fact-dependent.
`
`8
`
`
`
`created to raise capital to be invested in one specific opportunity, such as a specific
`
`hedge fund.
`
` 2. Status as Accredited Investor
`
`
`
`Rule 506 provides an exemption to filing a registration statement for issuers
`
`with an unlimited amount of capital raised, an unlimited number of “accredited
`
`investors”, and up to 35 non-accredited investors. 17 C.F.R. §§ 230.501(e); Rule
`
`506. An “accredited investor” includes “virtually every type of institution that
`
`participates in the private placement market, as well as individual investors with
`
`substantial income or a large net worth.” Johnson, et al., § 7.04(B). Specifically,
`
`“accredited investors” include: (i) certain institutional investors (
`
`i.e., banks,
`
`savings and loans associations, insurance companies, registered investment
`
`companies, government pension plans, employee benefit plans, as well as
`
`corporations, LLCs, partnerships, and business trusts with total assets over $5
`
`million and not formed for the specific purpose of acquiring the securities offered);
`
`(ii) certain trusts (i.e., trusts with at least $5 million total assets and not formed for
`
`specific purpose of acquiring the securities offered and which is directed by a
`
`sufficiently sophisticated person); (iii) certain insiders of the issuer and its general
`
`partners (i.e., directors, executive officers or general partners of the issuer or of a
`
`general partner of the issuer); (iv) certain wealthy individuals ( i.e., natural persons
`
`who meet requirements as to minimum net worth ($1 million, individually or
`
`9
`
`
`
`jointly) or minimum income ($200,000 individually; $300,000 jointly)); and (v)
`
`accredited investor entities (
`
`i.e., any entity in which all equity owners are
`
`accredited investors. See 17 C.F.R. § 230.501(a). Hedge fund investors typically
`
`fall into one of the foregoing categories.
`
`
`
`
`
`10
`
`
Accessing this document will incur an additional charge of $.
After purchase, you can access this document again without charge.
Accept $ Charge
Still Working On It
This document is taking longer than usual to download. This can happen if we need to contact the court directly to obtain the document and their servers are running slowly.
Give it another minute or two to complete, and then try the refresh button.
A few More Minutes ... Still Working
It can take up to 5 minutes for us to download a document if the court servers are running slowly.
Thank you for your continued patience.
This document could not be displayed.
We could not find this document within its docket. Please go back to the docket page and check the link. If that does not work, go back to the docket and refresh it to pull the newest information.
Your account does not support viewing this document.
You need a Paid Account to view this document. Click here to change your account type.
Your account does not support viewing this document.
Set your membership
status to view this document.
With a Docket Alarm membership, you'll
get a whole lot more, including:
- Up-to-date information for this case.
- Email alerts whenever there is an update.
- Full text search for other cases.
- Get email alerts whenever a new case matches your search.
One Moment Please
The filing “” is large (MB) and is being downloaded.
Please refresh this page in a few minutes to see if the filing has been downloaded. The filing will also be emailed to you when the download completes.
Your document is on its way!
If you do not receive the document in five minutes, contact support at support@docketalarm.com.
Sealed Document
We are unable to display this document, it may be under a court ordered seal.
If you have proper credentials to access the file, you may proceed directly to the court's system using your government issued username and password.
Access Government Site
