RealWorld Trading Interview with Hannah Terhune, Attorney

Dave: Are these documents boiler plate or created individually for each fund?

Hannah: They are created individually for each client.

Dave: Does this paperwork need to be filed with the SEC or anyone?
Hannah: Form D is filed with the SEC and other forms may be required to be filed with each state where investors are located.

Dave: What is the definition of “accredited investor”?
Hannah: The safe harbor protection most often relied upon by hedge funds under Rule 506 exempts offerings that are made exclusively to “accredited investors.” Issuers are permitted under these provisions to sell securities to an unlimited number of “accredited investors.” In addition, if the offering is made only to accredited investors, no specific information is required to be provided to prospective investors. The term “accredited investors” is defined to include: Individuals who have a net worth, or joint worth with their spouse, above $1,000,000, or have income above $200,000 in the last two years (or joint income with their spouse above $300,000) and a reasonable expectation of reaching the same income level in the year of investment; or are directors, officers or general partners of the hedge fund or its general partner; and Certain institutional investors, including: banks; savings and loan associations; registered brokers, dealers and investment companies; licensed small business investment companies; corporations, partnerships, limited liability companies and business trusts with more than $5,000,000 in assets; and many, if not most, employee benefit plans and trusts with more than $5,000,000 in assets.

Dave: Does everyone who invests in a hedge fund need to be an “accredited investor” or high net worth individual?
Hannah: No.

Dave: I have several friends who would love to invest in a hedge fund, but don’t meet the above criteria. Is there anyway around the regulation?
Hannah: Yes, non accredited investors can invest in a hedge fund. It depends on the fund manager’s discretion.

Dave: Does the manager need to have a Series 7 or other licenses?
Hannah: No, a Series 7 is not relevant to this discussion.

Dave: How about registration? Does the manager need to register with the SEC?
Hannah: Yes, in certain cases, given recent law changes.

Dave: Does the manager need to register in the state the fund is domiciled in?
Hannah: Form D needs to filed with the SEC.

Dave: What about the funds trader (s). Do they need to register with anyone?
Hannah: Yes, in certain cases. This requires a state-by-state determination. A fund manager must sign up with their state as the investment adviser if they have less than $25 million under management. Between $25 million and under $30 million under management, the fund manager may choose the regulator—either the state or the SEC. If the fund manager has more than $30 million under management, the fund manager would need to register with the SEC as an investment adviser.

Dave: What if the investors are from different states? Does the manager need to register in every state an investor is from?

Hannah: Yes, usually a notice filing is required as long as they are registered in another state or with the SEC.

Dave: Is this in all cases? What about very small start up funds?
Hannah: It depends on the state and the structure the fund manager opts to use.

Dave: Is there anyway to legally avoid registration?
Hannah: You either have to register or you fall within an exemption.

Dave: If the manager is a CTA does he still need to register as a fund manager?
Hannah: The difference between a CPO and a CTA is that a CTA manages individual accounts, while a CPO manages only the hedge fund, or Pool. Few of our clients remain interested in the CTA option once they realize the administrative hassle associated with managing the separate accounts. No sponsor is needed to take the Series 3 exam. The Series 3 exam is given under the auspices of the NASD’s testing program. Two different testing services provide their services to the NASD.
Unlike a traditional hedge fund (where the SEC may end up being a regulator if enough money is under management), the government regulator that may associated with CPOs is the CFTC—the Commodity Futures Trading Commission.

The CFTC has allowed the National Futures Association (NFA) to become the primary regulator of futures and commodity products (as a Self-Regulatory Organization, similar to the NASD’s status with the SEC). It is my opinion that the NFA is a very effective and competent regulator.

Dave: How about if the manager has a series 7. Is registration still required?
Hannah: A Series 7 is of no particular value to either an RIA or a CPO. If someone has a current Series 7 (they’ve been registered within the past two years with a broker/dealer), they can choose to take the Series 66 instead of the Series 65. The Series 7 plus the Series 66 is always (in all states) equivalent to the Series 65. After two years of not being with a broker/dealer, all prior registrations (such as a Series 7) expire and are no longer valid. Similarly, if someone previously passed the Series 65 but has not had it registered with either a broker/dealer or an investment advisory firm, the exam has expired and will need to be taken again. Some states will not consider someone for investment advisory status unless they were previously registered as a Series 7 with a broker/dealer.

Dave: Ok, now that we have the basics out of the way. What’s the first step someone should take before launching a fund?


Dave: Is there a minimum capital amount that you feel is needed before launch?
Hannah: No.

Dave: What about someone who does not have any investors yet, who just wants to set up the fund structure for the future? Set up an incubator fund? I know your firm runs some type of “hedge fund incubator” Can you explain what this is?
Hannah: It’s a start up process for a prospective fund manager to develop and document a track record that could be legally marketed to prospective investors when he or she is ready to open the fund to outside investors.