Connecticut

Many major investment firms and funds have regional offices in Connecticut, and NYC is a short train ride away, so many NYC employees of asset managers are actually based in Connecticut.  In this sense, Connecticut is even more popular than New Jersey, and, as such, has one of the highest concentrations of hedge funds and managers in the country.

Connecticut is a friendly jurisdiction for emerging managers owing to its straightforward and favorable exemption framework, which has fairly relaxed requirements to be exempt from registration (such a person, an “exempt reporting adviser” or “ERA“) when operating one or multiple private funds.  This framework is essentially the federal private fund adviser exemption framework (described below) but applied at the state level.  Connecticut ERAs are able to accept accredited investors that are not also qualified clients (we’ll call such investors “merely accredited investors“), and they are also not required to undergo an annual audit of their funds.  That means that funds can often launch with greater flexibility and lower administrative and dollar costs compared to many other states.

Context: the federal private fund adviser exemption:

In general, once a fund manager hits $100m in assets under management (“AUM“), it must begin to file Form ADV with the SEC, alongside whatever state requirements it has.  Below this threshold, the Form ADV is used for notice filing with the state only.  So, as a somewhat obscure technical matter, there is a period of time wherein emerging managers file as exempt with both the state and the SEC between $100m and $150m ($150m being the threshold at which non-venture private fund managers must register with the SEC).

In any case, the rules for exemption status federally are almost always a lower standard than a given state’s exemption framework, so this requirement to now also meet and file as an ERA with the SEC is typically trivial.  The requirements for a federal ERA, pursuant to 203(m) of the Investment Advisers Act of 1940¹, are simply that (i) the adviser is exclusively advising private funds, and (ii) it has more than $100m and less than $150m AUM.  203(m) does not specify any any audit requirement or investor minimum type, although other acts that apply to private funds and/or concurrent state frameworks implicitly enforce an investor minimum type.

In short, advisers solely to private funds typically must file Form ADV with the SEC as federal ERAs between $100m and $150m AUM.

Connecticut’s state-level exemption:

Connecticut, by way of an order called the Dodd-Frank IA Exemptive Order dated as of July 11, 2011², has implemented a framework that allows a private fund manager that meets the definition of a private fund adviser under the SEC’s 203(m), described above, to be exempt at the state-level.

However, instead of only applying to advisers with between $100m and $150m with respect to filing Form ADV, any private fund adviser in Connecticut with less than $150m must notice file with the state by way of Form ADV.

This means that an adviser exclusively to private funds in CT is generally able to be exempt.

Investor type restrictions:

Although CT’s exemption framework does not specify a restriction on the types of investors that may invest into a private fund managed by an exempt manager, as is often the case in other states, that does not mean that such funds can freely accept any investors regardless of their financial status.

Because of the Securities Act of 1933 (the “Securities Act“), which governs the sale of private securities/private placements (i.e. bringing on investors to a hedge fund), all hedge funds by definition are engaged in selling securities.  With that being the case, the Securities Act provides for certain allowable “safe harbor” private placement types called 506(b) and 506(c).  In short, in either case, investors must generally be accredited at a minimum.  There are some common misconceptions about taking up to 35 non-accredited investors, but this article will not contemplate the reasons behind that and that notion should generally be disavowed.

Put another way, although CT-specific adviser related law does not impose a restriction on investor types, advisers that manage hedge funds are subject to multiple regulatory frameworks, and some of these other regulatory frameworks, such as the Securities Act, apply concurrently and impose investor-type restrictions.

A ridiculous but hopefully digestable analogy is, say, rules relating to jaywalking.  Nothing about those rules specifies that you can’t mug someone while crossing the street (or so let’s just assume; we are not actually jaywalking-law experts or counsel…); nonetheless, it would be a crime to do so, because there are other laws that concurrently apply.

Fund audit requirements:

In the context of exempt and registered investment advisers, an audit typically refers to an audit of an underlying private fund’s financials, and not of the manager itself.  When required, an audit typically must be completed on an annual basis and have its results distributed to underlying investors.  Additionally, the auditor must be a licensed auditor that is distinct from the fund’s third-party administrator.

When an audit is required, the requirement typically stems from the Investment Advisers Act and/or similar state level adviser law, such as a state’s exemption framework requirements.  In many states, even when an exemption framework exists, funds must be audited.

In Connecticut, there is no such requirement.  Therefore, funds managed by exempt CT-based managers do not need to undergo an annual audit, although many managers will still electively opt for an audit for marketing and investor assurance purposes.  That said, the flexibility to not get audited is a useful administrative and cost-cutting tool for an emerging manager, especially if they launch part-way through the year and their initial investors don’t require one; it is often the case that managers who electively opt for audits will roll their initial partial year into their first full year (e.g. an 18 month audit instead of a 6 month and 12 month audit).

Conclusion:

Connecticut is amongst the most favorable places to launch as an emerging manager, with close to as few restrictions as any state has.

Most CT emerging managers will be able to take advantage of the exemption framework.  Such an exempt manager can take on merely accredited investors into its private funds, does not need to have its funds audited annually, and can have an unlimited number of funds, so long as their net AUM totals to less than $150m.

Contact Repool to learn more about how we can help with launch or administration for Connecticut based funds.