Florida

With Miami’s rising prominence as a financial hub, with many major asset managers relocating and/or opening major office presences there, as well as Florida’s overall strong economic presense, Florida, although not at the absolute top of the list, has a relatively high number of fund managers.  This is further buoyed by its strong alt asset fund presense as well as its favorable exemption and exclusion frameworks for private fund advisers.

In FL, there are two different ways that a private fund manager can operate as exempt (an “exempt reporting adviser” or “ERA“) or excluded (an “excluded adviser” and not technically an ERA, but commonly still referred to as an ERA) and not have to register with the state (as a “registered investment adviser” or “RIA“).  This is relatively unique, in the sense that most states with an exemption have just a singular framework for exemption.  This is not a bad thing, and the exemption + exclusion routes offered by the Florida Divison of Securites are no more onerous than typical exemption frameworks (in fact, both are arguably more favorable and more flexible than average), but it does cause some confusion and can quickly become problematic if requirements are mixed up, as the two routes are not necessarily fully compatible.

The two routes are (1) a heavily modified NASAA model rule framework with some favorable differences, whereby investors need to be accredited (the model rule requires them to also be “qualified clients“, but FL lowered the standard, so to say), and an annual audit is not required; or (2) a state-specific framework wherein certain private fund advisers can claim to be excluded from the FL definition of “investment adviser” altogether, thereby also avoiding any registration requirement for investment advisers (as FL would not consider such an adviser to be an “investment adviser” – in the formal definition – at all).  This distinction may seem relatively unclear at first.  Let’s dive in, first by establishing context on the aforementioned NASAA model rule, and then following by discussing the two FL frameworks thereafter.

The NASAA Model Rule for exempt advisers:

The most common exemption framework is called the “NASAA model rule.”  This is an exemption framework created by the North American Securities Adminstrator’s Association in collaboration with state-level legislators.  Of the states with exemption frameworks, many have elected to adopt the NASAA model rule essentially outright and/or on a modified basis.

In the NASAA model rule¹, advisers exclusively to private funds are able to be exempt from being required to become RIAs with their state (note that regardless, non-VC private fund advisers must become RIAs with the SEC/federally once they manage $150m+ in assets, so exemption is not possible indefinitely), subject to certain criteria.  There are a variety of criteria, much of which is important but likely a non-issue for most emerging managers (e.g. it is not available to certain “bad actors” or folks with certain prior securities violations, standard filings need to be completed, disclosures need to be given to investors, etc).

The two most subjectively notable requirements are:

1. Investors in exempt manager-managed private funds must be “qualified clients,” ($2.2m+ net worth) and not merely accredited investors.
2. An annual audit is required per each fund (generally within 120 days of calendar year close) and the results must be distributed to investors.

The adviser and fund-level filings with the SEC and/or applicable states are generally outsourced, and, if a provider like Repool is utilized, a relative non-issue.  The disclosures requirements are handled by way of a quality set of standard hedge fund offering documents, such as those that Repool creates in the course of our fund-in-a-box offerings.

Thus, assuming (1) and (2) above can be met, and there is less than $150m at play across the fund(s) in question, a private fund adviser can be exempt under the NASAA model rule and states that follow its framework.

Florida framework #1: modified NASAA-model rule exemption:

Florida, inspired by the NASAA model rule, recently adopted its own exemption framework for private fund managers beginning in 2023 via a bill called CS/CS/HB 253.  The exemption can be read about in greater detail at FL 517.12. While it does reference the NASAA rule heavily, the primary considerations of the NASAA model rule are both changed.

First, instead of needing investors in an exempt-adviser-managed fund to be qualified clients, they only need to be accredited investors.

Second, unlike the model rule, there is no annual audit requirement (although it is still common to electively pursue an audit).

Because this first framework is newer, and because its use case is relatively niche, this is, in FL, the less common route.  The reason that taking this exemption instead of the exclusion is niche is further explained below.

Florida framework #2: Exclusion from being considered an investment adviser:

This is the more common path, and this is also the more long-standing path, with the exemption route only being introduced recently.

So – to be exact, this is not an exemption framework.  This is an exclusion from being considered an investment adviser at all by FL.  As described above, the exemption is only in play if there is an investment adviser to one or more private funds.  If you aren’t an investment adviser at all, then you don’t need to be exempt, and you don’t need to be registered; FL doesn’t consider you an investment adviser!  Note, though, that SEC jurisdiction still kicks in at $25m, and the SEC will still generally consider any adviser to private funds to be an investment adviser, even if the state doesn’t.  We know – a bit confusing!

Anyways, by virtue of being excluded, which is a fairly rare circumstance that only a few states have a framework for, then all requirements drop away with respect to investor type and audit.

Put another way, if the exclusion route is taken, instead of being limited to qualified clients and also needing to get the fund(s) audited annually as per the NASAA model rule, or being limited to accredited investors as per the FL-modified NASAA rule, you technically have no restrictions on either front.  That said, there are still other regulatory frameworks that apply, such as the Investment Company Act of 1940 and the Securities Act of 1933, which relate to the fund, and, in short, generally has the outcome of still requiring investors to be accredited investors.  This article is not going to contemplate those other frameworks in any deetail, though.

Some things to note:

• If you take on accredited investors (in either the exempt or exclusion route), but in the future exceed $150m, the SEC registration threshold, you could no longer charge those accredited investors performance-related fees;
• The exclusion criteria only allows for up to five (5) clients.  Each fund is considered a client, so this means that a fund manager could not have more than 5 funds;
• When the excluded adviser hits $25m, although the state will continue to consider the adviser excluded under FL law, the SEC will not.  The SEC will need that adviser to meet SEC exempt reporting adviser criteria, which it most likely can, as the SEC does not follow the model rule either and does not require investors to be qualified clients nor for an annual audit.  However, the SEC will require Form ADV to be filed.

If you go down this route and end up exceeding $25m, you will be in the fascinating and uncommon circumstance of simultaneously:

– Not being considered an investment adviser at all by FL, but
– Still being considered an investment adviser by the SEC.

The definition of an investment adviser and exclusion criteria for FL can be found here.

Additionally, many investors may still wish to see a Form ADV filed (which isn’t required if you are a sub $25m excluded adviser), and many investors also will wish to see an annual audit.  Accredited but not qualified client investors are also considered less sophisticated and although permissable, they likely carry slightly higher suitability risk.

The exempt route and excluded route sound very similar?  What’s the point of the exempt route?

This is a fair observation.  In other states that have an exemption and exclusion framework, such as Pennsylvania, the exempt route more closely follows the NASAA model rule and as such, exclusion in such a state allows for accredited investors whereas exemption only allows for qualified client investors, and there is a greater impact in choosing one route vs the other.

In Florida, the exemption route was introduced in 2023.  Repool cannot speculate as to the intention of why it was introduced, but in almost all cases a private fund adviser could simply opt to be excluded instead of exempt.  If a fund manager had six (6) or more private funds, it would not be able to be excluded, and in that case, it would have to go down the exemption route instead.  That said, an investment adviser with more than $150m in AUM has to become a registered investment adviser with the SEC anyways, at which point the exemption is moot, and it seems like a rare set of circumstances that a manager would both (i) have six (6) or more funds under its management, but also (ii) still have less than $150m AUM.

To be clear, one cannot be both exempt and excluded.  Either you have the position that you are excluded from the defintion of investment adviser, or you take the position that you are an investment adviser but exempt from registration.  While very similar, private fund advisers should understand their regulatory posture.

Conclusion and summary:

FL is a relatively favorable place to launch as an emerging manager, owing to having both an exemption framework as well as an exclusion framework that is in some senses, more favorable and flexible.  Historically, because the exemption route didn’t exist, most emerging managers have gone down the exclusion route, and this is still a viable path for most private fund advisers.  However, in certain niche cases, or if a manager simply wishes to be more conservative and/or its investors prefer, it can avail itself of the exemption instead of the exclusion.

If you’d like to explore launching as an emerging manager in FL under either the exemption or the exclusion framework, Repool can help.  Let us know how you’re thinking about your fund here and someone will reach out.