New Jersey

New Jersey is home to many NYC based finance employees and many NYC transplants; consequently, while not quite as popular as New York or Connecticut, there are still a relatively high number of hedge fund managers and hedge funds in New Jersey and this effect makes New Jersey one of the top states in the country by fund count.

New Jersey is also a friendly jurisdiction for emerging managers owing to its relatively favorable exemption framework, which provides straightforward and relaxed requirements for operating as an adviser to one or multiple hedge funds without having to become a registered investment adviser (an “RIA“).  This being exempt from registration is commonly known as being an “exempt reporting adviser,” or “ERA,”  and also has the effect of reducing minimum operational costs due to the lack of an audit requirement.  That means that funds can launch at slightly smaller sizes in New Jersey compared to many other states while having comparable economics, and allows emerging managers to get off the ground sooner as such.

The NASAA Model Rule for exempt advisers:

(New Jersey does not use the NASAA model rule nor a modified version of it; this section is for context.)

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 rule, 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.

New Jersey’s state-specific exemption framework:

Instead, New Jersey simply allows for investment advisers with five (5) or fewer clients to be exempt from needing to register as a registered investment adviser¹.  In this context, a private fund is considered a single client.

Note that once an adviser/manager hits $150m in aggregate regulatory assets under management (“AUM”), it must become a registered investment adviser with the SEC (i.e. a “federally covered investment adviser”).  Therefore, most private fund managers in New Jersey will be able to operate as exempt until they hit the federal registration limit, as it is exceedingly unlikely that a manager would have six (6) or more funds but still be under $150m anyways.

New Jersey hedge fund investor type restrictions:

Although NJ’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 NJ-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.

New Jersey private 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 New Jersey, there is no such requirement.  Therefore, funds managed by exempt NJ-based managers do not need to undergo an annual audit, although, much like filing Form ADV, 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:

NJ is amongst the most favorable places to launch as an emerging manager, in the sense that it has a relatively relaxed set of rules and restrictions around who may be and how they may be exempt from registration as an investment adviser.  Most NJ emerging managers launching with less than $150m will be able to take advantage of this exemption framework.