Ohio

Ohio is arguably one of the most friendly jurisdictions in the United States for emerging managers, but does not have a particularly prominent hedge fund industry by number of funds; probably, most managers in the region end up in New York, Connecticut, Pennsylvania, and Illinois instead.  In any case:

Fund managers in Ohio can avail themselves of its exemption framework, which is amongst the least stringent in the country.  In some states, no exemption framework exists, and in such a state a manager must become a registered investment adviser (an “RIA”), which is significantly more costly intitially and on an ongoing basis.  In most other states, an exemption framework exists, but oftentimes, investors (regardless of whether they are in the state or not) must meet additional financial criteria beyond being merely accredited, an annual fund audit is required (which increases cost significantly), and other state-specific additional requirements may apply.

Consequently, fund managers in Ohio can both raise from lower net-worth investors, increasing the pool of possible investors, and also operate at lower cost, since they have no audit or registration requirements.

The NASAA Model Rule for exempt advisers:

(Ohio 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”, and, of the states that have exemption frameworks, the most popular framework is the NASAA model rule or a substantially similar adaptation of it.  In this rules framework, it is possible to be exempt, but underlying investors in funds managed by such exempt advisers must be “qualified clients,” ($2.2m+ net worth) and not merely accredited investors.

Additionally, an annual audit is required. This is not particularly restrictive for most funds, as investors in hedge funds should be sophisticated to be suitable and typically are qualified clients, but in some cases, some emerging managers desire to raise from accredited investors that are not qualifed clients, and this can be restrictive.  The annual audit is perhaps of greater import, as it affects operating costs which must be paid out of pocket and/or by fund investors (and thereby drags performance).

Ohio’s state-specific exemption framework:

For clarity, Ohio has not (yet) adopted the NASAA model rule.  As discussed above, Ohio simply allows for advisers with fifteen (15) or fewer clients to be exempt from registration as an investment adviser, and also allows such managers to operate funds with investors that are merely accredited.

Note that a state’s particular rules principally apply based on the place of business of the manager.  Additionally, this is determined based on a physical presence test; one cannot simply “opt out” of the state in which they reside/work by acquiring an out-of-state virtual address, office, or lease (much as one cannot opt out of their state’s taxes through similar means).

Once a manager reaches $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“), at which point such federal registration supersedes state adviser rules.

Therefore, most private fund managers in Ohio can operate as exempt until they hit that federal limit.

Ohio hedge fund investor restrictions:

While other regulatory acts may impose investor type restrictions on hedge funds (e.g. the Securities Act or the Company Act), in most cases, the maximum standard imposed by these other acts is that of accredited investor status.  Also note that this restriction is based on the location of the manager, not of its investors.

“Accredited investor” means (a) for individuals, either persons with a net worth of at least $1m, not including the value of their primary residence, if any, or persons who have made and will continue to make at least $200k in income per year (the net worth threshold is the same for married couples, but the combined income threshold is $300k in such case); and (b) for entities, those with a net worth of at least $5m.  There are a few other means of accreditation, but they are relatively uncommon.

At the state level, states often impose an additional restriction that investors in private fund vehicles must be “qualified clients,” meaning individuals or entities with a net worth in excess of $2.2m, not including the value of their primary residence, if any, and no means of being a qualified client by way of income.

This is not the case in Ohio, though, whose state-level exempt reporting adviser rules also only required investors to be accredited.

Ohio 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.

An audit typically costs, at the lowest end, around $15k per year, which, for some funds, is effectively a double up of their annual costs.  Audits can easily scale into the $100k+ range for larger and more complex funds, and/or depending on the auditor.

In Ohio, there is no such audit requirement for funds advised by exempt private fund managers.  Although many funds will still electively undergo an audit for a variety of reasons, such as their investors demanding as such, the flexibility to not have to get audited is a useful administrative and cost-cutting tool for an emerging manager.

Conclusion:

OH is amongst the most favorable places to launch as an emerging manager with some of the lowest ongoing operational costs possible in the country.  There are still a wide variety of administrative and regulatory filing obligations to consider, as launching a private fund is no trivial task, but Repool’s fund-in-a-box can significantly simplify matters and make operating a fund as an Ohio based emerging manager as simple as possible, allowing managers to launch quickly and focus primarily on fundraising and investing.