Yes, state-specific framework
Qualified clients
Yes
Yes
Disclaimer
Summary
With the second largest population and GDP in the US, Texas is a popular location for investment advisors despite not being on the east coast and does have an exempt private fund adviser framework. However, Texas does not use the common “NASAA model rule” exemption framework and has a few state-specific nuances of note.
Texas specific adviser rules
Texas has an exemption framework but does not follow the "NASAA model rules," an exemption framework that is commonly used by states. For the most part, the practical restrictions and requirements are substantially similar to model rule states, but there are some key, non-trivial additional reporting requirements.
Investor restrictions
Hedge funds operated by exempt Texas-based advisers are restricted to qualified clients ($2.2m+ net worth). Certain PE, VC, and RE funds don't have this restriction, but that does not help most hedge funds.
Reporting requirements
State notice filing by way of Form ADV is required. Additionally, most private fund advisers have additional, Texas-specific investor reporting requirements. See below for further information.
Audit requirement
Practically speaking, audits for funds are required; however, there is theoretically a (subjectively impractical) way to not do audits. See below for further information.
State specific nuances
Two prominent state-specific requirements. First, there is an alternative to audits but few advisers make use of it. Second, exempt private fund advisers must provide all underlying fund investors with account statements from any custodian utilized by the fund on a quarterly basis. See below for more information.
Detailed Summary
Texas has implemented a variation of the standard NASAA Registration Exemption for Investment Advisers to Private Funds Model Rule. The default NASAA rule allows “private fund advisers” – advisers who solely advise private pooled investment vehicles such as a hedge fund – to be potentially exempt from needing to register as an investment adviser (i.e. not need to take a FINRA exam and become a registered investment adviser) so long certain requirements are met, which include, most notably, that (i) all clients are qualified clients; (ii) the fund(s) undergo an annual audit and provide such audited statements to investors; and (ii) the adviser is not subject to a disqualification event (e.g. securities law violations, felony acts, etc).
Similarly, Texas restricts exempt “Private Fund Advisers” to only being allowed to manage hedge funds whose investors are “qualified clients” ($2.2m+ net worth).
Texas state-specific nuance #1: Delivery of Custodian Reports:
As alluded to earlier on this page, Texas has two prominent state-specific requirements.
The first is with respect to delivery of reports to investors.
Texas requires exempt private fund advisers to adhere to custody rules for Texas RIAs (§116.17) as if they were registered; these custody rules for registered investment advisers (and also exempt private fund advisers) require that account statements for any custodian of underlying client funds are supplied directly to each underlying investor of a private fund on at least a quarterly basis. These statements must identify the ending cash-equivalent account balance and all transactions that occured during the period.
This means that a Texas based fund manager, exempt or not, must take care to have a process by which they can retrieve and distribute copies of account statements across the entire chain of asset custody, from the bank(s) they utilize to their prime broker(s) and other similar such vendors; any place that the fund’s assets are held, in whole or in part. This is not a particularly hard thing to do nor does it necessary have a monetary cost, but it is administratively cumbersome and care should be taken to remember to do so, as this is not a service that is typically outsourced to vendors.
For context, this is a fairly unique requirement for Texas. Generally, states that utilize the NASAA model rule or other exemption frameworks do not have such a requirement.
Texas state-specific nuance #2: Audit-Alternative:
This second nuance is somewhat theoretical in the sense that, at least observationally, most managers seem to opt to have their funds audited and avoid this alternative.
A TX private fund adviser could technically forego getting its fund(s) audited each year, but, if so, the manager must arrange for a licensed independent public accountant to conduct a surprise examination for each fund, at a random time, once per year, and create a report, file a certificate on the advisers Form ADV relating to the examination, as well as other deliverables.
Many managers would consider this to be a significantly more onerous – and potentially more expensive – process than simply getting audited financials of their underlying funds, especially considering that many investors want to see audited financials in any case as a prerequisite to investing in a private fund anyways.
Special cases (that are probably not that helpful for hedge fund managers):
Certain “Private Equity Funds,” “Real Estate Funds,” and “Venture Capital Funds,” as defined by Texas’ code, are not restricted to taking on qualified clients even when managed by a Texas exempt Private Fund Adviser. However, these terms have specific meanings, cannot be arbitrarily opted in to, and, as may be discerned by the terminology, most hedge funds would not qualify and would therefore still be limited to qualified clients.
Despite the (likely) lack of relevance, this exception is called out because it is not uncommon for a prospective hedge fund manager to talk to friends, colleagues, and connections that are non-hedge fund private fund managers, and assume that their experience and guidance maps 1 to 1 to what their own needs will be. In those such situations, such emerging managers may conflate the correct requirements and restrictions for their own fund and be caught unawares during their planning – or worse, after already having paid for fund documents (this does happen more than you think!).
If you have had similar conversations and/or have been given a similar understanding (sometimes even by legal counsel or fund servicing providers stepping outside their domain of expertise), these special cases may be the reason.
