Utah

Utah is not a particularly prominent hedge fund hub, perhaps even less so than one would expect, and no doubt part of the reason is it’s lack of a viable exemption framework for hedge fund managers.  Utah does have a more generous framework for VC/PE-style fund managers, but this is not helpful for prospective emerging hedge fund managers.

At a national level, most (but not all) states provide for an exemption framework, and those that do generally utilize what is called the “NASAA model rule” or a substantially similar ruleset.  The NASAA model rule is explained further below for context.  However, Utah does not.

The most prominent restriction is that a Utah-based exempt reporting adviser (an “ERA“) is not able to take on individual investors; all investors must be entities.  This has the effect of substantially restricting the viability of many emerging managers.

When does state-specific jurisdiction apply?

One common question from emerging managers is when and whether a given state’s adviser rules apply.  The answer is relatively straightforward, but worth clarifying.  It is not uncommon for first-time managers to think something to the effect of: “I am forming a Delaware hedge fund, so I care about Delaware hedge fund adviser laws”; if that’s you, you are probably mistaken unless you actually live in Delaware.  Instead, it’s most likely the case that if you live in Utah, you care about Utah’s regime.  Note also that restrictions on investor types apply based on the location of the adviser, not of those of the state(s) the investor(s) are in.

A state’s jurisdiction applies if:

1. The manager is not yet an SEC-registered investment adviser (aka a “federally covered investment adviser”).
2. Any personnel of the manager involved in providing investment advice is based in that state.

Practically speaking, and except for the rare case where personnel both (i) work in an office almost all of the time; and (ii) that office is in a different state than where they live, the simple output is that a state’s jurisdiction with respect to adviser matters applies if personnel of the manager live in that state.  Even simpler: if you are reading this article, probably it’s the case that wherever you live is whatever your applicable jurisdiction is.  Managers literally cannot register as SEC-registered investment advisers until they hit $100m in AUM (and must do so at $150m), and, in any case, the purpose of this article and the goal of most managers is to not register if possible.

For clarity, personnel involved in investment decision making or fundraising are considered to be in the business of providing investment advice.  Additionally, the place of formation of the fund is irrelevant; most funds are Delaware entities, but that does not mean Delaware adviser law applies (this is similar to how most companies are Delaware corporations but subject to the laws and taxes of their state of business).   Similarly, the address of the fund doesn’t matter if it doesn’t represent the actual physical presence of its personnel.  A lease or virtual address in some other place does not make that place the place of business from a regulatory structure; if that were the case, the law would have very little teeth and everyone would opt out of unfavorable states.

The NASAA Model Rule for exempt advisers:

This section is for context.  Feel free to skip to the next section if you wish to read about Utah specifically.

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 many states with exemption frameworks, a large portion 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.

Both of these requirements match those of RIAs for private funds (i.e. RIAs are also restricted to qualified clients in pooled capital vehicles that charge performance-based fees and must have each of their funds undergo an annual, third-party audit).  However, ERAs have significantly less requirements in other respects, such as record-keeping, custody, policies and procedures, etc.

There are other requirements associated with being an ERA under the NASAA model rule that this article does not consider, but generally speaking, such requirements (such as certain disclosures and reporting to investors) are de facto handled in the course of procuring standard hedge fund back office services such as fund administration or fund offering documents, and don’t require specific pre-launch contemplation as such.

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.

Utah’s Exemption Framework:

Utah does not use the above model rule.

In Utah, the circumstances that would allow a private fund adviser to be exempt from registration are set forth in Utah Admin Code R164-4-9¹, which, generally speaking, states that an investment adviser can only be exempt from registration requirements if their investors are any of:

• Non-individual (i.e. entity) accredited investors
• “Qualified institutional buyers” (who would be de facto accredited anyways), meaning certain entities with $100m+ in assets.
• Corporations, partnerships, trusts, estates, or other non-individual entities having a net worth in excess of $10m

Alternatively, if the fund invests primarily in non-public equitites (i.e. VC/PE investments) and has control of the companies it invests in, amongst some other things, it could be exempt, but the aforementioned alone renders this exemption path non-useful for hedge funds.

Put another way, a hedge fund operated by a Utah based exempt manager cannot take on individual investors.

On the other hand, a registered investment adviser could operate a hedge fund with individual investors that meet the standard of being “qualified clients” ($2.2m+ net worth), meaning that, uniquely, in Utah, it is generally the case that a prospective hedge fund manager should seek to be an RIA instead of an ERA if it wishes to have such clients.  In most other states, RIA restrictions are the same and/or more restrictive than those imposed on ERAs.  The downside, however, is that such an adviser must go through the process of necessary licensure, registration, filings, and ongoing compliance and administration of an RIA, which has substantial initial and ongoing costs.

Conclusion:

Utah does have an exemption framework, but is not useful to the average emerging manager; as such, a prospective hedge fund manager based in Utah is likely to want to pursue registration.  To do so, such a person should contact legal counsel with familiarity with Utah state specific investment registration laws and requirements.  The cost to do so could be in the dozens of thousands initially.

Outside of RIA considerations, the process of launching, structuring, and then assembling the required back office functions of a hedge fund is itself a complex process with many moving pieces and traditionally, high costs.  Done the traditional way, hedge fund launch commonly costs $50-100k year 1 and can take 3-6 months.

If you are the rare Utah adviser that can be an ERA, or you are an RIA or thinking of becoming one and wish to launch a hedge fund, Repool can dramatically simplify the process, reduce costs, and accelerate launch timing on the hedge fund side.  However, we cannot assist with registration as an adviser.  Let us know how you’re thinking about your fund here and someone will reach out.