Wisconsin

Better known for other industries like healthcare, Wisconsin does not have a particularly prominent asset management industry or number of hedge funds; indeed, most of the states in the region, sans Illinois, are not hedge fund hubs.  That said, it is a perfectly viable locale for prospective emerging managers based in the state, owing to its adoption of the “NASAA model rule,” the most common exemption framework used nationally (explained further below), by an order from the Wisconsin Department of Financial Institutions Division of Securities on February 17, 2012¹.

Uncommonly, Wisconsin provides two different paths to exemption.  Other than the NASAA model rule, Wisconsin has a state-specific framework by which certain private fund advisers can be exempt if and only if they restrict their clients (i.e. investors) to certain types of accredited investors.  However, this means is relatively obscure, as Wisconsin has eliminated the most common accreditation means from qualifying, and no individual is considered accredited for the purposes of this second, state-specific framework; as such, most emerging managers, who often rely upon individual investors, would not be able to make use of this exemption and are likely to need to utilize the NASAA model rule route instead.

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.  Some folks reading this article may be doing so because they are thinking 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 there.  For residents of Wisconsin, it is almost certainly the case that Wisconsin’s laws apply.

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.

An important note is that restrictions on allowable investor types stem from the adviser’s state’s requirements, not those of the state the investor is based in.  In other words, it does not matter what state an investor is in in terms of the restrictions described herein.

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:

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.

Wisconsin’s Exemption Frameworks:

Wisconsin has two exemption frameworks.

1. First, Wisconsin has adopted the NASAA model rule essentially in its entirety.  Therefore, the above mentioned restrictions accurately describe considerations for private fund managers seeking to be exempt in Wisconsin.
2. Second, Wisconsin also provides for an exemption from registration for private fund advisers under 551.403².  If an adviser has clients (investors) that are:

• • Federally covered investment advisers, state registered investment advisers, or broker-dealers
  • Institutional investors (with a few exceptions not discussed herein)
  • Accredited investors, but if and only if they are accredited in the specific ways described in Rule 501(a)(1) or (a)(3), which are:
    • Certain banks, savings and loan institutions, broker or dealers, registered investment advisers, registered investment companies, business development companies, rural business investment companies, state/governmental plans and employee benefit plans; or
    • Certain corporations, trusts, partnerships, and LLCs, not purpose formed to invest in the fund, with total assets exceeding $5 million.
  • A few other uncommon means, not discussed herein.

Then such an adviser can be exempt from registration.  In effect, this means that no individual natural persons can be investors, and only certain entities that are accredited may invest.  Because most emerging managers will raise a significant amount of capital from natural persons, and any entities that meet the above criteria are likely to be qualified clients anyways (and thereby satisfy the NASAA model rule), the NASAA model rule is almost certainly the preferred route.  The only “benefit” to the second route is that, in theory, an audit is not required, but it is almost certainly the case that such investor types would demand an audit anyways (and many managers electively opt for an audit of their funds generally), so that is relatively de minimus as a practical matter.

Conclusion:

While Wisconsin technically has two different paths to exemption from registration as an investment adviser, for prospective emerging hedge fund managers, only the NASAA model rule route is likely to be practical.  As long as a Wisconsin-based emerging manager is able to raise its capital goals exclusively from investors that are qualified clients in addition to being accredited, and have sufficient minimum capital to support the additional cost implications of an annual audit, most such emerging managers will be able to avoid registration and instead operate as exempt.

Outside of these 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.

If you are thinking about launching a hedge fund as a WI-based manager, Repool’s deep expertise and fund-in-a-box can help; let’s get in touch.