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Chapter 2: Regulations & compliance

US hedge fund managers face significant regulatory requirements, which this chapter cannot possibly cover in detail. But there are a few key areas of particular import, which shall be summarised below. In addition, this chapter will highlight some of the key considerations for implementing a compliance manual; a must-do task for any ambitious start-up manager who intends to incorporate best practices from the get-go and place themselves in the best possible light with prospective investors.

Dodd-Frank Act

Already six years in, US hedge fund managers are subject to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If the fund manager has less than USD150m in assets under management they can avoid registering with the Securities and Exchange Commission. Generally speaking, hedge fund managers with up to USD25m in assets must register with the relevant state regulatory authority. Once the manager has reached USD150m in private fund assets they are required to file two important documents: Form PF, and Form ADV.

Form PF

Form PF includes specific data fields regarding trading and clearing mechanisms; percentage of the reporting fund's net asset value; turnover by asset class; aggregated hedge fund exposures; turnover value of advised hedge funds; exposure to counterparties; concentration of investor base; and geographical breakdown of investments. 

According to a white paper entitled Practical Compliance and Risk Management for the Securities Industry, the SEC and CFTC estimate that for smaller advisers, the initial Form PF would take 40 hours to complete and that subsequent filing would take 15 hours to complete. It's important to note that within Form PF, managers must report on the fund's regulatory assets under management (`RAUM'). 

This is defined as being the gross assets under management (including leverage), unlike net assets under management, which is calculated by subtracting outstanding liabilities from fund assets. 


Any investment adviser is required to file form ADV if they have USD150m or more in assets under management, or more than USD100m in private fund assets; for example, they might have USD100m in private fund assets and USD10m in a segregated managed account from a seed investor. 

If the state where the manager's principal place of business is located does not subject the firm to examination by state regulators they must also register with the relevant state regulatory authority if they have between USD25m and USD100m. 

According to Brian Roberts, Senior Compliance Analyst for ACA Compliance Group, a leading regulatory compliance and consulting firm, start-up managers should file Form ADV and get it approved by the SEC before they cross the USD150m threshold in regulatory assets under management. 

"Going forward, investment advisers are required to submit an annual update and they are also required to update their filings on an intra-annual basis if there are certain items that become materially inaccurate; e.g., if they move office or experience financial difficulties. 

"Form ADV does not have the same level of detail as Form PF, which involves a number of complex calculations, but it will ask for details on things such as: location of the hedge fund manager, level of regulatory AUM, percentage of private fund assets owned by the management company versus external investors," explains Roberts.

The form is divided into two sections. Part one provides information about past disciplinary actions, if any, against the adviser. Part two summarises the adviser's background, investment strategies, services, and fees.

Form ADV is crucial for those who are going to register or who are classified as exempt reporting advisors (ERAs); An ERA will not be required to register with the SEC but will be subject to certain reporting, recordkeeping, and other obligations. 


The Foreign Account Tax Compliance Act (FATCA) makes no distinction between managers. Whether they are a USD50m start-up or a USD5bn veteran, everybody falls under its gaze. 

Investor transparency lies at the heart of FATCA and there are a couple of terms that managers need to be aware of. The first is `US Indicia'. This means you find something that doesn't tally up e.g. an investor has a US address and they are but are claiming tax-exempt status. This doesn't necessarily mean there's anything wrong but it requires the manager collecting additional documentation.

The second is the `recalcitrant' investor. This is where the manager is trying to get documentation on an investor to prove who they are but the investor is not providing that documentation. US fund managers are required to have a Global Intermediary Identification Number or `GIIN' for every legal entity they manage. In turn, they must ensure that each one of the fund's trading counterparties also has a valid GIIN. If the manager does not have a GIIN they will not be able to do business with their appointed counterparties so this is something that must be factored in at the pre-launch phase. 


The Alternative Investment Fund Managers Directive is comparable to the Dodd-Frank Act in the US and will only apply to those start-up managers who have visions of raising assets from European investors. In brief, the AIFMD is an EU regulatory framework that controls the way that hedge funds are marketed and distributed into Europe. 

In the context of this report, US managers with a Cayman fund would be viewed by ESMA, the European regulator, as non-EU AIFMs running non-EU AIFs. As such, any manager wishing to market their fund into Europe would be required to comply with the National Private Placement Regimes of the respective EU Member State i.e. the UK. They would need to file an annual report, namely Annex IV, under Article 42. In the UK, the AIFM does not need to worry about providing look-through information on the Master Fund, which is the case in certain EU Member States such as Belgium. 

Finally, whereas Form PF is based upon fiscal year-end, Annex IV is based on calendar year-end. 

Culture of compliance

In order to cope with the myriad regulatory reports, start-up managers should try to adopt best practices and establish a culture of compliance, even if at the time of launch they are not going to be SEC-registered. Speak to most compliance specialists in the industry and the general consensus is `if you want to be taken seriously, operate as if you are SEC-registered'. 

As such, incorporating a sound compliance framework is advisable. Most new managers will do this by working with an outsourced compliance firm who can guide them through all the necessary twists and turns. The benefit to this is once the manager does become registered it isn't a shock to the system and doesn't require any drastic overhaul of compliance workflows and processes. "Incorporating best practices will allow the firm to be proactive in their compliance programme versus reactive," says Frank Napolitani, Director, Financial Services at EisnerAmper LLP. 

"If you realise that you are going to need to become registered with the SEC at some point in the future adopt best practices from Day One; even though you're not obligated to do so set up compliance processes and policies. Establish a culture of compliance so that when the time comes to become SEC-registered you already have the practices in place and it becomes an easy transition," emphasises Anchin Block Anchin's Rosenthal. He continues:    

"From a marketing perspective, when investors perform their due diligence you can demonstrate that even though you aren't yet SEC-registered you have a proper compliance programme in place. Don't just think about where you are today. Think about where you want to be."

Implementing the compliance manual

Once the compliance manual has been finalised and adopted, a training element is normally required. This is where working with an outsourced compliance partner becomes beneficial. According to ACA Compliance Group's Roberts, this training element is two-fold. Firstly, training those who are going to be responsible for implementing the policies and procedures; determining exactly what their individual responsibilities will be in implementing the compliance manual. 

Secondly, training employees about their obligations under the compliance manual. 

"Mostly, this second type of training will focus on employees' responsibilities under the code of ethics with respect to personal trade reporting, reporting gifts and entertainment, political contributions, code of conduct, and whistleblowing. 

 "The above would relate more to start-ups who plan on getting SEC-registered immediately. But new managers that plan on becoming SEC-registered should be aware that they'll eventually need to adopt similar policies and procedures," says Roberts. "Hedge fund advisers that are not SEC-registered still owe their clients a fiduciary duty, and are subject to restrictions on insider trading, principal transactions and cross trades, and a number of other activities. These advisers should consider adopting, at a minimum, policies that address these risk areas."

Books and records

Again, this only applies to managers who become SEC-registered but it is useful for all start-ups to be aware of. It is a detailed rule and is referred to as Rule 204-2 under the Investment Advisers Act. 

The kinds of records that the investment adviser will be required to retain include: corporate documents (formation documents, financial and accounting documents); trading and account management records; proxy voting records. There is also a rule called the Order Memorandum Rule that requires investment advisers to keep records on all of a fund's order and trades that they execute on behalf of their funds. 

"People trip up in this area quite often," says Roberts. "The information you are required to keep is very specific and managers sometimes overlook certain items. For example, you have to specify in the memoranda whether each trade is discretionary or non-discretionary, who it was that recommended the trade and who executed the trade. These things tend to fall through the cracks."

The SEC will request all such record keeping documents if they visit a manager to conduct an examination. If the manager is unable to produce the documents in a timely fashion – within 24 to 48 hours – then the SEC may get upset and issue a deficiency letter. 

It is advisable that as part of a business continuity plan, the manager has an off-site server to store the investment books and records so that if something were to happen to the principal office (i.e. flooding or fire) they wouldn't lose anything. 

Chief Compliance Officer

One question that tends to come up at start-up manager conferences is when the manager concerned should appoint a Chief Compliance Officer (CCO). Firstly, all SEC-registered investment advisors have to have a CCO in place. And whilst it is not mandatory, start-up managers with aspirations of becoming a serious registered fund management entity should probably think about having a CCO in place early on. This could be someone who performs both the CFO and CCO role or the COO and CCO role. 

Ongoing compliance review

Registered advisers are required under Rule 2064-7 to conduct an annual compliance programme review. This will include an overview of the compliance programme, seeing what controls work and testing to see if there are any violations. Again, this is something that outsourced compliance experts will typically help managers with.

"Most of our consultants have former regulatory experience and we tend to do a lot of mock SEC audits for our clients. For those who are not registered, it is good practice to review the compliance manual each year and update it; basically a lighter touch version of what an SEC-registered manager will be required to do," concludes Roberts.

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