Tag: Abrahamson

Is a Fund Manager an Investment Adviser?

Yes, for private investment funds, the general partner is generally considered an investment adviser under the Investment Adviser Act.

Let’s start with the definition of an investment adviser from the Investment Advisers Act:

“any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities…” [202(a)(11)]

You can parse three elements out of that definition:

  1. Compensation
  2. Advice concerning securities
  3. In the business

Compensation

The first one is the easiest. I don’t think you’re going to find a fund manager who is not getting paid. It may be a combination of management fees or carried interest, but it’s still compensation. You could look at some academic arguments about who would fall in and out of the definition, but those arguments are irrelevant to fund managers.

Advice concerning securities

If you are giving recommendations to buy or sell, then you are giving advice. In addition, if you are telling people when to switch between different investments or how to select investment advisers then you are giving advice. The fund manager is making the decision about what to buy, sell and finance so the fund manager is giving advice. [I’m writing about the “securities” side in another post.]

In the business

Lastly, you need to be “in the business” of giving advice. That’s going to rule out your shoeshine boy, but clearly fund managers are in the business of giving advice. Again, there are some academic questions that could make this prong of discussion interesting. But for a fund manager, it’s very straightforward.

Abrahamson

It’s not just me making this interpretation. The Second Circuit answered this question in 1978. [See: Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir. 1977) , overruled in part on other grounds by Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979)] “These provisions reflect the fact that many investment advisers ‘advise’ their customers by exercising control over what purchases and sales are made with their clients’ funds.”

Exclusions

There are six exclusions in the definition of the “Investment Adviser” [202(a)(11)]but they are inapplicable to most fund managers:

  1. banks
  2. lawyers, accountants, teachers and engineers
  3. Certain broker/dealers
  4. publishers of bona fide newspapers and magazines in general circulation
  5. government securities advisers
  6. Nationally recognized statistical rating organization

Registration

That means fund managers are typically going to be considered to investment advisers. That also means that they may have to register with the SEC, unless there is an exemption from registration. Up until the Dodd-Frank Act, there was the 15 client exemption. That’s gone.

Counting Clients under the Investment Advisers Act – The Demise of the Hedge Fund Rule

Section 203(b) lays out the exceptions to registration under the Investment Advisers Act. Section 203(b)(3) exempts you if during the previous 12 months (i) you have fewer than 15 clients and (ii) you do not hold yourself out as an investment adviser.

For private investment funds, the general partner is generally considered an investment adviser [See: Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir. 1977) , overruled in part on other grounds by Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979)]

In the private investment world, as long as you had fewer than 15 funds and did not hold yourself out as an investment adviser you did not have to register.  The question is what was a fund/client for the purposes of the Investment Company Act?

With the demise of Long Term Capital, the SEC was interested in regulating hedge funds. In 2004 the SEC passed the Hedge Fund Rule which tried to expand the scope of the Investment Advisers Act by defining “client” under Section 203(b)(3). The rule specified that for “[f]or purposes of section 203(b)(3) of the [Advisers] Act (15 U.S.C. § 80b-3(b)(3)), you must count as clients the shareholders, limited partners, members, or beneficiaries . . . of [the] fund.” § 275.203(b)(3)-2(a). Effectively, the SEC tried to shift the definition from the fund up to the investors in the fund.

This Hedge Fund Rule was overturned by the United States Court of Appeals for the District of Columbia Circuit in the appelate case of Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).

“An investor in a private fund may benefit from the adviser’s advice (or he may suffer from it) but he does not receive the advice directly. He invests a portion of his assets in the fund. The fund manager – the adviser – controls the disposition of the pool of capital in the fund. The adviser does not tell the investor how to spend his money; the investor made that decision when he  invested in the fund. Having bought into the fund, the investor fades into the background; his role is completely passive. If the person or entity controlling the fund is not an “investment adviser” to each individual investor, then a fortiori each investor cannot be a “client” of that person or entity.”