The rules and regulations specified by the SEC, the Securities and Exchange Commission, which oversees the nation's securities industry, state that a hedge fund has an exemption from registration as an investment company. That is only true of course if the fund meets the exemption qualifications of Section 3(c) (1) or Section 3(c) (7) of the Investment Company Act of 1940. Section 3(c) (1) says that a fund is only exempt from registering as an investment company if their securities are owned 100 or fewer people. In order to determine the number of investors, usually the people are all counted separately.
The Investment Company Act of 1940 specifically defines a person as "a natural person or a company." Today, however, the SEC will look at a company that has invested money into a hedge fund and then proceed to take a count of each of the individual investors in the company that hold security in the fund as individual people. Section 3(c) (7) of the Investment Company Act of 1940 says that a hedge fund has an exemption from registration as an investment company as long as the securities are exclusively owned by "qualified purchasers." If a hedge fund has more than 500 investors then it must register its funds with the SEC in order to be compliant.
It is fairly common to see hedge fund managers rely on the exemption from registration as an investment company that falls under Section 3(c)(1) of the Act to avoid registration. Even if a hedge fund is exempt under either of these sections however, it is still barred from offering any of its securities to the public as stated by the Securities Act of 1933. Various other regulations strictly guard against any hedge funds that rely on exemptions of either section from advertising or just soliciting in general. The managers of these hedge funds need to be very cautious when selling to make sure that they don't risk losing the exempt status of their fund.
It is still sometimes possible for those employees of a hedge fund that are well informed to be able to get hold of securities without endangering the fund's exemption from registration as an investment company, as they are not counted towards the 100 person limit. The "well informed" people list is defined as people like directors, general partner, executive officers, or an affiliate that oversees the investments of the fund. It can also include people who play a smaller, but still important role, like a trustee or advisory board member.
Next: Determining the Number of Investors in a Hedge Fund ››
