A fund of funds (FoF) manager might be able to avoid registering as an investment adviser, but it depends heavily on how the fund is structured, who is making the investment decisions, and which exemptions are being relied upon under federal and state law.
Here’s a breakdown:
1. Investment Adviser Registration Trigger
Under the Investment Advisers Act of 1940, a person or entity generally must register as an investment adviser if they:
- Are in the business of giving advice about securities
- Are compensated for this advice
- Provide this advice to others (including pooled investment vehicles like LLCs or LPs)
In a fund of funds context, managing a pooled investment vehicle that invests in securities typically qualifies as giving investment advice for compensation, even if indirectly through performance fees or management fees.
2. Limited Liability through Passive Voting Structures
Two mechanisms that could potentially limit exposure are:
- Letting investors vote before any investment decisions are made
- Letting investors opt in or out of individual investments
These approaches attempt to avoid the adviser classification by arguing that the manager is not unilaterally making investment decisions. However, SEC and state regulators look at substance over form.
The SEC could still determine the manager is acting as an investment adviser, if:
- The manager controls the investment strategy
- Investors have little real discretion
- There is a pattern of investment advice or discretion
3. Private Fund Adviser Exemption
Even if the manager is considered an investment adviser, they might still qualify for an exemption. Private Fund Adviser Exemption (Rule 203(m)-1) is available to advisers who:
- Only advise private funds (like 506(b) or 506(c) offerings)
- Have less than $150 million in assets under management (AUM)*
- Do not hold themselves out to the public as investment advisers
*AUM is dynamic: It includes increases or decreases in asset value over time due to market appreciation, depreciation, income earned or realized/unrealized gains or losses. It reflects total value managed, not just the amount of cash raised or deployed. For example, if a fund raised $10 million and used it to acquire property that later appraises at $12 million, the AUM is considered to be $12 million.
4. Requirements Under the Private Fund Adviser Exemption
Under this exemption, the manager would have to file as an Exempt Reporting Adviser (ERA) and may still face state-level registration or reporting (see more on that below).
To get the ERA exemption, the manager must file as an Exempt Reporting Adviser with the SEC through Form ADV Part 1.
- The ERA filing involves initial disclosure and ongoing annual updates, even though it is less burdensome than full registration,
- Between $25 million and $100 million in assets under management, advisers may qualify for either state or SEC jurisdiction depending on specific factors, but full SEC registration typically becomes mandatory at $110 million or more AUM.
State-level investment adviser requirements vary:
- Some states require ERAs to file and pay fees.
- Some states may require ERA firms to register and satisfy licensing requirements, including passing the Series 65 exam.
- Some states impose additional compliance requirements, including periodic reporting or audits or additional restrictions on who can invest, which may be more than accredited investors.
Being an ERA also carries additional regulatory considerations:
- Fund investors may be restricted to accredited or “qualified client” (≥$5M in assets) financial qualifications.
- Managers must comply with applicable marketing rules and antifraud provisions of the Investment Advisers Act.
- Recordkeeping and conflict-of-interest policies must be maintained.
Even without full SEC registration, investment adviser status can result in compliance burdens that must be addressed during fund formation and throughout the life of the fund.
4. Key Compliance Considerations
- Offering documents (PPM, Subscription Agreement, Operating Agreement) must clearly define the investment strategy and who makes decisions.
- If voting or opt-in/opt-out structures are used, they must be robust and meaningful, not just window dressing.
- The fund’s operations, marketing, and compensation structure must be reviewed to avoid inadvertently triggering adviser status.
5. Conclusion
The strategy discussed in this article attempts to structure around investment adviser registration by using investor consent mechanisms and by limiting discretion. However, this does not guarantee exemption, especially if regulators determine the manager is effectively providing investment advice for compensation.
Recommendation
If you’re considering launching or managing a fund of funds:
- Engage a securities attorney to review the structure
- Evaluate eligibility for the private fund adviser exemption
- Ensure disclosures and voting mechanisms are legally and practically enforceable
