Syndicators and Fund managers often wonder whether the way they are compensated can trigger regulatory obligations. A common method of compensation is based on a percentage of assets under management (AUM). This article explores whether AUM-based compensation classifies a manager as an investment adviser under U.S. securities law.
What is AUM?
- 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.
Why AUM-Based Compensation is a Trigger
Under the Investment Advisers Act of 1940, an individual or entity is likely considered an investment adviser if they:
- Provide advice about securities (directly or indirectly)
- Are compensated for that advice
- Engage in this activity as part of a regular business
Compensation calculated as a percentage of AUM strongly suggests that the manager is being paid for managing investor assets—a classic hallmark of investment adviser status.
Exceptions and Exemptions
There are limited exemptions, but they do not remove the “investment adviser” classification entirely:
Private Fund Adviser Exemption (Rule 203(m)-1)
- Available if you only manage private funds, have less than $150 million AUM, and don’t hold yourself out to the public as an adviser
- Requires filing as an Exempt Reporting Adviser (ERA), which can be burdensome
- May still require state-level registration, which also can be burdensome and may require taking a test and obtaining a securities license or restrict the financial qualifications of your investors.
What If a Syndicate Only Buys Real Estate That It Owns or Controls?
When a syndicate only purchases real estate that it directly owns or controls, it may reduce the likelihood that the manager would be considered an investment adviser under federal securities laws. However, that determination depends on several key factors.
The Investment Advisers Act of 1940 generally applies to people or entities that provide advice about securities. Real estate in its direct form is not considered a security. Therefore:
- If the syndicate acquires and holds fee simple title to real property, the investment is typically not treated as a security.
- The manager is usually considered to be running an operating business or a real estate enterprise rather than advising on securities investments.
This is commonly referred to as the real estate exception to investment adviser status.
But even if the underlying asset is real property, the Investment Advisers Act may still apply if:
- The syndicate interests sold to investors meet the definition of an investment contract under the Howey Test (i.e., investors are passive and rely on the efforts of the manager for returns), AND
- The manager receives fees based on invested capital and exercises discretionary control
In these cases, even though the investment involves real estate, the syndicate interests are considered securities and the activity could still be subject to investment adviser regulation.
Common Structures That Do Not Trigger Adviser Registration
You are less likely to trigger investment adviser registration if:
- The syndicate buys and directly holds real property
- The manager earns compensation based on net income or performance, not based on AUM or capital invested
- The offering is structured as a one-time syndication for a specific, disclosed asset or project
Structures That Raise Compliance Concerns
Even with real estate assets, concerns arise when:
- The syndicate uses investor funds to invest in interests in other entities (such as funds or joint ventures), particularly if those interests are securities, or
- The investors are fully passive, and the manager exercises total discretion, or
- The manager is paid based on the amount of capital raised or under management
Owning or controlling real estate directly reduces the likelihood that a syndicate manager would be required to register as an investment adviser. However, if the offering structure involves passive investors, discretionary control by the manager, and compensation based on capital under management, adviser compliance concerns may still arise—even when real estate is the core asset.
Risk Management Tip
If the fund manager is paid a fixed administrative fee rather than a percentage of AUM, and does not exercise discretionary investment authority, it may be easier to argue that they are not functioning as an investment adviser. However, the SEC looks at substance over form—if you’re acting like an adviser and being paid like one, you’re likely to be regulated as one.
Bottom Line
Receiving compensation based on AUM is a strong indicator that the manager is acting as an investment adviser and would likely trigger registration or exempt reporting obligations unless a valid exemption applies.
