Israel’s emerging hedge fund managers are beginning to attract interest from United States investors, including seed investors. To make the most of this opportunity, it is important for Israeli managers to understand the implications of potentially becoming regulated by the United States Securities and Exchange Commission (“SEC”). Israeli managers considering raising capital in the United States need to know whether they will be required to register with the SEC or whether they may take advantage of an exemption from registration. Israeli managers may even want to consider registering voluntarily with the SEC, because many potential United States institutional investors prefer to invest with SEC-registered investment advisers.
According to Tzur Management, there are a total of at least 60 hedge fund managers based in Israel. These managers are mainly “emerging managers” by international standards. In other words, most of these Israeli investment managers are at the start-up stage, and are managing relatively small pools of assets. Their situation is arguably analogous to that of Israeli high-tech companies. Israeli start-ups and even more mature companies have great technology, but the Israeli capital market is small disproportionately small for a country with such advanced technology. For this reason, in order to succeed, Israeli high-tech companies have had to access international capital markets particularly U.S. markets at a higher rate than companies in nearly any other country in the world. Similarly, to achieve scale and establish a robust hedge fund industry in a country with a limited number of institutional investors, Israeli managers will need to raise capital overseas.
As a general rule, the United States Investment Advisers Act of 1940 (the “Advisers Act”), makes it illegal for any investment adviser that is not registered with the SEC to do business as an investment adviser in the United States, unless it is exempt from registration.
An Israeli investment adviser may rely on the special exemption available to a “foreign private adviser.” A foreign private adviser is an adviser (a) with no place of business in the United States, (b) with fewer than 15 clients and investors in the United States in hedge funds advised by it, and (c) with aggregate assets under management attributable to clients in the United States and investors in the United States in hedge funds advised by it of less than $25 million. In addition, the Israeli adviser must neither hold itself out generally to the public in the United States as an investment adviser, nor act as an investment adviser to any United States registered investment company or business development company.
Another exemption available to Israeli hedge fund managers is called the “private fund adviser exemption.” In general, this exemption is available to advisers that provide investment advice solely to hedge funds (and/or other private funds, such as private equity funds) and have assets under management of less than $150 million in the United States. There is no limit on the number of hedge funds that the adviser is permitted to advise under this exemption, although an adviser that has even one client that is not a fund (for example, a separate managed account that is not owned by a fund) cannot take advantage of this exemption. If an Israeli (or non-U.S.) manager relies on this exemption but has no office in the United States, then there is no limit on the amount of United States hedge fund assets it can manage. These managers, however, are subject to the Advisers Act’s antifraud laws, including those relating to political campaign contributions to United States state and local officials. They are also required to file and periodically update reports containing some of the information required by Form ADV (described below), but non-United States-based advisers do not need to provide information about non-United States private funds that are not offered in the United States and do not have United States investors. The SEC has said that it does not currently intend to conduct routine examinations of these “exempt reporting advisers.”
Despite the availability of these exemptions, an Israeli manager may wish to voluntarily register with the SEC. This option is available to a manager whose principal office and place of business is not in the United States, regardless of the amount of assets it manages that are attributable to United States investors.
The drawback of registering is that doing so imposes costs and burdens on the manager. The manager is required to publicly file Form ADV, which discloses, among other things, the ownership structure of the manager, assets under management, hedge funds managed, number of employees, conflicts of interest and bad acts, and is required to update this form at least annually. The manager also has to provide a disclosure brochure to its clients. Registered investment advisers also need to have a compliance manual, a code of ethics and a chief compliance officer, and keep extensive records, including of electronic communications, and are generally required to have a third party custodian for assets, including for funds domiciled outside the United States. There are also rules governing principal transactions, the payment of performance fees and adviser advertising. In addition, employees of a registered investment adviser are required to provide information regarding their personal trading. The SEC examines registered investment advisers periodically to monitor compliance with the above. That being said, if a non-United States investment adviser registers with the SEC, the SEC has said that it will not apply many of these requirements to the adviser’s non-U.S. clients. For example, many of the recordkeeping requirements will not apply, the adviser will not have to deliver a disclosure brochure to its non-United States clients or investors, and the rules regarding third party custodians and payment of performance fees will not apply.
On the other hand, the main benefit of registering from the perspective of an Israeli manager is the comfort that being a registered investment adviser provides to U.S. investors and potential investors, because they know that the manager is being regulated by the SEC, and that the manager is required to put in place the compliance procedures required by the SEC. A registered investment adviser with proper procedures and institutional service providers is more likely to be perceived by investors as running a professional money management operation. Registration with the SEC has also become a due diligence requirement for investment by many United States institutional investors.
Israeli investment managers that wish to grow and attract international capital should explore with United States legal counsel whether SEC registration makes sense for them, or whether they should seek to take advantage of an exemption from registration. The answer to this question will depend on the extent of potential United States investor interest in the manager, the amount and expected timing of any investments by U.S. investors, and the nature of those investors. As with many decisions an investment manager makes in connection with its business, decisions about SEC registration will involve a cost-benefit analysis. With increased interest from international investors, the benefits may begin to outweigh the costs for certain Israeli investment managers.
Max Karpel Esq. is a partner at New York law firm Kleinberg, Kaplan, Wolff & Cohen, P.C., where he represents United States and Israeli hedge fund managers, among other clients.
Published by Globes [online], Israel business news - www.globes-online.com - on October 15, 2012