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Hedge Funds...and other Pooled Investments call the Division at (801) 530-6600
Key Questions Before Investing
  • What type of security is being offered?
    Companies raise capital through debt or equity financing. You may be issued an equity interest (e.g. partnership interest, stock, or interest in a limited liability company) for your investment and may receive dividends or a share of profits. Your investment may also be a loan, or debt, to the company (e.g. promissory note, bond) that is to be repaid according to certain terms that may include payments of interest. Debt may also be secured or unsecured.
  • Is the security properly registered with the Utah Division of Securities or federal government?
    If the company is properly registered, you should be able to find the company in the Division’s online database or the S.E.C.’s Edgar database. If the company says it is exempt, they should be able to provide you with a legal citation of the law that they are relying upon for exemption. If they cannot, the security is likely illegitimate and you should not invest.
  • Have you been offered some disclosure document?
    To help you perform the proper due diligence before investing, you should be provided a private placement memorandum or some similar document that fully details information about the fund, including: its managers, its financials, its track record, its investment strategy, and the risks associated with that strategy. Like a mutual fund’s prospectus, a hedge fund’s disclosure document should be substantial in length (typically 30 to 60 pages).
  • Have you been offered audited financials from the company?
    Generally, audited financials are reviewed to assess the financial status of the company, including outstanding liabilities. This provides the investor an additional layer of review since an accountant will have reviewed the company’s assets and liabilities to report on the company’s current financial condition.
  • What type of investments will the manager make with your money?
    A hedge fund may invest in many types of investments each of which carry their own particular risks. The fund should disclose in writing the types of investments it will make and the risks associated with those investments. If the fund cannot or will not disclose what types of investments it will make with your money, you should not invest.
  • Is the fund manager licensed as an investment adviser?
    Fund managers are required to license as investment advisers in most instances. To verify whether the fund manager is licensed, please contact the Utah Division of Securities.
  • Does the fund’s investment strategy make sense?
    If you cannot understand how the fund’s investment strategy is supposed to earn money, do not be surprised if you lose your money. Some investment strategies may be complicated, but they should ultimately make sense. Some fund managers may say their investment strategy is proprietary, but that should only apply to the specific price points or other metrics that trigger their purchases and sales, the overall strategy should be disclosed in writing.
  • Does the fund’s history of returns seem to be too good to be true?
    The risk/reward principal dictates that the higher the return, the greater risk. Historically, a good rate of return is 7-8 percent per year (above inflation), but some hedge funds boast rates of return as high as 10 percent per month. While such returns are suspect on face, even if they were accurate, they would reflect serious risks. In short, if it’s too good to be true, it probably is.
  • What experience does the fund manager have?
    Managing an investment fund is a highly technical and specialized job. Most professional fund managers have had years of experience not only in the securities industry, but specifically working as analysts for other funds before starting their own. While experience is not a requirement, it is definitely something to consider. The fund manager’s experience should be fully detailed in the fund’s disclosure document and you should contact the Utah Division of Securities for further information.
  • Have you researched the company and fund manager?
    Before investing you should research the fund and its manager. The first step may be a simple search on google.com or bing.com to find any information, but you should contact the Utah Division of Securities to see if the fund and its manager have any negative information reported on their licenses. You may also search other regulators, such as real estate or insurance. Greater due diligence may require looking for any court records for criminal or civil matters.
Tools and Resources

What is a Hedge Fund?

While there is no concrete definition of a hedge fund, a hedge fund can be simply defined as a private pool of investor money that a manager uses to make investments. Traditionally, the term hedge fund was used to indicate an investment strategy of “hedging” the risks of the broader market, but today’s hedge funds often engage in highly speculative trading strategies without any such hedging. Due to these speculative investment strategies, hedge funds and other investment funds are only suitable for wealthy investors that can afford to lose their entire investment.

Hedge funds and other investment funds operate like mutual funds in that a manager makes the investment decisions for the fund. The key difference between hedge funds and mutual funds is that your participation in a hedge fund or other investment fund is a private securities transaction. Since hedge funds and other investment funds are private offerings, some of their activity is unregulated, which places more responsibility on the investor to research the fund, its managers, its financials, its track record, its investment strategy, and the risks associated with that strategy to determine whether the hedge fund or investment fund is a sound and prudent investment.

To help you perform the proper due diligence before investing, you should be provided a private placement memorandum (PPM) or some similar document that fully details the information discussed above. Like a mutual fund’s prospectus, a hedge fund’s disclosure document should be substantial in length (typically 30 to 60 pages). Investors should carefully read the document to understand the details of the investment. Also, investors should contact the Utah Division of Securities before investing to verify the security is legitimate and the fund manager is properly licensed.

Concerns with Hedge Funds and Other Investment Funds

The Division sees a few common problems with hedge funds and other investment funds offered in Utah.

Registration Concerns

Any person or company that seeks to pool investor money has created a security that must be:

  1. properly registered under Utah law;
  2. exempt from registration under Utah law; or
  3. be a federal covered security notice filed in Utah.

In many cases, hedge funds and other investment funds fail to properly follow securities laws and offer unregistered securities to Utah investors, which is a violation of the law.

Fraud Concerns

Many hedge funds and investment funds either fail to provide investors with a disclosure document as described above or provide inadequate disclosure in their document. Some hedge funds and investment funds even mislead or misrepresent information in their disclosure documents. The omission or misrepresentation of material information in the offer or sale of a security is considered securities fraud. Sometimes investors trust the person selling the investment and rely on that relationship rather than the written disclosures, which is often a strategy known as affinity fraud. For more information on affinity fraud, click HERE.

Licensing Concerns

By making the investment decisions for the hedge fund or investment fund, the manager will typically be required to license as an investment adviser. When a fund manager licenses as an investment adviser, the Division often has additional information about the fund that it can offer to prospective investors seeking to research the fund. Licensing as an investment adviser also ensures that the manager’s fees will not exceed industry standards.

Additionally, if a third party is compensated for introducing the issuer and investor, that third party needs to be licensed as an issuer-agent, broker-dealer agent, or investment adviser representative depending on the specific arrangements.

To determine whether licensing is required or for other questions regarding hedge funds, contact the Utah Division of Securities at (801) 530-6773.

Ponzi Scheme Concerns

A Ponzi scheme is when a new investor’s money is used to pay returns to previous investors, giving the appearance that the fund is earning money. Often investors do not question whether they are investing in a Ponzi scheme because they believe the reports and statements issued by the fund manager, but those documents can be easily faked. Many Ponzi schemes issue reports and statements that reassure investors their money is held in an account and has been earning a good rate of return. The only way to verify this information is to verify the institution that has physical custody of the funds, obtain independently-audited financials of the hedge fund, and discuss the financials of the company with their accountant. A common red flag to identify a Ponzi scheme is whether the fund manager simply invests in another investment fund or actually invests in a business that generates revenue through the sale of a product or service. To read more about Ponzi schemes, click HERE.

Multilevel Marketing/Feeder Fund Concerns

Some hedge funds and other investment funds have been created merely so they can qualify to invest in some other hedge fund. While there may be technical concerns for the hedge fund that accepts pooled money from these feeder funds, investors should be aware that their investment is with the feeder fund and not the ultimate hedge fund that may be boasted. Often these feeder funds are sold in the same fashion as a multilevel marketing scheme where investors are asked to create their own pool of other investors in a partnership or limited liability company of their own. This practice is particularly concerning because each feeder fund is its own securities offering and must meet regulatory requirements to be done appropriately.

Blind Pool Concerns

While some hedge funds may claim they do not need to be licensed as an investment adviser, this may be inaccurate if the fund fails to limit itself to specific investments that are not securities. The hedge fund or investment fund may call such open investment arrangements a “blind pool” in which the fund manager has complete discretion of what investments to make. In nearly every instance, these fund managers are required to license as investment advisers and failure to do so is against the law. To determine if a fund manager needs to be licensed, please contact the Utah Division of Securities at (801) 530-6773.