Converting hedge funds into mutual funds – a primer

PurposeThe purpose of this article is to describe the process for forming and registering a new investment company (or mutual fund) or converting an existing hedge fund into a mutual fund and registering the converted fund. This article discusses the timing, tax and regulatory implications under Delaware law, the US Internal Revenue Code of 1986, the Investment Company Act of 1940 (the “1940 Act”), the Investment Advisers Act of 1940 (the “Advisers Act”), the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”).Design/methodology/approachThis article summarizes and analyzes rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to forming and registering new mutual funds and converting existing hedge funds into mutual funds under the 1940 Act and Advisers Act.FindingsFor smaller hedge fund managers who have recently registered with the SEC and desire to sponsor a new registered fund product as part of their advisory business, converting and registering an existing hedge fund is a viable alternative to forming an entirely new fund. The conversion process involves converting an existing hedge fund into a Delaware trust and then registering the new trust as a mutual fund under the 1940 Act. The adviser may, under certain circumstances, advertise the past performance of the hedge fund when marketing the new mutual fund. In addition, the adviser may continue to receive performance based or incentive compensation within the boundaries established by the Advisers Act. The authors believe that the conversion process is a viable and cost‐effective method for smaller hedge fund advisers to expand their existing investment advisory products and more easily grow assets under management.Originality/valueThis article provides a useful summary of the process for forming a new mutual fund or converting an existing hedge fund, including a brief outline of the SEC rules and regulations applicable to the fund registration process generally under the 1940 Act. Many hedge fund managers have recently incurred significant compliance costs as a result of registering as an investment adviser with the SEC. This article provides insight into the fund conversion process, which the authors believe is an overlooked and viable option for smaller hedge fund advisers to leverage existing compliance costs through sponsoring a registered fund product.