Proprietary Trading Firm Vs. Hedge Fund

All, I was hoping that someone out there can provide some help or guidance.

I am setting up a closely held firm that will trade in securities on a proprietary basis. My family and I will own all of the voting and control stock, but may issue preferred shares from time to time, within private offering exemptions, to raise additional capital. I can’t believe we would be regulated as a hedge fund or as an investment adviser, but I keep running into a regulatory wall which brings me back to having to register as an adviser, at least within the state. Does anyone out there have any similar experiences? I’m talking about a few hundred thousand dollars of my family’s own capital, issuing only a small amount of preferred shares to supplement our capital. On its face, there seems to be o difference between me and any other small business, except that instead of selling products, I trade in securities. Am I missing something? Does issuing preferred shares constitute giving investment advice? Is such a company a “client” even if I am employed by it and own it? Is an employee of a company considered an “investment adviser”?

I know you guys may not be able to give legal advice, but I was wondering if anyone came across similar issues. I don’t want to spend tens of thousands of dollars in legal fees on something that I hope I’m just over thinking.

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Why not issue loans and/or set up managed accounts instead of issuing preferred shares…with the SEC you can selfregulate, which is easy as chips.

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I’m not an attorney, but I’ve been owning and running small business for many years, raising money for ventures through corporations and partnerships. In short, technically speaking, the SEC considers any pooled investment a security, even something as simple a two guys buying a rent house. As a practical matter, that’s not enforced. The Securities Act of 1933 essentially requires all investments to report as if public unless they claim an exemption, of which there are many. For example, if all of the investors are Accredited Investors. I think most attorneys would say, for a family business, don’t bother filing a Form D unless there’s some good reason.

I think where the SEC gets interested is when you are taking a fee (including payroll). In effect, then you’re participating in a regulated industry (just like if you took a fee to sell your neighbors house, you would need a real estate license). Advice given for free, even investment advice, is generally unregulated.

If you’re buying public equities, a partnership may be ideal (but I’m not a tax expert, and it likely depends on your individual circumstances). If you’re all partners buying in at the same price (no preferences or commissions or compensation), I don’t see any reason for concern. If you’re intending to take compensation (of ANY kind), then you’ll need to walk through the Securities Act and the Investment Company Act of 1940 and Investment Advisors Act of 1940 (all available online). It’ll be a few hours well spent.

When I began managing my own equities, with the thought that I might do so for a fee later, I established a partnership for which my company was the 0% general partner (allowed in most states) with myself (individually) and another company of mine as the limited partners. Later, I registered the general partner as a Registered Investment Adviser and began charging an advisory fee, and have since admitted additional partners, but doing so requires the creation of a private placement memorandum, filing a Form D, being aware of state and federal securities laws, etc.

I also manage clients through separately-managed accounts, which is very easy with the technology available these days. You can block-trade multiple accounts without commingling them, etc. You should give me that a lot of consideration.

As it should be, there’s no way around the issue that if you are receiving compensation for providing investment advice, then you need to qualify as and register as an adviser (just like a doctor, barber, or real estate agent). You can register at the state level, which is pretty simple. Typically, you’ll need to pass the local state law exam (Series 65) which you can take at a local testing center after reading a “Pass the 65” book. You’ll need to register with the IARD (Independent Adviser Registration Depository), which has some very minor fees. That offers your clients a place to check for any prior complaints, etc. Being an RIA is much much simpler than being a broker dealer. There are a number of technical differences, but I perceive the most important is that an RIA has a direct fiduciary duty to look after the best interests of the client; whereas a broker dealer has a fiduciary duty to make sure the client is suitable for the investment. The practice of selling securities on commission creates significant conflicts of interest, and therefore increased regulatory attention. I recommend avoiding that if possible.

If you have any questions, feel free to contact me at

I love to see people taking control of their own investments.

If you want legal advice (in Texas), I can recommend a few different attorneys.