CFM Fund Structuring & Legal Frameworks 3 — Questions and Answers
Question 1: Which of the following is a key structural difference between a hedge fund and a private equity fund?
- Hedge funds use a closed-end structure; private equity funds are open-end
- Hedge funds typically allow periodic redemptions; private equity funds lock up capital for the fund's life (Correct answer)
- Private equity funds are required to register under the Investment Company Act
- Hedge funds cannot use leverage under SEC rules
Correct answer: Hedge funds typically allow periodic redemptions; private equity funds lock up capital for the fund's life
Hedge funds generally offer liquidity windows while private equity funds employ long-term lockups matched to illiquid investment horizons.
Question 2: A Delaware Limited Partnership (DLP) is a popular domicile for U.S. private funds because:
- It provides a public registry shielding investor identities from all disclosures
- Delaware partnership law is well-developed, flexible, and widely understood by institutional investors (Correct answer)
- Delaware imposes no filing fees or formation requirements
- It automatically qualifies the fund for SEC registration exemptions
Correct answer: Delaware partnership law is well-developed, flexible, and widely understood by institutional investors
Delaware's mature, precedent-rich partnership law and flexibility make it the preferred domestic jurisdiction for private funds.
Question 3: What does the term 'clawback provision' refer to in private equity fund agreements?
- The GP's right to recall previously distributed capital for new investments
- The obligation of the GP to return excess carried interest if LPs do not achieve their preferred return over the fund's life (Correct answer)
- A mechanism allowing LPs to increase their capital commitments
- The right to claw back management fees if performance targets are missed
Correct answer: The obligation of the GP to return excess carried interest if LPs do not achieve their preferred return over the fund's life
A clawback requires the GP to return carried interest received in excess of what is warranted once overall fund performance is assessed.
Question 4: Which regulatory framework primarily governs the registration and reporting obligations of investment advisers managing private funds in the U.S.?
- Securities Exchange Act of 1934
- Investment Advisers Act of 1940 (Correct answer)
- Investment Company Act of 1940
- Dodd-Frank Wall Street Reform Act (as a standalone framework)
Correct answer: Investment Advisers Act of 1940
The Investment Advisers Act of 1940 establishes the registration, fiduciary duty, and reporting obligations for investment advisers.
Question 5: A '3(c)(7)' fund under the Investment Company Act of 1940 restricts ownership to:
- No more than 100 investors
- Only registered investment companies
- Qualified purchasers, with no numerical limit on investor count beyond 2,000 (Correct answer)
- Accredited investors with assets below $5 million
Correct answer: Qualified purchasers, with no numerical limit on investor count beyond 2,000
Section 3(c)(7) exempts funds sold solely to 'qualified purchasers' and permits more than 100 investors, up to the 2,000-holder Reg D ceiling.
Question 6: In a fund-of-funds structure, which of the following is a primary disadvantage for investors?
- Inability to diversify across multiple managers
- An additional layer of fees on top of underlying fund fees (Correct answer)
- Mandatory direct exposure to individual securities
- Restricted access to offshore fund strategies
Correct answer: An additional layer of fees on top of underlying fund fees
Fund-of-funds investors pay management and performance fees at both the FoF level and the underlying fund level, creating a double fee burden.
Question 7: What is the primary legal purpose of a 'subscription agreement' in a private fund?
- To outline the fund's investment strategy in detail
- To allow investors to formally commit capital and confirm their eligibility as accredited/qualified investors (Correct answer)
- To appoint the fund's auditor and legal counsel
- To establish management fee and carried interest terms
Correct answer: To allow investors to formally commit capital and confirm their eligibility as accredited/qualified investors
The subscription agreement documents the investor's capital commitment and contains representations confirming their investor status and eligibility.
CFM Fund Structuring & Legal Frameworks 3
Which of the following is a key structural difference between a hedge fund and a private equity fund?