Hedge Fund Law and Legal Definition

Hedge funds are private and unregistered investment pools which are similar to mutual funds in that they both are pooled investment vehicles that accept investors’ money and generally invest it on a collective basis. However, unlike mutual funds, hedge funds are not required to register under the federal securities laws. They are not required to register because they generally only accept financially sophisticated investors and do not publicly offer their securities. Hedge funds are primarily organized as private partnerships to provide maximum flexibility in constructing a portfolio. Hedge funds can take both long and short positions, make concentrated investments, use leverage, use derivatives, and invest in many markets.

Hedge funds also are not subject to the numerous regulations that apply to mutual funds for the protection of investors—such as regulations requiring a certain degree of liquidity, regulations requiring that mutual fund shares be redeemable at any time, regulations protecting against conflicts of interest, regulations to assure fairness in the pricing of fund shares, disclosure regulations, regulations limiting the use of leverage, and more. This freedom from regulation permits hedge funds to engage in leverage and other sophisticated investment techniques to a much greater extent than mutual funds. "Hedging" roughly means managing risk. Tools and techniques of hedging include: raising cash, selling short, buying or selling options, futures, commodity and/or currency futures, etc. Although hedge funds are not subject to registration and all of the regulations that apply to mutual funds, hedge funds are subject to the antifraud provisions of the federal securities laws.

Hedge funds generally rely on Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 to avoid registration and regulation as investment companies. To avoid having to register with the SEC the securities they offer, hedge funds often rely on Section 4(2) and Rule 506 of Regulation D of the Securities Act of 1933.