United States: What You Need To Know When Setting Up A New CLO Manager

Last Updated: November 7 2013
Article by Grant E. Buerstetta and Jaiho Cho

Due to the continuing changes in the regulatory landscape, establishing a new investment management firm with a focus on collateralized loan obligations ("CLOs") requires careful planning and efficient execution. In addition to regulatory issues, the founding members are likely to have tax and other considerations that should be carefully analyzed to allow the overall structure to be customized to meet the parties' needs.

This article summarizes some of the more common legal issues that a new CLO manager should consider in launching a firm.


  • When organizing a new firm, the founding members and the sponsor should consider corporate governance issues, such as control, transfer of ownership interest, dispute resolution, and wind-up mechanisms.
  • The entity structure for a new firm should be designed so that the related management activities and associated fees are handled in a tax-efficient manner.
  • One of the key regulatory issues to be addressed by nearly all new CLO managers is registration with the Securities and Exchange Commission (the "SEC") as a registered investment adviser.

Entity Types

The entity type (pass-through versus corporate) is typically determined based on tax considerations. A closely held management firm may be organized as a limited liability company ("LLC"), a limited liability partnership ("LLP"), or a limited partnership ("LP"). LLCs are more common as they do not require the additional layer of having a general partner and can have a single member.

If the firm will have a widely held ownership structure (i.e., if it plans to make a public offerings of its shares), the founders may choose to organize the entity as a corporation. In the near term, however, tax considerations are often the prevailing consideration, with a pass-through entity (LLC, LLP, LP) generally favored in order to avoid an additional level of taxation that would exist with a corporate structure. Initial organizational decisions will not foreclose later changes should circumstances dictate.

Establishing a Control Framework

A new firm, controlled by one person, can be organized with straight-forward structures and legal documentation. When two or more individuals will be involved in the management, ownership, and profits of the new firm, careful consideration must be given to issues that may later lead to disputes and disagreements, including:

  • determining on-going distributions,
  • winding up of the firm, and
  • resolving disputes.

For example, the firm's corporate governing document should address what happens when one principal leaves the firm (by choice, for cause or as a result of death or incapacity). The questions that should be answered in advance include whether the exit by a principal would result in the firm's wind up or whether the remaining principals would have a right or obligation to acquire the interests of the departing principal and, if so, how those interests would be valued.

The valuation method of the principals' ownership interests and other related questions should be discussed and agreed upon by the founding members (and the sponsors) at inception in order to adequately provide for any subsequent "change in control" transactions.

For managers with multiple principals, investing the time to address areas of potential friction will give all parties a clear expectation of how issues will be handle. While the formation documents cannot address every conceivable issue, the agreements should establish a basic framework for areas of concern and provide a basis on which the principals can explore potentially divisive issues.

SEC Registration and Reporting

An investment management firm that has assets under management exceed $150 million generally will be required to register with the SEC. Because virtually all CLOs exceed the $150 million threshold, a CLO manager should expect to be registered with the SEC. Among other things, registered investment advisers are subject to periodic reporting requirements under Form PF and reviews by SEC staff. Firms that are not required or eligible to register with the SEC must generally register with state regulatory authorities in the state where the manager maintains its principal business office, subject to any minimum requirements for registration in that state.

Investment firms in New York State are subject to somewhat different rules. Because New York does not periodically audit or inspect the operation of state registered investment advisors, firms in New York may register with the SEC if assets under management exceed $25 million.

The SEC and most states require registration to be accomplished through the filing of a Form ADV, which requires detailed information about the operations and personnel of the manager. In addition, the Form ADV requires a brochure explaining various aspects of its fee arrangements and types of advisory services provided. The brochure must be made available to clients and is publicly available through the SEC's website.

New York Tax Considerations

Investment advisers to hedge funds located in New York City sometimes elect to receive management fees and incentive fees in separate entities in order to minimize the impact of the unincorporated business taxable income. This structure is not common among CLO managers, but relatively common among hedge fund managers. As many CLO managers also manage credit hedge funds, separate subsidiaries and affiliated entities may be used in different business endeavors in order to achieve maximum tax benefit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Grant E. Buerstetta
Jaiho Cho
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