Category Archives: News and Commentary

JOBS Act Opportunities for Hedge Fund Managers

The JOBS Act has already sparked a number of interesting questions from hedge fund managers who want to begin more aggressive advertising campains under the new laws. We have generally been cautioning managers on starting any campaign until after the SEC has promulgated regulations. However, we do think that managers may want to start thinking about how they may implement a more robust marketing program as part of their overall capital raising plan. The article below, contributed by Meredith Jones and Joseph Pacello of Rothstein Kass, provides some insights into the opportunities available for fund managers post JOBS Act.

[HFLB Note: all links in the article below were not links in the original. The links in the article below are to other posts on this website and are not necessarily endorsed by the writers of the article.]

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JOBS Act Opens New Window of Opportunity for Hedge Fund Marketing

The Jumpstart Our Business Startups (JOBS) Act, signed into law by President Obama on April 5, offers hedge funds and other private investment vehicles more latitude for their marketing efforts. In this article, Meredith Jones and Joseph Pacello discuss some of the implications of the bill and issues that need to be on the agenda of savvy fund managers.

Since the launch of the first hedge funds in the 1940s, hedge funds have been subject to Securities and Exchange Commission (SEC) prohibitions on advertising and general solicitation. While “namebrand” funds with widespread name recognition and extensive investor relationships have generally not been impacted by these restrictions, the inability to solicit capital from accredited investors who were not previously known significantly curtailed the marketing and capital raising efforts of smaller funds. Over the last three years, in the wake of the global economic contraction of 2008, managers with less than $1 billion particularly chafed under these restrictions, as they chased scarce investors, often with fewer resources.

The JOBS Act potentially removes those prohibitions, pending formal rulemaking by the SEC, who will have final say on how the JOBS Act is implemented. Under the new rules, the SEC would eliminate the prohibition on general solicitation as it relates to hedge funds, provided that the only purchasers are accredited investors. As a result, accredited investors will no longer have to be previously known to the fund. In addition, the Act theoretically removes the prohibition on general advertising, giving funds greater opportunity to and options for communication with potential investors.

While managers with more than $1 billion under management appear to be taking the rule change in stride, for funds with less than $1 billion under management, this new freedom to communicate with investors presents a wealth of potential new capital raising avenues. Fully leveraging this opportunity, however, will require funds to become more sophisticated and strategic in their marketing efforts. Those that fail to do so risk being alsorans in what is sure to be a more competitive period ahead.

Frankly, the previous regulations made “hedge fund marketing” almost a contradiction in terms. Much of the capital raising success of a fund was predicated on the fund’s existing relationships, or their ability to develop new contacts through limited resources, such as hedge fund databases, conferences and networking events. While relationships—not to mention performance—will always be important, the JOBS Act should result in a greater emphasis on marketing strategy and execution in the capital-raising process.

The fact that all funds will be able to solicit all accredited investors means that more investors will be hearing from more funds. The increased volume of conversations means that funds will have to “rise above the noise” to succeed in capital raising. Firms that plan and communicate effectively will therefore have a strategic advantage over those who do not.

The implementation of changes to the existing solicitation and advertising restrictions will not occur before early July, the deadline by which the SEC must complete rulemaking for this section of the JOBS Act. To be clear, we have yet to see how the SEC will interpret this change. For example, fund-sponsored mailings or events could be permitted, but not without extensive records of investor qualification documents being collected in advance. Press releases could be more common, but there could be limitations on what can be discussed. As a result, in this interim period it is probably wise not to be overly aggressive with new marketing avenues or advertisements. However, this doesn’t mean that funds should sit back and wait for the SEC’s final rule to begin preparations.

Because the capital raising environment was already becoming more competitive, particularly at the smaller and emerging ends of the alternative investment spectrum, funds should use the next 90 days to carefully review the quality of their marketing materials. In particular, funds should examine their marketing through the eyes of a potential investor and ask:

Does the fund know its competition and can it differentiate itself with a clearly defined value proposition? This is particularly important if the fund operates in a highly saturated area, such as long-short equity, macro, futures trading and private equity.

Are the fund’s marketing materials clear and concise? It is a common mistake to assume length equals conviction. Indeed, most investors offer approximately one hour for an initial meeting and length can spell repetition of some facts, while having to omit others due to time constraints. A clearly defined value proposition often takes fewer words, not more.

Is there a well defined “story?” Although tempting, particularly for funds where the manager pulls double-duty as a marketer, it is not always advisable to assume the strategy and opportunity speaks for itself. It is vital that the documents and pitch communicate not just what you do, but who you are as a manager and a firm, including how you view risk and run a business.

Do the marketing materials have a sophisticated look and feel? While the content of the materials does the heavy lifting, their look and feel set the tone. Does your firm appear to be institutional? Are the slides dense or wellpaced? Do you have a consistent brand? Aim for crisp and clean layouts that help the reader through the material.

How strong is the fund’s marketing capability? Few hedge funds have the luxury of a full-time dedicated marketing (as opposed to fund-raising) professional on staff. Firms should consider bringing in an experienced outside consultant who can make high-value, targeted improvements.

In this evaluation process, it is also important to recognize that things like pitch books are more than mere props—they structure the conversation a fund has with its potential investors. A poor pitch book means that important points are likely to be skipped over (or blunted from repetition); a good pitch book amplifies the effectiveness of the presenters.

When revising communications materials, remember that anti-fraud regulations remain in place; a fund needs to be scrupulous in its representations and consistent in its themes. For some in the marketing world, “gilding the lily” is a common practice, however in the investment arena, it is one to be avoided. Explanatory notes, review by the firm’s legal counsel and truth in advertising will still be required under the new rules. Also note that as more materials are generated and sent to a wider audience, the ability to track communication will become more important as well. If the SEC audits your firm post JOBS Act, you will need to be able to present full documentation of your marketing efforts.

Regardless of the final interpretation of the JOBS Act by the SEC, funds also need to develop a marketing plan to guide their outreach to potential investors. Again, the competition for assets has gotten more, not less, fierce over the last three years. Putting a strategic marketing plan in place will curtail the impulse to cast the widest possible net and pursue every available audience. Because most funds have limited marketing resources, it is essential to allocate those resources strategically. This requires looking at three factors:

1. Capacity: Marketing efforts need to be scaled to how much capital needs to be raised. A stellar marketing campaign that results in turning away a significant number of investors represents wasted resources. A fund that is making steady progress toward being fully subscribed may in fact be able to meet its goals by continuing its current network-based outreach.

2. Manpower: Pursuing investors takes time, and for many firms, that means time away from other tasks, including investment management. Funds need to determine, given their capacity, which audiences are most likely to result in the largest return on their marketing investment and prioritize accordingly.

3. Money: A firm’s marketing spend needs to be allocated so that it is directed toward strategically valuable efforts and does not cannibalize other functions.

Certainly, the potential benefit of the JOBS Act is that funds, particularly those with less than $1 billion under management, will be able to leverage their capital raising efforts. Blogs, websites, email campaigns, advertisements, press releases and other marketing activities may allow funds to extend their reach, effectively providing a type of “air cover” for their one-on-one capital raising efforts. However, any decisions to engage in these activities should be evaluated in light of the restrictions above.

In conjunction with a review of marketing, funds should also examine their investor relations bandwidth. For 3(c)7 funds directed toward qualified purchasers, the JOBS Act raises the maximum number of holders of record from 499 to 1,999. This means that funds that are near their investor maximum could potentially make the decision to allow more investors (capacity of the strategy permitting), or consolidate existing 3(c)7 funds. It is unlikely that these changes will have a tremendous impact on all but the largest fund complexes at the present time. However, if a manager does decide to increase his investor headcount, then effective and proactive investor relations will undoubtedly become a greater concern, which we will address in a future article.

Rothstein Kass will be monitoring the SEC rulemaking in connection with the JOBS Act and its impact on private funds.

By Meredith Jones, Director and Joseph A. Pacello, CPA, JD, Principal

For more information on this article and for services offered by Rothstein Kass, please contact Meredith Jones, Director at 972.581.7066 or via e-mail at mjones@rkco.com.

Meredith Jones, Director

Meredith Jones is a director at Rothstein Kass responsible for generating research and content on the alternative investment industry by and on behalf of the firm. She also provides business advisory services to the firm’s clients. Meredith has more than 14 years of experience in the alternative investment industry, with extensive expertise in research, writing, consulting, marketing, business development, due diligence, index construction and asset allocation. Her research has been published in a number of books and journals and in the international press.

Prior to joining Rothstein Kass, Meredith was a director in the Barclays Capital Inc. Strategic Consulting Group, where she was responsible for producing thought leadership content on a variety of manager and investor focused topics, as well as leading consulting projects for BarCap clients. She previously served as a managing director at PerTrac Financial Solutions (PFS), a leading provider of investment analytics. At PFS, Meredith was responsible for research, marketing, investment data, and was a fixture on the international hedge fund conference circuit.

Meredith began her career in alternative investments at Van Hedge Fund Advisors International in 1998, where she became the senior vice president and director of research. Meredith led the team responsible for hedge fund due diligence, manager selection, portfolio construction, hedge fund data, index creation and industry research while at VAN.

Over the past 14 years, Meredith has presented her original research and insights to industry participants around the world and has had her findings published in books, journals, industry publications and major media outlets, including The Economist, The Wall Street Journal, The Journal of Investing, Alternative Investment Quarterly and the Financial Times.

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Cole-Frieman Mallon & Hunt LLP is a law firm to the investment management industry and runs the Hedge Fund Law Blog. Bart Mallon can be reached directly at 415-868-5345.

Announcing Cole-Frieman & Mallon LLP

Friends:

We are pleased to announce today the merger of our respective firms to form Cole-Frieman & Mallon LLP, a law firm focused on the hedge fund industry.  Below is our press release announcing the merger.  We look forward to continuing to provide top-tier legal services to both large and start-up managers and will continue to focus on bringing useful information to the hedge fund community through the Hedge Fund Law Blog.

Many thanks to everyone who has supported this website and our practices over the years.

– Karl Cole-Frieman & Bart Mallon

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Cole-Frieman LLP & Mallon P.C. merge to form 3rd largest hedge fund practice based in San Francisco

– Combined firm has over 200 hedge fund industry clients

San Francisco, July 27th, 2011 – Two fast-growing San Francisco based law firms, Cole-Frieman LLP and Mallon P.C., today announced an agreement to combine businesses. The combined firm, known as Cole- Frieman & Mallon LLP, will be a boutique generalist firm focusing on hedge fund managers and hedge fund investors. Karl Cole-Frieman and Bart Mallon will be Co-Managing Partners of the eight person firm, which is headquartered in San Francisco and has a satellite office in New York. With 215 clients in the hedge fund industry, the firm also managed over 100 hedge fund launches in the last two years.

Cole-Frieman & Mallon LLP provides advice on a broad range of corporate, regulatory and litigation matters including hedge fund formation, adviser registration, CFTC and NFA matters, ISDAs and counterparty documentation, loan trading and distressed debt transactions, seed deals, employment and compensation matters and regulatory inquiries.

The firm will also manage the widely read and highly influential Hedge Fund Law Blog (http://www.hedgefundlawblog.com), which focuses on legal issues that impact the hedge fund community.

“This merger will create an industry leading firm that provides a full suite of services to hedge funds and others in the alternative investment community,” says Karl Cole-Frieman. Mallon notes, “Many larger managers are opting to bifurcate their legal work between our firm and a large law firm. Whether the client needs start-up support or more tailored advice, we are able to provide high level, cost-effective services which consider the manager’s needs from a business as well as a legal perspective.”

“There are few firms that can provide an institutional quality product at a reasonable price point. With Cole-Frieman & Mallon LLP we get the benefit of top notch expertise, as well as the personalized service and attention of a boutique firm” said Dennis Carlton, General Counsel of WMD Asset Management, LLC.

Bruce Wilson at North Creek Advisors, LLC adds “Cole-Frieman & Mallon LLP bring to the table a deep understanding of the hedge fund business and hedge fund operations. They are business partners, as well as counselors, who engineer the solutions for their clients.”

About Cole-Frieman & Mallon LLP

Informed by significant in-house and private practice experience at some of the most prestigious Wall Street firms, hedge funds, and law firms Cole-Frieman & Mallon LLP has the business acumen and market knowledge to

provide legal solutions for a wide range of financial services matters. With offices in San Francisco and New York, Cole-Frieman & Mallon LLP has a nationwide practice that services both start-up managers as well as multi-billion dollar firms. Cole-Frieman & Mallon LLP provides a variety of services including: hedge fund formation, advisor registration and counterparty documentation, CFTC and NFA matters, seed deals, internal investigations, operational compliance, regulatory risk management, hedge fund due diligence, marketing and investor relations, employment and compensation matters, and routine business matters. For more information please visit us at: http://www.colefrieman.com/.

Karl Cole-Frieman can be reached at 415-352-2300.

Bart Mallon can be reached directly at 415-868-5345.

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Private Equity Fund Manager Registration Exemption Approved by House Committee

Small Business Capital Access and Job Preservation Act Moves Toward Vote

The SEC recently finalized the new investment adviser registration regulations and under those regulations private equity fund managers will be required to be registered with the SEC.  However, Congress has recently been taking steps that may ultimately mean that private equity fund managers will escape registration requirements.

The Small Business Capital Access and Job Preservation Act (the “Bill”) proposed in March, would amend the Investment Advisers Act to provide an exemption from registration for some private equity fund managers.  Recently the House Committee on Financial Services (“Committee”) amended and approved the Bill which will ultimately need to be passed by the full House and Senate before being presented to the President for signature. The amended text makes an exemption from registration available to advisers of private funds that have outstanding debt that is less than twice the amount investors have committed to the private funds (less than a 2-1 leverage ratio).

Proposed Requirements for Private Equity Fund Managers

The amended Bill would require the SEC to define “private equity fund” and to promulgate reporting and record-keeping requirements for those private equity fund managers who utilize the exemption. Specifically, the SEC would have to enact rules that require the managers “to maintain

such records and provide to the Commission such annual or other reports as the Commission taking into account fund size, governance, investment strategy, risk, and other factors, as the Commission determines necessary and appropriate in the public interest and for the protection of investors….”  The SEC will be required to issue any regulations within 6 months of the date the Bill is signed into law.

This means that while PE fund managers would be exempt from registration, there would still be fairly significant compliance responsibilities.  Essentially these managers would face a regulatory regime similar to exempt reporting advisers.

Support for the Bill

Supporters of the Bill essentially assert that because private equity funds neither caused nor contributed to the financial crisis, it would be unduly burdensome for these fund managers to register with the SEC. Specifically, supporters point to the costs associated with registration, the jobs created by the funds, and the general lack of systemic risk posed by the funds.

According to the Committee report, registration would be burdensome because:

“advisers to private equity funds will be required to calculate the value and performance of each of their funds on a monthly basis, which will in turn require advisers to private equity funds to calculate the value of each company in which the fund has invested on a monthly basis as well. Such valuations are time consuming and costly, and they divert much-needed capital and effort away from job creation and investment activities.”

The Committee received testimony stating:

“As of June 30, 2009, companies that received backing from private equity investment funds employed more than 6 million people. Studies show that the workforces of companies acquired by private equity firms increased by an average annual rate of 5.7 percent, compared to 1.1 percent for all U.S. companies. The Committee also received testimony about the costs of registering with the SEC, which some have estimated to be as high as $500 million industry-wide…”

The concerns were primarily that the burden imposed by the registration requirements could inhibit the creation of more jobs, with struggling or growing companies receiving less capital from such funds. The amended Bill would provide relief from registration for advisers to private equity funds that are levered by less than a 2-1 ratio.

Final Thoughts

Private equity fund managers should not stop beginning preparations to register as investment advisers with the SEC.

The Bill is a long way from being enacted into law – it still must be passed by the full House, the full Senate, and signed by the President. It will then take (at least) another 6 months for the SEC to issue final rules regarding record-keeping and reporting and to clarify the definition of “private equity fund.” Even with the Dodd-Frank registration deadline pushed back to March 30, 2012, waiting until the Bill and its accompanying rules and regulations are finalized would leave managers of these funds with little time to register in the event they ultimately do not fall within the exemption in its final form.

The Committee’s report is available here.

The full text of the Bill is available here.

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Cole-Frieman & Mallon LLP is a law firm which provides adviser registration, compliance and legal support to SEC registered fund managers.  Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

SEC Rulemaking Agenda for Hedge Fund Registration

Timeline for Proposed & Final Manager Registration Rules Released

The Dodd-Frank bill requires the SEC and CFTC to propose and promulgate final rules with respect to a number of important areas for investment managers.   As we have seen, significant time has already been devoted to trying to develop a framework for OTC derivatives clearing.  Over the next couple of months, however, hedge fund and private equity fund managers will begin to see how the registration and hedge fund compliance process will proceed under the new laws and regulations.

The SEC has released a timeline for implementing the provisions under Dodd-Frank.  While the SEC discusses a number of the major rule making initiatives, below we have only reprinted the items relating to investment adviser registration.  We have also provided some of our thoughts on these items.  [Note: section numbers reference the Dodd-Frank act.]

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October

§409: Propose rules defining “family office”

This definition will be important because “family offices” are not required to register as investment advisers with the SEC.  Family offices which manage the assets of numerous families will need to pay special attention to the proposed rule because it is possible that the SEC may not provide such offices with an exemption or exclusion from the registration provisions.

See SEC Proposes “Family Office” Definition on Hedge Fund Law Blog

Novemeber – December 2010 (planned)

§§407 and 408: Propose rules implementing the exemptions from registration for advisers to venture capital firms and for certain advisers to private funds

Private equity fund advisers are going to be carefully reviewing this provision to see if there is any way to escape SEC registration.  Depending on the scope of the definition of “venture capital,” managers to private equity funds may be able to find a way to fall outside of registration.

§410: Propose rules and changes to forms to implement the transition of mid-sized investment advisers (between $25 and $100 million in assets under management) from SEC to State regulation, as provided in the Act

This will be an important provision for a number of managers who are currently registered with the SEC.  Both the SEC and the states want to see an easy and seemless transition from SEC to state registration and there will need to be significant coordination between the SEC, NASAA, the states and FINRA (which runs the investment adviser registration depository).

§418: Propose rules to adjust the threshold for “qualified client”

Changes to the definition of “qualified client” will require hedge fund managers to revise their fund offering documents.  Additionally, currently unregistered private equity fund managers should note that they will be subject to the qualified client regulations (i.e. performance fees or the carried interest may be charged only to an investors who fall within the definiton of qualified client).  Accordingly, private equity fund managers may need to start thinking about revising their offering documents and/or begin requesting more information from their investors with respect to net worth.

§413: Propose rules to revise the “accredited investor” standard

The SEC has already promulgated guidance with respect to the accredited investor standard which states that an investor’s equity in a primary residence does not count toward the net worth requirement.  It is likely that the proposed rules will mirror the guidance.

§926: Propose rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated

NASAA has lobbied hard to have the ability to have greater control over Regulation D offerings if the promoters of the offerings have previous been subject to certain regulatory or criminal proceedings.  Any proposed provision would likely limit the ability of such promoters to offer securities to investors without first going through a rigourous process with each of the states where the securities are sold.

§§404 and 406: Propose (jointly with the CFTC for dual-registered investment advisers) rules to implement reporting obligations on investment advisers related to the assessment of systemic risk

Investment managers with a large amount of AUM will likely be subject to increased reporting requirements to the SEC.  The SEC (and the CFTC) will likely use this information (potentially in conjunction with other government agencies) to determine the risk the manager poses to the financial system.  It is expect that most, if not all, of the information to be provided to the SEC and CFTC under this provision will not be available to the public, even under a FOIA request.

§913: Report to Congress regarding the study of the obligations of brokers, dealers and investment advisers

NASAA has been fighting for a uniform fiduciary standard for brokers and investment advisers.  After the Dodd-Frank act was signed into law, the SEC solicited comments from the public on whether there should be a uniform fiduciary standard.  The SEC has already received a large number of comments on this very important issue.

§914: Report to Congress regarding the need for enhanced resources for investment adviser examinations and enforcement

The SEC needs more resources.  Ultimately the lack of proper funding for this agency will likely lead to the creation of a self regulatory organization for investment managers similar to FINRA for broker-dealers.  This is a separate subject which we intend to discuss in future posts.

§919B: Complete study of ways to improve investor access to information about investment advisers and broker-dealers

It will be interesting to see what additional information that the SEC would like advisers to give investors.  The Form ADV and Part 2 are publicly available to investors through the SEC’s Advisor Search tool.  Additionally, the SEC recently changed the format of Part 2 to provide more information to investors about investment managers.

April – July 2011 (planned)

During this time the SEC will be adopting finalized rules (taking into account public comments on the proposed rules) with respect to the following matters:

  • reporting obligations on investment advisers related to the assessment of systemic risk
  • exemption from registration for advisers to venture capital firms
  • “family office” definition
  • transition of mid-sized investment buy cialis soft online advisers (between $25 and $100 million in assets under management) from SEC to State regulation
  • “qualified client” definition
  • “accredited investor” definition
  • disqualifying Regulation D offerings by certain felons

Additionally, the SEC may decide to propose rules during this time based on the §913 study conducted on the obligations of brokers, dealers and investment advisers

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Other related hedge fund law articles:

Bart Mallon, Esq. runs the hedge fund law blog and provides registration and compliance services to hedge fund managers through Cole-Frieman & Mallon LLP, a leading hedge fund law firm.  He can be reached directly at 415-868-5345.

Recap of San Francisco CFA Hedge Fund Event

SF Managers Talk About Starting a Hedge Fund

On September 16, members of the San Francisco investment management community gathered at the Ritz-Carlton to listen to four hedge fund managers talk about their experiences starting a hedge fund.  The event was sponsored by the San Francisco CFA society.  The event sold out prior to the event and the attendees seemed to be mostly CFA charterholders and other future hedge fund managers.  The moderaters, two CFA charterholders, asked pre-prepared questions to the managers and opened the panel up to questions from the audience at the end.

The following are some of my notes from the event.  Each bullet point is a talking point from an individual manager who I have chosen not to identify as I do not have their direct permission.  Since these are notes, I am paraphrasing the thoughts of the managers and I may have modified the comments slightly so they make sense in the context of this post.  Many of the points below are quite good and focus on the business and operational matters of running a fund which are very important.

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Is there a certain background that is helpful to be a hedge fund manager?

  • MBA and CFA charterholder are good designations to have, but it is also about experience and attitude – being able to jump into a new and difficult situation is important.
  • Being a manager is about differentiation and having a distinct strategegy.  Whatever is different in your background is what you should emphasize (e.g. Ph.D).  You should put out your qualifications and background.
  • A CFA is not a necessity, but you should differentiate yourself because there are so many funds out there.
  • A manager does not need to have a cookie-cutter background.  Managers should emphasize what will help them to outperform other managers.

It is common for successful hedge fund managers to start at a large firm, build a reputation and then start a fund – what are your thoughts?

  • It does help to go that route because investors know the manager and have worked with the manager previously.
  • Most people who are very successful do come from large firms.  However, launching a hedge fund now is different than it was in the 90s post market crash and Madoff.

What motivated you to start your own hedge fund?  Was it the glamour, money, challenge?

  • Professional challenge – liked the work but thought that “I could do better.”  It is also fun to run a company and be an entrepreneur.  Glamour is irrelevant.
  • Glamour is irrelevant.  The personal challenge is a central part.  Being able to make your own schedule and be your own boss is important.  Being able to determine the course that the fund will take is important.
  • There is no glamor in being a start-up fund manager.  Motivation came from knowing that you can offer something to investors that they can’t get from other groups.
  • The motivation was that it is intellectually challenging and it is rewarding to run your own business.

How do you transition from being an employee to being an employer?

  • For one manager, it was easy because they cam from a small firm (6-7 people).  The key is that you need to be the master of everything – trading, researching, marketing, etc.
  • For another manager who came from a larger firm, he had a range of duties at the previous firm so it was a relatively easy transition.

What is your investment process, edge and benchmark?

  • Long/short absolute returns.  Don’t benchmark.
  • Benchmark against the HFR Long-short equity index.  However, the index is not always a good indicator because of survivorship bias.  The HFR is also usually long-biased.
  • Benchmarks usually provide an idea of what would be a low-cost beta for investors.  For the particular stategy, it would be the Goldman Commodities Index.

Did you go it alone as a manager or do you have a team?

  • It really depends on your situation.  For us (team with 2 principals), we worked together for 10 years and liked working together so it was natural to start the fund together.  We started as two persons at my house planning things out.  We slowly started hiring people we knew previously and gradually built out the team.  We needed help on the business and operations side.
  • I went alone by choice.  Other people didn’t have the capital to go 2-3 years without a salary.  You need to know if you can afford to be in a start-up.
  • I went out on my own because of the investment process – it is systematic so there is not a need to have other people.  About 9 months in, I had to hire someone to do marketing and investor relations.
  • I stated on my own and then hired people.  You have to hire people you like and want to work with.  Other hires came later and for various reasons.

With respect to compensation – how do you divide profits with the team?

  • There is a certain percentage which is devoted to profit-share with the employees.  Profits outside of that are divided by the two principals of the management company 50/50.
  • It is difficult to figure out the compensation because the principal is the one who really puts everything on the line.  Generally you would give a small portion of the management company to employees and then let that grow over time.
  • Compensation depends on the facts of the situation.  Each negotiation is different.

Did you invest your own capital in your fund?

  • Yes
  • Yes.  Also had investments in the beginning from the father and father-in-law.
  • Most start-up manager have their own capital invested in the fund in addition to family and friends.
  • Yes – about 70% of non-retirement assets in the fund.

Who do you get to invest in your fund at the beginning?

  • Friends and family; those who know you well and trust you are more likely to invest.  Also, people in the industry who know you and your background are usually good groups to help.
  • People who you have worked with in the past.  Also, talk to everyone including capital raisers.

How do you get high net worth investors to invest in your fund?

  • There are two routes – (1) find large institutions to invest large amounts or (2) be really good at shaking hands and developing personal relationships.  If you can develop good personal relationships this is great because the money is usually sticky.  Institutions are tough – you’re checking boxes, on phone calls, etc.  Also, the people who work at institutions move from allocator to allocator so you can get into the situation where you are talking to an institution for a while and then you essentially get dropped because your point person moves jobs.  One reason LinkedIn is such a good tool is that you can always keep up with where a person goes.

How do you get in front of investors?

  • Beg, plead, try to get others to vouch for you, cold call.

Follow-up:  what is the batting average for cold calls?

  • Very low – 1 out of 50.  If you do get money, it is a process.  My two biggest clients came from short meetings with the right people.  It was serendipitous, but perseverance is key.

How much time do you spend trying to raise assets?

  • 30 to 35% of the time.
  • It is tough to do everything.  Portfolio management takes say 60%, sales and marketing takes 60% of your time.  Now I hired a marketer to take weight off.  There are a ton of investors out there – probably 100 people in Silicon Valley with a million or more – but not all will invest…
  • Maybe 20% of the time is devoted to fundraising.

What about 3rd party marketers?

  • You should be aware of the selling agreement.  You want to be careful with respect to scope – you don’t want them to send you a phone book of potential investors.
  • 3rd party marketers are good because they are doing something that I cannot do or do not have the time to do.
  • With respect to how much you pay these groups, it will usually be 20% of all revenues that are attributable to the assets they bring in – it is better to get 80% of something instead of 100% of nothing.
  • I’ve had both good and bad experiences with these groups.

The common statement is that if an investor doesn’t bite in 2 days then they won’t invest – is this true?

  • No, I’ve had a group that has been receiving my monthly statements for a long time but eventually they invested.
  • Some institutional investment cycles take years.  If you are a new firm they are not just going to invest right away.  It is worth it to keep up the communications with these groups.
  • Sometimes you have investors who say they will invest and then get sidelined.  Sometimes you have someone who pops up out of the blue.

What is the length of the investment cycle for a high net worth investor versus an institutional investor?

  • Yes, high net worth investors will likely invest sooner.  RFP (request for proposal) – if you don’t know what this means – learn it.
  • With respect to institutions, they look not only at return risks, but the persons who make the investment decisions are also concerned about losing their job.  There is an asymmetrical risk-reward system for these people.  No one gets fired for buying IBM and this is why some managers will continue to get money (e.g. the guys from LTCM and Brian Hunter).

Dedicated sales person?

  • I am not a good salesperson so I needed someone who could do this for me – I took it too personally.

Do you have thoughts on seed money?

  • We thought about it and in this environment, it is helpful.  Right now you are competing for capital with funds which are now open (and which have traditionally been closed to new capital).  Having a seed investor allows you to get on the radar and the seeder can be a reference, provide credibility and also do initial due diligence (which will also be completed by institutional investors).  It is similar to ventural capital where it is worth giving up some economics for a change in the trajectory of your group.  With respect to fees, it will really depends on the facts of your situation and there are no standard terms.  Some seed deals range from 20-30% of revenue.
  • Different seeders have different economics.
  • Generally a good rule of thumb will be 1% (of the management company equity) for each million they invest in the fund, but again it depends.
  • The market is in the seeder’s favor, not the manager’s.

What is the hardest question you’ve been asked when raising money?

  • The big issue that many managers have when raising money is that their presentation is too long – manager’s need to sharpen their focus.

Where are you domiciled, what are your fees?

  • Standard fee structure and organizational structure.
  • Started with a stepped or graduated performance fee where the investors benefit, but it was too complicated.  The investor actually wanted something standard.
  • We went with a standard fee structure and have a Cayman master-feeder.  Terms are standard.  Managers sometimes spend too much time with structure – just go with the standard.
  • In addition to a fairly standard structure, the manager also does separately managed accounts (SMAs) for investors who want increased liquidity and transparency.  The common saying is that the manager will charge what the market can bear.

Audience Questions

Would you be affected if Congress changes the tax rate on the carried interest?

  • For us it is not a big deal because we do not have long term capital gains in our structure.
  • For our program (futures/commodities), there is 60/40 taxation so tax on the carried interest is not really an issue.

With respect to due diligence, has it changed recently?

  • People take due diligence seriously and it can take a long time to complete.
  • Watch out for the “toxic allocator” that asks for way too much information.  Be careful with your time and ask yourself if what is being requested is reasonable or just wasting your time.
  • The allocators who say that they “meet with everyone” are probably not worth your time.  Many institutions require the person who is making investment decisions to meet with a certain amount of managers – many times these persons know who they are going to allocate to, but need to meet their meeting quota.
  • One good issue that was discussed during the due diligence process was the succession plan.  For a one-man management company, having a succession plan in place makes good business sense and makes investors comfortable.

What is the minimum amount you take in a separately managed account?

  • 5 million.  You’ve got to take into account the hassle associated with SMAs and your bandwidth.  Other institutions will also ask you how many SMAs you are managing.
  • Smaller amount, but that is because economics and business are different.

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Cole-Frieman & Mallon LLP, a hedge fund law firm, sponsors the Hedge Fund Law Blog.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Law Blog Nominated for the LexisNexis Top 25 Business Law Blogs

We are happy to announce that the Hedge Fund Law Blog has been nominated for the LexisNexis Top 25 Business Law Blogs of 2010.  We thank our audience for reading and being engaged in the discussion, and of course for the nomination.

Call to Action!

We are not yet a Top 25 Business Law Blog – the next step is to submit a comment to LexisNexis to let them know about Hedge Fund Law Blog.  After the public best viagra and popular in uk comment period and voting ends (October 8th), the LexisNexis board of editors will select the Top 25 based in part on the public comments.  The final announcement is expected to be made on October 31.

To vote for the Hedge Fund Law Blog, please go here and fill out a comment.

Other Blogs

There are a number of very good blogs which are also nominated.  The blogs that I actively read include:

Other blogs that are in my RSS reader and which I think highly of:

Many thanks again for reading.

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Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides hedge fund legal services through Cole-Frieman & Mallon LLP. He can be reached directly at 415-868-5345.

SEC Requires Municipal Advisors to Register

New Form MA-T Released

Under the Dodd-Frank FinReg bill, municipal advisors are required to register with the SEC by October 1, 2010.  Municipal advisors are firms or individuals who provide advice to state and local governments and other borrowers involved in the issuance of municipal securities.  The definition includes financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and certain swap advisors that provide municipal advisory services.

Interim Final Temporary Rule 15Ba2-6T

In the SEC’s adopting release, the

The Commission is adopting an interim final temporary rule, Rule 15Ba2-6T, in order to provide a method for municipal advisors to temporarily satisfy the statutory registration requirement of Section 15B(a)(1) of the Exchange Act (as amended by Section 975(a)(1) of the Dodd-Frank Act) until the Commission has promulgated a final permanent registration program. The interim final temporary rule will expire on December 31, 2011.

Form MA-T Requirements

Form MA-T is a short six page form which requires municipal advisors to provide the following information:

  • Identifying information (name, EIN, place of business, contact person, website, etc.)
  • Type of advisory services
  • Disciplinary information
  • Execution

Municipal advisors should take note that the above information will be publicly available on the SEC website.

The release can be found here.

Further information can be found here.

Adopting Release can be found here.

Please also see the complete Form MA-T

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Bart Mallon, Esq. runs the hedge fund law blog and provides hedge fund registration and compliance services to hedge fund managers through Cole-Frieman & Mallon LLP, a hedge fund law firm.  He can be reached directly at 415-868-5345.

Cole-Frieman & Mallon LLP Quarterly Newsletter | 2nd Quarter 2010

Below is our quarterly newsletter.  If you would like to be added to our distribution list, please contact us.

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July 31, 2010
www.colefrieman.com

Clients and Friends,

We take this opportunity to provide you with a brief overview of the major items we have reported on over the last quarter.  While we are a little late with the newsletter, the past couple of weeks have been especially busy with the passage of the Dodd-Frank reform bill.  There will be continuous rulemaking and proposals over the course of the next 12 months and this newsletter will provide an overview of the issues which we will be discussing in the future.  Also, please be sure to skim the ongoing compliance update below to make sure your firm is up to date with compliance.

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Financial Reform Bill – The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed by President Obama on July 21, 2010, will meaningfully change the investment management industry in a number of ways. Important changes include:

  • Manager Registration – Managers to hedge funds and private equity funds will generally be required to  register with the SEC by July 21, 2011 if they have $150 million or more in AUM.
  • Accredited Investor Definition – The definition of accredited investor has changed. Now, investors cannot include the value of their primary residence when computing net worth. The qualified client definition may also be changed in the future.
  • BD Fiduciary Standard – The SEC will study and potentially institute a fiduciary standard for broker-dealer representatives.
  • Increased State Regulation of Investment Advisers – Previously, the states only had jurisdiction over managers up to $25 million of AUM. Now the states have jurisdiction over managers with up to $100 million of AUM. We have provided our comments on the increase in state regulatory jurisdiction in light of state budget shortfalls.
  • Regulation of the OTC Derivatives Markets – Previously unregulated contacts (like credit default swaps) will be subject to a clearing requirement. There will be much written on this over the next few months as the CFTC and SEC begin establishing a framework for such clearing.
  • Imposition of Position Limits on Certain Commodities (see below)

In addition to the changes to the securities and commodities laws, there will be a number of rulemaking initiatives by both the SEC and CFTC which will augment the statutory language of the bill.

Busy, Busy SEC – Notwithstanding preparations for the Dodd-Frank bill, the SEC has been especially busy over the last quarter.  The big news was obviously the Goldman settlement, but there were a number of other SEC initiatives as well. These include:

New ADV Part 2 Released – The SEC just released the requirements for the new Form ADV Part 2 which will now be publicly available through the SEC’s Advisor Search program.  New Part 2 will require registered managers to provide a narrative of their investment program and other relevant information. Managers also need to provide investors with supplements detailing certain background information about the representative directing an investor’s account.  Most currently registered managers are required to post a new Part 2 during the first quarter of 2011.

Pay to Play Rule Adopted – The SEC adopted new Rule 206(4)-5 under the Investment Advisers Act prohibiting certain political contributions by investment advisory firms.  Firms are urged to update their compliance policies and procedures to account for the new rule.

Advisor Representative Disclosures – The SEC updated its Advisor Search program so that information on investment adviser representatives will now be publicly available online.  Prior to the update, disciplinary and other background information was only publicly available to the extent it was disclosed on the adviser’s Form ADV.

Futures/ Commodities Issues – Like the SEC, the CFTC has been very busy over the last quarter and will continue to be busy proposing rules under the Dodd-Frank bill. Accordingly, there are a number of interesting items concerning both the CFTC and NFA. These include:

Position Limits – Dodd-Frank mandates the CFTC to impose position limits across different markets including traditional futures markets, agricultural markets, and with respect to certain swap instruments. The CFTC will be releasing orders or proposed rules establishing limits within 180 days for energy commodities and within 270 days for agricultural commodities.  Position limits will affect commodities transactions that have previously qualified for broad statutory exemptions and traders will need to closely monitor trading activity to avoid violating the limits when they are established and implemented.

CFTC Releases Report on NFA – The CFTC audited the NFA in 2009 to gauge how successfully the self regulatory organization implemented certain CFTC regulations.  The CFTC noted a number of areas where the NFA should improve procedures.  We have already seen some of the suggestions implemented and, accordingly, the registration process (in certain instances) is taking a little longer than usual.

CTA & CPO Disclosure Document Bios – For CTAs and CPOs registering with the CFTC, one area where the NFA seems to spend considerable time is the biography portion of the disclosure documents.  Because of common deficiencies with respect to the biographies (or manager backgrounds), the NFA released guidance on how this part of a disclosure document should be completed.

Form 8-R Revised – Form 8-R applications for principal and associated person registration has been revised to include demographic information on the registrant.  The newly added information includes sex, race, eye color, hair color, height and weight.  The purpose of the additions was to help speed up the background check process for principals and associated persons.

NFA Forex Workshop Announced – In expectation of the CFTC finalizing the forex registration rules for forex CTAs, CPOs and IBs, the NFA is conducting a registration and compliance workshop for forex managers.  The workshop will take place on September 25th, 2010 at Caesar’s Palace in Las Vegas. NFA staff will be on hand to discuss the registration process and to take questions from managers.

Other Notes

Hedge Fund Carried Interest – Every few months the taxation of the carried interest becomes a political football.  Early in the quarter it looked like the carried interest tax would be changed as part of an unemployment extension bill.  However, that bill never passed and the proposal to tax the carried interest as ordinary income died.  We expect to probably hear another proposal like this in the next 12 to 18 months.

Hedge Fund Court Case – Earlier this year a court case was decided in favor of a hedge fund manager when that manager suspended redemptions and was subsequently sued by an investor.  We discussed the facts of the case and the manager takeaways.

Ongoing Compliance – At the end of every quarter, managers should take time to address any ongoing compliance matters.  Managers who are registered in any capacity (state, SEC or CFTC) should review their compliance calendar or policies and procedures to ensure that all quarterly compliance matters are completed.  Additionally managers should always be sure to complete all state blue sky filings and commodity pool operators should make sure they complete their Rule 2-46 quarterly filings.

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For assistance with any compliance, registration, or planning issues with respect to any of the above topics, please contact Bart Mallon of Mallon P.C. (www.mallonpc.com) at 415-868-5345 or bmallon@mallonpc.com.

Cole-Frieman & Mallon LLP is a hedge fund law firm with a national client base and is focused on the investment management industry.  Our clients include hedge fund managers, investment advisers, commodity advisors, and other investment managers.  We also provide general business and start up legal advice and have an emerging practice in real estate and cleantech.

150 Spear Street, Suite 825
San Francisco, CA 94105
Telephone: (415) 352-2300
Fax: (646) 619-4800

Survey of State Securities Divisions

Are States Equipped to Handle Increased IA Registrations?

Under the new financial reform bill, expected to be signed into law sometime in July 2010, the state securities divisions will play a larger role in the oversight of investment managers.  Under the current system, investment advisers (who generally provide financial planning services or investment advice to individuals) with $30 million of AUM are required to register with the SEC.  Under the new laws to take effect under the reform bill, investment advisers with up to $100 million of AUM will be required to register with the state of their principal place of business.  This means that thousands of managers who are currently subject to SEC jurisdiction and oversight will become subject to state jurisdiction and oversight.  We do not believe that the states have the desire, expertise or, most importantly, the budget to handle an increase in the jurisdiction and oversight.  Because we think the states securities divisions are cash strapped, we conducted our own mini-survey to find out the answer.  [Note: we also recommend the article The New Sheriffs in Town about this same issue.]

Survey of State Securities Divisions

Over the past couple of weeks, we called each state securities division and tried to speak with a person familiar with each division’s financial situation and other aspects of their operations.  While we were not always able to speak with the appropriate person, we were at times able to divine interesting information from our discussion.  For many states we have sent in record requests under the Freedom of Information Act and while our reports below are not complete, they do show us that a number of securities divisions are in fact having financial difficulties.  These questions focus on the issues we think are important.  [Please note: most of the answers below are not official but were instead taken from our informal phone conversations with people in the various divisions.]

Question: Is the securities division facing budget cuts?

  • Arizona – yes, there have been budget cuts over the last couple of years.
  • Delaware – no, but statewide salaries have been cut 2.5%
  • Kansas – there is a constrained budget
  • New Mexico – yes
  • Oregon – yes
  • Pennsylvania – budget restraints
  • Utah – yes
  • Vermont – yes, as of 2009
  • Washington – yes
  • Other: A number of divisions either stated no or that they could not provide that information.

Question: has the securities divisions faced staff reductions?

  • Utah – yes
  • Washington – operating under a hiring freeze
  • Other:  A number of states said there were vacant positions (Alaska, Arizona, Delaware, Kansas, New Mexico (3))

Question: are division staff forced to take furlough days?

  • California – yes, either 1 or 2 Fridays a month
  • Colorado – yes, 1 days per month instituted in Fall of 2009
  • Connecticut – yes, instituted in 2008
  • Delaware – yes, instituted in 2009
  • Hawaii – yes
  • Maine – yes
  • Michigan – yes
  • Minnesota – yes
  • Nevada – yes
  • New Mexico – in 2009 (5 days) but not in 2010
  • Oregon – yes
  • Vermont – yes – instituted in 2009
  • Virginia – yes
  • Washington – yes
  • Wisconsin – yes
[Note: we expect this number to rise as soon as we receive information back from our Freedom of Information Act requests.]

Question: how many staff members does the division employ?

  • Arkansas – 38
  • Delaware – 13 (2 examiners)
  • Indiana – 18-20 (1 examiner)
  • Louisiana – 11 (2 examiners)
  • Montana – 5 (2 examiners)
  • Nebraska – 10 (1 examiner)
  • New Hampshire – 10 (2 examiners)
  • New Mexico – 22 (1 examiner)
  • North Dakota – 9 (3 examiners)
  • Utah – 19 (5 examiners)
  • Washington – 38 (8 examiners)
  • West Virginia – 11 (5 examiners)
  • Wisconsin – 16 (10 examiners)
Question: how often does the division audit registrants?

  • Indiana – 3-4 year cycle
  • Louisiana – 2 year cycle
  • Montana – 3 year cycle
  • Nebraska – every 2-3 years
  • New Hampshire – risk-based cycle
  • New Mexico – 3 year cycle
  • Utah – 5 audits per month (3 routine, 2 for cause; mostly broker-dealer issues)
  • Virginia – 3.5 year cycle
  • Washington – high-risk firms audited 1-2 years; lower risk firms audited every several years
  • Wisconsin – 3 year cycle

We will periodically update this information as we receive it from the divisions.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Law Blog Notes For Week

Adviser Registration, Accredited Investors, Carried Interest, Insider Trading, Cap and Trade

Below are some thoughts on some of the major issues over the last couple of weeks.

Have a great Memorial Day Weekend!

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Hedge Fund Regulation and Registration – While the Private Fund Investment Advisers Registration Act of 2010 was passed this month in the Senate, there has not been as much discussion in the news about this issue and manager registration.  I expected that we would hear more, especially with regard to the following issues:

  • Section 407 – Exemption of VC Funds
  • Section 408 – Exemption from Reporting Requirements for Private Equity Funds
  • Section 410 – State Authority for Managers with AUM of up $100MM (this is generally a bad idea in my opinion and we will be writing a post about this soon…)
  • Section 412 – Adjusting Definition of Accredited Investor (see also below)

I imagine we will hear more as the Senate and House begin to reconcile their two bills and before President Obama signs the final Financial Reform bill into law, which some think may happen before the July 4th holiday.

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Definition of Accredited Investor – The Senate version of the Financial Reform bill will change the definition of an “accredited investor” in the future.  Generally “accredited investors” are those individuals with a net worth of $1,000,000.  Under current regulations, individuals can include the equity in their private residence when determining their net worth.  In the future, they will need to exclude the equity in their private residence when determining their net worth.  This potentially may have a deleterious effect on the hedge fund industry, but also on other industries which rely on private placements.

According to some sources, at least one Senator is asking that the definition of accredited investor be expanded to include state and local governments.  I agree with this approach – if the Senate is taking the time to mess with the definition right now then the Senate should spend a little time addressing other issues.  For instance, the definition of accredited investor should also be expanded to include Native American Tribes.  I have specifically talked with the SEC staff about this issue a couple of years ago and they have categorically refused to issue a no-action or other interpretive release on this issue – we believe that now is the time to include Native American Tribes in the definition of accredited investor.

For more information, please see the Native American Capital, LP policy briefing and the National Congress of American Indians letter to the SEC on this issue.

See also Perkins Coie discussion of this issue.

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Carried-Interest Issue -it looks like the carried interest tax laws will be changing in 2011.  In addition to hedge fund managers, managers to other pooled investment vehicles will be greatly affected (such as VC and private equity fund managers, as well as real estate fund managers).  The change in the laws will likely affect more VC and PE managers than hedge fund managers because of the nature of the underlying gains in the respective investment vehicles (VC and PE fund managers typically have mostly long term capital gains and hedge fund managers may have a combination of long term and short term capital gains).  There is likely to be a large number of industry groups which come out in opposition to the changes in the next couple of weeks.

We do not agree with the proposed changes – it seems as though Congress is specifically attacking an easy target  in the investment management community.

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Insider Trading Issue – just today the SEC announced an insider trading case brought against a hedge fund manager Pequot Capital Management, Inc., and its Chairman and CEO Arthur Samberg.  This issue has been thoroughly discussed most recently after the Galleon affair.  Hedge funds managers and compliance personnel need to be even more vigilant about establishing comprehensive compliance programs and making sure that traders are not engaging in insider trading.  Please see our previous thoughts on Hedge Funds and Insider Trading.

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Green Tech/ Cap and Trade – clean and green tech continue to gain traction in the investment management industry as a bill which would create federal carbon cap and trade system was introduced recently.  Next weekend the South Asian Bar in San Francisco will have a panel discussion. entitled “Green 2 Green: Carbon Credits, Renewable Energy Certificates and the New Markets driving the Clean Energy Economy”.  According to the program,

Attendees will receive a quick primer on market-based regulatory responses to climate change designed to foster the development of renewable power plants and spur long term investment in clean and sustainable energy. Panelists will address state and federal legislation setting green house gas emission caps, establishing renewable portfolio standards, and creating new markets for carbon credits and renewable energy certificates. We’ll discuss the regulatory origins and key characteristics of these and other green commodities, as well as the structure and rules of markets created to transition industry and consumers from the present carbon economy toward tomorrow’s clean energy economy.

Mallon P.C. will be represented at the panel discussion so please come and talk to us there.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP works with many managers who invest in various commodities and with groups who work in the clean tech space.  Mallon P.C. is a top hedge fund law firm which provides comprehensive formation and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.