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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.


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.


Other related hedge fund law articles:

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.

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


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.

July 31, 2010

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.


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.


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. ( at 415-868-5345 or

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.


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!


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.


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.


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.


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.


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.


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.

Cleantech: A Viable Option for Hedge Funds and Investors?

By Bart Mallon (

100 Women in Hedge Funds Hosts Panel of Cleantech Industry Professionals to Discuss the Future of Cleantech Investments

On March 24, 2010, 100 Women in Hedge Funds, a global association of investment management professionals, presented “Is the Grass Really Greener? The Case for Investing in Cleantech”, a networking and educational event focused on the clean technology (“cleantech”) movement and the push for venture capitalists and hedge funds to invest in cleantech technologies. The event, which took place at the Pillsbury Winthrop Shaw Pittman law offices in San Francisco, was host to 100 or so investment management and cleantech professionals from the San Francisco Bay Area who were all noticeably enthusiastic about the evening’s topic.

Kim Tomsen Budinger (of KTB Counsel), who is part of the 100 Women’s Northern California Steering Committee and who co-organized the event with Marianne O (of Lumen Advisors, LLC), introduced the moderator Scott Jacobs, a consultant at McKinsey & Company, and welcomed the following panelists:

  • Richard Bookbinder, Founder of New York-based hedge fund TerraVerde Capital Management LLC
  • Thomas Toy, Co-Founder and Managing Director of Menlo Park-based venture capital firm PacRim Venture Partners
  • Garvin Jabusch, Co-Founder and CIO of Boulder- and Silicon Valley-based investment advisors Green Alpha Advisors, LLC

What is Cleantech?

The discussion started with each of the panelists providing their own definition of cleantech – while each stated that the term is hard to define, it was noted that sectors like water, agriculture, and clean energy fall into the category of cleantech. The panelists also noted that varying definitions of “cleantech” can lead to investor confusion so managers will tend to define “cleantech” through examples of individual companies for instance.* [This confusion actually led to the creation of indicies focused on the sector.]

Despite the challenges of coming to an agreement on a definition, the panelists did express strong optimism about the potential financial growth – cleantech is expected to have revenues of approximately $3 trillion by 2030.  The panelists also discussed cleantech becoming its own sector and reference was made to a November 2009 report by Bank of America/Merrill Lynch entitled “A Stock Analyst’s View of Renewable Energy Technologies”.  The report says that cleantech will be the “sixth technology revolution” (i.e Industrial Revolution, Age of Information and Telecommunications), meaning that the next type of technology the world will operate on will be clean technology from natural resources.

* Cleantech Group LLC, an organization that advises investors and corporations interested in cleantech investing, provides a good overview of cleantech here.

Cleantech Hedge Funds

At a few points during the panel, the discussion went to cleantech hedge funds even though the panelists admitted there are not many cleantech focused hedge funds. Out of a potential universe of say 15,000 global hedge funds, the panelists had only identified around 120 funds focusing on the space. Many of these funds are part of larger hedge fund structures.  For instance, a manager may have a multi-billion dollar flagship fund and then create smaller funds focused on separate strategies or sectors such as cleantech. For many of these managers there is either a personal commitment to renewable energy or demand from mission-based investors (mostly on the high net worth side) for these products.

Of the funds that do focus on cleantech, most will be smaller ($50MM to $200MM) or very small ($10MM to $50MM).  Most of these funds will be either long/short or long only funds. The panel noted that while the cleantech “asset class” is relatively small right now, it is likely to become a larger part of the investing mandate going forward, so we are likely to see an increase (gradually, for right now) in the amount of funds focused on this space.

Challenges for Cleantech – Capital, Management, Government/Regulation

An overriding theme of the discussion was that, as an infant industry in the U.S., Cleantech faces a number various challenges including high capital requirements, relatively inexperienced management teams, and the lack of strong regulatory support.  Together these challenges help to explain why Cleantech in the U.S. is not as developed in other nations like China and Germany.

Perhaps the most difficult issue that the U.S. cleantech industry faces is an ambivalence from Washington and the states.  While some individual states are creating programs aimed to foster investments into cleantech and other earth friendly initiatives (see cap and trade below), at the federal level there are still massively unequal subsidies which are going to older poluting technologies.  In fact, the moderator asked whether the panelists believed that national legislation is “anti-cleantech” (i.e. subsidies to non-cleantech industries show bias toward legacy technologies), but the panelists disagreed.

Obviously consumers will be a driving force toward the allocation of more resources (tax breaks and tax dollars) to the industry even though it is not currently a high priority legislative issue for most Congressmen.  The fact is, however, that the U.S. is lagging other world leaders in cleantech – at several points in the discussion, the panelists made reference to the progress that China and Germany have made in the cleantech in comparison to the U.S. “We [the U.S.] are not at the top of the list”, one panelist said. “The gap is widening between the U.S. and China and Germany. Capital and technology is moving from the US to other countries.” It was noted that the cleantech industry needs to be concentrated domestically but should still have global outreach.

Cleantech Opportunities

Cleantech and institutional demand

One panelist pointed out that there are a number of attractive opportunities and that investors need to be poised to take advantage of these opportunities. Despite the drop in VC investment in the sector in recent years, cleantech remains the number one sector which VCs are allocating to.  (See page 16 of the Bank of America/Merrill Lynch report which contains statistics on venture capital investments in cleantech:

While the panelists were optimistic about the future of cleantech, the uncomfortable issue of risk-reward characteristics of investment in the sector was a predominant theme.  Essentially the sector returns (probably) do not justify investment right now because of the numerous risks, as described briefly above.  While more benchmarks are likely to be produced in the future (to appropriately identify those managers who can generate alpha), that will only be the first in a series of metrics which will need to be developed in order to appropriately quantify whether investment in the sector and certain companies is appropriate for investors.  Once the sector is more developed managers are more likely to be able provide the appropriate risk-return metrics to institutional investos, who themselves have to balance risk-return on a portfolio allocation basis.

For some investors, however, risk-return is not part of the investment equation.  Mission-based investors will make investments in the cleantech space because of their belief in the mission of the companies.  These mission-based investors are the groups which are more likely to be the allocating to cleantech managers and VCs at this point in time.

Carbon/Cap and Trade

The panel spent relatively little time discussing carbon and cap and trade systems.  While different from cleantech, carbon emission reduction through a cap and trade system (or systems) may present possibilities for future economic growth and investing and also present attractive potential opportunities for mission-based investors. However, post Copenhagen, it is clear that the major nations will need more time until any kind of comprehensive multi-national treaty is debated and ratified.  Resistance in the U.S. to a federal cap and trade system is keeping the price of carbon extremely low (in the voluntary systems), however Europe has proven that a mandated cap and trade market can work.  Political complexities, both at the national and international level, are likely to stall the development of a U.S. cap and trade regime.  Voluntary markets like the Regional Greenhouse Gas Initiative (RGGI), the Chicago Climate Exchange, and the Western Climate Initiative show that there continues to be strong interest in the cap and trade system.


While the discussion itself was not confined to the subject areas described above, and while the issues surrounding cleantech seem to make it a risky sector to be investing in, the panel and the audience showed great enthusiasm for the subject and the professionals in attendance seemed to feel that this is a sector which is poised for great growth in the future.


About Cole-Frieman &  Mallon LLP

Cole-Frieman & Mallon LLP is a San Francisco based law firm focused on the investment management industry. The firm’s services include hedge fund formation, startup services, investment adviser registration, and hedge fund consulting. Additionally, Cole-Frieman & Mallon LLP works with groups in the cleantech and carbon trading space.

Cole-Frieman & Mallon LLP is able to provide the following legal services to both domestic and offshore hedge funds:

  • Offer investment advice to funds interested in the purchase of carbon offsets
  • Provide legal advice to clients in regards to carbon market regulations
  • Assist hedge funds with the creation of investment projects that generate credits and offsets
  • Advise on marketing strategies for those clients interested in selling their carbon offsets or promoting their renewable energy projects
  • Provide networking opportunities with other lawyers engaged in the carbon market field
  • Advise clients on the policies and risks involved with credit trading

For more information, please call Bart Mallon Esq. at 415-868-5345.  Many thanks to Kristina Maalouf for her help with this article.

Securities Exam Changes in 2010

Series 63, Series 65 and Series 66 Changed as of January 1, 2010

In an earlier post, we discussed that the passing grades for the Series 65 and 66 have increased.  Below is further information from the Securities Training Corporation on the changes to the securities exams in 2010.


The Series 63, 65, and 66 Examinations Are Changing

The North American Securities Administrators Association (NASAA), the organization responsible for designing the Series 63, 65, and 66 Examinations, has informed us that the composition of these examinations will change as of January 1, 2010. The most significant impact will be on the Series 66 Examination, in which the balance of the questions will change significantly. In comparison, the changes to Series 63 and Series 65 are relatively minor.

Series 66

The Series 66 Examination currently consists of 100 questions, 80 of which test the candidate’s knowledge of Legal and Regulatory Issues (including Unethical Business Practices). The remaining 20 questions cover Investment Analysis, Recommendations, and Strategies.

The revised Series 66 will still contain 100 questions. As of January 1, 2010, however, there will be 50 questions covering Legal and Regulatory Issues and 50 questions testing Investment Recommendations, Strategies, and Products.

NASAA is also adding new topics to the Series 66 outline concerning specific Investment Products and Strategies, such as Annuities, much of which we already cover in our materials. NASAA stated that these changes are “based on responses to the survey indicating that dually licensed individuals should have enhanced testing in the areas of Economic Factors and Business Information, Investment Vehicle Characteristics and Client Investment Recommendations and Strategies.”

Series 65

The Series 65 Examination currently has 130 questions.  Of these questions, 45 test Legal and Regulatory Issues, while 80 questions cover Economic Concepts, as well as Investment Products, Recommendations, and Strategies. The new examination will still have a total of 130 questions, but the number of questions devoted to Legal and Regulatory Issues will decrease from 45 to 40. In addition, there will be a few questions on Capital Markets Theory and specific types of accounts, such as College Savings Plans.

Series 63

NASAA has not added new topics to the Series 63 Examination, and the test will continue to contain 60 questions. The distribution of these questions, however, will change on January 1, 2010.  There will be 3 more questions covering business practices (now called Ethical Practices and Fiduciary Obligations). There will also be an additional 6 questions devoted to the Registration and Regulation of Broker-Dealers, Agents, Investment Advisers, and Investment Adviser Representatives. The number of questions covering the Registration and Issuance of Securities will be decreased correspondingly.

STC will have supplemental material available in late November for students who anticipate taking one of these examinations in January. Our online practice examinations will be updated by January 1.


Other related hedge fund law articles:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

Fund Appreciation Rights

Alternative Hedge Fund Compensation Structure

At the very beginning of this year there was much discussion about the hedge fund compensation structure in light of the horrible returns from 2008.  Many funds lost money but managers aren’t typically subject to the same types of clawback provisions as private equity fund managers.  Additionally some funds had to close shop because of talent retention issues or because the manager realized that reaching a previous high water mark would take too long.  Generally investors who have lost money will prefer to stay in a fund (all else being equal) because of the high water mark – when investors go into a new fund, there high water mark is their initial investment which means they are going to be subject to hedge fund performance fees sooner than in a fund which has previously lost money.

FAR Alternative

As an alternative to the traditional performance fee/ allocation structure, some hedge funds are instituting a different compensation structure called fund appreciation rights (FARs).  Generally this structure provides a more aligned incentive structure for the manager.  Essentially the FARs provide an option like mechanism for the manager.  This option also has the potential to allow the manager to defer recognition of income which may be an added tax benefit for the manager.  [Note: a longer discussion on this issue will be forthcoming shortly.]

Issues with FARs

FARs are new.  It is not known how many groups have implemented FARs or whether they will catch on (or become the next standard).  It is likely that any movement in this area will be driven by the demand (if any) by institutional investors for such products.  FARs are also untested and it is not clear how they will be viewed by the IRS.  As we have recently seen, there has been a big push to disallow the tax advantages of the performance allocation to hedge fund managers and in the current political climate it is likely that the IRS will scrutinize such transactions.

We will continue to research and report on this and other tax structures for hedge fund managers.


Other related hedge fund law articles:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

Weekly Hedge Fund News Stories | November 30 – December 4

Below are a list of some of the news stories which caught my attention this week.


Hedge Fund Carried Interest Tax “Loophole” Repeal? – the hedge fund carried interest “loophole” is again being discussed as a potential issue to be addressed by Congress before the end of the year.  One proposal introduced by Representative Levin (R) has reportedly passed the House twice but is meeting opposition in the Senate.  Watch for a bill to be included as a last minute rider.  For more background, see articles by and Reuters.

Wall Street “Transaction Tax” Introduced in House
– A group of Congressmen introduced legislation to tax Wall Street.  According to a press release by Representative Peter DeFazio (D-OR), investment transactions (including stocks, futures, swaps, CDSs, and options) will be subject to “small” transaction taxes which could raise up to $150 billion a year.   The tax would not apply to certain groups like IRAs, mutual funds, and HSAs.  See also a SIFMA press release which discusses this issue.

Florida to Invest $500MM in Hedge Funds – managers who are looking for an allocation from a large pension plan should look toward Florida which is looking to get into hedge funds.  According an article on Pension & Investments, Florida has hired Cambridge Associates as a consultant to help with the search.

Positive November for Hedge Funds – Hedge fund managers gained an average of 1.8% in November according to this Market Watch article.


Other articles I liked this week:


There is a lot of chatter out there about hedge funds and insider trading.  Evidently the SEC is continuing to pursue large hedge fund groups who may have been involved.

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.