Monthly Archives: August 2008

Offshore hedge fund director requirements

Two of the most popular offshore hedge fund jurisdictions are the Cayman Islands and the British Virgin Islands. In another post I will detail the requirements for registration or recognition with these jurisdictions, but for the purposes of this article it is enough to point out that both jurisdictions will generaly require each hedge fund entity (in the case of a master feeder structure there would normally be two offshore entities) to have two directors.

Cayman Islands Director Requirements

In the Cayman there are two types of funds – (i) Cayman Islands Monetary Authority (“CIMA”) registered funds and CIMA non-registered funds. CIMA registration is required if a hedge fund is open-ended (allows investors the option to redeem) and has 16 or more investors. CIMA registration is not required if a hedge fund is closed-edned (does not allow investor the option to redeem) or if a hedge fund has 15 or fewer investors who have the right to appoint or remove directors.

For CIMA registered funds, there must be at least 2 directors who must be individuals. For non-CIMA registered funds, there must be at least 1 director who must be an individual. The individual directors do need not to be a Cayman resident.

BVI “four eyes” policy

In the BVI most hedge funds are deemed to be mutual funds. Because they are mutual funds, they will need to be “recognized” as such with the BVI’s Financial Services Comission (“FSC”).

Pursuant to BVI laws and statutes all companies (including hedge funds) are only required to have 1 director. However the FSC has just recently instituted a new “four eyes” policy which effectively requires that all funds have two directors (the “four eyes” policy has been applied for some time in relation to BVI-incorporated investment managers; however, its application to BVI based funds is a new development). This policy is not codified and it seems to be enforced only on a case by case basis. We are recommending to our clients that they name 2 directors because the liklihood of the FSC requiring 2 directors prior to recognition is quite high.

In the BVI a hedge fund can name a company to be a director.

Offshore Nominee Directors

Not all hedge funds will not have two persons who wish to serve as directors of the fund. The reasons may vary from unwanted perceptions to unwanted responsibilities. For whatever reason in these instances the hedge fund will need to name another person (or a company, for the BVI) which will serve as a director for the fund.

In such cases an offshore hedge fund manager may want to think about using a “nominee” director. There are companies in both the BVI and the Cayman Islands which can provide nominee director services, usually on an annual basis, for a fee. While these fees will depend on a number of factors, including the percieved risk of the fund and the manager, you will probably be looking at anywhere from US $5,000-$10,000 per year.

When searching for a nominee director we recommend shopping around as there are going to be groups which naturally feel more and less comfortable with your program. Some nominees will require some sort of involvement in the high-level affairs of the fund. Some nominees will also ask to be at least be co-signatories on any bank accounts opened in the name of the fund. These precautions are understandable as the nominee services are typically provided by services companies (registered office, registered agent, etc) who could potentially lose their license if something happens with the fund.

Directors from non-US jurisdictions

Please note with all directors the issue of perception. There have been recent instances of large brokerage firms refusing to establish brokerage accounts for some hedge funds because the directors (or even a director) were from states known to support terrorism. It will be a good idea to think about selecting a director who is from country which supports or sponsors terrorism. I do not think that this is a wide-spread practice; however, if a brokerage firm does not allow for the account formation because a new director will need to be appointed, you are going to end up delaying your launch.

Confidentiallity of Director information

In the BVI, the details of directors and shareholders of BVI funds is strictly confidential and not a matter of public record. Funds can if they wish elect to file a register or a document which details directors &/or shareholders but this is not common practice. Obviously the details of directors and shareholders may come into the public domian when they are distributed to third parties (e.g. administrators or auditors) but many times these third parties have previously agreed to keep also such information strictly confidential. Any information held by a fund’s registered agent, likewise, will be kept confidential unless required to be disclosed by order of the FSC (believing it to be in the best interests of the jurisdiction – this is not common and generally requires substantial proof of criminal activity), or a BVI Court.

Offshore Director due diligence requirements

Becoming a director of a company which acts as a hedge fund is not difficult but there are many due diligence requirements for all directors of these companies. While all jurisdictions will differ, the BVI and the Caymans will typically require the following documents from each director:

  • List of director details – name, address, etc
  • Copy of director utility bill – can include: gas, power, electric, water, television/cable, phone/internet; showing home address; notarized
  • Copy of director passport – showing a clear picture of the director, notarized
  • Director bank reference – should include length of relationship; may need to include average amount of assets
  • Director professional reference – should be from a lawyer or accountant who has had a previous professional relationship with the director
  • List of owners/shareholders of director (if an entity)
  • Copy of director formation documents (if an entity)
  • Other items as requested by the registered agent

Please contact us if you have any questions on any of the above or would like to inquire about a nominee director or establishing an offshore hedge fund.

SEC files complaint against forex fraud


Last Wednesday the SEC filed a complaint against a forex hedge fund manager who was supposedly using a “trading robot” to generate huge returns. It turns out the forex hedge fund manager and the trading robot did not generate the outsized returns, but instead lost investor money. There are two very important items to note here:

1. It is scams like this that has the SEC and CFTC on the offensive to regulate the spot forex market.

2. Again, it is so important for all investors to do proper due diligence on managers and to make sure they know what they are investing in. These fraudsters give a bad name to all hedge fund managers and, sometimes, they can be stopped if the right questions are asked in the beginning.

SEC Release:

Litigation Release No. 20688 / August 22, 2008

Securities and Exchange Commission v. Royal Forex Management, LLC and Patrick H. Haxton, (U.S.D.C., Northern District of Texas, Dallas Division, Civil Action No. 3:08-CV-1467-L)

SEC Accuses Carrolton, Texas, Man of Selling Fraudulent Securities Involving Foreign Currency Trading

On August 20, 2008, the Securities and Exchange Commission filed an action in Dallas federal court to halt an alleged unregistered and fraudulent offering of securities by Patrick H. Haxton of Carrollton, Texas, and his company Royal Forex Management, LLC (“Royal”). The securities were investment contracts involving the trading of foreign currencies on the Forex market. On August 21, 2008, United States District Judge Sam A. Lindsay entered a temporary restraining order suspending the offering and orders freezing the defendants’ assets, requiring sworn accountings, prohibiting any alteration or destruction of documents and expediting discovery. The court set a hearing for September 4, 2008 to consider the Commission’s application for preliminary injunctive relief.

The defendants named in the Commission’s Complaint are: Patrick H. Haxton, age 51, of Carrollton, Texas, the owner and sole manager of Royal; and Royal Forex Management, LLC, a Texas limited liability corporation operated out of Haxton’s Carrollton home.

The Commission’s Complaint alleges that from at least June 2007 to the present Haxton, personally and through Royal, raised at least $305,000 from 8 investors in three states. Haxton offers the Forex investments through the Royal web site (, advertising on his work truck and personal contacts. Royal’s promotional materials and Haxton’s oral statements are replete with representations of phenomenal past trading returns, including claims of 400% to 500% annual returns, generated by a complex software program named “The Currency Trading Robot” (“Trading Robot”), purportedly created by Haxton. On the web site, Haxton claims to have a great history and to have been a very successful trader since 2000. Haxton and the web site also represent that there is very little risk of loss.

The Commission alleges, however, that these representations are materially false and misleading. For instance, the Commission contends that Haxton and Royal never generated the claimed phenomenal returns by trading currency. Indeed, according to the Complaint, Haxton lost a significant portion of investor funds trading foreign currencies and misappropriated the remaining funds for his own personal use. In some instances, investor funds were never traded, but were used to pay business and personal expenses.

The defendants are charged with securities fraud under Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and with conducting an unregistered offering under Section 5 of the Securities Act. The Complaint also seeks permanent injunctions, civil penalties and disgorgement of ill-gotten gains, among other relief, against each defendant.

The Commission would like to thank and acknowledge the assistance of the Texas State Securities Board in this matter.

Hedge fund author fined $100k by the SEC for fraudulent hedge fund


Mark J.P. Boucher, the author of the book The Hedge Fund Edge, was involved in a hedge fund scam where he lured investors into a real-estate hedge fund which was was supposed to be secured by real property. The fund was not and investors lost millions of dollars. This underscores the necessity for hedge fund investors to protect themselves from these fraudsters by completing proper hedge fund due diligence. Please contact us if you have questions on hedge fund due diligence.

SEC Release:

Litigation Release No. 20689 / August 27, 2008
Securities and Exchange Commission v. Mark Joseph Peterson Boucher and Gary Paul Johnson,, Case No. CV 08-4088 (N.D. Cal. filed August 27, 2008); Securities and Exchange Commission v. John E. Brake,, Case No. CV 08-4089 (N.D. Cal. filed August 27, 2008)

SEC Charges Bay Area Investment Adviser, Others in Real Estate Investment Scam

The Securities and Exchange Commission today charged a Portola Valley investment adviser and newsletter publisher, Mark J.P. Boucher, with misleading clients into investing in two failed real estate development companies.

According to the Commission, Boucher helped raise around $20 million for the companies by falsely representing that the investments were secured by real estate, when in reality one of the companies owned no property, and the other owned a single property that was wholly underwater in debt. The Commission also sued the owners of each company, John E. Brake and Gary P. Johnson (both of Southern California) for misappropriating millions of dollars of investor funds to finance everything from beachfront homes to undisclosed side businesses. Boucher and Johnson have settled with the Commission without admitting or denying the allegations.

According to complaints filed today in federal district court in San Francisco, from 1999 through 2005, the defendants collectively raised about $20 million from investors based upon misrepresentations that the money would be used to fund large-scale real estate development projects and that the investments were secured by real property. In reality, the investments were not secured: one development company never owned property, and by the summer of 2002, the other company’s lone property was so heavily debt laden that its debts exceeded potential profits. In the end, neither company successfully developed a real estate project, and investors lost millions of dollars.

The Commission alleges that many investors became interested because Boucher — a hedge fund manager and the author of the book The Hedge Fund Edge — recommended the investments in a monthly newsletter he circulated to his advisory clients.

The Commission’s complaints allege that the defendants misused investor funds to pay for a wide variety of personal expenses. Among other things, Brake allegedly used investor funds to pay for a beachfront home rental in Carmel, California, luxury automobiles, a personal chauffeur, private jet travel, jewelry and designer clothing, while Johnson used investor funds to launch a failed furniture business. The Commission also alleges that Boucher used investor money to pay a portion of the mortgage on his personal residence.

Boucher, without admitting or denying the allegations in the Commission’s complaint, has agreed to a permanent injunction from further violations of Sections 17(a) and 17(b) of the Securities Act of 1933 (“Securities Act”), Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder (“Exchange Act”), and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. Boucher will also pay a $100,000 civil penalty. In addition, Boucher has consented to the institution of public administrative proceedings against him in which he will be barred from serving as an investment adviser with a right to reapply after five years.

Johnson, without admitting or denying the allegations, has likewise agreed to a permanent injunction from further violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Johnson has also consented to an order requiring him to disgorge more than $1.8 million in ill-gotten gains and approximately $700,000 in prejudgment interest, and to pay a civil penalty of $120,000.

Brake is charged with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The Commission is seeking injunctive relief, disgorgement, and civil money penalties against Brake.

MFA hires new lobbyist


WASHINGTON, D.C., August 26, 2008 — Managed Funds Association (MFA), the
leading trade association of the hedge fund industry, announced today that Roger Hollingsworth has been named executive vice president and managing director, government relations, effective September 8, 2008. He will be responsible for the implementation of the Association’s political and government relations outreach before the Executive Branch, Congress and relevantregulatory agencies. Mr. Hollingsworth joins MFA from the United States Senate Banking Housing and Urban Affairs Committee, where he served as deputy staff director and senior policy advisor to Committee Chairman Christopher J. Dodd (D-CT).

Richard H. Baker, MFA President and CEO, said, “We are extremely pleased to have
Roger join MFA in this important capacity. His exceptional credentials and proven skills are ideal for our Association, and we are confident that his expertise will help us facilitate an important expansion of MFA’s agenda as we deepen our policy engagement in Washington.”

Mr. Hollingsworth will work directly with Mr. Baker to develop and coordinate MFA’s
legislative and regulatory priorities and initiatives.

As deputy staff director of the Senate Banking Committee, Mr. Hollingsworth coordinated
strategy for moving the Committee’s financial services legislative agenda through the 110th
Congress, including measures recently enacted in response to the ongoing crisis in global
mortgage, credit and capital markets. Before joining Chairman Dodd’s staff in January 2007, he served as vice president and director, federal government affairs for Securities Industry
Association (formerly SIA, now SIFMA). In that position, Mr. Hollingsworth was a senior lobbyist responsible for member relations and advocacy of SIA’s legislative and regulatory priorities. Mr. Hollingsworth has previously served as deputy chief of staff and legislative director for Senator Jon S. Corzine, (D-NJ) and as banking committee aide to Senator Charles E. Schumer (D-NY).

Mr. Hollingsworth received his B.A. in communications and finance from University at
Albany, State University of New York.

About Managed Funds Association

MFA is the voice of the global alternative investment industry. Its members are
professionals in hedge funds, funds of funds and managed futures funds, as well as industry
service providers. Established in 1991, MFA is the primary source of information for policy
makers and the media and the leading advocate for sound business practices and industry
growth. MFA members include the vast majority of the largest hedge fund groups in the world
who manage a substantial portion of the approximately $2 trillion invested in absolute return strategies. MFA is headquartered in Washington, D.C., with an office in New York. For more information, please visit:

How to grow your hedge fund

There are several effective ways to grow your hedge fund. Many of those methods will be discussed and evaluated here. Obviously superior performance among investors with comparable risk is a great way to grow your fund. This section will delve into how investment teams can derive the superior performance that all funds strive for.

Character of the Management Team

There are certain key characteristics of successful investors that generally indicate whether the management team will be successful. A concentration on the business processes of the fund and consistent learning rather than daily results will generally lead to a knowledgeable management team. Most successful money managers understand that markets tend to be fickle and daily results are not always a good barometer of achievement. Hubris has the potential to plague intelligent investors; however, humility tends to lead to personal improvement and less risky investment strategies.

Investment managers should focus on their love for their work. Investors like to invest with people they can trust and those that exude a love for their work. A common trait amongst successful investors is a deep understanding of how investing induces the progress of our society. If investors have a sense that they are actually doing good for society, they tend to be more enthusiastic about their work which encourages investment. Investors should focus on the value that they provide to society. Many sophisticated investors want to believe in positive effects of their investments in addition to creation of wealth.

In addition, managers should focus on their skills rather than attempting to predict general macroeconomic trends. Successful managers know that there are always excellent opportunities in the markets to exploit. There are many trading strategies that successful investors can employ but the management team should focus on their abilities. Good management teams are patient. They fully understand their methodology. They rarely look for shortcuts or the easy way out.


Investment professionals aspiring to become masters will strive for understanding and be consistent in their philosophy. Novices tend to look for an easy way to succeed. New investors will extrapolate previously successful investment models in books and project future gains. Inexperience leads investors to search for immediate profits rather than the consistent model of return that successful long term managers achieve. Thus, patience and consistency is a virtue.

Understanding and Application of Economics

A superior understanding of market forces can lead to growth of a fund. Investors that align their investment strategies with the overall economic and liquidity environment tend to be more successful and are able to maximize profit in nearly all environments. An intrinsic understanding of the drivers of market prices and examples of investment success guides successful funds. In addition, staying dynamic and perceptive of changing market trends is vital to maintaining the edge that superior economic knowledge grants.

Being able to time the liquidity cycle of the market should be a determinant in how a fund allocates capital. It has been found that 97% of equities fall in a period of tightening while 90% of equities rise in a steep yield curve environment. In addition, liquidity cycles can be utilized to determine the attractiveness of foreign markets that actively trade stocks and bonds. In an increasingly flat economic environment understanding global liquidity and economic indicators is essential to most funds.

Asset Allocation

Large cash positions provide low returns but good investors should be patient within their preferred asset class. Thus, investors looking to grow their funds should seek out other asset classes in which to allocate capital. While investors should find asset classes that best match their portfolio, it has been found that allocating 10 to 25 percent of assets to actively managed futures can increase long term returns and decrease long term risk. Many studies have found that adding actively managed futures to a portfolio of stocks/bonds can decrease volatility and increase gains.

In addition, investors should understand the almost universally recognized truth that joining several risky investments into one portfolio decreases risk and raises return. Mixing together uncorrelated assets should smooth out long term performance and increase fund size as the investments will react to different market forces.

Effective Marketing

In today’s increasingly competitive market for the capital of sophisticated investors, hedge fund managers need to market their fund properly in order to encourage large infusions of capital. A hedge fund manager may not solicit investment into the fund through any “general solicitation” or “general advertisement” per SEC regulations and thus funds rely upon advisory services to raise capital. Hedge funds used to rely on networks of advisors and their high net worth clientele; however, with the increasingly flat investment world, hedge fund consultants can be easily contact via the internet. Hedge fund advisors utilizing the internet are subject to the same SEC regulations as traditional advisors. Operational websites must adhere to the following regulations: the site is password protected, there are no references to a specific fund on the home page, the internal contents of the website are only available to qualified clients, and prospective investors are required to wait thirty days before investing.

In addition, a hedge fund administrator may be helpful in marketing and managing the fund. A hedge fund administrator provides valuable third party resources that: reduce expenses of the fund, validate performance results to investors, increase the managers’ time available to focus on investing, and provide access to accounting and finance professionals.

Hedge funds can benefit from using banks as a prime broker as it provides many resources and most importantly a centralized clearing house for transactions. Prime brokerages also provide value-added services of: capital introduction, risk management advisory services, and consulting services. Outsourcing non-investment activities to another firm decreases distractions, allowing the managers to focus on investing.

Transparency and Simplicity

Hedge funds trying to grow should encourage capital infusion by being somewhat transparent and simple. Typically hedge funds want to be relatively opaque; however, increasing investors are requesting more information and a minimum level of transparency for effective due diligence in now usually required. A level of transparency can be accomplished with an operational website that complies with all regulations. Many investors may not seriously consider investment in a fund without a website. In addition, managers should list performance on hedge fund databases. Acknowledgment of outperforming associated risk benchmarks on a hedge fund database will typically induce some investors to choose your fund over another.

CTA registration requirement and exemption

Question: does my commodity/futures trading firm need to register as a CTA?

Answer: Generally Section 6m(1) of the Commodities Exchange Act (“CEA”) requires that any person (or firm) which falls within the definition of a CTA be registered as such. Section 6m(1) of the CEA states:

“It shall be unlawful for any commodity trading advisor or commodity pool operator, unless registered under this chapter, to make use of the mails or any means or instrumentality of interstate commerce in connection with his business as such commodity trading advisor or commodity pool operator”

The Commodities Exchange Act (“CEA”) specifically defines a Commodity Trading Adviser (“CTA”) as:

“any person who– (i) for compensation or profit, engages in the business of advising others, either directly or through publications, writings, or electronic media, as to the value of or the advisability of trading in– (I) any contract of sale of a commodity for future delivery made or to be made on or subject to the rules of a contract market or derivatives transaction execution facility; (II) any commodity option authorized under section 6c of [the CEA]; or (III) any leverage transaction authorized under section 23 of [the CEA]; or (ii) for compensation or profit, and as part of a regular business, issues or promulgates analyses or reports concerning any of the activities referred to in clause (i)”

Because the above definition is quite broad, Congress specifically excluded certain groups from the definition. These groups include:

  • any bank or trust company or any person acting as an employee thereof;
  • any news reporter, news columnist, or news editor of the print or electronic media, or any lawyer, accountant, or teacher;
  • any floor broker or futures commission merchant;
  • the publisher or producer of any print or electronic data of general and regular dissemination, including its employees;
  • the fiduciary of any defined benefit plan that is subject to the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq.);
  • any contract market or derivatives transaction execution facility; and
  • such other persons not within the intent of this paragraph as the Commission may specify by rule, regulation, or order.

I have previously discussed how to register as a CTA in the article titled How to register as a CPO or CTA.

Question: are there any exemptions from CTA registration?

Answer: Yes. Section 6m(1) of the CEA states:

That the [registration] provisions of this section shall not apply to any commodity trading advisor who, during the course of the preceding twelve months, has not furnished commodity trading advice to more than fifteen persons and who does not hold himself out generally to the public as a commodity trading advisor. [emphasis added]

To fall within the above exemption, both elements must be met. That is, the CTA must

  • have less than 15 clients over the preceeding 12 months and
  • not hold himself out generally to the public as a CTA

The question then becomes what does “holding out” as a CTA entail?

The CFTC views “holding oneself out as a CTA” to include such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contact with prospective clients. Thus, unless a CTA restricts his clients to family, friends, and existing business associates, a CTA generally will be viewed as holding himself out to the public as a CTA and would not be able to claim the exemption from registration in Section 6m(1).

The CFTC specifically gave such guidance in the following letter.

CFTC Letter No. 97-26
March 26, 1997
Division of Trading & Markets

Re: Section 4m(1): Exemption from CTA Registration

Dear [_______]:

This is in response to your letter dated January 29, 1997 to the Division of Trading and Markets (the “Division”) of the Commodity Futures Trading Commission (the “Commission”), whereby you inquire as to whether you may claim an exemption from registration as a commodity trading advisor (“CTA”) pursuant to Section 4m(1) [now 6m(1)] of the Commodity Exchange Act (the “Act”). *

Based on your letter, we understand the pertinent facts to be as follows. You intend to sell subscriptions to a fax service (the “Service”) entitled “A”, of which you are the sole designer. The Service will provide subscribers with buy and sell recommendations for Eurodollar futures and option contracts traded on “X”.

Section 4m(1) [now 6m(1)] of the Act generally requires that a person who provides commodity interest trading advice to the public must register as a CTA. Section 4m(1) does, however, provide an exemption from registration as a CTA for a person who satisfies two conditions: (1) during the course of the preceding twelve months, he has not furnished commodity trading advice to more than fifteen persons; and (2) he does not hold himself out generally to the public as a CTA. The Division views “holding oneself out as a CTA” to include such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contact with prospective clients.** Thus, unless a CTA restricts his clients to family, friends, and existing business associates, a CTA generally will be viewed as holding himself out to the public as a CTA and would not be able to claim the exemption from registration in Section 4m(1) [now 6m(1)]. This is true whether or not the CTA is advising fifteen or fewer persons, since in order to qualify for the Section 4m(1) exemption, the CTA must satisfy both conditions. [Emphasis added]

Thus, if you plan to solicit clients other than immediate family members, friends, and business associates, you would be holding yourself out as a CTA and would be required to register as such prior to marketing the Service. You would also be required to comply with all other provisions of the Act and Commission’s regulations thereunder applicable to registered CTAs, including Section 4b and Section 4o,*** the antifraud provisions of the Act, Part 4 of the Commission’s regulations applicable to CTAs, and the reporting requirements for traders set forth in Parts 15, 18, and 19 of the Commission’s regulations.

The advice provided herein is based upon the representations that you have made to us. Any different, changed or omitted facts or conditions might require us to reach a different conclusion. In this connection, we request that you notify us immediately in the event your activities change in any way from those as represented to us.

If you have any questions concerning this correspondence, please feel free to contact me or Monica S. Amparo, an attorney on my staff, at (202) 418-5450.

Very truly yours,

Susan C. Ervin

Chief Counsel

* 7 U.S.C. §6m(1) (1994).

** Division of Trading and Markets Interpretative Letter 91-9, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,189 (Dec. 30, 1991). We have enclosed a copy of this letter for your reference.

*** 7 U.S.C. §§ 6b and 6o (1994).

SEC fines adviser and revokes registration

The SEC fined an investment adviser and revoked its registration because of willful refusal to follow simple investment adviser rules such as updating form ADV and submitting to a reasonable examination of its books and records.

From SEC website:

Commission Declares Decision as to Amaroq Asset Management, LLC and Dwight Andre Sean O’Neal Jones Final

The decision of an administrative law judge ordering Amaroq Asset Management, LLC, and Dwight Andree Sean O’Neal Jones to cease and desist from committing or causing any violations or future violations of Section 204 of the Investment Advisers Act of 1940 and Advisers Act Rule 204-1 has been declared final. The law judge further ordered that the registration of Amaroq Asset Management, LLC be revoked; that Dwight Andree Sean O’Neal Jones be barred from association with any investment adviser, with a right to apply for association after one year; and ordered that Jones pay a civil penalty in the amount of $15,000.

The law judge concluded that Jones willfully aided and abetted and was a cause of Amaroq’s failure to: (1) file annual amendments to Form ADV; (2) promptly update its Form ADV to reflect its current business address; (3) submit to a reasonable examination and failing to furnish copies of the required books and records in connection with the scheduled examination. The law judge found that Jones showed indifference and/or a series of broken promises, when Commission attorneys repeatedly and explicitly informed him of the law’s requirements, thereby demonstrating extreme recklessness. (Rel. IA-2770) Finality Order; File No. 3-12822)

For final decision, click here.

What licenses do you need to start or manage a hedge fund?

Question: What licenses do you need to start or manage a hedge fund?

Answer: This is a question that comes up quite often. Many people wonder whether they need a series 7 license or the series 65 license or the series 3 to manage a hedge fund. First, a potential hedge fund manager does not need to have a series 7 license in order to manager a hedge fund. The series 7 license is the general securities representative licese which allows an individual to be a representative (broker) of a FINRA registered member firm (brokerage firm or broker-dealer). The series 7 allows a representative to take and place trades for a customer. It is also a prerequisite for many of the other FINRA exams (such as the series 24). Because the hedge fund in not regulated as a broker, a hedge fund manager does not need to have a series 7 license (assuming that the manager is also concurrently acting as a broker-dealer representative).

Second, a start up hedge fund manager may need to have a series 65 license in order to become registered as an investment adviser. There are two potential ways a hedge fund manager would be required to register as an investment adviser – under the federal rules (the Investment Advisers Act of 1940) or under the various state rules (commonly referred to as the state blue sky laws). If a manager is required to register with the SEC under the Advisers Act* then, for federal purposes, the manager will not need to have taken the Series 65. However, the Advisers Act allows states to impose certain requirements on all federally registered investment advisers with a place of business in their state. Generally the states will require all federally registered investment advisers to “notice file” in their state which entails paying a fee to the state. The state can also require that all investment adviser representatives have the series 65 license. This means that anyone who talks to clients/investors or makes any trading decisions or analysis will need to have this license. The definition of investment adviser representative basically encompasses every employee or owner of the investment adviser other than secretary type employees. If you are a federally registered investment adviser you should discuss whether members of your team need to be licensed as representatives at the state level.

If you are not a federally registered investment adviser (generally all managers with less than 30 million of assets under management) then you will need to determine whether your management firm needs to be registered as an investment adviser at the state level. Many states require investment advisers with a place of business** in the state to register. Some popular states that require investment adviser registration are California, Texas, Washington and Colorado. However, there are many states which have exemptions from the registration requirements. Some popular states that have exemptions (through regulation or special order) from investment adviser registration for hedge fund managers are New York, Connecticut, Florida and Georgia. Again, you should speak with your legal counsel or compliance professional to determine whether your hedge fund management firm will need to be licensed as an investment adviser in the state.

Finally, if the hedge fund trades futures or commodities then the manager may need to be registered as a commodity pool operator with the National Futures Association. In order to register as a commodity pool operator at least one person at the management company will need to take the Series 3 exam. For more information on the Series 3 exam and this part of the registration process please read how to register as a CPO or CTA.

* Many potential hedge fund managers are confused with whether a management company will need to be registered as an investment adviser with the SEC. The answer is that in most cases a hedge fund manager will not have to be registered as an investment adviser with the SEC because of an exemption provision within the investment advisers act. Section 203(b)(3) of the Advisers Act specifically exempts from the registration provisions “any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser …” The term “client” in the hedge fund context means a “corporation, general partnership, limited partnership, limited liability company, trust …, or other legal organization … to which you provide investment advice based on its investment objectives rather than the individual investment objectives of its shareholders, partners, limited partners, members, or beneficiaries…”

This means that as long as a hedge fund manager will not need to count the investors in the hedge fund as his “client” and that the hedge fund itself is the only “client.” You will probably recall that a couple of years ago the SEC proposed a change to the rules under the Advisers Act that required a manager to count all of the investors in the hedge fund as clients. Under the proposed rule hedge fund managers would have been required register with the SEC (if they had at least $30 million under management), but Phillip Goldstein successfully challenged the SEC in court. His successful challenge to the rule change allows hedge fund managers to escape SEC regulation.

** “Place of business” of an investment adviser means: (1) An office at which the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and (2) Any other location that is held out to the general public as a location at which the investment adviser provides investment advisory services, solicits, meets with, or otherwise communicates with clients.

India Embraces Private Equity Funds

The following is a press release from the international law firm Walkers discussing private equity funds in India.  The release can be found here.

India Embraces Private Equity

Walkers, the global offshore law firm of choice for companies, financial organizations, and international law firms reports that private equity has emerged as a popular financing option in India for capital investment and expansion programs.

“The global credit crunch has tightened the availability of banking finance, forcing investors in India and worldwide to reach out to private equity funds as an alternative source of funding their capital investment/expansion programs. Despite India’s recent weakened economic outlook and inflation at a 13-year high, the infrastructure sector continues to attract global equity funds,” Caroline Williams, Private Equity partner in Walkers’ Cayman office, said. “Additionally, India is realizing increased interest from offshore money, which will be invested into the national infrastructure program over the next five to seven years.”

In 2007, India attracted more private equity funds than China, and also has more private enterprises. The high priority for development of infrastructure, anticipated to need US$500bn in the next five years, makes construction one of the most popular segments for investments. As an example, last month, Red Fort announced an infrastructure fund focused on ports and power station development that is estimated to raise in excess of US$600m by the end of 2008. The company has already closed seven deals in the real estate market worth US$200m in the first half of 2008 and anticipates investing another US$300m by the end 2008 to make a total of around 10-12 deals in 2008.

“The driving motivation for foreign direct investment inflows into India continues to be double tax treaties associated with offshore jurisdictions. Private equity funds establish wholly-owned subsidiaries in offshore jurisdictions to invest into the Indian target company,” said Philip Millward, a Private Equity partner in Walkers’ Hong Kong office. “Clients of Walkers’ Hong Kong office have established Special Purpose Vehicles (SPVs) in the Cayman Islands and British Virgin Islands to operate as holding companies for investments into India. These SPVs typically invest into underlying Indian investee companies via a wholly-owned subsidiary established in a country that has a double tax treaty with India, namely Mauritius, Singapore, or Cyprus. By creating an offshore holding structure, the private equity fund may avoid transferability restrictions on an eventual exit from the underlying investment.”

Despite some concern over valuations of Indian companies, the high growth of the Indian economy has kept it attractive to private equity.  Private equity investment has risen consistently from US$2.03bn in 2005 to US$17.14bn in 2007. And the deals are getting bigger. In 2007, 48 deals of over US$100m were closed compared to 11 deals of over US$100m in 2006.

“Private equity funds are extremely keen to identify and invest in growth opportunities in the Indian pre-IPO market. This enthusiasm, coupled with a lack of viable investment opportunities in other markets, has made private equity financing an easier source of capital than financial institutions that are scaling back their lending activities in emerging markets,” said Richard Addlestone, a Private Equity partner in Walkers’ Cayman office. “However, private equity’s insistence on taking quasi-management positions within the investee companies can be perceived as an encroachment on the funded company’s ability to independently control the growth and direction of the business. This can often lead to a focus on short- to medium-term growth to facilitate an exit for the private equity fund, not longer term strategies.”

Sovereign wealth funds (“SWF”), such as Temesek, Dubai Investment Corporation and others are also investing heavily in India.  SWFs tend to be known more for providing cash rather than management expertise. However, SWFs are evolving, hiring staff with similar skills to those in private equity houses and morphing into a type of private equity firm, themselves and so leveling the playing field.

“While India does present some challenges due to the strict restrictions of the Indian Companies Act, 1956 and the material regulatory barriers if a fund investing in India is not a member of IOSCO, we anticipate continued interest in India, and more activity from India investors,” continued Mr. Millward. “By working with a sophisticated law firm that has vast experience both in private equity funds and in the Asian markets, institutional investors and global financial organizations can leverage the power of this emerging market.”

Related HFLB posts include:

CFTC order levies major fine on hedge fund trader


The CFTC ordered a hedge fund manager who operated four commodity pools to pay more than $279 mm in restitution to prior hedge fund investors as well a $20 mm civil penalty for his fraud. The manager concealed huge losses from investors by issuing false account statements which reflected consistently profitable trades. The hedge fund manager also misappropriated some of the investor’s assets.

Press Release:

Release: 5531-08
For Release: August 19, 2008

Hedge Fund Trader Paul Eustace and Philadelphia Alternative Asset Management Co. Ordered to Pay More Than $279 Million to Defrauded Customers and More than $20 Million in Civil Monetary Penalties in CFTC Action

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that Paul Eustace of Ontario, Canada, was ordered to pay more than $279 million in restitution and a $12 million civil penalty, based on an order that resolves a CFTC enforcement action against him for defrauding commodity pool participants in four pools that he managed.

The court also entered an order of default judgment against the commodity pool operator that Eustace controlled, the Philadelphia Alternative Asset Management Co. (PAAM), imposing permanent trading and registration bans, requiring payment of restitution of approximately $276 million, subject to offset by prior disbursements and payments by Eustace, and imposing an $8.8 million civil monetary penalty.

The supplemental consent order, entered by the Hon. Michael M. Baylson of the U.S. District Court for the Eastern District of Pennsylvania on August 13, 2008, follows a July 13, 2007 consent order of permanent injunction against Eustace that enjoins Eustace from further violations, and imposes permanent trading and registration bans.

“This concludes a successful effort by our Division of Enforcement to stop fraud in its tracks, return as much money as possible to defrauded investors, and to bring wrongdoers to justice,” said CFTC Acting Chairman Walter Lukken.

The orders arise out of a CFTC complaint filed on June 21, 2005, and later amended, against Eustace and PAAM. (See CFTC Press Release 5091-05, June 29, 2005.)

At the outset of the litigation, the CFTC’s action froze all the assets under the control of PAAM and Eustace and preserved more than $70 million for return to pool participants. The CFTC also obtained the appointment of a receiver to recover and distribute funds to defrauded participants. Through related receivership litigation, an additional $96 million has been obtained to date for the benefit of defrauded pool participants. Defendants’ restitution obligation shall be offset by any funds distributed through the receivership.

As alleged in the amended complaint, and as the 2007 consent order found, from at least the spring of 2001 through June 2005, Eustace fraudulently operated four commodity pools: the Option Capital Fund LP (Option Capital Fund); and, through PAAM, the Philadelphia Alternative Asset Fund, L.P. (LP Fund); the Philadelphia Alternative Feeder Fund LLC; and the Philadelphia Alternative Asset Fund, Ltd., an offshore fund with over $250 million in assets. During this time, Eustace incurred losses of approximately $200 million trading commodity futures and options either in accounts held in the name of the funds or in his name. Eustace concealed those losses by issuing or causing to be issued, false account statements reflecting highly and consistently profitable trading results. Eustace also misappropriated assets of the Option Capital and LP Funds and received incentive and management fees through his fraudulent operation of the pools. Eustace was also charged with fraudulent solicitation and registration violations.

The CFTC Division of Enforcement appreciates the assistance of the Ontario Securities Commission and the National Futures Association in this matter.

In December 2007, the CFTC issued a related order filing and settling failure to supervise and recordkeeping charges against MF Global, Inc. (MFG), a registered futures commission merchant, and Thomas Gilmartin, a former associated person of MFG relating to their mishandling of certain trading accounts managed by Eustace and PAAM that sustained losses of approximately $133 million. MFG and Gilmartin paid collectively $2.25 million in civil monetary penalties and Gilmartin agreed never to seek registration with the Commission. (See CFTC Press Release 5427-07, December 26, 2007.)

The following CFTC Division of Enforcement staff members are responsible for this case: Gretchen L. Lowe, Michael J. Otten, Kara Mucha, Glenn I. Chernigoff, Richard B. Wagner, and Vincent McGonagle.