Monthly Archives: October 2008

Differences between the Series 65 and the Series 66

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Hedge fund managers who must register as investment advisor representatives with the SEC (through notice filings) or the state securities commission will need to have the proper FINRA exam licenses. Generally this means that the hedge fund manager will need to have passed the Series 65 exam within two years of registration (or the license must not have been inactive for two years prior to the registration).

However, if a manager has a Series 7 exam license, he will only need to take the Series 66 exam instead of the Series 65. This would generally be a good idea because the Series 66 exam is easier than the Series 65 exam and managers should be able to pass the Series 66 with less effort than the Series 65. I have detailed below the different requirements for the Series 65 versus the Series 66

Series 65 Exam

  • 140 multiple choice questions
  • 10 pre-test; 130 count towards score
  • 180 minutes to take the exam
  • Must achieve a 72% to pass
  • Test covers: economics and analysis; investment vehicles; investment recommendations and strategies; and legal and regulatory guidelines, including prohibition on unethical business practices.
  • NASAA test outline link.

Series 66 Exam

  • 110 multiple choice questions
  • 10 pre-test; 100 count towards score
  • 150 minutes to pass the exam
  • Must achieve 72% to pass
  • Test covers: much of the material included on the Series 65, but it does not include the product, analysis and strategy questions that are a large part of the Series 65.
  • NASAA test outline link.

Other related articles include:

If you have any questions, please contact us.

Hedge Fund Due Diligence Firm Expands

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This week we’ve seen a deluge of hedge fund press releases which indicate that the industry which supports hedge funds remains strong a growing.  The press release below provides details on a hedge fund due diligence firm which is expanding its operations.  In the coming months and years hedge fund due diligence is poised to become a central part of the hedge fund investing process.

October 14, 2008

Gillian Scott, CA CFA, Joins Castle Hall Alternatives as Managing Director; Castle Hall Opens Office in Halifax, Nova Scotia

MONTREAL – Castle Hall Alternatives, a leading provider of hedge fund operational due diligence, announced today that Gillian Scott, CA CFA, has joined the firm as Managing Director. She will lead the firm’s new presence in Halifax, Nova Scotia, where Castle Hall joins several leading administrators and other service providers to help establish a growing pool of hedge fund expertise in Canada.

Gillian previously held the position of Group Financial Controller of The Atlantic Philanthropies, a leading international philanthropy with an investment portfolio in excess of $4 billion. Gillian was a key contributor to the design and development of the group’s operational due diligence process, completing due diligence reviews for a significant portion of Atlantic’s portfolio. She was also responsible for Atlantic’s group audit and internal control environment. Prior to joining Atlantic in 2001, Gillian was an audit manager with the Bermuda office of PricewaterhouseCoopers, where she was responsible for a wide range of hedge fund and investment related audits.

Gillian is a member of the Canadian Institute of Chartered Accountants and is also a CFA (chartered financial analyst) charterholder.

Commenting on her new role, Gillian said “in the current markets, hedge fund investors face multiple challenges that, more than ever, involve operational risk. Investors must understand many new issues, including counterparty risks, the impact of FAS 157 and how to deal with funds which impose gates, suspend redemptions or restructure. Castle Hall helps investors enhance their due diligence program and better respond to these new challenges.”

Chris Addy, Castle Hall’s President and CEO, said “we are delighted to welcome Gillian to our firm and expand our presence to Nova Scotia. Castle Hall’s unique due diligence model enables us to provide the objective and fully independent advice that investors need to navigate today’s markets. We are particularly proud to have assembled what is now the industry’s largest and most experienced team dedicated solely to operational due diligence on behalf of the investor community.”

Hedge Fund Administrator Tests Prime Brokerage Waters

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There was a previous press release about a hedge fund prime broker expanding its services.  We can see from the press release below that hedge fund adminsitrators are also expanding their service offerings.  I believe the reason for the expansion in the service offerings of these firms indicates a belief that the hedge fund space will continue to grow.  It also indicates that hedge fund service providers are looking to be more diversified – these service providers are looking to become one stop shops for hedge fund managers.

Conifer Securities Launches Prime Brokerage Through J.P. Morgan Chase

NEW YORK, Oct 15, 2008 /PRNewswire via COMTEX/ — Move Comes as Hedge Funds Look for New Financing and Prime Brokerage Options

Conifer Securities, a leading provider of business and operations solutions to asset managers and institutional investors, today announced that it has entered the prime brokerage business. Working with J.P. Morgan’s Broker Dealer business services, Conifer is now building upon its Fund Administration and Outsourced Trade Execution services by offering hedge funds a full-suite of prime brokerage services including financing, securities lending, asset custody and daily account reporting. J.P. Morgan’s capital position, extensive capabilities and innovative approach stand out during the current market volatility.

The ongoing financial turmoil and growing interest in counterparty diversification have created a strong demand for additional, experienced prime brokers to step in and service hedge funds. Many hedge fund managers today want to create relationships with multiple prime brokers who can provide alternate sources of financing as well as premium service. Given its 19-year track record as a top-tier hedge fund service provider, the agreement to clear and custody with J.P. Morgan puts Conifer in a very strong position to provide managers with alternative prime brokerage and financing sources.

Conifer’s move into the prime brokerage business is being spearheaded by Richard (Dick) Del Bello, who has more than 15 years of prime brokerage experience, including seven years as the head of prime brokerage for the Americas at UBS.

“The credit crisis and subsequent market turbulence have transformed our industry as hedge funds shift assets to the most financially stable investment and commercial banks,” said Mr. Del Bello. “At the same time, some of the large prime brokers are squeezing the tails of their client rosters, eliminating hedge fund accounts that aren’t suitable for their business–and that’s where Conifer comes in.”

Jack McDonald, Conifer’s president & CEO, added, “J.P. Morgan’s prime brokerage offering is the perfect complement to Conifer’s core middle and back office business, resulting in our emergence as a leading prime broker to hedge funds. Given our existing relationships with all of the other major prime brokers, we can also service established hedge funds requiring multiple relationships by providing them with centralized reporting and an infrastructure otherwise available only to the largest funds. Conifer has successfully expanded its business through the cyclical market extremes of the last twenty years. This in-depth experience and broad expertise will provide the stability and support our client partners need in growing their business.” McDonald concluded.

In addition to its prime brokerage services, Conifer provides comprehensive middle- and back-office services to its clients including: global fund accounting and administration, trade operations, outsourced trade execution, executive office space, compliance, corporate accounting, consulting services and business infrastructure.

Press Release: Hedge Fund Prime Broker Expands Services

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Contrary to the spate of terrible news regarding the financial markets, the hedge fund industry, specifically, the hedge fund service provider industry is poised and ready for continued growth.  The following press release showcases a prime brokerage firm which is actually expanding its operations.

Merlin Securities Expands Client Services Team to Keep Pace with Business Growth

Industry Veteran Michael Tumulty to Lead Client Services in New York David Newman and Walter Paleski Join as Account Executives

SAN FRANSCISCO, Oct 14, 2008 – Merlin Securities, a leading prime brokerage services and technology provider for hedge funds, funds of funds and long-only managers, today announced that it has hired Michael Tumulty, an industry veteran with more than 25 years experience, to head its New York client services team. The firm also hired David Newman and Walter Paleski as account executives in the New York office.

“Merlin is benefitting from the monumental shift taking place in the prime brokerage industry, specifically the movement toward multiple prime brokers and a focus on custodial risk,” said Aaron Vermut, senior partner and chief operating officer of Merlin Securities. “Having experienced account executives in place is critical to maintaining our commitment to outstanding client service. I am delighted to welcome Mike, Walter and Dave to the team.”

Michael Tumulty has more than 25 years of financial services experience, most of which has focused on prime brokerage. Most recently he was a director of financial client management at Merrill Lynch’s prime brokerage, where he worked closely with the firm’s top-tier hedge fund clients. Prior to that, he was with Bear Stearns for 17 years as a director of hedge fund client services. Tumulty holds an M.S. in investment management and a B.S. in business administration.

David Newman is returning to the prime brokerage industry after successfully co-founding and serving as president of Holedigger Studios, an independent film company. Previously, he served as vice president of operations for GH Associates and managed relationships with hedge fund clients at the prime brokerages of Banc of America Securities and ING Furman Selz.

Walter Paleski brings more than 20 years of industry experience and was most recently at CastleRock Asset Management as financial controller, operations manager, and trader. Previously he was a senior account executive for prime brokerage hedge fund clients at ING Furman Selz and, prior to that, Morgan Stanley. Paleski began his career with Shearson Lehman.

Overview of Regulation D for Hedge Funds

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Interests in hedge funds are securities which mean that hedge fund managers must follow the federal (and state) laws regarding the sale of securities to investors.  Typically, securities will need to be registered under the Securities Act of 1933 unless there is an exemption from the registration provisions.

There are two main exemptions from the registration provisions – Section 4(2) of the Securities Act and the Regulation D (also known as “Reg D”) safe harbor rules promulgated by the SEC under Section 4(2).  Typically hedge funds will offer their securities pursuant to the Regulation D safe harbor and specifically under Rule 506 which allows a hedge fund to offer an unlimited amount of interests to investors.

Below is a quick synopsis of the Regulation D rules (I have left out Rule 507 and Rule 508).  I have also posted all of the rules here: Regulation D Rules.  Most important to hedge fund managers will be Rule 502 which requires that the manager not engage in any public solicitation and Rule 506.

Rule 501 – Definitions and Terms Used in Regulation D

In general this rule defines certain terms used in the rest of the rules.  The most important definition is probably the accredited investor definition.

Rule 502 – General Conditions to Be Met

In general, this rule discusses certain aspects of the offering which should be met.  A fund’s attorney will be familiar with these issues.

Specifically, this rule addresses certain integration issues, the information which must be provided to investors who are not accredited investors and the limits of resale of interests in a Regulation D offering.  Most importantly, the rule does not allow fund managers to engage in any sort of general solicitation.  Because this is really the most important aspect of the rule for hedge fund managers, I will include this section explicitly below:

c.  Limitation on manner of offering. Except as provided in Rule 504(b)(1), neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

1.    Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and

2.    Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising;

Provided, however, that publication by an issuer of a notice in accordance with Rule 135c shall not be deemed to constitute general solicitation or general advertising for purposes of this section; Provided further, that, if the requirements of Rule 135e are satisfied, providing any journalist with access to press conferences held outside of the United States, to meeting with issuer or selling security holder representatives conducted outside of the United States, or to written press-related materials released outside the United States, at or in which a present or proposed offering of securities is discussed, will not be deemed to constitute general solicitation or general advertising for purposes of this section.

Because of the broadness of this rule, hedge fund managers should consult with their attorney if they have any question regarding the prohibition on general advertising.

Rule 503 – Filings of Notice of Sales

In general this rule outlines of the requirement for hedge fund managers to file Form D with the SEC within 15 days of the first sale of securities.  See link below on blue sky filings for more information.

Rule 504 – Exemption for Limited Offerings and Sales of Securities Not Exceeding $1,000,000

This rule is known as the intrastate offering exemption, and generally this provides an exemption from registration if the offering  of hedge fund interests is made wholly intrastate and if the amount to be raised is less than $1million.  Few if any hedge funds will utilize this exemption.

Rule 505 –  Exemption for Limited Offers and Sales of Securities Not Exceeding $5,000,000

In general, this rule provides that an offering is exempt from registration if the issuer raises $5 million or less over any 12-month time period.  This rule also provides that there can be no more than 35 non-accredited investors.

Rule 506 – Exemption for Limited Offers and Sales without Regard to Dollar Amount of Offering

In general, this rule provides that an offering is exempt from registration if the fund raises money from no more than 35 non-accredited investors, provided that all non-accredited investors, either alone or with his purchaser representative(s), has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.  This rule does allow a hedge fund to sell an unlimited dollar amount of interests.

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The discussion below from the SEC on regulation D offerings is aimed more at hedge fund investors and the hedge fund due diligence which such investors should engage in; the discussion can be found here.  Managers are urged to discuss the Regulation D offerings with their hedge fund attorneys.

Regulation D Offerings

Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D (or Reg D) contains three rules providing exemptions from the registration requirements, allowing some smaller companies to offer and sell their securities without having to register the securities with the SEC. For more information about these exemptions, read our publications on Rules 504, 505, and 506 of Regulation D.

While companies using a Reg D exemption do not have to register their securities and usually do not have to file reports with the SEC, they must file what’s known as a “Form D” after they first sell their securities. Form D is a brief notice that includes the names and addresses of the company’s executive officers and stock promoters, but contains little other information about the company.

If you are thinking about investing in a Reg D company, you should access EDGAR Company Search to determine whether the company has filed Form D. If the company has filed a Form D, you can request a copy. If the company has not filed a Form D, this should alert you that the company might not be in compliance with the federal securities laws.

You should always check with your state securities regulator to see if they have more information about the company and the people behind it. Be sure to ask whether your state regulator has cleared the offering for sale in your state. You can get the address and telephone number for your state securities regulator by calling the North American Securities Administrators Association at (202) 737-0900 or by visiting its website. You’ll also find this information in the state government section of your local phone book.
For more information about the SEC’s registration requirements and common exemptions, read our brochure, Q&A: Small Business & the SEC.

HFLB note: other articles you may be interested in are:

Please contact us if you have any questions.

Hedge Fund Investors Overview

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The lifeblood of the hedge fund industry are hedge fund investors, those persons and institutions which put their money at risk with the hope of generating positive investment returns.  While there have been recent predictions of large amounts of investor money leaving the hedge fund space due to poor performance, there are many potential hedge fund investors who are just beginning to warm to the idea of investing in a hedge fund.

Who can invest in a hedge fund?

In general there are two types of hedge funds which are open to different types of investors.

Section 3(c)(1) hedge funds are open to investors who are both accredited investors and qualified clients. An accredited investor is generally an individual with a $1 million dollar net worth (can include the equity in the investor’s primary residence) or an individual who has made $200,000 in each of the two most recent years (or joint income with that person’s spouse in excess of $300,000 in each of those years) and has a reasonable expectation of reaching the same income level in the current year.  A qualified client is generally an individual with a $1.5 million dollar net worth.  Because investors will need to be both an accredited investor and a qualified client, many hedge fund managers will just say that the investor needs to be a qualified client as it has the higher net worth threshold.

Section 3(c)(7) hedge funds are open to qualified purchasers, which is a higher net worth threshold than for the accredited investor or qualified client standard.  A qualified purchaser is generally an individual investor with a $5 million dollar liquid net worth (cannot include the equity of the investor’s primary residence).

Occasionally you will see some Section 3(c)(1) hedge funds which allow non-accredited investors to invest in the fund.  In such instances, the fund will typically charge the non-accredited investor a higher management fee because the non-accredited investor cannot be charged a performance fee.  In general, hedge fund managers will not allow non-accredited investors into the hedge fund except for very close family and friends.

Why would someone invest in a hedge fund?

Hedge funds have historically been viewed as nimble investment vehicles run by savvy managers who are able to produce steady and absolute returns.  Hedge funds come in a variety of different sizes (from the one-man shops to the multi-billion dollar operations) and strategies.  The great diversity of funds and their investment objectives is what makes them exciting, but which also makes it difficult to describe them as a whole.  Suffice it to say that whatever investment strategy an investor is looking for, there is a hedge fund which would be able to meet the needs of that investor.

Who can recommend hedge fund investments?

Hedge fund investments are made through private placements according to the Regulation D offering rules.  This means that only the hedge fund manager and certain hedge fund brokers can offer an investor interests in a hedge fund, and that is only if the manager or the broker has a pre-existing relationship with the investor.  There are some ways which investors can gain access to hedge funds, most notably through hedge fund databases.

What should an investor do before investing in a hedge fund?

At a minimum an investor should carefully read the hedge fund’s offering documents.  An investor should also discuss any questions or concerns with the hedge fund manager.  Additionally, I always recommend that investors conduct some sort of due diligence on the hedge fund and the manager.

HFLB note: we are not recommending that readers invest in hedge funds and we are not recommending any specific hedge funds.  If an investor makes an investment into a hedge fund, any such investments should be made only after consultation with such investor’s legal and accounting advisors.

Other articles you may be interested in:

Overview of New Form D for Hedge Funds

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As we noted in a previous post about filing Form D online, Form D has been changed and I believe that the new Form D is a great improvement and is more appropriate for hedge fund offerings.  As we’ve noted before, many of the securities laws were drafted in the 1930s and 1940s and have not been overhauled to accommodate the current practices within the securities industry.  With the new Form D, we see a giant step forward and commend the SEC on producing a form which asks questions which are appropriate for both operating businesses and hedge funds.

The new Form D is cleaner and easier to read.  There is plenty of space for explanations if a hedge fund’s structure does not exactly fit the parameters of a specific question.  The new Form D also has great instructions on how to complete the various items.

Please note that hedge fund managers should have a hedge fund lawyer or compliance person complete and submit Form D on their behalf.  The SEC expects that each Form D will take approximately 4 hours to complete.  Please click to view a copy of the new Form D .

Items by Item run through of the new Form D is below:

Item 1. Issuer’s Identity – background information on the issuer including name, entity type, year of organization.

Item 2. Principal Place of Business and Contact Information

Item 3. Related Persons – should include the hedge fund manager;  additionally there is a continuation page where the manager will include key members of the management entity.

Item 4. Industry Group – there is a specific box for hedge or other investment funds.  This is a significant improvement over the old Form D which did not include anything like this.

Item 5. Issuer Size – hedge funds will now provide an aggregate net asset value range, which is a more appropriate inquiry.

Item 6. Federal Exemptions and Exclusions Claimed – here most hedge funds will check at least a couple of boxes, your attorney or compliance professional will be able to help you with this.

Item 7. Type of Filing – you will provide information on whether this is a new filing or an amendment to a previous filing.  The instructions to the Form D provide a list of times when it is necessary to file an amendment.

Item 8. Duration of Offering – generally hedge fund interests are offered on a continual bases and the hedge fund will accordingly indicate that the offering will last greater than one year.

Item 9. Type(s) of Securities Offered – the hedge fund will typically check two boxes here.

Item 10. Business Combination Transaction

Item 11. Minimum Investment – old Form D also required this information

Item 12. Sales Compensation – if a hedge fund uses a broker or a third party marketer to raise money then the hedge fund will need to provide certain information on the broker or third party marketer.

Item 13. Offering and Sales Amounts – here hedge funds will typically check “Indefinite” where appropriate.

Item 14. Investors – the SEC requests information on whether there have been sales to persons who are not accredited investors (typically referred to as non-accredited investors)

Item 15.  Sales Commissions and Finders’ Fees Expenses – here the hedge fund will provide more information on the transactions discussed in Item 12.

Item 16. Use of Proceeds

Other related articles of interest:

Hedge Fund Administration – New Issues for Managers to Consider

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I came across another very good article which examines the new landscape of the hedge fund industry and brings up some pertinent points which both hedge fund managers and investors should be aware of.  The issue is that many of the prime brokerage firms and very large global banks have established administration businesses to cater to the ever growing hedge fund industry.  While this expansion gives managers more choices for administration (and arguably better service as admin and other back office functions, like banking, can be handled by one organization), it does create new risks that both managers and investors should investigate.  This article details some of the issues which should be considered; these issues should probably be talking points between the manager and the administrator during the process of choosing an administrator.   The original article can be found here: www.castlehallalternatives.com.

How will the credit crisis impact the administration industry?

In the past two weeks, Fortis has been rescued not once, but twice.  While hardly at the top of the priority list in times of global economic meltdown, it’s still an interesting question to ask what would have happened to Fortis’ administration business if the bank had ceased operations.

Thinking of a different point, it’s also ironic – and fortuitous – that Lehman was one of the few of the prime brokers which had not decided to create a fund admin sideline to help attract managers to the firm’s PB services.

In this environment, however, both hedge fund managers and investors need to evaluate the stability and viability of fund administration entities.  There is both a possibility of direct bankruptcy and also a risk that a parent entity in financial distress could decide to close a peripheral admin business in short order.
We can immediately think of several issues:

1) If the administrator goes bankrupt, do funds have a contingency plan in place to enable them to continue operations?  Do hedge funds have copies (ideally electronic) of the administrator’s accounting which could be given to a new provider?

While audit firms in the US may not agree with us (they tend to audit the manager’s accounting and largely ignore the admin), the offshore administrator’s accounting forms the official books and records of a hedge fund.  If the administrator is no longer in business, does the fund have a contingency plan to recover those records so that the next NAV can be struck on a timely basis?

2) Administrators usually control cash movements for subscriptions, redemptions and fund expense payments.

Do these cash movements pass through a cash account within the administrator?  This would, of course, expose a fund to loss if cash is sitting in an account at the time of bankruptcy.

More discreetly, does the administrator use some form of commingled Escrow account to receive incoming subscriptions and perhaps hold cash until anti money laundering procedures have been completed?  Are hedge funds sure that these assets are properly segregated and controlled?

Separately, if the administrator is the only one with signing authority over the offshore bank account, can the manager withdraw any residual cash and process new redemption and expense payments if the signatories are no longer available?

3) If administrators complete anti money laundering and know your customer checks, does the hedge fund have access to these records to prove that AML has been performed in the event that the admin is bankrupt?

4) Does the hedge fund have access to the full shareholder’s register / list of partners capital accounts to identify all investor balances in the event that the administrator is bankrupt?

More generally, it’s worth noting that many administration companies are small, independent firms which may not be well capitalized.  In an environment which sees a sharp fall in hedge fund assets through both negative performance and net redemptions, administrators’ fees will also fall. Administrator financial viability is, therefore, a real issue for both managers and investors as we navigate the coming year.

HFLB note – other related articles include:

Press Release: Hedge Fund White Paper Indicates Growth in Family Office Investments

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The press release below discusses a report on investments in hedge funds by single family offices.  The report finds that single family offices are willing to invest in hedge funds and also lays out some of the major concerns about hedge fund investing.  The central issue for single family offices is transparency in the underlying hedge fund.  This indicates that hedge funds are likely to see a rise in the request for due diligence on the fund and management company.

SINGLE FAMILY OFFICES BOLSTER ALTERNATIVE INVESTMENT SECTOR

New Survey from CPA Firm Rothstein Kass Finds Nearly 75% of Single Family Offices Invest in Hedge Funds
Almost 60% Plan to Increase Allocations to Alternative Investments in the Next 12 Months

Roseland, NJ – October 14, 2008 – The alternative investment sector will continue to benefit from increasing asset allocations from Single Family Offices (SFOs), according to “On the Rise,” the latest research report sponsored by CPA firm Rothstein Kass. The white paper, co-sponsored by G Capital highlights the growing relationship between the alternative investment community and SFOs, entities established to serve the needs of individual high-net-worth families. “On the Rise” was co-authored by Russ Alan Prince, a leading authority and counselor on private wealth, and Hannah Shaw Grove, a widely recognized expert on behaviors and finances of high-net-worth individuals. Among notable findings:

  • Almost three-quarters of SFOs currently invest in hedge funds, with nearly 60% of this group planning additional allocations in the coming year
  • SFOs with hedge fund allocations hold an average of 3.2 hedge funds or fund-of funds in the portfolio
  • Nearly 70% of SFOs with hedge fund allocations report that these investments have met or exceeded performance expectations over the past 12 months
  • Over 80% of respondents reported 24 month performance was ‘as expected’ or better
  • More than 70% of SFOs with hedge fund allocations report “lack of transparency” as a key concern. Other concerns sited include lock-up periods (60%), style drift (55%) and fraud (37%)

“Single Family Offices are trusted and highly valued by high-net-worth families they serve because of the individualized attention and customized solutions they provide to holistic wealth management. However, our research suggests that persistent market volatility has placed added importance on the asset allocation function. As SFOs consider an ever-expanding range of investment options, they are increasingly turning to the alternative investment sector and its proven ability to deliver superior returns independent of underlying market conditions,” said Rick Flynn, a Principal in Rothstein Kass’ Family Office Group. “Moreover, our findings suggest that performance continues to drive alternative investment allocations. Nearly 70% of those polled said that performance over the last 12 months has been ‘as expected’ or ‘better than expected.’”

The “On the Rise” survey was based on telephone interviews with 146 SFOs and was concluded in August 2008. Investable assets ranged from $312.2 million to $1.3 billion, with a median of roughly $500 million. Just under 60% of the firms polled are based in the Americas, with the balance operating in Europe (21%) and Asia (20%). Additional results were generated from only those entities with reported allocations to the alternative investment sector. For the purposes of this research, SFOs are defined as “created exclusively for or by a single exceptionally wealthy family to provide control, negotiating leverage, and a defense for family members.”

“’On the Rise’ details the latest evidence of the growing interrelation between SFOs and the alternative investment community. While high-net-worth individuals generally recognize advantages of hedge fund investing, they are frequently confounded by the growing roster of products and services available. SFOs have had great success in bridging this knowledge gap,” said Peter Gerhard, Chief Executive Officer of G Capital Management LLC. “Still, lingering challenges face this blossoming relationship. Both transparency (73%) and style drift (55%) rated as key concerns among respondents. It seems that although high-net-worth families are comfortable involving SFOs in the asset allocation process, they themselves retain a level of involvement. Investors need to feel confident that the funds that have been selected are not only good choices in the moment, but reflect overarching and longer-term investment objectives.”

About Rothstein Kass:

Rothstein Kass is a premier financial services firm, recognized nationally as a top service provider to the alternative investment industry. The Firm provides audit, tax, accounting and consulting services to hedge funds, fund of funds, private equity funds, brokerdealers and registered investment advisors. Rothstein Kass is recognized nationally as a top service provider to the industry through its Financial Services Group. The Financial Services Group consults on a wide range of organization, operational and regulatory issues. The Firm also advises on fund structure, both inside and outside the US, compliance and financial reporting, as well as tax issues from a federal, state, local and international compliance perspective. Rothstein Kass has offices in New York, New Jersey, California, Colorado, Texas and the Cayman Islands. www.rkco.com

The Rothstein Kass Family Office Group offers a wide range of financial, wealth planning and lifestyle management services to family offices and high-net-worth individuals, including family members, business owners and members of the financial services, entertainment and sports industries. Composed of seasoned financial professionals and certified public accountants, the Rothstein Kass Family Office Group applies proven expertise with the utmost discretion and attention.

About G Capital Management LLC

By leveraging state-of-the-art capital markets expertise and select advanced planning concepts, G Capital has raised the bar for the next generation of family offices. In addition to the highly effective and sophisticated solutions its family members require, the organization’s structure and capabilities create an efficient, scalable and profitable operating environment that can be readily adapted to capture new businesses opportunities.

About the Authors:

Russ Alan Prince is the world’s leading authority on private wealth, the author of 40 books on the topic, and a highly-sought counselor to families with significant global resources, and their advisors. He is co-author of Fortune’s Fortress: A Primer on Wealth Preservation for Hedge Fund Professionals.
www.RussAlanPrince.com

Hannah Shaw Grove is a widely recognized author, columnist, speaker and an expert on the mindset, behaviors, concerns, preferences and finances of high-net-worth individuals. She is co-author of Inside the Family Office: Managing the Fortunes of the Exceptionally Wealthy.
www.HSGrove.com

Section 3(c)(1) Hedge Funds

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Almost all hedge funds which trade securities are deemed to be “investment companies” under the Investment Company Act of 1940.  All “investment companies” are required to register under the Investment Company Act (like all mutual funds must do) unless the “investment company” falls within an exemption from the registration provisions.

There are two separate exemptions from the registration provisions of the Investment Company Act.  This post deals with the more common Section 3(c)(1) exemption which generally requires that the hedge fund have 100 or fewer investors.

Not Owned by More Than 100 Investors

A 3(c)(1) hedge fund is exempt under the Investment Company Act provided that the fund is beneficially owned by not more than 100 investors and is not making a public offering of its securities.  The actual text of Section 3(c)(1) provides:

None of the following persons is an investment company within the meaning of this title: Any issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities. Such issuer shall be deemed to be an investment company for purposes of the limitations set forth in subparagraphs (A)(i) and (B)(i) of section 12(d)(1) [15 USCS § 80a-12(d)(1)(A)(i), (B)(i)] governing the purchase or other acquisition by such issuer of any security issued by any registered investment company and the sale of any security issued by any registered open-end investment company to any such issuer. For purposes of this paragraph:

(A) Beneficial ownership by a company shall be deemed to be beneficial ownership by one person, except that, if the company owns 10 per centum or more of the outstanding voting securities of the issuer, and is or, but for the exception provided for in this paragraph or paragraph (7), would be an investment company, the beneficial ownership shall be deemed to be that of the holders of such company’s outstanding securities (other than short-term paper).

(B) Beneficial ownership by any person who acquires securities or interests in securities of an issuer described in the first sentence of this paragraph shall be deemed to be beneficial ownership by the person from whom such transfer was made, pursuant to such rules and regulations as the Commission shall prescribe as necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this title, where the transfer was caused by legal separation, divorce, death, or other involuntary event.

Certain Look Through Rules

Part A above provides “look through” provisions for certain entity investors.  This rule provides that if another 3(c)(1) hedge fund (the “Investor Fund”) owns more than 10% of another 3(c)(1) hedge fund (the “Investee Fund”) then the Investee Fund would count all of the investors of the Investor Fund as investors as well.  This rule is designed to prevent the pyramiding of 3(c)(1) funds to avoid the application of the mutual fund registration rules.  Through various no-action letters the SEC has provided further guidance in this area which we will be writing about shortly.

Types of 3(c)(1) Investors

Generally speaking investors in Section 3(c)(1) hedge funds will be both accredited investors and qualified clients.  A 3(c)(1) fund must limit its investors to qualified clients if it wants to charge a performance fee.

Other related articles include:

For more information on mutual funds in general, mutual fund investment programs and investing in mutual funds, please see investing in no load mutual funds.  No load mutual funds are funds which do not have a front or back end load because the distribution fees are usually paid through section 12b-1 fees.

Please contact us if you have any questions.