Monthly Archives: October 2008

Hedge Fund Administrator – What is a Hedge Fund Administrator?

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A hedge fund administrator is a service provider to the hedge fund; the main job of the administrator is to provide certain accounting and back office services to a hedge fund as detailed below.

Hedge fund administrator services

Generally, administrators will provide a variety of services to the hedge fund manager.  The central service is monthly or quarterly accounting of investor contributions and withdrawals and computing the profits and losses for the accounting period.  The administrator may also provide other back end services such as transfer agent services (handling the subscription documents and making sure checks are cashed or wires are appropriately handled).

A relatively new service which some administrators provide is a “second signer” service which is designed to give investors greater confidence that a hedge fund manager will not run off with their money.  Under a “second signer” agreement, the hedge fund manager will need to get a sign off from the administrator before the manager can make a transfer or a withdrawal from the fund’s account.

In addition to the above, the hedge fund administrator may perform the following duties:

  • calculating the management fee and performance fee
  • working with the auditor
  • keeping certain financial records
  • may act as the registered agent and registrar (offshore hedge funds)
  • Anti Money Laundering review (generally only for offshore hedge funds)

Three types of hedge fund administrators

Small administration firms – these types of administrators are very lean organizations which are controlled and run by one or two people.  Typically the one or two people will have significant experience in the hedge fund industry, many times with other administration firms, hedge fund audit firms and hedge fund consultants.  The typical client will be a start-up hedge fund.  While these administrators can handle funds with assets of up to and sometimes beyond $500 million, most of their clients will generally start with less than $50 or $100 million.

These administrators are going to be the most cost-effective solution for a start up hedge fund.  Additionally, these administrators often provide some of the best customer service – usually the manager will be able to talk to the principal at any time.  For these administrators, the manager will be looking at a start-up fee of anywhere from $500 – $1,500 and then a monthly administration fee of $750 – $1,500.

Medium-sized firms – these firms are usually established businesses with strong structure, have been around for a while, and have a fairly large and established client base.  It is expected that a medium-sized firm would have one to two principals with 10-20 years of experience in the hedge fund industry.  These firms will have clients that range in size from $50 to $500 million and may have clients which have $2 to $5 billion in assets.

Medium-sized firms will charge a start-up fee of $1,500 or more and will usually base their administration fee as a percentage (basis points) of AUM, subject to a minimum monthly fee which is usually around $2,000.

Large firms – these firms are well-established within the hedge fund industry and are thriving businesses themselves.  These firms may be subsidiaries of large international banks or (former) investment banks.  The principals of these firms are well-connected to the major players in the industry and most of the clients of these firms are the large hedge funds.  If a hedge fund uses a large firm for administration, the fund should expect to pay a minimum of around $5,000 a month.  Because of the relatively high costs of the large administrators, it may not make sense for a fund with less than $250 million to use such an administrator.

Offshore hedge fund administration

Offshore hedge fund administration generally refers to the administration of an offshore hedge fund.  Typically the process and function will be the same, but there are more issues that come into play with an offshore hedge fund.  Because offshore hedge fund fees can be structured in a variety of ways, the administrator may want to discuss the structure with the hedge fund attorney if there are any uncertainties with the structure.

Questions on hedge fund administrators

1.  How do I find a hedge fund administrator?

There are many ways you can find a hedge fund administrator and other hedge fund service providers.  Your hedge fund attorney can help recommend a administrator based on the needs of your fund.  Please note that not all administrators offer services to all types of hedge funds.  Please contact us if you would like us to recommend a hedge fund administrator (or if you have any other hedge fund administration questions).  Additionally, you can reference this survey of hedge fund administrators.

2.  Who pays for the costs of the administrator?

As I noted in an article on hedge fund expenses, the costs of the administrator are usually paid by the fund and not by the management company.  Some managers may choose to pay the administration costs so that these costs will not be a drag on performance.  You should discuss this issue with your attorney.  Additionally, please note that the costs above are general guidelines – if your strategy requires more in-depth valuation practices  (i.e. the fund trades hard to value instruments), the administration costs may be higher.

3.  Does a start-up hedge fund need an administrator?

Yes.  While there is no law that requires a domestic hedge fund to have an administrator, there is no real good reason why a hedge fund should not have an administrator.  Outside verification of a hedge fund’s numbers, especially given the current state of the capital markets, is becoming a requirement for hedge fund investors.  Additionally, there are law firms which will not work with start-up hedge funds that do not have an administrator.  Another consideration is the audit – if there are no independent third party numbers to review, the audit becomes more difficult and potentially more costly.

Hedge Funds in the BVI – new requirement to submit annual information

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The British Virigin Islands (BVI) is a popular jurisdiction for many offshore hedge funds to be located.  The BVI is known to have good financial oversight and relatively reasonable offshore hedge fund formation fees.  Over the past year the BVI Financial Services Commission (FSC) has become more involved in hedge fund oversight as political pressure increases.  It is expected that the BVI’s Mutual Funds Law will undergo changes within the next 6 months to a year because of this political pressure.

In addition, on September 9 the FSC surprisingly announced that BVI hedge funds (known as “mutual funds” in the BVI) will need to submit a yearly Annual Return to the FSC which provides information about the fund to the FSC.  This is a new requirement for all BVI based hedge funds.  Before this year the FSC had a voluntary mutual funds survey which requested information similar to the information requested in the Annual Return.  Certain closed end funds (generally private equity funds established in the BVI) will not need to submit the Annual Return.

BVI Annual Return Requirement

The items a fund will need to submit are:

–    Basic information on the fund and its service providers, including the registered agent
–    Financial information including:

Beginning NAV
Total subscriptions
Total redemptions
Net income/ net loss
Dividends/ distributions
Ending NAV
Year end gross assets

–    General description of the fund’s asset allocation (but not individual positions)

The Annual Return will need to be submitted to the FSC by June 30 of 2009.  Funds which do not submit the Annual Return by that date may face an enforcement action.

A sample Annual Return can be found here: sample-annual-return

What this means for offshore hedge funds

With regard to this new requirement, current BVI funds are going to need to complete the Annual Return.  While the Annual Return will not be a huge resource drain, it will take some time to complete.  Generally most of the questions can be answered fairly quickly by the hedge fund manager or by an assistant.  Some of the information may require input from the hedge fund administrator and potentially the hedge fund attorney as well.

In the future, this seems to be the first step towards greater scrutiny and disclosure requirements from offshore hedge fund jurisdictions.  However, it is unclear whether this will affect the number of start up funds which will be based in the BVI as the intrusion is relatively mild.  However, it may mean that other offshore jurisdictions such as Nevis, Guernsey and Dubai become more popular in the future.

Please see guidance from here from Maples and Calder, an offshore law firm: BVI Annual Return Requirement

Hedge Fund Liquidation Procedure

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It has been a tough year for many managers and there are many funds that will be shutting their doors before the end of the year.  Funds may decide to close their door for many reasons which might range from poor performance to large amounts of investor withdrawals.  While many of the managers and traders at these funds will go on to work for other firms, many of these managers and traders will start new hedge funds and potentially with some of the same investors.

In either case, there are a few things that a hedge fund manager will need to do in order to ensure the orderly liquidation and winding down of the hedge fund.

Liquidation pursuant to the offering documents

The hedge fund limited partnership agreement or LLC agreement (part of the hedge fund offering documents) will set out the manner in which the dissolution and liquidation of the fund will proceed.  Generally there will be some sort of liquidation and then final accounting.  The timing of these will be determined by the offering documents.

Talk with the hedge fund service providers

A manager should first contact his hedge fund attorney to inform him of the plans to close down the fund.  The lawyer will be able to help guide the manager through the process and will be able to help with any issues which may arise.  The auditor, broker and administrator should also be contacted so that these service providers can begin their own processes for winding the fund down.  During the wind down process, the manager should expect to talk with each of the service providers a few times.

Inform your investors

A manager will need to inform the investors that the fund will be winding down.  The manager will probably want to do this through some sort of letter.  After the manager has discussed the wind down with the attorney, the attorney can help the manager draft the letter.  The letter should inform the investors that the fund will be closing and also let the investors know what steps are being taken before the final liquidation is complete.  The manager may also ask the investor how the final proceeds should be sent to the investor – either through wire or through a check.  Additionally, if the manager is going to be starting a new hedge fund, he may want to mention this in the letter.  (However, the manager will need to be careful that the mention of the new fund does not rise to the level of a public offering – the attorney can discuss this with the manager.)

During this time, it is critical for the manager to keep the lines of communication with the investor open.  During a wind down when emotions are high, investors may be looking for any reason to complain or create a reason for a suit against the general partner.  It is most important to be honest during these times.

Make the final wind down and distributions

The final wind down is the process of liquidating all of the fund’s positions to cash and then transferring the fund’s assets to the fund’s bank account.  From the bank account, the manager will then be able to distribute the assets to the investors pursuant to the final accounting by the administrator and/or auditor.

Provide the final audit

The auditor will provide final audited financial statements to the manager who will then provide these statements to all of the investors in the fund.  Usually the final audit will be completed prior to the actual distribution of the assets to the investors in the fund.

Close down the entities

After the final audit and distribution to the investors, the manager will want to close down, or cancel, the fund entity.  To do this the attorney will:

  1. Submit articles of cancellation to the Delaware Secretary of State to close down the entity.  The filing fees for this are typically $200-$300 dollars payable to Delaware.
  2. Pay any outstanding Delaware franchise taxes.  Generally these are going to be less than $200, but it will depend on the fund.  The attorney will be able to contact Delaware to determine the amount of the taxes owed.
  3. Provide the manager with an explanation of how to contact the IRS about the canceled entity.
  4. Contact the registered agent in Delaware to cancel registered agent services with them.

The above is a rough outline of the steps involved in closing a Delaware entity and will usually be completed by a paralegal in a few hours.  There are more steps involved with the process of closing down an offshore entity which will depend on the jurisdiction of the fund.  Generally the wind down process for each offshore entity will range in cost from $800 – $3,000 or more depending on the circumstances of the wind down.
Additionally, the hedge fund manager should also decide whether the hedge fund management company will also need to be wound down.  In many cases, the entity will be kept alive in order to serve a future purpose for the manager; in some cases the management company will serve as the general partner to a new hedge fund.

Potential roll over issues

For mangers who are simultaneously closing one hedge fund and starting another, a common practice is to simply roll the assets from the old fund to the new fund.  In such instances the manager will definitely need to have close contact with all of the service providers to ensure a smooth transition.  Additionally, there may be some issues which the manager will need to discuss with counsel if there are tax-exempt entities in the old fund.

If you have any questions on the process, please feel free to contact us at any time.

Hedge Fund IRA Investments

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Individual retirement account (IRA) investments into hedge funds are increasing rapidly.  Below are some common questions hedge fund managers have about potential investments by IRAs.

Can an IRA invest in a hedge fund?

Generally yes, however the IRA and the hedge fund must make sure to follow certain regulations which a manager should discuss with a hedge fund attorney.    A manager should not accept IRA investments into the hedge fund without first discussing this with his lawyer.

How does an IRA actually make the investment into the hedge fund?

Each IRA investment into the hedge fund needs to be made by the custodian of the IRA.  That is, the beneficial owner of the IRA cannot simply take the money out of his IRA account and then place the money in the hedge fund – this would be deemed to be a withdrawal from the IRA and would be subject to very negative tax consequences.

In order to avoid these negative tax consequences the custodian needs to directly transfer the IRA assets to the hedge fund.  Typically this is done through a self directed IRA account at a brokerage firm.  Many brokerage firms do not have these self directed programs in place.  If the brokerage firm does not have such a program in place the beneficial owner of the IRA would need to transfer the IRA to another custodian which does.  Our law firm has worked with many custodians who have these programs and we can make recommendations.

Each custodian has different requirements for an investment into a hedge fund from an IRA.  Typically the hedge fund manager is going to need to fill out a few pages of paperwork with the custodian and provide custodian with the fund’s offering documents.  After the custodian’s compliance department has reviewed the paperwork, the custodian will be able to make the investment into the fund on behalf of the IRA.  During this process the hedge fund manager is going to be spending time talking with the custodian and the compliance department.  Additionally the law firm may need to be involved with the process as well; however, this is usually to a much lesser extent.

Are there any other issues with IRA investments into hedge funds?

Yes.  There are many issues which a hedge fund manager should be aware of which include the following:

1.  The manager should be sure that the hedge fund and the management company do not engage in any prohibited transactions with respect to the fund and the IRA.  [More on this in a later article.]

2.  The manager should make sure that if it uses any sort of leverage that such activities are clearly discussed in the fund’s offering documents.  In certain circumstances where there is leverage, an IRA could be subject to tax on its unrelated business taxable income or UBTI.

3.  The manager should make sure that the fund does not stray from its investment program.  IRA are not allowed to make certain investments like investments in life insurance policies (life settlements).
As noted in an earlier article on hedge funds and ERISA, while IRAs are not specifically ERISA assets, they do count towards the 25% threshold and thus the manager needs to be aware of the amount of IRA and other ERISA assets in the hedge fund.

HFLB Note

Because of the gravity of the tax consequences to potential IRA investors, please contact your hedge fund attorney or accountant if you have specific questions about IRA investments into your fund.  Additionally, savvy hedge fund investors will usually want to make sure that their own tax advisors have reviewed the hedge fund offering documents before investing in the fund.

Please contact us if you have any questions on the above.  Also, please read our disclaimer with regard to discussions about tax items.

Hedge Fund UBTI (unrelated business taxable income)

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Hedge fund investors are always cognizant of the potential tax consequences of an investment into a hedge fund.  One of the issues which a hedge fund manager should be aware of is the concept of unrelated business taxable income or UBTI.

What is UBTI and why is it important?

As it relates to a tax-exempt investor in a hedge fund, UBTI is debt financed income derived by the hedge fund which does not relate to the activities of the tax-exempt investor.  As hedge funds are “flow through” vehicles, the designation of income as UBTI flows through the tax-exempt investor.  This is important because the tax-exempt investor must pay tax (called the unrelated business income tax or UBIT) on that portion of the income received by the fund which is UBTI.  UBTI is generally going to be taxed at a 35% rate.
Is there a way to get around UBTI?

There are two ways to make sure that tax-exempt investors do not receive any UBTI.  The first and most obvious is to make sure that the fund will use no leverage.  Because this might not be an option for some hedge funds, and because these funds would like to receive assets from tax-exempt entities, another option is for the fund to create an offshore hedge fund (either through a side by side structure or a master feeder structure).  In these structures that income does not “flow-through” to the investors like with the domestic hedge fund, but rather the income is paid to the investors through a dividend which is generally not taxable to a tax-exempt organization.  Using an offshore structure in this manner is often described as using a “blocker” because the UBTI is blocked out.

Do short sales give rise to UBTI?

Short sales alone do not give rise to UBTI.  The IRS has specifically provided guidance to the hedge fund community on this issue.  Please see Revenue Rule 95-8.  However, if a hedge fund borrowed money to engage in the short sale, this would probably give rise to UBTI.  If the fund utilizes short sales and engages in no leverage activities, then the there will likely be no UBTI with regard to the short sales.

What are the tax code provisions dealing with UBTI?

The following are links to the tax code dealing with UBTI:

Section 511 – provides for a tax on UBTI

Section 512 – defines UBTI and provides for the pass through treatment of UBTI to tax-exmpt investors in a fund (see 512(c))

Section 513 – provides a definition for “unrelated trade or business.”

Section 514 – provides additional definitional support for determining the amount of UBTI under section 512.

Third Party Marketing Press Release

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Hedge Fund Third Party Marketing Firm, Agecroft Partners, Hires 5th Managing Director

Hedge fund third party marketing firm, Agecroft Partners which recently received the 2008 Third Party Marketer of the Year award, has hired its 5th Managing Director, Jarratt Ramsey. Jarratt spent the last 11 years at multi-billion dollar hedge fund Chesapeake Capital Management. Jarratt’s responsibilities will include: assisting with due diligence on potential hedge funds the firm may represent and introducing the firm’s hedge fund clients to large institutional investors located within the Northern region of the United States.

Richmond, VA (PRWEB) October 6, 2008 — Hedge fund third party marketing firm, Agecroft Partners which recently received the 2008 Third Party Marketer of the Year award, has hired its 5th Managing Director, Jarratt Ramsey. Jarratt spent the last 11 years at multi-billion hedge fund Chesapeake Capital Management. Jarratt’s responsibilities will include: assisting with due diligence on potential hedge funds the firm may represent and introducing the firm’s hedge fund clients to large institutional investors located within the Northern region of the United States.

“Jarratt is a wonderful addition to our firm. Our business model is to introduce large well established hedge funds in a consultative manner to institutional investors. It is imperative that the members of our firm are highly technically competent. Jarratt’s educational and professional experiences are very impressive. Furthermore, his knowledge of the hedge fund industry, and security markets should give him a lot of credibility with large institutional investors,” stated Agecroft Partners’ Managing Partner Don Steinbrugge.

Agecroft Partners is a global consulting and third party marketing firm for hedge funds. It was founded by Donald A Steinbrugge, CFA, a Founding Principal of Andor Capital Management when it was the 2nd largest hedge fund firm in the world. Don was also Head of Institutional Sales for Merrill Lynch Investment Managers. Agecroft Partners, LLC is a Member FINRA and SIPC.

Treasury Announces Method of Selecting Asset Managers

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The U.S. Department of the Treasury (Treasury) will use the following procedures to select asset managers for the portfolio of troubled assets, pursuant to the authorities given to the Treasury in the Emergency Economic Stabilization Act of 2008 (Act).

Securities vs. Whole Loans. The Treasury will select asset managers of securities separately from asset managers of mortgage whole loans, but in each case these procedures will apply. Securities asset managers will handle Prime, Alt-A, and Subprime residential mortgage backed securities (MBS), commercial MBS, and MBS collateralized debt obligations, and possibly other types of securities acquired to promote market stability. Whole loan asset managers may handle a range of products, including residential first mortgages, home equity loans, second liens, commercial mortgage loans, and possibly other types of mortgage loans acquired to promote market stability.

Financial Agents. Asset managers will be financial agents of the United States, and not contractors. The Act authorizes the Secretary of the Treasury (Secretary) to designate “financial institutions as financial agents of the Federal Government, and such institutions shall perform all such reasonable duties related to this Act as financial agents of the Federal Government as may be required.” As financial agents, asset managers will have a fiduciary agent-principal relationship with the Treasury with a responsibility for protecting the interests of the United States.

Organizational Eligibility. Financial Institutions are eligible to be designated as financial agents of the United States. The Act defines “Financial Institution” to mean “any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands, and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government.”

Open Notice. Prospective financial agents will be solicited through the issuance of a public notice, posted on the Treasury website, requesting that interested and qualified Financial Institutions submit a response. The notice will describe the asset management services sought by the Treasury, set forth the rules for submitting a response, and list the factors that will be considered in selecting Financial Institutions. The notice will also include minimum qualifications, such as years of experience and minimum assets under management, and eligibility requirements, such as a clean audit opinion. The Treasury will release one notice for securities asset managers, and a separate notice for whole loan asset managers.

Reviewing Responses and Second Phase. The Treasury will evaluate the initial responses from all interested and qualified Financial Institutions, and will invite certain candidates to continue to the second phase of the financial agent selection process. This second phase, and subsequent phases, may be conducted under confidentiality agreements to facilitate information exchange, but consistent with the public disclosure and transparency provisions of the Act. In the second phase, the prospective financial agents will provide additional information about their expertise, as well as asset management strategies, risk management, and performance measurement. This phase may include telephone conversations to allow questioning by and of the Treasury.

Final Phase and Selection. The Treasury will evaluate the responses from the second phase candidates, and will determine whether a candidate will continue to be considered. In this last stage, a Financial Institution may be required to conduct face-to-face discussions on portfolio scenarios, public policy goals, and statutory requirements, and to respond to interview questions to assess the capabilities of prospective individuals to be assigned to manage assets. Following any face-to-face meetings, the Treasury will make final selections of the Financial Institutions to be designated as asset managers.

Financial Agency Agreement. Financial Institutions selected to be asset managers must sign a Financial Agency Agreement with the Treasury, a copy of which will be provided for review during the second stage of the selection process. The Financial Institution’s willingness to enter into the standard Financial Agency Agreement, with the established terms and conditions currently applied to financial agents of the United States, will be among the factors used in evaluating the Financial Institution.

Evaluations and Decisions. At each stage in the selection process, personnel from the Offices of the Fiscal Assistant Secretary and the Assistant Secretary for Financial Markets, and possibly additional personnel within the Offices of Domestic Finance and Economic Policy, will evaluate the candidate submissions and make recommendations to the head of the Office of Financial Stability, who will make the final decision.

Multiple Managers. The Treasury expects to designate multiple asset managers and submanagers to obtain the proper expertise in different asset types and different segments of the mortgage credit market. However, the Treasury may not, in its discretion, select all asset managers at the same time, but rather in some sequence that matches the Treasury’s asset acquisition schedule and project plan for the portfolio. For example, an asset manager for whole loans may not be selected at the same time as an asset manager for MBS, or a primary manager may be selected prior to a sub-manager. Furthermore, as business requirements evolve, the Treasury may issue additional notices in the future to select more asset managers, consistent with the process set forth in this document.

Small and Minority- And Women-Owned Businesses. The Treasury will issue separate notices, consistent with these procedures, specifically to identify smaller and minority- and women-owned Financial Institutions that do not meet the minimum qualifications for current assets under management in the initial notices. Such Financial Institutions will be designated as sub-managers within the portfolio.

Urgency and Timeline. Given the urgent need to implement the Troubled Assets Relief Program quickly, the selection process for asset managers may involve extremely short deadlines for submitting information and for traveling to Washington, D.C. for meetings or interviews.

Costs of Applying. The Treasury will not reimburse or otherwise compensate a prospective asset manager for expenses or losses incurred in connection with the selection process.

Hedge Fund CPO Exemptions

[Editor’s note: this article will be updated shortly.  Please note that 4.13(a)(4) is no longer available for managers.  05-121-17]

As I’ve detailed before, under the Commodities Exchange Act (CEA), hedge funds which invest in commodities/ futures or in other hedge funds which invest in commodities/ futures are deemed to be commodity pools.  The managers of these commodity pools will need to be registered as commodity pool operators (CPOs) unless the manager fits within an exemption from the registration provisions. For more information on registration with the National Futures Association (NFA), please see article on how to register as a CPO.

There are a few rules under the CEA exemptions from the registration provisions which I have detailed below.  Many will not be applicable to the average hedge fund manager.  Generally hedge fund managers are going to rely on 4.13(a)(3) below, or if the fund is a 3(c)(7) hedge fund, then they may rely on 4.13(a)(4).  The CPO exemptions are:

Rule 4.13(a)(1) – closely held pool

This rule provides relief from CPO registration if all of the following provisions are met:

1.    Manager operates only one pool at a time;

2.    Manager does not receive any form of compensation;

3.    Manager does not advertise; and

4.    Manager is not otherwise required to register with the NFA

Please see Rule 4.13(a)(1).

Rule 4.13(a)(2) – small pool

This rule provides relief from CPO registration if the following provisions are met:

1.     The manager does not operate any pools which have 15 or more investors (excluding the manager and certain related persons); and

2.    The total gross capital contributions in all pools operated or intended to be operated by the manager do not in the aggregate exceed $400,000 (certain capital contributions, including those of the manager, will not be counted for the purposes of this rule)

Please see Rule 4.13(a)(2).

Rule 4.13(a)(3) – deminimus rule

This rule provides relief from CPO registration if the following provisions are met:

1.    The commodity pool interests are exempt from registration under the Securities Act of 1933, and such interests are offered and sold without marketing to the public in the United States;

2.    All of the investors in the pool must be an accredited investors (or similar qualification as specified in the rule); and

3.    One of the following tests is met:

a.    The aggregate initial margin and premiums required to establish such positions, determined at the time the most recent position was established, will not exceed 5 percent of the liquidation value of the pool’s portfolio, after taking into account unrealized profits and unrealized losses on any such positions it has entered into; or

b.    The aggregate net notional value of such positions, determined at the time the most recent position was established, does not exceed 100 percent of the liquidation value of the pool’s portfolio, after taking into account unrealized profits and unrealized losses on any such positions it has entered into.

Please see Rule 4.13(a)(3).

Rule 4.13(a)(4) – all QEPs

NOTE: THIS EXEMPTION IS NO LONGER AVAILABLE FOR MANAGERS

This rule provides relief from CPO registration if the following provisions are met:

1.    The commodity pool interests are exempt from registration under the Securities Act of 1933, and such interests are offered and sold without marketing to the public in the United States; and

2.    Investors must generally be qualified purchasers.  (HFLB note: the definition makes reference to qualified eligible persons but in this case it will generally include only those investors who are qualified purchasers.)

Please see Rule 4.13(a)(4).

Rule 4.5 Exemption

Certain management entities which are already registered with other regulatory bodies do not need to also be registered as a CPO with the NFA.  Some of these entities include managers to registered mutual funds, insurance companies, banks and ERISA fiduciaries.  A CPO claiming rule 4.5 exemption must file of notice of the exemption with the NFA and make certain disclosures to the investors in the pool.

Please see Rule 4.5.

Rule 4.7 Exemption

Registered CPOs must adhere to certain disclosure and reporting requirements as specified in the rules under the CEA.  With regard to certain commodity pools which they manage, managers may want to consider running certain funds under the “lite-touch” rule 4.7 which allows CPOs to run their fund pursuant to lighter regulations.  Specifically, the CPO would be exempt from the specific requirements of Rule 4.21, Rule 4.22(a) and (b), Rule 4.24, Rule 4.25 and Rule 4.26 with respect to each exempt pool.  To claim this exemption all of the investors in the commodity pool must be qualified eligible persons which generally will mean that they are qualified purchasers.  CPOs claiming rule 4.5 exemption must still file of notice of the exemption with the NFA.

Please see Rule 4.7.

Rule 4.12 Exemption

Like the rule 4.7 exemption, the rule 4.12 exemption is for registered CPOs.  While under 4.7 there is no limitation to the amount of commodities held by the pool, rule 4.12 limits the amount of commodities held to 10% of the pools assets and requires that all commodity trading be solely incidental to securities trading activity.  Under this exemption the CPO will need to file a notice with the NFA and will need to adhere to certain disclosure regulations. Both the 4.7 and 4.12 exemptions are used less often than the 4.13 exemptions.

Please see Rule 4.12.

Hedge Fund Stories and Analysis for the Week of October 5, 2008

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This past week has seen no shortage in the amount of articles on the hedge fund industry and the effect of the market and governmental events.  Below I’ve highlighted a few stories which I found particularly interesting and relevant for hedge fund managers.  Additionally, I think the following are points which hedge fund managers should be particularly aware of in light of recent events.

1. Hedge Fund Offering Documents are important. Most hedge fund offering documents are written very broadly and give the manager wide latitude in managing the fund.  The stories below highlight the important powers given to hedge fund managers.

2. Managers should start thinking of long term business continuity planning. While no one wants to think about and discuss what would happen during if the fund does have negative performance during the year, a well prepared manager will have a plan in place.  The stories below on blocked redemptions and re-negotiation of fees is showing us that managers were not prepared for the possibility of running a fund during lean times.  Managers should potentially think about retaining some performance fees in the management company so that they will be able to keep the doors open while trying to claw back to the high watermark.  Additionally, I believe that hedge fund due diligence will begin to include questions on how a manager would deal with a negative year.

Blocked Hedge Fund Withdrawals

A central concern for many market watchers (and investors) is whether hedge funds will have huge redemptions which would spark a sell off over the next couple of months.  We’ve seen some interesting items.  First, there is a fund which is actually blocking investor withdrawals in order to protect remaining investors from a fire sale of the fund’s assets (see story).

Restructure of Hedge Fund Performance Fees

As hedge fund managers see that the is the likliehood of negative returns this year, and the looming hedge fund high watermark provision, managers are rushing to cut deals with investors so that the funds can stay alive for the foreseeable future. According to a Wall Street Journal story, investors in the UK hedge fund RAB Capital agreed to “a three-year lockup in exchange for a management fee of 1% of assets and performance fee of 15% of returns, instead of 2% and 20%.”  The Stamford advocate reported that Camulos Capital LLC, a Greenwich-based hedge fund, and Ore Hill, a New York-based fund, among others, have restructured their fees to keep investors in their respective funds.

ABL Hedge Funds to step into the role of the banks?

If you listen to the news, and even the presidential candidates, you’ll hear about the “impending doom” in the banking industry – how mom and pop shops will not be able to get any loans to keep their business afloat.  While there have been many anectodes which suggest that this is, and is not, the case, it is likely that the banks will choose to pass on certain types of riskier loans, creating a great opportunity for non-traditional forms of finance.  Asset based lending is a hedge fund strategy in which the manager will make loans to business which will be backed by certain collateral, whether a receivable or some other physical asset.

I believe that we are going to see the launch of several asset based lending funds in the next few months and into the next year.  If the current banking climate remains how it is, asset based lending hedge funds might even become the next neighborhood banking center.  I have also previously written about the popularity of asset based lending hedge funds.

Hedge Fund Due Diligence 2.0

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We hear about the “web 2.0” and today’s San Francisco Chronicle used the term “Wall Street 2.0” which made me wonder what the hedge fund industry will look like after this mess clears itself over the next couple of months.  First, it is obvious that there is going to be government regulation of some sort over the hedge fund industry which I will be detailing over the coming weeks and months.  Additionally, investors are going to need to take proactive steps to protect their investments and hedge fund due diligence will become a greater part of the hedge fund industry – I’m dubbing this “Hedge Fund Due Diligence 2.0”.

Hedge Fund Due Diligence 2.0 is likely to include more questions on the hedge fund manager’s business acumen and operations.  The current crisis has showed us, in numerous circumstances, that hedge fund managers were simply not prepared to handle a complete market crisis.  Hedge fund managers already have to answer in depth questions relating to risk management policies and procedures, but these questions will likely become more in depth.  Specifically, Hedge Fund Due Diligence 2.0 will likely inquire into a manager’s specific cash management policies.  While this might be viewed as digging into the manager’s operational business (as opposed to just the managers performance results), it is necessary to protect an investor’s investment in the event that a high watermark provision is implicated.

More to come on this topic …