Monthly Archives: July 2009

Series 79 Exam Approved

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SEC Approves  New Exam for “Limited Representative” Investment Bankers

The long anticipated Series 79 Examination has finally received approval by the SEC, and information will now be made available to the public regarding the content of the exam, the modifications to the original licensure rules, and the scope and intent of the new rule in establishing the new “limited representative” classification among investment brokers. Information recently released to the public regarding the Series 79 is copied in full below, and can also be found here.

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Regulatory Notice 09-41 – Investment Banking Representative
SEC Approves Rule Change Creating New Limited Representative – Investment Banker Registration

Category and Series 79 Investment Banking Exam
Effective Date: November 2, 2009

Notice Type

  • Rule Amendment

Suggested Routing

  • Compliance
  • Continuing Education
  • Investment Banking
  • Legal
  • Operations
  • Registration
  • Sales
  • SeniorManagement

Key Topic(s)

  • Continuing Education
  • Investment Banking
  • Qualification Examinations
  • Registration
  • Supervision

Referenced Rules & Notices

  • NASD Rule 1022
  • NASD Rule 1032

Executive Summary

Effective November 2, 2009, amendments to NASD Rules 1022 and 1032 require individuals whose activities are limited to investment banking and principals who supervise such activities to pass the new Limited Representative – Investment Banking Qualification Examination (Series 79 Exam). Individuals who are registered as a General Securities Representative (Series 7) and engage in the member firm’s investment banking business as described in NASD Rule 1032(i)may “opt in” to the new registration category by May 3, 2010 (within six months of the effective date).

Frequently asked questions about registration as an investment banking representative are listed in Attachment A. The text of the rule change is set forth in Attachment B. Questions concerning this Notice should be directed to:

  • Philip Shaikun, Associate Vice President and Associate General Counsel, at (202) 728-8451;
  • JoeMcDonald, Director, Qualifications and Examinations, at (240) 386-5065; or
  • Tina Freilicher, Director, Psychometrics and Qualifications, at (646) 315-8752.

Background and Discussion

NASD Rule 1032(i) requires an associated person to register with FINRA as a Limited Representative – Investment Banking (Investment Banking Representative) and pass a corresponding qualification examination if such person’s activities involve:

  1. Advising on or facilitating debt or equity securities offerings through a private placement or a public offering, including but not limited to origination, underwriting, marketing, structuring, syndication, and pricing of such securities and managing the allocation and stabilization activities of such offerings, or
  2. Advising on or facilitatingmergers and acquisitions, tender offers, financial restructurings, asset sales, divestitures or other corporate reorganizations or business combination transactions, including but not limited to rendering a fairness, solvency or similar opinion.

The registration category does not cover individuals whose investment banking work is limited to public (municipal) finance or direct participation programs as defined in NASD Rule 1022(e)(2).  Moreover, individuals whose investment banking work is limited to effecting private securities offerings as defined in NASD Rule 1032(h)(1)(A)may continue to function in such capacity by registering as a Limited Representative – Private Securities Offerings and passing the corresponding Series 82 exam. Individuals whose activities require registration as an Investment Banking Representative will be required to pass the Investment Banking Representative Qualification Examination (Series 79) or obtain a waiver. FINRA has developed this exam to provide amore targeted assessment of the job functions performed by the individuals that fall within the registration category.

The exam will be required in lieu of the current General Securities Representative (Series 7) exam or equivalent exams1 by the individuals who perform the job functions described in the new registration category. Any person whose activities go beyond those of the Investment Banking Representative registration category must separately qualify and register in the appropriate category or categories of registration attendant to such activities.

Transition “Opt-In” Period

Beginning on the effective date of NASD Rule 1032(i) and ending May 3, 2010, six months following implementation of these requirements, registered individuals as well as new applicants whose job functions are described in Rule 1032(i) will be able to register as an Investment Banking Representative as follows:

  1. Currently registered representatives who have passed the Series 7 or a Series 7-equivalent exam
    Investment bankers who hold the Series 7 registration, as well as those who have passed and are registered with a “Series 7-equivalent exam”may opt in to the Investment Banking Representative registration,2 provided that, as of the date they opt in, such individuals are engaged in investment banking activities covered by Rule 1032(i).3 Those individuals who choose to opt in will retain their Series 7 or Series 7-equivalent registered representative registration in addition to the investment banking registration. After May 3, 2009, any person who wishes to engage in the specified investment banking activities will be required to pass the Series 79 Exam or obtain a waiver.
  2. New Investment Banking Representative Candidates
    During the six-month transition period, FINRA will permit new Limited Representative – Investment Banking candidates to take either the Series 7 Exam, Series 7-equivalent exam (if eligible) or Series 79 Exam. Those who choose to take and pass the Series 7 Exam or Series 7-equivalent exam may then opt in to the Investment Banking Representative registration.

Training Program Exception

Rule 1032 provides an exception for member firms that operate training programs in which certain new employees are exposed to the firm’s various business lines by rotating among departments, including investment banking. Specifically, Rule 1032(i) does not require an employee placed in such program to register as an Investment Banking Representative for a period of up to six months from the time the employee first engages in activities that otherwise would trigger the requirement to register as an Investment Banking Representative. This exception is available for up to two years after the employee commences the training program. Firms that wish to avail themselves of this exception are required to maintain documents evidencing the details of the training program and identifying the program participants who engage in activities that otherwise would require registration as an Investment Banking Representative and the date on which such participants commenced such activities.

Principals

The Series 79 Exam will be added to the list of representative exams that satisfy the prerequisite requirement for the General Securities Principal exam (Series 24). Note that the scope of the general securities principal’s supervisory responsibility will be determined by the representative-level exam passed. Individuals who wish to act as a general securities principal for activities requiring registration under Rule 1032(i)must obtain the Investment Banking Representative registration—either by opting in or passing the Series 79 Exam—and also pass the General Securities Principal exam. Such individuals will be limited to acting as a general securities principal for the investment banking activities covered by Rule 1032(i). Individuals who wish to function in the capacity of general principal for broader securities-related activities must take another appropriate qualification examination, such as the Series 7 or Series 7-equivalent exam, in addition to the General Securities Principal exam.

Individuals currently functioning as a general securities principal supervising investment banking activities as described in Rule 1032(i) have the same six-month period during which they may opt in to the Investment Banking Representative registration. Those individuals who choose to opt in will retain their Series 7 or Series 7- equivalent registered representative registration in addition to the Investment Banking Representative registration. After the end of the opt-in period, individuals who wish function as a general securities principal overseeing investment banking activities covered by the rule change will be required to pass the Series 79 Exam to function as a general securities principal supervising investment banking activities pursuant to Rules 1022 and 1032(i).

Exam Content

The qualification exam consists of 175 multiple-choice questions. Candidates are allowed 300minutes (five hours) to take the exam. Candidates will receive an informational breakdown of their performance on each section of the exam, along with their overall score and pass/fail status at the completion of the exam session.

A content outline that provides a comprehensive guide to the topics covered on the examination and is intended to familiarize candidates with the range of subjects covered by the examination is available at the FINRA website.

Firms may wish to use the content outline to structure or prepare training material, develop lecture notes and seminar programs, and as a training aide for the candidates.
The examination questions are distributed among four major functions reflecting the overall knowledge, skills and abilities required of an investment banker. Detail on the content of each of these four major job functions, the tasks associated with the job functions and the knowledge necessary to perform the tasks is included in the text of the content outline. The allocation of test questions among the four major functions is described below:

Section                                                  Description                                          Number of Questions

1                                                     Collection, Analysis and                                              75
Evaluation of Data

2                                                      Underwriting/New Financing                                   43
Transactions, Types of Offerings
and Registration Of Securities

3                                                 Mergers and Acquisitions, Tender                               34
Offers and Financial Restructuring
Transactions

4                                           General Securities Industry Regulations                        23

Total                                                                175

The questions used in the examination will be updated to reflect the most current interpretations of the rules and regulations on which they are based. Questions on new rules will be added to the pool of questions for this examination within a reasonable time period of the effective dates of those rules. Questions on rescinded rules will be deleted promptly from the pool of questions. Candidates will be asked questions only pertaining to rules that are effective at the time they take the exam.

The test is administered as a closed-book exam. Severe penalties are imposed on candidates who cheat on FINRA-administered examinations. The proctor will provide scratch paper, an exhibits book and a basic electronic calculator to candidates. These items must be returned to the proctor at the end of the session.

The Investment Banking Representative Qualification Examination will be administered at test centers operated by Pearson VUE and Prometric professional testing center networks. Appointments to take the examinations can be scheduled through either network:

  • Pearson Professional Centers: contact Pearson VUE Registration Center at (866) 396-6273 (toll free), or (952) 681-3873 (toll number).
  • Prometric Testing Centers: contact Prometric’s National Call Center at (800) 578-6273 (toll free).

Registration Procedures

A Uniform Application for Securities Industry Registration or Transfer Form(FormU4) must be submitted to FINRA via Web CRD in order to register an individual as an Investment Banking Representative. For persons already registered with a firm who currently hold the Series 7 or Series 7-equivalent registration and who are opting in to the Investment Banking Representative registration category, the firm need only submit an amended FormU4 to request the Limited Representative—Investment Banking registration.

For new employees, a firm must submit a full FormU4 application to request the registration and any other documents required for registration. The exam fee is $265; the registration fee for new applicants is $85.

For new Investment Banking Representative candidates who choose to first take the Series 7 Exam or Series 7-equivalent exam during the opt-in period and then opt in to the Investment Banking Representative registration, the firm must first submit a Form U4 to request the General Securities Representative or Series 7-equivalent registration.
Once the candidate has passed the Series 7 Exam or Series 7-equivalent exam, the Firm may then submit an amended FormU4 to request the Limited Representative— Investment Banking Representative registration.

Effective Date

The registration and qualification requirements for Investment Banking Representatives will become effective November 2, 2009. The six-month opt-in period will begin November 2, 2009, and end May 3, 2010.

Endnotes

1. The “Series 7 equivalent exams” and registrations are the Limited Representative— Corporate Securities (Series 62), the United Kingdom (Series 17) or Canada (Series 37/38) Modules of the Series 7.

2 The Web CRD registration position code for individuals who pass the Investment Banking Representative Series 79 Exam is “IB. ”The registration position codes for individuals who pass the Limited Representative—Corporate Securities Series 62 exam, Limited Registered Representative Series 17 exam and Canada
Modules of the Series 7 exam Series 37/38 exams are “CS,” “IE” and “CD/CN,” respectively.

3 No associated persons of a firm will be eligible to opt in unless the firm’s current Form BD indicates that the firm engages in investment banking activities.

Attachment A

FAQ About Registration as an Investment Banking Representative
General

Q 1: If I currently hold a Series 7 registration and am engaged in investment banking activities, must I take the Series 79 Exam to engage in a member firm’s investment banking business?

A 1: No, provided you opt in by May 3, 2010. Current Series 7 or Series 7-equivalent registered representatives who function in the firm’s investment banking business as described in NASD Rule 1032(i)may opt in to the Investment Banking Representative position without having to take the Series 79 Exam for a period of six months after implementation of the registration category. Such persons also will be able to retain their Series 7 or Series 7 equivalent registration.

Q 2: How do I opt in to the new investment banker registration category?

A 2: For persons registered with a firm who currently hold the Series 7 or Series 7- equivalent registration and who function in the firm’s investment banking business as described in NASD Rule 1032(i), the person’s firm need only submit an amended FormU4 to request the Limited Representative – Investment Banking registration. The submission must be made during the six-month opt in period (November 2, 2009 –May 3, 2010). The FormU4 will not reflect the new registration category until the start of the opt-in period.

Q 3: My firm has not yet developed a training program for the Series 79 Exam. Will I have to take the Series 79 Exam once it is implemented in order to get the Investment Banking Representative registration?

A 3: No, during the six-month transition period (November 2, 2009 –May 3, 2010), new Investment Banking Representative candidates who are in the process of qualifying for the new Investment Banking Representative registration category can take either the Series 79, the Series 7 or a Series 7-equivalent exam. A candidate who takes and passes the Series 7 Exam or Series 7- equivalent exam could then opt in to the Investment Banking Representative registration.

Q 4: I plan on taking the Series 79 Exam to qualify for the Investment Banking Representative registration. If in the future I move into a different position
Within my firm, such as retail sales, will I need to take the Series 7 Exam?

A 4: Yes. The Series 79 Exam will qualify an Investment Banking Representative for only those activities covered under Rule 1032(i). If the representative engages in activities not covered by the Investment Banking Representative registration, such as retail or institutional sales, the representative will need to take the appropriate qualification exam, such as the Series 7 or Series 7-equivalent exam.

Q 5: I currently have a Series 7 registration. If I do not opt in to the Investment Banking Representative registration during the opt-in period, but subsequently decide to become an investment banker, must I take the Series 79 Exam to get the Investment Banking Representative registration?

A 5: Yes. FINRA is providing a grace period of six months for Series 7 or Series 7-equivalent representatives who function in the member firm’s investment banking business as described in NASD Rule 1032(i) to opt in to the Investment Banking Representative registration position. After May 3, 2010, persons who seek Investment Banking Representative registration will need to take and pass the Series 79 Exam, regardless of whether or not they have a Series 7 or Series 7-equivalent registration.

Q 6: I work at a small investment banking firm and engage in activities ranging From investment banking to institutional and retail sales. I have a Series 7 registration. How will this new exam and registration category affect me?

A 6: If you opt-in to the Investment Banking Representative registration position within the designated time period, you will have both the General Securities Representative and Investment Banking Representative registrations. Therefore, you would be able to engage in activities covered in both registration categories.

Q 7: I own a small investment banking firm and have employees that engage in activities ranging from investment banking to institutional and retail sales. These employees have a Series 7 registration. If I hire a new employee after the end of the opt-in period, how will this new exam and registration category affect this employee?

A 7: If the new employee engages in activities that fall into both the General Securities Representative and Investment Banking Representative registration categories, then he or she will need to take and pass both the Series 7 and Series 79 Exams.

Q 8: Will I be able to register as agent with a state after passing the Series 63 Exam if I have the Investment Banking Representative registration?

A 8: Yes (provided all of the other state requirements are met).

Q 9: Currently, for a candidate to qualify to register as agent and investment adviser with a state with the Series 66 Exam in lieu of the Series 63 and 65 Exams, the Series 7 Exam is required. Will the Series 79 Exam also allow me to qualify in those capacities with the Series 66 Exam?

A 9: No. States will continue to require the Series 7 Exam for use with the Series 66 Exam.

Test Administration

Q 10: Since the Series 79 Exam is a five-hour test, will I be allowed to take a break during the session?

A 10: The Series 79 Exam must be taken in one continuous, five-hour session. Candidates are permitted to take an unscheduled break during the exam session. However, the test clock will not stop while the candidate takes a break.

Q 11: Will I be allowed to use my own calculator during the exam session?

A 11: No. Series 79 Exam candidates are only allowed to use a basic electronic calculator provided by the testing center.

Principals

Q 12: I am currently a General Securities Principal supervising investment bankers. Do I need to opt in to the Investment Banking Representative position?

A 12: Yes. However, if you do not opt in prior to the end of the opt-in period, you will need to take and pass the Series 79 Exam in order to continue supervising Investment Banking Representatives.

Q 13: I plan on taking the Series 79 Exam. In the future, will I be able to qualify for the General Securities Principal registration category by taking and passing the Series 24 exam?

A 13: Yes, the Series 79 Exam will meet the prerequisite for taking the Series 24 Exam. However, such persons will be limited to acting as a general principal for investment banking-related activities and will need to take and pass another qualification examination, such as the Series 7 or Series 7 equivalent exam, to act as a general securities principal for broader securities-related activities.

Q 14: I am currently a General Securities Principal in a non-investment banking firm. If I do not opt in now and then move in five years to an investment banking Firm in which I will supervise investment bankers, will I need to take the Series 79 Exam?

A 14: Yes. The opt-in accommodation is available only to individuals who are currently functioning in a firm’s investment banking business. A General Securities Principal who qualifies via the Series 7 or Series 7 equivalent exam cannot act as a general principal for investment banking activities. Such person would need to take and pass the Series 79 Exam to do so.

Q 15: I currently hold a Series 7 registration and plan to opt in to the Investment Banking Representative position. If in the future I become a General Securities Principal by passing the Series 24 Exam, will I be able to supervise other securities-related activities including investment banking activities?

A 15: Yes. If you are eligible to opt in and do so, you will be able to supervise the firm’s investment banking activities upon passing the Series 24 Exam. In addition, because you also held the Series 7 position, you will be able to act as a general securities principal for broader securities-related activities.

Public Financing

Q 16: Are public finance offerings (municipals) covered on the Series 79 Exam?

A 16: No. Individuals who work on public finance offerings will continue to take the Series 7 or Series 52 Exams.

Q 17: I work on both corporate and public finance offerings. I have a Series 7 registration. How will this new exam and registration category affect me?

A 17: If you opt in to the Investment Banking Representative position by May 3, 2010, you can continue to engage in all activities without taking the Series 79 Exam.

Q 18: I plan on taking the Series 79 Exam to qualify for the Investment Banking Representative position. If in the future I want to work on public finance offerings, will I need to take the Series 7 or Series 52 Exams?

A 18: Yes. The Series 79 Exam will qualify you for only the Investment Banking
Representative position and activities covered under that registration position. If you begin to work on public finance offerings, you will need to take the Series 7 or Series 52 Exam.

Prerequisites

Q 19: Aside from satisfying the prerequisite for taking the Series 24 Exam, will the Series 79 Exam meet the prerequisite for any other exams that currently require either a Series 7 or Series 7 equivalent exam?

A 19: No. The Series 79 Exam will not fulfill the prerequisite requirement for the following exams:

Series 4 – Registered Options Principal
Series 9/10 – General Securities Sales Supervisor
Series 23 – General Securities Principal Sales Supervisor Module
Series 26 – Investment Company Products/Variable Contracts Principal
Series 39 – Direct Participation Program Principal
Series 42 – Registered Options Representative
Series 52 –Municipal Securities Principal
Series 55 – Equity Trader Limited Representative
Series 86/87 – Research Analyst/Research Principal

Continuing Education

Q 20: If I pass the Series 79 Exam and hold an Investment Banking Representative registration, will I still take the Regulatory Element S101 continuing education session?

A 20: Yes. A person holding an Investment Banking Representative registration will continue to take the Regulatory Element S101. However, in the future, FINRA is planning to modify the Regulatory Element to tailor it to certain types of job functions, such as investment banking.

Attachment B

Text of Amended Rule
New language is underlined; deletions are in brackets.

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1022. Categories of Principal Registration

(a) General Securities Principal
(1) Each person associated with a member who is included within the definition of principal in Rule 1021, and each person designated as a Chief Compliance Officer on Schedule A of Form BD, shall be required to register with the Association as a General Securities Principal and shall pass an appropriate Qualification Examination before such registration may become effective unless such person’s activities are so limited as to qualify such person for one or more of the limited categories of principal registration specified hereafter. A person whose activities in the investment banking or securities business are so limited is not, however, precluded from attempting to become qualified for registration as a General Securities Principal, and if qualified, may become so registered.

(A) Subject to paragraphs (a)(1)(B), (a)(2) and (a)(5), [E]each person seeking to register and qualify as a General Securities Principal must, prior to or concurrent with such registration, become registered, pursuant to the Rule 1030 Series, either as a General Securities Representative or [as] a Limited Representative-Corporate Securities.
(B) A person seeking to register and qualify as a General Securities Principal who will have supervisory responsibility over investment banking activities described in NASD Rule 1032(i)(1)must, prior to or concurrent with such registration, become registered as a Limited Representative– Investment Banking.
(C) A person who has been designated as a Chief Compliance Officer on Schedule A of Form BD for at least two years immediately prior to January 1, 2002, and who has not been subject within the last ten years to any statutory disqualification as defined in Section 3(a)(39) of the Act; a suspension; or the imposition of a fine of $5,000 or more for violation of any provision of any securities law or regulation, or any agreement with or rule or standard of conduct of any securities governmental agency, securities self-regulatory organization, or as imposed by any such regulatory or self-regulatory organization in connection with a disciplinary proceeding shall be required to register as a General Securities Principal, but shall be exempt from the requirement to pass the appropriate Qualification Examination. If such person has acted as a Chief Compliance Officer for a member whose business is limited to the solicitation, purchase and/or sale of “government securities,” as that term is defined in Section 3(a)(42)(A) of the Act, or the activities described in Rule 1022(d)(1)(A) or Rule 1022(e)(2), he or she shall be exempt from the requirement to pass the appropriate Qualification Examination only if he or she registers as a Government Securities Principal, or a Limited Principal pursuant to Rules 1022(d) or Rule 1022(e), as the case may be, and restricts his or her activities as required by such registration category. A Chief Compliance Officer who is subject to the Qualification Examination requirement shall be allowed a period of 90 calendar days following January 1, 2002, within which to pass the appropriate Qualification Examination for Principals.

(2) through (5) No change.
(b) through (h) No change.

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1032. Categories of Representative Registration

(a) through (h) No change.
(i) Limited Representative-Investment Banking

(1) Each person associated with a member who is included within the definition of a representative as defined in NASD Rule 1031 shall be required to register with FINRA as a Limited Representative-Investment Banking and pass a qualification examination as specified by the Board of Governors if such person’s activities involve:
(A) advising on or facilitating debt or equity securities offerings through a private placement or a public offering, including but not limited to origination, underwriting, marketing, structuring, syndication, and pricing of such securities and managing the allocation and stabilization activities of such offerings, or
(B) advising on or facilitating mergers and acquisitions, tender offers, financial restructurings, asset sales, divestitures or other corporate reorganizations or business combination transactions, including but not limited to rendering a fairness, solvency or similar opinion.

(2) Notwithstanding the foregoing, an associated person shall not be required to register as a Limited Representative-Investment Banking if such person’s activities described in paragraph (i)(1) are limited to:
(A) advising on or facilitating the placement of direct participation program securities as defined in NASD Rule 1022(e)(2);
(B) effecting private securities offerings as defined in paragraph
(h)(1)(A); or
(C) retail or institutional sales and trading activities.

(3) An associated person who participates in a new employee training Program conducted by a member shall not be required to register as a Limited Representative-Investment Banking for a period of up to six months from the time the associated person first engages within the program in activities described in paragraphs (i)(1)(A) or (B), but in no event more than two years after commencing participation in the training program. This exception is conditioned upon the member maintaining records that:
(A) evidence the existence and details of the training program, including but not limited to its scope, length, eligible participants and administrator; and
(B) identify those participants whose activities otherwise would require registration as a Limited Representative-Investment Banking and the date on which each participant commenced such activities.

(4) Any person qualified solely as a Limited Representative-Investment Banking shall not be qualified to function in any area not described in paragraph (i)(1) hereof, unless such person is separately qualified and registered in the appropriate category or categories of registration.

(5) Any person who was registered with FINRA as a Limited Representative-Corporate Securities or General Securities Representative (including persons who passed the UK (Series 17) or Canada (Series 37/38) Modules of the Series 7) prior to [effective date of the proposed rule change], shall be qualified to be registered as a Limited Representative-Investment Banking without first passing the qualification examination set forth in paragraph (i)(1), provided that such person requests registration as a Limited Representative-Investment Banking within the time period prescribed by FINRA.

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Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about the Series 79 or investment banking activities, please call Mr. Mallon directly at 415-296-8510.

SEC Announces New Short Sale Rules

One of the major regulatory pushes this year by the SEC has been to revamp the short sale rules.  Today the SEC announced some specific measures which are intended to curtail abusive short sales.  We will likely have more comments on this issue going forward and will publish hedge fund industry reaction.

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SEC Takes Steps to Curtail Abusive Short Sales and Increase Market Transparency
FOR IMMEDIATE RELEASE
2009-172

Washington, D.C., July 27, 2009 — The Securities and Exchange Commission today announced several actions that would protect against abusive short sales and make more short sale information available to the public.

“Today’s actions demonstrate the Commission’s determination to address short selling abuses while at the same time increasing public disclosure of short selling activities that affect our markets,” said SEC Chairman Mary Schapiro.

First, the Commission made permanent an interim final temporary rule, Rule 204T, that seeks to reduce the potential for abusive “naked” short selling in the securities market. The new rule, Rule 204, requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale. The temporary rule, approved by the SEC in the fall of 2008, was set to expire on July 31.

Additional Materials

Rule 204: Amendments To Regulation SHO (Release No. 34-60388)

Second, the Commission and its staff are working together with several self-regulatory organizations (SRO) to make short sale volume and transaction data available through the SRO Web sites. This effort will result in a substantial increase over the amount of information presently required by another temporary rule, known as Temporary 10a-3T. That rule, which will expire on August 1, applies only to certain institutional money managers and does not require public disclosure.

Apart from these measures, the Commission is continuing to actively consider proposals on a short sale price test and circuit breaker restrictions.

Third, the Commission intends to hold a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures. The roundtable will consider, among other topics, the potential impact of a program requiring short sellers to pre-borrow their securities, possibly on a pilot basis, and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities.

Overview

Short selling often can play an important role in the market for a variety of reasons, including contributing to efficient price discovery, mitigating market bubbles, increasing market liquidity, promoting capital formation, facilitating hedging and other risk management activities, and importantly, limiting upward market manipulations. There are, however, circumstances in which short selling can be used as a tool to manipulate the market.

“Naked” Short Sales: In a “naked” short sale the investor sells shares “short” without first having borrowed them. Such a transaction is permitted because there is no legal requirement that a short seller actually borrow the shares before effecting a short sale.

But, before effecting a short sale, Rule 204T requires that the broker-dealer, as opposed to the seller, “locate” an entity that the broker reasonably believes can deliver the shares within three days after the trade — what’s known as T+3. Also, if reasonable, a broker-dealer may rely on a short seller’s assurance that the short seller has located his or her own lender that can deliver shares in time for settlement.

“Fails-to-deliver”: If an investor or its broker-dealer does not deliver shares by T+3, a “failure to deliver” occurs. Where an investor or its broker-dealer neither locates nor delivers shares, a “naked” short sale has occurred.

A “fail to deliver” can occur for legitimate reasons, such as mechanical errors or processing delays. Further, a “fail to deliver” could occur as a result of a long sale — that is the typical buy-sell transaction — as well as a short sale.

“Fails to deliver”, such as fails resulting from potentially abusive “naked” short selling, may have a negative effect on shareholders, potentially depriving them of the benefits of ownership such as voting and lending. They also may create a misleading impression of the market for an issuer’s securities.

Adopting Regulation SHO: Due to its concerns regarding persistent “fails to deliver” and potentially abusive “naked” short selling, the Commission adopted Regulation SHO, which became effective in early 2005. This regulation imposes, among other things, the requirement that broker-dealers locate a source of borrowable shares prior to selling short.

In addition, it requires that firms that clear and settle trades must purchase shares to close out these “fails to deliver” within a certain time frame, 13 days. This “close-out” requirement only applies to certain equity securities with large and persistent “fails to deliver,” known as threshold securities.

The requirement included two major exceptions: the so-called “grandfather” and “options market maker” exceptions. Both of these exceptions provided that certain “fails to deliver” in threshold securities never had to be closed out. The Commission eliminated both exceptions in August 2007 and September 2008, respectively.

Making Permanent A Rule to Curtail Naked Short Selling

Adopting Rule 204: The Commission has made permanent a temporary rule that was approved in 2008 in response to continuing concerns regarding “fails to deliver” and potentially abusive “naked” short selling. In particular, temporary Rule 204T made it a violation of Regulation SHO and imposes penalties if a clearing firm:

  • does not purchase or borrow shares to close-out a “fail to deliver”
  • resulting from a short sale in any equity security
  • by no later than the beginning of trading on the day after the fail first occurs (T+4).

Cutting Down Failures to Deliver: An analysis conducted by the SEC’s Office of Economic Analysis, which followed the adoption of the close-out requirement of Rule 204T and the elimination of the “options market maker” exception, showed the number of “fails” declined significantly.

For example, since the fall of 2008, fails to deliver in all equity securities has decreased by approximately 57 percent and the average daily number of threshold list securities has declined from a high of approximately 582 securities in July 2008 to 63 in March 2009.

Due to the success of these measures in furthering the Commission’s goals of reducing fails to deliver and addressing potentially abusive “naked” short selling, the Commission has made permanent the requirements of Rule 204T with only limited modifications to address commenters’ operational concerns.

Increasing Transparency Around Short Sales

In the fall of 2008, the Commission also adopted a short sale reporting interim rule, Rule 10a-3T. The rule requires certain market participants to provide short sale and short position information to the Commission.

The Commission made the rule temporary so that it could evaluate whether the benefits from the data justified the costs associated with the rule.

Instead of renewing the rule, the Commission and its staff, together with SROs, are working to substantially increase the public availability of short sale-related information through a series of other actions. These actions should provide a wealth of information to the Commission, other regulators, investors, analysts, academics, and the media.

Specifically, the Commission and its staff are working together with several SROs in the following areas:

  • Daily Publication of Short Sale Volume Information. It is expected in the next few weeks that the SROs will begin publishing on their Web sites the aggregate short selling volume in each individual equity security for that day.
  • Disclosure of Short Sale Transaction Information. It is expected in the next few weeks that the SROs will begin publishing on their Web sites on a one-month delayed basis information regarding individual short sale transactions in all exchange-listed equity securities.
  • Twice Monthly Disclosure of Fails Data. It is expected in the next few weeks that the Commission will enhance the publication on its Web site of fails to deliver data so that fails to deliver information is provided twice per month and for all equity securities, regardless of the fails level. For current fails to deliver information, see http://www.sec.gov/foia/docs/failsdata.htm.

Hosting a Roundtable

Finally, the Commission also is examining whether additional measures are needed to further enhance market quality and transparency, as well as address short selling abuses.

As part of its examination, the Commission intends to hold a public roundtable on Sept. 30, 2009, to solicit the views of investors, issuers, financial services firms, self-regulatory organizations and the academic community regarding a variety of trading and market related practices. The roundtable will focus on issues related to securities lending, pre-borrowing, and possible additional short sale disclosures.

The roundtable panelists will consider, among other things, additional means to foster transparency, such as adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities, and requiring public disclosure of individual large short positions. Panelists will also consider whether it would be appropriate to impose a pre-borrow or enhanced “locate” requirement on short sellers, potentially on a pilot basis. Additionally, panelists will discuss issues related to securities lending such as compensation arrangements, disclosure practices, and methods of collateral and cash-reinvestment.

# # #

http://www.sec.gov/news/press/2009/2009-172.htm

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GIPS Compliance Information For Hedge Funds

Hedge Funds and GIPS Compliance

The Chartered Financial Analysts (CFA) Institute has spearheaded and implemented the Global Investment Performance Standards (GIPS) for investment managers as a means of establishing a higher standard for compliance with measurement and reporting of hedge fund performance.  GIPS standards set forth a universal set of guidelines and standards for measuring, calculating, and presenting aggregate gain and loss percentages in discretionary, managed investment accounts. Compliance with GIPS standards is voluntary, but it helps investment managers to attract and retain institutional investors who may require a higher standard for disclosure and accurate reporting.

What is GIPS?

The reporting and measuring standards from which GIPS originated were developed by CFA Institute beginning in the late 1980’s and have been gradually modified and reevaluated over the years.  While the CFA Institute initiated and funded the development of GIPS, the GIPS Executive Committee is responsible for maintaining the standards.  The key provision of GIPS is the requirement to include all of a firm’s fee-paying, discretionary amounts in a ‘composite’, or an aggregate of portfolios that share common investment objectives or strategies. The goal of using composites is to ensure ease of comparability between firms due to enhanced consistency.  To further aid the comparison of fund performance, the standards specifically disallow ‘nondiscretionary’ accounts from being included in the composites (where certain client restrictions render the fund’s performance more reflective of the clients’ decisions than the managers’ decisions).  Understanding and adhering to strict composite construction requirements is critical to GIPS compliance.

When should a Manager use GIPS?

There are several advantages to complying with GIPS and getting third-party verification. First and foremost is the added credibility of your hedge fund brought on by the claim of compliance (to be used in presentations, marketing materials, advertising, service agreements, etc.).  This credibility can help reinforce investor trust and create new relationships with new prospective clients.  Secondly, the level of consistency brought on by adherence to GIPS creates a more cohesive set of procedures regarding the calculation and presentation of performance. Thirdly, compliance with GIPS can assist firms with keeping up with the requirements of the SEC and avoid encountering claims of fraudulent conduct.  This is especially important for managers who may have had a prior track record with such claims or have had any actions brought against them by the SEC – incorporating GIPS compliance standards into the hedge fund practice will vindicate these managers of their past and help rebuild investor trust.

Twelve Steps to GIPS Compliance

The following procedure has been recommended by GIPS Execute Committee members in order to establish an effective compliance program for your firm.

  1. Management support. Management must make a commitment of time and resources to bring the firm into compliance.
  2. Know the Standards. Assign individuals or teams to review and familiarize themselves with the Standards and to complete each subsequent step.
  3. Define the firm. The definition should accurately reflect how the entity is held out to the public and will determine the scope of firm wide assets under management.
  4. Define investment discretion. The Standards use the term “discretion” more broadly than just whether or not a manager can place trades for a client. Defining investment discretion is an important step in determining whether or not accounts must be included in a composite.
  5. Identify all accounts under management within the defined firm over the past five years, or since firm inception if less than five years. This should include all discretionary and nondiscretionary accounts, including terminated relationships.
  6. Determine if your firm has the appropriate books and records to support historical discretionary account performance.
  7. Separate the list of accounts into groups based on discretionary status, investment mandate, and/or other criteria. These groups will be the foundation for your composites.
  8. List and define the composites that will be constructed.
  9. Document your firm’s policies and procedures for establishing and maintaining compliance with the Standards.
  10. Document reasons for composite membership changes throughout each account’s history and reasons for nondiscretionary status, if applicable.
  11. Calculate composite performance and required annual statistics.
  12. Develop fully compliant marketing materials.

How to Get Started

As of 2007, 28 countries have adopted the GIPS standards or have had their local performance reporting standards endorsed by the GIPS Executive Committee.  Formally recognized in 29 major financial markets, GIPS compliances enables investment firms to fairly compete throughout the world and provides a standard framework to ensure that funds’ performance figures are directly comparable. Although it is in the best interest of any investment firm that wants to compete effectively and fairly to adhere to the GIPS standards, the issue for most firms is how to accomplish this successfully and cost-efficiently. For many firms, this may require adding GIPS experts to staff or turning to outside professionals, depending on the firm’s size, available resources, and overall business strategy. There are many GIPS service providers, including software vendors and verification/consulting firms, that can help investments firms become and remain GIPS compliant.

To help you select a service provider to help your firm get started with compliance efforts, you can refer to the list of GIPS Service Providers. You can also find the full text of the GIPS standards here.

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Please contact us if you have any questions or would like to start a hedge fund.  Other related hedge fund law articles include:

Prime Brokers, Margin Lock-ups & Hedge Funds

Today we have another guest post from Karl Cole-Frieman who specializes in providing legal advice to hedge funds and other alternative asset managers.  Mr. Cole-Frieman specializes in Loan Trading and Distressed Debt Transactions, ISDAs, Soft Dollars and Commission Management arrangements, and Wage and Hour Law Matters among other legal matters which hedge fund managers face on a day to day basis.
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The Margin Lock-up Returns to Prime Brokerage
By Karl Cole-Frieman, www.colefrieman.com

In 2009, the problems affecting major banks have also impacted their prime brokerage units, and accordingly there is less appetite to extend credit to hedge funds.   As the banking industry recovers, however, credit terms are beginning to loosen up again.  As a result, we are beginning to see the return of the margin lock-up for larger prime brokerage clients, who may in fact be in a stronger bargaining position for such agreements than they were a year ago.

What is a Margin Lock-up or Term Commitment?

In the most basic terms, a “margin lock-up” or a “term commitment” is a credit facility extended by a prime broker to a hedge fund or other institutional client.  The terms are used interchangeably in the industry.  Margin lock-ups prevent the prime broker from changing margin rates, collateral requirements, and often from declining to clear the hedge fund’s trades during the term of the lock-up.  For large managers, they are often 90 days, but can range from 30 days to 120 days, and perhaps even longer for the largest hedge fund managers.  Practically speaking, the way the arrangement works is that if a prime broker wants to make a change covered by the margin lock-up, they will provide the manager with the requisite notice before doing so.

Margin Lock-ups and Prime Brokerage Agreements

A margin lock-up is negotiated separately from a prime brokerage agreement, but ideally the two agreements are negotiated at the same time.  Our experience has been that it is significantly more difficult to negotiate a margin lock-up after the prime brokerage relationship has been established, and that a fund’s greatest negotiating leverage is before signing the prime brokerage agreement.

Negotiating a Margin Lock-up

There are two significant points to negotiate in a margin lock-up: (1) the scope of the commitment (and exclusions), and (2) the termination events.  For the scope of the commitment, it is essential that the commitment includes clearing trades.  Remember that a prime brokerage arrangement is a demand facility, and the prime broker can normally decide to stop clearing a hedge fund’s trades at any time and for any reason.  This is potentially highly disruptive, and could result in significant losses for a fund.  If clearing trades are covered by the margin lock-up, the prime broker will have to provide the requisite notice, which will allow time to make alternative arrangements with other counterparties.

Termination Events and Margin Lock-ups

Termination events can be very contentious in a margin lock-up negotiation.  The termination events in a margin lock-up give the prime broker the right to terminate the margin lock-up if a certain event occurs.  The prime brokers will want to negotiate off of their templates, which will initially have so many termination events it would make the margin lock-up worthless.  Managers should be wary of a completely subjective termination event, and such provisions should be negotiated out of the agreement.  For example, some prime brokers will try to insist on including a provision that it will be a termination event if the prime broker determines that it would cause the prime broker reputational risk to continue to do business with the fund.   More typical termination events include NAV triggers and key person provisions.

Bilateral Termination Events are a Secondary Consideration

Some hedge fund lawyers advocate that the termination events in a margin lock-up should not be completely unilateral, meaning, for example, that the credit rating of the prime broker should be a termination event.  We view this as a secondary consideration, and not a point to get bogged down on in the negotiation.  If a manager is concerned about the credit rating of the prime broker, they can simply move their balances.  They don’t need to terminate the lock-up – leave it in place in case the fund restores balances with that prime broker.

To find out more about margin lock-ups and other topics relating to prime brokerage or custody, please contact Karl Cole-Frieman of Cole-Frieman & Mallon LLP (www.colefrieman.com) at 415-352-2300 or [email protected]

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If you are thinking of starting a hedge fund, please contact Mr. Bart Mallon, Esq. at 415-296-8510.  Other related hedge fund law and start up articles include:

Hedge Fund Auditors | Thought Piece From Castle Hall Alternatives

The following article is by Christopher Addy, President and CEO of Castle Hall Alternatives, a hedge fund due diligence firm.  We have published a number of pieces by Mr. Addy in the past (please see Hedge Fund Fees, Hedge Fund Due Diligence Issues, Issues for Hedge Fund Administrators to Consider and ERISA vs. the Hedge Fund Industry).  The following post can be found here.

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And the auditors work for….

Audit opinions of a hedge fund’s financial statements are unlikely to make the New York Times bestseller list.  As a result, we can certainly understand if the auditor’s fine print is not exactly top of the list for investor attention.  However, not all audit opinions are the same and, over time, it seems that different audit firms are quietly introducing different standards of care and attention – and, of course, liability, which is always the 800 pound gorilla.

The issue is the addressee of the audit report – or, put more simply, who the auditor works for.  In a public company, the auditors report to both the shareholders and the Board of Directors.  A quick web search gives us a couple of examples – GE and Goldman Sachs (don’t laugh at the Level III assets, by the way).

In a hedge fund, however, sometimes the audit report mentions the shareholders, but sometimes it does not.  What seems to be a fine difference is actually very profound – exactly why would a hedge fund auditor report only to the Board of Directors and deliberately fail to address their report to the shareholders?  Adding insult to injury, of course, is the reality that the average Board of Caymanian rent-a-directors hardly acts with the same vigor and intervention as the non execs on the boards of GE and Goldman.

In our experience, certain audit firms appear to have taken a deliberate decision to direct their audit opinions, wherever possible, only to the directors.  This is a difference which applies across both US GAAP reports as well as audits completed under International Financial Reporting Standards.  Check 10 audit reports from different firms, and see what we mean.

The underlying issue – of course – is the lack of investor control.  Investors, if asked, would very likely have an opinion on this issue: but, needless to say, they are not asked.  Audit engagement letters are signed under cloak and dagger secrecy (usually because they include ever more expansive terms seeking to limit auditor liability under Caymanian law).  Thereafter, as investors and due diligence practitioners know to their ongoing annoyance, it proves incredibly difficult and pointlessly time consuming to get some auditors even to confirm that they are the auditor of record for the hedge fund in question.

In the short term, one answer would be for offshore jurisdictions such as the Cayman Islands to mandate that all audit reports filed for Caymanian hedge funds be addressed to the shareholders rather than just the Board.  If it’s good enough for GE, it should be good enough for any hedge fund.

In the bigger picture, however, this is just one question within the broad construct of Hedge Funds 2.0 post Madoff.  Unfortunately, it is only investor pressure which can enforce any change so that service providers – auditors, administrators, lawyers et al – take responsibility and recognize that their primary duty of care is to the investors that pay them.  Without that pressure, hedge funds will continue to be the asset class where everyone wants to get paid, but no-one wants to take responsibility.

www.castlehallalternatives.com
Hedge Fund Operational Due Diligence

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Series 3 Exam | Commodities & Futures Exam Topics

Hedge Fund Managers and the Series 3 Exam

Those managers who engage in commodities and futures trading (and who don’t qualify for an exemptions) will need to register as commodity pool operators with the CFTC and become members of the NFA.  In order to do this all owners and “associated persons” of the manager/CPO will need to take and pass the Series 3 exam.  This article provides a brief overview of the Series 3 exam for hedge fund managers.

Commodities and Futures Contracts License

The NFA requires an individual to successfully complete the Series 3 in order to become qualified to sell commodities or futures contracts.  The exam is designed for anyone who is going to act as an Associated Person, Commodity Trading Advisor, Commodity Pool Operator, Introducing Broker, or Futures Commission Merchant.  [Note: under the forex registration rules, those managers who trade in the spot forex markets will soon also need to take the Series 3 and a new exam called the Series 34 exam.]  The Series 3 is also a prerequisite to the Series 30 Futures Branch Manager exam.

The Series 3 exam is required of individuals who conduct business with the public on the U.S. futures exchanges and:

  • offer or solicit business in futures or options on futures at a futures commission merchant (FCM) or introducing broker (IB) or who supervise any such person.
  • are associated with a commodity trading advisor (CTA) who solicits discretionary accounts or who supervises persons so engaged.
  • are associated with a commodity pool operator (CPO) who solicits funds for participation in a commodity pool or who supervises such persons.

Registration Process

The NFA Series 3 Exam is administered by FINRA. There is a two-step process that a candidate must complete to be able to take the Series 3 Exam.

Step 1 – The individual must apply with FINRA to take the exam by completing and submitting an application form and payment, or by submitting the application online. The testing application form can be downloaded from the FINRA’s web site. Effective January 2, 2009, the fee for an individual to take the Series 3 National Commodity Futures Examination will be $105.

Step 2 – Once the U10 registration has been approved and processed by FINRA, a Notice of Enrollment will be emailed to the candidate. FINRA will assign a 120-day window during which the exam can be scheduled and taken. The candidate may then contact their local test center to schedule an appointment to sit for the exam. Due to the many sessions administered at testing centers, the candidate should schedule test-taking as far in advance as possible to secure an appointment on the desired date.

Testing Locations

The exam is delivered via a computer system specifically designed for the administration and delivery of computer-based testing and training. Exams are given at conveniently located test centers worldwide and an appointment to take your exam can be scheduled online or by calling your local center. For a list of test centers in your area (U.S. and International) click here.

Series 3 Exam Overview

The Series 3 Exam for commodity futures brokers is divided into two parts – futures trading theory and market regulations. Each part must be passed with a score of at least 70 percent. There are 120 total multiple choice and true/false questions, and exam takers are provided 2 hours and 30 minutes to complete the exam. The Series 3 Exam also contains 5 additional experimental questions that do not count towards the exam taker’s score, and additional time is built into the exam to accommodate for these questions.

The Series 3 exam is divided into ten topics and is graded in two main parts: Market Knowledge and Rules/Regulations. The Market Knowledge part covers the first nine of the following topics, and  consists of 85 questions. The Rules/Regulations part covers category ten, and consists of 35 questions. You must achieve a 70% on each part in order to pass the exam.

Part 1: Market Knowledge – The first part of the Series 3 exam covers the basics of the futures markets. Exam takers will need to understand futures contracts, hedging, speculating, futures terminology, futures options, margin requirements, types of orders, basic fundamental analysis, basic technical analysis and spread trading.

Part 2: Rules/Regulations – The second part of the Series 3 exam consists of market regulations. Exam takers must familiarize themselves with relevant NASD rules and regulations for this part of the exam.

Exam Topics

  1. Futures Trading Theory
  2. Margins, Limits, Settlements
  3. Orders, Accounts, Analysis
  4. Basic Hedging
  5. Financial Hedging
  6. Spreads
  7. General Speculation
  8. Financial Speculation
  9. Options
  10. Regulations

Useful Terms to Know for the Series 3 Exam

Exam takers are expected to be familiar with the following terms and definitions prior to taking the Series 3 exam. The definitions presented below have been extracted from  Investopedia.

Bucketing: A situation where, in an attempt to make a short-term profit, a broker confirms an order to a client without actually executing it. A brokerage which engages in unscrupulous activities, such as bucketing, is often referred to as a bucket shop.

Delta: The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Sometimes referred to as the “hedge ratio”.

Double Top: A term used in technical analysis to describe the rise of a stock, a drop, another rise to the same level as the original rise, and finally another drop.

First Notice Day: The first day that a notice of intent to deliver a commodity can be made by a clearinghouse to a buyer in fulfillment of a given month’s futures contract.

Intrinsic Value: 1. The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value. 2. For call options, this is the difference between the underlying stock’s price and the strike price. For put options, it is the difference between the strike price and the underlying stock’s price. In the case of both puts and calls, if the respective difference value is negative, the intrinsic value is given as zero.

Inverted Market: In the context of options and futures, this is when the current (or short-term) contract prices are higher than the long-term contracts.

Long Hedge: A transaction that commodities investors undertake to hedge against possible increases in the prices of the actuals underlying the futures contracts.

Offset: 1. To liquidate a futures position by entering an equivalent, but opposite, transaction which eliminates the delivery obligation.2. To reduce an investor’s net position in an investment to zero, so that no further gains or losses will be experienced from that position.

Scalpers: A person trading in the equities or options and futures market who holds a position for a very short period of time, attempting to make money off of the bid-ask spread.

Straddle: An options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date.

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Hedge Funds and Rehypothication

Ongoing Legal Issues For Hedge Fund Managers

While many of the posts on this blog deal with start-up and regulatory issues that hedge fund managers face, we also are aware that there are many ongoing legal issues which affect the business of the fund.  Below is a guest post from Karl Cole-Frieman on hedge fund rehypothication and the prime brokerage relationship.

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What is Rehypothication?
By Karl Cole-Frieman, www.colefrieman.com

One of the most frequent questions that I am asked these days is to explain the term “rehypothication” in the context of a prime brokerage agreement.  The concept of rehypothication has been imbedded in the credit arrangements of prime brokerage agreements for years, but until 2008 and the collapse of Bear Sterns and Lehman Brothers, it was rarely discussed (except by certain lawyers who negotiate these agreements).  In the simplest terms, hypothication is the posting of securities or other collateral to a prime broker in exchange for credit or margin.  Rehypothication is the further pledging or lending by the prime broker of the already hypothecated securities or other collateral by the customer for its own purposes.

Prime Brokerage and Rehypothication

In modern prime brokerage, rehypothication is deeply ingrained in the business model of the major prime brokers.  Typically, hedge fund customer assets are rehypothicated to other banks to raise cash for the prime brokers.  Allowing the prime brokers to rehypothicate assets has historically kept down the cost of borrowing money for hedge fund managers.  In recent years, hedge funds have benefited from this arrangement by obtaining very cheap margin pricing.

Bankruptcy of a Prime Broker

The problem for hedge fund managers is that if there is a bankruptcy filing of their prime broker, hedge funds may have difficulty getting their rehypothicated assets back, particularly if these assets are held by the prime broker’s London affiliate, as the UK has more relaxed rules regarding rehypothication.  A number of highly successful managers had to literally shut their doors in September 2008 because their assets were tied up in Lehman Brothers’ London affiliate.  Lehman filed for bankruptcy in September 2008, and Pricewaterhouse Coopers, Lehman’s European administrator, currently estimates that assets may be returned to clients in the first quarter of 2010 – a year and a half later.

Hedge Fund Managers and Rehypothication

It is important for hedge fund managers to understand this concept of rehypothication for several reasons.  First, managers need to take ownership of their prime brokerage arrangements and understand them in general.  It has been my experience that many managers that take extreme care in making portfolio decisions pay absolutely no attention to their prime brokerage or custody arrangements.  As the events of 2008 demonstrated, they do so at their peril.  Imagine being up for the year, and then losing everything because the manager neglected to monitor their prime brokerage and custody arrangements.

Second, investors are asking about it.  The concept of rehypothication entered the hedge fund vernacular in 2008 and is here to stay.  Investors now frequently ask about rehypothication, and other prime brokerage concepts/arrangements, in due diligence, and there are a lot of misconceptions about the term.  Nevertheless, especially in the current environment, a lack of understanding about prime brokerage, custody, etc . . . can make the difference in receiving an allocation from an investor or cause a manager to fail operational due diligence.  Managers need to be prepared to discuss these concepts and be aware of the terms in their own prime brokerage agreements.

To find out more about rehypothication and other topics relating to prime brokerage or custody, please contact Karl Cole-Frieman of Cole-Frieman & Mallon LLP (www.colefrieman.com) at 415-352-2300 or [email protected]

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Other related hedge fund law and start up articles include:

Series 7 Exam Overview | General Securities Representative Exam

What is the Series 7 Exam?

The Securities and Exchange Commission requires that individuals who want to enter the securities industry to sell any type of securities must take and pass the Series 7 examination to qualify as a general securities representative.  Individuals who are Series 7 licensed are eligible to register with all self-regulatory organizations to trade. The cost of the exam is $250, and it can be taken at any of numerous testing centers across the country on any regular business day.  The only prerequisite for the exam is that the exam taker must be sponsored by a financial company who is a member of FINRA or a Self-Regulatory Organization (SRO).

Breakdown of the Exam

The Series 7 consists of 250 multiple choice questions, divided into two sections of 125 questions each, and exam takers are allotted 3 hours per section.  The registration qualifies a candidate for the solicitation, purchase, and/or sale of al securities products, including corporate securities, municipal securities,  municipal fund securities, options, direct participation programs, investment company products, and variable contracts. The exam covers a broad range of investments including: stocks, bonds, options, limited partnerships, and investment company products (e.g., open- and closed-end funds).  A candidate must answer 70% of the questions correctly in order to pass.

The exam typically has the following breakdown with regards to how the questions are categorized:

  • Prospecting for and Qualifying Customers:
    9 questions,  4% of exam
  • Evaluating Customer Needs and Objectives:
    4 questions, 2% of exam
  • Providing Customers with Investment Information and Making Suitable Recommendations:
    123 questions, 48% of exam
  • Handling Customer Accounts and Account Records:
    27 questions, 11% of exam
  • Understanding and Explaining the Securities Markets’ Organization and Participants to Customers:
    53 questions, 21% of exam
  • Processing Customer Orders and Transactions:
    13 questions, 5% of exam
  • Monitoring Economic and Financial Events, Performing Customer Portfolio Analysis and Making Suitable Recommendations:
    21 questions, 8% of exam

The Series 7 exam topics include:

  • Fiduciary Accounts
  • Hypothecation
  • Roth IRA
  • Insider Trading
  • Short Selling
  • SIPC
  • FINRA Code of Procedure
  • Discretionary Brokerage Accounts
  • Fannie Mae
  • Certificates of Deposit
  • SEC Act of 1934
  • Cyclical Industries
  • Short Interest Theory
  • 401k Plans
  • Foreign Mutual Funds
  • New York Stock Exchange
  • Combination Privilege
  • Stock Split
  • Margin Trading
  • Benefits of Stock Ownership
  • REITs
  • Authorized Stock
  • Company’s Net worth
  • Book Value vs. Market Value
  • Stock Certificate
  • Warrants
  • American Depositary Receipt
  • Dividends

Useful Terms to Know for the Series 7 Exam

Exam takers are expected to be familiar with the following terms and definitions prior to taking the Series 7 exam. The definitions presented below have been extracted from  Investopedia.

1.   Collateralized Mortgage Obligation – CMO:

A type of mortgage-backed security that creates separate pools of pass-through rates for different classes of bondholders with varying maturities, called tranches. The repayments from the pool of pass-through securities are used to retire the bonds in the order specified by the bonds’ prospectus.

2.  Defensive Investment Strategy:

A method of portfolio allocation and management aimed at minimizing the risk of losing principal. Defensive investors place a high percentage of their investable assets in bonds, cash equivalents, and stocks that are less volatile than average.

3.  Direct Participation Program – DPP:

A business venture designed to let investors participate directly in the cash flow and tax benefits of the underlying investment. DPPs are generally passive investments that invest in real estate or energy-related ventures.

4.  Liquidity Risk:

The risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss.

5.  No-Par Value Stock:

Stock that is issued without the specification of a par value indicated in the company’s articles of incorporation or on the stock certificate itself.

6.  Options Clearing Corporation – OCC:

A clearing organization that acts as both the issuer and guarantor for option and futures contracts.

7.  Repurchase Agreement – Repo:

A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day.

For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.

8.  Systematic Risk:

The risk inherent to the entire market or entire market segment.  Also known as “un-diversifiable risk” or “market risk.”

9.  U.S. Treasury:

Created in 1798, the United States Department of the Treasury is the government (Cabinet) department responsible for issuing all Treasury bonds, notes and bills. Some of the government branches operating under the U.S. Treasury umbrella include the IRS, U.S. Mint, Bureau of the Public Debt, and the Alcohol and Tobacco Tax Bureau.

How to sign up to take the Series 7

The Financial Industry Regulatory Authority (FINRA) administers the Series 7 in the United States at Thomson Prometric Testing Centers or Pearson Professional Center.  To make a test appointment or to address any questions related to a test appointment with Thompson Prometric Testing Center, exam takers may contact the Thomson center ( 1-800-578-6273) or the Pearson Center (1-866-396-6273).

To register for the exam, exam takers must complete the Form U-4 application. The sponsoring firm should then send the U-4 form along with your fingerprints, to FINRA for processing. Once the information has been processed, a confirmation will be sent to the sponsoring firm.

What Exam Takers are Saying

The Series 7 is considered to be one of the more comprehensive and lengthy exams administered by FINRA, mainly because it is required of anyone who intends to become a licensed stock broker.  The pass rate is approximately 65-70%.

In the Series 7, questions regarding options tend to be one of the biggest challenges, according to test takers.  This is primarily because these questions make up a large part of the exam (50 questions total, 35 of which deal with options strategies) and many candidates have never been exposed to options contracts and strategies.

In general, purchasing study guides or taking a prep class is the most common approach among those who have passed the Series 7 exam on the first try.  While there are a variety of resources available in print and online, the majority of test takers surveyed agree that the best way to ensure first-time passage is to take numerous practice tests and familiarize oneself with the terminology and question types presented in the the exam.

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SEC Supports Private Funds Transparency Act of 2009

Testimony Concerning Regulating Hedge Funds and Other Private Investment Pools

The SEC released a testimony from Andrew J. Donohue before the U.S. Senate about the regulation of hedge funds and other private investment pools.  According to Mr. Donohue’s statement, securities laws have not kept pace with the growth market and thus the SEC has very little oversight authority over these advisors and private funds with regards to conducting compliance examinations, obtaining material information, etc primarily because these requirements only apply to those advisors  and entities registered with the SEC.  Because advisors to private funds have the option to ‘opt out’ of registration, they can easily bypass any monitoring and oversight. The Commission strongly supports the enforcement of the new Private Funds Transparency Act of 2009,* which attempts to close this regulatory gap by requiring advisors to private funds to register under the Advisers Act if they have at least $30 million of assets under management.  The Commission also notes that in order to be effective, the new regulatory reform should acknowledge the differences in the business models pursued by different types of private fund advisers and should address in a proportionate manner the risks to investors and the markets raised by each.

The various compliance requirements on advisors to private funds as set forth by this new legislation is outlined in the testimony, reprinted in full below.

*Note: this testimony was given the same day that the Treasury announced the Private Fund Investment Advisers Registration Act of 2009 which is very similar to the Private Funds Transparency Act of 2009.

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Testimony Concerning Regulating Hedge Funds and Other Private Investment Pools
by Andrew J. Donohue
Director, Division of Investment Management
U.S. Securities and Exchange Commission

Before the Subcommittee on Securities, Insurance, and Investment of the U.S. Senate Committee on Banking, Housing, and Urban Affairs
July 15, 2009

Chairman Reed, Ranking Member Bunning and Members of the Subcommittee:

I. Introduction

Thank you for the opportunity to testify before you today. My name is Andrew Donohue, and I am the Director of the Division of Investment Management at the Securities and Exchange Commission. I am pleased to testify on behalf of the Commission about regulating hedge funds and other private investment pools.1

Over the past two decades, private funds, including hedge, private equity and venture capital funds, have grown to play an increasingly significant role in our capital markets both as a source of capital and the investment vehicle of choice for many institutional investors. We estimate that advisers to hedge funds have almost $1.4 trillion under management. Since many hedge funds are very active and often leveraged traders, this amount understates their impact on our trading markets. Hedge funds reportedly account for 18-22 percent of all trading on the New York Stock Exchange. Venture capital funds manage about $257 billion of assets,2 and private equity funds raised about $256 billion last year.3

The securities laws have not kept pace with the growth and market significance of hedge funds and other private funds and, as a result, the Commission has very limited oversight authority over these vehicles. Sponsors of private funds—typically investment advisers—are able to organize their affairs in such a way as to avoid registration under the federal securities laws. The Commission only has authority to conduct compliance examinations of those funds and advisers that are registered under one of the statutes we administer. Consequently, advisers to private funds can “opt out” of Commission oversight.

Moreover, the Commission has incomplete information about the advisers and private funds that are participating in our markets. It is not uncommon that our first contact with a manager of a significant amount of assets is during an investigation by our Enforcement Division. The data that we are often requested to provide members of Congress (including the data we provide above) or other federal regulators are based on industry sources, which have proven over the years to be unreliable and inconsistent because neither the private funds nor their advisers are required to report even basic census-type information.

This presents a significant regulatory gap in need of closing. The Commission tried to close the gap in 2004—at least partially—by adopting a rule requiring all hedge fund advisers to register under the Investment Advisers Act of 1940 (“Advisers Act”).4 That rulemaking was overturned by an appellate court in the Goldstein decision in 2006.5 Since then, the Commission has continued to bring enforcement actions vigorously against private funds that violate the federal securities laws, and we have continued to conduct compliance examinations of the hedge fund advisers that remain registered under the Advisers Act. But we only see a slice of the private fund industry, and the Commission strongly believes that legislative action is needed at this time to enhance regulation in this area.

The Private Fund Transparency Act of 2009, which Chairman Reed recently introduced, would require advisers to private funds to register under the Advisers Act if they have at least $30 million of assets under management.6 This approach would provide the Commission with needed tools to provide oversight of this important industry in order to protect investors and the securities markets. Today, I wish to discuss how registration of advisers to private funds under the Advisers Act would greatly enhance the Commission’s ability to properly oversee the activities of private funds and their advisers. Although the Commission supports this approach, there are additional approaches available to that also would close the regulatory gap and provide the Commission with tools to better protect both investors and the health of our markets.

II. The Importance and Structure of Private Funds

Private funds are generally considered to be professionally managed pools of assets that are not subject to regulation under the Investment Company Act of 1940 (“Investment Company Act”). Private funds include, but are not limited to, hedge funds, private equity funds and venture capital funds.

Hedge funds pursue a wide variety of strategies that typically involve the active management of a liquid portfolio, and often utilize short selling and leverage.

Private equity funds generally invest in companies to which their advisers provide management or restructuring assistance and utilize strategies that include leveraged buyouts, mezzanine finance and distressed debt. Venture capital funds typically invest in earlier stage and start-up companies with the goal of either taking the company public or privately selling the company. Each type of private fund plays an important role in the capital markets. Hedge funds are thought to be active traders that contribute to market efficiency and enhance liquidity, while private equity and venture capital funds are seen as helping create new businesses, fostering innovation and assisting businesses in need of restructuring. Moreover, investing in these funds can serve to provide investors with portfolio diversification and returns that may be uncorrelated or less correlated to traditional securities indices.

Any regulatory reform should acknowledge the differences in the business models pursued by different types of private fund advisers and should address in a proportionate manner the risks to investors and the markets raised by each.

III. Current Regulatory Exemptions

Although hedge funds, private equity funds and venture capital funds reflect different approaches to investing, legally they are indistinguishable. They are all pools of investment capital organized to take advantage of various exemptions from registration. All but one of these exemptions were designed to achieve some purpose other than permitting private funds to avoid oversight.

A. Securities Act of 1933

Private funds typically avoid registration of their securities under the Securities Act of 1933 (Securities Act) by conducting private placements under section 4(2) and Regulation D.7 As a consequence, these funds are sold primarily to “accredited investors,” the investors typically receive a “private placement memorandum” rather than a statutory prospectus, and the funds do not file periodic reports with the Commission. In other words, they lack the same degree of transparency required of publicly offered issuers.

B. Investment Company Act of 1940

Private funds seek to qualify for one of two exceptions from regulation under the Investment Company Act of 1940 (Investment Company Act). They either limit themselves to 100 total investors (as provided in section 3(c)(1)) or permit only “qualified purchasers” to invest (as provided in section 3(c)(7)).8 As a result, the traditional safeguards designed to protect retail investors in the Investment Company Act are the subject of private contracts for investors in private funds. These safeguards include investor redemption rights, application of auditing standards, asset valuation, portfolio transparency and fund governance. They are typically included in private fund partnership documents, but are not required and vary significantly among funds.

C. Investment Advisers Act of 1940

The investment activities of a private fund are directed by its investment adviser, which is typically the fund’s general partner.9 Investment advisers to private funds often claim an exemption from registration under section 203(b)(3) of the Advisers Act, which is available to an adviser that has fewer than 15 clients and does not hold itself out generally to the public as an investment adviser.

Section 203(b)(3) of the Advisers Act contains a de minimis provision that we believe originally was designed to cover advisers that were too small to warrant federal attention. This exemption now covers advisers with billions of dollars under management because each adviser is permitted to count a single fund as a “client.” The Commission recognized the incongruity of the purpose of the exemption with the counting rule, and adopted a new rule in 2004 that required hedge fund advisers to “look through” the fund to count the number of investors in the fund as clients for purposes of determining whether the adviser met the de minimis exemption. This was the rule overturned by the appellate court in the Goldstein decision. As a consequence, approximately 800 hedge fund advisers that had registered with the Commission under its 2004 rule subsequently withdrew their registration.

All advisers to private funds are subject to the anti-fraud provisions of the Investment Advisers Act, including an anti-fraud rule the Commission adopted in response to the Goldstein decision that prohibits advisers from defrauding investors in pooled investment vehicles.10 Registered advisers, however, are also subject to periodic examination by Commission staff. They are required to submit (and keep current) registration statements providing the Commission with basic information, maintain business records for our examination, and comply with certain rules designed to prevent fraud or overreaching by advisers. For example, registered advisers are required to maintain compliance programs administered by a chief compliance officer.

IV. Options to Address the Private Funds Regulatory Gap11

As discussed below, though there are different regulatory approaches to private funds available to Congress, or a combination of approaches, no type of private fund should be excluded from any new oversight authority any particular type of private fund. The Commission’s 2004 rulemaking was limited to hedge fund advisers. However, since that time, the lines which may have once separated hedge funds from private equity and venture capital funds have blurred, and the distinctions are often unclear. The same adviser often manages funds pursuing different strategies and even individual private funds often defy precise categorization. Moreover, we are concerned that in order to escape Commission oversight, advisers may alter fund investment strategies or investment terms in ways that will create market inefficiencies.

A. Registration of Private Fund Investment Advisers

The Private Funds Transparency Act of 2009 would address the regulatory gap discussed above by eliminating Section 203(b)(3)’s de minimis exemption from the Advisers Act, resulting in investment advisers to private funds being required to register with the Commission. Investment adviser registration would be beneficial to investors and our markets in a several important ways.

1. Accurate, Reliable and Complete Information

Registration of private fund advisers would provide the Commission with the ability to collect data from advisers about their business operations and the private funds they manage. The Commission and Congress would thereby, for the first time have accurate, reliable and complete information about the sizable and important private fund industry which could be used to better protect investors and market integrity. Significantly, the information collected could include systemic risk data, which could then be shared with other regulators.12

2. Enforcement of Fiduciary Responsibilities

Advisers are fiduciaries to their clients. Advisers’ fiduciary duties are enforceable under the anti-fraud provisions of the Advisers Act. They require advisers to avoid conflicts of interest with their clients, or fully disclose the conflicts to their clients. Registration under the Advisers Act gives the Commission authority to conduct on-site compliance examinations of advisers designed, among other things, to identify conflicts of interest and determine whether the adviser has properly disclosed them. In the case of private funds, it gives us an opportunity to determine facts that most investors in private funds cannot discern for themselves. For example, investors often cannot determine whether fund assets are subject to appropriate safekeeping or whether the performance represented to them in an account statement is accurate. In this way, registration may also have a deterrent effect because it would increase an unscrupulous adviser’s risk of being discovered.

A grant of additional authority to obtain information from and perform on-site examinations of private fund advisers should be accompanied with additional resources so that the Commission can bring to bear the appropriate expertise and technological support to be effective.

3. Prevention of Market Abuses

Registration of private fund advisers under the Advisers Act would permit oversight of adviser trading activities to prevent market abuses such as insider trading and market manipulation, including improper short-selling.

4. Compliance Programs

Private fund advisers registered with the Commission are required to develop internal compliance programs administered by a chief compliance officer. Chief compliance officers help advisers manage conflicts of interest the adviser has with private funds. Our examination staff resources are limited, and we cannot be at the office of every adviser at all times. Compliance officers serve as the front-line watch for violations of securities laws, and provide protection against conflicts of interests.

5. Keeping Unfit Persons from Using Private Funds to Perpetrate Frauds

Registration with the Commission permits us to screen individuals associated with the adviser, and to deny registration if they have been convicted of a felony or engaged in securities fraud.

6. Scalable Regulation

In addition, many private fund advisers have small to medium size businesses, so it is important that any regulation take into account the resources available to those types of businesses. Fortunately, the Advisers Act has long been used to regulate both small and large businesses, so the existing rules and regulations already account for those considerations. In fact, roughly 69 percent of the investment advisers registered with the Commission have 10 or fewer employees.

7. Equal Treatment of Advisers Providing Same Services

Under the current law, an investment adviser with 15 or more individual clients and at least $30 million in assets under management must register with the Commission, while an adviser providing the same advisory services to the same individuals through a limited partnership could avoid registering with the Commission. Investment adviser registration in our view is appropriate for any investment adviser managing $30 million regardless of the form of its clients or the types of securities in which they invest.

B. Private Fund Registration

Another option to address the private fund regulatory gap might be to register the funds themselves under the Investment Company Act (in addition to registering their advisers under the Advisers Act). Alternatively, the Commission could be given stand-alone authority to impose requirements on unregistered funds. Through direct regulation of the funds, the Commission could impose, as appropriate, investment restrictions or diversification requirements designed to protect investors. The Commission could also regulate the structure of private funds to protect investors (such as requiring an independent board of directors) and could also regulate investment terms (such as protecting redemption rights).

C. Regulatory Flexibility through Rulemaking Authority

Finally, there is third option that in conjunction with advisers’ registration may be necessary to address the regulatory gap in this area. Because it is difficult, if not impossible, to predict today what rules will be required in the future to protect investors and obtain sufficient transparency, especially in an industry as dynamic and creative as private funds, an additional option might be to provide the Commission with the authority that allows for additional regulatory flexibility to act in this area. This could be done by providing rule-making authority to condition the use by a private fund of the exceptions provided by sections 3(c)(1) and 3(c)(7) of the Investment Company Act. These conditions could impose those requirements that the Commission believes are necessary or appropriate to protect investors and enhance transparency.13 In many situations, it may be appropriate for these requirements to vary depending upon the type of fund involved. This would enable the Commission to better discharge its responsibilities and adapt to future market conditions without necessarily subjecting private funds to Investment Company Act registration and regulation.

V. Conclusion

The registration and oversight of private fund advisers would provide transparency and enhance Commission oversight of the capital markets. It would give regulators and Congress, for the first time, reliable and complete data about the impact of private funds on our securities markets. It would give the Commission access to information about the operation of hedge funds and other private funds through their advisers. It would permit private funds—which play an important role in our capital markets—to retain the current flexibility in their investment strategies.

The Commission supports the registration of private fund advisers under the Advisers Act. The other legislative options I discussed above, namely registration of private funds under the Investment Company Act and/or providing the Commission with rulemaking authority in the Investment Company Act exemptions on which private funds rely, should also be weighed and considered as the Subcommittee considers approaches to filling the gaps in regulation of pooled investment vehicles.

I would be happy to answer any questions you may have.

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Endnotes:

1 Commissioner Paredes does not endorse this testimony.

2 The National Venture Capital Association (NVCA) estimates that 741 venture capital firms and 1,549 venture capital funds were in existence in 2007, with $257.1 billion in capital under management. NVCA, Yearbook 2008 at 9 (2008). In 2008, venture capital funds raised $28.2 billion down from $35.6 billion in 2007. Thomson Reuters & NVCA, News Release (Apr. 13 2009). In 2007, the average fund size was $166 million and the average firm size was $347 million. Id. at 9.

3 U.S. private equity funds raised $256.9 billion in 2008 (down from $325.2 billion in 2007). Private Equity Analyst, 2008 Review and 2009 Outlook at 9 (2009) (reporting Dow Jones LP Source data.

4 Investment Advisers Act Release No. 2333 (Dec. 2, 2004).

5 See Goldstein v. S.E.C., 451 F.3d 873 (D.C. Cir. 2006).

6 Section 203A(a)(1) of the Act prohibits a state-regulated adviser to register under the Act if it has less than $25 million of assets under management. The Commission has adopted a rule increasing the $25 million threshold to $30 million. See Rule 203A-1 under the Advisers Act. The threshold does not apply to foreign advisers. Section 3 of the Private Fund Transparency Act would establish a parallel registration threshold for foreign advisers, which would prevent numerous smaller foreign advisers that today rely on the de minimis exception, which the Act would repeal, from being required to register with the Commission.

7 Section 4(2) of the Securities Act of 1933 provides an exemption from registration for transactions by the issuer of a security not involving a public offering. Rule 506 of Regulation D provides a voluntary “safe harbor” for transactions that are considered to come within the general statutory language of section 4(2).

8 “Qualified purchasers” generally are individuals or family partnerships with at least $5 million in investable assets and companies with at least $25 million. The section 3(c)(7) exception was added in 1996 and specifically anticipated use by private funds.

9 Private funds often are organized as limited partnerships with the fund’s investment adviser serving as the fund’s general partner. The fund’s investors are limited partners of the fund.

10 See Rule 206(4)-8 under the Advisers Act.

11 Commissioner Casey does not endorse the approaches discussed in sections IV. B and C.

12 The Private Fund Transparency Act includes some important although technical amendments to the Advisers Act that are critical to the Commission’s ability to collect information from advisers about private funds, including amendments to Section 204 of the Act permitting the Commission to keep information collected confidential, and amendments to Section 210 preventing advisers from keeping the identity of private fund clients from our examiners.

13 For example, private funds might be required to provide information directly to the Commission. These conditions could be included in an amendment to the Investment Company Act or could be in a separate statute.

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Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  Mallon P.C. helps hedge fund managers to register as investment advisors with the SEC or the state securities divisions.  If you are a hedge fund manager who is looking to start a hedge fund or register as an investment advisor, please contact us or call Mr. Mallon directly at 415-296-8510.  Other related hedge fund law articles include:

Series 79 Exam – Waiting for SEC Approval

Post courtesy of www.series79exam.com.

SEC to Shed Light on the New Series 79 Exam

Pursuant to a proposal set forth by FINRA in February of this year, it is anticipated that the Series 79 will be introduced as a simplified alternative exam for investment bankers. Prior to the introduction of this new exam, all registered representatives were required by NASD Rule 1032 to take the Series 7 exam. The proposal modified this Rule to condense the exam for those individuals whose activities are limited to investment banking. The primary reason behind the FINRA proposal for a new abridged exam was that the Series 7 exam covers a broad array of functions that do not pertain to the day-to-day activities of an investment banker.

On July 13, 2009 we contacted FINRA to determine what information, if any, has been released on the new Series 79 exam.  According to FINRA, the SEC has approved the proposal set forth by FINRA as of April of this year, but SEC approval on the content of the exam and related fees is still pending. Thus, there is limited information available to prospective exam takers regarding the proposed content of the exam, the timeline for required registration, the release of related study materials and/or course offerings, and related exam fees.  Once the SEC issues its approval, a formal press release will be issued to the public regarding the structure of the exam as well as an expected date as to when the modified NASD Rule 1032(i) will be enforced, thereby establishing the Series 79 as the new license requirement for investment bankers.

All information regarding the Series 79 Exam will be available on this site for prospective exam takers once it is formally approved by the SEC.

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Please contact us if you have any questions or would like to  learn how to start a hedge fund.  Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.