Category Archives: Business Issues

Karl Cole-Frieman Speaking at San Francisco Hedge Fund Event

Dodd-Frank Implementation Considerations for Private Equity and Hedge Funds

On October 18th Grant Thornton LLP and Financial Women’s Association of San Francisco will be hosting a panel discussion and reception focused on regulatory issues for hedge funds and private equity funds. Karl Cole-Frieman, a partner with Cole-Frieman & Mallon LLP, will be the attorney on the panel and will be discussing both the legal and business aspects of compliance with the various Dodd-Frank regulations.

Information on the event is posted below and you can register for the event by clicking here.

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Grant Thornton LLP and the Financial Women’s Association of San Francisco invite you to join our upcoming panel discussion, focusing on implementation considerations for Private Equity and Hedge Funds under the Dodd-Frank Act. At this informative event, professionals from the industry will discuss various hot topics including:

Registration requirements
Restructuring considerations
Implementation and best practices
Focus areas of SEC examinations
Cost effective ways to comply with Dodd-Frank

Featured Panelists

Winston Wilson – National Financial Services Sector Leader, Grant Thornton LLP

Mark Catalano – Director, Deutsche Bank, Alternative Fund Services

Chris Lombardy – Member, Regulatory compliance, Kinetic Partners

Karl Cole-Frieman – Partner, Cole-Frieman & Mallon LLP

Moderated by Ann Oglanian, President & CEO, ReGroup LLC

Agenda

4:00 – 4;30 p.m. Registration*

4:30 – 6:00 p.m. Panel / Q&A

6:00 – 7:00 p.m. Cocktail reception

Location

Omni Hotel

500 California Street

2nd Floor

San Francisco, CA 94104

* This event is by invitation only. Spots are limited so register early!

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Cole-Frieman & Mallon LLP provides a variety of services including: hedge fund formation, advisor registration and counterparty documentation, CFTC and NFA matters, seed deals, internal investigations, operational compliance, regulatory risk management, hedge fund due diligence, marketing and investor relations, employment and compensation matters, and routine business matters. For more information please visit us at: http://www.colefrieman.com/.

Hedge Fund "First-Loss" Capital Programs

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Hedge Fund Seeder & Capital Alternative

Although industry assets are at record levels, start-up and emerging hedge fund managers are finding it extremely difficult to raise capital. The overwhelming majority of asset inflows have gone to managers with assets in excess of $5 Billion despite empirical evidence that suggests that smaller/emerging mangers perform better. As a result, emerging managers are seeking capital sources active in the emerging manager space that can help grow their business. These capital sources range from traditional hedge fund seeding arrangements to acceleration capital (which is essentially a late stage seeding). One lesser known source of capital available to start-up and emerging managers that has been growing in popularity is so called “risk based managed accounts” or “first-loss” capital. This article will provide a general overview of how these programs are structured and explain the points that managers should consider when evaluating these programs.

Overview of First-Loss Type Programs

The capital provider that manages the program generally allocates to a separately managed account for the manager to trade. In order to receive the allocation the manager is required to contribute capital equal to a fixed percentage ranging from 10%-20% of the total managed account depending on the provider. The manager receives a higher than industry normal performance fee and for this higher payout the manager’s capital sits in a first position with respect to losses. What this means is that if there are losses in the account then they are absorbed first by the managers capital. However, it’s important to understand that in months following losses the manager receives 100% of all future profits until the manager is made whole, so it is effectively a “first-first” account whereby, losses are first absorbed by the manager’s capital account but first re-paid to the manager’s capital account upon future profits.

For example, if the capital provider allocates 10MM then the manager will be required to contribute approximately 1MM. If in the first month the account had a negative P&L of 100k, the manager’s capital account would equal 900k. If the following month the account had positive P&L of 200k the first 100k would go back to the manager and the remaining 100k would be split according to the performance fee payout.

Benefits for a Prospective Manager

The basic benefits to the managers include the following:

High performance payout – these firms pay a higher than industry normal performance payout

Increased capital base – these firms often allocate significant amounts of capital 25-100MM

Monthly payouts – the manager receives his split on the P&L on a monthly basis vs. having to wait till year end or post an audit

Cost effective and turnkey – the cost to the manager is minimal as these firms handle all of the set up and administration related costs

Establish a track record with a best ideas or second strategy – the track record is owned by the manager, and these firms allow managers to run portfolios that are different than the manager’s core fund.

Traditional allocations – there are certain first-loss groups that are affiliated with traditional allocation vehicles, fund of funds, etc. Such groups will use these managed account as form of active due diligence and allocate traditionally to managers who consistently perform

Fund Manager Considerations

As with any potential service provider, mangers who are considering running these accounts should perform due diligence on the program sponsors as there are differences between the various program sponsors. Important questions to ask when reviewing a sponsor include:

Is it a reputable firm? Can they provide me with industry references, and current manager references? Who controls the firm?
How long has the firm been running the program, and what experience does the sponsor have in the space?
Who or whom is the capital behind the program? Is the capital committed for a long time period and/or has there been a longstanding relationship in place?
Does the firm offer any additional opportunities for managers, such as the potential for traditional allocations? Are they actively making these allocations, and do they have recent live examples?
What is the provider’s risk management policy & procedures?
How is the first-loss capital provider compensated? Are they compensated strictly based on the manager’s performance or are they also paid a portion of the trading revenues?
What are the details of the deal? Does the capital provider change the account level or your ability to use the capital at a certain level of losses thereby making it harder to make back previous losses? At what point is the account terminated?
What are the fees and expenses including commissions, financing charges, or management fees?

As with any due diligence inquiry, there are a number of other questions and inquiries a manager should undertake when selecting a risk based managed account capital provider. Certainly, an onsite visit makes sense for any managers who are in the final stages of their due diligence.

Capital Providers

There are multiple firms that sponsor these first-loss capital programs. Of the various providers, two in particular are most prominent in the space, Topwater Capital Partners and Prelude Capital. Topwater Capital has been existence since 2002 and is widely credited for creating the structure and is the clear leader in the space.

Fund Investor Legal and Regulatory Considerations

Mangers who ultimately decide to participate in a risk based managed account programs will need to discuss with their legal counsel the issue of disclosure. The discussion is likely to be cenetered around conflicts of interest, drawdown risks/ volatility, different terms for different investors (if in a fund structure) and/or discussion of investment through separate account structures. Additionally, if managers are registered with the state or SEC the manager may need to provide disclosures in the Form ADV Part 2. If a manager faces an examination by a securities division, it is likely that the structure will be scrutinized by examiners who may or may not understand the structure. Mangers who enter into these arrangements may also need to review compliance procedures and may need to receive certain reps and warranties from the program sponsor.

[Note: because of the bespoke nature of these arrangements, we cannot list all potential issues or considerations. Please also note we are not providing legal advice and please read our disclaimer.]

Risk Based Managed Accounts vs. Traditional Seed and Acceleration Capital

A risk based managed account program is often considered by managers when evaluating seed capital or acceleration capital. There are distinct advantages for managers pursuing a risk based managed account relationship as opposed to a seed or acceleration relationship. The most significant advantage of first-loss over seed/acceleration is ownership. Typical seed and acceleration deals involve the manager giving up an ownership stake or revenue share % to the seed/acceleration capital provider, which results in topline revenue shares for 5-10 years and in some cases, perpetuity. When managers are able to end the seed or acceleration partnership they are generally forced to buy back the stake in their company, which is valued by a number of different metrics depending on the deal. Additionally, seed/acceleration capital providers are generally granted a number of other benefits, including capacity rights, information rights, and preferred redemption rights. In many instances seeding or acceleration deals also put restrictions on the managers portfolio composition, risk management processes, and limit withdrawals by key employees.

The various restrictions placed on managers who enter seed or acceleration deals are one reason why many managers choose to manage risk based managed accounts instead. By choosing risked based managed accounts over seed or acceleration capital, managers maintain their autonomy and discretion as to how to run their business. Also, risk based managed accounts generally pay performance fees to managers on a monthly basis which can provide the cash-flow necessary to hire and retain key employees. Risk based managed account programs can also help increase the visibility of managers, which depending on the risk based managed account capital provider, can result in direct allocations into their fund.

Conclusion

There is a growing interest in first-loss programs for good reason. These structures allow for managers to grow their business, generate cash-flow, and receive higher than average performance fees, which are just a few of the reasons why managers choose to manage these accounts. The capital raising environment is tougher than ever and risk based managed accounts allow managers to grow their AUM without giving up a piece of their business to a seeder or accelerator. While these structures are growing in popularity, it is important that managers involved discuss their disclosure requirements with their counsel. Additionally, as mentioned earlier, managers subject to SEC examination might have to educate the examiners on the structure, which is why it is important that managers work with experienced attorneys, accountants, and first-loss capital providers.

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Cole-Frieman & Mallon LLP is a hedge fund law firm and provides advice with respect to seeding arrangements, separately managed accounts and other structuring issues for fund managers. Bart Mallon can be reached directly at 415-868-5345. Karl Cole-Frieman can be reached at 415-352-2300.

FINRA Rule 5131 Effective September 26, 2011

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FINRA “Anti-Spinning” Rule 5131

The anti-spinning provisions of FINRA Rule 5131, which addresses certain conflicts of interest in allocation of New Issues, will go into effect September 26, 2011. Although Rule 5131 only applies to FINRA members (broker-dealers), hedge funds that invest in initial public offerings will be required to provide certain representations to their broker-dealer before they will be allowed to participate in New Issues. The definition of “New Issues” for purposes of Rule 5131 is the same as for FINRA Rule 5130, and includes most initial public offerings of equity securities.

Please note: Rule 5131 does not replace Rule 5130 and it creates additional requirements with respect to New Issues.

Spinning Prohibition

The purpose of the anti-spinning provision of FINRA Rule 5131 is to prohibit the practice of broker-dealers from allocating New Issues to executive officers and directors of current or potential clients in exchange for investment banking business (the practice commonly known as “spinning”).

Rule 5131 generally prohibits a broker-dealer from allocating New Issues to any account (including an account maintained by a hedge fund) in which beneficial interests are held by the following persons, if the broker-dealer currently has or has the expectation of a relationship with that company:

an executive officer or director of a public company or a covered non-public company, or
a person materially supported by such executive officer or director.

25% De Minimus Exemption

In addition to specific exemptions for certain types of accounts, the prohibition does not apply to an account where the interests of executive officers or directors of a public company or a covered non-public company, or persons materially supported by them, are less than 25% of such account. This means that if two investors in a hedge fund are both directors of the same public company but their combined interest in the fund is 20% of the fund, the broker-dealer will not be prohibited from allocating New Issues to that hedge fund.

Broker-Dealer Compliance with Rule 5131

Before allocating New Issues to any account, a broker-dealer will need to confirm the following:

whether the underlying investors in the account are executive officers or directors of a public company or a covered non-public company, or persons materially supported by them;
if yes, what company that investor is associated with, and
whether the interests of any one company are more than 25% of the account.

Correspondingly, investment managers will need to obtain this information from the underlying investors in their fund.

Implications for Investment Managers

If you currently manage a fund that invests in New Issues, you will likely be asked to complete a Rule 5131 certification by your broker-dealer. You will need to contact your existing investors and obtain written representations regarding their status, which may be done in the form of a questionnaire. You will also need to revise your hedge fund subscription documents to include similar representations for each new investor. Investor representations will need to be updated annually, which may be done through the use of a negative consent letter.

Even if more than 25% of the fund is owned by executive officers or directors (or persons materially supported by them) of one company, the fund may still participate in New Issues by implementing “carve-out” procedures to reduce the beneficial interests of those persons below 25%. Managers wishing to make use of such carve-outs should make sure the operating documents of their fund allow such procedures.

Please contact us if you need assistance in preparing questionnaires, revising offering documents or if you have questions regarding your ability to participate in New Issues under Rule 5131.

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Cole-Frieman & Mallon LLP is a firm with a practice focused on investment management law. Bart Mallon is a hedge fund attorney and can be reached directly at 415-868-5345.

FINRA Rule 5131 – New Issue Allocations and Distributions

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Full Text of FINRA Rule 5131

The following is the full version of FINRA Rule 5131 effective as of September 26, 2011. This rule, in conjunction with FINRA Rule 5130, governs the manner in which investors may participate in New Issues. Specifically, Rule 5131 prevents “spinning” which is the practice of allocating new issues to executive officers and directors of current or potential clients in exchange for investment banking business.

The following rule can also be found on the FINRA website here.

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5131. New Issue Allocations and Distributions

(a) Quid Pro Quo Allocations

No member or person associated with a member may offer or threaten to withhold shares it allocates of a new issue as consideration or inducement for the receipt of compensation that is excessive in relation to the services provided by the member.

(b) Spinning

(1) No member or person associated with a member may allocate shares of a new issue to any account in which an executive officer or director of a public company or a covered non-public company, or a person materially supported by such executive officer or director, has a beneficial interest:

(A) if the company is currently an investment banking services client of the member or the member has received compensation from the company for investment banking services in the past 12 months;

(B) if the person responsible for making the allocation decision knows or has reason to know that the member intends to provide, or expects to be retained by the company for, investment banking services within the next 3 months; or

(C) on the express or implied condition that such executive officer or director, on behalf of the company, will retain the member for the performance of future investment banking services.

(2) The prohibitions in this paragraph shall not apply to allocations of shares of a new issue to any account described in Rule 5130(c)(1) through (3) and (5) through (10), or to any other account in which the beneficial interests of executive officers and directors of the company and persons materially supported by such executive officers and directors in the aggregate do not exceed 25% of such account.

(1) No member or person associated with a member may directly or indirectly recoup, or attempt to recoup, any portion of a commission or credit paid or awarded to an associated person for selling shares of a new issue that are subsequently flipped by a customer, unless the managing underwriter has assessed a penalty bid on the entire syndicate.

(2) In addition to any obligation to maintain records relating to penalty bids under SEA Rule 17a-2(c)(1), a member shall promptly record and maintain information regarding any penalties or disincentives assessed on its associated persons in connection with a penalty bid.

(d) New Issue Pricing and Trading Practices

In a new issue:

(1) Reports of Indications of Interest and Final Allocations. The book-running lead manager must provide to the issuer’s pricing committee (or, if the issuer has no pricing committee, its board of directors):

(A) a regular report of indications of interest, including the names of interested institutional investors and the number of shares indicated by each, as reflected in the book-running lead manager’s book of potential institutional orders, and a report of aggregate demand from retail investors;

(B) after the settlement date of the new issue, a report of the final allocation of shares to institutional investors as reflected in the books and records of the book-running lead manager including the names of purchasers and the number of shares purchased by each, and aggregate sales to retail investors;

(2) Lock-Up Agreements. Any lock-up agreement or other restriction on the transfer of the issuer’s shares by officers and directors of the issuer entered into in connection with a new issue shall provide that:

(A) Any lock-up agreement or other restriction on the transfer of the issuer’s shares by officers and directors of the issuer shall provide that such restrictions will apply to their issuer-directed shares; and

(B) At least two business days before the release or waiver of any lock-up or other restriction on the transfer of the issuer’s shares, the book-running lead manager will notify the issuer of the impending release or waiver and announce the impending release or waiver through a major news service, except where the release or waiver is effected solely to permit a transfer of securities that is not for consideration and where the transferee has agreed in writing to be bound by the same lock-up agreement terms in place for the transferor;

(3) Agreement Among Underwriters. The agreement between the book-running lead manager and other syndicate members must require, to the extent not inconsistent with SEC Regulation M, that any shares trading at a premium to the public offering price that are returned by a purchaser to a syndicate member after secondary market trading commences:

(A) be used to offset the existing syndicate short position, or

(B) if no syndicate short position exists, the member must either:

(i) offer returned shares at the public offering price to unfilled customers’ orders pursuant to a random allocation methodology, or

(ii) sell returned shares on the secondary market and donate profits from the sale to an unaffiliated charitable organization with the condition that the donation be treated as an anonymous donation to avoid any reputational benefit to the member.

(4) Market Orders. No member may accept a market order for the purchase of shares of a new issue in the secondary market prior to the commencement of trading of such shares in the secondary market.

(e) Definitions

For purposes of this Rule, the following terms shall have the meanings stated below.

(1) A “public company” is any company that is registered under Section 12 of the Exchange Act or files periodic reports pursuant to Section 15(d) thereof.

(2) “Beneficial interest” shall have the same meaning as in FINRA Rule 5130(i)(1).

(3) “Covered non-public company” means any non-public company satisfying the following criteria: (i) income of at least $1 million in the last fiscal year or in two of the last three fiscal years and shareholders’ equity of at least $15 million; (ii) shareholders’ equity of at least $30 million and a two-year operating history; or (iii) total assets and total revenue of at least $75 million in the latest fiscal year or in two of the last three fiscal years.

(4) “Flipped” means the initial sale of new issue shares purchased in an offering within 30 days following the offering date of such offering.

(5) “Investment banking services” include, without limitation, acting as an underwriter, participating in a selling group in an offering for the issuer or otherwise acting in furtherance of a public offering of the issuer; acting as a financial adviser in a merger, acquisition or other corporate reorganization; providing venture capital, equity lines of credit, private investment, public equity transactions (PIPEs) or similar investments or otherwise acting in furtherance of a private offering of the issuer; or serving as placement agent for the issuer.

(6) “Material support” means directly or indirectly providing more than 25% of a person’s income in the prior calendar year. Persons living in the same household are deemed to be providing each other with material support.

(7) “New issue” shall have the same meaning as in Rule 5130(i)(9).

(8) “Penalty bid” means an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member in connection with an offering when the securities originally sold by the syndicate member are purchased in syndicate covering transactions.

(9) “Unaffiliated charitable organization” is a tax-exempt entity organized under Section 501(c)(3) of the Internal Revenue Code that is not affiliated with the member and for which no executive officer or director of the member, or person materially supported by such executive officer or director, is an individual listed or required to be listed on Part VII of Internal Revenue Service Form 990 (i.e., officers, directors, trustees, key employees, highest compensated employees and certain independent contractors).

• • • Supplementary Material: ————–

.01 Issuer Directed Allocations. The prohibitions of paragraph (b) above shall not apply to allocations of securities that are directed in writing by the issuer, its affiliates, or selling shareholders, so long as the member has no involvement or influence, directly or indirectly, in the allocation decisions of the issuer, its affiliates, or selling shareholders with respect to such issuer-directed securities.

.02 Annual Representation. For the purposes of paragraph (b), a member may rely on a written representation obtained within the prior 12 months from the beneficial owner(s) of the account, or a person authorized to represent the beneficial owner(s) of the account, as to whether such beneficial owner(s) is an executive officer or director or person materially supported by an executive officer or director and if so, the company(ies) on whose behalf such executive officer or director serves. A member may not rely upon any representation that it believes, or has reason to believe, is inaccurate. A member shall maintain a copy of all records and information relating to whether an account is eligible to receive an allocation of the new issue under paragraph (b) in its files for at least three years following the member’s allocation to that account.

.03 Lock-up Announcements. For the purposes of this Rule, the requirement that the book-running lead manager announce the impending release or waiver of a lock-up or other restriction on the transfer of the issuer’s shares shall be deemed satisfied where such announcement is made by the book-running lead manager, another member or the issuer, so long as such announcement otherwise complies with the requirements of paragraph (d)(2) of this Rule.

Amended by SR-FINRA-2011-017 eff. Sept. 26, 2011.

Adopted by SR-NASD-2003-140 eff. May 27, 2011.

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Cole-Frieman & Mallon LLP is a hedge fund law firm. Bart Mallon can be reached directly at 415-868-5345.

GAO Report on SRO for Private Fund Advisers

SRO for Private Fund Adviser could be established, but not without challenges

Over the last few weeks we have heard much talk about the potential formation of a self-regulatory organization (“SRO”) for registered investment advisers (i.e. hedge fund managers). In July the U.S. Government Accountability Office (“GAO”) released a report on the feasibility of forming an SRO to provide oversight to private fund advisers. The report was required by the Dodd-Frank Act and it discusses the feasibility of establishing the SRO as well as the potential advantages and disadvantages of forming such an organization. This report comes on the heels of an SEC study of IA examinations which analyzed whether an IA SRO would be feasible. [We concluded: This study simply states the obvious – the SEC does not have the resources it needs to adequately do its job. It seems like the major conclusion has already been reached – IA firms are going to need to pay for their oversight because Congress will not pay for it.] In the GAO report, the issue is examined further and the conclusion states that an SRO could be established and there would be potential advantages and disadvantages for doing so.

Feasibility of Establishing the SRO

The report discussed the feasibility of establishing the SRO. In general there are a number of items which would need to be put into place before an SRO could be formed and operating. The main item is that Congress would need to specifically authorize, through legislation, the creation of the SRO which would then be subject to SEC oversight. After authorization, a determination would be made as to whether the SRO would be created ab initio or if an existing SRO would take over the responsibilities of overseeing private fund advisers. It is likely that, given the costs of establishing an entirely new entity, an existing SRO (such as FINRA or the NFA) would simply be given the new oversight responsibilities. Once an SRO was determined, bylaws and operational issues will need to be addressed including fee and governance structures, board of directors, compliance rules and enforcement rules.

In any event, establishing an SRO for private fund advisers is likely to be resource intensive and subject to various levels of the political process – Congress, the SEC, (potentially) the CFTC, NASAA, and the SRO would all have agendas with respect to the SRO. Additionally, even within the private fund advisers group there is likely to be political positioning – large managers are going to have different concerns

than small managers and are most likely going to want to have a larger say with respect to operations (especially if they are paying a disproportionate amount of the fees to support the IA oversight functions of the SRO).

Potential Advantages of a Private Fund Adviser SRO

The report listed the following as potential advantages of the SRO:

Advantages of a private fund adviser SRO include its potential to (1) free a portion of SEC’s staff and resources for other purposes by giving the SRO primary examination and other oversight responsibilities for advisers that manage private funds, (2) impose higher standards of conduct and ethical behavior on its members than are required by law or regulations, and (3) provide greater industry expertise and knowledge than SEC, given the industry’s participation in the SRO.

Potential Disadvantages of a Private Fund Adviser SRO

The report listed the following as potential disadvantages of the SRO:

Some of the disadvantages of a private fund adviser SRO include its potential to (1) increase the overall cost of regulation by adding another layer of oversight; (2) create conflicts of interest, in part because of the possibility for self-regulation to favor the interests of the industry over the interests of investors and the public; and (3) limit transparency and accountability, as the SRO would be accountable primarily to its members rather than to Congress or the public

State Registration Issues

One of the questions which this particular report did not address is whether managers registered with a state securities division (instead of the SEC) would be subject to oversight by the SRO. The discussion of the advantages and disadvantages did not include state jurisdictional issues, but these issues are important. The state securities divisions are subject to the same budgetary limitations as the SEC and many times the states do not (contrary to reports by NASAA) have the expertise necessary to properly examine fund managers and other investment advisers. If state managers are not required to be part of the SRO then you are likely to see a wide disparity in examination and oversight between state registered managers and SEC registered managers (who would also be subject to SRO oversight). Expect to see this discussed in greater depth going forward.

Conclusion

The issue of whether or not there should be an IA SRO is not going to go away any time soon – especially with the SEC under intense budget pressure and the looming deadline for hedge fund IA registration (March 30, 2012). It is clear that in the race to be the SRO for investment advisers, FINRA is the leader and really probably the only viable option. While having FINRA oversee both BDs and IAs may not make the most sense, it is probably better than the alternatives which right now include (1) the NFA (which oversees managed futures firms) or (2) starting an SRO from scratch. Expect to hear more on this issue soon from both Congress and the SEC.

For the full GAO report, please see GAO Private Fund Adviser SRO Report.

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Cole-Frieman & Mallon LLP is a law firm which provides adviser registration, compliance and legal support to SEC registered hedge fund managers. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

Hedge Fund SEC Custody Rule Overview

Compliance Requirements of the SEC Custody Rule

Hedge fund managers are preparing to register as investment advisers with the SEC pursuant to the new Dodd-Frank registration requirements. One of the issues which managers will be dealing with during that process is the hedge fund custody rule (Rule 206(4)-2 under the Investment Advisers Act). In general this means that the SEC registered fund manager will need make sure that the fund (1) maintains its assets with a qualified custodian and (2) has an annual audit by a PCAOB Registered and Inspected audit firm.

Hedge Fund Managers Generally Have Custody

The requirements of the SEC Custody Rule are triggered when an investment adviser has “custody.” A fund manager is deemed to have “custody” of the fund's assets when it, or a related person, directly or indirectly has authority to obtain possession of” the fund's assets. The Rule specifically indicates that custody includes any capacity (such as general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives the investment adviser or a related person “legal ownership of or access to client funds or securities.”

Because hedge funds are generally structured so that the manager or a related entity serves as the general partner, hedge fund managers will generally be deemed to have custody under the Rule. Managers who also provide advice through separate accounts would not be considered to have custody of those separate accounts unless they have authority to automatically deduct fees from the account (or have custody for some other reason). If a manager is deemed to have custody, the manager will generally need to follow certain safe-keeping requirements.

Qualified Custodian Requirement

The first safe-keeping requirement of the Rule is that a fund's cash and securities must be maintained at a qualified custodian in “a separate account for each [fund] under that [fund’s] name” or in an account under the name of the fund manager as agent for the fund. Under the Rule, “qualified custodians” include banks, registered broker-dealers, registered futures commission merchants, and foreign financial institutions that customarily hold financial assets for their customers. Hedge fund managers generally satisfy the qualified custodian requirement by holding funds’ cash and securities at a prime broker or other broker-dealer.

Audit Requirement

Managers of hedge funds are exempt from the Rule’s other safe-keeping requirements (or are deemed to comply with those requirements) if the fund has its financial statements audited annually and upon liquidation. The audited financial statements must be prepared in accordance with generally accepted accounting principles (GAAP) and the audit must be conducted by an “independent public accountant that is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by, the Public Company Accounting Oversight Board [(PCAOB)] in accordance with its rules.” Care should be taken to ensure that any audit firm engaged by a fund is subject to regular inspection by the PCAOB.

The annually audited financial statements must be delivered to all limited partners within 120 days of the end of” a fund’s fiscal year.

Alternative to the Annual Audit Requirement

If a hedge fund manager does not qualify for the exemptions from other safe-keeping requirements by conducting an annual fund audit as discussed above, the other provisions to the Rule require that the manager to: (1) instruct the fund's qualified custodian(s) to send quarterly account statements directly to each limited partner, and (2) engage an independent public accountant to conduct an actual “surprise” examination of the funds’ cash and securities and file Form ADV-E with the SEC.

Because most funds will have an annual audit, the surprise examination alternative is rare.

Responses to Form ADV Questions Regarding Custody

In addition to satisfying the safe-keeping requirements of the Rule, hedge fund managers must make certain disclosures regarding custody on their Form ADV. Form ADV Part 1, Item 9.A requires managers to disclose the amount of funds and securities for which they have custody and Item 9.B requires the same disclosure for related persons of the manager. Additionally, Item 9.C requires managers to indicate whether they have engaged an accountant to conduct an annual audit of funds’ financial statements (and whether the managers use other means of satisfying the Rule’s safety requirements). The name and contact information of the accountant so engaged must be provided in Form ADV Schedule D, Section 9.C. Information provided on Form ADV Part 1, Item 9 (except the amount of funds and securities and number of clients for which the manager has custody) is considered material and must be updated promptly whenever there is a change.

Item 15 of Form ADV Part 2 (the Brochure) requires additional disclosures for those managers who have instructed qualified custodians to send account statements directly to the investors.

Other Items

For most fund managers who will be going through the SEC registration process, complying with the custody rule will be a straight forward exercise. State-registered investment advisers are subject to the various custody rules of the states in which they are registered.

For more information, please also see SEC Responses to Custody Rule Questions.

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Cole-Frieman & Mallon LLP provides investment adviser registration and compliance support to hedge fund managers. Bart Mallon can be reached directly at 415-868-5345. Karl Cole-Frieman can be reached at 415-352-2300.

Hedge Fund Carried Interest on Chopping Block Again?

President Obama Proposes Taxing Carried Interest as Ordinary Income

Every couple of years there are various proposals floated around congress to tax the hedge fund performance fee (or “carried interest”) as ordinary income (see a previous post on this topic from 2009 here). This week President Obama announced a proposal to tax the “carried interest” of an investment partnership as ordinary income. The tax will help to pay for the $447 billion American Jobs Act. According to the White House’s section-by-section analysis of the proposed legislation, the current capital gains treatment of income from the performance of services “creates an unfair and inefficient tax preference.”

The Proposal

Because the carried interest from an investment partnership is derived from the performance of services, the proposal would tax a service partner’s carried interest as ordinary income and make it subject to self-employment tax. The proposed language indicates that “in the case of an investment services partnership interest . . . an amount equal to the net capital gain with respect to such interest for any partnership taxable year shall be treated as ordinary income.” An investment services partnership interest is defined as “any interest in an investment partnership acquired or held by any person in connection with the conduct of a trade or business” that includes providing investment advice, managing or acquiring assets, arranging financing with respect to acquiring assets, or any activity in support of providing investment advice.

The proposal excludes any partnership interest that is attributed to invested capital (which is called “qualified capital interest” in the proposal) of a partner providing investment management services from being recharacterized as ordinary income as long as the partnership reasonably allocates its income and loss between the invested capital and any interest derived from the performance of services for the partnership.

The proposed language with respect to the carried interest can be found here under Title IV, Subtitle B – Tax Carried Interest in Investment Partnerships as Ordinary Income.

Time to Worry?

The sky is not falling yet. This proposal affects more groups than simply hedge fund managers – private equity, real estate and VC fund managers would be affected by the proposal as well. Accordingly, there are a number of interested parties ready to challenge the bill and there is already a strong lobbying presence in Washington. In the past we've seen this issue die relatively quickly and, given we are entering another election year, it is likely that we will see it die again in committee soon.

If enacted, the proposal would be effective for taxable years beginning after December 31, 2012.

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Cole-Frieman & Mallon LLP provides legal advice to hedge funds and private equity funds. Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund State and Local Business Requirements

Compliance Guide for New Hedge Fund Managers

Like any new business a hedge fund manager must comply with state and local ordinances, and make local business filings. However, when launching a hedge fund, a manager may become so consumed with preparing launch documents, opening prime brokerage accounts and, most importantly, meeting with potential investors that these formalities might be overlooked. In response to numerous questions from our clients, we prepared this guide for managers located in New York, San Francisco, and Chicago. Please contact your attorney if you have questions about these or any other locations.

Because most manager entities are formed in Delaware, but are operating in another state, it is necessary to register them in their home state; this process is also known as qualifying the entity to conduct business, or applying for authority to conduct business, in the state where they are located. Additional requirements typically include state and local taxes, payroll and other employment matters and city business licenses.

A checklist and quick reference table are provided as links at the bottom of this post. All forms, procedures, fees, taxes or other requirements discussed below are subject to change by the state and local authorities; this guide is not intended to be an exhaustive list of all possible requirements in these locations. Please confirm any requirements with your attorney or the authority in question before making any filings.

New York, New York

New York State Authority to Conduct Business. Delaware limited liability companies (“LLCs”) and limited partnerships (“LPs”) must apply for authority to conduct business in New York State by filing an Application for Authority (“NY Application”) with the Department of State – Division of Corporations, along with a Certificate of Existence (called a Certificate of Good Standing in Delaware) from the state of formation (“COE”). New York requires that the COE is dated within one year of the date the NY Application will be filed.

New York State Certificate of Publication. Once the NY Application has been certified by the Department of State, the manager must publish in two newspapers a copy of the application for authority or a notice related to the qualification of the entity. Publication must be done in the specific newspapers designated by the clerk of the county in which the manager is located. After publication, the printer or publisher of each newspaper will provide an affidavit of publication. A Certificate of Publication with the affidavits of publication of the newspapers attached must be submitted to the Department of State – Division of Corporations. The publication process must be completed within 120 days after the filing of the NY Application.

Please also see our post on the New York Publication Requirement.

New York State Workers’ Compensation. Any business operating in New York State must have workers’ compensation coverage for all employees. Employers can obtain a workers’ compensation insurance policy with a private carrier, with the New York State Insurance fund or through self-insurance. Failure to carry workers’ compensation insurance constitutes a misdemeanor or a felony punishable by a fine of $1,000 up to $50,000. The level of offense depends upon whether an employer has five or more employees and whether the violation is a first or a repeated offense. The Workers’ Compensation Board may also issue a stop work order to any business that fails to obtain a policy or owes a fine to the Board. Failure to keep the required records is punishable by fines of $5,000 to $10,000 for a first-time violation.

New York State Disability Coverage. Any business operating in New York State with employees must also provide disability benefits coverage. The law provides for the payment of cash benefits to employees who have become disabled because of injuries or illnesses that have no connection to their employment, and for disabilities arising from pregnancies. The law allows, but does not require, an employer to collect contributions from its employees to offset the cost to provide this benefit. Employers may obtain coverage through a private carrier, the New York State Insurance fund or through self-insurance. Failure to obtain disability benefits coverage constitutes a misdemeanor, punishable by a fine of $100 to $500 and/or imprisonment for not more than one year. Additionally, an employer without coverage will be liable for any benefits due to an injured employee.

New York State Unemployment Insurance. Employers must file a Quarterly Combined Withholding, Wage Reporting and Unemployment Insurance Return with the New York State Department of Labor. Generally, all employment performed for an employer is covered whether it is on a part-time, full-time, temporary, seasonal, or casual basis. If all required parts of the return are not received by the due date, the return is considered delinquent. The penalty for failure to file is the greater of $1,000 or $50 per employee listed on the latest quarterly return, up to a maximum fine of $10,000.

New York City Unincorporated Business Income Tax. The Unincorporated Business Tax (the “UBT”) is imposed on partnerships and limited liability companies, which would include most hedge funds and investment managers. The UBT is equal to four percent of taxable income allocable to New York City, but the net effective tax rate for hedge fund managers could be near two percent after tax credits and deductions. This stems from the deductibility of local business tax payments on federal taxes, and a twenty-three percent credit for UBT taxes against New York City personal income liability. At present, the New York City Administrative Code taxes fees earned by managers, but carried interest may be exempt. To obtain some relief from this tax, managers located in New York City typically form a separate entity to serve as the general partner of their onshore funds, rather than having the manager serve as general partner.

New York City Commercial Rent Tax. A business must file a Commercial Rent Tax Return if the occupied premises are located in Manhattan, south of 96th Street, and the annual or annualized gross rent paid for such location is at least $250,000. This tax also applies to: (i) those who occupy space in buildings they themselves own, individually or jointly with another person other than a spouse; (ii) those who occupy space in buildings owned by corporations where they are an officer or holder of all or part of the corporation stock; (iii) a corporation, occupying space in a building that is owned by a subsidiary corporation or by a parent corporation; and (iv) a corporation, occupying a space in building owned by an officer or stockholder of the corporation.

New York City Waste Removal and Recycling. A commercial business is required to dispose of its waste, including recyclable materials, through a private disposal company. All businesses are required to recycle office paper, corrugated cardboard, magazines, catalogs, and newspapers. Businesses must post signs notifying employees, and customers where relevant, about what and how to recycle and must place labeled recycling containers where waste is routinely discarded. Usually the building management makes arrangements with a disposal company for removal of recycling and waste for the entire building. Regardless of a building's recycling arrangements, every company is required by law to maintain separate labeled recycling bins for paper. Fines will be levied for violations.

San Francisco, California

California Business Registration. LLCs and LPs must qualify to transact business in California by filing an Application for Registration (“CA Application”) and a COE with the California Secretary of State. In addition, within 90 days after the CA Application has been filed, an LLC must file a Statement of Information (“SOI”) with the California Secretary of State. Thereafter, the SOI is due every other year on or before the anniversary of the initial SOI filing. LPs are not subject to the SOI filing requirements.

California Franchise Tax Board. Registered LLCs and LPs are subject to an $800 annual tax even if they conduct no business in California. They may also be subject to an annual fee based upon total income from all sources derived or attributable to California. Additionally, an entity that has members or partners who are not residents of California must file consents signed by the nonresident individuals and foreign entity members to show their consent to California’s jurisdiction to tax their distributive share of income attributable to California sources. The LLC or LP must pay the tax for every nonresident member or partner who does not sign the consent.

California Withholding on Distributions. LPs and LLCs must withhold 7% on distributions of California source income made to nonresident partners or members when distributions to a particular partner or member exceed $1,500 for the calendar year. LPs and LLCs must withhold on allocations of California source income to foreign partners and members (payees) at the maximum applicable California tax rate.

California Payroll Taxes. A business becomes subject to state payroll taxes upon paying wages over $100 in a calendar quarter to one or more employees. Wages include cash payments, commissions, bonuses, and the reasonable cash value of noncash payments (such as meals or lodging) for services performed. Once subject, an employer must complete and submit a registration form to the Employment Development Department (“EDD”) within 15 days. After registering, a business will receive a State Employment Identification Number. Employers must report wages paid, taxes withheld and pay unemployment insurance, state disability insurance and employment training tax on employee wages.

California Workers’ Compensation. California Labor Code requires employers with at least one employee to carry workers’ compensation insurance. Employers may finance liability for workers’ compensation through self-insurance, private insurance or through the California State Compensation Insurance Fund. Failure to carry workers’ compensation coverage is a misdemeanor punishable by a fine up to $10,000 and/or one year in jail. The Division of Labor Standards Enforcement can issue a stop order preventing an employer from using employee labor until coverage is obtained.

San Francisco Business Registration and Renewal. Every person or entity doing business in the City and County of San Francisco must have a valid Business Registration Certificate (“SF Certificate”). A certificate is required for businesses located outside of San Francisco that transact business or perform services within San Francisco. The registration fee varies based on a business’s estimated annual payroll tax expense.

The SF Certificate is issued annually and must be renewed by February 28th of each year. All businesses must report their taxable payroll tax expense, even if it was zero, as part of the Business Registration Renewal process. Businesses meeting a specified payroll threshold (which may be adjusted each year) are required to submit an additional Payroll Expense Tax Statement.

San Francisco Payroll Expense Tax. The tax amount is equal to 1.5% of a business’ annual San Francisco payroll expense. The recently-passed Proposition Q raised the payroll tax exemption for small businesses whose payroll expense for the year is $250,000 or less and extended the applicability of payroll expense tax to include compensation for personal services paid to owners of LPs, LLCs and other entities. If a business has at least four W-2 employees based in San Francisco, the amount of payroll included for each individual owner of a pass-through entity may be calculated under the “safe harbor provision” by adding to his or her base salary an amount equal to 200% of the average annual compensation paid to the W-2 employees of the pass-through entity whose compensation is in the top 25% of that entity's employees based in San Francisco.

Please also see our post on San Francisco Proposition Q.

San Francisco Assessor Tax. A business entity’s property is reappraised annually. This includes all property owned or leased by a business except licensed vehicles, business inventory, intangible assets or application software. Businesses that receive a property statement from the Assessor’s Office or that own taxable property with a total cost of $100,000 or more must file a 571-L business property statement each year by April 1st. The filing must detail the costs of all supplies, equipment, and fixtures, improvements, land improvements, and land and include other information requested on the form at each location. The 2010 tax rate for business property was 1.159% of the value of assessable property. Such value is determined based upon cost, tax, freight, installation and depreciation.

San Francisco Labor Laws. Three San Francisco labor laws generally apply to all employers with employees performing work within the City of San Francisco. First, the Health Care Security Ordinance requires for-profit businesses with twenty or more employees to spend a minimum amount on health care for each employee working eight or more hours per week in San Francisco. The Paid Sick Leave Ordinance entitles all employees (no minimum) working in San Francisco to paid time off when they or family members are sick or need medical care. It also sets a minimum rate of accrual for sick leave of 1 hour for every 30 hours worked; fractional accruals are not permitted. Finally, San Francisco has a minimum wage of $9.79 per hour for all employees who work in San Francisco more than two hours per week.

Exemptions for Businesses Located within the Presidio. The Presidio is an area in the city that is owned by the federal government. The Presidio Trust Act explicitly gives the Presidio Trust immunity from state and local taxes, which extends to property interests of third parties under “leases, concessions, permits and other agreements associated with Trust properties.” Under federal law only income and use taxes can be levied on federal enclaves. Because the business registration fees and payroll taxes discussed above are not income or use taxes, businesses located in the Presidio are exempt from these requirements imposed on businesses located elsewhere in San Francisco.

Chicago, Illinois

Illinois Admission to Conduct Business. An LLC must submit an Application for Admission to Transact Business and a COE authenticated within the last 60 days to the Illinois Secretary of State. An LP must submit a similar “Application for Certificate of Authority” along with a COE authenticated within the last 30 days (either, the “IL Application”).

Illinois Department of Revenue Registration. A business must register with the Illinois Department of Revenue to receive a Certificate of Registration and Illinois Business Tax number. Registration must be completed before a business makes sales, or when it hires employees. This certificate must be displayed in a prominent location

Illinois Unemployment Insurance. If a business hires employees to work in Illinois, it must register with the Department of Employment Security (“IDES”) within 30 days of the date it starts doing business in the state to receive an Illinois Unemployment Account number. On a quarterly basis, employers must file an “Employer’s Contribution and Wage Report” and pay contributions to IDES. The penalty for failure to file the report is the lesser of $5 for each $10,000 or fraction thereof of the total wages for insured work during the period, or $2,500 for each month or part thereof of such failure to file the report. The amount of the total fine is capped at the lesser of $5,000 or $10 for each $10,000 or fraction thereof of the total wages for insured work during the period.

Illinois Workers’ Compensation. All employers must obtain workers’ compensation insurance, post a notice in the workplace listing the insurance carrier and workers’ rights, and keep records of work-related injuries. Accidents involving more than three lost workdays must be reported to the Workers’ Compensation Commission. Employers may be fined up to $500 for each day without insurance, with a minimum fine of $10,000. The commission may issue a stop-work order for a knowing failure to carry insurance. Corporate officers may be held personally liable and/or sent to prison.

City of Chicago Business License. All persons who “conduct, engage in, maintain, operate, carry on or manage a business” in the City of Chicago must obtain a business license from the Department of Business Affairs and Consumer Protection (the “BACP”), unless exempted by state law or regulated by another license category. Applicants must complete a Business Information Sheet listing the business name, a detailed business description,

square footage, address, ownership information, and Illinois and federal tax numbers. Businesses operating in a properly zoned area will be automatically approved when applying; these businesses need only file a tax registration form with the city.

The business license must be posted in a conspicuous place. In the event of a violation, the BACP may issue a notice, a cease and desist order and depending on the type of business, the BACP may also confiscate personal property or make an arrest. Additionally, fines may be imposed ranging from $200 to $10,000 per day.

Chicago Employers’ Expense Tax. Businesses that employ fifty or more full-time employees who perform 50% or more of their work per calendar quarter in the City of Chicago and who earn more than $900 in a calendar quarter must pay the Employers’ Expense Tax. The tax is equal to $4.00 per employee per month. In determining the number of employees, employees of a “unitary business group” will be combined, i.e., a group of people under common ownership or control, whose business activities are in the same general line and whose members are functionally integrated through centralized management.

To help managers keep track of the filings that they should complete we have created a checklist, please see Checklist for State and Local Business Filings. For information on division contact persons that can help with information on how to complete the above filings, please see our Quick Reference and Contact Information guide. If you have questions on any of the items in this post, please feel free to contact us.

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Cole-Frieman & Mallon LLP provides a variety of legal services to hedge fund managers including entity formation, general business issues, legal advice with respect to hedge fund seeding, employment matters and matters related to hedge fund formation. Karl Cole-Frieman can be reached at 415-352-2300; Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Subscription & Withdrawal Process

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The hedge fund subscription process (i.e. placing investor money into the fund’s brokerage account for investment) is a basic process that may be slightly different for each fund based on a number of factors. Managers should make sure they understand the subscription process because investors may ask questions about the process and how the subscription amounts ultimately get into the fund’s trading account. This post will discuss the framework for how subscription amounts move from the investor to the fund’s bank and brokerage accounts.

Bank Accounts

We previously discussed items related to establishing bank accounts for a hedge fund structure. In general bank accounts will be established for the fund as well as the management company. Establishing a bank account for a fund will be required when a fund’s broker requires all subscriptions and withdrawals to come from/go to a “same name” bank account. Some managers may choose not to establish a bank account for the fund and simply have the prime broker deal with subscriptions, redemptions and fund expenses if their prime broker does not have “same name” requirements. For the purposes of this article we generally discuss the subscription process with respect to structures where there are bank accounts for each individual fund.

Fund Administrator

The subscription process will be different if the fund utilizes a full service administrator instead of a non-full service administrator.

Full Service Fund Administration

If a fund’s administrator deals with the subscription process as well as the general accounting and NAV calculations (usually referred to as “full service” administration), then the fund manager generally will not deal with the subscription process at all. Many times the “full service” administrator will actually establish (or work with the manager to establish) the bank and brokerage accounts and will dictate to the manager the subscription process. Usually in these circumstances the administrator will also act as a “second signer” to add a layer of protection to the assets. [Note: the “second signer” process essentially involves the fund administrator reviewing and approving all movements of money from the fund’s bank accounts. While this service has been around for a number of years, it has become more common post-Madoff.]

Non- Full Service Fund Administration

For fund’s which do not have full service fund administration, the manager will be generally responsible for accepting subscription amounts and then making sure the amounts are properly moved to the brokerage account. Generally the attorney will work with the manager to help the manager establish the proper structure and processes but managers should also discuss the process with the administrator to make sure all parties understand how the movement of subscription proceeds affect the calculation of the NAV.

Subscription Process in General

Generally the investor will wire the subscription amount to the fund’s bank account. In the case of individual investors, subscriptions may sometimes be made by check. Once the subscription amount has been credited to the fund’s bank account, it may either be wired to the fund’s brokerage account or it may sit there until the first

day of the trading period.* Either the manager or the administrator (as described above) will work with the bank and broker to make sure the subscriptions are correctly transferred.

* Note: there are a number of different issues which may arise at this point including situations where the subscription is placed in the brokerage account before or after the first day of the trading period, and whether the investor will receive interest on the subscription amounts prior to the amounts being transferred to the brokerage account. These issues should be discussed between the fund manager, administrator and lawyer prior to the fund launch.

Single Fund Structure – Domestic or Offshore Hedge Fund

In a single fund structure, whether the fund is located in the U.S. or offshore, moving subscription amounts is straight-forward. Investors will place assets in the fund’s bank account and then the subscription amounts will be wired to the fund’s brokerage account. Generally a withdrawal is processed by a wire from the fund’s brokerage account to the fund’s bank account and then by a wire from the bank account to the withdrawing investor. Depending on the broker, subscriptions and redemptions may be able to be effected directly between the investor and broker for credit/debit directly to the fund’s brokerage account.

Single Fund Subscription Process: Single Fund Structure Org Chart – Investor Subscription Process

Offshore Master-Feeder Hedge Funds

Offshore master-feeder funds will have process similar to the single entity fund structure process. The general master-feeder hedge fund will have domestic taxable investors invest into a domestic feeder fund and offshore and non-taxable U.S. investors invest into an offshore feeder. Both feeder funds will then invest directly into the master fund which ultimately makes investments directly. A typical investment process might be: investors wire funds to the appropriate feeder fund bank account, the feeder fund then wires the subscription to the master fund bank account and from there the subscription amount would be wired to the brokerage account. As above, withdrawals would be processed in the reverse order.

Master-Feeder Subscription Process: Master Feeder Org Chart – Investor Subscription Process

Mini-Master Hedge Funds

Mini-master hedge funds are becoming more popular because of cost considerations. Additionally these structures can be easier to deal with from an operational perspective. In the basic mini-master structure there will be two fund entities – an offshore fund and a domestic fund. Then, like the traditional master-feeder structure, offshore investors and non-taxable U.S. investors will place their assets in the offshore feeder and U.S. taxable investors will place their assets in the domestic feeder. Domestic investors will subscribe to the domestic fund which will act as the “master” fund. From there the offshore fund will invest its assets in the domestic “master” fund, becoming in-essence an investor in the domestic fund. [Note: separate post on mini-master hedge funds to be coming soon.]

Mini-Master Fund Subscription Process: Mini-Master Org Chart – Investor Subscription Process

Other Items

The above discussion is general – each fund structure is unique and there may be certain reasons why a specific fund may have a process which is different from the discussion above. Indeed, in many cases the administrator and broker may be able to handle subscription amounts which bypass the bank accounts or the feeder funds in master-feeder structures. In any event, the fund manager’s operational team should work closely with the administrator to develop processes to ensure that the subscription process is seamless. We have specifically not discussed offshore segregated portfolio companies or series LLC structures because these structures are unique and subscription processes may vary widely.

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Cole-Frieman & Mallon LLP is a hedge fund law firm which provides comprehensive formation and SEC/CFTC regulatory support to start-up and established hedge fund managers. Please contact us if you have any questions.

Bart Mallon, Esq. can be reached directly at 415-868-5345. Karl Cole-Frieman can be reached at 415-352-2300.

Karl Cole-Frieman Quoted on Expert Networks

Insider Trading Remains Popular Topic in Hedge Fund Regulation

Insider trading by hedge funds and the use of expert networks has been a hot compliance topic in 2010 and 2011. The topic remains in the spotlight as Massachusetts recently passed new expert network regulations. Under the new regulations, registered investment advisers in Massachusetts will be required to maintain certain records with respect to transactions with expert network firms. [Note: we will be detailing these and other regulations recently adopted by Massachusetts which will become effective as of December 1, 2011.]

Karl Cole-Frieman was quoted by Law360.com in an article on the new Massachusetts expert network regulations (subscription required). In the article Karl is attributed with providing information on the effect the regulations may have on expert networking firms, how expert networking firms may respond to the Massachusetts regulations and how hedge fund managers may modify their compliance programs to adhere to Massachusetts (and potentially other state) regulations.

We expect to see more states come out with similar laws and we will provide updates and more information as appropriate.

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Karl Cole-Frieman is a managing partner at Cole-Frieman & Mallon LLP and he provides advice to fund managers with respect to insider trading and the use of expert network firms. He can be reached

at 415-352-2300 or through our contact form.

Hedge Fund Law Blog

Hedge fund laws, starting a hedge fund, news and events…

Category Archives: Business Issues

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Hedge Fund Subscription & Withdrawal Process

Karl Cole-Frieman Quoted on Expert Networks