Category Archives: Hedge Fund Questions and Answers

Series 79 Questions and Answers | Investment Banking Exam

Q&A For New FINRA Exam License

We have fielded a number of questions regarding the new Series 79 exam for investment banking professionals.  We are creating this question and answer page as a service to our readers.  We will attempt to answer questions as best as possible and our understanding the 79 exam license and the way it will be utilized in practice will develop over time so we expect this resource to become more valuable over time.  Please help us to make this a valuable resource by adding your questions, responses or comments below.


Question: While the series 79 makes sense in allowing investment bankers to focus on more pertinent test questions,  do the principal requirements for a boutique (i.e. 3 person) investment banking shop remain the same.  In other words,  is a small shop doing only investment banking still required to  be a BD with series 24 and series 27 registered principals which are tested extensively on managing a full Reg Rep not a Ltd Rep as in series 79?  Thanks!

Answer: I believe you are asking whether a small BD, which is only engages in investment banking activities, needs to continue to have a General Securities Profession (Series 24) and a Financial and Operations Principal (Series 27) – if so, then yes.  Additionally, such a firm will need to make sure that the Series 24 licensed principal also has a Series 79 license.  Generally all Series 24s will have the Series 7 as well so the Series 24 principal will need to opt-in to the Series 79 license prior by May 3, 2010.

To opt-in, a Series 7 licensed representative or principal will need to amend their Form U4 to request the Investment Banking representation.  The opt-in period will not begin until November 2, 2009 and will run until May 3, 2010.  After May 3, 2010, if a Series 7 licensed individual has not opted-in to the Series 79, then the individual will need to take the exam in prior to participating in investment banking activities.  The Form U4 will be amended to include this new registration category.


Question: I have been a business brokers in [state] under the Real Estate license. Will I be required [to have] a Series 79 license in order to continue my [business] broker practice whereby assets are sold through every transaction?  Thanks.

Answer: This question is basically asking whether a business broker will need to be registered as a broker-dealer if the broker is only advising on the sale of assets (and not the securities of a company).  This question is fact specific and the answer will depend on the specific facts of the situation and the various state laws which may be implicated.  You should discuss this issue with an attorney.


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.

Hedge Fund Law Questions

Recently I have received a few good hedge fund law questions.  Please remember that these answers are general discussions of the law and should not be a substitute for actual legal advice.  This discussion does not form an attorney-client relationship, please see our disclaimer.


Question: [with reference to the new Hedge Fund Registration article] So what’s to say a hedge fund can’t just become the outside advisor to a series of managed accounts?  If so, does the fund still need to register?

Answer:  Many hedge fund management companies do provide individual account management outside of the hedge fund.  Typically this is described as hedge fund separately managed accounts. There are many reasons why a manager may have such accounts, including the fact that many large institutional investors require that their assets be managed in this way.

With regard to registration, yes a manager may have to register as an investment advisor if he manages separately managed accounts outside of the hedge fund.  There are two separate levels of registration – State and SEC.  Generally the SEC does not require a manager to register unless the manager has 14 or less clients over the last 12 months.  This generally means that a hedge fund manager can have 13 separately managed account clients (in addition to the hedge fund) without implicating the SEC registration requirements (see Hedge Fund Registration Exemption).  However, states are free to adopt their own registration laws and many would require a manager with 5 separately managed account clients (in addition to the hedge fund) to register as an investment advisor with the state securities commission.

Each manager’s situation is unique and if the manager has specific questions regarding his legal or registration status he should discuss with legal counsel.  Additionally, if the Hedge Fund Transparency Act is passed, it is likely that hedge fund managers with $50 million or more of AUM will need to register as investment advisors with the SEC.

Question:  Regarding the 3c7 Funds, does the counting of investors require a ‘look through’?  I.e. If an qualified investor was a Fund of Funds, would the counting up to the limit of 500 investors require counting the underlying investor of the Fund of Funds?

Answer: If the investing fund was also a Section 3(c)(7) hedge fund then there would be no “look through.”  If the investing fund was a Section 3(c)(1) hedge fund then there would be certain issues which the Section 3(c)(1) would need to take into consideration.  We will be writing a post about this issue shortly.

Question: What happens if you are NOT an accredited investor, but you have already been allowed to invest into a hedge fund that requires you to be an accredited investor?

Answer: I am not quite sure how this would happen but I believe there might be two separate ways.  First, the investor may have lied in the hedge fund subscription documents.  The subscription documents require the investor to make certain representations regarding the investor’s net worth.  Generally hedge fund managers have no duty to inquire further about the representations made in the subscription documents.  If this happens then generally the investor will not receive the protections under the law for non-accredited investors.

Second, the investor may have been an accredited investor at the time the subscription documents were signed and, because of outside circumstances, the investor later becomes a non-accredited investor.  In this instance the newly non-accredited investor should immediately contact the hedge fund manager and inform him of the new circumstances.

Question: Can you recommend a cost-effective (cheap) administrator for a hedge fund start up?

Answer: Yes.  It is common for me to provide clients with recommendations for all service providers including hedge fund administrators.  There are many hedge fund administration firms and there are many low cost providers which I can put you in touch with.  Usually I will want to get to know you and your firm before I make recommendations.  If you are interested, please contact us now.

Hedge Fund Affiliated Broker Dealer

What does it mean for a hedge fund to have an affiliated broker-dealer?

Definition of Broker-Dealer

We will start off by defining a broker-dealer.  Basically a broker-dealer is the term used in the investment management industry for a firm which executes securities trades.  The trades may be executed by these firms through an agency relationship (commission) with the client or through dealer (mark up) relationship with a customer.  Some firms act in only one capacity and some act in both capacities depending on the securities traded. Continue reading

Hedge Fund Comments/ Questions and Answers

Questions and discussions from Hedge Fund Law Blog readers

I get quite a few questions from readers and usually I am able to answer these questions via email within a couple of days.  If you have any questions, comments or simply want more information on starting a hedge fund, please feel free to contact us.  We also will take requests for blog posts on certain issues and we also will publish articles (with all appropriate recognition and links) by guest authors.  [Note: any grammatical errors in the original messages have not been corrected.] Continue reading

Do Commodity Pool Operators also need to be registered as Commodity Trading Advisors?

A common question for hedge fund managers which are registered as commodity pool operators is whether they also need to be registered as commodity trading advisors (CTA) with the NFA.  The answer is generally no.

There is no need for a commodity-based hedge fund manager (i.e., CPO) to register as a CTA so long as the manager’s commodity trading advice is restricted solely to advising the pool it is running.  This applies to BOTH CFTC/NFA Registered AND unregistered pool operators.  However, if the CPO has clients outside of the pool which the CPO provides advice to regarding commodities, then the manager may need to be registered as a CTA.

Rule 4.14(a)(4) applies to those managers which are registered as CPOs with the NFA.  Rule 4.14(a)(5) applies to those managers which are not registered (exempt) as CPOs.  The full rules are below.

Rule 4.14(a)(4)

A person is not required to register under the Act as a commodity trading advisor if it is registered under the Act as a commodity pool operator and the person’s commodity trading advice is directed solely to, and for the sole use of, the pool or pools for which it is so registered.

Rule 4.14(a)(5)

A person is not required to register under the Act as a commodity trading advisor if it is exempt from registration as a commodity pool operator and the person’s commodity trading advice is directed solely to, and for the sole use of, the pool or pools for which it is so exempt.
Please contact us if you have any questions.  Other HFLB articles related to this topic include:

Related HFLB articles:

Hedge Fund Manager – Information on Hedge Fund Managers

I have seen many hedge fund managers and, like the investment strategies they pursue, each one is different.  This article will attempt to discuss hedge fund managers in general, if you have any specific questions, please feel free to contact us.

Who are hedge fund managers?

In general hedge fund managers are people who have a strong conviction about their certain investment program and who are willing to put their money where their mouth is so to speak.  At any given time there are any number of different ways to make money and because of this we have a chance to see all types of hedge fund managers, even those who go against conventional wisdom.

What types of backgrounds do hedge fund managers have?

I have seen all types of hedge fund managers.  Many were traders at other investment advisory firms or were brokers at a broker or investment bank.  Many managers were previously employed outside of the financial industry and traded for themselves on the side – managers like this have often found a program that works and want to allow their friends, family and other investors participate in the investment program and potential gains.  Some hedge fund managers were involved in real estate and choose to run a real estate hedge fund or some sort of hybrid hedge fund.  Some managers have relatively less experience in managing money and will act as a kind of sponsor of the hedge fund – participating in the business aspects of the hedge fund like raising assets.

Most all hedge fund managers will have at least a college degree.  Many hedge fund managers, and analysts, will also have a Masters in Business Administration (MBA).  Some hedge fund managers will be former professionals such as doctors or lawyers.  It is also common to see a manager with a third party designation like a Chartered Financial Analyst (CFA) which is bestowed by the CFA Institute.

Are there any exam or qualification requirements to be a hedge fund manager?

There are no specific requirements to be a hedge fund manager, but depending on the domicile of the manager he may need to be registered as an investment advisor with the state securities commission or the SEC.  If a manager was required to be registered as an investment advisor, he would likely need to have the Series 65 exam license or the Series 7 and Series 66.  Depending on the nature of the hedge fund and the extent of the hedge fund’s activities, the manager may need to have the Series 7 and the fund, or a related company, would need to be registered as a broker-dealer.

Is there anything hedge fund managers cannot do?

Generally a hedge fund manager can mold his investment program as he sees fit.  However there are two specific items to note.  First, the manager should be careful when trading that he stays within the description of the trading program.  Especially in these very volatile times, investors are very aware of style drift and managers should be very cognizant of this.

Second, the hedge fund manager cannot violate any laws while trading.  The federal securities laws apply to hedge fund managers who are not registered as investment advisers in certain instances.  In addition to out and out fraud, the manager should not engage in any activities which he is not sure is legal.  If there are any questions, the hedge fund manager should consult a hedge fund attorney.

What are the common qualities of hedge fund managers?

The number one commonality between hedge fund managers is a desire to see their program and ideas come to fruition.  Another trait which is common to hedge fund managers is a very strong work ethic.

What about pedigree?

You will often hear advisors and consultants talk about pedigree, especially hedge fund marketers.  To these groups the term “pedigree” essentially means the strength of the manager’s bio.  A manager who went to Harvard undergrad, Harvard MBA and then worked for Goldman Sachs will have a strong pedigree.  It is generally going to be easier for a manager with a strong pedigree to get his foot in the door with regard to institutions and high net worth investors.

However, having a strong pedigree does not guarantee a hedge fund manager will be able to sell his hedge fund to investors.  Indeed, I have seen firsthand instances where a manager with a strong pedigree did very poorly in front of institutional investors.  Likewise, I have seen where a manager with a less strong pedigree shot the lights out during an institutional investor presentation.  All this is to say that while pedigree is important in the eyes of some, it will not necessarily help a hedge fund manager to raise assets and of course, once a manager has assets, the manager must perform.

Start up hedge fund managers

If you are a start up hedge fund manager, you will first need to discuss the hedge fund formation process with a hedge fund attorney.  Some other articles which provide background on many of the subjects covered in this article include:

Hedge Fund Performance Fees

The hedge fund performance fee (also known as the “performance allocation,” the “incentive allocation,” the “incentive fee,” among other aliases), is a periodic fee which is calculated as a percentage of any gains of a hedge fund over a predetermined period of time.

The fee is normally taken on both realized and unrealized gains of the hedge fund.

How often do most managers take the performance fee?

The performance fee can be taken over any predetermined period of time.  For most hedge fund managers, the performance fee is taken on a yearly basis.  However, many managers will take the performance fee on a quarterly basis as well.  Some managers (mostly in the forex and futures arenas) will take a performance fee on a monthly basis.

The manager should consider the characteristics of the hedge fund strategy when determining the appropriate time period to measure performance.  If a manager is a long-term investor holding positions for 12 or more months, then it would not really be appropriate to take a performance fee on a quarterly or monthly basis.  However, for a day trader or a forex manager, who is in and out of multiple positions on a daily basis, it might make sense to have a performance fee period of shorter than one year.

What is the most common performance fee?

The most common performance fee is 20% of the gains of the fund during the performance fee period.  For managers who have shown exceptional returns over a long period of time the performance fees may be as high as 40% or 50%.

For hedge fund-of-funds the performance fee is typically 10%.  Sometimes hedge fund-of-funds will have performance fees as low as 5% and as high as 15%.

What are some of the variations of the performance fee structure?

Some managers will only take performance fees over a hurdle rate, or a minimum return required before the performance fee is taken.  Some managers will have a graduated performance fee structure where the performance fee will increase as the returns to the fund increase.

Also you should note that the hedge fund may not always have a performance fee when there are gains if the gains to not exceed the hedge fund high watermark.

Some other articles you may be interested in:

If you have any questions, please contact us.

Hedge Fund Administrator – What is a Hedge Fund Administrator?

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

Hedge fund administrator services

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

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

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

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

Three types of hedge fund administrators

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

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

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

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

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

Offshore hedge fund administration

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

Questions on hedge fund administrators

1.  How do I find a hedge fund administrator?

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

2.  Who pays for the costs of the administrator?

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

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

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

Hedge Fund IRA Investments

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

Can an IRA invest in a hedge fund?

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

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

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

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

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

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

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

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

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

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


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

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

Hedge Fund UBTI (unrelated business taxable income)

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

What is UBTI and why is it important?

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

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

Do short sales give rise to UBTI?

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

What are the tax code provisions dealing with UBTI?

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

Section 511 – provides for a tax on UBTI

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

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

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