Category Archives: Hedge Fund Structure

Offshore hedge fund director requirements

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Two of the most popular offshore hedge fund jurisdictions are the Cayman Islands and the British Virgin Islands. In another post I will detail the requirements for registration or recognition with these jurisdictions, but for the purposes of this article it is enough to point out that both jurisdictions will generaly require each hedge fund entity (in the case of a master feeder structure there would normally be two offshore entities) to have two directors.

Cayman Islands Director Requirements

In the Cayman there are two types of funds – (i) Cayman Islands Monetary Authority (“CIMA”) registered funds and CIMA non-registered funds. CIMA registration is required if a hedge fund is open-ended (allows investors the option to redeem) and has 16 or more investors. CIMA registration is not required if a hedge fund is closed-edned (does not allow investor the option to redeem) or if a hedge fund has 15 or fewer investors who have the right to appoint or remove directors.

For CIMA registered funds, there must be at least 2 directors who must be individuals. For non-CIMA registered funds, there must be at least 1 director who must be an individual. The individual directors do need not to be a Cayman resident.

BVI “four eyes” policy

In the BVI most hedge funds are deemed to be mutual funds. Because they are mutual funds, they will need to be “recognized” as such with the BVI’s Financial Services Comission (“FSC”).

Pursuant to BVI laws and statutes all companies (including hedge funds) are only required to have 1 director. However the FSC has just recently instituted a new “four eyes” policy which effectively requires that all funds have two directors (the “four eyes” policy has been applied for some time in relation to BVI-incorporated investment managers; however, its application to BVI based funds is a new development). This policy is not codified and it seems to be enforced only on a case by case basis. We are recommending to our clients that they name 2 directors because the liklihood of the FSC requiring 2 directors prior to recognition is quite high.

In the BVI a hedge fund can name a company to be a director.

Offshore Nominee Directors

Not all hedge funds will not have two persons who wish to serve as directors of the fund. The reasons may vary from unwanted perceptions to unwanted responsibilities. For whatever reason in these instances the hedge fund will need to name another person (or a company, for the BVI) which will serve as a director for the fund.

In such cases an offshore hedge fund manager may want to think about using a “nominee” director. There are companies in both the BVI and the Cayman Islands which can provide nominee director services, usually on an annual basis, for a fee. While these fees will depend on a number of factors, including the percieved risk of the fund and the manager, you will probably be looking at anywhere from US $5,000-$10,000 per year.

When searching for a nominee director we recommend shopping around as there are going to be groups which naturally feel more and less comfortable with your program. Some nominees will require some sort of involvement in the high-level affairs of the fund. Some nominees will also ask to be at least be co-signatories on any bank accounts opened in the name of the fund. These precautions are understandable as the nominee services are typically provided by services companies (registered office, registered agent, etc) who could potentially lose their license if something happens with the fund.

Directors from non-US jurisdictions

Please note with all directors the issue of perception. There have been recent instances of large brokerage firms refusing to establish brokerage accounts for some hedge funds because the directors (or even a director) were from states known to support terrorism. It will be a good idea to think about selecting a director who is from country which supports or sponsors terrorism. I do not think that this is a wide-spread practice; however, if a brokerage firm does not allow for the account formation because a new director will need to be appointed, you are going to end up delaying your launch.

Confidentiallity of Director information

In the BVI, the details of directors and shareholders of BVI funds is strictly confidential and not a matter of public record. Funds can if they wish elect to file a register or a document which details directors &/or shareholders but this is not common practice. Obviously the details of directors and shareholders may come into the public domian when they are distributed to third parties (e.g. administrators or auditors) but many times these third parties have previously agreed to keep also such information strictly confidential. Any information held by a fund’s registered agent, likewise, will be kept confidential unless required to be disclosed by order of the FSC (believing it to be in the best interests of the jurisdiction – this is not common and generally requires substantial proof of criminal activity), or a BVI Court.

Offshore Director due diligence requirements

Becoming a director of a company which acts as a hedge fund is not difficult but there are many due diligence requirements for all directors of these companies. While all jurisdictions will differ, the BVI and the Caymans will typically require the following documents from each director:

  • List of director details – name, address, etc
  • Copy of director utility bill – can include: gas, power, electric, water, television/cable, phone/internet; showing home address; notarized
  • Copy of director passport – showing a clear picture of the director, notarized
  • Director bank reference – should include length of relationship; may need to include average amount of assets
  • Director professional reference – should be from a lawyer or accountant who has had a previous professional relationship with the director
  • List of owners/shareholders of director (if an entity)
  • Copy of director formation documents (if an entity)
  • Other items as requested by the registered agent

Please contact us if you have any questions on any of the above or would like to inquire about a nominee director or establishing an offshore hedge fund.

SEC fines adviser and revokes registration

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The SEC fined an investment adviser and revoked its registration because of willful refusal to follow simple investment adviser rules such as updating form ADV and submitting to a reasonable examination of its books and records.

From SEC website:

Commission Declares Decision as to Amaroq Asset Management, LLC and Dwight Andre Sean O’Neal Jones Final

The decision of an administrative law judge ordering Amaroq Asset Management, LLC, and Dwight Andree Sean O’Neal Jones to cease and desist from committing or causing any violations or future violations of Section 204 of the Investment Advisers Act of 1940 and Advisers Act Rule 204-1 has been declared final. The law judge further ordered that the registration of Amaroq Asset Management, LLC be revoked; that Dwight Andree Sean O’Neal Jones be barred from association with any investment adviser, with a right to apply for association after one year; and ordered that Jones pay a civil penalty in the amount of $15,000.

The law judge concluded that Jones willfully aided and abetted and was a cause of Amaroq’s failure to: (1) file annual amendments to Form ADV; (2) promptly update its Form ADV to reflect its current business address; (3) submit to a reasonable examination and failing to furnish copies of the required books and records in connection with the scheduled examination. The law judge found that Jones showed indifference and/or a series of broken promises, when Commission attorneys repeatedly and explicitly informed him of the law’s requirements, thereby demonstrating extreme recklessness. (Rel. IA-2770) Finality Order; File No. 3-12822)

For final decision, click here.

SEC to replace ancient EDGAR database

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Summary:

On Tuesday the SEC announced that a new company filing database which will be faster and easier to use than the current EDGAR system. The new system is called IDEA, short for Interactive Data Electronic Applications. With IDEA, investors will be able to instantly collate information from thousands of companies and forms, and create reports and analysis on the fly, in any way they choose.

Press Release:

SEC Announces Successor to EDGAR Database
“IDEA” Will Make Company and Fund Information Interactive
FOR IMMEDIATE RELEASE
2008-179

Washington, D.C., Aug. 19, 2008 — Securities and Exchange Commission Chairman Christopher Cox today unveiled the successor to the agency’s 1980s-era EDGAR database, which will give investors far faster and easier access to key financial information about public companies and mutual funds.

The new system is called IDEA, short for Interactive Data Electronic Applications. Based on a completely new architecture being built from the ground up, it will at first supplement and then eventually replace the EDGAR system. The decision to replace EDGAR marks the SEC’s transition from collecting forms and documents to making the information itself freely available to investors to give them better and more up-to-date financial disclosure in a form they can readily use.

Currently, most SEC filings are available only in government-prescribed forms through EDGAR. Investors looking for information must sift through one form at a time, and then re-keyboard the information — a painstaking task. With IDEA, investors will be able to instantly collate information from thousands of companies and forms, and create reports and analysis on the fly, in any way they choose.

IDEA will ensure that both the SEC and the investors who rely upon the financial reporting the agency demands are ready for the new world of financial disclosure that will soon arrive when financial information is presented in interactive data format. The SEC has formally proposed requiring U.S. companies to provide financial information using interactive data beginning as early as next year, and separately has proposed requiring mutual funds to submit their public filings using interactive data.

“IDEA will ensure that the SEC continues to stay ahead of the needs of investors,” said Chairman Cox. “This new SEC resource powered by interactive data will give investors far faster, more accurate, and more meaningful information about the companies and mutual funds they own. IDEA’s launch represents a fundamental change in the way the SEC collects and publishes company and fund information – and in the way that investors will be able to use it.”

Interactive data relies on computer “tags,” similar in function to bar codes, which identify individual items in a company’s financial disclosures. With every number on an income statement or balance sheet individually labeled, information about thousands of companies contained on thousands of forms could be easily searched on the Internet, downloaded into spreadsheets, reorganized in databases, and put to any number of other comparative and analytical uses by investors, analysts, journalists, and financial intermediaries.

The ease with which interactive data will make financial information available also is expected to generate many new Web-based services and products for investors.

As he unveiled the new IDEA platform at a Washington news conference today, Chairman Cox announced that the IDEA logo will begin to appear immediately on the SEC’s Web site as the agency transitions to making IDEA the new primary source for all SEC filings. Companies’ interactive data filings are expected to be available through IDEA beginning late this year.

Investors and others who currently use EDGAR will be able to continue doing so for the indefinite future. During the transition to IDEA, investors will be able to take advantage of new interactive, IDEA-like features that will be grafted onto EDGAR in the short run. This will make it possible for investors to tap IDEA’s advanced search capabilities, and to use the information from EDGAR within spreadsheets and analytical software – something that was never possible with EDGAR. The EDGAR database also will continue to be available as an archive of company filings for past years.

“When Congress created the SEC, and even when EDGAR was launched, the markets worked on paper and by mail. Today, the marketplace works online and by e-mail,” explained disclosure and transparency expert Dr. William D. Lutz, who is leading the SEC’s 21st Century Disclosure Initiative. “Companies and investors alike compile, analyze, and produce information and reports electronically. With the move to an electronic data-based filing system, the SEC will not only keep pace with the markets, but will provide investors with a dynamic system they can use to get the information they need, rather than having to wade through an avalanche of paper forms, legalese, and doublespeak.”

David Blaszkowsky, Director of the SEC’s Office of Interactive Disclosure, added, “After 75 years of document-based static financial reporting, whether in paper documents or in electronic equivalents, it is exciting to see the SEC poised to cross the ‘data threshold’ and help investors receive financial information that is dynamic, usable and ready to go as they make their investment decisions. And when the investor wins, so does the public company, fund, or other filer who simultaneously benefits from greater transparency and trust in our markets. By tapping the power of interactive data to tear down barriers to quick and meaningful investment information, markets can become fairer and more efficient while investors can possess far better quality data than was ever possible before.”

What expenses does a hedge fund pay for?

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Question: What costs does a hedge fund pay for and what costs does the hedge fund management company pay for?

Answer: This is another very common question. Most hedge fund offering documents provide a boilerplate approach for splitting costs between the hedge fund and the management company. The general rule of thumb is that any cost which is directly associated with the fund’s investment activities (e.g. brokerage costs) will be paid for by the hedge fund. Any cost which is directly associated with the management company’s operations or overhead (e.g. salaries) will be paid for by the management company.

There are some costs which, arguably, could go either way – one such item is a Bloomberg terminal. A Bloomberg terminal could arguably be an expense of the management company (a Bloomberg is an informational tool similar to magazines and other information that a manager must use to shape its decision-making process) or of the hedge fund (information from the Bloomberg is directly attributable to investment decisions which are made). I do not have a bias as to which entity should pay these fees; however, a hedge fund manager with a smaller asset base that pays for the Bloomberg out of the fund must beware of the effect of Bloomberg’s costs on the fund’s performance.

Hedge Fund Expenses

  • hedge fund management fee
  • hedge fund performance allocation
  • offering and other start-up related expenses (often the management company will pay these expenses)
  • the administrator’s fees and expenses
  • accounting and tax preparation expenses
  • auditing
  • all investment expenses (such as brokerage commissions, expenses related to short sales, clearing and settlement charges, bank service fees, spreads, interest expenses, borrowing charges, short dividends, custodial expenses and other investment expenses)
  • costs and expenses of entering into and utilizing credit facilities and structured notes, swaps, or derivative instruments
  • quotation and news services (Bloomberg, NASDAQ) (or can be a management company expense)
  • ongoing sales and administrative expenses (e.g. printing)
  • legal and fees and expenses related to the fund (include Blue Sky filing fees)
  • optional: professional fees (including, without limitation, expenses of consultants and experts) relating to investments
  • optional: the management company’s legal expenses in relation to the Partnership
  • optional: advisory board fees and expenses
  • optional: reasonable out-of-pocket expenses of the management company (such as travel expenses related to due diligence investigations of existing and prospective investments)
  • other expenses associated with the operation of the hedge fund, including any extraordinary expenses (such as litigation and indemnification)

Hedge Fund Management Company Expenses

  • offering and other start-up related expenses (often the fund will pay these expenses)
  • salaries, benefits and other related compensation of the management company’s employees
  • rent
  • maintenance of its books and records
  • fixed expenses
  • telephones
  • computers
  • general purpose office equipment

While the above list of expenses is fairly standard, please remember that these expenses can be switched around to a certain extent. If you are a hedge fund manager, you should discuss with your attorney how the expenses are split between the hedge fund and the management company.

Distressed debt hedge fund closes doors

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I previously wrote an article about distressed debt hedge funds and the popularity of such funds as they try to get in for a deal. However, the considerable amount of media attention which has been focused on this sector of the market has spooked investors enough to get them moving on redemption day. FINaltenatives is reporting that a fairly large hedge fund managed by Turnberry Capital Management is completely closing its doors. It is at least somewhat surprising that a group this large (the fund reportedly ran up to $800 million at one point) would close its doors immediately instead of trying to wind the fund down over the course of a couple redemption dates.

A few reasons why they might want to wind down the fund over a period of time may include: (1) the fund offering documents did not include a hedge fund gate provision, (2) the manager no longer thought the fund’s strategy was viable with such a severely reduced asset base or (3) the manager thought that he could get the best prices on the assets if he sold them in a large bundle instead of piece meal over time. The article also stated the manager is planning to start a corporate bond fund, which is another reason the manager decided to wind the fund down immediately.

What is most interesting about this event is the disconnect between the strategies managers wish to pursue and the strategies that the investing masses are willing to (remain) invest(ed) in.

The article is at http://www.finalternatives.com/node/5251.

Article: What happened with the Quants?

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I wrote this article last October after a presentation made at a Southeastern Hedge Fund Association meeting. The title of presentation was “A Feature Presentation with Matthew Rothman, Managing Director and U.S. Head of Quantitative Portfolio Strategies, Lehman Brothers, Inc.” The meeting was held October 23, 2007 at The Ritz Carlton (Buckhead) in Atlanta, Georgia. Attendees included manager’s from Atlanta’s hedge funds, administrators, prime brokerage representatives and, of course, hedge fund lawyers.

October 24, 2007

We know the basic story for the quant blow-up this summer: in the beginning of July a few very large multi-strategy funds started experiencing large losses (at around the same time that the sub-prime sector was experiencing a melt-down). The funds began getting margin calls and needed to raise liquidity quickly beginning a chain reaction which eventually sent stocks lower, fueling the need sell more to meet margin calls.

While this is an overly simplistic reading of what happened over the summer, this overview set the stage for a presentation by Dr. Mathew S. Rothman on Tuesday to the Southeastern Hedge Fund Association. With some of the finest members of the south east’s hedge fund community gathered to examine what exactly happened with the quants this summer, Dr. Rothman, current Managing Director and U.S. Head of Quantitative Portfolio Strategies at Lehman Brothers, discussed his views on the events.

For those in attendance, including fund managers, lawyers, accountants, administrators and CFAs, the central concern was not exactly what happened in August, but what those events would mean for quants and investors going forward.

What quant managers will need to be aware of in the future

Our law firm helps to form hedge funds for new and emerging managers, including managers who are quants. It is common for lawyers and other service providers to explain to managers, especially new and emerging managers, what potential investors will look for from a quant program. We often provide clients with input on their pitchbooks and how they should “sell” their program to potential investors. In the wake of the quant blow-up this summer, and the insights provided by Dr. Rothman, we will be highlighting the following points for our quant clients.

Increase Transparency

The most important thing for potential investors is transparency. The more transparency a manager provides, the easier it is going to be to raise money. (Obviously this is not strictly true for the large established funds with stellar track records.) Quant is not an asset class and a quant program cannot be the sales pitch – emerging quant managers will need to sell their “type” of quantitative program. Managers need to get away from the “black box” mentality open up a bit, tell investors some of the inputs that will be used and also let investors know some of the inputs that will not be used – this is what we look at, this is what we throw away.

Be prepared to talk about Risk Management

Quant managers should have a good understanding of the risks of their program and be able to discuss these risks with investors. Specifically, managers will need to be able to discuss leverage and any human intervention or overrides of the models.

Understanding a program’s sustainable leverage levels is probably the most important risk management aspect of a quant program. While leverage provides a means to achieve incredible returns, it can also cripple a quant program. Levered programs may not be able to weather a prolonged downturn, which unlevered programs will.

[The fund managed by Dr. Rothman, which used no leverage, was actually up 30bps for August. While the fund was down 7% over 9 days, he was able to stick to his model because he did not have to unwind positions in order to meet margin calls. In contrast, Marketwatch reported that Goldman’s Global Alpha fund was down 22.5% for the month and J.P. Morgan’s Highbridge Capital was down roughly 18%.]

The human element and interaction with the quant model is also an important part of risk management. A quant model is just that – a model. While the model is designed to weather storms to a certain extent, some managers will include a “human override” component to the program. In some instances, allowing for a human override could prove to be exactly the wrong the strategy. Dr. Rothman noted that quant programs who stuck to their models during August were generally those programs which caught the snap-back. Those managers who rebalanced their portfolios (weather for reason of leverage or the human override) were those managers who missed the nice snap-back and ultimately were worse off then if they had followed their programs.

Be prepared for questions related to the August blow-ups

Fat tails and black swans are now standard terms investors use when talking about quant programs. It is very likely that you will be asked about fat tails and black swans by future prospective investors. Does this mean we will tell advisers to rewrite their risk models? No. However, you should at least be able to answer the question as to why your models do not address this phenomenon and it is a good idea to understand a model’s limitations during these times.

The Conclusion

While we may not completely understand what exactly happened in August, it is clear that prospective future investors are aware of the limitations of quant models and will generally want to see more information from managers. While it is always up to the market to decide what any one manager will need to tell prospective investors, moving forward we will let our quant clients know that it would be wise to address the above items when crafting a description of their investment program and deciding how they will market their fund.

Hedge fund hurdle rate

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When a manager decides on an investment program and how he will be able to sell his program to investors (whether institutional or otherwise), a potentially attractive part to the program would be a hurdle rate.  This basically limits the performance allocation to the general partner. It is a way for the manager to make sure that the investor is compensated before the manager takes his allocation. The hurdle rate used to be a more prevalent feature of hedge funds. In the past couple of years, I’ve seen the use of the hurdle rate decline…but in the past six to eight months I’ve seen a resurgence of the use of the hurdle rate, especially with regard to groups that plan to court institutional investors in the near future.

The two major considerations for the manager with the hurdle rate is:

  1. What should the rate be?
  2. How will the rate be calculated?

What should the rate be?

Obviously the named hurdle rate is a business point, not a legal point. The manager should consider who his potential investors would be and what they would like to see.  Also, the rate should relate, if applicable, to the investment program. If you have a bond program and your investment objective is to exceed the lehman aggregate bond index, a natural hurdle rate would be that index. For funds with a blue chip bias, a hurdle might be the return of the S&P 500 or the DJIA. However, in these instances it is more likely to see something like LIBOR or LIBOR plus one or two percent as the hurdle rate.

How will the rate be calculated?

There are three ways to calculate the hurdle rate: a hard hurdle, a soft hurdle or a blended hurdle.

  1. The hard hurdle – the hard hurdle is calculated on all profits above the hurdle rate. The hard hurdle is the most investor-friendly of the three and provides the manager with limited upside.
  2. The soft hurdle – the soft hurdle is calculated on all profits IF the hurdle is achieved. In this instance, in certain situations, if the hurdle rate is achieve, the investor actually would have a higher return if the partnership had a lower return. The soft hurdle is the least investor-friendly.
  3. The blended hurdle – the blended hurdle is calculated on all profits if the hurdle is achieved; however, if the hurdle rate is achieved, the return to investors cannot dip below the hurdle rate. The blended hurdle rate has the upside of the soft hurdle (see difference below if a 10% return is achieved) but protects the investor from the undesirable consequences, in certain instances, of the soft hurdle (see 9% return for the soft hurdle).

The chart below shows the mechanical application of the hurdle rate at various return levels. It contemplates a yearly application of a 20% performance allocation and a 8% hurdle rate.

Return

Hard hurdle

Soft hurdle

Blended hurdle

Investors

GP

Investors

GP

Investors

GP

8

8

0

8

0

8

0

9

8.8

0.2

7.2

1.8

8

1

10

9.6

0.4

8

2

8

2

The negative hurdle rate

In addition to the hurdle rates named above, a fund might also have a negative hurdle rate. The negative hurdle rate comes into play when the hurdle rate is actually below zero. Say for instance if the S&P is down 10% for the year and the fund returns 0%, the manager would actually earn a 2% performance allocation, even though the fund did not return anything. For various reasons, the negative hurdle rate is rarely done. There are plenty of issues with this type of hurdle rate, the most important being the fact that it is going to be hard to tell investors that the fund lost money and owes a performance allocation. In practice, funds with the negative hurdle rates have tended, over time, to drop this provision.

Start-up hedge fund timeline | How to Start a Hedge Fund

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Starting a Hedge Fund Timeline

Many prospective hedge fund managers know that they would like to start a hedge fund but have not gone through the process necessary to understand what the process is like or how long it will take. For some managers the process is painless, for others the process is more time consuming and frustrating than they would like. Unfortunately, the timing of an actual fund launch cannot usually be determined with absolute certainty and will depend upon, in large part, your program and your service providers.

A good rule of thumb (for managers who do not need to register as investment advisers with their states) is that the fund formation process should take about 2 months. Often a fund can be up in running in a month or less, but to be on the safe side, I recommend 2 months.* If you need to register with a state, you are going to want to add anywhere from 3 – 6 weeks to the process.**

* It is not unheard of to have funds up and running in a couple of weeks. I’ve had a fund up and running in 4 days. If I need to work with a manager on an extremely tight deadline, this can probably be done in 2 to 3 days, depending on the availability of outside service providers.

** States like California will be closer to 3 weeks (UPDATE: CA is now taking two months to register investment advisers 08-18-09); states like Texas are going to be closer to 6 weeks.

In general the timeline might look like this:

Day 1 – Discussion with legal counsel regarding the structure of your fund (fees, contribution provisions, withdrawal provisions, other items to be included in the legal documents). During this time you will also discuss your investment program and your background.

Day 7-10 – Delivery of offering documents. During this time your legal team should respond to you with your legal documents. Your hedge fund’s legal documents will include the following:

  • Private placement memorandum
  • Limited partnership agreement (or limited liability company operating agreement)
  • Subscription documents

Don’t be scared when you first review these offering documents – they will usually be around 100 pages. Some very large fund offering documents might be up to 200 page or more in length.

Day 10-14 – Review of your offering documents. During this time you should be reviewing the offering documents and familiarizing yourself with their provisions. You will need to understand what all of the legal provisions in your documents mean. If you don’t understand a concept or phrase – mark it down and be sure to ask your attorney. Remember, these are your legal documents and you paid very good money for them – you should know what they say.

Day 17 – Discussion with legal counsel regarding offering documents. You should take about an hour (sometimes it is more or less) to discuss the key points of your offering documents with your legal counsel. You should bring up items which you have questions on and your lawyer should run down the key points of the offering documents with you.

Day 24 – Delivery of revised offering documents. Your legal team should be able to deliver you revised offering documents within about a week. At this time the offering documents are very close to being complete. You should review the documents to make sure that all your questions have been addressed and your changes incorporated. If the revised wording does not make sense, let your attorney know as soon as possible.

At this point these offering documents are in good enough shape to send to your administrator and your auditor (if you decide to name an auditor in the offering documents). In addition, you should begin the account application process with your broker or prime broker.

Day 24-30 – Begin finalizing service provider contracts and make sure all service providers are on the same page. The brokerage account application can potentially be a stumbling block in the process. Certain brokers have certain due diligence requirements which must be met before the account will be ready for live trading. You might not know of these requirements beforehand or the broker’s compliance department may come back with extra requirements – you never know what might be required. For example: one fund was not allowed to have the word “Fund” in their name if they started with less than $2 million in AUM. Another fund was not allowed to clear through a certain prime broker because the managing member of the management company did not have enough experience in the eyes of the clearing broker. While stories like this are the exception rather than the rule, the brokerage account opening process is the most uncertain in terms of time.

Day 30-45 – Last minute prep work with lawyers and service providers. The auditors or administrators may have some minor comments for the lawyers on the offering documents. Some of these service providers may require certain disclaiming language regarding the services which will be provided. It is not uncommon for these requested modifications to be passed on directly to the attorney, sometimes these requests will go through you.  Your lawyer will send you finalized offering documents during this time.

Day 46-60 – Begin getting ready for trading. You should make sure that everything is in place for a smooth first day – make sure you know when and how you will be doing your trading. Make sure you will have assets in the brokerage account on Day 1. Make sure your computers will be working.

Keys to remember during the process

  1. Start early. Give yourself too much time.
  2. Be responsive to all emails and phone calls.
  3. Keep the lines of communication open with your service providers. This is your fund and you are paying your service providers good money. They should be responsive to you and should answer all of your questions. If you do not get the response you would like it is your responsibility to discuss this with your service providers.
  4. Be patient.

****

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. has written most all of the articles which appear on the Hedge Fund Law Blog.  Mr. Mallon’s legal practice, Cole-Frieman & Mallon LLP, 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 investment adviser registration with the SEC or state securities commission, please call Mr. Mallon directly at 415-296-8510.

Hedge fund early redemption fees

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It was very common a couple of years ago, after the hedge fund registration rule, for funds to institute lock-ups of two years or more. After the hedge fund registration rule was effectively vacated by the courts, the lock-ups came down. Many hedge funds now have shorter lock-ups and many choose to go with a 1 year lock-up.

Whatever the time horizon, the issue often arises as to what to do when an investor needs to get out of the hedge fund because of an extreme personal emergency. Almost all hedge fund documents will give the manager the flexibility to allow a redemption in such an instance.  However, by doing so, the manager may be disadvantaging the other investors in the hedge fund (including the manager himself).

To discourage early requests for withdrawal (and to compensate the manager or other investors for the potential disadvantage of having to reposition the fund), the manager can institute an early redemption fee. The early redemption fee is simply a fee which is deducted from the withdrawal proceeds. The early redemption fee can be paid to the hedge fund manager, the hedge fund investors, or a combination of the two. The early redemption fee can range anywhere from 1% to 10% with a majority in the range of 2% to 5% of the withdrawal proceeds. Obviously, the exact amount a manager charges will depend on his investment strategy and the extent to which an early withdrawal would disadvantage the other investors and manager.

What is a “gate” provision?

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A “gate” provision is a hedge fund manager’s right to limit the amount of withdrawals on any withdrawal date to not more than a stated percentage of a fund’s net assets — often 10% to 25%, depending on how frequently investors have a right to withdraw capital. Gates are a very common feature in hedge funds of almost all strategies. Imposing a gate slows a potential “run on the fund” by forcing investors to wait until the next regular withdrawal date to receive the unfulfilled balance of their withdrawal requests. Gates are especially important for hedge fund strategies which are more illiquid like MBS strategies.