Category Archives: Marketing Your Hedge Fund

JOBS Act Proposed Regulations Passed

Fund Managers Allowed to Advertise According to New Rules

Additional Regulations Proposed by SEC

The long-awaited JOBS Act proposed regulations which will allow private fund managers to generally solicit investors for a private fund offering were finalized today.  In addition, the SEC proposed additional regulations with respect to offerings in which there has been a general solicitation.

We will be able to provide more detailed information on these developments over the coming days, but for now the following links provide helpful information:

  • SEC Adopting Release – Release No. 33-9415; No. 34-69959; No. IA-3624; File No. S7-07-12RIN 3235-AL34; Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings
  • SEC Proposing Release – Release No. 33-9416; Release No. 34-69960; Release No. IC-30595; File No. S7-06-13 RIN 3235-AL46;Amendments to Regulation D, Form D and Rule 156 under the Securities Act
  • JOBS Act Ban on General Solicitation Lifted for Fund Managers – blog post from Sansome Strategies (compliance firm)

Below is some direct language from the adopting and proposed releases.  Please contact us if you have questions on the releases or how they may relate to a proposed offering.


Adopting Release (regulation effective 60 days after publishing in Federal Register)

SEC Summary:

The amendment to Rule 506 permits an issuer to engage in general solicitation or general advertising in offering and selling securities pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takesreasonable steps to verify thatsuch purchasers are accredited investors. The amendment to Rule 506 also includes a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons. … We are also revising Form D to require issuers to indicate whether they are relying on the provision that permits general solicitation or general advertising in a Rule 506 offering.

New Regulation 506(c)(2)(ii) will read as follows:

The issuer shall take reasonable steps to verify that purchasers of securities sold in any offering under paragraph (c) of this section are accredited investors. The issuer shall be deemed to take reasonable steps to verify if the issuer uses, at its option, one of the following non-exclusive and nonmandatory methods of verifying that a natural person who purchases securities in such offering is an accredited investor; provided, however, that the issuer does not have knowledge that such person is not an accredited investor:

(A) In regard to whether the purchaser is an accredited investor on the basis of income, reviewing any Internal Revenue Service form that reports the purchaser’s income for the two most recent years(including, but not limited to, Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040) and obtaining a written representation from the purchaser that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;

(B) In regard to whether the purchaser is an accredited investor on the basis of net worth, reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed:

(1) With respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and

(2) With respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies; or

(C) …

(D) In regard to any person who purchased securities in an issuer’s Rule 506(b) offering as an accredited investor prior to the effective date of paragraph (c) of this section and continues to hold such securities, for the same issuer’s Rule 506(c) offering, obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.

New Regulation Proposal Release (comment period open for 60 days)

SEC Summary:

… the[se] proposed amendments to Regulation D would require the filing of a Form D in Rule 506(c) offerings before the issuer engages in general solicitation; require the filing of a closing amendment to Form D after the termination of any Rule 506 offering; require written general solicitation materials used in Rule 506(c) offerings to include certain legends and other disclosures; require the submission, on a temporary basis, of written general solicitation materials used in Rule 506(c) offerings to the Commission; and disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years, with Form D filing requirements in a Rule 506 offering. The proposed amendmentsto Form D would require an issuer to include additional information about offerings conducted in reliance on Regulation D. Finally, the proposed amendments to Rule 156 would extend the antifraud guidance contained in the rule to the sales literature of private funds.


Cole-Frieman & Mallon LLP is a boutique law firm focused on providing legal services to private fund managers.  Bart Mallon can be reached directly at 415-868-5345.

Positive 2010 Outlook for Investors and Hedge Funds

In March, Deutsche Bank’s Hedge Fund Capital Group presented a closer look at the current status of the hedge fund industry in its “2010 Alternative Investment Survey” report (see press release).  The report focuses on responses from 606 investors.  42% of the respondents were Fund of Funds, 21% were asset management companies, 12% were family offices/high net worth individuals, and the remaining group consisted of corporations, foundations and endowments, insurance companies, investment consultants, private banks, and private and public pensions.

This article summarizes the 2010 outlook from investors and the increasing relevance of the seeding business.  In particular, it presents the strategies being favored/disfavored, regional markets being favored/disfavored, predicted allocation amounts, and other information related to due diligence and reasons for investing in hedge funds.

For the most part, investors are optimistic about 2010 and money is flowing back into the industry.  Strategies for this year reflect concerns about the lack of transparency and protection in uncertain markets in 2008 and 2009.  Investors are making choices that ride on renewed confidence in the industry and that favor reduced volatility.


Investors Generally Optimistic for the Future

Investor sentiment about how the hedge fund industry will fare in 2010 has greatly improved.  In 2009, 41% predicted net asset outflows of over $150 billion and 30% predicted outflows of over $200 billion.  In contrast, 73% of investors surveyed this year predict net asset inflows of over $100 billion and fewer than 2% are predicting outflows.  Consistent with those percentages, investors are also predicting a positive 2010 performance on the leading indices (S&P500, MSCI World, and MSCI EM).

Favored and Disfavored Strategies

Surveyed investors predict that some of the best strategies for 2010 are global macro, equity long/short, distressed, and event driven.  In fact, equity long/short makes up the largest portion of hedge fund assets.  51% of investors plan to add assets to this strategy (an increase from 31% in 2009), 38% plan to maintain their assets in the strategy, and 5% plan to reduce assets.  Event driven also performed very well in 2009 with 42% of surveyed investors now planning to add assets to this strategy and 41% planning to maintain their assets.  Investor interest in merger arbitrage has also jumped greatly from 6% intending to increase exposure to 26% in 2010.  While 29% of investors planned to reduce exposure in 2009, only 4% now seek to reduce exposure.

The strategies that are anticipated to perform the worst in 2010 include cash, volatility arbitrage, CTA, convertible arbitrage, market neutral, and asset backed securities.  Market neutral was one of the worst strategies for 2009 when other strategies were bouncing back.  The percentage of investors seeking to add assets to this strategy has decreased from 26% in 2008 to only 17% this year.  In terms of cash allocation, only 3% of investors plan to increase exposure (a drop from 13% last year), 43% plan to maintain their assets, and a whopping 32% plan to reduce their assets.

Regional Allocations

Overall, investors predict that the Asia region (excluding Japan) will perform the best in 2010 and the Western European region will perform the worst.  This year, 45% of investors plan to invest in Asian (excluding Japan) funds–a significant jump from only 18% in 2009.  Interest in investing in Chinese and Japanese funds is high compared with other countries.  The percentage of investors that do not plan to allocate to each country is 22% and 23% respectively. In contrast, 52% of investors do not plan to allocate in Russia, 44% do not plan to allocate in Eastern and Central Europe (excluding Russia), and 37% of investors do not plan to allocate in India.

Surveyed investors expressed a similar interest in the Emerging Markets, with 38% wanting to increase exposure, 38% wanting to maintain exposure, and only 6% wanting to reduce exposure.  These findings are in response to the strong 2009 returns after a rough 2008 that saw many Emerging Market funds close.  In contrast, investors anticipate the Western European region will not fare well–with 56% seeking to maintain their current assets, 23% seeking to increase exposure, and 12% seeking to reduce exposure.

Hedge Funds

Investors are increasingly investing in hedge funds.  In fact, 76% of consultants surveyed indicated that their clients were increasing allocations to this investment vehicle.   When asked what the main benefit of investing in hedge funds was, 68% of the investors surveyed indicated that hedge funds provide “better risk adjusted returns.”  This benefit is particularly valuable in a volatile and uncertain market.   “Diversification,” which was previously the number one answer, remains a close second.

Amount Currently Invested in Hedge Funds

Currently, over 50% of surveyed investors still manage less than $1 billion in hedge funds.  The Hedge Fund Capital Group expressed concern about this figure, explaining that more than $1 billion AUM is often necessary to build the institutional infrastructure for greater investments and to perform vigorous due diligence.  On the other side of the range, the number of investors with under $100 million invested in hedge funds is decreasing.  The Hedge Fund Capital Group explains that these funds have likely simply shut down due to the economy and inability to attract institutional investors, pension funds, endowments, and other larger investors.

A majority of surveyed investors have track records of investing in hedge funds for longer than five years (only 17% have less than 5 years), with nearly all of those with 15 or more years of experience based in North America, compared with their European and Asian investor bases.

Hedge Fund Managers

Since 2008 and in part due to the market, investors have been reducing the number of managers they use.  They have also started disfavoring portfolios that are too diverse due to the fact that due diligence requirements are now more costly and timely.  In addition to reducing the number of managers investors place their money with, investors are also preferring to place their money in larger hedge funds with AUMs of over $1 billion.  Those investors focused on managers with smaller AUMs are generally based in Asia or Europe.


In 2009, most investors made 5-10 initial allocations.  Those investors who made over 10 initial allocations in 2009 were concentrated in Europe–a total of 54%.  But in terms of follow-on allocations, U.S. based investors led the pack, with 50% making over 30 follow-on allocations.


Despite generally positive performance last year, investors are continuing to make redemptions–the Hedge Fund Capital Group explains this as a result of those managers who have not performed during the market bounce or those that froze assets and their investors are only now able to begin redeeming.  The investors that have made the most partial redemptions–30 or more in the last year, were primarily fund of funds and private banks.  This finding is consistent with the perception that these investors are performance chasers.

Available Cash to Allocate

Compared with 2009, surveyed investors are generally holding less cash.  50% of investors are either fully invested or only holding 0-5% cash.  But the good news is that 29% have 10% or more cash available for investment.

Following up on the previous findings, surveyed investors are confident for 2010.  Those that predict they will be fully invested in the next six months increased from 18% to 21%.  Those that predict they will hold 0-5% cash increased from 32% to 39%, demonstrating a goal of investing more.

Hedge Fund Managers

Challenges and Assessing a Manager

In terms of the biggest challenges investors faced in 2009 and 2010, “selecting and monitoring manager” posed the biggest challenge, with “lack of transparency” also ranking highly.  This year, “investments frozen with a manager” was a new category and also ranked very high.  When assessing a hedge fund manager, investors used to cite the 3Ps: performance, philosophy, and pedigree.   While those qualities continue to be important, investors have increasingly focused on risk management and transparency.     This reflects greater caution and less reliance merely on manager pedigree.  Performance ranks first, risk management ranks second, and philosophy ranks third in terms of importance.

Length of Due Diligence Process

The due diligence process has gotten more costly and timely.  For most investors–over 50%, need 3-6 months to conduct due diligence of a manager.  This statistic is consistent over the last three years.  The percentage of investors who can complete this in less than 3 months has increased slightly and so has the percentage of those who need 7-12 months.

Seeding Business

The institutionalization of hedge fund investing is making it increasingly difficult for new launches to attract investors. While a minimum of $50 million AUM was once sufficient, the critical minimum is now $100 million.  Emerging managers are therefore increasingly turning to the seeding business “to overcome the hurdle of reaching the critical size to gain visibility and profitability.”  17% of the investors surveyed seed managers.  The majority of seeders are U.S. based–59%, with 30% in Europe, 9% in Asia, and 2% in Australia.  Funds of funds are the primary investors that seed, with asset management companies and high net worth individuals following.

45% of fund of funds seed managers, followed 26% of asset management companies and 17% of family office/high net worth individuals.

There are three seeding business models: (1) revenue split, (2) equity split, and (3) platform.  Under the revenue split model, seeders provide capital in exchange for participation in management and incentive fees.  Nearly half of seeders surveyed use this model.  Seeders provide capital in exchange for equity ownership and generally take active partnership role under the equity split model.  19% of seeders surveyed adopt that model.  Finally, under the platform model, established hedge funds and financial institutions provide capital and “turnkey” solutions in exchange for profit share.  Only 9% of seeders surveyed adopt the platform model.  Before a manager turns to the seeding business, it should consider the support offered by the seeder, including the form of operations, risk management, marketing, strategic assistance and business development, and compliance and legal support.  In addition to providing funding, well-respected seeders can also provide reputational capital.

For the most part, the average seeding ticket ranges from $25 million to $75 million, with fewer under $10 million and even fewer greater than $100 million.


6% of the surveyed investors consider themselves to be investment consultants.  The findings show that there has been an increasing presence of such consultants in the hedge fund industry.  These firms serve as the “bridge between investment managers and pension funds.”  The largest percentage of the consultants’ client base is the family office/high net worth individuals, followed by government funds, and fund of funds.

Hedge fund investors are also more frequently turning to consultants to perform extensive due diligence.  These investors do not have the resources to perform increasingly rigorous due diligence and rely on consultants.


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Audit Issues from Due Diligence Provider

The following article is written by Chris Addy, president and CEO of Castle Hall Alternatives which is a hedge fund due diligence firm.

For funds raising assets from institutional investors, the due diligence process will be quite familiar and Chris describes some of the frustrations from the investor/due diligence standpoint.  I would imagine that these issues will continue to arise as more service providers strive to find ways to limit their potential future liability.  Please feel free to comment below.


A recap on some audit issues

Looking back over our posts over the past year or so, we’ve commented on a number of issues which impact investors’ due diligence procedures when thinking about the audit process, the financial statements, and the auditor themselves.

We thought it would be useful to recap on a group of issues which continue to be troubling:

1) And why can’t the auditor identify themselves?

Back in November, we commented on the challenge of getting the Big 4 audit firms to admit that they are, actually, the auditor of the fund in question.  In the six months since then, practices appear to have standardized: typically, the Big 4 will now provide a form response, but only after the investor has signed an extensive disclaimer letter.  The slight snag?  The disclaimer is usually so wide ranging that it appears to materially impact the investors’ ability to sue the auditor in the event of audit failure (which, of course, is the idea).  We advise our clients not to sign it.

As a counterpoint, it is worth noting – and forcefully reminding the Big 4 – that every other auditor on the planet makes the confirmation process smooth and effective.  Castle Hall is particularly appreciative of the responsiveness and professionalism of Rothstein Kass each time we make an audit confirmation request.  In fact, that reminds me…do I actually need a Big 4 auditor?

2) And it’s pretty much the same for SAS 70s..

Unfortunately, the SAS 70 process is pretty much the same – it is becoming increasingly difficult for the end investor to obtain a copy of the SAS 70 document for many administrators.  This is, of course, despite the fact that the SAS 70 is now a key marketing point in the admin industry.

It’s particularly annoying when the SAS 70 is stated only to available (i) to the auditors of (ii) the administrator’s clients, the funds.  The first point makes the SAS 70 process seem more than a little self serving, as the auditors give each other work for the sake of it.  The second raises the broader issue (and one of our favorite topics) of who exactly is the administrator’s client – the fund or the investor?

A particular black mark goes to those administrators who will not provide investors with a copy of the SAS 70 under any circumstances, and insist on providing a summary of the SAS 70…prepared by themselves.  And exactly how is the investor supposed to place any reliance on that?

An honorable mention in the hall of shame must go, however, to those administrators who try to charge the costs of their SAS 70 review through to their fund clients as an out of pocket expense.  In other words, the admin expects the funds’ shareholders’ to pay for their own SAS 70.

And no, we still can’t see it.

3) Who distributes the financial statements?

While the confirmation issue above is tediously annoying, thinking practically, the risk that a hedge fund simply fabricates a relationship with PwC or KPMG is pretty remote.  What is more likely is that a reputable audit firm has been appointed and completes their work…but a manager then elects to change some or all of the financial statements and gives investors a set of fake accounts.  As we have said before, a copy of Adobe photoshop only costs $500.

The double irony is that, even with the audit confirmation we discussed above, the auditor does not send the investor the accounts directly.  There is, therefore, no way of getting a direct confirmation from the auditor that the accounts in your possession are, in fact, genuine.

One suggestion we have heard would be, in the offshore world at least, for investors to access financial statements direct from the Cayman Monetary Authority (perhaps via a secure website with appropriate authorizations).  This would draw on the requirement that the fund auditors must give the Cayman authority a copy of the (genuine) accounts themselves.  An excellent idea….Cayman?

As a more immediate solution, we are always anxious to confirm that the fund administrator receives the audited financials direct from the auditor and thereafter sends them to investors.  This is a great control – it ensures that the financial statements are authentic, and it also unequivocally confirms the identity of the auditor at the same time.

The snag?  While this is crucially important, administrators seem pretty casual about the whole process.  Admins are generally happy to do this, but only if a fund asks for this “service”, and many admins are certainly far from proactive on this topic.  There are some admins, mind you, that don’t want to get involved (we came across one admin that had decided, on a related point, that they would not send offering memos to investors.)

In our mind, this is a vital control and should be mandatory for every administrator.  Getting the financials from the admin is just as important as ensuring that the investor monthly NAV statements come from the admin and not from the manager.

4) And who is the audit report addressed to?

Another particular bugbear is the obsession of one of the Big 4 audit firms in Cayman to change the addressee of the audit report from “to the board of directors and shareholders” to just “to the board of directors”.  The objective, of course, is transparent and predictable – the auditor is looking to enhance the concept of privity and assert that the firm only has a relationship with the Board and no relationship – none, never, nada – with the investor.

The irony here – the directors who are now the sole recipient of the audit are usually our rent a director friends who sit on a few hundred other hedge fund boards.  And does anyone really think – including the partner at the Big 4 firm signing the opinion – that these guys really have time to read every set of audited financial statements from cover to cover?

One solution here – could the Cayman regulator mandate that the audit opinion must be addressed to the shareholders in order to be meet Cayman requirements?  Again, this would be a small change that would send a very helpful, investor friendly signal from this jurisdiction.

5) In fact, do you even have to leave the office?

A final observation reflects what seems to be an emerging trend over the past audit cycle – certain auditors (and certain offices of certain auditors in particular) seem to be adopting a desk fieldwork process.  We have recently completed due diligence on a number of funds – albeit usually long short equity – when both the administrator and the manager stated that the audit team had never came on site to do any audit work.  All work was done remotely from the auditor’s own offices.

Now, aside from the fact that fieldwork is called fieldwork for a reason (er…you’re in the field) we see this as a worrying trend.  It stands to question that the quality of the audit is not the same if you never look the individual responsible for preparing the accounts in the eye.

As a counterpoint to our observations, we do continue to recognize that the audit process is ever more challenging and that many skilled professionals work incredibly hard, especially during busy season. As just one example, we were recently speaking with the audit partner of a Big 4 firm discussing FIN 48 – a tortuous challenge for the profession.

At the same time, the audit process is critical for investors and we’re certainly entitled to ask tough questions – we are “sophisticated”, after all.

It’s also worth noting that the auditors’ ever increasing fees are, of course, borne by the end allocator.  We’re happy to pay….provided we get good value.  Net net, the hedge fund audit profession would certainly be well served to make things a little easier for the person cutting the pay cheque.
Hedge Fund Operational Due Diligence
“Risk Without Reward” is a trademark of Entreprise Castle Hall Alternatives Inc.  All rights reserved.


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP is one of the top hedge fund law firms and provides comprehensive formation and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

For more articles by Chris Addy, please see the Castle Hall Alternatives post where we have listed our reprinted articles.

Hedge Fund Marketing – Building a Strong Brand Identity

Importance of Brand Identity Emphasized in Recent White Paper

There has been a clear trend over the last 12-18 months for hedge funds to focus on a number of operational issues in order to become more attractive to institutional investors.  While much of focus has been on the risk management side, I have seen more recent emphasis placed on brand building and image refinement.  This can take many forms of course, including making sure that your hedge fund marketing pieces look professional. However, it is becoming evident managers will need to go further and make sure their entire product offering is designed for the needs of their target investors.

In a recent white paper, produced BK Communications Group, this argument was expanded upon and discussed in depth.  The following are the overview highlights of the white paper:

  • Performance alone isn’t enough to get allocations.  Recent surveys of institutional investors find reputation has become a primary consideration when choosing a hedge fund manager.  And with institutions now representing up to 70% of hedge fund investors, the demand has increased for high-level communications that speak to a sophisticated audience.
  • A step-by-step program to build a strong brand identity – the sum total of associations people have with an organization – can help a fund manager heighten name recognition and credibility.  Professional-level materials that reflect the brand identity can position a fund to take advantage of opportunities in the institutional space and beyond.
  • A strong brand identity can also help fund managers weather severe setbacks by allowing them to draw on a reservoir of good associations already in place.
  • Managers often underestimate the importance of marketing communications, and can be misinformed about what they are allowed to communicate.  Many lack the internal resources or capability to effectively build a brand identity and get their message out across a spectrum of materials and media.

While many in the industry understand that performance is not everything, many managers do not believe this (…for some managers, growth is an offshoot of fantastic performance, see David Einhorn, but this is not always the case).  I think that this paper presents important information for such managers.  As the industry continues to become more instiutionalized, I believe we will see a greater emphasis placed on brandbuilding and I believe consultants will play a larger part in the investment process (including helping the manager to complete the due diligence process).

For the full white paper, please see: BKCG White Paper: Brand Identity for Hedge Funds


Please contact us if you have a question on this issue or if you would like to start a hedge fund.  Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

NFA Provides Social Networking Compliance Guidance

Member Firms Subject to Increased Oversight & Compliance Responsibilities

In early December the National Futures Association (“NFA”) submitted two proposed amendments proposed amendments to the Commodity Futures Trading Commission (“CFTC”) regarding NFA Member Firms and their use of the internet and social media networks.  The amendments focus on communications by firms over the internet in various capacities including blogs, chat rooms, forums, and various social media websites (i.e. Facebook, Twitter, etc). While these amendments will increase the oversight responsibilities for Member Firms, it makes sense for the NFA to alert members to their responsibilities with regard to these growing forms of communication.  This post describes the two amendments, application to forex managers, the NFA social media podcast and the impact these amendments are likely to have on all NFA Member firms.  The NFA’s Notice to Members on this issue is also reprinted at the end of this post.

Overview of Amendments

Amendment to Rule 2-29

Rule 2-29 was broadened by the following changes (underline and strikethrough):

(h) Radio and Television Advertisements.

No Member shall use or directly benefit from any radio or television advertisement or any other audio or video advertisement distributed through media accessible by the public if the advertisement that makes any specific trading recommendation or refers to or describes the extent of any profit obtained in the past that can be achieved in the future unless the Member submits the advertisement to NFA’s Promotional Material Review Team for its review and approval at least 10 days prior to first use or such shorter period as NFA may allow in particular circumstances.

By broadening the rule the NFA effectively is requiring Member Firms to make sure all audio and video internet advertising (i.e. podcasts, youtube, voiceover presentations, etc) be reviewed prior to use.  Effectively groups who have used these channels to market their services will need to (i) have all such media reviewed by the NFA or (ii) take all media off of the internet.

Interpretive Notice: Internet Communication & Social Media

This interpretive notice is not so much an amendment of an existing Interpretive Notice as it is simply the creation of a new notice.  The full Interpretive Notice can be found in the proposed amendments link above, but I have also reprinted some of the more interesting parts of the notice:

The form of communication does not change the obligations of Members and Associates who host or participate in these groups, and electronic communications must comply with Compliance Rules 2-9, 2-29, 2-36, and 2-39.


Therefore, content generated by the Member or Associate is subject to the requirements of NFA Compliance Rules 2-29, 2-36, or 2-39. The same is true for futures, options, or forex content written by a Member or Associate and posted on a third party’s site.


Members should have policies regarding employee conduct. These policies could require employees to notify the employer if they participate in any on-line trading or financial communities and provide screen names so that the employer can monitor employees’ posts periodically. Alternatively, the policy could simply prohibit participation in such communities. The Member must, of course, take reasonable steps to enforce whatever policies it adopts.


The issue becomes more complicated for user-generated comments responding to a Member or Associate’s blog and for Members and Associates who host chat rooms or forums. What is their responsibility for posts from customers or others over whom the Member or Associate has no direct control? When inadequately monitored, social networking sites may contain misleading information, lure customers into trades that they would not normally make, or be used in an attempt to manipulate prices.

The biggest take-away is that the NFA is expecting NFA Members to integrate a social media awareness into their current compliance program.  Accordingly, compliance programs (especially those parts dealing with Compliance Rules 2-9, 2-29, 2-36, and 2-39) will need to be updated appropriately to reflect the requirements of the Interpretive Notice.  Member Firms will also need to vigillantly follow their new/revised compliance procedures and monitor their employees – it will be very easy for the NFA to do simple internet searches and potentially “catch” firms who do not adequately comply the Interpretive Release.

Issues for Forex Managers

Forex is specifically discussed throughout the Interpretive Notice so it is clear that the NFA’s intent is to make sure that forex communications, especially, are subject to monitoring and oversight.  Currently this rule applies to those firms who are NFA Member Firms (currently registered) and, in the future, after the forex registration rules have been adopted, it will apply to all registered forex firms (CTAs, CPOs, IBs and FDMs/FCMs).  The NFA has made it clear before that forex managers/traders are in the NFA’s regulatory cross-hairs and this Interpretive Notice reinforces that impression.

NFA Podcast on Social Media

The NFA has produced a podcast titled “Use and Supervision of Online Social Networking Communication” and can be found with other NFA produced podcasts.  This podcast is helpful to provide Member Firms with some helpful guidance on some of the major issues to consider when developing a social media policy to comply with the Interpretive Notice and Rule amendment.  There are a number of considerations that firms will need to make and the social media policy must be tailored to the business practices of the firm.  There are likely to be a number of hot button issues which will develop regarding Member Firms and this policy, especially concerning oversight of associated persons.  The podcast also hints at one of the big compliance issues which managers should be aware of – the reposting of content.  Because internet posts are routinely “scraped” from the original website and reposted on other websites, Member Firms should be aware of this issue and create appropriate procedures.

It is recommended that compliance officers listen to this podcast when developing their social media compliance policies and procedures.

Impact on NFA Members

I view these amendments as relatively major – because so many firms use the internet for marketing and because prior NFA rules essentially did not address the issues of social networks there has been a bit of a regulatory gap.  However, I do think that the NFA is doing the right thing by publicly notifying Member Firms that this will be a compliance issue going forward – this is much better than a retroactive interpretation of existing NFA compliance rules. One thing I think that member firms should be especially concerned with is potential liability for what 3rd parties do with information which is posted online.  On the podcast, the NFA specifically suggested that firms should be policing their content and actively follow how it might be used by 3rd parties which is obviously problematic given the way the internet works.

Because these amendments affect both a current NFA Rule as well as the NFA’s Interpretive Releases, these amendments may make their way (eventually) onto the various exams (Series 3, Series 30, Series 34 especially).

These rules are also likely to create a compliance nightmare for many firms which have utilized the internet previously (and social media specifically).

Compliance Recommendations

The safest approach to social media compliance for all NFA Member Firms is to not allow the use any social media websites or other means of internet communication which would subject the firm to have a robust social media policy (including record retention policy for such media).  It will be much less costly to put a blanket prohibition on these types of activities than to develop and monitor such a policy.  For those firms who are willing to spend the time and money to implement a policy, such firms should make sure that all major aspects of the amendments are included in the policy.  Such items to consider will include: internet and social media content review, recordkeeping and storage, oversight of employees (including spot-checking internet posts and activity), and reposting review procedures, among other issues to consider.  It will be absolutely critical to make sure the policy addresses all issues raised in the Interpretive Notice and podcast because the NFA has not minced words – this is going to be a hot-button issue and it will be something the NFA will actively pursue during examinations.

Of course we will be able to provide greater guidance over the next few months as we see how the NFA handles this issue during and outside of examinations.


Notice to Members I-10-01

January 5, 2010

Effective Dates of NFA Requirements Regarding On-Line Advertising and Social Networking Groups

NFA has received notice from the Commodity Futures Trading Commission (“CFTC”) that NFA may make effective certain proposed amendments regarding the use of internet and on-line social networking groups when communicating with the public. The Interpretive Notice entitled “Use of On-Line Social Networking Groups to Communicate with the Public” makes clear that on-line communications are subject to the same standards as other types of communications with the public and provides guidance to Members to meet their responsibilities in this area. The Interpretive Notice became effective on December 24, 2009.

A related amendment to Compliance Rule 2-29(h) requires that any audio or video distributed through media accessible by the public (e.g., through the internet) that makes any specific trading recommendation or refers to the extent of profit previously obtained or achievable in the future must be submitted to NFA for review and approval at least 10 days prior to first use. In this way the amendment subjects certain on-line advertising to the same requirements as similar television and radio advertising. To allow Members sufficient time to submit these types of advertisements to NFA for approval, the amendment becomes effective as of February 1, 2010. Accordingly, any audio or video advertisements that a Member posts on-line after January 31, 2010, must have been previously reviewed and approved by NFA.

NFA’s December 8, 2009, submission letter to the CFTC contains a more detailed explanation of the changes. You can access an electronic copy of the submission letter at:

Questions concerning these changes should be directed to Sharon Pendleton, Director, Compliance ([email protected] or 312-781-1401) or Michael A. Piracci, Senior Attorney ([email protected] or 312-781-1419).


Other related hedge fund law blog articles include:

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman & Mallon LLP at 415-868-5345.

Hedge Fund Audit Firms and Agreed Upon Procedures

Hedge Fund Due Diligence Firm Discusses “Agreed Upon Procedures”

We’ve published a number of thoughtful pieces on this blog from Chris Addy, president and CEO of Castle Hall Alternatives (see, for example, article on Hedge Fund Operational Issues and Failures).  Today we are publishing a piece by Chris which discusses hard to value hedge fund assets (so called Level III assets).  In certain situations hedge fund audit firms will be engaged to perform an “Agreed Upon Procedures” review of the pricing of these assets.  As discussed in the article below, agreed upon procedures engagements do not provide hedge fund investors with a great deal of comfort with regard to the pricing of these assets.  It is unclear whether in the future investors will push back with regard to such engagements and require more robust pricing audits.  The problem with more robust procedures, obviously, is increased cost (because of increased liability for the audit firms).

Managers who are engaging audit firms pursuant to agreed upon procedures should be aware that they may face tougher questions from investors going forward.


Agreed Upon Procedures

A number of our recent posts have focused on the challenges of the hedge fund administrator‘s role in relation to security valuation.  We will, of course, return to this topic – but, in the meantime, wanted to focus on some of the alternatives to administrator pricing.

One of the more common comments from today’s administrators is that, while an admin may be able to price Level I and Level II securities, they do not necessarily have information to price Level III instruments.  (To recap, the US accounting standard FAS 157 divides portfolios into three levels, being Level I, liquid instruments readily priced from a pricing feed (typically exchange traded); Level II, instruments priced using inputs from “comparable” securities (essentially mark to model, albeit with mainstream models); and Level III, everything else.)

This leaves investors with a challenge – if administrators cannot price Level III instruments, who can? Moreover, to repeat one of our frequent comments, it is self evident that if a hedge fund manager wishes to deliberately mismark securities, they would most likely misprice a Level III instrument.  It is, of course, very hard to fake the price of IBM common stock, but much easier to mismark emerging market private loans.

Two of the most common tools available to hedge fund managers looking for third party oversight over pricing for Level III instruments – assuming the administrator has washed their hands of the problem – are third party pricing agents and auditor agreed upon procedures, or “AUP”.  We will return to the strengths and weaknesses of third party pricing agents in a subsequent post, but wanted to focus this discussion on AUP.

In an Agreed Upon Procedures engagement, the auditor completes specific procedures which have been dictated by the client.  The procedures are specified and the auditor then prepares a report outlining the findings of that specific work.

We have two comments here: the first is to take a high level view as to the adequacy of these procedures, and the second is to dig a little more deeply into the actual audit guidance that covers this type of work.

Our first comment is, unfortunately, an Emporer Has No Clothes observation.  The significant majority of hedge fund AUP engagements we have seen require the auditor to test a fund’s pricing on a quarterly basis.  This usually involves (i) obtaining a portfolio list from the investment manager and (ii) testing the pricing support for those positions.

There are, however, generally two snags.  Firstly, many AUP only test a sample of prices, not the whole portfolio.  Sample testing clearly provides much less assurance than a price review of all positions: the administrator, for example, is usually expected to price the entire book (would any investor accept a NAV which has been priced on a “sample” basis???)

The bigger problem, however, is the type of testing completed by the auditor.  In way, way too many cases, the auditor tests security prices back to the manager’s own pricing support and makes no attempt to obtain independent pricing information.

This type of work is, clearly, somewhere between minimal and absolutely no value for investors.  If the auditor receives a spreadsheet from the manager showing the matrix of broker quotes received, how does the auditor know that the manager has not adjusted that spreadsheet to exclude quotes which were uncomfortably low?  Even more importantly, if all the auditor does is to check prices back to pieces of paper in the manager’s own pricing file, how does the auditor know that those pieces of paper are genuine?  As we have said before, and will keep on saying, it only costs $500 to buy a copy of Adobe Photoshop if you are of a mind to alter documentation.

When discussing this type of work, the manager typically notes that, if the auditor was to complete a full, independent pricing review, it would be too costly and too time consuming to be practical on a quarterly basis.  A full, GAAP audit review is, of course, performed at year end – this does include independent pricing (although – investor fyi – auditors will still only sample test many portfolios.)

While these are fair points, it remains the case that this type of AUP provides minimal protection against pricing fraud.  In the meantime, the manager gets the marketing benefit of being able to claim enhanced scrutiny and oversight from a Big 4 firm each quarter.

Which leads to our second point.  Why would an auditor accept to complete agreed upon procedures when any reasonable accountant would rapidly conclude that the typical scope of these AUP provide pretty much nil controls assurance?  Why does the auditor not insist that, if their name is to be associated to this work, then the procedures must be meaningful and sufficient to meet an actual control standard?

To this point, the actual audit standard applicable to AUP is available here.  The standard states:

An agreed-upon procedures engagement is one in which a practitioner is engaged by a client to issue a report of findings based on specific procedures performed on subject matter. The client engages the practitioner to assist specified parties in evaluating subject matter or an assertion as a result of a need or needs of the specified parties. Because the specified parties require that findings be independently derived, the services of a practitioner are obtained to perform procedures and report his or her findings. The specified parties and the practitioner agree upon the procedures to be performed by the practitioner that the specified parties believe are appropriate. Because the needs of the specified parties may vary widely, the nature, timing, and extent of the agreed upon procedures may vary as well; consequently, the specified parties assume responsibility for the sufficiency of the procedures since they best understand their own needs. In an engagement performed under this section, the practitioner does not perform an examination or a review, as discussed in section 101, and does not provide an opinion or negative assurance. Instead, the practitioner’s report on agreed-upon procedures should be in the form of procedures and findings.

In practice, this all gets horribly circular.  Per the standard, a client requests an auditor to complete AUP to assist “specified parties” to “evaluate subject matter or an assertion”.  In our case, the assertion would be “are hard to value securities valued correctly at quarter end.”

However, the specified party is usually the manager itself, making the client and specified party the same person.  The particular trick applied, in many cases, is for the auditor to seek to prevent the investor from actually seeing the AUP in the first place!  However, if the investor is to have access to the AUP, the auditor universally requires the investor to sign a Catch 22 document which requires the investor to acknowledge that the AUP are “sufficient for their needs”.  So, even if the investor believes that the AUP are not “sufficient for their needs” – which is hardly a long stretch – the investor has to sign that the procedures are sufficient if they are to even see the auditor’s work.  With this magic piece of paper, the auditor has met its requirements and can sleep easy.  Meanwhile, the auditor will send a bill to – guess who – the fund, meaning that investors have, once more, had to foot the bill.

As always, Caveat Emptor.

Hedge Fund Operational Due Diligence


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Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and can be reached directly at 415-868-5345.

Raising Hedge Fund Assets | New Market Requires New Strategies

As part of our ongoing discussion on how to raise assets for hedge funds, today we have another guest post from Karl Cole-Frieman who specializes in providing legal advice to hedge funds and other alternative asset managers.  Mr. Cole-Frieman specializes in Loan Trading and Distressed Debt Transactions, ISDAs, Soft Dollars and Commission Management arrangements, and Wage and Hour Law Matters among other legal matters which hedge fund managers face on a day to day basis.

The article below details the strategies which hedge fund managers should consider when creating a marketing strategy for their fund.


AWAI Panel: How Growing Funds Can Beat the Odds in the “New” Market

By Karl Cole-Frieman,

On September 24, 2009, we attended a panel organized by the Association of Women in Alternative Investing, and sponsored by Pillsbury Winthrop at Pillsbury’s offices in San Francisco.  The panel consisted of several extremely experienced hedge fund professionals and was moderated by Angela Osborne, Senior Director of Global Cash & Derivatives Operations at BGI.  Prior to joining BGI, Angela was Head of West Coast Client Service at Morgan Stanley Prime Brokerage.

The other panelists were:

  • Nicole Civitello, Capital Introduction at BNP Paribas.  Nicole was formerly at Bank of America Prime Brokerage in New York and San Francisco (BofA Prime Brokerage was sold to BNP in 2008).
  • Ildiko Duckor, Counsel at Pillsbury Winthrop.  Ildi had previously been Counsel at Howard Rice, and has represented hedge fund managers for many years.
  • Robin Fink, Head of Prime Brokerage Sales at Jefferies & Company, Inc. Jefferies has been aggressively increasing its market share in prime brokerage, and Robin has been leading that effort on the West Coast.

The panel began with an overview by Ildi Duckor regarding proposed regulatory changes relating to the hedge fund industry.

Develop a Strategic Marketing Plan

The discussion then moved to ideas for successful marketing, and we thought the panel’s insights were useful.

Nicole Civitello emphasized developing a strategic marketing plan.  She made the following points about developing a plan:

  1. Targeting the right investors.  For example, start up managers should not target corporate pensions and other investors that will require a lengthy track record.  Instead, start up managers should look to friends and family investors and family offices for initial capital.
  2. Understanding the investors.  Managers should research potential investors the same way they research investment ideas.  They can use their personal network or capital introduction resources for help with this.  Robin Fink added that managers should do their homework to understand an investor’s strategy.
  3. Invest in CRM software.  Managers should invest in customer relationship management software to track investor communications, feedback and follow-up actions.
  4. Increase dialogue with investors.  This could be face to face meeting, conference calls, quarterly or monthly letters.  Panelists indicated that this is a trend in the industry.  Ildi Duckor suggested that conference calls are optimal because they can be well scripted to keep on message.
  5. Dedicated Investor Relations function.  Firms that lost assets in the last year often did not have a dedicated investor relations function to communicate with investors.

Portfolio Managers and Marketing

There also was a discussion about whether Portfolio Managers should be the main marketing face to investors.  Ildi Duckor emphasized that whoever is before investors should be familiar with both the strategy and the documents.  Nicole Civitello noted that many investors want to see the Portfolio Managers early because inevitably there are questions that a marketing person will be unable to answer and, if the Portfolio Manager is not available, the investor will need to have a second meeting.  Robin Fink noted that marketing professionals in 2009 need to have an intimate knowledge of the portfolio and a granular understanding of the business.  They need to be more than executive secretaries planning trips and meetings.

Due Diligence in the Post-Madoff Environment

Another topic addressed by the panel that is of interest to hedge fund managers is due diligence in the post-Madoff envornment.  Nicole Civitello laid out the landscape in 2009:

  1. Longer review period.  In the past, investors often made investments after looking at a fund for three to six months.  Now the timeline has shifted to six months to a year or longer.
  2. Flows to managers in 2009.  Flows in 2009 have generally gone to the following: (a)Funds that outperformed on a relative basis in 2008; (b) Funds previously closed to new investments; and (c) Funds tracked by an investor for several years.
  3. Transparency.  It was emphasized by all of the panelists that investors are demanding more transparency.

Ildi Duckor noted a focus on operations by investors, and a movement away from self-administration.  The practical effect of this for startup managers is that they will not be able to give management fee concessions because they will need the management fees for increased operational costs.

Angela Osborne also noted that successful hedge fund managers have cohesion between the front and the back offices.  Great stock pickers are not necessarily great business managers, and they should be thoughtful in bringing in talent to run the business.

To find out more about marketing issues for hedge fund managers and other topics impacting hedge fund managers, please contact Karl Cole-Frieman of Cole-Frieman & Mallon LLP ( at 415-352-2300 or [email protected]


Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog.  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 are a current hedge fund manager with questions about the laws regarding raising hedge fund assets, please contact us or call Mr. Mallon directly at 415-868-5345.  Other related hedge fund law articles include:

Raising Hedge Fund Capital is Not Easy

I have written before that the biggest issue start-up and emerging hedge fund managers face is raising capital for their funds.  I seem to have the same conversation on a weekly basis – the “how to do I grow my fund” conversation.  Unfortunately I do not have the guaranteed step-by-step guide to raising boatloads of capital, but that is not to say that smaller managers cannot raise capital.  I have seen plenty of groups who have made it over the proverbial hump by working ridiculously hard.

The article below (written by Richard Wilson of Hedge Fund Blogger) discusses some ideas that managers will want to consider when developing a program to raise hedge fund capital.  Richard’s group provides consulting services and helps managers to raise money for their hedge funds.


This is Bad News: There is NO Magic Bullet
Richard Wilson

The bad news is there is no magic bullet to raising capital. I spoke with at least a dozen managers this past week at our Hedge Fund Premium networking event in Chicago. Most were looking for capital raising help of some type and we discussed many roadblocks that managers are seeing between them and the AUM levels they are trying to achieve.

Our firm provides some capital raising tools, but I believe that daily action and discipline is the best thing that a fund can do to raise capital. They must take responsibility for marketing their fund and have someone reaching out to new investors on a daily basis, if they do not they will forever remain in the bottom 20% of the industry in terms of assets. Very few funds gain their initial assets through a super powerful third party marketing firms, third party marketers like to typically work with managers which have some AUM momentum or foundation underneath them.

To raise capital I believe that managers need to have superior tools and processes when compared to their competitors. This means superior investor cultivation processes in place, superior investor relationships management, superior marketing materials, superior outreach efforts, superior email marketing, and superior focus on investors which actually have the potential of making an investment. Each of those topics mentioned above could be discussed for a whole conference and all of these moving parts need to be in place to compete in today’s industry. While this does not mean you need to out-spend others you do need to strategically plan your marketing campaign.

There is a good quote that I heard which goes something like “If you want to have what others don’t you have to do what others won’t” In other words if you want to grow assets you must put in the extra work, planning, and strategy that others skip over.

Every morning I try to listen to a 45 minute custom MP3 audio session of business lessons, marketing tips and positive thinking notes. One great quote I hear every morning by our friend Brian Tracy, “Successful people dislike to do the same things that unsuccessful people dislike to do, but successful people get them done anyways because that is what they know is the price of success.” This is connected to an interview Brian conducts in which a multi-millionaire says that success is easy, “you must decide exactly what it is you want, and then pay the price to get to that point.”

All of this may sound wishy washy or non-exact but I think it is very important to realize that there is no one single magic bullet for raising capital. It takes hard work, trial and a superior effort on all fronts to stand out from your competition.

Read dozens of additional articles like this within our Marketing & Sales Guide.

– Richard


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 investment adviser registration with the SEC or state securities commission, please call Mr. Mallon directly at 415-296-8510.

Hedge Fund Investors Asking for More Meaningful Communication

Clients are demanding that investment managers communicate more than just data

The following white paper was released by BK Communications Group, a company which provides outsourced marketing and client communications solutions for the asset management industry.  According to a recent survey of institutional hedge fund investors, clients largely prefer that managers take the call for transparency one level further and communicate to them in a meaningful way that explains what they’re doing with the funds.  Popular forms of communication adopted by investment firms include pitch-books, websites, and personal contact.  According to a report by McKinsey & Co., providing full transparency and enhancing communication efforts can be useful in client retention and future asset gathering.

The executive summary and highlights of the paper is re-printed in full below as well as a link to the paper.


BKCG White Paper
June 2009
The New Transparency: Words

Clients are demanding that investment managers communicate more than just data

Executive Summary

Transparency has typically been equated with access to data (trade, exposure, valuation, etc.), but the financial crisis and fund scandals have led clients, investors, as well as regulators to demand more. Major surveys and anecdotal evidence indicate communication is now in demand. Clients want managers to put the numbers in context, to explain what they’re doing, to communicate on a clear and meaningful basis. This expanded transparency can help retain clients and strategically position a firm for future asset gathering, both by building a brand associated with full transparency and by ensuring that all touchpoints – from pitchbooks to websites to personal contact – are fully in place and high quality. Investment firms must carefully examine how they currently communicate, decide on any adjustments that must be made, and determine whether they have the internal capabilities and resources to execute on those adjustments.


  • Communication is the new transparency. Data alone is no longer sufficient. Clients want managers to put the numbers in context, to explain what they’re doing, to communicate on a clear and meaningful basis
  • SEI/Greenwich Associates’ global survey of institutional investors finds investors will “intensify their scrutiny of investment processes” and increasingly emphasize client reporting and communications.
  • Preqin’s survey of 50 institutional hedge fund investors finds that events of the past 12 months have led 43% of respondents to expect “increased transparency and understandable strategy.”
  • Providing full transparency can be a way of helping to retain clients and strategically position a firm for future asset gathering. McKinsey & Co’s major report (“The Asset Management Industry in 2010”) concludes that “winning asset managers will be those who forge a superior reputation and capabilities for service and sophisticated advice.”
  • Communications transparency can be approached strategically, to ensure an investment firm’s brand is associated with openness and clarity, and to establish a reputation for thought leadership, as this is associated with mastery of core competence.
  • Communications transparency can also be approached tactically by making sure that all touchpoints – from pitchbooks to websites to personal contacts – are fully in place and high quality.
  • Many investment firms are shedding internal resources that are not profit centers, including communications personnel, or are hesitant to bring on those resources – leaving them without the necessary skills, or bandwidth, for an appropriate level of communications.

For the full report, please see BKCG Transparency White Paper


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, please call Mr. Mallon directly at 415-296-8510.

Deal Book: New Hedge Fund with Questionable Name

The New York Times Deal Book today ran a story about a new hedge fund named Ground Zero Strategic Commodities.  The author of the story noted that:

Putting the words “Ground Zero” in a hedge fund name may disturb many people as it undoubtedly conjures up images of the site where the World Trade Center was destroyed nearly eight years ago.

We agree.  Raising assets for hedge funds can be hard enough – a manager should try to choose a name for their fund that is not likely to put off potential investors.  We have written about hedge fund names before and while it is always advisable to try to have a name which represents the manager or strategy or outlook in some way, it should not be a distraction.


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