Section 204A | Investment Advisers Act of 1940

Section 204A — Prevention of Misuse of Nonpublic Information

Every investment adviser subject to section 204 shall establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser’s business, to prevent the misuse in violation of this Act or the Securities Exchange Act of 1934, or the rules or regulations thereunder, of material, nonpublic information by such investment adviser or any person associated with such investment adviser. The Commission, as it deems necessary or appropriate in the public interest or for the protection of investors, shall adopt rules or regulations to require specific policies or procedures reasonably designed to prevent misuse in violation of this Act or the Securities Exchange Act of 1934 (or the rules or regulations thereunder) of material, nonpublic information.

Secondary Loan Market | LSTA Conference

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Trends for Distressed Debt Hedge Fund Managers

Distressed debt hedge funds often face a number of legal issues with regard to their investments. Post-Lehman, understanding the rights and liabilities attached to the actual contracts has become paramount for managers. The following article, contributed by Karl Cole-Frieman of Cole-Frieman & Mallon LLP, provides some background on a recent conference which discussed the secondary loan market.

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The LSTA Annual Conference and the Secondary Loan Market

On October 29, 2009, we attended the annual conference for the Loan Syndications and Trading Association (the “LSTA”). Conference attendance was significantly up in 2009 from 2008, reflecting an increase in trading volume in the secondary loan market, and robust market conditions for service providers as a result of the spike in settlement on distressed documentation following Lehman’s collapse in 2008.

Secondary Loan Market Panel

Of particular interest was the panel regarding “Recent Developments in the Secondary Loan Market” moderated by Elliot Gans, Executive Vice President and General Counsel of the LSTA. Other panelists included:

Linda Giannattasio, Director and Counsel in Citigroup’s Office of the General Counsel.
Robbin Schulsohn, Karl Cole-Frieman’s former colleague at JPMorgan Chase, where she is Executive Director and Assistant General Counsel.
Claire Pierce, Managing Director if Chapdelaine Credit Partners. Claire was in-house at Bank of America for many years before joining Chapdelaine.
Bridget Marsh, Senior Vice President & Assistant General Counsel of the LSTA.
Jennifer Tallmadge, Assistant General Counsel at Bank of America.

Notably, the panel lacked a Buy Side perspective, which impacted the topics of discussion.

Buy-In/Sell-Out Provisions (“BISO”)

A relatively recent change in standard documentation for Par Trades is the inclusion in the LSTA Par/Near Par Trade Confirmation of a BISO provision for confirmations beginning February 2009. The BISO provisions addressed the problem of counterparty risk for failure to settle a trade. Previously, if a counterparty refused to settle a trade, there was little that the performing party could do short of litigation. The BISO provisions, which have recently been modified, establish the circumstances under which a performing party in a Par Trade may terminate its obligations under a trade confirmation and effect a cover transaction in respect of the loans. There is a lot of discussion about adding a BISO provision to the LSTA Distressed Trading Documents.

The panel expressed some mixed views about the success of the Par BISO provisions. In general, the BISO provisions have been considered successful in reducing settlement times in 2009. However, the provisions have only been in effect in a rising market, and it remains to be seen what will happen next time there is a systemic downturn in the market. It is possible that market participants could become overwhelmed sending and responding to BISO notices.

Distressed Documents for Performing Loans

The panel also discussed the phenomenon post-Lehman of trades that settled on distressed documents for performing loans. After the Lehman bankruptcy the loan prices fell significantly even for performing loans. Buyers reacted by insisting that trades settle on distressed documents instead of Par documents, causing significant delays in settlements. Generally the panel, which was dominated by Sell Side representatives, felt the market behaved irrationally in requiring distressed documents for performing loans based solely on price. One the other hand, the distinction between par and distressed has historically been determined solely by price. It is not clear what other objective measures loan purchasers can rely on. From a Buy Side perspective, it might be worth spending an additional $20,000 in delayed compensation to make sure their $200,000,000 is fully protected.

Settlement Times for Loan Trades

Despite the BISO provisions in the Par confirmations, there are systemic problems causing settlement delays in 2009. Although Linda Giannattasio indicated that 90 percent of Citibank’s par trades are settling in T+7, Elliot Gans provided raw data for 3Q 2009 that shows that problems persist. For par trades, the average trade settled in 18 days, while the median settlement time was 11 days. For distressed trades, the average trade settled in 45 days, while the median trades settled in 36 days. Performing loans that trades on distressed documents post-Lehman are shifting back to Par documents, contributing to the delays.

Shift Date Rule

The LSTA plans to publish new rules for determining the “shift date,” or the date in which loans shift from Par to Distressed, and therefore must settle on distressed documents. The existing process, which has never worked well, is that the LSTA polls dealers on the shift date. Under the forthcoming rules, the LSTA will select the shift date and it will be binding on all parties. Upon request, the LSTA will review trade data and other supporting material to determine the date. Where unable to make a determination, the LSTA will assemble a Determinations Committee made up of LSTA Board members. Elliot Gans indicated that some market participants would prefer the LSTA select a random date to the current polling system. Nevertheless, we expect these new rules to be somewhat controversial when rolled out by the LSTA.

To find out more about the secondary loan market and other topics impacting hedge fund managers, please contact Karl Cole-Frieman of Cole-Frieman & Mallon LLP (www.colefrieman.com) at 415-352-2300 or [email protected].

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Other related hedge fund law articles include:

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

Forex PAMM Accounts

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By Bart Mallon, Esq. (www.colefrieman.com)

State Securities Agency Calls PAMM Accounts Securities

Forex investment managers who offer forex separately managed account programs need to be aware of the risks of offering trading programs which use PAMM accounts. PAMM accounts are functionally equivalent to “bunched” or “batched” order master accounts which are common at most futures comission merchants for futures and commodities trading. However, there is the risk that PAMM accounts could be deemed to be “securities” under state securities laws.

In the following securities release, reprinted in full below, the Pennsylvania Securities Commission announced an action against a forex manager who was managing forex accounts for individuals through a PAMM structure. The Commission “ordered the Respondent to stop offering or selling the Program in the Commonwealth of Pennsylvania, in violation of the Pennsylvania Securities Act of 1972, and in particular Section 201 thereof.” Section 201 provides that “It is unlawful for any person to offer or sell any security in this State unless the security is registered under this act, the security or transaction is exempted under section 202 or 203 hereof or the security is a federally covered security.”

In our opinion this action is odd, but forex managers should be aware that states can make such claims and if a state does make such a claim, the manager will either need to comply with the state order or fight the state in court. If the manager does the former then he is essentially forfitting the right to have clients from certain state. If he does the latter, he is potentially looking at a large legal bill with an uncertain outcome.

So, the question is what should managers do to protect themselves if they are using PAMM accounts? The answer is unclear. To be safe, a manager may want to write no-action letters to the state securities commissions where they will have clients. This is likely to be an expensive endeavor, however. Managers may want to weigh the risks of having clients in PAMM accounts who are residents of Pennsylvania – from the release below it seems clear that having Pennsylvania clients brings regulatory risk to the company. Managers should also be aware of their internet presence – it is interesting how the release below emphasizes the promotion of the trading program over the internet.

If you are running a managed forex trading program with PAMM accounts, you should discuss this issue with your legal counsel.

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For Immediate Release: 06/13/2007

Commission Halts Unregistered Activity By Pace Capital Group, LLC, Robert Cavallaro, Shawn May, and Courtney May

Harrisburg, PA, 06/13/2007 — To halt the offer and sale of unregistered securities in Pennsylvania, the Pennsylvania Securities Commission issued a Summary Order to Cease and Desist against Pace Capital Group, LLC (Pace), an entity with an address in Eagleville, Pennsylvania and Robert Cavallaro (Cavallaro), Shawn May (S. May) and Courtney May (C. May) each individuals with addresses in Eaglesville, Pennsylvania and each founding members of Pace.

From in or about May 2007 to the present, Pace maintained a web site at www.pacecapitalgroup.com (Web Site) which contained offering materials (Materials) that solicit investors (Investors) to purchase an investment program (Program).

The Materials state that Pace is in the business of investing and managing Investor’s money in the Foreign Exchange Capital Markets (Forex); that pursuant to the Program, the Investor signs a Managed Account Agreement (MA Agreement) and a Limited Power of Attorney Agreement (LPOA); that pursuant to the MA Agreement, Investors open an investment account with an initial deposit, which is in turn managed by Pace; that Pace provides Investors with a choice of two Forex Currency Trading Systems (Systems); that each System is comprised of pre-existing technically formulated strategies of Forex trading; that each System is managed by an “advisor” for Pace (Advisor); and that pursuant to the LPOA Agreement, Investors assign their investment rights to an Advisor, which allows the Advisor to trade, invest, and manage the investments on the Investor’s behalf.

In or about May 2007, Pace offered for sale the Program to at least one Pennsylvania resident (PA Resident).

In or about May 2007, S. May e-mailed additional information (E-mail) to at least one PA Resident. The E-mail states that Pace will place an Investor’s money into a “PAMM”, i.e., percentage allocation account; that Pace will pool all the Investors’ funds and trade the funds as one investment in order to increase returns; and that Pace’s goal for returns on investments is 3% to 5% a month.

The Commission ordered the Respondent to stop offering or selling the Program in the Commonwealth of Pennsylvania, in violation of the Pennsylvania Securities Act of 1972, and in particular Section 201 thereof.

Any further solicitations or sales made by these respondents in Pennsylvania will constitute violations of the 1972 Act and the Commission’s Orders. Any person who is solicited by or has information about these respondents is asked to immediately notify the Pennsylvania Securities Commission by calling 800-600-0007, or, in Harrisburg: (717) 787-8062, in Pittsburgh: (412) 565-5083 or in Philadelphia: (215) 560-2088.

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Other articles related to forex trading and forex hedge funds:

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

Series 79 Training Materials | Series 79 Study Guide

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Information on Study Materials and Classes for Series 79 Exam

One of the inquires I receive most often about the Series 79 exam involves study materials. As of right now I have not heard of any groups who have produced a study guide or other materials for this exam. I know that both Kaplan and STC are working on producing exam study guides and other materials. STC in particular has been moving forward very quickly with their materials. The information below was prepared by Gary Fox of the Securities Training Corporation. and outlines the products which they will be introducing over the next couple of months. We will continue to publish information on Series 79 products as they are released.

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FINRA began administering the Examination on Monday, November 2. As with all other FINRA Examinations, there is little or no guidance as to how topics are being tested other than the outline.

STC’s Series 79 Training Manual and Practice Examinations will be available in December. The Manual will be in printed format, the Practice Examinations will be available in online format. We will be offering live and virtual training classes starting in January, which will give you the opportunity to complete your reading before classes begin. We strongly recommend attending the class, particularly if you have no prior experience with FINRA Examinations.

We would also like to remind you of the opt-in provisions FINRA offers with the Series 79. If you hold any one of the following registrations-Series 7, 17, 24, 37, 38, or 62, you do not need to sit for the Series 79, provided you file the appropriate opt-in forms with FINRA. You have until May 2 to take advantage of the opt-in provision. We offer training for all registrations.

If you do not hold any of these registrations, and do not want to wait until December for our training program, you could take any one of the previously mentioned examinations, opt-in to the new FINRA registration category, and bypass the need to sit for Series 79. As a reminder, STC does not offer guidance as to which registrations may be appropriate for your firm. Please contact your compliance department or legal counsel for proper registration and the procedure for opting in.

You can sign up for updates regarding our Series 79 Training Program and get more information about all of our programs and your options by visiting www.stcusa.com.

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Other related hedge fund law articles include:

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

CTA Lead List Basics

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By Bart Mallon, Esq. (www.colefrieman.com)

“Purchased Lead Lists and How to Use Them”

A good resource for CTAs that are actively trying to raise money are lead lists – lists of names and contact information of potential future clients or investors. This overview is for the CTA Expo 2009 program entitled Purchased Lead Lists and How to Use Them. The program was sponsored by Patke & Associates and featured Jacques DeRouen of Pinnacle Alternative Investments.

Jacques started off by telling all of the CTAs that they need to get out and market to investors. The point is to get your story to willing listening. He then provided us with a brief background of how he got involved with lists and how he learned to use lists effectively. The biggest takeaway is that getting good at using lead lists takes time and dedication – but don’t let the list intimidate you. From here he discussed a number of items about lead lists in general.

Lead Lists in General

There are many different types of lists and the lists come in a variety of different formats and include various different types of information. CTAs should research exactly what they will get with these lists and some questions which the purchaser should ask include the following:

Has the list maker described their list and what they provide?
What is the reputation of the list maker?
Does the list have references, if no, then why?
Is there a free sample?
What information is on the list – key contact names, size of the investor, email addresses.

CTA managers should think about making some calls to the investors on the sample lists which are released. Basically the manager wants to make sure that the list is not something that was simply culled from the phone book – the leads need to be warmer. If they are providing a general list of investors, this is ok but it will probably take you more time.

Budget

The biggest thing to consider is your budget. If you don’t have money in the budget to buy a list, then don’t buy it. A CTA should always be aware of the fees coming in and be able to justify any expenses, which includes a list.

Prepping an Investor Database

When you get a lead list it will typically be in some sort of spreadsheet like excel and it will be up to the CTA to clean up the data and make it user friendly. There are a number of different ways to establish databases that will work for keeping track of investors contacted and to contact. After formatting a database or input, the CTA should always back-up the new, manipulated data. From here the CTA will want to export the manipulated data to a CRM. There are a number of customer relationship management (CRM) software solutions which allow managers to manipulate large raw sets of data, such as the lead lists. It is very important for the CTA to take good notes about the interactions with the leads.

Notes About Emailing Investors from Lead Lists

Emailing your marketing presentation can be a very effective way to market to some of the investors on the lead lists. However, CTAs should not send every piece of marketing material that they have. A CTA may want to think about emailing a summary presentation with bullett points. A teaser like this sets the plate so that when the CTA follows up with the lead (with a phone call), the lead has a little bit of background on the manager, but is not overwhelmed (or worse, annoyed). CTAs should be aware that even with the best lead lists there is likely to be some email kickback from natural changes in the composition of the company. The best systems are likely to have 2-3% kickback, the middle tiered lists are likely to have 5-10% kickback and the lower quality lists are likely to have much more.

Approaching Fund of Fund Investors

While many fund of fund investors don’t actively advertise that they allocate to emerging managers, they do and CTA firms should be calling these managers. Even if a FOF manager decided not to invest with the CTA manager, calling is still a good way to connect and develop a relationship – potentially that relationship can develop down the line. Fund of fund managers do like CTA and other emerging managers not only because of the potential returns but also because the FOF managers are likely to be able to negotiate carve-outs of the CTA manager’s future capacity.

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This article first appeared in the CTA Expo Blog run by Bart Mallon, Esq. Mr. Mallon also runs the Hedge Fund Law Blog and is committed to providing useful and easy to understand information for CTAs and CPOs which can be found in our CTA and CPO Registration and Compliance Guide. For more information on CTA registration or compliance services please contact Mr. Mallon at 415-868-5345.

Another PPIP Closing

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The following Treasury press release can be found here. Please also see the article on earlier PPIP closings.

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Treasury Announces Additional initial closing of Legacy Securities Public Private Investment Fund

November 5, 2009
TG-357

Treasury Department Announces Additional initial closing of Legacy Securities Public Private Investment Fund

WASHINGTON — The U.S. Department of the Treasury today announced that RLJ Western Asset Management, LP, has completed an initial closing of a Public-Private Investment Fund (PPIF) established under the Legacy Securities Public-Private Investment Program (PPIP). RLJ Western Asset Management, LP, is a minority-owned partnership between The RLJ Companies, LLC and Western Asset Management.

To date, seven PPIFs have completed initial closings on approximately $4.09 billion of private sector equity capital which has been matched 100 percent by Treasury, representing $8.18 billion of total equity capital. Treasury has also provided $8.18 billion of debt capital, representing $16.36 billion of total purchasing power for all PPIFs.

Treasury expects initial closings for the remaining two PPIFs to be announced soon. Following an initial closing, each PPIF has the opportunity to conduct additional closings over the following six months to receive matching Treasury equity and debt financing, with a total Treasury equity and debt investment in all PPIFs equal to $30 billion ($40 billion including private investor capital). Treasury will continue to provide updates as subsequent PPIF closings occur.

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Other related hedge fund law articles include:

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

Hedge Fund Investment Adviser Insurance

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E&O or D&O Insurance For Registered Investment Advisers

Yesterday I had the opportunity to talk with an insurance broker whose business focuses on providing insurance to registered investment advisers and hedge fund managers. This article is based on that conversation.

Insurance Premiums for Small Funds

For smaller funds (say less than $100 million in AUM) with no operational history, the minimum premium amount is likely to be in the $10,000 to $15,000 range for about $1 million in coverage. Usually premiums will stay around those levels as the AUM grows, but at around $200 million in AUM the premiums may start to increase. For those types of premiums you are usually looking at deductibles in the $25,000 range, which is going to be pretty standard for smaller groups. Depending on the exact nature of the group’s business the deductible may end up being as high as $50,000 or $75,000. Of course these are only ranges and the final premium and deductible amounts will be established based on the unique circumstance of the manager.

Hedge Fund Insurance Underwriters

While the insurance brokers are able to place policies for smaller managers at some of the major carriers like Chubb, many times they will need to have scripted policies which require the insurance carriers (groups like Lloyds) to write a policy specifically for the management company. In these cases the premiums are likely to be on the higher end of the ranges discussed above.

What does Insurance Cover?

The central reason that hedge fund investment advisers will buy insurance is to protect against potential claims by the limited partners. Generally the insurance can be purchased as Errors & Omissions/Directors & Officers Liability (E&O/D&O). While each policy will cover different acts, generally the insurance will cover the negligent acts of all past and present employees, offices and directors. Independent contractors (such as sub-advisers and potentially, in certain circumstances hedge fund service providers) may or may not be covered under the policy.

If a lawsuit is initiated against the manager, after the deductible the insurance company will pick up all costs associated with the lawsuit up to the coverage maximum (in the case quoted above, this would be $1 million). Because of the costly nature of litigation and because any litigation will likely be based on significant losses, it might be the case that the liability in the case exceeds the insurance coverage in which case the managers or employees may be liable for the remainder of the judgment or legal costs (see How Much E&O Should I Buy). Many hedge funds will have exculpation and indemnification provisions which will protect officers and employees of the management company for acts done in good faith.

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Related articles from Hedge Fund Law Blog:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog. If you are a hedge fund manager who is looking to start a hedge fund or if you have questions about your investment advisor compliance program, please contact us or call Mr. Mallon directly at 415-868-5345.

Public Comments on SEC Proposed “Pay to Play” Rules

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SEC Proposed Pay to Play Rules Draw Many Comments

Earlier this year the SEC proposed so-called “pay to play” rules which would restrict SEC registered investment advisers from managing money from state and local governments under certain circumstances. According to the SEC press release, “the measures are designed to prevent an adviser from making political contributions or hidden payments to influence their selection by government officials.” The rule would do four major things:

Restricting Political Contributions
Banning Solicitation of Contributions
Banning Third-Party Solicitors
Restricting Indirect Contributions and Solicitations

The comment period, which ran for 60 days, produced some very good points. As a general matter most groups opposed the proposed rules for some reason or another. Below I have gathered some of the more interesting or important points which were raised in the comments which are publicly available here. All of the following quotes are directly from the comments of the submitters which are identified.

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Joan Hinchman – Executive Director, President and CEO, of NSCP (National Society of Compliance Professionals Inc.)

The practical result of the ban will be that an adviser will be economically compelled to end its relationship with a governmental entity.
The ban will deprive participants and beneficiaries of public funds of well qualified advisers and drive up the cost of investment advisory services due to higher compliance costs.
The Rule will affect at a minimum all registered investment advisers that not only advise governmental public pension funds, but also may cover investment companies in which governmental pension funds choose to invest.
Advisers lacking capital to hire employees to obtain government clients or the experience and sophistication to do so would be placed at a material competitive disadvantage.