Hedge Fund Analyst Fined for Insider PIPE Trading

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According to a SEC litigation release, a hedge fund analyst was fined $317,000 for engaging in insider trading with regard to a PIPE investment.  PIPE transactions are subject to close scrutiny from the SEC.  In this instance the fund which the analyst worked for established a short position in a company which was completing a PIPE transaction.  Evidently the reason the fund established the short was because of inside information about the deal from the analyst.  The SEC release can be found here.

U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20784 / October 20, 2008
SEC v. Brian D. Ladin et al., Civil Action No. 1:08-CV-01784 (RBW) (D.D.C.)

SEC Charges Former Hedge Fund Analyst with Improper Trading

The Securities and Exchange Commission today charged Brian D. Ladin, a former analyst for Bonanza Master Fund Ltd. (“Bonanza”), a Dallas-based hedge fund, with improper trading in the U.S. District Court for the District of Columbia. Ladin, without admitting or denying the allegations in the Commission’s complaint, agreed to settle charges that he engaged in unlawful insider trading in connection with a 2004 “PIPE” (an acronym for private investment in public equity) offering conducted by Radyne Comstream Inc. As detailed below, Ladin agreed to entry of a final judgment imposing an injunction and ordering him to pay $330,427, consisting of $13,427 in disgorgement and prejudgment interest and a $317,000 civil penalty.

The Commission’s complaint alleges, among other things, that Ladin accepted a duty to keep the offering information confidential. The Complaint further alleges that Ladin, on the basis of the material, non-public PIPE information, presented an investment in Radyne to Bonanza, resulting in Bonanza establishing a 100,000 share short position in Radyne stock. The Commission’s complaint further alleges that Ladin, in signing the offering’s stock purchase agreement on behalf of Bonanza, represented that Bonanza did not hold a short position in Radyne common stock when he knew, or was reckless or negligent in not knowing, that Bonanza held a short position in Radyne’s common stock.

Ladin consented to the entry of a final judgment (i) permanently enjoining him from future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Section 17(a) of the Securities Act of 1933; (ii) ordering him to pay $10,895 in disgorgement, along with $2,532 in prejudgment interest thereon; and (iii) ordering him to pay a $317,000 civil penalty. Bonanza and its investment adviser, Bonanza Capital, Ltd., consented to the entry of a final judgment ordering them, as relief defendants, to pay a total of $371,429 in ill-gotten gains derived from Ladin’s unlawful conduct (and prejudgment interest thereon).

For more information on this subject, please see:

  • Hedge Funds and PIPE Transactions

If you have any questions, please contact us.

Hedge Fund Service Providers Expanding During Market Turmoil

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If you read a lot of the stories which have been coming out in the last couple of weeks, you would think that the hedge fund industry was about to go the way of the dinosaur.  (See NYT Deal Book Article)  Personally, I think the exact opposite – that the hedge fund industry, after a bit of a cooling off period, will see assets come back to the table in greater force than before.  I also believe that hedge funds will become more institutionalized products with more robust due diligence procedures as a standard practice and that hedge funds will (eventually) emerge as retail products.  Whether any of the above happens quickly or slowly remains to be seen, but there were four separate press releases we published last week that shows hedge fund service providers are especially bullish on the industry.

The four press releases deal with (1) expanding hedge fund due diligence; (2) increased investment from single family offices; (3) prime brokers continuing expansion based on industry changes and (4) a hedge fund administrator moving into the prime brokerage arena.  I’ve highlighted the takeaways from the press releases below.

1.  Hedge Fund Due Diligence Firm Expands. (Link to release)  The press release below provides details on a hedge fund due diligence firm which is expanding its operations.  In the coming months and years hedge fund due diligence is poised to become a central part of the hedge fund investing process. Specifically, the press release quotes the new hire as saying… “in the current markets, hedge fund investors face multiple challenges that, more than ever, involve operational risk. Investors must understand many new issues, including counterparty risks, the impact of FAS 157 and how to deal with funds which impose gates, suspend redemptions or restructure. Castle Hall helps investors enhance their due diligence program and better respond to these new challenges.”  I completely agree.  For more information on due diligence, please see the following HFLB articles:

2.  Single family offices to increase hedge fund investing in the next year. (Link to release) Rothstein Kass, a well known hedge fund audit and administration firm, released a study which indicates that Single Family Offices will continue to invest in hedge funds.  This press release states two interesting items from the report:

Good Performance and Additional Investment – family offices are generally happy with the performance of hedge funds and will commit more money to funds within the next twelve months.

Transparency – the release states that more than 70% of single family offices said that a lack of transparency in their hedge fund investments is concerning.  Additionally, a director of Rothstein Kass is quoted as saying  “while high-net-worth individuals generally recognize advantages of hedge fund investing, they are frequently confounded by the growing roster of products and services available.”  This really comes as no surprise and signals that hedge fund due diligence will become a major focus from here on out.  Transparency is achieved not only through the hedge fund manager, but also through hedge fund service providers who have developed technology solutions to offer to hedge fund managers.  On a going forward basis hedge funds are going to need to be more transparent.  For more information, please also see:

3.  Prime Broker continues to expand during industry changes. (Link to release) The prime brokerage industry is going through a lot of changes currently as the biggest prime brokerage firms, Goldman and Merrill have changed into bank holding companies.  Additionally, with the collapse of Lehman, the conventional wisdom is for larger hedge funds to prime with multiple brokers.  As this trend continues to develop I expect that more firms will jump into the prime brokerage business and that prime brokers will begin to offer more back office and administration services to hedge funds.  New and surviving hedge funds should benefit as prices decrease and quality of services increase.

4.  Hedge fund administration and back office firm, announced that it is expanding into hedge fund prime brokerage. (Link to release) This press release highlights two specific interesting trends in the hedge fund industry.  The first is the move from segregated service providers to shows which provide a whole suite of services including back office, admin and prime brokerage.  The second trend is the move from one main prime broker to housing assets at many prime brokerage firms.  We saw with the collapse at Lehman and the corresponding freeze of some hedge fund assets, that small and large funds alike want to diversify across brokers and custodians.  I believe Conifer is the first in a wave of admin/ back office firms which will put a shingle out as a mini-prime or introducing prime broker.

Conclusion

While none of these individually provide conclusive evidence that the industry will remain strong in the coming months, it does show that people in the industry are investing in the infrastructure which will allow the industry to expand in the coming years. Please feel free to contact us if you have questions or comments on any of the above.

Hedge Fund Graduated Performance Fees

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No two hedge funds or hedge fund managers are the same – the same is also true for hedge fund performance fees which can take any structure that the hedge fund manager fancies.  I have seen many different styles of performance fees and many different hedge fund hurdle rates.

Some managers will institute “graduated” performance fees.  The graduated performance fee is characterized by fees which change based on the returns to the partnership.  The fee is typically calculated on gross returns.  Many times you will see a hurdle rate with a graduated performance fee. An example of a graduated performance fee follows:

  • Returns up to 20% will be charged a 20% performance fee
  • Returns of 20% to 40% will be charged a 25% performance fee
  • Returns of 40% to 50% will be charged a 35% performance fee
  • Returns greater than 50% will be charged a 40% performance fee

There are two different ways the fee can be applied.  The fee can be on the overall returns or it can be on the returns from the plateau only.  Using the numbers from above, here is how it would work:

If straight 20% performance fee applies:

Total
Return    % to Manager        % to Investors
20%        4%                        16%
40%        8%                        32%
50%        10%                      40%
60%        12%                      48%

If fee applies to overall returns:

Total
Return    % to Manager        % to Investors
20%        4%                        16%
40%        10%                      30%
50%        17.5%                   32.5%
60%        24%                      36%

If fee applies to return on each plateau only:

Total
Return    % to Manager        % to Investors
20%        4%                        16%
40%        9%                        31%
50%        12.5%                   38.5%
60%        16.5%                   43.5%

The purpose of the graduated performance fee is to provide greater marginal compensation to the hedge fund manager when the fund’s performance is particularly good.  One downfall of the graduated performance fee is the potential for the manager to take excessive risks once a certain return level has been reached in order to get to a higher performance plateau.  Generally, it seems that in my experience, both investors and managers can benefit from the graduated performance fee structure.  As I noted above, though, each hedge fund fee structure is different and a graduated performance fee may not be appropriate in all situations.

Other related articles:

Please contact us if you would like to discuss performance fees or other issues.

Hedge Fund Manager Fined and Banned for a Year for “Portfolio Pumping”

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This is another example of a hedge fund manager acting with incredible audacity.

Last week the SEC issued a release detailing an action taken against a hedge fund manager for his “portfolio pumping” practices.  Bascially the manager was caught buying a large amount of shares through another fund he ran in order to boost the price of the thinly traded security.  The manager then charged higher management fees based on the inflated price of the securities.  The manager was fined $100,000 and ordered to disgorge the higher management fee of $80,000.

The end of the release states that the adviser will be allowed to reapply for association with an investment advisor for a year, but I believe the damage has been done.  If this manager does start another fund, proper hedge fund due diligence will show this SEC action which by itself should send investors running for the door.  In this case the hedge fund manager ruined his career for a few thousand dollars.

The release can be found in full here.

SEC Charges San Francisco Hedge Fund Adviser for “Portfolio Pumping”
FOR IMMEDIATE RELEASE
2008-251

Washington, D.C., Oct. 16, 2008 — The Securities and Exchange Commission today charged San Francisco investment adviser MedCap Management & Research LLC (MMR) and its principal Charles Frederick Toney, Jr. with reporting misleading results to hedge fund investors by engaging in a practice known as “portfolio pumping.”

The SEC alleges that Toney made extensive quarter-end purchases of a thinly-traded penny stock in which his fund was heavily invested, more than quadrupling the stock price and allowing him to report artificially inflated quarterly results to fund investors. Without admitting or denying the SEC’s allegations, MMR and Toney have agreed to settle the charges by paying financial penalties and agreeing to an order barring Toney from acting as an investment adviser for at least one year.

“Fund investors relied on MMR and Toney to abide by their fiduciary duties and put the fund’s interests ahead of their own,” said Marc J. Fagel, Regional Director of the SEC’s San Francisco Regional Office. “Instead, Toney engaged in trading activity which hid his poor performance.”

According to the SEC’s order, MedCap Partners L.P. (MedCap), a hedge fund run by MMR and Toney, was suffering from dramatic losses and facing increasing redemptions from fund investors by September 2006. Over the last four days of the month, Toney — through a separate fund that MMR managed — placed numerous buy orders for a thinly-traded over-the-counter stock in which MedCap already was heavily invested. Toney’s buying pressure caused the stock price to more than quadruple, from $0.85 to $3.72.

The SEC alleges that because the stock represented over one-third of MedCap’s holdings, the brief boost in its price inflated MedCap’s reported value by $29 million, masking what would otherwise have been a 40 percent quarterly loss for MedCap. Immediately after the quarter ended, Toney reported to MedCap’s investors that the fund’s investments had begun to “bounce” and that the fund’s performance was improving. Toney failed to disclose that this “bounce” was almost entirely the result of his four-day purchasing spree. Following MMR’s brief buying activity, both the stock price and MedCap’s asset value declined to their previous levels.

According to the SEC’s order, at the same time, MMR charged fees to the fund based on the inflated quarter-end asset value.

The Commission found that MMR and Toney breached their fiduciary duties to MedCap and to MMR’s other fund in which the penny stock was acquired. Toney and MMR, without admitting or denying the Commission’s findings, have agreed to cease and desist from violating the antifraud provisions of the Investment Advisers Act of 1940. MMR also will disgorge the higher management fees it received due to the inflated fund asset value, plus interest — an amount totaling $70,633.69 — and receive a Commission censure. Toney also has agreed to a bar from association with any investment adviser with the right to reapply after one year, and to pay a $100,000 penalty.

Other releated articles:

Please contact us if you have questions or if you would like to discuss.

NFA to Begin Regulating FOREX

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The last unregulated space within the hedge fund industry was the retail foreign exchange (“Forex”) market.  As of November 30 of this year, many hedge fund managers which invest in the spot forex markets will need to be registered with the NFA.  More analysis on this to follow.

The press release and the new NFA rules follow below.

Notice I-08-26

October 16, 2008

Effective Date of NFA Compliance Rules 2-41 and 2-42: Disclosure by Forex Pool Operators and Trading Advisors

NFA has received notice that the Commodity Futures Trading Commission has approved NFA Compliance Rules 2-41 and 2-42. The new rules will become effective on November 30, 2008. Accordingly, after November 30th Members that manage forex accounts on behalf of customers or offer pools trading forex must provide prospective clients and pool participants with a disclosure document that has been filed with NFA prior to use. The new rules only apply if the forex pool or the person for whom the forex account is being managed is not an eligible contract participant as defined in Section 1a(12) of the Commodity Exchange Act. A forex pool, however, may not claim to be an eligible contract participant by virtue of Section 1a(12)(A)(v)(II) or (III) of the Commodity Exchange Act.

The disclosure document must provide disclosures similar to those currently required under CFTC Part 4 regulations. Finally, a Member operating a pool subject to the new rules must provide periodic (monthly or quarterly) account statements and an annual report to the pool participants.

Copies of the new rules are attached for your convenience. Additionally, NFA’s February 29, 2008, submission letter to the CFTC contains a more detailed explanation of the changes. You can access an electronic copy of the submission letter at http://www.nfa.futures.org/news/newsRuleSubLetter.asp?ArticleID=2101.

Questions concerning these changes should be directed to Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Susan Koprowski, Manager, Compliance ([email protected] or 312-781-1288).

COMPLIANCE RULES

* * *

Part 2 – RULES GOVERNING THE BUSINESS CONDUCT OF MEMBERS REGISTERED WITH THE COMMISSION

* * *

RULE 2-41. FOREX POOL OPERATORS AND TRADING ADVISORS

(a) Pool Operators. Except for Members who meet the criteria in Bylaw 306(b) and Associates acting on their behalf, any Member or Associate operating or soliciting funds, securities, or property for a pooled investment vehicle that is not an eligible contract participant as defined in Section 1a(12) of the Act must comply with this section (a) if it enters into or intends to enter into any transaction described in NFA Bylaw 1507(b)(1) except as described in NFA Bylaw 1507(b)(3). For purposes of this section, a pooled investment vehicle may not claim to be an eligible contract participant by virtue of Section 1(a)(12)(A)(v)(II) or (III) of the Act.

(1) For each such pooled investment vehicle, the Member or Associate must prepare a Disclosure Document and must file it with NFA at least 21 days before soliciting the first potential pool participant that is not an eligible contract participant.

(2) The Member or Associate must deliver the Disclosure Document to a prospective pool participant who is not an eligible contract participant no later than the time it delivers the subscription agreement for the pool. Any information delivered before the Disclosure Document must be consistent with the information in the Disclosure Document.

(3) The Disclosure Document must comply with the requirements in CFTC Regulations 4.24, 4.25, and 4.26 as if operating a pool trading on-exchange futures contracts. The term “commodity interest” in those regulations should be read to include forex transactions, and the Risk Disclosure Statement required by CFTC Regulation 4.24(b)(1) must be replaced by the following if the pool does not trade on-exchange contracts and must be added as a separate statement if the pool trades both on-exchange contracts and forex.

RISK DISCLOSURE STATEMENT

YOU SHOULD CAREFULLY CONSIDER WHETHER YOUR FINANCIAL CONDITION PERMITS YOU TO PARTICIPATE IN A POOLED INVESTMENT VEHICLE. IN SO DOING, YOU SHOULD BE AWARE THAT THIS POOL ENTERS INTO TRANSACTIONS THAT ARE NOT TRADED ON AN EXCHANGE, AND THE FUNDS THE POOL INVESTS IN THOSE TRANSACTIONS MAY NOT RECEIVE THE SAME PROTECTIONS AS FUNDS USED TO MARGIN OR GUARANTEE EXCHANGE-TRADED FUTURES AND OPTIONS CONTRACTS. IF THE COUNTERPARTY BECOMES INSOLVENT AND THE POOL HAS A CLAIM FOR AMOUNTS DEPOSITED OR PROFITS EARNED ON TRANSACTIONS WITH THE COUNTERPARTY, THE POOL’S CLAIM MAY NOT RECEIVE A PRIORITY. WITHOUT A PRIORITY, THE POOL IS A GENERAL CREDITOR AND ITS CLAIM WILL BE PAID, ALONG WITH THE CLAIMS OF OTHER GENERAL CREDITORS, FROM ANY MONIES STILL AVAILABLE AFTER PRIORITY CLAIMS ARE PAID. EVEN POOL FUNDS THAT THE COUNTERPARTY KEEPS SEPARATE FROM ITS OWN OPERATING FUNDS MAY NOT BE SAFE FROM THE CLAIMS OF OTHER GENERAL AND PRIORITY CREDITORS.

FOREX TRADING CAN QUICKLY LEAD TO LARGE LOSSES AS WELL AS GAINS. SUCH TRADING LOSSES CAN SHARPLY REDUCE THE NET ASSET VALUE OF THE POOL AND CONSEQUENTLY THE VALUE OF YOUR INTEREST IN THE POOL. IN ADDITION, RESTRICTIONS ON REDEMPTIONS MAY AFFECT YOUR ABILITY TO WITHDRAW YOUR PARTICIPATION IN THE POOL.

INVESTMENTS IN THE POOL MAY BE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT, ADVISORY, AND BROKERAGE FEES, AND THE POOL MAY NEED TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETING OR EXHAUSTING ITS ASSETS. THIS DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF EACH EXPENSE (SEE PAGE [insert page number]) AND A STATEMENT OF THE PERCENTAGE RETURN NECESSARY TO BREAK EVEN, THAT IS, TO RECOVER THE AMOUNT OF YOUR INITIAL INVESTMENT (SEE PAGE [insert page number]).

THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER FACTORS NECESSARY TO EVALUATE YOUR PARTICIPATION IN THIS POOL. THEREFORE, BEFORE YOU DECIDE TO PARTICIPATE YOU SHOULD CAREFULLY REVIEW THIS DISCLOSURE DOCUMENT, INCLUDING A DESCRIPTION OF THE PRINCIPAL RISK FACTORS OF THIS INVESTMENT (SEE PAGE [insert page number]).

NATIONAL FUTURES ASSOCIATION HAS NEITHER PASSED UPON THE MERITS OF PARTICIPATING IN THIS POOL NOR THE ADEQUACY OR ACCURACY OF THIS DISCLOSURE DOCUMENT.

(b) Trading Advisors. Except for Members who meet the criteria in Bylaw 306(b) and Associates acting on their behalf, any Member or Associate managing, directing or guiding, or soliciting to manage, direct, or guide, accounts or trading on behalf of a client that is not an eligible contract participant as defined in Section 1a(12) of the Act by means of a systematic program must comply with this section (b) if it intends to manage, direct, or guide the client’s account or trade in transactions described in NFA Bylaw 1507(b).

(1) The Member or Associate must prepare a Disclosure Document and must file it with NFA at least 21 days before soliciting the first potential client that is not an eligible contract participant.

(2) The Member or Associate must deliver the Disclosure Document to a prospective client who is not an eligible contract participant no later than the time it delivers the agreement to manage, direct, or guide the client’s account or trading. Any information delivered before the Disclosure Document must be consistent with the information in the Disclosure Document.

(3) The Disclosure Document must comply with the requirements in CFTC Regulations 4.34, 4.35, and 4.36 as if managing, directing, or guiding accounts or trading in on-exchange futures contracts. The term “commodity interest” in those regulations should be read to include forex transactions, and the Risk Disclosure Statement required by CFTC Regulation 4.34(b)(1) must be replaced by the following if the managed, directed, or guided account or trading will not include transactions in on-exchange contracts and must be added as a separate statement if it will include transactions in both on-exchange contracts and forex.

RISK DISCLOSURE STATEMENT

THE RISK OF LOSS IN FOREX TRADING CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. IN CONSIDERING WHETHER TO TRADE OR TO AUTHORIZE SOMEONE ELSE TO TRADE FOR YOU, YOU SHOULD ALSO BE AWARE OF THE FOLLOWING:

FOREX TRANSACTIONS ARE NOT TRADED ON AN EXCHANGE, AND THOSE FUNDS DEPOSITED WITH THE COUNTERPARTY FOR FOREX TRANSACTIONS MAY NOT RECEIVE THE SAME PROTECTIONS AS FUNDS USED TO MARGIN OR GUARANTEE EXCHANGE-TRADED FUTURES AND OPTIONS CONTRACTS. IF THE COUNTERPARTY BECOMES INSOLVENT AND YOU HAVE A CLAIM FOR AMOUNTS DEPOSITED OR PROFITS EARNED ON TRANSACTIONS WITH THE COUNTERPARTY, YOUR CLAIM MAY NOT RECEIVE A PRIORITY. WITHOUT A PRIORITY, YOU ARE A GENERAL CREDITOR AND YOUR CLAIM WILL BE PAID, ALONG WITH THE CLAIMS OF OTHER GENERAL CREDITORS, FROM ANY MONIES STILL AVAILABLE AFTER PRIORITY CLAIMS ARE PAID. EVEN CUSTOMER FUNDS THAT THE COUNTERPARTY KEEPS SEPARATE FROM ITS OWN OPERATING FUNDS MAY NOT BE SAFE FROM THE CLAIMS OF OTHER GENERAL AND PRIORITY CREDITORS.

THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN FOREX TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS.

MANAGED ACCOUNTS MAY BE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES AND THE ACCOUNT MAY NEED TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETING OR EXHAUSTING ITS ASSETS. THIS DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF EACH FEE TO BE CHARGED TO YOUR ACCOUNT BY THE ACCOUNT MANAGER. (SEE PAGE [insert page number]).

THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND SIGNIFICANT ASPECTS OF THE FOREX MARKETS. THEREFORE, YOU SHOULD CAREFULLY REVIEW THIS DISCLOSURE DOCUMENT BEFORE YOU TRADE, INCLUDING THE DESCRIPTION OF THE PRINCIPAL RISK FACTORS OF THIS INVESTMENT (SEE PAGE [insert page number]).

NATIONAL FUTURES ASSOCIATION HAS NEITHER PASSED UPON THE MERITS OF PARTICIPATING IN THIS TRADING PROGRAM NOR THE ADEQUACY OR ACCURACY OF THIS DISCLOSURE DOCUMENT.

RULE 2-42. FOREX POOL REPORTING

(a) Except for Members who meet the criteria in Bylaw 306(b), any Member operating a pool that trades forex must comply with the requirements in CFTC Regulation 4.22 in the same manner as would be applicable to the operation of a pool trading on-exchange futures contracts. The term “commodity interest” in that regulation should be read to include forex transactions.

(b) A Member may file with NFA a request for an extension of time in which to file the annual report in the same form as provided for in CFTC Regulation 4.22(f).

Differences between the Series 65 and the Series 66

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Hedge fund managers who must register as investment advisor representatives with the SEC (through notice filings) or the state securities commission will need to have the proper FINRA exam licenses. Generally this means that the hedge fund manager will need to have passed the Series 65 exam within two years of registration (or the license must not have been inactive for two years prior to the registration).

However, if a manager has a Series 7 exam license, he will only need to take the Series 66 exam instead of the Series 65. This would generally be a good idea because the Series 66 exam is easier than the Series 65 exam and managers should be able to pass the Series 66 with less effort than the Series 65. I have detailed below the different requirements for the Series 65 versus the Series 66

Series 65 Exam

  • 140 multiple choice questions
  • 10 pre-test; 130 count towards score
  • 180 minutes to take the exam
  • Must achieve a 72% to pass
  • Test covers: economics and analysis; investment vehicles; investment recommendations and strategies; and legal and regulatory guidelines, including prohibition on unethical business practices.
  • NASAA test outline link.

Series 66 Exam

  • 110 multiple choice questions
  • 10 pre-test; 100 count towards score
  • 150 minutes to pass the exam
  • Must achieve 72% to pass
  • Test covers: much of the material included on the Series 65, but it does not include the product, analysis and strategy questions that are a large part of the Series 65.
  • NASAA test outline link.

Other related articles include:

If you have any questions, please contact us.

Hedge Fund Due Diligence Firm Expands

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This week we’ve seen a deluge of hedge fund press releases which indicate that the industry which supports hedge funds remains strong a growing.  The press release below provides details on a hedge fund due diligence firm which is expanding its operations.  In the coming months and years hedge fund due diligence is poised to become a central part of the hedge fund investing process.

October 14, 2008

Gillian Scott, CA CFA, Joins Castle Hall Alternatives as Managing Director; Castle Hall Opens Office in Halifax, Nova Scotia

MONTREAL – Castle Hall Alternatives, a leading provider of hedge fund operational due diligence, announced today that Gillian Scott, CA CFA, has joined the firm as Managing Director. She will lead the firm’s new presence in Halifax, Nova Scotia, where Castle Hall joins several leading administrators and other service providers to help establish a growing pool of hedge fund expertise in Canada.

Gillian previously held the position of Group Financial Controller of The Atlantic Philanthropies, a leading international philanthropy with an investment portfolio in excess of $4 billion. Gillian was a key contributor to the design and development of the group’s operational due diligence process, completing due diligence reviews for a significant portion of Atlantic’s portfolio. She was also responsible for Atlantic’s group audit and internal control environment. Prior to joining Atlantic in 2001, Gillian was an audit manager with the Bermuda office of PricewaterhouseCoopers, where she was responsible for a wide range of hedge fund and investment related audits.

Gillian is a member of the Canadian Institute of Chartered Accountants and is also a CFA (chartered financial analyst) charterholder.

Commenting on her new role, Gillian said “in the current markets, hedge fund investors face multiple challenges that, more than ever, involve operational risk. Investors must understand many new issues, including counterparty risks, the impact of FAS 157 and how to deal with funds which impose gates, suspend redemptions or restructure. Castle Hall helps investors enhance their due diligence program and better respond to these new challenges.”

Chris Addy, Castle Hall’s President and CEO, said “we are delighted to welcome Gillian to our firm and expand our presence to Nova Scotia. Castle Hall’s unique due diligence model enables us to provide the objective and fully independent advice that investors need to navigate today’s markets. We are particularly proud to have assembled what is now the industry’s largest and most experienced team dedicated solely to operational due diligence on behalf of the investor community.”

Hedge Fund Administrator Tests Prime Brokerage Waters

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There was a previous press release about a hedge fund prime broker expanding its services.  We can see from the press release below that hedge fund adminsitrators are also expanding their service offerings.  I believe the reason for the expansion in the service offerings of these firms indicates a belief that the hedge fund space will continue to grow.  It also indicates that hedge fund service providers are looking to be more diversified – these service providers are looking to become one stop shops for hedge fund managers.

Conifer Securities Launches Prime Brokerage Through J.P. Morgan Chase

NEW YORK, Oct 15, 2008 /PRNewswire via COMTEX/ — Move Comes as Hedge Funds Look for New Financing and Prime Brokerage Options

Conifer Securities, a leading provider of business and operations solutions to asset managers and institutional investors, today announced that it has entered the prime brokerage business. Working with J.P. Morgan’s Broker Dealer business services, Conifer is now building upon its Fund Administration and Outsourced Trade Execution services by offering hedge funds a full-suite of prime brokerage services including financing, securities lending, asset custody and daily account reporting. J.P. Morgan’s capital position, extensive capabilities and innovative approach stand out during the current market volatility.

The ongoing financial turmoil and growing interest in counterparty diversification have created a strong demand for additional, experienced prime brokers to step in and service hedge funds. Many hedge fund managers today want to create relationships with multiple prime brokers who can provide alternate sources of financing as well as premium service. Given its 19-year track record as a top-tier hedge fund service provider, the agreement to clear and custody with J.P. Morgan puts Conifer in a very strong position to provide managers with alternative prime brokerage and financing sources.

Conifer’s move into the prime brokerage business is being spearheaded by Richard (Dick) Del Bello, who has more than 15 years of prime brokerage experience, including seven years as the head of prime brokerage for the Americas at UBS.

“The credit crisis and subsequent market turbulence have transformed our industry as hedge funds shift assets to the most financially stable investment and commercial banks,” said Mr. Del Bello. “At the same time, some of the large prime brokers are squeezing the tails of their client rosters, eliminating hedge fund accounts that aren’t suitable for their business–and that’s where Conifer comes in.”

Jack McDonald, Conifer’s president & CEO, added, “J.P. Morgan’s prime brokerage offering is the perfect complement to Conifer’s core middle and back office business, resulting in our emergence as a leading prime broker to hedge funds. Given our existing relationships with all of the other major prime brokers, we can also service established hedge funds requiring multiple relationships by providing them with centralized reporting and an infrastructure otherwise available only to the largest funds. Conifer has successfully expanded its business through the cyclical market extremes of the last twenty years. This in-depth experience and broad expertise will provide the stability and support our client partners need in growing their business.” McDonald concluded.

In addition to its prime brokerage services, Conifer provides comprehensive middle- and back-office services to its clients including: global fund accounting and administration, trade operations, outsourced trade execution, executive office space, compliance, corporate accounting, consulting services and business infrastructure.

Press Release: Hedge Fund Prime Broker Expands Services

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Contrary to the spate of terrible news regarding the financial markets, the hedge fund industry, specifically, the hedge fund service provider industry is poised and ready for continued growth.  The following press release showcases a prime brokerage firm which is actually expanding its operations.

Merlin Securities Expands Client Services Team to Keep Pace with Business Growth

Industry Veteran Michael Tumulty to Lead Client Services in New York David Newman and Walter Paleski Join as Account Executives

SAN FRANSCISCO, Oct 14, 2008 – Merlin Securities, a leading prime brokerage services and technology provider for hedge funds, funds of funds and long-only managers, today announced that it has hired Michael Tumulty, an industry veteran with more than 25 years experience, to head its New York client services team. The firm also hired David Newman and Walter Paleski as account executives in the New York office.

“Merlin is benefitting from the monumental shift taking place in the prime brokerage industry, specifically the movement toward multiple prime brokers and a focus on custodial risk,” said Aaron Vermut, senior partner and chief operating officer of Merlin Securities. “Having experienced account executives in place is critical to maintaining our commitment to outstanding client service. I am delighted to welcome Mike, Walter and Dave to the team.”

Michael Tumulty has more than 25 years of financial services experience, most of which has focused on prime brokerage. Most recently he was a director of financial client management at Merrill Lynch’s prime brokerage, where he worked closely with the firm’s top-tier hedge fund clients. Prior to that, he was with Bear Stearns for 17 years as a director of hedge fund client services. Tumulty holds an M.S. in investment management and a B.S. in business administration.

David Newman is returning to the prime brokerage industry after successfully co-founding and serving as president of Holedigger Studios, an independent film company. Previously, he served as vice president of operations for GH Associates and managed relationships with hedge fund clients at the prime brokerages of Banc of America Securities and ING Furman Selz.

Walter Paleski brings more than 20 years of industry experience and was most recently at CastleRock Asset Management as financial controller, operations manager, and trader. Previously he was a senior account executive for prime brokerage hedge fund clients at ING Furman Selz and, prior to that, Morgan Stanley. Paleski began his career with Shearson Lehman.

Overview of Regulation D for Hedge Funds

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Interests in hedge funds are securities which mean that hedge fund managers must follow the federal (and state) laws regarding the sale of securities to investors.  Typically, securities will need to be registered under the Securities Act of 1933 unless there is an exemption from the registration provisions.

There are two main exemptions from the registration provisions – Section 4(2) of the Securities Act and the Regulation D (also known as “Reg D”) safe harbor rules promulgated by the SEC under Section 4(2).  Typically hedge funds will offer their securities pursuant to the Regulation D safe harbor and specifically under Rule 506 which allows a hedge fund to offer an unlimited amount of interests to investors.

Below is a quick synopsis of the Regulation D rules (I have left out Rule 507 and Rule 508).  I have also posted all of the rules here: Regulation D Rules.  Most important to hedge fund managers will be Rule 502 which requires that the manager not engage in any public solicitation and Rule 506.

Rule 501 – Definitions and Terms Used in Regulation D

In general this rule defines certain terms used in the rest of the rules.  The most important definition is probably the accredited investor definition.

Rule 502 – General Conditions to Be Met

In general, this rule discusses certain aspects of the offering which should be met.  A fund’s attorney will be familiar with these issues.

Specifically, this rule addresses certain integration issues, the information which must be provided to investors who are not accredited investors and the limits of resale of interests in a Regulation D offering.  Most importantly, the rule does not allow fund managers to engage in any sort of general solicitation.  Because this is really the most important aspect of the rule for hedge fund managers, I will include this section explicitly below:

c.  Limitation on manner of offering. Except as provided in Rule 504(b)(1), neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

1.    Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and

2.    Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising;

Provided, however, that publication by an issuer of a notice in accordance with Rule 135c shall not be deemed to constitute general solicitation or general advertising for purposes of this section; Provided further, that, if the requirements of Rule 135e are satisfied, providing any journalist with access to press conferences held outside of the United States, to meeting with issuer or selling security holder representatives conducted outside of the United States, or to written press-related materials released outside the United States, at or in which a present or proposed offering of securities is discussed, will not be deemed to constitute general solicitation or general advertising for purposes of this section.

Because of the broadness of this rule, hedge fund managers should consult with their attorney if they have any question regarding the prohibition on general advertising.

Rule 503 – Filings of Notice of Sales

In general this rule outlines of the requirement for hedge fund managers to file Form D with the SEC within 15 days of the first sale of securities.  See link below on blue sky filings for more information.

Rule 504 – Exemption for Limited Offerings and Sales of Securities Not Exceeding $1,000,000

This rule is known as the intrastate offering exemption, and generally this provides an exemption from registration if the offering  of hedge fund interests is made wholly intrastate and if the amount to be raised is less than $1million.  Few if any hedge funds will utilize this exemption.

Rule 505 –  Exemption for Limited Offers and Sales of Securities Not Exceeding $5,000,000

In general, this rule provides that an offering is exempt from registration if the issuer raises $5 million or less over any 12-month time period.  This rule also provides that there can be no more than 35 non-accredited investors.

Rule 506 – Exemption for Limited Offers and Sales without Regard to Dollar Amount of Offering

In general, this rule provides that an offering is exempt from registration if the fund raises money from no more than 35 non-accredited investors, provided that all non-accredited investors, either alone or with his purchaser representative(s), has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.  This rule does allow a hedge fund to sell an unlimited dollar amount of interests.

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The discussion below from the SEC on regulation D offerings is aimed more at hedge fund investors and the hedge fund due diligence which such investors should engage in; the discussion can be found here.  Managers are urged to discuss the Regulation D offerings with their hedge fund attorneys.

Regulation D Offerings

Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D (or Reg D) contains three rules providing exemptions from the registration requirements, allowing some smaller companies to offer and sell their securities without having to register the securities with the SEC. For more information about these exemptions, read our publications on Rules 504, 505, and 506 of Regulation D.

While companies using a Reg D exemption do not have to register their securities and usually do not have to file reports with the SEC, they must file what’s known as a “Form D” after they first sell their securities. Form D is a brief notice that includes the names and addresses of the company’s executive officers and stock promoters, but contains little other information about the company.

If you are thinking about investing in a Reg D company, you should access EDGAR Company Search to determine whether the company has filed Form D. If the company has filed a Form D, you can request a copy. If the company has not filed a Form D, this should alert you that the company might not be in compliance with the federal securities laws.

You should always check with your state securities regulator to see if they have more information about the company and the people behind it. Be sure to ask whether your state regulator has cleared the offering for sale in your state. You can get the address and telephone number for your state securities regulator by calling the North American Securities Administrators Association at (202) 737-0900 or by visiting its website. You’ll also find this information in the state government section of your local phone book.
For more information about the SEC’s registration requirements and common exemptions, read our brochure, Q&A: Small Business & the SEC.

HFLB note: other articles you may be interested in are:

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