Tag Archives: hedge fund law

Important Hedge Fund Articles

As of the date we published this list of important hedge fund articles, the Hedge Fund Law Blog has over 600 posts.  In order to highlight some of the more important items on this website we have created the following list of articles which we think will be useful for most of our readers.  Articles without links will be forthcoming and we look forward to hearing your feedback on what information you would like to see in the future.  The categories include:

  1. Basics & Structure
  2. Offering Documents
  3. Service Providers
  4. Investment Adviser Regulation
  5. Futures & Commodities Regulation
  6. Marketing & Advertising
  7. Operational Issues

We would also like to remind managers who are thinking of starting a fund to view our Start Up Presentation.

BASICS & STRUCTURE

OFFERING DOCUMENTS

INVESTMENT ADVISER

FUTURES & COMMODITIES

MARKETING & ADVERTISING

OPERATIONAL ISSUES

ERISA

LAWS & REGULATIONS

OTHER ISSUES

FOREX

COLE-FRIEMAN & MALLON LLP QUARTERLY NEWSLETTERS

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Cole-Frieman & Mallon LLP, a hedge fund law firm, sponsors the Hedge Fund Law Blog.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Insider Trading Overview

In light of the recent focus on insider trading, we are publishing the SEC’s discussion on Insider Trading which can also be found here.  The information below contains a broad overview of some of the important aspects which hedge fund managers should understand about the insider trading prohibitions.

For a greater background discussion on the legal precedents which helped shaped the state of law today, please see Insider Trading—A U.S. Perspective, a speech by staff of the SEC.

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Insider Trading

“Insider trading” is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC. For more information about this type of insider trading and the reports insiders must file, please read “Forms 3, 4, 5” in our Fast Answers databank.

Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.

Examples of insider trading cases that have been brought by the SEC are cases against:

  • Corporate officers, directors, and employees who traded the corporation’s securities after learning of significant, confidential corporate developments;
  • Friends, business associates, family members, and other “tippees” of such officers, directors, and employees, who traded the securities after receiving such information;
  • Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
  • Government employees who learned of such information because of their employment by the government; and
  • Other persons who misappropriated, and took advantage of, confidential information from their employers.

Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.

The SEC adopted new Rules 10b5-1 and 10b5-2 to resolve two insider trading issues where the courts have disagreed. Rule 10b5-1 provides that a person trades on the basis of material nonpublic information if a trader is “aware” of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. The rule permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.

Rule 10b5-2 clarifies how the misappropriation theory applies to certain non-business relationships. This rule provides that a person receiving confidential information under circumstances specified in the rule would owe a duty of trust or confidence and thus could be liable under the misappropriation theory.

For more information about insider trading, please read Insider Trading—A U.S. Perspective, a speech by staff of the SEC.

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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 Series 79 exam website.  He can be reached directly at 415-868-5345.

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.

Hedge Fund Manager Charged with Insider Trading

SEC Brings Case Against Raj Rajaratnam

Below is another case of a hedge fund manager who was alledgedly engaged in insider trading. The SEC seems particularly excited about this cased because of the high profile nature of the manager who was involved. The major charge is against Raj Rajaratnam who reportedly has a net worth in excess of $1 billion and who is a member of the Forbes 400 richest persons in the world.

There will undoubtedly be continued press in this case which is not good news for the hedge fund industry. The industry has been subject to criticism and increased calls for regulation for the last year and high profile cases like this one only serve to rile up members of congress. The SEC seems to be particularly proud about this “catch” as the agency has itself been under increasing scrutiny as the details of the fumbled Madoff case have been made public.

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SEC Charges Billionaire Hedge Fund Manager Raj Rajaratnam with Insider Trading

FOR IMMEDIATE RELEASE
2009-221

High-Ranking Corporate Executives Also Charged in Scheme That Generated More Than $25 Million in Illicit Gains

Washington, D.C., Oct. 16, 2009 — The Securities and Exchange Commission today charged billionaire Raj Rajaratnam and his New York-based hedge fund advisory firm Galleon Management LP with engaging in a massive insider trading scheme that generated more than $25 million in illicit gains. The SEC also charged six others involved in the scheme, including senior executives at major companies IBM, Intel and McKinsey & Company.

The SEC’s complaint, filed in federal court in Manhattan, alleges that Rajaratnam tapped into his network of friends and close business associates to obtain insider tips and confidential information about corporate earnings or takeover activity at several companies, including Google, Hilton and Sun Microsystems. He then used the non-public information to illegally trade on behalf of Galleon.

“This complaint describes a web of fraud that has been unraveled,” said SEC Chairman Mary L. Schapiro.

“What we have uncovered in the trading activities of Raj Rajaratnam is that the secret of his success is not genius trading strategies. He is not the astute study of company fundamentals or marketplace trends that he is widely thought to be. Raj Rajaratnam is not a master of the universe, but rather a master of the rolodex,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “He cultivated a network of high-ranking corporate executives and insiders, and then tapped into this ring to obtain confidential details about quarterly earnings and takeover activity.”

In addition to Rajaratnam and Galleon, the SEC’s complaint charges:

  • Danielle Chiesi of New York, N.Y. — a portfolio manager at New Castle Funds.
  • Rajiv Goel of Los Altos, Calif. — a managing director at Intel Capital, an Intel subsidiary.
  • Anil Kumar of Saratoga, Calif. — a director at McKinsey & Company.
  • Mark Kurland of Mount Kisco, N.Y. — a Senior Managing Director and General Partner at New Castle.
  • Robert Moffat of Ridgefield, Conn. — a senior vice president at IBM.
  • New Castle Funds LLC — a New York-based hedge fund

According to the SEC’s complaint, Rajaratnam and Galleon traded on inside information about the following events or transactions:

  • An unnamed source, identified in the SEC’s complaint as Tipper A, obtained inside information about earnings announcements at Polycom and Google, as well as a takeover announcement of Hilton. Tipper A then allegedly provided this information to Rajaratnam, who used it to trade on behalf of Galleon.
  • Goel provided inside information to Rajaratnam about certain Intel quarterly earnings and a pending joint venture concerning Clearwire Corp., in which Intel had invested. Rajaratnam then used this information to trade on behalf of Galleon. As payback for Goel’s tips, Rajaratnam, or someone acting on his behalf, executed trades in Goel’s personal brokerage account based on inside information concerning Hilton and PeopleSupport, which resulted in nearly $250,000 in illicit profits for Goel.
  • Kumar obtained inside information about pending transactions involving AMD and two Abu Dhabi-based sovereign entities, which he shared with Rajaratnam. Rajaratnam then traded on the basis of this information on behalf of Galleon.
  • Chiesi obtained inside information from an executive at Akamai Technologies and traded on the information on behalf of a New Castle fund, netting a profit of approximately $2.4 million. Chiesi also passed on the inside information to Rajaratnam, who then traded on behalf of Galleon.

The SEC also alleges that Moffat provided inside information to Chiesi about Sun Microsystems. Moffat obtained the information when IBM was contemplating acquiring Sun. Chiesi then allegedly traded on the basis of this information on behalf of New Castle, making approximately $1 million in profits.

The SEC’s complaint charges each of the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and, except for Kumar and Moffat, violations of Section 17(a) of the Securities Act of 1933 and. The complaint seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay financial penalties. The complaint also seeks to permanently prohibit Goel, Kumar and Moffat from acting as an officer or director of any registered public company.

The SEC acknowledges the assistance and cooperation of the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation.

The SEC’s investigation is continuing.

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For more information, contact:
David Rosenfeld
Associate Director, SEC’s New York Regional Office
(212) 336-0153

Sanjay Wadhwa
Assistant Director, SEC’s New York Regional Office
(212) 336-0181

http://www.sec.gov/news/press/2009/2009-221.htm

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Other related hedge fund law articles:

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 securities laws, please contact us or call Mr. Mallon directly at 415-868-5345.

Hedge Fund Regulation IT Solutions

Technology Solutions for Registered Hedge Fund Managers

http://www.hedgefundlawblog.com

It is the final quarter of this year’s political season and it has become clear that the earlier clamor for hedge fund registration has been overshadowed by larger political issues – namely health care legislation and the cap and trade bill.  Recent events, however, have shown that the registration issue is not dead and the venture capital industry has been able to potentially secure an exemption from the registration provisions. Even though we don’t know where regulation will take us in the next 6 to 18 months, it is likely that many hedge fund managers will need to institute compliance and IT programs as a result of forthcoming laws and regulations.

The article below, submitted by Meyer Ben-Reuven, CEO of Chelsea Technologies, details some issues which managers will need to be ready to handle once legislation and regulations go into effect.  State registered investment advisors should take note as they may already be required (under state law) to maintain such compliance programs.

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How is President Obama’s New Hedge Fund Regulation Plan affecting you?
By Meyer Ben-Reuven, CEO Chelsea Technologies

The challenging question Hedge Fund Managers should ask themselves is what should they be doing to be compliant with President Obama’s Hedge Fund Regulation Plan?  There are many questions and many tasks to accomplish, but most important is to understand the main points of the plan, what needs to be done and what are the costs associated.  In this paper I present you with a summary of the President’s plan and what a Chief Compliance Officer needs to face in conjunction with the IT department to be compliant with regulations.  Costs are important, but I will keep them away from this paper.

Obama’s New Hedge Fund Regulation Plan

In June 2009, President Obama presented a proposal for new regulations that affect Hedge Funds and fund managers.  The most important part of this new regulation will be to require Hedge Fund, Private Equity, and VC Fund Managers to register with the SEC as investment advisors.

Although it is a proposal, all fund managers will have to start thinking about the re-registration and the process to keep the fund compliant.

The plan’s 5 main goals are:

  1. Promote robust supervision and regulation of financial firms.
  2. Establish comprehensive supervision and regulation of financial markets.
  3. Propose comprehensive regulation of all OTC derivatives.
  4. Protect customers and investors from financial abuse.
  5. Raise international regulatory standards and improve international cooperation.

The idea is to require advisers to report financial information on their fund and its management and thus have the ability to assess whether the fund poses a threat to the stability of the financial system and at the same time strengthen investor protection.

The specific goals regarding hedge funds are as follows:

  • Data collection
  • SEC should conduct regular, periodic examinations of hedge funds
  • Reporting AUM and other fund metrics to the SEC
  • SEC would have ability to assess whether the fund or fund family is so large, highly leveraged, or interconnected that it poses a threat to financial stability

How will IT Departments have to help keep the funds within regulation rules?

As of February 2006, Hedge Fund Advisors were obliged to comply with SEC Rule 203(b)(3)-2 requiring registration under the Investment Advisor Act.   Under these rules, the Hedge Funds were advised to retain all internal and external email and IM business communications.  In June 2006, the Goldstein ruling against the SEC pushed several funds to de-register.  With the failure of the financial system since the end of 2007, the new administration has been poised to regulate the industry more than ever.

What needs to be done?

  1. Take a look at all the ways communications are conducted in the fund
  2. What are the devices used to communicate
  3. Always be on the lookout for new technologies

Afterwards, insure you have control over the different communication methods.  As stated, all electronic communication in and out of the fund has to be retained for future review.  This means that if it cannot be controlled and retained, it must be prohibited.

All internal rules have to be specified in IT policies and procedures, otherwise no one can be held accountable.

The following is how data needs to be archived for SEC purpose audits:

  1. Incoming/Outgoing Data must be kept in its original form
  2. Data has to be easily retrievable and searchable
  3. Data has to have a date and time stamp
  4. Data has to be retained in the main office for first 2 years
  5. Data has to be retained for 5 years
  6. Data has to be put into tamper proof media (meaning non-rewritable and non-erasable)
  7. Data has to be stored in a secondary backup location (preferably away from the same grid)
  8. Be able to produce data promptly (within hours)
  9. Be able to provide data in its original format in either view or print form
  10. Implement annual review of the system

It is highly recommended that data be tested for integrity including testing retrieval and searching, as well as accuracy.  The test should be conducted on a yearly basis, but better if on a more frequent basis.
Although the IT department is in charge of conducting the process, it is ultimately the Chief Compliance Officer who is responsible for this area.  The Chief Compliance Officer needs to dictate the test frequency as well as to advise everyone in the firm about the policies and make sure everyone understands the consequences of failure to comply.

All these internal policies have to be in writing and any violations have to be documented and fixed.  The regular testing and reviews have to be documented and be ready for presentation in case of an audit.

NOTE: TAPE BACKUP IS NOT A SUBSTITUTE FOR MESSAGE ARCHIVING

What are the different communication venues that exist and can be controlled and thus archived?

  1. Email and IM from Exchange
  2. Email and IM from Bloomberg and Reuters
  3. Blackberry archiving of Pin-to-Pin , SMS, Call Detail logs
  4. E-Faxes
  5. Blogs
  6. Chat Rooms
  7. Message Boards
  8. Twitter
  9. Facebook
  10. LinkedIn

Since all of the above require certain technologies and software for archiving and retaining, you have to make an effort to comply with the regulations or otherwise prohibit the usage of such technologies in the work place.

How do you implement compliance?

There are two schools of thought to achieve compliance:

  1. Build an in-house system
  2. Use a third party system

The in-house system is more complex and often requires a larger upfront investment to build and maintain.  Keep in mind you will have to have the following:

  1. Servers, storage, and software
  2. Backup Servers, storage, and software in a location out of the main location grid
  3. Replication system
  4. Maintain both the main and backup location

The responsibility and costs can escalate, but depending on the size of the firm, it might be the most cost efficient.

The third party systems, which have built an infrastructure that is scalable, keep on growing as more clients join their list.  The time to implement is a fraction of building an in-house system.  Depending on the third party provider, there are several ways of getting the data:

  1. Have the data arrive to the email server and from there delivered to the third party provider
  2. Have the data arrive to the third party provider and then to the email server

Both methods of delivery have issues of their own.  The first method requires you to be diligent about monitoring the email flow and ensure data is routed to the archiving provider – the responsibility is shifted completely to you.  The second method, where the provider requires the email to be routed through their system before it arrives to your server, usually poses a different challenge where emails might get delayed at the provider.

If you decide on any of the above systems, you should try to utilize an external anti-spam solution to keep your storage usage to a minimum as well as to make sure that non-account emails do not reach your email server.  These measures will keep all spam from being part of your retention data.

References and information used from the following sources: Global Relay, Zantaz, LiveOffice, NextPage, Hedge Fund Law Blog

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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 ERISA, please contact us or call Mr. Mallon directly at 415-868-5345.  Other related hedge fund law articles include:

Hedge Funds and Insider Trading

Hedge Fund Manager/Trader Settles Charges with SEC

Insider trading cases pop up every now and again and most cases do not warrant highlighting – post-Boesky everyone in the securities industry is well aware that trading on inside information is illegal.  However, it warrants emphasis that the SEC will crack down on hedge fund managers or traders involved with insider trading and the penalties are harsh.  The individuals (including a hedge fund manager) involved in the action described in the SEC litigation release reprinted below were subject to fines and disgorgement, of course, but were also barred from the securities industry.  The severity of such a penalty underscores the importance of understanding and abiding by the insider trading rules.

As noted below, trading on insider information is illegal under both civil (Section 17(a) of the 1933 act, Section 10(b) of the 1934 act, and Rule 10b-5 thereunder) and criminal laws (generally securities fraud, but depending on the facts charges may also include wire fraud and commercial bribery).

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U.S. Securities and Exchange Commission
Litigation Release No. 21244
October 8, 2009

SEC v. Mitchel S. Guttenberg, Erik R. Franklin, David M. Tavdy, Mark E. Lenowitz, Robert D. Babcock, Andrew A. Srebnik, Ken Okada, David A. Glass, Marc R. Jurman, Randi E. Collotta, Christopher K. Collotta, Q Capital Investment Partners, LP, DSJ International Resources Ltd. (d/b/a Chelsey Capital), and Jasper Capital LLC, C.A. No. 07 CV 1774 (S.D.N.Y) (PKC)

Three Defendants in Wall Street Insider Trading Ring Settle SEC Charges

The Securities and Exchange Commission announced today that on September 29, 2009, the Honorable P. Kevin Castel, United States District Judge for the Southern District of New York, entered final judgments against defendants Erik R. Franklin, Q Capital Investment Partners, LP (“Q Capital”), and David M. Tavdy, in SEC v. Guttenberg, et al., C.A. No. 07 CV 1774 (S.D.N.Y.), an insider trading case the Commission filed on March 1, 2007. The Commission’s complaint alleged illegal insider trading in connection with two related schemes in which Wall Street professionals serially traded on material, nonpublic information tipped by insiders at UBS Securities LLC (“UBS”) and Morgan Stanley & Co., Inc. (“Morgan Stanley”), in exchange for cash kickbacks.

The Commission’s complaint alleged that from 2001 through 2006, Mitchel S. Guttenberg, an executive director in the equity research department of UBS, illegally tipped material, nonpublic information concerning upcoming UBS analyst upgrades and downgrades to two Wall Street traders, Franklin and Tavdy, in exchange for sharing in the illicit profits from their trading on that information. The complaint also alleged that Franklin was a downstream tippee in another scheme in which, in 2005 and 2006, Randi Collotta, an attorney who worked in the global compliance department of Morgan Stanley, illegally tipped material, nonpublic information concerning upcoming corporate acquisitions involving Morgan Stanley’s investment banking clients.

The complaint alleged that Franklin illegally traded on the inside information for two hedge funds he managed, Lyford Cay Capital, LP and Q Capital, and in his personal accounts. Tavdy illegally traded on the inside information (i) for Andover Brokerage, LLC and Assent LLC, registered broker-dealers where Tavdy was a proprietary trader, (ii) in his own personal account, (iii) in the accounts of a relative and friend, and (iv) in the accounts of Jasper Capital LLC, a day-trading firm with which Tavdy was associated. Franklin and Tavdy also had downstream tippees who traded on the inside information. Without admitting or denying the allegations in the complaint, Franklin, Q Capital, and Tavdy settled the Commission’s insider trading charges.

Franklin and Q Capital consented to the entry of a final judgment which (i) permanently enjoins them from violating Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), Rule 10b-5 thereunder, and Section 17(a) of the Securities Act of 1933 (“Securities Act”); and (ii) orders, on a joint and several liability basis, disgorgement of $5,400,000, with all but $290,000 waived based on a demonstrated inability to pay. In a related administrative proceeding, Franklin consented to the entry of a Commission order barring him from future association with any broker, dealer, or investment adviser. In a parallel criminal case, Franklin previously pled guilty to charges of securities fraud and conspiracy to commit securities fraud and is awaiting sentencing. U.S. v. Erik Franklin, No. 1:07-CR-164 (S.D.N.Y.).

Tavdy consented to the entry of a final judgment which (i) permanently enjoins him from violating Section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and Section 17(a) of the Securities Act; and (ii) orders him to pay disgorgement of $10,300,000. In a related administrative proceeding, Tavdy consented to the entry of a Commission order barring him from future association with any broker or dealer. In a parallel criminal case, Tavdy previously pled guilty to charges of securities fraud and conspiracy to commit securities fraud, and was sentenced to 63 months in prison. U.S. v. Mitchel Guttenberg and David Tavdy, No. 1:07-CR-141 (S.D.N.Y.).

The Commission also announced that Samuel W. Childs, Jr., a former general securities principal at Assent LLC, consented to a Commission order barring him from future association with any broker or dealer, based on his criminal conviction for conspiracy to commit securities fraud, wire fraud and commercial bribery. U.S. v. Samuel W. Childs, Jr. and Laurence McKeever, No. 1:07-CR-142 (S.D.N.Y.). In that case, the criminal indictment alleged that Childs accepted bribes from traders at Assent LLC in exchange for not reporting their illegal trading to Assent management.

The Commission acknowledges the assistance and cooperation of the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation.

For further information, see Litigation Release Nos. 20022 (March 1, 2007), 20367 (November 20, 2007), 20725 (September 18, 2008), and 21086 (June 16, 2009).

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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 securities laws, please contact us or call Mr. Mallon directly at 415-868-5345.  Other related hedge fund law articles include:

Obama on Financial Reform

President Discusses Future Financial Regulations in Advance of G20

Earlier today President Obama gave a speech in New York discussing the administration’s future plan for greater regulation of the financial markets in the wake of the financial crisis of 2008/2009.  Speaking strongly the President said:

So I want everybody here to hear my words:  We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.

And we intend to pass regulatory reform through Congress.

Of course no political speech about the financial crisis will fail to take a swipe at the hedge fund industry.  Obama took this opportunity to say that hedge funds “can operate outside of the regulatory system altogether.” Oft-repeated statements like these not only grossly mischaracterize the current regulatory system, but also unjustly serve to cast hedge funds as a progenitors of the financial crisis. [HFLB Note to President Obama – if you give me a call I am happy to give you a brief overview of how hedge funds are currently regulated under the securities laws.]

While there is really nothing new in this speech, it does drive home that increased financial regulation is likely coming soon.  I have reprinted the entire speech below and it can also be found here.

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THE WHITE HOUSE

Office of the Press Secretary

For Immediate Release
September 14, 2009

REMARKS BY THE PRESIDENT
ON FINANCIAL RESCUE AND REFORM

Federal Hall
New York, New York

11:59 A.M. EDT

THE PRESIDENT:  Thank you very much.  It is wonderful to be back in New York after having just been here last week.  It is a beautiful day and we have some extraordinary guests here in the Hall today.  I just want to mention a few.

First of all from my economic team, somebody who I think has done extraordinary work on behalf of all Americans and has helped to strengthen our financial system immeasurably, Secretary Tim Geithner — please give him a big round of applause.  (Applause.)  Somebody who is continually guiding me and keeping me straight on the numbers, the chair of the Council of Economic Advisers, Christina Romer is here.  (Applause.)  We have an extraordinary economic recovery board and as chairman somebody who knows more about the financial markets and the economy generally than just about anybody in this country, Paul Volcker.  Thank you, Paul.  (Applause.)  The outstanding mayor of the city of New York, Mr. Michael Bloomberg.  (Applause.)  We have Assembly Speaker Sheldon Silver is here, as well; thank you.  (Applause.)

We have a host of members of Congress, but there’s one that I have to single out because he is going to be helping to shape the agenda going forward to make sure that we have one of the strongest, most dynamic, and most innovative financial markets in the world for many years to come, and that’s my good friend, Barney Frank.  (Applause.)  I also want to thank our hosts from the National Park Service here at Federal Hall and all the other outstanding public officials who are here.

Thanks for being here.  Thank you for your warm welcome.  It’s a privilege to be in historic Federal Hall.  It was here more than two centuries ago that our first Congress served and our first President was inaugurated.  And I just had a chance to glance at the Bible upon which George Washington took his oath.  It was here, in the early days of the Republic, that Hamilton and Jefferson debated how best to administer a young economy and ensure that our nation rewarded the talents and drive of its people.  And two centuries later, we still grapple with these questions — questions made more acute in moments of crisis.

It was one year ago today that we experienced just such a crisis.  As investors and pension-holders watched with dread and dismay, and after a series of emergency meetings often conducted in the dead of the night, several of the world’s largest and oldest financial institutions had fallen, either bankrupt, bought, or bailed out:  Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, Wachovia.  A week before this began, Fannie Mae and Freddie Mac had been taken over by the government.  Other large firms teetered on the brink of insolvency.  Credit markets froze as banks refused to lend not only to families and businesses, but to one another.  Five trillion dollars of Americans’ household wealth evaporated in the span of just three months.  That was just one year ago.

Congress and the previous administration took difficult but necessary action in the days and months that followed.  Nonetheless, when this administration walked through the door in January, the situation remained urgent.  The markets had fallen sharply; credit was not flowing.  It was feared that the largest banks — those that remained standing — had too little capital and far too much exposure to risky loans.  And the consequences had spread far beyond the streets of lower Manhattan.  This was no longer just a financial crisis; it had become a full-blown economic crisis, with home prices sinking and businesses struggling to access affordable credit, and the economy shedding an average of 700,000 jobs every single month.

We could not separate what was happening in the corridors of our financial institutions from what was happening on the factory floors and around the kitchen tables.  Home foreclosures linked those who took out home loans and those who repackaged those loans as securities.  A lack of access to affordable credit threatened the health of large firms and small businesses, as well as all those whose jobs depended on them.  And a weakened financial system weakened the broader economy, which in turn further weakened the financial system.

So the only way to address successfully any of these challenges was to address them together.  And this administration, under the outstanding leadership of Tim Geithner and Christy Romer and Larry Summers and others, moved quickly on all fronts, initializing a financial — a financial stability plan to rescue the system from the crisis and restart lending for all those affected by the crisis.  By opening and examining the books of large financial firms, we helped restore the availability of two things that had been in short supply:  capital and confidence.  By taking aggressive and innovative steps in credit markets, we spurred lending not just to banks, but to folks looking to buy homes or cars, take out student loans, or finance small businesses.  Our home ownership plan has helped responsible homeowners refinance to stem the tide of lost homes and lost home values.

And the recovery plan is providing help to the unemployed and tax relief for working families, all the while spurring consumer spending.  It’s prevented layoffs of tens of thousands of teachers and police officers and other essential public servants.  And thousands of recovery projects are underway all across America, including right here in New York City, putting people to work building wind turbines and solar panels, renovating schools and hospitals, repairing our nation’s roads and bridges.

Eight months later, the work of recovery continues.  And though I will never be satisfied while people are out of work and our financial system is weakened, we can be confident that the storms of the past two years are beginning to break.  In fact, while there continues to be a need for government involvement to stabilize the financial system, that necessity is waning.  After months in which public dollars were flowing into our financial system, we’re finally beginning to see money flowing back to taxpayers.  This doesn’t mean taxpayers will escape the worst financial crisis in decades entirely unscathed.  But banks have repaid more than $70 billion, and in those cases where the government’s stakes have been sold completely, taxpayers have actually earned a 17 percent return on their investment.  Just a few months ago, many experts from across the ideological spectrum feared that ensuring financial stability would require even more tax dollars.  Instead, we’ve been able to eliminate a $250 billion reserve included in our budget because that fear has not been realized.

While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we’re beginning to return to normalcy.  But here’s what I want to emphasize today:  Normalcy cannot lead to complacency.

Unfortunately, there are some in the financial industry who are misreading this moment.  Instead of learning the lessons of Lehman and the crisis from which we’re still recovering, they’re choosing to ignore those lessons.  I’m convinced they do so not just at their own peril, but at our nation’s.  So I want everybody here to hear my words:  We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.  Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

And that’s why we need strong rules of the road to guard against the kind of systemic risks that we’ve seen.  And we have a responsibility to write and enforce these rules to protect consumers of financial products, to protect taxpayers, and to protect our economy as a whole.  Yes, there must — these rules must be developed in a way that doesn’t stifle innovation and enterprise.  And I want to say very clearly here today, we want to work with the financial industry to achieve that end.  But the old ways that led to this crisis cannot stand.  And to the extent that some have so readily returned to them underscores the need for change and change now.  History cannot be allowed to repeat itself.

So what we’re calling for is for the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenges of this new century.  That is what my administration seeks to do.  We’ve sought ideas and input from industry leaders and policy experts, academics, consumer advocates, and the broader public.  And we’ve worked closely with leaders in the Senate and the House, including not only Barney, but also Senators Chris Dodd and Richard Shelby, and Barney is already working with his counterpart, Sheldon [sic] Bachus.  And we intend to pass regulatory reform through Congress.

And taken together, we’re proposing the most ambitious overhaul of the financial regulatory system since the Great Depression.  But I want to emphasize that these reforms are rooted in a simple principle:  We ought to set clear rules of the road that promote transparency and accountability.  That’s how we’ll make certain that markets foster responsibility, not recklessness.  That’s how we’ll make certain that markets reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system.

So let me outline specifically what we’re talking about.  First, we’re proposing new rules to protect consumers and a new Consumer Financial Protection Agency to enforce those rules.  (Applause.)  This crisis was not just the result of decisions made by the mightiest of financial firms.  It was also the result of decisions made by ordinary Americans to open credit cards and take on mortgages.  And while there were many who took out loans they knew they couldn’t afford, there were also millions of Americans who signed contracts they didn’t fully understand offered by lenders who didn’t always tell the truth.

This is in part because there is no single agency charged with making sure that doesn’t happen.  That’s what we intend to change.  The Consumer Financial Protection Agency will have the power to make certain that consumers get information that is clear and concise, and to prevent the worst kinds of abuses.  Consumers shouldn’t have to worry about loan contracts designed to be unintelligible, hidden fees attached to their mortgage, and financial penalties — whether through a credit card or a debit card — that appear without warning on their statements.  And responsible lenders, including community banks, doing the right thing shouldn’t have to worry about ruinous competition from unregulated competitors.

Now there are those who are suggesting that somehow this will restrict the choices available to consumers.  Nothing could be further from the truth.  The lack of clear rules in the past meant we had the wrong kind of innovation:  The firm that could make its products look the best by doing the best job of hiding the real costs ended up getting the business.  For example, we had “teaser” rates on credit cards and mortgages that lured people in and then surprised them with big rate increases.  By setting ground rules, we’ll increase the kind of competition that actually provides people better and greater choices, as companies compete to offer the best products, not the ones that are most complex or the most confusing.

Second, we’ve got to close the loopholes that were at the heart of the crisis.  Where there were gaps in the rules, regulators lacked the authority to take action.  Where there were overlaps, regulators often lacked accountability for inaction.  These weaknesses in oversight engendered systematic, and systemic, abuse.

Under existing rules, some companies can actually shop for the regulator of their choice — and others, like hedge funds, can operate outside of the regulatory system altogether.  We’ve seen the development of financial instruments — like derivatives and credit default swaps — without anyone examining the risks, or regulating all of the players.  And we’ve seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to somebody else.  Those who refused to game the system are at a disadvantage.

Now, one of the main reasons this crisis could take place is that many agencies and regulators were responsible for oversight of individual financial firms and their subsidiaries, but no one was responsible for protecting the system as the whole — as a whole.  In other words, regulators were charged with seeing the trees, but not the forest.  And even then, some firms that posed a “systemic risk” were not regulated as strongly as others, exploiting loopholes in the system to take on greater risk with less scrutiny.  As a result, the failure of one firm threatened the viability of many others.  We were facing one of the largest financial crises in history, and those responsible for oversight were caught off guard and without the authority to act.

And that’s why we’ll create clear accountability and responsibility for regulating large financial firms that pose a systemic risk.  While holding the Federal Reserve fully accountable for regulation of the largest, most interconnected firms, we’ll create an oversight council to bring together regulators from across markets to share information, to identify gaps in regulation, and to tackle issues that don’t fit neatly into an organizational chart.  We’ll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior.  That’s one of the lessons of the past year.  The only way to avoid a crisis of this magnitude is to ensure that large firms can’t take risks that threaten our entire financial system, and to make sure that they have the resources to weather even the worst of economic storms.

Even as we’ve proposed safeguards to make the failure of large and interconnected firms less likely, we’ve also created — proposed creating what’s called “resolution authority” in the event that such a failure happens and poses a threat to the stability of the financial system.  This is intended to put an end to the idea that some firms are “too big to fail.”  For a market to function, those who invest and lend in that market must believe that their money is actually at risk.  And the system as a whole isn’t safe until it is safe from the failure of any individual institution.

If a bank approaches insolvency, we have a process through the FDIC that protects depositors and maintains confidence in the banking system.  This process was created during the Great Depression when the failure of one bank led to runs on other banks, which in turn threatened the banking system as a whole.  That system works.  But we don’t have any kind of process in place to contain the failure of a Lehman Brothers or AIG or any of the largest and most interconnected financial firms in our country.

And that’s why, when this crisis began, crucial decisions about what would happen to some of the world’s biggest companies — companies employing tens of thousands of people and holding trillions of dollars of assets — took place in hurried discussions in the middle of the night.  That’s why we’ve had to rely on taxpayer dollars.  The only resolution authority we currently have that would prevent a financial meltdown involved tapping the Federal Reserve or the federal treasury.  With so much at stake, we should not be forced to choose between allowing a company to fail into a rapid and chaotic dissolution that threatens the economy and innocent people, or, alternatively, forcing taxpayers to foot the bill.  So our plan would put the cost of a firm’s failures on those who own its stock and loaned it money.  And if taxpayers ever have to step in again to prevent a second Great Depression, the financial industry will have to pay the taxpayer back — every cent.

Finally, we need to close the gaps that exist not just within this country but among countries.  The United States is leading a coordinated response to promote recovery and to restore prosperity among both the world’s largest economies and the world’s fastest growing economies.  At a summit in London in April, leaders agreed to work together in an unprecedented way to spur global demand but also to address the underlying problems that caused such a deep and lasting global recession.  And this work will continue next week in Pittsburgh when I convene the G20, which has proven to be an effective forum for coordinating policies among key developed and emerging economies and one that I see taking on an important role in the future.

Essential to this effort is reforming what’s broken in the global financial system — a system that links economies and spreads both rewards and risks.  For we know that abuses in financial markets anywhere can have an impact everywhere; and just as gaps in domestic regulation lead to a race to the bottom, so do gaps in regulation around the world.  What we need instead is a global race to the top, including stronger capital standards, as I’ve called for today.  As the United States is aggressively reforming our regulatory system, we’re going to be working to ensure that the rest of the world does the same.  And this is something that Secretary Geithner has already been actively meeting with finance ministers around the world to discuss.

A healthy economy in the 21st century also depends on our ability to buy and sell goods in markets across the globe.  And make no mistake, this administration is committed to pursuing expanded trade and new trade agreements.  It is absolutely essential to our economic future.  And each time that we have met — at the G20 and the G8 — we have reaffirmed the need to fight against protectionism.  But no trading system will work if we fail to enforce our trade agreements, those that have already been signed.  So when — as happened this weekend — we invoke provisions of existing agreements, we do so not to be provocative or to promote self-defeating protectionism, we do so because enforcing trade agreements is part and parcel of maintaining an open and free trading system.

And just as we have to live up to our responsibilities on trade, we have to live up to our responsibilities on financial reform as well.  I have urged leaders in Congress to pass regulatory reform this year and both Congressman Frank and Senator Dodd, who are leading this effort, have made it clear that that’s what they intend to do.  Now there will be those who defend the status quo — there always are.  There will be those who argue we should do less or nothing at all.  There will be those who engage in revisionist history or have selective memories, and don’t seem to recall what we just went through last year.  But to them I’d say only this:  Do you really believe that the absence of sound regulation one year ago was good for the financial system?  Do you believe the resulting decline in markets and wealth and unemployment, the wrenching hardship that families are going through all across the country, was somehow good for our economy?  Was that good for the American people?

I have always been a strong believer in the power of the free market.  I believe that jobs are best created not by government, but by businesses and entrepreneurs willing to take a risk on a good idea.  I believe that the role of the government is not to disparage wealth, but to expand its reach; not to stifle markets, but to provide the ground rules and level playing field that helps to make those markets more vibrant — and that will allow us to better tap the creative and innovative potential of our people.  For we know that it is the dynamism of our people that has been the source of America’s progress and prosperity.

So I promise you, I did not run for President to bail out banks or intervene in capital markets.  But it is important to note that the very absence of common-sense regulations able to keep up with a fast-paced financial sector is what created the need for that extraordinary intervention — not just with our administration, but the previous administration.  The lack of sensible rules of the road, so often opposed by those who claim to speak for the free market, ironically led to a rescue far more intrusive than anything any of us — Democratic or Republican, progressive or conservative — would have ever proposed or predicted.

At the same time, we have to recognize that what’s needed now goes beyond just the reforms that I’ve mentioned.  For what took place one year ago was not merely a failure of regulation or legislation; it wasn’t just a failure of oversight or foresight.  It was also a failure of responsibility — it was fundamentally a failure of responsibility — that allowed Washington to become a place where problems — including structural problems in our financial system — were ignored rather than solved.  It was a failure of responsibility that led homebuyers and derivative traders alike to take reckless risks that they couldn’t afford to take. It was a collective failure of responsibility in Washington, on Wall Street, and across America that led to the near-collapse of our financial system one year ago.

So restoring a willingness to take responsibility — even when it’s hard to do — is at the heart of what we must do.  Here on Wall Street, you have a responsibility.  The reforms I’ve laid out will pass and these changes will become law.  But one of the most important ways to rebuild the system stronger than it was before is to rebuild trust stronger than before — and you don’t have to wait for a new law to do that.  You don’t have to wait to use plain language in your dealings with consumers.  You don’t have to wait for legislation to put the 2009 bonuses of your senior executives up for a shareholder vote.  You don’t have to wait for a law to overhaul your pay system so that folks are rewarded for long-term performance instead of short-term gains.

The fact is, many of the firms that are now returning to prosperity owe a debt to the American people.  They were not the cause of this crisis, and yet American taxpayers, through their government, had to take extraordinary action to stabilize the financial industry.  They shouldered the burden of the bailout and they are still bearing the burden of the fallout — in lost jobs and lost homes and lost opportunities.  It is neither right nor responsible after you’ve recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system, and a more broadly shared prosperity.

So I want to urge you to demonstrate that you take this obligation to heart.  To put greater effort into helping families who need their mortgages modified under my administration’s homeownership plan.  To help small business owners who desperately need loans and who are bearing the brunt of the decline in available credit.  To help communities that would benefit from the financing you could provide, or the community development institutions you could support.  To come up with creative approaches to improve financial education and to bring banking to those who live and work entirely outside of the banking system.  And, of course, to embrace serious financial reform, not resist it.

Just as we are asking the private sector to think about the long term, I recognize that Washington has to do so as well.  When my administration came through the door, we not only faced a financial crisis and costly recession, we also found waiting a trillion dollar deficit.  So yes, we have to take extraordinary action in the wake of an extraordinary economic crisis.  But I am absolutely committed to putting this nation on a sound and secure fiscal footing.  That’s why we’re pushing to restore pay-as-you-go rules in Congress, because I will not go along with the old Washington ways which said it was okay to pass spending bills and tax cuts without a plan to pay for it.  That’s why we’re cutting programs that don’t work or are out of date.  That’s why I’ve insisted that health insurance reform — as important as it is — not add a dime to the deficit, now or in the future.

There are those who would suggest that we must choose between markets unfettered by even the most modest of regulations, and markets weighed down by onerous regulations that suppress the spirit of enterprise and innovation.  If there is one lesson we can learn from last year, it is that this is a false choice.  Common-sense rules of the road don’t hinder the market, they make the market stronger.  Indeed, they are essential to ensuring that our markets function fairly and freely.

One year ago, we saw in stark relief how markets can spin out of control; how a lack of common-sense rules can lead to excess and abuse; how close we can come to the brink.  One year later, it is incumbent upon us to put in place those reforms that will prevent this kind of crisis from ever happening again, reflecting painful but important lessons that we’ve learned, and that will help us move from a period of reckless irresponsibility, a period of crisis, to one of responsibility and prosperity.  That’s what we must do.  And I’m confident that’s what we will do.

Thank you very much, everybody.  (Applause.)

END
12:29 P.M. EDT

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Other hedge fund law articles related to President Obama and increased hedge fund regulation:

Outstanding Congressional Bills increasing financial regulation:

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.

Investment Advisory Fees | Hedge Fund Performance Fees and Management Fees

Review of State Investment Advisory Fee Rules

One of the things I have tried to emphasize within this blog is that there is no “one size fits all” legal solution to hedge fund formation.  Each client/manager has a unique set of circumstances and will be subject to a potentially different sets of laws or regulations depending on those circumstances.  This is especially true with regard to those managers who must register in a state that requires hedge fund manager registration.  Because no two sets of state laws and regulations are the same, the manager must make sure that he understands the rules which are specific to his state.

High Asset Management Fees and Disclosure

One issue which comes up every now and again is whether or not disclosure will be required when the manager charges an annual asset management fee in excess of 3% of AUM.  Generally regulators will require that certain disclosures be made to investors through the manager’s disclosure documents (generally in both the Form ADV and the hedge fund offering documents).  Sometimes the regulator will require such disclosures based on a general provision (see CO IA fee rule discussion below) or on more explicit provisions (see 116.13(a) of the Texas Administrative Code).  In either case managers will generally be required to make a prominent disclosure to investors that a 3% (or higher) annual asset management fee is in excess of industry norms and that similar advisory services may be obtained for less (whether or not this is true).  While such a disclosure would, in most instances, be a best practice, managers should be aware that it may also be required if they are registered with a particular state.

State Performance Fee Rules

Like management fee disclosures, the rules for performance fees may differ based on the state of registration.  For example, here are how four different states deal with performance fee issue:

Texas – Like most states, Texas allows state-registered investment advisers to charge performance fees only to those investors in a fund which are “qualified clients” as defined in Rule 205-3 of the Investment Advisers Act. This means that a hedge fund manager can only charge performance fees to investors in the fund which have a $1.5 million net worth or who have $750,000 of AUM with the manager (can be in the fund and through other accounts).  See generally  116.13(b) of the Texas Administrative Code reprinted below.

New Jersey – Many states adopted laws and regulations based on the 1956 version of the Uniform Securities Act and have yet to make the most recent update to their laws and regulations (generally those found in the 2002 version of the Uniform Securities Act).  Under the New Jersey laws a manager can charge performance fees to those clients with a $1 million net worth.

Indiana – similar to New Jersey, Indiana has laws which allow a manager to charge performance fees to those investors with a $1 million  net worth.  Additionally, Indiana allows a manager to charge performance fees or to those investors who have $500,000 of AUM with the manager (can be in the hedge fund and through other separately managed accounts).  Indiana also has an interesting provision which specifies the manner in which the performance fee may be calculated – it requires that the fee be charged on a period of no less than one year.  This rule is based on an earlier version of SEC Rule 205-3.  What this means, essentially, is that managers who are registered in Indiana cannot charge quarterly performance fees, but must charge their performance fees only on an annual basis (or longer).

Michigan – Unlike any other state, Michigan actually forbids all performance fees for Michigan-registered investment advisors.  The present statute is probably an unintended consequence of some sloppy drafting.  Nonetheless, it is a regulation on the books.  Hedge Fund Managers registered with Michigan, however, should see the bright spot – Michigan is in the process of updating its securities laws and regulations.  This means that sometime in late 2009 or early 2010 it should be legal for investment advisors in Michigan to charge their clients a performance fee under certain circumstances (likely to mirror the SEC rules).

New York – Sometimes, states will have some wacky rules.  In the case of New York, there are no rules regarding performance fees.

Other Issues

With regard to performance fees, the other issue which should be discussed with your hedge fund lawyer is whether or not the state “looks through” to the underlying investor to determine “qualified client” status.  Generally most states will follow the SEC rule on this issue and look through the fund to the underlying investors to make this determination.

While these cases are just a couple of examples of the disparate treatment of similarly situated managers, they serve as a reminder that investment advisor (and securities) laws may differ wildly from jurisdiction to jurisdiction.  Managers should be aware of the possibility of completely different laws and should be ready to discuss the issue with legal counsel.

The various rules discussed above have been reprinted below.

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Texas Rule

The full text of the Texas IA fee rules can be found here and are copied below.

§116.13.Advisory Fee Requirements.

(a) Any registered investment adviser who wishes to charge 3.0% or greater of the assets under management must disclose that such fee is in excess of the industry norm and that similar advisory services can be obtained for less.

(b) Any registered investment adviser who wishes to charge a fee based on a share of the capital gains or the capital appreciation of the funds or any portion of the funds of a client must comply with SEC Rule 205-3 (17 Code of Federal Regulations §275.205-3), which prohibits the use of such fee unless the client is a “qualified client.” In general, a qualified client may include:

(1) a natural person or company who at the time of entering into such agreement has at least $750,000 under the management of the investment adviser;

(2) a natural person or company who the adviser reasonably believes at the time of entering into the contract:  (A) has a net worth of jointly with his or her spouse of more than $1,500,000; or (B) is a qualified purchaser as defined in the Investment Company Act of 1940, §2(a)(51)(A) (15 U.S.C. 80a-2(51)(A)); or

(3) a natural person who at the time of entering into the contract is: (A) An executive officer, director, trustee, general partner, or person serving in similar capacity of the investment adviser; or (B) An employee of the investment adviser (other than an employee performing solely clerical, secretarial, or administrative functions with regard to the investment adviser), who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser, provided that such employee has been performing such functions and duties for or on behalf of the investment adviser, or substantially similar function or duties for or on behalf of another company for at least 12 months.

CO Rule

The full text of the Colorado laws and regulations can be found here.  The fee discussion is reprinted below.

51-4.8(IA) Dishonest and Unethical Conduct

Introduction

A person who is an investment adviser or an investment adviser representative is a fiduciary and has a duty to act primarily for the benefit of its clients. While the extent and nature of this duty varies according to the nature of the relationship between an investment adviser and its clients and the circumstances of each case, an investment adviser or investment adviser representative shall not engage in dishonest or unethical conduct including the following:

J. Charging a client an advisory fee that is unreasonable in light of the type of services to be provided, the experience of the adviser, the sophistication and bargaining power of the client, and whether the adviser has disclosed that lower fees for comparable services may be available from other sources.

New Jersey

The full text of the New Jersey performance fee rules can be found here and are copied below.

13:47A-2.10 Performance fee compensation

(b) The client entering into the contract subject to this regulation must be a natural person or a company as defined in Rule 205-3, who the registered investment advisor (and any person acting on the investment advisor’s behalf) entering into the contract reasonably believes, immediately prior to entering into the contract, is a natural person or a company as defined in Rule 205-3, whose net worth at the time the contract is entered into exceeds $1,000,000. The net worth of a natural person shall be as defined by Rule 205-3 of the Investment Advisors Act of 1940.

http://www.njconsumeraffairs.gov/bos/bosregs.htm

Indiana

The Indiana rule can be found here and is reprinted below.

(f) The client entering into the contract must be either of the following:

(1) A natural person or a company who immediately after entering into the contract has at least five hundred thousand dollars ($500,000) under the management of the investment adviser.

(2) A person who the investment adviser and its investment adviser representatives reasonably believe, immediately before entering into the contract, is a natural person or a company whose net worth, at the time the contract is entered into, exceeds one million dollars ($1,000,000). The net worth of a natural person may include assets held jointly with that person’s spouse.

Michigan

The current law (until October 1, 2009) can be found here and is copied below.

451.502 Investment adviser; unlawful practices.

(b) It is unlawful for any investment adviser to enter into, extend, or renew any investment advisory contract unless it provides in writing all of the following:

(1) That the investment adviser shall not be compensated on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client.

New York

No laws regarding performance fees for state registered investment advisers.

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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, Cole-Frieman & Mallon LLP, is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

Hedge Funds and TV Tokyo

One of the interesting aspects about having a hedge fund blog is that it provides me with the opportunity to connect with many people in the hedge fund industry whom I would normally not have a chance to meet.  I also have the opportunity to talk with various media publications regarding hedge funds.  The two inquiries below come from TV Tokyo who is spotlighting the Lehman crises and doing a report on how hedge funds are currently fairing.  I have received two inquiries now, so if you are interested in talking with them, I am happy to pass along the appropriate contact information.

Any other media organizations who wish to discuss hedge funds or the legal and regulatory aspects of hedge funds are welcome to contact me directly to discuss.

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Hi, I’m from TV Tokyo, Japanese TV production. I’m working on the story about what is going on hedge fund industory after Lehman crises. For our segment,  I’m looking for the indivisual investor who put their money into hedge fund due to due to improved transparency and liquidity terms.and I would like to ask the investor to have our taped interview in next week. If you know someone, please let me know. Thank you so much for taking your time to read this message.

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Dear Bart,

I am a producer at TV Tokyo, a Japanese television network. I am producing a documentary about recovery in financial institutions and markets.  Over the past year or two, markets plunged and many financial institutions, including hedge funds, were bankrupted or merged out of existence.  In a relatively brief time, however, certain markets and financial institutions demonstrated surprising resilience and a return to profitability. This recovery is in marked contrast to the decade long process of recovery in Japan.

In the documentary, I will focus on how financial institutions, markets and exchanges have managed to again make profits in such short period. Among markets, I will focus on the commodity market, which has benefitted from economic expansion in emerging markets and concerns about inflation elsewhere.  As part of that examination, I would also like to feature the IntercontinentalExchange (ICE). Much of the volume in recent commodities trading has occurred on ICE, however, many of our viewers are unfamiliar with it.

I am seeking individuals to interview for the documentary who can speak authoritatively about the above topics.  If you can address these topics on camera, please contact me.

My deadline for filming is the end of August/beginning of September.
I look forward to your reply.

Sincerely,

[Producer]

About TV Tokyo:
TV Tokyo is one of Japan’s six television networks and is a subsidiary of Nihon Keizai Shimbun (Nikkei), Japan’s premier financial journal. We produce Japan’s only daily business and economic news programs, World Business Satellite and News Morning Satellite. Their combined audience averages 5-6 million viewers daily, including Japanese business leaders and influential politicians. A recent study showed our audience to be the most affluent and highly educated in Japan. Past guests include: Prime Minister Yasuo Fukuda; Former Harvard University president Lawrence Summers; professors Joseph Stiglitz (Nobel laureate), Jeffrey Sachs, and Alan Blinder; CEOs Michael Eisner, Steve Forbes, Bill Gates, Steve Ballmer, Jack Welch, Jeffrey Immelt, Larry Ellison, Scott McNealy; investor Jim Rogers, George Soros, Warren Buffett and numerous Japanese business and political leaders.

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Other related hedge fund law articles:

Hedge Funds and Rehypothication

Ongoing Legal Issues For Hedge Fund Managers

While many of the posts on this blog deal with start-up and regulatory issues that hedge fund managers face, we also are aware that there are many ongoing legal issues which affect the business of the fund.  Below is a guest post from Karl Cole-Frieman on hedge fund rehypothication and the prime brokerage relationship.

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What is Rehypothication?
By Karl Cole-Frieman, www.colefrieman.com

One of the most frequent questions that I am asked these days is to explain the term “rehypothication” in the context of a prime brokerage agreement.  The concept of rehypothication has been imbedded in the credit arrangements of prime brokerage agreements for years, but until 2008 and the collapse of Bear Sterns and Lehman Brothers, it was rarely discussed (except by certain lawyers who negotiate these agreements).  In the simplest terms, hypothication is the posting of securities or other collateral to a prime broker in exchange for credit or margin.  Rehypothication is the further pledging or lending by the prime broker of the already hypothecated securities or other collateral by the customer for its own purposes.

Prime Brokerage and Rehypothication

In modern prime brokerage, rehypothication is deeply ingrained in the business model of the major prime brokers.  Typically, hedge fund customer assets are rehypothicated to other banks to raise cash for the prime brokers.  Allowing the prime brokers to rehypothicate assets has historically kept down the cost of borrowing money for hedge fund managers.  In recent years, hedge funds have benefited from this arrangement by obtaining very cheap margin pricing.

Bankruptcy of a Prime Broker

The problem for hedge fund managers is that if there is a bankruptcy filing of their prime broker, hedge funds may have difficulty getting their rehypothicated assets back, particularly if these assets are held by the prime broker’s London affiliate, as the UK has more relaxed rules regarding rehypothication.  A number of highly successful managers had to literally shut their doors in September 2008 because their assets were tied up in Lehman Brothers’ London affiliate.  Lehman filed for bankruptcy in September 2008, and Pricewaterhouse Coopers, Lehman’s European administrator, currently estimates that assets may be returned to clients in the first quarter of 2010 – a year and a half later.

Hedge Fund Managers and Rehypothication

It is important for hedge fund managers to understand this concept of rehypothication for several reasons.  First, managers need to take ownership of their prime brokerage arrangements and understand them in general.  It has been my experience that many managers that take extreme care in making portfolio decisions pay absolutely no attention to their prime brokerage or custody arrangements.  As the events of 2008 demonstrated, they do so at their peril.  Imagine being up for the year, and then losing everything because the manager neglected to monitor their prime brokerage and custody arrangements.

Second, investors are asking about it.  The concept of rehypothication entered the hedge fund vernacular in 2008 and is here to stay.  Investors now frequently ask about rehypothication, and other prime brokerage concepts/arrangements, in due diligence, and there are a lot of misconceptions about the term.  Nevertheless, especially in the current environment, a lack of understanding about prime brokerage, custody, etc . . . can make the difference in receiving an allocation from an investor or cause a manager to fail operational due diligence.  Managers need to be prepared to discuss these concepts and be aware of the terms in their own prime brokerage agreements.

To find out more about rehypothication and other topics relating to prime brokerage or custody, 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 and start up articles include: