Tag Archives: hedge fund performance reporting

JOBS Act Signed Into Law

Allows Hedge Funds to Openly Solicit Investors

President Obama has signed into law the Jumpstart Our Business Startups Act (“JOBS Act”), a law which eases some of the private investment fund industry’s long-standing regulatory burdens.

There are two parts of the JOBS Act which in particular stand out for the hedge fund industry: (1) private investment fund managers including hedge fund managers may now make general solicitations and advertise their fund in order to attract investors, as long as the funds only have accredited investors; and (2) private funds and hedge funds may now have up to 1,999 accredited investors, or 500 non-accredited investors, without having to register with the SEC under the 1934 Act. [For background information on this issue, please see section “500 or Fewer Investors” on our post about Section 3(c)(7) hedge funds.]

During the next 90 days the SEC will be promulgating regulations with respect to the changes in the securities laws.

Ban Lifted on General Solicitation and Advertising

Previously Rule 506 of Regulation D prevented private fundsfrom advertising publicly or soliciting the public for investment. This rule raised the specter of liability in numerous contexts. For example, private fund managers and employees could face serious consequences – including risking the fund’s SEC filing exemption (different from IA registration exemption) – for discussing their investment strategy with certain potential clients, or for putting their contact information on a fund’s publicly-accessible website. The JOBS Act changes this statutory scheme, allowing private funds to advertise publicly and to solicit the public for investment. It is not yet clear precisely what forms of advertising and solicitation will be permitted under the new rule. The SEC still has 90 days from the date of the signing of the JOBS Act to issue final regulations which will likely include more details on allowable advertisements and solicitation.

Increased Number of Accredited Investors

Prior to the JOBS Act, the Securities Exchange Act of 1934 required private funds to register with the SEC if they had more than 499 accredited investors (see 3(c)(7) link above). Under the new law, a private fund may have as many as 1,999 accredited investors without triggering that registration requirement. Increasing the number of permitted investors may allow private funds to raise more capital. [Note: the new law also creates a new source of financing called “crowdfunding.” A detailed analysis of this topic is beyond the scope of this blog post, but it should be noted that purchasers in a crowdfunding are not counted toward the 1,999 investor limit. Also not counted are employees who receive securities from a fund pursuant to an executive compensation plan.]

Other Items

The new rules do not apply to commodity pools which are subject to other regulatory oversight from the CFTC because of the Commodities Exchange Act. In general many commodity pool operators are going through the CFTC CPO registration process because of separate CFTC rulemaking which we detailed in a previous post.


While many groups including hedge fund managers are applauding this shift in the law, the SEC is likely to craft regulations which seek to limit the full extent of the potential general solicitations. Fund managers should remember that while general solicitations may be allowable in the future, managers may still be subject to other regulations under the Investment Advisers Act, especially after the Dodd-Frank requirement for hedge funds to register with the SEC. Specifically, fund managers who are SEC registered IAs cannot use testimonials and there are a number of requirements for hedge fund performance reporting which will need to be followed. While it is clear that private fund managers will have more flexibility with respect

to advertising than before the JOBS Act was passed, managers will need to be vigilant with their compliance programs if they decide to adopt more agressive public advertising campaigns.

Many more updates on this topic are expected.


Cole-Frieman Mallon & Hunt LLP provides regulatory and legal services to the investment management community. Bart Mallon’s practice focuses on both hedge fund manages as well as the managed futures industry. Please contact us or you can reach Bart Mallon directly at 415-868-5345.

Requirements for Hedge Fund Performance Reporting

Performance results are the ribbons of the hedge fund industry. In order to raise institutional money for your hedge fund, you will need good performance results. Even hedge fund managers who will not be focusing on raising money from institutional investors will need to have performance results in order to market the hedge fund. Performance results are usually displayed in a hedge fund pitchbook format, a tearsheet format and/or with monthly or quarterly performance reports to investors. Whenever performance results are included, the manager must make sure that the proper performance disclosures accompany the results. As a routine matter, all hedge fund performance results and advertisements should be reviewed by a hedge fund attorney.

SEC Guidance – Clover Capital No-Action Letter

The SEC has authority under the anti-fraud provisions of the investment adviser’s act (which apply to both registered and unregistered hedge fund managers) to police the performance results of hedge fund managers. [HFLB note: please see “Basis of SEC authority” below for explanation.] Under this authority, the SEC has provided some guidance on this subject through the Clover Capital no-action letter. Clover Capital is not famous because of the position of the staff with regard to a certain party, but because the staff went further and provided guidelines for all managers in how performance results should be disclaimed.

The Clover Capital letter is notable for a few reasons including that (i) it provides guidance on both model results (sometimes referred to as “backtested”) and actual results and (ii) it requires that performance results be present “net of fees.” While some aspects of the Clover Capital requirements have been softened in certain specific fact circumstances, through subsequent no-action letters, Clover Capital remains the central source of guidance for performance reporting requirements. These requirements (with footnotes omitted) are broken down below.

Model and Actual Results

With regard to model and actual results, the staff believes that a hedge fund manager is prohibited from publishing an advertisement that:

  1. Fails to disclose the effect of material market or economic conditions on the results portrayed (e.g., an advertisement stating that the accounts of the adviser’s clients appreciated in the value 25% without disclosing that the market generally appreciated 40% during the same period);
  2. Includes model or actual results that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid;
  3. Fails to disclose whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;
  4. Suggests or makes claims about the potential for profit without also disclosing the possibility of loss;
  5. Compares model or actual results to an index without disclosing all material facts relevant to the comparison (e.g. an advertisement that compares model results to an index without disclosing that the volatility of the index is materially different from that of the model portfolio);
  6. Fails to disclose any material conditions, objectives, or investment strategies used to obtain the results portrayed (e.g., the model portfolio contains equity stocks that are managed with a view towards capital appreciation);
  7. Fails to disclose prominently the limitations inherent in model results, particularly the fact that such results do not represent actual trading and that they may not reflect the impact that material economic and market factors might have had on the adviser’s decision-making if the adviser were actually managing clients’ money;
  8. Fails to disclose, if applicable, that the conditions, objectives, or investment strategies of the model portfolio changed materially during the time period portrayed in the advertisement and, if so, the effect of any such change on the results portrayed;
  9. Fails to disclose, if applicable, that any of the securities contained in, or the investment strategies followed with respect to, the model portfolio do not relate, or only partially relate, to the type of advisory services currently offered by the adviser (e.g., the model includes some types of securities that the adviser no longer recommends for its clients);
  10. Fails to disclose, if applicable, that the adviser’s clients had investment results materially different from the results portrayed in the model;

Actual Results

Additionally, with regard to actual results, the staff believes that a hedge fund manager is prohibited from publishing an advertisement that fails to disclose prominently, if applicable, that the results portrayed relate only to a select group of the adviser’s clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material.


The SEC staff closed the Clover Capital letter with the following statement that should be given great weight by all hedge fund managers:

We wish to emphasize that: (1) it is the responsibility of every adviser using model or actual results to ensure that the advertisement is not false or misleading; (2) the list set forth above of advertising practices the staff believes are prohibited by Rule 206(4)-1(a)(5) is not intended to be all-inclusive or to provide a safe harbor; and (3) the staff, as a matter of policy, will not review specific advertisements.

Clover Capital – Basis for SEC authority

The following comes from the Clover Capital no-action letter and states the SEC staff’s basis for their authority to produce guidance on performance advertising requirements.

Section 206 of the Act prohibits certain transactions by any investment adviser, whether registered or exempt from registration pursuant to Section 203(b) of the Act. Under paragraph (4) of Section 206, the Commission has authority to adopt rules defining acts, practices, and courses of business that are fraudulent, deceptive, or manipulative. Pursuant to this authority, the Commission adopted Rule 206(4)-1, which defines the use of certain specific types of advertisements by advisers as fraudulent, deceptive, or manipulative.* Although the rule does not specifically prohibit an adviser from using model or actual results, or prescribe the manner of advertising these results, paragraph (5) of the rule makes it a fraudulent, deceptive, or manipulative act for any investment adviser to distribute, directly or indirectly, any advertisement that contains any untrue statement of a material fact or that is otherwise false or misleading.** Accordingly, the applicable legal standard governing the advertising of model or actual results is that contained in paragraph (5) of the rule, i.e., whether the particular advertisement is false or misleading.***

* For example, Rule 206(4)-1 prohibits an adviser from using advertisements that include testimonials (paragraph (a)) or that refer to past specific recommendations unless certain information is provided (paragraph (b)). The staff is currently reviewing Rule 206(4)-1 to determine whether it needs to be revised or updated. See Investment Advisers Act Rel. No. 1033 (Aug. 6, 1986).

** As a general matter, whether any advertisement is false or misleading will depend on the particular facts and circumstances surrounding its use, including (1) the form as well as the content of the advertisement, (2) the implications or inferences arising out of the advertisement in its total context, and (3) the sophistication of the prospective client. See, e.g., Covato/ Lipsitz, Inc. (pub. avail. Oct. 23, 1981)(“Covato”); Edward F. O’Keefe (pub. avail. Apr. 13, 1978)(“O’Keefe”); Anametrics Investment Management (pub. avail. May 5, 1977)(“Anametrics”).

*** Of course, if an advertisement containing model or actual results also includes any of the specific advertising practices addressed by paragraphs (a)(1)-(a)(4) of the Rule 206(4)-1, the advertisement would have to comply with the requirements of these paragraphs.

If you have any questions on this article or would like to discuss your hedge fund performance results, please contact us.