Tag Archives: hedge funds

FLOORED Film Peeks Inside Chicago Trading World

Audience Reacts Positively to James Allen Smith’s Documentary on Chicago Floor Trading

On Thursday evening at the Roxie Theatre in San Francisco, the professional women’s organization 100 Women in Hedge Funds sponsored the showing of Floored, a documentary by ex-floor trader James Allen Smith that offers a peek inside the lives, successes, and struggles of former traders of the Chicago trading floor (a.k.a. the “pit”).

Those who showed up to watch the film made for the perfect audience–traders, hedge fund managers, and other financial industry professionals schmoozed over wine and cheese before the showing, during which boos, laughter, applause, and verbal comments erupted each time the audience could relate to traders’ stories or make fun of their often idiosyncratic comments. Upon leaving trading, one notable former trader (and quite the character) Mike Walsh took up the hobby of hunting lions, giraffes, and other wild animals.

Through interviews and live footage of pit trading, the documentary tells the story of the Chicago Board of Trade’s (now the Chicago Mercantile Exchange, CME) humble beginnings–it opened in 1898 as the Chicago Butter and Egg Board because it only traded butter and egg contracts!–to the roller coaster ride experienced by floor traders during the peak of futures and options floor trading in the mid-1990s.

Starting in 1992 and still in use today in the pit is the combination of open outcry, the system of loudly shouting over competitors often associated with floor trading, and GLOBEX, an electronic trading system which works alongside open outcry to make trading more efficient. The idea behind trading revolves around buying a commodity at one price and then trying to sell it for a better price in order to make a profit.  In the film, the traders described this system as a game–one trader stated that when the bell goes off (to initiate the opening of trading hours), he experiences an adrenaline rush as if he were playing a sports game.  Another trader commented, “Trading is not a normal job. When you are in there [the pit] from 8:30 to 3:15, it’s all about money!”

The main issue traders discussed was the shift from floor trading to electronic trading. The majority opinion was that computers changed the dynamic of trading in an unfavorable way and that trading in person helps make the price of commodities more efficient. One trader commented that open outcry was more “honorable”. There is also a generational issue, as older traders who did not grow up using computers had trouble figuring out complicated electronic trading platforms. Essentially, those traders who still had enough money to continue trading and who were able to use the electronic systems continued trading, while those who lost too much money in the pit were forced to leave trading altogether.

According to the CME, the options and futures trading floor remains grounded in floor trading, which accounts for 90% of trades with the remaining 10% occurring electronically. The futures pit, however, has seen the biggest crossover to electronic trading, with approximately 85% of trades taking place on the computer and the remaining ones in the pit.

After the film, Smith, who watched the film alongside his audience, stood at the front of the theatre for a Q&A session. He was asked about his background–he went to art school then found himself doing web design for finance businesses in Chicago, where a friend suggested he make a movie about floor traders. He even dabbled in trading and reached out to his network when casting traders for the film. When asked why former traders were willing to open up about their personal lives on film, he commented that less successful traders are often more likely to talk, while more successful traders remain tighter-lipped. Finally, when asked what impression of traders he wanted to leave with audiences, Smith replied that traders are usually stereotyped as “greedy a**holes”, and he wanted to show that traders are more “dynamic than just that part of their personalities” by offering a “more rounded impression [of traders]” through his film.

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For information about future Floored showings, click here.

Other related Floored and CME articles include:

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

Fund Appreciation Rights

Alternative Hedge Fund Compensation Structure

At the very beginning of this year there was much discussion about the hedge fund compensation structure in light of the horrible returns from 2008.  Many funds lost money but managers aren’t typically subject to the same types of clawback provisions as private equity fund managers.  Additionally some funds had to close shop because of talent retention issues or because the manager realized that reaching a previous high water mark would take too long.  Generally investors who have lost money will prefer to stay in a fund (all else being equal) because of the high water mark – when investors go into a new fund, there high water mark is their initial investment which means they are going to be subject to hedge fund performance fees sooner than in a fund which has previously lost money.

FAR Alternative

As an alternative to the traditional performance fee/ allocation structure, some hedge funds are instituting a different compensation structure called fund appreciation rights (FARs).  Generally this structure provides a more aligned incentive structure for the manager.  Essentially the FARs provide an option like mechanism for the manager.  This option also has the potential to allow the manager to defer recognition of income which may be an added tax benefit for the manager.  [Note: a longer discussion on this issue will be forthcoming shortly.]

Issues with FARs

FARs are new.  It is not known how many groups have implemented FARs or whether they will catch on (or become the next standard).  It is likely that any movement in this area will be driven by the demand (if any) by institutional investors for such products.  FARs are also untested and it is not clear how they will be viewed by the IRS.  As we have recently seen, there has been a big push to disallow the tax advantages of the performance allocation to hedge fund managers and in the current political climate it is likely that the IRS will scrutinize such transactions.

We will continue to research and report on this and other tax structures for hedge fund managers.

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Other related hedge fund law articles:

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

Weekly Hedge Fund News Stories | November 30 – December 4

Below are a list of some of the news stories which caught my attention this week.

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Hedge Fund Carried Interest Tax “Loophole” Repeal? – the hedge fund carried interest “loophole” is again being discussed as a potential issue to be addressed by Congress before the end of the year.  One proposal introduced by Representative Levin (R) has reportedly passed the House twice but is meeting opposition in the Senate.  Watch for a bill to be included as a last minute rider.  For more background, see articles by Boston.com and Reuters.

Wall Street “Transaction Tax” Introduced in House
– A group of Congressmen introduced legislation to tax Wall Street.  According to a press release by Representative Peter DeFazio (D-OR), investment transactions (including stocks, futures, swaps, CDSs, and options) will be subject to “small” transaction taxes which could raise up to $150 billion a year.   The tax would not apply to certain groups like IRAs, mutual funds, and HSAs.  See also a SIFMA press release which discusses this issue.

Florida to Invest $500MM in Hedge Funds – managers who are looking for an allocation from a large pension plan should look toward Florida which is looking to get into hedge funds.  According an article on Pension & Investments, Florida has hired Cambridge Associates as a consultant to help with the search.

Positive November for Hedge Funds – Hedge fund managers gained an average of 1.8% in November according to this Market Watch article.

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Other articles I liked this week:

Other:

There is a lot of chatter out there about hedge funds and insider trading.  Evidently the SEC is continuing to pursue large hedge fund groups who may have been involved.

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

Hedge Funds, the Secondary Market and PTP Issues

Secondary Hedge Fund Market Poses Issues for Fund Managers

Recently there have been a number of groups springing up to provide a secondary hedge fund market.  While such platforms provide investors with a potential avenue to get out of their illiquid investment (the investment in the fund may be illiquid for a number of reasons including the imposition of a gate provision), they pose problems for the hedge fund manager who will have to deal with the mechanical issues involved in a transfer of the fund interests.  Additionally, as noted in the article below, the manager may have to worry about the PTP issues involved with such potential transfer.

The following article was written by Doug Cornelius of the Compliance Building blog and is reprinted with permission.  All links in the article are from the original.

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Classification of Private Funds as Publicly Traded Partnerships

Due to the increasing incidence of fund investors who want to transfer their investment fund interests, private investment funds face a risk of being classified as publicly traded partnerships. That would mean the fund would become taxable as a corporation.

A bad result.

Under Internal Revenue Code § 7704, a partnership will be classified as a publicly traded partnership if (1) the fund interests are traded on an established securities market or (2) the fund interests are readily tradable on a secondary market or its substantial equivalent.

The big problem is determining when you have a “substantial equivalent” of a secondary market. Under the regulations, the IRS uses a facts and circumstances test to determine if “partners are readily able to buy, sell, or exchange their partnership interests in a manner that is comparable, economically, to trading on an established securities market.” You hate to get into a facts and circumstances discussion with the IRS.

Fortunately there are some safeguards in the implementing regulations at 26 C.F.R. § 1.7704-1.

Involvement of the Partnership

For purposes of section 7704(b), interests in a partnership are not readily tradable on a secondary market or the substantial equivalent unless (1) The partnership participates in the establishment of the market or (2) The partnership recognizes any transfers made on the market by (i) redeeming the transferor partner or (ii) admitting the transferee as a partner.

Since most fund partnerships require the general partner to approve the the transferee and then admit the transferee, they are unlikely to be able to take advantage of this safe harbor.

De Minimis Trading Safeharbor

The focus of a fund should be on the 2% de minimis safe harbor. 26 C.F.R. § 1.7704-1(j) provides for interests in a partnership to be deemed not readily tradable on a secondary market or the substantial equivalent thereof if the sum of the percentage interests in partnership capital or profits transferred during the taxable year of the partnership does not exceed 2 percent of the total interests in partnership capital or profits.

You want avoid having more than 2 percent of the partnership interests changing hands each tax year.

If you get close to that number there are several transfers that are disregarded transfers for this safeharbor, including:

  • block transfers by a single partner of more than 2% of the total interests
  • intrafamily transfers
  • transfers at death
  • distributions from a qualified retirement plan
  • Transfers by one or more partners of interests representing  50 percent or more of the total interests in partnership

Private Placement Safeharbor

The regulations deem a transfer to not be a trade if it was a private placement. But the regulations have their own definition of a private placement: (1) the issuance of the partnership interests had to be exempt from registration under the Securities Act of 1933,  and (2) the partnership does not have more than 100 partners at any time during the tax year of the partnership. 26 C.F.R. § 1.7704-1(h)

The first prong should be straight-forward for most private funds. The trickier part is the second prong. In some circumstances the IRS can look through the holder of a partnership interest to its beneficial owners and expand the number of partners to include the beneficial holders of that interest.

Passive Income Safeharbor

If a fund is determined to be a Publicly Traded Partnership, it will nonetheless not be taxed as a corporation if 90% or more of the fund’s gross income is passive-type income. [26 U.S.C. § 7704(c)] Passive-type income generally includes dividends, real property rents, gains from the sale of real property, income from mining and oil and gas properties, gains from the sale of capital assets held to produce income, and gains from commodities (not held primarily for sale in the ordinary course of business), futures, forwards, or options with respect to commodities. The income test is on a taxable year basis and must be have been met each prior year.

References:

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Please also see the post on hedge fund compliance and twitter which includes another reprint of a Compliance Building article.

Other related hedge fund law articles include:

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

Hedge Funds and Insider Trading after Galleon

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

High Profile Case Highlights Issues for Hedge Fund Managers to Consider

Insider trading is now an operational issue for hedge fund managers.  The high profile insider trading case involving RR and the Galleon hedge fund has put the spotlight directly on hedge funds again and has also sparked a debate of sorts on the subject.  Given the potential severity of penalties for insider trading, it is surprising that we still periodically hear about such cases, but nevertheless it is something that is always going to be there – human nature is not going to change.

As such hedge fund managers need to be prepared to deal with this issue internally (through their compliance procedures) and also will need to be able to communicate how they have addressed this issue to both the regulators and institutional investors.  While managers always need to be vigilant in their enforcement of compliance policies and procedures, during this time of heightened insider trading awareness, managers need to be even more vigilant about protecting themselves.  As the Galleon liquidation too vividly shows, a lapse in operational oversight can and will take down an entire organization.

Insider Trading Overview and Penalties

We have discussed insider trading before, but as a general matter insider trading refers to the practice of trading securities based on material, non-public information.  Whether information is material depends on case law.  In general information will be material if “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision (see TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).  Information is non-public if it has not been disseminated in a manner making it available to investors generally. An insider is generally defined as officers, directors and employees of a company but it can also refer to a company’s business associates in certain circumstances (i.e. attorneys, accountants, consultants, and banks, and the employees of such organizations).  Additionally, persons not considered to be insiders may nevertheless be charged with insider trading if they received tips from insiders – such persons generally are referred to as tippees and the insider is generally referred to as the tipper.  [HFLB note: more information on insider trading generally can be found in the discussion of Regulation FD on the SEC website.]

The penalties for insider trading are potentially harsh – censures, cease and desist orders, fines, suspension and/or revocation of securities licenses are all potential penalties.  Depending on the severity of the insider trading there may be criminal sanctions in addition to the listed civil penalties.  Securities professionals (or other business professionals like an attorney or accountant) may jeopardize their ability to work in their industry if they are caught engaging in insider trading which, for most people, would be a large enough deterrent to engage in such activity.

Addressing Compliance Inside the Firm

Insider trading is usually addressed in the firm’s compliance policies and procedures.  Indeed, Section 204A of the Investment Adviser Act of 1940 requires SEC registered investment advisers to maintainpolicies and procedures to detect against insider trading.

Usually such policies and procedures forbid employees from trading on material non-public information (as well as “tipping” others about material non-public information).  Additionally, employees typically are required to disclose any non-public material information they receive to the chief compliance officer (“CCO”) of the firm.  The employee is generally prohibited from discussing the matter with anyone inside or outside of the firm.  The policies and procedures may require the CCO to take some sort of action on the matter.  There are a number of different ways that the CCO can handle the situation including ordering a prohibition on trading in the security (including in options, rights and warrants on the security).  The CCO may also initiate a review of the personal trading accounts of firm employees.  Usually when the CCO is informed of such information the CCO would contact outside counsel to discuss the next course of action.

Dealing with Regulators

While many large hedge fund managers are registered as investment advisors with the SEC, many still remain unregistered in reliance on the exemption provided by Section 203(b)(3).  With the Private Fund Investment Advisers Registration Act likely to be passed within the next year, managers with a certain amount of AUM (either $100 million or $150 million as it now stands) will be forced to register with the SEC.  Of course, this means that such managers will be subject to examination by the SEC and insider trading will be one of the first issues that a manager will likely deal with in an examination.

As we discussed in an earlier insider trading article, the SEC has unabashedly proclaimed war against insider trading and they will be aggressively pursuing any leads which may implicate managers.

Some compliance professionals believe that the SEC comes in with a view that the manager is guilty until proven innocent.  While I do not necessarily subscribe to this blanket viewpoint, I do believe that managers, as a best practice, should be able to show the SEC the steps they have taken to ensure that compliance with insider trading prohibitions is a top priority of the firm.  The firm and CCO should be prepared to describe their policies and structures that are in place to deal with this issue.

Institutional Standpoint

Potentially more important than how a firm deals with the SEC, is how a firm describes their internal compliance procedures to institutional investors.  The question then becomes, how are institutional investors going to address this risk with regard to the managers they allocate to – what will change?

Right now it appears a bit unclear.  Over the past week I have talked with a number of different groups who are involved hedge fund compliance, hedge fund consulting, and hedge fund due diligence and I seem to get different answers.  Some groups think that institutional investors will be focusing on this issue (as many managers know, one of the important issues for institutional investors is the avoidance of “headline risk”); other groups seem to think that this is an issue that institutional groups are not going to focus on because there are other aspects of a manager’s investment program and operations which deserve more attention.

We tend to agree more with the second opinion, but we still believe that robust insider trading compliance policies and procedures are vital to the long term success of any asset management company.  We also encourage groups to discuss their current procedures with their compliance consultant or hedge fund attorney.

Outsourcing and Technology solutions

Many large managers have implemented compliance programs which have technology solutions designed to track employee trading.  Presumably there will be technology programs developed to address this concern for manager.  Although I do not currently know of any specific outsourced or technology solutions which address this issue, I anticipate discussing this in greater depth in the future – perhaps there is some data warehousing solution.  [HFLB note: please contact us if you would like to discuss such a solution with us.]

Final Thoughts

The Galleon insider trading case could not have happened at a worse time for the hedge fund industry which is trying to put its best face forward as Congress determines its future regulatory fate.  However, increased awareness of this issue will force managers to address it from an operational standpoint which will only help these managers down the road.  While the full effect of this case will not be understood for a while, in the short term it is likely to cost managers in terms of time and cost to review and implement increased operational awareness and procedures.

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Other related hedge fund law articles:

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.

Hedge Fund Operations During a Pandemic

Thoughts on Business Continuity Planning

Over the past week, I have attended a couple of interesting panel discussions on the hedge fund industry.  At these events, one of the common themes was that the investment management industry is changing and hedge fund management companies need to make sure that operations are tight – this means that a management company should have developed and robust procedures for disasters including, as the article below indicates, pandemics.  It is expected that this topic will become even more important if the impact of the H1N1 virus does not abate.

The article below was provided by Lisa Smith of Eze Castle Integration, an IT solutions firm for hedge fund management companies. This article is part of our guide to Hedge Fund Business & Technical Issues.

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Business Continuity: A Look at Pandemic Response Planning
By: Lisa Smith, Certified Business Continuity Planner, Eze Castle Integration

As the last several months have unfolded, one thing has become clear: the influenza A (H1N1) virus is not going away.  After the initial panic subsided, fear and concern seemed to diminish even though the World Health Organization and U.S. Centers for Disease Control insist that the threat is not over.  Now, nearly five months since the first case of H1N1 was reported in Mexico, a pandemic has emerged as predicted.

As of November 1, 2009, 199+ countries have reported laboratory confirmed cases of pandemic influenza H1N1 2009, including over 482,000 cases and 6,000 deaths (World Health Organization).  U.S. health officials estimate that the virus could directly and indirectly affect up to 40 percent of the nationwide workforce over the next two years (Centers for Disease Control).

What does this mean for hedge funds?  It is more important than ever to ensure a firm can and will remain functional if you are affected by a pandemic. Particularly, hedge funds must be mindful of the repercussions of the virus, as a decrease in staff could cause potential downtime.

Below are six essential pandemic response steps that firms need to undertake to ensure their businesses remain at peak performance, even if an outbreak occurs in the office.

Begin response procedures BEFORE a disaster strikes.

Organizational resiliency starts by strengthening your organization during normal business operations prior to a disaster such as a pandemic.  It should not take a disaster to compel your firm to evaluate its business continuity and response processes.  One should be in place long before disasters strike.

Identify who will serve as crisis leaders and be in charge of handling situational changes that may occur, including communication to other employees about response procedures and alternative site locations.  An ideal crisis leader is someone who demonstrates good leadership skills during normal business operations and has experience dealing with crises.  Typical crisis leaders are members of the senior management team (i.e. COO, CFO or Portfolio Manager).  Firms must also ensure all employees are mentally and physically able to respond to changes, especially if they are telecommuting.

Also, certify that all employees are cross-trained within the organization; if there is a staff shortage as a result of a pandemic, employees will need to fill additional roles and responsibilities.  Non-critical employees, including business development, accounting and research analysts, may be able to take larger roles and assist during a pandemic response phase.

Develop disaster / pandemic procedures based on a variety of scenarios.

Be proactive.  As part of the planning process, create a list of potential scenarios and define your firm’s response strategies.  Impact scenarios should include both potential internal and external occurrences.

For instance, what is your response if access to your office building is restricted due to extensive H1N1 exposure?  How will you access your email, market data and portfolio management systems?  Where will employees work and how will they communicate with colleagues and counterparties?

Externally, how will you operate if your prime broker or fund administrator contacts are unavailable?  Being prepared will ensure your business operations continue seamlessly and without interruption.

Thoroughly review and modify your business’ Employee Assistance Program (EAP).

An EAP provides assistance and access to counseling services for issues in and out of the workplace.  In the event of a disaster, employees may wish to speak with a professional counselor to deal with any stress or negative emotions that have resulted from the event.  If you cannot provide a physical counseling presence, provide a list of area clinics that offer comparable services.  In advance, consider preparing educational materials that inform employees of the various stress indicators and reactions they may experience as a result of a disaster.  If employees know that support is available prior to a disaster, it will mitigate panic and stress, and they will be better able to adapt to changes in their environment.

You should also inform employees about current sick leave and family support policies in the event that someone is forced to take an extended leave of absence.

In addition to developing and strengthening your EAP, you might also consider having upper management and emergency response team leaders partake in Critical Incident Stress Management (CISM) training, which will provide advanced preparation for responding to critical situations.

Test alternate site and remote access capabilities.

If a crisis situation is directly affecting your physical workspace or your employees, you must be prepared to provide alternatives.  You may choose to move business operations to an alternate site where employees can go without risk.  An alternate site would make sense for crisis situations that are confined to specific areas, such as natural disasters, outages or other situations.

In a pandemic situation – particularly if you have had any outbreaks of illness amongst your employees – you may choose to allow employees to work remotely.  If this is a viable alternative, ensure ahead of time that you have adequate capacity and infrastructure to support multiple virtual private networks (VPN) and remote access capabilities.  Confirm the number of Citrix licenses you have available; if there are not enough to support your complete staff, you may need to consolidate responsibilities.

Review your business response plan and procedures with team members and leaders.

Develop communication notification and escalation procedures for response team leaders and assign internal notification tasks to each leader.  Identify if there are external business partners who need to be notified as well (i.e. investors, service providers, etc.).  Assign a primary and secondary spokesperson in case the public needs to be notified, and ensure the spokesperson(s) has training and experience dealing with the media.  If your spokesperson does not have training, now is the time to arrange for crisis communications training.

Test your pandemic response plan.

It is important to test your company’s response plan with leaders and response team members to ensure there are no glitches or obstacles in the event of a real disaster.  Test internal communication strategies – from response team leaders to staff members.  This can be done manually or through an automatic notification system.  You can also send employees to work at the alternate site or to work remotely to ensure there are no technical issues that can affect productivity.  It is imperative that the teams and employees are able to work together and build trusting relationships today.  A strong foundation that includes good performance and trusting relationships will enable your business to recover from any kind of crisis.

Business Continuity Professionals say that “planning” helps mitigate panic and downtime.  It takes work and resources to develop a resilient organization prior to an interruption or disaster, but it is imperative if businesses want to stay operational.  Businesses cannot function without employees that maintain knowledge and expertise to operate the business, and those employees need to know what to do during an interruption or disaster.  Without a plan, you will spend the entire time chasing the incident instead of recovering from it.

For more information, please see http://www.eci.com.

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Other related hedge fund law articles include:

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

Hedge Fund Investment Adviser Insurance

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

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

Insurance Premiums for Small Funds

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

Hedge Fund Insurance Underwriters

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

What does Insurance Cover?

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

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

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Related articles from Hedge Fund Law Blog:

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

Hedge Fund Investors to Sue SEC

SEC’s Madoff Failure Cited in Lawsuit

Just a quick note that the New York Times has written an article about two Madoff investors who are suing the SEC for not doing its job.  It will likely be a tough case for the investors/plaintiffs to prevail upon because of the doctrine of sovereign immunity (i.e. government agencies cannot be sued for actions made pursuant to their legislative mandate).  However, the inspector general’s Madoff report, which in no uncertain terms castigates the SEC, is likely to be the basis of many of the investors’ complaints.

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Other related hedge fund law and Madoff stories:

Raising Hedge Fund Assets | New Market Requires New Strategies

http://www.hedgefundlawblog.com

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

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

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

By Karl Cole-Frieman, www.colefrieman.com

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

The other panelists were:

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

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

Develop a Strategic Marketing Plan

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

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

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

Portfolio Managers and Marketing

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

Due Diligence in the Post-Madoff Environment

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

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

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

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

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

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

Purchasing an ERISA Fidelity Bond

Information on How to Buy ERISA Bond

Purchasing an ERISA Fidelity Bond is essentially the same as purchasing a fidelity bond for an investment advisory firm and this article is meant to serve as guide as to cost and timing to secure one of these bonds.

Overview

Generally a manager will need to make sure that the bond is for 10% of the amount of the ERISA assets (subject to a minimum bond requirement of $1,000). This means that if the ERISA assets in the fund are $1MM, the manager will need to have a bond for at least $100,000.

However, the maximum bond amount with regard to any one plan is $500,000. This means that if the manager has ERISA assets in the fund (from one plan) of $6MM, the manager will only need to have a bond in the amount of $500,000 with respect to that plan.

Generally, if the manager had two plans in his fund – one with $6MM in assets and one with $2MM in assets, the manager would need to have $700,000 worth of coverage ($500,000 and $200,000 respectively). The best way to accomplish this is to have separate bonds for the separate ERISA plans invested in the fund.

Cost of ERISA Bond

A bond consultant or insurance broker will generally be able to provide a quote for the ERISA coverage needs. The costs are fairly reasonable – generally around $200 to $400 for every $100,000 of coverage per year. For newly formed management companies, the amount of the bond may be based on the personal credit score of an officer of such management company.

Application Process and Timing

ERISA bonds are fairly easy to purchase and can be delivered quickly. The application process is generally pretty basic – applications will require basic information about the management company, the fund and/or the officer(s) of the management company. Different bond companies will require different information or have different application processes or procedures.

In my experience, managers have been able to secure a bond within about a week of submitting an application. If you are a manager that is likely to receive an allocation from an ERISA plan, the best practice is to have the bond in place prior to the time that the ERISA assets are wired to the fund account. Accordingly, the manager should take care to make sure the bonding company has all necessary information in order to place the bond by the necessary time.

Other Notes

As with other sensitive areas of hedge fund law (like taxation) managers should take extra care when dealing with ERISA investors and ERISA requirements. I always recommend discussing any ERISA issues with an ERISA specialist.

Please also see our disclaimer with regard to the information presented on this website.

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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: