Tag Archives: investment adviser

Financial Reform Bill Passes Senate

As has been widely reported, the Senate passed the Financial Reform Bill setting the stage for President Obama to sign the bill within the next week.  With respect to investment advisors, one of the central items is the private equity and hedge fund registration requirement.  We will be reporting further on the bill in the coming days and weeks.

Hedge Fund Compliance Guide

After the passage of the Dodd-Frank financial reform bill, managers and service providers will be preparing to go through the registration process. Managers should note that while the registration process is fairly straightforward, the ongoing compliance requirements under the Investment Advisers Act are perhaps more important. In this guide we will be providing an overview and links to the important compliance considerations.

Specifically, we will be discussing the practical application of the following rules to both hedge fund managers and private equity fund managers:

Rule 204-2 — Books and Records to Be Maintained by Investment Advisers
Rule 204-3 — Written Disclosure Statements
Rule 204A-1 — Investment Adviser Codes of Ethics
Rule 205-3 — Exemption from the Compensation Prohibition of Section 205(a)(1) for Investment Advisers
Rule 206(3)-2 — Agency Cross Transactions for Advisory Clients
Rule 206(4)-1 — Advertisements by Investment Advisers
Rule 206(4)-2 — Custody or Possession of Funds or Securities of Clients
Rule 206(4)-3 — Cash Payments for Client Solicitations
Rule 206(4)-4 — Financial and Disciplinary Information that Investment Advisers Must Disclose to Clients
Rule 206(4)-6 — Proxy Voting
Rule 206(4)-7 — Compliance Procedures and Practices

Business Continuity Plans

Rule 206(4)-8 — Pooled Investment Vehicles

This guide will complement the hedge fund registration guide we have developed as well.

Investment Adviser Representative Information Now Publicly Available on IAPD

IAPD Update Provides Information on IA Reps

The Investment Adviser Public Disclosure (IAPD) was updated this week so that information on investment adviser representatives will now be available online.  Previously the search function allowed members of the public to access information on IA firms only.  The previous information available through the adviser search function consisted of an advisory firm’s Form ADV, Form ADV Part II and Schedule F.  Now, the IAPD provides the following information on each representative of a registered investment advisory firm:

  • Current employer (including employer’s IARD number and adress)
  • Number of jurisdictions representative is registered in
  • Whether the representative is suspended in any jurisdictions
  • Registration and Employment History (including dates registered at previous firms)
  • Disclosure information (including any U-4 disclosures and current and past complaints)
  • Whether there is information on representative in BrokerCheck (run by FINRA)

Certain representatives will not show up in the system if the person is not currently registered with a state, has not been registered with a state in the last two years, or has not been the subject of a final regulatory event that has been reported to IARD.

It is important for representatives of investment advisory firms to understand that the above information will now be publicly available and may be accessed by investors during the due diligence process.   Accordingly, we recommend reps occasionally check their profile on the IAPD to make sure there is no incorrect information listed.


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive regulatory support and hedge fund registration services.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Massachusetts Hedge Fund Exemption

Exclusion From Definition of Investment Adviser

Generally Massachusetts will require hedge fund managers with a place of business in Massachusetts to register as an investment adviser with the Massachusetts Securities Division.  However, there is an exemption from registration for some hedge fund managers located in Massachusetts.  [Note: to be more accurate, the “exemption” really is an exclusion from the definition of investment adviser under the Massachusetts Securities Act.]

Definition of Investment Adviser

Under Section 401(m) of the Massachusetts Securities Act, the term investment adviser means:

any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities. …“Investment adviser” shall not include: … a person whose only clients in this state are federal covered advisers, other investment advisers, broker-dealers, banks, savings institutions, trust companies, insurance companies, investment companies as defined in the Investment Company Act of 1940, employee benefit plans with assets of not less than $5,000,000, governmental agencies or instrumentalities, or other financial institutions or institutional buyers, whether acting for themselves or as trustees with investment control; (emphasis added)

This definition is similar for most states and is based on the Uniform Securities Act which was designed to help standardize state securities laws.  Normally the definition of “other financial institutions or institutional buyers” is not defined under state law or division regulations and will normally be understood to mean large institutions.

Massachusetts has specifically defined “Institutional Buyer”.

Definition of “Institutional Buyer” for Section 401(m)

Under Massachusetts regulations,

Institutional Buyer shall include any of the following:

a. An organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $ 25 million.

b. An investing entity whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $ 50,000.

c. An entity whose only investors are financial institutions and institutional buyers as set forth in M.G.L. c. 110A, § 401(m) and 950 CMR 12.205(1)(a)6.a. and b.

See 950 CMR Section 12.205(1)(a)(6)

For hedge fund managers, section (b) above is important.  A hedge fund would be considered to be an “institutional buyer” if (i) the fund only accepts accredited investors and if (ii) each investor has contributed at least $50,000 to the fund.  If the fund does not meet both parts of the test, the fund will not be an “institutional buyer” and the fund manager would not be excluded from the definition of investment adviser and would need to register as such with the Massachussetts Securities Division.

Consequences for Not Registering

If a fund manager does not meet the two tests above, the manager will need to be registered or face certain consequences.  These consequences may include:

  • An order to cease and desist conducting business
  • A requirement to register with the division
  • Administrative fines
  • Offer of rescission of fund interests to investors
  • Further division scrutiny

Some managers may be tempted to not register but as we can see from a previous Massachussetts Securities Division Complaint against an unregistered hedge fund manager, the consequences and the time/money/effort spent with a formal division complaint will be far more cumbersome than simply registering with the division in the first place.


Many states have intricate laws with respect to hedge fund manager registration.  These laws will become even more important to understand if/when the Wall Street Reform bill passes in which case many SEC registered advisers will need to switch to state registration.


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund formation and regulatory support.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Massachusetts RIA Net Worth Reminder

Today we received an email reminder from the Massachusetts Securities Division with respect to investment adviser minimum financial requirements.  Essentially hedge fund managers registered as investment advisers with Massachusetts will either need to (i) post a $10,000 surety bond or (ii) establish a separate account with $10,000 and maintain a positve net worth.  Managers who choose to establish the separate account need to provide the Securities Division with a balance sheet on an annual basis.

The email stated:

Please see the attached reminder of the Division’s policy regarding minimum financial requirements for certain Massachusetts-based registered investment advisers.  Please call the Division if you have any questions.

The attachment stated:



The Massachusetts Securities Division (the “Division”) hereby provides this reminder to certain investment advisers described as follows:  those (1) who are required to be registered with the Division; and (2) whose principal place of business is in Massachusetts; and (3) who (i) exercise investment or brokerage discretion, (ii) have custody of clients’ funds or securities, or (iii) require the payment of more than $500 in advisory fees more than 6 months in advance.  The regulation found at 950 CMR 12.205(5) requires such investment advisers to either (a) post a $10,000 surety bond, or (b) establish a separate, segregated account of $5,000 [for (i) above] or $10,000 [for (ii) and/or (iii) above] and maintain at all times a positive net worth.  The Division requires that those investment advisers who choose option (b) demonstrate, on an annual basis, their positive net worth with a certified balance sheet prepared in accordance with generally accepted accounting principles applied on a consistent basis.  See 950 CMR 14.412(C).

If you are registered as an investment adviser in Massachusetts and have any questions, please feel free to contact us at Mallon P.C.


Other related hedge fund law articles include:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for managers and registered investment advisers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

State Budget Shortfalls and Investment Adviser Registration

Financial Reform Bill May Devastate Overburdened State Securities Divisions

As many states are facing huge budget shortfalls, government services have been cutback and certain states have furloughed workers in certain divisions. In a number of states (including California) these budget cuts have affected the state securities divisions and accordingly the many state securities divisions are running dangerously lean. For example, I just recently talked with an examiner in the Oregon Division of Finance and Corporate Securities regarding a state blue sky filing for a hedge fund manager. The examiner told me that because of budget cuts and furlough days, the division will not even have a chance to review the blue sky filing we submit for five months! (Of course, they will cash the check immediately.)

This is obviously a huge issue and is only one instance of a state which does not currently have the resources to adequately perform oversight of the investment and securities activity which occur within its borders. In fact, many states currently don’t have the staff or expertise to adequately oversee the investment advisers and brokers registered with their securities division. While this is troubling, the problem is only going to get worse if the Financial Reform Bill proceeds as currently drafted.

While many have lauded the Senate bill, which will require hedge fund registration for managers with $100MM in AUM or more, an important issue has been overlooked. All investment advisers (in addition to hedge fund managers) with AUM of less than $100MM will be subject to state and not SEC registration. The $100MM threshold is an increase from the current threshold of $25MM. This means that a financial planner overseeing $90MM in assets (which was previously subject to SEC registration and periodic examination) will now be subject to regulation, generally, by the state in which that manager resides.

This means that if the financial reform bill goes through as currently drafted in the senate, the states are suddenly going to be responsible for overseeing a larger pool of managers. Even though the state will have increased responsibility, it is unlikely that state budgets will provide the securities divisions with more funding to properly oversee the new managers the divisions will be responsible for regulating. We find this troubling for investor protection reasons and for manager business continuity – that is, managers would be better off registered at the SEC level and subject to examination by SEC staff better trained (presumably) than state regulators.

We concede that the SEC has its own problems with funding and this provision allows them to focus on larger, more systemically important managers. However, we believe that states are going to be greatly burdened by the increase in jurisdictional oversight. Accordingly, we believe either Congress or the SEC provide a grandfathering provision which would allow current managers who exceed the $25MM threshold (but not the new $100MM threshold) to register or remain registered with the SEC.


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP is one of the top hedge fund law firms and provides comprehensive formation and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Manager Registration to Cost Taxpayers $140 Million (at least)

CBO Calculates Cost of House Hedge Fund Bill

This past week the Congressional Budge Office (“CBO”) released a cost estimate of H.R. 3818, the Private Fund Investment Advisers Registration Act of 2009.  In a number of private conversations I have had about hedge fund registration over the last 9-12 months one of the issues that was continually raised was appropriate funding for the SEC.  As we have seen recently (most notably from the Inspector General’s Madoff report), the SEC’s budget is not large enough to adequately fulfill their investor protection mandate.  Adding hedge fund registration would obviously further burden the cash-strapped agency (for more see Schumer Proposal to Double SEC Budget).  According to the CBO, and based on the SEC’s estimates that it will need to add 150 employees, the estimated outlays over four years will be equal to $140 million.

However, taxpayers should understand that this assumes that registration will only be required for those managers with at least $150 million in assets under management.   At the $150 million AUM level, the CBO expects that 1,300 hedge fund managers would be required to register.  The current draft of the Senate hedge fund registration bill calls for managers with $100 million in AUM to register – lowering the AUM exemption threshold will increase the amount of managers required to register.  Additionally, there are outstanding political issues.  First, it is unclear whether the final bill will require private equity fund managers and venture capital fund managers to register – we do not necessarily understand the arguably arbitrary carve-out for these industries.  Second, it is clear that a majority of the state securities commissions are unable and unwilling to be responsible for overseeing managers with up to $100 million in assets.  Hedge fund managers who would subject to state oversight would rightly want to be subject to SEC oversight (which does not say much for many state securities commissions).  These issues will continue to be addressed during the political sausage-making process.

Of additional interest – the CBO estimates that hedge fund registration is likely to cost around $30,000 per each SEC registrant which is welcome news to investment adviser compliance consultants and hedge fund lawyers!

For full report, please see full CBO Hedge Fund Cost Estimate.

Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and provides hedge fund manager registration service through Cole-Frieman & Mallon LLP 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.


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.

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 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.


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.