The hedge fund subscription process (i.e. placing investor money into the fund’s brokerage account for investment) is a basic process that may be slightly different for each fund based on a number of factors.  Managers should make sure they understand the subscription process because investors may ask questions about the process and how the subscription amounts ultimately get into the fund’s trading account.  This post will discuss the framework for how subscription amounts move from the investor to the fund’s bank and brokerage accounts.

Bank Accounts

We previously discussed items related to establishing bank accounts for a hedge fund structure.  In general bank accounts will be established for the fund as well as the management company.  Establishing a bank account for a fund will be required when a fund’s broker requires all subscriptions and withdrawals to come from/go to a “same name” bank account.  Some managers may choose not to establish a bank account for the fund and simply have the prime broker deal with subscriptions, redemptions and fund expenses if their prime broker does not have “same name” requirements.  For the purposes of this article we generally discuss the subscription process with respect to structures where there are bank accounts for each individual fund.

Fund Administrator

The subscription process will be different if the fund utilizes a full service administrator instead of a non-full service administrator.

Full Service Fund Administration

If a fund’s administrator deals with the subscription process as well as the general accounting and NAV calculations (usually referred to as “full service” administration), then the fund manager generally will not deal with the subscription process at all.  Many times the “full service” administrator will actually establish (or work with the manager to establish) the bank and brokerage accounts and will dictate to the manager the subscription process.  Usually in these circumstances the administrator will also act as a “second signer” to add a layer of protection to the assets.  [Note: the “second signer” process essentially involves the fund administrator reviewing and approving all movements of money from the fund’s bank accounts.  While this service has been around for a number of years, it has become more common post-Madoff.]

Non- Full Service Fund Administration

For fund’s which do not have full service fund administration, the manager will be generally responsible for accepting subscription amounts and then making sure the amounts are properly moved to the brokerage account.  Generally the attorney will work with the manager to help the manager establish the proper structure and processes but managers should also discuss the process with the administrator to make sure all parties understand how the movement of subscription proceeds affect the calculation of the NAV.

Subscription Process in General

Generally the investor will wire the subscription amount to the fund’s bank account.  In the case of individual investors, subscriptions may sometimes be made by check.  Once the subscription amount has been credited to the fund’s bank account, it may either be wired to the fund’s brokerage account or it may sit there until the first

day of the trading period.*  Either the manager or the administrator (as described above) will work with the bank and broker to make sure the subscriptions are correctly transferred.

* Note: there are a number of different issues which may arise at this point including situations where the subscription is placed in the brokerage account before or after the first day of the trading period, and whether the investor will receive interest on the subscription amounts prior to the amounts being transferred to the brokerage account.  These issues should be discussed between the fund manager, administrator and lawyer prior to the fund launch.

Single Fund Structure – Domestic or Offshore Hedge Fund

In a single fund structure, whether the fund is located in the U.S. or offshore, moving subscription amounts is straight-forward.  Investors will place assets in the fund’s bank account and then the subscription amounts will be wired to the fund’s brokerage account. Generally a withdrawal is processed by a wire from the fund’s brokerage account to the fund’s bank account and then by a wire from the bank account to the withdrawing investor.  Depending on the broker, subscriptions and redemptions may be able to be effected directly between the investor and broker for credit/debit directly to the fund’s brokerage account.

Single Fund Subscription Process: Single Fund Structure Org Chart – Investor Subscription Process

Offshore Master-Feeder Hedge Funds

Offshore master-feeder funds will have process similar to the single entity fund structure process.  The general master-feeder hedge fund will have domestic taxable investors invest into a domestic feeder fund and offshore and non-taxable U.S. investors invest into an offshore feeder.  Both feeder funds will then invest directly into the master fund which ultimately makes investments directly.  A typical investment process might be: investors wire funds to the appropriate feeder fund bank account, the feeder fund then wires the subscription to the master fund bank account and from there the subscription amount would be wired to the brokerage account.  As above, withdrawals would be processed in the reverse order.

Master-Feeder Subscription Process: Master Feeder Org Chart – Investor Subscription Process

Mini-Master Hedge Funds

Mini-master hedge funds are becoming more popular because of cost considerations.  Additionally these structures can be easier to deal with from an operational perspective.  In the basic mini-master structure there will be two fund entities – an offshore fund and a domestic fund.  Then, like the traditional master-feeder structure, offshore investors and non-taxable U.S. investors will place their assets in the offshore feeder and U.S. taxable investors will place their assets in the domestic feeder.  Domestic investors will subscribe to the domestic fund which will act as the “master” fund.  From there the offshore fund will invest its assets in the domestic “master” fund, becoming in-essence an investor in the domestic fund. [Note: separate post on mini-master hedge funds to be coming soon.]

Mini-Master Fund Subscription Process: Mini-Master Org Chart – Investor Subscription Process

Other Items

The above discussion is general – each fund structure is unique and there may be certain reasons why a specific fund may have a process which is different from the discussion above.  Indeed, in many cases the administrator and broker may be able to handle subscription amounts which bypass the bank accounts or the feeder funds in master-feeder structures.  In any event, the fund manager’s operational team should work closely with the administrator to develop processes to ensure that the subscription process is seamless.  We have specifically not discussed offshore segregated portfolio companies or series LLC structures because these structures are unique and subscription processes may vary widely.

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Cole-Frieman & Mallon LLP is a hedge fund law firm which provides comprehensive formation and SEC/CFTC regulatory support to start-up and established hedge fund managers.  Please contact us if you have any questions.

Bart Mallon, Esq. can be reached directly at 415-868-5345.  Karl Cole-Frieman can be reached at 415-352-2300.