Tag Archives: hedge fund investor

Anecdotal Evidence of Strong Investor Appetite in 2017

Hedge funds to be attractive investments in new year?

By: Bart Mallon

Over the past couple of years hedge funds have seemingly taken a back seat to private equity, which has seen a significant amount of attention and inflows from institutional investors.  However, it is beginning to feel as though hedge funds are poised for a banner year – in the past two weeks we’ve received more investor due diligence inquires (confirmation of our law firm’s relationship with a manager) than we’ve had over the past six months.  Perhaps even more interesting is that investor demand is coming from all sources (fund of funds, institutional allocators, due diligence specialist firms and individual investors) and has been for potentially large subscription amounts.

Although our firm saw some managers receive major allocations from large pension funds and other investors in 2016, a high percentage of managers were seeing mild to poor interest in their products last year and it is no secret that fund launches were down significantly as well, continuing the trend of fewer fund launches over the last few years.  While to some extent investor appetite is driven by individual managers (right performance, right strategy, right time), it seems to us that we are seeing diligence inquiries that are not solely focused on the hot investment strategy du jour.  The inquiries also fall along various parts of the asset spectrum and can’t be solely classified as pertaining only to funds over say $250M AUM.

I did not expect this surge in inquiries, but I was not surprised it – in late November to early December (after the post-election market surge), we were hearing anecdotal evidence from some of our asset-raising friends that capital was ready to flow and that investors were inquiring about hedge fund products.  It seems the bullishness of late November and December has continued into this new year.  If this continues, we may see more launches in Q2 and Q3 of this year as portfolio managers decide to leave firms after bonus season, whether or not they have investors already lined up.  In any event, we hope we see both more launches in 2017 and more investment in those launches.

Here’s to the new year and my best wishes to all of you – managers, investors, allocators, compliance firms, service providers – for a fantastic 2017.

Bart Mallon
www.colefrieman.com/bart-mallon
415-868-5345

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Cole-Frieman & Mallon LLP is a boutique hedge fund law firm and provides comprehensive formation and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached 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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Hedge Fund Domain Names

Picking a domain name for your hedge fund website

Start up hedge fund managers always have the difficult task of thinking up a new, good names for their management company and hedge fund (see Naming Your Hedge Fund).  This difficulty is compounded by the fact that the desired name may not be available to use in the state which the management company resides (or with regard to the fund, in Delaware).  An added difficulty is thinking of a name that also has a good available website domain available.

Why Have a Hedge Fund Website?

Website domains are now an integral part of the hedge fund package.  Hedge fund investors are becoming more technology savvy and many communications can be done over the internet or through a website.  This means that the process of setting up a fund can potentially be more demanding (depending on the launch and the needs of the potential hedge fund investors) – not only must managers have all of the back end business operations and legal infrastructure in place, but the manager must also understand, implement and maintain an appropriate web presence.  The foundation for a strong web presence starts with the domain name.

Finding a Hedge Fund Domain Name

While we would all love to have a great one word domain name, it probably is not going to happen (unless you want to shell out a ton of cash).  Even good two word domain names are going to be taken.  To find out if a desired domain name is taken, you can go to any domain agent like www.godaddy.com.  If you search for your domain and don’t find what you are looking for, there are a couple of different options to get a domain you are happy with –

1. Modify your search parameters – if the domain you are trying to get is taken, you can change the wording of the name you are looking for.  If you cannot find a suitable

Company name: XYZ Capital Management, LLC
Desired domain: www.xyz.com  (not available)
Other options: www.xyzcapital.com, www.xyzcapitalmanagement.com, www.xyzcapitalmangementcompany.com, www.xyzcapmanagement.com, www.xyzcapitalmgmt.com, www.xyzcapmgmt.com

For other thoughts on changing the name or spelling, see this Business Week article on company domain names.

2. Buy the desired domain name – if the domain name is taken by a person or a company, you can contact that person or company directly or through a domain agent and try to purchase the domain.  I would expect that for a good domain name it will cost at least $2,000 upwards to $10,000.  Premium names of course can be sold for much higher amounts.  There are also a number of groups out there which domain squat – one group that has a number of hedge fund management company domain names is www.namethat.com.

Other notes

  • Price – the domain name will cost about $10 a year from a group like GoDaddy.
  • Length of time – I recommend buying a domain name for long period of time.  I would say the minimum length should be 5 years.
  • .com or .net? – always go with a .com domain name
  • Compliance – there are no compliance issues which jump out at me right away, but I will keep thinking of this issue.  Obviously if you host a website at the domain you will need to make sure that all marketing done is within the rules, see Hedge Fund Website Rules
  • Hosting – there are a number of ways you can host your domain name and I will be dealing with this issue in a later article on technology for hedge fund managers

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Please contact us if you have any questions or would like to  learn how to start a hedge fund.  Other related hedge fund law articles include:

Bay Area Hedge Fund Roundtable Event

Panel Discussion on State of Hedge Fund Industry

Yesterday afternoon (May 6th) the Bay Area Hedge Fund Roundtable, a group of professionals within the hedge fund industry, gathered for a panel presentation entitled “Change…Critical Legal, Tax, Acounting and Regulatory Updates You Need to Know.”  The presentation was moderated by Pamela S. Nichter (Osterweis Capital Management) and included the following panel participants:

Vincent J. Calcagno (Rothstein Kass)
Geoffrey Haynes (Shartsis Friese)
Tony Hassan (Ernst & Young)
Anita K. Krug (Howard Rice)

Presentations like these are great because they allow professionals to share insights into what is going on in different parts of the industry – many of the topics discussed allowed the panelists to really dig deep into the issues and provide some context to what is happening at both the regulatory and investor levels.  I took notes during the presentation and will summarize some of the main points discussed by each of the presenters (please don’t hold anything against the speakers if I mis-paraphrase or mis-interpret and as always nothing in this summary is tax or legal advice)…

Anita K. Krug

Anita discussed a number of the laws which have been discussed or proposed over the past 6 to 8 months including the following:

  • Barney Frank’s Recent Comments (see Reuters article)
  • Mary Shapiro’s Recent Comments (see Bloomberg article where Shapiro says she wants the ability to make rules regulating hedge funds)
  • Discussion of the Hedge Fund Transparency Act which was proposed in the Senate earlier this year (see also Overview of the Hedge Fund Transparency Act)
  • Hedge Fund Advisor Registration Act which was proposed in the House earlier this year
  • Geithner’s hedge fund proposals (see NY Times article for background information)
  • Discussion of the past short selling rules (see HFLB article) and the new short selling rules which will be closer to the old “uptick” rule (see SEC overview; note: I have not yet had an opportunity to thoroughly review these proposed rules)
  • European Rules which have been proposed which may have an effect on US based managers with EU investors (Anita raised many of the same issues which were also raised in this article)

Geoffrey Haynes and Vincent J. Calcagno

Geoffrey and Vincent went back and forth discussing some of the tax issues which managers are likely to face this year and potentially going forward.  This discussion included the following issues:

  • Discussion of the new offshore deferral rules by dint of new Section 457A of the Internal Revenue Code (see generally this alert).  Note: discussions on the ramifications of this new section to managers who currently have deferral arrangements took a majority of the time.  There are a number of issues involved including issues with side pockets, options, and non-conventional performance fee periods.
  • San Francisco Payroll Tax of 1.5% (see background on this issue here)
  • Discussion of the Levin proposal to tax the carried interest as ordinary income (see Hedge Fund Carried Tax Increase?).  [The panelists seemed to think that Congress would not vote on this bill until sometime in 2010 (if the bill was actually even voted on) with an effective date, if passed, of sometime in 2010 – the panelists did not seem to think it would be retroactively applied.]
  • Discussion of a bill which would eliminate UBTI for U.S. based non-taxable investors investing in U.S. hedge funds which utilize leverage (note: I was not aware of this bill and am not sure what bill exactly was referred to – please feel free to contact me if you know about this bill).  The panelists seemed to think this bill was likely DOA.
  • Discussion of the Stop Tax Haven Abuse Bill by Senator Levin (see Senator Levin’s press release)
  • Discussion of Obama’s Offshore Tax Plan (see generally the White House press release)

Tony Hassan

Tony discusses what is changing in the area of hedge fund operations.  Tony’s discussion of current topics was maybe one of the more important parts of the panel in terms of providing insight on current investing trends and due diligence requests.  Many of the items in this section were part of a dialogue between Tony and Vince as noted in the parenthesis below.

  • There is no secret that due diligence is a more central and important part of the investing process than it was previously.  (Tony and Vince)
  • Due diligence is also changing in many respects – at E&Y Tony has had specific requests from potential invests to send them directly the financial statements.  Of course this brings up many legal and client issues (the hedge fund, not the potential investor, is the client of E&Y) and because of this these requests are often denied. (Vince)
  • Managers are providing verified transparency “quarterly reviews” which aim to show investors that the fund’s assets are actually there.  (Vince)
  • Some funds are instituting a half-yearly audit (in addition to the end of year audit).  (Vince)
  • Some funds are instituting agreed upon procedure reports.  In these reports the auditor will come in an verify that certain procedures are being completed.  This may be especially important with regard to the valuation of the fund’s assets.  (Vince)
  • Tony noted that this is really a new form of due diligence and used the term “Hedge Fund Due Diligence 2.0” – a term I used in October of 2008 (see post).
  • Investor questions to hedge funds are changing.  While previous questions would have stopped after “Do you have a 3rd party administrator?”  Now the questioning continues – investors want to know about the administrators technical expertise, who exactly will be the account representative and what type of capital markets experience does that person or group have, what inputs will be used to value assets, etc.  Investors also want to know what sort of contingency plan is in place should the administrator fail or if there is a disaster; investors will want to know if the fund is keeping shadow books.  (Tony)
  • Tony also participated in the discussion with Pamela below with regard to managed accounts.

Pamela S. Nichter

Pamela, the moderator of the discussion, also weighted in on certain operational issues which fund managers should be prepared for in the new climate.  In general Ms. Nichter is seeing more investor requests and communications.  Now there is greater communication between the investor and the fund manager.  Ms. Nichter also discussed the trend toward greater liquidity and transparency through separate account structures.

Separate accounts are something that more and more investors are seeking but there are many considerations for managers.  Specifically separate accounts can be a drain on resources, especially if the investors request their own specific administrators or auditors.  Because of the greater amount of resources which need to go into the back office to handle what is in essence a more traditional asset management business, the manager must be ready to change the business model to a certain extent.  Specific issues will include:

  • having a robust trade allocation policy
  • understanding that there is likely to be a disparity of performance
  • potential registration issues
  • potential integration issues
  • performance reporting issues (may need to go back to GIPS)

Questions and Conclusion

After the panel finished their discussion the floor was open to questions.  During this time there were a number of good questions.  One issue focused on what will performance fees look like going forward which led to a discussion about creative performance fees (like instituting some sort of clawback provision like what is found in private equity funds).  Another issue was whether and to what extent the Managed Funds Association will be representing the industry during this time of legislative/regulatory changes.  The answer is that the MFA will be doing everything it possibly can to represent the hedge fund industry and it is our job to make sure that the MFA knows how the industry feels about many of the current legislative proposals.

Accredited Investor Net Worth Question

Most hedge funds will require investors to be “accredited investors.”  In general, a natural person is deemed to be an accredited investor if (1) the natural person has an individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase (i.e. investment into the hedge fund) or (2) the natural person has an income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year. (See generally Accredited Investor Definition.)

One common question is “does net worth include the equity a person has in their personal residence?”  The answer is yes. The SEC specifically addressed this question in their Interpretive Release On Regulation D.  Below is the actual text from the release which is applicable to this question:

(21) Question: In calculating net worth for purposes of Rule 501(a)(6), may the investor include the estimated fair market value of his principal residence as an asset?

Answer: Yes. Rule 501(a)(6) does not exclude any of the purchaser’s assets from the net worth needed to qualify as an accredited investor.

Note the difference between accredited investors and qualified purchasers with respect to this issue.  Individuals cannot include equity in their personal residence for the purpose of meeting the “qualified purchaser” definition.

Please contact us if you have a question on this issue or if you would like to start a hedge fund.  If you would like more information, please see our articles on starting a hedge fund.  Other related hedge fund law articles include:

Secondary Hedge Fund Market

Company Promotes Secondary Hedge Fund Trading

Some hedge funds, for a number of potential reasons, are closed for further investment by outside investors.  In these cases outside investors can try to get into the funds organically or they can enter the fund through the secondary hedge fund market.  In the secondary market, interests in a hedge fund are sold by withdrawing investors to investors who want to get into the fund.  There are many reasons why an investor would choose to sell through the secondary market instead of simply redeeming.  The most obvious is that the investor needs immediate liquidity.  While there is a small secondary market in hedge fund interests, it is not always easy to find investors wishing to sell on the secondary market.  Continue reading

How to Invest in a Hedge Fund

Hedge Fund Investors Guide

Many potential hedge fund investors come to this website for information on how to invest in a hedge fund.  While there are many headlines and resources for hedge fund managers, there are fewer resources out there for hedge fund investors.  This article will provide an overview of how to go about investing in a hedge fund. Continue reading

Alabama Hedge Fund Law – Regulation D Filings

In our continuing effort to expand our hedge fund law resources on this blog, we will be posting statutes and other legal resources from each of the states.  Because each state has different laws and enforces those laws differently, hedge fund lawyers often discuss state specific hedge fund issues with the securities division prior to providing advice to clients.  The post below provides information on Alabama’s regulation D requirements.  Please contact us if you would like to establish an Alabama hedge fund or have questions on Alabama investment advisory issues. Continue reading

Hedge Fund Due Diligence 2.0

We hear about the “web 2.0” and today’s San Francisco Chronicle used the term “Wall Street 2.0” which made me wonder what the hedge fund industry will look like after this mess clears itself over the next couple of months.  First, it is obvious that there is going to be government regulation of some sort over the hedge fund industry which I will be detailing over the coming weeks and months.  Additionally, investors are going to need to take proactive steps to protect their investments and hedge fund due diligence will become a greater part of the hedge fund industry – I’m dubbing this “Hedge Fund Due Diligence 2.0”.

Hedge Fund Due Diligence 2.0 is likely to include more questions on the hedge fund manager’s business acumen and operations.  The current crisis has showed us, in numerous circumstances, that hedge fund managers were simply not prepared to handle a complete market crisis.  Hedge fund managers already have to answer in depth questions relating to risk management policies and procedures, but these questions will likely become more in depth.  Specifically, Hedge Fund Due Diligence 2.0 will likely inquire into a manager’s specific cash management policies.  While this might be viewed as digging into the manager’s operational business (as opposed to just the managers performance results), it is necessary to protect an investor’s investment in the event that a high watermark provision is implicated.

More to come on this topic …

What is a qualified purchaser?

We have previously discussed the difference between a 3(c)(1) hedge fund and a 3(c)(7) hedge fund. Unlike a 3(c)(1) hedge fund where investors only generally need to be accredited investors and potentially qualified clients, all investors in a 3(c)(7) hedge fund must be “qualified purchasers.” A qualified purchaser is a greater requirement than an accredited investor and a qualified client. Generally only super high net worth individuals and institutional investors will fit within the definition of qualified purchaser. Because of this fact, there are fewer 3(c)(7) hedge funds than 3(c)(1) hedge funds. Also, most 3(c)(7) funds are going to be funds with greater intial investment requirements and will be marketed towards the institutional market. Because of this, 3(c)(7) hedge funds will tend to have greater assets than many 3(c)(1) hedge funds.

The definition of “qualified purchaser” is found in the Investment Company Act of 1940. The definition includes:

i. any natural person (including any person who holds a joint, community property, or other similar shared ownership interest in an issuer that is excepted under section 3(c)(7) with that person’s qualified purchaser spouse) who owns not less than $ 5,000,000 in investments, as defined below;

ii. any company that owns not less than $ 5,000,000 in investments and that is owned directly or indirectly by or for 2 or more natural persons who are related as siblings or spouse (including former spouses), or direct lineal descendants by birth or adoption, spouses of such persons, the estates of such persons, or foundations, charitable organizations, or trusts established by or for the benefit of such persons;

iii. any trust that is not covered by clause (ii) and that was not formed for the specific purpose of acquiring the securities offered, as to which the trustee or other person authorized to make decisions with respect to the trust, and each settlor or other person who has contributed assets to the trust, is a person described in clause (i), (ii), or (iv); or

iv. any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $ 25,000,000 in investments.

v. any qualified institutional buyer as defined in Rule 144A under the Securities Act, acting for its own account, the account of another qualified institutional buyer, or the account of a qualified purchaser, provided that (i) a dealer described in paragraph (a)(1)(ii) of Rule 144A shall own and invest on a discretionary basis at least $25,000,000 in securities of issuers that are not affiliated persons of the dealer; and (ii) a plan referred to in paragraph (a)(1)(D) or (a)(1)(E) of Rule 144A, or a trust fund referred to in paragraph (a)(1)(F) of Rule 144A that holds the assets of such a plan, will not be deemed to be acting for its own account if investment decisions with respect to the plan are made by the beneficiaries of the plan, except with respect to investment decisions made solely by the fiduciary, trustee or sponsor of such plan;

vi. any company that, but for the exceptions provided for in Sections 3(c)(1) or 3(c)(7) under the ICA, would be an investment company (hereafter in this paragraph referred to as an “excepted investment company”), provided that all beneficial owners of its outstanding securities (other than short-term paper), determined in accordance with Section 3(c)(1)(A) thereunder, that acquired such securities on or before April 30, 1996 (hereafter in this paragraph referred to as “pre-amendment beneficial owners”), and all pre-amendment beneficial owners of the outstanding securities (other than short-term paper) or any excepted investment company that, directly or indirectly, owns any outstanding securities of such excepted investment company, have consented to its treatment as a qualified purchaser.

vii. any natural person who is deemed to be a “knowledgeable employee” of the [fund], as such term is defined in Rule 3c-5(4) of the ICA; or

viii. any person (“Transferee”) who acquires Interests from a person (“Transferor”) that is (or was) a qualified purchaser other than the [fund], provided that the Transferee is: (i) the estate of the Transferor; (ii) a person who acquires the Interests as a gift or bequest pursuant to an agreement relating to a legal separation or divorce; or (iii) a company established by the Transferor exclusively for the benefit of (or owned exclusively by) the Transferor and the persons specified in this paragraph.

ix. any company, if each beneficial owner of the company’s securities is a qualified purchaser.
For the purpsoes of above, the term Investments means:

(1) securities (as defined by section 2(a)(1)of the Securities Act of 1933), other than securities of an issuer that controls, is controlled by, or is under common control with, the prospective qualified purchaser that owns such securities, unless the issuer of such securities is: (i) an investment vehicle; (ii) a public company; or (iii) a company with shareholders’ equity of not less than $50 million (determined in accordance with generally accepted accounting principles) as reflected on the company’s most recent financial statements, provided that such financial statements present the information as of a date within 16 months preceding the date on which the prospective qualified purchaser acquires the securities of a Section 3(c)(7) Company;

(2) real estate held for investment purposes;

(3) commodity interests held for investment purposes;

(4) physical commodities held for investment purposes;

(5) to the extent not securities, financial contracts (as such term is defined in section 3(c)(2)(B)(ii) of the ICA entered into for investment purposes;

(6) in the case of a prospective qualified purchaser that is a Section 3(c)(7) Company, a company that would be an investment company but for the exclusion provided by section 3(c)(1) of the ICA, or a commodity pool, any amounts payable to such prospective qualified purchaser pursuant to a firm agreement or similar binding commitment pursuant to which a person has agreed to acquire an interest in, or make capital contributions to, the prospective qualified purchaser upon the demand of the prospective qualified purchaser; and

(7) cash and cash equivalents (including foreign currencies) held for investment purposes. For purposes of this section, cash and cash equivalents include: (i) bank deposits, certificates of deposit, bankers acceptances and similar bank instruments held for investment purposes; and (ii) the net cash surrender value of an insurance policy.