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Overview of U.S. Hedge Fund Law In the United States, hedge funds are regulated under Regulation D of the Securities Act of 1933. However, there is an exemption that allows you to make a private placement of your hedge fund without having to register the security with the U.S. Securitiesand Exchange Commission (SEC) and each state (an expensive and time-consuming process). The attorneys that create your offering documents will ensure that the disclosures in the documents will allow you to achieve this exemption. The exemption is great news, and all the states honor this exemption from registration.
If you desire the exemption, you probably want to form what is known as a Section 3(c)(1) fund (from the Investment Company Act of 1940). That kind of a fund allows you to have fewer than 100 investors, up to 35 of whom can be non-accredited investors. A typical hedge fund manager has only one client - the hedge fund. The individuals that buy into the hedge fund are the investors. Hedge funds and their advisers are governed primarily by the Investment Company Act of 1940, the Securities Act of 1933 and the Investment Advisers Act of 1940.
Securities Act of 1933 Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives: require that investors receive financial and other significant information concerning securities being offered for public sale; and prohibit deceit, misrepresentations, and other fraud in the sale of securities. Section 5 of the Securities Act mandates the registration with the SEC of public securities offerings and the delivery to purchasers of a prospectus containing specified categories of information about the issuer and the securities being offered, unless there is an available exemption from the registration requirements. Since limited partnership, LLC and other interests offered to investors in the case of a typical hedge fund fall within the definition of the term “securities” for purposes of the federal securities laws, the hedge funds must either register the offer and sale of the securities or rely on an exemption from registration. Offerings of hedge fund securities in the United States generally rely on the private offering exemption in Section 4(2) of the Securities Act or Rule 506 promulgated under that Section to avoid the registration and prospectus delivery requirements of Section 5.
The Private Offering Exemption of the Securities Act Section 4(2) of the Securities Act exempts from the registration and prospectus delivery requirements of Section 5 any “transactions by an issuer not involving any public offering.” The Section 4(2) exemption, commonly known as the “private offering” or “private placement” exemption, requires no notice or other filing or regulatory approval as a prerequisite for its availability.
Regulation D and Rule 506 Rule 506 of Regulation D under the Securities Act is a set of requirements issued by the SEC to govern hedge funds. Although compliance with the Rule 506 requirements is not required to establish the availability of a private offering exemption, satisfaction of the conditions of the rule entitles an issuer to claim the Section 4(2) exemption. In this sense, Rule 506 establishes “safe harbor” criteria for the private offering exemption, but is not the exclusive means of establishing entitlement to the exemption. Because of a degree of uncertainty as to the availability of the Section 4(2) exemption, many hedge funds tailor their offering and sale procedures to the criteria specified in Rule 506.
Investment Advisers Act of 1940 This law regulates investment advisers. With certain exceptions, this Act requires that firms or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors.
Investment Company Act of 1940 This Act regulates the organization of companies, including mutual funds, that engage primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The regulation is designed to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations. It is important to remember that the Act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments. Most hedge funds have substantial investments in securities that would cause them to fall within the definition of investment company under the Investment Company Act. Hedge funds, however, typically rely on one of two statutory exclusions from the definition of investment company, which enables them to avoid the regulatory provisions of that Act.
Section 3(c)(1) Exclusion Section 3(c)(1) of the Investment Company Act excludes from the definition of investment company any issuer whose outstanding securities are beneficially owned by not more than 100 investors and which does make a public offering of its securities. Hedge funds relying on Section 3(c)(1) may not make a public offering. These hedge funds must comply with Section 4(2) of the Securities Act, and frequently do so by relying on the safe harbor available under Regulation D under that Act. Consequently, hedge funds may offer their securities only to “accredited investors,” and may not engage in any general solicitation or general advertising of their shares.
Section 3(c)(7) Exclusion Section 3(c)(7) of the Investment Company Act excludes from the definition of investment company any issuer whose outstanding securities are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers,” and which is not making a public offering of its securities. A hedge fund relying on Section 3(c)(7) may accept an unlimited number of qualified purchasers for investment in the fund. As a practical matter, however, most funds relying on Section 3(c)(7) have no more than 499 investors in order to avoid the registration and reporting requirements of the Securities Exchange Act of 1934 (“Exchange Act”).
Section 3(c)(7) Qualified Purchasers Section 2(a)(51) of the Investment Company Act generally define qualified purchaser” to be: (1) any natural person who owns not less than $5 million in investments; (2) any family-owned company (as described in that section) that owns not less than $5 million in investments; (3) any other trust the trustee and settlor(s) of which are qualified purchasers that was not formed for the specific purpose of acquiring the securities of the Section 3(c)(7) fund; and (4) any person acting for its own account or the accounts of other qualified purchasers, that owns and invests on a discretionary basis not less than $25 million in investments.
Offerings to Accredited Investors The safe harbor protection most often relied upon by hedge funds under Rule 506 exempts offerings that are made exclusively to “accredited investors.” While Rule 506(b)(2)(i) limits the number of purchasers in a Rule 506 transaction to 35, this numerical limitation becomes irrelevant if the offering is made only to “accredited investors” because Rule 501(e)(1)(iv) provides that “accredited investors” are not counted for purposes of determining whether the issuer has exceeded the 35-purchaser limit. Issuers are permitted under these provisions to sell securities to an unlimited number of “accredited investors.” In addition, if the offering is made only to accredited investors, no specific information is required to be provided to prospective investors.
Hannah Terhune Interview with Real World Trading Hi, My name is Dave Goodboy. I am executive producer of Real World Trading. Traders and money managers often dream about one day running their own hedge fund, managing large sums of money, and competing head to head with the world’s top traders. For many, this dream remains an unfulfilled desire since they really don’t know where to begin. My guest this week will answer your questions, simplify this often complex subject, and point you in the right direction. Hannah Terhune is chief attorney and member manager of Capital Management Services Group.com, Inc. Get ready for a tours de force education!
Dave: Greetings Hannah, Thank you for joining me today. Let’s start right at the beginning. Exactly what is a hedge fund?
Hannah: Although there is no universally accepted definition of the term hedge fund,” the term generally is used to refer to an entity that holds a pool of securities and perhaps other assets, whose interests are not sold in a registered public offering and which are not registered as an investment company under the Investment Company Act. Alfred Winslow Jones is credited with establishing one of the first hedge funds as a private partnership in 1949. That hedge fund invested in equities and used leverage and short selling to “hedge” the portfolio’s exposure to movements of the corporate equity markets. Over time, hedge funds began to diversify their investment portfolios to include other financial instruments and engage in a wider variety of investment strategies. Today, in addition to trading equities, hedge funds may trade fixed income securities, convertible securities, currencies, exchange-traded futures, over-the-counter derivatives, futures contracts, commodity options and other non-securities investments. Furthermore, hedge funds today may or may not utilize the hedging and arbitrage strategies that hedge funds historically employed, and many engage in relatively traditional, long-only equity strategies. In short, the term generally identifies an entity that holds a pool of securities and perhaps other assets that does not register its securities offerings under the Securities Act and which is not registered as an investment company under the Investment Company Act. Hedge funds are also characterized by their fee structure, which compensates the adviser based upon a percentage of the hedge fund’s capital gains and capital appreciation. Hedge fund advisory personnel often invest significant amounts of their own money into the hedge funds that they manage. As discussed in the Report, although similar to hedge funds, there are other unregistered pools of investments, including venture capital funds, private equity funds and commodity pools that generally are not categorized as hedge funds. Hedge funds are often compared to registered investment companies. In addition, unregistered investment pools, such as venture capital funds, private equity funds and commodity pools, are sometimes referred to as hedge funds. Although all of these investment vehicles are similar in that they accept investors’ money and generally invest it on a collective basis, they also have characteristics that distinguish them from hedge funds.
Dave: When did this concept originate? Briefly, what’s the history? Hannah: Hedge funds, while representing a relatively small portion of the U.S. financial markets, have grown significantly in size and influence in recent years. The SEC recognized over 30 years ago that hedge fund trading raises special concerns with respect to their impact on the securities markets. The growth in hedge funds has been fueled primarily by the increased interest of institutional investors such as pension plans, endowments and foundations seeking to diversify their portfolios with investments in vehicles that feature absolute return strategies – flexible investment strategies which hedge fund advisers use to pursue positive returns in both declining and rising securities markets, while generally attempting to protect investment principal. In addition, funds of hedge funds (“FOHF”), which invest substantially all of their assets in other hedge funds, have also fueled this growth.
Dave: What are the parts of a hedge fund? Hannah: The parts of a hedge fund include the private placement memorandum, the subscription agreement, and the operating agreement for the fund. Hedge fund advisers typically provide information to investors during an investor’s initial due diligence review of the fund, although some, more proprietary, information may not be provided until after the investor has made a capital commitment to the fund, if at all. Most hedge funds provide written information to their investors in the form of a private offering memorandum or private placement memorandum (“PPM”). This reflects market practice and the expectations of the sophisticated investors who typically invest in hedge funds. It also reflects the realization of the sponsors and their attorneys that the exemptions from the registration and prospectus delivery provisions of Section 5 of the Securities Act available under Section 4(2) of the Securities Act and Rule 506 there under do not extend to the antifraud provisions of the federal securities laws. The disclosures furnished to investors serve as protection to the principals against liability under the antifraud provisions. Some of the information may be disclosed less formally in one-on-one conversations between investors and the hedge fund adviser. Hedge fund advisers may also provide information to hedge fund investors in the form of letters, conference calls and financial statements. In addition, some hedge fund advisers may provide prospective investors with access to their prime brokers and other service providers, such as administrators, both during the investor’s initial due diligence of the hedge fund and subsequently.
Hedge fund investors must often spend significant resources, frequently hiring a consultant or a private investigation firm, to discover or verify information about the background and reputation of a hedge fund adviser. In practice, even very large and sophisticated investors often have little leverage in setting terms of their investment and accessing information about hedge funds and their advisers. As a matter of practice, hedge funds generally provide investors with a PPM before an investment is made. As with any other offering solely to accredited investors, there are no specific disclosure requirements that pertain to the PPM under Section 4(2) or Rule 506. While we are not passing on the adequacy and content of PPM disclosure generally, we note that certain basic information about the hedge fund’s adviser and the hedge fund is typically disclosed. The information disclosed in PPMs varies from adviser to adviser, however, and often is general in scope. PPMs generally discuss in broad terms the fund’s investment strategies and practices. They also typically disclose that the hedge fund’s investment adviser may invest fund assets in illiquid, difficult-to-value securities and that the adviser reserves the discretion to value such securities as it believes appropriate under the circumstances. The PPM also may disclose that the adviser may exercise its discretion to invest fund assets outside the stated strategy or strategies. PPMs also generally discuss qualifications and procedures for a prospective investor to become a limited partner, as well as provide information about the hedge fund’s operations. For example, PPMs generally discuss fund expenses, allocations of gains and losses, tax aspects of investing in the fund and may incorporate the hedge fund’s financial statements. PPMs disclose any lock-up period that new investors must observe, as well as laying out the specifics for when investors will be able to redeem some or all of their investments out of the hedge fund. PPMs also may name frequently used service providers to the fund. PPMs may generally disclose potential conflicts of interest to investors, frequently under the heading of “risk factors.” A hedge fund’s PPM may note that the fund’s valuation practices give rise to an inherent conflict of interest because the level of fees that the investment adviser earns is based on the value of the fund’s portfolio holdings as determined by the fund’s adviser. PPMs also may discuss potential conflicts arising from the adviser’s “side-by-side management” of multiple accounts, including the hedge fund, private accounts, proprietary accounts and registered investment companies. A hedge fund’s PPM may also disclose the investment adviser’s conflicts in allocating its time and certain investment opportunities among its clients. Some PPMs spell out allocation policies with respect to limited investment opportunities in great detail, while others may list, and only briefly discuss, the factors on which such allocations will be decided. PPMs also often provide information concerning the use of affiliated services providers, including affiliated broker-dealers. Some PPMs also may note that the hedge fund may direct brokerage business to, and use other services of, firms that introduce investors to the fund. PPMs may disclose that the adviser may use soft dollars to pay for research and other services used by the adviser to benefit other accounts that it manages, and may further disclose that soft dollars.
Dave: Are these documents boiler plate or created individually for each fund?
Hannah: They are created individually for each client.
Dave: Does this paperwork need to be filed with the SEC or anyone? Hannah: Form D is filed with the SEC and other forms may be required to be filed with each state where investors are located.
Dave: What is the definition of “accredited investor”? Hannah: The safe harbor protection most often relied upon by hedge funds under Rule 506 exempts offerings that are made exclusively to “accredited investors.” Issuers are permitted under these provisions to sell securities to an unlimited number of “accredited investors.” In addition, if the offering is made only to accredited investors, no specific information is required to be provided to prospective investors. The term “accredited investors” is defined to include: Individuals who have a net worth, or joint worth with their spouse, above $1,000,000, or have income above $200,000 in the last two years (or joint income with their spouse above $300,000) and a reasonable expectation of reaching the same income level in the year of investment; or are directors, officers or general partners of the hedge fund or its general partner; and Certain institutional investors, including: banks; savings and loan associations; registered brokers, dealers and investment companies; licensed small business investment companies; corporations, partnerships, limited liability companies and business trusts with more than $5,000,000 in assets; and many, if not most, employee benefit plans and trusts with more than $5,000,000 in assets.
Dave: Does everyone who invests in a hedge fund need to be an “accredited investor” or high net worth individual? Hannah: No.
Dave: I have several friends who would love to invest in a hedge fund, but don’t meet the above criteria. Is there anyway around the regulation? Hannah: Yes, non accredited investors can invest in a hedge fund. It depends on the fund manager’s discretion.
Dave: Does the manager need to have a Series 7 or other licenses? Hannah: No, a Series 7 is not relevant to this discussion.
Dave: How about registration? Does the manager need to register with the SEC? Hannah: Yes, in certain cases, given recent law changes.
Dave: Does the manager need to register in the state the fund is domiciled in? Hannah: Form D needs to filed with the SEC.
Dave: What about the funds trader (s). Do they need to register with anyone? Hannah: Yes, in certain cases. This requires a state-by-state determination.
Dave: What if the investors are from different states? Does the manager need to register in every state an investor is from? Hannah: Yes, usually a notice filing is required as long as they are registered in another state or with the SEC.
Dave: Is this in all cases? What about very small start up funds? Hannah: It depends on the state and the structure the fund manager opts to use.
Dave: Is there anyway to legally avoid registration? Hannah: You either have to register or you fall within an exemption.
Dave: If the manager is a CTA does he still need to register as a fund manager? Hannah: The difference between a CPO and a CTA is that a CTA manages individual accounts, while a CPO manages only the hedge fund, or Pool. Few of our clients remain interested in the CTA option once they realize the administrative hassle associated with managing the separate accounts. No sponsor is needed to take the Series 3 exam. The Series 3 exam is given under the auspices of the NASD’s testing program. Two different testing services provide their services to the NASD. Unlike a traditional hedge fund (where the SEC may end up being a regulator if enough money is under management), the government regulator that may associated with CPOs is the CFTC—the Commodity Futures Trading Commission.
The CFTC has allowed the National Futures Association (NFA) to become the primary regulator of futures and commodity products (as a Self-Regulatory Organization, similar to the NASD’s status with the SEC). It is my opinion that the NFA is a very effective and competent regulator.
Dave: How about if the manager has a series 7. Is registration still required? Hannah: A Series 7 is of no particular value to either an RIA or a CPO. If someone has a current Series 7 (they’ve been registered within the past two years with a broker/dealer), they can choose to take the Series 66 instead of the Series 65. The Series 7 plus the Series 66 is always (in all states) equivalent to the Series 65. After two years of not being with a broker/dealer, all prior registrations (such as a Series 7) expire and are no longer valid. Similarly, if someone previously passed the Series 65 but has not had it registered with either a broker/dealer or an investment advisory firm, the exam has expired and will need to be taken again. Some states will not consider someone for investment advisory status unless they were previously registered as a Series 7 with a broker/dealer.
Dave: Is there a minimum capital amount that you feel is needed before launch? Hannah: No.
Dave: What about someone who does not have any investors yet, who just wants to set up the fund structure for the future? Set up an incubator fund? I know your firm runs some type of “hedge fund incubator” Can you explain what this is? Hannah: It’s a start up process for a prospective fund manager to develop and document a track record that could be legally marketed to prospective investors when he or she is ready to open the fund to outside investors.
Dave: Do you actually do capital introductions? Hannah: Yes, often, as a professional courtesy to our clients. We do not accept referral fees from non lawyers, as we are prohibited from accepting such fees by the rules governing the practice of law. We have an extensive network of contacts worldwide. We endeavor to set up our clients for success and look toward a long term relationship as well as build global relationships.
Dave: How about hooking a fledging manager up with a prime broker? Hannah: Yes, as a professional courtesy to our clients. We do not accept referral fees from non lawyers, as we are prohibited from accepting such fees by the rules governing the practice of law. We have an extensive network of contacts worldwide. We endeavor to set up our clients for success and look toward a long term relationship.
Dave: I see, your firm is really a “one stop shop”. Do you do the back office stuff too? Hannah: Yes, of course.
Dave: While we are on this topic, what is a “back office”? Hannah: Many clients are accustomed to being one-person businesses, trading from their home office. They are interested in trading for others to leverage their knowledge and make more money, but they don't want to change how they work. They don't want to have to hire accountants and secretaries, or rent an office or gain tons of paperwork. They don't want to spend their days with attorneys, accountants, consultants and business operation hassles. We provide a full service, virtual Web-based and e-commerce solution takes all the hassle out of entering the hedge fund business. Clients can continue working from home, without any of the above mentioned hassles. We handle all of the charges to your investors for the management fees and the performance allocations as well as prepares the statements for investors. Most of clients use our hedge fund accounting services on a monthly basis; others on a weekly, quarterly, annually basis, or whenever they like. The work product includes NAV, performance records, brokerage statement reconciliation, advisory fee billing, performance allocation, investor changes, and other related reports generated from the software programs.
Dave: When the fund grows, are there capital levels or partner numbers that need to be watched? What I mean is, is there additional regulation, registration, et al on a 100 million dollar fund than there is on a 250k startup? Hannah: No.
Dave: Recently, I have noticed a proliferation of off shore funds. What exactly is an off shore fund? What reasons would a manager want to set up an off shore fund? Hannah: The word “offshore” has a certain mystique to many. Offshore hedge funds are investment vehicles organized in offshore financial centers (“OFC”). OFCs are countries that cater to the establishment and administration of mutual and hedge funds (“funds”). Offshore funds offer securities primarily to non-U.S. investors and to U.S. tax-exempt investors (e.g., retirement plans, pension plans, universities, hospitals, etc.). U.S. money managers who have significant potential investors outside the United States and tax-exempt investors typically create offshore funds. In many OFCs, the low costs setting up a company along with a kind tax environment make them attractive to establishing funds. Offshore hedge funds are typically organized as corporations in countries such as the Cayman Islands, British Virgin Islands, the Bahamas, Panama, the Netherlands Antilles or Bermuda. Offshore funds generally attract investment of U.S. tax-exempt entities, such as pension funds, charitable trusts, foundations and endowments, as well as non-U.S. residents. U.S. tax-exempt investors favor investments in offshore hedge funds because they may be subject to taxation if they invest in domestic limited partnership hedge funds. Offshore hedge funds may be organized by foreign financial institutions or by U.S. financial institutions or their affiliates. Sales of interests in the United States in offshore hedge funds are subject to the registration and antifraud provisions of the federal securities laws. Offshore hedge funds typically contract with an investment adviser, which may employ a U.S. entity to serve as sub adviser. An offshore hedge fund often has an independent fund administrator, also located offshore, that may assist the hedge fund’s adviser to value securities and calculate the fund’s net asset value, maintain fund records, process investor transactions, handle fund accounting and perform other services. An offshore hedge fund sponsor typically appoints a board of directors to provide oversight activities for the fund. These funds, especially those formed more recently, may have directors who are independent of the investment adviser.
Dave: Sounds like a good way to avoid taxes. Does the manager of a fund domiciled off shore still need to pay capital gain taxes, etc? Hannah: The Do’s and Don’t of offshore funds are can be summed up as follows:
Do: Consider setting up an offshore fund is you manage money for either foreign and/or U.S. tax-exempt individuals and businesses. Under U.S. income tax laws, a tax-exempt organization (such as an ERISA plan, a foundation or an endowment) engaging in an investment strategy that involves borrowing money is liable for a tax on “unrelated business taxable income” (“UBTI”), notwithstanding its tax-exempt status. The UBTI tax can be avoided by the tax-exempt entity by investing in non-U.S. corporate structures (i.e., offshore hedge funds).
Don’t: Go offshore to avoid U.S. taxation. This is the wrong reason to consider an offshore fund. In short, setting up an offshore fund is not a tax minimization strategy as U.S. citizens, resident aliens (e.g., green card holders) are taxable on their worldwide income. The U.S. tax results depend on the nationality and domicile of the fund manager and his or her management company.
Dave: Am I able to set up an off shore fund without ever even visiting the country? Hannah: Yes, of course. Our firm liaisons with foreign legal counsel. Everything is handled on a turnkey basis. You don’t need to stop trading or take a break from the markets. Just call us as we will work around your trading schedule.
Dave: What countries are most hospitable to off shore funds? Hannah: Investment fund managers typically create offshore funds in Caribbean OFCs, although a European offshore entity may be more appropriate if a significant number of European investors are involved. Funds legally domiciled in OFCs hold around half of the hedge fund assets reported by the TASS hedge fund data base, with the British Virgin Island and the Cayman Islands being the most popular location. It has been estimated that over half of the world’s funds are incorporated in the British Virgin Islands However, management of funds is often conducted in or near major international financial centers such as London and New York although the actual fund is registered in an OFC. Ask where a hedge fund is domiciled and you are likely to hear the name of a handful of places worldwide. In the United States, domestic hedge fund businesses tend to cluster in a few states, in particular California, Delaware, Connecticut, Illinois, New Jersey, New York and Texas. Each state has different tax and regulatory laws. Outside the United States, several centers in the Caribbean and Europe present different benefits and costs to fund managers. Regulatory burdens and expenses can be worth bearing, depending on the nature of the investment vehicle and its clients.
Dave: Is there anywhere you would avoid and why? Hannah: Any country lacking monetary or political stability.
Dave: Moving onto the next structure. Master-Feeder funds. What are they? Hannah: The corporate structure of a hedge fund depends primarily on whether the fund is organized under U.S. law (“domestic hedge fund”) or under foreign law and located outside of the United States (“offshore hedge fund”). The investment adviser of a domestic hedge fund often operates a related offshore hedge fund, either as a separate hedge fund or often by employing a “master-feeder” structure that allows for the unified management of multiple pools of assets for investors in different taxable categories. The master/feeder fund structure allows the investment manager to collectively manage money for varying types of investors in different investment vehicles without having to allocate trades and while producing similar performance returns for the same strategies. Feeder funds invest fund assets in a master fund that has the same investment strategy as the feeder fund. The master fund, structured as a partnership, engages in all trading activity. In today's trading environment, a master/feeder structure will includes a US limited partnership or limited liability company for US investors and a foreign corporation for foreign investors and US tax-exempt organizations. The typical investors in an offshore hedge fund structured as a corporation will be foreign investors, US tax-exempt entities, and offshore funds of funds. Although certain organizations, such as qualified retirement plans, generally are exempt from federal income tax, unrelated business taxable income (UBTI) passed through partnerships to tax-exempt partners is subject to that tax. UBTI is income from regularly carrying on a trade or business that is not substantially related to the organization's exempt purpose. UBTI excludes various types of income such as dividends, interest, royalties, rents from real property (and incidental rent from personal property), and gains from the disposition of capital assets, unless the income is from "debt-financed property," which is any property that is held to produce income with respect to which there is acquisition indebtedness (such as margin debt). As a fund's income attributable to debt-financed property allocable to tax-exempt partners may constitute UBTI to them, tax-exempt investors generally refrain from investing in offshore hedge funds classified as partnerships that expect to engage in leveraged trading strategies. As a result, fund sponsors organize separate offshore hedge funds for tax-exempt investors and have such corporate funds participate in the master-feeder fund structure. If US individual investors participate in an offshore hedge fund structured as a corporation, they may be exposed to onerous tax rules applicable to controlled foreign corporations, foreign personal holding companies, or a passive foreign investment companies (PFIC). To attract US individual investors, fund sponsors organize separate hedge funds that elect to be treated as partnerships for US tax purposes so that these investors receive favorable tax treatment. These funds participate in the master/feeder structure. Under the US entity classification (i.e., check-the-box) rules, an offshore hedge fund can elect to be treated as a partnership for US tax purposes by filing Form 8832, "Entity Classification Election," so long as the fund is not one of several enumerated entities that are required to be treated as corporations.
Hedge Fund Phenomena Hedge funds manage over two trillion dollars in assets worldwide and they are a prominent feature on the investment landscape. The size of the hedge fund market has grown dramatically in recent years, and issues arising from hedge fund investments and management now have broad implications for the entire financial industry. Hedge funds may involve complex, illiquid or opaque investments and investment strategies and receive little regulatory oversight. Hedge funds are suitable only for sophisticated investors who are able to evaluate, select, monitor, and exit these investments. The hedge fund industry differs from the traditional asset management industry in several ways. The hedge fund industry itself is relatively young and has been an important source of new investment management ideas. Managers are often early adopters of investment strategies and new securities, and they frequently use investment vehicles and techniques that are unavailable to more constrained investors. It is important to note that hedge funds are lightly regulated vehicles that usually operate with a broad investment mandate and few limits on the investment authority of the funds.
Exactly what is a hedge fund? Although there is no universally accepted definition of the term hedge fund,” the term generally is used to refer to an entity that holds a pool of securities and perhaps other assets, whose interests are not sold in a registered public offering and which are not registered as an investment company under the Investment Company Act. Alfred Winslow Jones is credited with establishing one of the first hedge funds as a private partnership in 1949. That hedge fund invested in equities and used leverage and short selling to “hedge” the portfolio’s exposure to movements of the corporate equity markets. Over time, hedge funds began to diversify their investment portfolios to include other financial instruments and engage in a wider variety of investment strategies. Today, in addition to trading equities, hedge funds may trade fixed income securities, convertible securities, currencies, exchange-traded futures, over-the-counter derivatives, futures contracts, commodity options and other non-securities investments. Furthermore, hedge funds today may or may not utilize the hedging and arbitrage strategies that hedge funds historically employed, and many engage in relatively traditional, long-only equity strategies.
The term “hedge fund” refers to an investment pool that provides exposure to a set of financial risk factors not typically associated with traditional (equity and fixed income) long-only investments. This may include investments in limited partnerships, limited liability corporations, or other vehicles. These vehicles carry out the investment program under the direction of an investment manager. The term "hedge fund" may also refer to the manager of the investments of a hedge fund.
Hedge Fund Defined Hedge funds invest in a wide variety of financial instruments using a variety of investment techniques. Hedge funds use a broad range of portfolio strategies and are exposed to a similarly broad range of risks. Hedge funds do not represent a single asset class, but are a type of investment vehicle that provides exposure to a range of investment strategies. Hedge funds come in different sizes and have different management strategies and styles. They follow different administrative, valuation, and disclosure practices. Management of a hedge fund portfolio must be appropriate for its particular investments. Historically, hedge funds have focused on publicly traded securities, commodities, currencies, and their derivatives in such a way as to be “hedged”, in large measure, from material changes in stock and bond markets. Increasingly, however, hedge funds have exposure to a broader investment spectrum, including not only traditional markets but also sectors typically associated with other investment vehicles, such as private equity and real estate.
In short, the term generally identifies an entity that holds a pool of securities and perhaps other assets that does not register its securities offerings under the Securities Act and which is not registered as an investment company under the Investment Company Act. Hedge funds are also characterized by their fee structure, which compensates the adviser based upon a percentage of the hedge fund’s capital gains and capital appreciation. Hedge fund advisory personnel often invest significant amounts of their own money into the hedge funds that they manage. As discussed in the Report, although similar to hedge funds, there are other unregistered pools of investments, including venture capital funds, private equity funds and commodity pools that generally are not categorized as hedge funds.
Hedge funds are often compared to registered investment companies. In addition, unregistered investment pools, such as venture capital funds, private equity funds and commodity pools, are sometimes referred to as hedge funds. Although all of these investment vehicles are similar in that they accept investors’ money and generally invest it on a collective basis, they also have characteristics that distinguish them from hedge funds.
When did this concept originate? Briefly, what’s the history? Hedge funds, while representing a relatively small portion of the U.S. financial markets, have grown significantly in size and influence in recent years. The SEC recognized over 30 years ago that hedge fund trading raises special concerns with respect to their impact on the securities markets. The growth in hedge funds has been fueled primarily by the increased interest of institutional investors such as pension plans, endowments and foundations seeking to diversify their portfolios with investments in vehicles that feature absolute return strategies – flexible investment strategies which hedge fund advisers use to pursue positive returns in both declining and rising securities markets, while generally attempting to protect investment principal. In addition, funds of hedge funds (“FOHF”), which invest substantially all of their assets in other hedge funds, have also fueled this growth.
CapitalManagementServicesGroup.com is recognized by discriminating fund managers and businessmen as being the foremost tax and legal authority in the business. Attorney Hannah Terhune's education and experience are unsurpassed in the area of hedge funds creation and management platforms, and the complex body of related tax laws. Ms. Terhune's extensive knowledge and experience have made her an indispensable resource for serious hedge fund and business professionals. Ms. Terhune's articles on the subjects have appeared in over 100 publications worldwide. Chances are, if you have read about the above matters, Ms. Terhune has written about them.
Give us the opportunity to use that knowledge and experience for you. We have both regulatory experience and the understanding of the foreign exchange and securities markets. We know how to navigate the compliance with rules and regulations in the United States as well as in regulated jurisdictions such as United Kingdom, Singapore, Hong Kong, Canada and the British Virgin Islands. Each client receives personalized attention from our attorneys and staff. No client is too large or small though because of our boutique size. We pride ourselves in providing personal attention to each client.
CMSG provides the best services and support needed for hedge funds and business projects. No need to coordinate work between different firms--we handle the entire business process from start to finish. We offer accounting, tax planning services, tax return preparation, business consulting, and U.S. and international company formation services. Our professionals provide the highest quality services at competitive rates. But don't take our word for it, give us a call and let us prove what we can do for you. Read our Leading Media Articles, Customer Testimonials and learn more About Us.
Personal Consultations You get answers to your specific questions by speaking directly to Hannah Terhune, an experienced hedge fund and international tax attorney. Ms. Terhune's hard-earned knowledge and experience can be put to work to save you unnecessary steps and costly wasted effort. The consult is an invaluable opportunity to speak to Hannah one-on-one, and learn how to achieve more in less time. As a result, you can anticipate that the return on your investment will far outweigh the costs associated with our unsurpassed services. Ms. Terhune's credentials reflect an invaluable resource that combines a well-informed professional practitioner with sound ethical judgment that cannot be over-estimated. The expertise required to recommend best solutions and provide sound advice should never be taken lightly. We are confident that when you are finished with your consultation, you will be impressed and more informed about your business plans than ever before. Call (307) 213-4732 orClick Here to Request Services.
Our Commitment Henry David Thoreau wrote: "Do not hire a man who works for money, but him who does it for love of it." We are committed to your business plans and bringing you the best possible options. We are an established and internationally recognized business that serves and educates our clients throughout the industry. We do this by striving for the best results. Above all, we are a law firm. A lawyer is a philosopher and role model. The ability to improve our clients' lives is a privilege that we do not take lightly. There is tremendous power in being able to effect a positive change in our clients' lives. Our aim is to welcome our clients and to provide a comfortable, warm environment for all. Thanks for visiting our website. We hope to have the opportunity to serve you.
Why Hire Us? When you engage us for hedge fund you get a unique combination of securities, tax, and international experience, focused on the trader niche. We have established a leadership position with traders. We are one destination for all your very special hedge fund and trader tax needs. We think we have the best set of offering documents based on the current and ever changing federal, state and offshore securities, commodities, and tax laws. We aim and deliver quick turnaround times, because we understand that our customers want to begin their money management business as soon as possible. We conceive, structure, and deploy the best tax saving strategies into your hedge fund vehicle (for the benefit of the manager and their investors) and your management company. Investors value tax-savings strategies and we utilize all our special knowledge and ideas in this area. Our customers value our one-stop relationship. We will help you start your business and continue to assist you. Our tax services division handles accounting, software, and tax compliance, including all tax matters (tax planning and tax returns). Only one thing counts with us and that's our customer relationships!