1. finance
2. investing
3. funds
4. hedge fund

SpECial
REpoRT
How to start a
hedge fund in the US
Getting a head start
Making the most of the opportunities
presented by a still buoyant US market
Bermuda Stock Exchange | Kaufman, Rossin & Co
Tannenbaum Helpern Syracuse & Hirschtritt | Tennyson Fund Solutions
Providing Solutions
TM
•
•
•
•
•
•
•
•
•
•
•
•
•
Private Investment Funds
Hedge Funds
Private Equity Funds
Corporate, Capital Formation & Securities Law
Mergers and Acquisitions and Commercial Business Matters
Financial Services Law and SEC Regulation
Real Estate, Construction and Environmental Law
Creditors’ Rights, Bankruptcy and Business Reorganizations
Employment Law, ERISA and Executive Compensation
Litigation and Dispute Resolution
Distribution, Franchising and E-Commerce
Tax Law
Estate Planning
New York 900 Third Avenue 212.508.6700
London 84 Brook Street +44.20.7665.1632
www.thshlaw.com
how to start a hedge fund in the us
Land of opportunity
D
espite difficulties in the global financial markets in the second half of last
year, total assets under administration in the hedge fund industry continued to grow strongly, and such a robust and defiant display surely bodes
well for the continued development of the sector during 2008. To this end, this
HFM How to Start a Hedge Fund in the US 2008 Report draws upon the experience and expertise of senior industry professionals and key service providers to
guide you towards achieving the ultimate goal of establishing a hedge fund which
thrives in the US space.
Michael G Tannenbaum of Tannenbaum Helpern Syracuse & Hirschtritt opens
the report with a concise and detailed exploration of the legal terrain those aiming
to establish a hedge fund to access US capital will inevitably need to negotiate.
Having advised hundreds of private funds and advisers on matters of US law and
regulation for more than 30 years, his contribution makes essential reading for
anyone looking to set up a hedge fund in the US.
A n administrator’s perspective is supplied by Tony Stocks of Tennyson Fund
Solutions, interviewed on the eve of the launch of their US operation aimed
at servicing funds managing between US$200m and US$500m. Renowned
throughout the hedge fund world for his role in setting Citco on the road to
becoming the world’s largest hedge fund administrator, Stocks brings the benefit
of his considerable expertise and experience to the 2008 report.
Robert Kaufman of Kaufman, Rossin & Co considers the new auditing standards
recently issued by the American Institute of Certified Public Accountants (AICPA).
He usefully outlines the positive aspects of these new measures for hedge fund
managers, such as helping them to meet the demands of new investors performing
due diligence and protecting their fund, and themselves, from risk.
Finally, Greg Wojciechowski documents the continued success and development
of the Bermuda Stock Exchange and outlines the ever-expanding opportunities it
affords international investors and hedge funds.
The strong growth and development of the hedge fund industry looks set to
continue apace during 2008, and this report aims to show you how to establish a
successful hedge fund in what remains one of its key loci of opportunity.
S tephen Carter
Report editor
Michael g ttannenbaum discusses the wide range of issues
involved in setting up a hedge
fund and accessing us capital
12 A different approach
t stocks of tennyson
tony
t
fund
solutions outlines their strategy
for targeting a currently underserved sector of the us hedge
fund market
www.hfmweek.com
New York: 1375 Broadway, 11th floor,
new York, nY 10018
Report editor: stephen Carter
Tel: +44 (0)20 7269 7598
[email protected]
Staff writer: Aimee Donnellan
Tel: 44 (0)20 7269 7590
[email protected]
Production editor: Melanie rockett
Tel: +44 (0)20 7269 7594
[email protected]
Sub-editor: Claudia honerjager
Tel: +44 (0)20 7269 7587
[email protected]
Operations director: sebastian timpson
Managing director: Charlie Kerr
Associate publisher: Poppy edwards
Tel: +44 (0)20 7269 7585
[email protected]
Senior publishing executive:
robert Bennett
Tel: +44 (0)20 7269 7576
[email protected]
Subscriptions and circulation:
duncan Murray
Tel: +44 (0)20 7269 7574
[email protected]
in This issue…
04Through the looking glass
London: dunstan house,
14a st. Cross street, London eC1n 8Xa
Tel: +44 (0)20 7269 7575
Fax: +44 (0)20 7269 7570
14 Total control
robert Kaufman of Kaufman,
rossin & Co explores the positives of new auditing standards
for hedge fund managers
17 Going forward
greg wojciechowski explains
the advantages afforded to
international investors by the
flourishing Bermuda stock
exchange
HedgeFuNdMANAgeR is published
weekly by Pageant Media Ltd, a certified
member of the PPa issn 1748-5894
Printed by wyndeham grange
© 2008 all rights reserved. no part of this
publication may be reproduced or used
without the prior permission from the
publisher
HFMWEEK | 3
asia-pacific
how
to startspecial
a hedge
report
fund in the us
LEGAL
Michael G Tannenbaum discusses the wide range of issues involved in setting up a
hedge fund and accessing US capital
Through the
looking glass
T
his article addresses the legal and business issues that go into setting up a hedge
fund, accessing investment capital from
US sources and explores the numerous regulatory
issues that need to be understood to be successful.
Our law firm prefers to use the nature of the investor as the starting point. So let’s start this multifaceted process and just ‘dig in’.
As will be seen, US investors prefer to invest in
structures that are look-through vehicles for US
tax purposes, so are taxed as partnerships. Non-US
investors and tax-exempt investors tend to prefer
non US corporate vehicles. Let’s drill down to determine why this is so, and look first at the underlying tax concepts and then the various structures
used to accommodate.
Tax aspects
Michael G Tannenbaum
heads Tannenbaum
Helpern’s global
Financial Services,
Hedge Funds and
Capital Markets
Group. For more than
30 years, he has
advised hundreds
of private funds and
advisers on matters of
US law and regulation.
4 | HFMWEEK
To understand the several hedge funds structures,
certain US income tax issues need to be understood. As will be seen, one size does not fit all in
the hedge fund world; different types of investors
dictate different types of structures.
Partnerships. It is critical that US partnerships
are not subject to income tax at the entity level. Instead, items of gain, loss, credit flow through the
partnership to its partners, pro rata to their percentage ownership. The character of those items is
preserved – for example, long or short gain – as it
flows through to the investors. This is true even in
the case of non US entities, even if they are corporations under the laws of formation, provided the
entity makes a timely ‘check the box’ election pursuant to the Internal Revenue Service (IRS) rules
to be treated as a partnership for US tax purposes.
It is not unusual for the US fund to actually be a
non-US entity provided it has checked the box to
be treated that way.
PFICs. Passive Foreign Investment Companies
(PFICs) are entities that derive a significant percentage of their income from passive sources such
as interest, dividends, and capital gains. Non-US
corporate hedge funds naturally fall within this
definition and are PFICs. Under the Internal Revenue Code (Code), PFICs are taxed in a way generally unfavourable to US-taxable investors, so it is
unlikely a US-taxable investor would wish to invest
in a PFIC. Unlikely, not illegal – the IRS would be
pleased to accommodate. In fact, there are even
times when such an investment might make sense,
but that is a different discussion.
UBTI. US investors exempt from US taxation
– ERISA plans, other pension schemes, IRAs, endowments, charitable trusts and the like – do in
fact pay tax on income that is generated using leverage or derived from business operations. Why?
Because the Code says so – there is an exception to
the tax-exemption rule. This income is called Unrelated Business Taxable Income (UBTI) and, as
with partnership accounting, it will flow through a
partnership to its owners. It is irrelevant to taxable
partners, but if the partner is a tax-exempt organisation, that organisation will be required to pay tax
on its percentage share of such income. Central
to UBTI planning is the fact that UBTI does not
flow through a corporate vehicle to its shareholders, only through a partnership to its partners. For
this reason, tax-exempt investors prefer to invest
in non-US corporate entities where the hedge fund
uses leverage as part of its investment programme.
Again, not illegal – the IRS is happy to collect tax
– just unlikely. It is in fact this tax attribute that is
www.hfmweek.com
LEGAL
at least partially the driving force behind the enormous growth in the non-US hedge fund market.
Bills have been introduced in Congress that would
change UBTI taxation to the detriment of tax-exempt investors in non-US hedge funds, but as of
this writing, such matters are pending and the outcome is uncertain.
Fund structures
With these concepts in mind, we turn to fund
structures.
US funds. US hedge funds are generally established as Delaware limited partnerships or Delaware limited liability corporations (virtually interchangeable entities). The partnership is the hedge
fund, the limited partners are the investors and
the entity is managed by the partnership’s general
partner (GP) In this model, the GP would receive
the incentive allocation. While it might also receive
the management fee, the management function is
often delegated to a further entity – the investment
manager or investment adviser – which would receive the management fee. In some jurisdictions,
such as New York City, this distinction is important, as it affects certain taxes payable on the management fee portion of the income, but not on the
incentive allocation.
These funds are suitable for US taxable investors. Setting up a Delaware limited partnership en-
www.hfmweek.com how to start
asia-pacific
a hedge fund
special
in the
report
us
tails establishing the GP first, then the partnership
entity. The time to do this is measured in days.
Non-US funds. These entities are formed in
jurisdictions outside of the US, like the Cayman
Islands, Bermuda, Guernsey, or the BVI. Jurisdictional or ‘domicile’ choice is often driven by such
factors as banking stability and currency, local
law and regulation, existence of a competent work
force and the availability of multiple service providers, language, time zones, ease of access and
similar practical matters. Different jurisdictions
have different legal structures available, multi class
ability, segregated cells, trusts, others do not. There
are times when the special needs of the investors
or of the investment activities of the fund will dictate the domicile because of a treaty or special rule
of law. Legal counsel can help you choose. These
funds are suitable for non-US investors and for US
tax-exempt investors.
Side-by-sides; master feeders. A hedge fund
group consisting of a US-based fund and a nonUS-based fund are referred to as side-by-side
funds for obvious reasons. There are times when
it is advisable to link the two funds with a third
called a master fund. The assets of each of the initial funds, now called feeders, pour into a central
pot, called a master fund, to form a master feeder
arrangement. This would be desirable when the
size of one of the feeders has not attained a critical
HFMWEEK | 5
how to startspecial
a hedge
fund in the us
asia-pacific
report
mass needed for the investment strategy or similar
practical considerations. Note that when a master
feeder structure is chosen, the master fund checks
the box for US tax purposes so as to be treated as a
partnership. US-taxable investors invest in the US
feeder, non-US investors and tax-exempt investors
invest in the non-US feeder. The trading is done at
the master fund level and the auditors divide the
profit and loss between the two or more feeders.
The master feeder arrangement tends to be a bit
more expensive to operate than side-by-side funds
(additional audit fees and added set-up cost being
only two such costs), consequently the side-by-side
arrangement is in vogue today.
Regulation of the fund; raising capital
Now that the investor base has been identified, the
tax aspects understood and the hedge fund group
has a structure, attention is given to the regulatory
issues facing the fund and the investment adviser,
all in the context of raising capital from US sources.
A number of regulatory provisions come into play,
and virtually every one has its own definitional
pattern. In reading the several sections that follow
concerning the 33 Act, the 40 Act and the Advisers
Act, note that each has its own place in the patchwork quilt that makes up the regulatory scheme.
33 Act Private Placements. The 33 Act applies
6 | HFMWEEK LEGAL
to funds, venture capital, businesses in general –
virtually any activity seeking capital from investors, not only hedge funds. Unless an exemption
applies, a security (here the interests in the fund)
sold in the US must first be registered with the Securities and Exchange Commission (SEC) as an
initial public offering (IPO) under the Securities
Act of 1933 Act (33 Act) or the Investment Company Act of 1940 (40 Act), or both. These are rarely if
ever desirable for a typical hedge fund. Full-blown
33 Act or 40 Act registrations are reserved for mutual funds and for certain funds of funds that seek
to appeal to a wider audience than is possible with
non registered products.
Fortunately, the 33 Act provides a private placement exemption called Regulation D (Reg D) to
enable a hedge fund to proceed without SEC registration. To meet Reg D, the hedge fund (the issuer)
must make a full and fair disclosure of all material
elements of the deal – risk factors, fees arrangements, subscription and withdrawal features, lockups gates, biographical data of the decision makers,
and a description of the strategy and investment
programme descriptions and the like. The private
placement memorandum and subscription documents are designed to make such a disclosure. In
addition, the fund may only be sold to offerees with
whom the offeror has a pre-existing relationship,
arising out of other than this transaction, and the
investors who are accredited investors. Up to 35 of
the investors may be non-accredited, but require a
heightened level of financial disclosure by the fund
and present certain complications, especially with
regard to state ‘blue sky’ filings. Consequently, the
fund often limits the investor base to accredited
investors only.
Accredited investors are those with either a net
worth of US$1m or with income during the past
two years of US$200,000, or US$300,000 with
spouse, expecting the same for the current year.
The SEC has stated publicly it is considering increasing these limits, and the author would expect
that to happen, probably raising the net worth test
to US$1.5m. Expect the SEC to introduce new categories of investors, the accredited natural persons
and the large accredited investor, the latter two reserved for investment into certain types of hedge
funds, the clear intention to raise the bar to investment. The law firm’s website should be consulted
for the latest information (www.thshlaw.com).
The 40 Act. The 40 Act and the 33 Act are
closely intertwined. While the 33 Act regulates the
method by which a security can be sold in the US,
the 40 Act looks at and deals with the nature of
the investment activity within the fund itself, the
key investigation being whether or not the fund is
www.hfmweek.com
how to start a hedge fund in the us
an ‘investment company’, another word for a mutual fund. If it is, it needs to register as such with
the SEC and adhere to the full panoply of complex
rules and administrative burdens that face mutual
funds. To avoid such registration, a fund must avoid
the definition of being an ‘investment company’.
Virtually all hedge funds fall within the definition
of investment company which, under the 40 Act
is, in general terms, is a company whose primary
activity is buying and selling securities. Therefore,
it is essential for the fund to meet one of two established exceptions: Sec. 3c1 or Sec. 3c7.
In the case of either exception, it must be the
case that the fund is not making or proposing to
make a public offering of its shares (in order to
meet the Reg D private placement exemption).
Note that without the Reg D exemption applying,
it would not be possible to meet either Sec. 3c1 or
Sec. 3c7.
Sec. 3c1. The Sec.3c1 exception saves (from registration) funds that limit the number of its beneficial owners to 100 or less. There are critical ‘lookthrough’ rules in counting to 100: First, if our fund
is a US-based fund, the investor test is worldwide;
for a non-US-based fund, the test is for US investors
only. Secondly, with regard to entities that invest in
our fund, if the entity investor was formed primarily to make the investment into our fund, then each
of the entity’s beneficial owners is to be considered
in making our 100 count. (If the investing entity
has invested 40% or more of its assets in our fund,
then there is a presumption that it was formed for
the purpose of making the investment). Lastly, if
an investing entity is one that itself relies on either
8 | HFMWEEK
LEGAL
Sec. 3c1 or Sec. 3c7 (for example another fund, or a
fund of funds) and if that investor fund owns 10%
or more of a fund, then its beneficial owners are
added to those of a fund in making the 100 count.
Sec. 3c7. The second exception is the Sec. 3c7
exception. The focus is on the financial quality of
the investor. Sec. 3c7 permits the fund to have up
to 499 investors (better than 100, of course) but
each and every investor needs to be a qualified
purchaser (QP). The statute does not reference
the number 499. It is read into Sec. 3c7 by section 12(g) of the Securities Exchange Act of 1934,
which requires an issuer of securities with more
than US$1m in assets and 500 or more investors
to register the securities (file a registration statement with the SEC). By this definition, the offering
can no longer be ‘private’.
The QP definition differs for individuals and for
entities. In general terms, for individual investors,
a QP is one with at least US$5m of investible assets
– ‘investments’. The term ‘investments’ is a defined
term, including marketable securities or real estate, provided neither the owner nor a dependent
resides in it, or closely held stock, provided the investor is not working for the company issuing the
stock. The full definition is complex and should
be consulted before relying on this exception. It is
posted on the law firm’s website.
For entities, the test is US$25m or more investments, unless each equity owner of the entity
is himself a QP. And lastly, there is a category of
QP that is unrelated to the asset test, namely the
knowledgeable employee. Knowledgeable employees include officers, directors or partners of the
www.hfmweek.com
LEGAL
hedge fund or its adviser, and certain professional
investment personnel.
Non-US funds selling into the US. Such funds
face essentially the same issues as US-based funds.
Most non-US funds will already have an information memorandum to sell interests outside of the
US. To sell to US investors, the document needs to be
reviewed by US legal counsel and supplemented to
supply missing disclosures that need to be provided
to US investors, such as US tax issues and the like.
So assuming the placement meets the Reg D
private placement rules and limits the investor base
in a way that meets either Sec. 3c1 or Sec. 3c7, the
fund will be able to avoid registration under the 33
Act and the 40 Act. If the adviser is SEC registered,
the qualified clients rule applies (see Regulation of
the adviser, below) and lastly, the Reg D private
placement rules will need to be met in all cases.
Regulation of the adviser
In accordance with the Investment Advisers Act of
1940 (Advisers Act), a person that gives investment
advice for compensation to US clients must register as an investment adviser (RIA) with the SEC if
it has 15 or more clients and has US$30m or more
of assets under management. It sounds simple, but
many of the phrases just set out interpretations,
and the one to be highlighted in this overview is the
meaning of ‘client’. As of this writing, a hedge fund
counts as a single client in making the 15 count.
Even if the fund is a full-blown Sec. 3c1 fund, with
99 investors in it, the fund itself is a single client.
The underlying investors are not counted.
The SEC attempted to change the client definition by adopting the private fund rule (which was
to be effective February 1 2006), that among other
things required the adviser to look through the
fund to the number of investors in making the 15
count. A US federal court set aside the proposed
rule, stating that the SEC overstepped its bounds
in redefining the word client. As a result, the narrower definition of the ‘client’, (the hedge fund being one client) prevails and a manager setting up
a US fund, a non-US counterpart and perhaps a
master fund linking the two (feeders), would have
only three clients at most, well short of the 15 that
triggers the registration. The amount of assets under management is irrelevant if the client count is
less than 15.
From a business standpoint, it should be stated
that there are times when registration is desirable.
A manager may register once it has at least US$25m
under management. It may wish to do so because
of marketing issues. Many institutional investors,
pensions, large family offices and the like draw
comfort from the fact that the manager is regu-
www.hfmweek.com
how to start a hedge fund in the us
lated by the SEC. And furthermore, managers with
offices in more than one state can avoid regulation
at the various state levels by registering federally
because the SEC registration pre-empts the states.
To register with the SEC, form ADV part 1 is
submitted to the SEC via its website (www.sec.gov)
and various policies and procedures are needed.
The adviser becomes subject to periodic SEC inspections. As of now, there is no minimum capital
requirement nor is there an exam requirement.
The adviser needs to prepare and distribute a brochure (ADV Part 2) to its prospective clients setting forth the fee arrangement, conflicts of interest
and other usual regulatory data. Ample information is available on the subject.
Typically, investment advisers charge performance incentive arrangements. RIAs are prohibited from charging performance based fees or
having incentive arrangements with regard to investors who is a qualified client (QC), namely an
investor with a net worth of US$1.5m or one who
has invested at least US$750,000 into the deal.
Investments
Hedge fund managers and funds are known for
being opportunistic and engage in a variety of
transactions in a search for returns that are noncorrelated to the stock market. Apart from the usual stock and securities transactions, several are of
note when planning to establish a hedge fund.
Commodities and futures. When using futures
transactions, whether for outright speculation or
for hedging, the manager may need to register under the Commodity Futures Trading Commission
(CFTC) and National Futures Association (NFA)
rules. There are several important exemptions, one
of which may be available.
Trade or business. While a manager searches
for returns, it is not unusual for opportunities to
present themselves that are outside of those traded
on stock exchanges. These may be distressed credit
matters, investments in loans and private equity
transactions. If the manager migrates from being
a passive participant in the activity (for example,
it causes the fund to buy a loan portfolio) to being an active participant in the business terms of
the transaction (for example, it causes the fund to
negotiate the terms of the loan, the interest rate,
placement fees, default provisions, collateral requirements and the like) the activity may move
from being an investment to being a trade or business activity. The determination depends on the
facts and circumstances of each transaction.
To a US-taxable investor, the matter is of no
concern. Whichever way the IRS characterises it,
if the activity makes a profit, the US-taxable inves-
HFMWEEK | 9
how to start a hedge fund in the us
tor incurs a tax liability. To a non-US participant,
the matter is of great concern, especially where the
investor is from a jurisdiction without a tax treaty
with the US. Since funds domiciled in tax haven
jurisdictions like Bermuda or the Cayman Islands
do not, by definition, have such treaties, when they
engage in transactions that can be re-characterised
by the IRS as trade or business transactions, the
income derived is subject to withholding tax provisions that are quite onerous. It is essential that
these issues be understood, where the lines are
drawn, and how to plan accordingly.
Other regulatory aspects
ERISA. The Employee Retirement Income Security Act of 1974 (ERISA) governs, among other
things, the investment by pension plans in hedge
funds. The Department of Labor (DOL) adopted
the so-called ‘plan asset’ rule to deal with such
matters. In short, if a hedge fund or any class of the
fund is composed of 25% or more investments from
benefit plan investors (BPIs), a number of important DOL rules are triggered (prohibited transaction rules, limits on lock-ups and indemnification,
valuation procedures, and more). While a fund
would not want to inadvertently stray into this area,
if the rules are understood in advance, planning is
quite feasible and beneficial. BPI investors include
ERISA investors and IRAs but exclude government
plans and non-US employee benefit arrangements.
Blue Sky. State laws govern the sale of securities
transaction within the states. New York requires
a filing before the first solicitation is made. Most
states require filings within 10 or 15 days after
the sale is made in the state. Some states require
a number of sales before a filing is made, others
10 | HFMWEEK LEGAL
after the first sale. In any event, there are a variety
of models. These are called ‘blue sky’ laws, and the
bottom line is that care needs to be taken to assure
that the proper filings are made.
New developments
Many hedge funds are reserving the right to investment in illiquid transactions, such as private equity transactions, and are using mechanisms called
side pockets to account for these investments.
Hedge funds are doing this more and more. At the
same time, private equity funds are seeking returns
in strategies that have been traditionally reserved
for hedge funds. This migration of one towards the
other is now referred to as convergence.
The US Congress has a bill before it entitled the
Hedge Fund Study Act which, as the name implies,
will be a study of the industry. At time of writing, it
is unclear as to the direction Congress will take, as
to whether or not the recent SEC’s initiatives which
would have led to a virtually universal registration
requirement of most hedge fund managers will be
reinstated or whether or not other regulatory action will be taken.
Conclusion
The process of setting up a hedge fund can be accomplished with the proper legal advisors and related consultants. This need not be a mysterious
process. To be sure, there are rules, but every jurisdiction has rules, certainly the US and the UK, but
they can be well understood and explained by professional advisors and thereby managed in a way
that facilitates the business process. Tannenbaum
Helpern, with offices in New York and in London,
is well suited to render this advice.
www.hfmweek.com
1 TERRITORY
3 LETTERS
30 ISLANDS
1,000,000 BUSINESS OPPORTUNITIES
The real beauty of the British Virgin Islands is its proven leadership in meeting the needs of
international business.
A strong partnership between the public and private sectors has been a core factor in the sustained
growth of its captive insurance business.
The jurisdiction now has the fourth highest number of captive registrations in the world, supported
by a growing pool of licensed end experienced professionals
Captive insurers in the BVI benefit from:
- Business-enabling regulatory standards which accommodate sophisticated structures and
Segregated Portfolio Companies
- A sound business operating infrastructure
- Enduring political and economic stability
For more information, contact:
Sherri Ortiz, Chief Operations Officer
BVI International Finance Centre,
Road Town,Tortola,
British Virgin Islands.
Telephone: (+1-284) 494-1509
Facsimile: (+1-284) 494-1260
E-mail: [email protected]
www.bviifc.vg
asia-pacific
HOW
TO STARTspecial
A HEDGE
report
FUND IN THE US
administration
Speaking on the eve of Tennyson Fund Solutions’ US launch, Tony Stocks outlines their
strategy for targeting a currently under-served sector of the market
A different
approach
T
Tony Stocks is the
CEO of Tennyson Fund
Solutions. Previously
global head of Citco
Fund Services, Tony’s
hedge fund career
began in 1985. He is
adviser and consultant
to several hedge funds
and sits on a selection
of hedge fund boards.
12 | HFMWEEK
ony Stocks, the CEO and principal of independent global fund administrator Tennyson Fund Solutions, certainly knows more
than most about the fund administration business.
As the former global head of Citco Fund Services,
Stocks played a pivotal role in building Citco’s fund
administration business into the world’s largest,
overseeing the growth of assets under administration (AUA) from US$1bn to $US110bn during
his tenure.
HFMWeek spoke to Stocks on the eve of the
opening of Tennyson’s New York office, and asked
him first about what inspired his recent move back
into the fund administration business. “After I left
Citco in 2001, I stayed on as a director of various
funds which I’d been administering, and I became
a consultant for other funds who wanted to bring
new products to the market or to restructure the
hedge funds themselves.
“A few of them were asking me to find hedge
fund administrators for them, and it was actually proving very hard for funds with US$350m,
US$400m AUA to find an administrator who was
willing to look at them seriously. I know the industry has grown tremendously, but there should be
administrators who can service funds of that size,
not just the billion-dollar funds. Eventually, several of them said, ‘If you went back into the administration business, we’d use you.’ With my children
having grown up, I thought the time was right to
go back in there and service the gap in the market
for funds with up to US$500m AUA.”
With Tennyson about to launch in New York,
the global hub of hedge fund managers, a clearly
targeted strategy will be crucial to succeeding in an
established and highly competitive fund administration sector, as Stocks explains. “We’ll be looking
to target funds with up to US$500m AUA. I grew
up working with global macro funds. I’d also like to
target anybody who’s dealing in quoted securities
and derivatives with or without over-the-counter
options (OTCs). That would cover everyone from
long-short equity, to futures, options, derivatives,
FX and bonds. I would have to say our ideal client
would be a multi-strategy or event driven, or global
macro or futures fund, as well as single strategy equity or futures funds that invest in derivatives and
other products to enhance or protect returns.”
A fully integrated service
So what exactly will set Tennyson’s offering apart
from those of the other administrators targeting
this particular client base? “Primarily, our systems.
Linedata’s Beauchamp Hedge Fund Solutions are
providing our front and middle office systems
and Paxus our back-end systems. We will also, of
course, offer traditional fund administration to
start-ups and existing funds, and integrate with
whatever systems the manager uses, rather than
always insist on our own platform, but still with
that daily mentality.
“For the small funds, it’s easy to get a fund administrator who will do the old-fashioned monthly
service of reconciling the manager trades, the
prime broker statements and produce a monthly
NAV. However, very few administrators can provide a fully integrated service offering, front to
back, for clients running up to US$500m. Tennyson are able to set up the infrastructure of
their full range of products for clients, based on
an ASP offering, for perhaps half the price they’d
normally get it for.”
Remaining current and responsive to the particular needs of the funds they will be servicing
will also be essential to Tennyson’s ongoing success in the US market, as Stocks explains. “I think
www.hfmweek.com
ADMINISTRATION
that comes from client demand. For example, yesterday I was having a conversation with a start-up fund. They were
asking if they could have their NAV on
their Blackberries, because Bloomberg
POMS supplied that. I thought, ‘We
could do that’, because there’s a Beauchamp product called Position Manager, which gives you all of your trades and
all of your positions on a real-time basis.
Position Manager can be accessed from
Blackberries, so we came back in the
office today and set to work and those
clients now have Beauchamp Position
Manager available on Blackberry.”
Stocks’ plan is to develop Tennyson’s
fund administration business incrementally over the next 12 months by
taking on a couple of clients in each
centre per month, thus ensuring that all
clients coming on board will receive a
consistent, high-quality service tailored
to their individual needs. “We’re looking
to take on around 20 funds in the UK
and around 10 in the US during 2008,
and we’re also looking to launch operations in Perth and Bermuda. We hope
that fund managers who are experiencing a limited service from the larger administrators will see the front-to-back
tailored service we are providing and
move across to us.”
According to Stocks, the recent trend
towards consolidation in the industry
has further impaired the quality of service available to entrepreneurial hedge
fund managers. “Instead of being treated as a special client and serviced as if by
private bankers, they’re being treated as
a mutual fund. This really isn’t to their
detriment as much as to the detriment
of the investors, who are being treated
as mutual fund investors rather than
what they are, which is family offices,
high-net-worth individuals. We’re going to give them the full systems, which
will allow people to invest in them since
they’ve got decent operations.”
Untapped potential
Indeed, Stocks sees making these hitech risk/compliance systems available
to small and medium-sized managers
as crucial in helping to loosen the current grip of the larger firms on the institutional investment increasingly seen as
www.hfmweek.com HOW TO START
asia-pacific
A HEDGE special
FUND IN report
THE US
the lifeblood of the hedge fund manager. As without these on board, small and
medium-sized firms are seen as unable
to tap into the institutional investment
now accounting for an ever-growing
proportion of the money pouring into
hedge funds.
Stocks also believes it will become
easier for the small and medium-sized
managers Tennyson is looking to service to bridge the gap to the larger firms
by growing their business incrementally through consistent alpha generation over several years. This certainly
runs counter to the current wisdom
that only the big can get bigger and
that consolidation is inevitable for small
and medium-sized firms looking to
bridge the gap.
“If you look at the profile of the size of
hedge funds, it’s what they call a bookend graph, with lots of small funds,
lots of big funds, and comparatively
few firms in between. However, I think
we’re going through a state of flux at the
moment. As the institutions suddenly
realise they have too much money to go
into the big, institutional hedge funds,
they’re going to have to look for the
alpha generators and the people who
made this industry in the first place. I
think it will then trickle down and then
the graph will develop a more normal
distribution. The institutions will look
for smaller and smaller funds and the
big hedge funds will close or be consolidated into investment banks.”
Finally, Stocks remains highly optimistic regarding the prospects for the
hedge fund industry in 2008, despite
the recent uncertainty in the markets.
“I agree that the subprime meltdown
probably hasn’t finished yet, but the
banks still regard the hedge funds as
good risk. From the perspective of Tennyson, entering into the US market at
this time, it could be to our disadvantage
that we’re a small, new counterparty at
a time when people may be looking for
more established counterparties, but
I think my history in the fund administration business negates that. People
will be looking for expertise and we certainly have plenty of that.”
HFMWEEK | 13
asia-pacific
HOW
TO STARTspecial
A HEDGE
report
FUND IN THE US
audit
New auditing standards are not all bad news for hedge fund managers. Robert Kaufman
of Kaufman, Rossin & Co explores the positives
Total control
I
nternal controls? Sure, every business needs
them, to make sure that oh-so-dependable
employees aren’t taking advantage of some
just-too-tempting opportunity to add to their
Hugo Boss collections.
But in the hedge fund business the stakes are
higher. There is a lot more at risk, and many more
people may share that risk. When considering an
investment, potential investors want to look behind
the scenes. They want to see how you’re protecting them against a whole range of risks, including
the possibility that you, the fund manager, might
be plotting to defraud them. They are starting to
look more closely at the procedures you are using
for just about everything – accepting their money,
investing their money, executing trades, valuing
their holdings, recording transactions, reporting
on activities, and that is just the beginning.
And now it is not just investors who want to inspect your controls. Now your auditors are in the
game, too. New auditing standards issued by the
American Institute of Certified Public Accountants
(AICPA) require auditors to focus on companies’
internal controls over financial reporting.
Protecting your fund
Robert A Kaufman
is the principal
technician of
Kaufman, Rossin &
Co’s financial services
practice, including US
regulatory reporting
and compliance. He
leads the firm’s hedge
fund audit practice.
14 | HFMWEEK
So where is the good news? It is simple: if you are
starting a new fund, you can establish and document operating procedures to comply with the
new audit requirements. In the process, you will
be documenting procedures that will meet the demands of new investors performing due diligence.
And you may even protect your fund – and yourself
– from risk.
Statements on Auditing Standards 104-111
(commonly referred to as the ‘risk assessment
standards’) and 114 are effective generally for audits of financial statements for the year ending 31
December 2007. The standards affect all private
companies, including hedge funds. Under these
new standards, auditors need to develop a more
thorough understanding of internal controls, including the control environment, key controls over
significant transactions and upper management
oversight of the financial reporting process. The
standards also require auditors to assess whether
those controls have been implemented and are operating effectively.
As you set up your new fund, the following
checklist can help you document your operational
processes and procedures for each aspect of your
business, and your corresponding internal controls
over those processes. If you outsource any of these
processes to a third party administrator or prime
broker, documentation should focus on your management and supervision of their processes. You
can outsource the process, but you are still responsible for putting controls in place to ensure the
accuracy and completeness of their functions and
work products.
For investor transactions, document procedures
and controls for:
Investor subscription process, (including
maintenance of proper documentation), with
respect to compliance, AML procedures and
determination of eligibility to participate in
new issue income and incentive fees.
l Regulatory issues concerning ERISA compliance and number of investor limitations.
l Side-letter arrangements or investor-level
modifications to fees as outlined in the fund’s
governing documents.
l Investor transaction (subscriptions, redemptions and pro-rata distributions) approvals
and processing, including charging redemption fees (if applicable), in the aggregate and
on an individual investor basis.
l
For trading and operations, document procedures and controls for:
I nvestment transactions being properly
authorised and approved with respect to
security type, specific position, price and
counterparty.
l Investment transactions executed do not viol
www.hfmweek.com
audit
late the trading parameters outlined in the fund’s governing documents or regulatory constraints.
l Investment transactions and holdings are completely accounted for,
including all custodial and/or cash
accounts as well as securities for
which there is no custodian (such
as other fund investments) or for
securities for which you maintain
physical custody.
l Cash payments or security distributions get to the intended party
and for the correct amount, with
respect to payment of expenses
and/or capital withdrawals.
l Computer systems utilised for
trading, banking, accounting and
investor servicing can only be accessed and/or modified by authorised personnel.
l For fund-of-fund or private equity
investments only: the due diligence
process prior to making investment
and on an ongoing basis that ensures the appropriateness of such
investment with respect to risk
thresholds to your fund, as well as
the investment’s ability to provide
adequate and timely financial information so that you can comply
with your own reporting needs.
For accounting, financial statement
preparation and disclosure, and investor reporting, document procedures
and controls for:
Valuations of investments owned
or sold short are properly valued at
fair value at each interim periodend, as well as year-end (be specific
for each category of investments).
l Trading and investment activity (including investment holdings and related cash effects) are
tracked and processed in accordance with generally accepted accounting principles (GAAP) with
respect to trade-date accounting.
l Corporate actions (mostly related
to interest and dividend accruals)
are monitored and captured with
respect to investments owned or
sold short during and at each period-end.
l
www.hfmweek.com HOW TO START
asia-pacific
A HEDGE special
FUND IN report
THE US
Cash, margin, investment holdings
and other bank balances are complete and properly recorded.
l Related-party transactions (including management’s compensation
in the form of management and/or
performance fees or reallocations)
are properly identified calculated
and recorded.
l Realised and unrealised gains and
losses are properly calculated and
recorded.
l Allocation of profit/loss to investors is properly recorded with respect to period earned and correct
sharing ratios.
l For funds trading in fixed income
securities: discount/premium amortisation is properly calculated
and recorded (for both long and
short positions).
l Soft-dollar transactions and arrangements affecting the fund are
properly recorded and disclosed.
l Financial statements, including
footnote disclosures, the condensed
schedule of investments, and fil
nancial highlights, are prepared in
accordance with GAAP.
l Fund level and specific investor returns as well as investor capital balances are properly calculated and
reported to investors (also describe
the frequency of such reporting).
l Regulatory body (SEC, IRS, NFA,
CIMA) filing deadlines and other
rules are monitored and complied
with.
l Start-up and organisational costs
have been properly accounted for
and recorded in accordance with
GAAP.
Documenting procedures and the
controls over those procedures may
seem like a daunting task, and one you
would like to put off as long as possible.
But with proper controls in place at the
start, your new fund gains an advantage
in satisfying potential investors and
fulfilling auditors’ requirements. You
may even protect yourself (and your investors) from a trusted employee’s Rolex
addiction.
HFMWEEK | 15
GET MORE OUT OF YOUR HEDGE FUND
THE LEADING BUSINESS MAGAZINE FOR HEDGE FUND MANAGERS
SUBSCRIBE NOW AND SAVE!
With the best read in the hedge fund industry
EVERY WEEK your receive the latest:
n Exclusive industry news
n Exclusive data on performance, launches
and searches
n Investment strategy analysis
n Topical comment from leading industry
figures
n Exclusive research surveys
n Regulatory developments
n People on the move
n reviews of books, papers, presentations you
should know about
As a subscriber, you will also receive full
registration to www.hfmweek.com where you
can access:
n Daily updated performance data
n Industry jobs
n Weekly and industry scoop news wires
n Industry events information
n Service directory listings and much more...
Subscribe before March 31st 2008 and you can save £100 on an annual subscription to HFM Week.
Pay just £895. Simply fill in the form below and fax to +44 (0)20 7269 7570 or call +44 (0)20 7269 7583.
o Please debit my credit card
o Please invoice me
Valid from:
Name
Job Title
Expires on:
Company Name
Address
Postal/Zip Code
Country
Tel
Email
Fax
Type of organisation
CALL +44 (0) 20 7269 7583 OR FAX BACK TO +44 (0) 20 7269 7570
stock exchange
how to start a hedge fund in the us
Greg Wojciechowski explains the advantages afforded to international investors by the
flourishing Bermuda Stock Exchange
Going forward
B
ermuda is home to a thriving and dynamic offshore financial services industry. For many years, Bermuda has been
the leader in creating and implementing the business and regulatory models that have become the
standard for other jurisdictions to follow.
Bermuda is located within two hours flying
time from most US East Coast hubs and a short
flight to Canada. Daily air services to the UK and
Europe make Bermuda the gateway between Europe and North America. Proximity to the world’s
largest capital markets and global business centres has been a key ingredient in Bermuda’s success. Bermuda has carved out a niche in the global
financial services industry which is well known
and highly regarded.
Bermuda’s pragmatic commercial approach
has created an operational, technical and regulatory infrastructure focused on clients’ needs
which is the result of a collaborative effort between the private and public sectors of the jurisdiction. This model ensures jurisdictional policies
remain in line with or ahead of market developments and keeps Bermuda’s regulatory oversight
at prudent levels, whilst also maintaining support
and appreciation for the entrepreneurial spirit
that drives innovation.
This approach has driven the development
and success of Bermuda’s insurance and global
financial services industries.
Transformation
Bermuda has been transformed from a tourist
destination in the 1950s to the enviable position
as being one of the most significant insurance and
reinsurance centres in the world. At the end of
2006, the Bermuda Monetary Authority reported
over 1,400 insurance and reinsurance companies
on its register, with over US$100bn in assets and
capital and surplus of over US$110bn (for the
year ending 2005).
www.hfmweek.com Historically, Bermuda was seen as a captive
insurance jurisdiction. However, over the last 15
years. Bermuda has evolved to become a multiline global leader and is now supplying 40% of the
US and European market property catastrophe
reinsurance coverage. Bermuda reinsurers rank 13
out of the top 40 in the Standard and Poor’s reinsurer rankings and 15 out of the top 35 AM Best
reinsurer rankings. Bermuda’s foundation for success in a global marketplace has been its support
of the capital markets, a centre of excellence with a
diverse and talented underwriting pool and an effective and appropriate regulatory regime.
Household names, such as Citigroup, The Bank
of New York Mellon, Nomura Securities, HSBC,
Ace and XL Capital have established a prominent
presence in Bermuda.
The mainstays of Bermuda’s strength as a
leader in the offshore financial services industry
can easily be traced to the jurisdiction’s longevity in the business. As one of the early pioneers in
the offshore financial services business, Bermuda
has developed a commercially sensible level of
regulation based upon years of experience, and
has created products that meet the needs of its
sophisticated client base. Bermuda’s experience
has produced a deep and knowledgeable infrastructure of service providers. Bermuda’s infrastructure extends to services provided by global
fund administrators, attorneys, banks, auditors
and the Bermuda Stock Exchange. Bermuda has
evolved to offer a sophisticated product to a sophisticated and selective client base.
A recent example of this innovative approach
is the ‘Launch ‘n’ List’ product made available to
the global hedge fund industry. Launch ‘n’ List is
the result of collaboration between the Bermuda
International Business Association (BIBA), the
Bermuda Monetary Authority (BMA) and the
Bermuda Stock Exchange (BSX). Launch ‘n’ List
was developed as a result of industry feedback
Greg Wojciechowski
is chief executive
of the Bermuda
Stock Exchange.
He was previously
its chief operating
officer, responsible
for the development
of regulatory
and operational
infrastructure as
well as the day-today running of the
exchange.
HFMWEEK | 17
how to start a hedge fund in the us
stock exchange
which indicated a growing frustration among practitioners with the length of time they experienced
when creating, domiciling and listing a structure.
Launch ‘n’ List is a direct response to this frustration, as the procedure seeks to reduce and eliminate duplicate effort, which in turn reduces the
amount of time to market.
A complete solution
The Bermuda Stock Exchange (BSX) has been in
existence since 1971 and has carved a niche in the
global stock exchange industry, with nearly 550
listed issuers with a combined market capitalisation of around US$330bn. Offering a complete
stock exchange solution in one of the world’s most
respected and sophisticated offshore financial centres, the BSX trades and settles stock and cash
transactions daily through its electronic trading,
settlement and depository systems.
The development and success of the BSX has
helped the growth of Bermuda’s capital market
and has provided opportunities for international
clients. The BSX’s commercially sensible regulatory approach dovetails with that of the jurisdiction,
and is based upon currently accepted international
regulatory and operational standards. It seeks to
achieve an appropriate balance between providing issuers with access to the market at the earliest
opportunity, and investors with certain safeguards
and timely information for the purpose of enabling
them to make informed decisions on the value, risk
and merit of listed securities.
The BSX’s regulatory approach has been embraced by the global fund industry. Of the nearly
550 BSX listed vehicles, over 100 are hedge funds
or have hedge fund attributes. Recently, the BSX
has seen interest growing in the listing of fixed income products and derivative warrants, with over
100 derivative warrant structures listing in 2007.
The BSX’s international regulatory recognitions and longevity in the stock exchange business
has resulted in the BSX becoming the location of
choice in the offshore world for those entities wishing a superior level of support and distinction from
their listing. In fact, over half of the funds listed on
the BSX originate from other jurisdictions.
Going forward, Bermuda will continue to drive
innovation in its core financial services industries.
The stakeholders in Bermuda have always embraced change in anticipation of the potential opportunities that may follow.
From the BSX’s perspective, we see huge opportunity in the global stock exchange industry
for the Bermuda Stock Exchange. Our unique approach, in respect of our regulatory infrastructure
coupled with our strategic geographical location
and internationally recognised electronic stock exchange platform, places the BSX in a very exciting
position to take advantage of rapidly changing and
expanding global capital market opportunities.
Bermuda Stock Exchange (BSX)
l Established in 1971, the Bermuda Stock Exchange (BSX) is
now the world’s leading fully electronic offshore securities
market, with a current market capitalisation (excluding mutual funds) in excess of US$330bn.
l There are nearly 550 securities listed on the BSX, of which
nearly 300 are offshore funds and alternative investment
structures.
l The success of the BSX lies in its innovative approach to new
products and markets and its ability to offer a ‘commercially
sensible’ regulatory environment. The Exchange specialises
in listing and trading of capital market instruments such as
equities, debt issues (including specialised debt structures),
18 | HFMWEEK
funds (including hedge fund structures) and derivative
warrants programmes.
l The BSX is a full member of the World Federation of
Exchanges (WFE) and is located in an OECD member nation.
In addition, the BSX is a Recognised Investment Exchange,
as set out by the Bermuda Monetary Authority.
l The BSX has been granted Approved Stock Exchange status
under Australia’s Foreign Investment Fund (FIF) taxation
rules and Designated Investment Exchange status by the UK’s
Financial Services Authority.
l In recent developments, the BSX was designated a Recognised Stock Exchange by the UK’s HM Revenue and Customs.
www.hfmweek.com
A NEW DAWN FOR
FUND ADMINISTRATION
AT TENNYSON,
WE DO ThINGS A lITTlE DIFFERENTlY
Our big idea for fund administration is really quite a simple one.
Good old-fashioned service.
You get reporting that’s never late, incomplete or inaccurate.
No systems hassle, with total integration of front, middle and back office.
Knowledgeable, friendly staff who respect your time
and give you the answers you need – fast.
Like we said, it’s simple.
So why isn’t everyone doing it?
OpENING IN NEW YORK SOON
Call Tony Stocks on: +44 (0) 20 7518 8200 for more information
or email: [email protected]
tennysonfunds.com