Hedge Fund Book

FORMING AND OPERATING A HEDGE FUND - A Guide for Emerging Fund Managers
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FORMING AND OPERATING
A HEDGE FUND
A Guide for Emerging Fund Managers
By John S. Lore, Esq.
© 2015 Capital Fund Law Group

2 FORMING AND OPERATING A HEDGE FUND - A Guide for Emerging Fund Managers FORMING AND OPERATING A HEDGE FUND - A Guide for Emerging Fund Managers
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ABOUT THE AUTHOR.................................................................................................................................... 7 D. Investment Management Agreement.......................................................................................................... 20

CONTENTS
E. Management Company Operating Agreement........................................................................................... 20

ABOUT CAPITAL FUND LAW GROUP....................................................................................................... 9 F. Form D Filings, Investment Advisor Registration....................................................................................... 20
A. Our Services.................................................................................................................................................. 9 IV. COMMON

HEDGE FUND STRATEGIES............................................................................................ 21
B. Our Philosophy............................................................................................................................................. 9
A. Long/Short Equity...................................................................................................................................... 21
INTRODUCTION............................................................................................................................................. 11 B. Credit Funds................................................................................................................................................ 21
i. Distressed Debt....................................................................................................................................... 21
Part I................................................................................................................................................................ 11 ii. Fixed Income.......................................................................................................................................... 21
Part II.............................................................................................................................................................. 11 C. Arbitrage..................................................................................................................................................... 22
Part III............................................................................................................................................................. 11 i. Fixed Income Arbitrage.......................................................................................................................... 22
Glossary........................................................................................................................................................... 11 ii. Convertible Arbitrage............................................................................................................................. 22
iii. Relative Value Arbitrage........................................................................................................................ 22
PART 1: HEDGE FUND FORMATION BASICS iv. Merger Arbitrage................................................................................................................................... 22
D. Event-Driven.............................................................................................................................................. 22
I. AVOIDING POTENTIAL LIABILITY..................................................................................................... 13 E. Quantitative (Black Box)............................................................................................................................. 23
F. Global Macro............................................................................................................................................... 23
A. Improper Offering Document Preparation Could Result in Fraud Violations............................................ 13 G. Multi-Strategy............................................................................................................................................ 23
i. Liabilities for Violating Federal Anti-Fraud Provisions.......................................................................... 13
ii. Liabilities for Violating State Anti-Fraud Provisions............................................................................. 13 V. WHO CAN INVEST IN A HEDGE FUND?........................................................................................... 25
B. Proper Legal Advice and Careful Disclosure............................................................................................... 13
A. The Accredited Investor Standard............................................................................................................... 25
II. S
ELECTING HEDGE FUND SERVICE PROVIDERS......................................................................... 15 i. The Net Worth Test................................................................................................................................. 25
ii. The Income Test..................................................................................................................................... 25
A. Legal Counsel.............................................................................................................................................. 15 B. The Qualified Client Standard..................................................................................................................... 25
B. Administrator............................................................................................................................................... 16 C. Principals of the Fund................................................................................................................................. 25
C. Auditor......................................................................................................................................................... 16
D. Prime Broker/Custodian.............................................................................................................................. 16 VI. MARKETING A HEDGE FUND............................................................................................................. 27
III. H
EDGE FUND OFFERING DOCUMENTS......................................................................................... 19 A. Seed Raise................................................................................................................................................... 27
B. Using Intermediaries to Raise Capital......................................................................................................... 27
A. Private Placement Memorandum................................................................................................................ 19 C. Broker-Dealer Placement Agents............................................................................................................... 27
B. Limited Partnership Agreement.................................................................................................................. 19 D. Finders........................................................................................................................................................ 27
C. Subscription Documents............................................................................................................................. 20 E. General Advertising.................................................................................................................................... 28
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i. The JOBS Act Allows General Advertising for Certain Offerings.......................................................... 28 X. P
ROPERLY SECURING A REGULATION D EXEMPTION.............................................................. 41
ii. Lifting of the Advertising Ban for Private Placements–New Rule 506(c)............................................. 28
a. What are reasonable steps?................................................................................................................ 28 A. Rule 506 Exemption................................................................................................................................... 41
b. W ill Advertising Be Effective in Raising Capital?............................................................................ 28 i. Federal Preemption Over State Law....................................................................................................... 41
c. Proposed Rules Requiring Additional SEC Disclosures................................................................... 29 ii. Reduced Risk of Losing the Exemption................................................................................................. 41
d. Advertising Must Not Be Misleading............................................................................................... 29 iii. Advertising............................................................................................................................................ 41
e. No Other Offerings Affected............................................................................................................ 29 B. State Exemptions......................................................................................................................................... 42
C. Form D Filing............................................................................................................................................. 42
VII. B
EGINNING WITH AN INCUBATOR FUND................................................................................... 30 i. State Requirements................................................................................................................................. 42
A. Why an Incubator Fund?............................................................................................................................ 30 XI. I NVESTMENT ADVISOR REGISTRATION........................................................................................ 43

i. Structure.................................................................................................................................................. 30
ii. Minimal Regulatory Requirements........................................................................................................ 30 A. Requirements for Investment Advisor Registration.................................................................................... 43
iii. Cost....................................................................................................................................................... 30 i. Will the fund invest in “securities?”......................................................................................................... 43
B. Self-Funded................................................................................................................................................. 30 ii. What will be the size of the fund?.......................................................................................................... 43
C. How is an Incubator Fund Taxed?.............................................................................................................. 31 iii. In what state is the management team located?.................................................................................... 43
D. Transition to a Full Hedge Fund................................................................................................................. 31 iv. In what states will the investors be located?........................................................................................... 44
B. Investment Advisor Representatives............................................................................................................ 44
PART 2: HEDGE FUND TERMS, STRUCTURE, AND REGULATION C. Series 65 Examination................................................................................................................................ 44
D. Documents Required for Registration........................................................................................................ 44
i. ADV Parts 1 and 2.................................................................................................................................. 44
CONTENTS
VIII. C
OMMON HEDGE FUND TERMS.................................................................................................... 33 a. Form ADV Part 1............................................................................................................................. 44
1. ADV Part 1A.............................................................................................................................. 45
A. Hedge Fund Manager Compensation......................................................................................................... 33 2. Form ADV Part 1B..................................................................................................................... 45
i. Management Fees.................................................................................................................................... 33 b. Form ADV Part 2............................................................................................................................. 45
ii. Performance Allocation.......................................................................................................................... 33 1. Firm Brochure (Part 2A)............................................................................................................. 45
iii. Tax Advantages of the Performance Allocation..................................................................................... 33 2. Brochure Supplement (Part 2B).................................................................................................. 46
iv. High Water Marks................................................................................................................................. 34 i. Code of Ethics/Compliance Manual............................................................................................................ 46
B. Hurdle Rates............................................................................................................................................... 34 ii. Bonding Requirement.................................................................................................................................. 46
C. Contribution & Withdrawal....................................................................................................................... 34 iii. Ongoing RIA Compliance Obligations...................................................................................................... 46
i. Minimum Initial Contributions.............................................................................................................. 34 a. Annual Renewals.................................................................................................................................... 46
ii. Lock-up Period...................................................................................................................................... 35 b. Record Keeping...................................................................................................................................... 46
iii. Gates..................................................................................................................................................... 35 c. Ongoing Client Disclosure..................................................................................................................... 46
D. Fund Expenses............................................................................................................................................ 35 d. Maintenance of Compliance/Ethics Manuals........................................................................................ 47
E. Side Letters................................................................................................................................................. 35
XII.HEDGE FUNDS INVESTING IN COMMODITIES.......................................................................... 48
IX. H
EDGE FUND STRUCTURE AND JURISDICTION......................................................................... 37
A. What is a commodity Interest?................................................................................................................... 48
A. Open vs. Closed-End Fund Structures....................................................................................................... 37 B. CPO/CTA Registration.............................................................................................................................. 48
B. 3(c)(1) Funds vs. 3(c)(7) Funds................................................................................................................... 37 C. Streamlined Process for Funds with only “Qualified Eligible Participants”................................................. 48
i. 3(c)(1) Funds........................................................................................................................................... 37 D. The de minimus Exemption......................................................................................................................... 48
ii. 3(c)(7) Funds.......................................................................................................................................... 38
C. Domestic and Offshore Fund Structures..................................................................................................... 38 PART 3: SAMPLE DOCUMENT EXCERPT
i. Domestic Fund Structure........................................................................................................................ 38
ii. Offshore Fund Structures....................................................................................................................... 38 PPM EXCERPT WITH ILLUSTRATIVE EXPLANATIONS.................................................................... 51
a. Master-Feeder Fund.......................................................................................................................... 38
b. Parallel Fund Structure..................................................................................................................... 38 GLOSSARY OF TERMS................................................................................................................................... 74
D. Offshore Jurisdictions................................................................................................................................. 38
i. Cayman Islands....................................................................................................................................... 39 DISCLAIMER.................................................................................................................................................... 83
ii. British Virgin Islands (BVI)................................................................................................................... 39
CONTACT INFORMATION.......................................................................................................................... 85

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ABOUT THE AUTHOR
John S. Lore, Esq. is the managing partner of changes. Prior to founding Capital Fund Law Group,
Capital Fund Law Group, an investment fund law Mr. Lore practiced corporate and securities law at a
boutique focused on domestic and offshore hedge number of law firms, including the investment funds
fund formation and compliance. Mr. Lore advises division of Akin Gump Strauss Hauer & Feld, one of
established and emerging fund managers throughout the largest international law firms in the world, in its
the United States in forming and operating hedge New York City and Moscow offices.
funds, private equity funds, real estate funds and other
private securities offerings across multiple industry Mr. Lore received his Juris Doctorate, with honors,
sectors. from the University of Utah, S.J. Quinney College of
Law, where he served as a senior member of the Utah
Mr. Lore advises investments on all aspects of their Law Review staff. John Lore is a frequent panelist and
business, from capital raising and fund formation presenter at various investment fund and Regulation
to implementation of their business models. His D professional and educational events. Mr. Lore is
representation of a broad range of asset managers allows a holder of the Series 65 Investment Adviser Law
him to keep abreast of emerging trends and regulatory Examination.

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ABOUT CAPITAL FUND LAW GROUP
Capital Fund Law Group advises emerging and strategy, management background, risks and
established hedge fund managers on all aspects of fund other necessary issues;
formation and ongoing operations. Our attorneys have
• preparing the limited partnership agreement or
spent their legal careers structuring hedge funds and
operating agreement governing the fund;
other private securities offerings. We form investment
funds for sponsors throughout the United States and • preparing the investment management agree-
internationally varied investment strategies, fund ment between the fund and the investment
vehicles, jurisdictions and industry sectors. management company;
Our firm advises hedge funds of all investment • forming the most advantageous entities in the
strategies and asset classes, including: long/short appropriate jurisdictions;
equity, fixed-income, event-driven, multi-strategy,
quantitative, and sector funds (including health care, • preparing and filing the fund’s federal Form D as
technology, energy, and others) as well as real estate required by the securities registration exemption
and private equity funds. found in Rule 506 of Regulation D;
Our attorneys are regularly called upon to give • advising the fund sponsors on marketing and
presentations at securities law and investment fund operating issues;
forums and educational panels.
• coordinating with the fund administrator,
auditor, prime broker and other service providers;
A. Our Services and
Capital Fund Law Group is committed to providing
• advising on capital raising issues and sources.
the highest quality of services on a personal level and
in a timely manner. We offer flat-fee engagements,
which include start-to-finish counsel with all aspects B. Our Philosophy
of launching a domestic or offshore hedge fund. Our No two funds are identical and each client has unique
services include: objectives and circumstances. We use a client-based
approach to our fund structuring and analysis. Our
• structuring market-appropriate investment fund clients routinely comment on the excellence of our
terms to compensate fund sponsors, properly personal service and the time we take to properly
allocate risk and secure tax advantages for the understand and implement the client’s unique
fund sponsors and investors; circumstances and objectives. Capital Fund Law
• reparing the private placement memorandum
p Group is committed to providing the highest quality
to disclose the fund’s investment terms, trading of services on a personal level and in a timely manner.

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INTRODUCTION
This ebook provides a guide through the process of sponsor and investors;
structuring, launching and raising capital for domestic • properly securing appropriate securities registra-
and offshore hedge funds and other private investment tion exemptions;
funds. In this book, we highlight pitfalls that fund
sponsors should watch for and suggest best practices • satisfying investment advisor registration re-
to safely and effectively navigate the process of forming quirements;
and operating a fund. • determining whether commodities regulation
registration is needed; and
The ebook is divided into three main parts, ascending
• maintaining regulatory compliance.
in the level of detail and complexity.
Part III
Part I
Part III is a brief excerpt of a sample hedge fund
Part I provides an overview of the hedge fund formation private placement memorandum (PPM) for a fictitious
process and discusses some of the broad topics and key master-feeder hedge fund. The excerpt contains
considerations involved in forming a fund, including: footnoted explanations of key provisions of a properly-
structured PPM, as well as a deeper level discussion
• how to avoid securities liability as a hedge fund
of certain hedge fund topics. Part III also highlights
manager;
common drafting errors and how to avoid them.
• who is eligible to invest in a fund;
• how to legally market a hedge fund to investors; The model PPM places particular emphasis on the risk
factor section, which is one of the most important and
• when it is appropriate to start with an incubator most customized components of a hedge fund PPM.
fund; Part III gives readers a sample of the level of detailed
• what service providers are needed to operate a disclosure that should be expected in a properly drafted
hedge fund; and offering memorandum.
• what documents are needed to launch a hedge
fund. Glossary
The complexity of investment fund regulation requires
Part II an investment manager to be familiar with key
Part II gives an in-depth discussion of key investment investment fund legal terminology. Throughout the
terms, structure and regulatory considerations involved ebook, key definitions are highlighted in blue and
in forming a fund, including: linked to definitions and explanations in the glossary.
• setting market-appropriate investment terms;

• structuring the fund to minimize taxes for the

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PART 1: I. AVOIDING POTENTIAL LIABILITY
HEDGE FUND FORMATION Operating a hedge fund entails significant legal
exposure, with substantial liability for improper
the company, and in some cases an officer or director,
would be required to repay the purchase price of the
BASICS disclosure. Even inadvertent mistakes can lead to

substantial personal liability.
investment made, together with interest, attorney fees,
and other costs.
Payment of the liability under this section can be

A. Improper Offering ordered by the court against the individual directors’
and officers’ personal assets. Furthermore, if the SEC
Document Preparation can prove that the material omissions or misstatements
Could Result in Fraud were willful, a court can impose fines on individuals of
Violations up to five million dollars and/or imprisonment of up
to twenty years.
The SEC, the CFTC, the NFA and state securities
commissions have developed a network of complex
regulations with which a fund sponsor must comply ii. L
iabilities for Violating State Anti- Fraud
Provisions
to avoid liability. In recent years SEC regulations
have undergone and continue to undergo major shifts, Similar to the SEC, each state has its own securities
largely in response to the Dodd-Frank Wall Street laws that effectively piggyback the Exchange Act and
Reform and Consumer Protection Act (Dodd Frank impose civil liability on persons who misrepresent or
2010) and the Jumpstart Our Business Startups Act omit material facts. They include personal liability
( JOBS Act 2012). against directors and officers. Thus, after the SEC
imposes its penalties, each state in which a security
Failure to properly navigate the complex and was sold may then impose its own penalties against
continually changing regulations carries significant the directors and officers of the issuing company.
liability, including personal civil liability and criminal
penalties in some cases.
B. P
roper Legal Advice and
i. L
iabilities for Violating Federal Anti- Careful Disclosure
Fraud Provisions
Hedge fund disclosure documents not only require
Section 10(b) of the Securities Exchange Act of 1934 specific disclosures of present information about the
(Exchange Act), imposes liability on a person who fund and its managers, but also requires a recitation
misrepresents or omits a material fact in connection of potential risks of the investment (known as risk
with the sale of securities. The primary penalty imposed factors). Risk factors vary significantly from one fund
is a rescission of the investor’s contract to purchase the to another and require the drafting attorney to foresee
security. A rescission of the contract means that potential contingencies and assumptions that may
result in unfavorable investment outcomes.

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The risk factors must be crafted to fit specific risks
that the fund may face. Experienced securities
Unintentionally deviating from the disclosure
requirements can result in serious consequences for II. SELECTING HEDGE FUND
SERVICE PROVIDERS
counsel will help the fund sponsors make the the issuer and its directors, officers, and managers.
proper disclosures required throughout the Private An experienced hedge fund attorney by your side
Placement Memorandum and protect the fund from will guide you through the complex regulations
unintentionally making misleading statements and promulgated by the SEC, FINRA and the states, and
material omissions. A hedge fund PPM requires help you minimize tax liability. Emerging hedge fund managers face a maze of After the offering documents have been finalized, the
specific language, drafting style, disclosures, and regulatory and tax considerations, investor reporting hedge fund attorney will act as an ongoing resource
content. requirements, and business operation issues. Managers and will assist the fund on an as-needed basis with
must also balance investor relationships, capital raising, the legal and operational issues. Among the ongoing
developing their investment strategies, and a myriad of services that the hedge fund attorney will provide
other roles. include the following:
Experienced and committed service providers play a • review marketing and promotional material;
vital role in guiding managers through their various
• provide answers to investor questions;
responsibilities. A skilled team of service providers
helps managers avoid devastating mistakes and can • prepare amendments to fund offering documents
free them to perform their most important roles of as needed;
raising capital and executing the fund’s investment
• prepare side letter agreements for strategic
strategy. Choosing the right team of service providers
investors;
can mean the difference between an emerging fund’s
success or failure. • answer structural and operational questions;
• assist managers with modifications to the fund;

A. Legal Counsel and
A hedge fund attorney is usually the initial contact for • advise managers on the eligibility of certain
startup fund managers. The hedge fund managers work investors.
closely with the attorney to develop the fund’s structure
Choosing a hedge fund legal advisor is among the
and terms, in light of the fund’s investment strategies.
most important decisions that an emerging manager
The hedge fund attorney advises the managers on
will face. Prospective fund managers should seek for
applicable regulatory obligations including required
fund counsel with substantial knowledge of the hedge
filings, examinations and registrations.
fund industry from both a regulatory and business
Once the fund’s terms and regulatory structure are perspective. It is also vital that the hedge fund attorneys
defined, the hedge fund attorney will begin preparation be committed to working directly with the fund
of the hedge fund’s offering documents (including the manager through all aspects of the fund formation
PPM, partnership agreement, subscription agreement, process.
and certain regulatory filings.) Further, the hedge fund
In addition to the experience of the fund attorney,
attorney will refer managers to other needed service
the cost of legal startup services is a key consideration
providers, including administrators, prime brokers and
when selecting counsel. Legal startup costs are typically
auditors.

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born by the fund, and can cause substantial drag on Depending on jurisdiction and other factors, a fund and transfer all assets through the prime broker. This that are generally not able to service a hedge fund
the fund’s reported performance. A reputable boutique may or may not be required to use the services of an custodial relationship facilitates simpler reporting of until it reaches $100 million or more in assets under
law firm provides the advantages of a specialized law administrator. Regardless of legal requirements, using the fund’s positions (which in turn simplifies the work management. However, a mini-prime broker or
practice, while keeping formation costs manageable. one is strongly encouraged and has become a de facto of the administrator and auditor). “introducing broker” acts as a liason between a hedge
Boutique law firms also tend to provide direct access requirement among sophisticated investors. Outside fund and the large prime brokers, providing startup
to the firm’s partners. verification of the fund’s financial performance creates In addition to custodial services, prime brokers can fund managers access to the full range of services
a needed layer of protection for investors. Additionally, provide leverage and margin, facilitate short sales, provided by prime brokers. Most startup hedge funds
having calculations prepared by a skilled fund provide soft dollar arrangements, perform portfolio begin their fund with an introducing broker. Your
B. Administrator administrator significantly decreases the difficulty and analysis, stress testing and other services. hedge fund attorney can suggest introducing brokers
cost of an outside audit. Your hedge fund attorney can or prime brokers appropriate for your fund.
The administrator acts as an intermediary between Most prime brokers are large Wall-Street institutions
direct you to administrators that are aligned with your
the fund’s managers and investors and provides an
strategy needs and budget requirements.
additional layer of protection to investors. The hedge
fund administrator provides accounting and back
office functions for the hedge fund.
C. Auditor
The administrator provides an independent From an investor’s perspective, the reputation of
calculation of the net asset value (NAV) of the fund the auditing firm is among the most important due
portfolio, calculates performance compensation, and diligence items when investing in a fund.
provides periodic financial performance statements to
investors. The administrator also typically handles the The auditor works closely with the hedge fund manager
investor subscription process and reviews incoming to assess the valuation of the fund. The auditor will
subscriptions. A relatively new service provided by carefully review the fund’s account statements, which
hedge fund administrators is a “second signer” service, are usually prepared by the fund administrator.
designed to provide investors increased security
against hedge fund fraud. A “second signer” agreement Audited financial statements contain a wealth of
requires the fund’s management to obtain a signature information not only about the financial position of
from the administrator prior to making a transfer or the fund, but also regarding key decisions the fund has
withdrawal from the fund’s account. In addition to the made, expense levels and the overall opinion of the
above, the hedge fund administrator may perform the auditor of the financial statements.
following:
Your hedge fund attorney will make recommendations
• portfolio and cash reconciliation reporting; for auditors appropriate for your fund.
• investor services;
• treasury services; D. Prime Broker/Custodian

• tax compliance services; A prime broker is a central broker through which the
fund executes most or all of its trades and that acts
• audit report preparation and auditor as custodian of the fund’s assets. When the hedge
coordination; and fund executes trades through other brokers, the prime
• SEC compliance and consulting broker works with the executing brokers to settle

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III. H
EDGE FUND OFFERING
DOCUMENTS
Your hedge fund attorneys will prepare five core partnership agreement outlines the terms of the
documents, which are necessary to launch the fund: fund and rights of an investor and fund manager. In
contrast with the private placement memorandum,
(A) a private placement memorandum, (B) a limited which is written in plain English (accessible to non-
partnership agreement, (C) a subscription agreement, legally trained readers), the fund’s limited partnership
(D) an investment management agreement, and (E) agreement is a lengthy and complex legal document.
a management company operating agreement.The Among the terms of the limited partnership agreement
attorneys will also prepare and file the necessary are:
regulatory filings (which can include Form D filings,
investment advisor registration and commodities • a description of the powers and activities of the
registration). Regulatory filings will be discussed in general partner (typically also the fund manager);
subsequent chapters.
• a thorough discussion of all fees and expenses,
including management, performance or other
potential fees as well as legal startup costs,
A. P
rivate Placement brokerage, administration, and audit expenses;
Memorandum
• a n explanation of the allocations and
A private placement memorandum (PPM) is a distributions of profits to all partners, including
securities disclosure document that provides investors how profits are calculated and timing of
with material information about the fund to enable distributions;
an investor to make an informed investment decision.
Similar to a prospectus in an initial public offering, • a description of withdrawal provisions, including
a PPM provides potential investors with specific minimum and maximum withdrawal amounts,
information about the terms of the fund, the structure lock-up periods, gates, and distribution dates;
of the investment, background of the managers and and
other disclosure issues. • a designation of power of attorney, which
authorizes the fund manager to act on the
limited partner’s behalf for such purposes as
B. L
imited Partnership voting the fund’s securities, buying and selling
Agreement fund securities, admissions of new limited
partners, and amendments to fund formation
The limited partnership agreement (or in the case of
documents and other documents necessary for
an LLC-based fund, an operating agreement) is the
continued fund activity.
legal governing document of the fund. The limited

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To become a limited partner of a fund, an investor
must sign a countersignature page in which he or she
the fund manager the broad discretionary authority
to manage such investor funds and securities in a IV. COMMON
HEDGE FUND
STRATEGIES
agrees to be bound by the terms of the agreement. manner that the fund manager believes is consistent
with the investment strategy of the fund. Since the
fund manager and the fund are controlled by the same
C. Subscription Documents individuals, the investment management agreement is
typically signed by the same individuals on both sides. Hedge fund strategies encompass a broad range of brought a resurgence in credit funds, which tend to
Subscription documents provide investors with a risk tolerance and investment philosophies within a follow cyclical patterns. Credit funds include distressed
description of the steps necessary to purchase limited wide array of instruments, including debt and equity debt strategies, fixed income strategies, direct lending
partnership interests in a fund and provide fund securities, commodities, currencies, derivatives, real and others.
managers with eligibility information about the E. M
anagement Company
estate and other investment vehicles. The horizon
investor. This is the investor’s contract with the fund, Operating Agreement of hedge fund investment strategies has seen
which specifies the subscription amount and outlines i. Distressed Debt
The fund manager operating agreement is the legal unprecedented expansion in recent years. Investment
the terms under which the investment is being made. governing document that provides for the rights of terms are driven in large part by the fund’s strategy and Distressed debt involves investment in corporate
For fund managers, this document requires investors the founders of the fund. This document specifies level of liquidity. bonds, bank debt, and occasionally common and
to attest that they meet certain eligibility standards, how ownership of the fund is divided among the preferred stock of companies in distress. When a
such as being an “accredited investor” or “qualified principals of the fund. The management company Below is a description of some of the more common company is unable to meet its financial obligations, or
client”, as required by SEC regulations and state law. operating agreement and its contents are not disclosed hedge fund strategies. is in a liquidity crisis, its debt is devalued. Distressed
to investors. debt funds use fundamental analysis to identify
undervalued investments. Hedge funds that invest in
D. Investment Management A. Long/Short Equity distressed debt need to employ more stringent lock-up
and withdrawal terms, including side pockets (accounts
Agreement F. F
orm D Filings, Investment One of the most commonly used strategies for startup
to separate illiquid assets). A fund sponsor looking to
The investment management agreement is an Advisor Registration hedge funds is the long/short equity strategy. As the
form a distressed debt fund should speak with a hedge
agreement between the fund and the investment name suggests, the long/short equity strategy involves
In addition to the five core fund documents, the fund attorney to determine whether a private equity
management company (often the same entity as the taking long and short positions in equity and equity
hedge fund attorneys will prepare applicable SEC and fund would be more appropriate. Unlike hedge funds,
general partner). It defines the services that a fund derivative securities. Funds using a long/short strategy
state filings, including Form D filings and in some which allow regular withdrawals, private equity funds
manager will provide. It also assigns to the fund manager employ a wide range of fundamental and quantitative
cases, investment advisor registration and CFTC are usually closed-ended and have a finite duration,
a power of attorney over the fund’s assets, including the techniques to make investment decisions. Long/
registration, which will be discussed in detail in Part usually between five and ten years.
contributions made by the limited partners, and gives short funds tend to invest primarily in publicly traded
II of the book.
equity and their derivatives, and tend to be long
biased. Long/short funds also tend to have fairly ii. Fixed Income
straightforward investment fund terms. Accordingly, Fixed income funds invest in long-term government,
lock-ups, gates and other withdrawal terms in long- bank and corporate bonds, debentures, convertible
short funds are usually on the more permissive side notes and capital notes, and their derivatives, which
because of the ease of liquidating positions to facilitate pay a fixed rate of interest. Many fixed income funds
investor withdrawals. have lower risk tolerances than distressed debt funds
and place capital preservation as a higher priority,
leading to more diversification and volatility-reducing
B. Credit Funds strategies. A common fixed income hedge fund
Credit funds make debt investments based on lending strategy is fixed income arbitrage, discussed below.
inefficiencies. The financial downturn of 2008-2009

23
Although simple in theory, proper execution of investment in equity, debt, commodities, futures,
C. Arbitrage E. Quantitative (Black Box)
convertible arbitrage strategies requires careful currencies, real estate and other assets in various
Arbitrage strategies seek to exploit observable price timing to avoid losses. Furthermore, the increasing Quantitative hedge fund strategies rely on quantitative countries. Currency traders rely heavily on global
differences between closely-related investments popularity of convertible arbitrage has had the effect analysis to make investment decisions. Such hedge macro strategies to forecast relative currency values.
by simultaneously purchasing and selling related of diminishing available price inefficiencies, making fund strategies typically utilize technology-based Likewise, interest rate portfolio managers, who trade
investments, while minimizing volatility. When it difficult to achieve significant returns without using algorithmic modeling to achieve desired investment instruments that are keyed into sovereign debt markets
properly used, arbitrage strategies produce consistent extensive leverage. objectives. Quantitative strategies are often referred are heavily involved with global macro fundamental
returns with relatively low risk. However, because to as “black box” funds, since investors usually have analysis.
price inefficiencies between investments tend to be limited access to investment strategy specifics. Funds
iii. Relative Value Arbitrage
slight, arbitrage funds must rely heavily on leverage to that rely on quantitative technologies take extensive
obtain substantial returns. Relative value arbitrage, or “pairs trading” involves precautions to protect proprietary programs.
taking advantage of perceived price discrepancies
G. Multi-Strategy
Due to heavy use of leverage, some arbitrage firms have between highly correlated investments, including Multi-strategy funds are not confined to a single
investment strategy or objective, but instead use a
suffered monumental losses when pricing differences stocks, options, commodities, and currencies. A pure F. Global Macro
unexpectedly shifted. For example, Long Term Capital relative value arbitrage strategy involves high risk and variety of investment strategies to achieve positive
Global macro refers to the general investment strategy returns regardless of overall market performance.
Management, the infamous fixed income arbitrage requires extensive expertise.
of making investment decisions based on broad Multi-strategy funds tend to have a low risk tolerance
fund from the 1990s that suffered catastrophic losses
political and economic outlooks of various countries. and maintain a high priority on capital preservation.
and had to be bailed out by a government-brokered iv. Merger Arbitrage Global macro strategy involves both directional Even though multi-strategy funds have the discretion
consortium of Wall-Street banks.
Merger arbitrage involves taking opposing positions in analysis, which seeks to predict the rise or decline to use a variety of strategies, fund managers tend
two merging companies to take advantage of the price of a country’s economy, as well as relative analysis, to focus primarily on one or more core investment
i. Fixed Income Arbitrage evaluating economic trends relative to each other.
inefficiencies that occur before and after a merger. strategies.
Fixed income arbitrage seeks to exploit pricing Upon the announcement of a merger, the stock price
differences in fixed income securities, most commonly of the target company typically rises and the stock Global macro funds are not confined to any specific
by taking various opposing positions in inefficiently price of the acquiring company typically falls. Merger investment vehicle or asset class, and can include
priced bonds or their derivatives, with the expectation arbitrage is a form of event-driven hedge fund strategy,
that prices will revert to their true value over time. discussed below.
Common fixed income arbitrage strategies include
swap-spread arbitrage, yield curve arbitrage and
capital structure arbitrage. The fictitious fund used for D. Event-Driven
the model hedge fund PPM excerpt in Part III of this
Event-driven strategies are closely related to arbitrage
book is based on a fixed income arbitrage strategy.
strategies, seeking to exploit pricing inflation
and deflation that occurs in response to specific
ii. Convertible Arbitrage corporate events, including mergers and takeovers,
Convertible arbitrage seeks to profit from price reorganizations, restructuring, asset sales, spin-offs,
inefficiencies of a company’s convertible securities liquidations, bankruptcy and other events creating
relative to its stock. At its most basic level, convertible inefficient stock pricing. Event-driven strategies require
arbitrage involves taking long positions in a company’s expertise in fundamental modeling and analysis of
convertible securities while simultaneously taking corporate events. Examples of event-driven strategies
a short position in a company’s common stock. include: merger arbitrage, risk arbitrage, distressed
debt, and event-based capital structure arbitrage.

25
V. W
HO CAN INVEST IN A HEDGE
FUND?
There are two standards of investor suitability that ii. The Income Test
may apply to investment fund investors, depending Alternatively, an accredited investor can also be a
whether the fund manager is required to be registered natural person who has an individual income in excess
as an investment adviser: (i) the “accredited investor” of $200,000 in each of the two most recent years or
standard; or (ii) the significantly higher “qualified joint income with that person’s spouse in excess of
client” standard. $300,000 in each of those years and has a reasonable
expectation of reaching the same income level in the
current year.
A. T
he Accredited Investor
Standard B. T
he Qualified Client
Even in states where hedge fund managers at a given
level of assets under management are not required
Standard
to register as an RIA, all U.S. investors must at least Hedge fund managers that are subject to federal or
be accredited investors. States that do not require state investment adviser registration may only receive
registration as an RIA include New York, California, performance based compensation from “qualified
Connecticut, Georgia, Florida, Pennsylvania and clients”; a qualified client generally includes:
many other (principally Eastern) states. However, all
U.S. investors should at least be accredited investors. • (i) an individual that has a net worth (together,
in the case of a natural person, with assets held
The accredited investor standard is the investment jointly with a spouse) of more than $2 million at
suitability standard under Regulation D, the safe- the time the contract is entered into, exclusive of
harbor exemption from registration under the primary residence; or
Securities Act for private securities offerings. An
• (ii) an individual with at least $1 million under
accredited investor is an investor that meets either the
management of the investment adviser.
net worth or income test established by the SEC.
i. The Net Worth Test C. Principals of the Fund

For individuals, the investor must be a natural person Executive officers, directors, and general partners of the
whose individual net worth or joint net worth with his fund, by their position and responsibilities, can qualify
or her spouse, exceeds $1 million. Net worth means the as accredited investors and qualified clients without
excess of total assets (excluding a principal residence) meeting the income or net worth requirements.
at fair market value minus total liabilities. An entity
or trust investor must have a minimum net worth of
$5,000,000.
27
VI. MARKETING A HEDGE FUND
A. Seed Raise C. B
roker-Dealer Placement
Typically, the starting point for finding seed investors Agents
is direct contacts of the fund’s directors, managers, Only broker-dealers registered with FINRA can
officers, or employees. These individuals can raise receive transaction-based compensation for raising
investments from investors with whom they have capital. Broker-dealers tend to be very selective in
existing relationships. accepting engagements, as broker-dealers and their
insurers carry significant liability in connection with
However, an issuer should be aware of the SEC’s
private offerings. Before a broker-dealer will agree
disqualification of certain individuals, including those
to participate as a placement agent, it will perform a
currently under order of suspension or expulsion from
due diligence review of the fund to establish that the
the SEC or FINRA, or other specified self-regulating
fund meets the risk profile of the broker-dealer and its
agency. Further, the company should be aware of the
insurer.
SEC’s bad actor disqualification for individuals that
have been expelled or suspended from membership
of any self-regulatory organization, or have been
convicted of securities violations. Should the company
D. Finders
have any concerns that an associated person might The use of individuals not registered as broker-dealers
fail one or more of the above provisions, it is strongly as intermediaries (so called “finders”) is allowed
urged you speak with our firm before proceeding. only in an extremely narrow set of circumstances.
Generally, providing transaction-based compensation
to a finder for selling securities is illegal, although it
B. U
sing Intermediaries to remains a common practice. The SEC has noted the
widespread use of finders and as a result has increased
Raise Capital its enforcement against unregistered individuals and
After the initial seed raise, many funds find it imposed liability for noncompliance.
advantageous to raise capital through suitable
intermediaries. When using intermediaries, a fund Concurrently, the SEC has also intensified its
must (unless conducting a Rule 506(c) offering, which enforcement actions against issuers and the officers or
allows advertising) ensure that the intermediaries directors of the issuers who employ finders in violation
follow the rules requiring substantive pre-existing of SEC regulations. Because engaging finders can
relationships with any prospective investors, and avoid subject a fund and its management to significant
advertising and solicitation. Intermediary violations liability, we strongly recommend that finders be
of securities rules and regulations can subject the fund avoided. If you have specific questions on the use of
to the same liabilities as if the fund had committed the finders, please call our office to discuss your specific
violations. circumstances.

29
publicly to accredited investors, via social media, print toward investments may be treated with suspicion. • written solicitation materials would need to be
E. General Advertising
materials, email, group seminars and other means. There is also deep concern that advertising private submitted to the SEC by the first day they are
For decades, federal and state securities regulations placements will introduce a new pathway for fraudulent used and would be required to bear specified
have contained a general prohibition against an issuer or offerings. Fund management will need to exercise skill legends and disclosures.
ii. Lifting of the Advertising Ban for Private
its agents using general advertisements or solicitations and discretion in promoting their offerings.
Placements–New Rule 506(c)
in connection with most private placements. The d. Advertising Must Not Be Misleading.
prohibition has included such methods as television, Under the newly adopted Rule 506(c), a hedge fund is
permitted to engage in advertising and solicitation if: c. P
roposed Rules Requiring Additional State and federal law against misleading statements or
radio, print, internet advertisements, cold calling
SEC Disclosures material omissions are unchanged by this rule change.
(calling individuals that the issuer or its agents have
• all purchasers are accredited investors (generally In addition to lifting the ban on advertising and The standard for what constitutes a “misleading
no prior relationship with), distributing brochures to
$1 million dollar net worth excluding residence solicitation, the SEC proposed new rules that place statement” in a securities offering is much stricter than
potential investors, setting up booths at shows, fairs,
or $200,000 net income); and additional regulatory burdens on issuers using this the general standard for misleading advertising. Even
or other events and soliciting individuals or companies
rule, especially for those using advertisements in a seemingly innocent mistake in wording could have
with whom the agents do not have a pre-existing • the fund takes “reasonable steps” to verify that
written form. These changes will not go into effect serious consequences. A securities attorney should
relationship. investors are accredited.
until finalized and adopted. These changes are briefly review all marketing and advertising material.
For most hedge fund offerings, that prohibition is still summarized as follows:
a. What are Reasonable Steps?
in place, and fund managers should insure that when e. No Other Offerings Affected.
raising capital, no advertising is conducted. Further, The SEC has provided a non-exclusive list of ways to • the federal Form D, which is presently required
verify whether an investor is accredited (among the Note that this rule affects only offerings under Rule
fund managers need to be cautious that the fund to be filed 15 days after the first sale of securities,
list, only the first will be acceptable to most private 506 that are sold exclusively to accredited investors.
manager or its agent has a substantive pre-existing would need to be filed 15 days before engaging
fund managers): No other offerings are affected and the ban against
business or personal relationship with a potential in advertising; and
advertising will remain in place.
investor prior to discussing the offering. However, a
• obtaining written certification from a licensed
recent regulatory development has paved the way for
attorney, CPA or broker-dealer certifying that
hedge funds to engage in advertising, although much
the professional has reviewed documentation
is still unknown about potential risks and implications
indicating that the investor meets the
of relying on the new regulatory structure.
accreditation standard;
i. T
he JOBS Act Allows Advertising for • reviewing recent IRS forms, along with self-
Certain Offerings certification by the investor; and
In 2013 the SEC implemented provisions of the JOBS • reviewing bank and brokerage documents,
Act to lift the ban on advertising and solicitation for together with self-certification by the investor.
certain Regulation D private placement offerings. At
the same time, the SEC proposed new rules that will b. Will Advertising Be Effective in Raising
require additional regulatory burdens. Capital?
Many practitioners and commentators have expressed
The lifting of the ban on advertising represents one
doubt as to whether advertising will be an effective
of the most fundamental shifts to securities regulation
way to reach accredited investors. The argument is
in nearly 80 years. Under the new rules, hedge funds
that accredited investors may be somewhat more leery
and other private issuers seeking to raise capital are
of telemarketing, advertisements and direct mail than
now permitted to market their private placement
would the general populace. Advertisements directed

31
VII. BEGINNING WITH AN C. H
ow is an Incubator Fund
Taxed?
D. T
ransition to a Full Hedge
Fund
INCUBATOR FUND An incubator fund is generally set up using a pass- To transition to a hedge fund, legal counsel will
through fund entity (typically a Delaware limited assist the fund managers in the preparation of
partnership). The fund’s realized income and gains formal offering documents. Will include a private
For managers without ready access to initial investors, ii. Minimal Regulatory Requirements are only taxed at the individual level. Tax gains and offering memorandum, partnership agreement, and
an incubator fund provides a cost effective way to Because an incubator fund does not have outside loss pass through to an investor’s tax return. Items subscription documents, as well as the necessary
begin building a marketable performance record investors, it is generally not subject to many of the on Schedule K-1 retain their tax character for the regulatory filings and applicable registrations.
using the managers’ personal funds. An incubator regulatory and filing requirements required by federal manager.
fund allows a fund manager to fine-tune its trading and state law, such as investment advisor registration,
strategy while creating a marketable track record. commodities registration and Form D filing. However,
Incubator funds typically remain in place from three a manager should check with a hedge fund attorney
to twelve months, during which time the managers prior to concluding which regulatory requirements
can contemporaneously prepare for any applicable must be satisfied.
FINRA examinations, file for regulatory registrations,
prepare the fund’s marketing documents, website, and
iii. Cost
work with legal counsel to prepare the fund's offering
documents. An incubator fund significantly reduces start-up
capital risk while the strategy is tested. The cost to
form an incubator fund is considerably lower than the
A. Why an Incubator Fund? cost to form a hedge fund. The incubator fund can
be easily transitioned to a full hedge fund once the
Trading in a startup hedge fund involves different
fund sponsors have established a performance record
strategies than trading as part of an organization.
(usually between three to twelve months).Since an
Securities laws make it difficult for a manager to use
incubator fund formation involves some of the work
prior performance figures to promote a new fund. The
that will be performed in forming the hedge fund,
concept of “cherry picking” discourages a manager
our firm offsets the cost of the incubator fund against
from disclosing certain personal performance while
the subsequent preparation of the full hedge fund
omitting others. The incubator fund allows a manager
formation documents.
to show actual performance in the same entity structure
that will eventually be used for the fund vehicle.
B. Self-Funded
i. Structure
With very few exceptions, the incubator fund should
An incubator fund is an investment fund structure not accept outside investors. Even investment from
comprised of a limited partnership as the fund entity close friends and family can run afoul of state and
and an LLC as the management company entity. The federal securities law. Likewise, a sponsor should not
same entities will eventually be used for the hedge borrow capital from others to invest in the incubator
fund. Unlike a full hedge fund, an incubator fund fund. You should consult a hedge fund attorney prior
does not include the securities offering documents and to accepting any outside funds from any source.
regulatory filings necessary to sell to outside investors.

33
PART 2: VIII. C
OMMON HEDGE FUND
HEDGE FUND TERMS, TERMS
STRUCTURE, AND As part of the hedge fund formation process, the fund
manager works closely with the fund legal counsel to
Following the economic contraction, there was a
general trend to significantly lower management fees,
REGULATION
craft the terms to which the fund and its investors and rely more heavily on performance allocations,
will be bound. When properly structured, hedge fund where compensation is earned only when funds
offering documents contain terms that adequately perform in positive territory. In recent years we have
protect the fund sponsor and are attractive to investors. seen the management fees creep back up to the 1.5% to
Hedge fund terms are driven by the market trends 2% range. Emerging funds seeking to entice investors
within the fund’s specific strategy, asset class and the often elect to initially maintain a low management fee
particular needs and objectives of the fund. or to forgo it entirely until the fund has shown proven
success.
The following is a brief summary of some of the most
common hedge fund terms.
ii. Performance Allocation
The performance allocation is one of the defining
A. H
edge Fund Manager characteristics of hedge funds and private equity
Compensation funds and distinguishes them from mutual funds,
Hedge fund manager compensation typically which charge only a management fee. A performance
consists of: (a) an annual management fee; and (b) a allocation is a percentage of the increase in the value
performance allocation, also referred to as incentive of the fund assets (usually around 20%) allocated to
allocation, or carried interest. The latter is not the fund’s general partner as an incentive for positive
technically a “fee,” but rather a capital allocation, as performance. The performance allocation is intended
will be discussed below. to align the interests of the fund manager with those
of the investor and provide significant upside potential
for fund managers. As with the management fee, there
i. Management Fees
is variance among funds in the percentage charged. It
A management fee is assessed annually, typically can range from 10% to 50% depending on the fund’s
ranging from 1% to 2%, of the aggregate assets structure and performance, but are typically from 15%
under management of a fund, regardless of the fund’s to 30%.
performance. The management fee is intended to
cover manager salaries and general overhead. The
iii. Tax Advantages of the Performance
management fee is deducted from each investor’s
Allocation
account periodically (usually in advance) as set forth
in the offering documents. As mentioned above, the performance allocation
is not designated as a “fee,” but rather a “capital
Prior to 2008, a 2% management fee was standard reallocation of the profits” of the fund, which, if
for most funds, with some funds charging up to 3%. permitted by the offering documents, can be drawn by

35
the manager at the manager’s discretion or at regular setting a minimum between $100,000 and $250,000
B. Hurdle Rates D. Fund Expenses
intervals. The distinction is for tax purposes. A fee for most funds (with manager discretion to accept
is compensation for services rendered. For a fund Some funds require the investment manager to achieve lesser amounts). During the formation process the fund sponsor
manager, the investment management fee is always a certain level of return, either as a fixed percentage or designates which of the expenses of the fund will be
subject to ordinary income rates and is considered a benchmark rate (such as LIBOR or the S&P 500) borne by the manager and which will be borne by the
ii. Lock-up Period
self-employment income and subject to FICA taxes before managers are entitled to receive performance fund.
(in addition to the Unincorporated Business Tax for compensation. Hurdle rates can be either a “hard It is typical for a hedge fund to require an initial
fund managers located in New York City). hurdle” or “soft hurdle.” lock-up period of one year or more, before investors Typically, the fund bears expenses directly related
can withdraw invested funds, after which quarterly to forming and operating the fund, including: legal
When properly structured, a performance allocation is A hard hurdle means that the manager only receives or semi-annual redemption is allowed. The lock-up formation costs, accounting and administrative
not considered a “fee,” but a reallocation of partnership performance compensation that exceeds the hurdle period can be shortened or lengthened depending on services, regulatory filings, brokerage costs, clearing
profits from an investor’s capital account to the general rate. A soft hurdle means that no performance the fund’s investment strategy. Lock-ups usually range costs, etc. Note that most funds amortize startup costs
partner’s capital account. In other words, the investors compensation is received if performance falls short from six months to two years. over a 60 month period, to prevent early investors
are never allocated the 20% profit allocation, and the of the soft hurdle rate, but once the soft hurdle rate from being unfairly impacted, even though it is not in
amount is treated as profit allocated directly to the is exceeded, the manager is entitled to the entire If a fund strategy involves fairly illiquid investments, alignment with GAAP.
fund’s general partner. Where the fund holds positions performance compensation. such that a one to two year lock-up period is
longer than one year, the performance allocation can insufficient, the sponsor should consider a closed-end
result in long-term capital gains treatment. Where private equity fund. E. Side Letters
the fund holds short-term investments, the allocation C. C
ontribution & Most offering documents allow the management
would be considered short-term capital gains (which Withdrawal iii. Gates team to negotiate special terms (known as side letters)
is the same as ordinary income). However, short-term To prevent funds from being forced to inconveniently that are not applicable to other investors. Often the
Contribution and withdrawal provisions are among the
capital gains are not considered self-employment liquidate investment positions to satisfy large special arrangement involves better economic terms,
most important terms of the fund offering. Provisions
income and with certain exceptions are not subject to redemption requests, many hedge funds limit the such as reduced management or performance fees,
vary significantly from one fund to another to meet
Social Security taxes. percentage of the portfolio that can be withdrawn in or more convenient withdrawal terms. Care must be
the needs of a given fund’s strategy and investor base.
any given redemption period (often 10%-25%). This taken, however, not to allow side letters to prejudice
iv. High Water Marks is known as a gate. In 2008-2009 a large number of other investors. For example, side letters that provide
i. Minimum Initial Contributions additional information rights or preferential liquidity
To prevent a manager from receiving duplicate funds invoked gate provisions to prevent being forced
Hedge fund offering documents typically contain to sell assets at unfavorable terms. treatment should be avoided.
performance compensation following periods of
minimum investment thresholds as a condition
volatility, most funds allow investors to recoup past
to investment. Each additional investor adds an
losses before the fund manager is entitled to receive
administrative burden and a degree of liability to the
additional performance compensation.
fund. Additionally, the number of investors allowed in
To accomplish this, a high water mark is established any given fund is finite. In a 3(c)(1) fund the number
immediately following the allocation of incentive of investors is currently limited to 100 investors.
compensation. Under the “loss carry forward” terms,
Generally the investment minimum amounts are set
fund management is only entitled to be compensated
in the discretion of the fund manager. Note however,
for performance that exceeds the prior “high water
that funds organized under the laws of the Cayman
mark.”
Islands require a statutory minimum initial investor
contribution of $100,000. We generally recommend

37
IX. H
EDGE FUND STRUCTURE
AND JURISDICTION
The structure of a hedge fund is dependent on a In contrast, most open-end funds require immediately
number of tax, regulatory, and financial considerations. deployable funds (or in-kind asset contributions).
Fund structure is also driven in large part by the fund’s Closed-end funds typically use a distribution waterfall
strategy, such as the degree of liquidity of the portfolio detailing how funds will be distributed when portfolio
investments. The fund structure should be based on investments are sold. For example, an investor
careful and thorough analysis with assistance of an typically will receive his or her initial investment plus
experienced fund attorney. a specified preferred return before the fund manager
receives distributions.
A. O
pen vs. Closed-End
Fund Structures B. 3
(c)(1) Funds vs. 3(c)(7)
A closed-end fund is an investment fund intended Funds
to last for a fixed term, usually between five and ten The Investment Company Act of 1940 generally
years. Investors in a closed-end fund are generally requires investment companies to register with the
not permitted to make withdrawals or additional SEC. Hedge funds can be structured under one of two
capital contributions during the life of the fund. Most exemptions from registration under the Investment
private equity funds, venture capital funds, real estate Company Act of 1940. Section 3(c)(1) allows a fund
funds and other funds investing in illiquid assets are to have up to 100 investors. Section 3(c)(7) allows
structured as closed-end funds. Most hedge funds, on a fund to have up to 2,000 investors, but requires a
the other hand, invest primarily in liquid assets, and significantly higher net worth suitability requirement
are structured as open-end funds, allowing investors to for each investor.
make periodic redemptions and contributions (subject
to limitations in the fund’s offering documents). i. 3(c)(1) Funds
Closed-end funds typically have a fixed duration A 3(c)(1) fund is limited to 100 investors, all of which
(usually from five to ten years) and do not allow early should be “accredited investors” pursuant to Regulation
redemptions. Rather, investors are redeemed on a pro- D. An Accredited investor (if an individual) must
rata basis upon the sale of assets and liquidation of the have either (i) a minimum of $1 million net worth or
fund. Additionally, closed end funds typically require (ii) $200,000 annual income/$300,000 if combined
investors to make a legal commitment to invest in the with spouse, or (if an entity or trust) a minimum of
fund (a capital commitment) at a future date when the $5 million net worth. As a general rule, most startup
fund managers are ready to deploy committed capital funds are structured as 3(c)(1) funds because of the
(a capital call). lower investor suitability requirements.

39
jurisdiction of the fund sponsor. In some cases Virgin Islands (BVI).
the general partner and the investment manager
ii. 3(c)(7) Fund are formed as two separate entities, such as when i. Cayman Islands ii. British Virgin Islands (BVI)
multiple funds are contemplated, or if the fund
A 3(c)(7) fund must be owned by “qualified purchasers.” will be managed in New York City (for local tax The Cayman Islands has historically been the top BVI is a popular jurisdiction for offshore hedge funds
A qualified purchaser (if an individual) must have reasons). choice for offshore funds because of its business and other private funds. BVI has recently gained the
a minimum of $5 million in net investments, or (if friendly structure, stable government and well reputation as being a cost-effective and convenient
an entity or trust) a minimum of $25 million in net Investors become limited partners of the fund and all developed investment laws. Cayman Islands is a tax- jurisdiction. BVI’s regulatory structure has sought to
investments. Section 3(c)(7) funds may technically the trading activity of the fund takes place within the exempt jurisdiction, allowing offshore investors and create a flexible jurisdiction with streamlined processes
have unlimited investors but typically limit the number fund entity. The management fees and performance U.S. tax-exempt investors (that would otherwise be and strong legal certainty. BVI’s regulatory filing fees
of investors to 2,000to avoid registration under the compensation are paid to the investment manager/GP, subject to UBTI taxes) to avoid paying US taxes on are considerably lower than those of the Cayman
Securities Exchange Act of 1934 as a publicly traded which is owned by the fund sponsors. investment gains. The Cayman Islands is the world Islands and does not require a country-specific audit,
partnership. Because of the high barrier to investment, leader as a jurisdiction for hedge fund domicile. as does the Cayman Islands.
the 3(c)(7) exemption is typically used only by ii. Offshore Fund Structures
established funds backed by institutional investors.
When properly structured, an offshore fund structure
blocks offshore and tax-exempt U.S. investors from
C. D
omestic and Offshore direct U.S. tax liability. The most common offshore
Fund Structures fund structures are the master-feeder structure and the
side-by-side structure.
Another initial consideration when structuring a
hedge fund is whether to form the fund domestically,
offshore or both. If a fund sponsor expects to have only a. Master-Feeder Fund
U.S. investors, a domestic entity is sufficient. However, A master feeder structure consists of a domestic
if a sponsor anticipates significant participation by feeder fund and an offshore feeder fund (in a tax-free
offshore investors or U.S. tax-exempt investors (IRAs, jurisdiction) that feed into a single offshore master
pension plans, endowments, etc.) an appropriate fund, where all the trading activity of the fund takes
offshore fund will be needed to shield such investors place.
from U.S. tax liability.
b. Parallel Fund Structure

i. Domestic Fund Structure
A side-by-side structure has a U.S. fund and offshore
A domestic-only hedge fund structure is typically fund that parallel each other in trading and have
comprised of the following entities: the same investment manager but maintain separate
investment portfolios.
• A limited partnership to act as the fund entity
(although LLCs are becoming increasingly
popular). The fund entity is formed in the state
of Delaware.
D. Offshore Jurisdiction
Once the structure of the offshore fund has been
• An LLC to act as the investment manager and determined, the next step is choosing an offshore
general partner (GP) of the fund (managing jurisdiction. While hedge funds can be formed in a
member in the case of an LLC). The investment number of reputable jurisdictions, the most common
manager/GP entity is typically formed in the jurisdictions are the Cayman Islands and the British
41
X. P
ROPERLY SECURING A
REGULATION D EXEMPTION
Selling a hedge fund investment is a sale of securities, there is no need to register at the state level or find any
and as such, the fund must obtain an exemption state exemption. Congress has specifically preempted
from SEC and state registration. The Securities Act states’ authority to review securities exempted under
of 1933, often referred to as the “Securities Act” is a Rule 506 or impose additional requirements through
federal statute that governs securities at issuance to the National Securities Markets Improvement Act of
ensure that investors can make informed decisions 1996 (NSMIA). The NSMIA effectively took away
about investments. This act establishes laws against the states’ power to review an offering under Rule 506.
misrepresentation and fraudulent activities in the States may only require that issuers submit a notice
securities market. Section 5 of the Securities Act filing with the state and impose filing fees, typically
requires that all non-exempt securities issuances be between $200 – $700 per state.
registered with the SEC.
ii. Reduced Risk of Losing the Exemption
Regulation D contains safe harbor provisions that
provide exemptions for securities issuers (including Additionally, if an offering under Rule 506 is made
hedge funds) from federal registration. These include to only accredited investors, the company making the
exemptions under Rule 504, Rule 505, and Rule 506. offering will not lose its exemption from failure to make
Rule 506 is the most commonly relied upon exemption any prescribed disclosures as could be the case with
in private offerings, accounting for more than 90% of other exemptions. A private placement memorandum
offerings, according to SEC statistics, and the only should be drafted carefully to protect the company
exemption that a hedge fund should typically consider. from violations of the “anti-fraud” provisions under
the Securities Act and the Exchange Act as well as
state securities laws.
A. Rule 506 Exemption
iii. Advertising
Rule 506 is governed by Section 4(a)(2) of the
Securities Act of 1933 (the “Securities Act”). It permits Recently, the SEC adopted final rules lifting the ban
a company to offer securities to an unlimited number on general solicitation and advertising under Rule 506
of accredited investors and up to 35 unaccredited for offerings in which the issuers took reasonable steps
investors. It is strongly discouraged for a fund to to verify that all purchasers of its securities qualified as
have even one unaccredited investor, because of the accredited investors. This is now known as Rule 506(c),
significantly increased liability. Non-advertised offerings are designated as Rule 506(b)
offerings. Allowing advertisement in exempt private
i. Federal Preemption Over State Law offerings is a major shift in the regulatory system, and
presents opportunities to issuers never before available.
Rule 506 is unique among the Regulation D exemptions, However, the new regulations (as well as additional
in that with a properly prepared Regulation D offering,

43
proposed regulations) require additional burdens on
issuers, which should be carefully considered.
document, and must be filed within 15 days of the
first sale to investors and if the offering is ongoing, the XI. I NVESTMENT ADVISOR
REGISTRATION
Form D must be filed again in one year.
B. State Exemptions A Form D must be filed each subsequent year while

the offering remains open. The fund must also disclose
In addition to the federal exemptions, state securities are subject to state regulation and, depending on the
any sales compensation that has or will be paid directly A. R
equirements for
laws, also known as Blue Sky Laws, require funds to state, may be subject to registration.
or indirectly in connection with the sale of securities.
either register their securities or find an applicable
Our firm offers issuers assistance in preparing and investment advisor
exemption. States may not impose additional
filing Form Ds as part of our flat fee services. registration iii. In what state is the hedge fund
registration requirements with respect to an offering
Not all hedge funds are subject to investment advisor management team physically located?
relying on Rule 506 for federal and state exemption
other than to require a notice of Form D and a filing ii. State Requirements registration. To determine whether a fund needs to In most states, a hedge fund that invests in securities
fee. In addition to the federal Form D requirements, register, we ask our clients the following four questions: and has less than $150 million under management
individual states require Form D notification filings. must register as a state investment advisor in the state
(i.) Will the fund invest in “securities?” where the primary operations of the fund manager
Note that the state of Florida does not currently
C. Form D Filing require any notice filing. Each state’s requirements
(ii.) What will be the size of the fund?
are located (note that establishing a business in a state
differ on the content requirements of the required other than where the managers are physically located
Form D is a federal notice of an exempt securities
notice-filing. Most states require the notice-filing to will have no effect on jurisdiction).
offering that is filed with the SEC when relying on (iii.) In what state will the fund management team
be made within fifteen days after a resident of the state physically located?
Regulation D for an exempt offering. This document Several states, including California, New York, New
makes an investment. Note that New York requires
discloses biographical information about the fund and Jersey, Connecticut, Georgia, Florida, and many other
that the notice-filing be made prior to any offer of (iv.) In what states will the investors be located?
the managers. Form D is not subject to a review or (primarily Eastern states) recognize an exemption
securities within the state.
approval by the SEC, but is a required notification from registration for managers that solely advise
i. Will the fund invest in “securities?” private funds. At the outset, hedge funds in these
Only funds that invest in securities are required to jurisdictions are exempt from registration both at the
register as an investment advisors. Funds that invest SEC and state level. Note that managers that advise
only in commodities, futures, currencies, real estate only venture capital funds, regardless the state of
investments, or certain private equity investments, domicile, are generally exempt from state or federal
would not be subject to investment advisor registration. RIA registration.
The definition of a “security” is very expansive, and Note that once a fund in one of these jurisdictions
covers a broad range of investment instruments, passes the $25 million threshold, it will be required
schemes and structures. Consult with an experienced to file a truncated registration with the SEC, which
securities attorney before concluding that a fund does entails much lighter disclosure than full registration,
not invest in securities. and once a fund passes $150 million in assets under
management it will be required to be fully registered
with the SEC.
ii. What will be the size of the fund?
A securities hedge fund manager that manages over Funds that are subject to SEC or state registration
$150 million is automatically required to register as an can only accept performance compensation from
investment advisor with the SEC. All other managers “Qualified Clients,” while funds that are not subject

45
to advisor registration may (subject to limitations) page. ADV Part 1A contains the following: (1) general Supplement. Federal registration requires investment
D. Documents Required for
accept investments from only “Accredited Investors.” background information about the investment advisor, advisor applicants to prepare only a Firm Brochure;
See Chapter V: Who Can Invest in a Hedge Fund for Registration its owners, and officers; (2) discussion about business while state registrations generally require applicants
a description of the accredited investor and qualified The first step in the registration process is setting up practices, including services provided and fees to be to prepare both the Firm Brochure and the Firm
client standards. accounts with the Investment Advisor Registration charged; (3) other activities of the investment advisor; Supplement.
Depository (the “IARD”), and WebCD. Upon and (4) certain disclosures about civil, criminal or
receiving the necessary login information (known other actions against the investment advisor, its 1. Firm Brochure (Part 2A)
iv. In what states will the investors be
located? as the entitlement package) investment counsel can owners, and officers. The information in these sections
The Firm Brochure discloses specific information
begin to prepare the necessary registration documents. is supplemented by the schedules and disciplinary
Many states require hedge fund investment managers about an investment advisor and must be written
reporting page.
to register in the state once a certain threshold of in a narrative format and in plain English. It is
investors has been reached (usually five). In many i. ADV Parts 1 and 2 composed of numerous section headings, in which an
There are three schedules in Part 1A of Form ADV,
states, this will only be triggered if an investment investment advisor discloses information including:
The principal component of federal or state registration called Schedules A, B, and D. Schedule A lists all direct
manager is required to register its own state. Consult (1) the advisory services of the firm; (2) fees and
is the Uniform Application for Investment Adviser owners of the investment advisor with an ownership
a hedge fund attorney to understand your registration compensation that the firm charges for its services;
Registration and Report by Exempt Reporting interest of at least 5% and information about certain
obligations in any given state. (3) types of clients of the firm; (4) code of ethics and
Advisers (ADV). The ADV has two parts: Part 1 executive officers or individuals performing similar
personal trading; (5) brokerage practices; (6) custody
requires disclosure regarding the business operations functions. Schedule B lists all indirect owners of
of funds and investment discretion; and (7) financial
of the advisor and background information about the investment advisor with an ownership interest of at
B. Investment Advisor information about the firm. State registrations and
controlling individuals. Part 2 is a written disclosure least 25%. Schedule D lists various miscellaneous
investment advisors must also disclose certain state
Representatives. statement discussing the services to be rendered, fees information about the investment advisor such as
required information in additional sections.
imposed, conflicts of interest, and other information information about the investment advisor’s website,
In addition to registration of the RIA firm, require
that is material to investors. Part 2 must be given to affiliated organizations, wrap fee programs, and
each individual performing advisory services on The Firm Brochure is considered a public document
investors and potential investors and must be updated location of records.
behalf of an RIA must register as an investment that will be published with the Investment Advisor
annually (or more frequently if the RIA makes material
advisor representative. Most states require advisor Public Disclosure (the “IAPD”). It also must be
changes). 2. ADV Part 1B
representatives to submit a Uniform Application for provided to clients either prior to or at the time
Securities Industry Registration or Transfer (U-4), Part 1B of Form ADV is an eleven page document that the client enters into an investment advisory
containing specific background information about the a. Form ADV Part 1 used for investment advisors registering with specific agreement with the investment advisor. Therefore, it
advisor representative. As previously noted, Form ADV Part 1 requires states and not the SEC. It requests information about must be carefully drafted to conform to the specific
disclosure regarding the business operations of the the states of registration, the individual in charge of requirements of federal and state regulators.
advisor and background information about the supervision and compliance, proof of bonding, and
C. Series 65 Examination controlling individuals. Form ADV Part 1 is further outstanding judgments, liens, and investment related Failure to provide proper disclosures and other required
subdivided into two subparts: Part 1A and Part 1B. arbitrations. information can result in rejection of an investment
Most states require advisor representatives to pass the advisor’s application. Additionally, if the Firm
Series 65 examination (or an equivalent examination Part 1A is used for both SEC and state registrations.
Part 1B is used only for state registrations. Form ADV Brochure contains false or misleading information,
combination or professional designation). The Series b. ADV Part 2
part 1 must be filed online through the FINRA system its publication can result in criminal or civil liability
65 examination is a 130 question multiple choice Part 2 of Form ADV is a written disclosure statement against the investment advisor, its owners, and officers.
test administered by FINRA covering topics such as part of the investment advisor registration process.
required for federal and state investment advisor After initial registration, the Firm Brochure must be
as: securities regulations, ethical guidelines, security registration. It is further divided into two subparts. amended annually or at any time that the included
1. ADV Part 1A
products, methods for evaluating securities, securities Part 2A is commonly referred to as the Firm Brochure, information becomes materially inaccurate.
trading strategies, principals of economics, and others. Part 1A is a 46 page document consisting of twelve while Part 2B is referred to as the Brochure Firm
sections, three schedules, and a disciplinary reporting

47
2. Brochure Supplement (Part 2B) cases, maintenance of compliance/ethics manuals. d. Maintenance of Compliance/Ethics
Investment advisors should work closely with an Manuals
The brochure supplement is required only for
experienced investment management attorney to If an RIA is required to have a compliance manual
registration with certain states and not the SEC. It
maintain compliance with its obligations. and/or ethics manual, care must be taken to observe
requests information in narrative format discussing
additional background information about the firm and their requirements. When specific procedures are
the individual advisor representatives, as required by a. Annual Renewals improperly followed, the RIA has a duty to keep a
the states. SEC and state registered investment advisors are record of violations and record of corrective action
required to annually update their ADV in the form taken. Additionally, compliance manuals must be
Investment advisor registration requires disclosure in of an annual amendment. Investment advisor continuously reviewed and revised to keep them
compliance with complex state and federal regulation. representatives are likewise required to renew their state updated with current law and in line with business
An RIA registration applicant should consult an or federal registration. Renewals are processed through practices and objectives.
experienced investment attorney to assist it in the IARD system. An RIA or its representative that
navigating the intricacies of Form ADV. fails to timely and properly renew its registration can
face significant penalties, including loss of the RIA.
i. Code of Ethics/ Compliance Manual
The SEC requires the RIA to provide a code of ethics b. Record Keeping
outlining internal policies relating to ethics matters, One of the most important compliance issues for
as well as a policies and procedures manual outlining investment advisors is proper record keeping. Detailed
the advisor’s policies to protect investor interests and records and ledgers must be kept to document accounts,
comply with advisor regulations. Some states require purchase and sales history, transactions, advertising and
RIAs to submit a code of ethics, and/or compliance performance claims, personal transactions of advisor
manual. representatives, investor disclosure, powers of attorney,
and many other advisory matters.
ii. Bonding Requirement
Most states require RIAs to provide a surety bond, c. Ongoing Client Disclosure
in a statutory amount. The bonding requirement can As a fiduciary, the RIA’s first duty is to act in the best
also be satisfied by providing proof of net assets of a interests of its clients. This involves providing full and
statutory amount, accompanied by audited financials. adequate disclosure to clients on all matters involving
Hedge funds that have custody of client assets and as the investment advisor relationship, including potential
such are required to obtain a larger bond or show a conflicts of interest. SEC and state regulations require
higher net worth than non-custodial advisors. advisors to provide specific disclosures to investors
regarding fees, conflicts and procedures. As changes
iii. Ongoing RIA Compliance Obligations to the RIA’s business occur, it must be diligent in
identifying potential disclosure events and make the
Following registration, an RIA becomes subject to
proper amendments. Legal counsel will then be able
ongoing compliance obligations, including annual
to make the appropriate amendments to the Form
license renewals, detailed recordkeeping, ongoing
ADV Part 2 and properly revise the fund’s offering
investor disclosure requirements and in some
documents.

49
XII.HEDGE FUNDS INVESTING IN • the aggregate net notional value cannot exceed
100% of the liquidation value.
even if the fund is exempt under the de minimus
exemption. However, in 2014, the CFTC issued an
COMMODITIES
exemptive order to address this issue.
To use the de minimus exemption, a fund sponsor must
file a Notice of Claim for Exemption with the NFA. The exemptive order applies only to issuers that rely
An affidavit confirming that the commodities interest on Regulation D Rule 506(c), as well as certain Rule
Any hedge fund trading in commodities, futures Full CPO registration is an involved process that takes fall within the exempt threshold must be filed yearly 144 issuers. The order permits general solicitation
or swaps must comply with the Commodities from six to eight weeks. The fund must submit Form thereafter. for Commodity Pool Operators (CPSOs) relying on
Exchange Act or obtain the appropriate registration 7-R and associated persons must submit Form 8-Rs the de minimus exemption. Unlike Rule 506(c), the
Note that the advertising and solicitation offering CFTC exemption is not self-executing. To use this
or exemption. Any hedge fund trading in commodity along with fingerprints and proof of completion of the
available under the JOBS Act and Rule 506(c) does exemption, CFTC regulated hedge funds must file a
interests is considered a commodity pool. The sponsor proficiency examination.
not apply to a fund engaged in commodities investing, claim for exemptive relief.
of a commodity pool is a commodity pool operator
(CPO) and the manager of a commodity pool is a
commodity trading advisor (CTA). C. S
treamlined Process for
Funds with only “Qualified
A. W
hat is a commodity Eligible Participants”
Rule 4.7 provides relief from some of the regulatory
Interest? burdens, including recordkeeping, disclosure and
Commodity interests include: futures contracts, reporting requirements for CPOs that offer interests
options on futures contracts, and, as was recently added solely to “Qualified Eligible Participants” (QEP).
by Dodd-Frank, swaps. Certain foreign exchange The definition of a QEP is defined in Rule 4.7 of the
transactions are considered swaps, including cash- Commodity Exchange Act and is quite complex and
settled forex forwards, currency swaps, and cash-settled beyond the scope of this ebook. Please call Capital
forex swaps. Security-based swaps are not considered Fund Law Group to discuss the multi-prong definition
a commodity interest. Note that investments in a fund of a QEP.
that trades in commodity interests are also considered
commodity interests.
D. T
he de minimus
Exemption
B. CPO/CTA Registration
The most common exemption from commodities
Unless an exemption applies, hedge funds that meet registration is Rule 4.13(a)(3), often referred to as
the above definition are required to register with the the “de minimus exemption.” Hedge funds that invest
Commodity Futures Trading Commission (CFTC) in limited commodities interests, which represents a
as a CPO and CTA and become a member of the small enough percentage of the fund’s assets under
National Futures Association (NFA). Associated management, can obtain an exemption under Rule
persons of a CPO/CTA are required to pass a 4.13(a)(3). To meet the de minimus exemption two
proficiency examination. As part of the NFA tests must be met:
membership application, hedge funds must submit
offering documents to the NFA for its review and • aggregate initial margin and premiums cannot
approval, as well as submitting to an annual audit. exceed 5% of the aggregate value of the fund’s
portfolio; and

51
PART 3: PPM EXCERPT WITH
SAMPLE DOCUMENT ILLUSTRATIVE EXPLANATIONS
EXCERPT The Following is a concise model excerpt of a hedge fund private placement memorandum (PPM) with footnoted
explanations of the PPM provisions. The PPM is based on a fictitious master-feeder hedge fund using a global
fixed-income arbitrage strategy. XYZ Feeder Fund, LP is a domestic feeder fund to a Cayman Island master
fund. The accompanying explanations discuss the reasons behind certain disclosure language as well as detailed
examination of certain fund topics and how they apply to the disclosure document. The excerpt also provides
drafting tips, best practice recommendations, potential pitfalls and common mistakes in hedge fund PPMs.
Although the XYZ Feeder Fund, LP uses a fixed-income arbitrage strategy, the explanations provide information
that should be helpful to fund managers using any strategy.

53
Name of Offeree: 1
Memorandum No.: 2
OR SELF REGULATORY AGENCY. NO GOVERNMENTAL AGENCY6, INCLUDING THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION,
NOR ANY SELF-REGULATORY AGENCY HAS PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM. ANY REPRESENTATION
CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM TO THE CONTRARY IS A CRIMINAL OFFENSE.
PLACEMENT OF LIMITED PARTNERSHIP INTERESTS INTERESTS IN THE FUND ARE NOT REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (“SECURITIES ACT”), IN RELIANCE ON THE PROVISIONS OF REGULATION
D UNDER THE SECURITIES ACT. THE INTERESTS ARE SUBJECT TO RESTRICTIONS ON
TRANSFERABILITY AND RESALE AND GENERALLY MAY NOT BE TRANSFERRED OR RESOLD
XYZ FEEDER FUND, LP3
EXCEPT AS PERMITTED UNDER THE SECURITIES ACT AND APPLICABLE STATE SECURITIES
LAWS, PURSUANT TO REGISTRATION THEREUNDER OR EXEMPTION THEREFROM, AND
(A DELAWARE4 LIMITED PARTNERSHIP5)
AS PERMITTED IN THE FUND’S AGREEMENT OF LIMITED PARTNERSHIP.
THE LIMITED PARTNERSHIP INTERESTS IN XYZ FEEDER FUND, LP (THE “FUND”), HAVE
INTERESTS IN THE FUND ARE NOT FREELY MARKETABLE AND INVOLVE A HIGH DEGREE
NOT BEEN REGISTERED WITH OR RECOMMENDED BY THE SECURITIES EXCHANGE
OF RISK. SEE THE DISCUSSION UNDER “Certain Risk Factors” AND ELSEWHERE HEREIN.
COMMISSION, ANY STATE SECURITIES COMMISSION OR ANY OTHER GOVERNMENTAL
The date of this Confidential Private Placement Memorandum is January 1, 2015.7
1 Managers must carefully track the circulation of the PPM and the other fund offering documents to remain
in compliance with the registration exemption under the Investment Company Act of 1940 (the “Investment 6 This required disclosure informs investors that the notice filing of a Regulation D offering does not imply
Company Act”) to show that the fund is not making a “public offering.” Additionally, tracking circulation of that the SEC or any state has sanctioned the offering. This seeks to clarify that the filing of a Form D notice filing
offering documents is essential to satisfy New York’s pre-offer Regulation D filing requirement and to satisfy does not involve government approval, as in the case of a public offering. New York requires a submittal of the
potential SEC or state audits. Beyond the regulatory requirements, as a practical matter it is important to know offering in connection with the Form D notice filing prior to making an offering in the state but does not approve
which version of an offering document was given to which investor, as modifications are common. or disapprove the offering. Other states will review certain hedge fund managers that are required to register as a
Each PPM should bear the name of the intended offeree and a unique identifying number. The fund manager state-regulated investment advisor. Additionally, when a broker-dealer is used as a placement agent, the offering
should maintain a spreadsheet showing the name and number of each PPM distributed, together with the date of documents must be reviewed by FINRA.
offer, the version of the document, and a description of any written information provided to the investor. 7 Generally the date of a PPM does not reflect the date that the PPM was given to an investor, but the
2 As noted above, each memorandum should be numbered, preferably non-sequentially. date on which the most recent version of the PPM was finalized. When material changes occur that affect the
fund or its management, such changes should be reflected in an amended PPM and the date should be modified
3 The fictitious fund in this illustrative PPM excerpt is a New-York-based feeder fund set up as a limited
accordingly.
partnership feeding into a Cayman Islands master fund, with separate general partner and investment management
company entities.
4 Domestic hedge funds are typically structured as either limited partnerships or limited liability companies
(LLCs). Limited partnerships have historically been the entity of choice for most funds, although LLCs are
gaining in popularity. LLC-structured hedge funds can present some complication for investors in certain states
and municipalities. Most funds opt for the limited partnership structure unless there is a specific reason to use an
LLC. One situation where the LLC fund is especially useful is in a multi-series fund, where multiple fund series
can be created without the effort and expense of filing additional formation documents for successive funds.
5 Delaware is the most popular jurisdiction for domestic hedge fund entities. Delaware provides well-
developed limited partnership laws and an investment-experienced judiciary.

55
INTRODUCTION This Confidential Private Placement Memorandum (this “Confidential Memorandum”), relates to the offering of
limited partnership interests of the Fund (the “Interests”), and sets forth information with respect to the investment
XYZ Feeder Fund, LP (the “Fund”), is a limited partnership organized under the laws of the State of Delaware objective and policies of the Fund, certain risks related to an investment in the Fund, management of the Fund and
on January 1, 2015. The general partner of the Fund is XYZ General Partner, LLC, a NewYork limited liability its investments, the principal terms of the Agreement of Limited Partnership of the Fund dated January 1, 2014
company (the “General Partner”)8 . XYZ Investment Manager, LLC is the investment manager to the Fund (the (the “Partnership Agreement”), the terms upon which the Interests are being issued, the suitability requirements
“Investment Manager”).9 for an investment in the Fund and certain other matters.10 However, this Confidential Memorandum does not
address all aspects of the topics described herein and this Confidential Memorandum may not contain all of the
The Fund expects to invest substantially all of its assets in XYZ Master Fund Cayman Ltd. (the “Master Fund”), a information that a potential investor may deem material for purposes of deciding whether to invest in the Fund.
business company incorporated under the laws of the Cayman Islands. XYZ OffshoreFeeder Fund Cayman Ltd. In making an investment decision, potential investors in the Fund must rely upon their own examination of the
(the “Offshore Fund”), a business company incorporated under the laws of the Cayman Islands, has an investment Fund and the terms of this offering, including the merits and risks involved.
objective and a strategy identical to the Fund, and it will alsoinvest substantially all of its assets in the Master
Fund. The Offshore Fund was established to serve as an investment vehicle for investments from certain U.S. INTERESTS ARE SUITABLE ONLY FOR SOPHISTICATED INVESTORS FOR WHOM AN
tax-exempt persons and non-U.S. persons. The Investment Manager provides investment advisory services to the INVESTMENT IN THE FUND DOES NOT CONSTITUTE A COMPLETE INVESTMENT
Offshore Fund and the Master Fund. PROGRAM AND WHO FULLY UNDERSTAND AND ARE WILLING TO ASSUME THE RISKS
INVOLVED IN THE FUND’S INVESTMENT STRATEGY.11 THE FUND EXPECTS TO INVEST
SUBSTANTIALLY ALL OF ITS ASSETS IN THE MASTER FUND. THE INVESTMENT PRACTICES
OF THE FUND AND THE MASTER FUND, BY THEIR NATURE, MAY BE CONSIDERED TO
8 The general partner and management fund entities are established in the jurisdiction in which the fund’s
INVOLVE A SUBSTANTIAL DEGREE OF RISK. (SEE “Investment Objective and Strategies” and “Certain
management team is physically located, whereas the limited partnership (the fund entity) is established in
Risk Factors”.)
Delaware. For purposes of determining state investment advisor jurisdiction, a management company must look
to the state in which its primary investment activity is located. The minimum investment in the Fund is $250,000, except that the General Partner reserves the right, in its sole
As noted in Chapter XI, some states have exemptions for investment fund managers from state investment advisor and absolute discretion, to accept subscriptions in lesser amounts from investors who otherwise satisfy the Fund’s
registration (up to certain AUM level and number of funds) while others do not. Wyoming, in fact, has no state suitability criteria. Additional investments may be for a minimum of $50,000, unless otherwise determined by the
investment advisor statute whatsoever. Fund managers often inquire as to whether they can form the general General Partner in its sole and absolute discretion. The Interests in the Fund are being offered solely to a limited
partner/management company in a state in which the manager is not physically located and thus be governed by
state law. Unfortunately, the only way for a fund manager to avail itself of a state’s law is to physically move the 10 It is vital that the PPM properly reflect the underlying limited partnership agreement and subscription
business operations to the state, or at least have a key individual residing and working in the state. agreement. In performing offering document reviews from prior drafters, we often discover significant discrepancies
9 Many hedge funds combine the functionality of the general partner and the investment manager into between the summarized terms of the PPM and the actual terms of the limited partnership agreement. One
a single entity. This is usually an appropriate and cost effective structure for a startup fund manager looking reason for this is that fund managers, and unfortunately some legal counsel, view the PPM as the primary offering
to manage a single fund. There are, however, circumstances in which the general partner and the management document, to which a limited partnership agreement may be quickly conformed.
company should be established as separate entities. It is important to understand the distinction between the functions of the PPM versus that of the limited
First, two separate entities should be created when the management team is located in New York City to shield partnership agreement and subscription agreement. The PPM is not a binding contractual document, but a
the general partner from New York City’s Unincorporated Business Tax (UBT). New York City imposes UBT on disclosure of the terms and risks of investment in the fund and a summary of the binding investment terms in the
any person or entity carrying on a trade or business in the city. If the general partner’s business activity is limited limited partnership agreement and subscription agreement.
to holding a carried interest in the fund, rather than active management, the general partner would fall within the 11 The suitability standard disclosed here (and later attested to in the subscription agreement and investor
“trading for one’s own account” exemption. questionnaire) provides that the offering is only suitable for sophisticated investors for whom the offering does
not constitute a complete investment program. As discussed in Chapter V, if an investor is “accredited” it need
Second, when multiple funds are established, a single management company typically manages all the funds
not also meet the “sophistication” requirement. Even though all of the investors are accredited (under Regulation
collectively, up to a maximum of fifteen funds (per the Investment Advisors Act of 1940). However, each fund
D) or qualified clients (under the Investment Advisors Act of 1940) this language should still be included for an
should have its own independent general partner that shields the performance capital allocations from liability
extra layer of protection, even if not strictly required from a regulatory perspective.
from the other funds managed by the investment manger.

57
number of investors, each of which qualifies as (1) an “accredited investor,” as defined in Rule 501 of Regulation D DISCUSSES SOME OF THE IMPORTANT RISK FACTORS THAT MAY AFFECT THE FUND’S
under the Securities Act; (2) a “qualified client,” as defined under Rule 205-3(d)(1) of the Investment Advisers Act RETURNS. THERE CAN BE NO ASSURANCE THAT THIS CONFIDENTIAL MEMORANDUM
of 1940, as amended (the “Investment Advisers Act”), or a “qualified purchaser” or a “knowledgeable employee,” DISCUSSES ALL SUCH RISKS. PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER
as defined in Section 2(a)(51) of the Investment Company Act of 1940, as amended (the “Investment Company THOSE RISKS, IN ADDITION TO OTHER INFORMATION IN THIS CONFIDENTIAL
Act”); and (3) a “United States person” as defined in the Internal Revenue Code of 1986, as amended (the “Code”). MEMORANDUM AND THE RESULTS OF THEIR OWN INDEPENDENT REVIEW OF THE
There will be no public offering of Interests, no trading market for the Interests will develop and the Interests will FUND, BEFORE DECIDING WHETHER TO INVEST IN THE FUND.13
be subject to substantial restrictions on transfer.
THERE MAY BE CONFLICTS OF INTERESTS BETWEEN THE LIMITED PARTNERS, THE
Pursuant to the Partnership Agreement, the General Partner is entitled to receive an incentive allocation based GENERAL PARTNER AND THE INVESTMENT MANAGER. (SEE “Certain Risk Factors – Conflicts
upon the increase in value of the Fund. There are certain risks to investors associated with performance fees. (See of Interest” and “Management – Conflicts of Interest”.)
“Certain Risk Factors – Management Fees and Incentive Allocation”.)12
This Confidential Memorandum constitutes a solicitation for offers to purchase rather than an offer to sell.
IMPORTANT INFORMATION REGARDING THIS CONFIDENTIAL MEMORANDUM THIS CONFIDENTIAL MEMORANDUM DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY IN ANY STATE OR OTHER JURISDICTION IN WHICH
This Confidential Memorandum, including the exhibits hereto, is confidential. By accepting delivery of this SUCH AN OFFER OR SOLICITATION IS NOT AUTHORIZED.
Confidential Memorandum, the recipient agrees not to reproduce or disclose any of its contents to any person,
other than the potential investor’s spouse, employees and professional advisors, without the prior written consent Although the information specified in this Confidential Memorandum is believed to be accurate, none of the
of the General Partner. The recipient further agrees promptly to return this Confidential Memorandum and Fund, the General Partner or the Investment Manager makes any expressed or implied representation or warranty
all related documents, without retaining any copies thereof, in the event that the potential investor does not as to the accuracy or completeness of that information. NO PERSON OTHER THAN THE GENERAL
purchase any Interests, if the prospective investor’s subscription is not accepted, or if the offering is terminated. PARTNER HAS BEEN AUTHORIZED TO MAKE ANY REPRESENTATION, OR GIVE ANY
Notwithstanding the foregoing, each potential investor (and each spouse employee, representative or other agent INFORMATION, WITH RESPECT TO THE FUND, EXCEPT THE INFORMATION CONTAINED
of the potential investor) may disclose to any and all persons, without limitation of any kind, the tax treatment and IN THIS CONFIDENTIAL MEMORANDUM AND IN OTHER DOCUMENTS DISTRIBUTED
tax structure of an investment in the Fund and all materials of any kind (including opinions or other tax analysis) BY THE GENERAL PARTNER, AND ANY SUCH REPRESENTATIONS OR INFORMATION, IF
that are provided to the potential investor relating to such tax treatment and tax structure (as such terms are GIVEN, MAY NOT BE RELIED UPON.14
defined in Treasury Regulation Section 1.6011-4).
This Confidential Memorandum contains forward-looking statements based on the experience of the General
13 Risk factors are intended to convey the major areas of risk that an investor may face when investing in a
Partner and the Investment Manager and expectations about the markets in which the Fund intends to invest and
fund. Risk factors need not (and cannot) be an exhaustive enumeration of all potential risks or potential obstacles
the methods by which the General Partner and the Investment Manager expect to invest in those markets. Those
that the fund may encounter. Rather, the risk factors provide a roadmap of key considerations that an investor
statements are sometimes indicated by words such as “expects,” “believes,” “seeks,” “may,” “intends,” “attempts,”
should consider before investing in a fund. Of utmost importance is that the risk factors be tailored to the
“will” and similar expressions. Such forward-looking statements are not guarantees of future performance and are
strategy and structure of the fund. Generalized risk factors, while important and necessary, are insufficient if not
subject to many risks, uncertainties and assumptions that are difficult to predict. Therefore, actual returns could
accompanied by thorough disclosure of risk exposure specific to the fund.
differ materially and adversely from those expressed or implied in any forward-looking statements as a result of
various factors. None of the Fund, the General Partner or the Investment Manager undertake any obligation to 14 While this clause attempts to mitigate statements conflicting with the PPM by telling the investor they
revise or update any forward-looking statement for any reason. may not rely upon them, the effectiveness of such language in a court proceeding is uncertain. Any statement
made by a representative of a hedge fund to a prospective investor concerning the offering, whether verbal or
THE SECTION ENTITLED “Certain Risk Factors” IN THIS CONFIDENTIAL MEMORANDUM written, has the potential to be construed as a representation, warranty, or material misstatement.
Fund sponsors have to be just as careful when crafting statements in marketing material, presentations and email
12 A key concept of a securities offering document is to include multiple references to important information as they would be when making disclosures in the PPM. Your investment fund counsel should review all marketing
or key risks. When a discussed topic can be found in greater detail elsewhere in the PPM, a cross-reference to the material prior to circulation. Marketing material should bear legends instructing investors to make investment
specific section should be included. decisions based on the PPM.

59
IT IS EXPECTED THAT EACH POTENTIAL INVESTOR WILL PURSUE AN INDEPENDENT The Fund reserves the right to withdraw this offering at any time prior to the acceptance of investor subscription
INVESTIGATION REGARDING THE FUND AND AN INVESTMENT IN THE INTERESTS. agreements and to terminate the offering of Interests any time thereafter. The Fund further reserves the right
Prospective investors and/or their advisers, upon request to the General Partner, will be furnished with or will be to accept or reject in its sole and absolute discretion and for any reason whatsoever, any offer by an investor to
able to obtain all financial, business and other information with respect to the Fund and its proposed business if purchase securities.
available without unreasonable effort or expense. (See “Access to Information”.)
FIDUCIARIES OF EMPLOYEE BENEFIT PLANS SUBJECT TO THE EMPLOYEE RETIREMENT
The description in this Confidential Memorandum of certain terms of the Fund’s Partnership Agreement and INCOME SECURITY ACT OF 1974, AS AMENDED (“ERISA”), SHOULD CONSIDER WHETHER
the other agreements referred to in this Confidential Memorandum are summaries only, and do not purport INVESTMENT IN THE FUND IS PRUDENT AND OTHERWISE IN COMPLIANCE WITH ERISA.
to be complete. These summaries may omit information significant to a particular prospective investor. These THE GENERAL PARTNER INTENDS TO RESTRICT ADMISSION OF LIMITED PARTNERS AND
summaries are qualified by reference to the complete versions of the agreements, and potential investors are THE TRANSFER OF INTERESTS SO THAT EMPLOYEE BENEFIT PLANS WILL NOT HOLD,
urged to review these agreements carefully. A copy of the Fund’s Partnership Agreement and of the Subscription DIRECTLY OR INDIRECTLY, 25% OR MORE OF THE INTERESTS.
Agreement that each investor will be required to sign are attached as exhibits to this Confidential Memorandum,
and copies of the other agreements referred to in this Confidential Memorandum are available upon request from IRS CIRCULAR 230 NOTICE: THE INFORMATION CONTAINED IN THIS CONFIDENTIAL
the General Partner. MEMORANDUM AS TO U.S. FEDERAL TAX MATTERS IS NOT INTENDED OR WRITTEN
TO BE USED, AND CANNOT BE USED, FOR THE PURPOSE OF AVOIDING U.S FEDERAL
Information specified in this Confidential Memorandum is as of the date of this Confidential Memorandum. TAX PENALTIES. SUCH INFORMATION IS PROVIDED TO SUPPORT THE PROMOTION OR
Neither the delivery of this Confidential Memorandum nor any transaction entered into as a result of this MARKETING OF THE TRANSACTIONS OR MATTERS ADDRESSED IN THIS OFFERING
Confidential Memorandum shall create, in any circumstance, the implication that there has been no change in DOCUMENT. YOU SHOULD SEEK ADVICE BASED ON YOUR PARTICULAR CIRCUMSTANCES
any information specified in this Confidential Memorandum after the date specified on the front cover of this FROM AN INDEPENDENT TAX ADVISER.
Confidential Memorandum.
NOTICE TO RESIDENTS OF FLORIDA:
THE CONTENTS OF THIS CONFIDENTIAL MEMORANDUM SHOULD NOT BE CONSIDERED
TO BE LEGAL OR TAX ADVICE, AND PROSPECTIVE INVESTORS SHOULD CONSULT UPON THE ACCEPTANCE OF FIVE (5) OR MORE FLORIDA INVESTORS, AND IF THE FLORIDA
WITH THEIR OWN COUNSEL AND ADVISERS AS TO ALL MATTERS CONCERNING AN INVESTOR IS NOT A BANK, A TRUST COMPANY, A SAVINGS INSTITUTION, AN INSURANCE
INVESTMENT IN THE INTERESTS.15 COMPANY, A DEALER, AN INVESTMENT COMPANY AS DEFINED IN THE INVESTMENT
COMPANY ACT OF 1940, AS AMENDED, A PENSION OR PROFIT-SHARING TRUST, OR A
QUALIFIED INSTITUTIONAL BUYER (AS DEFINED IN RULE 144A UNDER THE SECURITIES
ACT), THE FLORIDA INVESTOR ACKNOWLEDGES THAT ANY SALE OF AN INTEREST TO
THE FLORIDA INVESTOR IS VOIDABLE BY THE FLORIDA INVESTOR EITHER WITHIN
THREE DAYS AFTER THE FIRST TENDER OF CONSIDERATION IS MADE BY THE FLORIDA
15 Under the Employee Retirement Income Security Act of 1974 (“ERISA”), a hedge fund becomes subject INVESTOR TO THE ISSUER, OR AN AGENT OF THE ISSUER, OR WITHIN THREE DAYS AFTER
to significant increased regulatory: obligations and fiduciary liability if more than 25 percent of the fund’s assets THE AVAILABILITY OF THAT PRIVILEGE IS COMMUNICATED TO THE FLORIDA INVESTOR,
under management are subject to ERISA. WHICHEVER OCCURS LATER. 16
In calculating the ERISA percentage of assets under management, all assets owned by the general partner or its
[End of section excerpt. This section has been significantly shortened for use in this sample]
affiliates is excluded from the denominator. The calculation must be made on a class-by-class basis, so that in a
multi-class fund, if any class holds more than 25% of the assets under management, the entire fund becomes a plan
asset fund. The Internal Revenue Code of 1986 and the Pension Protection Act of 2006 present additional issues 16 State legends contain specific state securities requirements and restrictions specific to investors residing in
for fund managers that are ERISA plan asset funds. a given state. Many of the state restrictions found in state legends, particularly those that add requirements for
purchaser eligibility, are not applicable to Regulation D Rule 506 offerings, since Rule 506 preempts state law.
However, a number of state legends, including the Florida legend, contain important restrictions and disclosures
required by state law.

61
SUMMARY17 References in this Confidential Memorandum to the investment program and
related matters of the Fund also include the Master Fund, as applicable.
The following summary is qualified in its entirety by the more detailed information contained elsewhere in this Confidential
Private Placement Memorandum (this “Confidential Memorandum”). Prior to making an investment in Zeus Alpha, The portfolios of the Fund and the Offshore Fund may differ to the extent that
LP (the “Fund”), each person who is considering investing in the Fund should read the various other documents described investments made directly by one might not be made by the other. This could
herein, some of which are attached as Exhibits18 to this Confidential Memorandum and the remainder of which are occur for a variety of reasons, including, without limitation, because of different
available upon request from the General Partner. tax and regulatory considerations applicable to the Fund and the Offshore Fund.
Such differences will result in differences between the returns of the Fund and the
The Fund e Fund is a limited partnership organized under the laws of the State of Delaware
Th Offshore Fund.
on January 1, 2014. The General Partner of the Fund is XYZ Partners, LLC,
New York limited liability company (the “General Partner”). The general partner, Risk Factors20 There are a number of risks associated with becoming a limited partner of the
is the investment adviser to the Fund (the “Investment Manager”) and formulates Fund (a “Limited Partner”). An investment in Interests will be subject to various
and implements the Fund’s investment program. risks, including, but not limited to, risks relating to the newly formed nature of
the Fund; certain strategic, investment and market risks; the use of leverage and
The Master Fund The Fund expects to invest substantially all of its assets in XYZ Master Fund other investment techniques; and the illiquid nature of Interests. There can be no
Cayman Ltd. (the “Master Fund”), a business company incorporated under the assurance that the Fund will achieve its investment objective or be able to meet
laws of the Cayman Islands.19 The Fund may, however, invest a portion of its assets redemption requests. In addition, an investment in the Fund involves a high degree
directly rather than investing through the Master Fund. of risk and is suitable only for sophisticated investors for whom an investment
in the Fund does not constitute a complete investment program and who fully
In addition to the Fund, XYZ Offshore Fund Cayman Ltd. (the “Offshore Fund”), understand and are willing to assume the risks involved in the Fund’s investment
a business company incorporated under the laws of the Cayman Islands, will also strategy. (See “Certain Risk Factors”.)
invest substantially all of its assets in the Master Fund. The Offshore Fund has an
investment objective and a strategy identical to the Fund, and it was established The Investment Manager21 The Investment Manager provides investment advisory services to the Fund, the
to serve as an investment vehicle for investments from certain U.S. tax-exempt Offshore Fund and the Master Fund
persons and non-U.S. persons. The Investment Manager also provides investment
advisory services to the Offshore Fund and the Master Fund. The Investment Manager is currently exempt from registration with the Securities
and Exchange Commission (the “SEC”), as an investment adviser under the
Investment Advisers Act of 1940, as amended (the “Advisers Act”), and is currently
exempt from registration as an investment adviser with the State of New York.22
17 The summary of terms provides highlights of the key components of the offering, the fund structure,
compensation provisions and key fund terms. Each of these items would be dealt with in detail in the body of The Investment Manager is responsible for implementing the Fund’s compliance
a typical PPM. For purposes of this excerpt, we have necessarily shortened the summary of terms to include
only a few of the many fund provisions. Notably, we have not included information summarizing the fictitious
investment strategy and management information. 20 Proper risk factor disclosure is at the heart of a well drafted PPM. Risk factors should be specific, relevant
18 The PPM is only one of a number of private placement offering documents, which are typically attached as to the investment strategy and management background, and thorough. Inadequate attention to risk factors (or
exhibits to the PPM. These include: (i) the limited partnership agreement (operating agreement if an LLC-based relying on boilerplate risk factors) can be problematic.
fund); (ii) the subscription agreement/investor questionnaire; (iii) form ADV Part II brochure supplement (if the 21 When the investment advisor and the investment manager are split into separate entities as is done in New
fund manager is required to register as an investment advisor). York or in fund structures requiring successive funds, it is the investment manager, rather than the general partner,
19 Under the master-feeder structure, both the U.S. and offshore feeders invest into a master offshore fund, that performs most of the services for the fund.
which then allocates investments on a pro-rata basis from each of the feeders. Investment gains and losses are 22 The investment advisor registration is performed by the investment manager entity, rather than the fund
likewise allocated between the domestic and feeder funds. entity.

63
program and for performing administrative duties and managing the ongoing Expenses25 The General Partner and the Investment Manager are responsible for and pay their
business operations of the Fund. Without limiting the generality of the foregoing, own ordinary office overhead expenses, which include rent, supplies, secretarial
the Investment Manager is responsible for making investment decisions on behalf expenses, printing and stationery, charges for furniture and fixtures and compensation
of the Fund. The Investment Manager initiates all orders for the purchase and sale of administrative personnel. All other expenses are borne by the Fund including,
of securities and other investments on behalf of the Fund, selects the brokers and legal, accounting, audit and other professional expenses, direct office expenses,
dealers with and through which the Fund invests and is responsible for the day to including but not limited to postage, overnight delivery and information systems,
day management of the Fund’s investment activities and holdings. The Investment investment expenses such as commissions, taxes, interest charges, borrowing charges
Manager is also responsible for performing the necessary research and acquiring for securities sold short, custodial fees, administrator fees, financial institution
the necessary information to make investment decisions. (See “Management”.) service charges and all other expenses related to the purchase, sale, clearance and
holding of Fund assets.
Capital Accounts The Fund will establish and maintain on its books a Capital Account (“Capital
Account”), for each Limited Partner and the General Partner, into which its capital The Fund’s initial offering and organizational expenses were advanced by the
contribution(s) (“Capital Contribution”), will be credited and in which certain General Partner. The Fund will reimburse the General Partner for the payment of
other transactions will be reflected. (See “Allocation of Gains and Losses.”) such costs and expenses, and these expenses may be amortized in equal monthly
amounts over a period of up to thirty-six (36) months. Such treatment is not
Management Fee and in accordance with generally accepted accounting principles (“GAAP”), and the
Incentive Payments Management Fee. For the services it renders to the Fund, the Investment Manager General Partner may determine to accelerate such amortization or make other
shall receive a monthly management fee equal to 0.1666% (2.00% annually) of each GAAP conforming changes for financial reporting purposes if the General Partner
Limited Partner’s Capital Account (the “Management Fee”). The Management Fee believes that doing so would be in the best interests of the Fund. (See “Expenses.”)
is accrued as of the first business day of each calendar month. The Management
Fee is payable monthly in advance.23 A pro rata Management Fee will be charged Allocation of Gains
to Limited Partners on any amounts permitted to be invested during any month, and Losses Limited Partners. The net capital appreciation or net capital depreciation of the
but will not be refunded on any amounts permitted to be withdrawn during any Fund as of the end of each calendar month (as described below) will be allocated
month. The Investment Manager, in its sole and absolute discretion, may waive any to each Limited Partner pro rata in proportion to each Limited Partner’s Capital
or all of the Management Fee in respect of any Limited Partner without notice to Account as of the beginning of each calendar month. For financial accounting
or the consent of other Limited Partners. (See “Fees”.) purposes, net capital appreciation or net capital depreciation of the Fund will be
determined on the accrual basis of accounting and will be deemed to include net

Incentive Allocation. The General Partner will receive the Incentive Allocation, as unrealized appreciation or depreciation on securities positions as of the end of each
described below. The General Partner, in its sole and absolute discretion, may waive fiscal period.
any or all of the Incentive Allocation24 in respect of any Capital Account without
notice to or the consent of other Limited Partners. (See “Incentive Allocation.”) In the event that the General Partner determines that for tax or regulatory reasons,
or any other reason as to which the General Partner and any Limited Partner agree,
such Limited Partner should not participate in the net capital appreciation or net
capital depreciation, if any, attributable to any security or type of security, or to any
23 Management fees are typically paid monthly or quarterly and can be paid in advance or in arrears (usually other transaction, the General Partner may allocate such net capital appreciation
in advance).
24 Although the fund has the authority to waive or reduce the inventive allocation and management fees, 25 It is industry standard for the hedge fund to bear the cost of the fund formation, administration,
such as performance allocation, it is generally not advisable to do so. One question we encounter often is whether accounting, custodial and prime brokerage fees, auditing, trading costs and similar fund-specific items. However,
a fund can waive the incentive allocation to allow accredited investors that are not qualified clients to invest in a some funds find it advantageous in capital raising to limit the expenses that are passed on to the fund and use the
fund of which the manager is registered as an RIA. Although it may be technically allowed, such an arrangement management fee for some of the fund expenses, particularly in very small funds, where expenses can dramatically
causes concern for the remaining investors and can lead to investor dissatisfaction and disclosure issues. affect performance.

65
or net capital depreciation only to the Capital Accounts of holders of general and the beginning of such fiscal year after giving effect to any withdrawals from, and
limited partnership interests of the Fund, (the “Partners”), other than such Limited distributions by, the Fund relating to prior periods. The Hurdle Amount will not be
Partner, and if appropriate, may establish a separate memorandum account in which cumulative from year to year. The Hurdle Amount will be appropriately adjusted
only the remaining partners having an interest in such security, type of security, for periods of less than one year using the applicable Hurdle Rate.
or transaction shall have an interest and net capital appreciation and net capital
depreciation for such separate memorandum account shall be separately calculated. For a Limited Partner’s initial Capital Contribution, an Incentive Allocation will
(See “Allocation of Gains and Losses”.) be charged with respect to such Limited Partner’s Capital Account and declared
and paid on the last day of the calendar year in which the investment was made.

Incentive Allocation. The Fund will make an annual performance-based allocation Accordingly, the first Incentive Allocation with respect to an investment generally
(the “Incentive Allocation”), to the General Partner. In general, the Incentive will be calculated based upon a period of less than 12 months. Thereafter, the
Allocation will be an amount equal to 20% of the excess of (1) the net capital Incentive Allocation will be based upon the net capital appreciation, if any, allocable
appreciation (less any net capital depreciation) otherwise allocable for such year to such Limited Partner’s Capital Account each year.
(the “Excess Capital Appreciation”), to each Limited Partner’s Capital Account
over (2) any balance remaining in such Limited Partner’s Loss Recovery Account The General Partner, in its sole and absolute discretion, may waive or reduce the
(defined below) for the applicable period provided, however, that the Excess Incentive Allocation with respect to any Capital Account; any such waiver or
Capital Appreciation exceeds the sum of (i) any balance remaining in such Limited reduction will not increase the Incentive Allocation with respect to other Capital
Partner’s Loss Recovery Account (defined below) for the applicable period and (ii) Accounts whose Incentive Allocation is not so waived or reduced. The General
the Hurdle Amount (defined below) with respect to such Capital Account. Partner may, in its sole and absolute discretion, agree that certain Capital Accounts
be subject to different Incentive Allocation arrangements as it deems appropriate,
To calculate the Incentive Allocation, a “Loss Recovery Account” 26 will be all without notice to or consent of the Limited Partners.
established for each Limited Partner, the opening balance of which will be zero.
As of the end of each calendar year, the balance in each Limited Partner’s Loss No Incentive Allocation will be charged to the General Partner’s Capital Account.
Recovery Account will be increased by any net capital depreciation, or reduced by
any net capital appreciation, allocated to such Limited Partner’s Capital Account Determination of
for such year. The balance in a Loss Recovery Account will never be reduced below Net Asset Value28 The net asset value of the Fund (the “Net Asset Value”) is determined in accordance
zero. The net capital appreciation and net capital depreciation are calculations based with the terms of the Partnership Agreement and is generally equal to the amount
on the Net Asset Value (as defined below) of the Fund’s securities at the beginning by which the value of the Fund’s assets exceeds the amount of its liabilities. Net
and ending valuation periods as determined in accordance with the Partnership Asset Value determinations are made by the General Partner as of the end of each
Agreement. quarter (or other period, as the case may be) in accordance with United States
generally accepted accounting principles (“U.S. GAAP”) consistently applied.
The “Hurdle Amount” is calculated by multiplying: (1) two percent (2%) (the
“Hurdle Rate”)27 , and (2) the opening balance of each Capital Account as of In making such determinations, securities which are listed on a national securities
exchange or over the counter securities listed on Nasdaq are valued at their last sales
26 A Loss Recovery Account refers to the high water mark, which prevents the general partner from receiving
multiple incentive allocations when the portfolio has reduced in value. The high water mark is discussed in detail the entire performance compensation. This example uses a hard hurdle.
in Chapter VIII. 28 One of the vital services performed by the fund administrator is calculating the net asset value of the fund
27 A hurdle rate requires a fund to achieve a certain level of return, either as a fixed percentage or a benchmark portfolio. The assets of the portfolio must be valued in order for an open-end fund to calculate performance fees,
rate (such as LIBOR or the S&P 500) before managers are entitled to receive performance compensation. Hurdle management fees, taxes, investor redemptions, and other functions. Calculating the net asset value of a fund that
rates can be either a “hard hurdle” or “soft hurdle.” A hard hurdle means that the manager only receives performance invests in liquid securities or provides lending investments is much simpler than calculating illiquid securities,
compensation that exceeds the hurdle rate. A soft hurdle means that no performance compensation is received if including real estate, private equity, etc. As a general rule, such funds would be better structured as closed-end
performance falls short of the soft hurdle rate, but once the soft hurdle rate is exceeded, the manager is entitled to funds, where performance compensation and investor payout occurs upon the sale of an asset.

67
price on such date, or, if no sales occurred on such date, at the “bid” price for a long Changes in Investment Strategies. There can be no assurance that the Investment Manager will be successful in
position and the “ask” price for a short position. implementing the Fund’s investment strategy. The Investment Manager may from time to time formulate new
approaches to carry out the Fund’s investment objective, and there can be no assurance that any of such new
For securities not listed on a security exchange or quoted on an over-the-counter approaches will be successful.30
market, but for which there are available quotations, such valuation will be based
upon quotations obtained from market makers, dealers or pricing services. The Investment Risks in General. The Fund will engage in speculative investment strategies. The prices of instruments
General Partner may, in accordance with the Partnership Agreement, use other in which the Fund will trade may be volatile. Market movements are difficult to predict and are influenced by,
methods of valuing securities if it believes that an alternate method is preferable. among other things, government trade, fiscal, monetary and exchange control programs and policies; changing
Securities which have no public market and all other assets of the Fund are supply and demand relationships; national and international political and economic events; changes in interest
considered at such value as the General Partner may reasonably determine. All rates; and the inherent volatility of the financial markets. In addition, governments from time to time intervene,
values assigned to securities by the General Partner pursuant to the Partnership directly and by regulation, in certain markets, often with the intent to influence prices directly. The effects of
Agreement are final and conclusive as to all Partners. governmental intervention may be particularly significant at certain times in the financial instrument and currency
markets, and such intervention (as well as other factors) may cause these markets and related investments to move
[End of section excerpt. This section has been significantly shortened for use in this sample] rapidly and lose value.
General Economic Conditions. The success of any trading activity may be affected by general economic conditions,
which may affect the level and volatility of securities prices, interest rates and the extent and timing of investors’
CERTAIN RISK FACTORS 29 participation in the markets for currencies, securities and other instruments. Unexpected changes in volatility or
liquidity in the markets in which the Fund directly or indirectly holds positions could impair the Fund’s ability to
An investment in the Fund may be deemed to be a speculative investment and is not intended as a complete carry out its business or cause it to incur losses.
investment program. It is designed only for sophisticated persons who are able to bear the risk of loss of
their entire investments. Among the risks that should be carefully evaluated by a prospective investor before Debt and Other Income Securities. The Fund intends to invest in fixed income and adjustable rate securities. Fixed
making an investment in the Fund are the following: income securities, such as many of the bonds in which the Fund is likely to invest, are subject to interest rate,
market and credit risk. Interest rate risk relates to changes in a security’s value as a result of changes in interest
Investment Risks rates generally. Even though such instruments are investments that may promise a stable stream of income, the
Specialized Investment Skills. Successful arbitrage investing is a specialized investment approach requiring a prices of such securities are inversely affected by changes in interest rates and, therefore, are subject to the risk of
combination of extensive quantitative and qualitative skills. Both the experience and judgment of the Investment market price fluctuations. In general, the values of fixed income securities increase when interest rates fall and
Manager, as well as its use of sophisticated analytical tools, will be integral to the success of the Fund’s investment decrease when interest rates rise. Market risk relates to the changes in the risk or perceived risk of an issuer, asset
strategy. Failure of the manager to successfully execute the intended strategy could lead to poor fund performance. class, country or region. Credit risk relates to the ability of the issuer or underlying assets to make payments of
principal and interest. The values of income securities may be affected by changes in the credit rating or financial
condition of the issuing entities.31
30 Regardless of the fund’s intended strategy, managers should usually maintain the flexibility and discretion
29 The risk factor section is one of the most valuable components of a private placement memorandum to modify or mix strategies to achieve its investment objective.
for liability mitigation. Risk factors should be one of the first sections in a private placement memorandum.
31 When disclosing investment strategy risks, fund managers are often tempted to add mitigating language
This section is usually quite voluminous, often spanning dozens of pages, and covering many subcategories, with
explaining why their strategy has a high probability of avoiding the disclosed risks. Such risk factor clauses
disclosures ranging from broad and generic risks to highly specific risks covering the investment strategy, sub
are simple to identify: They often begin with “while,” “though” or “however.” SEC releases have given specific
strategy, or market sector. In this illustrative excerpt, we have provided two of the many risk factor categories
guidance to avoid mitigating language in risk factors. Risk factors should be limited to identification and brief
(which have been shortened considerably for this excerpt). These are: “Investment Risks,” and “Risks Related to
description of material risks. That is not to say disclosure of mitigating strategies should not be discussed in the
Particular Types of Investments.” Other risk categories that would be included (depending on the fund structure
PPM, but the language should not appear in the risk factors. The appropriate place to elaborate on risk mitigation
and strategy) include: market risk, partnership risk, management risk, regulatory risks, tax risk, and others.
strategies is the investment strategy and business sections.

69
Market Risk. The profitability of a significant portion of the Fund’s investment methods depends to a great extent of investment. The Fund could be subject to significant losses if it holds a large position in a particular investment
upon correctly assessing the future course of the relative price movements of securities and other investments. that declines in value or is otherwise adversely affected, including default of the issuer or underlying collateral.
There can be no assurance that the Investment Manager will be able to predict accurately these price movements.
Regardless of the hedging methods employed, there is always some and occasionally a significant degree of market Limited Liquidity. In certain circumstances, certain of the Fund’s holdings may become illiquid and unable
risk inherent in the Fund’s core portfolio trading strategies. to be sold. This could adversely affect the ability of the Fund to dispose of these securities, including to meet
redemption obligations.
Instruments Below Investment Grade. The global securities in which the Fund may invest include instruments
that have low ratings that indicate that the ratings agencies view them as highly risky and have predominantly Valuation of Certain Investments. Because the secondary markets for certain investments, such as bank loans,
speculative characteristics with respect to their capacity to pay interest and repay principal. The Fund may invest may be limited, it may be difficult to value such investments. Where market quotations are not readily available,
in bonds rated lower than investment grade, which may be considered speculative. The Fund may also invest a valuation may require more research than for more liquid investments. In addition, elements of judgment may play
substantial portion of its assets in high-risk instruments that are low rated or unrated. The market values of these a greater role in valuation in such cases than for investments with a more active secondary market because there
instruments tend to reflect short-term corporate, economic and market developments and investor perceptions of is less reliable objective data available. (See also “Risk Factors – Management Risks – Valuation of Investments.”)
the issuer’s or underlying collateral’s credit quality to a greater extent than lower yielding, higher-rated bonds. In
addition, it may be more difficult to dispose of, or to determine the value of, high-yield, high-risk bonds. Ability to Participate in Rule 144A Offerings. Most new issues in the bond market rated lower than investment
grade are sold pursuant to Rule 144A under the Securities Act. As such, they can only be purchased by “qualified
Leverage Risk. The Fund, when it is deemed appropriate by the Investment Manager and subject to applicable institutional buyers” (“QIBs”). The Fund does not initially expect to qualify as a QIB, and will therefore not
regulations (including margin requirements), intends to use leverage to attempt to capitalize on situations where be eligible to invest in new bond issues that are limited to QIBs. This may initially limit the Fund’s ability to
the Investment Manager believes there is a high probability that a particular investment strategy will be profitable. participate in certain investments and could potentially limit its ability to generate high returns.
The extent to which such leverage is used fluctuates depending on market conditions. To the extent that the Fund
uses leverage, the Fund’s net assets will tend to increase or decrease at a greater rate than the overall market (i.e., it Prepayment Risk. Prepayment risk is the risk that principal on fixed income securities may be paid prior to the
may have an amount greater than its net assets subject to market risk). While the use of leverage can substantially stated maturity date. This risk is especially acute for those instruments without call protection, such as bank loans
improve the return on the Fund’s investments, such use also may increase the adverse impact of unfavorable and certain other instruments, which may be paid at any time. If the Fund purchases an investment at a premium,
price movements. In extreme cases, a significant loss of equity could require the Investment Manager to execute a faster than expected prepayment rate will reduce both the market value and the yield to maturity from those
trades based solely on the need to generate investable funds rather than as part of the Fund’s core portfolio that were anticipated. A prepayment rate that is slower than expected will have the opposite effect of increasing
trading strategies. Under these circumstances, the Investment Manager could be forced to liquidate securities or yield to maturity and market value. Conversely, if the Fund purchases an investment at a discount, faster than
other assets held by the Fund under less than favorable conditions. Use of leverage will subject the Fund to risks expected prepayments will increase, while slower than expected prepayments will reduce, yield to maturity and
normally associated with debt financing, including the risk that the Fund’s cash flow will be insufficient to meet market values. Prepayment of fixed income securities can be expected to accelerate during periods of declining
required payments of principal and interest. The risk exists that indebtedness on the Fund’s investments will be interest rates.
subject to margin calls due to asset devaluation, which in turn could force the Fund to sell assets at unfavorable
prices. In addition, the Fund expects to incur indebtedness, which may carry variable interest rates, and such debt Margin Risk. Markets in futures, options and other derivatives contracts can be highly volatile and investment in
creates higher debt service requirements if the market interest rates increase. The Fund may engage in transactions them carries a high risk of loss. This stems from the margining system applicable to such contracts that generally
to limit its exposure to rising interest rates as, in the Investment Manager’s sole and absolute discretion, are involves a comparatively modest performance deposit in terms of the overall contract value, so that a relatively
appropriate and cost effective, and such transactions could expose the Fund to the risk that such transactions may small market movement can have a disproportionately dramatic effect on the value of an investment. If the market
not adequately perform and cause the Fund to lose anticipated benefits therefrom.32 movement is favorable, a good profit return may be achieved, but an equally small adverse market movement can
result not only in the loss of the entire amount of margin on deposit, but may also expose the Fund to the distinct
Concentration. The Fund has the ability to concentrate investments. Concentration may create the risk that the possibility of a loss exceeding the initial margin requirement.
Fund could change in value suddenly based on potential exposure of a significant amount of assets to a limited area
If the market moves against the Fund, the Fund may be called upon to deposit substantial additional margin, at
32 The use of leverage is a key risk factor that should be thoroughly disclosed. This illustrative excerpt short notice, to maintain its position. Failure to provide such additional funds within the time required may result
assumes that the fund has no present intent to use leverage. A fund that has a strategy that relies on significant in the Fund’s position being liquidated at a loss and the Fund will be liable for any resulting deficit.
levels of leverage should include several risk factors disclosing various facets of how the leverage could affect fund
performance and investment loss.

71
Counterparty Risk. The Fund will be subject to the risk of the inability of any counterparty (including any prime participations. In these cases, the Fund generally will have no right to directly enforce compliance by the borrower
broker and custodian) to perform with respect to transactions, whether due to insolvency, bankruptcy or other with the terms of the loan agreement, nor any rights of set-off against the borrower, and the Fund may not directly
causes. The Fund may utilize swaps and other derivative transactions. To the extent the Fund invests in repurchase proceed against the collateral supporting the loan. In addition, when the Fund acquires a participation, its ability
agreements, swaps, forwards, futures, options and other “synthetic” or derivative instruments, counterparty to receive principal and interest may be subject to the credit risk of the lender from which the participation
exposures can develop and the Fund bears the risk of nonperformance by the other party on the contract. This originates. A selling lender may sell or otherwise dispose of its interest in the loan after the Fund acquires the
risk may differ materially from those entailed in exchange-traded transactions which generally are supported by participation, in which case the credit of the new owner of that interest would be substituted for the credit of the
guarantees of clearing organizations, daily marking-to-market and settlement, segregation and minimum capital original selling lender. Moreover, to the extent that a loan has been participated out, the originating lender will
requirements applicable to intermediaries. Transactions entered directly between two counterparties generally have a substantially reduced interest, or none at all, in the debtor’s performance under the loan, and may have other
do not benefit from such protections and expose the parties to the risk of counterparty default. In international business relationships with the borrower that conflict with the interests of the Fund as loan participant.
securities markets the existence of less mature settlement structures and systems can result in settlement default
and exposure to counterparty credits. In addition, entering into these types of agreements involves, to varying (b) Lender Liability Considerations: A number of judicial decisions in the United States have upheld the legal
degrees, elements of credit and market risk. Such risks include the possibility that there is no liquid market for right of borrowers to sue lending institutions on the basis of various evolving legal theories (collectively termed
these agreements and there may be unfavorable changes in the fluctuation of interest rates and market value. These “lender liability”). Generally, lender liability is founded upon the premise that the institutional lender has violated
types of agreements also involve the risk of mispricing or improper valuation and the risk that changes in the value a duty (whether implied or contractual) of good faith and fair dealing owed to the borrower or has assumed a
of the derivative may not correlate with the underlying asset, rate, or index. degree of control over the borrower resulting in creation of a fiduciary duty owed to the borrower. By purchasing
bank loans, the Fund may be subject to risks of lender liability.
Use of Hedging. The Investment Manager may employ certain hedging techniques, directed primarily toward
general market risks, but is not required to do so. If employed, hedging against a decline in the value of a portfolio (c) Environmental Liability of Portfolio Investments: Collateral (whether or not real property) that secures bank
position does not eliminate fluctuations in the values of portfolio positions or prevent losses if the values of such loans may have associated environmental liabilities and borrowers may participate in activities with environmental
positions decline, but establishes other positions designed to gain from those same developments. For a variety of implications. In the event a bank loan is secured by collateral with environmental liabilities or is made to a
reasons, the Investment Manager may not seek or be able to establish a sufficiently accurate correlation between borrower that has environmental liabilities, it is possible that the ability of the borrower to repay the bank loan
hedging instruments and the portfolio holdings being hedged. Such imperfect correlation may prevent the Fund or to make interest payments will be impaired as a result of expenses related to the environmental liabilities. In
from achieving the intended hedge or expose the Fund to risk of loss. In addition to possible losses on the position addition, while the Fund does not intend to participate in the management of any borrower, if the Fund were
sought to be hedged notwithstanding the attempted hedge, the Fund could incur losses on the hedging position nonetheless deemed to be an “operator” of a borrower under applicable environmental laws, the Fund could itself
itself. become liable for those environmental liabilities. Environmental liability could also arise as a result of the Fund
becoming the owner, through foreclosure or otherwise, of collateral with environmental liabilities. Any such Fund
Moreover, all hedging strategies necessarily involve costs, which could be significant, whether or not the hedge liability would affect all assets of the Fund and such liability would not necessarily be limited to the value of the
sought is successful. The Fund may invest in markets or instruments as to which hedging strategies are limited particular bank loan with respect to which the liabilities have arisen.
or unavailable. Hedging instruments which are potentially available may nonetheless involve costs or risks which
the Investment Manager deems prohibitive in the context of the Fund. Hedging, if employed at all, is expected to Non-Investment Grade Bonds. The Fund’s investments in non-investment grade bonds will be predominantly
be employed as a technique to seek to limit certain market risks. As a general matter, the Fund’s portfolio is still speculative because of the credit risk of the issuers or underlying collateral. While normally offering higher yields,
exposed to risks attendant to its investment strategy, which risks are not generally hedged. non-investment grade bonds typically entail greater potential price volatility and may be less liquid than higher-
rated securities. Issuers or underlying collateral of non-investment grade bonds are more likely to default on their
Risks Related to Particular Types of Investments33 payments of interest and principal owed to the Fund, and such defaults will reduce the Fund’s net asset value and
income distributions. The prices of these lower rated obligations are more sensitive to negative developments
(a) Risks Associated with Participations: A portion of the Fund’s investments may be in the form of
than higher rated securities. Adverse business conditions, such as a decline in the issuer’s or underlying collateral’s
revenues or an economic downturn, generally lead to a higher non-payment rate. In addition, a security may lose
33 This section contains risk factors that pertain to specific investments in which the fund will engage. It significant value before a default occurs as the market adjusts to expected higher non-payment rates. Adverse
is beyond the scope of this ebook to provide further explanations of the underlying instruments and strategies. publicity and changing investor perceptions may affect the ability to obtain prices for or to sell these securities.
Rather, these are provided to show the degree of specificity that should be included in a hedge fund offering
document’s risk factors.

73
Other Instruments and Future Developments. The Fund may take advantage of opportunities in the area of options Synthetic Bonds. Incidental to other transactions in fixed income securities and/or for investment purposes, the
on securities, swaps, swaptions and other synthetic or derivative instruments that are not presently contemplated Fund may combine options on fixed income securities with cash, cash equivalent investments or other fixed
for use by the Fund or that are not currently available, but that may be developed, to the extent such opportunities income securities in order to create “synthetic” bonds that approximate desired risk/ return profiles. This may
are both consistent with the Fund’s investment objective and legally permissible for the Fund. The Fund may be done where a “non-synthetic” security having the desired risk/return profile either is unavailable or possesses
become a party to various other customized derivative instruments entitling the counterparty to certain payments undesirable characteristics. The use of synthetic bonds may involve risks different from, or potentially greater than,
on the gain or loss on the value of an underlying or referenced instrument. All of the investments described above risks associated with direct investments in securities and other assets. Synthetic bonds may increase other Fund
could magnify the gain or loss that would be incurred in a direct investment in the underlying securities or trading risks, including market risk, liquidity risk, and credit risk, and their value may or may not correlate with the value
positions and may be made without the approval of Limited Partners. of the relevant underlying asset.
Collateralized Debt Obligations. The Fund’s investments in collateralized debt obligations (“CDOs”), may involve Derivatives. The Fund may utilize derivatives for hedging or for other purposes related to the management of
a high degree of business and financial risk particularly due to the limited recourse or non-recourse nature of the the Fund. Derivatives may be entered into on established exchanges or through privately negotiated, or “over-
obligations (i.e., payable solely from the assets pledged by the issuer of such obligations), the subordination of the-counter” (“OTC”), transactions. Generally, derivatives are financial contracts whose value depends upon, or
such obligations and the character of the collateral securing such obligations. The underlying collateral of any is derived from, the value of an underlying asset, reference rate or index. Examples of derivatives that the Fund
CDO may consist primarily of non-investment grade loans and interests in non-investment grade loans. The may use include futures, options, swaps (including interest rate and credit default swaps), forwards, credit-linked
collateral may also include bonds, structured finance obligations and synthetic securities. These assets are subject securities and other hybrid instruments. Derivative instruments are specialized products that require investment
to liquidity, market value, credit, interest rate, prepayment and certain other risks that are generally greater than techniques and risk analyses different from those associated with stocks and bonds. These instruments typically
those of investment grade corporate obligations. These risks could be exacerbated to the extent that the Fund is allow an investor to hedge or speculate upon the price movements of a particular security, financial benchmark or
concentrated in one or more particular types of collateral obligations. The underlying loans are also subject to index at no cost or at a fraction of the cost of investing in the underlying asset. The use of a derivative requires an
prepayment risk, which may affect the market value of those loans and the collateralized obligation. understanding not only of the underlying asset but also of the derivative itself, without the benefit of observing the
performance of the derivative under all possible market conditions. As the value of this type of instrument depends
Options. The Fund will utilize options in furtherance of its investment strategy and for both investment and largely upon price movements in the underlying asset, many of the risks applicable to trading the underlying asset
hedging purposes. Options positions may include long positions, where the Fund is the holder of put or call are also applicable to trading derivatives related to such asset.
options, as well as short positions, where the Fund is the seller (writer) of an option. Although option techniques
can increase investment return, they can also involve a relatively higher level of risk. The writing (selling) of Risks associated with using derivatives include the risk of mispricing or improper valuation of derivatives and
uncovered options involves a theoretically unlimited risk of a price increase or decline, as the case may be, in the the inability of derivatives to correlate perfectly with underlying assets, rates and indices. Many derivatives,
underlying security. The expiration of unexercised long option positions effectively results in loss of the entire in particular privately negotiated derivatives, are complex and often valued subjectively. In addition, improper
cost or premium paid for the option. Option premium costs, as well as the cost of covering options written by the valuations can result in increased cash payment requirements to counterparties or a loss of value to the Fund.
Fund, can reduce or eliminate position profits or create losses as well. The Fund’s ability to close out its position Certain derivatives have the potential for unlimited loss regardless of the size of the original investment. The
as a purchaser of an exchange-listed option is dependent upon the existence of a liquid secondary market on market for credit derivatives is somewhat illiquid and there are considerable risks that it may be difficult to either
option exchanges. On occasion the Fund may also utilize options, particularly in foreign markets, which may have buy or sell the contracts as needed or at reasonable prices. Although the Investment Manager will implement
limited liquidity. risk management techniques designed to limit potential losses, such techniques may not accurately predict all
derivatives trading risks.
Warrants. The Fund may hold warrants as a result of a workout of debt. Warrants are instruments that entitle the
holder to buy a fixed income or other debt security at a specific price for a specific period of time. Changes in the [End of illustrative excerpt]
value of a warrant do not necessarily correspond to changes in the value of its underlying security. The price of a
warrant may be more volatile than the price of its underlying security, and a warrant may offer greater potential for
capital appreciation as well as capital loss. Warrants do not entitle a holder to coupon or other interest payments
with respect to the underlying security and do not represent any rights in the assets of the issuing company. A
warrant ceases to have value if it is not exercised prior to its expiration date. These factors can make warrants more
speculative than other types of investments.

75
GLOSSARY OF TERMS Accredited Investor: An accredited investor is
an investor that meets certain income or net worth
law, most often Regulation D Rule 506. Even with the
registration exemption, Regulation D issuers must still
requirements set by the Securities and Exchange file a Form D notice filing and pay a state statutory
Commission under Rule 501 of Regulation D. For fee in each state where investors have subscribed. This
individuals, the income requirement is $200,000 notice filing is often referred to as a “blue sky” filing.
annual income (or $300,000 when combined with a
spouse) for the preceding two years with the reasonable
Broker-Dealers: A broker-dealer is an individual
or firm that purchases or sells securities for itself or
expectation of achieving the same in the coming year.
on behalf of others, often acting as a placement agent.
The net worth requirement is $1,000,000. “Net worth”
Broker-dealers must be registered with FINRA and are
means the excess of total assets at fair market value,
subject to extensive regulation. Only registered broker-
including principal residence, but only if the current
dealers are permitted to accept commissions or other
encumbrances on the primary residence exceed the
transaction-based compensation for making capital
fair market value of the principal residence, home
introductions. So-called “finders” or unregistered
furnishings and automobiles, over total liabilities.
placement agents that make capital introductions are
Administrators: Hedge fund administrators not permitted to accept any form of transaction-based
perform certain back office accounting, operations compensation for capital raising efforts.
and valuation services. Administrators send periodic
financial performance reports to investors, process
BVI (British Virgin Islands): The British Virgin
Islands (BVI) is a popular jurisdiction for offshore
subscriptions, calculate periodic net asset value for the
hedge funds and other private funds. The BVI has
fund portfolio, calculate performance compensation
gained the reputation as being a cost-effective and
and perform many other important support functions.
convenient jurisdiction. BVI’s regulatory structure has
Anti-Fraud Provisions: Anti-fraud provisions sought to create a flexible jurisdiction with streamlined
refer to Section 17(a) of the Securities Act of 1933, processes and strong legal certainty. BVI’s regulatory
Section 10(b) and Rule 10b-5 of the Securities filing fees are considerably lower than those of the
Exchange Act of 1934 that require issuers to make Cayman Islands.
certain required disclosures to investors when offering
and selling securities. Additionally, each state has
Capital Account: A capital account is an account
on the fund’s books that shows the equity owner’s net
its own securities fraud provisions. The anti-fraud
investment in the fund. It is calculated by taking the
provisions prohibit the making of a misstatement
capital contribution of the owner, adding the owners’
or omission of a material fact in connection with an
share of fund’s profits, and then subtracting the owner’s
offering of securities. The company and its officers and
share of fund losses in addition to the distributions
directors can be held liable for violations.
or returns of capital. Capital accounts are used in
Blue Sky Laws: Blue sky laws are state laws limited partnerships, LLCs and other flow-through,
governing the issuance and registration of securities partnership-based entities.
within that state. Blue sky laws contain registration
requirements and anti-fraud provisions. Investment
Cayman Islands, Offshore Fund Jurisdiction:
The Cayman Islands is the world leader as a jurisdiction
funds and most other private placement issuers rely on
for hedge fund domicile, with the BVI coming in
exemptions from the registration requirements of state
second. The Cayman Islands has historically been the

77
top choice for offshore funds because of its business regarding investment in commodities futures and other the company. A finder may not receive transaction- Fund Sponsor: Also known as the fund manager,
friendly structure, stable government and well- instruments covered by the Commodity Exchange based compensation.Only registered broker-dealers the fund sponsor is the individual that organizes,
developed investment laws. Cayman Islands is a tax- Act. Absent an applicable exemption, such advisors may receive transaction-based compensation. manages and makes investment decisions in a hedge
exempt jurisdiction, allowing offshore investors and must register with the Commodity Futures Trading fund.
U.S. tax-exempt investors to avoid paying US taxes on Commission (CFTC) and become a member of the (FINRA) Financial Industry Regulatory
hedge fund gains. National Futures Association (NFA). Associated Authority: Financial Industry Regulatory Authority Gate: To prevent funds from being forced to
persons of a CTA must pass the Series 3 Examination. (FINRA) is a regulatory agency that assists the SEC untimely liquidate investment positions to satisfy
Closed-End Fund: A closed-end fund is an in regulating financial markets. Specifically, FINRA large redemption requests, most hedge funds limit
investment fund intended to last for a fixed term, (CTFC) Commodity Futures Trading handles all the registrations of broker-dealers eligible the percentage of the portfolio that can be withdrawn
usually between five and ten years. Investors in a Commission: The Commodity Futures Trading to solicit investments to investors. All state and federal in any given redemption period (often 10%-25%
closed-end fund are not generally permitted to make Commission (CFTC) is an independent federal agency investment advisor registrations are processed through of Assets Under Management). This is known as a
withdrawals or additional capital contributions. Most created by the Commodity Exchange Act to regulate FINRA’s Investment Advisor Registration Depository gate. In 2008-2009 a large number of funds invoked
private equity funds, venture capital funds, real estate the commodities futures and commodities options (IARD) system. FINRA administers the various gate provisions to prevent being forced to untimely
funds and other funds investing in illiquid assets are markets in the United States. Absent an exemption, licensing examinations from the securities financial liquidate poor-performing investments.
structured as closed-end funds. a hedge fund that trades commodities derivatives markets.
must register with the CFTC as a commodity pool High Water Mark: To prevent a manager from
Commodity Exchange Act: The Commodity operator (CPO) and its associated persons must pass Form D: An SEC form used to file a notice of an receiving duplicate performance compensation
Exchange Act prohibits fraudulent practices in trading the Series 3 examination. CFTC registration requires exempt offering of securities under Regulation D. following periods of volatility, most funds allow
futures contracts and other commodity derivatives, and membership in the National Futures Association Privately held companies that raise capital (including investors to recoup past losses before the fund
provides for regulation of the managed futures industry. (NFA), a self-regulatory organization responsible for hedge funds) are required to file a Form D with the manager is entitled to receive additional performance
Any hedge fund manager trading in commodities or overseeing the managed futures market. SEC. compensation. To accomplish this, a high water
futures must comply with the Commodities Exchange mark (or loss carry forward provision) is established
Act. Dodd-Frank Wall Street Reform and Form U-4: The SEC and most states require advisor immediately following the allocation of incentive
Consumer Protection Act: The Dodd-Frank representatives to submit a Uniform Application for
compensation. Under the “loss carry forward” terms,
Compliance Manual: The SEC requires the Wall Street Reform and Consumer Protection Act is Securities Industry Registration or Transfer (U-4),
fund management is only entitled to be compensated
RIA to provide a policies and procedures manual a federal law enacted in 2010. The Dodd-Frank Act containing specific background information about the
for performance that exceeds the prior “high water
(Compliance Manual) outlining the advisor’s policies brought sweeping changes to financial regulation advisor representative.
mark.”
to protect investor interests and comply with advisor affecting almost every component of the financial
regulations. Forward-Looking Statements: Forward-looking Hurdle: Some funds require the investment manager
services industry. The most monumental change for
statements are statements made in a private placement
hedge fund regulation was an enactment found in Title to achieve a certain level of return, either as a fixed
(CPO) Commodity Pool Operator: A memorandum (or public securities disclosure) that
percentage or a benchmark rate (such as LIBOR or
IV, requiring certain previously exempt investment
commodity pool operator is a pooled investment are predictive of events to occur, but which have
advisers to register under the Investment Advisers the S&P 500) before managers are entitled to receive
vehicle (including a hedge fund) that invests in not actually occurred. They are predicated through
Act. Regulation resulting from Dodd-Frank also performance compensation. Hurdle rates can be
commodities, futures and other instruments covered by the use of certain words and are based on certain
made changes to the definition of investor suitability either a “hard hurdle” or “soft hurdle.” A hard hurdle
the Commodity Exchange Act. Absent an applicable assumptions. Should the statements fail to come to
standards of an “accredited investor” and a “qualified means that the manager only receives performance
exemption, a CPO must register with the Commodity fruition, actual results, performances, or goals could be
client.” compensation that exceeds the hurdle rate. A soft
Futures Trading Commission (CFTC) and become a materially different than those proposed. The use of
hurdle means that no performance compensation
member of the National Futures Association (NFA). Finder: A finder is an individual who is not registered forward-looking statement requires care, and must be
is received if performance falls short of the soft
with FINRA as a broker-dealer, but who locates accompanied by appropriate explanatory language.
(CTA) Commodity Trading Advisor: A hurdle rate, but once the soft hurdle rate is exceeded,
potential investors on behalf of an issuer and then the manager is entitled to the entire performance
commodity trading advisor (CTA) is an individual or
facilitates the introduction between the investor and compensation.
organization that, for compensation, provides advice

79
Intermediary: An intermediary, also referred to as between the fund and the investment management permitted. The lock-up period can be shortened Operating Agreements: The fund manager
a placement agent, is a person or organization that company (often the same entity as the general partner). or lengthened depending on the fund’s investment operating agreement is the legal governing document
assists a fund in raising capital. Intermediaries can It defines the services that a fund manager will provide. strategy. that provides all of the rights of the founders of the
include broker-dealers, regulated by FINRA, as well It tpically gives the fund manager broad discretionary fund. This document specifies how ownership of the
as unregistered finders. Care must be taken when authority to manage the fund’s investments in a Management Fees: A management fee is assessed fund is divided among the principals of the fund. The
manner that the fund manager believes is consistent annually, typically ranging from 1% to 2% of the
entering into any transaction with a finder, since management company operating agreements or its
with the investment strategy of the fund. Since the aggregate assets under management of a fund, regardless
only registered broker-dealers are allowed to be paid contents is not disclosed to investors.
fund manager and the fund are controlled by the same of the performance of the fund. The management fee
transaction-based compensation for making a capital
introduction. individuals, the investment management agreement is intended to cover manager salaries and general Performance Allocation: The performance
becomes a document signed by the same individuals overhead. The management fee is deducted from each allocation is one of the defining characteristics of hedge
Investment Advisor: (Also spelled “investment on both sides. investor’s account periodically (usually in advance) as funds and private equity funds and distinguishes them
adviser”). Investment Advisors are firms or individuals set forth in the offering documents. from mutual funds, which charge only a management
that receive compensation for advice on investing in Investor Suitability Questionnaire: An investor fee. A performance allocation is a percentage of the
securities. Hedge funds that invest in securities must suitability questionnaire is a document filled out Master-Feeder Structure: This hedge fund increase in the value of the fund assets (usually around
either register with the appropriate jurisdiction as an by an investor seeking to purchase securities in a structure involves creating both an offshore and
20%) allocated to the fund’s general partner as an
investment advisor or satisfy an exemption. private offering. The questionnaire asks the investor onshore feeder fund, and an offshore master fund
incentive for positive performance. The performance
to attest that he or she meets the appropriate investor to facilitate investment by foreign investors and tax
Investment Advisers Act of 1940: The allocation is intended to align the interests of the
qualification standards required by the SEC. This is exempt US investors. Investors invest in the feeder
Investment Advisers Act is a federal statute regulating fund manager with that of the investor and provide
typically included with the subscription agreement. fund, which invests in the master fund.
individuals and entities that, for compensation, provide significant upside potential for fund managers.
investment advice, analysis or recommendations JOBS Act: The JOBS Act is the Jumpstart Our Material Omissions: Material omissions are Placement Agent: A placement agent assists the
regarding securities or securities markets. With the Business Startups Act, a federal law that was enacted misstatements, willful or unintentional, or omissions
alternative investment community or private companies
exception of Wyoming, each state has its own version in 2012. This act loosened the restrictions on capital of material facts in association with an offering of
seeking to raise capital through private placement.
of the Investment Advisers Act. Hedge fund managers raising for small businesses including, most notably, securities.
Placement agents should be registered broker-dealers
that invest in securities must comply with federal and requiring the SEC to lift the ban against general to accept transaction-based compensation.
state investment advisers act statutes. National Futures Association: The National
advertising and solicitation on certain Regulation D
Futures Association (NFA) is a self-regulatory
private offerings. Private Placement Memorandum (PPM):
Investment Advisor Representatives: organization established by the Commodities
A private placement memorandum (“PPM”), also
Individuals who work for investment advisory Futures Trading Commission (CFTC) to regulate
Limited Partnership Agreement: The limited known as a private offering memorandum, is a
companies whose main responsibility is to provide the managed futures market and ensure compliance
partnership agreement (or in the case of an LLC-based securities disclosure document used in a private
investment advice. In addition to registration of the RIA with the Commodities Exchange Act. The NFA acts
fund, an operating agreement) is the legal governing offering of securities. From an investor’s point of view,
firm, most states require each individual performing as a watchdog organization to prevent commodities
document of the fund. The limited partnership the purpose of a PPM is to obtain needed information
advisory services on behalf of an RIA firm to register investment fraud.
agreement outlines the terms of the fund and rights about the security and the company, both good and
as an investment advisor representative. Most states
of the investor and fund manager. In contrast with bad, to allow investors to make an informed decision
require advisor representatives to submit a Uniform National Securities Markets Improvement
the private placement memorandum, which is written about whether to invest in the fund. From the fund’s
Application for Securities Industry Registration Act of 1996: The National Securities Markets
in plain English, the fund’s limited partnership perspective, the purpose of a PPM is to provide the
or Transfer (U-4), containing specific background Improvement Act of 1996 (NSMIA) was passed
agreement is a complex legal document. necessary disclosures about the fund to protect it
information about the advisor representative. A by congress to amend and simplify former security
acts to create one standard code for all companies against claims of misstatements or omissions.
number of states require advisor representatives to Lock-ups: It is typical for a hedge fund to require
provide fingerprinting. an initial lock-up period of one year or more before and regulators. Because of NSMIA, offerings made
investors can withdraw invested funds, after which in reliance of Rule 506 preempts state securities
Investment Management Agreement: The registration regulation.
quarterly or semi-annual redemption is typically
investment management agreement is an agreement

81
Qualified Clients: Hedge fund managers that However, such an offering would require registration for an issuer of private securities is Regulation D, better economic terms, such as reduced management
are subject to federal or state investment advisor or a state exemption in every state in which it is offered. which includes Rule 504, 505, and 506 (including the or performance fee, or more convenient withdrawal
registration may only earn a performance allocation new Rule 506(c)). terms. Care must be taken, however, not to allow side
from investors that are “qualified clients”. A qualified
Regulation D Rule 505: Regulation D Rule letters to prejudice other investors. For example, side
client generally includes:
505, like Rule 504, is governed by Section 3(b) of Securities Exchange Act of 1934: The Securities letters that provide additional information rights or
the Securities Act. It is a safe harbor provision for Exchange Act of 1934, often referred to as the preferential liquidity treatment can present significant
1. an individual or a company that has a net worth offerings that will not exceed five million dollars. “Exchange Act” governs securities transactions after liability.
(together, in the case of a natural person, with Because of the benefits that are offered under Rule issuance (i.e. on secondary markets) and regulates
assets held jointly with a spouse) of more than 506, this exemption is rarely relied upon, except as a the exchanges and broker-dealers in order to protect Side Pockets: Side pockets are accounts designed
$2,000,000 at the time the contract is entered backup exemption. Rule 505 permits the issuer to offer the public. The Exchange Act imposes ongoing to separate liquid from illiquid assets used in hedge
into, exclusive of primary residence; or securities to no more than 35 unaccredited investors. reporting requirements on certain companies that funds.
This rule prohibits general solicitation or advertising have registered with the SEC under the Securities
2. an individual with at least $1,000,000 under to potential investors. Rule 505 requires that strictly Act (reporting companies). Private issuers, including Subscription Agreement: A subscription
management of the investment adviser. prescribed information be given to the unaccredited private investment funds, seek to avoid the burdensome agreement is an application by an investor to engage
investors, including audited financial statements. ongoing requirements of the Exchange Act by in a limited partnership in which the company agrees
Regulation D: Regulation D is to safe harbor SEC to sell a certain number of shares at a specific price to
qualifying for exemption from registration under
regulation promulgated under the Securities Act, Rule 10b-5: Rule 10b-5 is an SEC regulation the investor. The investor in turn agrees to pay that
the Securities Act (most often under Regulation D,
which governs private placement securities exemptions, under the Securities and Exchange Act of 1934, price for the shares. The investor questionnaire is
specifically Rule 506), making such private issuers also
allowing issuers the ability to sell securities without which prohibits the use of false statements, omission typically included or integrated with the subscription
exempt from the ongoing reporting requirements of
registering with the SEC. Hedge funds that have of information and other deceptive practices in agreement.
the Exchange Act.
U.S. investors almost always rely on Regulation D, transactions involving stocks and securities. The
specifically, Regulation D Rule 506. company and its officers and directors can be held Series 65 Examination: Most states require advisor Transaction-based Compensation: Any
liable for violations. representatives to pass the Series 65 examination (or an compensation of an individual or firm in the form of
Regulation D Rule 504: Regulation D Rule 504 commission or sale of securities for capital introduction
equivalent examination combination or professional
is governed by Section 3(b) of the Securities Act. This Securities: Securities are financial or investment is transaction-based compensation. Transaction-based
designation). The Series 65 examination is a 130
rule is a safe harbor provision for private offerings that instruments that represent ownership positions in a compensation may only be paid to FINRA registered
question multiple choice test administered by FINRA
will not exceed one million dollars from an unlimited company, a creditor relationship with the company, broker-dealers.
covering topics such as: securities regulations, ethical
number of investors. A company that follows the or some derivative of either ownership or evidenced guidelines, security products, methods for evaluating
requirements of Rule 504 is exempt from registering debt. Securities include a broad array of financial UBTI Taxes: The Unrelated Business Taxable
securities, securities trading strategies, principals of
its securities with the SEC, but is still subject to state instruments, contracts and compensation schemes. Income (UBTI) Tax applies to income generated
economics, and others.
registration in each state in which the company offers by a tax-exempt organization by means of taxable
securities unless the company finds a state registration Securities Act of 1933: The Securities Act of Side-by-Side Structure: Also known as a Parallel activities. This type of income is generated outside of
exemption. Thus, even in offerings of less than one 1933, often referred to as the “Securities Act” is a fund structure, a side-by-side structure has a U.S. fund normal business operations. US tax-exempt investors,
million dollars, we recommend that issuers rely on federal statute that governs securities at issuance, and offshore fund that parallel each other in trading including RIAs and pension plans, may be subject to
Rule 506 rather than Rule 504 when possible, to including the transparency of financial statements to and have the same investment manager but maintain UBTI if the fund employs certain types of leverage as
avoid being subject to state registration requirements. ensure that investors can make informed decisions separate investment portfolios. part of its investment strategy. To avoid UBTI, such
Rule 504 is most commonly used when the company about investments. This act establishes laws against investors should invest through a tax-exempt offshore
needs to raise capital from more than 35 unaccredited misrepresentation and fraudulent activities in the Side Letters: Most offering documents allow investment fund, most commonly through a master-
investors and the company is not eligible for a Rule securities market. Section 5 of the Securities Act the management team to negotiate special terms feeder or side-by-side structure.
506 exemption. In certain cases, Rule 504 may be used requires that all non-exempt securities issuances be (known as side letters) that are not applicable to other
with general advertising without federal registration. registered with the SEC. The most common exemption investors. Often the special arrangement involves

83
DISCLAIMER
THIS EBOOK IS PROVIDED FOR GENERAL INFORMATION PURPOSES ONLY AND ITS
AUTHOR IS NOT PROVIDING LEGAL ADVICE TO ANY READER. THE EBOOK AND THE
CONTENT WITHIN IT ARE NOT INTENDED TO ESTABLISH AND THEIR USE DOES NOT
ESTABLISH AN ATTORNEY-CLIENT RELATIONSHIP. ANY DISCUSSION REGARDING
SECURITIES, COMMODITIES OR TAX LAWS OR REGULATIONS CONTAINED IN THIS
EBOOK IS INTENDED TO BE GENERAL IN NATURE AND IS NOT A SUBSTITUTE FOR
SEEKING ACTUAL LEGAL ADVICE FROM A LICENSED ATTORNEY. IF YOU HAVE A LEGAL
QUESTION ABOUT THE RULES OR REGULATIONS GOVERNING PRIVATE FUNDS PLEASE
CONTACT CAPITAL FUND LAW GROUP OR ANOTHER LICENSED ATTORNEY. THIS EBOOK
MAKES NO REPRESENTATIONS, GUARANTEES, OR WARRANTIES AS TO THE ACCURACY,
COMPLETENESS, CURRENCY, OR SUITABILITY OF THE INFORMATION PROVIDED VIA
THIS EBOOK. WE SPECIFICALLY DISCLAIM ANY AND ALL LIABILITY FOR ANY CLAIMS OR
DAMAGES THAT MAY RESULT FROM PROVIDING THE EBOOK OR THE INFORMATION IT
CONTAINS. THIS EBOOK MAY BE CONSIDERED TO BE ATTORNEY ADVERTISING IN SOME
JURISDICTIONS.

85
CONTACT INFORMATION
We would be delighted to discuss your private placement or answer any questions that you might have about your
offering. John Lore’s complete contact information is as follows:
John S. Lore, Esq.
1700 Broadway, 41st Floor
New York, New York 10019
Phone: (212) 203-4300
jlore@capitalfundlaw.com
capitalfundlaw.com

86 FORMING AND OPERATING A HEDGE FUND - A Guide for Emerging Fund Managers
A MUST READ FOR HEDGE FUND MANAGERS
This publication provides an in-depth g uide to a ssist e merging hedge fund managers t hrough t he process o f
successfully structuring, launching, and raising capital for a domestic or offshore hedge fund. Hedge fund attorney
John Lore highlights pitfalls that fund sponsors should watch for and suggests the best practices to safely and
effectively navigate the process of forming and operating a hedge fund. This book also contains a sample hedge
fund private placement memorandum excerpt, with footnoted explanations of key hedge fund provisions.
ABOUT THE AUTHOR

John S. Lore, Esq. is the managing partner of Capital Fund Law Group, an investment fund law boutique focused
on domestic and offshore hedge fund formation and compliance. Mr. Lore advises established and emerging fund
managers throughout the United States in forming and operating hedge funds, private equity funds, real estate
funds and other fund vehicles.
Prior to founding Capital Fund Law Group, Mr. Lore practiced corporate and securities law at a number of law
firms, including the investment funds division of Akin Gump Strauss Hauer & Feld in its New York and Moscow
offices. Mr. Lore received his Juris Doctorate, with honors, from the University of Utah, S.J. Quinney College
of Law, where he served as a senior member of the Utah Law Review staff. Mr. Lore is a holder of the Series 65
Investment Adviser Law Examination.
CAPITAL FUND LAW GROUP, P.C.
1700 Broadway, 41st Floor

New York, New York 10019
capitalfundlaw.com
(212) 203-4300

Serving clients throughout the United States.

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FORMING AND OPERATING A HEDGE FUND - A Guide for Emerging Fund Managers

By John S. Lore, Esq.

© 2015 Capital Fund Law Group

ABOUT THE AUTHOR.................................................................................................................................... 7 D. Investment Management Agreement.......................................................................................................... 20

E. Management Company Operating Agreement........................................................................................... 20

A. Our Services.................................................................................................................................................. 9 IV. COMMON

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A. Why an Incubator Fund?............................................................................................................................ 30 XI. I NVESTMENT ADVISOR REGISTRATION........................................................................................ 43

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• setting market-appropriate investment terms;

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BASICS disclosure. Even inadvertent mistakes can lead to

Payment of the liability under this section can be

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• assist managers with modifications to the fund;

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• treasury services; D. Prime Broker/Custodian

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i. The Net Worth Test C. Principals of the Fund

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b. Parallel Fund Structure

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B. State Exemptions A Form D must be filed each subsequent year while

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Call (212) 203-4300 or click here for a free consultation.

John S. Lore, Esq.

1700 Broadway, 41st Floor

New York, New York 10019

Phone: (212) 203-4300

Call (212) 203-4300 or click here for a free consultation.

ABOUT THE AUTHOR.................................................................................................................................... 7 D. Investment Management Agreement.......................................................................................................... 20

E. Management Company Operating Agreement........................................................................................... 20

A. Why an Incubator Fund?............................................................................................................................ 30 XI. I NVESTMENT ADVISOR REGISTRATION........................................................................................ 43