FEATURING eSentire // Eze Castle Integration // Piedmont Fund Services // Sadis & Goldberg // Stonegate Global Fund Services // S&Z Fund Services // US Bancorp

WEEKHFMS P E C I A L R E P O R T

TECHNOLOGY Cyber security and data access are essential to a start-up

RAISING CAPITAL Sophisticated investors demand a developed business plan

LEGAL REQUIREMENTS Making sure your fund documents are watertight

HOW TO START A HEDGE FUND IN THE US 2015

H F M W E E K . CO M 3

Published by Pageant Media Ltd LONDONThird Floor, Thavies Inn House, 3-4 Holborn Circus, London, EC1N 2HAT +44 (0) 20 7832 6500 NEW YORK 1441 Broadway, Suite 3024, New York , NY 10018 T +1 (212) 268 4919

t is hard to argue that starting and successfully growing a hedge fund in the US has become significantly more complex. The

steady increase of regulation and greater sophistication of investor due diligence procedures have added to the traditional barriers to entry.

On the other hand, as we discuss, advancements in technology now allow start-up funds to be created at a quicker pace and for a fraction of the cost. The existence of private cloud technology has allowed start-up funds to access a high level of processing power and develop a tailored technological

infrastructure that would previously have been far out of the reach of most emerging funds' budget.

In this latest HFM How to start a hedge fund in the US 2015 report we speak to leading industry figures including service providers, fund administrators and technology experts. These specialists discuss the various steps involved in launching a fund and the most suitable fund structures available.

We also analyse the evolving challenges facing start-up funds in 2015, from raising capital to cyber security requirements and regulatory compliance.

Finally, this report seeks to look ahead and educate emerging managers on the steps to take to give yourself the best chance to survive and prosper in this complex and fast-paced marketplace.

IH O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

REPORT EDITOR Drew Nicol T: +44 (0) 20 7832 6659 d.nicol@pageantmedia.com HFMWEEK HEAD OF CONTENT Paul McMillan T: +44 (0) 20 7832 6622 p.mcmillan@pageantmedia.com HEAD OF PRODUCTION Claudia Honerjager SUB-EDITORS Eleanor Stanley, Luke Tuchscherer, Mary Cooch CEO Charlie Kerr GROUP COMMERCIAL MANAGER Lucy Churchill T: +44 (0) 20 7832 6615 l.churchill@hfmweek.com SENIOR PUBLISHING ACCOUNT MANAGER Tara Nolan +44 (0) 20 7832 6612, t.nolan@hfmweek.com PUBLISHING ACCOUNT MANAGERS Amy Reed T: +44 (0) 20 7832 6618 a.reed@hfmweek.com; Jack Duddy T: +44 (0) 20 7832 6613 j.duddy@hfmweek.com; Alex Roper T: +44 (0) 20 7832 6594 a.roper@hfmweek.com CONTENT SALES Tel: +44 (0) 20 7832 6511 sales@hfmweek.com CIRCULATION MANAGER Fay Muddle T: +44 (0) 20 7832 6524 f.muddle@pageantmedia.com

HFMWeek is published weekly by Pageant Media Ltd ISSN 1748-5894 Printed by The Manson Group © 2015 all rights reserved. No part of this publication may be reproduced or used without the prior permission from the publisher

Drew NicolReport editor

4 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5 C O N T E N T S

FUND FORMATION & ADMINISTRATION

THE COMPETITIVE HEDGESM IN CREATING A SUCCESSFUL HEDGE FUNDJohn McCorvey III and William Chong of BlueFlame Global Wealth Management and Michael Blackburn of Stonegate Global Fund Services discuss the most successful approach to fund formation and global marketing to sophisticated institutional investors

FUND SERVICES

HOW TO START A FUNDGregory Zoraian of S&Z Fund Services discusses the steps needed to successfully launch a hedge fund

CYBER RISK

CYBER SECURITY CONSIDERATIONS FOR EARLY-STAGE FUNDSEldon Sprickerhoff, founder & chief security strategist of eSentire, talks to HFMWeek about the cyber security needs of emerging funds

FUND ADMINISTRATION

EVOLUTION OF THE INDUSTRYPiedmont Fund Services’ Ian Asvakovith, CPA, co-founder and CEO, talks to HFMWeek about the developing challenges facing emerging hedge fund managers

TECHNOLOGY

GIVING START-UPS A HELPING HANDHFMWeek catches up with Eze Castle Integration’s managing director, Vinod Paul, to discuss how technology can help tackle the challenges facing start-up funds

LEGAL

SUCCESSFULLY LAUNCHING A PRIVATE INVESTMENT FUNDRon S. Geffner and Daniel G. Viola of Sadis & Goldberg LLP explain the fund structures available to managers

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What’s keeping you up at night?g y g

C Y B E R S E C U R I T YYou are not alone. The SEC, SIFMA, FINRA, DHS and multiple other organizations are worried about the threat of cyber attacks and vulnerabilities like ShellShock.

eSentire is the leading provider of continuous active threat protection to the financial services industry. We’ve helped numerous clients exceed the expectations of regulatory associations while protecting their assets and investor interests 24x7.

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6 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

The hedge fund industry has seen a tremen-dous amount of growth over the past decade. When I fi rst entered this industry in the late 90s, there were roughly 3,000 funds with less than $500bn of assets under management. Th e industry was going through a transfor-

mation period aft er the fall of Long-Term Capital Man-agement. Prime brokers had to re-evaluate their business relationship with hedge funds, particularly when it came to collateral requirements and leverage. Th e accounting professionals were busy keeping up with new accounting regulatory requirements. Fund administration was at the infancy stage, and NAV-lites were widely acceptable for smaller managers. Hedge fund investors, comprised primar-ily of family offi ces and en-dowments, sought talent and fund performance over AUM, volatility, and even internal controls.

Fast forward to a decade and a half later, the hedge fund in-dustry has evolved to a more matured environment with over 12,000 funds and nearly $3trn of assets under manage-ment. As a broader base of institutional investors entered into the hedge fund investment program, the focus on strategy selection has shift ed away from performance generation to risk management. Investors’ de-mand has pivoted towards products with low correlation and low volatility. Th ere is also a perception that funds with larger AUM have a greater organisational stability. Th us, it seems for many prospective investors a fund’s AUM has taken priority over performance.

BEFORE LAUNCHING YOUR HEDGE FUNDAs you embark on the lucrative hedge fund business that att racts capital from various sources, it is important to understand that a successful launch requires substan-tial capital resources, time, and personal sacrifi ces. For managers who have not properly assessed the level of commitments involved in building a business, keeping the status quo with their career as an analyst/portfolio manager might be a bett er option. However, for those who are willing to give up a high paying job to build their own venture, the potential reward could be signifi cant. In order to market in the highly competitive hedge fund

space, an aspiring fund manager needs to present his/her investors with a clearly identifi able ‘edge’ and value proposition.

MONEY MANAGER VS BUSINESS OWNERMost hedge fund operators would have had an established career as money managers. However, with a new launch, they are forced into an unchartered territory of being a business owner. An example can be compared to a star chef who is looking to open his own restaurant and will have to face various aspects of running a business aside from food preparation such as reservations, table turnover

management, menu design, etc. While you may be very good at sourcing investment ideas, it is vital that you also focus on building an organisation with a sound infrastructure. Teaming with the right partners in the early stages is a critical success factor for your business.

SELECTING YOUR INVESTORSUnlike venture capital or pri-vate equity funds, where inves-tors’ capital can be tied up for a decade, hedge fund invest-ments tend to be much more liquid. While it may be tempt-ing to accept all investors will-ing to allocate, it is vital to part-ner with those investors who understand your investment philosophy. Exiting investment

positions in order to meet redemptions by panicking in-vestors at the wrong time may be detrimental to the fund longevity. Unrealised loss is temporary, but realised loss is permanent.

SELECTING YOUR KEY SERVICE PROVIDERSTh e key service providers are the prime broker, fund ad-ministrator, auditor, legal counsel, and technology pro-vider, and each of them plays a critical role in the success of your business. SEC registrants may also need to appoint a compliance specialist. Despite the saturation of the mar-ket and available choices, selecting the ‘right’ vendor can prove challenging and time-consuming. Each service pro-vider presents a unique set of strengths and weaknesses that make a great fi t for certain funds, but not others. Th ere is no one-size-fi ts-all solution, and a prospective manager has to determine which fi rms would align well with his/her philosophy and business needs.

AS A BROADER BASE OF INSTITUTIONAL INVESTORS

ENTERED INTO THE HEDGE FUND INVESTMENT PROGRAM, THE

FOCUS ON STRATEGY SELECTION HAS SHIFTED AWAY FROM

PERFORMANCE GENERATION TO RISK MANAGEMENT

”

PIEDMONT FUND SERVICES’ IAN ASVAKOVITH, CPA, CO-FOUNDER AND CEO, TALKS TO HFMWEEK ABOUT THE DEVELOPING CHALLENGES FACING EMERGING HEDGE FUND MANAGERS

EVOLUTION OF THE INDUSTRY

Ian Asvakovith, CPA, is the co-founder and CEO of Piedmont Fund Services, Inc. Since the inception of Piedmont in 2005, Asvakovith has helped his clients to successfully launch their hedge funds, and is routinely involved in their key business decisions throughout the fund’s lifecycle. He has been in the industry for over 15 years and spent his early career in the audit practice of Ernst & Young in San Francisco and New York prior to co-founding Piedmont.

F U N D A D M I N I S T R AT I O N

H F M W E E K . CO M 7

PRICING YOUR PRODUCTSA hedge fund is a rare business in which products of dif-fering quality are set to be priced similarly. Generally, con-sumers would not pay the same price for a mediocre and high quality item. Yet, in the hedge fund industry, a stand-ard fee structure of 2% management fee and 20% perfor-mance fee has been commonly applied across different funds regardless of their performance or ability to gener-ate investment alpha. In the past, investors have been will-ing to accept this fee structure, but the trend has evolved to reflect more objective, investor-aligned offerings.

Examples of non-traditional fees structures:1. Founder’s class – Invites early subscriptions by of-

fering investors an incentive to take on a start-up risk with a fee discount (i.e. during the first year of opera-tions). Post founder’s-class offering period, investors are subject to standard fees. This time component provides an incentive that factors into an investor’s choice to al-locate to a new/emerging manager over one with an es-tablished track record.

2. Tier scale management fee – For certain types of funds, particularly ones with a limited investment capac-ity, it may make sense to have a tier scale to reduce the management fee after the targeted AUM is reached. By lowering management fees for the AUM above a stated threshold, managers are incentivised to deliver because their compensation is less asset-based and more perfor-mance-based.

OTHER KEY CONSIDERATIONS FOR 2015 LAUNCHESIn the post-Dodd-Frank era, regulatory compliance has become an integral part of the hedge fund business. New managers must be familiar with the key regulatory re-quirements impacting the industry:

1. Fatca (Foreign Account Tax Compliance Act): ap-plies to all offshore funds and potentially US domestic funds with foreign investors. Foreign financial institutions (FFIs) are required to be registered and obtain a global intermediary identification number (GIIN). The primary objective of this bill is to combat tax evasion by US per-sons who disguise themselves as foreign taxpayers. Fatca is complex, and managers should seek guidance from their tax advisors to determine the scope of compliance.

2. The AIFMD (Alternative Investment Fund Manag-ers Directive): mandates that alternative investment fund managers (AIFMs) that market or manage alternative in-vestment funds (AIFs) to EU investors must comply with heightened reporting and disclosure requirements; note the imposition of the new Annex IV reporting require-ment on AIFMs with assets under management of at least €100m. Annex IV is a large complex filing, similar to Form PF filed with the SEC, and it must be filed regularly with the National Competent Authority (NCA) of each EU member state where AIFs are marketed. If you have EU-based investors or intend to solicit capital from EU-based investors, you should consult with your legal counsel re-garding the AIFMD requirements.

T E C H N O L O G Y

H F M W E E K . CO M 9

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

HFMWeek (HFM): Are you seeing a healthy market for new hedge fund launches in the US?Vinod Paul (VP): 2013 and 2014 were very strong years for start-ups in the US. Our US pipeline is also quite healthy for 2015 in terms of start-ups, which is a litt le dif-ferent to Europe, where there aren’t as many launches. In terms of overall US business, 50% of the clients we brought on in 2014 were start-ups; this is up from 40% in 2013.

Th ere are several factors that have contributed to this, some that we cannot control, such as how the wider mar-ket performs. Institutional money coming back into the market is causing some of the start-up activity. Many of the start-ups we have been able to bring on were funded by larger institutions.

HFM: How are today’s start-up funds diff erent than those from fi ve years ago?VP: Th e barriers to entry are harder now compared to three or fi ve years ago due to reg-ulatory and compliance require-ments, as well as increased inves-tor due diligence expectations. In the past, due diligence around technology consisted of merely check boxes, to see if a fund had disaster recovery and a compli-ance system in place.

Th ere is now a dramatic shift in the due diligence process, es-pecially in the last year. Th ose conducting due diligence are much more educated on technol-ogy and the various solutions out there and are asking deeper ques-tions. Th ey are also more familiar with solutions like the private cloud and they want to under-stand all the facets of technology,

such as, what’s being outsourced and to whom. Investors want to know that funds are following proper processes and procedures.

Th e Securities and Exchange Commission in the US has taken a strong look at cyber security this past year. Th ese forces have created the need for bett er due diligence ques-tionnaire (DDQ) processes, as well as bett er education and awareness to potential investors regarding technology and security systems.

HFM: What are some key op-erational priorities for a fi rm starting out? VP: We are seeing a real invest-ment in the back and middle of-fi ce processes. A few years ago, when a start-up was entering the market they oft en had one person responsible for several functions. Today, the chief operating offi cer (COO) might also be the chief compliance offi cer (CCO), but they are now utilising all the tools that are out there to support their operations and workfl ows.

Another operational priority is to have a processor round to conduct clear due diligence con-cerning the fi rm’s investment in

THERE ARE NOW MORE TECHNOLOGIES OUT THERE THAT MAKE IT EASIER FOR START-UPS TO MANAGE A FUND AND THE DIFFERENT

OPERATIONAL NEEDS REQUIRED OF THE FUND

”

HFMWEEK CATCHES UP WITH EZE CASTLE INTEGRATION’S MANAGING DIRECTOR, VINOD PAUL,TO DISCUSS HOW TECHNOLOGY CAN HELP TACKLE THE CHALLENGES FACING START-UP FUNDS

GIVING START-UPSA HELPING HAND

Vinod Paul, managing director of service and business development, leads a talented team of customer service and engineering professionals and oversees all customer-facing engagements for Eze Castle Integration. Paul joined the company in 2002, and his responsibilities include service delivery and business development for the firm.

T E C H N O L O G Y

1 0 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

compliance, disaster recover, written information security and managing all of their vendors and partners (including prime brokers, order management systems and client rela-tion management tools).

In addition, unlike years ago when people had servers in their office and disaster recovery in another location, when the location of data was easier to understand, with the advent of cloud technology, a top priority now is un-derstanding where their data is and what is the most im-portant data to them.

HFM: Overall, has launching a start-up become easier due to improved access to better technology or has reg-ulatory developments made it more complex?VP: There are two answers to that. As I mentioned previ-ously, the barriers to entry are tougher. At the same time, there are now more technologies out there that make it easier for start-ups to manage a fund and the different op-erational needs required of the fund.

Five years ago deploying an order management system was very costly and you could spend thousands of dollars in server software, while the deployment time was often several weeks. Now you can deploy the same system in a few days and readily obtain the processing power in the private cloud with the redundancies built in on day one, all at a much lower cost.

HFM: What role does technology play in powering hedge fund start-ups to compete with established in-vestment firms?VP: Simply, technology is critical to the successful opera-tional management of any fund, start-up or established. Technology is exceptionally important for start-ups be-cause it allows them to compete for institutional invest-ments.

In terms of cyber security there are many third-party firms out there that can help protect your fund as well as mobility tools. The world has changed quite a bit over the course of the last five years and access to information is now vital for funds that are trading and making decisions on the go. The mobility tools in the marketplace have only

made it easier for funds to react quickly to these changing conditions.

We were extremely involved in that process of launch-ing each of the start-ups we brought on in 2014. This helps them make the right decision at those early critical points, like picking the right technology platform from the start. It’s vital not to take shortcuts from day one because it makes it harder to make the necessary process changes later on.

The other advantage of the cloud is it allows firms to layer on tools as their assets grow.

HFM: Cyber security is only going to become more rel-evant in years to come. How are start-ups able to offer a competitive level of cyber protection to investors?VP: The best way to protect yourself and your clients is by having layers of security; there isn’t one silver bullet that can cover you entirely when it comes to cyber risk. You must ensure you have the right technologies and deploy the right policies and procedures. We even take it a step further by partnering with eSentire, which specialises in cyber security.

My advice to start-ups would be to make sure you pick the right provider – a reputable one – by doing the correct due diligence to ensure they are also using layers to man-age security. In this way a start-up fund is able to protect their fund as much as is reasonably possible.

HFM: How do cost implications affect a start-up’s abil-ity to gain a high level of protection?VP: This is where the private cloud really excels. If a fund was to privately build what can be offered on the cloud it can cost up to $500,000 a year. By deploying storage area networks, bringing in high-end firewalls and hiring third-party security systems, a firm can really succeed opera-tionally. By using a private cloud provider, funds are able to offer scalability on a per user, per month basis. They could boast all the same features, redundancies and pro-tections as an on-site infrastructure, but in a much more cost-effective manner.

MY ADVICE TO START-UPS WOULD BE TO MAKE SURE YOU PICK THE RIGHT PROVIDER – A REPUTABLE ONE – BY DOING THE CORRECT DUE DILIGENCE TO ENSURE THEY

ARE ALSO USING LAYERS TO MANAGE SECURITY

”

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1 2 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

Successfully launching a private investment fund, involving hedging strategies, private equity, venture capital or real estate is de-pendent upon selecting the proper corporate structure and complying with regulations promulgated by regulatory agencies that

govern funds and their managers in the United States, including the US Commodity Futures Trading Commis-sion (CFTC) and the US Securities and Exchange Com-mission (SEC).

Some US-based funds and their managers that are based in the US may also be subject to oversight by non-US based regulators. Structuring a fund involves creating one or more entities through which investments will be made (domestic and off shore funds), as well as manage-ment entities through which the advisory services will be provided to the funds (the general partner and/or the investment manager).

STRUCTURING THE FUND Th e structure and domicile of the fund is primarily de-pendent upon the nature and demographics of the pro-spective investors and the invest-ment strategy employed by the manager. Th e structure and domi-cile of the manager is primarily determined by the citizenship and tax considerations of its principals, as well as the regulatory regime of the domicile.

Investors can be divided into three classes: (i) US taxable inves-tors, (ii) US tax exempt investors, and (iii) non-US persons. In the majority of circumstances, if the investors are US taxable investors, the fund will be formed as a US limited partnership or a limited lia-bility company and is oft en referred to as a ‘domestic fund’. Most domestic funds are organised in Delaware.

If the investors are US tax-exempt investors or non-US persons, the fund will be formed in a jurisdiction outside of the US as a corporation (or other analogous entity), oft en referred to as an ‘off shore fund’. Popular off shore jurisdictions include Bermuda, the British Virgin Islands and the Cayman Islands. US tax-exempt investors typi-cally prefer to invest in an off shore fund set up as a cor-poration because if the off shore fund purchases securi-ties on margin (oft en referred to as leverage), an off shore fund which is set up as a corporation blocks the unrelated

business taxable income (UBTI) that would otherwise be taxable to the US tax-exempt investor.

ECONOMIC ANALYSISIn determining whether to form both a domestic and an off shore fund, it is advisable to determine the anticipated assets which will be invested in the funds shortly aft er the launch. Th e anticipated aggregate investment at or shortly aft er the launch may not justify the formation of both a domestic and off shore fund. To create both funds may impair the manager’s ability to survive due to the or-ganisational expenses and the costs of maintaining both funds. With early stage managers, cash burn is oft en over-looked but can be critical to survival and the opportunity to establish a proven track record.

STANDARD FUND STRUCTURESTh e three most common fund structures when launch-ing domestic and off shore funds are: side-by-side, master feeder and mini-master.

In a side-by-side structure, the domestic and off shore funds make direct investments pursuant to the invest-

ment strategy and trade tickets are allocated between the domestic and off shore funds.

In a master feeder structure, a third entity is created (master fund) and the domestic fund and off shore fund, rather than mak-ing direct investments, invest all of their assets into the master fund and in turn, the master fund makes the investments on behalf of the domestic fund and the off -shore fund (oft en referred to as the domestic feeder and off shore feeder).

Th e mini-master structure is comprised of two entities; an

off shore feeder and a master entity. While the off shore feeder is taxed as a corporation to benefi t US tax ex-empt investors and block UBTI, the master entity may be structured for tax purposes as a partnership. Rather than the US-based manager receiving its incentive as a fee from the off shore fund and being subject to ordinary income tax, the US-based manager may receive the in-centive as an allocation from the master entity, in an at-tempt to benefi t from capital gains tax treatment.

Th ere are many legal and commercial drivers in deter-mining the ideal structure. For example, if the strategy calls for signifi cant investment in illiquid or thinly traded posi-

WITH EARLY STAGE MANAGERS, CASH BURNIS OFTEN OVERLOOKED BUT CAN BE CRITICAL

TO SURVIVAL

”

RON S. GEFFNER AND DANIEL G. VIOLA OF SADIS & GOLDBERG LLP EXPLAIN THE FUND STRUCTURES AVAILABLE TO MANAGERS

SUCCESSFULLY LAUNCHING A PRIVATE INVESTMENT FUND

Ron Geffner is a partner of Sadis & Goldberg LLP and oversees the Financial Services Group. He regularly structures, organises and counsels private investment vehicles, investment advisory organisations, broker-dealers, commodity pool operators and other investment fiduciaries, and routinely counsels clients in connection with regulatory investigations and actions.

Daniel G. Violais a partner and head of the Regulatory Compliance Group of Sadis & Goldberg LLP. He structures and organises broker-dealers and investment advisers and regularly counsels investment professionals in connection with regulatory matters.

H F M W E E K . CO M 13

L E G A L

tions, which are difficult to allocate among two brokerage accounts, a master feeder structure may be preferred as the investments will be allocated on a pro rata basis at the mas-ter fund, yet only require the manager to purchase and sell the positions through one brokerage account.

In addition, in many transactions involving early stage or ‘seed’ investment, if the seeder is located offshore, it may prefer a master feeder structure so that all fees and allocations may be taken at the master fund and thus avoid the US tax regime. Conversely, employing a tax efficient strategy for US taxable investors may be of lit-tle benefit or even detrimental to US tax-exempt inves-tors and non-US persons. Thus, a side-by-side structure allows the manager the ability to employ tax efficiency with the domestic fund, while maximising the entry and exit points of securities positions without regard to long-term tax gains for the offshore fund.

STRUCTURING & DOMICILEThe structure and domicile of a manager is primarily de-termined by the citizenship and tax considerations of its principals. The majority of funds which are man-aged by US-domiciled entities are structured as either limited liability companies or limited part-nerships, which are taxed as flow through vehicles (rather than as corporations).

With non-US persons, if they own the majority of equity or receive the majority of the economics from the manager, and their interests are control-ling, the manager may be organised in an offshore jurisdiction to accommodate the tax needs of the non-US persons.

REGULATORY ANALYSISManagers must also evaluate the various exemp-tions associated with adviser registration with the SEC and/or the CFTC, depending on the fund’s investment strategy. For example, the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) introduced new regis-tration requirements based on the total amount of assets managed in the US, instead of the number of clients advised by the manager.

Therefore, a manager that only manages funds in the US will be required to register with the SEC, appoint a chief compliance officer and implement written compliance procedures subject to review from the SEC, if its ‘regulatory assets under management’, which includes the assets managed and any leverage uti-lised by the manager, exceeds $150m.

Non-US based managers may also be required to reg-ister with the SEC and/or the CFTC if they cannot rely on exemptions from registration. Likewise, managers are required to verify the tax status of the investors in a fund under the Foreign Account Tax Compliance Act (Fatca) and to comply with the relevant blue-sky requirements for offers made to investors residing in the US.

RECENT REGULATORY DEVELOPMENTSAIFMDRegarding EU-based prospective investors the manager must comply with the Alternative Investment Fund Man-

agers Directive of 2013 (AIFMD),which applies to US and non-US based funds and requires registration and reporting requirements that vary depending on each pro-spective investor’s residence. Provided no valid exemp-tions apply to AIFMD, the manager is subject to certain registration and reporting requirements and the fund’s offering documents require amendments.

Marketing relief from the CFTCMost managers rely on Rule 506(b) under Regulation D (Rule 506(b)) of the Securities Act of 1933 (Securi-ties Act) to avoid registering their offerings with the SEC under the Securities Act. Rule 506(b) prohibits general advertising of the fund, such as placing an ad in a news-paper or on the internet seeking new investors. The SEC, pursuant to the Jumpstart our Business Startups Act of 2012 ( JOBS Act) permits managers to utilise general advertising under certain limited circumstances.

Prior to September 2014, the CFTC prohibited general advertising if the manager was relying on certain exemp-tions from CFTC registration. As such, those managers

that wanted to continue to rely on certain CFTC exemptions were not able sell their fund interests using general advertising methods, despite the JOBS Act. However, on 9 September, the CFTC determined that funds may rely on Rules 4.7(b) and 4.13(a)(3) under the Commodity Exchange Act when they conduct general solicitation and advertising activities provided that the funds: (i) file a Form D, indicating that they are relying on Rule 506(c) of Regulation D (not Rule 506(b)); (ii) verify the accreditation of each investor; and (iii) do not allow any non-accredited investors to invest into the fund relying on Rule 506(c).

Accredited Investor StandardUnder the Dodd-Frank Act, the SEC is required to review the ‘accredited investor’ definition every four years. Section 911 of the Dodd-Frank Act established the Investor Advisory Commit-tee (IAC) to make recommendations to the SEC regarding certain regulatory priorities, including the current definition of an accredited investor and whether this definition should be changed. On 9 October, 2014, the IAC suggested that the

SEC develop an alternative criteria which is a more real-istic and practical determinants of whether an individual is financially sophisticated. However, to date the SEC has not issued a revised definition.

CONCLUSION It is important to use law firms with corporate, tax and regulatory experience in connection with structuring and maintaining hedge funds. Failure to properly structure your firm will have material opportunity costs. A firm with structural issues is less likely to attract investment and more likely to be plagued with investor litigation, regulatory prosecution, limitation on capital resources and reputational damage. In many cases, the costs asso-ciated with fixing a problem far exceed the costs of doing the job correctly at the outset. In certain cases, the prob-lems cannot be fixed.

IN MANY CASES, THE COSTS ASSOCIATED WITH FIXING A PROBLEM FAR EXCEED THE COSTS OF

DOING THE JOB CORRECTLY AT THE OUTSET. IN CERTAIN

CASES, THE PROBLEMS CANNOT BE FIXED

”

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burden on hedge funds report-

ing in different jurisdictions,

although no regulator would

comment publicly on the talks.

In an interview with

HFMWeek, NFA vice presi-

dent, compliance, Regina

Thoele said the NFA would

like to work with the SEC, and

alongside the CFTC, to harmo-

nise the SEC’s Form PF and the

CFTC/NFA Form PQR. She

also said the NFA is “very open”

to engaging with the UK’s FCA

on harmonisation, as firms pre-

pare to file their first Annex IV

submissions under the AIFMD

by the 31 January deadline.

She cautioned it would not

be an easy task. “It’s going to be

hard to do – you’re bringing a

lot of regulators together.

“But I think it’s important

for us to collect the data that

we can use and make sure it’s

meaningful data.”

The SEC would not comment

on the NFA’s call. However, a

source within the reg-

ulator warned Form

US regulator says CFTC,

SEC and FCA should work

towards unified reporting

BY MAIYA KEIDAN

03

COMMENT L E V E R A G E D I S C LO S U R E A N D M E A S U R E M E N T14

NFA calls for

global reporting

harmonisation

HFMWEEK MEETS

THE NFA

REGINA THOELE DISCUSSES

FEES, EXAMS AND COMMON

DEFICIENCIESFEATURE 16

The long and the short of it

ISSUE 361 20 November 2014

LAUNCH 11

FORMER UBS DIRECTOR PREPS MARKET-NEUTRAL FUND

Australian Qato Capital to launch market-neutral fund

STRATEGY 03

BH MACRO CHAIR FORECASTS ‘FERTILE’ TIME FOR MACROS

Economic divergence to boost strategy, says Plenderleith

BUYOUT 05

STATE STREET GLOBAL ADVISORS TO SELL SSARIS IN MBO

Senior management to buy 60% stake in FoHF platform

FE ATURE 19The Shanghai-Hong Kong Connect

pilot scheme is not the only big

opportunity for hedge funds in China

CHINESE TAKE-OFF

s indd 1

18/11/2014 16

www.hfmweek .com

THE TOP 10 alternative Ucits

umbrellas saw a huge 43%

growth this year as experts

noted US managers reacting to

the AIFMD and the success of

’40 Act funds as a major con-

tributor to nearly $9bn of fresh

assets. The year-on-year increase

from $20.14bn to $28.86bn,

for the year to 31 October, is

the biggest asset growth since

HFMWeek began its Ucits plat-

form survey in 2010. Assets

grew by $6.33bn in 2013,

$5.26bn in 2012 and $4.49bn

in 2011.

Seven out of the 10 grew

assets by over 50% over the

previous 12 months, with

Bank of America Merrill Lynch

(Baml) adding the most assets

($2.95bn) and Schroder Gaia

tailing closely behind, with

an increase of $2.68bn. Lyxor

added $1.22bn as its assets

more than quadrupled from

last year.“The single biggest trend has

been the rise in interest from

US-based managers looking

to launch a Ucits,” Andrew

Dreaneen, head of Schroder

GAIA Product & Business

Development, told HFMWeek.

“There are a number of reasons

for this, including the need to

have an AIFMD or Ucits pass-

port to market widely in Europe.”

Seven out of 10 umbrellas

enjoy over 50% YOY asset

increase BY MAIYA KEIDAN

03

COMMENT S H O RT S E L L I N G A N D T I G E R G LO B A L

14

US effect helps Ucits platforms surge by

nearly $9bn

THE BIGGEST UCITS PLATFORMS THIS

YEARALTERNATIVE UCITS HEDGE FUND

UMBRELLAS ENJOYED RECORD

GROWTH

ANALYSIS 22

The long and the short of it

ISSUE 362 4 December 2014

LAUNCH 10

TENOR CAPITAL PLANS TO LAUNCH ARBITRATION FUND

New York fi rm targeting $150m raise and H1 2015 fi rst close

LEGAL 05

DECURA CLAIMING $167M AS UBS COURT BATTLE BEGINS

UBS is accused of reneging on 2012 marketing deal

PEOPLE MOVES 08

SKYBRIDGE CAPITAL’S EUROPEAN CEO TO LEAVE

Max von Bismarck will depart at the end of the year

UCITS

ANALYS IS 16

HFMWeek’s 23rd biannual assets

under administration survey –

Part 1: Single managers

ASSETS UNDER ADMINISTRATION

001_003_HFM362_News.indd 1

02/12/2014 15:00

www.hfmweek .com

MAJOR BANKS ARE drop-

ping administration services for

smaller hedge fund managers,

HFMWeek has learned.

HSBC, BNY Mellon and

Citi have undertaken business

reviews of hedge fund clients

and shifted strategy, leading to

several managers with less than

$500m in AuM being dropped.

BNY Mellon is handing out

notice periods as short as 90

days to existing clients to find

new administrators. It is under-

stood HSBC has also shed a

number of clients and is turning

away business below a certain

level. HFMWeek has been told

Citi is undertaking a similar

review of business and shed-

ding clients.

A COO of a $170m manag-

er, who was dropped by BNY

Mellon with 90 days’ notice,

said it was “annoying” to be

dropped so abruptly.

He said: “We didn’t see this

coming when we signed the

contract. It’s clear that some of

the bigger names have decided

to turn their back on the smaller

manager sector. There are still

plenty of people who will still

talk to you and give you some

sensible proposals. Some of the

smaller administrators can give

good service but without the

bank name.”

BNY Mellon insisted it was

still committed to

hedge funds, pointing

BNY Mellon, HSBC and Citi

becoming more selective

BY SAM DALE

03

COMMENT W I L L A SSE T S EGREGAT ION BENEF I T I N VESTORS? 14

Major bank

admins cutting off

smaller managers

ASSETS UNDER

ADMINISTRATION

SURVEYHFMWEEK’S 23RD BIANNUAL

AUA SURVEY – PART 2: FUNDS

OF HEDGE FUNDS ANALYSIS 16

The long and the short of it

ISSUE 363 11 December 2014

CLOSURE 11

PRAXIENT CAPITAL CLOSING PANTHER EVENT-DRIVEN FUND

European equity and credit vehicle to shut after redemptions

PRIME BROKERAGE 05

POTENTIAL PB ENTRANTS LOOK FOR WHITE-LABEL SOLUTIONS

Experts predict “creative solutions” will develop

REGULATION 07

EU RETHINKS BAN ON BANKS FROM BACKING HEDGE FUNDS

Lord Hill warns over lack of agreement in private letter

ANALYS IS 19HFMWeek looks back at the highs

and lows of the past 12 months

2014REVIEW OFTHE YEAR

09/12/2014

www.hfmweek .com

F O R M E R C H E Y N E CAPITAL partner Simon

Davies has hired ex-Eclecti-ca COO Paul Bramley as his

event-driven firm Sand Grove Capital Management received

its FCA permissions this week, HFMWeek has learned.

Former Cheyne Capital colleague Anooj Unarket has

also joined the start-up with Thomas Roberts, previously

head of sales and market-ing at systematic firm Octave

Investment Management, leading investor relations.

Davies left his position as head of European event-driv-

en trading at $6bn Cheyne Capital in September. Unarket,

who was a partner at Cheyne, left in July shortly after news of

Davies’ plans broke. Two other members of Cheyne’s event-driven team,

Michel Massoud and Joseph Gebran, left last year, although

it is not known whether they will be involved with Sand

Grove.Bramley left Hugh Hendry’s

Eclectica Asset Management last May as part of a cost-cut-

ting drive sparked by a sus-tained period of investment

losses and redemptions.Bramley was the most sen-

ior of several departures at the London firm, which was

founded in 2005 when Hendry left

Paul Bramley joins former Cheyne partner’s new launch

BY JASMIN LEITNER

03

COMMENT 20 1 5 P RED I C T I ONS

14

Ex-Eclectica COO hired as Sand Grove gets FCA go-ahead

WHO IS SET TO CAPITALISE ON BANK ADMIN PULL-BACK?HFMWEEK FINDS OUT WHICH FIRMS WON’T BE DITCHING LOWER VALUE ADMIN CLIENTSANALYSIS 16

The long and the short of it

ISSUE 364 15 January 2015

LEGAL 07

NAYA AND CO-FOUNDER REACH LEGAL SETTLEMENT

Bruce Emery claimed he was owed a third of the business

REGULATION 03

LACK OF EU INVESTMENT PROMPTS DEREGISTRATIONS

Exiting AIFMs aim to do so before Annex IV deadline kicks in

AIFMD 05

UK ANNEX IV PLATFORM STILL NOT ACCEPTING NON-UK AIFMS

FCA says fixing Gabriel problem is a top priority

ANALYS IS 18

HFMWeek assesses what 2015 may

have in store for the hedge fund sector

PREVIEW

001_003_HFM364_News.indd 1

F U N D F O R M AT I O N & A D M I N I S T R AT I O N

H F M W E E K . CO M 15

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

In the competitive world of fi nance the hedge fund industry is seen as the most gruelling and com-petitive business.

Alternative asset management is a perfor-mance-driven industry and having a competitive edge is critical for both portfolio management and

operational management success. Managers need every advantage in order to achieve true organisational and fi -nancial success.

PORTFOLIO MANAGEMENT Analysing a globally connected macro-economy, evalu-ating micro-economic environments, geo-political con-cerns, business cycles, industry trends, company analyses for position decisions, as well as tech-nical analysis for trading those positions; these are all basic re-quirements in the portfolio man-agement decision chain fuelling the ability to consistently outper-form the overall markets and pro-vide alpha to fund investors.

For those investment manage-ment teams that are fortunate enough to generate solid invest-ment performance, the above dissertation does not factor in all of the other critical aspects of running the ‘business of the busi-ness’; which are just as important for the organisation to achieve true success and att ract institu-tional capital.

FUND FORMATION & OPERATIONAL MANAGEMENT During the start-up phase, the management team has the task of evaluating and selecting key service providers for fund formation, regulatory and compliance, legal coun-sel, prime brokerage, fund administration, audit and tax services.

In order to garner signifi cant capital, the manager must build an institutional quality infrastructure inclusive of trading and order management systems, middle offi ce

and back offi ce staff and technology. Th e fund manager also needs to develop a national or global marketing plan, create a corporate branding and marketing package, and build an investor relations and marketing team in order to bring awareness to the fund and att ract additional assets.

YOUR COMPETITIVE HEDGESM IN FUND FORMATION & OP-ERATIONAL MANAGEMENTIn order to assist alternative fund managers in achieving operational success, Stonegate Global’s comprehensive solution streamlines the formation process for the man-agement team and also supports the ongoing operations of the fund. Its Innovative Alternative Fund SolutionsSM

consists of fund formation, regu-latory and compliance services, fund administration, and an array of prime brokerage/cus-tody options including many of the world’s largest custodians, as well as audit and tax services through a number of its strategic relationships.

Stonegate Global takes a stra-tegic business advisory role by creating innovative fund struc-tures that consider each client’s current and projected needs. Our clients have an end in mind and the Stonegate team creates a road map to achieve these objectives. Th e Innovative Alternative Fund SolutionsSM concept is based on an old Chinese proverb – ‘to know the road ahead, ask those coming back’. Stonegate helps its

clients understand what’s around the next corner by lever-aging the fi rm’s extensive experience in global, multi-asset class fund formation, fund administration, prime broker-age, capital raising, global fund marketing and distribu-tion. Stonegate evaluates all aspects of each client’s project to select the most appropriate jurisdiction, customise vari-ous structural elements, implement multi-jurisdictional tax mitigation strategies, develop global marketing cam-paigns, and provide other critical value-added services to

STONEGATE GLOBAL TAKES A STRATEGIC BUSINESS

ADVISORY ROLE BY CREATING INNOVATIVE FUND STRUCTURES THAT CONSIDER EACH CLIENT’S CURRENT AND

PROJECTED NEEDS

”

JOHN MCCORVEY III AND WILLIAM CHONG OF BLUEFLAME GLOBAL WEALTH MANAGEMENT AND MICHAEL BLACKBURN OF STONEGATE GLOBAL FUND SERVICES DISCUSS THE MOST SUCCESSFUL APPROACH TO FUND FORMATION AND

GLOBAL MARKETING TO SOPHISTICATED INSTITUTIONAL INVESTORS

THE COMPETITIVE HEDGESM IN CREATING A SUCCESSFUL

HEDGE FUND

John McCorvey III is the CEO of BlueFlame Global Wealth Management and Stonegate Global Fund Services. McCorvey is a successful investor and entrepreneur involved in venture capital, private equity and hedge funds. McCorvey has created and run numerous successful businesses in the financial services industry, including wealth management, electronic trading, prime brokerage and fund administration.

F U N D F O R M AT I O N & A D M I N I S T R AT I O N

1 6 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

assist its clients in creating and running successful alterna-tive investment fund businesses.

Our expertise in domestic and off shore fund forma-tion ranges from hedge funds, commodity pools, venture capital funds, private equity, real estate funds, REIT funds, ABL funds, oil and gas funds and fund of funds.

CAPITAL FLOW TRENDS & OPERATIONAL REQUIREMENTS OF INSTITUTIONAL INVESTORSTrends in the institutional investor arena have changed dramatically over the past few years, and even more so in the past 12 months. Institutional investors account for over 60% of all hedge fund investments. Given the global fi nancial crisis of 2008, the Madoff scandal, and other recent events, institutional investors have become much more risk conscious and require signifi cant transparency in terms of portfolio risk. Considering that over half of as-set manager failures are associated with operational risks, it’s not surprising that institutional investors are highly concerned and focused on operational infrastructure, or-ganisational strength, governance and independent verifi -cation, as well as investment performance.

Although the alternative investments industry as a whole continues to grow, and is anticipated to continue on its unparalleled track of asset growth, there are numer-ous concerns. In 2014, Calpers, one of the largest pension funds in the US, along with pension funds in New Jersey, Ohio, and other well-known pension funds, announced signifi cant reductions in hedge fund allocations. Th is is a very strong signal that a substantial paradigm shift in the industry is underway. Large institutional investors fol-lowed Calpers in the late 1990s and early 2000s by invest-ing in hedge funds, and it appears that the institutional community has taken notice.

Although it is unlikely that institutional investors would completely move away from the hedge fund asset class, this new industry shift will certainly lead to institutional investors and sophisticated family offi ces demanding per-formance and economic alignment from hedge fund man-agers. Th is is already being demonstrated by a demand for lower management fees, an increase in the use of hurdle rates, risk transparency, and through other aspects of the relationship with alternative investment fund managers.

Institutional investors consider expertise and risk trans-parency just as important as investment performance. Th ey are seeking institutional quality infrastructure, operational strength as regulations continue to evolve, sophisticated reporting and stronger governance frameworks, including independent verifi cation of controls and procedures.

Institutional hedge fund investors are now pushing for managers to follow best practices of their private equity peers, based on the ‘industry best practices’ which was is-sued by institutional investors of private equity funds in 2009.

INDUSTRY REGULATORY CHANGESIn addition to the aforementioned infrastructure mandates from institutional investors and the costs thereof, portfolio managers must also consider regulatory elements.

Th ey must manage and budget for AIFMD requirements for AIF managers in the EU, Dodd-Frank regulations and RIA/IA requirements and other recent regulatory changes

in the US due to the new JOBS Act, Ucits IV requirements for cross-border marketing, upcoming Ucits V regulations which were approved in 2014, and Basel II and III banking initiatives which impact custody and prime brokerage.

Moreover, the Solvency II EU directive’s impact on the hedge fund market, IFRS/GAP accounting standards, GIPS compliant reporting requirements, new CAQ AI-CPA guidelines released in late 2014, SEC independence rules, Fatca tax reporting requirements, and other global regulatory and operational issues must be considered by portfolio managers.

ATTRACTING INSTITUTIONAL CAPITAL In the wake of the shift ing and evolving demands from institutional investors, as well as an ever-changing regula-tory landscape, successful portfolio management teams must budget signifi cant capital to fund their operational infrastructure to meet the aforementioned requirements. Th ese additional costs could range from a few hundred thousand dollars per year to well over $1m per year, all depending on the investment strategy, investor mandates, and the goals and objectives of the portfolio manager.

BlueFlame Global Wealth Management off ers select portfolio managers a ‘plug and play’ solution into its exist-ing institutional multi-strategy fund infrastructure.

BlueFlame maintains all of the necessary operational staff and infrastructure, along with handling all aspects of fund compliance and operations, investor relations, global and cross-border marketing and distribution. It provides seasoned and credentialed portfolio management teams with the independence and autonomy as a portfolio man-ager of a completely separate fund product, while simulta-neously operating as a part of a much larger institutional organisation. Current hedge fund managers can also mi-grate existing fund products onto the BlueFlame platform.

CONCLUSIONHedge funds and other alternative investment funds con-tinue to be the most engaging and exciting investment vehi-cles for savvy institutional investors and family offi ces. Given the vast array of investment strategies, a myriad of structural options, as well as various tax advantages, alternative invest-ment funds should continue to att ract signifi cant amounts of capital for the foreseeable future. Having the appropriate infrastructure off ers successful portfolio management teams the best opportunity to continuously att ract assets from so-phisticated global institutional investors and family offi ces.

HEDGE FUNDS AND OTHER ALTERNATIVE INVESTMENT

FUNDS CONTINUE TO BE THE MOST ENGAGING AND EXCITING

INVESTMENT VEHICLES

”

Michael Blackburn, associate counsel of Stonegate Global Fund Services, assists clients with domestic and offshore fund structuring, as well as regulatory and compliance matters. Blackburn has industry experience in wealth management, trust formation and estate planning for high-net-worth and ultra-high-net-worth clients. He also brings experience from both Merrill Lynch and Empire Wealth Strategies.

William Chong is the chief operating officer of BlueFlame Global Wealth Management and also serves as the SVP head of alternative fund services at Stonegate Global. Chong has more than 15 years of experience in the financial services industry, having served as head of fund administration at HSBC, also as the chief financial officer for an $800m hedge fund, and as an audit manager at Ernst & Young.

You have enough to think about when launching a new fund. Don’t add technology to the mix. Let us handle it.

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1 8 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

Ihave to admit something, it is probably not every litt le boy’s (or girl’s) dream at seven or eight years old to one day start a hedge fund. I wanted to play second base for the New York Yankees, just like my favourite player, Bobby Richardson. Now that I have dated myself properly, once dreams of success on a

major league baseball fi eld faded, a more att ainable path towards fame and/or fortune has become, for many peo-ple, starting a hedge fund. While it was decidedly less com-plicated and easier to raise capital in the 1980s and 1990s, it is still possible to start a hedge fund in the 21st century if the fund is launched aft er a great deal of thought, careful planning and advice obtained from quali-fi ed third-party experts.

FIRST STEPSTh e fi rst step to launching a fund simply is the decision to go for-ward. It seems like every trader or research analyst who has worked for a hedge fund, whether the fund was successful or not, be-lieves they have what it takes to run a hedge fund. Th is idea has its roots in the 1990s when the stock market generally made a genius out of everyone. Today it’s not so simple. Markets have become more challenging, regulation, thanks to 2008, has run amuck, and providers of capital have become much more discriminating when it comes to investing in a hedge fund. Th ese days, a fund needs a successful track record of three to fi ve years before any institutional investor would even consider making an investment. Unless you are willing and fi nancially able to build out the appropriate infrastructure and spend the inordinate amount of time necessary to cre-ate a successful fund, you are bett er off fi nding another path.

Let’s assume you have thought it all out thoroughly and want to go forward with starting your fund. Th e fi rst step has to be the development of a business plan. No business, whatever the industry, has much of a chance for success without a well-thought-out plan. You may want to att empt to att ract a ‘seed investor’ If your plan is strong and de-tailed enough, and if you have a verifi able track record at another fi rm, you might be able to fi nd someone to make

an investment in the fund in exchange for a part-interest in the general partner. In eff ect, you sell a portion of your future profi t potential in exchange for fi nancial stability and staying power. While some people might be loath to forgo a portion of future profi ts, do not underestimate the importance of staying power. Th ere has always been a ‘survivor bias’ in the hedge fund industry. Th is can be a fi nancially rewarding business but only for the funds that survive. Having a stable capital base that believes in your plan will go a long way to seeing your fund through periods of instability in fi nancial markets.

Issues to be included in your business plan are fund structure; will you manage a domestic fund only? Is there a demand for an off shore fund? If so will it be a master-feeder structure or side-by-side? Will you take separately managed accounts? You will have to decide on a structure and dom-icile for general partner and or the investment manager. Do you want to put a cap on total AUM? How many employees will you launch with? Include a fl ow-chart which details your fi rm employee structure and the investment pro-cess. An example of the new and exciting regulatory requirements

is Fatca, which pertains to the reporting requirements relating to possible US investors in off shore funds. Th e penalties for failing to comply can be severe so if your plan includes an off shore fund, you must consider how you will be Fatca compliant.

LEGALLY BOLDTh e next step in forming your fund should be the creation of fund documents. While it can be fairly expensive to hire an experienced law fi rm to write the documents, we can-not emphasise enough the importance of gett ing the legal structure right the fi rst time. Th e typical domestic hedge fund is formed as a US limited partnership or limited li-ability company. Th e general partner is typically a limited liability company with one or more members. Most do-mestic funds are organised in Delaware with the general partner organised in the founder’s state of domicile. If an off shore fund is contemplated, it will usually be organised

IN EFFECT, YOU SELL A PORTION OF YOUR FUTURE

PROFIT POTENTIAL IN EXCHANGE FOR FINANCIAL

STABILITY AND STAYING POWER

”

GREGORY ZORAIAN OF S&Z FUND SERVICES DISCUSSES THE STEPS NEEDED TO SUCCESSFULLY LAUNCH A HEDGE FUND

HOW TO START A FUND

Gregory Zoraian, is the director of S&Z Fund Services, as well as a partner in Sasserath & Zoraian, the related CPA firm. He has been responsible for the growth of the fund administration business from its inception in 2005 until today.

F U N D S E R V I C E S

H F M W E E K . CO M 19

in the Cayman Islands, Bermuda or the British Virgin Islands. Each jurisdiction has its own legal rules and requirements so you will have to hire a local attorney to write those documents. The off-shore fund is commonly formed as a corporation due to tax issues which can develop if securities are bought on margin. Some of the important issues to decide on are: fee structure; will there be a fixed and performance fee? Will there be a hurdle rate? With respect to invested capital. What are the sub-scription and withdrawal dates is there a lock-up or a ‘gate’ structure? Fortunately, the cost associated with creating the fund documents is typically a ‘fund’ expense and is generally amortised over five years. Therefore the effect on the fund’s perfor-mance is spread out over this period when hopeful-ly, capital is growing. Hiring a fund administrator is usually done just before launch, but if you find one with sufficient experience, it’s possible to get some helpful advice when trying to make sense of all these issues with the hope of keeping the legal costs down.

BEING DILIGENTAfter the completion of fund documents it’s important to turn to investor due diligence concerns. Some of the things to consider: the manager’s non-investment operations, will work be done in-house or outsourced? The compli-ance function, in-house or outsourced? Have you devel-oped and fine-tuned your risk management techniques, position sizes, sector limits etc. The best way to deal with these issues is to have a standard due diligence question-naire to distribute to potential investors.

So now you have articulated a clear business plan, you have fund documents, service providers, a prime broker, all you need is capital. Unless you have been fortunate enough to locate a seed investor, the only effective way to get the fund off the ground and start to develop a track

record is by attracting capital from friends and family. Many potential clients come to us with pro-forma track records based upon two years of ‘back-testing’. These results make for very pretty presentations but will in most cases, re-sult in only ‘pro-forma’ capital contributions. The only way to attract investors who are not friends and family is by establishing a verifiable record which includes the managers own capi-tal. While certainly not a requirement, most in-vestors want to see the portfolio manager with ‘skin’ in the game.

GOING ON UPYou should also try and enlist your prime bro-ker in the capital raising effort. Most larger, well-established firms have capital introduc-tion teams whose job it is to match investors looking for opportunities with hungry, emerg-

ing hedge fund managers. Many emerging managers tend to focus on finding a prime broker that offers the lowest commission charge, but few frills while you are in a capital raising mode, it may be beneficial to use a broker who can also help grow your fund. While the hedge fund industry is currently dominated by a few dozen firms who control the bulk of the AUM, in contradiction to that fact is the belief among many investors that smaller, more nimble hedge funds are capable of higher returns than their more established brethren. In the words of the immortal Gor-don Gekko, “greed is good”. That goes for investors as well who would like nothing more than to brag to their friends and colleagues at the next cocktail party that they ‘discov-ered’ the next Tiger Capital or Lone Pine. The only way to give yourself a chance at that is to start your fund the right way and then concentrate on performance while you allow others to manage the non-investment parts of the business.

START YOUR FUND THE RIGHT WAY AND THEN

CONCENTRATE ON PERFORMANCE WHILE YOU ALLOW OTHERS TO MANAGE

THE NON-INVESTMENT PARTS OF THE BUSINESS

”

C Y B E R R I S K

H F M W E E K . CO M 21

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

Regardless of size, all funds must keep cy-ber security in mind. I make this asser-tion for a few reasons: first, the threat is greater than ever. Criminals, from the most technically inept (consider Nigerian email scammers), through to more techni-

cally capable ‘smash-and-grab’ att ackers (simply looking for bank and trading account information to aff ect wire transfers), to the organised criminal element (with real technical chops) are actively looking for victims. Th ey understand that while larger targets may be more att rac-tive, they likely have bett er protection, which by default increases the appeal of smaller targets.

Secondly, cyber security is of high priority to regula-tors (think the SEC, the Financial Stability Oversight Council, the Federal Trade Commission and various States’ Att orneys General). Considerable focus is being placed on registered investment advisors (RIAs) as a matt er of stability to the fi nancial system at large – es-pecially when it comes to matt ers of public confi dence. Released in April 2014, the SEC’s Cyber Security Risk Alert (AKA Th e 28 Questions), is part of an eff ort to raise the visibility of cyber security threats.

Lastly, investors’ due diligence teams are spending more time inquiring into the preparedness of funds’ cy-ber security defenses. In previous years they may have merely asked about the existence of a fi rewall and/or anti-virus soft ware, however, today many due diligence teams have taken a cue from the SEC’s questionnaire and incorporated some of their questions into their own analy-sis. If the intent of the fi rm is to att ract further investments and grow, it is critical that cyber se-curity responses are both well defi ned and accurate.

Th ere is no silver bullet that will guarantee protection for your fi rm. Given a long enough timeline, it’s virtually guaranteed that, large or small, all fi rms will experience some form of att ack. Practically eve-ry organisation has sensitive data to protect but the key to defending it is to understand where your data resides and

identify exactly what you need to do to protect it. It’s not expected that small RIA’s require the same

amount of cyber security infrastructure and process as their larger counterparts. But it is critical that several specifi c considerations be implemented as an ‘appropri-ate and pragmatic response’ to improve your fi rm’s cyber security posture and protect against the imminent cyber-att ack. Th e considerations are as follows:

RECOGNISE HOW THE MOST COMMON SUCCESSFUL AT-TACKS ARE INITIATEDInoculate and foster a healthy skepticism in users so they don’t just click everything they see. Never assume emails are legitimate (consider blocking certain email at-tachments) and if something ‘feels wrong’, go with your gut—report the incident to your IT team. By default, don’t trust inbound phone calls (they oft en involve some form of social engineering, like phishing).

Spear-phishing is among a sub-set of phishing cam-paigns gaining momentum. Th ese att acks are far more surgical and are generally less obvious than brute force credential att acks (where an external att acker makes thousands of password guesses to try and log in). Social engineering or readily available intelligence gained from the internet may grant cyber criminals with the basic, preliminary information necessary to launch a spear-phishing campaign.

Once the att acker is able to identify valid executive-level personnel, they go to work, craft ing elaborate email

campaigns targeting employ-ees. Th e objective is always the same – gain access to either the credentials or the local net-work. Th ey may convince the recipient to enter their creden-tials by requesting identity ver-ifi cation, which silently installs malware. In a business sett ing, employees sift ing through hundreds of emails daily could see such a message as innocu-ous, and click a link or submit credentials without a second thought, especially given its seemingly reputable sender and perfectly branded message.

In the vast majority of suc-

GIVEN A LONG ENOUGH TIMELINE, IT’S VIRTUALLY

GUARANTEED THAT, LARGE OR SMALL, ALL FIRMS WILL

EXPERIENCE SOME FORM OF ATTACK

”

ELDON SPRICKERHOFF, FOUNDER AND CHIEF SECURITY STRATEGIST OF ESENTIRE, TALKS TO HFMWEEK ABOUT THE CYBER SECURITY NEEDS OF EMERGING FUNDS

CYBER SECURITY CONSIDERATIONS FOR EARLY-STAGE FUNDS

Eldon Sprickerhoff co-founded eSentire, Inc. in 2001, a managed security services provider specialising in the alternative asset management fund space. Today, eSentire manages security operations for over 450 companies, including nearly one-quarter of the world’s hedge funds, representing nearly over $2trn in managed assets. At eSentire, Sprickerhoff leads the security research team as well as the customer-facing team that conducts vulnerability assessments.

C Y B E R R I S K

2 2 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 5

cessful breaches this year, employees have unknowingly become the weakest link. Regardless of cyber security defenses in place, employees regularly fall victim to spear-phishing campaigns or click a mali-cious link. In addition to robust cyber se-curity policies, staff training and education is critical. Be sure to communicate cyber security risks and the nuances of phishing to employees at any level across the or-ganisation. Regular ‘self-inflicted’ phishing tests may also gauge employees’ resilience to phishing attacks and can help to deter-mine the efficacy of the training.

CREATE AN ACCEPTABLE USE POLICY (AUP) AS PART OF A LARGER SECURITY POLICY. Create an AUP and train your staff and verify that everyone in your organisation follows the AUP (as part of a broader secu-rity policy implementation). Try to address broad categories of security concerns, including software installed on end-user systems, the use of cloud providers (e.g. Gmail, Dropbox, Evernote), and personal information shared on social media sites (e.g. LinkedIn, Facebook). eSentire has created a baseline information security policy framework specifically tailored for RIA’s, available free of charge under a creative commons license and may be found at: http://info.esentire.com/esentire-startingpoint-security-policy-0

ENFORCE A RIGOROUS PASSWORD POLICY. Change passwords regularly, do not share passwords across accounts (especially on public services) or net-work devices, avoid dictionary terms and never use de-fault passwords. When possible, use two-factor authenti-cation if available (especially for remote access).

MINIMISE USERS WITH ADMINISTRATIVE PRIVILEGES. Minimise users with administrative privileges (both lo-cal or domain). Always segregate ‘secret sauce’ (i.e. ‘data

that is either critical or confidential’) sys-tems and ensure they are better protected. Promptly disable users’ access when they leave employment.

Ensure that all patching is kept up-to-date and done so in a timely manner.

Most importantly, this includes Micro-soft Windows and Office, Adobe software, and all browsers. Ensure that all security infrastructure (e.g. firewalls, Anti-Virus, etc.) is configured properly and regularly receiving updates. Don’t forget about physical security (restricted access areas, locked doors, and encryption on portable devices). Log system accesses and main-tain regular review to look for anomalies. Keep a detailed log history and security event monitoring, but pay particular atten-tion to authentication failures, especially ones associated with high-profile users.

PERFORM REGULAR VULNERABILITY ASSESSMENTS AGAINST INFRASTRUCTURE Regular vulnerability scanning (as part of a broader risk assessment) can ensure that vulnerabilities are reviewed and addressed in a timely manner. At least once a year, infrastructure should be analysed to ensure a strong defense.

I liken this to annual x-rays performed at the dentist – while you might brush your teeth a few times a day, floss often, and have regular check-ups, an annual x-ray to ‘look deeper’ into possible weak points and allow ad-vanced detection and early response to problems is also necessary.

IMPLEMENT CONTINUOUS MONITORING Implement a continuous monitoring methodology to watch for and defend against breaches, enforce the ac-ceptable use policy, and maintain a strong environment.

In 2014 leading analyst firm Gartner Research identi-fied a new cyber security solutions model called Contin-uous Advanced Threat Protection. The approach outlines a five-part defense model and architecture that empha-sises the paradigm shift in security we’re witnessing to-day. Continuous Advanced Threat Protection positions monitoring and analytics as the core of all next-genera-tion security platforms.

As firms grow, they must shift their focus from purely relying on security infrastructure to that of an ongoing, embedded incident response function, of which continu-ous monitoring is a key component.

No matter the size of your firm, you are still a target. In one way or another, every firm has some valuable data that is of interest to a criminal element. When starting a fund, you may not have the resources readily available to implement elaborate defenses.

However, by employing the tips mentioned here, you’re already well on your way to mitigating cyber risk and enabling future growth.

REGULAR VULNERABILITY SCANNING (AS PART OF A BROADER

RISK ASSESSMENT) CAN ENSURE THAT VULNERABILITIES ARE

REVIEWED AND ADDRESSED IN A TIMELY MANNER

”

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