SADIS & GOLDBERG LLC

Ron S. Geffner, Esq.

463 Seventh Avenue, Suite 1601

New York, New York 10018

Telephone (212) 947-3793

Facsimile (212) 947-3796

March 2000

I. Structure

A. The Investment Manager determines the rules governing the fund.



B. Two primary concerns:



1. Utilizing a structure most appealing to investors - the structure should be familiar to investors and the manager should not try to create a new approach; and



2. The Structure must comply with all applicable laws and regulations (e.g. Federal and State securities laws, Tax Code, ERISA).



C. Traditional Structure


The Fund



1. The fund is typically structured as a limited partnership. There is no tax at partnership level - limited partners (investors) are taxed directly on the partnership's profit and loss.



2. Ordinarily limited partners have no liability for any partnership loss other than their capital account in the partnership - capital account includes initial investment, any subsequent investment and any gains.



3. The investment manager serves as the general partner of the partnership and thus, is the only entity or person with discretion to manage the partnership's assets.



4. Performance allocations to the general partner are taxed to the investment manager and not included in income of limited partners.



5. To attract initial investors, the investment manager may offer an equity interest in the general partner to a key investor, or provide reduction of its performance allocation or management fee - reductions in revenue to the general partner should be of limited duration (5-10 years).



The Investment Manager



1. The investment manager typically is organized as a limited liability company or an S corporation, dependent on a state's tax laws and the number of persons owning equity in the investment manager.



2. The investment manager, dependent on the laws of the state in which it will maintain its office, as well as its intention on managing investors' assets outside the fund, may be required to register as an investment adviser, either with a state regulatory body or the U.S. Securities & Exchange Commission (SEC).

1. Interests in the partnership are securities and ordinarily require registration with the SEC unless exempt. The primary exemption from registration which these partnerships usually rely on is referred to as the "private placement" exemption, Rule 506 under Regulation D.



2. Regulation D prohibits the sale of securities through the means of a "general solicitation" or the use of "advertising". The general partner is prohibited from selling interests in the partnership through:




• Any advertisement, article, notice or other communication published in any newspaper, magazine or similar media or broadcast over television or radio; and
  

  
  

• Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
  


3. Many funds are limited to accredited investors only.



4. The Securities Act does not limit on number of accredited investors who may invest in the partnership. Pursuant to the Investment Company Act, however, there are limitations on the number of persons who may invest in the partnership. See section entitled "Investment Company Act".



5. Disclosure document can be somewhat less extensive, although almost never recommended;



6. Generally, states require notice filings pursuant to the"blue sky" laws; and



7. If any non-accredited investors are allowed to invest in the partnership:




• Not more than 35 non-accredited investors may invest;
  

  
  

• The disclosure provided must be equivalent to the information contained in a registration statement; and
  

  
  

• All investors should have knowledge and experience in business and investments sufficient to be able to evaluate merits and risks of investing in fund.
  

1. An investment manager must register with the SEC as "investment adviser", unless exempt. Although there are several exemptions from the registration requirement available, the most frequently used exemption is for a "private investment adviser". The conditions applicable to this exemption are:



• Fewer than 15 "clients" over any consecutive 12 month period. The Partnership is deemed to be one "client"; and
  

  
  

• The adviser does not "hold itself out" to the public as an investment adviser. Articles that feature a manager and hedge fund directories that include a manager may cause the manager to lose this exemption.
  


2. SEC registration as investment adviser is required to manage certain ERISA plan assets.



3. An investment adviser registered with the SEC may not charge a performance fee unless the advisory client has $750,000 under management with the adviser or a net worth equal to or in excess of $1,500,000.

1. Ordinarily a fund would have to register as a mutual fund with the SEC unless it
is exempt from registration. The two exemptions available are Rule 3(c)(1) and Rule 3(c)(7). The exemption available under Rule 3(c)(1) is most commonly used and requires that a fund have no more than 100 beneficial owners and does not make any public offering under the Securities Act of 1933 Act.



2. For purposes of counting investors in connection with the 100 "person" limitation imposed by Section 3(c)(1), normally, each person is counted separately. The Investment Company Act defines "person" to mean a "natural person or a company." Pursuant to the "look-through" provisions of Section 3(c)(1), however, the SEC staff will look-through a company that invests in a fund and count each of the security holders of that company as a separate investor of the fund, if:




• The investor is either a registered investment company or a private investment company organized pursuant to an exemption from the Company Act pursuant to either Section 3(c)(1) or Section 3(c)(7); and
  

  
  

• The investment company beneficially owns 10% or more of the outstanding voting securities of the fund.
  



3. In addition to looking through an investment company in certain circumstances, the SEC staff has also looked through other investment groups or entities. For example, certain employee benefit plans will be looked through if they provide their individual investors investment discretion.

1. An investment manager has to register as a commodity pool operator if the
fund trades any commodity options or futures.



2. In addition to the registration requirement, additional disclosure in an
offering circular (confidential private placement memorandum) must be approved by the National Futures Association.



3. If aggregate initial margin and option premiums in the fund never exceed 10%,
or investments in the fund are limited to Qualified Eligible Participants, streamlined disclosure may be made.

If 25% or more of the Partnership's assets are ERISA plan assets at any time that an ERISA plan invests, several ERISA rules are applicable:



• Additional fiduciary duties;
  
  
• Co-fiduciary liability;
  
  
• Prohibited transactions;
  
  
• SEC registration;
  
  
• Limitations on performance fees; and
  
  
• Bonding.
  


Unrelated business taxable income may result from margin trading under the tax code.

1. Many states require the investment manager to register as an
"investment adviser" with the state regulatory body - The mechanisms triggering the registration requirement are different from the SEC and each state has different rules; and



2. Provide exemptions similar to Regulation D, but laws of each state
where prospective investors are located must be reviewed and complied with.

1. Confidential Private Placement Memorandum - Primarily serves to protect the investment manager



2. Limited Partnership Agreement - Governs the legal relationship between the investment manager and investors



A. Minimum Capital Contributions.

B. Withdrawals (When Permitted and Conditions)

C. Performance allocation:


a. How much;

b. When charged;

c. How calculated;

d. High water mark; and

e. Hurdle rate.



D. Fixed fee:


a. How much;

b. When charged (monthly/quarterly); and

c. In advance or in arrears.


E. Retirement, disability or death of Investment Manager

F. Expenses (Investment Manager/Partnership)

G. Hot issue carve-out.

H. Custody of assets.

I. Termination.






3. Subscription agreement and offering questionnaire.

I. Benefits of setting up an offshore Fund?

1. Taxation:


a. Generally no U.S. tax for foreign investors on capital gains from sale of securities or commodities (sale of stock of certain U.S. real property corporations generates taxable income);



b. The fund may be subject to U.S. tax on U.S. source dividend income and certain types of interest income;



c. Foreign investors who do not reside in the U.S. are not subject to U.S. estate tax on ownership interest in fund; and



d. U.S. tax exempt entities may want to invest in offshore corporations to avoid UBTI on margin debt.



2. Investors' identities not reported to the IRS, SEC or other U.S. government agencies.



3. Foreign investors are familiar with the concept.

1. The costs of organizing and operating an offshore fund are significantly greater than operating a domestic partnership.

1. The offshore fund counts as a "client" to a U.S. investment manager in connection with the analysis of fewer than 15 "clients" for private investment adviser exemption.



2. Offshore investors do not count towards the 100 person limitation pursuant to the 3(c)(1) exception.



3. If you allow U.S. taxable investors into an offshore fund, they will be integrated with the domestic partnership - If only U.S. tax-exempt investors are permitted in the offshore fund, the investors in the offshore fund are not integrated with the investors in the domestic partnership.

1. Corporation is the most familiar structure to foreign investors. Foreign investors purchase shares of the corporation at their net asset value (NAV). The investment manager enters into an investment management agreement with the corporation, which is organized and administered offshore. Typically, under the investment management agreement, the U.S. investment manager periodically bills the offshore fund for all performance fees and the U.S. investment manager is subject to U.S. tax on such payment. The U.S. investment manager, however, may enter into a deferral fee arrangement with the offshore fund before the beginning of any year in which fees accrue, in which case the U.S. investment manager may not be taxed on those performance fees until they are actually paid, but such fees must remain in the offshore fund and be subject to claims of creditors of such fund.



2. Accounting issues created by the corporate structure if there is a performance fee.




• If an investor invests in an offshore fund at the current NAV when that fund has sustained earlier losses that have created a so-called "high water mark," the investor may enjoy a windfall because it will enjoy appreciation in the fund without having to pay any performance fee until the prior losses related to the high water mark have been recouped.
  

  
  

• If an investor invests during a year at the then current NAV when the fund is up for that year, the investor may be burdened with a portion of the performance fee that is charged at the end of the year with respect to the appreciation that occurred before its funds were invested.
  

  
  

• These issues are typically addressed in one of two ways, creating a rather complicated equalization factor/depreciation deposit mechanism to adjust for these inequities, or creating a new class of shares with its own NAV for each investor in the offshore fund. In both of these cases, one is imposing partnership accounting methods on the corporate structure.
  


3. Jurisdiction to organize the offshore fund.



• The least expensive jurisdictions to organize an offshore fund are Cayman Islands, British Virgin Islands, Netherlands Antilles and Bermuda.
  

  
  

• The more expensive jurisdictions to organize an offshore fund are Ireland and Luxembourg; although they are more costly they provide better access to the retail market and to some institutional investors.
  


4. When selecting a jurisdiction, managers should focus on whether the target group of prospective investors will be familiar and comfortable with the jurisdiction, the tax and regulatory burdens/conveniences of the jurisdiction, the depth of professional service firms (administrators, accountants and attorneys) available in that jurisdiction and its political stability.



5. Participants in the process:




• Administrator: Handles investor lists, accepts subscriptions, responsible for disseminating all material mailings to current and prospective investors, processes redemptions, pays all bills, organizes all corporate housekeeping requirements. In addition, the U.S. investment manager can calculate daily/monthly NAV internally or the administrator can do it for an additional fee.
  

  
  

• Accountant: Audits the offshore fund's quarterly or year end computations.
  

  
  

• Offshore Counsel: Reviews all offering materials prepared by U.S. counsel and prepares and files all organizational documents for the offshore fund.
  

  
  

• U.S. Counsel: Prepares all offering materials. Coordinates the project with each of the participants.
  

1. Regulation S.



• Foreign Issuer: Less than 50% of stock held by U.S. residents and it reasonably believes there is no U.S. market interest in the securities offered (met if no significant trading activity in securities occurs on U.S. exchanges).
  

  
  

• Offshore Transaction: Offer made outside U.S. and (1) Buyer is outside U.S. when buy order is originated (can be U.S. investor) or (2) transaction physically executed on trading floor of a foreign exchange.
  

  
  

• No directed selling efforts in U.S.: Reg S prohibits, in connection with the sale of the non-registered securities, directed selling efforts in the U.S. market, include but not limited to mailing printed material to U.S., U.S. seminars, advertisements in general circulation publications.
  

  
  

• Anti-Fraud Provisions: Compliance with Reg S does not affect applicability of anti-fraud provisions of U.S. law which will protect U.S. investors and foreign investors in U.S. markets where either significant conduct occurs within the U.S. or where conduct outside U.S. has significant effect in the U.S. or on U.S. investors. Another reason an investment manager should still use an offering circular.
  


2. The investment manager must also comply with the securities laws of the jurisdiction of each investor.

1. The offshore fund and its foreign investors generally are not subject to U.S. tax
on capital gains from the sale of securities or commodities. An exception to this rule applies to sales of stock of certain real property corporations; however, if the stock is publicly traded and the offshore fund owns less than 5% of the stock, there is no U.S. taxation on the capital gains.



2. 30% U.S. withholding tax on U.S. source dividend income and on certain types of U.S. source interest income. However, most U.S. source interest income is exempt from this withholding tax (e.g., interest on deposits with U.S. banks and on certain obligations issued in registered form by U.S. corporations or the U.S. government after July 18, 1984).

1. Subject to certain exceptions, U.S. beneficial owners are generally taxed each year on their prorata share of undistributed offshore income.



2. The U.S. investors may face significant tax disadvantages under passive foreign investment company (PFIC) rules.




• The U.S. investor generally pays tax on withdrawals and sales of the stock at ordinary rates plus an interest charge, calculated as if gain was earned ratably over investor's holding period for the PFIC stock.
  

  
  

• Alternatively, U.S. investor can elect to have PFIC treated as Qualified Electing Fund. Under this election, the U.S. investor pays tax each year on its share of the undistributed earnings of the fund, but there is no pass through of losses of the fund which can be a huge negative. U.S. investor can make an additional election to defer payment of the tax until actual distributions are made, but interest is charged.
  


3. The U.S. investors may be required to be integrated with the investors in the investment manager's domestic partnership for purposes of staying at or below 100 beneficial owners of the onshore fund to avoid registration as an investment company under the exemption provided by Section 3(c) (1) of the Investment Company Act.



4. If the U.S. investment manager trades futures or other commodity interests, admitting a U.S. investor to the offshore fund would require registration as a commodity pool operator under the Commodity Exchange Act (registration of an offshore fund without U.S. investors is probably not required but the authority for this position is not absolutely clear).



5. The Performance Fee Rule (Rule 205-3) provisions requiring investors to have a $1,500,000 net worth or $750,000 under management probably do not apply if the offshore fund has only foreign investors but does apply to all of the investors (U.S. and foreign) if any U.S. investor is permitted to invest.