Soft Dollars

The term "soft dollars" is generally used to describe a transaction in which a broker-dealer provides a hedge fund manager with research or other services or products in return for commission dollars paid for executing transactions rather than charging a separate fee for the research, services or products.

A typical soft dollar transaction is structured as follows:

• The manager directs a broker-dealer to execute trades on behalf of the hedge fund;
• The broker-dealer may charge a higher commission or, in some cases, the manager may direct a high volume of transactions to the broker-dealer at a normal commission rate;
• The broker-dealer, in addition to executing the transaction, provides the manager with goods and services or engages a third party to provide the goods and services to be utilized by the manager.

As set forth below, Section 28(e) of the Securities Exchange Act of 1934 (the "Safe Harbor"), has several elements. Managers who comply with the Safe Harbor may take into consideration the products and services received in connection with soft dollar arrangements when selecting a broker-dealer. Managers that enter into soft dollar arrangements, regardless of whether such arrangements fall within the Safe Harbor, should obtain client consent after full and fair disclosure. The elements of the Safe Harbor include:

• The services or products paid for with soft dollars must be "brokerage" or "research" related;
• The manager must make a good faith determination of the value of the services or products provided;
• The brokerage services or research products must be provided by the broker-dealer;
• The soft dollars must be generated in connection with securities transactions; and
• The securities transactions must be executed on an agency basis.

Managers should exercise extreme caution when engaging in soft dollar transactions as the staff of the U.S. Securities and Exchange Commission has regularly expressed concerns over the legality of soft dollar arrangements. Among other things, the SEC is concerned with whether:

• The soft dollar arrangements are within the Safe Harbor;
• The products and services received by the manager or its affiliates have been adequately disclosed to investors; and
• Investors have consented to the soft dollar arrangements.

Section 13D Filings

Section 13(d)(1) of the Securities Exchange Act of 1934 ("Exchange Act") requires any person who acquires the beneficial ownership of more than five (5%) percent of any equity security of a class that is registered pursuant to Section 12 of the Exchange Act to file with the United States Securities and Exchange Commission ("SEC") within ten (10) days, and send to the company and to the exchanges where the company's stock is traded, a statement containing detailed information concerning the identity and background of the purchaser, its interest in such securities, the source and amount of funds or other consideration, the purpose of the transaction and any contracts, arrangements, understandings or relationships with respect to such securities. Rule 13d-1(a) requires this statement to be filed on Schedule 13D. The Schedule 13D must be complete and accurate and timely filed.

If any material change occurs in the facts as set forth on Schedule 13D, an amendment must be promptly filed. A material change would be deemed to occur, in part, if there is an acquisition or disposition of securities in an amount equal to one (1%) percent or more of the class of securities.

A violation of Section 13(d) may be established by the SEC without showing that the violation arose as a result of intentional conduct. Section 13(d) imposes an affirmative reporting duty on the purchasers of equity securities registered pursuant to Section 12 of the Exchange Act.

There are several remedies available against violators of Section 13(d). On a finding that a purchaser's Schedule 13D is inaccurate, incomplete or misleading, a federal court has the power to require the filing of an amended Schedule 13D, or in the event that any Schedule(s) 13D was not filed, require the filing of such delinquent Schedule(s) 13D. In other instances, purchasers of securities who have failed to file Schedule(s) 13D have consented to the entry of a cease and desist order by the SEC which requires compliance with Section 13(d). Additionally, in situations where purchasers have repeatedly failed to report securities transactions as required by the Exchange Act, some courts have imposed an injunction, concluding that the purchasers' past conduct was highly suggestive of the purchasers' propensity to committing securities law violations and the likelihood that they would commit such violations in the future. A person or entity who has failed to timely file a Schedule 13D, for example, may be enjoined from voting any stock owned in excess of five (5%) percent. Finally, in situations in which a material misrepresentation or omission was intentional, such violation has resulted in criminal sanctions, as well as disgorgement of any profits and prejudgment interest on the amount disgorged.

Section 13G Filings

Regulation 13G was adopted to ease the beneficial ownership requirements for "passive investors." In lieu of filing a Schedule 13D, a passive investor whose beneficial ownership exceeds five percent (5%) of any registered security may file a Schedule 13G. A "passive investor" is defined as any person who can certify that they did not purchase or do not hold the securities for the purpose of changing or influencing control over the issuer and hold no more than twenty percent (20%) of the issuer's securities.

Passive investors choosing to file a Schedule 13G must do so within ten (10) calendar days after crossing the five (5%) percent threshold. Unlike Schedule 13D which requires an amendment to be filed upon every one (1%) percent change in ownership, Schedule 13G requires amendments to be filed promptly after more than five (5%) percent changes in position. Passive investors must also amend their Schedule 13G within forty-five (45) days after the end of the calendar year to report any changes in the information previously reported.

A hedge fund manager who is registered as an investment adviser with either the U.S. Securities and Exchange Commission or under the laws of any state is a "Qualified Institutional Investor." As a Qualified Institutional Investor, the manager may file Schedule 13G within forty-five (45) days after the end of the calendar year in which the fund's beneficial ownership exceeded five percent (5%).

Section 13F Filings

Section 13(f) of the Securities Exchange Act of 1934 requires that every institutional investment manager which exercises investment discretion with respect to accounts holding certain equity securities having an aggregate fair market value on the last trading day in any of the preceding twelve (12) months of at least one hundred million ($100,000,000) dollars, file reports with the United States Securities and Exchange Commission ("SEC"). Such reports shall include for each equity security held on the last day of a reporting period, the name of the issuer, title, class, CUSIP number, number of shares or principal amount, the aggregate fair market value of each security and the nature of investment discretion and voting authority possessed. These reports are required to be filed annually within forty-five (45) days after the last day of the calendar year on Form 13F.

An "institutional investment manager" includes "any person, other than a natural person .buying and selling securities for its own account, and any person exercising investment discretion with respect to the account of any other person." An institutional investment manager is deemed to exercise "investment discretion" with respect to all accounts over which any person under its control exercises investment discretion.

The equity securities referenced in Section 13(f) refers to certain classes of securities admitted to trading on a national securities exchange or quoted on the automated quotation system of a registered securities association. Institutional investment managers may rely on a list of these securities as published by the SEC.

Hot Issues

FINRA Conduct Rule IM-2110-1 entitled "Free Riding and Withholding" is designed to protect the integrity of the public offering system by ensuring that members make a bona fide public distribution of "hot issue" securities and do not use the securities for their own benefit or to reward business associates. Hot issues are defined as securities of a public offering that trade at a premium in the secondary market whenever such trading begins. The Rule prohibits members from retaining the securities of hot issues in their own accounts and restricts the sale of hot issues to specific categories of persons otherwise known as "restricted persons." Restricted persons include FINRA members or associated members, other broker/dealers, employees and family members who receive substantial support, and senior officers of banks, savings and loan institutions, insurance companies, investment companies, investment advisory firms, which includes hedge funds.

Limited partnerships and offshore entities were originally ineligible to purchase hot issues if the partnership had a restricted person as a partner. The FINRA currently allows investment partnerships to use "carve out" procedures to prevent restricted persons with an interest in an investment partnership from participating in hot issue allocations. Ordinarily, hot issue security purchases are settled in a separate "hot issue account" and the cash proceeds are then transferred to the regular trading account.

When purchasing hot issues, domestic limited partnerships must meet the following conditions:

• Establish a separate brokerage account for hot issues;
• Prior to initial hot issue transaction, the partnership's legal counsel or independent certified public accountant must provide a written representation stating that the partnership complies with the hot issue rules;
• The hedge fund manager certifies in writing to the independent certified public accountant that hot issues are in a separate account and partners participating are not restricted;
• Annually, the independent certified public accountant must confirm in writing that hot issue allocations were made in accordance with the carve out provisions.

The hedge fund manager should maintain supporting documentation for how it determined whether each partner was restricted (i.e. subscription documents). This information should be kept in the partnership's files for at least three (3) years after the last hot issue purchase and updated on a regular basis. The hedge fund manager may accept investments from other investment companies (e.g. hedge funds, fund of funds) as partners and those other investment companies may participate in hot issues, provided the hedge fund manager obtains documentation stating that restricted persons in these other investment companies will not receive income generated from trading hot issue securities from the partnership.

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