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Editor's Desk: Stating the Case for Small Hedge Funds to Register


Managers of startup hedge funds who think they won't have to register with regulators because of their size had better think again.

They may not have to file details on who they are and what they're doing with the Securities and Exchange Commission. But states are another matter.

Small hedge funds may have to get C-level, operations and IT executives prepared to fill out the necessary - and some of the same - paperwork at the state level as they would have with the SEC, if they were bigger.

The four states that hedge fund managers will need most to keep track of are New York, Connecticut, Massachusetts, and California, says Douglas MacLean, an attorney and founder of Armor Compliance in Boston. That is because they are the states in which most managers will likely open shop.

The bad news: Wherever a fund manager registers, the firm must complete Parts One and Parts Two of Form ADV, aka "Advisor." The good news: it's the same form which investment advisors must complete to register with the SEC. If those startup hedge fund managers have already registered with the SEC they can use the same form. However, if they haven't registered with the SEC, they must start from scratch.

The SEC says it is working with state regulators to coordinate items and instructions so a uniform brochure can be used for both state and federally registered advisers so that comparison-shopping can be made easier. Advisers must give the brochure to the client before or at the time the client invests the funds and make available to client an annual summary of any "material changes."

"Before chief compliance officers can finalize Form ADV part two they will need input from chief financial officers, operations and IT executives," says MacLean. That means gathering the data from multiple internal applications such as trade execution, order management, risk analytics and portfolio accounting programs to name a few.

Of the 18 items that must be included in the new brochure, four will require additional work for operations and IT executives: fees and compensation; methods of analysis, investment strategies and risk of loss; performance-based fees and side-by-side management; code of ethics, participation or interest in client transactions and personal trading; and brokerage practices.

In the case of performance-based fees and side-by-side management, operations executives must also explain the logic behind the fund manager's trade order management system to decide what percentage of a block trade is allocated to which fund and in what amount. Fund managers should sit down and talk with their operatiosn and IT staffs. Soon.

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Chris Kentouris is Operations Editor of Money Management Executive.