GETTING STARTED HEDGE FUND Hedge Fund Sales   - Hedge Fund Offering   - Hedge Fund Resales   - Hedge Fund Private Placement Memorandum   - Hedge Fund Subscription Agreement   - Hedge Fund Pre-Existing Relationship   - Hedge Fund Finders/Solicitors   - Hedge Fund Filings .   Sales The investment adviser of the hedge fund may sell interests in the fund only in private transactions. Interests in hedge funds are securities for purposes of the Securities Act of 1933 ("1933 Act"). Consequently, the offering of hedge fund interests in a private fund must be made in a manner so that the interests are exempt from registration from the 1933 Act. To avoid having to register such securities with the SEC and certain states, the adviser must take a number of steps and refrain from certain activities. Section 4(2) An offering of hedge fund interests will be exempt from registration with the SEC by Section 4(2) of the 1933 Act if the interests are sold in transactions that do not involve a "public offering." Generally, an offering will not be a public offering for purposes of Section 4(2) if the investment manager does not advertise the offering or actively solicit investors, and the offering is limited to a small number of offerees who are financially sophisticated. Due to the uncertainty surrounding what constitutes a public offering and thus the availability of the Section 4(2) exemption, it is prudent for an investment manager to comply with the regulatory safe harbor available in Regulation D under the 1933 Act when offering limited partnership interests. There are also a number of other exemptions available under the 1933 Act. Regulation D Regulation D under the 1933 Act is a regulatory safe harbor, which means that if the hedge fund complies with each of its provisions, the SEC will deem the offering of interests to not be a public offering for purposes of the 1933 Act. To rely on Regulation D, the hedge fund must comply with each of its rules. Most hedge funds rely on Rule 506 because it permits a larger offering and the offering is exempt from state registration as well as federal registration. Rule 504 and 505 offerings must be registered in each state, unless an exemption is available in the state. Investment Company Act of 1940 An investment manager organizing a hedge fund will seek to avoid having to register the fund as an investment company with the SEC. Investment companies are subject to extensive disclosure and regulatory requirements under the Investment Company Act of 1940 (the "1940 Act"). Securities Exchange Act of 1934 A hedge fund adviser will seek to avoid being subject to the reporting requirements of the Securities Exchange Act of 1934 (the "1934 Act"). An entity with $10 million or more of assets and 500 or more interest holders will be subject to reporting and certain other requirements of the 1934 Act. Structuring the Offering A hedge fund will not have to register its interests under the 1933 Act, register itself as an investment company under the 1940 Act, or file reports under the 1934 Act if it limits the number and types of investors. Investor Types The three main types of investors are: Non-Accredited Investor: an individual investor who earns less than $200,000 and has assets worth less than $1,000,000 and certain entities; Accredited Investor: an individual who earns $200,000 or more or has assets worth $1,000,000 or more and certain entities; and Super-Accredited Investor: an individual who owns $5,000,000 worth of investments and certain entities that own $25,000,000 of investments. Please note that even "non-accredited investors" must have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the investment in the hedge fund. To minimize potential liability, many hedge fund advisers choose to sell interests only to accredited investors. Number of Investors Generally, a hedge fund may have either: Up to 100 investors, provided that no more than 35 investors are non-accredited investors with the rest being accredited investors (sometimes called a "3(c)(1)-type hedge fund);" or Up to 500 super-accredited investors (sometimes called a "3(c)(7)-type hedge fund"). When counting non-accredited investors for purposes of the 35-investor limit, the following persons are not counted: Any relative, spouse or relative of the spouse of the purchaser, provided such person lives in the purchaser's principal residence; Any trust, estate or corporation in which a purchaser or persons related to the purchaser has a 50% or greater interest in; and Any knowledgeable employees of the investment adviser. When counting investors for purposes of the 100-investor and 500-investor limits, the investors in a fund that owns 10% or more of the hedge fund will be counted. Offering Size A Rule 504 offering may not exceed $1 million within any 12-month period; a Rule 505 offering may not exceed $5 million within any 12-month period; and a Rule 506 offering may be of any size. Offering Process A typical hedge fund offering occurs in four stages: The adviser or its placement agent (broker-dealer) establishes a pre-existing relationship with the investor; The adviser or its placment agent discusses the hedge fund with the investor and may provide the investor with the hedge fund's private placement memorandum. No other documents discussing the offering should be delivered to the prospective investor during this stage; and The adviser or its placement agent delivers the investor the offering package, which includes the hedge fund's private placement memorandum, subscription agreement and questionnaire. The hedge fund adviser should number each offering package and create a log containing the names of each recipient of an offering package and the date the package was received. The investor executes the subscription agreement, wires funds to pay for his or her interests, and is entered into the hedge fund's records as a limited partner or member. Offering Frequency The investment adviser has flexibility regarding when it will permit new investors to the hedge fund. The adviser may want to keep the hedge fund open until it reaches a critical size either in terms of the aggregate size of investments or number of investors. The investment adviser can also limit new investors and investments during the course of the year (e.g., every six months). By having more opportunities for investors to invest during the year, the adviser can add new investments to grow the fund. On the other hand, numerous investments during the course of the year makes it more difficult and expensive to maintain the accounts of the hedge fund. This is especially true if the adviser charges a performance fee and has to track the period of each investor's investment. Integration In counting the number of investors for purposes of Regulation D and the 1940 Act, offerings and partnerships may be integrated. See Rule 502(a) of Regulation D; PBT Covered Option Fund (pub. avail. Feb. 17, 1979). Integration may occur in three situations: Timing: The SEC will aggregate all of the offerees in two or more offerings that are made with six months of each other. Similarity: The SEC will aggregate all of the limited partners of two or more partnerships with the same investment objective, portfolio composition or other similarities. Whether or not two funds will be integrated turns on whether a reasonable investor would consider an interest in one fund to be materially different from the interest in the other fund. Vertical Integration: For purposes of the 100 person limit, the beneficial owners of an entity (such as another hedge fund) that owns 10% or more of the hedge fund, will count towards the 100 person limit (with certain exceptions). Underwriters A hedge fund may not be able to rely upon the Regulation D safe harbor if investors in the fund are "underwriters." An "underwriter" is a person that purchases securities with the intent to distribute or resell them to the public. Thus, to rely upon Regulation D, the hedge fund must take reasonable steps to ensure that its interests will not be sold to persons who intend to resell the securities shortly after acquiring them. Such persons may be deemed to be an "underwriter" for the purposes of the 1933 Act. Regulation D is not available for persons selling securities to underwriters because such sales would be de facto public offerings. Therefore, a hedge fund adviser must monitor the original interest holders in the hedge fund, as well as those persons who acquire the interests from the original interest holders. Most investment managers of hedge funds employ the following methods to restrict the investor's ability to resale his or her securities: Legends: Place a legend on the PPM, subscription agreement, and securities themselves stating that the hedge fund interests have not been registered under the Securities Act of 1933 and that the hedge fund interests may not be resold unless they are registered or sold pursuant to an exemption under the Securities Act of 1933. Subscription Agreement: Require the purchaser of the interests in the hedge fund to represent and warrant that he or she is acquiring the interests for his or her own account, and not for the purpose of reselling the interests. Limited Partnership or Operating Agreement: Include a provision in the limited partnership agreement that prohibits the limited partner from selling his or her limited partnership interests to any person other than the general partner or a person approved by the general partner. Broker-Dealer Registration Generally, an investment adviser operating a hedge fund desires to avoid registration under the Securities Exchange Act of 1934 as a broker-dealer. Such registration requires a comprehensive regulatory filing and subjects the investment adviser to numerous restrictions on its operations. An investment adviser will have to register as a broker-dealer if it effects transactions in securities for the accounts of others when selling the hedge fund interests.