ALTAVRA | Trend-Following Managed Futures and the ...

MFA in Washington................................5By John G. Gaine, President,Managed Funds Association

Implications of the CommodityFutures Modernization Act forCPOs, CTAs and Hedge Funds ...........8By Rita M. Molesworth, Associate,Willkie Farr & Gallagher

Netting of Derivatives Contracts inthe Spotlight in Congress andat Enron..........................................11By Michael P. Malloy, Warren T. Pratt,and Joan Ohlbaum Swirsky, DrinkerBiddle & Reath LLP

Private Placement Life Insurance:The New Alternative in Insurance ...14By Brad Cole and Christine Kailus,Cole Partners LLC

CFTC Expands Rule ConcerningQualified Eligible Persons...............20By Steven J. Fredman, Lawrence T.Eckert, and Peter W. Gold, SchulteRoth & Zabel, LLP

MFA on Accounting:Dealer Securities Futures Contracts: The IRS “DecidesNot to Decide”?...............................22By Scott S. Anderson, CPA, andJeffrey A. Clayman, CPA, Esq.

Press Check.........................................23

Forum 2002 Schedule ........................24

Inside This Issue

ReporterApril 2002

Reporting on issues for investment professionals in futures,hedge funds and other alternative investments

MFA

Immediately following the financial market turmoil of August-September 1998,the managed futures industry appeared, for what was possibly the first time, tobe on firm marketing ground with institutional investors. Many CTAs had deliv-

ered on their promise to provide meaningful diversification to traditional portfolios,especially in the worst of times. Some major institutional CIOs finally took notice.But industry performance over the next few years was not particularly impressive.The potential seemed to fizzle out. Overall, not much has changed in the level ofinstitutional interest since the renewed optimism of late 1998.

While the industry has notachieved wide acceptancein the institutional world,I would argue that it hasestablished a foothold. Tobuild from here willrequire a focused andcoordinated effort, as wellas the adoption by many(though not all) trend-fol-lowing CTAs of a new wayof looking at how theymarket to institutions. Notall CTAs wish to manage institutional assets, recognizing that the learning curve inthat world is steep and the allocation process time-consuming. But for those whodo, it’s time to confront the obstacles head-on.

Are there factors beyond industry performance that block the path to institutionalacceptance? Other alternative strategies, as well as traditional asset classes, haveperiodically suffered lackluster years and then recaptured their widespread

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Trend-Following ManagedFutures and theInstitutional InvestorBy Randolf Warsager, Director of Education, Center for InternationalSecurities & Derivatives Markets, University of Massachusetts, Amherst,and Vice President, Carr Futures, Alternative Investment [email protected]

There is a compellingmessage in the conver-gence/divergenceapproach to trendfollowing but theindustry has notfully exploited it.

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Trend-FollowingManaged Futures andthe Institutional Investor

appeal. Conversations with a variety of institutional invest-ment professionals, consultants, and managers, however,bring to light a set of obstacles to broaden institutionalacceptance of managed futures. As an industry, we need torecognize and deal with these. Failing that, we will be betteroff remaining focused on the non-institutional marketplace.

1. An Inherent Rate of ReturnPhilip Halpern, vice president and treasurer at theUniversity of Chicago, said in 1997 (when he wastreasurer at CalTech): “Many institutions believe thatthere is not a sustainable, exploitable reason to investin the underlying instruments.” This point has beenechoed by many of Mr. Halpern’s peers.

The MLM Index and the Commercial Market Index (CMI),both simple, transparent trend-following models, havehistorical performance that is evidence for an inherentreturn to trend following. Institutional awareness ofthem, while growing, is still relatively limited. Theapproach they exemplify, however, has struck a positivechord with certain institutions. This interest may providea seed to support the growth of actively managed pro-grams if they are marketed with the inherent return inmind. Several institutions, in fact, invest in both activeand passive approaches. Further information about thisapproach to investing is available at the Web sites of therespective index developers, www.mtlucas.com and www.assetsight.com.

With regard to the economics underlying trend-following returns, research by William Fung and DavidHsieh argues that trend-following returns are theresults of a type of long volatility exposure, broadlyspeaking, and can be explained in terms of the strate-gies’ long option-like properties (“The Risk in HedgeFund Strategies: Theory and Evidence from TrendFollowers, The Review of Financial Studies, Summer2001, Vol. 14, No. 2, pp. 313-341). Researchers atthe Center for International Securities and DerivativesMarkets at University of Massachusetts are lookingclosely at the economics underlying hedge fundreturns, managed futures included, to further explainthe return generating processes.

2. BenchmarkingMr. Halpern also cited “the absence of a universally

accepted benchmark that can serve as a default positionand as a performance measurement tool.” There is notyet a ‘universally accepted benchmark,’ but there is avariety of peer group indices in use, and the MLMIndex and CMI, though different in their constructionand degree of correlation with CTA indices, arguablyserve as a proxy for the inherent return in trend-follow-ing and allow investors to measure the skill of managersin relation to this return.

3. The Mystery of the Black BoxInstitutions often comment that systematic CTAs donot adequately explain their strategies to prospectiveinvestors. This is a familiar complaint. Some observersargue that there is an institutional bias toward discre-tionary traders to begin with, so seemingly mysteriousBlack Box systems are hard to sell. Managers who aresecretive about their strategy when meeting with institu-tions will probably not raise assets in this area.

The MFA Reporter is the newsletter of the Managed Funds Association. Itspurpose is to publish the most useful and timely news and ideas from themost knowledgeable industry professionals.

Bob MurrayCommunications Committee

Chair/Editor, MFA2025 M Street, N.W., Suite 800Washington, DC 20036-3309

Tel.: 202.367.1140 ■ Fax: 202.367.2140Web site: www.mfainfo.org

Reproduction by any means of the entire contents or any portion of thispublication without prior permission is strictly prohibited. This publicationis designed to provide accurate and authoritative information to MFAmembers in regard to the subject matter covered. The articles containedherein are the opinions of the individual authors and do not constitute therendering of legal, accounting or other professional advice. If legal or otherprofessional assistance is required, the services of a competent profes-sional should be sought.

© 2002 Managed Funds Association. All rights reserved.

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4. Consultants The managed futures industry has still not penetratedthe consulting and investment advisory communities.Jim Tomeo, C.O.O. and senior portfolio manager atSSARIS Advisors, points out that two of the biggesthedge fund “beacons,” Cambridge Associates and TheCommonfund, are advocates of hedge fund investingbut have not embraced managed futures. This appliesto most of the other major consultants as well.

5. Developing a Consistent Marketing MessageThe industry is hurt by the absence of a consistentmarketing message. According to one school of thought,this is not so much about getting the diversificationpoint across as it is about CTAs communicating thattrend-followers share a common source of returnsgenerated by the risk transfer process in commercialmarkets, to which they add alpha with the range of skillsthat managers can apply. Perhaps not everyone acceptsthis particular inherent return argument, but as PhilipHalpern says, most institutions want to be confidentthat any strategy they invest in has an underlying,inherent return.

6. Convergence and DivergenceThis issue is related to number 5 and the need forknowledge building among institutions. There is acompelling message in the convergence/divergenceapproach to trend following but the industry has notfully exploited it. There is strong evidence that not justtraditional portfolios, but multi-manager hedge fundportfolios, benefit significantly from adding a diver-gence, long-volatility component. This approach wasarticulated elegantly by Mark S. Rzepczynski when hewas head of research (he is now president and chiefinvestment officer of the firm) at John W. Henry &Company, Inc. (“Market Vision and Investment Styles:Convergent vs. Divergent Trading”, Mark S. Rzepczynski,The Journal of Alternative Investments, Winter 1999,Volume 2, Number 3, pp. 77-82). (An abstract of hisarticle is available on Institutional Investor’s Web site atwww.iijournals.com.) The long-volatility descriptionof trend-following is not unanimously accepted in theindustry, though these disagreements may revolvearound different uses of the word ‘volatility.’

7. Returns In terms of returns alone, performance across themanaged futures industry has not, in the view of manyinstitutions, been attractive enough to warrant the inter-nal advocacy that is necessary on the part of investmentstaff to successfully bring the strategy to the attention ofskeptical investment committees. Brad Cole, presidentof Cole Partners LLC, believes, “As an overall category,managed futures has not delivered the kind of absolutereturns that institutions are looking for. Our industryhas not given the fence-sitters a compelling reason toinvest.” Mr. Cole adds, “Most investors who are contem-plating an investment in CTAs are performance-driven,but the favorable correlation characteristics aredrowned out by lack of good absolute performance. Inall fairness to trend-followers, however, I will say thatthe trading environment has been unfavorable in theabsence of inflationary pressures. The velocity of pricechanges has been low, so there has been a shortage ofopportunities for this strategy.”

8. Lingering Memories of Widely ReportedInstitutional Experiences The experiences of Kodak, Federal Express, and VirginiaRetirement System are still a sticking point for manyinstitutions. They regard these institutions as the firstcasualties. Institutional memories of those situations,accurate or not, fair or not, are still out there. Thisfact was noted by several managed futures-friendlyinstitutional CIOs.

9. Competition from Other Alternative Investments This applies especially to leveraged buy-outs and venturecapital. These asset classes are stiff competition formanaged futures, according to Alan Kaufman, chairmanof AssetSight, Inc., because they are essentially longequity investments, and therefore well within the com-fort zone of most institutions. Richard Huddleston,investment analyst at Detroit General Retirement Sys-tems, agrees, “Private equity is easier for Boards tounderstand and feel comfortable with.”

10. A Shortage of Widely Recognized ManagersThe industry does not have many managers with name

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Trend-FollowingManaged Futures andthe Institutional Investorcontinued from page 2

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recognition in the institutional world. Mr. Huddlestonof the Detroit Systems says, “The stock and bondindustries have more recognizable names. It’s not somuch an image problem for managed futures but a‘recognizability’ problem. There aren’t many names thatinvestors are comfortable with in the way there are onthe traditional side.”

11. The Need for an Advocate The absence of a managed futures advocate, or champi-on, at the large majority of institutions means there is noone to persistently make the case for this strategy, tobring it to the Board again and again until its strengthsare understood. With a lesser known alternative strategylike managed futures, it will not generally take holdunless it has a strong and respected advocate at a highlevel within the institution. A principal at a large CTAobserved that, “One of the issues we face as an industryis the way in which investment professionals at institu-tions are rewarded. They are not rewarded for takingchances. There is career risk simply in doing somethingthat one’s peers are not doing. If it doesn’t work, theperson can be fired. If it does work, there will be littlerecognition for its success.”

12. The Boxes In the institutional world, investors are predisposed toput investments in well-defined boxes. There is no boxfor managed futures in its common form. Some in theindustry thought that financial engineering wouldaddress this by leading to the creation of a range offixed income products whose performance was tied toCTA returns. This has happened on the retail side butnot widely on the institutional side.

More Observations from the Institutional SideThe chief investment officer of a major pension, who askedto remain anonymous, recently made a successful argumentfor hedge funds to his Investment Committee and Boardand initiated an investment program. But managed futuresis not on the radar screen there. When asked why managedfutures has not been accepted by his peers, this CIO said,“Managed futures has yet to make its case with the pensionfund consultant community.”

Mark Yusko, chief investment officer at the University ofNorth Carolina, Chapel Hill, believes there is a fundamentalimage problem for managed futures. “In general,” heargues, “many Board members at institutions know some-one, or know someone who knows someone, who has hada bad experience with commodities or futures. But theseexperiences have nothing to do with managed futures. It’sjust that they leave a bad taste with some Boards. Even ifone person on the Board feels this way, it can lower theodds that this strategy will be approved for an allocation.”

Mr. Yusko has many years of experience with hedgefunds. And he believes that managed futures is an under-appreciated alternative strategy. Among the reasons, hesays, “is the sad truth that there is a negative impressionstill out there among institutions about the experience ofKodak and VRS. This is still resonating.” He argues that inthe collective institutional mind the memory is much worsethan the reality was.

“Overall, nothing much has changed over the last severalyears,” Mr. Yusko says, adding, “I still contend that a diver-sified pool of CTAs can have very strong risk and rewardbenefits to a portfolio, but it’s still a difficult sale, in partfor the simple reason that the name Commodity TradingAdvisor is a bad one. It hasn’t fit these managers for years.It creates the notion in the minds of institutional fiduciariesthat the main activity will be commodity trading, which isnot accurate.”

An experienced pension consultant, speaking off therecord, says, “All the marketing stuff is not helping. Onlyrobust academic work is useful. The articles advocatingmanaged futures that are written by managers are seen,not surprisingly, as biased. And CTAs have not made aconvincing case that they should be seen as part of thehedge fund world.”

ConclusionThis article is a sober assessment but is not meant to bepessimistic. Unless we as an industry understand theobstacles to growth and the misperceptions of managedfutures, CTAs will struggle to achieve the recognition frominstitutions that many of them deserve. This would be


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Author’s Note: Immediately prior to going to press, theTreasury issued a temporary exemption for no more thansix months for certain investment companies (includinghedge funds, private equity funds and venture capitalfunds), commodity pool operators, and commodity trad-ing advisors, among others, from the April 24 deadlinefor anti-money laundering requirements of Section 352of the USA PATRIOT Act. From our vantage point inWashington, DC, MFA anticipates hedge funds are a highpriority with the Treasury Department and will be gov-erned by the requirements well before October 24. Infact, a Treasury official was quoted as saying regulationsfor hedge funds would be coming in "a few weeks."As always, MFA will keep you apprised of further devel-opments. Email MFA at [email protected] with anyquestions or concerns.

MFA has been particularly active in pursuing its legislativeand regulatory agenda in the last few months. Anti-moneylaundering and Enron continue to be the two hot issues,with several others in the periphery, but not out of focus.

Leading the Way to Anti-MoneyLaundering ProgramsSince President Bush signed the USA PATRIOT Act into lawon October 26, 2001, MFA has been working diligently toprepare for the anticipated implementation of Section 352 ofthe Act, which requires that all “financial institutions” adoptanti-money laundering programs by April 24, 2002. MFA haslong supported the financial industry’s anti-money launder-ing efforts, and MFA quickly stepped up to the plate to assistwith this particular initiative. To aid its Members in meetingthe anticipated requirements of Section 352 by the April 24implementation deadline, MFA recently published “Prelimi-nary Guidance for Hedge Funds and Hedge Fund Managerson Developing Anti-Money Laundering Programs.”

As a result, MFA has emerged as the leading voice in thedevelopment of anti-money laundering programs for thefinancial services industry. As such, MFA hosted two semi-nars with major prime brokers to present the Guidance tohedge fund professionals. MFA President John G. Gainepresided over the seminars, accompanied by KennethRaisler of Sullivan & Cromwell. At each presentation, BruceNemirow, MFA’s Membership Committee Chairman andManaging Director of Capital Growth Advisors, reiterated

the importance of MFA Members’ support, both old andnew, to enable MFA to continue to be the strong voice inWashington that it has been for over a decade.

Since the release of the Guidance, industry professionalshave besieged MFA with requests for copies, indicatingthat the Guidance has become the preeminent sourcefor hedge fund managers in developing anti-money laun-dering programs.

Despite the immensely positive response to MFA’s Guidance,Section 352 of the USA PATRIOT Act has not been withoutcontroversy. One of the main points of contention withmany industry professionals is whether Section 352 evenapplies to hedge funds. Some maintain that hedge funds arenot “financial institutions” under the current regulatoryscheme, and therefore, need not adhere to the require-ments of Section 352.

While MFA appreciates the importance of such a debate aca-demically, from a pragmatic standpoint, we are recommend-ing that Members go forward as if Section 352 does includehedge funds and hedge fund managers both as a sound busi-ness practice and a good faith measure during a time whenunregistered investment vehicles are coming under fire.

Also, much talk has been made of a deferral of the April24 deadline. Regardless of this possibility, MFA maintainsa “better safe than sorry” mentality, urging Members todevelop anti-money laundering programs as if Section 352implementation will occur as planned.

The Guidance consists of over 50 pages of guidelines, annex-es and model policies and procedures for the developmentof an anti-money laundering program. In the manual,Members will find chapters that address investor identifica-tion policies and procedures (including natural personsand corporations), reliance upon investor identificationprocedures performed by third parties, designation of ananti-money laundering compliance officer, ongoing employeetraining programs, independent audit functions, and proce-dures for identifying and reporting suspicious activity.

In addition to these main topics, the manual includessample representation/covenants to be obtained from thirdparties who perform investor identification procedures,including provisions for fund administrators, investor

MFA in WashingtonMFA in Washington

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By John G. Gaine, MFA President

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MFA in Washington cont’dMFA in Washington cont’dcontinued from page 5

intermediaries and subscription documents. Users willfind sample board resolutions for adopting an anti-moneylaundering program, appointing an anti-money launderingcompliance officer, and adopting anti-money launderingtraining programs. Finally, the Guidance provides a calen-dar of effective dates of certain provisions of the USAPATRIOT Act, lists of Financial Action Task Force (FATF)Members and non-cooperative countries and territories,lists maintained by the Office of Foreign Assets Control,and money laundering advisories issued by the FinancialCrimes Enforcement Network (FinCEN).

MFA recognizes that anti-money laundering compliance willevolve substantially as regulations implementing the USAPATRIOT Act are promulgated and as industry practicesdevelop. Consequently, MFA anticipates updating the Guidanceas necessary to reflect any of these changes. Undoubtedly,this resource—a benefit of MFA Membership—is the mostconcise and thorough tool a hedge fund manager can use todevelop an anti-money laundering program.

MFA will also continue to work closely with the Treasuryand other governmental agencies, such as the Securities andExchange Commission (SEC) and the Commodity FuturesTrading Commission (CFTC), as new rules are developed,proposed and promulgated pursuant to the USA PATRIOT Act.

Political Mood Swings: Reactionand AnticipationFinger-pointing has been at an all-time high in the midst ofthe Enron debacle. Eventually, assertions of blame start tocircle Washington, DC like vultures.

In reaction to accusatory stares, as they did in the after-math of Long Term Capital Management, legislators andregulators alike are scrambling to discover and explainhow Enron managed to create, use and manipulate com-plex financial instruments that led to its demise. At issue isthe role of deregulated energy markets, the result of theprogressive and revolutionary Commodity Futures Modern-ization Act of 2000 (CFMA).

As Congress is developing a comprehensive energy bill, thequestion of federal oversight of these deregulated energymarkets has loomed large. Senator Dianne Feinsteing (D-Calif.) introduced Amendment No. 2989 to the Senate ver-sion of the bill, S. 517, to expand federal oversight ofenergy derivatives. The Feinstein amendment would have

effectively negated the achievements of the CFMA by repeal-ing key provisions of the Commodity Exchange Act thatcarve out from regulations energy derivatives contractstraded over-the-counter (OTC). The amendment would alsohave expanded the CFTC’s jurisdiction over online tradingof energy derivatives.

Sensing the danger of such a reactionary amendment, MFAPresident John G. Gaine worked actively in opposing Sena-tor Feinstein’s amendment. Consequently, on April 10, amotion to invoke cloture on the amendment failed by a voteof 48-50 with 2 Senators not voting. The amendment waswithdrawn in the Senate later that day.

The comprehensive energy bill, however, continues to bea work in progress. Similar amendments could be reintro-duced in the Senate, or Sen. Feinstein could attempt to tackher amendment onto another bill. Meanwhile, representa-tives in the House are cooking up their own version of theFeinstein Amendment. Ever-vigilant, MFA will be sure tostand strong against any attempts to eviscerate the CFMA.

Fortunately, for the most part, Congress appears to beunready to make drastic changes to the current system,specifically since the CFMA is still new law. MFA anticipatesthat Enron will continue to make waves in the media, butthat the regulatory impact will be minimal for the managedfunds industry. MFA has worked hard to educate legislatorsand media about the true nature of the hedge fund industry,including OTC derivatives. As a result, the legislative moodswing seems to be balancing out as understanding ofthe industry proves to have a leveling effect on the mindsof Congress.

Hedge Fund Manager Exemptions—Progress or Regress? If you are a hedge fund manager exempt from registrationas an investment adviser with the SEC because, amongother things, you have fewer than 15 clients, your exemptstatus might be in jeopardy. Currently, each fund you adviseis counted as one client under Rule 203(b)(3)-1. SeveralSEC staff members have suggested changing this rule, vis àvis the definition of “client,” and counting each investor ina fund as a client, thereby eliminating the exemption formost hedge fund managers.

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unfortunate all around because managed futures is a setof strategies that clearly has much to offer institutionalinvestors, just as it has for decades to many high-net-worthindividuals and families.

Some of the dozen points listed in this article are simplematters of misunderstanding. Others are more substantive.I hope outlining the issues that the managed futures indus-try needs to confront to attract institutional assets will helpfocus the considerable energy and talent in this industry onovercoming the obstacles to growth. ■


MFA is adamant in defending the current definition of“client.” Any move on the part of the SEC to require regis-tration of hedge fund managers who currently enjoy theexemption will damage the freedom and integrity of themarket by imposing burdensome limitations on the opera-tions of the funds.

Such changes by the SEC could also negate progress in BlueSky laws in both California and New York. Both states havestatutory schemes that mirror Rule 203(b)(3)-1. Exemp-tion from registration at the state level is essentially irrele-vant if required to register federally.

MFA will remain on guard, poised to respond quickly if theSEC should pursue these rule changes.

A Global Voice on a Global CommitteeMFA has been asked to join the Global DocumentationSteering Committee (GDSC), which was formed to imple-ment the documentation-related recommendations of the1999 Report published by the Counterparty Risk Manage-ment Policy Group (CRMPG). The CRMPG was a group of12 major internationally active commercial and investmentbanks formed with the objective of promoting enhancedstrong practices in counterparty credit and related riskmanagement after the market disruptions of 1997 and1998. The GDSC, whose members are very senior profes-sionals in the financial markets, aims to lower documenta-

tion basis risk by encouraging harmonized standard docu-mentation used in over-the-counter markets.

MFA’s work with the GDSC will be in furtherance of MFA’srecent responses to the International Swaps and DerivativesAssociation, Inc’s (“ISDA”) suggested changes to the 1992ISDA Master Agreement. MFA strongly objected to several ofthe proposed amendments that disproportionately wouldfavor dealers to the detriment of end users, thereby possi-bly increasing, rather than decreasing, systemic risk. Forthe comprehensive rewrite of the Agreement, which is nowunderway, MFA is encouraging language that promotesfinancial stability that is fair and acceptable to all parties.MFA looks forward to continuing to work with ISDA in aproductive and meaningful way.

Educating EducatorsMFA President John G. Gaine furthered MFA’s goal of educa-tion by speaking at the academic investment conference“Innovations in Finance” at the Owen Graduate School ofManagement, Vanderbilt University, on April 11, 2002. Mr.Gaine’s presentation detailed the major issues currentlyimpacting the managed funds industry— most importantly,MFA’s anti-money laundering Guidance and the collapse ofEnron. Mr. Gaine also spoke on other issues such as theadvent and obstacles of single-stock futures, the status ofexempt funds and advisors, and the entry of hedge fundsinto the retail market. ■

MFA in Washington cont’dMFA in Washington cont’dcontinued from page 6

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Implications of the Commodity FuturesModernization Act for CPOs, CTAs, andHedge FundsBy Rita M. Molesworth, Associate, Willkie Farr & Gallagher

The Commodity Futures Modernization Act (CFMA)streamlined regulation of futures markets andeliminated prescriptive regulation of exchanges in

favor of core principles. Regulation of intermediaries suchas commodity pool operators (CPOs) and commodity tradingadvisors (CTAs) was left relatively unchanged by both theCFMA and the rules promulgated in its wake. CPOs, CTAs andhedge funds should be aware, however, of the new statutoryand regulatory developments discussed below. In addition,as required by the CFMA, theCommodity Futures TradingCommission (CFTC) is study-ing intermediary regulationand considering furtherregulatory relief. Therefore,changes in addition to thosedescribed below may beexpected over the nextcouple of years.

Security FuturesThe CFMA lifted the long-timeban on futures on single secu-rities or narrow-based indicesof securities. Security futuresare defined as securities forpurposes of the Securities Actof 1933 (the 1933 Act),the Securities Exchange Act of1934 (the 1934 Act), the Investment Company Act of 1940(the 1940 Act) and the Investment Advisers Act of 1940(the Advisers Act). Security futures are defined as futuresfor purposes of the Commodity Exchange Act (CEA). There-fore, an adviser that trades security futures is subject toregulation as both an Investment Adviser (IA) and a CTA.

New Exemptions from CTA and IA RegistrationThe CFMA created a new exemption from registration as aCTA under the CEA for any CTA that is registered with theSecurities and Exchange Commission as an IA whosebusiness does not consist primarily of giving commodity

trading advice. To qualify for the exemption, the CTA maynot act as a commodity trading advisor to any fund that isengaged primarily in trading futures on or subject to therules of any contract market or registered derivatives trans-action execution facility. Similarly, the CFMA amended theAdvisers Act to create a new exemption from registration asan IA for any IA that is registered with the CFTC as a CTAwhose business does not consist primarily of acting as aninvestment adviser, and that does not act as an investment

adviser to a registered investmentcompany or a business develop-ment company. The meaning of“primarily” remains to be deter-mined.

Security Futures and FundsThe CFMA did not create any deminimis exemptions from regis-tration under the CEA for opera-tors of funds engaged primarily insecurities trading but who tradesome futures contracts. The opera-tor of a collective investment vehi-cle that trades even one futurescontract must register as a CPOand comply with CFTC regulations.The CPO must, among otherthings, prepare an offering docu-ment or qualify for an exemption

from that requirement with respect to the fund. Becausesecurity futures are defined as futures, the operator of ahedge fund that to date has traded only securities may nottrade security futures without registering as a CPO andcomplying with CFTC regulations.

Until now, a privately offered pool that traded only futuresneeded to comply with a private offering exemption (gen-erally Regulation D) to avoid registration of its securitiesunder the 1933 Act. Such a pool was not required to com-

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The USA PATRIOT Act,which was passed byCongress in the wake ofthe September 11 terroristattacks, broadened thedefinition of “financialinstitution” for purposesof a variety of anti-moneylaundering laws toinclude CPOs, CTAsand FCMs.

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ply with the 1940 Act even if the pool kept a substantialamount of its assets in Treasury securities.

Now, if that privately offered pool wants to trade securityfutures it might be considered an investment companyunder the 1940 Act. If so, it must register under the 1940Act or come within an available exemption. If the pool hasmore than 100 beneficial owners, the 1940 Act’s Section3(c)(1) exemption would not be available. If each investoris not a qualified purchaser (generally, individual investorswith $5 million in investments and entity investors with $25million in investments), the Section 3(c)(7) exemptionwould not be available. Notably, qualified purchaser stan-dards exceed those of both Reg. D and CFTC Rule 4.7.

Ethics TrainingAssociated Persons must attendethics training within six monthsof registration and periodicallythereafter. The CFTC recentlyeliminated Rule 3.34, which pre-scribed a one-size-fits-allapproach to ethics training.Instead, the CFTC has adopted aStatement of Acceptable Prac-tices that permits registrants todetermine for themselves theformat, frequency and durationof ethics training programs. Inaddition, ethics training providers are no longer requiredto meet any particular qualification criteria.

Registration ChangesThe CFTC eliminated Rule 3.32 which required a newregistration for an entity in the event of certain changes inprincipals, such as a change in CEO or a new owner of10% or more of the entity. Such changes may now be re-ported by filing a Form 3-R to amend the firm’s Form 7-Rto add or delete principals and by filing a Form 8-R foreach new natural person principal.

PrincipalsThe CFTC amended the definition of “principal” in theregistration rules. Principals now include any 10%

beneficial owner of a registrant, its directors, president,CEO, COO, CFO, managing member(s), and any personwith the power to exercise a controlling influence over theregistrant’s activities that are subject to CFTC regulation, aswell as any person who is in charge of a principal businessunit that is subject to CFTC regulation. Other officers whodo not exercise a controlling influence over the registrantare no longer principals. This rule change should reducethe number of persons required to be listed as principalsfor many registrants.

Disclosure DocumentsDisclosure documents for CPOs and CTAs now need toinclude background and performance information onlywith respect to principals who participate in trading or

operational decisions for theCPO or CTA or who supervisesuch persons, rather than allofficers and directors.

Eligible ContractParticipantThe definition of “eligible con-tract participant” (ECP) in theCEA includes a commodity poolthat has total assets exceeding$5 million and that was formedand is operated by a person

subject to regulation by the CFTC regardless of whethereach investor in the commodity pool is itself an ECP. This isconsistent with the definition of qualified eligible person(QEP) in Rule 4.7, which provides that a non-Rule 4.7 poolwith assets in excess of $5 million is a QEP, provided that(i) it was not formed for the specific purpose of satisfyingthe QEP requirement and (ii) its trading is directed by aQEP (e.g., a registered CPO or CTA). Many pools, therefore,will be both ECPs and QEPs even if each of their investorsis not.

CTA Trading on a DTEFDerivatives transaction execution facilities (DTEF) are lessregulated than designated contract markets. The CFMA

Implications of theCommodity FuturesModernization Act continued from page 8

CPOs and CTAs are re-quired to establish AMLprograms by October 24,2002, unless earlier com-pliance is required by theTreasury Department.

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limited DTEF access to retail (i.e., non-ECP) customers offutures commission merchants (FCMs) meeting certainsuitability requirements. Recently enacted Rule 4.32permits a registered CTA to enter trades on a DTEF for itsnon-ECP discretionary accounts as long as the CTA has atleast $25 million under management at the time any tradeis entered. Rule 4.32 requires the CTA to disclose to itsclients that such trades may be entered on the client’sbehalf. In addition, the account must be cleared by aregistered FCM. National Futures Association intends toissue a Statement of Acceptable Practices with respect todisclosures to be made to a non-ECP whose account istraded by a CTA on a DTEF.

Closing Out of Offsetting PositionsCPOs and CTAs who wish to close out positions in theirclients’ futures accounts on an instruct-basis, rather thanfirst-in first-out, may now do so because the CFTC amendedRule 1.46 to permit FCMs to deviate from the first-in first-out default rule for closing out offsetting positions. If a CPOor CTA so instructs an FCM with respect to an account itcontrols, this fact must be disclosed to the client in theCPO’s or CTA’s disclosure document.

Privacy RulesThe CFMA amended the Gramm-Leach-Bliley Act toinclude CPOs and CTAs within the definition of “financialinstitution” for purposes of that act. The CFMA also madethe CFTC a “federal functional regulator” charged withpromulgating privacy rules for the financial institutionssubject to its jurisdiction. Privacy notice obligations extendonly to individual (i.e., natural person) clients. Part 160 ofthe CFTC’s rules requires CPOs and CTAs to provide initialnotices to “customers” at or prior to the time a customerrelationship is established, and annually thereafter. Initialnotices must also be provided to “consumers” prior todisclosure of any of their nonpublic personal information.A “consumer” is an individual who provides nonpublicpersonal information while seeking to obtain a financial

product or service from a CPO or CTA. A “customer” is anyconsumer who has an ongoing relationship with a CPO orCTA. Generally, the notices must describe what nonpublicpersonal information is collected and how it is protected.

Anti-Money Laundering LawsThe USA PATRIOT Act, which was passed by Congress in thewake of the September 11 terrorist attacks, broadened thedefinition of “financial institution” for purposes of a varietyof anti-money laundering (AML) laws to include CPOs,CTAs and FCMs. FCMs were required to establish AMLprograms in compliance with the USA PATRIOT Act by April24, 2002. CPOs and CTAs are required to establish AMLprograms by October 24, 2002, unless earlier complianceis required by the Treasury Department. ■

Implications of theCommodity FuturesModernization Act continued from page 9

11

Netting of derivatives contracts has been on the legisla-tive agenda for several years. Most recently, onNovember 1, 2001, Representative Patrick Toomey

(R-Pennsylvania) introduced an additional piece of proposedlegislation – H.R. 3211 – which would clarify that a broad-ened array of these arrangements is enforceable in the eventof a party’s insolvency. The netting legislation has languishedduring the current Congressional session because it is em-bedded in a broader bankruptcy reform bill. The new billis more likely to pass because it breaks out the netting pro-posal into a separate piece of legislation.

Many support the break out of the netting provisions fromthe remainder of the pending bankruptcy proposals to ex-pedite netting legislation, including House Financial Ser-vices Chairman Michael Oxley(R-Ohio) and such prominentofficials as Federal ReserveChairman Alan Greenspan, SECChairman Harvey Pitt and Trea-sury Secretary Paul H. O’Neill.The netting provisions are wide-ly seen as non-controversial,consensus provisions. However,for that very reason, some onCapitol Hill prefer to retain thenetting provisions as part of theomnibus bankruptcy proposals,to encourage legislators to pressforward on those broader pro-posals. House Judiciary Chairman James Sensenbrenner(R- Wisconsin) and Senator Chuck Grassley (R - Iowa),Ranking Republican Member of the Committee on Finance,for example, fall within that category. So, while the recentproposal provides a new opportunity for netting legislationto move through quickly, that result is not assured.

Netting refers to the netting of cash flows or obligationsamong parties to multiple derivative contracts, such asswaps or foreign exchange forward contracts. Under abilateral netting arrangement, two counterparties agreewith one another to net their obligations. They may sign amaster netting agreement specifying the types of netting tobe performed and the contracts which may be affected.Under a multilateral netting arrangement, multiple counter-

parties net derivatives contracts among one another.

Netting is widespread because, among other things, it helpsreduce credit risks among parties. Credit risk is reducedbecause each counterparty has a single legal obligationcovering all included individual contracts. Upon a defaultby a counterparty, a party to a netting arrangement neednot cover its full cost to find a replacement contract forthe defaulted contract; it need only cover its net cost. Mul-tilateral netting provides even more opportunity to spreadthe costs of covering defaulted contracts among theparties involved.

Industry participants have focused lately on the possibleeffects on a netting arrangement of the insolvency of a partyto the arrangement. If netting is enforced, the counterparty

to the insolvent party can termi-nate its agreement with thedebtor promptly and liquidate itsposition, notwithstanding thedebtor’s insolvency. The insolventparty’s obligations would be thenet sum of all positive and nega-tive values of contracts includedin the netting arrangement. Thenetting would allow for a quickresolution to complex financialcontracts, and the counterpartyto an insolvent entity would beprotected from market fluctua-

tions in the value of the contract which might occur overtime if the counterparty were unable to terminate and net.

However, under insolvency laws, it is possible that theright to net may be suspended, or a netting transaction maybe reversed if attempted. This is because in some cases,legal prohibitions (referred to as “stays”) forbid a creditor(such as a party who wishes to close a netting arrange-ment) from exercising rights against an insolvent entity –for example, rights to close the netting arrangement. Also,legal prohibitions may result in the reversal (or “avoid-ance”) of a closing transaction on a netting arrangement

Netting of Derivatives Contracts in theSpotlight in Congress and at EnronBy Michael P. Malloy, Warren T. Pratt, and Joan Ohlbaum Swirsky, Drinker Biddle & Reath LLP

Netting refers to thenetting of cash flows orobligations among partiesto multiple derivativecontracts, such as swapsor foreign exchangeforward contracts.


12

carried out by an insolvent entity on the eve of an insolven-cy proceeding, on the theory that the exercise of the credi-tor’s right to net is a forbidden “preference” in favor of thatparticular creditor.

In order to limit the possible disruption of financialmarkets which might occur if certain types of transactionswere stayed or avoided, federal insolvency provisions ex-cept from the stay and avoidance provisions a limited vari-ety of agreements, such as forward contracts and swapagreements, giving these types of agreements a “safe har-bor” from the typical results of insolvency.

The issue of the enforceability of netting arrangementshas been highlighted in the news since Enron Corp. filedfor bankruptcy protection onDecember 2, 2001. Enronreportedly had tens of billions ofdollars worth of netting contractswith hundreds of trading part-ners. Those partners presumablywould rather net contracts,instead of waiting for repaymentin a bankruptcy proceeding, likeother creditors are required todo. Reportedly, some tradingpartners have been worried thatEnron may seek to reduce theamount it owes them, by chal-lenging some of the nettingarrangements under current insolvency provisions whichdo not explicitly allow for netting certain new kinds ofderivatives that have been created since the applicable lim-ited insolvency provisions were enacted. The importance ofthe netting issue was highlighted on December 10, 2001.On that date, Enron submitted a motion for authority tonegotiate and enter into termination agreements for itsderivatives and netting contracts. Several days later, numer-ous Enron creditors filed various objections to Enron’srequest. The Enron creditors asserted that the bankruptcycourt should set guidelines for Enron’s authority to dealwith the netting arrangements. At this writing, the matterhas not yet been finally resolved.

The netting issue also attracted attention about three yearsago, in connection with the near-collapse of Long TermCapital Management (LTCM). At that time, many wonderedhow its netting arrangements would be treated. Rather thanendure the risks of a default by LTCM and a possible bank-ruptcy proceeding, a number of LTCM’s trading partnersbailed out the company, investing in return for an equitystake and operational control. So, there was no opportunityto test the extent of netting protections in a bankruptcyproceeding.

The proposed legislation clarifies and broadens nettingprovisions which apply to: (1) depository institutions,which are governed by the Federal Deposit Insurance Act;(2) brokers and dealers, which are governed by the

Securities Investor ProtectionAct of 1971; and (3) others,which are governed by the Unit-ed States Bankruptcy Code. Theproposed amendments broadenthe definitions of terms describ-ing the types of contract whichare subject to “safe harbor”exceptions to the otherwiseapplicable insolvency stay andavoidance provisions of thesestatutes. The broadened defini-tions clarify that the termsinclude a broader array of swap

and other derivative transactions (including, in some cases,transactions that are “similar” to those described in thestatute, and, in the case of swaps, including generally, anytransaction that “in the future becomes the subject ofrecurrent dealings in the swap markets”). The broadeneddefinitions also cover any combination of agreements ortransactions in the specified types of derivatives, and mas-ter agreements. A “master agreement” may relate to varioustypes of derivatives, so that cross product netting ofamounts due under one type of contract against amountsdue under another type of contract is permitted.


Netting of Derivatives Contracts In the Spotlightin Congress and at Enroncontinued from page 11

The issue of theenforceability of nettingarrangements has beenhighlighted in the newssince Enron Corp. filedfor bankruptcy protectionon December 2, 2001.

13

Netting of Derivatives Contracts In the Spotlightin Congress and at Enroncontinued from page 12

Supporters of the netting proposals, such as the MFA, havestated that these reforms would help promote the orderlytransfer, liquidation or close out of financial contracts ofa troubled financial institution and provide more legalcertainty. The SEC, the CFTC and the organization chargedwith overseeing the financial services industry in the U.K.(the Financial Services Authority, through its predecessorthe Securities and Investments Board) have agreed that“Appropriate netting arrangements that are legally en-forceable in a bankruptcy proceeding are a criticalcomponent of risk management by enabling financialmarket participants to control and manage their creditexposure to counterparties,” and have advocated therelevant amendments to insolvency laws. During 1999,the President’s Working Group on Financial Markets alsorecommended that Congressenact provisions to supportfinancial contract netting.

Industry representatives havecited a number of specific bene-fits which arise when insolvencylaw allows the en-forcement ofnetting provisions and doesn’tmake them subject to any stay,nor allow the insolvency receiv-er (or other equivalent party) to“cherry pick” the debtor’sfinancial assets through selectiveapplication of avoidance provi-sions – that is, to enforce transactions that are favorable tothe defaulting party but repudiate the transactions that arefavorable to the non-defaulting party.

A representative of the Financial Services Roundtable intestimony before the U.S. House Committee on Banking andFinancial Services noted, in particular, the following points.First, netting allows credit providers under these contractsto calculate their exposure to counterparties with greatercertainty. Second, netting reduces risk by reducing thecredit providers’ exposure from the gross to the net amount

under the contracts involved, making it more likely thatcreditors will continue to transact business withcounterparties whose credit is deteriorating. This, in turn,allows those counterparties the opportunity to strengthentheir financial position, and makes it less likely that asingle large default will have a ripple effect throughoutthe industry. Third, under the risk-based capital rules ofbanking regulators, reduction in counterparty obligationsthrough netting enables banks to reduce their capitalneeds, and therefore to reduce their prices. Finally, byincreasing certainty and reducing risk and cost, nettingenhances the liquidity of global financial markets. 2002may be the year that netting legislation is passed, due towidespread support and the spotlight shone on the issueby the Enron bankruptcy. ■

Michael P. Malloy is the head ofand a Partner in the Invest-ment Management Group([email protected]);Warren T. Pratt is a Partner inthe Bankruptcy Group ([email protected]); and JoanOhlbaum Swirsky is Counsel inthe Investment ManagementGroup ([email protected])at Drinker Biddle & Reath LLP.

Drinker Biddle & Reath LLP, aPennsylvania Limited Liability

Partnership, is a full service law firm of more than 425attorneys headquartered in Philadelphia, PA, with officesin New York, NY, Princeton and Florham Park, NJ,Berwyn, PA, Washington, DC and Los Angeles and SanFrancisco, CA. The Investment Management Group of thefirm includes over 50 professional and support staff,including approximately 25 attorneys. The Group advis-es a broad array of investment management clients onfinancial services, products and related matters, includ-ing alternative products such as private funds.www.dbr.com

On December 10, 2001,Enron submitted a motionfor authority to negotiateand enter into terminationagreements for its der-ivatives and nettingcontracts.

14

As equity market profits have eroded over the lastcouple years, interest in hedge funds and other liquidalternative investment strategies has increased dram-

atically. Once considered investment toys of the wealthy,hedge funds are quickly becoming part of mainstreamportfolios as a diversifier to traditional holdings. Thesefunds satisfy investor demand for market diversification,often through the use of hedging, leveraging, or varioustrading strategies. As the demand for hedge fund productsincreases, financial services firms and members of thebrokerage community are looking for means to facilitaterelated products.

Insurance companies are oneexample of traditional financialservices firms integrating hedgefunds into their offerings. Whilemany insurance companiesembrace the hedge fund con-cept, finding efficient ways tofeed hedge fund products totheir policyholders is still a workin progress. Within this article,we attempt to illustrate a simplebridge between the hedge fundand insurance language andproducts, attempting to uncover the edge that exists incombining these fundamental vehicles of traditional andalternative investment worlds.

Insurance OverviewFirst, we will consider some insurance basics. A key featureto distinguish among various insurance products is flex-ibility. The simplest insurance products do not offer policyholders their choice of underlying investment vehicles orpayment structure, while more sophisticated products offercustomization in almost every area. Figure A (on page 15)outlines some of the rudimentary elements of commoninsurance products; below, we summarize someimportant points.

One broad distinction to make among insurance productsis whether or not they build cash value. Cash value pro-ducts introduce an investment component and thus will bethe focus of our discussion. Cash value insurance prod-ucts generally have higher premiums than term insurance

products. Essentially, the policyholder overpays the premi-ums and assets are considered the cash value of the policy.The cash value is invested to build up overall policy assets,and monthly withdrawals are made to cover the cost ofinsurance and related charges, see Figure B (on page 16).Because returns on investments made under the lifeinsurance wrapper compound tax-deferred, insuranceemerges as a tax-advantaged investment vehicle.

A simple cash value product is whole life insurance.Generally, a whole life policy consists of fixed premium pay-ments where the policy’s cash value is invested in the insur-

ance company’s general account.The insurance company oftenmanages this account internally,investing in conservative equityand fixed-income funds. Univer-sal life insurance is similar, butthe policyholder may adjust thepremium payments and facevalue of the policy. The cashvalue, however, is invested in anew money rate portfolio.

Variable products introduceflexibility to the underlying investment vehicle and are oftencombined with universal policies to create a similar prod-uct known as variable universal life insurance. In vari-able universal products, the policyholder decides how thecash value will be invested. The issuing company typicallyoffers a directory of traditional stock, bond, and moneymarket mutual funds to choose from. (At this point, it’s stilltoo soon for hedge funds to be an option). Returns onthese investments compound tax-free. The risk in this typeof policy is that the cash value of a policy can decrease withill-performing investments. As financial markets have strug-gled in recent years, this possibility has become a legiti-mate concern.

Products for the Sophisticated Investor In response to the need for higher returns and morediversification in underlying investments, insurancecompanies have introduced a new wave of insurance

Private Placement Life Insurance: The NewAlternative in InsuranceBy Brad Cole and Christine Kailus, Cole Partners LLC


Private placement lifeinsurance (PPLI) is onlyavailable to accreditedinvestors who may chooseto invest their policyassets in hedge funds.

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Private Placement Life Insurance: The NewAlternative in Insurancecontinued from page 14

Figure A


16

products. This is where the diversification benefits ofhedge funds emerge.

Investors seeking uncorrelated returns now have the optionof purchasing private placement life insurance (PPLI),which is essentially an unregistered variable universalpolicy. Because these policies are considered privateplacements, PPLI is only available to accredited investors.As such, these investors may choose to invest their policyassets in hedge funds.

There are two ways to invest in private placement products:offshore and domestic onshore. Many states were slow tolift restrictions on insurance companies investing in hedgefunds, which initially prompted some hedge fund investorsto create this type of arrangement offshore. Schmidt Finan-cial Group is a Chicago-based financial consulting firm thatspecializes in implementing offshore private placement lifeinsurance products. Their clients are usually investors whowould like to invest their existing hedge funds with theinsurance tax wrapper.

“The overall motive here is not for insurance, but for taxdeferral,” Sandy Schmidt, president of Schmidt FinancialGroup, says.

This idea seems to have caught on; many states have relaxedtheir restrictions on insurance investments and many of thelarge domestic carriers are becoming involved as well.

Bob Hebron, senior vice president of New York LifeInsurance Company explains why PPLI can be so attractiveto policyholders: “The build-up on these investments, aslong as the product stays within the realm of life insurance,is tax deferred.”

Hebron notes several qualifications a PPLI must meet inorder to maintain its tax-deferred “life insurance” statusunder the Internal Revenue Code. One requirement con-cerns investor control. If the policyholder has too muchcontrol over the underlying investments, the policy willnot qualify as life insurance. Policyholders may talk to



Figure BStructure of a GeneralCash Value Product

Monthly costs include:

a) cost of insurance

b) administration charges

c) mortality and expense charges

17


the manager if they have questions about the fund or performance, but should not have the ability to influencethe investment decisions of the manager. Essentially, theinsurance company becomes the client of the hedgefund and the policyholder owns an insurance contract;they do not own the underlying investments. Anotherrequirement pertaining to underlying investments relates todiversification. According to section 817(h) of the InternalRevenue Code, no more than 55 percent of the value of thetotal assets of the account can be placed with any oneinvestment. No more than 70 percent may be placed withany two investments; no more than 80 percent with anythree investments; no more than 90 percent with anyfour investments.

A third requirement considers the amount that is investedversus the amount that is available for insurance. If theratio of premium payments to death benefit is too great, thepolicy may be classified as a modified endowment contractand lose the benefit of tax-free policy loans.

Products that meet these requirements will be consideredlife insurance and growth on underlying investments willaccumulate tax-deferred. The death benefit will also be tax-deferred. These tax benefits are applicable to any life in-surance product, but in the case of PPLI, the advantagesmay be more significant for two reasons. First, becausePPLI is only available to accredited investors, the largeramount of assets involved can create higher tax conse-quences for a non-deferred strategy. Second, hedge fundsare typically short-term trading vehicles, which can subjecttheir returns to significant taxes when considered withoutthe insurance wrapper.

“When it comes to hedge funds, people see the possibilitiesfor higher returns but also see the tax consequences,” JudyRudnick, industry knowledge manager for the Family OfficeExchange says. “The advantage here is that you can investin a taxable investment that has a high rate of return, butwithout certain tax consequences.”

The Family Office Exchange (FOX) is an organization thatacts as an independent resource for wealthy families whooperate single or multi-family offices. Rudnick is involvedwith a FOX program that provides a PPLI solution to weal-thy families. Underlying investments may grow tax-deferreduntil death, but they will eventually still become an estateplanning issue. Therefore, Rudnick suggests that PPLI

investors work with an estate planner to configure themost inclusive tax-advantaged scenario.

Another consideration policyholders face is that in orderfor a hedge fund to be involved in a life insurance product,large domestic insurance carriers often require that thefund only accept insurance money. To meet this require-ment, Hebron notes, hedge funds generally createa “clone” of their original fund that only accepts lifeinsurance assets. This generally does not happen in thecase of offshore products because investment managers areoften negotiating with a smaller, less well-known insurancecarrier that does not require an insurance-only fund.

The process of structuring a customized private placementcontract can take as long as six to nine months. In anattempt to make the process more efficient, New York Lifeand other large insurance carriers are starting to createprivate placement products that will bring hedge funds tothe table, rather than have the investor choose the funds.These new products will give policyholders the option ofinvesting in hedge funds that a) the insurance company hasalready negotiated with and b) already have insurancefunds established. The advantage of a product like this isthat the investor does not have to seek out a hedge fundand start the clone fund alone.

“Previously, only a certain number of accredited investorshad the resources to initiate a PPLI product,” Hebron says.“To start the insurance fund, they would need at least $10-$20 million and insurance underwriting. Hedge fund in-vestors are used to a $1 million minimum investment.Because PPLI has more substantial minimum, it has beenvery hard – up until now – for such investors to go intoprivate placement life insurance.”

PPLI products offer a minimum investment that can be aslow as $1 million, but is commonly closer to $5 million(Minimum investments are determined jointly by the insur-ance company and investment manager). The minimuminvestment often has premiums paid in over a few years,thus reducing the initial investment.

“Someone could potentially invest in a private placementproduct for $250,000 a year,” Schmidt says.


PPLI Risks and RegulatorsInvestors must consider, however, that investments madewith the cash value of one’s policy may not necessarilygenerate a profit. If the investor’s chosen fund proves tobe ill-performing, the investor may have to sell shares,realize a loss, and invest in something else. The realizedloss cannot be used to offset personal realized gains forincome tax purposes.

The law firm of KMZ Rosenman has facilitated the pro-duction of hedge fund insurance products, representedinsurance companies negotiating PPLI products, andrepresented individuals investingin PPLI. Wesley Nissen, a partnerin the Chicago office of the firm,notes another important consid-eration for PPLI investors – cred-it exposure. When an investorbuys into a fund directly, theinvestor is generally subject onlyto the credit risks of the funditself. However, when investingthrough PPLI products, theinvestor also is subject to thecredit risks of, and possibledefaults by, the insurance carrier.“Investors should look to thestrength of the institution theyare buying from,” Nissen says.“It may be important.”

For example, in the occurrenceof carrier insolvency, the assetsin a segregated private placement account are safe fromcreditors, but the death benefit (the net amount at risk –the difference between the cash value and the death bene-fit) may be subject to claims of other creditors.

The Securities and Exchange Commission (SEC) doesnot regulate private placement products because they areunregistered, but two new regulatory figures emerge inits absence.

The Internal Revenue Service (IRS) regulates the taxtreatment of different life insurance policies and monitors

investor control. Most insurance companies, when creatingPPLI products, use Section 817(h) of the Internal RevenueCode as their guide and may interpret it as conservativelyor aggressively as they feel comfortable doing, whichexplains the variance among policy norms. Well-knownlarge domestic carriers tend to have a more conservativeinterpretation, while less well-known offshore carriers maytake a more aggressive stance. There is no need for officialregulatory approval because the product is a private place-ment, but the product must lie within the boundaries of817(h) to have tax-deferred status.

The other regulatory body is theinsurance industry. Hedge fundmanagers have a certain amountof freedom not available to man-agers of SEC-regulated products,but must accommodate the reg-ulatory requests of an insurancecompany to get involved in PPLI.When negotiating with hedgefund managers, insurance com-panies often employ a thoroughdue diligence process anddemand a high level of trans-parency. Again, the company’sinterpretation of 817(h)determines how rigorousthis process can be.

These products may presenthedge fund managers with anopportunity for new assets and

an additional marketing channel, but they also introducesome new considerations.

One very important issue is the new “clone” fund amanager may have to create for onshore carriers. Thenew fund can be created through a partnership arrange-ment whereby the hedge fund manager sets up a partner-ship with the insurance carrier and the carrier has partnerownership of the fund.

18



The Internal RevenueService (IRS) regulatesthe tax treatment ofdifferent life insurancepolicies and monitorsinvestor control. Mostinsurance companies useSection 817(h) of theInternal Revenue Codeas their guide and mayinterpret it as they feelcomfortable doing.

After the fund is established with insurance assets, the man-ager may co-mingle assets from other insurance carriers. Itis important to note that each policy counts as one investorunder the regulations regarding 3C1 or 3C7 funds, thuscapacity may become a concern for the hedge fund manag-er. Being aware of exactly how many policyholders areinvested under the insurance company’s holdings is theresponsibility of the manager.

Another issue to consider is the liquidity requirements setforth by the insurance carrier. Lock up periods for hedgefunds may range from one month to over a year, but be-cause the insurance contract requires certain payouts to bemade from a policy, the hedge fund manager may have tomake some adjustments. There are two issues to confrontwhen discussing liquidity: 1) coverage for monthly policywithdrawals and 2) coverage for death benefit payouts.Depending on the policy and the agreement between themanager and insurance carrier, the manager may berequired to surrender some of his lock-up provisions. Inthe case of the death benefit payout, the manager may beasked to provide emergency liquidity, whereby lock-up pro-visions are waived at a policyholder’s death and assets maybe redeemed. Once these matters are dealt with though, themanager can essentially go about business as usual.

Beyond the PPLI MarketplaceWith all the recognizable advantages of these products,insurance companies and managers alike are nowfocusing on bringing related products to a wider audience.For example, institutional investors who find PPLI withembedded hedge fund components attractive can findsimilar investment opportunities in the form of structuredproducts. Insurance companies have been engineeringthese products in the form of guaranteed notes.

Products aimed at institutional clients are becomingavailable with the tax-advantaged insurance wrapper.At AEGON, one of the world’s largest insurance groups,they are developing a product geared toward theinstitutional investor.

According to Mike Herp, director of business developmentfor AEGON’s Structured Products division, the product will

be a medium-term, principal guaranteed note. Assets withinthis product will initially be fully invested in hedge funds orfund of funds. If performance deteriorates, some assets willbe moved to an “immunization cell” of fixed incomeinvestments. The investor fully participates in the returns(net of fees) of the fund and fixed income investments. Thereturns on these investments will accrue and be paid out asa lump sum at maturity. The accrual of returns is assumedto be tax-deferred, but as the product is aimed at offshoreinstitutional investors, the payout at maturity will be subjectto tax regulations of the investor’s home country.

The principal is guaranteed, so the investor gets at least theprincipal amount when the note matures. The aim of aproduct like this is to allow institutional investors access toalternative investments while mitigating some of the riskassociated with such investments. In order to protect theinvestor’s assets, there is a stop-out point at which allhedge fund assets will be transferred to fixed income inv-estments. “We have derived a formula,” Herp says. “If thecushion begins to erode, cash in hedge funds or fund offunds will be transferred to fixed-income instruments.” Thisproduct demonstrates a new approach to these insuranceofferings, and we are bound to see more in the future.

Private placement life insurance is a hot topic in theinsurance world; it’s a hot topic in the hedge fund world.The bottom line here is that there is an exceptional opp-ortunity for tax deferral for hedge fund investors. The bene-fits of investment diversification are secondary, and theneed for actual life insurance is tertiary at best. When youcouple this with an attractive fee stream to the brokers,we will most likely witness an aggressive shift in productmarketing to help exploit this opportunity.

Between the structured notes for institutions, the domesticpre-packaged offerings of the bigger insurers, and thecustomized offshore partnerships, hedge funds are movingcloser to mainstream America. Does this signal the broadbased inclusion into whole life products for non-accreditedinvestors? It is too soon to tell.

Right now, what’s most important is to gain understandingof the language and risks involved with matching hedgefunds to insurance related private placements. ■

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20

CFTC Expands Rule Concerning QualifiedEligible PersonsBy Steven J. Fredman, Partner, ([email protected]), Lawrence T. Eckert, Associate, ([email protected])and Peter W. Gold ([email protected]), Schulte Roth & Zabel LLP

In August 2000, the Commodity Futures Trading Commis-sion (CFTC) adopted amendments to its Rule 4.7 (New4.7), expanding the categories of “qualified eligible

persons” (QEPs), to whom commodity pool operators(CPOs) and commodity trading advisors (CTAs) may provideservices without compliance with most otherwise applicabledisclosure, reporting and recordkeeping requirements. New4.7 aligns the new QEP definition more closely with the typesof investors that are permitted to acquire interests in privateinvestment funds excepted from registration under Section3(c)(7) of the Investment Company Act of 1940 (ICA).

BackgroundFor CPOs, Rule 4.7 permits an exemption from otherwiseapplicable CFTC disclosure rules which generally requirethat an offering memorandum contain extensive informa-tion, as specified by such rules, and be pre-cleared bythe National Futures Association (NFA). For a pool that isexempt under Rule 4.7 (an exempt pool), a CPO needonly distribute to pool investors a quarterly reportcontaining certain information concerning the pool’s netasset value for the period and an annual financial report(the latter must be filed with the CFTC and NFA) Inaddition, the CPO of an exempt pool must maintain certainbooks and records of the pool, including informationsubstantiating each investor’s status as a QEP andperformance representations.

For CTAs, Rule 4.7 permits, for each advisory accountexempt under Rule 4.7 (an exempt account), relief fromCFTC disclosure and investor reporting rules that wouldotherwise apply. A CTA managing one or more exemptaccounts under Rule 4.7 must maintain certain booksand records related to the account, including informationsubstantiating the status of the account’s owner as a QEPand performance representations.

QEP DefinitionWhile all of those persons who qualified as QEPs under theprior Rule 4.7 continue to qualify under New 4.7, the New 4.7expands the group of qualifying persons generally. Among theadditional persons that are now defined as QEPs are:

1) “qualified purchasers” as defined in Section2(51)(A) of ICA (essentially, individuals and “family”entities that have investment portfolios of at least $5million in value, and other investors having investmentportfolios of at least $25 million in value);

2) “knowledgeable employees” as defined in ICA Rule3c-5 (very generally, executive officers and employeesthat actively participate in the management of the fund’sinvestments);

3) trusts, provided that the trustee or person autho-rized to make investment decisions for the trust, andeach settlor or other person who has contributedassets to the trust, is a QEP;

4) affiliates (i.e., a person that directly or indirectlycontrols, is controlled by, or is under common controlwith the CPO or CTA) of the CPO or CTA;

5) principals (as defined under CFTC rules) of (i)the exempt pool, (ii) the CPO, CTA or an investmentadviser to the exempt pool, (iii) the CTA of the exemptaccount, or (iv) an affiliate of any of the foregoing;

6) under certain circumstances, the spouse, child,sibling or parents of certain “insiders”;

7) certain transferees; and

8) non-United States persons investing in an exemptaccount (prior Rule 4.7 only addressed non-U.S.persons investing in exempt pools).

Specific Aspects of the New QEP Definition

Offshore Pools with U.S. and Non-U.S. Investors.As was true with respect to the prior Rule 4.7, a non-UnitedStates person includes as a QEP a pool with both non-Unit-ed States persons and United States persons as members, aslong as less than 10% of the beneficial ownership of thepool is held by United States persons and the pool is notformed principally to include non-QEP United States


21

persons. New 4.7, however, explicitly excludes from the10% calculation United States persons that are QEPs.

Trusts, Charitable Organizations and Pools.New 4.7 would make it easier for certain funds of funds,charitable organizations and trusts to be QEPs. Under theprior Rule 4.7, not more than 10% of the fair market valueof the assets of the trust or other collective investmentvehicles could be used to purchase interests in exemptpools, unless all participants in the trust or other collectiveinvestment vehicle were themselves QEPs. Under New 4.7,the “10% rule” is eliminated; therefore, any trust or othercollective investment vehicle can qualify as a QEP, investingup to all of its assets in exemptpools or accounts, if it has over$5,000,000 in assets, it is notformed for the purpose ofinvesting in an exempt pool orexempt account and its invest-ments are directed by a QEP.Alternatively, a trust qualifies asa QEP under New 4.7, even if itdoes not meet the foregoingrequirements, if (1) the trust isnot formed for the purpose ofparticipating in an exempt poolor opening an exempt accountand (2) the trustee or other per-son authorized to make theinvestment decisions for thetrust and each settlor or otherperson who has contributed assets to the trust is a QEP.

Certain CPOs, CTAs, Employees of Pools, Agentsand Certain of those Employees’ ImmediateFamily Members.In addition to “knowledgeable employees,” New 4.7includes in the definition of QEP (1) any employee of theexempt pool, CPO, CTA, or investment adviser of the exemptpool or their affiliates or (2) an agent engaged to performlegal, accounting, auditing or other financial services forthe exempt pool, CPO, CTA or investment adviser of theexempt pool, or their affiliates that: (1) is an accredited

investor as defined in Rules 501(a)(5) or 501(a)(6) underthe Securities Act of 1933 (Accredited Investor); and (2)has been employed by his or her present employer, or byanother person engaged in providing commodity interest,securities or other financial services, for at least 24months. Financial, compliance and operational profession-als, brokers, traders and attorneys who would not qualifyas QEPs because they are not “knowledgeable employees,”as defined in the ICA, could qualify as QEPs under this ruleif they are accredited investors and have two years of rele-vant experience. Employees who perform solely clerical,secretarial or administrative functions would not be includ-

ed in this QEP definition.

New 4.7 includes similar quali-fications for employees oragents of CTAs of exemptaccounts or their affiliates inorder for such employees oragents to qualify as QEPs.

Family Members.New 4.7 includes as a QEP thespouse, child, sibling or parentof (1) the CPO, CTA or invest-ment adviser to an exempt pool,(2) a person who is a principalor an employee (who himselfor herself qualifies as a QEP, asdiscussed above) of the CPO,CTA or investment adviser, and

(3) an affiliate of any of the foregoing (related QEP); pro-vided that the investment in the exempt pool by any familymember of a related QEP is made with the knowledge of,and at the direction of, the related QEP. Similarly, New 4.7includes in the QEP definition the spouse, child, sibling orparent of the CTA of an exempt account or of a person whois either an affiliate, principal or employee (who himself orherself qualifies as a QEP) of the CTA (also a related QEP),provided that the establishment of an exempt account byany family member is made with the knowledge and at thedirection of the related QEP.

CFTC Expands Rule Concerning Qualified Eligible Personscontinued from page 20

Rule 4.7 aligns the QEPdefinition more closelywith the types of investorsthat are permitted to ac-quire interests in privateinvestment funds exceptedfrom registration underSection 3(c)(7) of theInvestment CompanyAct of 1940.


22

MFA on AccountingMFA on Accounting

As it has been known for sometime, the CommoditiesFutures Modernization Act of 2000 authorized the tradingof securities futures contracts. However, two years later,one still can not actually trade a securities futures contracton a U.S. exchange and certain regulatory and tax questionsstill remain unanswered. The IRS finally issued a pro-nouncement, Revenue Procedure 2002-11, that sheds alittle light on one aspect of the tax treatment for securitiesfutures contracts. Some critics of this ruling would insiston emphasizing the word “little” regarding the actuallevel of guidance given because they believe that thisruling is tantamount to a “decision not to decide.” Is thehype associated with this ruling accurate? Did the IRS“decide not to decide?” You decide!

Before we provide an update on this issue, a brief recapmay be in order. The Internal Revenue Service (IRS)published a notice in 66 Federal Register 13836 (March 7,2001) soliciting comments on the criteria that should beused to determine whether a taxpayer should be considereda dealer in securities futures contracts for Internal RevenueCode (the Code) Section 1256 purposes. As we previouslystated in our August 2001 article titled Securities FuturesContracts Update, we responded to the IRS request forcomments. We lobbied for an expansion of the definitionof dealers to include taxpayers other than those that havetraditionally been considered dealers such as, investmentpartnerships. We are also aware of other submissionstouting both expanded definitions and restricted definitions.Please keep in mind that regardless of how “dealer” isdefined, it is our understanding that Code Section 1256treatment for securities futures contracts will essentiallynot be available for investors. Only those who are activein a trade or business can qualify for this favorabletax treatment.

Although the IRS issued Revenue Procedure 2002-11, as wepreviously stated, many critics in the industry have deemedthis ruling as a “decision not to decide.” The following dis-cussion provides a brief examination of this recent ruling,as well as a glimpse into the intentions behind the ruling.

Revenue Procedure 2002-11 discloses the procedures thatan exchange may follow to enable the IRS to determinewhether persons trading on that exchange under certaindefined criteria qualify as “dealers” under Section 1256(g)(9) of the Code. Basically, this guidance will come inthe form of a request by an exchange for a private letterruling (PLR). Each exchange must request a PLR in orderto determine whether a specific category of persons tradingsecurities futures contracts, as well as options on suchcontracts, on that exchange qualifies for dealer statusunder Section 1256(g)(9). After issuing the PLR, the IRSis expected to publish the same conclusion in a revenueruling in a “timely” manner.

While trading rules are being developed by the individualexchanges, and regulatory requirements are being devel-oped by the Securities and Exchanges Commission and theCommodity Futures Trading Commission, the IRS felt thatthe unilateral issuance of proposed regulations on thisissue would not be effective. According to the ruling “giventhe likely diversity of trading platforms and the potentialfor new trading models, the Service and Treasury havedetermined that encouraging exchanges to apply for case-by-case determinations while they are developing theirtrading rules is preferable to either writing general rulesbefore the trading structures are known or waiting untilthe structures are finally established and then making the exchanges wait for a general rule to be crafted.”

We contacted the IRS attorneys responsible for authoringthis ruling, as well as for drafting the language identifyingthe parameters to be used in determining which taxpayersshould be considered dealers for Code Section 1256 pur-poses. Their main concern was that they did not want todraft restrictive regulations that would be impossible froma practical standpoint for individuals who are essentiallyfunctioning in the capacity of a dealer from being treated assuch. They also asserted that priority would be given to allPLRs relating to this issue and that the expected ancillaryrevenue rulings would be issued in a timely manner so that


Dealer SecuritiesFutures Contracts:The IRS “DecidesNot to Decide”By Scott S. Anderson, CPA, and Jeffrey A. Clayman,CPA, Esquire, Arthur F. Bell, Jr. & Associates, L.L.C.

SEC Plans Self-Policing for Mutual Funds, Financial Times FM, 4-15-02

PATRIOT Act Deadline May Be Extended Briefly,Infovest21, 4-12-02

U.S. Hedge Funds May Get Time to Act on MoneyLaundering, Reuters, 4-11-02

Hedge Fund Anti-Laundering Move, Financial Times, 4-9-02

Hedge Funds Get New Guidelines to Battle MoneyLaundering, Financial News (London), 4-9-02

U.S. Hedge Funds Prepare for Laundering Law,Wall Street Journal Europe, 4-8-02

MFA Issues Preliminary Guidance on Anti-Laundering Compliance, Alternative Investment News, 4-8-02

MFA Recommends Starting PATRIOT Act Compliance,Infovest21, 4-8-02

Anti-Money Laundering: MFA Briefing, PreliminaryGuidance, Hedge World News, 4-8-02

Hedge Funds Roll out Anti-Money LaunderingGuide, Reuters, 4-5-02

Hedge Fund Group Issues Anti-Money LaunderingGuidelines, Dow Jones Newswires, 4-5-02

An Insider’s Guide to Alternative Investing, Worth,April 02

Roye Speaks of Hedge Fund Fraud in Speech to ICI,Black Enterprise Magazine, 3-29-02

Hedge Fund Lawyer McCarty to Take GovernmentJob, Reuters, 3-20-02

CFTC Announces General Counsel, Securities Week, 3-11-02

Hedge Fund Worry Anti-Terrorist Regs May DisruptForeign Operations, Securities Week, 3-4-02

Independent vs. Managed Trading, Futures, March 02

Ready or Not, Here Come Single Stock Futures, Global Investment, March 02

Integrity, Fresh Approach Key to More Money,Futures, March 02 ■

23

other individuals trading under similar circumstancescould rely on the guidance provided by the IRS.

Accordingly, taxpayers who hope to expand the definition ofdealer should contact the exchange in which they tradeto ascertain the plans of the exchange with respect topreparing a PLR.

We will continue to monitor this issue and provide an updateif the ultimate outcome warrants additional comments.

The information discussed in this article is codified in Rev-enue Procedure 2002-11 and related code sections. Theaforementioned information is intended to be used as abrief explanation of certain tax aspects with regards todealers securities future contracts and is by no means anexhaustive analysis of the issue. Due to the complexities ofthis topic, we suggest that you consult your tax advisor. ■

Arthur F. Bell, Jr. & Associates, L.L.C. is a publicaccounting firm providing a wide range of accounting,audit, tax and consulting services to the managedfunds industry.

continued from page 22

MFA on Accounting cont’dMFA on Accounting cont’d

Press CheckPress Check

Transferees. New 4.7 also includes as a QEP any person who acquires aparticipation in an exempt pool or an interest in an exemptaccount by gift or bequest or under an agreement relating toa legal separation or divorce from an “Insider” (that is,from any of the CPOs, CTAs, employees, agents and familymembers qualifying as QEPs). In addition, an insider’sestate or a company established by an Insider exclusively forthe benefit of (or owned exclusively by) the insider will alsoqualify as a QEP. This language generally follows the provi-sions of Rule 3c-6(b) under the ICA, which applies to trans-fers of interests in Section 3(c)(1) and 3(c)(7) funds;however, in the case of its applicability to QEPs, this trans-feree rule is limited only to transfers from insiders ratherthan to transfers from all QEPs. ■

CFTC Expands Rule Concerning Qualified Eligible Personscontinued from page 21

Preliminary Schedule of EventsSchedule Subject to Change. Visit www.mfaino.org for schedulte updates

Tuesday, July 911:00 a.m. - 5:00 p.m. Registration Open

12:00 noon - 5:00 p.m. Exhibits Open

12:15 p.m. - 2:00 p.m. Opening Luncheon Keynote Speaker: Sam Wyly, Ranger Capital Group

2:15 p.m. - 3:30 p.m. Concurrent Sessions I:1. Winning an Allocation from a Pension Plan or Endowment – Track B

Moderator: Randy Warsager, Carr Futures, Inc.Panelists: Richard Huddleston, Detroit General Retirement System

2. Single Stock Futures – Track AThomas A. Ascher, Nasdaq Liffe Markets (NQLX)

3:30 p.m. - 4:00 p.m. Refreshment Break in the Exhibit HallSponsor: Eclipse Capital Management, Inc.

4:00 p.m. – 5:15 p.m. Concurrent Sessions II:1. Trading Research/Strategy – Track C2. Trade Execution Plus – Track A/C

4:00 p.m. - 4:30 p.m. MFA Annual MeetingThe annual meeting will address MFA’s programs.

5:00 p.m. - 6:00 p.m. New CTA/New Member Reception Sponsor: Kenmar Asset Allocation, Inc.

6:30 p.m. - 8:00 p.m. Welcome Reception – Your Platform to Global BusinessCo-Sponsors: Chicago Board of Trade, Chicago Mercantile Exchange, Mayer Brown & Platt,Nasdaq Liffe Markets (NQLX), New York Mercantile Exchange

Concurrent Session TracksTrack A – Administrative Track B – Marketing Track C – Trading Management

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Best Practices for Hedge Fund andFutures Professionals

July 9-11, 2002The Fairmont Chicago

oster Growth,

dd Performance

anage Risk,

25

Wednesday, July 10

8:00 a.m. - 5:00 p.m. Registration OpenExhibits Open

8:00 a.m. - 9:00 a.m. Continental Breakfast in the Exhibit Hall

9:00 a.m. – 9:45 a.m. Keynote Address – Regulation and Financial Markets Richard Lindsey, Co-President, Bear Stearns Securities Corporation

9:45 a.m. – 10:30 a.m. General Session: Anti-Money Laundering: Post-September 11 Impact on Fund ManagersModerator: John G. Gaine, Managed Funds Association

10:30 a.m. - 11:00 a.m. Refreshment Break in the Exhibit HallSponsor: Goldman Sachs Princeton LLC/Hedge Fund Strategies Group

11:00 a.m. - 12:00 noon General Session: The Institutionalization of Hedge Funds – Can This Sector Grow Up?Peggy Eisen, DeGuardiola Advisors Dana Hall, Lighthouse Partners

12:15 p.m. - 2:00 p.m. LuncheonKeynote Speaker: Nancy Havens–Hasty, Founder, President and Managing Member,Havens Advisors, L.L.CSponsor: Allied Irish Capital Management, Ltd.

2:15 p.m. - 3:30 p.m. Concurrent Sessions I:1. Risk Reporting to Investors – Track A/C

Panelist: Rich Horwitz, Kenmar Asset Allocation, Inc.

2. Internal vs. External Marketing – Track B Moderator: Burt Kozloff, ARIS Partners, L.L.CPanelist: Bruce Nemitow, Capital Growth Advisors, L.L.C

3:30 p.m. - 4:00 p.m. Refreshment Break in the Exhibit HallSponsor: Chesapeake Capital Corporation

4:00 p.m. – 5:15 p.m. Concurrent Sessions II:1. What to Expect When You Market to Family Offices/High-Net-Worth

Investors – Track B

2. Disclosure Issues for Hedge Funds/Back Office – Track A Panelists: Guy Castranova, Derivatives Portfolio Management, L.L.C. Michael Cyran, Ernst & Young

5:00 p.m. – 6:00 p.m. Exhibitor Reception

6:30 p.m. – 8:00 p.m. Cocktail Reception – MFA Salutes 100 Women in Hedge FundsCo-Sponsors: EMC Capital Management, Inc., Morgan Stanley FX, Sidley Austin Brown & Wood

26

Thursday, July 118:00 a.m. – 3:30 p.m. Registration Open

Exhibits Open

8:00 a.m. - 9:00 a.m. Continental Breakfast in the Exhibit HallSponsor: Willowbridge Associates, Inc.

9:00 a.m. – 9:45 a.m. Keynote Address: Structured ProductsJohn Kelly, Global Head of Hedge Fund Marketing, Man Group plc

9:45 a.m. – 10:30 a.m. Keynote Address - Topic TBDRobert Schulman, President, Tremont Advisors, Inc.Robert Sloan, Managing Director, Credit Suisse First Boston

10:30 a.m. - 11:00 a.m. Refreshment Break in the Exhibit Hall

11:00 a.m. - 12:00 noon General Session: Hedge Fund Incubators Panelists: Jeffrey D. Izenman, BRI PartnersMark Jurish, Hedge Fund Investment Corp.Sarah Street, XL Capital Investment Partners, Inc.

12:15p.m. - 2:00 p.m. Star Search ProgramModerator: Esther Goodman, Kenmar Asset Allocation, Inc.

Box Lunches will be available

2:15 p.m. - 5:15 p.m. Special Program for Emerging Fund Managers: Best Practices for Success Co-Sponsors: BRI Partners, Rabar Market Research, Inc.

2:15 p.m. – 3:15 p.m. I. Building the Foundation of a Strong Money Management FirmSpeakers to be announced

3:15 p.m. – 4:15 p.m. II. What Asset Allocators Look for in Due DiligenceScott Copenhaver, Morgan Stanley Managed Futures

4:15 p.m. – 5:15 p.m. III. Successfully Raising Assets in the Global MarketplaceSpeakers to be announced

5:15 p.m. – 6:30 p.m. Conference Finale Networking ReceptionSponsor: Derivatives Portfolio Management, L.L.C.

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ADP/OMRAllied Irish Capital Management, Ltd.Bode & Associates, Inc.BRI PartnersCampbell & Company, Inc.Cargill Investor Services Inc.Chesapeake Capital CorporationChicago Board of TradeChicago Mercantile ExchangeDerivatives Portfolio Management, L.L.C.Eclipse Capital ManagementEMC Capital Management, Inc.Goldman Sachs Princeton LLC/ Hedge Fund Strategies GroupJohn W. Henry & Company, Inc.Kenmar Asset Allocation, Inc.Mayer Brown & PlattMorgan Stanley FX

Morgan Stanley Managed FuturesNasdaq Liffe Markets (NQLX)New York Board of Trade

New York Mercantile ExchangeRabar Market Research, Inc.Sidley Austin Brown & WoodWelton Investment CorporationWillowbridge Associates, Inc.

Best Practices for Hedge Fund andFutures Professionals

July 9-11, 2002The Fairmont Chicago

oster Growth,

dd Performance

anage Risk,

Forum 2002 is Sponsored by: