O n December 18, 2003, the National investment company, investment - PDF document

G Investment Management Alert March 2004 Rule 2790 Dealing with New Issues: Deadline for Compliance is March 23, 2004 O n December 18, 2003, the National investment company, investment adviser, or Association of Securities Dealers, Inc. collective investment account (including a hedge (the “NASD”) issued a Notice to fund); and certain immediate family members (as Members adopting Rule 2790 (the “Rule”), which defined in the Rule) of any of the aforementioned deals with the sale and purchase of new issues – persons. Note that hedge fund investment initial public offerings of equity securities. Firms managers (“Fund Managers”), who were must be in compliance with the Rule by March 23, “conditionally restricted persons” under the Free 2004. This alert summarizes the most important Riding and Withholding Interpretation, are issues arising from the adoption of the Rule. For Restricted Persons under the Rule. more detailed guidance on the differences between To comply with the Rule, brokers will require Rule 2790 and the previous rule issued by the their clients (the funds) to obtain information NASD, the “Free Riding and Withholding about the funds’ investors to determine if they are Interpretation,” see our Investment Management Restricted Persons under the Rule. Initially, this Alert, “SEC Adopts NASD Rule 2790 to information must be obtained by a positive Replace ‘Hot Issues’ Rule,” available at certification from each investor; it must be http://www.lowenstein.com/new/InvMngt12-03.pdf. updated every 12 months. Based on these certifications, a Fund Manager will be able to Collecting Information about Investors certify to a broker selling new issues whether or not Securities brokers selling new issues must the fund is eligible to purchase new issues. determine before each sale whether the purchaser is a “Restricted Person” under the Rule. “Restricted Although funds may have certifications from Persons” include: NASD members and other their investors pertaining to the Free Riding and broker-dealers; officers, directors, general partners, Withholding Interpretation, it is advisable for associated persons, employees, and certain owners every fund to obtain a re-certification from existing and affiliates of members and broker-dealers; investors who have not submitted a recent portfolio managers, i.e., persons or entities with the certification. Please contact Lowenstein Sandler authority to buy or sell securities for a bank, savings to obtain an updated form of questionnaire for and loan institution, insurance company, investors. This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. L Roseland, New Jersey Telephone 973.597.2500 65 Livingston Avenue www.lowenstein.com 07068-1791 Fax 973.597.2400

G recordkeeping and accounting complications that Funds with Restricted Person Owners would arise from using such partial carve-out Funds in which Restricted Persons, in the methods. aggregate, own less than ten percent of the ownership are considered “unrestricted” and are eligible to The Notice to Members also provides for a post- purchase new issues. A fund that has entity investors IPO re-allocation. Although not permitted to will have to “look through” to determine aggregate share in the gains and losses from new issues, Restricted Person ownership. The NASD Notice to Restricted Persons may participate in subsequent Members adopting Rule 2790 illustrates the method gains and losses from securities that originally were by which a fund should look through to the purchased as new issues. The fund’s accounting underlying beneficial owners of the entity investor records must reflect a re-allocation of the securities and multiply (i) the percentage of the entity investor that originally were purchased as new issues among owned by Restricted Persons, by (ii) the percentage of the investors’ shares in the fund, at the prevailing the fund owned by the entity investor. If the fund market price. Any fund that wishes to utilize this cannot meet the ten-percent “de minimis” test, the re-allocation provision will need to disclose to Rule allows the fund to purchase new issues only if the investors the procedures to be followed by the fund fund “carves out” the Restricted Persons, as discussed when making such re-allocation. Those procedures in further detail below. should include details on how and at what time of day the market price will be determined. Applying Carve-Out Provisions Management Fees and Incentive Allocations A complete carve-out of Restricted Persons from purchases of new issues, as was required under the Fund Managers, or those with the authority to buy Free Riding and Withholding Interpretation, may or sell securities for a collective investment account, still be used under the Rule. Based upon informal are restricted under the Rule. However, the Rule guidance provided by the NASD, a partial carve- contains an exception for management fees or out, which would allocate not more than ten incentive allocations received by Fund Managers. percent of any new issues purchase to Restricted The exception provides that such fees, although Persons, would also be acceptable. The partial arising from the purchase of new issues, will not carve-out option would require a fund in which increase the fund’s Restricted Person ownership for Restricted Persons owned more than ten percent of purposes of the carve-out exception. However, if the equity to set aside ten percent or less of each management fees and incentive allocations were to new issues purchase and to allocate a pro rata be reinvested in the fund on the Fund Manager’s portion of that amount, based on ownership of the behalf, such fees and/or allocations would then be fund, to each Restricted Person. This could be designated an ownership interest and would be done with separate accounts for new issues or by required to be included in the calculation of adjusting the capital accounts of Restricted Persons percentage of Restricted-Person ownership. accordingly. However, funds should consider

G Changes to Fund Documents If you have any questions regarding this, or any investment management issue, contact a member of the Fund subscription documents should be revised Investment Management Practice Group at to comply with the Rule. Specifically, a Fund 973.597.2500. Manager must be able to determine the percentage interests of Restricted Person owners in the fund. The information obtained from subscription documents will be needed to issue a sufficient statement to broker-dealers selling new issues to Investment Management Practice Group the fund to assure that the sale complies with the Rule. Co-Chairs: A fund’s Agreement of Limited Partnership, Allen B. Levithan, alevithan@lowenstein.com Limited Liability Company Agreement and/or Robert G. Minion, rminion@lowenstein.com Articles of Association should be amended to grant Partners: the general partner, managing member or directors, as applicable, the discretion to distribute and John L. Berger, jberger@lowenstein.com re-allocate new issues profits and losses. Andrew E. Graw, agraw@lowenstein.com Michael N. Gooen, mgooen@lowenstein.com Conclusion Steven J. Tsimbinos, stsimbinos@lowenstein.com Compliance with the Rule will require drafting Counsel: and implementing new policies and procedures, as Thomas L. Fraser, tfraser@lowenstein.com well as adopting amendments to each fund’s documents. To purchase new issues, Fund Paul W. Hartzel, phartzel@lowenstein.com Managers must determine the percentage of the Brian A. Silikovitz, bsilikovitz@lowenstein.com fund owned by Restricted Persons and must be able Douglas N. Bernstein, dbernstein@lowenstein.com to certify such information to a broker-dealer. Associates: Please contact Lowenstein Sandler for Carolene S. Eaddy, ceaddy@lowenstein.com information on implementing the new policies Marie T. DeFalco, mdefalco@lowenstein.com required and on amending fund documents to Elaine M. Hughes, ehughes@lowenstein.com comply with the Rule. Mark A. Dorfman, mdorfman@lowenstein.com For Further Information Scott H. Moss, smoss@lowenstein.com Lowenstein Sandler’s Investment Management Benjamin B. Allensworth, ballensworth@lowenstein.com Practice Group will continue to monitor and report Javier Cuebas, jcuebas@lowenstein.com on developments regarding the issues affecting Erik W. Johnson, ejohnson@lowenstein.com private investment funds and other matters of interest to our clients.