By February 2006, most hedge fund managers will need to be registered with the Securities and Exchange Commission (the “SEC”) and thereby become subject to the SEC’s inspections and examinations program. It is clear from recent SEC enforcement actions that one of the primary areas of focus for the SEC when conducting examinations of hedge fund advisers will be the calculation and dissemination of performance information. The calculation and communication of performance information is governed by the anti-fraud provisions of the Investment Advisers Act of 1940 (the “Advisers Act”), specifically Section 206 of the Advisers Act and, in the case of advertising performance information, Rule 206(4)-1 thereunder.

All hedge fund managers are subject to the anti-fraud provisions regardless of whether they are registered with the SEC. But with the routine examinations that come along with registration, SEC scrutiny of how an investment adviser calculates performance and presents that information to investors and potential investors must now be a major concern for hedge fund managers. Thus, hedge fund managers should closely monitor and evaluate their advertisements, whether or not the advertisements contain performance information, to ensure that they do not violate Rule 206(4)-1.

The purpose of Rule 206(4)-1 is to prohibit investment advisers from misleading investors by engaging in fraudulent, deceptive, or manipulative activities. Rule 206(4)-1 defines advertisements as offers of investment advisory services regarding securities, which are communicated or addressed to more than one person, or made in any publication or by radio or television. Although these rules do not specifically apply to one-on-one presentations, it is still illegal to mislead potential investors regardless of the context.

Accordingly, below we have provided a brief overview of certain considerations for investment advisers when creating communications to clients. The factors provided below are intended to give investment advisers an idea of the types of information that should or should not be included in an investment adviser’s client communications. This overview is not intended to address all advertising practices nor is it intended to cover all factors that the SEC may consider when determining whether an advertisement violates Rule 206(4)-1.

Generally, an investment adviser’s advertisement should accurately state all information and contain prominent disclosures (i.e., not in the footnotes) of the following, if applicable:

• the effect of material economic and/or market conditions on the investment results;

• whether the investment results reflect any re-investment of dividends, interest, or other earnings;

• whether the investment results reflect the deduction of advisory fees, brokerage or other commissions, or any other expenses charged to the client;

• that past performance does not guarantee future results;

• all material facts regarding any comparison with an index;

• all material conditions, objectives, or investment strategies used to obtain the investment results; or

• if the investment results are hypothetical, then the methodology used to create the hypothetical performance results.

If actual performance results are used, the advertisement should prominently disclose the following, if applicable:

• that the results portrayed only relate to a select group of clients, the basis for the selection of these clients, and the effect of this practice on the results portrayed, if material;

• the material changes in the conditions, objectives, and/or investment strategies of the investment portfolio during the period portrayed and the effect of the changes;

• that a portion of the investment portfolio’s securities or strategies do not relate, or only partially relate, to the investment adviser’s current services; or

• that the investment adviser’s clients’ investment results materially differed from the results portrayed in the investment portfolio.

In addition, an investment adviser’s advertisement should not:

• contain a testimonial (i.e., a statement of a client’s experience with or endorsement of an investment adviser) regarding the investment adviser or the investment adviser’s advice, analysis, report, or other services;

• refer to any past specific recommendations that were or would have been profitable, unless the investment adviser provides or offers to provide a list of all recommendations made within the one-year period preceding the advertisements, the information relevant to the recommendation (e.g., the name of the security recommended; whether to buy, sell, or hold; the gain or loss on the recommendation; etc.), and a statement, in a font size as large as the largest font size used in the relevant text, which states “it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list”;

• represent that any graph, chart, formula or other device offered could be used to make a trading decision, without prominently disclosing the limitations and/or difficulties with respect to its use;

• state that a report, analysis, or service is free when it is not;

• contain any untrue statement of material fact or be false or misleading; or

• make a claim about potential profit without mentioning the possibility of loss.

Investment advisers who are concerned that their client communications may contain information prohibited by Rule 206(4)-1 should review the SEC’s “no-action letters” pertaining to advertisements under Rule 206(4)-1 for guidance. An investment adviser may also seek it’s own request for “no-action” assurance from the SEC, however, advisers should think long and hard before approaching the SEC with an idea for an advertisement or the presentation for performance that could later be found to have violated the anti-fraud provisions of the Advisers Act.

Note:

White & Case LLP represents hedge fund and private equity fund sponsors and advisers, prime brokers, and administrators through its 38 offices in 25 countries around the world. For further information on the White & Case investment funds practice, contact:

Jay B. Gould, Esq.
White & Case LLP

Four Embarcadero Center, 24^th Floor
San Francisco, California 94111
415-544-1112 (O)
310-800-6500 (C)
jgould@whitecase.com

Michael G. Wu, Esq.
White & Case LLP

Four Embarcadero Center, 24^th Floor
San Francisco, California 94111
415-544-1104 (O)
415-722-8476 (C)
mwu@whitecase.com