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Investment Management Hot Topics

Allocation of Investment Opportunities Workshop April 4, 2013

1. About the Speakers

2. PowerPoint Presentation

3. Allocation of Investment Opportunities

4. Allocation Documentation Samples


1. About the Speakers

Investment Management Hot Topics © 2013 Schulte Roth & Zabel LLP. All Rights Reserved.

Brad L. Caswell Special CounselSchulte Roth & Zabel LLP919 Third AvenueNew York, NY 10022+1 212.756.2072 | [email protected]

Brad focuses his practice on counseling hedge and private equity funds on operational, regulatory and compliance matters. He provides guidance to clients on a broad range of issues, including those related to the U.S. Investment Advisers Act, other federal, state and self-regulatory organization requirements and securities trading rules in the United States. Brad also provides guidance to clients with operations in Hong Kong, Japan and other markets throughout Asia and the U.K. with respect to regulatory, compliance, trading and operations.

Prior to joining SRZ, Brad served for 12 years in various in-house roles, including as general counsel and chief compliance officer of investment advisers ranging from multi-billion dollar funds to start-ups, and as a member in the asset management group of a leading investment bank. This in-house experience, coupled with his results-oriented approach to legal problem solving, enables Brad to offer clients a valuable perspective on investment management operations and compliance issues.

Brad is also a frequent speaker and writer on the topics of fund operations and regulatory compliance. He presented “Compliance Spotlight” at SRZ’s Private Investment Funds Seminar and addressed the “New Private Placement Rules Under the JOBS Act” for a Financial Executives Alliance forum. Brad recently co-authored “The SEC’s New ‘Presence Exams’“ for The Investment Lawyer and also co-authors a periodic column on regulatory and compliance issues of interest to hedge funds for HFMWeek. His latest column was “The Long View: Why Working Through Every Item on an Extensive Checklist May Obscure the Bigger Risks — Particularly Conflicts of Interest.”

Brad received his J.D., cum laude, from Boston College Law School and his B.A., magna cum laude, from Georgetown University.


Brian T. Daly PartnerSchulte Roth & Zabel LLP919 Third AvenueNew York, NY 10022+1 212.756.2758 | [email protected]

Brian focuses on advising hedge and private equity fund managers on regulatory, compliance and operational matters, including registration and disclosure obligations, trading issues, advertising and marketing and the establishment of compliance programs.

Having spent nearly a decade serving in-house as general counsel and chief compliance officer at several prominent hedge fund firms, Brian is well-versed in a wide range of legal and business challenges facing investment advisers and other financial services entities and has represented clients in proceedings and interactions with regulators in the U.S., the U.K. and Asia. He also has extensive experience interfacing with internal and external resources to design and improve processes and organizational systems.

Brian is well-known for his thought leadership in the regulatory and compliance area as it affects alternative investment funds. He recently co-authored “FSA Conflicts of Interest Safeguards: Action To Be Taken by All UK-Authorised Hedge Fund Managers” for The Hedge Fund Journal and presented on a “US Regulatory Update” and “40 Act Developments” panels at the Bank of America Merrill Lynch COO and CFO Hedge Fund Symposium. Brian has also served as co-chair of the Managed Funds Association’s General Counsel Forum and as a steering committee member of its Investment Advisory Committee. He is a visiting lecturer at Yale Law School, where he teaches a class on legal ethics, and frequently speaks on industry panels and at educational outreach events.

Brian received his J.D., with distinction, from Stanford Law School, his M.A. from the University of Hawaii and his B.A., magna cum laude, from Catholic University of America.


Jennifer DunnPartnerSchulte Roth & Zabel LLP919 Third AvenueNew York, NY 10022+1 212.756.2009 | [email protected]

Jennifer advises hedge funds, private equity funds (including mezzanine and distressed funds), hybrid funds, funds of funds and investment advisers in connection with their structuring, formation and ongoing operational needs, general securities laws matters, and regulatory and compliance issues. Her experience includes structuring and negotiating seed and strategic investments, advising investment managers regarding the structure and sale of their investment management businesses and the structure of their compensation arrangements, and representing investment managers in connection with managed accounts and single-investor funds.

Jennifer most recently participated in “Form PF: A Roundtable Discussion for $5B+ Hedge Fund Managers” at an SRZ conference and “Form PF: Practical Guidance from Industry Experts” at a GlobeOp Insights event.

Jennifer earned her J.D. from Columbia University Law School, where she was a Harlan Fiske Stone Scholar, and her B.A., cum laude, from the University of Pennsylvania.

Marc E. Elovitz PartnerSchulte Roth & Zabel LLP919 Third AvenueNew York, NY 10012+1 212.756.2553 | [email protected]

Marc chairs Schulte Roth & Zabel’s Investment Management Regulatory & Compliance Group and advises private fund managers on compliance with the Investment Advisers Act of 1940 and other federal, state and self-regulatory organization requirements, including establishing compliance programs, registering with the SEC and CFTC, and on handling SEC and NFA examinations. Marc provides guidance to clients on securities trading matters and represents them in regulatory investigations and enforcement actions, arbitrations and civil litigation. He also regularly leads training sessions for portfolio managers, analysts and traders on complying with insider trading and market manipulation laws, and has developed and led compliance training sessions for marketing and investor relations professionals.

Recently, Marc has been working closely with clients undergoing SEC examinations and responding to deficiency letters and enforcement referrals. He has been developing new compliance testing programs in areas such as trade allocations and conflicts of interest. He also has been leading macro-level compliance infrastructure reviews with fund managers, identifying the material risks specific to each particular firm and evaluating the compliance programs in place to address those risks.

A frequent writer and speaker in his areas of expertise, Marc most recently co-authored “The SEC’s New ‘Presence Exams’” for The Investment Lawyer and presented “Compliance and Regulatory Examinations” and “AIFMD for US Private Fund Managers” at SRZ events and webinars. Marc is also a member of the Steering Committee of the Managed Funds Association’s Outside Counsel Forum, the Private Investment Funds Committee of the New York City Bar Association and the American Bar Association’s Hedge Funds Subcommittee.

Marc received his J.D. from New York University School of Law and received his B.A., with honors, from Wesleyan University.



2. PowerPoint Presentation

Notes:

Investment Management Hot Topics | 1© 2013 Schulte Roth & Zabel LLP. All Rights Reserved.

Notes:



3. Allocation of Investment Opportunities

© 2013 Schulte Roth & Zabel LLP. All Rights Reserved. Investment Management Hot Topics | 1

Allocation of Investment Opportunities

I. General Background to Allocation Issues

A. Investment advisers are fiduciaries

1. Investment advisers are, first and foremost, fiduciaries to their advisory clients. Advisers have a fundamental obligation to act in the best interests of their clients and to provide investment advice in their clients’ best interests. Advisers cannot use client assets for their own benefit or the benefit of other clients — at least without client consent.

2. Investment advisers should avoid engaging in any activity that appears to conflict or actually conflicts with the interests of a client. To the extent that an adviser finds itself with a conflict of interest with a client, the adviser must provide the client with full disclosure of that conflict, and seek to mitigate and resolve that conflict. Some conflicts can be resolved through client consent.

3. Departure from this fiduciary standard may constitute “fraud” under Section 206 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), or under Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

B. Allocation of investment opportunities raises serious potential conflict issues

1. In allocating investment opportunities among different clients, advisers need to act in the best interests of each client. The adviser is a fiduciary to each of its clients; thus, it must allocate investment opportunities fairly across clients. A “fair” allocation of opportunities generally includes a consideration of factors such as each client’s individual investment objectives, strategies, risk tolerance and guidelines.

2. Overall, the allocation process must be fair and reasonable, and avoid favoring one client over another client.

3. Conflicts of interest

(a) Differential fee structures

Many investment advisers serve as advisers to multiple funds, including private equity funds and hedge funds with different strategies (such as multi-strategy funds, distressed, event-driven, long/short, credit and quantitative strategies funds). Some advisers may also advise separately managed accounts, mutual funds, business development companies or other funds and accounts (perhaps in addition to advising private equity or hedge funds). These funds and accounts will often carry different fee structures, and some accounts may charge performance fees while others do not. In these situations, there are potential conflicts that create incentives for a manager to favor certain clients over other clients.

(b) Proprietary accounts

Potential conflicts in trade allocations may also arise if a firm manages proprietary accounts (or if the amount of proprietary capital in different funds varies). The Securities and Exchange Commission (the “SEC”) takes the position that if advisory personnel own more than 25 percent of an account, then transactions with that account by other clients are deemed to be transactions with the adviser (i.e., a so-called “principal transaction”). Allocations to proprietary accounts should be specifically addressed in trade allocation procedures.

(c) Allocating profitable trades to proprietary accounts, “dumping” losing trades to less favored accounts, and “cherry picking” profitable trades and re-allocating them to favored accounts are just a few of the potential conflicts that must be avoided and that are the focus of SEC (and, increasingly, National Futures Association (the “NFA”)) exams.


(d) The SEC is focusing on whether appropriate controls and procedures are in place to address these conflicts and on whether the manager has favored certain clients over other clients in allocating trades.

II. Traditional Treatment of Allocation Issues — Aggregate and Allocate Concept

A. If an investment adviser determines that the purchase or sale of a security is appropriate with regard to multiple client accounts, the investment adviser may, but is not obligated to, purchase or sell such a security on behalf of such accounts with an aggregated order, for the purpose of reducing transaction costs, to the extent permitted by applicable law.

B. When an aggregated order is filled through multiple trades at different prices on the same day, each participating account generally will receive the average price, with transaction costs generally allocated “pro rata” based on the size of each account’s participation in the order (or allocation, in the event of a partial fill) as determined by the investment adviser. In the event of a partial fill, allocations may be modified on a basis that the investment adviser deems to be appropriate, including, for example, in order to avoid odd lots or de minimis allocations.

C. When orders are not aggregated, trades generally will be processed in the order that they are placed with the broker or counterparty selected by the investment adviser. As a result, certain trades in the same security for one account (including an account in which the investment adviser and its personnel may have a direct or indirect interest) may receive more or less favorable prices or terms than another account, and orders placed later may not be filled entirely or at all, based upon the prevailing market prices at the time of the order or trade. In addition, some opportunities for reduced transaction costs and economies of scale may not be achieved.

D. Default of “pro rata” allocation

1. Most investment advisers have a general policy that the adviser will allocate investment opportunities fairly and equitably over time.

2. Most advisers have a general rule that they will allocate investment opportunities “pro rata” across funds and accounts for which participation in the respective opportunity is considered appropriate, taking into account, among other considerations:

(a) Whether the risk-return profile of the proposed investment is consistent with the account’s objectives, considered (i) in light of the specific investment under consideration and (ii) in the context of such account’s overall holdings.

(b) The potential for the proposed investment to create an imbalance in the account’s portfolio.

(c) Liquidity requirements of the account.

(d) Potentially adverse tax consequences.

(e) Regulatory restrictions that would or could limit an account’s ability to participate in a proposed investment.

(f) The need to re-size risk in the account’s portfolio.

(g) Investment restrictions.

(h) Risk tolerances.

III. Investment Allocation is a Focus Area for Regulators

A. SEC

1. SEC examinations

(a) Presence examinations


Registered advisers should be on notice that examiners will focus on, and request books and records relating to, among other areas:

Conflicts of interest, which could include an inquiry into the controls and procedures in place to “identify, mitigate, and manage” conflicts of interest, including in areas such as the allocation of investment opportunities, fees and expenses, payments by private funds to an adviser or to its related persons, outside business activities and personal securities trading of adviser personnel, and transactions with affiliates of the adviser.

(b) Selected current SEC exam questions

SEC examiners will ask for data and information relating to allocations of investment opportunities, including the relevant compliance policies and procedures relating to allocations.

Examples of language from exam request letters include:

(i) Portfolio management

(1) Names of securities held in all client portfolios (aggregate position totals for all instruments) as of ___. This record should include the security name, name of each client holding an interest, the amount owned by each client, the aggregate number of shares or principal and/or notional amount held and total market value of the position. The preferred format for this information is in Excel.

(2) For each fund, portfolio, or client account managed by the adviser during the examination period, provide monthly performance returns of each fund/portfolio/client from ___ to ___, as well as the returns for the accounts’ comparable indices or benchmarks. In addition, with respect to the funds managed by the adviser, please provide the monthly or quarterly returns for the fund’s peer group or category. If possible, provide this information electronically.

(3) Names of current investors including total value of each investor’s equity interest in the fund as of ____.

(ii) Trade allocations

(1) All initial public offerings and secondary offerings in which clients, proprietary accounts or access persons participated and, if not stated in policies and procedures or if the allocation did not follow standard policies and procedures, information regarding how allocation decisions were made. Include the trade date, security, symbol, total number of shares, and participating accounts. For initial public offerings, indicate whether shares traded at a premium when secondary market trading began. The preferred format for this information is in Excel.

(2) For each investment strategy, please provide the annualized performance returns of each client account and proprietary accounts during the period ____ through ____. Also include non-annualized quarterly performance returns or each quarter from ____ through ____. Please provide this information for each account separated by strategy. Additionally, please provide any performance dispersion analysis performed for accounts in similar strategies. If possible, provide this information electronically.

(3) Information regarding each private investment fund, including (among other information requested):

a. Name as shown in organizational documents (as amended).

b. Investment strategy (e.g., long-short, statistical arbitrage, fund of funds).

c. Number of investors and total assets at the end of the Examination Period.

d. Amount, if any, of adviser’s equity interest in each fund as of ____.


e. Amount, if any, of adviser’s affiliated persons’ interest as of ____.

(iii) Information to facilitate testing with respect to advisory trading activities

A trade blotter (i.e., purchases and sales journal) that lists transactions (including all trade errors, cancellations, re-bills, and re-allocations) in securities and other financial instruments (including privately offered funds) for: current and former clients; proprietary and/or trading accounts and access persons. The preferred format for this information is to provide it in Excel as indicated in Exhibit 1.

2. Enforcement

(a) SEC v. Aletheia Research and Mgmt., Inc., 12-cv-10692 (C.D. Cal. Dec. 14, 2012)

Allegations: In this case, a hedge fund adviser that is now in bankruptcy is alleged to have engaged in a cherry-picking scheme, whereby it allocated winning trades to certain accounts and losing trades to two hedge funds. The SEC alleges that under that scheme, the favored accounts gained over $4 million in profit and the two hedge funds suffered about $4.4 million in losses. The SEC additionally alleges that the defendant failed to timely disclose its dire financial condition to investors.

Status: The case is pending. The adviser is being charged with violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Section 204A of the Advisers Act and Rule 204A-1 thereunder, Section 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8 thereunder, and Sections 206(1) and (2) of the Advisers Act.

(b) In the Matter of Middlecove Capital, LLC and Noah L. Myers, Investment Advisers Act Release No. 3534 (Jan. 16, 2013)

Allegations: From late 2008 through early 2011, the owner of a registered investment adviser is alleged to have engaged in cherry-picking among his personal accounts and clients’ accounts. This case involved using a single omnibus account to purchase all securities, and the adviser delaying the allocation of the securities in that account until late in the day or until the morning of the day following the trade date, which allowed the owner of the adviser to disproportionately allocate favorable transactions and realized profits to accounts benefiting himself or his family members (and to allocate losing trades to client accounts in disproportionately high amounts).

Status: Settled, with a cease-and-desist order being lodged against the adviser entity and its owner, finding that both willfully violated Section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and Sections 206(1), 206(2) and 207 of the Advisers Act. The order also instituted an industry bar against Noah Myers, revoked the registration of Middlecove Capital, and required disgorgement and interest in an amount of nearly $500,000 and payment of a civil penalty of $300,000.

(c) In the Matter of Ark Asset Management Co., Inc., Investment Advisers Act Release No. 3091 (Sept. 29, 2010)

Allegations: A subsequently deceased portfolio manager is alleged to have engaged in cherry-picking that resulting in the adviser realizing over $19 million of performance fees by favoring certain proprietary accounts over other client accounts between 2000 and 2003. Additionally, the SEC alleged that the adviser’s Form ADV filings during the relevant period were materially misleading and the adviser also committed books and records violations by failing to make and keep true and accurate order memoranda.

Status: Settled with the adviser being directed to pay nearly $20 million in disgorgement (but which was satisfied by the payment of $750,000 as the adviser was liquidating in bankruptcy).


(d) In the Matter of Melhado, Flynn & Associates, Inc., George M. Motz and Jeanne McCarthy, Investment Advisers Act Release No. 3201 (May 11, 2011)

Allegations: From early 2001 through early 2005, the president and CEO of a registered investment adviser and broker dealer is alleged to have engaged in cherry-picking at Melhado, Flynn & Associates, Inc. by making late allocations of trades favoring, at some times, a proprietary account and, at other times, favored client accounts, all at the expense of other advisory client accounts. This process allegedly generated approximately $1.4 million in profits, as well as commissions charged for execution.

Status: Settled with a finding of violations of, among others, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4 thereunder, Sections 204, 206, and 207 of the Advisers Act and Rule 204-2(a)(3) and 206-4(7) thereunder. A cease-and-desist order was lodged against all defendants, the entity’s broker-dealer and investment adviser registrations were revoked, and the individuals received industry bars. The president was also directed to pay disgorgement and prejudgment interest totaling $864,806.

B. Notable CFTC enforcement actions

1. CFTC v. Donald A. Newell and Quiddity, LLC, 12-cv-06763 (N.D. Ill Aug. 23, 2012)

Allegations: A registered commodity pool operator and commodity trading adviser (and its controlling principal and associated person) is alleged to have fraudulently and on a delayed basis allocated commodity futures and options trades for the benefit of a proprietary account (and to the detriment of customer accounts) managed and traded by Quiddity. Wrongful profits for the proprietary account are alleged to have exceeded $1.1 million. The CFTC also alleges recordkeeping failures and the making of material false statements during investigative testimony.

Status: Litigation is ongoing, with the CFTC seeking restitution to defrauded customers, a return of ill-gotten gains, civil monetary penalties, trading and registration bans, and permanent injunctions against further violations of federal commodities laws.

2. In the Matter of Cadent Financial Services LLC, CFTC Docket No. 11-13 (May 25, 2011)

Allegations: The CFTC alleged that during 2007 Cadent, a registered futures commission merchant, failed to supervise its employees and associated persons with respect to futures orders of a guaranteed introducing broker. In particular, Cadent’s personnel permitted the introducing broker’s associated person, sole principal and owner to submit “bunched” trades and to unlawfully allocate profitable post-execution trades to his personal accounts and the unprofitable or less profitable trades to the introducing broker’s customer accounts and a commodity pool he operated.

Status: The matter was settled in May 2011, with the firm paying a $125,000 civil monetary penalty and a cease-and-desist order being lodged against it.

3. In the Matter of U.S. Securities & Futures Corp., et al., CFTC Docket No. 01-01 (Oct. 7, 2009)

Allegations: In 2000, the CFTC charged two corporations and eight individuals with violations of the Commodity Exchange Act. The matter involved the improper allocation of thousands of trades in the mid-1990s among a large number of sub-accounts, some of which were held by German nationals (which also triggered a German criminal proceeding and a jail sentence for the “mastermind” of the fraud). Personnel of the two corporations, a registered futures commission merchant and an unregistered commodity trading adviser, allegedly placed and conspired to place unallocated trades, which were then allocated unfairly among customer accounts to persuade new accounts to invest substantial additional sums with the unregistered adviser.


Status: Resolved following an appeal, with a variety of sanctions, including cease-and-desist orders, 10-year trading bans, and civil monetary penalties being assessed by the CFTC (all in addition to a German criminal conviction).

C. UK FSA

FSA rules require prompt and accurate recording, allocation and documentation of trades with hedge fund managers being required to maintain a clear and documented allocation policy. Trade allocations should be made between the investment adviser’s customers contemporaneously with the execution of the relevant trade(s) (or as close thereto as is feasible). In the event that an allocation is not contemporaneously made or is not allocated in a timely manner after the trade is executed, there should be a record made in the firm’s compliance files as to why the advisers considers:

1. The deviation from the policy to be in the best interests of the customers involved; and

2. That no customer suffers any detriment as a result of the allocation. If a manager engages in cross trades among customer accounts, the manager should be able to demonstrate that it has controls in place intended to ensure that the transaction is at a fair price.

IV. Investment Advisers Must Have Strong Compliance Policies and Procedures on Investment Allocation

A. Policies

1. Hedge fund managers that also manage non-performance fee paying accounts should review their trade allocation procedures to assure that the full range of potential conflicts are addressed. They should also periodically review allocations to determine that, in practice, all clients have been fairly treated.

2. Investment advisers should inventory products, strategies, guidelines and exceptions. Investment advisers need to carefully consider all of the products they are offering, structure their policies so that they are tailored to their business, and integrate and take into account each fund, account or other product to ensure fair treatment across clients.

B. Implementation and execution

1. Creating an allocation matrix/guidelines is extremely helpful. Consider creating a matrix by fund/account to show strategies, guidelines, risk areas and areas of overlap and non-overlap.

2. Inventorying your business and creating an allocation matrix will help prepare advisers for SEC and NFA examination.

3. Advisers need to carefully consider the objectivity or subjectivity of any “allocation exceptions” outside of a formulaic or “pro rata” approach. What does risk tolerance mean in this context? Is it enough to say, “there is too much risk in the portfolio?” Is this an objective criteria upon which to allocate or not allocate to a particular client? Is there a specific guideline to back this up? Or, is this a subjective determination to direct a trade towards one particular account?

4. Investment advisers also need to focus on consistency in their approach. If exceptions become the rule rather than the norm, this raises potential issues.

5. Documenting non-standard allocations that are based on subjective factors is important.


C. Testing

1. The SEC expects investment advisers to not only have policies and procedures but to implement them (doing everything these say they will do) and to test them to make sure employees are complying with the procedures and to ensure the policies and procedures are effective.

2. There are various tests that advisers should perform in testing the effectiveness of their policies on allocation of investment opportunities. The following tests should be considered and, if appropriate, performed on a periodic basis:

(a) Review the trade blotter to look for disparate treatment. Review trades that may be appropriate for multiple funds and review over time if these trades are being allocated “pro rata.”

(b) Review documentation and reasons for non-standard allocations. Are the reasons described in sufficient detail? Do the reasons make sense?

(c) Review non-standard allocations for consistency of approach over time.

(d) Perform additional reviews of any accounts with proprietary assets to look for any potential conflict or the appearance of favorable treatment.

(e) Review performance of funds/accounts and prepare and review a dispersion analysis.

(f) Meet regularly with operations, finance and accounting to inquire if they have noticed any issues, irregularities or red flags with respect to trade allocation.

(g) Meet regularly with traders and portfolio management to discuss any issues or non-standard allocations that may raise appearance issues.

(h) Review of trade allocation should be a focus area of an adviser’s annual review. However, on its own, an annual review is not sufficient. Allocation issues should be reviewed by legal/compliance on an ongoing basis, and at a minimum quarterly.

D. Training

1. Train all relevant employees on allocation of investment opportunities and impress upon all employees the importance of such issues, including portfolio managers, traders and operations, finance, accounting, information technology and legal/compliance personnel.

2. For firms with multiple funds and accounts with overlapping investments, annual training on allocations may be insufficient.


Exhibit I

Layout for Securities Trading Blotter/Purchase and Sales Journal

In conjunction with the scheduled examination, the staff requests records for all purchases and sales of securities for portfolios of advisory clients and proprietary accounts being advised by the Fund. Please provide this record in Microsoft Excel format on compact discs. This record should include the fields of information listed below in a similar format.

Please provide separate worksheets for: (i) equities (Note: ETF trades should be included with equities); (ii) fixed income; (iii) cash or cash equivalents, maturities, calls, pay-downs, expirations, or reinvestments of mutual fund dividends or capital gains distributions; (iv) mutual funds; and (v) options, futures, swaps and other derivatives.

Sample Trading Blotter for Equity Securities

Client Name/#

Trade Date

Settle Date

Buy/ Sell

CUSIP Security Symbol

Security Description

Quantity Unit Price

Principal/ Proceeds/

Notional Value

Total Commission

Fees Net Amount

Broker

Sample Trading Blotter for Fixed-Income Securities

Client Name/#

Trade Date

Settle Date

Buy/ Sell

CUSIP Security Description 1

(Issuer)

Security Description 2

(Coupon Maturity, etc.)

Quantity Unit Price

Accrued Interest

Principal Value/

Proceeds

Total Commission

Net Amount

Broker

Sample Trading Blotter for Derivative Securities

Client Name/#

Trade Date

Settle Date

Buy/ Sell

CUSIP Security Description 1

(Issuer)

Security Description 2

(Coupon Maturity, etc.)

Quantity Unit Price

Payments Principal Value/

Proceeds

Total Commission

Net Proceeds

Broker Security Type

Economic Position “Long

or Short” Position


4. Allocation Documentation Samples

BULL MARKET CAPITAL LP

Privileged and Confidential

MEMORANDUM

To: File

From: R Jones, CCO

Date: March 25, 2013

Re: XYZ 3/22 Trade Allocation Exception

On 3/22/13 we bought 9,103,500 of XYZ. At time of purchase, the multi-strat master fund held 3,111,213 shares and Skycap pension managed account held 500,000 shares. The default allocation policy is pro-rata by capital, which would mean the following allocation:

Multi-strat: 7,843,020 (~86%)Account: 1,260,480 (~14%)

Because the multi-strat expects to see a material redemption at the end of May, we reduced the order size (without the redemption, we would have purchased 10,000,000) and are allocating in an 80/20 proportion We computed a “virtual rebalance” assuming the redemption; we expect that after the redemption the relative exposures will be equivalent. We are taking this step because the stock is somewhat thinly traded and we had an opportunity to do a block purchase at a reduced commission price and minimal market impact – we think that this benefits investors.

Therefore, the trade was allocated as follows:

Multi-strat: 7,282,8000 (~80%)Account: 1,820,700 (~20%)

This allocation was made on Friday and was approved by myself and Mary White, the CFO, at the time of the trade; however, due to other time demands, we are documenting this today. (An email has a 12:42 pm timestamp.)

Approved: , CCO

Approved: , CFO

Formal memo on letterhead underscores strong process

Insert title of author (audience is outsiders)

Insert day of week. 3/25 is a Friday, so it makes the write-up look even later

Defines default outcome and reasons for deviation

Allocation overrides are “books and records,” not

privileged communications

“One stop shop” re line

Addresses late write-up

Solid reasoning

Multiple sign-offs

No one on the investment team?

Could be more granular on benefits

From: Jones, RalphSent: Wednesday, March 27, 2013 6:26 PMTo: White, MarySubject: RE: Final Four Picks

Hear you. Welcome back.

Also, while you were out, we had a reallocation on Monday. Ron allocated more than the pro rata amount to the overflow fund for a Friday trade. I asked him about it and he said that the multi-strat fund was at its (his?) risk tolerance for emerging market credit exposure. Instead of a 60/40 split, it went 20/80.

--Ralph

From: White, Mary Sent: Tuesday, March 26, 2013 10:16 AMTo: Jones, RalphSubject: Final Four Picks

My FF picks suck. Guess I’m not retiring this year. See you when I get back to NY tomorrow.

MRW

Informal notice (email) implies a lack of care

What is the retention process? Email archive? Is there a separate log?

Unilateral decision

CCO does question allocation

Subjective, no support, no process

Unclear what it is, however

Clear that there is a reporting processLate notice; no indication when

allocation decision made

4

Bull Market Capital Trade Allocation Log

Date Clients Instrument Allocation Action

Reason/Notes

10/15/12 BM Master

Fund- Euro Pension fund of one

Crude Oil (WTI) Master fund buy > fund of one buy (as % of buying power)

Hard cap on commodities exposure at FOO/fund of one

10/18/12 BM Master Fund- Euro Pension fund of one

Crude Oil (WTI) Master fund sale > fund of one sale

Hard cap -- FOO exposure still under desired portfolio level

11/15/12 BM Master Fund- Euro Pension fund of one

PM Buy at master fund only

Ban on tobacco stocks in FOO

1/2/13 Movieguy managed account

Euro Stoxx 50 future

Buy at mgd a/c only

New client "ramp up"

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