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Interpretive Letter to Budge Collins, Collins/Bay Island Securities

September 14, 2004

Mr. Budge Collins
Collins/Bay Island Securities
840 Newport Center Drive
Newport Beach, CA 92660

Re: Use of Related Performance Information in Communications with the Public for Private Funds

Dear Mr. Collins:

This letter responds to your letter of May 18, 2004, which seeks interpretive guidance regarding the use of related performance information.1   Specifically, your letter asks whether Collins/Bay Island Securities (“CBIS”) may distribute composite performance information to potential investors in funds excluded from the definition of investment company under Section 3(c)(1) of the Investment Company Act of 1940, as amended (the “1940 Act”), who are “qualified institutional buyers,” as defined in Rule 144A(a)(1) under the Securities Act of 1933 (“QIBs”).

Your letter recognizes NASD’s general prohibition on the use of related performance information in communications with the public.2   NASD staff recently modified this position in a letter to Davis Polk & Wardwell dated December 30, 2003, in which NASD staff stated that it “would not object if a member includes related performance information in sales material for Section 3(c)(7) funds, provided that the member ensured that all recipients of such sales material are 'qualified purchasers' under Section 2(a)(51) of the 1940 Act.”  NASD staff believes that the presentation of related performance information to potential investors in 3(c)(7) funds, who are “qualified purchasers,” does not present the same investor protection concerns as the presentation of related performance information in other contexts.  For the reasons set forth below, NASD staff declines, however, to extend this position to QIBs that are potential investors in 3(c)(1) funds.

Section 3(c)(1) of the 1940 Act does not impose qualifications on investors similar to those imposed by Section 3(c)(7).  In general, an exclusion from the definition of investment company under Section 3(c)(1) requires that a fund have not more than one hundred beneficial owners and not make a public offering of its securities.  While the prohibition on public offerings in Section 3(c)(1) may, in many instances, have the effect of limiting the offering to certain sophisticated investors, in other situations, this may not be the case.3 

The distribution of related performance information to QIBs that are potential investors in 3(c)(1) funds raises concerns that are not present in the context of 3(c)(7) funds.  First, by restricting the dissemination of such information to QIBs, there is the possibility that those potential investors who qualify as QIBs will be treated differently than other potential investors and will have access to information that is not available to others.  With 3(c)(7) funds, the risk of disparate treatment of potential investors is ameliorated by the fact that, with few exceptions, all investors in a 3(c)(7) fund must be qualified purchasers.4   Second, NASD staff believes that once communications with the public containing related performance information are created for one class of potential investors, such as QIBs, it will become difficult to ensure that such communications are not subsequently disseminated to other, less sophisticated investors.5

For the foregoing reasons, NASD staff will not permit CBIS to distribute related performance information to potential investors in 3(c)(1) funds, even where such related performance information would be distributed only to QIBs.6

I hope that this letter is responsive to your inquiry.  Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the NASD Board of Governors.  This letter responds only to the issues you have raised based on the facts as you have described them and does not address any other rule or interpretation of NASD, or all the possible regulatory and legal issues involved.


Gary L. Goldsholle
Associate Vice President and Associate General Counsel 

cc:   Elisabeth P. Owens, Senior Vice President, San Francisco District Office
Lani M. Woltmann, District Director, Los Angeles District Office

1 For purposes of this letter, the term “related performance information” includes the performance of other, separate investment companies, funds, portfolios, accounts, or composites thereof managed by the same investment adviser, sub-investment adviser, or portfolio manager that manages the hedge fund that the member is promoting.  This term includes the performance of so-called “clone” funds and other similarly managed accounts and funds, the performance of funds or accounts that preceded and were converted into advertised hedge funds, and composites of other similarly managed funds, accounts, or portfolios.

2 Letter from Gary L. Goldsholle to Michael D. Udoff, Vice President and Associate General Counsel of the SIA (Oct. 2, 2003).

3 For example, a fund relying on Rule 506 of Regulation D under the Securities Act of 1933 can have up to thirty-five purchasers that are not "accredited investors."  In addition, the standard for "accredited investors" set forth in Rule 501(a) is significantly lower than for qualified purchasers.

4 Rule 3c-5 under the 1940 Act excludes “knowledgeable employees” from the determination of whether the outstanding securities of 3(c)(7) funds are owned exclusively by qualified purchasers.  Because knowledgeable employees are generally executive officers, directors, trustees, general partners, advisory board members, investment advisory personnel, or persons serving similar functions, there is little danger that these potential investors will be disadvantaged if related performance information is provided solely to qualified purchasers.

5 Even 3(c)(1) funds that are limited to QIBs, accredited investors, or qualified clients (as defined in Rule 205-3(d)(1) under the Investment Advisers Act of 1940) and that do not meet the exception in Section 3(c)(7) would not be permitted to use related performance information in communications with the public.  In this regard, the NASD staff’s position with regard to the permissibility of presenting related performance information in communications with the public turns on the exception relied upon by the fund rather than the qualification of the potential investor to whom the member intends to distribute the information.

6 To the extent your letter raises issues under the federal securities laws or the rules of the SEC, those issues are not addressed in this response, which is limited solely to interpretations of relevant NASD rules.  Further, to the extent your letter includes conclusions of law regarding the federal securities laws or the rules of the SEC, this letter should not be interpreted as an endorsement of or agreement with those conclusions.