July 2009 A publication from the Financial Services Group
In this Issue
Considerations and Trends for Considerations and Trends for Independent
Independent Investment Fund
Administration in the Investment Fund Administration in the
Post-Madoff Era
By: Anthony Deliso PAGE 01
Post-Madoff Era
By Anthony Deliso
Carried Interest Update
Independent third party fund accounting and
By: Fran Vallone
administration has been pushed to the forefront
PAGE 03
of investor thinking in light of the Madoff and
other recently publicized investment scandals.
The current push is being driven primarily by de-
mand, both by institutional and individual inves-
tors, and also by fund managers attempting to
be proactive in implementing what many would
consider “best practices” in the operational area
of their fund(s) and trying to be ahead of the
curve as increased regulation appears certain.
This drive to outsource the accounting and
administration functions brings with it many
challenges and responsibilities. In addition to
satisfying investor demand for independent third
party accounting, there are many reasons why
a firm would outsource. Benefits may include
reducing the costs of an internal accounting
team, avoiding large investments in technol-
ogy and IT infrastructure, keeping focused on
management’s core competencies (investment
selection, portfolio management, raising capi-
tal), reduction of errors, timely and qualitative
reporting, and obtaining a marketing advan-
tage, to name a few. A higher level of comfort is
achieved when fund activity, portfolio holdings,
subscriptions/redemptions, and account bal-
ances are being reconciled to prime brokers and
custodians on a daily basis by an independent
third party. Common procedures now being
Eisner LLP performed by administrators include pricing the
Accountants and
portfolios daily, using independent third party
Advisors
pricing vendors, and reconciling the value of
Independent each security and the portfolio in aggregate to
Member of the prime broker/custodian (or to alternative
Baker Tilly pricing sources), and computing and communi-
International cating daily performance and attribution data.
www.eisnerllp.com
Investors are also demanding greater
transparency and access to fund informa-
tion as well as timely reporting of investor
balances. Access to information is one of
the main drivers behind the growth of se-
cure investor portals being offered by many
administrators, whereby investors log on to
secure websites and, with a user name and
password, obtain access to their capital
statements, performance data and, in some
cases, fund holdings.
Once the decision to outsource has been
made, the next logical question is: How do
you choose an administrator? While refer-
ences and reputation carry some weight,
your due diligence should include visiting
the offices of the administrator, meeting
and interviewing the team, understanding
their service model and technological capa-
bilities, and getting a feel for the qualifica-
tions and experience of the team members
who will actually be performing the work on
a daily basis. Make sure they have the req-
uisite skills to understand the instruments
traded by the fund, the technology in place
to efficiently process and store the transac-
tions, and the ability to provide scalability
as the fund grows, other strategies are
implemented, and additional prime brokers
or custodians are used. There should also
be a process in place for continued educa-
tion or training programs so the team is
up-to-date on recent accounting and regu-
latory changes affecting the industry. Of
utmost importance to many fund managers
is the timely delivery of reports, including
performance reports, monthly NAVs and
CONTINUED ON PAGE 2
PAGE 02

investor capital statements. A full-service administrator
should also have the skills, in-house, to prepare the draft
financial statements for the auditors and liaise with the
audit firm so that the audit is conducted efficiently and
timely. Other value-added services may include the abil-
ity to prepare the tax allocations and, in the most efficient
environment, the tax returns and K-1s as well.
A thorough understanding of onshore and offshore fund
structures, fee calculations, hurdles, redemption poli-
cies, gates, accounting rules, side pockets, and valuation
policies, as well as the ability to interpret and adhere to
the funds’ legal documents, are additional examples of
what to look for in an administrator. The administrator
can also be a valuable source of input when structuring
or updating the fund’s private placement memorandum
and limited partnership agreement, since they often see
many variations of these documents written by various
law firms.
An increase in investor requests to conduct their own due
diligence on the fund’s service providers, including the ad-
ministrator, is another consideration in the selection process.
Increased demand for independence, transparency, better
reporting and more frequent communication will influence
more and more funds to eventually turn to third party admin-
istrators to efficiently address these trends and concerns and
ultimately should bring more qualitative aspects to the hedge
fund industry.
Anthony Deliso is the director of operations of
Eisner Fund Services LLC.
For more information, you can contact Anthony
at 212.891.6874 or adeliso@eisnerfundservices.com.

Increased regulation will surely bring with it the need for

better organization, document retention and storage,
and more transparency of investment strategy, posi-
tions, fees and compensation--requiring state of the art,
flexible, customizable, and robust technology capable
of efficiently aggregating and accounting for fund and
investor data. A recent example of this is the surge in the
trend toward a multi-prime/multi-custodian environment,
post the Bear Stearns and Lehman situations. Changes
in accounting rules, such as the recently implemented
FAS 157, are another example of where technology is
going to be valuable in achieving an efficient process
and highlights the need of being up to speed on recent
accounting developments. The administrator should be
proactive on the accounting front and in agreement with
the auditors and fund management on policies, presen-
tation, footnotes, etc., in advance of year end.

Matching a service provider to fit the needs of your fund

can be challenging. Expectations and abilities need to be
managed by both parties. While you may be delegating
accounting and administration tasks to an outside third
party, you cannot delegate the responsibility for these
tasks. Management of the process typically requires
having dedicated personnel in-house who understand
the fundamentals of fund accounting and reporting and
have the ability to review and approve the work of the
administrator. Since at least some of the reporting (i.e.,
investor capital balances) may come directly from the ad-
ministrator to the fund’s investors, how the administrator
performs will be a reflection on the fund’s management.
www.eisnerllp.com

Carried Interest Update arrangement services with respect to “specified assets” held
by the partnership.
By: Fran Vallone
Specified assets include securities, rental and investment
Federal
real estate, partnership interests, commodities, and options
or derivative contracts related to the aforementioned assets.
On May 11, 2009, the Treasury Department issued the
As we can see from the Administration’s FY 2010 Proposals
“Green Book,” General Explanations of the Administra-
discussed below, H.R. 1935 provides narrower language to
tion’s Fiscal Year 2010 Revenue Proposals (Administration’s
define the type of income which would be subject to re-char-
FY 2010 Proposals) which details the Administration’s tax
acterization as ordinary income.
change proposals. Among the tax proposals is tax treatment
and character of carried interests.
Under H.R. 1935 income from “qualified capital interest” would
not be re-characterized as ordinary income. H.R. 1935 identi-
The President’s proposal to tax carried interests as ordinary
fies qualified capital interest as the fair market value of money
income subject to self-employment taxes rather than capital
or property contributed to the partnership, amounts included
gain is similar to H.R. 1935 which was introduced by Rep.
in gross income under IRC Sec. 83, and the cumulative net
Sander Levin (D-Mich.) on April 3, 2009. However, there are
income or gain taken into account for years to which the new
differences to note.
law would apply. Qualified capital interest would not include
capital contributions that are attributed to loans from or guar-
Background
anteed by any partner or the partnership.

In general, a non-public investment fund, structured as a lim-

In addition, the Bill provides that if a person would perform
ited partnership or LLC, has a general partner or managing
investment management services for any entity and held either
member of the LLC that serves as an investment manager to
directly or indirectly “disqualified interests” with respect to that
the fund.
entity, income or gain with respect to the interest would be
treated as ordinary income. In general, disqualified interests
The investment manager provides advisory and other ser-
include convertible or contingent debt of such entity and any
vices to the partnership for an interest in partnership’s future
derivative instruments entered into with such entity, where
profits. Under current law, once the partnership is profitable
the value of such interest would be related to the amount of
and meets certain hurdles per the partnership agreement,
income or gain from the assets to which the management
a share of partnership profit is allocated to the investment
services are provided.
manager. The partnership profit, or “carried interest,” retains
the character (including long-term capital gain) of the part-
Finally, income received by publicly traded partnership (PTP)
nership income in the hands of the investment manager.
from ISPI would be treated as ordinary income and would not
be treated as qualifying income under the PTP rules. Some
H.R. 1935 and the Administration’s
transition rules would apply.
FY 2010 Proposals
In contrast to H.R. 1935, the provision on carried interest in
H.R. 1935 proposes to introduce new Section 710 to Sub-
the Administration’s FY 2010 Proposals states that income
chapter K of the Internal Revenue Code. The Bill proposes
from a services partnership interest (“SPI”) would be taxed as
to tax income from investment services partnership inter-
ordinary income subject to self-employment taxes.
ests (“ISPI”) as ordinary income subject to self-employment
taxes. In addition, any gain recognized on the sale of ISPI
SPI is defined as “a carried interest held by a person who
generally would also be taxed as ordinary income.
provides services to the partnership.” The language is much
broader than H.R. 1935 in that it does not target investment
ISPI are interests received, if at the point the partner ac-
type services nor distinguish the types of assets required to be
quires the partnership interests, the partner or a related party
held by the partnership. In addition, gain on the sale of an SPI
is expected to provide advisory,management, or financing
would generally be taxed as ordinary income.
PAGE 04
The Administration’s proposal does provide an exception for
income attributed to “invested capital.” Invested capital is de-
fined as money or property contributed to the partnership. In-
come which is reasonably allocated to invested capital would
not be re-characterized as ordinary income. It is important to
note that invested capital would not include capital contribu-
tions that are attributed to loans or advances by any partner
or the partnership.
Finally, as an anti-avoidance measure which targets other
compensatory arrangements other than through partnership
interests, any person who would perform services for an en-
tity and hold a “disqualified interest,” such as convertible or
contingent debt, options or any derivative instruments, with
respect to that entity, would be subject to tax on ordinary
income.
The Administration’s FY 2010 Proposals would take effect in
2011.
New York State
Last year, New York Governor David Paterson put out a
proposed budget to tax non-New York resident partners on
the carried interest they receive for performing investment
management services to a partnership doing business in
New York. On April 7, 2009, Governor Patterson signed into
law the New York State Budget Bill and the carried interest
legislation was removed in its entirety. Under current law, if a
partner is not a resident of New York State, the income from
carried interest is not subject to New York tax. A non-resident
partner’s share of carried interest allocations made by a fund
to the general partner and allocated to the non-resident part-
ner of the general partnership entity does not constitute New
York source income, except if the general partner is engaged
in a New York trade or business.
©2009 Eisner LLP. You are welcome to reprint short quotations from the
material with credit given to Eisner LLP. Written requests for permission to
reprint articles should be made prior to use.
New York City
In June of 2008, New York City introduced legislation that
would impose the Unincorporated Business Tax (UBT) on
the carried interest received for investment management
services.
Under current law, the UBT is generally not imposed on
the income for carried interest. Carried interest received by
fund managers is exempt from the UBT.
On January 15, 2009, New York State Assemblyman Micah
Kellner reintroduced legislation to amend the New York City
Administrative Code and impose the UBT on carried inter-
est from investment management services.
Under New York State Assembly Bill A2415, income and
gain realized in connection with an “investment manage-
ment services interest” would not be subtracted from the
gross income of an unincorporated business with assets in
excess of $10 million for purposes of the UBT. This provi-
sion would not apply to the portion of an interest received
as a result of capital contributions. We will continue to
monitor carried interest legislation at the federal, state and
local levels.
Fran Vallone is a director in Eisner tax advisory
services group.
Questions? You can contact her at 212.891.6086
or fvallone@eisnerllp.com
This publication is intended to provide general information
for readers. It does not constitute accounting, tax, or legal
advice, nor is it intended to convey a comprehensive treat-
ment of the subject matter.
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