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PFIC Rules
Based on preliminary research, most foreign funds will be considered a Passive Foreign
Investment Company (PFIC). Specifically, as most offshore hedge funds are organized
as corporations for marketing, tax, and legal reasons, any US individual investor that
participates in an offshore hedge fund structured as a corporation, would be exposed to
the PFIC rules. Typical investors in offshore hedge funds structured as corporations will
be foreign investors, US tax-exempt entities, and offshore funds of funds.

Two tests can determine if a foreign corporation is a PFIC: asset tests and income tests.
An asset test establishes that if at least 50 percent of a foreign corporation¶s assets
produce or are held for the production of passive income (e.g. interest, dividends, capital
gains) it is a PFIC. An income test ascertains that a foreign corporation is a PFIC if at
least 75 percent of the corporation¶s gross income for the tax year is passive income.
Most offshore hedge funds organized as corporations will meet both tests and be
considered a PFIC.

Reasons for these rules are as follows:

‡ U.S. citizens could make an investment in a corporation organized in an offshore

jurisdiction that has no corporate tax.
‡ The corporation¶s only asset would be an investment portfolio of marketable securities.
‡ The U.S. investor would trade the portfolio, allow it to appreciate, take no distributions
and not recognize taxable income.
‡ Upon eventual liquidation of the offshore corporation, the U.S. investor would
recognize a long-term capital gain with a deferral of income.

Direct and indirect U.S. shareholders of a PFIC are all subject to PFIC rules and are taxed
in one of four methods:
÷ ÿualifying Electing Fund (ÿEF)
÷ Mark to Market rules
÷ Excess Distribution rules
÷ Sale of the PFIC.

Qualified Electing Funds

Direct U.S. investors can make a ÿEF election and report the realized income attributable
to PFIC shares, which most U.S. investors do. The fund must provide an annual statement
to shareholders, reporting their share of income (in U.S. dollars) based up on their
ownership of shares of stock. Income from a ÿEF is classified as ordinary or long-term
capital gain. While losses may not be deducted currently, short-term gains are included in
ordinary income. ÿEF election is made on Form 8621 and is binding for subsequent tax
years.

Mark to Market
U.S. shareholders may elect mark to market PFIC shares that qualify as ³marketable
stock´ to be taxed as ordinary income. Gain recognized to the extent that fair market
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value of PFIC at year-end exceeds its adjusted basis. Losses can be recognized only to the
extent that adjusted basis exceeds the fair market value and is limited to previously
recognized gains.

Excess distributions or dispositions of PFIC shares

An excess distribution is a distribution from a PFIC that exceeds 125 percent of the
average distributions made during the previous three years. If U.S. investors do not make
a ÿEF or mark to market election, the following assessments will be made:
‡ Taxes and interest charge. When interest charge is based upon the value of the tax
deferral when the investor disposes of the stock or receives excess distribution. The
income is currently taxed as ordinary subject to shareholders¶ effective tax rate.
‡ Rules do not apply to tax-exempt investors holding shares in a PFIC.
‡ Once a PFIC, always a PFIC.
‡ Most foreign countries do not have tax rules similar to U.S. rules, so there are no
negative tax consequences for foreign investors.

Reporting requirements for Offshore Corporations

U.S. taxpayers with ownership in offshore corporations are subject to reporting
requirements. These include tax return requirements, which dictate that offshore hedge
funds treated as foreign corporations for U.S. tax purposes do not have to file a U.S.
corporate tax return as long as their U.S. tax liability is satisfied through withholding.

Form 5471 (³Information Return of U.S. Persons with Respect to Certain Foreign
Corporation´) must be filed by U.S. persons (which include an individual, partnership,
corporation, estate and trust) who are officers, directors or shareholders in offshore
corporate hedge funds, U.S. persons that acquire a 10 percent or greater interest in an
offshore corporate hedge fund or U.S. persons who own more than a 50 percent interest
in the offshore corporate hedge fund. This form requires a balance sheet and income
statement of the foreign corporation and the shareholder¶s ownership percentage.

Alternative Structure (Master/Feeder Fund Structure)

To attract U.S. individual investors, fund sponsors organize separate hedge funds that
elect to be treated as partnerships for US tax purposes so that these investors receive
favorable tax treatment including qualified dividends, long-term capital gains, and
unrealized income. These funds participate in the master/feeder structure.

Master/Feeder Fund Structure

The master/feeder fund structure allows the investment manager to collectively manage
money for varying types of investors in different investment vehicles without having to
allocate trades and while producing similar performance returns for the same strategies.

Feeder funds invest fund assets in a master fund that has the same investment strategy as
the feeder fund. The master fund, structured as a partnership, engages in all trading
activity. A master/feeder structure will include a U.S. limited partnership or limited
liability company for U.S. investors and a foreign corporation for foreign investors and
US tax-exempt organizations. If U.S. partners exist, investors must file a U.S.
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partnership tax return and attach Schedules K-1 reporting income allocable to US
partners.

Conclusion
We should explore if a Master/Feeder Fund Structure is applicable to foreign
current clients. In the meantime, we should assume that current clients that are
foreign investment companies will be considered a PFIC and PFIC rules will apply
to U.S. investors.
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Blue Sky Regulation

A blue sky law is a state law in the United States that regulates the offering and sale of
securities to protect the public from fraud. Though the specific provisions of these laws
vary among states, they all require the registration of all securities offerings and sales, as
well as of stock brokers and brokerage firms. Each state's blue sky law is administered by
its appropriate regulatory agency, and most also provide private causes of action for
private investors who have been injured by securities fraud.

While anti-fraud regulations are most commonly enforced by the SEC and the various
SROs, the states also have the power and authority to bring actions against securities
violators pursuant to state law. Each state has its own securities act, known colloquially
as the "blue sky law", which regulates both the offer and sale of securities as well as the
registration and reporting requirements for broker-dealers and individual stock brokers
doing business (both directly and indirectly) in the state, as well as investment advisers
seeking to offer their investment advisory services in the state.

Recently, federal legislation was enacted which limited the ability of the states to review,
limit or otherwise restrict the sale of most securities. The legislation was designed to
eliminate the duplicative nature of the federal and state securities laws. Today, in most
instances, the states authority to review registration of securities offerings that are offered
on a national basis have been severely restricted. However, there are notice and filing
requirements in each state, which must still be complied with. Additionally, the
legislation did not affect the ability of the state regulators to conduct investigations and to
bring fraud actions.

Despite the differences between statutes from state to state, the blue sky laws share
certain features in their approach to prevent sales agents from promising unrealistic
returns and misinforming investors about the investment risks. The state laws provide for
oversight of the sales process and create liability for fraudulent sales in two ways. First,
the laws require the registration of securities that will be offered or sold within the
state, unless the offerings fall within specified exemptions from registration. In
addition, brokerage firms, issuers selling their own securities, and individual brokers
must be registered with and licensed by the state; some states also require additional
certifications for brokers. These processes are administered by a state¶s securities agency
or commission. The registration process for securities and securities transactions prevents
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fraudulent transactions by allowing state security commissions to review the securities

offerings and ensure that the individuals transacted in the securities markets are qualified
and regulated by the state. Similarly to the federal laws, the blue sky laws generally
operate on a disclosure-driven basis, and mandate that companies accurately disclose
information that will help investors make informed decisions.

Second, blue sky laws have antifraud provisions that create liability for any
fraudulent statements or failure to disclose information as required. The specific
kinds of statements and acts that can form the basis of a fraud claim will depend on a
state¶s statutes and case law. The right of action available and remedies available to
investors bringing private suits also differs from state to state, but may include rescission
of the transactions, forcing the seller to give up profits, or other measures of damages. In
New York, the securities statute is the Martin Act, which notably does not provide for a
private right of action. Under this act, only the attorney general, not individual plaintiffs,
can sue for fraudulent sales of securities. Individual investors must instead bring an
action under for common-law fraud and breach of fiduciary duty.

Exemption for Regulation D Securities

Just as there are exemptions from the registration requirements of the federal securities
laws, several types of securities and transactions are exempt from the registration
requirements of most states. The following are some common registration exemptions
under blue sky laws:

Three distinct exemptions from securities registration under the federal

securities laws are collected in SEC Regulation D: Rule 504, 505, and 506
offerings. SEC Rule 506 offerings involve a number of requirements regarding
advertising of the offering, qualifications for purchasers, and the ability of
purchasers to resell the securities. Under Rule 506, an unlimited amount of
securities may be sold to an unlimited number of high income or high net
worth investors and up to 35 other "sophisticated" investors without federal
registration. Under federal law, states are not permitted to require SEC Rule
506 securities to be registered at the state level. States remain free, however,
to insist that they be "notified" of the offering and to impose a notification fee.
If your offering conforms to the requirements of SEC Rule 506, state
registration will not be necessary, but notification and payment of a fee to the
relevant states may be required.

There is no similar prohibition against state registration when it comes to SEC

Rule 504 and SEC Rule 505 offerings. Most states, however, have adopted
exemptions that will be available for many Rule 504 and Rule 505 offerings. A
model state securities statute, the Uniform Securities Act of 1956 ("1956 Act"),
has been adopted (with modification) by 28 states, and permits offers or sales
to fewer than ten investors ± regardless of their level of sophistication or
resources ± without registration. Therefore, you can raise capital from up to
nine investors without registering within a state whose statutes are based on
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the 1956 Act.

In 2002, a revised model statute was created, the Uniform Securities Act of
2002 ("2002 Act"), and it has been adopted in some form by 14 states. The
2002 Act exempts sales to 25 or fewer investors in a 12-month period. To be
eligible to use this exemption, you are not permitted to publicly advertise the
offering or pay commissions based on the sales, and you may sell only to
persons you reasonably believe are buying with an intent to hold the
securities as an investment. The 2002 Act also exempts offers and sales to
State securities regulation. Therefore, in a state that has adopted the 2002 Act, you
may be able to raise an unlimited amount of capital from institutional investors
or from 25 or fewer non-institutional investors without registering the
securities.

Other Blue Sky Requirements

Even when an exemption from state registration applies, some states require
that issuers of securities notify the state securities regulator of the offering or
sale, and pay a notification fee. Additionally, some states do not require
certain securities to be registered, but still may require certain individuals
dealing in the securities, including sometimes officers and employees of the
company, to register.

Conclusion:

If all of the Offerings by CCs are ³Regulation D´ offerings, which I believe they are, and
specifically fall under Rule 506, then that Offering is exempt from state registration, but
notification and payment of a fee to the relevant states may be required. If any of the
CC¶s Offerings fall under Rule 504 or Rule 505, then pursuant to Uniform Securities Act
of 1956 ("1956 Act") and the 2002 Act, most states may not be required to file (See
above for further details).

This very imperative link, http://www.ppmfast.com/1a/members/bluesky1.html, states

Blue Sky laws State-by-State, and any variance within States can be pinpointed through
their State rule descriptions.

In either case, offerings of Reg. D securities must be made through a FINRA Registered
Broker-Dealer. 

In general, on Reg. D offerings, as long as the offering party (the CCs) follows the SEC
rules regarding investor suitability, number of investors, etc., as disclosed and outlined in
CC¶s Prospectus/PPM¶s in detail, there should not be any ³state´ issues.
I don¶t believe there is Federal Law that trumps any State laws.The Federal legislation
was designed to eliminate the duplicative nature of the federal and state securities laws.
State laws, however, provides oversight on 2 important topics: 1. the laws require the
registration of securities that will be offered or sold within the state, unless the offerings
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fall within specified exemptions from registration, and 2. blue sky laws have antifraud
provisions that create liability for any fraudulent statements or failure to disclose
information as required