Articles By Topic
By Topic: Side Letters
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From Vol. 6 No.8 (Feb. 21, 2013)
Mike Neus, Managing Partner and General Counsel of Perry Capital, Discusses Practical Solutions to Some of the Harder Fiduciary Duty and Other Legal Questions Raised by Side Letters
At their core, side letters are about defining specific rights and obligations with respect to a specific investment. Accordingly, the legal and practical issues raised by side letters, and best practices for addressing those issues, are often context-specific. This theme of specificity – the idea that effective solutions must be narrowly tailored to specific problems where side letters are concerned – was a leitmotif in our recent conversation with Michael Neus, Managing Partner and General Counsel of Perry Capital LLC. We posed some of the harder questions generally raised by side letters to Neus, and his answers – transcribed in this article – were typically nuanced, insightful and informed by current market practice. In particular, we covered trends in the use of and rights granted in side letters; the advisability of and approach to selective disclosure; concerns related to modification of fund redemption terms through side letters; the impact of different regulatory regimes on side letter drafting; strategies for drafting effective most favored nation provisions; strategies for gracefully declining side letter requests; the approach to using single-investor funds and managed accounts to address side letter requests; strategies for monitoring obligations in side letters; the proper party for executing side letters; and trends in negotiating capacity rights. See also “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013). Our interview with Neus was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013. That Symposium is scheduled to include a panel on side letters entitled “Navigating the Side Letter Negotiation & Due Diligence Process.” For a fuller description of the Symposium, click here. To register for the Symposium, click here. Subscribers to The Hedge Fund Law Report are eligible for a registration discount.
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From Vol. 6 No.7 (Feb. 14, 2013)
Peter Tsirigotis of Brown Brothers Harriman Discusses the Operational Challenges Posed by Side Letters
For hedge fund managers, the panoply of legal and fiduciary duty issues raised by side letters is daunting. For an insightful discussion of some of these issues, see “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013). Compounding the legal hurdles of side letters are the operational challenges they raise – the need to abide by a patchwork of different promises to different institutions, and the consequent pitfalls in the interstices of those promises. As SEC examiners and examined managers routinely tell The Hedge Fund Law Report, the most common violations by hedge fund managers are not of external law, but of their own promises and disclosures. In side letters, therefore, hedge fund managers raise the compliance bar on themselves considerably. Side letters help raise assets, but they also raise regulatory risk. Side letters have received considerable attention – including in the HFLR – from the ex ante perspective, that is, from the perspective of a manager negotiating such an instrument. See, e.g., “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013). But side letters have received less attention from the ex post perspective. There has been, that is, less discussion on how hedge fund managers can live with the deals they strike in side letters. We recently talked to Peter Tsirigotis, Senior Vice President at Brown Brothers Harriman, to shed some light on this as yet obscure area. In particular, our conversation with Tsirigotis covered, among other topics: reasons for side letters; categories of side letter rights requested; most favored nation provisions; methods for tracking manager obligations incurred through side letters; technologies used to assist managers in administering side letters; negotiation practices for side letters; and recommendations for protection of confidential information. This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013. That Symposium is scheduled to include a panel on side letters entitled “Navigating the Side Letter Negotiation & Due Diligence Process.” For a fuller description of the Symposium, click here. To register for the Symposium, click here. Subscribers to The Hedge Fund Law Report are eligible for a registration discount.
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From Vol. 6 No.5 (Feb. 1, 2013)
Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters
Hedge fund managers intent on attracting institutional capital often feel compelled to entertain requests for preferential treatment via side letters from institutional investors. But the “cost of capital,” as it were, may increase materially where a side letter is involved. Such instruments raise regulatory concerns, present business challenges and create operational issues. See “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013). In an effort to identify some of the chief regulatory concerns raised by side letters – and to offer suggestions on how to address those concerns in a way that makes business sense – The Hedge Fund Law Report recently interviewed Christopher Wells, a partner and head of the hedge fund practice at international law firm Proskauer Rose LLP. Our interview with Wells covered selective disclosure, the role of advisory committees, most favored nation provisions, allocation of costs of administering side letters, ERISA considerations, the role of state “sunshine” laws, considerations specific to sovereign wealth funds and much else. For additional insight from Wells, see “Managing Risk in a Changing Environment: An Interview with Proskauer Partner Christopher Wells on Hedge Fund Governance, Liquidity Management, Transparency, Tax and Risk Management,” The Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012). This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013. That Symposium is scheduled to include a panel on side letters entitled “Navigating the Side Letter Negotiation & Due Diligence Process.” For a fuller description of the Symposium, click here. To register for the Symposium, click here.
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From Vol. 6 No.1 (Jan. 3, 2013)
RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices
The Regulatory Compliance Association, in cooperation with major law firms and institutional investors, recently presented a Practice Readiness Series session entitled “Navigating the Side Letter and Due Diligence Process” (Session). The Session focused on issues involved in negotiating hedge fund side letters from the perspectives of hedge fund managers and investors. It also reviewed due diligence from both perspectives, highlighting the categories of due diligence performed by institutional investors and best practices for managers when responding to due diligence requests. This article summarizes the key points made during the Session.
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From Vol. 5 No.48 (Dec. 20, 2012)
Speakers at Walkers Fundamentals Hedge Fund Seminar Discuss Recent Trends in Hedge Fund Terms, Corporate Governance, Side Letters, FATCA and Cayman Fund Regulation
On November 8, 2012, international law firm Walkers Global hosted its annual Walkers Fundamentals Hedge Fund Seminar in New York City. Speakers at this event addressed various issues of current relevance to hedge fund managers, including: recent developments in fund structuring and terms; fund governance; recent Cayman legal developments (including those relating to side letter disputes); implications of the Foreign Account Tax Compliance Act for hedge fund managers; and regulatory developments, including proposed amendments to the Cayman Islands Exempted Limited Partnership Law and the impact of the EU’s Alternative Investment Fund Managers Directive. This article summarizes noteworthy points discussed during the seminar on each of the foregoing topics. For our coverage of last year’s Walkers Fundamental Hedge Fund Seminar, see “Speakers at Walkers Fundamentals Hedge Fund Seminar Provide Update on Hedge Fund Terms, Governance Issues and Regulatory Developments Impacting Offshore Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).
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From Vol. 5 No.39 (Oct. 11, 2012)
Sixth Annual Hedge Fund General Counsel Summit Highlights SEC Enforcement Priorities, Side Letters, Investment Allocations, Expense Allocations, Trade Errors, Record Retention, Fund Marketing, Secondaries, JOBS Act and STOCK Act (Part One of Two)
On September 18 and 19, 2012, ALM Events hosted its Sixth Annual Hedge Fund General Counsel Summit (GC Hedge Summit) at the University Club in New York City. Panelists, including regulators, in-house practitioners and law firm professionals, discussed topics of significant relevance for hedge fund general counsels, including: SEC enforcement priorities relating to hedge funds; the nuts and bolts of a successful hedge fund compliance program (including a discussion of side letters, investment allocations, expense allocations, trade errors and record retention); marketing of hedge funds (including a discussion of compensation of marketing professionals and the Jumpstart Our Business Startups (JOBS) Act); secondary market transactions in fund shares; and the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act) and its implications for the gathering of political intelligence. Our coverage of the GC Hedge Summit is provided in two installments. This first installment covers the session addressing the nuts and bolts of a successful compliance program and the session addressing marketing of hedge funds and secondary market transactions in hedge fund shares. The second article will cover the session discussing the SEC’s enforcement priorities and the session discussing the implications of the STOCK Act for the gathering of political intelligence by hedge fund managers. See also “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).
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From Vol. 5 No.37 (Sep. 27, 2012)
Cayman Grand Court Rejects Validity of Side Letter Entered Into Between an Investor in Investment Vehicles That Invested in the Matador Fund and a Director of the Matador Fund
A recent decision handed down by the Grand Court of the Cayman Islands (Court) emphasizes the importance of: (1) ensuring that the correct parties enter into side letters between an investor and a fund; and (2) ensuring that a fund’s governing documents permit the fund to enter into the type of side letter contemplated by the fund and the investor. This decision follows on the heels of another recent decision handed down by the Court that highlights similar principles. See “Recent Cayman Grand Court Decision Demonstrates the Practical and Legal Challenges of Investing in Hedge Funds through Nominees,” The Hedge Fund Law Report, Vol. 5, No. 29 (Jul. 26, 2012).
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From Vol. 5 No.35 (Sep. 13, 2012)
Fund Misrepresentations Inducing Investment: Claims and Remedies Available to Fund Investors and Protections Available to Promoters, Fund Managers and Directors
False statements inducing initial or continued investment in Cayman funds are relatively rare, but if they do occur, the financial consequences are often catastrophic for the misled investor and present him with a dilemma – whether to pull out and try to recoup the investment, or to stay in, try to recover what losses are retrievable and take whatever benefits there may be down the line. Although the decision may be easy enough as a matter of choice in principle, a number of thorny legal issues may arise, such as the right to rescind an allotment of shares, derivative claims and the bar on recovery of reflective loss. For promoters, managers and directors seeking to avoid such claims, the issue is how to protect themselves from accusations of misleading statements about the fund, and from consequent liability for such statements. In a guest article, Christopher Russell and Jeremy Snead of Appleby (Cayman) discuss the claims and remedies available to misled fund investors and the protections available to promoters, fund managers and directors that seek to protect themselves from allegations of misrepresentation.
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From Vol. 5 No.30 (Aug. 2, 2012)
Hedge Fund Side Letters: The View from the Fund Director’s Perspective
Most hedge funds are asked at one time or another by certain investors to provide side letters agreeing to preferential dealing, investment or other strategic terms. There are clear cases where a side letter would not be acceptable, e.g., it contains plainly egregious terms; has no legitimate purpose; or is clearly contrary to what the hedge fund or hedge fund manager is doing in practice. In most circumstances, however, there is no black and white answer as to what constitutes an acceptable side letter term or where the line should be drawn. In crafting a side letter term that is in the best interest of the hedge fund (and in particular, other investors in the fund), there is a difficult balancing act that managers must perform. On the one hand, the side letter can be used to facilitate a large investment that attracts other strategic investors, which could benefit the fund and the execution of its investment strategy. On the other hand, side letters generally raise various fiduciary and other concerns that must be addressed. In a guest article, Victor Murray, an independent accredited director at MG Management Ltd., discusses: side letter disclosure; ERISA considerations relating to side letters; unsavory terms; shareholder actions relating to side letters; lack of statutory provisions; derivative actions; fraud on the minority; and best practices in relation to directors’ review of side letters.
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From Vol. 5 No.29 (Jul. 26, 2012)
Recent Cayman Grand Court Decision Demonstrates the Practical and Legal Challenges of Investing in Hedge Funds through Nominees
A recent decision of the Grand Court of the Cayman Islands (Court) addressed a range of relevant questions for hedge fund managers and investors, among them: Does a side letter survive a fund restructuring? Does a side letter entered into between a hedge fund and a beneficial investor bind a nominee through which the beneficial investor subsequently invests? Is a beneficial investor a party to a hedge fund’s governing documents where it invests through a nominee? What is the legal status of a side letter entered into prior to (rather than simultaneously with) an investment in a hedge fund? In short, the decision illustrates the myriad legal and practical challenges faced by investors that invest in hedge funds through nominees; the relevance of the identity of contracting parties; and the scrutiny to which governing documents are subject in the course of hedge fund restructurings. This feature-length article describes the factual background and legal analysis in the decision, and extracts two key lessons for investors that wish to invest in hedge funds via nominees. See also “Investing in Cayman Islands Hedge Funds Through a Nominee or Custodian: An Unforeseen Peril,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).
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From Vol. 5 No.23 (Jun. 8, 2012)
SEC Sanctions Quantek Asset Management and its Portfolio Manager for Misleading Investors About “Skin in the Game” and Related-Party Transactions
Investments by hedge fund managers in their own funds and related party transactions (such as loans from a fund to a manager) exist at opposite sides of the incentive spectrum. The former – so-called “skin in the game” – is typically thought to align the interests of investors and managers while the latter is seen as pitting the interests of investors and managers in direct conflict. Investors want to know about both, for obviously different reasons. A May 29, 2012 SEC Order Instituting Administrative and Cease-And-Desist Proceedings against Quantek Asset Management LLC (Quantek), Javier Guerra, Bulltick Capital Markets Holdings, LP (Bulltick) and Ralph Patino highlights these and other investor considerations. This article summarizes the SEC’s factual and legal allegations against Quantek, Bulltick, Guerra and Patino, and the settlement among the parties. The SEC’s action follows private actions against the same or similar parties. See, e.g., “Fund of Hedge Funds Aris Multi-Strategy Fund Wins Arbitration Award against Underlying Manager Based on Allegations of Self-Dealing,” The Hedge Fund Law Report, Vol. 4, No. 39 (Nov. 3, 2011); “British Virgin Islands High Court of Justice Rules that Minority Shareholder in Feeder Hedge Fund that had Permanently Suspended Redemptions Was Not Entitled to Appointment of a Liquidator,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).
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From Vol. 5 No.22 (May 31, 2012)
Eight Recommendations for Hedge Fund Managers That Utilize Most Favored Nation Provisions in Side Letters
The challenging capital raising environment has generally tilted the typical balance of power in favor of institutional investors. As a consequence, with increasing frequency, institutional investors are requesting side letters from hedge funds or their managers. Side letters typically grant the requesting investor preferential rights that are not granted to other investors in the fund’s governing documents; these preferential rights can include special fee reductions, transparency rights, redemption rights, capacity rights, etc. Additionally, side letter requests now regularly include so-called “Most Favored Nation” (MFN) provisions – which are used by investors to ensure that any rights granted to current or future investors are also offered to the requesting investor. Requesting investors often demand broad protections in MFN provisions, arguing that they cannot anticipate what rights will be granted to future investors. While it may be convenient for hedge fund managers to dismiss MFN provisions as “standard” requests from investors, MFN provisions can present numerous pitfalls for fund managers if they are not properly evaluated, appropriately negotiated and effectively monitored to ensure compliance. This article provides a roadmap for understanding MFN provisions and their implications for a manager’s business, operations and compliance processes. Specifically, this article describes: the anatomy of an MFN provision; the key terms of an MFN provision; the three principal concerns raised by the use of MFN provisions; and eight recommendations for drafting and administering MFN provisions to mitigate key concerns.
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From Vol. 5 No.16 (Apr. 19, 2012)
Does a Side Letter Granting Preferential Redemption Rights Survive a Hedge Fund Restructuring?
In the aftermath of the 2008 financial crisis, some hedge fund managers felt compelled to restructure their funds to manage liquidity and to balance the interests of redeeming and continuing investors. Many such restructurings required investors to either consent to the restructuring or make an election relating to the restructuring. Nonetheless, many such reorganizations were quickly conceived and may not have considered the survivability of side letters pertaining to the original fund investment. In dueling complaints recently filed in courts in the Cayman Islands and New York State, a hedge fund and a fund of funds, and their respective managers, initiated litigation focused on the following question: Does a side letter that granted a hedge fund investor, among other things, preferential redemption rights, survive a hedge fund restructuring, or does such a side letter terminate upon the making of a restructuring election by the hedge fund investor? This article summarizes the complaints, the context and the implications of the litigation for hedge fund managers and investors. On preferential redemption rights generally, see “Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).
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From Vol. 4 No.44 (Dec. 8, 2011)
A Step-By-Step Guide to GIPS Compliance for Hedge Fund Managers
The Hedge Fund Law Report and others have reported on the post-crisis ascendance of non-performance factors in hedge fund due diligence and investment decision-making. In short, before 2008, hedge fund allocations were driven largely by a manager’s past performance. After 2008, factors such as transparency, liquidity and robust risk management surpassed performance in the hierarchy of concerns of institutional hedge fund investors. See “Survey by SEI and Greenwich Associates Identifies the Primary Decision Factors and Concerns of Institutional Investors When Investing in Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 11, 2011). However, we do not wish to overstate the case or the duration of the trend. The long-term lesson of the crisis likely will be that robust risk management, appropriate liquidity and transparency and well-developed infrastructure are necessary to justify a hedge fund investment, but not sufficient. Hedge fund managers without institutional caliber businesses will often be passed over, but as between two managers with good businesses, the deciding factor will often be past performance. Thus the immediate and important question for hedge fund managers: how can managers present performance information in a manner that maximizes capital raising efforts while complying with relevant law and standards? An increasingly common answer to this question in the hedge fund community is: by complying with the Global Investment Performance Standards (GIPS), an evolving set of practice standards designed to ensure consistency and uniformity in the presentation of investment performance results. Compliance with GIPS is ostensibly voluntary, but in practice, more and more institutional hedge fund investors are asking to see GIPS-compliant performance information. Accordingly, GIPS compliance is becoming a de facto requirement for hedge fund managers, and hedge fund managers are actively seeking to become GIPS compliant. The main challenge for hedge fund managers is that GIPS were originally designed for a long-only world. They have been an imperfect fit for managers with complex investment structures, side pockets, illiquid or hard-to-value assets and other typical elements of the hedge fund business. Sensitive to this, the GIPS Executive Committee recently promulgated guidance specific to alternative investment managers, and service providers have adapted their businesses to help hedge fund managers comply with GIPS and certify such compliance. However, despite the guidance and available assistance, GIPS compliance remains a challenge for hedge fund managers. This article aims to assist hedge fund managers in rising to that challenge and surmounting it. To do so, this article starts by providing a comprehensive overview of GIPS. The article then identifies five discrete categories of benefits of GIPS compliance and two categories of burdens of compliance. Next, and most importantly, this article provides a step-by-step process by which hedge fund managers can become GIPS compliant. In the course of this discussion, this article details the material points from two recent webinars and one recent white paper promulgated by leading GIPS service providers. Reading this article will enable a hedge fund manager to, among other things: revise its marketing materials to comply with GIPS; organize its front, middle and back offices to collect the data necessary to support a GIPS-compliant presentation; manage service providers with a view to GIPS compliance; ask the right questions of outside counsel; determine whether to engage a specific GIPS compliance service provider; define the scope of any such engagement; and respond effectively to due diligence inquiries on GIPS.
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From Vol. 4 No.32 (Sep. 16, 2011)
Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?
Generally, two categories of hedge fund managers will be required to register with the SEC as investment advisers by March 30, 2012: (1) managers with assets under management (AUM) in the U.S. of at least $150 million that manage solely private funds; and (2) managers with AUM in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle, such as a managed account. See “Will Hedge Fund Managers That Do Not Have To Register with the SEC until March 30, 2012 Nonetheless Have To Register in New York, Connecticut, California or Other States by July 21, 2011?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011). Registration will trigger a range of new obligations. For example, registered hedge fund managers that do not already have a chief compliance officer (CCO) will have to hire one. See “To Whom Should the Chief Compliance Officer of a Hedge Fund Manager Report?,” The Hedge Fund Law Report, Vol. 4, No. 22 (Jul. 1, 2011). Also, registered hedge fund managers will have to complete, file and deliver, as appropriate, Form ADV. See “Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011). But perhaps the most onerous new obligation for newly registered hedge fund managers will be the duty to prepare for, manage and survive SEC examinations. Most hedge fund managers facing a registration requirement for the first time have hired high-caliber people and completed complex forms. Therefore, hiring a CCO and completing Form ADV will exercise existing skill sets. But few such managers have experienced anything like an SEC examination. On the contrary, many such managers have spent years behind a veil of permissible secrecy, disclosing little, rarely disseminating information beyond top employees and large investors and interacting with the government only indirectly. Examinations will change all that. The government will show up at your office, often with little or no notice; they will ask to review substantially everything; and a culture of transparency will have to replace a culture of secrecy, where the latter sorts of cultures still exist. (The SEC does not appreciate secrecy and has any number of ways of demonstrating its lack of appreciation.) Hedge fund managers facing the new examination reality will have to think about two sets of issues. The first set of issues relates to examination preparedness, and The Hedge Fund Law Report has written in depth on this topic. See, e.g., “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011). The second set of issues relates to examination management and survival, and that is the broad topic of this article. Specifically, this article addresses a question that hedge fund managers inevitably face in connection with examinations: What should we tell investors and when and how? To help hedge fund managers identify the relevant subquestions, think through the relevant issues and hopefully plan a disclosure strategy in advance of the commencement of an examination, this article discusses: the three types of SEC examinations and similar events that may trigger a disclosure examination; the five primary sources of a hedge fund manager’s potential disclosure obligation; whether and in what circumstances hedge fund managers must disclose the existence or outcome of the three types of SEC examinations; rules and expectations regarding responses to due diligence inquiries; selective and asymmetric disclosure issues; how hedge fund managers may reconcile the privileged information rights often granted to large investors in side letters with the fiduciary duty to make uniform disclosure to all investors; whether hedge fund managers must disclose deficiency letters in response to inquiries from current or potential investors, and whether such disclosure must be made even absent investor inquiries; whether managers that elect to disclose deficiency letters should disclose the letters themselves or only their contents; best practices with respect to the mechanics of disclosure (including how and when to use telephone and e-mail communications in this context); and whether deficiency letters may be obtained via a Freedom of Information Act request.
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From Vol. 4 No.18 (Jun. 1, 2011)
Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?
We recently analyzed a decision of an SEC administrative law judge (ALJ) holding that fund-level information, as opposed to portfolio-level information, can constitute material nonpublic information (MNPI) for insider trading purposes. See “SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011). Specifically, the ALJ held that information regarding a major fund redemption, fund management’s decision to increase cash levels and efforts to sell a large portion of the bonds in the fund’s portfolio each constituted MNPI. Accordingly, the ALJ found that the fund manager’s recommendation to his daughter to sell fund shares while the manager was aware of the foregoing three categories of MNPI constituted insider trading under a tipper-tippee theory. On the scope of the tipper-tippee theory, see the heading “Insider Trading Law” in “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011). As explained in our analysis, while that decision arose in the mutual fund context, it has direct relevance for hedge fund managers and investors. One of the more provocative questions raised by the decision is: are side letters granting preferential transparency and liquidity terms to one investor ipso facto illegal? For more on side letters, see “What Is the Legal Effect of a Side Letter That Contains Specific Terms More Favorable Than a Hedge Fund’s General Offering Documentation?,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).
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From Vol. 4 No.16 (May 13, 2011)
What Is the Legal Effect of a Side Letter That Contains Specific Terms More Favorable Than a Hedge Fund’s General Offering Documentation?
A question that has arisen in the current climate of hedge fund investor caution in the approach to the terms of investment, and managers being more ready to negotiate the offering terms, is: What is the legal effect of side letters entered into between an investor and the fund (usually through the investment manager) following negotiations as to the terms of a specific investment, which provide for terms more favorable than those offered generally by the fund’s offering documentation? In a guest article, Christopher Russell and Rachael Reynolds, Partner and Managing Associate, respectively, at Ogier in the Cayman Islands, provide a detailed answer to this question, including a discussion of four principles that should be borne in mind when preparing a side letter to ensure that the letter has legal and binding effect.
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From Vol. 1 No.5 (Mar. 31, 2008)
Disclosure of Side Letter Terms: Are Some Investors More Equal Than Others?
- Do undisclosed side letter arrangements constitute fraud or raise potential conflicts?
- Preferential redemption rights, key man provisions, redemption gate waivers and portfolio transparency rights among potentially material terms often contained in side letters that may be appropriate for disclosure in the PPM.
- Non-preferred investors may claim that side letters violate fund managers’ fiduciary duty of fair treatment.
- U.K. regulators lead the way in guidance for disclosure of side letters, requiring that firms disclose the existence of side letters containing material terms.
- Some hedge fund attorneys advise clients to disclose in the PPM the existence of side letters arrangements or the fact that the fund may enter into such arrangements. However, disclosure has not been tested in court or an administrative proceeding, so it is not certain that hedge fund advisers can disclose their way out of breach of fiduciary duty claims based on preferential rights granted in side letters.