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    Jan. 12, 2012

Proposed New York City Audit Position Can Increase the Amount of Unincorporated Business Tax Paid by New York Hedge Fund Managers

Facing budget deficits and rising debt levels, federal, state and local government authorities have ratcheted up efforts to raise revenues, and one of the constituencies in their crosshairs has been hedge fund managers.  While proposals have been put forward at the federal and state level to raise revenues by taxing the carried interest received by hedge fund managers at ordinary income tax levels instead of at the favored long-term capital gains rates, New York City has seemingly opted for another approach by proposing to disallow some expense deductions claimed by hedge fund management entities that are subject to the New York City unincorporated business tax (UBT).  Specifically, the New York City Department of Finance (Department of Finance) has recently asserted a new proposed audit position (Proposed Audit Position) to require that a portion of the expenses of an investment manager entity be reallocated to a general partner entity because it believes that certain of those expenses are incurred in generating the incentive allocation received by the general partner entity.  This feature-length article begins by explaining in detail the UBT and what entities are subject to the UBT.  The article then explains how the UBT applies to hedge fund managers.  The article then moves to a discussion of the Proposed Audit Position, including a discussion of the potential application of the Proposed Audit Position to future audits.  Next, the article explains how audit positions are promulgated and identifies the sources of authority for the Department of Finance’s assertion of the Proposed Audit Position.  The article continues with a discussion how hedge fund managers can respond if the Department of Finance asserts the Proposed Audit Position in disallowing certain investment manager expenses during the course of an audit.  The article closes with a discussion of recommended courses of action for hedge fund managers that seek to mitigate the adverse tax impact of the Proposed Audit Position on their businesses.

STOCK Act Could Expand Insider Trading Laws to Prohibit Trading by Hedge Funds Based Upon Nonpublic “Political Intelligence”

Last month the Senate Homeland Security & Governmental Affairs Committee passed the “Stop Trading on Congressional Knowledge Act,” or “STOCK Act,” and the House Financial Services Committee held hearings on similar legislation.  The primary purpose of this Act is to close a loophole in the law that may allow Members of Congress to legally trade securities based upon nonpublic “political intelligence.”  However, hedge fund managers should watch this legislation closely as it could have significant, perhaps unintended, implications.  Depending on what provisions (if any) are ultimately enacted, the legislation could alter the way fund managers conduct basic regulatory due diligence in connection with investments.  The legislation could weaken a key provision of Regulation FD, which confirms the “mosaic theory” defense to federal insider trading charges, and impact the way fund managers use employees, expert networks, lobbyists and political intelligence firms to research federal legislative and political activities in connection with their investments.  In fact, the legislation could fundamentally alter the way that fund managers interact with federal employees, including Members of Congress.  In a guest article, Scott E. Gluck, Of Counsel at Venable LLP, discusses: the background of the STOCK Act; relevant insider trading law; specific provisions of the STOCK Act relevant to hedge fund managers; and seven distinct issues for hedge fund managers to monitor, including the potential impact of the STOCK Act on the “mosaic theory” defense to insider trading charges.

SEC Enforcement Action and Bulletins Shine Spotlight on Use of Social Media by Investment Advisers

Respondent Anthony Fields (Fields) is an Illinois accountant who operated as a registered investment adviser under the d/b/a Anthony Fields & Associates (AFA).  Fields was also the sole proprietor of Platinum Securities Brokers (Platinum), which was briefly registered as a broker-dealer.  The Securities and Exchange Commission (SEC) has issued an order commencing cease and desist proceedings against Fields, AFA and Platinum for various alleged violations of the securities laws.  Many of those violations arose from postings and offerings of fictitious securities made on the respondents’ websites and social media sites, including LinkedIn.  The SEC seeks injunctive relief, disgorgement of profits and civil penalties.  Simultaneously with the commencement of this enforcement proceeding, the SEC issued a “Risk Alert” covering compliance issues that arise when investment advisers use social media and two alerts that warn individual investors of the potential risks posed by social media sites.  This article summarizes the key points from the SEC’s order and the related alerts.  See also “Legal Considerations for Hedge Fund Managers that Use Social Media,” Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).

Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice

Ernst & Young recently released the provocative results of its annual hedge fund survey entitled, “Coming of Age: Global Hedge Fund Survey 2011.”  The survey polled hedge fund managers and investors on a range of relevant topics, notably including valuation and the use of administrators.  See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence,” Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Many of our subscribers are profoundly interested in the topics of valuation and administrators.  Accordingly, we recently interviewed Arthur Tully, the Co-Leader of E&Y’s Global Hedge Fund Practice, to dig deeper into the survey results on these two topics, and to go beyond the survey to explore Tully’s extensive experience in these areas.  Our interview covered a range of topics on which HFLR subscribers have requested additional insight, including: the level of comfort that investors should take in an administrator’s valuation of Level 3 assets; the level of interest on the part of investors in independent reconciliation of a hedge fund’s investment positions to custodians and prime brokers; who pays for “shadowing” of an administrator by a hedge fund manager and alternatives to shadowing that can provide the same level of comfort to investors; how managers can reconcile and document differences between their calculations of NAV and administrators’ calculations of NAV; independent administration considerations for UCITS funds; the interaction between valuation firms and administrators; hedge fund manager valuation committees; the roles of the board of directors and chief compliance officer in the valuation process; what SEC examiners are looking for with respect to valuation; and how to gather the data necessary to complete Form PF.  The full text of our interview with Tully is included in this issue of the Hedge Fund Law Report.

New York Court of Appeals Holds that The Martin Act, New York’s “Blue Sky” Law, Does Not Preempt Common Law Claims for Breach of Fiduciary Duty and Gross Negligence

On December 20, 2011, in an important decision for the investment management community, the New York Court of Appeals ruled that the Martin Act does not preclude overlapping private tort claims brought by individual investors.  See “First Department Decision May Give Aggrieved Hedge Fund Investors an Unexpected and Powerful Avenue of Redress,” Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).  This article details the background of the action, the court’s legal analysis and the potential implications of the decision for lawsuits by hedge fund investors against hedge fund managers.

Aksia’s 2012 Hedge Fund Manager Survey Reveals Managers’ 2012 Predictions Regarding Tail Risk Hedges, Portfolio Transparency, Movement of Balances Away from Counterparties and More

In November 2011, Aksia LLC (Aksia), an independent hedge fund research and advisory firm, published its 2012 Hedge Fund Manager Survey (Survey) in which it solicited predictions for 2012 from 125 hedge fund managers managing approximately $800 billion in assets and employing various investment strategies.  Thirty-eight percent of the respondents employ long-short equity strategies, 26% employ event-driven strategies, 18% employ relative value strategies and 18% employ tactical trading strategies.  Among other things, the respondents made predictions about market and investment strategy performance, economic growth projections and various scenarios with respect to the European financial crisis.  The respondents also shared their views on policymakers’ handling of the global financial crisis as well as the impact of market correlation and new financial regulations on their investment strategies.  Notably, respondents opined on hedge fund industry specific practices, such as the use of hedges for tail risk, portfolio transparency, movement of balances away from counterparties and the availability of financing in 2011.  This article summarizes the Survey’s findings.

Ropes & Gray Adds Private Equity Real Estate Lawyer Iain Morpeth to its London Office

Iain Morpeth recently joined the London office of Ropes & Gray as a partner in its private equity practice group.  For a discussion of one of the many ways in which the hedge fund and real estate industries overlap, see “For Hedge Funds, Ownership of Commercial Mortgage-Backed Securities Servicers Offers a Growing, Uncorrelated Stream of Fee Income and Advantageous Access to Distressed Mortgages, But Not Without Legal and Business Risk,” Hedge Fund Law Report, Vol. 2, No. 38 (Sep. 24, 2009).

Pluris Valuation Advisors Hires Kyle Vataha to Focus on Alternative Asset Management Company Valuations

On January 11, 2012, Pluris Valuation Advisors LLC announced that Kyle B. Vataha has joined the firm as Vice President with a mandate to focus on valuation of alternative asset management companies.  Valuation of a management company may come up in the contexts of seed investments, management company acquisitions, compensation discussions, fee negotiations and in other scenarios.

CFTC Chairman Names Vincente Martinez as Director of Its New Whistleblower Office

On January 6, 2012, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler announced that Vincente Martinez has been hired as the first director of the CFTC’s recently opened Whistleblower Office.  For more on whistleblower considerations for hedge fund managers, see “Wiretaps, Whistleblowers, Expert Networks and Insider Trading: A Conversation with Kevin O’Connor, Former Associate Attorney General of the U.S. and Former U.S. Attorney for Connecticut,” Hedge Fund Law Report, Vol. 4, No. 33 (Sep. 22, 2011).

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