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    Apr. 11, 2013

How Can Hedge Fund Managers Use Advisory Committees to Manage Conflicts of Interest and Mitigate Operational Risks? (Part One of Two)

Hedge fund managers often launch onshore and offshore versions of funds following substantially similar investment strategies.  Funds in different jurisdictions are intended to be different in some ways and similar in other ways.  They are intended to be different in terms of tax and regulation because different investors are subject to different tax and regulatory regimes.  (For example, U.S. tax-exempt entities often invest in offshore hedge funds to, among other things, avoid paying tax on Unrelated Business Taxable Income.)  They are typically intended to be similar in terms of strategy and performance, particularly where the onshore and offshore funds are feeders in a master-feeder or similar structure.  See “Hedge Fund Managers Using ‘Mini-Master Funds’ to Retain Favorable Tax Treatment of Performance-Based Revenue from Offshore Funds,” Hedge Fund Law Report, Vol. 2, No. 22 (Jun. 3, 2009).  Notably, onshore and offshore funds are intended to be similar in terms of fund governance.  However, the different structures typically used for onshore and offshore funds inhibit the similarity of governance across jurisdictions, at least structurally.  Many onshore funds are structured as limited partnerships, with no explicit governing body, and many offshore funds are structured as corporations, with a board of directors.  Experience and caselaw have highlighted shortcomings in the fund director model as it is often deployed.  See “The Cayman Islands Weavering Decision One Year Later: Reflections by Weavering’s Counsel and One of the Joint Liquidators,” Hedge Fund Law Report, Vol. 5, No. 36 (Sep. 20, 2012); “The Case in Favor of Focused, Experienced and Independent Hedge Fund Directors,” Hedge Fund Law Report, Vol. 4, No. 3 (Jan. 21, 2011).  Nonetheless, a growing chorus of institutional investors has highlighted the asymmetry in governing structures in the course of due diligence – focusing in particular on the absence of a board of directors of domestic hedge funds.  In response to the expressed concerns of institutional investors on this topic, hedge fund managers have started to explore – and in some cases, to implement – advisory committees.  Part of the purpose of such committees is to serve as a proxy board of directors for domestic funds.  But they do more than that for domestic funds, and also provide services to offshore funds.  They are an important, yet insufficiently understood, innovation in the relationship between hedge fund managers and investors.  To shed much-needed light on this innovation, the Hedge Fund Law Report is publishing this two-part series designed to help hedge fund managers and investors understand the reasons for and mechanics of establishing an advisory committee.  This first installment addresses what advisory committees are; their principal functions; how they are different from offshore fund boards of directors; how much authority advisory committees typically have; and the principal benefits and drawbacks of organizing and operating advisory committees.  The second installment will discuss what types of funds should organize advisory committees; the process of organizing an advisory committee (including determining the committee’s composition); the operation of advisory committees; benefits and drawbacks of serving as an advisory committee member; and liability and indemnity protections afforded to members of an advisory committee.

O’Melveny & Myers Partners Dean Collins and James Ford Discuss the Rationale, Mechanics and Common Terms for Secondary Market Sales of Private Equity Fund Interests

Fund documents generally require private equity fund investors to hold investments for a period ranging anywhere from ten to fourteen years.  However, in the course of that time, many developments can alter a fund investor’s desire to hold onto a private equity fund investment, for example, a change in the investor’s financial condition or significant regulatory reforms.  At the same time, prospective buyers, seeing an opportunity to purchase an attractive private equity fund interest, perhaps at a discount, help create the secondary market for transactions in such fund interests.  As the secondary market for private equity fund interests has evolved, it has grown more robust and well-defined.  To help prospective sellers and buyers understand this market and transactions in fund interests, the Hedge Fund Law Report recently interviewed Dean Collins and James Ford, partners in O’Melveny & Myers LLP’s Singapore and Hong Kong offices, respectively, each of which has wide-ranging expertise in private equity fund formation, secondary transactions and investments.  Our interview with Collins and Ford covered, among other topics: reasons for selling private equity fund interests; channels through which buyers and sellers indicate interest in such transactions; due diligence challenges for prospective buyers; trends in pricing of such transactions; the impact of regulations on the secondary market; steps in the sale of private equity fund interests; risks fund sponsors consider when evaluating whether to consent to such transactions; key transaction documents and negotiating points for such transactions; challenges in negotiating transaction documents; and fund sponsor buybacks of fund interests.  On legal considerations in connection with sponsor buybacks and other principal transactions, see “When and How Can Hedge Fund Managers Engage in Transactions with Their Hedge Funds?,” Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).

SEI Study Offers a Reality Check to Hedge Fund Managers on What Actually Works When Marketing to Institutional Investors

Financial and asset management services provider SEI has released its sixth annual survey of institutional hedge fund investors.  While hedge fund investors are “generally maintaining, and even somewhat increasing,” their hedge fund allocations, SEI cites “rising investor dissatisfaction” with hedge fund performance, which, going forward, could be further hindered by the “institutionalization” of the hedge fund space in response to more intensive investor due diligence and greater demands for transparency.  Moreover, as the line between hedge funds and other products offering hedge fund strategies continues to blur, it becomes more difficult for managers to distinguish their funds and convince investors that they offer good value.  See “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  This article summarizes key points from the survey.  For more on the expectations of fund managers and investors, see “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  For a general look at institutional investors’ priorities and perspectives on alternative investments, see “Natixis Global Asset Management Survey Reveals Institutional Investors’ Attitudes Towards Market Volatility, Risk Management, Portfolio Construction, Investment Concerns, Alternative Investments and Investment Priorities,” Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012).

Federal Antitrust Suit Against Ten Prominent Private Equity Firms Based on Allegations of “Club Etiquette” Not to Jump Announced Deals Survives Summary Judgment Motion

From 2003 through 2007, numerous private equity (PE) firms completed leveraged buyouts (LBOs) of 27 mega-cap publicly traded companies, including Hospital Corporation of America.  In 2007, former shareholders of those target companies commenced a private antitrust suit against ten PE firms that were involved in those deals.  They alleged that the PE firms had conspired to rig bids and engaged in other anticompetitive behavior in the LBO market, such as refraining from bidding on (“jumping”) each other's deals, that resulted in successful PE bidders paying less for target companies than they would have in a truly competitive sale process.  The defendant PE firms moved for summary judgment, claiming that the plaintiffs’ evidence was insufficient to sustain their antitrust claims.  The U.S. District Court for the District of Massachusetts recently ruled on their motions.  This article summarizes the plaintiffs’ claims and the Court’s analysis.

Does the U.S. Commodity Exchange Act Apply to Investments in Non-U.S. Commodity Funds?

A Federal District Court recently considered the extent of extraterritorial application of the Commodity Exchange Act to an investment in allegedly fraudulent non-U.S. funds that invest in commodities, among other assets.  See also “How Can Offshore Hedge Funds Ensure That Section 10(b) Will Apply to Their Transactions in Securities Not Listed on U.S. Exchanges,” Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012); and “Second Circuit Clarifies When Offshore Hedge Funds Can Make Section 10(b) Securities Fraud Claims in Connection with ‘Domestic Transactions’ with Conduct and Effects in the United States,” Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).

Seward & Kissel Study of New Hedge Fund Launches Identifies Trends in Preferred Investment Strategies, Fees, Liquidity Terms, Fund Structures and Strategic Capital Arrangements

The challenging capital raising environment has not deterred quality managers from launching their maiden funds.  With this in mind, Seward & Kissel LLP recently published a study detailing some key findings relating to first funds launched in 2012 by their U.S.-based manager clients.  The study highlights important information concerning investment strategies, management fees, incentive fees, liquidity terms, fund structures and strategic capital arrangements.  This article summarizes important takeaways from the study.  For a discussion of the 2011 version of Seward’s study, see “Seward & Kissel Study Highlights Trends in Hedge Fund Investment Strategies, Fee and Liquidity Terms, Fund Structures and Strategic Capital for New Managers,” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).

Former SEC Assistant Director Mary P. Hansen Joins Drinker Biddle

On April 9, 2013, Drinker Biddle announced that Mary P. Hansen has joined its White Collar Criminal Defense & Corporate Investigations Team.  For analysis from Drinker Biddle on social media issues, see “Legal Considerations for Hedge Fund Managers that Use Social Media,” Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  For analysis from Drinker Biddle on ERISA issues, see “Applicability of New Disclosure Obligations under ERISA to Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).

Carne Appoints Jean de Courrèges to Luxembourg Team of Independent Directors

Carne Group, a specialist provider of governance and oversight services to the global funds industry, recently announced the appointment of Jean de Courrèges as a Director within its international team of independent fund directors, serving Luxembourg and other jurisdictions.  See “Hedge Fund Side Letters: The View from the Fund Director’s Perspective,” Hedge Fund Law Report, Vol. 5, No. 30 (Aug. 2, 2012).  For analysis from Carne recently published in the HFLR, see “Identifying and Addressing the Primary Conflicts of Interest in the Hedge Fund Management Business,” Hedge Fund Law Report, Vol. 6, No. 3 (Jan. 17, 2013).

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