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    Apr. 9, 2015

Operational Conflicts Arising Out of Simultaneous Management of Hedge Funds and Alternative Mutual Funds Following the Same Strategy (Part Two of Three)

The simultaneous management of hedge funds and alternative mutual funds (or liquid alternative funds) is rife with potential conflicts and the corresponding risk that the manager or hedge fund investors can benefit at the expense of the mutual fund investors, despite the manager’s fiduciary duty to manage each fund in the best interests of that fund’s investors as well as requirements under the Investment Company Act of 1940 that joint enterprises involving a mutual fund and certain affiliates be fair to the mutual fund.  See “SEC and FSA Impose Heavy Fines on Investment Manager for Failing to Address Conflicts of Interest Associated with Side by Side Management of a Registered Fund and a Hedge Fund,” Hedge Fund Law Report, Vol. 5, No. 21 (May 24, 2012).  In addition to the incentive for the manager to allocate trades to the hedge fund over the mutual fund in certain circumstances (including in order to earn higher fees in the hedge fund), operational and other conflicts arise out of such simultaneous management.  This article, the second in a three-part series, discusses conflicts arising out of simultaneous management of a hedge fund and alternative mutual fund, including operational conflicts, conflicts of fee-related investment decisions, cross trades, soft dollar allocations, valuation concerns, reporting conflicts and marketing conflicts.  The first article provided an overall assessment of conflicts of interest in simultaneous management; outlined the conflicts inherent in allocation of investments between a hedge fund and an alternative mutual fund following the same strategy; and discussed leverage limits, liquidity issues and diversification requirements applicable to alternative mutual funds.  The third article will address ways to mitigate identified conflicts of interest.

Permanent Capital Structures Offer Managers Funding Stability and Access to Capital While Granting Investors Liquidity and Access to Managers

Client redemptions and the need to manage their funds’ underlying portfolios of investments to allow for investor liquidity are issues that hedge fund managers routinely face, especially since the market events of 2008 and 2009.  Consequently, managers may find their abilities to pursue their investment strategies constrained by the need to keep portions of their funds’ assets in cash or may have to reduce otherwise attractive positions held by their funds in order to fund client redemptions.  In an effort to counteract such issues, managers are increasingly exploring permanent capital structures – vehicles that would provide a stable source of assets to the manager.  In a recent interview with the Hedge Fund Law Report, Jay Gould and Christopher Zochowski, partners at Winston & Strawn LLP and members of its Permanent Capital Solutions Group, shared detailed insight into types of permanent capital structures used in the hedge fund and private equity industries; the benefits of such structures; the circumstances under which certain permanent capital structures may be employed by managers; potential investor concerns with such structures; and terms and features of certain permanent capital structures.  For more on permanent capital structures, see “Ares Management IPO Raises Permanent Capital and Creates Liquidity for Founders’ Interests,” Hedge Fund Law Report, Vol. 7, No. 14 (Apr. 11, 2014); and “Prospectus for Suspended Ellington Financial IPO Details Mechanics of a Hedge Fund Permanent Capital Vehicle,” Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).

RCA Session Offers Insights on Dodd-Frank Whistleblower Regime, Incentives, Anti-Retaliation Protections and Risks

The Dodd-Frank Act created incentives for whistleblowers to report violations of securities laws to the SEC and prohibits retaliation against persons who do so.  It has been nearly four years since the SEC issued its final whistleblower regulations.  A recent program offered by the Regulatory Compliance Association (RCA) provided a thorough overview of both the whistleblower bounty program and the anti-retaliation protections under the Dodd-Frank Act; considered how regulators and courts have interpreted and implemented those provisions; analyzed the interaction of the Dodd-Frank anti-retaliation provisions with those under the Sarbanes-Oxley Act; and offered strategies for mitigating whistleblower risks.  The program featured J. Ian Downes, counsel at Dechert LLP, and Kathleen M. Massey, a partner at Dechert LLP and an RCA Senior Fellow.  This article summarizes the key takeaways from the program.  This month, the RCA will be hosting its Regulation, Operations and Compliance (ROC) Symposium in Bermuda.  For more on ROC Bermuda 2015, click here; to register for it, click here.  For a discussion of another RCA program, see “RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence,” Hedge Fund Law Report, Vol. 8, No. 13 (Apr. 2, 2015).

BakerHostetler Event Highlights Investment Strategies, Considerations and Uncertainties of Distressed Debt Investments by Hedge Funds

In the current distressed debt environment, defaults have been relatively low, leading to fewer bankruptcies but opening the market up to increased restructurings and similar workouts.  However, the maneuvers available to distressed investors in the bankruptcy or restructuring process could be significantly impacted by two recent court cases, the results of which have created uncertainty in the marketplace by allowing minority bondholders to hold up or overturn restructuring proceedings and could have a major impact on future interpretations of the Trust Indenture Act of 1939 by courts in future proceedings.  See “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act,” Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015); and “Trust Indenture Act May Give Hedge Funds the Right to Challenge Involuntary Non-Judicial Debt Restructurings,” Hedge Fund Law Report, Vol. 8, No. 5 (Feb. 5, 2015).  Types and strategies of distressed investments, key legal issues relating to distressed investments, issues investors should consider in assessing distressed opportunities and the two recent court cases were highlights of a recent Hedge Funds and Distressed Debt Investing seminar held by law firm BakerHostetler.  This article summarizes the key issues discussed at that seminar.

SEC Fraud Charges Against Lynn Tilton, So-Called “Diva of Distressed,” Confirm the Agency’s Focus on Valuation and Conflicts of Interest

On March 30, 2015, the SEC announced the commencement of an enforcement action against Lynn Tilton, the so-called “Diva of Distressed,” and several entities she controls, arising out of the alleged overvaluation of distressed debt in the collateralized loan obligations (CLOs) they advise.  The SEC charges that Tilton improperly valued the loans owned by those CLOs, resulting in her receipt of nearly $200 million in compensation that she was not entitled to receive.  She also allegedly certified false and misleading financial statements for those CLOs and failed to disclose and obtain investor consent to the conflict of interest posed by her discretionary valuation method.  This article summarizes the SEC’s allegations and its specific charges.  For more on CLOs, see “Private Investment Funds Investing in CLO Equity and CLO Warehouse Facilities,” Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).

CFTC Extends Annual Report Deadline for Futures Commission Merchants, Registered Swap Dealers and Major Swap Participants

Commodity Futures Trading Commission (CFTC) Regulation 3.3(f)(2), promulgated under the Commodity Exchange Act, requires the chief compliance officer of a futures commission merchant, swap dealer or major swap participant to furnish an annual report to the CFTC not more than 60 days after the end of the applicable registrant’s fiscal year, simultaneously with the submission of Form 1-FR-FCM or the Financial and Operational Combined Uniform Single Report.  See “CFTC Issues Guidance for Completing Annual CCO Reports of Swaps and Futures Firms,” Hedge Fund Law Report, Vol. 8, No. 1 (Jan. 8, 2015).  However, in response to a joint request from the Futures Industry Association and the International Swaps and Derivatives Association, the Division of Swap Dealer and Intermediary Oversight of the CFTC issued no-action relief from those timing requirements.  Consequently, the deadline for those entities to file the required annual report has been extended.  This article explains the mechanics and impact of the extension.

Terrence Davis Joins Holland & Knight in Atlanta

On April 8, 2015, Holland & Knight announced that financial services attorney Terrence Davis has joined the firm’s Atlanta office as a partner.  Davis formerly practiced with Baker Donelson.  For insight from Davis, see “How Can Hedge Fund Managers Use Advisory Committees to Manage Conflicts of Interest and Mitigate Operational Risks? (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 15 (Apr. 11, 2013); and Part Two of Two, Vol. 6, No. 17 (Apr. 25, 2013).

Judith Donnelly Joins Squire Patton Boggs in London

Judith Donnelly recently joined Squire Patton Boggs as a partner in the Pensions practice in London.  She joins the firm from Clyde & Co where she was a partner; she also previously practiced at Linklaters and held in-house roles at Deutsche Asset Management and SG Asset Management.  Donnelly advises pension funds and other institutional investors on a wide range of issues, including investment, governance and regulatory matters.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part One of Three),” Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014); Part Two of Three, Vol. 7, No. 5 (Feb. 6, 2014); and Part Three of Three, Vol. 7, No. 7 (Feb. 21, 2014).

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