Hedge Fund Managers and Investors Turning to Dutch Auctions as an Alternative to Secondary Markets for Hedge Fund Interests
Hedge Fund Law Report
On the heels of dismal performance by hedge funds as a group during 2008, the discovery of frauds unprecedented in their pervasiveness and audacity and generally frozen credit markets, hedge funds have paid record amounts in redemptions and received record levels of redemption requests. In response to the daunting level of redemptions and requests, hedge fund managers have deployed tools that, until recently, were widely considered available but, from an investor relations points of view, impracticable – tools like redemption suspensions, gates, side pockets and redemptions in kind. As a means of reconciling investors’ demands for liquidity with managers’ goal of keeping capital invested in their funds, a growing number of investors have been turning to secondary markets for hedge fund interests. However, secondary markets for hedge fund interests suffer from various flaws. Most notably, in light of the confidentiality of information provided to hedge fund investors, selling investors are prohibited, absent manager consent, from providing potential purchasers with information relevant to an informed valuation – information such as fund liquidity and fee terms, performance data and portfolio composition. To preserve the intent of secondary market transactions while addressing some of the flaws in such markets, hedge fund managers and investors are increasingly working with banks to conduct so-called Dutch auctions of hedge fund interests. We explain the mechanics of Dutch auctions in the hedge fund context, compare the benefits and burdens of Dutch auctions versus secondary market trades, discuss two recent examples of hedge funds that have conducted Dutch auctions and conclude by highlighting practical and legal considerations.