Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers
Hedge Fund Law Report
Can there be circumstances in which it makes business and legal sense for a hedge fund manager to cause one of its managed hedge funds to lend money or other assets to the manager? The visceral response from most hedge fund legal and compliance professionals generally – and from those surveyed by the Hedge Fund Law Report on this question specifically – is: rarely, if at all. However, this is a question that merits attention from hedge fund managers for at least three reasons. First, even if loans from funds to managers are imprudent or prohibited in most circumstances, there may be some circumstances in which such loans may be permissible; and in a still-tight credit environment for most hedge funds and managers, it is important to be aware of the risks and benefits of all credit options. Second, it is more important to understand why such loans may be ill-advised than merely to understand that such loans may be ill-advised, in particular because the explanation touches on many other aspects of the hedge fund-manager relationship (including fiduciary duty, principal trading and others). Third, a wide range of transactions, some of them nonintuitive, may constitute loans from a hedge fund to a manager. For example, if an affiliate of the manager lends securities to the fund and that loan is secured by cash, does the “loan” of securities from the affiliate to the fund constitute a “loan” of cash from the fund to the manager? As discussed more fully below, the SEC’s standard document request letter for investment adviser examinations asks for documentation of loans from funds to advisers, and registered hedge fund managers will be subject to such examinations. Therefore, it is important for hedge fund managers to appreciate the full range transactions that may constitute loans for examination purposes. The goal of this article is to provide a fuller answer to that initial question – can there be circumstances in which it makes business and legal sense for a hedge fund manager to cause one of its managed hedge funds to lend money or other assets to the manager? To do so, this article begins by enumerating examples of circumstances in which a hedge fund may make or be construed to have made a loan to its manager. As indicated, some of those circumstances may be indirect, roundabout or non-obvious, and our point is not to provide an exhaustive list, but rather to suggest that many fact patterns that do not look like loans may be deemed (by the SEC or investors) to be loans. The article then goes on to address the chief legal concerns in connection with loans from funds to advisers, including concerns relating to fiduciary duty, SEC examinations, ERISA, principal trading, advisory boards, commodity pool operators, disclosure and manager defaults. The article includes concrete suggestions for structuring loans from hedge funds to managers in a way that may, in appropriate circumstances, pass muster with regulators and investors.