“Liquidity” describes the frequency with which investors can get their money back from a hedge fund. Typically, the governing documents of a hedge fund contain default liquidity provisions and a set of mechanisms the manager can use to vary those default provisions. For example, the default provisions may say that investors can redeem from the fund quarterly, but the documents may also permit the manager to reduce, delay or recharacterize redemption requests. Conceptually, liquidity management tools are motivated by investment and equitable considerations: it is difficult to execute an investment program on a fickle capital base, and a manager’s fiduciary duty flows to all investors in a commingled vehicle. In practice, however, investors are rarely happy to hear that they cannot get their money back. Prior to the 2008 financial crisis, liquidity management tools in hedge fund governing documents were effectively viewed as boilerplate: present, but rarely used. Then credit markets seized up, liquidity dried up and everybody needed cash – investors for their own investors or beneficiaries, managers to satisfy redemptions, banks to remain solvent, etc. Managers blew the dust off long dormant provisions in governing documents and actually imposed gates, suspended redemptions and use other heretofore unthinkable techniques to manage liquidity. The financial crisis has passed, but liquidity management remains an important topic in the hedge fund industry. Liquidity issues are often micro rather than macro, and, in any case, post-crisis documents have been drafted with a view to the next macro event. Recognizing the ongoing importance of liquidity management in hedge fund governance, Stephanie R. Breslow presented a session on the topic at the Practising Law Institute’s September 5, 2012 “Hedge Funds 2012” event. Breslow is a partner in the New York office of Schulte Roth &
Zabel LLP, co-head of Schulte’s Investment Management Group and a member of the firm’s Executive Committee. Breslow’s session focused on, among other topics: developments in fund liquidity terms since the 2008 financial crisis; tools available to a fund manager for managing liquidity risk, including the right to suspend redemptions, fund-level gates, investor-level gates, side pockets and in-kind distribution of assets; duties owed by a fund manager in the context of a liquidity crisis; the evolution in fund manager attitudes towards secondary market transactions in fund interests and shares; and why fund investors have not pushed for the right to remove fund managers in fund governing documents during liquidity crises. This article summarizes key points from Breslow’s session.