How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part One of Two)

Hedge fund due diligence is a courtship process in which institutional investors and their consultants spend considerable time and resources getting to know a manager’s philosophy, people, processes and performance.  See “Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  Headline performance numbers (phrased gross or net of fees), statements of strategy and similar routine and comparable data points are necessary but not sufficient to tell a manager’s story, or to convey what is unique in the manager’s value proposition.  See “Can Hedge Fund Managers Use Gross (Rather Than Net) Results in Performance Advertising? (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 42 (Nov. 1, 2013).  Investment and operational due diligence focus not only on what performance the manager achieved, but also on how the manager achieved that performance.  And there is no more comprehensive or persuasive way to convey the “how” of a manager’s processes than to walk investors step-by-step through the lifecycle of actual investments – in other words, to present case studies.  However, the instinct of managers (and their marketing and sales people) to put their best feet forward when presenting case studies is constrained by general and specific prohibitions in the federal securities laws and rules.  Generally, the federal securities laws and rules prohibit materially misleading statements or omissions in communications with investors and potential investors.  Applied to case studies, this general prohibition typically means that managers cannot discuss good investments without also discussing bad investments.  Specifically, Rule 206(4)-1(a)(2) under the Investment Advisers Act of 1940 (Advisers Act) – the so-called “cherry picking” rule – prohibits a manager from disseminating, directly or indirectly, advertisements that refer to specific past profitable recommendations unless the advertisement offers to provide a list of all of the manager’s recommendations for at least the past year.  In short, managers often have a compelling business rationale for telling their stories via case studies (and likely will have more opportunities to do so now that the JOBS Act rules have been finalized), but managers’ ability to present case studies is constrained by a patchwork of law and regulation.  See “A Compilation of Important Insights from Leading Law Firm Memoranda on the Implications of the JOBS Act Rulemaking for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013).  This article is the first in a two-part series designed to untangle that patchwork and enable managers to market via case studies within the scope of applicable authority.  In particular, this article describes the purposes and typical contents of case studies; identifies the types of managers and strategies that use and benefit from case studies; and highlights risks associated with use of case studies in marketing, including a discussion of the cherry picking rule.  The second article in the series will discuss additional risks of using case studies and provide best practices for managers wishing to use case studies in marketing.

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