The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Articles By Topic

By Topic: Due Diligence

  • From Vol. 11 No.25 (Jun. 21, 2018)

    The Importance of Exercising Due Diligence When Hiring Auditors and Other Vendors

    The SEC recently announced that it had issued an order against an accounting firm and two partners for willfully aiding and abetting violations of Rule 206(4)-2 (the so-called “custody rule”) of the Investment Advisers Act of 1940 relating to the audits of funds’ financial statements. The order bars the certified public accounting firm and two certified public accountants (CPAs) from appearing or practicing before the SEC as accountants for certain periods, and it requires payment of disgorgement, interest and civil penalties. The settlement of this enforcement action is relevant to registered investment advisers because it illustrates how critical errors by the accountants auditing a fund’s financial statements can result in custody rule violations by the adviser. This article examines the mistakes made by the accountants in the case; discusses the importance of exercising due diligence when engaging accounting firms and other vendors; and presents analysis from an attorney who is also a CPA. See “What Role Should the GC or CCO Play in the Audit of a Fund’s Financial Statements?” (Feb. 23, 2017).

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  • From Vol. 11 No.24 (Jun. 14, 2018)

    How the GDPR Will Affect Private Funds’ Use of Alternative Data

    The E.U.’s General Data Protection Regulation (GDPR), which took effect May 25, 2018, primarily affects investment managers and private funds that are based in the E.U. The GDPR’s restrictions on the processing of “personal data” of individuals in the E.U., however, may affect managers and funds that are located outside the E.U. if they process the data of individuals located in the E.U. in connection with the offering of services to those individuals. Because more funds are using alternative data in their operations – notably in driving their trading strategies and making investment decisions – the GDPR may impact how these funds obtain and use alternative data if that data contains what is arguably considered the personal data of individuals in the E.U. To help readers understand the potential impact of the GDPR on funds’ use of alternative data, The Hedge Fund Law Report interviewed Peter D. Greene, partner and vice-chair of the investment management group at Lowenstein Sandler. This article presents his insights. For more from Greene, see our three-part series on the opportunities and risks presented by big data: “Acquisition and Proper Use” (Jan. 11, 2018); “MNPI, Web Scraping and Data Quality” (Jan. 18, 2018); and “Privacy Concerns, Third Parties and Drones” (Jan. 25, 2018).

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  • From Vol. 11 No.17 (Apr. 26, 2018)

    Former CEO of JPAAM Discusses Risks and Challenges Facing the Hedge Fund Industry

    As the hedge fund industry continues to face challenges, it has never been more important for managers to ensure that they align their interests with those of their clients and provide first-rate service to their investors. The Hedge Fund Law Report recently interviewed Joel Katzman, president of Katzman Advisors, former president and CEO of J.P. Morgan Alternative Asset Management and a panelist at the 2018 Cayman Alternative Investment Summit. This article presents Katzman’s views on several of the current challenges facing the industry and provides his perspectives on the things that matter most to hedge fund allocators. For additional insights on the evolution of the hedge fund industry, see “How to Prepare for the Technological Revolution’s Transformation of the Hedge Fund Industry” (Apr. 5, 2018); and “Schulte Roth & Zabel Founding Partner Paul Roth Discusses the History and Future of the Hedge Fund Industry” (Feb. 8, 2018).

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  • From Vol. 11 No.15 (Apr. 12, 2018)

    How Fund Managers Should Structure Their Cybersecurity Programs: Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties (Part Three of Three)

    Cybersecurity stakeholders, particularly those in information security and legal/compliance, must communicate effectively to ensure that a fund manager’s cybersecurity program is fully implemented and able to respond to cyber attacks. Although managers of all sizes should aim to build in-house cybersecurity expertise to increase responsiveness, some may benefit from outsourcing or co-sourcing certain cybersecurity functions given the involved costs and shortage of qualified workers. Managers must, however, ensure that they properly vet and oversee third-party cybersecurity vendors, and this requires coordination between the chief compliance officer (CCO) and on-site technology leaders. This article, the third in our three-part series, evaluates methods for facilitating communication between cybersecurity stakeholders; outsourcing and co-sourcing of cybersecurity functions; and best practices for employing and overseeing third-party cybersecurity vendors. The first article discussed the risks and costs associated with cyber attacks; the global focus on cybersecurity; relevant findings observed by the Office of Compliance Inspections and Examinations during the examination of SEC registrants; and cybersecurity best practices. The second article analyzed the reasons why fund managers should hire a dedicated chief information security officer, reviewed information security governance structures and explored the role of the CCO as a strategic partner. See “Fund Managers Must Supervise Third-Party Service Providers or Risk Regulatory Action” (Nov. 16, 2017); and “How Managers Can Identify and Manage Cybersecurity Risks Posed by Third-Party Service Providers” (Jul. 27, 2017).

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  • From Vol. 11 No.15 (Apr. 12, 2018)

    How Quant Funds Can Maximize Appeal to Investors While Minimizing Cyber and Regulatory Risk

    In the hyper-connected trading and investment world of 2018, quant funds, which utilize highly sophisticated computer-based models to automatically carry out trades, are gaining increasing appeal. As the lure of these funds grows, however, it is critically important for investors to understand the differences between quant funds and seemingly similar vehicles; the various investment strategies that they offer; and the numerous risks that come with this type of trading. Managers must also recognize that running a quant fund raises unique operational and marketing challenges, not least because of the extremely high standard of due diligence that many institutional investors are likely to apply before making allocations. Quant funds also face unique external problems; for example, luring and retaining talent in a tech world dominated by Silicon Valley presents certain difficulties. To help readers understand these issues, The Hedge Fund Law Report interviewed Ildiko Duckor, head of the emerging hedge fund manager program and co-head of the investment funds practice at Pillsbury in San Francisco. This article presents her insights. For more from Duckor, see “What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?” (Feb. 18, 2011). For commentary from another Pillsbury attorney, see “ALM General Counsel Summit Reveals How Hedge Fund Managers Can Prepare for SEC Examinations” (Nov. 19, 2015).

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  • From Vol. 11 No.12 (Mar. 22, 2018)

    How Fund Managers Should Structure Their Cybersecurity Programs: Background and Best Practices (Part One of Three)

    Nation-states, organizations, groups and individuals continue to employ increasingly sophisticated methods to target information systems and computer networks. Governments and regulators – including the SEC and the U.K. Financial Conduct Authority – are also intensifying their scrutiny of organizations’ cybersecurity programs. See our two-part series “Navigating FCA and SEC Cybersecurity Expectations”: Part One (Jan. 7, 2016); and Part Two (Jan. 14, 2016). As a result, it is becoming more expensive to combat and contain cyber-related attacks. Given that cybersecurity is an enterprise-wide risk, fund managers must, at a minimum, ensure that they comply with industry best practices, including adopting one or more cybersecurity frameworks and creating a culture of cybersecurity compliance. This article, the first in a three-part series, discusses the risks and costs associated with cybersecurity attacks; the global focus on cybersecurity; relevant findings observed by the Office of Compliance Inspections and Examinations during the examination of SEC registrants; and cybersecurity best practices. The second article will analyze the need for fund managers to hire a dedicated chief information security officer, review information security governance structures and explore the role of the chief compliance officer as a strategic partner. The third article will evaluate methods for facilitating communication between cybersecurity stakeholders; outsourcing and co-sourcing of cybersecurity functions; and best practices for employing and overseeing third-party cybersecurity vendors. See our two-part series on how fund managers can meet the cybersecurity challenge: “A Snapshot of the Regulatory Landscape” (Dec. 3, 2015); and “A Plan for Building a Cyber-Compliance Program” (Dec. 10, 2015).

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  • From Vol. 11 No.4 (Jan. 25, 2018)

    A Fund Manager’s Roadmap to Big Data: Privacy Concerns, Third Parties and Drones (Part Three of Three)

    A fund manager’s use of new technologies and processes to streamline its business and generate improved performance comes with significant risk, which is pronounced when using big data, as few best practices currently exist within the industry. One of the most significant concerns about big data involves the acquisition or use of personally identifiable information (PII). Although PII enjoys broad protection under U.S. law, many state laws impose even more stringent restrictions on the use of personal data, and the E.U. General Data Protection Regulation provides a comprehensive and onerous framework for data tied to E.U. citizens. Managers must also understand how to deal with third-party data vendors, including how to conduct due diligence on and negotiate contractual provisions with those service providers. Finally, as growing numbers of drones are used to capture images, managers must recognize and comply with a web of federal regulations, as well as state laws, surrounding this use. This third article in our three-part series discusses the risks associated with data privacy, the acquisition of data from third parties and the use of drones, as well as recommended methods for mitigating those risks. The first article explored the big-data landscape, along with how fund managers can acquire and use big data in their businesses. The second article analyzed issues and best practices surrounding the acquisition of material nonpublic information; web scraping; and the quality and testability of data. For more on the adoption by fund managers of new technology, see our three-part series on blockchain: “Basics of the Technology and How the Financial Sector Is Currently Employing It” (Jun. 1, 2017); “Potential Uses by Private Funds and Service Providers” (Jun. 8, 2017); and “Potential Impediments to Its Eventual Adoption” (Jun. 15, 2017).

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  • From Vol. 11 No.3 (Jan. 18, 2018)

    A Fund Manager’s Roadmap to Big Data: MNPI, Web Scraping and Data Quality (Part Two of Three)

    As fund managers increasingly turn to sophisticated data streams to boost investment returns and produce greater operational efficiencies, it is critical that they understand the legal and practical risks posed by the use of big data. Issues surrounding material nonpublic information (MNPI) pose the greatest threat to firms. Managers must understand not only the misappropriation framework under the Securities Exchange Act of 1934, but also how the New York State Attorney General and regulators in the E.U. pursue insider trading claims. Additionally, whether engaging internally in web scraping or purchasing scraped data from third parties, managers must be conscious of contractual, intellectual property and tort claims that a site owner may allege against a fund manager. Finally, many of the largest challenges posed by the use of big data are practical or ethical in nature. This second article in our three-part series on big data analyzes issues and best practices surrounding the acquisition of MNPI; web scraping; and the quality and testability of data. The first article explored the big-data landscape and how fund managers can acquire and use big data in their businesses. The third article will discuss risks associated with data privacy, the acquisition of data from third parties and the use of drones, as well as recommended methods for mitigating those risks. For more on big data, see “Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping” (Jun. 15, 2017).

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  • From Vol. 10 No.50 (Dec. 21, 2017)

    Ernst & Young’s 2017 Global Hedge Fund and Investor Survey Examines Hedge Fund Operations; Talent Acquisition and Retention; and Steps Hedge Funds Can Take to Remain Competitive (Part Two of Two)

    Ernst & Young (EY) recently released the results of its 11th annual Global Hedge Fund and Investor Survey. Among other topics, the survey explored issues affecting operational efficiency, including headcount, fees, expense ratios, expense pass-throughs and passively managed funds; and the challenges of attracting, developing and retaining talent. The survey also explored steps fund managers can take to stay competitive in the evolving market. This article, the second in a two-part series, describes the survey’s key findings in these areas. The first article detailed the survey’s results concerning fund managers’ strategic priorities; investor allocation plans; offerings of non-traditional products by hedge fund managers; evolution of hedge funds’ front-office and investment functions; and key industry risks. For coverage of prior EY surveys, see “Hedge Fund Growth Priorities, Fee and Expense Climate, Prime Brokerage and Operational Matters” (Dec. 3, 2015); “Growth Areas for Hedge Fund Managers, Related Costs and Challenges, Operating Expenses and Cybersecurity” (Jan. 15, 2015); and “Trends in Asset Sourcing, Alternative Mutual Funds, Customized Solutions, Staffing, Administrator Shadowing, Expense Pass-Throughs and Outsourcing” (Dec. 5, 2013).

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  • From Vol. 10 No.45 (Nov. 16, 2017)

    Thomson Reuters Survey Reveals Concerns About and Shortcomings With AML Compliance

    U.S. financial firms are subject to a constantly evolving regime of domestic and foreign anti-money laundering (AML) regulations. Thomson Reuters (TR) recently asked more than 400 AML professionals for their insights on how to manage organizational AML compliance. The survey covered AML challenges, screening, monitoring, suspicious activity reports, beneficial ownership, enhanced due diligence, screening technology and budgets. Respondents noted challenges with increased regulation, lack of resources, concerns about liability and shortcomings with respect to the suspicious activity report process. This article highlights TR’s key findings. For another recent AML survey, see “ACA 2016 Compliance Survey Covers SEC Exams; Compliance Staffing and Budgeting; Annual and Ongoing Compliance Reviews; and AML/Sanctions Compliance (Part One of Two)” (Jan. 19, 2017).

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  • From Vol. 10 No.44 (Nov. 9, 2017)

    Perspectives on Operational Due Diligence From an Investor, Consultant and Manager

    Once an investor determines that a fund manager’s strategy and performance are a good fit, it must also confirm that the manager’s personnel, infrastructure, systems and controls are adequate and suited to support the investment function and ensure smooth operations. A recent panel at the ninth annual RSM Investment Industry Summit offered the perspectives of an institutional investor, consultant and fund manager on the operational due diligence (ODD) process, including yellow and red flags encountered during ODD and reasons why managers may fail ODD. Alan D. Alzfan, partner at RSM US, moderated the discussion, which featured Neil Datta, director at Optima Fund Management; Simon Fludgate, head of ODD at Aksia; and Louis LaRocca, general counsel and chief compliance officer of Gotham Asset Management. This article highlights their most salient points. For additional insight from Alzfan, see “Eight Refinements of the Traditional ‘2 and 20’ Hedge Fund Fee Structure That Can Powerfully Impact Manager Compensation and Investor Returns” (May 20, 2011). For further commentary from Aksia and Fludgate, see “Aksia’s 2015 Hedge Fund Manager Survey Reveals Industry Views on Liquidity, Financing, the AIFMD, Liquid Alternatives, Fees, Co-Investments and Risk Reporting” (Jan. 22, 2015); and “Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface With Investment Consultants to Access Institutional Capital (Part One of Two)” (Jul. 11, 2013).

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  • From Vol. 10 No.37 (Sep. 21, 2017)

    How Fund Managers Can Develop an Effective Third-Party Management Program

    Private fund managers rely on third parties for a variety of critical services. Identifying and managing those relationships in a systematic way is essential to minimizing enterprise risk and ensuring compliance with regulatory requirements. A recent MyComplianceOffice (MCO) presentation provided a framework for developing a program for managing third-party relationships. Although the primary focus of the program was on the broader financial services industry, the principles discussed are relevant to outsourcing decisions made by fund managers and their dealings with administrators, technology vendors, research firms and other key third parties. The program was hosted by Joe Boyhan of MCO and featured Linda Tuck Chapman, president of Ontala. This article summarizes the key takeaways from the presentation. For coverage of other MCO programs, see “Reading the Regulatory Tea Leaves: Recent White House and Congressional Action and Insights From SIFMA and FINRA Conferences” (Jul. 20, 2017); and “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016).

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  • From Vol. 10 No.37 (Sep. 21, 2017)

    Key Considerations for Fund Managers When Selecting and Negotiating With a Cloud Service Provider

    Operating an asset management business remains a resource-intensive endeavor, particularly as fund fees have come under pressure from investors. See “Investor Pressure Drives New Performance Compensation Models and Increased Disclosure Obligations for Managers” (Jun. 29, 2017). Some managers have sought to reduce their operational costs by moving at least some of their technological infrastructure – e.g., data storage, trade execution, accounting systems, client-relationship-management systems and disaster recovery services – to the cloud. While hosting these services in the cloud offers cost-effective and convenient technology solutions, fund managers must be cognizant of the potential cybersecurity risks associated with relying upon a cloud solution, including the legal risks that may be lurking in the standard service level agreements with cloud service providers. Considerations of potential risks and liabilities associated with engaging a cloud service provider, along with tips on how to conduct due diligence on a cloud vendor, were addressed at PLI’s Eighteenth Annual Institute on Privacy and Data Security Law. The panel featured Matthew Kelly, vice president and senior corporate counsel at cloud computing company ServiceNow, Inc. This article offers Kelly’s insights as to what an investment manager should and should not expect from cloud service providers, along with key provisions to understand in their service level agreements. For background on how private fund managers are using cloud computing, see “Can Emerging Hedge Fund Managers Use Technology to Satisfy Business Continuity Requirements and Mitigate Third-Party Risk?” (Sep. 3, 2016); and “Greenwich Associates Report Argues That Hedge Fund Managers Can Use the Cloud to Obtain Greater Computing Power at Lower Cost With Acceptable Risk” (Jun. 6, 2014).

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  • From Vol. 10 No.36 (Sep. 14, 2017)

    Insights on Operational Due Diligence From the IMDDA and the U.K. Pension Protection Fund

    The Investment Management Due Diligence Association (IMDDA) recently kicked off its year-long “Ask the Experts” question-and-answer series with industry professionals, the first of which focused on operational due diligence (ODD). Moderated by Herbert M. Chain, director of education at the IMDDA, and featuring Kevin J. Eastwood, ODD manager at the U.K. Pension Protection Fund and a member of the IMDDA advisory board, the program provided valuable insights to fund managers about ODD, including best practices for conducting ODD on managers and third-party service providers; advice for emerging managers; thoughts about fee and expense transparency; and considerations about cybersecurity. This article summarizes the key takeaways from Chain and Eastwood. For coverage of other IMDDA events, see “How Due Diligence Professionals Approach the Private Fund Review Process” (Jun. 15, 2017); “How Fund Managers Can Prepare for Investor Due Diligence Queries About Cybersecurity Programs” (Feb. 2, 2017); and “How Studying SEC Examinations Can Enhance Investor Due Diligence” (Oct. 6, 2016).

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  • From Vol. 10 No.32 (Aug. 10, 2017)

    Are Fund Platforms Truly a Turnkey Solution? Considerations When Selecting and Negotiating With a Platform Provider (Part Three of Three)

    The Alternative Investment Fund Managers Directive regime has increased the frequency with which U.S. fund managers are using sub-funds on an umbrella fund platform (Fund Platform) to market to E.U. investors. This trend has coincided with a proliferation of Fund Platform providers and broader range of terms to negotiate. Consequently, U.S. fund managers need to parse the various features offered by Fund Platform providers and build appropriate protections into their onboarding agreements in order to realize the benefits of this fund structure. This three-part series seeks to familiarize U.S. fund managers with Fund Platforms by analyzing issues to consider when evaluating the structure’s viability. This third article addresses attributes U.S. fund managers should consider when selecting a Fund Platform, as well as key protections to include in the onboarding documents. The first article provided a primer about Fund Platforms relative to other structures and ways that managers can “Brexit-proof” their use of the vehicle. The second article presented pros and cons of operating on Fund Platforms that U.S. fund managers can weigh when determining whether to adopt the structure. See “Beyond the Master-Feeder: Managing Liquidity Demands in More Flexible Fund Structures” (May 25, 2017). For more on marketing in the E.U., see “Six Common Misconceptions U.S. Fund Managers Have About Marketing in Europe” (Mar. 9, 2017); and “Leading Law Firms Discuss Hedge Fund Marketing and Distribution Opportunities in a Post-Brexit World (Part Two of Two)” (Jul. 14, 2016).

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  • From Vol. 10 No.30 (Jul. 27, 2017)

    How Managers Can Identify and Manage Cybersecurity Risks Posed by Third-Party Service Providers

    Weak cybersecurity practices of service providers pose material risks to private fund managers. As connectivity grows, managers run the risk that data entrusted to vendors could be compromised, or that the manager’s own system may be breached through one of its vendors. Consequently, it is critical to understand and manage the risks posed by vendors. See “Surveys Show Cyber Risk Remains High for Investment Advisers and Other Financial Services Firms Despite Preventative Measures” (Jul. 20, 2017); and “Study Reveals Weaknesses in Asset Managers’ Third-Party and Vendor Risk Management Programs” (Mar. 9, 2017). A recent program presented by Advise Technologies discussed ways to assess vendor risk; best practices for managing vendors; uses of due diligence questionnaires; and common errors in vendor management. Advise’s chief regulatory attorney and managing director, Jeanette Turner, moderated the discussion, which featured Jason Elmer, managing director at Duff & Phelps, and Aaron K. Tantleff, partner at Foley & Lardner. This article summarizes their insights. For recent commentary from Advise and Turner, see “A Roadmap of Potential Landmines for Fund Managers to Avoid When Completing the Revised Form ADV” (May 25, 2017); and “The ‘Why’ Behind the Recent Form ADV Amendments: What Information the SEC Will Require and How the Agency Intends to Use It” (May 4, 2017).

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  • From Vol. 10 No.28 (Jul. 13, 2017)

    Tips and Warnings for Navigating the Big Data Minefield

    Data-gathering and analytics have become valuable tools for private fund managers when making their investment decisions. As technology outpaces the law in this area, however, managers must use caution when acquiring and using data. See “Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping” (Jun. 15, 2017). A recent presentation featuring Proskauer partners Robert G. Leonard, Jeffrey D. Neuburger, Joshua M. Newville and Jonathan E. Richman discussed the evolving methods of collecting data, the risks involved and the ways managers can use big data without running afoul of applicable law. This article summarizes the panelists’ insights. For more from Leonard, see “How Fund Managers Can Prevent or Remedy Improper Fee and Expense Allocations (Part Three of Three)” (Sep. 15, 2016); and “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates: An Interview With Proskauer Partner Robert Leonard” (Mar. 5, 2015).

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  • From Vol. 10 No.26 (Jun. 29, 2017)

    Navigating the Intersection of ERISA Fiduciary Duties and Cybersecurity Data Breach Protections

    A hedge fund manager may become subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA) if it manages a “plan assets fund” or provides advice to retirement account clients. See our four-part series “A ‘Clear’ Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans”: Part One (Jul. 28, 2016); Part Two (Aug. 4, 2016); Part Three (Aug. 11, 2016); and Part Four (Aug. 25, 2016). A recent program presented by Poyner Spruill considered the relationship between cybersecurity and ERISA, looking at recent breaches and litigation involving ERISA plans; evaluating whether cybersecurity is a fiduciary duty under ERISA; analyzing whether ERISA preempts state cybersecurity and data-protection laws; and exploring how plan sponsors can implement effective cybersecurity measures. The panel featured Poyner Spruill partners Saad Gul and Michael E. Slipsky, along with associate Brenna A. Davenport. This article summarizes their key insights. See also our overview of ERISA issues for fund managers, “Happily Ever After? – Investment Funds That Live With ERISA, For Better and For Worse”: Part One (Sep. 4, 2014); Part Two (Sep. 11, 2014); Part Three (Sep. 18, 2014); Part Four (Sep. 25, 2014); and Part Five (Oct. 2, 2014).

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  • From Vol. 10 No.26 (Jun. 29, 2017)

    Transparency Tops Investment Considerations in Northern Trust Survey

    Northern Trust, in collaboration with The Economist Intelligence Unit, recently took the pulse of alternative investment managers and other institutional investors regarding transparency and other investment considerations. The study – as discussed in the white paper summarizing its results – found that transparency is a top investment consideration, the importance of which has increased following the 2008 financial crisis. Northern Trust also considered how respondents gather and manage data and oversee their transparency requirements. This article summarizes the key findings from the study. For additional insights from Northern Trust, see “Don Muller and Joshua Satten of Northern Trust Hedge Fund Services Discuss the Impact of OTC Derivatives Reforms on Hedge Fund Managers” (Feb. 7, 2013). For more on transparency from a fund manager’s perspective, see “How Are Your Peers Responding to the Most Intrusive Requests From Hedge Fund Investors?”: Part One (Mar. 17, 2016); and Part Two (Mar. 31, 2016).

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  • From Vol. 10 No.24 (Jun. 15, 2017)

    How Due Diligence Professionals Approach the Private Fund Review Process

    The Investment Management Due Diligence Association (IMDDA) recently issued a survey report providing valuable insight into the views of due diligence professionals as to the importance of operational and investment due diligence functions and responsibilities. This article summarizes the portions of the report that focus on the specific types of information that due diligence professionals review when examining a manager. For coverage of other IMDDA events, see “How Fund Managers Can Prepare for Investor Due Diligence Queries About Cybersecurity Programs” (Feb. 2, 2017); “How Studying SEC Examinations Can Enhance Investor Due Diligence” (Oct. 6, 2016); and “How Managers May Address Increasing Demands of Limited Partners for Standardized Reporting of Fund Fees and Expenses” (Sep. 1, 2016).

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  • From Vol. 10 No.17 (Apr. 27, 2017)

    Frontier Markets: Outsized Growth Opportunities Bring Legal, Compliance and Operational Challenges

    Traditional distinctions between developed and emerging markets – the sizes of their economies and markets, their government and corporate policies and even their growth rates – have blurred significantly over the past decade, resulting in higher correlations between developed and emerging market equities. Thus, global investors seeking growth and diversification must now look to the “emerging” emerging markets, or frontier markets. Although frontier markets offer opportunities, investing in them involves various risks: political risk (something increasingly prevalent in developed markets), macroeconomic risk (e.g., inflation risk, currency risk, etc.) and microeconomic risk (e.g., liquidity, custody and settlement risks). These markets are also harder to hedge, as investors often cannot hedge their currency exposure or short sell securities. For additional coverage of hedging currency risk, see “Local Currency Hedge Funds Expand Marketing and Investment Opportunities, but Involve Currency Hedging and Other Challenges” (Jan. 6, 2010). In a guest article, Marko Dimitrijević and Timothy Mistele, chairman and senior advisor, respectively, at private investment group Volta Global, and Bilzin Sumberg Baena Price & Axelrod partner Joshua M. Stone provide an overview of frontier markets, as well as analysis about the risks and considerations for investors seeking to invest in those markets. For more on navigating risks related to emerging markets, see “How Private Fund Managers Can Manage FCPA Risks When Investing in Emerging Markets” (Jan. 10, 2013).

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  • From Vol. 10 No.6 (Feb. 9, 2017)

    FCA Fines Deutsche Bank £163 Million for Lax AML Controls, Warns Other Firms to Review AML Procedures

    In early 2016, the U.K. Financial Conduct Authority (FCA) cited anti-money laundering (AML) as one of its priorities. See “FCA 2016-2017 Regulatory and Supervisory Priorities Include Focus on AML, Cybersecurity and Governance” (Apr. 14, 2016). True to its word, the FCA recently reached a £163 million settlement with Deutsche Bank AG (DB) over its suspect AML policies, procedures and controls. The action is notable both for the size of the fine and for the stern admonition in the press release announcing the settlement by Mark Steward, FCA Director of Enforcement and Market Oversight, who ominously warned that “other firms should take notice of today’s fine and look again at their own AML procedures to ensure they do not face similar action.” This article analyzes the suspect trades that gave rise to the enforcement action and the AML shortcomings cited by the FCA. For a recent look at AML enforcement efforts in the U.S., see “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016). For a discussion of the Financial Crimes Enforcement Network’s (FinCEN) new AML rules, see “Best Practices for Hedge Fund Managers to Adopt in Anticipation of Enactment of FinCEN AML Rule Proposal” (Aug. 4, 2016); and our series on the potential impact of the proposed FinCEN AML rule: Part One (Jun. 30, 2016); and Part Two (Jul. 7, 2016). 

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  • From Vol. 10 No.5 (Feb. 2, 2017)

    How Fund Managers Can Prepare for Investor Due Diligence Queries About Cybersecurity Programs 

    Cybersecurity remains a top-of-mind issue for regulators, investors and advisers. As part of operational due diligence, investors often evaluate whether an adviser has robust cybersecurity defenses. Similarly, advisers must ensure that their administrators, brokers and other third parties have appropriate defenses. A recent program presented by the Investment Management Due Diligence Association (IMDDA) explored the fundamentals of cyber due diligence, the role of insurance in cybersecurity preparedness, recommendations for evaluating cyber insurance coverage and the evolving cyber risk landscape. The program was moderated by Richard M. Morris, a partner at Herrick Feinstein, and featured Herrick partner Alan R. Lyons; Herrick associate Erica L. Markowitz; and Michael Stiglianese, a managing director of BDO USA. This article details the panelistsinsights, which provide valuable guidance to investors when conducting cyber due diligence on fund managers and to fund managers about the necessary elements of a cybersecurity program. For additional insights from Morris, see How Developments With Californias Pension Plan Disclosure Law, the SECs Rules and FINRAs CAB License May Impact Hedge Fund Managers and Third-Party Marketers” (Oct. 13, 2016); and How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part Two of Two)” (Dec. 12, 2013). For coverage of other IMDDA events, see How Studying SEC Examinations Can Enhance Investor Due Diligence” (Oct. 6, 2016); and How Managers May Address Increasing Demands of Limited Partners for Standardized Reporting of Fund Fees and Expenses” (Sep. 1, 2016).

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  • From Vol. 9 No.49 (Dec. 15, 2016)

    Challenges Fund Managers Face Meeting the Growing Demands of Employees, Investors and Regulators: An Interview With EY Principal Samer Ojjeh

    In a recent interview with The Hedge Fund Law Report, Samer Ojjeh, principal at Ernst & Young LLP (EY), analyzed the current state of the private funds industry. Specifically, Ojjeh discussed the high expectations of investors, the strategies currently attracting capital, barriers to entry for emerging asset managers and ways managers can retain top talent. Ojjeh’s remarks provide valuable perspective to hedge fund managers on the numerous demands they face from diverse parties, including investors, regulators and the managers’ own employees. For further commentary from Ojjeh, see “RCA Symposium Offers Perspectives From Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)” (Jan. 9, 2014); and “Certain Hedge Fund Managers Are Moving From Full to Partial Shadowing of Administrator Functions” (Sep. 12, 2013). For additional insights from EY professionals, see “Daniel New, Executive Director of EY’s Asset Management Advisory Practice, Discusses Best Practices on ‘Hot Button’ Hedge Fund Compliance Issues: Disclosure, Expense Allocations, Insider Trading, Political Intelligence, CCO Liability, Valuation and More” (Oct. 17, 2013); as well as our two-part series “Steps That Alternative Investment Fund Managers Need to Consider to Comply With the Global Trend Toward Tax Transparency”: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016). 

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  • From Vol. 9 No.47 (Dec. 1, 2016)

    How Fund Managers Can Mitigate Prime Broker Risk: Preliminary Considerations When Selecting Firms and Brokerage Arrangements (Part One of Three)

    The actions and potential failure of prime brokers pose sizable threats to the well-being of fund managers. In 2008, insolvencies by prominent prime brokers such as Bear Stearns and Lehman Brothers imperiled a number of hedge funds. See “Hedge Funds Turning to Prime Brokerage Trust Affiliates for Added Protection Against Prime Broker Insolvencies” (Jun. 24, 2009). In addition, as recently as July 2016, Merrill Lynch agreed to pay a $415 million settlement to the SEC in connection with actions that threatened its hedge fund clients. See “Merrill Lynch Settlement Reminds Hedge Fund Managers to Be Aware of How Brokers Are Handling Their Assets” (Jul. 7, 2016). In an effort to help our subscribers mitigate the risks posed by their prime brokers, this three-part series outlines steps that fund managers can take when engaging a prime broker. This first article details preliminary considerations when engaging prime brokers, including regulatory protections, several types of arrangements based on fund risk profiles and due diligence efforts managers can undertake. The second article will examine structural considerations to mitigate prime broker risk, including the viability of multi-prime and split broker-custodian arrangements. The third article will describe legal protections that can be included in prime brokerage agreements to mitigate risk, including with respect to rehypothecation limits and asset transfer restrictions. For more on prime broker selection, see “Factors to Be Considered by a Hedge Fund Manager When Selecting a Prime Broker” (Dec. 4, 2014); “How Should Hedge Fund Managers Select Accountants, Prime Brokers, Independent Directors, Administrators, Legal Counsel, Compliance Consultants, Risk Consultants and Insurance Brokers for Their Funds?” (Jun. 13, 2013); and “Prime Brokerage Arrangements From the Hedge Fund Manager Perspective: Financing Structures; Trends in Services; Counterparty Risk; and Negotiating Agreements” (Jan. 10, 2013).

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  • From Vol. 9 No.47 (Dec. 1, 2016)

    How Investment Managers Can Advertise Sub-Adviser Performance Without Violating SEC Rules 

    In a series of recent enforcement actions, the SEC has held investment advisers responsible for performance claims included in their marketing materials that they received from sub-advisers and that turned out to be false and misleading. Although the SEC acknowledged that the investment advisers may have been unaware that the performance information was false and misleading, the regulator concluded that they were nevertheless responsible for ensuring that the overall reported performance record from their sub-advisers was compliant with the Investment Advisers Act of 1940. To avoid running afoul of applicable law, investment advisers conveying third-party performance returns should obtain adequate documentation to verify their accuracy and establish policies and procedures that govern what due diligence they will conduct on the sub-advisers’ performance. In a guest article, Daniel G. Viola, partner at Sadis & Goldberg, and Antonella Puca, head of the investment performance attestation practice at RSM US, review the key aspects of the recent enforcement activity of the SEC on performance advertising and provide guidance on how to address some of the SEC’s concerns. For additional insight from Viola, see “Hedge Fund Managers Advised to Prepare for Imminent SEC Examination” (Jan. 28, 2016). For more on performance advertising, see “The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Retaining Performance Records (Part Two of Two)” (Nov. 17, 2016); and “Liquidity and Performance Representations Present Potential Pitfalls for Hedge Fund Managers” (Mar. 31, 2016).

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  • From Vol. 9 No.45 (Nov. 17, 2016)

    How Hedge Fund Managers Can Design an ESG Investing Policy (Part Two of Two)

    There is no one-size-fits-all approach for private fund advisers that incorporate environmental, social and governance (ESG) factors into their investment processes (ESG investing), in part because many early adopters of ESG investing in the hedge fund space have done so at the request of their investors. Consequently, managers have had to develop a variety of approaches to meet the diverse needs of investors without uniform requirements. Some large institutional investors with ESG investing criteria seek to bypass commingled funds and allocate to separately managed accounts, thereby allowing them to dictate the ESG parameters that apply to their accounts. A benefit to an ESG-sensitive investor of investing in a separately managed account is that it provides transparency into the portfolio to (1) ensure the investment manager adheres to the account’s ESG investment parameters; and (2) evaluate the efficacy of the investment from an ESG perspective. Not all investors, however, have sufficient assets to pursue their mandates through managed accounts, forcing them to allocate to managers applying ESG investing policies to commingled funds. This second article in our two-part series discusses various options available to hedge fund managers when adopting an ESG policy and outlines some of the due diligence inquiries managers with an ESG policy should expect to receive from investors. The first article explored the development of ESG investing and its prevalence in the hedge fund space.

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  • From Vol. 9 No.43 (Nov. 3, 2016)

    Five Compliance Lessons Private Fund Managers Can Glean From Och-Ziff’s FCPA Settlement

    Private fund managers should pay attention to Och-Ziff’s recent settlements with both the SEC and DOJ for violations of the Foreign Corrupt Practices Act (FCPA). Since the SEC launched a unit dedicated to enforcing compliance with the FCPA in 2010, many in the industry have speculated that it was only a matter of time until private funds became the focus of the SEC from an FCPA perspective. See “Private Equity FCPA Enforcement: High Risk or Hype?” (Feb. 19, 2015); and “The SEC’s Investigation of FCPA Violations and Sovereign Wealth Funds – Implications for Hedge Funds" (Feb. 3, 2011). Although its initial interest in FCPA compliance by private funds centered on a manager’s dealings with sovereign wealth funds, as the Och-Ziff settlements demonstrate, the SEC has expanded its review to cover investment transactions, particularly those conducted in high-risk jurisdictions. This change of focus has likely left some hedge funds, private equity firms, banks and other financial firms unprepared and potentially exposed from an anti-corruption perspective, as these institutions have historically focused the majority of their compliance resources related to foreign activities on anti-money laundering and sanctions programs. The details of the case, along with the terms of the company’s settlement, offer five key compliance lessons for firms in this industry. For details on the facts underlying the case and the terms of the settlement see our companion article “Recent SEC and DOJ Settlements With Och-Ziff and Two Executives Underscore FCPA Compliance Risks to Private Fund Managers” (Oct. 27, 2016).

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  • From Vol. 9 No.43 (Nov. 3, 2016)

    Current Trends in Operational Due Diligence and Background Checks

    Operational due diligence is an important part of the investment process. Investors are concerned not only with a manager’s performance but also with the security and stability of its operations. At the recent Third Party Marketers Association (3PM) 2016 Annual Conference, marketers and operational due diligence professionals offered insights into the types of operational due diligence they conduct and how hedge fund managers can prepare for due diligence inquiries. Although the presentation was geared toward third-party marketers, its lessons apply equally to investors because the process by which a third-party marketer investigates a potential client is analogous to how an investor evaluates a hedge fund manager with which it is considering investing. Introduced by Steven Jafarzadeh and moderated by Mark Sullivan, both managing directors and partners at alternative asset placement agent platform Stonehaven, LLC, the program featured Lauri Martin Haas, founder and principal of operational due diligence firm PRISM LLC, and Kenneth S. Springer, founder and president of business investigations firm Corporate Resolutions Inc. This article highlights the key takeaways from the panel. For coverage of another 3PM annual conference, see “Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation” (Dec. 1, 2011). For additional insight from Springer, see “Can Hedge Fund Managers Use Whistleblower Hotlines to Help Create and Demonstrate a Culture of Compliance?” (Jul. 23, 2010); and “Implications for Hedge Funds of New Whistleblower Initiatives by FINRA and the SEC: An Interview With Kenneth Springer of Corporate Resolutions Inc.” (Mar. 11, 2009).

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  • From Vol. 9 No.40 (Oct. 13, 2016)

    How Developments With California’s Pension Plan Disclosure Law, the SEC’s Rules and FINRA’s CAB License May Impact Hedge Fund Managers and Third-Party Marketers

    Hedge fund managers and many service providers have faced a wave of new regulatory requirements since the 2008 global financial crisis. This is particularly true for third-party marketers engaged by hedge fund managers to solicit clients and fund investors, which may be subject to a barrage of regulations at the federal, state and local level depending on the nature of their business. To explore some of the latest regulatory challenges faced by funds and their marketers, The Hedge Fund Law Report recently interviewed Susan E. Bryant, counsel at Verrill Dana LLP, and Richard M. Morris, partner at Herrick, Feinstein LLP. This article sets forth the participants’ thoughts on a host of issues, including new disclosure requirements for state pension plan investors; recent enforcement trends; and new rules adopted by the SEC, FINRA, Municipal Securities Rulemaking Board (MSRB) and state regulators. On Thursday, October 20, 2016, from 10:30 a.m. to 11:30 a.m. EDT, Morris and Bryant will expand on the topics in this article – as well as other issues that affect hedge fund managers and third-party marketers – during a panel moderated by Kara Bingham, Associate Editor of the HFLR, at the Third Party Marketers Association (3PM) 2016 Annual Conference. For more information on the conference, click here. To take advantage of the HFLR’s $300 discount when registering for the conference, click the link available in the article. For prior coverage of a conference sponsored by 3PM, see “Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation” (Dec. 1, 2011).

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  • From Vol. 9 No.40 (Oct. 13, 2016)

    How Hedge Fund Managers Can Accommodate Heightened Investor Demands for Bespoke Negative Consent, Liquidity, MFN and Other Provisions in Side Letters

    As investors increasingly demand tailored investment terms, fund managers find themselves forced to accommodate these requests in light of today’s difficult capital raising environment. See “How Emerging Hedge Fund Managers Can Raise Capital in a Challenging Market Without Overstepping Legal Bounds” (Aug. 4, 2016). Some fund managers are incorporating common investor demands into their standard side letters and fund documentation in order to limit negotiations. Many are also adopting side letter policies to accommodate investor demands while avoiding any appearance of preferential treatment and preventing friction among investors. These themes came across in the opening session of the Tenth Annual Hedge Fund General Counsel and Compliance Summit, hosted by Corporate Counsel and ALM on September 28, 2016. Moderated by Mark Proctor, a partner in the private funds group at Vinson & Elkins, the panel featured S. Dov Lando, managing director, general counsel and chief compliance officer at MKP Capital Management; Nicole M. Tortarolo, head of investment structuring at UBS Hedge Fund Solutions; Solomon Kuckelman, head of U.S. legal for Man Investments; and Marc Baum, general counsel and chief administrative officer at Serengeti Asset Management. This article presents the key takeaways from the panel discussion. For additional commentary from Baum, see “Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss CFTC Compliance, Conflicting Regulatory Regimes and Best Marketing Practices (Part Two of Four)” (Jan. 29, 2015). For insight from Tortarolo, see “RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence” (Apr. 2, 2015). For additional views from Lando, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and “Three Pillars of an Effective Hedge Fund Valuation Process” (Jun. 19, 2014).

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  • From Vol. 9 No.39 (Oct. 6, 2016)

    How Studying SEC Examinations Can Enhance Investor Due Diligence

    Investors who are performing or planning to undertake due diligence on hedge funds can glean practical guidance from SEC examinations of fund managers. This was the primary theme of a recent webinar presented by the Investment Management Due Diligence Association (IMDDA) featuring Kristina Staples, managing director of ACA Compliance Group. This article summarizes Staples’ primary insights from the webinar. For more on due diligence, see “RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence” (Apr. 2, 2015); “Operational Due Diligence From the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits” (Apr. 25, 2014); and “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers” (Apr. 18, 2014). For additional commentary from Staples, see “Five Steps That CCOs Can Take to Avoid Supervisory Liability, and Other Hedge Fund Manager CCO Best Practices” (Mar. 27, 2015). For coverage of a previous IMDDA webinar, see “How Managers May Address Increasing Demands of Limited Partners for Standardized Reporting of Fund Fees and Expenses” (Sep. 1, 2016).

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  • From Vol. 9 No.28 (Jul. 14, 2016)

    Caspersen Fraud Reminds Institutional Investors to Look Beyond a Hedge or Private Equity Fund’s Name to Verify Its Structure and Management

    Unlike alternative mutual funds and other registered investment companies, hedge and private equity funds are not subject to regulations regarding what they can be named. See “Hedge Fund Names: What a Hedge Fund Manager Should Do Before It Starts Using a Name” (Mar. 16, 2012). It is therefore incumbent on investors to look beyond the name of any fund in which it is considering investing and conduct due diligence to verify the actual structure, sponsorship and management of the entity. The recent guilty plea of Andrew Caspersen is a reminder of this and the peril faced by institutional and other sophisticated investors that fail to conduct this necessary due diligence. Using confusingly named entities and bank accounts, Caspersen, an investment principal and partner in two alternative asset management firms, perpetrated a scheme of securities and wire fraud. This article summarizes the DOJ’s criminal complaint against Caspersen and details several lessons for institutional investors to protect themselves from fraud. For another scheme involving the sale of bogus promissory notes in the hedge fund industry, see “Federal Judge Approves Settlement Agreements Arising out of Marc Dreier’s Criminal Fraud; Hedge Fund Victims ‘Squabble’ Over Proposed Recovery” (Feb. 17, 2010). For more on conducting due diligence, see “Why Should Hedge Fund Investors Perform On-Site Due Diligence in Addition to Remote Gathering of Information on Managers and Funds?”: Part One (Jan. 29, 2015); Part Two (Feb. 5, 2015); and Part Three (Feb. 12, 2015).

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  • From Vol. 9 No.13 (Mar. 31, 2016)

    How Are Your Peers Responding to the Most Intrusive Requests From Hedge Fund Investors? (Part Two of Two)

    Faced with increasingly intrusive requests for information from current and prospective investors, a hedge fund manager must be prepared to tactfully respond by disclosing an appropriate amount of information while otherwise protecting its business. While a manager may be willing to disclose particular items, it is likely to find itself subject to a growing number of due diligence requests for sensitive information and documents. In an effort to determine industry best practices for responding to such requests, The Hedge Fund Law Report surveyed 20 general counsels and other “C-level” decision-makers at leading hedge fund managers. We present the results of that survey in this two-part article series. The first part described the types of information requests that hedge fund managers are encountering from investors, focusing on the most intrusive requests. This second article explores how managers have actually responded to those requests and what they did to mitigate the potential negative consequences of releasing sensitive information. For more on due diligence, see “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers” (Apr. 18, 2014). For analysis of the investor view of due diligence, see “What Should Hedge Fund Investors Be Looking For in the Course of Operational Due Diligence and How Can They Find It?” (Oct. 13, 2011); and “Legal, Operational and Risk Considerations for Institutional Investors When Performing Due Diligence on Hedge Fund Service Providers” (Jul. 8, 2010).

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  • From Vol. 9 No.11 (Mar. 17, 2016)

    How Are Your Peers Responding to the Most Intrusive Requests From Hedge Fund Investors? (Part One of Two)

    Hedge fund investors have become increasingly savvy in recent years, and one sign of that growing sophistication is the level of scrutiny focused on managers of hedge funds in which they are considering investing. Far beyond the simple review process that it once was, due diligence of hedge fund managers and their funds has become an intrusive process, as prospective investors seek deeper looks into managers’ operations and access to sensitive documents. Consequently, a manager must be prepared to tactfully respond to these invasive requests for information, providing sufficient information to satisfy the investors’ requests while protecting the manager’s business and confidentiality. In an effort to determine industry best practices for responding to such requests from prospective investors, The Hedge Fund Law Report surveyed 20 general counsels and other “C-level” decision-makers at leading hedge fund managers. We are presenting the results of that survey in a two-part article series. This first part describes the types of information requests that hedge fund managers are encountering from investors, focusing on the most intrusive requests. The second article will explore how managers have responded to those requests while mitigating the potential negative consequences of releasing sensitive information. For more on due diligence, see “Why Should Hedge Fund Investors Perform Onsite Due Diligence in Addition to Remote Gathering of Information on Managers and Funds? (Part Three of Three)” (Feb. 12, 2015). For analysis of the investor view of due diligence, see “Operational Due Diligence From the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and Onsite Visits” (Apr. 25, 2014). For another industry survey conducted by the HFLR, see our two-part series on how hedge fund managers: “Define and Handle Trade Errors” (Oct. 15, 2015); and “Detect and Bear Responsibility for Trade Errors” (Oct. 22, 2015).

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  • From Vol. 9 No.9 (Mar. 3, 2016)

    Hedge Fund Managers Are Advised to Build Robust Infrastructure

    As investors conduct deeper due diligence into infrastructure – such as compliance policies and procedures, technology systems and cybersecurity protections – hedge fund managers must ensure that their programs and systems are robust and able to withstand scrutiny. See “Legal, Operational and Risk Considerations for Institutional Investors When Performing Due Diligence on Hedge Fund Service Providers” (Jul. 8, 2010). Managers may choose to supplement their in-house infrastructure by outsourcing and delegating to third-party service providers, while monitoring those providers to ensure quality. At a recent seminar hosted by Backstop Solutions Group and ACA Compliance Group, panelists discussed the integration of technology and compliance, outsourcing of business functions to third parties, due diligence of service providers and investor scrutiny of hedge fund managers. This article highlights the salient points raised during the program. For additional insight from Backstop, see “Essential Tools for Hedge Fund Managers to Combat Escalating Cyber Threats” (Feb. 4, 2016). For coverage of a recent program jointly offered by the HFLR and ACA, see “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends” (Oct. 22, 2015).

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  • From Vol. 9 No.8 (Feb. 25, 2016)

    FCA Report Enjoins Hedge Fund Managers to Improve Due Diligence

    In a recent report, the U.K. Financial Conduct Authority (FCA) noted that hedge fund managers and other financial advisory firms must improve due diligence of products and services they recommend for their clients. Firms must also appropriately manage conflicts of interest between themselves and their clients. This article details the key points raised in the FCA report. For more on due diligence conducted by hedge fund managers, see “How Should Hedge Fund Managers Select Accountants, Prime Brokers, Independent Directors, Administrators, Legal Counsel, Compliance Consultants, Risk Consultants and Insurance Brokers for Their Funds?” (Jun. 13, 2013); and “Best Practices for Due Diligence by Hedge Fund Managers on Research Providers” (Mar. 14, 2013).

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  • From Vol. 9 No.2 (Jan. 14, 2016)

    RCA Compliance, Risk and Enforcement Symposium Highlights Methods for Hedge Fund Managers to Upgrade Compliance Programs

    The development of a robust compliance program by hedge fund managers that addresses key issues, such as valuation, conflicts of interest and the use of expert networks, continues to be a focus for the SEC. Among various topics discussed during the recent Regulatory Compliance Association (RCA) Compliance, Risk and Enforcement Symposium, panelists proffered ways for hedge fund managers to enhance their compliance programs, including interaction with other groups within the firm; controls around expert networks; and the use of technology to augment compliance testing and controls to identify and address issues. This article highlights the salient points made on the foregoing issues. For additional insight from the RCA, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and “Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)” (Jan. 9, 2014).

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  • From Vol. 8 No.49 (Dec. 17, 2015)

    Distribution and Operational Due Diligence Considerations for Hedge Fund Managers Launching UCITS Funds (Part Two of Two)

    As a growing number of hedge fund managers look to Undertakings for Collective Investments in Transferable Securities (UCITS) funds as a means of accessing the European market, those managers must establish a framework for distributing UCITS funds.  While UCITS products are more regulated and transparent than private hedge funds, investors must still conduct thorough operational due diligence before investing in those funds.  At the recent Liquid Alternative Strategies Global conference held in London, speakers delved into these topics as part of a broader discussion about the rise of alternative UCITS as a global investment solution.  This article, the second in a two-part series, focuses on distribution of UCITS products and operational due diligence.  The first article addressed the drivers behind the recent growth in alternative UCITS funds and several key factors that managers should consider when assessing their ability to capitalize on demand for UCITS products.  For more on UCITS, see “U.K. Government Proposes to Implement UCITS V Measures Applicable to Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 43 (Nov. 5, 2015); and “FCA Consults on Implementation of UCITS V Provisions Applicable to Managers,” The Hedge Fund Law Report, Vol. 8, No. 36 (Sep. 17, 2015).  For more on operational due diligence, see “PLI ‘Hot Topics’ Panel Addresses Operational Due Diligence and Registered Alternative Funds,” The Hedge Fund Law Report, Vol. 8, No. 48 (Dec. 10, 2015); and “FRA Liquid Alts 2015 Conference Highlights Due Diligence Concerns with Alternative Mutual Funds (Part Three of Three),” The Hedge Fund Law Report, Vol. 8, No. 19 (May 14, 2015).

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  • From Vol. 8 No.48 (Dec. 10, 2015)

    PLI “Hot Topics” Panel Addresses Operational Due Diligence and Registered Alternative Funds

    A recent panel discussion at The Practising Law Institute’s Hedge Fund Management 2015 program, “Hot Topics for Hedge Fund Managers,” offered insight on current investor due diligence practices and a look at the challenges of starting a registered alternative fund, in addition to providing the perspective of an SEC counsel on cybersecurity and a summary of significant developments in swaps regulation.  Nora M. Jordan, a partner at Davis Polk & Wardwell, moderated the discussion, which featured Jessica A. Davis, chief operating officer and general counsel of investment adviser Lodge Hill Capital, LLC; Jennifer W. Han, associate general counsel at the Managed Funds Association; and Aaron Schlaphoff, an attorney fellow in the Rulemaking Office of the SEC Division of Investment Management.  This article summarizes the key takeaways from the program with respect to operational due diligence and registered alternative funds.  For additional coverage of PLI’s Hedge Fund Management 2015 program, see “PLI ‘Hot Topics’ Panel Addresses Cybersecurity and Swaps Regulation,” The Hedge Fund Law Report, Vol. 8, No. 43 (Nov. 5, 2015); and “SEC’s Rozenblit Discusses Operations and Priorities of the Private Funds Unit,” The Hedge Fund Law Report, Vol. 8, No. 37 (Sep. 24, 2015).

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  • From Vol. 8 No.42 (Oct. 29, 2015)

    European Hedge Fund Managers Must Incorporate New Guidelines on Risk Factors into Due Diligence Processes

    The E.U. Directive to prevent money laundering and terrorist financing via the financial system (AML Directive) became effective on June 26, 2015.  It seeks to bring Europe into alignment with the 2012 International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation (Standards).  Following the Standards, the AML Directive puts the onus on Member States, competent authorities and in-scope firms – including hedge fund and other investment managers – to assess and manage anti-money laundering risks and implement appropriate counter-terrorist financing measures.  Consequently, European hedge fund managers will be required to determine the extent of their customer due diligence (CDD) measures on a risk-sensitive basis, applying simplified CDD for low-risk relationships but enhanced CDD for higher-risk relationships.  To help firms identify, assess and manage money laundering and terrorist financing risk – as well as help national competent authorities measure the adequacy of such firms’ actions – the European Supervisory Authorities jointly issued draft risk factor Guidelines for risk assessments, outlining how firms may adjust their CDD commensurate with identified risks.  This article summarizes those sections of the Guidelines applicable to hedge fund managers; outlines the impact of the Guidelines on hedge fund managers; and sets out the timeframe for implementation and compliance.  For more on anti-money laundering, see “Do Hedge Funds Really Pose a Money Laundering Threat? A Decade of Regulatory False Starts Raises Questions,” The Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012); and “FinCEN Working on a Proposed Rule That Would Require Investment Advisers to Establish Anti-Money Laundering Programs and Report Suspicious Activity,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).

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  • From Vol. 8 No.23 (Jun. 11, 2015)

    WilmerHale Attorneys Discuss FCPA Risks Applicable to Private Fund Managers (Part Two of Two)

    The financial services industry is under increased scrutiny from anti-corruption enforcement authorities in the U.S. and abroad.  Foreign Corrupt Practices Act (FCPA) enforcement actions have the potential to implicate hedge funds, private fund managers and even fund investors themselves.  Accordingly, hedge fund managers must be aware of FCPA risks and take steps to mitigate them.  See “FCPA Compliance Strategies for Hedge Fund and Private Equity Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014); and “FCPA Considerations for the Private Fund Industry: An Interview with Former Federal Prosecutor Justin Shur,” The Hedge Fund Law Report, Vol. 7, No. 20 (May 23, 2014).  This article, the second in a two-part series, summarizes the main points raised at a recent program regarding FCPA risks threatening private fund managers and summarizes recent FCPA enforcement actions involving financial institutions.  The program featured WilmerHale partners Kimberly A. Parker and Erin G.H. Sloane.  The first article in this series summarized the key points from that presentation regarding the current U.S. and global anti-corruption enforcement climate and the relevant provisions of the FCPA.

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  • From Vol. 8 No.19 (May 14, 2015)

    FRA Liquid Alts 2015 Conference Highlights Due Diligence Concerns with Alternative Mutual Funds (Part Three of Three)

    With the significant expansion of the liquid alternatives (or alternative mutual fund) space in recent years and the increase in offerings of alternative mutual funds by hedge fund managers, the importance of conducting proper due diligence has commensurately grown.  Investors looking to allocate funds to alternative mutual funds need to consider numerous factors when evaluating potential candidates for investments, and managers deciding to launch alternative mutual funds must also conduct thorough due diligence on service providers for their structures.  This topic was among those discussed at the recent Liquid Alts 2015 conference hosted by Financial Research Associates, LLC.  This article, the third in a three-part series, focuses on the panel discussions of issues investors should consider while conducting due diligence on an alternative mutual fund, as well as due diligence issues managers should consider while establishing a fund structure under the Investment Company Act of 1940 (the ’40 Act).  The first article discussed the keys to successfully launching and operating an alternative mutual fund.  The second article explored ’40 Act fund structures and regulatory concerns with liquid alternative funds.  For more on alternative mutual funds, see “Five Key Compliance Challenges for Alternative Mutual Funds: Valuation, Liquidity, Leverage, Disclosure and Director Oversight,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

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  • From Vol. 8 No.18 (May 7, 2015)

    FRA Liquid Alts 2015 Conference Highlights ’40 Act Fund Structures and Regulatory Concerns with Alternative Mutual Funds (Part Two of Three)

    As the liquid alternatives (or alternative mutual fund) space has expanded significantly in recent years, offerings of alternative mutual funds by hedge fund managers have similarly increased.  Accordingly, as more hedge fund managers look to launch alternative mutual funds, it is important for them to understand the common structures under the Investment Company Act of 1940 (’40 Act).  Additionally, as regulators are interested in ensuring alternative mutual funds meet regulatory requirements and managers of those funds operate within the confines of applicable regulations, it is imperative that managers launching alternative mutual funds understand those regulatory concerns.  See “Alternative Mutual Fund Managers Have Two Custody Rules to Worry About,” The Hedge Fund Law Report, Vol. 8, No. 8 (Feb. 26, 2015).  These topics were among those discussed at the recent Liquid Alts 2015 conference hosted by Financial Research Associates, LLC.  This article, the second in a three-part series, focuses on the panel discussions of ’40 Act fund structures and regulatory concerns with liquid alternative funds.  The first article discussed the keys to successfully launching and operating an alternative mutual fund.  The third article will review issues investors should consider while conducting due diligence on an alternative mutual fund.  For more on alternative mutual funds, see “Regulatory and Practitioner Perspectives on Alternative Mutual Fund Compliance Risk,” The Hedge Fund Law Report, Vol. 8, No. 8 (Feb. 26, 2015).

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  • From Vol. 8 No.18 (May 7, 2015)

    Experts Offer Advice on Initiating and Structuring M&A Transactions in the Asset Management Industry (Part One of Two)

    Mergers, acquisitions, joint ventures, acquisitions of minority interests and lift-outs of teams occur in the asset management industry for many reasons; managers may seek to grow assets under management, plan for succession, add new products or strategies or add new distribution channels.  A panel of experts from K&L Gates recently discussed current trends in the asset management industry and a number of considerations in planning an acquisition or other deal with an asset manager, broker-dealer or adviser, including choice of partner, due diligence, structuring, taxation and various regulatory and compliance considerations.  Moderated by Michael S. Caccese, a practice area leader, the program featured partners Kenneth G. Juster and Michael W. McGrath; and practice area leaders D. Mark McMillan and Robert P. Zinn.  This article, the first in a two-part series, summarizes the key takeaways from that program with respect to asset management industry trends, choosing a partner, due diligence and structuring considerations.  The second article will address taxation, regulatory and business integration concerns.  See also “Buying a Majority Interest in a Hedge Fund Manager: An Acquirer’s Primer on Key Structuring and Negotiating Issues,” The Hedge Fund Law Report, Vol. 4, No. 17 (May 20, 2011). 

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  • From Vol. 8 No.13 (Apr. 2, 2015)

    RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence

    As institutional investors seek better returns or mitigation of downside risk in their portfolios, they frequently turn to hedge funds.  A recent program sponsored by the Regulatory Compliance Association provided an overview of the basic due diligence steps that such investors take with regard to investments with hedge fund managers, and focused on alignment of interests, indemnification provisions, liquidity, investor consent and the issues raised when investing through or alongside separate accounts.  The program was moderated by Scott Sherman, a Managing Director at Blackstone and Senior RCA Fellow from Practice.  The other speakers were Maura Harris, a Senior Vice President at The Permal Group; Nicole M. Tortarolo, an Executive Director at UBS A.G.; and David Warsoff, Executive Director at J.P. Morgan Alternative Asset Management.  For more on investor due diligence, see “Operational Due Diligence from the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits,” The Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).  For fund managers’ perspectives on investor due diligence, see “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014).  For more on due diligence from the Regulatory Compliance Association, see “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  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 “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them,” The Hedge Fund Law Report, Vol. 8, No. 5 (Feb. 5, 2015).

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  • From Vol. 8 No.13 (Apr. 2, 2015)

    FRA Compliance Master Class Highlights Operational and Regulatory Issues for Hedge Fund Managers Considering Launching Alternative Mutual Funds

    Seeking to access a vast source of capital that is not readily accessible by traditional hedge funds, hedge fund managers have been launching or contemplating the launch of alternative mutual funds.  Aside from the opportunity to expand the manager’s investor base, launching an alternative mutual fund allows a hedge fund manager to expand and diversify its product offering.  In the U.S., such funds are governed by the Investment Company Act of 1940 and, as such, must meet a broad array of regulatory and compliance requirements.  See “The First Steps to Take When Joining the Rush to Offer Registered Liquid Alternative Funds,” The Hedge Fund Law Report, Vol. 7, No. 42 (Nov. 6, 2014).  For a general discussion of ways that hedge fund managers can enter the retail alternatives space, see “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  Speakers at FRA LLC’s Private Investment Funds Compliance Master Class – including Marie Noble, partner, general counsel and CCO at SkyBridge Capital; and Robert Schwartz, general counsel and CCO at Loeb King Capital Management – discussed issues to consider when converting a hedge fund strategy to a mutual fund structure, due diligence of mutual fund service providers, alternative mutual fund compliance and marketing.  This article highlights the key points discussed on each of the foregoing topics.  For additional coverage of this conference, see “Five Steps That CCOs Can Take to Avoid Supervisory Liability, and Other Hedge Fund Manager CCO Best Practices,” The Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For a discussion of another kind of conversion, see “Legal Mechanics of Converting a Hedge Fund Manager to a Family Office,” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).

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  • From Vol. 8 No.11 (Mar. 19, 2015)

    Structuring Private Funds to Profit from the Oil Price Decline: Due Diligence, Liquidity Management and Investment Options

    Energy companies directly or indirectly reliant on reserve based lending and public equity markets are feeling pressure as markets have tightened, as evidenced by recent significant stock declines, IPO delays, dividend and distribution cuts and missed interest payments leading to bankruptcy filings.  If lower prices are sustained, this financial pressure will continue over time as reserves are increasingly valued at lower prices, interest rates move upward and poorly hedged exploration and production companies and counterparties face unfavorable positions.  In such a market, leveraged and shale focused high-yield exploration and production companies, shale-reliant and undiversified oil field services companies and small- to medium-sized financial institutions with significant exposure to such companies and the boom oil patch areas generally will present distressed investors with plenty of opportunities to extract value from current market conditions.  Along with the financial considerations, investment funds looking to take advantage of distressed energy opportunities will have to consider various legal matters including structuring the investments, due diligence and dealing with potentially illiquid positions.  This guest article describes the market context, focusing on opportunities for hedge funds and other players arising out of the oil price plunge; the palette of investment options available to managers looking to invest in or around oil price movements; the balance between speed and comprehensiveness in due diligence; and tax, liquidity and other fund structuring considerations.  The authors of this article are James Deeken and Shubi Arora, both partners at Akin Gump Strauss Hauer & Feld; Jhett Nelson, counsel at Akin; and Stephen Harrington, an Akin associate.

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  • From Vol. 8 No.6 (Feb. 12, 2015)

    Why Should Hedge Fund Investors Perform On-Site Due Diligence in Addition to Remote Gathering of Information on Managers and Funds? (Part Three of Three)

    On-site visits have become de rigueur in operational due diligence, with many investors putting a high premium on face-to-face meetings with fund managers.  But the difference between a superficial and an effective on-site visit can be profound.  Merely showing up is not sufficient.  In fact, going on site without the right strategy can create the illusion of a “deep dive” without the substance.  Effective on-site due diligence is not just a matter of staying longer, asking more questions and reviewing more documents.  It is a discipline unto itself, with techniques that are proven to work.  Usually, those techniques can only be learned through trial and error.  This article, the third in a three-part series, aims to minimize the “error” part of that learning process by revealing best practices learned by long-time ODD practitioners.  Specifically, this article details: workable and effective on-site diligence procedures, including evaluating cybersecurity programs; red flags to identify; and an investor’s options following the on-site visit.  The first article focused on the rationale for the on-site visit and the mechanics of preparation.  The second article discussed how investors should conduct due diligence visits, and how managers can prepare for them effectively.  See also “Operational Due Diligence from the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits,” The Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).

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  • From Vol. 8 No.5 (Feb. 5, 2015)

    Why Should Hedge Fund Investors Perform On-Site Due Diligence in Addition to Remote Gathering of Information on Managers and Funds? (Part Two of Three)

    An on-site visit has become an essential element of a hedge fund operational due diligence program.  As one allocator told the HFLR, “There are a few important questions that can only be asked while looking into the eyes of the COO or CFO.”  But what are those questions and, more generally, what practices, approaches and techniques can investors implement to extract maximum value from an on-site visit?  This article is the second in a three-part series detailing how and why investors should perform on-site due diligence visits.  Based on insight from operational due diligence veterans, this article describes how investors should conduct diligence visits, and how managers can prepare for them effectively.  The first article focused on the rationale for the on-site visit and the mechanics of preparation.  The third article will discuss further on-site procedures, including red flags to identify, and an investor’s options following the on-site visit.  See also “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014).

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  • From Vol. 8 No.4 (Jan. 29, 2015)

    Why Should Hedge Fund Investors Perform On-Site Due Diligence in Addition to Remote Gathering of Information on Managers and Funds? (Part One of Three)

    Technology is an important adjunct to hedge fund investments and operations, but the human element continues to loom disproportionately large in operational due diligence.  Institutional investors review voluminous information in the course of due diligence, and a year-long courtship is not unusual before making an investment.  Much of that information is obtained and reviewed remotely, but according to the smart money, an operational due diligence process is not complete without an on-site visit.  What can institutional investors glean on-site that they cannot obtain remotely?  To answer that question, The Hedge Fund Law Report interviewed practitioners working in various phases of the hedge fund investment process.  This article – the first in a three-part series – conveys the key findings of our interviews on topics including: general goals of an on-site review; the four core benefits of an on-site review; how to prepare for an on-site visit; the role of background checks and confidentiality agreements; how to structure an on-site visit agenda to maximize productivity; and who should participate in an on-site visit and what materials participants should bring.  The second article in this series will address protocol for the on-site visit, and the third article will discuss an investor’s options following the on-site visit.  See also “Operational Due Diligence from the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits,” The Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).

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  • From Vol. 7 No.31 (Aug. 21, 2014)

    The Role of Background Checks in Hedge Fund Investor Due Diligence and Hedge Fund Manager Hiring

    A thoroughgoing understanding of the backgrounds of principals and employees of a hedge fund management company has historically been a matter of prudence; increasingly, it is also a matter of regulatory compliance.  The “bad actor” disqualification provisions of the JOBS Act, Form ADV and the anti-fraud provisions of the Investment Advisers Act all require hedge fund managers to accurately understand the litigation, licensing, disciplinary, employment, educational, financial and other history of their actual and potential principals and employees.  For hedge fund investors, best operational due diligence practices involve examination of at least the foregoing categories of information for management company principals.  In addition, both managers and investors are well-advised to understand the backgrounds of decision-makers at service providers (such as prime brokers, law firms, administrators, accountants, companies that provide fund directors and others).  Importantly, background checks should not be a rote exercise: if they uncover red flags, those red flags should be pursued vigorously, and should, if serious and not subject to remedy, cause a change of plan (e.g., passing on an investment or a candidate, or terminating an employee).  In an effort to assess the market for important components of background checks as commissioned by investors and managers, The Hedge Fund Law Report recently interviewed Richard “Bo” Dietl, a former New York City police officer and decorated detective, and a seasoned veteran of the private fund background check business.  Dietl provided on-the-ground intelligence on specific goals and targets of background checks by investors and managers; coverage in background checks of nonpublic information; the top three “red flags” that investors are looking for in background checks on managers; best practices for managers in responding to identified red flags; background check pricing and resulting work product; state requirements for employee consent and disclosure to manager background checks; the interaction between background checks and the bad actor disqualification rule; frequency with which background checks should be updated; and whether background checks should be performed on fund directors.

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  • From Vol. 7 No.16 (Apr. 25, 2014)

    Operational Due Diligence from the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits

    On March 25 and 26, 2014, at the Princeton Club in New York, Financial Research Associates held the most recent edition of its annual Hedge Fund Due Diligence Master Class.  This article summarizes a series of panels at the event focusing on operational due diligence from the investor perspective.  In particular, this article covers seven categories of “deal breakers” that investors can discover in the course of operational due diligence (ODD); a three-part framework for thinking about manager liquidity; six categories of people that should serve on a hedge fund manager valuation committee; five best practices for institutional investors that elect to conduct due diligence on their own, without a dedicated ODD team; how investors can work with consultants to conduct ODD; and the three phases of on-site ODD visits.  Prior articles in the HFLR covered an overview presentation at the same event, and another series of panels focusing on operational due diligence from the manager perspective.  See “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014).

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  • From Vol. 7 No.15 (Apr. 18, 2014)

    Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers

    On March 25 and 26, 2014, at the Princeton Club in New York, Financial Research Associates held the most recent edition of its annual Hedge Fund Due Diligence Master Class.  This article summarizes a series of panels at the event focusing on operational due diligence from the manager perspective.  In particular, this article covers evolving operational due diligence trends, due diligence on emerging hedge fund managers, due diligence on service providers, corporate governance and cybersecurity considerations for hedge fund managers.  A prior article in the HFLR covered an overview presentation at the same event.  See “Seward & Kissel Partner Steven Nadel Identifies 29 Top-of-Mind Issues for Investors Conducting Due Diligence on Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 13 (Apr. 4, 2014).  And a subsequent article will cover panels at the event focusing on operational due diligence from the investor perspective.

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  • From Vol. 7 No.13 (Apr. 4, 2014)

    Seward & Kissel Partner Steven Nadel Identifies 29 Top-of-Mind Issues for Investors Conducting Due Diligence on Hedge Fund Managers

    On March 25 and 26, 2014 at the Princeton Club in New York, Financial Research Associates held the most recent edition of its annual Hedge Fund Due Diligence Master Class.  During an opening “fireside chat,” Seward & Kissel LLP partner Steven Nadel identified 29 areas of concern for investors engaged in due diligence of hedge fund managers.  Many of these concerns overlap with concerns of regulators examining hedge fund managers.  This article lists the issues identified by Nadel and relays his market color on each.

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  • From Vol. 7 No.6 (Feb. 13, 2014)

    OCIE Risk Alert Identifies the Chief Concerns of Pension Fund Gatekeepers When Performing Hedge Fund Due Diligence

    The SEC’s Office of Compliance Inspections and Examinations (OCIE), in coordination with the Division of Investment Management and the Asset Management Unit of the Enforcement Division, recently issued a Risk Alert summarizing the due diligence procedures that certain investment advisers employ when considering hedge funds and other alternative investments for their clients.  This article summarizes the key findings of the Risk Alert.  See also “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).

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  • From Vol. 7 No.1 (Jan. 9, 2014)

    RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)

    This is the third installment in our three-part series covering the RCA’s Compliance, Risk & Enforcement 2013 Symposium.  It summarizes key points from two sessions, one offering perspectives from regulators and industry participants on regulatory risks and compliance best practices relating to expert networks, valuation, custody and allocation of expenses; and another providing a detailed look into fund administrator shadowing.  The first installment covered highlights from two sessions, one addressing effective risk assessments for hedge fund managers and the other offering current and former government officials’ perspectives on expert networks, political intelligence, insider trading and valuation-related conflicts of interest.  The second installment summarized the most salient points from two sessions, including the keynote address by OCIE Director Andrew Bowden, and a session addressing fund distribution, the JOBS Act, broker registration, National Futures Association oversight of hedge fund marketing practices and the EU’s Alternative Investment Fund Managers Directive.

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  • From Vol. 6 No.48 (Dec. 19, 2013)

    Expert Panel Underscores Heightened Foreign Corrupt Practice Act Enforcement Risk Facing Hedge Fund and Other Private Fund Managers 

    “Hedge funds are under the FCPA microscope now,” Lauren Resnick, a partner at Baker Hostetler LLP, warned during a recent panel discussion addressing corruption risks that private fund managers, including hedge fund managers, face.  She and her colleague Marc Kornfeld, along with James “Bucky” Canales, Chief Operating Officer of StoneWater Capital LLC, detailed how the FCPA affects the private fund industry and what hedge fund managers and others should be doing to minimize the risk of an FCPA violation, or the violation of another global anti-bribery law.  This article highlights salient points from the panel discussion.  See also “Practical Considerations for Compliance by Hedge Fund Managers with the FCPA When Evaluating and Engaging Foreign Advisors in Connection with Foreign Bankruptcy Investments,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    Implications for Hedge Fund Managers of the SEC’s Recent Guidance on the Rule 506 Bad Actor Disqualification Provisions

    On December 4, 2013, the staff of the Division of Corporate Finance of the SEC published “Compliance and Disclosure Interpretations” (interpretative guidance) addressing the applicability of the recently-adopted “bad actor” disqualification provisions (Rules 506(d) and (506(e)) recently adopted by the SEC as part of its JOBS Act rulemaking.  See “SEC JOBS Act Rulemaking Creates Opportunities and Potential Burdens for Hedge Funds Contemplating General Solicitation and Advertising,” The Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  The interpretative guidance addressed, among other things, the scope of covered persons and disqualifying events covered by the rules, acceptable due diligence measures that issuers can employ to avoid disqualification, guidance with respect to an issuer’s dealings with compensated solicitors to avoid disqualification, circumstances in which issuers need not and cannot seek waivers from application of Rule 506(d) and the scope of an issuer’s Rule 506(e) disclosure obligations.  The interpretations have numerous implications for hedge funds that seek to offer securities in reliance on Rule 506.  This article summarizes key takeaways from the interpretative guidance and outlines important implications for hedge fund issuers arising out of the guidance.  For additional insight on interpretation of the bad actor disqualification provisions, see “How Can Hedge Fund Managers Negotiate the Structuring, Operational and Due Diligence Challenges Posed by the Bad Actor Disqualification Provisions of Rule 506(d)?,” The Hedge Fund Law Report, Vol. 6, No. 39 (Oct. 11, 2013).

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  • From Vol. 6 No.40 (Oct. 17, 2013)

    Six Critical Questions to Be Addressed by Hedge Fund Managers That Outsource Employee Background Checks (Part Three of Three)

    This is the third installment in our three-part series on employee background checks in the hedge fund industry.  This article begins by weighing three factors favoring conducting background checks in-house against five factors favoring outsourcing of background checks.  The article then identifies and addresses six important questions to be answered by any hedge fund manager that outsources the employee background check process.  The first article in this series outlined the imperative of conducting background checks, cataloging the wide range of regulatory and other risks presented by employees.  See “Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).  And the second article in the series discussed the mechanics of conducting a background check, identified three common mistakes made by hedge fund managers in conducting background checks and detailed four legal risks in conducting background checks.  See “Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part Two of Three),” The Hedge Fund Law Report, Vol. 6, No. 39 (Oct. 11, 2013).  The backdrop for our discussion of backgrounds is the growing competition for top talent in the hedge fund industry.  In brief, assets under management by hedge funds are growing rapidly; Citi Prime Finance, for example, forecasts that institutional investment in hedge funds will reach $2.314 trillion by 2017, up from $1.485 trillion in 2012.  Managers that can attract and retain the best and the brightest are more likely to capture a larger slice of a growing pie.  See “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).  Also, insightful investment talent can enable a manager to explore creative structuring options such as alternative mutual funds, funds of one and reinsurance vehicles.  The opportunities can cause a manager to rush headlong into the market for talent, and at least one of the purposes of this series is to suggest that managers pause to separate the peccadilloes from the fundamental problems.  Before you can know your customer, you need to know your employees.

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  • From Vol. 6 No.39 (Oct. 11, 2013)

    Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part Two of Three)

    This is the second article in our three-part series on employee background checks in the hedge fund industry.  The occasion for this series is a growing recognition in the industry that people can be either the best asset of a manager or a manager’s worst liability.  The potential value of people is implicit in the impressive returns of some managers; the road of good returns invariably leads back to human insight.  And – less pleasantly – the industry graveyard is littered with management companies laid low by human foibles rather than investment mistakes.  See, e.g., “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013); and “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  How can managers obtain the data necessary to identify aspects of a prospective employee’s background that are or may become problematic?  The high-level answer is: By conducting background checks.  But since a background check is a capacious concept – covering everything from a Google search to a private investigation – managers can benefit from more detail on the topic.  This series is designed to provide that detail.  In particular, the first article in this series outlined the case for conducting background checks, cataloging the wide range of regulatory and other risks presented by employees (including discussions of insider trading, Rule 506(d), pay to play, track record portability, restrictive covenants and other topics).  See “Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).  This article discusses the mechanics of conducting a background check, including four specific activities that managers or their service providers should undertake; identifies three common mistakes made by hedge fund managers in conducting background checks; and details four legal risks in conducting background checks.  The final article in this series will weigh the benefits and burdens of outsourcing background checks versus conducting them in-house.

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  • From Vol. 6 No.39 (Oct. 11, 2013)

    How Can Hedge Fund Managers Negotiate the Structuring, Operational and Due Diligence Challenges Posed by the Bad Actor Disqualification Provisions of Rule 506(d)?

    Generally, rulemaking under the JOBS Act has relaxed decades-old restrictions on marketing by hedge fund managers.  See “A Compilation of Important Insights from Leading Law Firm Memoranda on the Implications of the JOBS Act Rulemaking for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013).  However, the JOBS Act rulemaking also added a new subsection (d) to Rule 506, which generally prohibits “bad actors” from accessing the expanded marketing rights under the JOBS Act.  Specifically, Rule 506(c) allows hedge fund managers to engage in general solicitation and advertising, but Rule 506(d) provides that hedge funds may not offer securities in reliance on Rule 506 if covered persons associated with the hedge fund (including the manager, distributors and certain investors, officers and directors) have engaged in specified misconduct.  See “SEC JOBS Act Rulemaking Creates Opportunities and Potential Burdens for Hedge Funds Contemplating General Solicitation and Advertising,” The Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  For hedge fund managers that wish to partake of the expanded marketing opportunities offered by the JOBS Act, Rule 506(d) creates structuring, operational and due diligence challenges.  Some of those challenges are obvious from the face of the rule, for example, identifying covered persons within the management company.  Other challenges are less obvious but no less important.  For example, under what circumstances, if any, can sub-advisers or fund of funds investors constitute covered persons?  When and how should managers conduct a covered person analysis on their range of relationships?  How does Rule 506(d) interact with the manager’s hiring program?  Does the bad actor disqualification regime impact the negotiation of settlement agreements with the SEC and CFTC?  To address these and other challenging issues raised by Rule 506(d), The Hedge Fund Law Report recently interviewed Rory Cohen, currently a partner at Mayer Brown, formerly a managing director at Bear Stearns, and a practitioner with decades of experience in hedge fund and broker-dealer law, regulation and operations.  Our interview with Cohen – the full transcript of which is included in this article – was conducted in connection with the Regulatory Compliance Association’s upcoming Compliance, Risk & Enforcement 2013 Symposium, to be held at the Pierre Hotel in New York City on October 31, 2013.  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three)

    Hedge fund management is a human capital business, and employees are (or should be) the key asset of a manager.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).  However, employees can also be a manager’s most dangerous liability.  One rogue employee can destroy or seriously damage even the best hedge fund franchise by, among other things, inviting a presumption that the employee is not rogue but representative of a culture of permissiveness.  See “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  Recognizing the risks of picking bad apples, hedge fund managers are increasingly using employee background checks as a downside mitigation strategy.  But the concept of a background check spans a wide range of activities – everything from a superficial online search to a deep, manual process.  Whether to conduct a background check in the first instance, and what kind of background check to conduct, depends on dynamics specific to the industry, firm and prospective employee.  To assist hedge fund managers in understanding the role of background checks in their hiring and “people” processes, The Hedge Fund Law Report is publishing a three-part series on the role of background checks in the hedge fund industry, with the three parts focusing on, respectively, three questions: Why, how and who.  More specifically, this article – the first in the series – outlines the case for conducting background checks, cataloging the wide range of regulatory and other risks presented by employees (including discussions of insider trading, Rule 506(d), pay to play, track record portability, restrictive covenants and other topics).  The second installment will describe the anatomy of an employee background check, highlighting mechanics, common mistakes and risks.  And the third part will weigh the benefits and burdens of outsourcing background checks versus conducting them in-house.

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part Two of Two)

    This is the second article in a two-part series detailing the application of abstract insider trading principles to specific scenarios and challenges faced by hedge fund managers.  This article discusses the misappropriation theory of insider trading; recent caselaw on the element of scienter; channel checking and field research; insider trading issues raised when fund investors are affiliated with portfolio companies; special insider trading rules that apply to tender offers; and criminal and civil penalties for insider trading.  The first article in this series discussed the definition of nonpublic information; the scope of the concept of materiality; the limits of the concept of fiduciary duty as it relates to insider trading; and the mosaic theory of insider trading.  See “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).  The author of this article series is Ralph Siciliano, head of the Governmental and Regulatory Investigations Practice at Tannenbaum Helpern Syracuse & Hirschtritt LLP.

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  • From Vol. 6 No.28 (Jul. 18, 2013)

    Deutsche Bank’s Hedge Fund Consulting Group Provides a Roadmap to Hedge Fund Managers in Navigating the Operational Due Diligence Process

    Deutsche Bank’s Hedge Fund Consulting Group recently released a report analyzing the results of a survey of institutional investors on operational due diligence (ODD).  Survey participants included 68 investors that collectively manage or advise $2.13 trillion in total assets, including $764 billion of assets invested in hedge funds.  Among other things, the report discussed the composition of ODD teams; the frequency and duration of ODD visits; how investors approach the ODD process; circumstances in which ODD teams have and use investment veto rights; priority focus areas for investor ODD reviews; operating and allocation preferences (including which expenses investors perceive as acceptable for charging to the fund); and recommendations to managers in preparing for ODD reviews.  The insights from investors captured in the Deutsche Bank report can help hedge fund managers refine their approach to the ODD process.  In turn, a well-informed, coherent and credible approach to ODD can pay dividends to hedge fund managers in the form of increased allocations and more effective marketing.  This article extracts insights from the report that managers can incorporate directly into their responses to due diligence inquiries.  For more on ODD, see “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012); and “FRA Conference Juxtaposes Manager and Investor Perspectives on Hedge Fund Due Diligence (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 23 (Jun. 6, 2013).

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  • From Vol. 6 No.25 (Jun. 20, 2013)

    What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence On and Negotiate For Investments in Their Funds?

    Pension and other plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) have sought out hedge fund investments as a way of achieving more attractive risk-adjusted returns.  However, ERISA plan trustees must be careful to fulfill their fiduciary duties and comply with other ERISA requirements when investing plan assets in hedge funds.  Because such regulations can be daunting, a recent program provided a roadmap for ERISA plans considering making investments in alternative investment funds.  Specifically, the program provided both general insights into key criteria that ERISA plans consider when evaluating hedge fund managers as well as specific insights concerning the types of provisions that ERISA plans negotiate for in hedge fund subscription documents and side letters.  The program was instructive not only for ERISA plan investors, but also for managers who seek to raise assets from ERISA plan investors.  This article summarizes the key takeaways from the program.  See also “Application of the QPAM and INHAM ERISA Class Exemptions to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 46 (Dec. 6, 2012).

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    How Should Hedge Fund Managers Select Accountants, Prime Brokers, Independent Directors, Administrators, Legal Counsel, Compliance Consultants, Risk Consultants and Insurance Brokers for Their Funds?

    This article discusses what hedge fund managers should look for in the companies that provide accounting, brokerage, directorial, administration, legal, consulting, risk management and technology services to a fund.  To do so, this article focuses on questions that hedge fund managers should ask and issues they should address when retaining or changing service providers.

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  • From Vol. 6 No.23 (Jun. 6, 2013)

    FRA Conference Juxtaposes Manager and Investor Perspectives on Hedge Fund Due Diligence (Part Two of Two)

    Financial Research Associates LLC recently hosted a two-day seminar entitled “Hedge Fund Due Diligence Master Class.”  This is the second article in a two-part series extracting and summarizing key lessons from the event.  Specifically, this article discusses counterparty risk and valuation issues, recent regulatory developments impacting due diligence, strategic planning for sustainable due diligence programs, evolution of the due diligence process and manager perspectives on due diligence.  The first installment discussed red flags that investors should look for during diligence, the tension between increased portfolio transparency and protection of a manager’s proprietary information and investor perspectives on enterprise risk management by managers.  See “FRA Conference Juxtaposes Manager and Investor Perspectives on Hedge Fund Due Diligence (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 22 (May 30, 2013).

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  • From Vol. 6 No.22 (May 30, 2013)

    FRA Conference Juxtaposes Manager and Investor Perspectives on Hedge Fund Due Diligence (Part One of Two)

    Hedge fund managers and investors sometimes view the same topic very differently.  See, e.g., “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  The all-important topic of hedge fund due diligence is no exception to this industry truism.  This divergence of interests, experience and expectations was in evidence at a recent conference entitled “Hedge Fund Due Diligence Master Class,” and hosted by Financial Research Associates LLC (FRA).  But, equally if not more importantly, the FRA event also highlighted areas of shared concern among managers and investors, as well as specific due diligence techniques that benefit both constituencies.  Hedge fund due diligence has become a condition precedent of the initiation and continuation of a relationship between a manager and investor.  It is front and center in terms of importance.  Therefore, the concerns, best practices, due diligence approaches and stories from the trenches shared at the FRA event hold important lessons for investors as well as managers.  The Hedge Fund Law Report is memorializing the key lessons from the event in a two-part series of articles.  This article, the first in the series, addresses key priorities and red flags that investors should look for during the manager diligence process; the tension between increased portfolio transparency and protection of proprietary information; and investor perspectives on enterprise risk management by managers.  The second installment will discuss custody and valuation issues; strategic planning for sustainable due diligence programs; recent regulatory developments and how managers should respond; questions that investors should ask during diligence; and ways in which managers are improving their due diligence processes.

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  • From Vol. 6 No.19 (May 9, 2013)

    Rothstein Kass 2013 Hedge Fund Outlook Highlights Managers’ Perspectives on Performance and Economic Trends, Leverage, Capital Raising Strategies, Due Diligence, Staffing, Operational Changes and Regulatory Concerns

    International services firm Rothstein Kass recently released a report detailing findings from its survey of 358 professionals at hedge fund managers regarding performance and economic outlook, use of leverage, capital raising concerns and strategies (including seed deals, use of separately managed accounts and fee breaks), investor due diligence, staffing issues and regulatory priorities.  This article summarizes the key takeaways from the survey.  For an article summarizing the 2012 version of this annual Rothstein Kass report, see “Rothstein Kass Report Discusses Marketing, Structuring, Tax, Leverage, Due Diligence, Hiring and Other Dominant Concerns for Hedge Fund Managers in a Competitive Capital Raising Environment,” The Hedge Fund Law Report, Vol. 5, No. 22 (May 31, 2012).

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  • From Vol. 6 No.17 (Apr. 25, 2013)

    Roundtable Addresses Trends in Hedge Fund Operational Due Diligence, Fund Expenses, Administrator Shadowing, Business Continuity Planning and Cloud Computing

    At a recent roundtable, hedge fund investor due diligence experts offered their perspectives on evolving hedge fund manager operations and investor due diligence practices.  The panelists addressed various specific topics, including: the impact of regulations on investor due diligence processes; investor responses to increased insider trading risks; scrutiny of fund expenses; administrator shadowing; business continuity planning for hedge fund managers; and the benefits and risks of cloud computing services.  These investor perspectives can provide useful information for hedge fund managers looking to refine their capital raising efforts.  This article highlights the salient points discussed on each of the foregoing topics.

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    How Can Hedge Fund Managers Wishing to Rely on the JOBS Act’s Advertising Relief Enhance Their Accredited Investor Due Diligence Procedures?

    The Jumpstart Our Business Startups (JOBS) Act provides relief from the ban on general solicitation and advertising contained in the Rule 506 securities registration safe harbor, as long as all purchasers of an issuer’s securities are accredited investors.  While the JOBS Act creates more opportunities for hedge fund managers to market their funds to the public, such opportunities are accompanied by an obligation on the part of managers to take “reasonable steps” to verify that all purchasers of fund securities are accredited investors.  However, the SEC has not yet adopted final rules to define when an adviser has taken such “reasonable steps.”  For a discussion of the SEC’s proposed rules, see “JOBS Act: Proposed SEC Rules Would Dramatically Change Marketing Landscape for Hedge Funds,” The Hedge Fund Law Report, Vol. 5, No. 34 (Sep. 6, 2012).  Despite the lack of definitive guidance from the SEC, hedge fund managers should nonetheless evaluate their investor due diligence procedures to ascertain whether they are sufficiently robust.  In a guest article, Philip Segal, founder of Charles Griffin Intelligence, provides recommendations to assist hedge fund managers in enhancing their investor due diligence practices.

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    Best Practices for Due Diligence by Hedge Fund Managers on Research Providers

    Recent high-profile enforcement actions, including that involving Mathew Martoma and CR Intrinsic, an affiliate of SAC Capital, highlight the SEC Division of Enforcement’s continuing commitment to aggressively prosecuting hedge fund insider trading cases.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  While registered hedge fund managers are required by Rule 206(4)-7 under the Investment Advisers Act of 1940 to adopt policies and procedures reasonably designed to prevent and detect insider trading and other federal securities law violations, it behooves all hedge fund managers (even those that are not registered) to adopt such policies and procedures.  See “Three Recent SEC Orders Demonstrate a Renewed Emphasis on Investment Adviser Compliance Policies and Procedures by the Enforcement Division,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  Many hedge fund managers have recognized the insider trading risks posed by the use of expert network firms and have adopted policies and procedures designed to address these risks.  But other types of research firms also present insider trading and other regulatory risks.  Before using any investment research firm, it is imperative for hedge fund managers to conduct thorough due diligence to appropriately assess and address those risks.  In a guest article, Susan Mathews and Sanford Bragg describe the different types of research providers in the marketplace; the general approach to research provider due diligence; and some best practices for conducting due diligence on research providers.  Bragg is CEO of Integrity Research Associates, LLC, a consulting firm specializing in evaluating investment research providers, including their compliance platforms.  Mathews is Counsel and head of Integrity Research Compliance.

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  • From Vol. 6 No.7 (Feb. 14, 2013)

    FATCA Implementation Summit Identifies Best Practices Relating to FATCA Reporting, Due Diligence, Withholding, Operations, Compliance and Technology

    On December 6, 2012, the Hedge Fund Business Operations Association and Financial Research Associates, LLC jointly sponsored a “FATCA Implementation Summit” in New York City (Summit).  Participants at the Summit discussed compliance requirements, recommendations and strategies in connection with the Foreign Account Tax Compliance Act (FATCA), in particular with respect to registration, reporting, due diligence and withholding.  Participants also addressed the operational and technological demands presented by FATCA, and best practices for meeting those demands.  This article summarizes the practical takeaways from the Summit and offers recommendations that hedge fund managers can apply directly to their FATCA compliance programs.

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  • From Vol. 6 No.1 (Jan. 3, 2013)

    RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices

    The Regulatory Compliance Association, in cooperation with major law firms and institutional investors, recently presented a Practice Readiness Series session entitled “Navigating the Side Letter and Due Diligence Process” (Session).  The Session focused on issues involved in negotiating hedge fund side letters from the perspectives of hedge fund managers and investors.  It also reviewed due diligence from both perspectives, highlighting the categories of due diligence performed by institutional investors and best practices for managers when responding to due diligence requests.  This article summarizes the key points made during the Session.

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  • From Vol. 6 No.1 (Jan. 3, 2013)

    How Can Hedge Fund Managers Identify, Mitigate and Insure Against Cyber Security Threats?

    On December 4, 2012, a webcast jointly sponsored by insurance brokerage firm Maloy Risk Services; insurer Chubb & Son; and Internet security software developer Trend Micro, provided an overview of the current cyber “threat landscape,” highlighted the critical need to vet the cyber defenses of third party service providers, and discussed insurance coverage available with respect to cyber attacks.  This article summarizes the key points from the webcast that are most relevant to hedge fund managers and includes a due diligence checklist for managers to verify cyber security measures taken by third party vendors.

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Release Letters: Key Provisions of Concern for Hedge Fund Managers

    In the course of performing due diligence on a potential investment, hedge fund managers often require access to expert reports or similar work product prepared by advisors engaged by third parties.  These third parties engage financial and other advisors to produce various memoranda and other due diligence materials in connection with anticipated investments.  For their part, the advisors generally provide their work product solely to the parties who engaged them to produce this work product with whom the advisors have a direct contractual relationship and who have accepted their standard terms and conditions.  Hedge fund managers, seeking to obtain the information contained in such expert reports for purposes of investment analysis in relation to the underlying assets or securities, but not being “clients” of the advisor for the purpose of the engagement, must sign a so-called “release letter” in order to obtain access to this work product.  These release letters are prepared primarily for the benefit of the advisor who produced the work product to be shared with “non-clients” (such as hedge fund managers or other investors or lenders) on a limited basis.  The release letters’ principal purpose is to exclude, or at least minimize, legal liability of the advisor as a result of the work product being used by such “non-client” third parties.  As such, release letters typically contain a number of important provisions, restrictions and negotiating points of which hedge fund managers should be aware.  In a guest article, William Frenkel, a Partner at Frenkel Sukhman LLP, identifies those provisions and provides guidance to hedge fund managers on how to negotiate them.

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  • From Vol. 5 No.37 (Sep. 27, 2012)

    BNY Mellon Study Identifies Best Risk Management Practices for Hedge Fund Managers

    In the last few years, hedge fund managers, investors and regulators have identified a growing roster of risks facing hedge fund investments and operations.  See, “SEC Provides Recommendations for Establishing an Effective Risk Management Program for Hedge Fund Managers at Its Compliance Outreach Program Seminar,” The Hedge Fund Law Report, Vol. 5, No. 4 (Apr. 5, 2012).  As a consequence, investors and regulators are increasingly demanding effective, appropriately tailored risk management systems, and managers are making an ongoing effort to divine best practices.  Recognizing and reflecting this trend, BNY Mellon issued a research study in August 2012 that provides a roadmap of the state of risk management in the hedge fund industry, risk management trends and best practices.  This article summarizes the key points from the study, with particular emphasis on tools and practices hedge fund managers can implement to identify, monitor, mitigate and report on risk.  See also “Ernst & Young Survey Shows Risk Managers Possess Tremendous Influence and Face Substantial Challenges in the Asset Management Industry,” The Hedge Fund Law Report, Vol. 5, No. 23 (Jun. 8, 2012).

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  • From Vol. 5 No.29 (Jul. 26, 2012)

    Hedge Fund of Funds Manager Principal Charged with Securities Fraud and Wire Fraud over Misrepresentations Concerning Fund Performance and Investment Due Diligence

    The U.S. has filed a seven-count indictment against Chetan Kapur, the sole principal of hedge fund manager Lilaboc, LLC, d/b/a ThinkStrategy Capital Management, LLC (ThinkStrategy).  Kapur is charged with securities, investment adviser and wire fraud arising out of his alleged misrepresentations to investors regarding due diligence of fund investments and fund performance.  Kapur and ThinkStrategy have previously settled civil charges brought by the SEC in connection with the same matters.  See “Private Lawsuits Against Hedge Fund Managers Can Be Important Sources of Examination and Enforcement ‘Leads’ for the SEC,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).  This article summarizes the background in this case (including a discussion of the enforcement action initiated by the SEC and the private investor suit brought against Kapur and ThinkStrategy) and outlines the criminal charges levied against Kapur.  See also “Federal Court Decision Holds That a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).

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  • From Vol. 5 No.28 (Jul. 19, 2012)

    Second Circuit Panel Upholds $20.6 Million FINRA Arbitration Award Against Prime Broker Goldman Sachs in Connection with Fraudulent Transfers Into and Among Bayou Fund Accounts

    The amount of due diligence that hedge fund prime brokers should conduct with respect to the source of funds deposited and maintained in brokerage accounts has been a topic of keen interest for hedge fund managers, investors and prime brokers, particularly in light of the ongoing litigation between the creditors of the defunct Bayou Group funds and the funds’ prime broker, Goldman Sachs Execution & Clearing, P.C. (GSEC).  See “Does a Prime Broker Have a Due Diligence or Monitoring Obligation When Paying With Soft Dollars for a Hedge Fund Customer’s Access to Expert Networks or Other Alternative Research?,” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  In the latest round of that litigation, a three-judge panel of the U.S. Court of Appeals for the Second Circuit denied GSEC’s appeal of a district court ruling that upheld a $20.6 million arbitration award against GSEC.  See “District Court Suggests That Prime Brokers May Have Expanded Due Diligence Obligations,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).  The arbitrators’ decision, seemingly based in part on the theory that GSEC should have identified red flags in connection with the Bayou fraud, was not rendered in “manifest disregard of the law,” suggesting that prime brokers are indeed at risk for such types of claims.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  This article analyzes the Second Circuit’s Summary Order.

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  • From Vol. 5 No.27 (Jul. 12, 2012)

    U.K. High Court of Justice Finds Magnus Peterson Liable for Fraud in Collapse of Hedge Fund Manager Weavering Capital and Weavering Macro Fixed Income Fund

    In 1998, defendant Magnus Peterson formed hedge fund manager Weavering Capital (UK) Limited (WCUK).  He served as a director, chief executive officer and investment manager.  One fund managed by WCUK, the open-end Weavering Macro Fixed Income Fund Limited (Fund), collapsed in the midst of the 2008 financial crisis.  Peterson was accused of disguising the Fund’s massive losses by entering into bogus forward rate agreements and interest rate swaps with another fund that he controlled.  In March 2009, the Fund suspended redemptions and went into liquidation when it could not meet investor redemption requests.  At that time, WCUK went into administration (bankruptcy).  WCUK’s official liquidators, on behalf of WCUK, brought suit against Peterson, his wife, certain WCUK employees and directors and others, seeking to recover damages for fraud, negligence and breach of fiduciary duty and seeking to recover certain allegedly improper transfers of funds by Peterson.  After a lengthy hearing, the U.K. High Court of Justice, Chancery Division (Court), has allowed virtually all of those claims, ruling that Peterson did indeed engage in fraud.  In a separate action, the Fund’s official liquidators recovered damages from Peterson’s brother, Stefan Peterson, and their stepfather, Hans Ekstrom, who served as Fund directors, based on their willful failure to perform their supervisory functions as directors.  See “Cayman Grand Court Holds Independent Directors of Failed Hedge Fund Weavering Macro Fixed Income Fund Personally Liable for Losses Due to their Willful Failure to Supervise Fund Operations,” The Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).  This article summarizes the factual background and the Court’s legal analysis in the liquidators’ action against Peterson and others.

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  • From Vol. 5 No.26 (Jun. 28, 2012)

    Delaware Chancery Court Decision Highlights the Imperative of Thorough Due Diligence on Potential Hedge Fund Business Partners

    As a hedge fund manager, you are required as a legal matter to “know your customers,” that is, your investors.  In addition, you are required as a practical matter to know your partners.  In many cases, this imperative is beside the point: many hedge fund management businesses are founded by partners that have been working together for years.  In other cases, however, management companies are organized by partners that met only recently.  In such cases, the partners should perform thorough due diligence on one another.  It may seem contrary to the optimism, trust and team spirit required to scale the increasingly high barriers to beginning in the hedge fund business.  But a recent Delaware Chancery Court (Court) opinion highlights the fact that the stakes are too high to rely on gut feelings.  The stakes are even too high to rely on routine due diligence conducted by credible service providers.  The stakes are nothing less than your personal reputation, and in the investment management business, that is all you have or can have.  Diligence in this context should be deep, customized and cross-checked.  Once you get into bed with a bad actor in the investment management business, it is virtually impossible – from a reputation point of view – to get out.

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  • From Vol. 5 No.23 (Jun. 8, 2012)

    SEC Sanctions Quantek Asset Management and its Portfolio Manager for Misleading Investors About “Skin in the Game” and Related-Party Transactions

    Investments by hedge fund managers in their own funds and related party transactions (such as loans from a fund to a manager) exist at opposite sides of the incentive spectrum.  The former – so-called “skin in the game” – is typically thought to align the interests of investors and managers while the latter is seen as pitting the interests of investors and managers in direct conflict.  Investors want to know about both, for obviously different reasons.  A May 29, 2012 SEC Order Instituting Administrative and Cease-And-Desist Proceedings against Quantek Asset Management LLC (Quantek), Javier Guerra, Bulltick Capital Markets Holdings, LP (Bulltick) and Ralph Patino highlights these and other investor considerations.  This article summarizes the SEC’s factual and legal allegations against Quantek, Bulltick, Guerra and Patino, and the settlement among the parties.  The SEC’s action follows private actions against the same or similar parties.  See, e.g., “Fund of Hedge Funds Aris Multi-Strategy Fund Wins Arbitration Award against Underlying Manager Based on Allegations of Self-Dealing,” The Hedge Fund Law Report, Vol. 4, No. 39 (Nov. 3, 2011); “British Virgin Islands High Court of Justice Rules that Minority Shareholder in Feeder Hedge Fund that had Permanently Suspended Redemptions Was Not Entitled to Appointment of a Liquidator,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).

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  • From Vol. 5 No.21 (May 24, 2012)

    Survey by AIMA and KPMG Identifies the Key Drivers of the Bifurcation of the Hedge Fund Industry Between Larger and Smaller Managers

    Life is very different these days for larger and smaller hedge fund managers.  As a general matter, larger managers can afford to be institutional.  They have the resources (derived from fees) to invest in the people and process required to attract institutional capital, which generate more fees, which increase the manager’s ability to invest in infrastructure – a seemingly virtuous cycle for larger managers.  Smaller managers, on the other hand, face roughly similar infrastructure expectations from potential institutional investors, but typically do not have the resources to invest in people and process at a level commensurate with their larger competitors.  Or are they competitors?  This is a fundamental question animating a recent report (Report) from the Alternative Investment Management Association and KPMG.  The Report echoes the oft-cited sentiment that the hedge fund industry is institutionalizing.  But the Report takes the discussion a step further by addressing the elements of institutionalization and the disparate impact of that process on managers of different sizes (measured by assets under management and headcount).  The Report also discusses transparency, due diligence, sources of capital by geography, FATCA, competition among managers and collaboration among them.  It is important for managers and investors to understand the drivers and consequences of institutionalization, and the Report advances the industry’s understanding on these topics.  But the most novel and provocative findings of the Report relate to smaller managers.  In particular, the Report identifies: an effective method whereby smaller managers can compete with larger managers via collaboration and emphasis on their competitive advantages; a specific channel of fund flows to smaller managers; and the geographic regions that smaller managers should be targeting in their capital raising.

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  • From Vol. 5 No.20 (May 17, 2012)

    Amber Partners White Paper Highlights Key Due Diligence Points for Hedge Fund Investors Evaluating Hedge Fund Portfolio Composition and Valuation

    Valuation is one of the key focal areas for many hedge fund investors because a hedge fund manager that utilizes poor valuation practices can present significant investment and operational risks.  At the same time, assessing valuation risk is often one of the most difficult tasks that a hedge fund investor faces in conducting an operational due diligence review.  This is due, in part, to the myriad investment strategies employed by hedge fund managers and the differing levels of transparency provided by hedge fund managers, which, in turn, lead to varying approaches in the presentation of portfolio information.  In April 2012, Amber Partners published a White Paper (Amber White Paper) that supplies hedge fund investors with a roadmap for assessing the level of valuation risk posed by a hedge fund manager.  Specifically, the Amber White Paper provides guidance to investors on how to evaluate the composition of a hedge fund portfolio as well as the manager’s controls over the month-end valuation process.  In addition to providing guidance to hedge fund investors, managers can also glean important lessons from the Amber White Paper on how to avoid valuation pitfalls and institute best-of-breed valuation practices.  This article details the recommendations described in the Amber White Paper.  See also “Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).

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  • From Vol. 5 No.18 (May 3, 2012)

    The Transformation of Third Party Hedge Fund Marketer Contracts and Compensation

    Asset raising and marketing are fundamental, life or death activities for hedge fund managers.  If you as a hedge fund manager (or your agents) cannot market effectively, you cannot survive, regardless of your investing prowess.  According to Rothstein Kass’ sixth annual hedge fund industry outlook survey, released in April 2012, “asset raising and marketing are far and away the top issues for funds in 2012, with 53.1 percent of respondents stating those are their biggest concerns.”  Hence the robust pay packages of the top in-house and third party marketers.  See “How Much Are In-House Hedge Fund Marketers Paid?,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011).  Marketing in the hedge fund industry is tough for business and legal reasons.  Hedge fund marketing is tough from a business perspective because, among other things: the sales cycle is long; investors have many choices; investors – especially big ones – have considerable bargaining clout; hedge funds are typically relatively liquid (and where they are not, big investors typically negotiate for liquidity); investors rarely provide feedback when they decide to forgo a hedge fund investment, so it is difficult to learn from your mistakes; it is often challenging to clearly articulate a complicated value proposition; etc.  Hedge fund marketing is tough from a legal perspective because the activity is subject to a dense and often opaque patchwork of law, regulation, policy and practice including – but by no means limited to – lobbying laws and rules and related compensation restrictions; performance reporting considerations; due diligence best practices; the JOBS Act and the evolving rules regarding general solicitation and advertising; the AIFMD in Europe; heightened and focused SEC enforcement activity; general contracting and structuring considerations; registration issues; etc.  In an effort to provide guidance to industry participants trying to navigate the business and legal challenges involved in hedge fund marketing, on April 4, 2012, the Third Party Marketers Association hosted a webinar entitled “The Transformation of Third Party Marketer Contracts and Compensation.”  The participants in the webinar were Matthew Eisenberg, a Partner at Finn Dixon & Herling LLP; Laurier W. Beaupre, a Partner at Proskauer Rose LLP; and L. Charles Bartz, a Partner with placement agent BerchWood Partners LLP.  The webinar was moderated by Mike Pereira, Publisher of The Hedge Fund Law Report.  The webinar covered many of the most important issues involved in structuring relationships between hedge fund managers and third party marketers.  This is our first of two articles covering the webinar.  This article summarizes the specific insights and concrete recommendations of the panelists on topics including: the JOBS Act; separate accounts; due diligence; who bears the risk of public plan-level restrictions on compensation; disclosure; looking through funds of funds; and other topics.

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  • From Vol. 5 No.16 (Apr. 19, 2012)

    Corgentum Webinar Highlights Trends, Challenges and Best Practices for Hedge Fund Investors in Conducting Operational Due Diligence

    We at The Hedge Fund Law Report have heard operational due diligence defined – persuasively but expansively – as the rigorous evaluation of all non-investment aspects of the business of a hedge fund manager.  A robust consensus has developed in the hedge fund industry around the importance of operational due diligence, but there is less consensus on precisely what operational due diligence entails or how to conduct it.  The absence of uniformity in implementation, in turn, is likely a function of the fact that no two managers are exactly alike.  The term “hedge fund manager” encompasses a wide range of businesses in terms of strategy, sophistication, staffing, size and other factors.  Therefore, operational due diligence is often driven by principles, experience and best practices rather than hard and fast rules.  See “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Hedge fund investors and managers must understand the operational due diligence process thoroughly, for different but related reasons.  Investors have to understand the process to make informed investments and avoid frauds, and managers have to understand the process to anticipate and accommodate due diligence requests from investors.  For parties in either category, the more you know, the better; you can never know enough; and what you think you know is constantly evolving.  To bring some clarity and coherence to this ambiguous but critical area, Corgentum Consulting, LLC (Corgentum), a firm that provides operational due diligence consulting services, recently hosted a webinar on trends, challenges and best practices in conducting operational due diligence on hedge fund managers.  Jason Scharfman, Managing Partner of Corgentum, conducted the webinar and covered, among other things: how to staff an operational due diligence team; trends and challenges that hedge fund investors face in conducting operational due diligence; and techniques that hedge fund investors can employ to maximize the effectiveness of their operational due diligence efforts.  This article summarizes the key points made during the webinar on each of these topics.

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  • From Vol. 5 No.15 (Apr. 12, 2012)

    Recent New York Court Decision Suggests That Hedge Funds Have a Due Diligence Obligation When Entering into Credit Default Swaps

    Domestic and foreign regulators have historically afforded differing levels of protection to retail investors as opposed to sophisticated investors, such as hedge funds, based on their presumptively differing levels of financial knowledge and abilities to conduct due diligence on prospective investments.  Sophisticated investors have been permitted to invest in more complicated financial products based on their presumed ability to understand and conduct due diligence on such investments.  However, the flip side of enhanced access is diminished investor protection, as evidenced by a recent court decision holding that sophisticated investors have a duty to investigate publicly available information in arms-length transactions.

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  • From Vol. 5 No.13 (Mar. 29, 2012)

    SEC Enforcement Action Against Investment Adviser Highlights Importance of Conducting Due Diligence on a Hedge Fund’s Auditor to Avoid Fraud

    Although hedge fund investment decisions are based on numerous factors, information relating to a hedge fund’s financial condition and performance results remains a critical component of any such decision.  See “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Various parties have a hand in creating and confirming the information that goes into financial statements and performance reporting.  Those parties include the manager, the administrator and the auditor.  Many investors pay particularly close attention to reports from auditors because of the rigorous standards governing the accounting profession and the presumably uniform application of those standards across different contexts.  However, information about a hedge fund provided by an accountant is only as good as the accountant itself.  A good accountant can provide, directly or indirectly, good information to an investor – even though the accountant’s duty typically does not flow to the investor – while a bad accountant can provide a false sense of security or, worse, cover for a fraud.  Indeed, a recurring feature of frauds in the hedge fund industry is an accountant that does not exist, is much smaller or less experienced than claimed or that is affiliated with the manager.  An accounting firm that was both fictitious and affiliated with the manager was a notable feature of the Bayou fraud.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  A fraudulent auditor and fictitious financial statements also featured prominently in a recently filed SEC action against an investment adviser.  This article summarizes the SEC’s Complaint in that action and describes five techniques that hedge fund investors can use to confirm the existence, competence and reliability of hedge fund auditors.

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    Use of SSAE 16 (SAS 70) Internal Control Reports by Hedge Fund Managers to Credibly Convey the Quality of Internal Controls, Raise Capital and Prepare for Audits

    An “institutional” quality infrastructure is becoming a prerequisite for hedge fund managers looking to raise capital from sophisticated investors.  But institutional is a difficult quality to define with precision in the hedge fund industry, a function of, among other things, the relative youth of the industry, asymmetry in the size and structure of management companies and the reluctance on the part of managers to disclose information.  As used by hedge fund investors, consultants, managers, regulators, service providers and others, institutional is more of a conclusion than a characteristic.  Managers are said to be institutional when they have fund directors with substance, gray hair in key operational roles, best-of-breed technology, brand name service providers, top tier investment talent and high caliber personnel focused on aspects of the business other than investing.  But a manager may be institutional without some of these elements, and even a manager with these elements can have holes in its processes that undermine the veneer of competence.  So how can investors reliably assess the institutional caliber of a manager, and how can managers credibly demonstrate their level of institutionalization?  Along similar lines, how can investors make institutional apples to apples comparisons when hedge fund management businesses are radically different in terms of size, structure, strategy and operations?  One method is to focus on the robustness of a manager’s internal controls, since robust internal controls are a necessary – though not sufficient – element of an institutional quality infrastructure.  Unlike other indicia of institutionalization, the robustness of internal controls can be measured at a single manager and compared across managers.  Such measurement can be accomplished by having an independent auditor conduct an internal control audit and issue an internal control report in accordance with Statement on Standards for Attestation Engagements No. 16 (SSAE 16), which replaced the long-standing Statement on Auditing Standards 70 (SAS 70).  While SSAE 16s have been in use in other industries for some time, they are a relatively new technique in the hedge fund industry.  However, in a climate of heightened regulator and investor scrutiny of non-investment aspects of the hedge fund business, SSAE 16s offer one of the most objective available barometers of institutionalization.  This article provides an introduction to the SSAE 16 audit process as applied to the hedge fund industry, including a description of the SSAE 16 audit and the corresponding internal control report; provides guidance regarding fund service providers a hedge fund manager should request an internal control report from and what should be covered in such internal control reports; outlines the reasons why hedge fund managers may consider obtaining an SSAE 16 audit on themselves, including a discussion of key benefits and costs of obtaining an internal control audit and report; describes the process for hedge fund managers to obtain an internal control audit and report; addresses who should pay for the internal control audit and report; addresses how often a hedge fund manager should obtain an internal control audit and report; identifies the challenges hedge fund managers face in obtaining an internal control audit and report; and explores whether there are any suitable alternatives to the internal control audit and report.

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  • From Vol. 5 No.9 (Mar. 1, 2012)

    Hedge Fund Investor Accuses Paulson & Co. of Gross Negligence and Breach of Fiduciary Duty Stemming from Losses on Sino-Forest Investment

    Hugh F. Culverhouse, an investor in hedge fund Paulson Advantage Plus, L.P., has commenced a class action lawsuit against that fund’s general partners, Paulson & Co. Inc. and Paulson Advisers LLC.  Culverhouse alleges that those entities were grossly negligent in performing due diligence in connection with the fund’s investment in Sino-Forest Corporation, whose stock collapsed after an independent research firm cast serious doubt on the value of its assets and the viability of its business structure.  Culverhouse seeks monetary and punitive damages for alleged breach of fiduciary, gross negligence and unjust enrichment.  This article does two things.  First, it offers a comprehensive summary of the Complaint.  This summary, in turn, is useful because lawsuits by investors against hedge fund managers are rare, and particularly rare against a name as noteworthy as Paulson.  Disputes between investors and managers are almost always negotiated privately, but such negotiation occurs in the “shadow” of relevant law.  This article outlines what the relevant law may be.  Second, this article contains links to various governing documents of Paulson Advantage Plus, L.P., including the fund’s private offering memorandum, limited partnership agreement and subscription agreement.  Regardless of the merits of Culverhouse’s claim, Paulson remains a well-regarded name in the hedge fund industry.  According to LCH Investments NV, Paulson & Co. Inc. has earned its investors $22.6 billion since its founding in 1994.  Those kinds of earnings can – and have – purchased highly competent legal advice, which translates into workably crafted governing documents.  Accordingly, the governing documents of the Paulson fund are useful precedents for large or small hedge fund managers looking to assess the “market” for terms in such documents or best practices for drafting specific terms.  Thus, we provide links to the governing documents.  See also “Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies,” The Hedge Fund Law Report, Vol. 4, No. 21 (Jun. 23, 2011).

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  • From Vol. 5 No.4 (Jan. 26, 2012)

    Recent SEC Enforcement Action Against Private Fund Manager Underscores Importance of Identifying and Understanding Money Transfers Between a Hedge Fund and the Hedge Fund Manager During the Investor Due Diligence Process

    On January 17, 2012, Judge Carol E. Jackson of the U.S. District Court, Eastern District of Missouri granted the SEC’s request for emergency injunctive relief (including an asset freeze and appointment of a receiver) against Burton Douglas Morriss as well as several investment management companies and private equity funds operated by Morriss in response to the SEC’s complaint alleging that Morriss misappropriated more than $9 million in investor assets from 2005 through 2011.  See generally “Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  This article describes the SEC action brought against Morriss and the investment management companies and private equity funds he operated.  The article also provides several recommendations to assist hedge fund investors in identifying and understanding asset transfers between a hedge fund manager and its hedge funds.  See also “Ten Steps That Hedge Fund Managers Can Take to Avoid Improper Transfers among Funds and Accounts,” The Hedge Fund Law Report, Vol. 4, No. 13 (Apr. 21, 2011).

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Legal and Operational Due Diligence Best Practices for Hedge Fund Investors

    In the wake of the financial crisis in late 2008, many investors were left trapped in suspended, gated or otherwise illiquid hedge funds.  Unfortunately, for many investors who had historically taken a passive role with respect to their hedge fund investments, it took a painful lesson to learn that control over fundamental fund decisions was in the hands of hedge fund managers.  Decisions such as the power to suspend or side pocket holdings were vested in managers either directly or through their influence over the board of directors of the fund.  In these situations, which were not uncommon, leaving control in the hands of the manager rather than a more independent board gave rise to a conflict of interest.  Managers were in some cases perceived to be acting in their own self-interest at the expense, literally and figuratively, of the fund and, consequently, the investors.  The lessons from the financial crisis of 2008 reinforced the view that successful hedge fund investing requires investors to approach the manager selection process with a number of considerations in mind, including investment, risk, operational and legal considerations.  Ideally, a hedge fund investment opportunity will be structured to sufficiently protect the investor’s rights (i.e., appropriate controls and safeguards) while providing an operating environment designed to maximize investment returns.  Striking such a balance can be challenging, but as many investors learned during the financial crisis, it is a critical element of any successful hedge fund program.  The focus on hedge fund governance issues has intensified in the wake of the financial crisis, with buzz words such as “managed accounts,” “independent directors,” “tri-party custody solutions” and “transparency” now dominating the discourse.  Indeed, investor efforts to improve corporate governance and control have resulted in an altering of the old “take it or leave it” type of hedge fund documents, which have become more accommodative towards investors.  In short, in recent years investors have become more likely to negotiate with managers, and such negotiations have been more successful on average.  In a guest article, Charles Nightingale, a Legal and Regulatory Counsel for Pacific Alternative Asset Management Company, LLC (PAAMCO), and Marc Towers, a Director in PAAMCO’s Investment Operations Group, identify nine areas on which institutional investors should focus in the course of due diligence.  Within each area, Nightingale and Towers drill down on specific issues that hedge fund investors should address, questions that investors should ask and red flags of which investors should be aware.  The article is based not in theory, but in the authors’ on-the-ground experience conducting legal and operational due diligence on a wide range of hedge fund managers – across strategies, geographies and AUM sizes.  From this deep experience, the authors have extracted a series of best practices, and those practices are conveyed in this article.  One of the main themes of the article is that due diligence in the hedge fund arena is an interdisciplinary undertaking, incorporating law, regulation, operations, tax, accounting, structuring, finance and other disciplines, as well as – less tangibly – experience, judgment and a good sense of what motivates people.  Another of the themes of the article is that due diligence is a continuous process – it starts well before an investment and often lasts beyond a redemption.  This article, in short, highlights the due diligence considerations that matter to decision-makers at one of the most sophisticated allocators of capital to hedge funds.  For managers looking to raise capital or investors looking to deploy capital intelligently, the analysis in this article merits serious consideration.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Recent SEC Enforcement Action Demonstrates the SEC’s Focus on the Accuracy and Consistency of Disclosures by Hedge Fund Managers in Form ADV

    The SEC initiated a record number of enforcement actions in fiscal year 2011.  Among other things, the SEC has focused more attention on ferreting out false and misleading statements made by investment advisers in communications with investors and regulators.  As recently as November 2011, Robert Khuzami, Director of the SEC’s Division of Enforcement, explained that the SEC is specifically targeting investment advisers that it suspects may have filed Forms ADV containing false or misleading statements.  This article describes a recent SEC action indicating that the agency will bring enforcement actions based on allegations of inaccuracies in Form ADV.  This article also makes recommendations that hedge fund managers can implement to avoid Form ADV-related violations.  For a discussion of another current SEC enforcement initiative, see “Hedge Fund Managers with Unexplained Aberrational Performance Are More Likely to Become Targets of SEC Enforcement Actions,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence

    Ernst & Young (E&Y) recently released the 2011 edition of its annual hedge fund survey entitled, “Coming of Age: Global Hedge Fund Survey 2011” (Report).  The Report conveys and compares the views of hedge fund managers and investors on topics including succession, independent board oversight, use of administrators, expense pass-throughs and due diligence.  This article summarizes the more salient findings from the Report.  One of the Report’s many interesting insights is that managers frequently receive little in the way of feedback when a potential investor declines an investment.  The Report partially fills this “feedback gap” by offering generalized insight on what matters most to investors.  For example, managers may be surprised to learn that the absence of a robust and reliable succession plan may have played as much or more of a role in a lost investment as performance or even operational issues.  (The HFLR will be covering succession planning for hedge fund managers in an upcoming issue.)  More generally, the depth of the disparity in perception between managers and investors on a range of topics, as found by the Report, is at times startling.  The Report therefore offers a sobering reality check for both managers and investors.  Both sides need one another, albeit for different reasons, and the lifecycle of an investment can be significantly more productive if expectations and assumptions are better aligned.

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  • From Vol. 4 No.43 (Dec. 1, 2011)

    Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation

    Changing investor expectations and heightened regulation of hedge fund marketing has ushered in a new era for hedge fund managers seeking to raise capital.  Hedge fund managers must continuously keep abreast of the issues that will impact their ability to effectively raise capital, particularly from institutional investors.  Additionally, recent regulatory developments have created new challenges for fund managers that use third party marketers to assist in raising capital.  This “New Normal” was the backdrop of the 2011 annual conference of the Third Party Marketers Association (3PM) in Boston on October 26 and 27, 2011.  This article focuses on the most important points for hedge fund managers that were discussed during the conference.  The article begins with a discussion of how fund managers can enhance their marketing efforts to raise more capital by understanding various aspects of the capital raising cycle, including the changing request for proposal (RFP) process, product positioning, the investor due diligence process and the manager selection process.  The article then moves to a discussion of the regulatory challenges facing hedge fund managers using third party marketers, including a discussion of third party marketer due diligence of fund managers and appropriate compensation arrangements for third party marketers in light of lobbying law changes and pay to play regulations.  The final section discusses impending and existing rules that will have a significant impact on hedge fund marketing.

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  • From Vol. 4 No.42 (Nov. 23, 2011)

    Private Lawsuits Against Hedge Fund Managers Can Be Important Sources of Examination and Enforcement “Leads” for the SEC

    On November 10, 2011, the Securities and Exchange Commission (SEC) announced the simultaneous filing and settling of charges against investment adviser Lilaboc, LLC d/b/a ThinkStrategy Capital Management, LLC (ThinkStrategy) and its founder and managing director, Chetan Kapur (Kapur, and together with ThinkStrategy, Defendants).  The SEC’s Complaint in the action (Complaint) alleges that over nearly seven years the Defendants made false statements to investors in ThinkStrategy Capital Fund (Capital), a hedge fund managed by the Defendants, and TS Multi-Strategy Fund (Multi-Strategy, and together with Capital, Funds), a fund of funds managed by the Defendants.  Those allegedly false statements related to the Funds’ performance, longevity and assets under management (AUM), as well as the credentials of Kapur and his management team.  Moreover, with respect to Multi-Strategy, the Complaint alleges that the Defendants failed to perform due diligence commensurate with their representations to investors before investing with underlying managers.  As a result of such inadequate due diligence, Multi-Strategy invested in notorious Ponzi schemes such as Bayou, Valhalla/Victory Funds and Finvest Primer Fund.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  Allegations in the SEC action incorporate and expand upon allegations in a private civil action recently filed against the Defendants, and – as discussed more fully in this article – highlight the interaction between private claims and SEC enforcement actions.  See “Federal Court Decision Holds that a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).

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  • From Vol. 4 No.41 (Nov. 17, 2011)

    SEC Commences Fraud Action against a Purported Hedge Fund Manager for Providing False Background Information and Including False Information on a Website

    On October 26, 2011, the Securities and Exchange Commission (SEC) filed suit against Andrey Hicks and the hedge fund manager he ran, Locust Offshore Management, LLC (LOM), alleging that they defrauded investors by fabricating the existence of a British Virgin Islands-incorporated pooled investment fund.  The SEC’s complaint (Complaint) also names the purported fund, Locust Offshore Fund, Ltd. (LOF), as a relief defendant.  The Complaint, among other things, sheds new light on an old due diligence verity – the imperative of thorough background checks.  See “In Conducting Background Checks of Hedge Fund Managers, What Specific Categories of Information Should Investors Check, and How Frequently Should Checks be Performed?,” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009).

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  • From Vol. 4 No.40 (Nov. 10, 2011)

    Principals of Paron Capital Management Sue Rothstein Kass for Negligence, Fraud and Breach of Contract Based on Alleged Failure to Obtain Third-Party Verification of Performance Results

    Plaintiffs Peter McConnon (McConnon) and Timothy Lyons (Lyons) are the current principals of plaintiff investment manager Paron Capital Management, LLC (Paron).  In April 2010, McConnon and Lyons were introduced to James Crombie (Crombie), who claimed to have run a successful commodity futures trading business and desired to form a new trading business with McConnon and Lyons.  McConnon and Lyons claim that Paron retained defendant accounting firm Rothstein, Kass & Company, LLP (Rothstein Kass) to verify Crombie’s claimed returns.  In particular, they asked Rothstein Kass to obtain third-party confirmation of data provided by Crombie.  According to the complaint, Rothstein Kass never did so.  It turned out that the historical performance data supplied by Crombie was a complete fabrication.  That false data formed the basis of Paron’s marketing materials.  Following investigations and enforcement actions by the National Futures Association and the U.S. Commodity Futures Trading Commission, Paron and Crombie were banned from futures trading and Paron’s business collapsed.  The plaintiffs seek damages from Rothstein Kass for negligence, fraud and breach of contract.  We detail the plaintiffs’ allegations and the allegations and findings in the enforcement actions.  Rothstein Kass told The Hedge Fund Law Report with respect to this matter: “We have no comment on these meritless claims.”

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  • From Vol. 4 No.39 (Nov. 3, 2011)

    Anti-Bribery Compliance for Private Fund Managers

    Managing the risks inherent in dealing with foreign officials should be a top priority for managers of hedge funds and private equity funds.  This is especially true in the current climate of expansive government interpretations of anti-bribery laws, new incentives for whistleblowers and the recent government scrutiny of the inner workings of fund managers.  It has become standard fare for fund managers to have regular interactions with foreign officials or their representatives in the ordinary course of raising capital and making investments.  There is nothing inherently wrong with such interactions.  Still, those dealings need to be informed by a heightened sensitivity to the possible appearance that something of value was given to a foreign official in connection with a particular investment or transaction.  The risk is that, regardless of the intent of the fund manager, certain conduct may be viewed in hindsight as an effort to improperly influence the actions of a foreign official.  As a result, a fund manager needs to focus on more than just the substance of the transaction and needs to consider both how the transaction might be perceived and the record that is being created.  As cross-border investments continue apace, fund managers can protect themselves by having adequate policies and procedures in place to identify potential bribery risks and to prevent violations from occurring.  Aggressive enforcement of the Foreign Corrupt Practices Act (FCPA) by U.S. authorities and the comprehensive overhaul of anti-corruption laws in the U.K., culminating in the new Bribery Act 2010 (Bribery Act), highlight the importance of implementing effective anti-corruption compliance policies and procedures.  In these circumstances, fund managers must do more than assure themselves that they are not acting with a corrupt intent; they also need to be alert to the risk of misunderstandings and to be diligent in creating a record of compliance.  In a guest article, Paul A. Leder and Sarah P. Swanz, partner and counsel, respectively, in the Washington D.C. office of Richards Kibbe & Orbe LLP, outline steps to take to identify and manage the compliance risks faced by fund managers both directly (through their own dealings with foreign officials) and indirectly (through investments in operating companies that operate overseas).  Specifically, Leder and Swanz identify conduct at the fund manager level that can put the manager at risk; discuss the importance of strong internal controls and compliance programs to mitigate corruption risks; and highlight categories of conduct at the portfolio company level that can put the manager at risk.  The authors then make specific suggestions for identifying potential bribery risks and managing such risks.  They conclude with a case study of a criminal prosecution that demonstrates the potential exposure for managers when making foreign investments.

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  • From Vol. 4 No.36 (Oct. 13, 2011)

    The Implications of UCITS IV Requirements for Asset Management Functions

    Undertakings for Collective Investment in Transferable Securities (UCITS) IV raised much industry debate prior to its introduction on July 1, 2011 across a number of areas.  Now, with the opportunity to begin assessing its implications in practice, it is likely that this debate will continue.  One area that is receiving increasing focus is the MiFID-esque conduct of business rules imposed on UCITS management companies (and self-managed UCITS) under the UCITS IV Management Company Directive.  In almost all cases at present, UCITS management companies (and self-managed UCITS) fully outsource the asset management function to one or more investment management firms.  These firms are now finding themselves directly subject to UCITS IV conduct of business rules.  So just how much will UCITS IV impact how investment managers manage UCITS?  In this article, Stephen Carty, a partner in the Dublin office of international law firm Maples and Calder, considers the new and enhanced policies and procedures that will be required as well as considering some of the practical implications.  In particular, Carty discusses: UCITS IV rules with respect to best execution, order handling and aggregation, due diligence and voting rights policies; the general absence of carve outs in UCITS IV; the lack of account in UCITS IV for the delegation model typical in the investment management field; and the differences in four important areas between UCITS IV and the MiFID regime.

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  • From Vol. 4 No.36 (Oct. 13, 2011)

    What Should Hedge Fund Investors Be Looking For in the Course of Operational Due Diligence and How Can They Find It?

    As previously reported in The Hedge Fund Law Report, on September 13, 2011, ALM Events hosted its fifth annual Hedge Fund General Counsel Summit at the Harvard Club in New York City.  See “Fifth Annual Hedge Fund General Counsel Summit Covers Insider Trading, Expert Networks, Whistleblowers, Exit Interviews, Due Diligence, Examinations, Pay to Play and More,” The Hedge Fund Law Report, Vol. 4, No. 33 (Sep. 22, 2011).  One of the panels at that Summit dealt with operational due diligence, an increasingly important topic in the hedge fund world.  See “Six Principles of Operational Due Diligence,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  One of the participants on the due diligence panel was William Woolverton, Senior Managing Director and General Counsel at fund of funds manager Gottex Fund Management.  We reported on some of Woolverton’s insights in our article on the Summit.  Following the Summit, we had the privilege of digging deeper into Woolverton’s thinking on operational due diligence in the form of an interview.  Gottex is a major investor in underlying hedge funds, and Woolverton participates materially in the operational due diligence process.  He speaks, accordingly, with the authority of experience, and his insights are relevant to investors honing their approach to due diligence, managers refining their responses to due diligence and others concerned with the hedge fund due diligence process.  This issue of The Hedge Fund Law Report contains the full transcript of our interview with Woolverton, which covered the following topics, among others: the specific non-investment aspects of the hedge fund business covered by operational due diligence; how managers can maintain the consistency of answers across people and documents; how managers can address requests for proprietary or confidential information; whether a manager should disclose an important disciplinary event, even if an investor does not ask about it; what investors can get from on-site visits that they cannot get remotely; whether integration clauses in fund documents have any value in light of the apparent ability of investors to sue based on oral representations by managers; the interaction among side letters, disclosure and certain regulatory developments; and what specific items investors should be looking for in background checks of managers.

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  • From Vol. 4 No.34 (Sep. 29, 2011)

    Practical Considerations for Compliance by Hedge Fund Managers with the FCPA When Evaluating and Engaging Foreign Advisors in Connection with Foreign Bankruptcy Investments

    In many emerging and opening markets, the level of apparent regulation can sometimes provide a false patina of order.  In practice, local laws and regulations are often a byzantine maze of stamps, taxes, rules, forms and other bureaucratic processes that present enormous hurdles to investing and operating in such markets.  Investments in distressed assets present special risks because nearly every stage of the investment involves interactions with foreign government officials of one stripe or another, from members of the local judiciary, to financial and securities regulators, to central government banks.  In such an environment, it is understandable that hedge fund managers turn to a variety of advisors and agents for guidance and assistance in navigating the local landscape.  However, the use of third party agents and intermediaries in foreign investments presents distinct risks under the U.S. Foreign Corrupt Practices Act (“FCPA”), which prohibits the payment of bribes to foreign government officials to obtain or retain business or a business advantage.  In particular, as U.S. hedge fund managers look to execute investment strategies in emerging markets, they must be aware of (and act in accordance with) the FCPA.  Not only does the law criminalize corrupt payments made directly to an official, it also prohibits the use of a third party agent or intermediary (regardless of the nationality or location of the agent or intermediary) to “knowingly” make such prohibited payments on behalf of a principal.  As a result, hedge funds that rely on third-party agents to assist and guide investments in foreign insolvency proceedings face a legal risk if such agents engage in corrupt activities in order to advance the business or investment interests of the fund.  In a guest article, Matthew T. Reinhard, a Member of Miller & Chevalier, Chartered, first provides a brief overview of the FCPA and how it relates to the use of third parties.  Next, Reinhard discusses practical steps hedge fund managers can take to vet their agents and protect themselves, their funds and their investors from engaging unscrupulous agents.  Finally, Reinhard discusses specific provisions hedge fund managers should include in their agreements with third parties and other steps that can be taken to guard against liability for corrupt acts by such agents.

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  • From Vol. 4 No.34 (Sep. 29, 2011)

    Six Principles of Operational Due Diligence

    Hedge funds have progressively moved into the mainstream of institutional investing.  While even ten years ago, hedge funds were still largely the “secret club of the super rich,” sophisticated investors such as pension funds, sovereign wealth funds and large endowments now embrace the absolute return and diversification benefits available from hedge funds.  Retail investors are also exposed to hedge funds as never before: many corporate pension schemes have added hedge fund exposure, and more generally, the movements of both stock and bond markets are now heavily influenced by hedge fund investment decisions and capital flows.  Since the 2008 market crisis – thanks in part to Bernie Madoff, Lehman and numerous funds gating and suspending redemptions – operational due diligence has become much more significant to the hedge fund selection process.  See “What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?,” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011).  While performance and strategy remain central to every decision to allocate to a fund, investors large and small must also ensure that they have selected a manager with sufficient controls and infrastructure to safeguard assets.  In a guest article, Christopher J. Addy, President and CEO of Entreprise Castle Hall Alternatives Inc., focuses on several more qualitative aspects of the hedge fund due diligence process, highlighting six principles which can guide the development of an effective due diligence function.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Fifth Annual Hedge Fund General Counsel Summit Covers Insider Trading, Expert Networks, Whistleblowers, Exit Interviews, Due Diligence, Examinations, Pay to Play and More

    On September 13, 2011, ALM Events hosted its fifth annual Hedge Fund General Counsel Summit at the Harvard Club in New York City.  Participants at the event discussed how the changing regulatory landscape is impacting the day-to-day policies, procedures and practices of hedge fund managers.  Of particular note, discussions focused on insider trading in the post-Galleon world; best compliance practices for engaging and using expert network firms; how to motivate employees to report wrongdoing internally rather than filing whistleblower complaints; the interaction between non-disparagement clauses in hedge fund manager exit agreements and the whistleblower rule; best practices for exit interviews; best practices for responding to initial and ongoing due diligence inquiries; consistency across DDQs and other documents; standardization of DDQs versus customized answers; whether to disclose the existence or outcome of regulatory actions; how to deal with government investigations and examinations; and strategies for complying with the pay to play rule.  This article summarizes the most noteworthy points made at the event.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Primary Legal and Practical Considerations for Hedge Fund Managers Looking to Outsource Their Operational Functions

    In September 2011, financial report publisher ClearPath Analysis released a report entitled “Fund Outsourcing: Assessing the Critical Issues and Considerations When Outsourcing Operational Functions as a Fund Manager” (Report).  The Report is a compilation of interviews, roundtables and white papers designed to guide fund managers through the outsourcing process.  This article summarizes the most important topics discussed in the Report including: (1) whether or not to outsource at all; (2) how to select a service provider (including how to think about track record, portfolio of clients and size); (3) the relevant legal and regulatory frameworks, including considerations under the AIFMD; and (4) how to properly manage and monitor the service provider.  For a further discussion of best practices related to outsourcing, see “BNY Mellon’s Pershing Unit Releases White Paper Detailing Best Practices for Hedge Fund Outsourcing Solutions,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    An Investment Adviser May Not Call Itself Independent If It Receives Fees from Underlying Managers

    The SEC recently commenced administrative proceedings against an investment adviser that allegedly received undisclosed fees for channeling over $80 million into SJK Investment Management, LLC (SJK).  As previously reported in The Hedge Fund Law Report, on January 6, 2011, the SEC filed an emergency civil injunctive action charging SJK and its principal, Stanley Kowalewski, with securities fraud, and obtained a temporary restraining order and asset freeze against SJK and Kowalewski.  See “Thirteen Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Fund of Funds Manager Alleging Misuse of Fund Assets,” The Hedge Fund Law Report, Vol. 4, No. 3 (Jan. 21, 2011).  The order in this administrative proceeding (Order) is interesting to hedge fund and hedge fund of funds managers primarily in helping clarify the circumstances in which managers may and may not claim to be “independent.”  The facts alleged by the SEC are rather egregious, and thus the Order itself does not make noteworthy new law.  However, the Order does raise close and interesting questions regarding the language of representations that hedge fund of fund managers and other investment advisers may make to investors with respect to independence; the channels through which such representations are made (including websites); how to approach disclosure with respect to conflicts and independence in Form ADV; and how to move client assets from one investment manager to another without breaching fiduciary duties or running afoul of the antifraud provisions of the federal securities laws.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?

    Generally, two categories of hedge fund managers will be required to register with the SEC as investment advisers by March 30, 2012: (1) managers with assets under management (AUM) in the U.S. of at least $150 million that manage solely private funds; and (2) managers with AUM in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle, such as a managed account.  See “Will Hedge Fund Managers That Do Not Have To Register with the SEC until March 30, 2012 Nonetheless Have To Register in New York, Connecticut, California or Other States by July 21, 2011?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Registration will trigger a range of new obligations.  For example, registered hedge fund managers that do not already have a chief compliance officer (CCO) will have to hire one.  See “To Whom Should the Chief Compliance Officer of a Hedge Fund Manager Report?,” The Hedge Fund Law Report, Vol. 4, No. 22 (Jul. 1, 2011).  Also, registered hedge fund managers will have to complete, file and deliver, as appropriate, Form ADV.  See “Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).  But perhaps the most onerous new obligation for newly registered hedge fund managers will be the duty to prepare for, manage and survive SEC examinations.  Most hedge fund managers facing a registration requirement for the first time have hired high-caliber people and completed complex forms.  Therefore, hiring a CCO and completing Form ADV will exercise existing skill sets.  But few such managers have experienced anything like an SEC examination.  On the contrary, many such managers have spent years behind a veil of permissible secrecy, disclosing little, rarely disseminating information beyond top employees and large investors and interacting with the government only indirectly.  Examinations will change all that.  The government will show up at your office, often with little or no notice; they will ask to review substantially everything; and a culture of transparency will have to replace a culture of secrecy, where the latter sorts of cultures still exist.  (The SEC does not appreciate secrecy and has any number of ways of demonstrating its lack of appreciation.)  Hedge fund managers facing the new examination reality will have to think about two sets of issues.  The first set of issues relates to examination preparedness, and The Hedge Fund Law Report has written in depth on this topic.  See, e.g., “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011).  The second set of issues relates to examination management and survival, and that is the broad topic of this article.  Specifically, this article addresses a question that hedge fund managers inevitably face in connection with examinations: What should we tell investors and when and how?  To help hedge fund managers identify the relevant subquestions, think through the relevant issues and hopefully plan a disclosure strategy in advance of the commencement of an examination, this article discusses: the three types of SEC examinations and similar events that may trigger a disclosure examination; the five primary sources of a hedge fund manager’s potential disclosure obligation; whether and in what circumstances hedge fund managers must disclose the existence or outcome of the three types of SEC examinations; rules and expectations regarding responses to due diligence inquiries; selective and asymmetric disclosure issues; how hedge fund managers may reconcile the privileged information rights often granted to large investors in side letters with the fiduciary duty to make uniform disclosure to all investors; whether hedge fund managers must disclose deficiency letters in response to inquiries from current or potential investors, and whether such disclosure must be made even absent investor inquiries; whether managers that elect to disclose deficiency letters should disclose the letters themselves or only their contents; best practices with respect to the mechanics of disclosure (including how and when to use telephone and e-mail communications in this context); and whether deficiency letters may be obtained via a Freedom of Information Act request.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    Nine Due Diligence Lessons Arising Out of the SEC’s Recent Enforcement Action Against the Manager of a Purported Quantitative Hedge Fund

    On August 10, 2011, the SEC filed a complaint (Complaint) against a hedge fund management company and its principal, generally alleging that the defendants solicited a $1 million investment based on five categories of misrepresentations.  The management company purported to manage a hedge fund with a quantitative investment strategy, and the investment came from an individual bond fund portfolio manager at a prominent New York hedge fund management company.  The misrepresentations in this matter highlight a number of pitfalls that hedge fund investors should avoid.  More generally, the matter highlights a number of due diligence points for investors to add to their DDQs – if the points are not there already.  This article describes the factual and legal allegations in the Complaint, then discusses the nine key lessons from the Complaint.

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  • From Vol. 4 No.29 (Aug. 25, 2011)

    How Should Hedge Fund Managers Account for Organizational Expenses and Fund Loans, and What Role Should Such Accounting and Manager Solvency Play in Operational Due Diligence?

    A recent federal court judgment against the manager of hedge funds purporting to follow a socially responsible investment strategy yields a number of important lessons for hedge fund investors when conducting due diligence.  Among other things, the judgment highlights the relevance of the financial condition of the manager and its principals; how managers should account for organizational expenses; how managers should account for fund loans, if they are used at all; and the perils of guaranteed returns.  See “Twelve Operational Due Diligence Lessons from the SEC’s Recent Action against the Manager of a Commodities-Focused Hedge Fund,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).

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  • From Vol. 4 No.27 (Aug. 12, 2011)

    Federal Court Decision Holds That a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally

    A recent federal district court order (Order) described the range of legal claims available to an investor in a hedge fund of funds for alleged inconsistencies between the fund of funds manager’s representations and actions regarding due diligence and monitoring.  Read narrowly, the Order may merely stand for the proposition that a fund of funds manager may not promise to undertake specific actions in the course of due diligence and monitoring, accept investor money based on those representations then fail to take those actions.  Read more broadly, the Order may foreshadow a heightening of the legal standard to which hedge fund of funds managers are held when conducting due diligence and monitoring.  That is, the Order may presage a decision on the merits to the effect that fund of funds managers have a legal duty more or less consonant with industry best practices regarding due diligence.  That would constitute a significant increase in the level of legal obligations applicable to fund of funds managers, but would not enhance the commercial standard of care, which already demands best practices.

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  • From Vol. 4 No.26 (Aug. 4, 2011)

    SEC Wins Summary Judgment in Its Fraud Suit Against Investment Adviser Locke Capital and Its Principal, Leila C. Jenkins, Who Fabricated a Non-Existent “Massive Swiss Banking Client” to Attract Investors

    Defendant Leila C. Jenkins (Jenkins) was the founder and sole owner of investment adviser Locke Capital Management, Inc. (Locke).  In 2009, the Securities and Exchange Commission (SEC) brought a civil enforcement action against Locke and Jenkins, alleging that they had fabricated a “massive Swiss banking client” to trick potential investors into believing that they had more than a billion dollars under management, when in fact they did not.  The initial misstatement of assets under management by the defendants, along with Jenkins’ clumsy efforts to conceal the deception, supported fraud and other charges under the Securities Act of 1933, the Securities and Exchange Act of 1934 and the Investment Advisers Act of 1940.  The U.S. District Court for the District of Rhode Island granted the SEC’s motion for summary judgment on all charges, directed the defendants to disgorge profits, imposed penalties and enjoined them from future securities laws violations.  This article summarizes the decision, which has important implications for hedge fund operational due diligence.

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  • From Vol. 4 No.25 (Jul. 27, 2011)

    Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices

    The United States District Court for the Southern District of New York recently issued judgments in favor of three bankrupt hedge funds in fraudulent conveyance actions against investors that redeemed within two years of the funds’ bankruptcy filings.  The hedge funds were members of the Bayou group of hedge funds, which – as the hedge fund industry knows well – was a fraud that collapsed in August 2005, resulting in bankruptcy filings by the Bayou funds and related entities in May 2006.  These judgments are very important for hedge fund investors because they illustrate what appears to be a direct conflict between bankruptcy law and hedge fund due diligence best practices.  In short, hedge fund due diligence best practices currently counsel in favor of redemption at the first whiff of fraud on the part of a manager.  However, bankruptcy law appears to require a hedge fund investor to undertake a “diligent investigation” when it obtains facts that put it on inquiry notice of insolvency of the fund or a fraudulent purpose on the part of the manager.  The immediacy of a prompt redemption is directly at odds with the delay inherent in a diligent investigation.  How can hedge fund investors reconcile the practical goal of prompt self-help with the legal obligation of a diligent investigation?  To help answer that question, this feature length article surveys the factual and procedural history of the Bayou matters, then analyzes the arguments and outcome in the recent Bayou trial.  The primary question at the trial was whether certain investors that redeemed from the Bayou funds could keep their redemption proceeds based on “good faith” defenses to the Bayou estate’s fraudulent conveyance actions.  In the absence of a court opinion, The Hedge Fund Law Report analyzed the 142-page transcript of the closing arguments, as well as the motion papers filed by the parties and four prior bankruptcy court and district court opinions.  This article embodies the results of our analysis.  The article concludes by identifying five ways in which hedge fund investors may reconcile hedge fund due diligence best practices with the seemingly draconian outcome in these recent Bayou judgments.

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  • From Vol. 4 No.25 (Jul. 27, 2011)

    Fourteen Due Diligence Lessons to Be Derived from the SEC’s Recent Action against a Serial Practitioner of Hedge Fund Fraud

    On July 13, 2011, the SEC issued an Order making findings and imposing remedial sanctions against an individual hedge fund manager.  The Order describes a career involving modest and infrequent investment successes, and predominantly characterized by repeated, serial and egregious frauds.  The diversity and audacity of the frauds make for lurid reading, but the relevance of the Order for The Hedge Fund Law Report and our subscribers resides in the due diligence lessons to be derived from the factual findings.  This article details the factual findings in the Order, then extracts 14 distinct due diligence lessons from those facts.  Many of our institutional investor subscribers will read the factual findings and say, “This could never happen to me.”  And they may be right.  But we never cease to be amazed by the level of sophistication of investors caught up in even the most crude and simple frauds.  Perhaps this is because our industry is based on trust, and despite the salience of fraud, fraud remains (fortunately) the exception to the wider rule of ethical conduct.  Perhaps it is because frauds that look simple in retrospect were difficult to discover in the moment.  Regardless of the reason, hedge fund investors of all stripes and sizes can benefit from ongoing refinement of their due diligence practices.  And we continue to believe that the best way to refine due diligence practices is to look at what went wrong in actual cases and to revise your list of questions and techniques accordingly.  Here is a useful test for hedge fund investors: read the facts of this matter, as described in this article, then pause to ask yourself: Would our current due diligence practices have discovered all of these facts and caused us to pass on this investment or to redeem?  If the answer is yes, you can stop reading.  But if the answer is no – that is, if your due diligence practices may have missed any aspect of this fraud – we strongly encourage you to read and incorporate our fourteen lessons.  We would also note that we have undertaken similar exercises with respect to prior SEC actions.  That is, we have reviewed allegations of hedge fund manager fraud and detailed the due diligence steps that may have uncovered such frauds.  All of our thinking on this topic is available in the “Due Diligence” section of our Archive.

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  • From Vol. 4 No.22 (Jul. 1, 2011)

    What Hedge Fund Managers Need to Know About Information and Data Security

    While hedge fund executives are experts at identifying and managing the risks relating to their financial assets and portfolios, they generally do not have the time or expertise to focus on the security of their people and intellectual property assets.  However, all organizations – especially financial institutions – must be prepared for the inherent risks and responsibilities associated with doing business in an online world through a sound digital risk management strategy.  The appropriate approach to digital risk management varies from firm to firm based on unique business models and requirements.  However, all hedge fund managers should take a risk-based approach to security and ensure that the approach is aligned with the way executives manage other business issues.  While physical security and information security present different challenges, they are strongly related, are part of internal controls and should be managed using an integrated strategy.  In a guest article, Edward Stroz, Co-President of Stroz Friedberg, a digital risk management and investigations firm, and Steven Garfinkel, Vice President of Stroz Friedberg’s Business Intelligence & Investigations Division – and both former FBI Special Agents – outline the most critical aspects involved in implementing a digital risk management program for hedge fund managers.

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  • From Vol. 4 No.21 (Jun. 23, 2011)

    Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies

    The negative publicity surrounding Chinese companies listed in the United States seemingly has reached a fevered pitch.  In April 2011, the Securities and Exchange Commission, or SEC, acknowledged that it had established a task force to address what it deemed to be abuses by Chinese companies accessing the U.S. markets through the use of reverse merger transactions.  SEC Commissioner Luis Aguilar referred to the proliferation of these companies as a “disturbing trend that seems to have challenging implications for capital formation and investor protection.”  In addition to the SEC, the U.S. national stock exchanges have been taking more aggressive actions against Chinese companies.  During 2011, almost two dozen Chinese companies have seen trading in their securities halted or have been delisted in large part due to accounting irregularities.  Against this backdrop, it has become increasingly difficult for investors in this space to separate the undervalued from the fraudulent.  In a guest article, Cavas S. Pavri, a Member in the Business Law Department of Cozen O’Connor, discusses areas that hedge fund managers should focus on in performing their due diligence on investments in Chinese companies.  Specifically, Pavri discusses, among other things: relevant PCAOB guidance; specific factors to consider in evaluating a Chinese company’s accounting firm; specific factors to consider in assessing a Chinese company’s chief financial officer and accounting staff; what to look for when evaluating the corporate governance of a Chinese company; considerations in connection with “variable interest entity” structures; local financial reporting; SAFE registration; the importance of a prior underwritten offering; and insurance considerations.

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  • From Vol. 4 No.19 (Jun. 8, 2011)

    Alternative Investment Management Association Publishes Institutional Investor Guide Covering Hedge Fund Governance, Risk, Liquidity, Performance Reporting, Investor Relations, Marketing, Operations, Valuation, Due Diligence and Other Topics

    On May 31, 2011, the Alternative Investment Management Association (AIMA), published a guide aimed at communicating institutional investors’ views, expectations and preferences to the hedge fund industry.  As described by AIMA Chairman Todd Groome, the guide was published “[i]n light of the ongoing ‘institutionalisation’ of the hedge fund industry and the growth of institutional investor participation.”  The authors of the guide, members of the AIMA Investor Steering Committee, and “some of the most influential investors and advisors in the industry,” include Luke Dixon of Universities Superannuation Scheme, Andrea Gentilini of Union Bancaire Privée, Kurt Silberstein of the California Public Employees Retirement Scheme, Michelle McGregor-Smith of British Airways Pension Investment Management and Adrian Sales of Albourne.  See “CalPERS ‘Special Review’ Includes Details of Misconduct and Recommendations That May Fundamentally Alter the Hedge Fund Placement Agent Business,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).  The guide covers a range of increasingly relevant operational and organizational issues that institutional investors consider in their due diligence reviews, including: hedge fund governance, constitutional documents, the role of the board of directors, performance reporting practices and transparency, counterparty risk, operations, fund liquidity, risk controls, ownership of the management company, sales and marketing, valuation, business continuity planning, compliance, service provider relationships and more.  This article offers a comprehensive discussion of the key principles, ideas and recommendations presented in the guide.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    Is a Hedge Fund Manager Required to Disclose the Existence or Substance of SEC Examination Deficiency Letters to Investors or Potential Investors?

    Following an examination of a registered hedge fund manager by the SEC staff, the staff typically issues a deficiency letter to the manager listing compliance shortcomings identified by the staff during the examination.  See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations?  (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011).  Quickly, comprehensively and conclusively remedying compliance shortcomings identified in a deficiency letter should be a first order of business for any hedge fund manager – that is the easy part, a point that few would dispute.  However, considerably more ambiguity surrounds the question of whether and to what extent hedge fund managers must disclose to investors and potential investors various aspects of SEC examinations – including their existence, scope, focus and outcome.  More particularly, hedge fund managers that receive deficiency letters routinely ask: must we disclose the fact of receipt of this deficiency letter or its contents to investors or potential investors?  And does the answer depend on whether potential investors have requested information about or contained in a deficiency letter in due diligence or in a request for proposal (RFP)?  The answers to these questions generally have been governed by a “materiality” standard – the same standard that, at a certain level of generality, governs all disclosure questions.  The consensus guidance has been: disclose whatever is material.  But this is more of a reframing of the question than an answer.  The practical question in this context is how to assess materiality in the interest of disclosing adequately, avoiding anti-fraud or breach of fiduciary duty claims and ensuring best investor relations practices.  A recently issued SEC order (Order) settling administrative proceedings against a registered investment adviser provides limited guidance on the foregoing questions.  This article describes the facts recited in the Order, the SEC’s legal analysis and how that analysis can inform decision-making of hedge fund managers considering whether and to what extent to disclose the existence or substance of deficiency letters to investors or potential investors.  This analysis has particular relevance for hedge fund managers seeking to grow institutional assets under management by responding to RFPs.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    How Can Hedge Fund Managers Structure the Compensation of Third-Party Marketers in Light of the Ban On “Contingent Compensation” Under New York City and California Lobbying Laws? (Part Two of Three)

    An authoritative recent interpretation of New York City’s lobbying law and recent amendments to California’s lobbyist law likely will require placement agents and other third-party hedge fund marketers, in-house hedge fund marketers and, in some cases, hedge fund managers themselves, to register as lobbyists.  Such registration will impose new obligations and prohibitions on hedge fund marketers and managers.  See “Recent Developments in New York City and California Lobbying Laws May Impact the Activities and Compensation of In-House and Third-Party Hedge Fund Marketers (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011).  Most dramatically, both California and New York City will prohibit a registered lobbyist from receiving contingent compensation, that is, compensation that is calculated by reference to the success of the lobbyist’s efforts in persuading a public pension fund to invest in a hedge fund.  Success-based compensation is the primary mechanism used to compensate and incentivize hedge fund marketers.  Accordingly, the legal change in California and the interpretive change in New York will fundamentally alter the economics of hedge fund marketing.  Or to set the stage in simpler terms: Hedge fund marketers will be required to register as lobbyists; hedge fund marketers are paid by commission; lobbying laws prohibit the payment of commissions to lobbyists; so how will hedge fund marketers be paid going forward?  This is the second article in a three-part series intended to address that question.  The first article included a comprehensive chart detailing the provisions relevant to hedge fund managers and marketers of the New York City and California lobbying laws.  This article examines how hedge fund managers can structure or restructure their arrangements with third-party hedge fund marketers in light of the ban on contingent compensation.  Specifically, this article discusses: the relevant provisions of the New York City Administrative Code and the California Code; trends in other states and municipalities; typical components, levels and structures of compensation of third-party hedge fund marketers (all of which were analyzed in depth in a prior article in the HFLR); four specific strategies that hedge fund managers can use to structure new arrangements with third-party marketers, and the benefits and burdens of each; three of the more challenging scenarios that hedge fund managers may face in restructuring existing agreements with third-party marketers, and the relevant legal considerations in each scenario; whether the New York City and California lobbying laws contain grandfathering provisions; special lobbying law considerations for funds of funds; and changes to representations, warranties, covenants and due diligence necessitated by the changes to the lobbying law.  The article concludes with a discussion of a “bigger issue” that has the potential to render the foregoing discussion largely moot.  (The third article in this series will examine related issues with respect to in-house hedge fund marketers.)

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    Twelve Operational Due Diligence Lessons from the SEC’s Recent Action against the Manager of a Commodities-Focused Hedge Fund

    On March 15, 2011, the SEC filed a complaint the U.S. District Court for the Southern District of New York against Juno Mother Earth Asset Management, LLC (Juno) and its principals, Arturo Rodriguez and Eugenio Verzili.  The complaint alleges that Juno and its principals started selling interests in the Juno Mother Earth Resources Fund, Ltd. (Resources Fund) in late 2006, and by the middle of 2008, substantially all of the Resources Fund's investors had requested redemptions.  The SEC alleges that during the short life of the Resources Fund, Rodriguez and Verzili engaged in a range of bad acts, including misappropriation of fund assets, inappropriate loans from the fund to the management company, misrepresentations of strategy and assets under management and disclosure violations.  Assuming for purposes of analysis that the allegations in the complaint are true, the complaint illuminates a variety of pitfalls for institutional investors to avoid.  This article describes the factual and legal allegations in the complaint, then details twelve important lessons to be derived from the complaint.  Similar to other articles we have published extracting due diligence lessons from SEC complaints, the intent of this article is to serve as a tool for institutional investors or their agents that can be used directly in performing due diligence, or can be used to update a due diligence questionnaire.  Our hope in publishing this article (and others of its type) is that at least one of the twelve lessons that we extract from the complaint enables an investor to identify a due diligence issue that it otherwise would have missed.  We think that there is no better way to identify future hedge fund frauds than to understand the mechanics and lessons of past frauds.

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    Survey by SEI and Greenwich Associates Identifies the Primary Decision Factors and Concerns of Institutional Investors When Investing in Hedge Funds

    A survey of 97 institutional investors and 14 investment consultants conducted by SEI Knowledge Partnership in collaboration with Greenwich Associates last October, and released earlier this year, identifies the hierarchy of considerations and concerns of institutional investors when investing in hedge funds.  One notable finding of the survey – especially for a publication, like the HFLR, focused on regulation – is the view of most institutional investors with respect to regulation.  That view is discussed in this article.  In addition, this article discusses the survey’s findings on the following topics: statistics with respect to hedge fund returns, assets under management, launches and liquidations during the last three years; plans with respect to hedge fund allocations during 2011; objectives of institutional investors when investing in hedge funds; most significant challenges in hedge fund investing; experience with and perceptions of liquidity; the 16 factors that investors consider most important when selecting among managers; four key takeaways for hedge fund managers from the survey findings; breakdown of hedge fund allocations by institutional investor type; trends with respect to fees; the role of consultants; the success rate of negotiations on liquidity terms; and trends with respect to the resources dedicated by institutional investors and consultants to hedge fund due diligence and monitoring.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks

    Hedge fund managers have responded to the ongoing expert networks investigation by revisiting their insider trading compliance policies and procedures generally, and their expert networks policies specifically.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  Institutional investors have responded by updating their due diligence questionnaires and approaches.  At a minimum, investors are asking their current or prospective managers: whether they use expert networks and if so which; what compliance policies and procedures they have in place with respect to the use of expert networks; and whether they are under investigation for insider trading in connection with expert networks.  But investor due diligence on this topic can get significantly more granular.  According to one well-regarded industry source with whom we spoke, some institutional investors, or their third-party due diligence service providers, are asking their current or prospective managers for records of trades (in hedge funds and personal accounts) in securities of companies mentioned in the primary civil and criminal expert network complaints, around the dates mentioned in those complaints.  The goals of this exercise are to uncover trading patterns that resemble the patterns described in the complaints, to discover spikes in advance of earnings releases mentioned in the complaints and to find other fund or personal trading that is suspicious in light of the allegations in the complaints.  Regulators have undertaken similar analyses of trading patterns for some time, usually with the goal of identifying evidence of insider trading or market manipulation; and those efforts have improved in speed and effectiveness as the relevant technology has improved.  But institutional investors generally have not undertaken due diligence of this sort because it has been considered too attenuated – too much of a search for a needle in a haystack.  The key difference here is that the expert networks insider trading complaints provide a roadmap to potentially problematic issuers, dates and events.  The practical problem is that those issuers, dates and events are buried in hundreds of pages of legal papers.  We at The Hedge Fund Law Report have solved this problem by: analyzing the primary civil and criminal complaints alleging the use of expert networks to facilitate insider trading in technology company shares (as distinct from the biotechnology-related matters); extracting the salient facts; and organizing them in a manner that can serve as a due diligence roadmap for institutional investors.  This article contains the results of that analysis.  This article is long – close to 20 pages – but shorter than the source documents, and a ready-made framework for hedge fund due diligence.  Specifically, this article contains: a chart listing the names of the key civil and criminal defendants, their employers and job descriptions during the relevant periods and the charges brought against them; a list of the public companies about which Primary Global Research, LLC (PGR) experts allegedly passed material nonpublic information (MNPI) to PGR clients; the language of PGR and relevant public company compliance policies; PGR revenues and revenue sources; compensation numbers of PGR experts and employees; and sources of the data and information underlying the allegations in the criminal complaints.  In addition, this article contains a detailed summary of the allegations in the primary civil and criminal complaints against various categories of defendants, including: employees or former employees of PGR; experts in PGR’s network who also worked at technology companies; and employees or principals of hedge fund management companies that were also clients of PGR.  To enhance the utility of this article, we have listed the allegations chronologically in each category and emphasized the specific types of information alleged to have been improperly communicated.  Also, for each material allegation mentioned in this article, we have included references to the specific paragraphs of the relevant complaint containing the allegation, and we have included links to the relevant complaints.  Finally, it should be emphasized that this article is intended for use not only by institutional investors, but also by hedge fund managers.  That is, just as institutional investors can use this article as a framework for performing due diligence, managers can use this article to prepare for due diligence requests that may be in the offing.  While such preparation likely would not rise to the level of an “internal investigation,” managers may consider an internal review of fund and employee trading based on the issuers, dates and events mentioned in the complaints in this article.  Just as it is preferable for a manager to uncover bad facts before the SEC does so in an examination, it is better for a manager to uncover bad facts before an investor does so in due diligence.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    Eight Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Hedge Fund Manager Alleging Misuse of Hedge Fund Assets to Make Personal Private Equity Investments

    On January 28, 2011, the SEC obtained a court order freezing the assets of Stamford, Connecticut-based, unregistered hedge fund manager Michael Kenwood Capital Management, LLC (MK Capital Management) and Francisco Illarramendi, who indirectly owns and controls MK Capital Management.  On January 14, 2011, the SEC had filed a complaint in the United States District Court for the District of Connecticut generally alleging that Illarramendi caused hedge funds managed by MK Capital Management to invest in private companies, with the shares of those private companies registered to advisory or investment entities indirectly owned and controlled by Illarramendi.  That is, the SEC essentially alleges that Illarramendi used fund assets to make personal private equity investments.  Moreover, the SEC alleges that a non-U.S. corporate pension fund was the source of approximately 90 percent of the assets in the two hedge funds involved in the matter.  The SEC’s allegations regarding misuse of fund assets shed light on the variety of things that can go wrong in a hedge fund investment, and how some of those wrong turns can be avoided.  Working from the allegations in the SEC’s complaint, we derive eight distinct due diligence lessons that investors can apply directly to their evaluation and monitoring of hedge fund managers.  This article details the eight lessons.  Before proceeding, a caveat is in order.  We have published a number of articles that analyze SEC complaints against hedge fund managers and extract due diligence lessons from the allegations in those complaints.  See “Thirteen Important Due Diligence Lessons for Hedge Fund Investors Arising Out Of the SEC’s Recent Action against a Fund of Funds Manager Alleging Misuse of Fund Assets,” The Hedge Fund Law Report, Vol. 4, No. 3 (Jan. 21, 2011); “Ten Due Diligence Questions that Might Have Helped Uncover the Fraud Described in the SEC's Recent Administrative Proceeding against Subprime Automobile Loan Hedge Fund Manager and Its Principals,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  But it is important to note that our articles of this type do not and are not intended to endorse or support SEC’s allegations or positions in the various matters.  For purposes of these articles, we do not undertake an independent investigation into the veracity of the SEC’s allegations.  Rather, we assume for analytical purposes that the SEC’s allegations are true, and we aim to be explicit about the procedural posture of covered matters.  We do not believe that this approach undermines the relevance or applicability of the due diligence lessons we describe.  Quite the contrary: we believe that our due diligence lessons are based on expressed concerns of the SEC, and thus are valid, generalizable and useful.  At best, these lessons can help our subscribers avoid investment and operational missteps.  However, in fairness to the defendants in these matters, we consider it important to emphasize that our analysis is based on allegations that remain to be proven or disproven.

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  • From Vol. 4 No.3 (Jan. 21, 2011)

    Thirteen Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Fund of Funds Manager Alleging Misuse of Fund Assets

    The SEC recently obtained an emergency asset freeze and temporary restraining order against a hedge fund of funds manager, Stanley J. Kowalewski (Kowalewski), and his management entity, SJK Investment Management LLC (SJK).  The SEC’s complaint, filed in federal district court in Atlanta, generally alleges that Kowalewski and SJK engaged in two categories of conduct in violation of federal securities laws.  First, Kowalewski and SJK allegedly used fund assets to pay management company and personal expenses.  Second, Kowalewski allegedly launched a hedge fund in which his fund of funds invested, but failed to disclose to his fund of funds investors either the existence of the underlying hedge fund or the investment by his fund of funds in it.  Neither the dollar values nor the creativity in this matter are particularly noteworthy.  The alleged fraud itself was trite, brief and straightforward.  However, a close reading of the SEC’s complaint offers a veritable treasure trove of insight into how investors in hedge funds and funds of funds can sharpen their due diligence practices.  We have extracted 13 key lessons from the matter that investors can use to revise their approach to hedge fund due diligence – or, even better, to confirm that their approach reflects current best practices.  This article details the SEC’s factual and legal allegations against Kowalewski and SJK, briefly discusses the procedural posture of the matter, then discusses in detail the 13 key lessons.

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  • From Vol. 3 No.50 (Dec. 29, 2010)

    Ten Due Diligence Questions that Might Have Helped Uncover the Fraud Described in the SEC's Recent Administrative Proceeding against Subprime Automobile Loan Hedge Fund Manager and Its Principals

    On December 21, 2010, the SEC instituted and settled administrative proceedings against a San Francisco-based hedge fund management company and its principals.  A hedge fund managed by that company purported to invest almost exclusively in subprime auto loans, but in fact wound up "investing" largely in debt owed to the fund by entities controlled by principals of the management company and other hedge funds managed by the management company.  The SEC's Order in the matter is a study in conflicts of interest, strategy drift, material misstatements and omissions in offering documents and Form ADV and improper principal trades.  Working from the alleged facts of this matter, we derive ten due diligence questions that any investor should add to its questionnaire or incorporate into in-person meetings with managers.  Importantly, these are questions that should be asked periodically, not just prior to an initial investment.

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  • From Vol. 3 No.49 (Dec. 17, 2010)

    Settlement of SEC Fraud Charges by Small San Francisco-Based Hedge Fund Manager Highlights Importance of Valuation Checks and Balances

    On December 1, 2010, the SEC instituted and simultaneously settled fraud charges against an individual hedge fund manager based in San Francisco.  (This matter is further evidence of reinvigorated enforcement efforts by the SEC's San Francisco office.  For a discussion of another matter recently initiated by that office, see "SEC Commences Civil Insider Trading Action Against Deloitte Mergers and Acquisitions Partner and Spouse Who Allegedly Tipped Off Relatives to Impending Acquisitions of Seven Public Companies," The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).)  The allegations in the SEC's Order tell a familiar story: a young manager raises, at peak, $30 million; while the Order does not specify, the money likely came from friends and family.  The manager experiences losses in a relatively conservative investment strategy.  The manager, presumably embarrassed, tells his investors that everything is fine, while trying to make up those losses by taking on slightly more risk.  But instead, the manager loses more money, and his misrepresentations to investors depart to a greater extent from the facts.  Eventually, the manager comes clean, the fund is liquidated and the manager is charged by the SEC with civil fraud.  What is noteworthy about this matter are two statements in the SEC's order.

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  • From Vol. 3 No.44 (Nov. 12, 2010)

    District Court Suggests That Prime Brokers May Have Expanded Due Diligence Obligations

    On November 8, 2010, the U.S. District Court for the Southern District of New York denied a petition by Goldman Sachs Execution & Clearing, L.P. (GSEC) to vacate a Financial Industry Regulatory Authority (FINRA) arbitration award ordering it to pay $20.58 million to the Official Unsecured Creditors' Committee of Bayou Group, LLC and others (Bayou Estate).  The court also granted a cross-petition by the Bayou Estate to confirm the award.  Importantly, the court noted that final judgment would not be entered in the case until the court issues an opinion setting forth the reasons for its ruling.  We are monitoring the docket for that opinion, and – in light of the importance of this case to the hedge fund community – will report on the opinion shortly after it is issued.  The opinion may expand the range of circumstances in which a prime broker has a legal obligation to investigate red flags suggesting potential fraud at a hedge fund customer, and to act on its findings.  See “In Petition to Vacate FINRA Arbitration Award, Goldman Seeks to Define the Scope of a Prime Broker’s Duty (If Any) to Investors in a Hedge Fund that is a Customer of the Prime Broker,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).

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  • From Vol. 3 No.41 (Oct. 22, 2010)

    Indemnification Provisions in Agreements between Hedge Fund Managers and Placement Agents: Reciprocal, But Not Necessarily Symmetrical

    In a recent article, we argued that the use of placement agents by hedge fund managers – especially smaller and start-up managers – is likely to continue and grow in the near term, for both macro and micro reasons.  At the macro level, we identified four rationales for this anticipated trend: (1) many new investments are going to larger managers; (2) many institutional investors plan to increase their hedge fund allocations in the next three to five years; (3) a noteworthy percentage of institutional investors plan to increase their allocations to new managers; and (4) manager reputation weighs heavily in the allocation decision-making of institutional investors.  And at the micro level, we suggested that the use of placement agents by hedge fund managers will continue and grow because placement agents provide a range of potentially valuable services to managers, including: marketing and sales expertise; division of labor between portfolio management and marketing; credibility; contacts and access; strategic and other services; geographic and cultural expertise; and the ability to avoid the question of whether the manager’s in-house marketing department must register with the SEC as a broker.  For a fuller discussion of each of these points, see “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010).  Another point we made in that article – and a large part of the reason why we have undertaken this article – is that while the business case for the use by hedge fund managers of placement agents is compelling, the recent regulatory attention focused on placement agent activities and hedge fund marketing more generally is unprecedented.  See, e.g., “Three Significant Legal Pitfalls for Hedge Fund Marketers, and How to Avoid Them,” The Hedge Fund Law Report, Vol. 3, No. 36 (Sep. 17, 2010); “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010); “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010); “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).  Accordingly, hedge fund managers are increasingly sensitive to the prospect that retaining placement agents can involve burdens as well as benefits.  At best, placement agents can dramatically increase assets under management, revenues and profits.  But at worst, placement agents can materially expand the range and severity of liabilities to which hedge fund managers are exposed.  At the same time, marketing and selling hedge fund interests can expose placement agents to liability.  In short, the exposure created by the relationship is reciprocal, but not necessarily symmetrical: in most cases, and as explained more fully below, placement agents have more opportunities to harm managers than vice versa.  Sophisticated hedge fund managers and placement agents recognize that their relationships may create these reciprocal, asymmetrical liabilities, and, to the extent possible, seek to allocate the burden of such liabilities ex ante, by contract.  Specifically, the indemnification provisions included in agreements between hedge fund managers and placement agents theoretically aim to allocate a particular category of liability to the party best situated to avoid it.  (Practically, they often allocate more liabilities to the party with less bargaining power.)  By allocating (in theory) liabilities to the “least cost avoider,” indemnification provisions also seek to affect behavior in a manner that mitigates the likelihood of loss.  The idea is that a party is more likely to take precautions against a loss if it is required to internalize the cost of that loss; and the party best situated to take such precautions is the party that can do so at the lowest cost. This article explores a question that frequently arises in the negotiation of agreements between hedge fund managers and placement agents: who should indemnify whom?  Or more particularly – since the answer is not so absolute – for what categories of potential liability should placement agents indemnify managers, and vice versa?  To answer that question, this article discusses: the activities of placement agents that can give rise to claims (by regulators or investors) against or can otherwise adversely affect managers; the activities of managers that can give rise to claims against or can otherwise adversely affect placement agents; how indemnification provisions in placement agent agreements are drafted to incorporate the various categories of potential liability; other mechanics of indemnification provisions (including the relevant legal standard, term, advancement of attorneys fees and clawbacks); the inevitable insufficiency of indemnification; the consequent heightened importance of due diligence and monitoring (including a discussion of ten best compliance practices and procedures for broker-dealers); and the interaction in this context among indemnification, directors and officers (D&O) insurance and errors and omissions (E&O) insurance.

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  • From Vol. 3 No.41 (Oct. 22, 2010)

    Participants at Fourth Annual Hedge Fund General Counsel Summit Outline Key Risks Facing Hedge Fund Managers and How to Address Them

    On October 4, 2010, ALM Events hosted its fourth annual Hedge Fund General Counsel Summit in New York City.  The event brought together a number of industry thought leaders who identified key areas of risk facing hedge fund managers, and offered ideas on how to address those risks.  Specifically, participants at the Summit discussed: Dodd-Frank; insider trading; implementing and maintaining ethical walls; investors’ due diligence expectations; risk management trends; preparing for an SEC examination; and developing pay to play policies and procedures.  This article summarizes some of the key ideas discussed at the Summit.

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  • From Vol. 3 No.34 (Aug. 27, 2010)

    Foundation for Accounting Education’s “2010 Hedge Funds and Alternative Investments” Conference Focuses on Taxation of Hedge Funds and Hedge Fund Managers, Structuring, Valuation, Risk Management, Due Diligence, Insurance and Regulatory Developments

    On July 29, 2010, the Foundation for Accounting Education (FAE) presented its 2010 Hedge Funds and Alternative Investments Conference in New York City.  Speakers at the one-day event focused on a range of issues impacting the hedge fund industry, including: FIN 48 (which relates to accounting for uncertain tax liabilities); ASU 2010-10 (which amends Statement of Financial Accounting Standards No. 167, which in turn requires nonpublic companies to publicly disclose their interests in variable interest entities in a similar manner to the disclosure provided by public entities); carried interest taxation developments; state and local tax developments relevant to hedge fund managers; tax implications of globalization of the hedge fund industry; special purpose vehicles; blockers; unrelated business taxable income and effectively connected income; mini-master funds; master-feeder and side-by-side structures; International Financial Reporting Standards; valuation trends; risk management; due diligence; insurance; and regulatory developments.  This article details the key points discussed during the conference.

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  • From Vol. 3 No.31 (Aug. 6, 2010)

    How Will the SEC’s New Pay to Play Rule Impact Mergers and Acquisitions of Hedge Fund Management Companies?

    Three trends are likely to increase the volume of mergers and acquisitions of hedge fund management companies – especially sales of smaller firms to larger firms and sales by banking entities of advisers to “sponsored” hedge funds.  First, various provisions of the Dodd-Frank Act (most notably, the registration provisions) are likely to increase ongoing compliance costs for hedge fund managers.  Many such costs will be fixed, and thus will adversely impact smaller hedge fund managers to a greater degree than larger ones.  Some of those smaller managers will determine that selling the advisory business is preferable to continuing to operate independently.  See “For Managers Facing Strong Headwinds, Sales of the Advisory Business Offer a Means of Preserving the Franchise While Avoiding Fund Liquidations,” The Hedge Fund Law Report, Vol. 2, No. 11 (Mar. 18, 2009).  Increased compliance costs also are likely to deter, at the margin, entry into the hedge fund management business by potential startups.  Second, the version of the Volcker Rule included in the Dodd-Frank Act is likely to cause some investment and commercial banks to divest certain internal hedge fund management businesses.  See “Implications of the Volcker Rule – Managing Hedge Fund Affiliations with Banks,” The Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010).  In cases where banks purchased going hedge fund management concerns rather than developing them internally, management buyouts may be a common deal structure.  Also, various hedge fund industry participants expect the Volcker Rule to displace traders and portfolio managers currently working at investment banks on proprietary trading desks or at in-house hedge funds.  Certain of those traders and managers will start new hedge fund management firms: some of those new firms will fail, some will continue independently and some will be sold to established players.  See “Stars in Transition: A New Generation of Private Fund Managers,” The Hedge Fund Law Report, Vol. 2, No. 49 (Dec. 10, 2009).  Third, the fundraising environment may remain difficult, causing smaller managers to sell to larger managers with more developed marketing and distribution infrastructures.  Indeed, distribution is a key consideration even in deals involving larger hedge fund managers: the proxy statement relating to Man Group’s acquisition of GLG Partners cited Man’s distribution capabilities as one of the strategic benefits of the transaction.  See "Transaction Analysis: Hedge Fund Managers Man Group and GLG Partners Announce Plans to Merge,” The Hedge Fund Law Report, Vol. 3, No. 21 (May 28, 2010).  (That acquisition is expected to close in the third quarter of 2010.)  The SEC’s recently approved pay to play rule (Rule) introduces a new category of legal risk into mergers and acquisitions of hedge fund management companies.  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).  At best, the Rule will add new categories of due diligence, new integration tasks and new post-closing training requirements to such transactions.  At worst, the Rule will delay or even derail such transactions.  This article identifies concerns raised by the Rule in the hedge fund manager M&A context, and offers strategies to address them.  Specifically, this article outlines fact patterns in which the Rule can adversely affect the outcome in the purchase or sale of a hedge fund management business; identifies notable recent investment management merger and acquisition transactions and transaction trend statistics; lists the four primary options available to hedge fund managers or others to prevent or remedy violations of the Rule in connection with acquisitions of hedge fund management businesses; discusses the pros and cons of each of the primary options; and outlines five alternative options, and the benefits and burdens of each.

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  • From Vol. 3 No.30 (Jul. 30, 2010)

    How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New “Pay to Play” Rule?

    On July 1, 2010, the SEC adopted Rule 206(4)-5 (Rule) under the Investment Advisers Act of 1940 (Advisers Act).  See “SEC Adopts Pay to Play Rules for Investment Advisers; Total Placement Agency Ban Avoided,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  The Rule generally seeks to curtail pay to play practices in the selection by state investment funds, most notably public pension funds, of hedge fund managers and other investment advisers.  Broadly, the Rule does this in three ways: (1) by limiting donations by principals of investment advisers and others with an economic stake in winning public fund business to election campaigns of public officials who may directly or indirectly influence the selection of the adviser to manage a public fund; (2) by prohibiting payments by investment advisers to any person for soliciting government entities for advisory services unless that person is (a) a registered investment adviser subject to the Rule or a registered broker dealer subject to a similar rule to be promulgated by FINRA, or (b) a principal or employee of the adviser; and (3) by revising Advisers Act Rule 204-2 (the recordkeeping rule) to require investment advisers with government clients, or advisers to hedge funds with government entity investors, to maintain records regarding political contributions by the adviser and its covered associates.  According to private fund data provider Preqin, public pension funds represent approximately 17 percent of all institutional hedge fund investors, with an average allocation of six percent of total assets to hedge funds.  The Rule governs the process by which hedge fund managers seek advisory business from this important constituency.  Accordingly, the Rule is of fundamental importance to a wide range of hedge fund managers, for whom the Rule creates a range of new compliance and marketing challenges.  The purpose of this article is to identify and provide guidance with respect to many of those new challenges.  In particular, the descriptive section of this article provides an overview of the mechanics of the Rule.  The analytic section of this article addresses areas in which hedge fund managers should revisit their policies and procedures in light of the Rule, including policies and procedures relating to: political contributions; monitoring contributions; preclearance of contributions; due diligence on placement agents; compliance training with respect to contributions; prescreening of new employees; acquisitions of hedge fund management firms; state, local and fund-specific rules relating to pay to play arrangements; sub-advisers and funds of funds; and mandatory redemptions.  The analytic section also includes a discussion of the implications of the Rule for lobbying by hedge fund managers.  See “Hedge Funds Increasing Lobbying Efforts, Focusing On Shaping Regulations Rather Than Preventing Them,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  The article concludes with a note on potential constitutional challenges to the Rule.  One of the more important points made by this article is that while the Rule has garnered significant attention, it is just part of a patchwork of federal, state, local and fund-specific rules governing the process by which hedge fund managers solicit investment advisory business from government entities.

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  • From Vol. 3 No.27 (Jul. 8, 2010)

    Legal, Operational and Risk Considerations for Institutional Investors When Performing Due Diligence on Hedge Fund Service Providers

    The old paradigm of hedge fund due diligence focused on the hedge fund manager and the new paradigm focuses on hedge fund service providers.  That is, the purpose of hedge fund due diligence used to be (broadly, pre-2008) to ensure that the hedge fund manager itself had, internally, sufficient people, process and plant to maintain its return and risk profile.  However, the credit crisis that began in 2008, and the frauds it brought to the fore, highlighted the franchise risk posed by service providers to hedge funds and managers.  Consequently, post-crisis hedge fund due diligence has focused more squarely and thoroughly on service providers.  For example, in a June 2010 study, hedge fund operational due diligence consulting firm Corgentum Consulting analyzed data from over 200 hedge fund allocators and concluded that hedge fund “investors are focusing the bulk of their due diligence efforts on legal, compliance and regulatory risks.”  The primary reason for this shift in focus – from managers and performance (then), to service providers and operations (now) – relates to the estimated harm from adverse outcomes.  In relative terms, most investment losses are high probability, low magnitude events, while most operational failures are low probability, high magnitude events.  The chief goal of due diligence is to avoid low probability, high magnitude events; and, moreover, the credit crisis taught that the probability of some operational failures may not be so low after all.  Lehman Brothers provides the most sobering example.  Hedge funds that used Lehman’s U.S. or U.K. brokerage entities as their only prime brokers and that did not perform adequate due diligence on Lehman’s custody and cash management arrangements – or that did perform such diligence but did not incorporate its lessons – wound up with significant investor assets tied up for long periods in bankruptcy, SIPA or administration proceedings.  The purpose of service provider diligence is to identify operational issues that can have a material adverse effect on investment outcomes – issues such as the commingling of hedge fund customer assets by certain Lehman brokerage entities.  With the twin goals of providing guidance to investors conducting due diligence on hedge fund service providers, and to hedge fund managers and service providers anticipating such diligence, this article: identifies key hedge fund service providers; details ten specific areas on which investors should focus when conducting service provider diligence; highlights areas of diligence specific to certain service providers; discusses strategies for accessing the data necessary to perform adequate due diligence; and incorporates recommendations regarding the timing and frequency of service provider due diligence.

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  • From Vol. 3 No.19 (May 14, 2010)

    NICSA’s "Trends in Hedge Fund Operations" Seminar Focuses on Liquidity, Managed Accounts, Third-Party Administration, Due Diligence, GIPS Standards and Related Topics

    On April 28, 2010, the National Investment Company Service Association, a not-for-profit trade association providing educational programming and information exchange within the operations sector of the worldwide investment industry, sponsored a webinar entitled "Trends in Hedge Fund Operations."  Speakers at the webinar focused on a range of issues of current relevance to hedge fund operations, including: fund-level and investor-level gates; side pockets; the frequency of use of managed accounts; the use of independent, third-party administrators; in-house administration; hybrid arrangements between third-party and in-house administration, including the use of agreed-upon procedures letters; investor due diligence and audit trends; GIPS standards; and the evolution of hedge fund technology.  This article summarizes the key points discussed during the webinar.

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  • From Vol. 3 No.17 (Apr. 30, 2010)

    Mandatory Redemptions Enable Hedge Fund Managers to Control Regulatory and Reputational Risks, Contain Costs and Accommodate Maturation of Investor Base

    Mandatory redemption provisions are provisions in hedge fund documents that generally permit a manager to eject an investor from the fund, in whole or in part, in the manager’s sole discretion, and against the investor’s will.  At first blush, such provisions would appear to have utility only in the best of times, when the demand for hedge fund capacity exceeds the supply.  But as discussed more fully below, a hedge fund manager has a continuous obligation, regardless of the marketing or investment climate, to control the composition of its investor base.  This is because the types of investors in the hedge fund – regardless of investment strategy or outcome – can have a material effect on the fund and the manager.  On the fund side, the types of investors in the fund can affect the fund’s regulatory status (in particular under the Employee Retirement Income Security Act of 1974 (ERISA) and the Investment Company Act) and costs.  And on the manager side, the types of investors in the fund can affect the manager’s time, reputation and flexibility in portfolio management.  A mandatory redemption provision provides a contractual basis for acting on the conclusion that the burdens to the fund or manager (regulatory, cost, reputational, etc.) of keeping an investor outweigh the benefits (fees, relationships, etc.) of keeping that investor.  In effect, mandatory redemption provisions are to a hedge fund investor base as a standard investment management agreement is to a hedge fund investment portfolio: both give a hedge fund manager considerable discretion to act in the best interests of the fund, even where those interests diverge from the interests of one investor.  We recognize that capital raising remains a paramount challenge and an urgent imperative for hedge fund managers – especially for startup managers, but even for established ones.  See “Why Does Capital Raising for Distressed Debt Hedge Funds Remain Particularly Challenging Despite the Recent and Anticipated Positive Performance of the Strategy?,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009); “How Can Start-Up Hedge Fund Managers Use Past Performance Information to Market New Funds?,” The Hedge Fund Law Report, Vol. 2, No. 50 (Oct. 1, 2009); “How Should Hedge Fund Managers Adjust Their Marketing to Pension Funds in Light of Potential Downward Revisions to Pension Funds’ Projected Rates of Return?,” The Hedge Fund Law Report, Vol. 3, No. 11 (Mar. 18, 2010).  Nonetheless, just as you cannot buy insurance after a storm hits, so a hedge fund manager would have difficulty interpolating a mandatory redemption provision into fund documents once the rationale for such a redemption crystallizes.  Instead, the time to consider and draft provisions in hedge fund documents is before they become necessary.  Put another way, hedge fund documents – and they are not alone among legal documents in this regard – generally should be drafted to accommodate worst-case scenarios and low-probability events.  The advisability of this approach was borne out during the credit crisis, when gate and liquidating trust provisions – quiescent in fund documents for years before the crisis – were suddenly put into practice.  See “Steel Partners’ Restructuring and Redemption Plan: Precedent or Anomaly?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  Thus the timing of this discussion.  To assist hedge fund managers in appreciating the range of circumstances in which mandatory redemption provisions may be useful, this article first catalogues eleven distinct rationales for using such provisions.  Notably, all of these rationales can apply in good times or bad.  That is, the breadth of these rationales indicates that mandatory redemption provisions are not just tools to be used when investors are beating down the door.  The article then describes a practice that we call “reverse due diligence.”  While the use of this phrase in the hedge fund context may be novel, this practice it describes is not, and it should be an ongoing activity at hedge fund managers.  The article then discusses the mechanics of mandatory redemption provisions in hedge fund governing documents, including the drafting of such provisions, triggering events, notice requirements and fee considerations, including suggesting (for the benefit of institutional investors) the novel (as far as we have been able to determine) possibility of a “reverse redemption fee.”  Finally, the article examines the interaction of mandatory redemption provisions and side pockets, and discusses alternatives to mandatory redemptions that may effectuate similar goals.

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  • From Vol. 3 No.17 (Apr. 30, 2010)

    Hedge Fund Operations and Technology Conference Focuses on SEC Reviews, Outsourcing of Operations, Operational Due Diligence, Multiple Prime Broker Relationships and More

    On April 21, 2010, Financial Technologies Forum LLC hosted its Third Annual Hedge Fund Operations & Technology conference in New York City.  The backdrop for the conference was a hedge fund industry coming out of two years of turmoil and refocused on hedge fund organizational structures, risk profiles, counterparties, trade processes, compliance policies, valuation approaches, information technology infrastructure and manager backgrounds.  The underlying question that the conference sought to address was how hedge fund operations and technology are evolving in light of the lessons learned during the crisis.  This article focuses on the more noteworthy points discussed during the conference, including potential new regulation and registration requirements; compliance policies and strategies (including use of a compliance calendar); anticipated increases in the frequency and depth of SEC reviews of hedge funds (including specific areas on which the SEC is expected to focus); demands from investors for increased transparency; outsourcing of operational functions (including appropriate service levels and due diligence to be performed on service providers); the specific components of operational due diligence, especially as it relates to service providers; and the rationale for and management of multiple prime brokerage relationships.

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  • From Vol. 3 No.9 (Mar. 4, 2010)

    Due Diligence Considerations for Hedge Funds That Invest in the Equities of Bankrupt Companies: Lessons of the Energy Partners, Ltd. Bankruptcy

    Hedge funds are recognizing with increasing frequency that the common stock of bankrupt companies or companies in the zone of insolvency may have post-reorganization value.  See “Interview with Mark Dalton, Alex Sorokin and Neil Wessan of Halsey Lane Holdings: Key Considerations for Distressed Debt Hedge Funds that become ‘Unnatural Owners’ of Equity Following a Reorganization,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  While investing in bankruptcy equities involves considerable risk – notably, the tangible likelihood of a complete loss of value – such investments also, in the right circumstances, offer the prospect of considerable upside.  In particular, bankruptcy equities may be attractive in at least three circumstances: (1) where creditors undervalue the assets of the debtor; (2) when an event (such as a lawsuit in which the debtor is a plaintiff) can act as a catalyst for value creation; and (3) where conditions in the relevant industry or credit markets may enable a debtor to emerge from reorganization while its bankrupt competitors do not.  See “Equities of Bankrupt Companies Offer Hedge Funds a High Risk, Potentially High Return Method of Investing in Restructurings,” The Hedge Fund Law Report, Vol. 2, No. 27 (Jul 8, 2009).  However, beyond the well-known financial risk of investing in bankruptcy equities, hedge funds should be cognizant of additional legal and structural risks that can adversely affect investment outcomes, or at least complicate the process of value creation.  In this article, Gregory C. White, an Associate at business valuation and litigation consulting firm Hill Schwartz Spilker Keller LLC, tells the story of hedge funds’ participation on the equity committee in the Chapter 11 bankruptcy of Energy Partners, Ltd. (EPL), a Louisiana-based exploration and production company.  In particular, this article outlines the facts of the case as they relate to the equity committee’s involvement in the valuation of EPL, focusing on relevant terms of the debtor’s engagement letter with its financial adviser.  The article then discusses two key lessons highlighted by the EPL case for hedge funds considering purchases of bankruptcy equities.

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  • From Vol. 2 No.52 (Dec. 30, 2009)

    Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris

    An article in last week’s issue of The Hedge Fund Law Report detailed a ruling by the New York State Supreme Court permitting a lawsuit by funds managed by Aris Capital Management (Aris) to proceed against hedge funds in which the Aris funds had invested and the managers of those investee funds.  See “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).  That lawsuit is one of various suits brought by Aris and its managed funds against hedge funds or managers in which the Aris funds have invested.  The Aris suits allege a variety of claims in a variety of circumstances, but collectively are noteworthy for their mere existence.  In the hedge fund world, there has been a conspicuous absence during the past two years of legal actions by hedge fund investors against hedge fund managers, despite the coming-to-fruition of circumstances that industry participants thought, pre-credit crisis, would augur an uptick in litigation: the imposition of gates, suspensions of redemptions, mispricing of securities, large losses, etc.  Jason Papastavrou, Founder and Chief Investment Officer of Aris, appears to have broken ranks with what seems like an unspoken agreement in the hedge fund world to avoid the courthouse steps, and he has done so with a considerable degree of thoughtfulness, for specific reasons and with particularized goals.  In an interview with The Hedge Fund Law Report, Papastavrou and Apostolos Peristeris, COO, CCO and GC of Aris, discuss certain of their lawsuits, why they brought them, what they seek to gain from them and what the relevant managers might have done differently to have avoided the suits.  They also discuss: seven explanations for the reluctance on the part of most hedge fund investors to sue managers; the fund of funds redemption process; how their lawsuits have affected their due diligence process; in-house administration; background checks; the importance of face-to-face meetings; side letters; how Aris investors have reacted to the lawsuits; and Aris’ transition to a managed accounts model from a fund of funds model.

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    Speakers at Walkers Fundamentals Hedge Fund Seminar Outline Hedge Fund Due Diligence and Financing Trends, as well as Predictions for 2010 and Beyond

    On December 2, 2009, international law firm Walkers Global held its Walkers Fundamentals Hedge Fund Seminar in New York City.  Speakers at this event addressed various current issues, including: the evolving nature, rigor and focus of hedge fund due diligence; renewed scrutiny of custody arrangements in the course of due diligence; post-investment due diligence and monitoring; financing for hedge funds and due diligence with respect to collateral; the regulatory outlook (with insight from Todd Groome, Non-Executive Chairman of AIMA); the duty of care applicable to hedge fund directors; Cayman Islands law with respect to indemnification of directors; and the outlook with respect to near-term fund-raising and a potential new government levy on hedge fund managers.  This article summarizes the key points discussed at the conference on each of the foregoing topics.

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    Big Boys Don’t Cry: How “Big Boy” Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations

    Various factors recently have increased the sensitivity of hedge fund managers, lawyers, compliance professionals, investors and others to insider trading concerns.  Those factors include, but are not limited to: insider trading allegations against Galleon Group founder Raj Rajaratnam and others; remarks delivered by SEC Enforcement Division Director Robert Khuzami on November 23 indicating that the Division will increase its enforcement activity with respect to insider trading by hedge funds, and in particular will focus on insider trading in the derivatives context; and press reports that the SEC has sent at least three dozen subpoenas to hedge fund managers and broker-dealers during November 2009 relating to communications in connection with healthcare industry transactions closed during the past three years and certain retail industry transactions.  See “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” The Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).  In light of the increased regulatory scrutiny of activity that may constitute insider trading, hedge fund lawyers, compliance professionals and others are re-examining how and where to draw the line between permissible and impermissible information, and how to police that line effectively.  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  In addition, hedge fund industry participants are refocusing on the promise and limits of tools they may employ to prevent or mitigate allegations of trading on material, nonpublic information.  One such tool is the so-called “Big Boy” provision, or disclaimer of reliance.  In our November 19, 2009 issue, we published the first part of a two-part analysis of Big Boy provisions in the hedge fund context by Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP.  That first part discussed the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no federal counterpart.  See “When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This second part expands on that analysis, focusing in depth on the enforceability of Big Boy provisions in securities and non-securities transactions, with a special emphasis on the enforceability of such provisions under New York law in the context of trading in bank loans.  In addition, this part includes a detailed discussion of, and a comprehensive review of the caselaw relating to, specific steps that hedge fund managers can take to increase the likelihood that a court will enforce a Big Boy provision.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance

    As a result of the recent “pay to play” scandals in New York, California and other states, the SEC, New York Attorney General Andrew Cuomo and certain state pension fund managers have restricted or prohibited hedge fund managers from using placement agents when marketing to state pension fund managers.  See “What Do the Regulatory and Industry Responses to the New York Pension Fund ‘Pay to Play’ Scandal Mean for the Future of Hedge Fund Marketing?,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  Prior to the pay to play scandals, placement agents often served an important intermediary role between investment managers and the trustees of state retiree money: they understood the investment goals of pension funds and the investment competencies of particular managers, and they added value by connecting goals with appropriate competencies.  However, the regulatory and industry responses to the pay to play scandals – still perceived in various quarters as unduly draconian – have all but eliminated placement agents from hedge fund manager marketing efforts, at least to the extent those efforts are directed at state pension funds, and at least for now.  At the same time, pension funds are expected to contribute a growing proportion of the assets under management by hedge funds in the next few years.  So who or what is going to fill the hedge fund marketing void that has opened up in the post-placement agent era?  In an effort to answer that question, this article revisits the New York State pension kickback case then discusses: the reduction in the use of placement agents by state pension funds in New York and California; the SEC’s recently proposed rule regarding placement agents; the move by pension funds away from allocations to funds of funds in favor of direct investments in hedge funds; specific examples of pension funds that have moved to single manager allocations; what precisely pension funds are looking for in allocating capital to single managers; specific steps that hedge fund managers can take to market to pension fund managers without relying on placement agents; considerations with respect to in-house marketing teams and prime broker capital introduction services; due diligence by pension funds; and background checks.

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  • From Vol. 2 No.44 (Nov. 5, 2009)

    How Can Hedge Fund Investors Hone Their Due Diligence in Light of Alarming Rate of “Verification Problems” Discovered in Recent Study of Hedge Fund Due Diligence Reports?

    In a draft paper dated October 16, 2009 and titled “Trust and Delegation,” four scholars analyzed the frequency of misrepresentations and inconsistencies on the part of hedge fund managers in the course of due diligence performed by institutional investors.  They did this by analyzing hundreds of due diligence (DD) reports prepared by a DD firm.  Most notably, they found that 21 percent of the hedge fund managers described in the reports they sampled misrepresented their past legal and regulatory history; 28 percent made incorrect or unverifiable representations about other topics; and 42 percent had had “verification problems” including either misrepresentations or inconsistencies.  This article describes in detail the more salient findings of the study and, more importantly, explores how hedge fund investors and managers can put those findings into practice.  For investors, this entails reviewing current approaches to DD to refocus on the most common categories of verification problems.  For managers, this involves focusing on knowledge management in order to avoid accidental or negligent misrepresentations, and recognizing the heightened importance of transparency and specificity in responding to DD inquiries.

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  • From Vol. 2 No.40 (Oct. 7, 2009)

    How Can Hedge Fund of Funds Managers Manage a “Liquidity Mismatch” Between Their Funds and Underlying Hedge Funds?

    The growing trend toward retailization of hedge funds of funds (FOFs) faces a considerable practical hurdle: retail investors demand frequent liquidity, while many of the more interesting opportunities for underlying hedge funds remain in less liquid investments.  See, e.g., “Why Does Capital Raising for Distressed Debt Hedge Funds Remain Particularly Challenging Despite the Recent and Anticipated Positive Performance of the Strategy?,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  For example, Alexandre Poisson, managing director of FOF HDF Switzerland recently stated that a well-structured FOF portfolio can give investors “monthly access to their money rather than quarterly, without any mismatch.”  But he added an important caveat: to accomplish this, the FOF must avoid illiquid strategies among its underlying funds.  At best, such avoidance restricts investment decision making.  At worst, it renders FOFs ineligible for some of the best opportunities, and thereby constrains alpha.  Are there better ways to reconcile liquidity and investment discretion?  To address this question – and hopefully to expand the range of options available to FOF managers looking to maintain their strategic approach while accessing a broader retail market – this article discusses the practical and legal bases for the obligation on the part of FOF managers to conduct thorough due diligence, especially with respect to the match between the liquidity of the FOF and the hedge funds in which it invests; the so-called “FOF regulatory loophole”; structural changes in the FOF market; the benefits and burdens of investments by FOFs in only liquid underlying funds; the early notification approach; FOF disclosure matters; side letters; and fee deferrals.  In addition, in mid-September 2009, the International Association of Securities Commissions (IOSCO) published a report titled “Elements of International Regulatory Standards of Funds of Hedge Funds Related Issues Based on Best Market Practices.”  The report broadly focuses on liquidity management and due diligence, and is both descriptive and prescriptive.  That is, it purports to describe how the market is, and how it should be.  We detail the salient points from the IOSCO report, and relay insights from industry participants on the extent to which the report reflects current market practice, and the extent to which the prescriptive sections may change market practice (to the extent they differ from it).

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  • From Vol. 2 No.40 (Oct. 7, 2009)

    What Can Hedge Fund Managers Learn From the SEC’s Failure to Catch Madoff? An Interview with Charles Lundelius, Senior Managing Director at FTI Consulting, Inc.

    FTI Consulting Inc. (FTI), a global business advisory firm, substantially assisted the Securities and Exchange Commission’s (SEC) Office of Inspector General (OIG) in preparation of its report on the agency’s responses – or failures to respond – to a series of “red flags” regarding Bernard Madoff and Bernard Madoff Investment Securities LLC (BMIS).  For more on that report, see “SEC Recommends More Hedge Fund Oversight in Audit on Its Failure to Uncover Madoff Fraud; House Oversight and Government Reform Committee Chairman Questions SEC Competence,” The Hedge Fund Law Report, Vol. 2, No. 38 (Sep. 24, 2009).  Charles Lundelius, a Senior Managing Director in the FTI Forensic and Litigation Consulting Practice, led the FTI engagement team, and thus has a uniquely clear perspective on the OIG’s review, the omissions in the SEC’s approach as determined by the OIG, structural flaws at the SEC as identified by the OIG and the OIG’s suggestions for remedying those flaws.  The Hedge Fund Law Report recently interviewed Lundelius, focusing on his experience assisting the OIG in preparation of its report.  The full transcript of that interview is included in this issue of The Hedge Fund Law Report, and touches on topics including: what FTI is and what they do; the most salient red flags that were missed by the SEC in the Madoff context; structural problems that may exist at the SEC and OCIE; the tendency of investigators to view new evidence in light of old experience; how the SEC – and for that matter, hedge funds and funds of funds – can use news and information services to discover information that may lead to red flags and ultimately to decisions against investments or in favor of redemptions; how the OIG’s report can offer tips to hedge funds of funds on how to conduct effective due diligence and how to detect fraud; and the role of hedge fund manager Renaissance Technologies in the Madoff investigation.

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  • From Vol. 2 No.39 (Oct. 1, 2009)

    Hedge Funds Turning to Life Settlements for Absolute, Uncorrelated Returns

    Among other lessons, the recent recession taught that the returns on many assets are more correlated than previously assumed.  From late 2007 through early 2009, it seemed that everything moved in the same direction: down.  Or almost everything.  A few asset classes – or more appropriately, investment categories – remained, during the recession and beyond, resolutely uncorrelated.  Litigation funding is one such investment category, as we discussed in a previous issue of The Hedge Fund Law Report.  See “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns,” The Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009).  Another such category is life settlements.  In a nutshell, a life settlement is the process by which an investor (often a hedge fund) purchases a life insurance policy from the person who originally purchased the policy – the so-called “insured.”  Specifically, the hedge fund or other investor generally pays the insured an amount greater than the cash surrender value of the policy, but less than the death benefit, in exchange for the right to collect the death benefit and the obligation to continue paying premiums for the life of the policy (and the insured).  For insureds, especially those that need money today, life settlements represent an opportunity to “cash out” of a policy for an amount often greater than what an insurance company will pay.  For hedge funds, life settlements offer an investment, the returns on which are driven largely by the fund manager’s ability to accurately predict the life expectancy of a group of insureds.  In other words, the success of a strategy focused on life settlements has less to do with microeconomic variables (such as corporate earnings) or macroeconomic variables (such as interest rates), and more to do with demographics.  It’s a different ball game, and a different skill set – the quintessential uncorrelated investment category.  Not surprisingly, hedge funds are becoming increasingly interested in life settlements.  Accordingly, this is the first part of a three-part series in which The Hedge Fund Law Report will provide a detailed analysis of the key legal and business considerations for hedge funds investing in life settlements.  In this part, we discuss: state and federal regulation of life settlements; premium financing; pricing of life settlements; advantages to hedge funds of investing in life settlements (including lack of correlation with other assets); concerns of which hedge funds should be cognizant when investing in life settlements (including illiquidity and longevity risk); structuring of hedge funds to invest in life settlements; cash management and adequate capital considerations; specific recommended items for disclosure in the private placement memorandum of a fund organized to invest in life settlements; due diligence considerations; a brief overview of the relevant tax considerations, including the recommended jurisdictions for organizing life settlement hedge funds; the tertiary market and securitization; and opposition from the insurance industry.  Part two in this three part series will focus in more depth on tax considerations relating to life settlement investing, and part three will focus in more depth on securitization of life settlements.

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  • From Vol. 2 No.39 (Oct. 1, 2009)

    Structuring Managed Accounts Key Focus of GlobeOp’s “Managed Accounts Insights for Investors” Event

    With the events of 2008 and early 2009 – faltering hedge fund performance, high profile frauds and prime broker and counterparty failures – hedge fund investors are showing increased interest in managed accounts.  Managed accounts generally are investment portfolios owned by the investor and managed by the hedge fund manager side by side with a primary hedge fund.  They can offer an efficient vehicle for investors looking to segregate their assets from the assets of a primary fund and to avoid the various problems (many having to do with the timing of redemptions) that can affect investors in a commingled vehicle.  See, e.g., “Investors in Hedge Fund Strategies Increasingly Demanding Separate Accounts to Avoid Gates and Other Consequences of Commingled Investment Vehicles,” The Hedge Fund Law Report, Vol. 2, No. 8 (Feb. 26, 2009); “Hedge Fund Managers Using Special Purpose Vehicles to Minimize Adverse Effects of Redemptions on Long-Term Investors,” The Hedge Fund Law Report, Vol. 2, No. 15 (Apr. 16, 2009); “How Can Hedge Fund Managers Prevent or Mitigate Revocations of Redemption Requests?,” The Hedge Fund Law Report, Vol. 2, No. 21 (May 27, 2009).  As a potentially attractive option for investors, managed accounts offer managers a method for attracting investor assets.  But the various investor and marketing benefits of managed accounts have to be balanced against the significant administrative burdens posed by managing separate accounts – including but not limited to accounting and allocation issues.  On September 17, 2009, GlobeOp Financial Services hosted the Managed Accounts Insights for Investors event in New York City.  During the one-day event, industry participants discussed such topics as structuring and negotiating managed account agreements, potential conflicts of interest and proper due diligence.  This article highlights and discusses the key points discussed at the conference.

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  • From Vol. 2 No.38 (Sep. 24, 2009)

    Primary Legal and Business Considerations in Hedge Fund Seeding Arrangements

    Over the last ten years it has become increasingly difficult for an emerging fund manager to start a hedge fund with minimal assets under management, establish a track record and use that record to attract additional capital.  With increased regulation on the horizon and its attendant compliance costs, not to mention investor wariness in the face of current economic conditions, the barrier to entry for hedge fund managers likely will increase even more.  One way for a manager to break through this barrier is to enter into an agreement with a seed investor.  In a typical seeding arrangement, the hedge fund manager or seedee receives start-up capital from a seed investor or seedor, typically a banking or other financial entity or else a fund of funds whose strategy is to invest in promising emerging managers.  In return, the seedor participates (more often than not though a contractual right to a portion of the revenues of the seedee rather than a direct ownership interest).  As a result, the seedor’s and the seedee’s interests appear to be aligned.  Each benefits from an increase in the manager’s assets under management and positive performance.  Yet, the seedor and the seedee have different expectations from a seeding arrangement.  These expectations color how the two parties look at the terms of the seeding arrangement.  In a guest article, Janet R. Murtha, a Partner at Warshaw Burstein Cohen Schlesinger & Kuh, LLP, explores the primary legal and business issues that frequently arise in seeding arrangements from the perspectives of both sides.  In particular, from the perspective of seedees, she examines: objectives; the term of a seed commitment; capacity rights; and other matters.  And from the perspective of seedors, she analyzes: objectives; reputational concerns and related due diligence; and back office concerns and related due diligence.  Finally, she explains the economics of seeding transactions and the use and structuring of put and call provisions.

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  • From Vol. 2 No.36 (Sep. 9, 2009)

    In Conducting Background Checks of Hedge Fund Managers, What Specific Categories of Information Should Investors Check, and How Frequently Should Checks be Performed?

    Background checks or investigations of managers of hedge funds, private equity funds and venture capital funds are in the spotlight with the recent frauds involving Bernard Madoff in New York and Stanford Financial in Houston.  For defrauded investors, the focus in the Madoff and Stanford contexts has shifted to litigation and asset recovery.  For those who still are invested in third-party managed funds or are considering investing in such vehicles, the Madoff, Stanford and other scandals have emphasized the importance of investigating the background of the individuals responsible for managing the funds.  No background investigation can prevent all fraud.  However, background investigations can indicate signs of a checkered past, which in turn can increase the risk profile of a potential investment.  In a guest article, Jack McCann and Daniel Weiss, both of investigation firm McCann Global, discuss the specific categories of information that investors should look into when conducting a background check on a hedge fund manager, the frequency with which background checks should be performed (and renewed) and the manner in which background checks should (and should not) be performed.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

    New Hedge Fund Transparency and Investors’ Rights – The Times They Are A Changin’

    So far in this century, hedge funds have raised and invested billions with minimal regulation and very little disclosure about their activities.  An investor turns over his money to the fund and goes along for the ride, usually without knowing what investments the fund manager has made, with little understanding of the strategies being employed and without access to information about where the fund is headed.  If an investor becomes dissatisfied, its only remedy is to withdraw from the fund.  Even that has strings attached to it.  Still, total hedge fund assets under management are estimated to have soared from approximately $450 billion in 1999 to over $2.5 trillion in June 2008, according to The Alternative Investment Management Association Limited.  During the fall of 2008, hedge fund returns plummeted, redemption requests poured in and many funds halted redemptions.  Several closed their doors; others sold their assets or have announced plans to do so.  Others are satisfying redemption requests with interests in newly formed pools of illiquid securities.  Add to this the fallout from Bernard Madoff and a few other high-profile hedge fund stories, and the stage is set for revisiting and rethinking the rights of investors in hedge funds.  The change has started even if, for the moment, it is still a trickle rather than a flood.  In a guest article, Robert L. Bodansky and E. Ann Gill, Partners at Seyfarth Shaw LLP, and Laura Zinanni, an Associate at the firm, discuss adopting private equity concepts in the hedge fund business model; advisory committees; charging performance fees only on realized gains; standards of conduct and fiduciary duty; most favored nations clauses and disclosure of side letters; investor reporting; indemnification carve outs; minimum levels of insurance; regulatory proposals in the United States and in Europe; pay to play regulation; due diligence; in-kind distribution issues; and more.

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  • From Vol. 2 No.27 (Jul. 8, 2009)

    Class Action Suit Against Hedge Fund that Invested in Madoff Feeder Fund Highlights the Standard of Care to which ERISA Fiduciaries are Held

    On February 12, 2009, the Pension Fund for Hospital and Health Care Employees (Fund) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Austin Capital Management Ltd. (Austin) for millions of dollars of losses due to allegedly improper investments in securities controlled by Bernard L. Madoff and his company.  Specifically, the complaint claimed that Austin “directed significant amounts of investment, estimated at present to be $184 million, into Madoff-related securities, virtually all of which were lost when the Ponzi scheme became known in December 2008.”  As a result, the complaint alleged that Austin failed to prudently invest the Fund’s assets, in violation of the Employee Retirement Income Security Act of 1974 (ERISA).  Then, on June 12, 2009, Spector Roseman Kodroff & Willis, P.C. (SRKW), a Philadelphia-based law firm, filed a second class action against Austin for more losses due to improper investments in securities controlled by Madoff.  This suit, brought on behalf of the Pittsburgh-based Board of Trustees of the Steamfitters Local 449 Retirement Security Fund and a nationwide class of similar funds, similarly alleged that Austin failed to prudently invest the benefit funds’ assets, in violation of ERISA.  These class actions are two of the many suits that have been brought in recent months against the “feeder funds” that contributed to Madoff’s Ponzi scheme, or funds that invested in such feeder funds.  The case highlights three issues relevant to hedge funds: (1) the question of when an alleged class of plaintiffs bringing suit against a hedge fund will be certified by a court; (2) the standard of care applicable to ERISA fiduciaries; and (3) the standard for consolidation and transfer of MDL cases.  The article analyzes each of those issues in detail.

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  • From Vol. 2 No.25 (Jun. 24, 2009)

    In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns

    As economic recovery lags and absolute, uncorrelated returns remain hard to come by, litigation funding – an investment strategy that has been popular in the U.K. and Australia for many years – is gaining traction among U.S. hedge funds.  The strategy essentially involves advancing a portion of the costs of a lawsuit in exchange for a multiple of the investment paid out of any damages or settlement.  This article provides a thorough overview of litigation funding, based on interviews with leading practitioners in the field, including discussions of: finding investment opportunities; the unique due diligence process; how litigation funding deals are structured; relevant legal concerns, including champerty and maintenance; attorney-client privilege issues; avoidance of influence on the litigation; the appeal of litigation funding as an investment strategy; and who is investing in the strategy.

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  • From Vol. 2 No.24 (Jun. 17, 2009)

    Interview with Duff & Phelps Director Eric S. Lazear on Operational Risk Due Diligence

    Amid the backdrop of recent high profile frauds, unprecedented market declines, poor hedge fund performance and resulting closures, hedge fund investors are placing heightened emphasis on due diligence.  In particular, investors are focusing in the course of due diligence on operational risks and business infrastructure.  Last month, independent financial advisory and investment banking firm Duff & Phelps Corporation created an Operational Risk Due Diligence (ORDD) practice to provide investors with an independent third-party assessment of their hedge fund managers’ operating policies and procedures.  The Hedge Fund Law Report spoke with Duff & Phelps Director Eric S. Lazear about the new ORDD practice; trends in operational risk due diligence; specific risks he has seen in the course of his practice (including risks relating to trading practices, valuation of illiquid assets, cash management, fund structuring and allocation of trades); and solutions recommended to institutional investor clients to address those risks.  The full text of the interview is available in this issue of The Hedge Fund Law Report.

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  • From Vol. 2 No.24 (Jun. 17, 2009)

    Regulatory Compliance Association Hosts Teleconference on “A New Era in Valuation”; Speakers Address Trans-Atlantic Convergence of Fair Value Accounting Principles, Indemnification of Hedge Fund Administrators and Due Diligence

    On June 10, 2009, The Regulatory Compliance Association (RCA) hosted a teleconference titled “A New Era in Valuation,” as part of its CCO University Outreach Series.  The speakers discussed international accounting standards and the price and valuation committees charged with implementing them; the roles, responsibilities and indemnification of service providers, in particular administrators; and how due diligence has and will continue to evolve in a “new era” characterized, as RCA Chairman Walter Zebrowski said, by the convergence of “market losses, declining fund values and rising liabilities.”  In this new era, Zebrowski noted, the International Accounting Standards Board and its U.S. counterpart, the Financial Accounting Standards Board, will continue to work toward more effective accounting principles, but in the glare of a political spotlight that was turned on by Enron and brightened by the off-balance-sheet accounting for various of the vehicles at the heart of the current credit crisis.  See generally “Key Lessons from the Second Annual Hedge Fund Tax, Accounting & Administration Master Class: IFRS, Fair Value and SEC Examinations,” The Hedge Fund Law Report, Vol. 2, No. 21 (May 27, 2009).  We summarize the key topics of discussion from the RCA teleconference.

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  • From Vol. 2 No.23 (Jun. 10, 2009)

    District Court Awards Hedge Fund Manager $1.5 Million “Break-Up” Fee Pursuant to Financing Deal’s Letter of Intent

    On May 19, 2009, the United States District Court for the Southern District of New York ordered Fair Finance Company, Inc. (FairFin), a financier of retail stores that traded in accounts receivables, to pay FCS Advisors, Inc. d/b/a Brevet Capital Advisors (Brevet), a hedge fund manager, a $1.5 million break-up fee and due diligence expenses based on FairFin’s breach of a letter of intent (LOI).  The LOI stipulated that Brevet would provide FairFin with up to $75 million in financing, and contained an exclusivity provision that required FairFin to pay Brevet $1.5 million if FairFin closed with another party “in lieu of” the financing contemplated in the LOI.  The district court entered summary judgment on behalf of Brevet after finding that no reasonable jury could dispute that Brevet had exercised its option to pursue financing with FairFin, that FairFin violated the exclusivity provision, and that FairFin then closed a similar financing transaction with another financier “in lieu” of a transaction with Brevet.  We explain the facts of the case and the court’s legal analysis.

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  • From Vol. 2 No.23 (Jun. 10, 2009)

    Migrating Toward Multi-Prime: Did Your Manager Decrease or Increase Operational Risk?

    In the wake of the Bear Stearns and Lehman difficulties, many hedge fund managers have migrated toward a “multi-prime” environment, in which more than one prime broker is utilized by the fund.  On closer examination, a number of hedge funds have failed in their dual objectives of setting up a true multi-prime relationship and reducing their overall operational risk.  Indeed, quite a few hedge fund firms have increased their operational risk without even realizing it.  In a guest article, Holly H. Miller, a Partner at Stone House Consulting, LLC, examines steps that hedge fund managers can take to achieve their objectives and enhance their operational risk profile.

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  • From Vol. 2 No.22 (Jun. 3, 2009)

    Protean Fraud Risk Appraisal Launches Hedge Fund Fraud Risk Certification

    On June 2, 2009, Protean Fraud Risk Appraisal announced that it had launched the investment industry’s first hedge fund fraud risk certification.  Protean Fraud Risk Appraisal is an independent risk certification firm specializing in the alternative investment sector.

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  • From Vol. 2 No.19 (May 13, 2009)

    The Fund of Hedge Funds Regulatory Loophole

    From a regulatory perspective, both in the United States and abroad, a hedge fund is essentially the same type of legal entity as a fund of hedge funds (FOHF).  As such all of the current and proposed hedge fund regulations apply virtually the same legal and compliance standards to both hedge funds and fund of hedge funds.  While such a distinction may have been too fine a regulatory point to make during the early stages of the modern hedge fund resurgence, this distinction can no longer be ignored.  Fund of hedge funds aggregate capital and allocate it to hedge funds.  They are supposed to be performing a certain minimum amount of due diligence (both investment and operational).  Unfortunately, as Madoff and the current Ponzimonium have demonstrated, FOHF were not performing such due diligence adequately.  All of the proposed hedge fund regulations dangerously ignore the opportunity to protect investors and institutions which place their capital within this lax due diligence framework.  In a guest article, Jason Scharfman, Managing Partner of Corgentum Consulting, LLC, critiques what he calls the “fund of hedge funds regulatory loophole.”

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  • From Vol. 2 No.17 (Apr. 30, 2009)

    How Has the New York Pension Fund Kickback Scandal Changed the Landscape for Placement Agents, and for Hedge Fund Managers who Use Them?

    Placement agents long have served as a conduit between hedge fund managers and institutional investors.  Placement agents provide managers with a range of marketing services, including introductions to capital sources, honing of marketing materials and presentations and explanations of how managers’ strategies can address investors’ goals.  However, that arrangement has come under pressure, in light of a sweeping indictment filed by the New York State Attorney General Andrew Cuomo and a parallel civil complaint filed by the SEC, both alleging that certain New York State officials conspired to condition access to investments by the state’s pension fund on the payment of kickbacks to state officials or their associates.  In addition, at least one former hedge fund manager has pleaded guilty to paying kickbacks in exchange for state investments in a hedge fund he managed.  The pay-to-play allegations raise a series of potentially game-changing questions for placements agents and hedge fund managers that use them.  At the most extreme, they give rise to the prospect that other state pension funds will follow New York’s lead in banning the use of placement agents, and that other significant private equity and hedge fund managers will cease using placement agents.  This would cause a secular shift in the placement agency business – in effect, would convert it from a business that in large part serves established managers in ongoing fundraising efforts to a business that primarily serves smaller, start-up managers.  A less draconian – and more certain and immediate – effect of the events will be to cause managers to scrutinize their placement agent relationships (current and new) significantly more closely, and to build more robust protections into their agreements with placement agents.  We explore the implications of the pay-to-play allegations for hedge fund managers and investors, and placement agents.

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  • From Vol. 2 No.17 (Apr. 30, 2009)

    Registered Investment Adviser Fined For Fraud and Failure to Perform Adequate Due Diligence

    On April 22, 2009, the Securities and Exchange Commission issued an order charging investment adviser Hennessee Group LLC and its principal, Charles J. Gradante, with violations of various federal securities laws for failing to perform due diligence before advising their clients to invest in the Bayou hedge funds, a fraudulent fund that later imploded.  Pursuant to the order, the Hennessee Group and Gradante settled the SEC’s accusations by agreeing to pay more than $814,000 in fines without being required to confirm or deny their guilt.  We explain the background and practical implications of the order.

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  • From Vol. 2 No.14 (Apr. 9, 2009)

    Hedge Funds Buffeted by Losses and Redemptions Consider Fund Mergers as an Alternative to Winding Up

    Losses and redemptions have combined of late to threaten the viability of many hedge funds managers, especially smaller and mid-sized managers.  In response to that threat, some hedge fund managers have sold their advisory businesses to larger entities.  While selling managers give up a degree of autonomy, they get (or hope to get) an offsetting amount of additional capital (from sale proceeds and new investor sources), operational resources, distribution reach and talent.  In the March 18, 2009 issue of The Hedge Fund Law Report, we explored in depth sales of hedge fund advisory businesses.  See “For Managers Facing Strong Headwinds, Sales of the Advisory Business Offer a Means of Preserving the Franchise While Avoiding Fund Liquidations,” The Hedge Fund Law Report, Vol. 2, No. 11 (Mar. 18, 2009).  A related type of transaction – less common in the hedge fund industry and hence less frequently discussed – involves mergers of hedge funds themselves.  Hedge fund mergers have similar goals to sales of advisory businesses (namely, avoiding a wind down and preserving a going concern), but implicate different legal, regulatory and operational considerations.  We explore various aspects of hedge fund mergers, including: investor consent requirements, opt-out rights, asset transfers, due diligence, valuation, treatment of side pockets, operational issues and talent retention.  We also describe a new strategic alternative available to fund managers struggling with losses and redemptions.

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  • From Vol. 2 No.11 (Mar. 18, 2009)

    For Managers Facing Strong Headwinds, Sales of the Advisory Business Offer a Means of Preserving the Franchise While Avoiding Fund Liquidations

    Many hedge fund managers, especially those with relatively lower levels of assets under management, find themselves between the Scylla and Charybdis of declining revenues and rising costs.  On the revenue front, performance declined an average of 18 percent across hedge fund strategies during 2008, meaning that many managers did not collect performance fees last year, and are unlikely to collect such fees until they regain their high water marks – which can take years.  Also, declining performance during 2008 and substantial redemptions shrunk assets under management, which reduced management fees.  At the same time, the exposure of various investment frauds, combined with widespread losses, increased scrutiny by major investors of hedge fund manager operations, compliance, risk management and reporting.  In short, as revenue has dwindled, the cost of doing business as a hedge fund manager has increased.  Managers faced with this daunting set of circumstances generally have the option (subject to the language of fund documents) of liquidating their funds and returning the proceeds to investors.  But many managers have invested a significant amount of time, effort and personal reputation in building a hedge fund management company; recreating that complex web of relationships among employees, investors, counterparties, creditors and others following a liquidation can be a herculean task.  Accordingly, instead of liquidation, various managers have evaluated and in some cases consummated sales of the management company to other, generally larger hedge fund managers or others in complimentary lines of business.  We explore in detail various aspects of sales of hedge fund advisory businesses, including: recent precedents, the scope and focus of due diligence, deal structures and consideration (including the increasing prevalence of earnouts), investor consent issues and key personnel retention mechanisms.

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  • From Vol. 2 No.8 (Feb. 26, 2009)

    MAXAM Fund Sues Auditors Over Madoff Losses

    On Friday, January 30, 2009, MAXAM Absolute Return Fund L.P. (MAXAM) filed a lawsuit in Connecticut Superior Court against its auditors Goldstein Golub Kessler LLP (GGK) and McGladrey & Pullen LLP (M&P and, collectively, the Auditors) alleging professional negligence, with the goal of recovering losses in connection with MAXAM’s investments in Bernard L. Madoff Investment Securities LLC (BMIS).  Implicit in the suit is the recognition that investment funds that invested in Madoff’s purported investment management business are unlikely to see any material recovery from Madoff himself or the firm he controlled.  Accordingly, plaintiffs are looking to service providers – even those who, like the Auditors in this case, provided services to the investor rather than to BMIS or Madoff.  As a general matter, while the facts of each case are unique, courts have not been receptive to claims against service providers in connection with alleged investment frauds, in the absence of any privity of contract between the service provider and the bad actor, or any independent bad act on the part of the service provider.  We describe the allegations in the complaint, including the specific claims of failure to follow Generally Accepted Auditing Standards.

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  • From Vol. 2 No.1 (Jan. 8, 2009)

    “Hedge Fund Operational Due Diligence: Understanding the Risks,” by Jason A. Scharfman; Wiley Finance, 320 pages

    Until not too long ago, operational or non-investment-related risk was given short shift vis-à-vis its more directly bottom-line related cousins: market, credit and liquidity risk.  In the current marketplace, however, the impact of operational due diligence on the profit and loss of investments in and by hedge funds is being starkly illustrated every day, most notably in the unfolding Madoff scandal.  Hedge funds and investors in hedge funds need to understand many new issues, including counterparty risk, the impact of new accounting pronouncements and how to deal with fraudulent schemes and funds which suspend redemptions or restructure.  In his book, “Hedge Fund Operational Due Diligence: Understanding the Risks,” Jason Scharfman, a director with Graystone Research at Morgan Stanley identifies these operational risks and recommends a strong and innovative “operational” due diligence review program as the best defense against them.  Our review of Scharfman’s new book offers a thorough overview of the book and its lessons.

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  • From Vol. 1 No.29 (Dec. 24, 2008)

    Involvement of Funds of Funds in Alleged Madoff Fraud Reemphasizes Importance of Due Diligence

    As Warren Buffett famously said in his 2001 Chairman’s Letter, “you only find out who is swimming naked when the tide goes out.”  According to a criminal complaint and press reports, the tide has clearly gone out on Bernard L. Madoff Investment Securities LLC and its founder Bernard Madoff, and a number of prominent funds of hedge funds have been caught swimming sans bathing trunks.  Specifically, a significant part of the value proposition of funds of funds is the ostensibly rigorous due diligence they perform on underlying managers.  Yet some of the biggest names in the fund of funds world appear to have invested in Madoff investment vehicles without performing adequate due diligence.  The anticipated losses of such names from the Madoff scandal emphasize the central importance of due diligence, especially for funds of funds, and the inadequacy of exclusive or near-exclusive reliance on personal relationships in making investment decisions.  We explore the implications of the Madoff scandal on the rigor and content of due diligence that should be performed by funds of funds prior to and after investing in underlying funds.

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  • From Vol. 1 No.29 (Dec. 24, 2008)

    Madoff: the SEC’s Complaint and What it May Mean for Private Fund Placement Agents

    On December 11, 2008, the Securities and Exchange Commission brought a civil action against Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC (BMIS), a broker dealer and investment adviser registered in both capacities with the SEC, in the United States District Court for the Southern District of New York, alleging that Madoff and BMIS committed fraud through the investment advisory activities of BMIS.  We detail the complaint and discuss a topic that has not yet received significant attention – the implications of the Madoff scandal for private fund placement agents.

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  • From Vol. 1 No.24 (Nov. 12, 2008)

    Petters’ Fraud Underlines Need for Vigilant Due Diligence

    Several hedge funds have been caught in a large-scale fraud alleged against Tom Petters, former CEO of Petters Companies Inc.  Based on a review of court filings and interviews with managers and attorneys at or representing funds who declined investments in Petters Co., we offer specific suggestions on how hedge funds can approach pre- and post-investment due diligence to avoid getting caught in fraudulent situations.

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  • From Vol. 1 No.21 (Sep. 22, 2008)

    Interview with Kenneth Springer of Corporate Resolutions Inc. on Hedge Fund Manager Due Diligence

    An investment in a hedge fund is more than just an investment in assets or instruments in which the fund invests. It’s also an investment in the managers of the fund – and not just in the investment prowess of the managers, but also in their integrity, transparency and forthrightness. An analysis of these factors should figure prominently into initial investment due diligence and ongoing investment monitoring, yet many investors pay inadequate attention to managers’ backgrounds, or lack the tools or know-how to adequately gather and evaluate such information. In this exclusive interview, Kenneth S. Springer, a Wall Street private investigator, former FBI agent and founder of Corporate Resolutions Inc., discusses hedge fund manager due diligence with The Hedge Fund Law Report.

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  • From Vol. 1 No.12 (May 20, 2008)

    Conference Board Governance Center Issues Report on Hedge Fund Activism

    Conference Board Governance Center’s Research Working Group on Hedge Fund Activism released a report outlining proposed recommendations for corporate directors, executives and investment professionals – various parties that might become involved in an activism campaign mounted by hedge funds.

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  • From Vol. 1 No.11 (May 13, 2008)

    Hedge Fund Due Diligence: Professional Tools to Investigate Hedge Fund Managers, by Randy Shain

    A new book provides a thoroughgoing blueprint for conducting due diligence on hedge fund managers prior to making an investment decision.

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