The Hedge Fund Law Report

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

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By Topic: Compensation

  • From Vol. 11 No.30 (Jul. 26, 2018)

    HFLR Program Looks at Recent Developments and Trends in Employment Law Relevant to Fund Managers

    A recent program presented by The Hedge Fund Law Report examined legislative responses to sexual harassment and the #MeToo movement; male dominance of the hedge fund industry; pay equity and pay history laws; arbitration; changes in the National Labor Relations Board under the Trump administration; and family and sick leave laws. The program featured Robin L. Barton, Senior Reporter at The Hedge Fund Law Report, and Richard J. Rabin, partner at Akin Gump Strauss Hauer & Feld. This article summarizes the key takeaways from the program. For more from Rabin on employment issues, see How Investment Managers Can Prevent and Manage Claims of Harassment in the Age of #MeToo” (Dec. 14, 2017).

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

    A Succession-Planning Roadmap for Fund Managers (Part Three of Three)

    Most organizations fail to plan for the departures of key employees until it is already too late. Fund managers must understand that creating an effective succession plan takes considerable time and requires an intimate understanding of the organization’s particularities. Informal succession plans are likely to lead to incoherent strategies, as well as biased employment decisions that may negatively affect firms’ abilities to adapt to the changing market and expose them to legal action. To avoid these dangers, a fund manager should adopt a mission statement; develop competency models; cultivate management buy-in; evaluate employee past performance and future potential; train, develop and retain high-potential employees; communicate the succession plan; and evaluate and test the plan. This article, the third in a three-part series, evaluates the risks of poor succession planning and provides a roadmap for developing a robust succession plan. The first article discussed the SEC’s proposed rule on business continuity and transition plans, the potential impact of the rule’s withdrawal, the importance of chief compliance officer (CCO) succession planning and the risks of using an outsourced CCO. The second article examined CCO hiring and onboarding; explored whether managers should departmentalize their compliance departments from their legal departments; and analyzed the risks of high CCO turnover. See our two-part succession-planning series: “A Blueprint for Hedge Fund Founders Seeking to Pass Along the Firm to the Next Generation of Leaders” (Nov. 21, 2013); and “Selling a Hedge Fund Founder’s Interest to an Outside Investor” (Jan. 16, 2014).

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  • From Vol. 11 No.20 (May 17, 2018)

    Ten Key Policies Fund Managers Should Include in Their Employee Handbooks (Part Two of Three)

    In order for advisers to fully benefit from the advantages that employee handbooks can provide, the policies within those handbooks need to be well-drafted; tailored to the adviser; fairly and uniformly administered; and compliant with applicable law. This article, the second in our three-part series, reviews ten policies that advisers should consider including in their handbooks, including a statement on at-will employment as well as policies prohibiting discrimination and harassment in the workplace. The first article outlined the key benefits to fund managers of adopting employee handbooks, the laws that frequently inform the policies included in handbooks and the administration of employee handbooks. The third article will explain how advisers can avoid common mistakes when drafting their employee handbook policies. See “How Investment Managers Can Prevent and Manage Claims of Harassment in the Age of #MeToo” (Dec. 14, 2017).

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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)

    FCA Chief Executive Touts Senior Managers Regime and Remuneration Restrictions As Important Incentives to Promote Good Culture at Fund Managers

    In a recent speech, Andrew Bailey, Chief Executive of the U.K. Financial Conduct Authority (FCA) extolled the U.K. Senior Managers and Certification Regime (SM&CR) and measures to govern the remuneration of senior managers as important ways to incentivize the creation of “good culture” – defined as encouraging good things, rather than simply stopping bad things from occurring – at fund managers and other financial services firms. Bailey outlined his thoughts on ways the FCA can promote good culture; discussed factors driving bad conduct at fund managers; lauded the SM&CR and remuneration guidelines as two recent developments that incentivize good culture; and promoted increased workplace diversity. Bailey’s remarks provide fund managers with important insight into the FCA, which views culture – and the protection of the public interest – as the responsibility of firms, their managers and owners. This article summarizes the key points from his speech. For more on the SM&CR, see “FCA Issues Guidance on Expansion of Senior Managers Regime to Fund Managers and Others” (Feb. 1, 2018). For additional commentary from Bailey and the FCA, see “FCA Details Three of Its 2017 Priorities: Competition in the Asset Management Market, Liquidity Management and Custodians” (May 4, 2017).

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

    Point72 Complaint Ignites Discussion on Relevant Facts in “Hostile Environment” Lawsuits

    In this era of heightened sensitivity to claims of sexual harassment, executives and managers in the asset management industry are likely to view with concern the complaint recently filed against billionaire Steven A. Cohen’s firm, Point72 Asset Management. The plaintiff, Point72 associate director Lauren Bonner, has alleged that Point72’s working environment was distinctly unwelcoming for female employees; that Bonner and other women at the firm suffered months-long hostile, demeaning and intimidating treatment; and that Point72 discriminated against Bonner by favoring male colleagues with regard to pay and promotions. While the allegations in the complaint are serious, the nature of the complaint has raised the eyebrows of some analysts, who have claimed that it includes dozens of inflammatory charges whose relevance to the treatment allegedly suffered by Bonner is often far from clear. To cast light on these issues and offer practical steps that asset managers can take to avoid similar legal trouble, this article analyzes the complaint and presents commentary from legal professionals with expertise in anti-discrimination law. For coverage of another lawsuit relating to harassment at a fund manager, see “Portfolio Manager Accuses Former Employer and Supervisor of Retaliation for Reporting Sexual Harassment” (Feb. 15, 2018).

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

    Panel Offers Perspectives on Internal Compensation Arrangements for Investment Professionals: Hedge Fund Compensation and Non-Competes (Part Two of Two)

    Hedge fund compensation is typically less complicated than private equity fund compensation: partners receive a share in a fund’s distributable profits while portfolio managers negotiate over levels of guaranteed compensation, expenses that are covered under the definition of “net profits” and their “buying power.” Private fund managers also routinely utilize non-compete agreements to bind employees, and although certain states disfavor non-compete agreements, they are generally enforceable. A recent program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), and featuring McDermott Will & Emery partners Ian M. Schwartz, Evan A. Belosa and Alejandro Ruiz, discussed these issues, among others. This article, the second in a two-part series, explores hedge fund compensation, including profit shares, and restrictive employment covenants. The first article discussed carried interest, taxation thereof and deferred compensation arrangements. For coverage of recent compensation surveys, see “RCA Compensation Trends Panel Discusses Strong Market for Private Fund Compliance and Legal Personnel” (Jan. 25, 2018); and “2017 Compliance Salary Survey: How Do Fund Managers Compare?” (Jan. 4, 2018). For additional commentary from Schwartz, see “Private Equity in 2017: How to Seize Upon Rising Opportunity While Minimizing Compliance and Market Risk” (Jun. 8, 2017). For coverage of a prior program hosted by MLA, see our two-part series featuring commentary from former SEC attorneys: “Chair Clayton’s Priorities and the Current Enforcement Climate” (Dec. 7, 2017); and “Current Regulatory Climate, Adviser Examinations and the Enforcement Referral Process” (Dec. 21, 2017).

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  • From Vol. 11 No.11 (Mar. 15, 2018)

    Panel Offers Perspectives on Internal Compensation Arrangements for Investment Professionals: Carried Interest and Deferred Compensation (Part One of Two)

    Private equity (PE) firms award carry at the fund level or on a deal-by-deal basis; while the deal-by-deal structure is more flexible, it is also more difficult to properly implement. Recent changes to the taxation of carried interest may further affect how PE firms award carry. In addition, private funds are increasingly deferring compensation to incentivize employees to stay, although significant issues persist over how employment contracts define “cause” and “good reason.” See “Ways Fund Managers Can Compensate and Incentivize Partners and Top Performers” (Dec. 14, 2017). A recent program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), and featuring McDermott Will & Emery partners Ian M. Schwartz, Evan A. Belosa and Alejandro Ruiz, discussed these and similar issues. This article, the first in a two-part series, discusses carried interest, taxation thereof and deferred compensation arrangements. The second article will explore hedge fund compensation, including profit shares, and restrictive employment covenants. For insight from another McDermott Will & Emery partner, see “Lessons for Hedge Fund Managers From the Government’s Failed Prosecution of Alleged Insider Trading Under Wire and Securities Fraud Laws” (Jul. 21, 2016). For coverage of prior programs hosted by MLA, see “Client Consent and Other Issues Requiring Careful Consideration by Fund Managers Involved in M&A Transactions” (May 18, 2017); and “Former Prosecutors Address Trends in Cybersecurity for Alternative Asset Managers, Diligence When Acquiring a Company and Breach Response Considerations” (Oct. 6, 2016).

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  • From Vol. 11 No.7 (Feb. 15, 2018)

    Portfolio Manager Accuses Former Employer and Supervisor of Retaliation for Reporting Sexual Harassment

    Distressed debt specialist Sara Tirschwell recently filed a five-count civil complaint against TCW Group Inc. (TCW Group), TCW LLC (TCW), TCW Group’s CEO and Jess Ravich in the New York State Supreme Court, New York County. Tirschwell claims that Ravich, her former boss, coerced her into a sexual relationship while she was developing a distressed debt fund for TCW and that TCW fired her in retaliation for reporting his alleged misconduct. She seeks more than $30 million in damages. This article analyzes the allegations in the complaint. See “How Investment Managers Can Prevent and Manage Claims of Harassment in the Age of #MeToo” (Dec. 14, 2017).

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  • From Vol. 11 No.4 (Jan. 25, 2018)

    RCA Compensation Trends Panel Discusses Strong Market for Private Fund Compliance and Legal Personnel

    The market for compliance and legal personnel is dynamic, with strong demand for skilled personnel. The Regulatory Compliance Association recently presented a program devoted to current compensation and hiring trends for compliance and legal professionals at private funds, traditional asset managers and sell-side firms based on the recent placement experience of executive recruiting firm JW Michaels & Co. (JWM). The program featured Jason M.E. Wachtel, founder and managing partner of JWM; Justin M. Mandel, JWM managing director and head of compliance; David Sawits, JWM vice president; and Mitch Avnet, founder and managing partner of Compliance Risk Concepts. This article explores the key takeaways from the presentation. For more on compensation of legal and compliance personnel at fund managers, see our series of two-part interviews with David Claypoole: “How Have Industry Developments Affected the Value of Legal and Compliance Staff?” (Feb. 2, 2017); “Will Industry Deregulation Affect the Value of Legal and Compliance Staff?” (Feb. 16, 2017); “What Is the Value of Legal and Compliance Staff?” (Mar. 12, 2015); and “Trends in Legal and Compliance Hiring and Staffing” (Mar. 19, 2015). For additional surveys on hedge fund personnel compensation, see our coverage of the reports by HedgeFundCompensationReport.com: 2015 Report and 2013 Report; and our coverage of the Greenwich Associates/Johnson Associates annual compensation studies: 2014 Compensation Study; 2013 Compensation Study; 2012 Compensation Study; and 2011 Compensation Study.

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  • From Vol. 11 No.1 (Jan. 4, 2018)

    2017 Compliance Salary Survey: How Do Fund Managers Compare?

    Chief compliance officers (CCOs) in the financial services industry rank fourth in terms of total compensation, according to a new compensation survey by the Society of Corporation Compliance and Ethics. In addition, the survey – which addresses pay rates as they relate to job responsibilities, title, type of organization, education level, geographic location and a variety of other factors – found, among other things, that the legal and regulatory field lacks ethnic diversity (the majority of survey respondents identified themselves as white) and that the vast majority of those in the field, from the CCO on down, are working without benefit of an employment contract. This article analyzes the details of the survey and its principal findings. See “Hedge Fund Manager Compensation Survey Looks at 2014 Compensation Levels, Job Satisfaction and Hiring Trends” (Jan. 22, 2015); and “Greenwich Associates and Johnson Associates Annual Compensation Report Shows Strength at Traditional Asset Managers Relative to Hedge Funds” (Nov. 6, 2014).

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  • From Vol. 10 No.49 (Dec. 14, 2017)

    Ways Fund Managers Can Compensate and Incentivize Partners and Top Performers

    Properly compensating employees is a perpetual issue for fund managers, as they must allocate management fee and performance compensation pools, balancing business and tax considerations while incentivizing and retaining key employees. A recent program sponsored by the New York Alternative Investment Roundtable provided a primer on how private fund managers can use management fee streams and performance fees to incentivize and compensate their partners and employees in a tax-efficient manner. Timothy Frazier, vice president of TriNet, hosted the presentation, which featured Gregory Kastner, senior tax manager for Baker Tilly Virchow Krause, who presented insights from the client alert he wrote on structuring employee compensation plans. This article summarizes the portions of the presentation most relevant to private fund managers. For more on hedge fund compensation, see our two-part series on deferred compensation plans: “Structuring Plans to Retain Top Talent” (Jun. 22, 2017); and “Practical Considerations: Vesting Schedules, Deferral Amounts and Compliance With Section 409A” (Jun. 29, 2017); as well as our two-part interview with David Claypoole: “How Have Industry Developments Affected the Value of Legal and Compliance Staff?” (Feb. 2, 2017): and “Will Industry Deregulation Affect the Value of Legal and Compliance Staff?” (Feb. 16, 2017).

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

    What Fund Managers Can Learn From “Tipper X”: Best Practices for Preventing and Detecting Insider Trading (Part One of Two)

    As regulators continue focusing on insider trading, hedge fund managers must strive to improve their compliance policies and procedures to prevent employee misconduct. See “SEC Complaint Suggests the Agency Will Continue Aggressive Enforcement Actions for Insider-Trading Violations” (May 11, 2017). To provide another perspective on insider trading, The Hedge Fund Law Report recently spoke with Tom Hardin, founder of Tipper X Advisors LLC. Known as “Tipper X,” Hardin was one of the most prolific informants in securities fraud history, assisting the U.S. government in numerous criminal insider trading cases as part of a DOJ cooperation agreement. As a convicted insider trader and informant, he has a unique perspective on insider trading, including how fund employees rationalize trading on material nonpublic information and how the private fund industry’s culture of compliance has evolved. This first article in our two-part series presents Hardin’s insights on how private fund compliance staff can prevent and detect insider trading activity, including best practices for training employees, ensuring prudent email use, preventing employees from rationalizing their insider trading, restructuring employee compensation to avoid incentivizing risky behavior and identifying insider trading activity. The second article will analyze ways regulators combat insider trading activity, the impact of recent insider trading cases on the regulatory environment and the potential effect of the current administration’s anti-regulatory stance on insider trading. See “General Insider Trading Policies and Procedures May Be Insufficient for Hedge Fund Managers to Avert SEC Enforcement Action” (Nov. 3, 2016); and our two-part coverage of the Seward & Kissel Private Funds Forum: “Mitigate Improper Dissemination of Sensitive Information” (Sep. 22, 2016); and “Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading” (Sep. 29, 2016).

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

    Practical Considerations for Hedge Fund Managers Establishing Deferred Compensation Plans: Vesting Schedules, Deferral Amounts and Compliance With Section 409A (Part Two of Two)

    When designing programs and incentives to attract and retain critical employees, deferred compensation plans warrant thoughtful consideration by hedge fund managers. Individuals who plan to remain with a firm for the long term often welcome these plans as a way to invest a portion of their income on a pre-tax basis and allow it to grow on a tax-deferred basis. Conversely, junior employees or those more fluid in their careers may prefer to receive cash compensation at the time it is earned. This two-part series provides an overview of deferred compensation plans in the hedge fund industry and key factors managers should consider when developing these plans. This second article examines how commonly these plans are adopted; discusses technical aspects of these plans, such as vesting schedules and forfeiture events; identifies categories of employees who are likely to participate in these plans; and reviews Section 409A of the Internal Revenue Code as it relates to these plans. The first article explored the intended goals of these programs and tax consequences associated with pre- and post-tax deferral plans. For discussion of other methods used by hedge fund managers to incentivize employees, see “Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation” (Apr. 18, 2014); “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?” (Aug. 22, 2013); and “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two)” (Feb. 23, 2012).

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  • From Vol. 10 No.25 (Jun. 22, 2017)

    How Hedge Fund Managers Can Structure Deferred Compensation Plans to Retain Top Talent (Part One of Two)

    It is often arduous and costly for hedge fund managers to build robust management teams with desirable talent in order to meet legal, regulatory and investor demands. Once found, retaining talented individuals becomes the next critical concern for managers, which they frequently address by using deferred compensation plans to delay an individual’s receipt of a portion of his or her compensation until a later point in time. See “Greenwich Associates and Johnson Associates Issue Report on Asset Management Compensation Trends in 2012” (Dec. 13, 2012). This two-part series provides an overview of the use of deferred compensation plans in the hedge fund industry, including the different forms these plans can take and certain tax matters to consider. This first article explores the intended goals of these programs and tax consequences associated with pre- and post-tax deferral programs. The second article will examine how commonly these plans are adopted in the hedge fund industry; discuss technical aspects of these plans, such as vesting schedules and forfeiture events; and identify categories of employees who are likely to participate in deferred compensation plans. For analysis of trends in compensation at hedge fund managers, see “How Much Are Hedge Fund Manager General Counsels and Chief Compliance Officers Paid?” (Jul. 24, 2014); and our two-part series on the market for in-house compensation at hedge fund managers: “What Is the Value of Legal and Compliance Staff?” (Mar. 12, 2015); and “Trends in Legal and Compliance Hiring and Staffing” (Mar. 19, 2015).

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  • From Vol. 10 No.19 (May 11, 2017)

    Four Steps NYC-Based Fund Managers Should Take in Light of Newly Enacted Law Prohibiting Compensation History Queries When Interviewing Prospective Employees

    On May 4, 2017, New York City Mayor Bill de Blasio signed into law legislation prohibiting firms based in New York City from inquiring about or relying upon the compensation history of applicants in connection with the hiring process. Following on the heels of last year’s amendments to the New York Equal Pay Act, the new law is intended to help close the gender-based pay disparity gap by largely removing reliance on current compensation levels at the time of hire. Critics argue that the law introduces considerable inefficiencies into the recruiting process, will have an inflationary impact on wages and will create traps for the unwary. The pay history law is just the latest in a raft of recent state and local legislation regulating the employment practices of New York City-based firms. In a guest article, Richard Rabin and Desireé Busching, partner and counsel, respectively, at Akin Gump, describe the new pay history law, including what practices will be permitted once the new law comes into effect, and provide four steps that advisers to private funds and other financial institutions should take now to prepare for the new law’s effective date. For additional insight from Rabin on employment related matters, see “Best Practices for Fund Managers to Mitigate Litigation and Regulatory Risk Before Terminating Employees” (Feb. 9, 2017); “Steps Hedge Fund Managers Can Take in Light of NY Attorney General’s View That Certain Non-Compete Clauses Are Unconscionable” (Sep. 22, 2016); and “What the NLRB Complaint Against Bridgewater Means for Hedge Fund Manager Employment Agreements” (Sep. 8, 2016).

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  • From Vol. 10 No.14 (Apr. 6, 2017)

    FCA Report Explores the Impact of Platforms, Governing Bodies and Manager Compensation Structures on Fund Competition (Part One of Two)

    The U.K. Financial Conduct Authority (FCA) recently issued its Asset Management Market Study – Interim Report, MS15/2.2 (Report). The FCA surveyed a broad segment of investors, asset managers and other stakeholders to consider the impact on competition in the asset management industry of investor behavior, consultants, barriers to innovation, platforms, fund boards and cost controls. The Report is vital reading for investors that wish to discern fee considerations and risk-management concerns when performing due diligence on funds, as well as for fund managers that need to anticipate and adjust to potential FCA regulatory developments in these areas. This first article sets forth the Report’s findings concerning the impact of platforms, fund governance bodies and manager compensation on fund fees and competition. The second article will detail the Report’s analysis of the benefits of actively managed funds relative to their associated costs, as well as the role that cost controls have on competition. For additional coverage of recent FCA guidance, see “U.K. Investment Advisers Fail to Meet FCA Expectations on Best Execution and Dealing Commissions” (Mar. 23, 2017); “U.S. Managers Marketing to U.K. Investors Could Face Ballooning Reporting Burdens Under Proposed Rule” (Jul. 28, 2016); and “U.K. Financial Conduct Authority Issues Feedback Statement Supporting Proposed E.U. Limits on Soft Dollars” (Mar. 5, 2015).

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  • From Vol. 10 No.7 (Feb. 16, 2017)

    Will Industry Deregulation Affect the Value of Legal and Compliance Staff? An Interview With David Claypoole on In-House Compensation at Fund Managers (Part Two of Two)

    Following the enactment of the Dodd-Frank Act, the market for in-house general counsels (GCs), chief compliance officers (CCOs) and junior legal and compliance personnel at fund managers bloomed. As the Trump administration has pledged to roll back Dodd-Frank, many wonder whether the opposite effect will be seen and whether the market for – and compensation of – in-house legal and compliance staff will decrease. In a recent interview with The Hedge Fund Law Report, David Claypoole, founder and president of Parks Legal Placement, shared detailed insight into the overall in-house legal and compliance market, based on more than a decade of compensation data. In this article, the second in a two-part series, Claypoole shares his thoughts on anticipated changes to the legal and compliance landscape under the new Trump administration, including a possible repeal of the Dodd-Frank Act; the movement of in-house staff from hedge funds to other industries or practices; and characteristics of successful in-house personnel. In the first article, Claypoole discussed how recent hedge fund performance may affect GC and CCO compensation; trends he has identified in legal and compliance compensation; the drivers of compensation for top legal and compliance personnel; and the backgrounds of candidates vying for these positions. In April, Claypoole will present on trends in legal and compliance compensation at GAIM Ops Cayman 2017. For more information on the conference, click here. To register, taking advantage of the HFLR’s promotional discount of 10 percent off the conference price (plus an additional $700 savings before February 17, 2017), click the link available in this article. For more on ways the Trump administration may affect the industry, see “How the Trump Administration’s Core Principles for Financial Regulation May Benefit the U.S. Funds Industry (Part One of Two)” (Feb. 16, 2017). For more on compensation, see also “Hedge Fund Manager Compensation Survey Looks at 2014 Compensation Levels, Job Satisfaction and Hiring Trends” (Jan. 22, 2015); and “Report Reveals Trends in Compensation of Investment Professionals at Buy-Side Firms” (Dec. 19, 2013).

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  • From Vol. 10 No.6 (Feb. 9, 2017)

    How Tax Reforms Proposed by the Trump Administration and House Republicans May Affect Private Fund Managers

    Tax reform has been a perennial centerpiece of the Republican Party’s agenda, and with the election of Donald Trump and a Republican majority in both houses of Congress, that reform may be more likely than ever. A recent program presented by the New York Hedge Fund Roundtable provided an overview of both the Trump and the House Republican tax proposals as they relate to individual and entity taxes, comparing and contrasting them with each other and the current tax regime and offering key takeaways for fund managers about each proposal. The program was led by Robert E. Akeson, chief operating officer at Mirae Asset Securities, and featured Vadim Blikshteyn, a senior tax manager at Baker Tilly Virchow Krause. This article summarizes the key insights from the program. For more on tax reform, see our two-part series on the global trend toward tax transparency: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016); as well as “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015). For a comprehensive look at hedge fund taxation, see our four-part series: “Allocations of Gains and Losses, Contributions to and Distributions of Property From a Fund, Expense Pass-Throughs and K-1 Preparation” (Jan. 16, 2014); “Provisions Impacting Foreign Investors in Foreign Hedge Funds” (Jan. 23, 2014); “Taxation of Foreign Investments and Distressed Debt Investments” (Jan. 30, 2014); and “Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles” (Feb. 6, 2014).

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  • From Vol. 10 No.5 (Feb. 2, 2017)

    How Have Industry Developments Affected the Value of Legal and Compliance Staff? An Interview With David Claypoole on In-House Compensation at Fund Managers (Part One of Two)

    In a regulatory landscape where fund managers are subject to greater scrutiny, the market for in-house legal and compliance personnel including general counsels (GCs), chief compliance officers (CCOs) and junior staff has flourished. Questions have arisen, however, as to whether the compensation of legal and compliance personnel will be affected by the increasingly volatile performance of private funds. In a recent interview with The Hedge Fund Law Report, David Claypoole, founder and president of Parks Legal Placement, shared detailed insight into the overall market for and compensation of legal and compliance personnel based on more than a decade of compensation data. In this article, the first in a two-part series, Claypoole discusses how recent hedge fund performance may affect GC and CCO compensation; trends he has identified in legal and compliance compensation; the drivers of compensation for top legal and compliance personnel; and the backgrounds of candidates vying for these positions. In the second installment in this series, Claypoole will share his thoughts on anticipated changes to the legal and compliance landscape under the new Trump administration, including a possible repeal of the Dodd-Frank Act; the movement of in-house staff from hedge funds to other industries or practices; and characteristics of successful in-house personnel. In April, Claypoole will be presenting on trends in legal and compliance compensation at GAIM Ops Cayman 2017. For more information on the conference, click here. To register for the conference, taking advantage of the HFLRs promotional discount of 10% off the conference price (plus an additional $700 savings before February 17, 2017), click the link available in this article. For more from Claypoole, see his prior two-part interview on the market for in-house compensation at hedge fund managers: What Is the Value of Legal and Compliance Staff?” (Mar. 12, 2015); and Trends in Legal and Compliance Hiring and Staffing” (Mar. 19, 2015).

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  • From Vol. 9 No.45 (Nov. 17, 2016)

    The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management (Part Two of Two)

    On August 25, 2016, the SEC adopted much-anticipated amendments to Form ADV, Part 1A and to Rule 204-2 (recordkeeping rule) under the Investment Advisers Act of 1940. These amendments further the SEC’s agenda to gather more information about its registrant base to inform the agency’s risk-based approach to adviser examinations. See “OCIE Director Marc Wyatt Details Use of Technology and Coordination With Other Agencies to Execute OCIE’s Four-Pillar Mission” (Nov. 3, 2016). In a two-part guest series, Michael F. Mavrides and Anthony M. Drenzek, partner and special regulatory counsel, respectively, at Proskauer Rose, review the amendments to Form ADV and the recordkeeping rule and provide practical guidance to SEC-registered investment advisers on the steps to take prior to the compliance date to ensure their firms are prepared to comply with the amended rules. This second article in the series discusses the new disclosure requirements relating to an adviser’s use of social media; office locations; the amount of an adviser’s proprietary assets and assets under management; the sale of 3(c)(1) fund interests to qualified clients; and the recordkeeping requirements regarding performance claims in communications that are distributed to any person. The first article reviewed the detailed disclosures that advisers will be required to provide with respect to managed account clients and the firm’s chief compliance officer, as well as factors to consider when pursuing an umbrella registration. For additional commentary from Proskauer partners, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates: An Interview With Proskauer Partner Robert Leonard” (Mar. 5, 2015); and “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters” (Feb. 1, 2013). For more on Form ADV, see “How Can Hedge Fund Managers Rebut the Presumption of Materiality of Certain Disciplinary Events in Form ADV, Part 2?” (Jan. 5, 2012); and “Recent SEC Enforcement Action Demonstrates the SEC’s Focus on the Accuracy and Consistency of Disclosures by Hedge Fund Managers in Form ADV” (Jan. 5, 2012).

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  • From Vol. 9 No.32 (Aug. 11, 2016)

    European Commission Issues “Largely Positive” Assessment of Remuneration Rules Applicable to E.U. Investment Firms and Other Financial Institutions

    On July 28, 2016, the European Commission (EC) issued its report (Report) to the European Parliament and the Council of the E.U. on the remuneration rules that were adopted in June 2013 for credit institutions and investment firms (Rules). The Report finds that the Rules – which impose limits on variable remuneration, require deferral of a portion of variable pay and mandate payment of a portion of variable compensation in non-cash instruments – have generally been well-received. However, the Report noted that it is too early to judge whether the limits on variable remuneration imposed by the Rules are having the intended effect of aligning individual and business interests and reducing risk. This article highlights the key provisions of the Report, with a focus on the provisions applicable to hedge and other private fund managers. For more on principal or employee compensation, see “Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation” (Apr. 18, 2014); and “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?” (Aug. 22, 2013).

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  • From Vol. 9 No.16 (Apr. 21, 2016)

    Becoming a Plan Assets Fund May Limit Hedge and Other Private Funds’ Abilities to Charge Fees

    One of the decisions faced by hedge funds and other private funds that accept “plan assets” subject to the Employee Retirement Income Security Act of 1974 (ERISA) is whether to cross the 25% threshold and become subject to ERISA. But taking that step is fraught with complex obligations and may significantly impact management and deferred performance fees. A recent segment of the “Pension Plan Investments 2016: Current Perspectives” seminar hosted by the Practising Law Institute (PLI) addressed issues for funds crossing the 25% threshold, including compensation practices for fiduciaries as well as management and performance fee structures of plan assets funds. The program, “Current Topics in Private Equity and Alternative Investments,” was moderated by Arthur H. Kohn, a partner at Cleary Gottlieb Steen & Hamilton; and featured Jeanie Cogill, a partner at Morgan, Lewis & Bockius; David M. Cohen, a partner at Schulte Roth & Zabel; and Steven W. Rabitz, a partner at Stroock & Stroock & Lavan. This article summarizes the key takeaways from the seminar with respect to the above matters. For additional commentary from this PLI program, see “Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA” (Apr. 14, 2016). For more on ERISA, see our two-part series on “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors”: Part One (Feb. 5, 2015); and Part Two (Feb. 12, 2015).

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    How Can Hedge Fund Managers Legally Penalize Employee Wrongdoing? (Part One of Two)

    As they continue to be scrutinized by the SEC and other regulators, hedge fund managers must ensure that their employees are properly trained and incentivized to avoid regulatory violations. See “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends” (Oct. 22, 2015). However, despite a manager’s best precautions, an employee’s actions may result in an adverse regulatory action or fine. In such situations, hedge fund managers may seek recourse against the employee responsible for the violation – to recoup losses to the hedge fund manager and to deter similar behavior by other employees. To determine industry best practices with respect to imposing fines on employees, The Hedge Fund Law Report spoke with employment counsel and also surveyed 15 general counsels and other “C-level” decision-makers at leading hedge fund managers. We present our findings in a two-part article series. This first part explores the options available to hedge fund managers for imposing penalties on their employees for regulatory violations and examines the limits of those options under employment law. The second part will examine how these options are put into practice, addressing the prevalence of these remedies in the industry and best practices for deployment. For more on hedge fund manager employment issues, see “New York Federal District Court, Applying ‘Faithless Servant’ Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading” (Feb. 6, 2014); and our two-part series on “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013).

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  • From Vol. 9 No.9 (Mar. 3, 2016)

    U.K. National Audit Office Report Questions FCA Effectiveness

    A recent report evaluates whether the U.K. Financial Conduct Authority (FCA) effectively protects consumers in the financial services industry, with potential implications for hedge fund managers and other financial firms. The U.K. National Audit Office (NAO) report provides insight into the FCA’s efforts to combat mis-selling and the effectiveness of those efforts. While commending those efforts, the report also calls for better data to determine whether the FCA’s efforts are providing “value for money.” Although the NAO report addresses consumer concerns, its recommendations could prompt the FCA to increase scrutiny of hedge fund managers and other financial services firms, which could result in stricter compensation and remuneration limitations on managers. This article examines the primary takeaways from the report. For a recent FCA report on hedge fund sales practices, see “FCA Report Enjoins Hedge Fund Managers to Improve Due Diligence“ (Feb. 25, 2016).

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  • From Vol. 9 No.7 (Feb. 18, 2016)

    FCA Policy Statement Fine-Tunes Rules to Implement UCITS V As Deadline Looms

    In July 2014, the E.U. adopted changes to its Directive on Undertakings for Collective Investment in Transferable Securities (UCITS), commonly referred to as “UCITS V.” Member states must implement UCITS V by March 18, 2016. In September 2015, the U.K. Financial Conduct Authority (FCA) issued a Consultation Paper seeking comment on its proposed rules to implement UCITS V. See “FCA Consults on Implementation of UCITS V Provisions Applicable to Managers” (Sep. 17, 2015); and “FCA Proposes Changes to Authorized Investment Funds Regulation” (Sep. 24, 2015). The responses the FCA received on the Consultation Paper were generally muted and concerned remuneration and disclosure requirements, as well as depositary rules. The FCA recently issued a Policy Statement which addresses those comments and makes final changes to its implementing regulations. This article examines the main provisions of the Policy Statement, including the transitional measures and operational difficulties that may impact UCITS managers and other regulated firms. For more on UCITS V, see “U.K. Government Proposes to Implement UCITS V Measures Applicable to Fund Managers” (Nov. 26, 2015). For more on UCITS, see “Are Alternative Investment Strategies Within the Spirit of UCITS?” (Jun. 8, 2012); and “The Implications of UCITS IV Requirements for Asset Management Functions” (Oct. 13, 2011).

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  • From Vol. 8 No.47 (Dec. 3, 2015)

    Advise Technologies Program Provides Guidance for Non-E.U. Hedge Fund Managers Registering Under E.U. Private Placement Regimes (Part One of Two)

    Many non-E.U. fund managers have hesitated to market their funds into the E.U. since the Alternative Investment Fund Managers Directive (AIFMD) took effect, because of national private placement regime (NPPR) requirements of each country in which the manager wants to market.  Non-E.U. managers have been concerned about potentially burdensome and disparate registration and reporting requirements.  A recent program presented by Advise Technologies sought to dispel some of those concerns and offered insights into how the NPPRs function in practice.  The program, “Non-E.U. Fund Managers: Why AIFMD Is Easier Than You Think,” was moderated by William V. de Cordova, Editor-in-Chief of The Hedge Fund Law Report, and featured Bill Prew, Founder and CEO of INDOS Financial; Tim Slotover, Founder and Director of flexGC; Jeanette Turner, Managing Director and General Counsel of Advise Technologies; and Arne Zeidler, Founder and Managing Director of Zeidler Legal Services.  This article, the first in a two-part series, summarizes the key takeaways from the program with respect to initial entry requirements, pre-investment disclosures and annual reporting requirements under the NPPRs.  The second article will address regulatory reporting requirements and the evolution of marketing under the NPPRs.  For more from Slotover, Turner and Zeidler on the AIFMD, see “AIFMD Is Easier for Non-E.U. Hedge Fund Managers Than Commonly Anticipated,” The Hedge Fund Law Report, Vol. 8, No. 41 (Oct. 22, 2015).  For more on marketing funds into the E.U., see “Passports, Platforms and Private Placement: Options for Marketing Funds in Europe in the Post-AIFMD Era,” The Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015); “Navigating the Patchwork of National Private Placement Regimes: A Roadmap for Marketing in Europe by Non-E.U. Hedge Fund Managers That Are Not Authorized Under the AIFMD,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014); and “Four Strategies for Hedge Fund Managers for Accessing E.U. Capital Under the AIFMD,” The Hedge Fund Law Report, Vol. 7, No. 6 (Feb. 13, 2014).

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  • From Vol. 8 No.44 (Nov. 12, 2015)

    Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action

    “Private equity advisers must be particularly vigilant about conflicts of interest and disclosure when entering into arrangements with affiliates that benefit them at the expense of their fund clients or when receiving payments from portfolio companies,” warned SEC enforcement director Andrew J. Ceresney in a press release announcing the SEC’s recent settlement with an investment adviser.  The SEC charged that the investment adviser and its principals failed to disclose conflicts of interest to clients and made statements to investors that omitted material information regarding consulting payments to an affiliate and incentive payments to certain adviser employees from a private equity portfolio company.  This article summarizes the facts underlying the enforcement proceeding, the SEC’s specific charges and the sanctions imposed.  For more on conflicts of interest involving fee and expense allocations, see “Blackstone Settles SEC Charges Over Undisclosed Fee Practices,” The Hedge Fund Law Report, Vol. 8, No. 41 (Oct. 22, 2015); “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); and “SEC Enforcement Action Involving ‘Broken Deal’ Expenses Emphasizes the Importance of Proper Allocation and Disclosure,” The Hedge Fund Law Report, Vol. 8, No. 27 (Jul. 9, 2015).  For ways to address and mitigate potential conflicts, see “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends,” The Hedge Fund Law Report, Vol. 8, No. 41 (Oct. 22, 2015).

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  • From Vol. 8 No.42 (Oct. 29, 2015)

    Rajaratnam Sued by Younger Brother for Alleged Unpaid Compensation and Indemnification of Legal Expenses

    Rengan Rajaratnam has filed a civil action in New York State Supreme Court against his brother Raj and various Galleon entities, claiming that he was fraudulently induced into settling his commission and compensation claims for a small fraction of what he was owed, and that he has a right to indemnification from the defendants for legal and other expenses he incurred in defending himself in the civil and criminal insider trading cases against him.  He seeks damages of at least $13.5 million, together with interest, attorneys’ fees and disbursements.  This article summarizes his allegations.  For coverage of other high-stakes compensation or severance disputes, see “New York Court Assesses the Validity of a Former Portfolio Manager’s Claim against a Fund Management Company for Unvested Performance Compensation,” The Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015); “U.S. District Court Evaluates FINRA Arbitration Decision in High-Stakes Severance Dispute Between UBS and Former Portfolio Manager,” The Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011); and “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).

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  • From Vol. 8 No.36 (Sep. 17, 2015)

    FCA Consults on Implementation of UCITS V Provisions Applicable to Managers

    The U.K. Financial Conduct Authority (FCA) has issued a Consultation Paper regarding regulation of authorized investment funds.  The FCA is consulting on proposed rules and guidance relating to the implementation of upcoming changes (commonly referred to as UCITS V) to the European Directive on Undertakings for Collective Investment in Transferable Securities (UCITS).  The proposals are relevant to managers of UCITS and other authorized funds, as well as other entities involved in the U.K. fund management industry.  This article sets out the UCITS regulatory framework and summarizes the FCA’s proposals addressing UCITS management company issues, which include remuneration, transparency and whistleblowing requirements.  For more on UCITS, see “Are Alternative Investment Strategies Within the Spirit of UCITS?,” The Hedge Fund Law Report, Vol. 5, No. 23 (Jun. 8, 2012); and “The Implications of UCITS IV Requirements for Asset Management Functions,” The Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  For additional analysis by the FCA, see “FCA Hedge Fund Survey Examines Key Risk Metrics Applicable to Hedge Funds,” The Hedge Fund Law Report, Vol. 8, No. 27 (Jul. 9, 2015).

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  • From Vol. 8 No.34 (Sep. 3, 2015)

    How Hedge Fund Managers Should Respond to Tax Regulator Attacks on “Disguised Management Fees” (Part Two of Two)

    In an effort to limit arrangements in which hedge fund managers and other private fund managers receive interests in funds in exchange for waiving management fees (thereby deferring recognition of income and changing its character), tax regulators in the United States recently proposed regulations to treat some investment fund management fee waivers and other payments in lieu of management fees as “disguised payments for services,” with immediate income tax consequences.  The U.S. tax authorities are not the only ones trying to strip the disguises from management fees.  In the United Kingdom, the Finance Act 2015 introduced disguised management fee rules to combat creative strategies to convert what is in economic substance a management fee – calculated by reference to funds under management and taxed as income at the rate of 45% – to capital gains taxable at 28%.  A new bill will also change the taxation of “good carry.”  In a guest article, the second in a two-part series, George J. Schutzer and Timothy Jarvis of Squire Patton Boggs outline proposed actions in the U.K. and suggest steps for hedge fund managers and others to take in response to the rules in place and the proposed new rules in the U.S. and the U.K.  The first article described common management fee waiver provisions and explained how the U.S. proposals would limit fee waivers that would be respected for tax purposes.  For more on proposals that could affect the taxation of hedge fund managers and their employees, see “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 16 (Apr. 23, 2015); and “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).

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  • From Vol. 8 No.33 (Aug. 27, 2015)

    Tax Regulators Attack Hedge Fund Manager Efforts to Disguise Management Fees (Part One of Two)

    Tax regulators in the United States and United Kingdom are attacking arrangements in which hedge fund managers and other private investment fund managers receive interests in funds in exchange for waiving management fees – or otherwise disguise fixed management fees – thereby deferring recognition of income and changing its character.  The IRS recently issued a notice of proposed rulemaking (Notice) that will treat such arrangements as “disguised payments for services,” resulting in immediate ordinary income for the manager or general partner that waives the fee.  Some fund sponsors will need to alter their current and future fee waivers to avoid this outcome, and they may need to act quickly because the Notice indicates that the IRS believes this reflects current law.  In a guest article, the first in a two-part series, George J. Schutzer and Timothy Jarvis of Squire Patton Boggs describe common management fee waiver provisions and explain how the U.S. proposals would limit fee waivers that would be respected for tax purposes.  The second article in the series will describe similar proposed actions in the U.K. and suggest steps for hedge fund managers and others to take in response to the rules in place and the proposed new rules in the U.S. and the U.K.  For more on tax proposals that could affect hedge fund managers and their employees, see “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015); and “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part One of Two),” The Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015).

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  • From Vol. 8 No.31 (Aug. 6, 2015)

    New York Appeals Court Rules on Applicability of New York Labor Law to Hedge Fund Incentive Compensation

    A recent decision by New York’s Appellate Division, First Department (Manhattan) is of great significance to hedge fund managers doing business in the state.  The ruling is important to hedge fund managers because it applies to the type of incentive-based compensation that is often made available to many financial industry employees – which typically depends on the overall success of the business or a team of employees – and determines whether such compensation merits the special protections provided by the Labor Law.  In a guest article, Sean R. O’Brien and Sara A. Welch, managing partner and counsel, respectively, at O’Brien LLP, discuss the Court’s decision in light of the Labor Law, as well as the ramifications of the ruling on the hedge fund industry.  For more from O’Brien and Welch, see also “Hedge Fund Incentive Compensation Not Subject to Wage Claim under New York Labor Law,” The Hedge Fund Law Report, Vol. 7, No. 14 (Apr. 11, 2014); and “How Can Hedge Fund Managers Protect Themselves Against Trade Secrets Claims?,” The Hedge Fund Law Report, Vol. 7, No. 19 (May 16, 2014).  For commentary on other rulings relating to hedge fund employee compensation, see “New York Court Assesses the Validity of a Former Portfolio Manager’s Claim against a Fund Management Company for Unvested Performance Compensation,” The Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015); “New York Federal District Court, Applying ‘Faithless Servant’ Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading,” The Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014); and “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).

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  • From Vol. 8 No.18 (May 7, 2015)

    New York Court Assesses the Validity of a Former Portfolio Manager’s Claim against a Fund Management Company for Unvested Performance Compensation

    After a portfolio manager was terminated following nine months of employment with a fund manager, he refused to sign a separation agreement that released the manager employer from a broad array of possible claims.  However, the separation agreement apparently permitted the portfolio manager to collect unvested performance fees in accordance with the conditions of the relevant vesting plan – one of which was that the portfolio manager sign such a release.  The former portfolio manager sued, claiming an entitlement to unvested performance fees.  This article summarizes the court’s decision and reasoning and provides relevant background information drawn from the complaint and the relevant motion papers.  For coverage of other high-stakes severance disputes, see “U.S. District Court Evaluates FINRA Arbitration Decision in High-Stakes Severance Dispute Between UBS and Former Portfolio Manager,” The Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011); and “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).

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  • From Vol. 8 No.17 (Apr. 30, 2015)

    Influential Proxy Adviser Expresses Cautious Support for Activist Director Compensation and Explores Potential Issues with Similar Arrangements

    Activist hedge fund managers frequently nominate directors to serve on the boards of target companies and seek to compensate those director nominees in order to attract top talent and ensure that those nominees perform.  However, special compensation arrangements have led to growing debate, with supporters asserting that these arrangements align the interests of activist nominees and shareholders and opponents arguing that they instead engender short-term thinking and result in dysfunctional boards.  See “Can Activist Hedge Fund Managers Provide Special Compensation to Nominees That Are Elected to the Board of a Target?  An Interview with Marc Weingarten, Co-Head of the Global Shareholder Activism Practice at Schulte Roth & Zabel,” The Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).  In a recent report, an influential proxy adviser expresses its support “with caution” for a compensation arrangement involving directors that an activist investor placed on the board of a target company.  After discussing the background and details of the director compensation arrangement, the report analyzes the merits of the arrangement in light of certain potential objections and then highlights several additional factors shareholders may wish to consider when evaluating future compensation arrangements.  This article examines the key points in the report with respect to the activist-nominated directors and their compensation structure.

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  • From Vol. 8 No.16 (Apr. 23, 2015)

    U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two)

    Whilst the U.K. tax treatment of management fees relating to, and performance fees arising from, fund arrangements has been the subject of debate for some time, the recent introduction of new U.K. legislation has brought the issue into sharper focus in the United Kingdom.  Accordingly, hedge fund personnel operating within the United Kingdom may be affected by the new legislation and thus subject to increased taxation on fees and compensation earned with respect to their investment management activities.  In a guest article, the second in a two-part series, Sidley Austin partner Will Smith details exceptions to the application of the new legislation, known as the “disguised fee rules,” and discusses certain practical consequences which may arise under the new legislation.  The first article discussed the background and enactment of the disguised fee rules and provided a summary of their technical application.  For additional insight from Smith, see “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  For insight from Smith’s partner Leonard Ng, see “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers from the January 2015 AIFMD Annex IV Filing,” The Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For insight from Sidley more generally, see “Sidley Partners Discuss Trends in Hedge Fund Seed Deals, Governance, Succession, Estate Planning and Tax Structuring (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014).

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  • From Vol. 8 No.15 (Apr. 16, 2015)

    U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part One of Two)

    Whilst the U.K. tax treatment of management fees relating to, and performance fees arising from, fund arrangements has been the subject of debate for some time, the recent introduction of new U.K. legislation has brought the issue into sharper focus in the United Kingdom.  Accordingly, hedge fund personnel operating within the United Kingdom may be affected by the new legislation and thus subject to increased taxation on fees and compensation earned with respect to their investment management activities.  In a guest article, the first in a two-part series, Sidley Austin partner Will Smith discusses the background and enactment of the new legislation known as the “disguised fee rules” and provides a summary of their technical application.  The second article in the series will detail exceptions to the application of the disguised fee rules and discuss certain practical consequences which may arise under the new legislation.  For additional insight from Smith, see “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  For insight from Smith’s partner Leonard Ng, see “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers from the January 2015 AIFMD Annex IV Filing,” The Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For insight from Sidley more generally, see “Sidley Partners Discuss Evolving Hedge Fund Fee Structures, Seed Deal Terms, Single Investor Hedge Funds, Risk Aggregators, Expense Allocations, Co-Investments and Fund Liquidity (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 36 (Sep. 25, 2014).

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  • From Vol. 8 No.11 (Mar. 19, 2015)

    Trends in Legal and Compliance Hiring and Staffing: An Interview with David Claypoole on the Market for In-House Compensation at Hedge Fund Managers (Part Two of Two)

    By studying legal and compliance staffing, one can see certain trends emerging – with respect to the makeup of legal and compliance teams at hedge fund managers and other private fund managers, and with respect to compensation.  In a recent interview with The Hedge Fund Law Report, David Claypoole, founder and President of Parks Legal Placement LLC, shared detailed insight into the overall market for and compensation of legal and compliance personnel, including general counsels (GCs), chief compliance officers (CCOs) and junior legal and compliance personnel.  In the first article in this two-part series, Claypoole discussed the factors that affect GC and CCO compensation; the current market for compensation of legal and compliance personnel; how compensation of dual-hatted employees compares to compensation of single-role GCs and CCOs; trends in how GCs and CCOs are viewed by employers; compensation of junior legal and compliance personnel; what makes an “exceptional” legal or compliance candidate; and how compensation of hedge fund GCs and CCOs compares to compensation of similar personnel at private equity and other types of managers.  In this second of two articles in the series, Claypoole shares the results of his research and experience on the relationship between fund performance and compensation; trends in legal and compliance compensation, including with respect to junior compliance personnel; investments by legal and compliance personnel in the funds managed by their management company employers; and reporting lines for GCs and CCOs.  On compensation, see also “Hedge Fund Manager Compensation Survey Looks at 2014 Compensation Levels, Job Satisfaction and Hiring Trends,” The Hedge Fund Law Report, Vol. 8, No. 3 (Jan. 22, 2015); “Annual Greenwich Associates and Johnson Associates Report Reveals Trends in Compensation of Investment Professionals at Buy-Side Firms,” The Hedge Fund Law Report, Vol. 6, No. 48 (Dec. 19, 2013).  On reporting, 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).  Claypoole will expand on the insights in this series at GAIMOps Cayman, to be held in the Cayman Islands from April 26-29, 2015.  For more information about GAIMOps Cayman, click here; to register, click here.

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  • From Vol. 8 No.10 (Mar. 12, 2015)

    What Is the Value of Legal and Compliance Staff?  An Interview with David Claypoole on the Market for In-House Compensation at Hedge Fund Managers (Part One of Two)

    Compensation of legal and compliance personnel at hedge fund managers is a complex and opaque topic.  In a recent interview with The Hedge Fund Law Report, David Claypoole, founder and President of Parks Legal Placement LLC, shared detailed insight into the overall market for and compensation of legal and compliance personnel, including general counsels (GCs), chief compliance officers (CCOs) and junior legal and compliance personnel.  In this article, the first in a two-part series, Claypoole discusses the factors that affect GC and CCO compensation; the current market standard compensation for legal and compliance personnel; how compensation of dual-hatted employees compares to compensation of single-role GCs and CCOs; trends in how GCs and CCOs are viewed by employers; compensation of junior legal and compliance personnel; when junior people reach their “legal bar mitzvah”; what makes an “exceptional” legal or compliance candidate; and how compensation of hedge fund GCs and CCOs compares to compensation of similar personnel at private equity and other types of managers.  In the second installment in the series, Claypoole will share his thoughts on the relationship between fund performance and compensation; trends in legal and compliance compensation, including with respect to junior compliance personnel; investments by legal and compliance personnel in the funds for which they work; and reporting lines for GCs and CCOs.  See also “How Much Are Hedge Fund Manager General Counsels and Chief Compliance Officers Paid?,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014); and “Annual Greenwich Associates and Johnson Associates Report Reveals Trends in Compensation of Investment Professionals at Buy-Side Firms,” The Hedge Fund Law Report, Vol. 6, No. 48 (Dec. 19, 2013).  Claypoole will expand on the thoughts in this series at GAIMOps Cayman, to be held in the Cayman Islands from April 26-29, 2015.  For more information about GAIMOps Cayman, click here; to register for the conference, click here.

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  • From Vol. 8 No.3 (Jan. 22, 2015)

    Hedge Fund Manager Compensation Survey Looks at 2014 Compensation Levels, Job Satisfaction and Hiring Trends

    HedgeFundCompensationReport.com recently released its 2015 Hedge Fund Compensation Report.  The Report covers compensation trends for hedge fund professionals, job satisfaction and hiring trends in 2014.  This article summarizes the key findings of the Report.  For coverage of the company’s 2014 survey report (covering 2013 trends), see “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  For other recent looks at hedge fund manager compensation trends, see “Greenwich Associates and Johnson Associates Annual Compensation Report Shows Strength at Traditional Asset Managers Relative to Hedge Funds,” The Hedge Fund Law Report, Vol. 7, No. 42 (Nov. 6, 2014); “How Much Are Hedge Fund Manager General Counsels and Chief Compliance Officers Paid?,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

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  • From Vol. 8 No.1 (Jan. 8, 2015)

    Answers to Questions Most Frequently Asked by U.S. and Other Non-E.U. Managers on the Impact and Implementation of the AIFMD

    The Alternative Investment Fund Managers Directive (AIFMD) continues to dominate discussions on global hedge fund regulation, marketing, remuneration, risk, reporting and related topics.  In this guest article, two of the leading global authorities on the AIFMD – Samuel K. Won, Founder and Managing Director of Global Risk Management Advisors, and Simon Whiteside, a Partner in the London office of Simmons & Simmons LLP – provide comprehensive answers to 14 of the questions most frequently asked by U.S. and other non-E.U. managers on the impact and implementation of the AIFMD.  Specifically, Won and Whiteside discuss the viability of reverse enquiry; the interaction between capital introduction and reverse enquiry; reliance on national private placement regimes; remuneration, side letter and leverage disclosure; AIFMD versus Form PF; content and frequency of AIFMD reporting; Annex IV reporting on master funds; and AIFMD-relevant risk management and reporting considerations.  See also “A Practical Comparison of Reporting Under AIFMD versus Form PF,” The Hedge Fund Law Report, Vol. 7, No. 41 (Oct. 30, 2014).

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  • From Vol. 7 No.46 (Dec. 11, 2014)

    Experts Discuss Viability and Use of Hedge Fund Appreciation Rights in Light of Revenue Ruling 2014-18

    Section 457A of the Internal Revenue Code, enacted in 2008, generally prohibits deferral of compensation paid by entities that are not subject to U.S. tax.  The tax risk created by that section caused private fund managers to avoid performance fees payable in respect of multi-year measurement periods, which could be considered to be deferred compensation.  Earlier this year, the IRS issued Revenue Ruling 2014-18, which generally confirms that fund managers may use fund appreciation rights (analogous to stock appreciation rights) to provide performance-based compensation on a tax-deferred basis.  A recent program considered the impact of that ruling, with an emphasis on the benefits that fund appreciation rights may provide as a compensation vehicle.  The program was moderated by COOConnect founding partner Dominic Hobson.  The speakers were David E. Francl, Director, Hedge Funds and Operations, in Intel’s Treasury Department; Andrew L. Oringer, a Partner at Dechert LLP; and Thomas M. Young, a Managing Director at Optcapital LLC.  For more on Revenue Ruling 2014-18, see “Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014).

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  • From Vol. 7 No.42 (Nov. 6, 2014)

    Greenwich Associates and Johnson Associates Annual Compensation Report Shows Strength at Traditional Asset Managers Relative to Hedge Funds

    Greenwich Associates, LLC, an international research-based consulting firm in institutional financial services, in cooperation with Johnson Associates, Inc., a financial services compensation consulting firm, have issued their 2014 U.S. Asset Management Compensation Study (Report).  The Report reveals that “the asset management industry is emerging as the first choice for many financial professionals” and provides an overview of buy-side compensation, including consideration of pay differentials between hedge fund professionals and other buy-side professionals, pay mix for buy-side professionals, bonuses and commission compensation.  This article summarizes the key insights from the Report.  The HFLR has covered the authors’ compensation reports for the past three years.  See our 2013 report coverage, 2012 report coverage and 2011 report coverage.  For an in-depth look at hedge fund compensation, see “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  See also “How Much Are Hedge Fund Manager General Counsels and Chief Compliance Officers Paid?,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

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  • From Vol. 7 No.36 (Sep. 25, 2014)

    NICSA/ALFI Program Considers Impact of AIFMD on U.S. Fund Managers

    NICSA, the National Investment Company Service Association, in cooperation with ALFI, the Association of the Luxembourg Fund Industry, recently presented an overview of the AIFMD and its impact on U.S. fund managers.  The program was moderated by Theresa Hamacher, President of NICSA.  The speakers were Michael Ferguson, Co-Chair of the ALFI Hedge Funds Sub-Committee and a Partner and Asset Management Leader at Ernst & Young; and Claude Niedner, Chair of the ALFI Alternative Investments Committee and a founding Partner of Luxembourg’s Arendt & Medernach.  See also “Navigating the Patchwork of National Private Placement Regimes: A Roadmap for Marketing in Europe by Non-EU Hedge Fund Managers That Are Not Authorized Under the AIFMD,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

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  • From Vol. 7 No.35 (Sep. 18, 2014)

    Internal Memo Describes IRS Position on Whether Limited Partner Exemption from Self-Employment Tax Is Available to Owners of an Investment Management Company

    The Office of Chief Counsel of the Internal Revenue Service (IRS) recently released a Memorandum that considers whether members of a limited liability company that serves as an investment manager to several investment funds are entitled to rely on the exemption from self-employment taxes afforded to “limited partners” under §1402(a)(13) of the Internal Revenue Code.  The IRS’ position is important because the federal Medicare tax applies to all self-employment earnings; there is no income limit, as there is for social security tax.  See also “Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions,” The Hedge Fund Law Report, Vol. 5, No. 40 (Oct. 18, 2012).

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  • From Vol. 7 No.30 (Aug. 7, 2014)

    Alternative Investment General Counsel Summit Covers Dual Registration, Valuation, Compensation Structures, the AIFMD, Presence Exams and Risk Alerts (Part One of Two)

    ALM’s Corporate Counsel recently hosted its inaugural Alternative Investment General Counsel Summit in New York.  Speakers at the event, including law firm partners, in-house counsel and regulators, addressed conflicts of interest raised by dual registration and valuation; the constituent elements of a culture of compliance; the interaction between compensation structures and regulatory developments; AIFMD compliance and timing; presence exam survival strategies; the role of risk alerts in refining a compliance program; effective responses to regulatory audits and examinations; insider trading; political intelligence; and expert networks.  This is the first article in a two-part series summarizing the points made at the Summit that can impact the design or implementation of hedge fund manager compliance programs.  See also “ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Distressed Debt Investing (Part Two of Three),” The Hedge Fund Law Report, Vol. 6, No. 46 (Dec. 5, 2013).

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  • From Vol. 7 No.28 (Jul. 24, 2014)

    How Much Are Hedge Fund Manager General Counsels and Chief Compliance Officers Paid?

    In a revealing recent interview with The Hedge Fund Law Report, Jason Wachtel, Managing Partner of JW Michaels, provided detailed insight into the structures and levels of compensation of hedge fund manager general counsels and chief compliance officers.  Specifically, Wachtel discussed the “market” for compensation of GCs and CCOs; the role of manager size and candidate experience in determining compensation; compensation of junior legal and compliance personnel; compensation of dual-hatted employees; how compensation of GCs and CCOs of hedge fund managers compares to the compensation of persons in similar roles at private equity fund managers; the relationship among fund performance, examination experience and compensation; how experience as a regulator or prosecutor affects compensation; investments by GCs and CCOs in the manager’s funds; and GC and CCO reporting lines.  See also “Annual Greenwich Associates and Johnson Associates Report Reveals Trends in Compensation of Investment Professionals at Buy-Side Firms,” The Hedge Fund Law Report, Vol. 6, No. 48 (Dec. 19, 2013).

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  • From Vol. 7 No.24 (Jun. 19, 2014)

    The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees

    The IRS recently issued Revenue Ruling 2014-18, addressing the application of certain anti-deferral provisions of the Internal Revenue Code to nonqualified stock option and stock appreciation right plans (together, Option Plans).  See “Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014).  In a guest article, Philip S. Gross and James D. McCann, both Members of Kleinberg, Kaplan, Wolff & Cohen, P.C., discuss some of the potential benefits and detriments of Option Plans from the perspectives of hedge fund managers and investors, and the potential impact of the Revenue Ruling on hedge fund manager taxation, structuring and compensation practices.

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  • From Vol. 7 No.23 (Jun. 13, 2014)

    Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?

    For years, hedge fund managers and investors have discussed the possibility of structuring the performance allocation payable by an offshore fund to its manager as an option on or appreciation right with respect to shares of the offshore fund.  The benefits of structuring the performance allocation as an option or appreciation right include tax deferral, an implicit clawback and a multi-year measurement period.  See “Hedge Fund Managers Considering Fund Appreciation Rights Compensation Structures to Defer Tax on Performance Compensation and to Better Align Manager and Investor Incentives,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).  However, implementation of such structures has been held up by tax risk: The IRS had not opined on whether options or appreciation rights in this context are subject to the anti-deferral provisions of Internal Revenue Code (IRC) Section 457A.  That ambiguity was resolved, in large measure, by a recent IRS revenue ruling.  This article identifies the specific issue addressed by the revenue ruling; summarizes relevant IRC provisions and Treasury Regulations; details the IRS’ analysis in the revenue ruling; and restates the revenue ruling’s conclusion.  Subsequent articles in the HFLR will delve into the consequences of the revenue ruling for structuring hedge fund performance compensation.

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  • From Vol. 7 No.21 (Jun. 2, 2014)

    Aligning Employee and Investor Interests Under the Volcker Rule

    The Volcker Rule limits the extent to which bank-affiliated asset managers and their employees may invest in hedge funds that they sponsor.  As a result, such managers need to ensure that any arrangements that allow for employee participation, including compensation arrangements, comply with the final Volcker Rule.  In a guest article, Tram N. Nguyen and Steven W. Rabitz, both partners at Stroock & Stroock & Lavan LLP, examine the different options that managers have under the final Volcker Rule in designing such arrangements.

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  • From Vol. 7 No.16 (Apr. 25, 2014)

    Can Activist Hedge Fund Managers Provide Special Compensation to Nominees That Are Elected to the Board of a Target? An Interview with Marc Weingarten, Co-Head of the Global Shareholder Activism Practice at Schulte Roth & Zabel

    Activist hedge fund managers typically seek to implement their ideas at a target company by nominating new directors and advocating for the election of those nominees.  Such nominees are more likely to be elected – and, once elected, are more likely to be effective in implementing the activist’s ideas – if they are better qualified, or, to use the activist term of art, if they are “rock stars.”  Accordingly, activists have asked how they can find rock star nominees and get the best performance out of those nominees if they are elected as directors.  At least two prominent hedge fund managers have answered this question by offering special compensation to nominees that are elected to the target board.  These managers and their supporters argue that such compensation arrangements align the incentives of activist nominees and shareholders.  Opponents argue that such special compensation arrangements engender short term thinking and result in dysfunctional boards.  To clarify the mechanics of such arrangements and to assess the merits of the arguments on either side of this debate – a debate that has real consequences for the rapidly growing volume of assets in activist hedge funds – The Hedge Fund Law Report recently interviewed Marc Weingarten, co-head (with David E. Rosewater) of the global shareholder activism practice at Schulte Roth & Zabel.  (On April 22, Schulte announced the expansion of that practice into the U.K.)  Our interview covered, among other things: the “market” for director compensation; structuring of special compensation of nominees by activists (including caps, the identity of the obligor and clawbacks); disclosure of such arrangements; the chief arguments for and against such arrangements; case studies involving the two managers referenced above; and the conflicting views of a prominent proxy adviser and law firm on a bylaw recommended by the law firm to prohibit compensation by shareholders of board nominees.  See also “How Can a Hedge Fund Manager Dislodge a Poison Pill at a Public Company?,” The Hedge Fund Law Report, Vol. 7, No. 12 (Mar. 28, 2014).

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  • From Vol. 7 No.15 (Apr. 18, 2014)

    Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation

    Private fund management companies, which are typically taxed as partnerships, often wish to incentivize key people with equity or equity-like interests in the management company.  A recent event examined the key elements of partnership taxation and considered the four available means of providing equity interests to employees and other service providers: profits interests, capital interests, options and phantom interests.  The discussion chiefly focused on profits interests, as such interests receive the most favorable tax treatment.  For discussion of another presentation on this topic, 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).

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  • From Vol. 7 No.14 (Apr. 11, 2014)

    Hedge Fund Incentive Compensation Not Subject to Wage Claim under New York Labor Law

    A recent decision by a New York court interpreting the State’s Labor Law is of great significance to hedge fund managers doing business in the State.  The ruling is important to hedge fund firms because it recognizes that incentive-based compensation to financial industry employees – which typically depends on the overall success of the business (or at least of a team of employees) and not on the performance of a single employee – is not the sort of compensation that merits protection under the Labor Law.  In a guest article, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, discuss the claims, the ruling and the ramifications and lessons of the decision.

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  • From Vol. 7 No.12 (Mar. 28, 2014)

    IRS Clarifies that Bitcoin and Other Virtual Currencies Are Treated as Property for U.S. Federal Tax Purposes

    Bitcoin is a virtual currency whose “supply” is determined by a preset computer algorithm and whose value is determined based on trading on dedicated exchanges.  (One notable Bitcoin exchange – Tokyo-based Mt. Gox – filed for bankruptcy protection in February of this year, claiming that 850,000 Bitcoins, worth about $500 million, were “stolen” by computer hackers.)  Hedge fund managers, manager principals and other types of investment managers (notably, venture capital fund managers) are interacting with the Bitcoin ecosystem in various ways.  For such managers and persons, a recently-issued IRS notice helps clarify the application of general tax principles to transactions using virtual currency.  For a related discussion of the role of different currencies in hedge fund structuring and marketing, see “Local Currency Hedge Funds Expand Marketing and Investment Opportunities, but Involve Currency Hedging and Other Challenges,” The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).

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  • From Vol. 7 No.10 (Mar. 13, 2014)

    SEC’s David Blass Expands on the Analysis in Recent No-Action Letter Bearing on the Activities of Hedge Fund Marketers

    The SEC recently issued a no-action letter (Letter) calling into question the long-held assumption that the receipt of transaction-based compensation necessarily requires broker registration.  See “SEC No-Action Letter Suggests That There May Be Circumstances in which Recipients of Transaction-Based Compensation Do Not Have to Register as Brokers,” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).  At a recent webinar, David W. Blass, Chief Counsel and Associate Director in the SEC’s Division of Trading and Markets, and others offered important insights on the applicability and interpretation of the Letter.  See also “Do In-House Marketing Activities and Investment Banking Services Performed by Private Fund Managers Require Broker Registration?,” The Hedge Fund Law Report, Vol. 6, No. 16 (Apr. 18, 2013).

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    New York Federal District Court, Applying “Faithless Servant” Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading

    On December 19, 2013, the United States District Court for the Southern District of New York allowed Morgan Stanley to recoup more than $31 million paid in compensation to a former portfolio manager who admitted to insider trading.  Morgan Stanley originally sued former FrontPoint Partners, LLC portfolio manager Joseph F. “Chip” Skowron III (Skowron) in October 2012 to recoup compensation paid to him.  Morgan Stanley based its allegation of the right to claw back such compensation upon Skowron’s 2011 guilty plea to insider trading and obstruction of justice charges.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  After prevailing on some of its claims and losing on others, Morgan Stanley moved for partial summary judgment, based on New York’s “faithless servant” doctrine.  This article summarizes the faithless servant doctrine and the Court’s analysis.

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  • From Vol. 6 No.48 (Dec. 19, 2013)

    Annual Greenwich Associates and Johnson Associates Report Reveals Trends in Compensation of Investment Professionals at Buy-Side Firms

    Greenwich Associates, LLC (Greenwich), an international research-based consulting firm in institutional financial services, in cooperation with Johnson Associates, Inc. (Johnson), a boutique financial services compensation consulting firm, have issued their 2013 report on U.S. asset management compensation (Report).  The Report is based on Greenwich’s interviews with “more than 1,000 financial professionals in equity and fixed-income investor groups at investment management firms, mutual funds, hedge funds, banks, insurance companies, government agencies, and pensions and endowments.”  Johnson used the data gathered by Greenwich, in conjunction with its proprietary compensation information and other industry data, to project trends for 2014.  Among other things, the Report broke out compensation between buy-side and sell-side firms.  The Report also broke out compensation among buy-side investment professionals, based on whether they were fixed-income or equity professionals and whether they worked at hedge fund firms or other buy-side firms.  The Report also highlighted trends in the compensation mix among buy-side professionals.  This article summarizes the key findings of the Report.  For coverage of prior years’ surveys, see “Greenwich Associates and Johnson Associates Issue Report on Asset Management Compensation Trends in 2012,” The Hedge Fund Law Report, Vol. 5, No. 47 (Dec. 13, 2012); and “Compensation Survey by Greenwich Associates and Johnson Associates Highlights Trends in Compensation and Best Practices for Hedge Fund Managers and Other Investment Professionals,” The Hedge Fund Law Report, Vol. 4, No. 46 (Dec. 21, 2011).

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Succession Planning Series: A Blueprint for Hedge Fund Founders Seeking to Pass Along the Firm to the Next Generation of Leaders (Part One of Two)

    A generation of hedge fund founders is arriving at a crossroads.  By one estimate, around $600 billion of the industry’s assets are managed by firms whose founding principals will reach at least their sixties in the next decade.  As they begin to contemplate retirement or devoting time to other projects, founders are considering a fundamental question: Do I want the firm to continue after I leave the stage?  Some founders will choose to wind up the firm.  Others, however, will want to leave behind an institutionalized business.  One way to do that is to sell a significant stake in the firm to an outside investor.  Alternatively, the founder may decide to groom a successor generation of leadership and make operational adjustments designed to let the firm thrive as an independent organization after the founder’s departure.  This guest article is about the latter approach to institutionalization – preparing to bequeath a free-standing franchise to the manager’s remaining principals and employees.  More specifically, this article addresses the imperative of advance planning for leadership transitions; choosing new leaders; the treatment of the founder’s economic interest in the firm; retaining and motivating key talent; and a variety of issues concerning succession execution, including investor communications, consent issues and key-man provisions in partnership agreements.  The authors of this article are Scott C. Budlong, William Q. Orbe and Kenneth E. Werner, all partners Richards Kibbe & Orbe LLP.  In a subsequent companion article, Budlong, Orbe and Werner will explore the possibility of selling an interest in the manager to a third party, where, in a different context, the institutionalization process is also important.  For more on succession planning, see “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).

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  • From Vol. 6 No.36 (Sep. 19, 2013)

    How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?  (Part Two of Three)

    Effective hedge fund capital raising requires effective marketers, and incentivizing effective marketers requires paying them for performance.  But paying in-house marketers for performance – paying them what the law calls “transaction-based compensation” or a “salesman’s stake” – requires the manager that employs those marketers to register as a broker.  How, then, can hedge fund managers attract, retain and incentivize top-tier marketers while avoiding a broker registration requirement?  This question has been looming over the hedge fund industry for years, but the question has been perceived as more theoretical than practical because of the absence of specific enforcement activity or speeches by SEC officials directly on the topic.  However, this all changed on April 5, 2013, when David W. Blass, Chief Counsel of the SEC’s Division of Trading and Markets, delivered a speech to the American Bar Association, Trading and Markets Subcommittee, generally addressing this topic.  See “Do In-House Marketing Activities and Investment Banking Services Performed by Private Fund Managers Require Broker Registration?,” The Hedge Fund Law Report, Vol. 6, No. 16 (Apr. 18, 2013) (analyzing the Blass speech).  The Blass speech was notable for highlighting questions and SEC concerns rather than providing conclusive answers or concrete guidance.  Blass noted, for example, that “[t]he SEC and SEC staff have long viewed receipt of transaction-based compensation as a hallmark of being a broker” – which the industry already knew – but he did not describe the types of compensation structures or scenarios that, in the SEC’s view, could constitute transaction-based compensation.  Nor has any other SEC speech, enforcement action or other category of authority particularized the “transaction-based compensation” analysis in a comprehensive manner.  In the absence of relevant and reliable regulatory guidance, this article – the second in a three-part series – distills best industry practices for determining when compensation paid to in-house hedge fund marketers constitutes transaction-based compensation.  Or, put another way, this article outlines strategies for structuring the compensation of in-house marketers to avoid the transaction-based compensation designation, and thereby avoid a broker registration requirement.  This article also discusses the Rule 3a4-1 issuer safe harbor and describes how managers can operate in-house marketing activities within the “spirit” of the safe harbor to minimize the risk of triggering a broker registration requirement.  The first installment in this series explored the activities that could trigger a broker registration requirement, as well as other factors that bear on the registration analysis, including the time devoted to marketing by an employee, the employee’s job title and the employee’s other responsibilities.  See “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?  (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 35 (Sep. 12, 2013).  The third installment will examine alternative solutions for managers looking to structure in-house marketing activities in a manner that accomplishes the fundamental business goals (most notably, capital raising) without triggering a broker registration requirement.

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  • From Vol. 6 No.33 (Aug. 22, 2013)

    How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?

    The competition for key talent among hedge fund managers is fierce, and many have resorted to offering their key employees a stake in the manager’s business to attract the best and the brightest.  “Equity” compensation has become so prevalent that more than one-quarter of hedge fund manager employees have reported owning an equity interest in their firms.  See “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  The forms of equity compensation that hedge fund managers can offer include profits interests, capital interests, options and phantom income in the firm.  Each of these options has economic and other ramifications, both for the offering firm and the offeree.  A recent program provided an overview of the various forms of equity participation that a hedge fund manager can offer its personnel.  Among other things, the panelists discussed the intricacies of profits interests; the current status of carried interest legislation; four different types of equity compensation that managers can offer personnel (including profits interests, capital interests, options and phantom income); tax consequences of becoming a “partner” as a result of the receipt of equity participation in the firm; and the applicability of Section 409A of the Internal Revenue Code to various forms of equity compensation offered by managers.  This article summarizes the key takeaways from the program.

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part Two of Two)

    Employee compensation clawbacks can help hedge fund managers deter bad acts, preserve reputation and demonstrate a commitment to compliance.  However, compensation clawbacks are only effective if properly structured, carefully drafted and consistently enforced.  This is the second article in a two-part series designed to help hedge fund managers think through the pros and cons of implementing compensation clawbacks.  In particular, this article starts by exploring some of the cons, including those relating to federal employment and tax law; state wage, labor and tax law; whistleblower issues; and logistical concerns.  This article then identifies four best practices for structuring and implementing clawbacks, and concludes with an appendix including three sample clawback provisions provided by sources and actually used by hedge fund managers, and one definition of “cause” used in connection with a clawback provision.  The first installment in this series provided an overview of employee clawbacks at hedge fund managers; discussed the types of employees, misconduct and triggering events covered by clawbacks; and highlighted the benefits of implementing clawbacks.  See “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    Second Circuit Evaluates Whether Hedge Fund Employee Who Pled Guilty to Insider Trading Is Responsible for Reimbursing Morgan Stanley for Compensation and Legal Expenses

    The Second Circuit Court of Appeals (Court) recently considered a decision by the U.S. District Court for the Southern District of New York holding that Joseph “Chip” Skowron is responsible for reimbursing his former employer $10 million in compensation and legal expenses incurred in defending Skowron as a result of the SEC’s investigation into his insider trading.  Among other things, the Court evaluated to what extent the Mandatory Victims Restitution Act is available to employers that wish to claw back compensation from their employees for illegal conduct.  See “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).  This article outlines the factual and procedural background in this case as well as the legal analysis underpinning the Court’s decision.

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  • From Vol. 6 No.31 (Aug. 7, 2013)

    Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two)

    Hedge fund compensation discussions have typically focused on upside – on how structuring acumen, tax strategy and legal legerdemain can be used to maximize post-tax compensation to good performers.  See “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  However, in the wake – or in the midst – of unprecedented insider trading and other enforcement in the hedge fund industry, there is a growing recognition among managers that compensation can also be used to mitigate downside.  In particular, hedge fund managers are increasingly exploring, implementing and using employee compensation clawbacks to minimize the ex ante risk of bad acts and mitigate the ex post impact of such acts.  For example, S.A.C. Capital Advisors, LLC (SAC Capital) announced in May 2013 – shortly before various SAC Capital entities were indicted for securities fraud and wire fraud – that it planned to implement a policy allowing the firm to claw back compensation from employees engaged in misconduct.  See “SAC Capital Entities Indicted for Securities Fraud and Wire Fraud in Connection With Employees’ Alleged Insider Trading,” The Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).  In October 2012, Morgan Stanley went beyond mere implementation to actual enforcement, suing former FrontPoint Partners, LLC portfolio manager Joseph “Chip” Skowron to recoup compensation paid to Skowron.  Morgan Stanley generally alleged that it had the right to claw back such compensation because of Skowron’s 2011 guilty plea to insider trading and obstruction of justice charges.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Employee compensation clawbacks offer powerful advantages to hedge fund managers, particularly in the current heightened enforcement climate.  They can deter bad acts, preserve reputation and broadcast a manager’s commitment to compliance.  However, clawbacks are not without legal and practical risk, including potential civil and criminal liability for managers that do not properly structure or enforce clawbacks.  To help hedge fund managers in evaluating the utility of clawbacks to their businesses, The Hedge Fund Law Report is publishing a two-part series on employee compensation clawbacks in the hedge fund industry.  This article, the first installment, provides an overview of employee clawbacks at hedge fund managers; discusses the types of employees, misconduct and triggering events covered by clawbacks; and highlights the benefits of implementing clawbacks.  The second installment will identify drawbacks of clawbacks; outline legal and other considerations for managers in structuring and enforcing clawbacks; describe documentation of clawbacks; enumerate best practices for structuring clawbacks; and provide sample employee clawback provisions.

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    Application of the AIFMD to Non-EU Alternative Investment Fund Managers (Part Two of Two)

    As most fund managers who either market a fund into the European Union (EU) or manage certain EU funds now know, from July 22, 2013, the EU’s Alternative Investment Fund Managers Directive (Directive or AIFMD) will impact many non-EU managers in potentially significant ways.  The preparation required can be significant.  As a result, The Hedge Fund Law Report is publishing this two-part series designed to help non-EU private fund managers understand the steps they must take to prepare for effectiveness of the AIFMD.  The first installment focused on the impact of the Directive during the period from July 2013 through 2015 – the period that first article referred to as “Stage I,” during which non-EU managers will not be fully authorized under the Directive, but nonetheless can be subject to many parts of the Directive, depending on the scope of their activities touching the EU.  See “Application of the AIFMD to Non-EU Alternative Investment Fund Managers (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 21 (May 23, 2013).  This second installment focuses on what this article refers to as the Directive’s “Stages II and III,” which are due to come into effect in 2015 or later, which contemplate a transition to full authorization under the Directive by all fund managers that are subject to the Directive’s jurisdiction.  The authors of the series are John Adams, counsel in the Asset Management Group at Shearman & Sterling LLP; Nathan Greene, a partner and Co-Practice Group Leader in Shearman’s Asset Management Group; Christian Gloger, a senior associate in the Group; and Christine Ballantyne-Drewe, an associate in the Group.

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  • From Vol. 6 No.8 (Feb. 21, 2013)

    Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends

    HedgeFundCompensationReport.com, a division of Job Search Digest, has published its 2013 Hedge Fund Compensation Report.  Among other things, the Report provided a comprehensive look at compensation levels at hedge fund managers across job titles, by manager characteristics (including size, investment strategy and performance) and other criteria; composition of compensation; and employee compensation satisfaction levels.  The Report also contained data addressing employee ownership of hedge fund managers’ equity; hiring trends; and employee concerns over job security.  The Report generally revealed broad gains in average employee compensation for 2012.  This article highlights selected takeaways from the Report.

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  • From Vol. 6 No.3 (Jan. 17, 2013)

    Identifying and Addressing the Primary Conflicts of Interest in the Hedge Fund Management Business

    Regulators are increasingly keen on scrutinizing how fund managers address conflicts of interest.  Norm Champ, then-Deputy Director of the SEC’s Office of Compliance Inspections and Examinations, spoke about conflicts at a May 2012 seminar held at the New York City Bar Association.  See “Davis Polk ‘Hedge Funds in the Current Environment’ Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).  The SEC has indicated that it intends to scrutinize fund managers’ handling of conflicts of interest during “presence examinations” of newly registered managers to be conducted in the next two years.  See “Former SEC Asset Management Unit Co-Chief Robert Kaplan and Former NYS Insurance Superintendent Eric Dinallo, Both Current Debevoise Partners, Discuss the Purpose, Process and Consequences of Presence Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 48 (Dec. 20, 2012).  In addition, the FSA has expressed its own concerns with asset managers’ handling of conflicts of interest by penning a “Dear CEO” letter to asset managers identifying areas where it has particular concerns.  See “FSA Report Warns Investment Managers to Revise Their Compliance Policies and Procedures to Address Key Conflicts of Interest,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  Moreover, regulators have initiated enforcement actions to address conflicts of interest that were not appropriately managed, handled and documented.  The most notable of these actions was levied against Harbinger Capital Partners and its principal, Philip Falcone, in the summer of 2012.  See “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).  Like regulators, hedge fund investors are concerned with conflicts of interest at managers.  See “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,” The Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).  Left unchecked, conflicts can ripen into legal violations and lost investments.  Accordingly, hedge fund managers must be vigilant in identifying and addressing conflicts.  While the details of conflicts may differ from firm to firm, certain general conflicts pervade the industry.  In a guest article, John Ackerley, a Director with Carne Global Financial Services in the Cayman Islands, provides a checklist of those pervasive conflicts, which are also those that matter most to regulators and investors.  In addition, Ackerley discusses specific measures that hedge fund managers can take to mitigate such conflicts.  Managers can expect questions from regulators and investors on each of the conflicts discussed herein.  Therefore, this article can be useful as a reference point in a mock examination, to prepare for marketing meetings and for other purposes.

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  • From Vol. 6 No.1 (Jan. 3, 2013)

    Citi Prime Finance Report Dissects the Expenses of Running a Hedge Fund Management Business, Identifying Components, Levels, Trends and Benchmarks

    Citi Prime Finance (Citi) recently released its “Citi Prime Finance Hedge Fund Business Expense Survey,” a follow up on and expansion of previous reports on hedge fund industry expenses.  The report provides an independent analysis of the various costs associated with operating a hedge fund management business; identifies trends and patterns within those expenses among different categories of hedge fund managers; and provides benchmarks so that hedge fund managers can ascertain whether their expense levels are above or below the expense levels of similarly situated peers.  This article details key findings outlined in the report.  For a discussion of another useful Citi analysis of trends in the hedge fund industry, see “Citi Prime Finance Survey Predicts Hedge Fund Industry Assets Will Nearly Double by 2016 and Highlights Opportunities for Hedge Fund Managers to Grow Assets Under Management,” The Hedge Fund Law Report, Vol. 5, No. 25 (Jun. 21, 2012).

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  • From Vol. 5 No.47 (Dec. 13, 2012)

    Greenwich Associates and Johnson Associates Issue Report on Asset Management Compensation Trends in 2012

    Greenwich Associates, an international research-based consulting firm in institutional financial services, in cooperation with Johnson Associates, Inc., a boutique financial services compensation consulting firm, have issued their 2012 U.S. Asset Management Compensation Report.  The Report provides an overview of 2012 compensation levels and trends; discusses differences in compensation between portfolio managers, traders and analysts at hedge fund managers and other asset managers; considers the impact of new regulations on compensation; and discusses changes in compensation structures.  This article summarizes key points from the Report.  See also “Compensation Survey by Greenwich Associates and Johnson Associates Highlights Trends in Compensation and Best Practices for Hedge Fund Managers and Other Investment Professionals,” The Hedge Fund Law Report, Vol. 4, No. 46 (Dec. 21, 2011).

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  • From Vol. 5 No.44 (Nov. 21, 2012)

    Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors

    On November 5, 2012, Ernst & Young released the results of its most recent annual global hedge fund survey, conducted in association with Greenwich Associates, in which one hundred of the world’s largest hedge fund managers and 50 major institutional investors representing $715 billion invested in hedge funds revealed their often differing views on topics of current interest to hedge fund industry participants.  Topics covered by the survey included the effectiveness of hedge fund regulation; the alignment of fund manager compensation with risk and performance; manager selection and redemption criteria; regulatory, capital, technology and hiring expenditures; fund of funds; and Eurozone considerations.  This article summarizes the key findings from the survey.  See also “Ernst & Young’s Arthur Tully Talks in Depth with The Hedge Fund Law Report About Hedge Fund Governance, Succession Planning, Valuation, Form PF and Administrator Shadowing,” The Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).

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  • From Vol. 5 No.34 (Sep. 6, 2012)

    U.K. Hedge Fund Manager Taxed on Bonuses Delivered Through Tax-Avoidance Scheme

    On July 16, 2012, the First-Tier Tribunal of the U.K. Tax Chamber issued a decision rejecting an appeal by hedge fund manager Sloane Robinson Investment Services Limited of a tax imposed on bonuses it delivered to its director-employees through a tax avoidance scheme.  This article summarizes the decision, including the factual findings, the parties’ arguments and the Tribunal’s legal analysis.  This article also provides insight on what the decision means for tax and compensation structuring for U.K. hedge fund managers.

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  • From Vol. 5 No.14 (Apr. 5, 2012)

    Former Employee Seeks Over $150 Million in Damages from Daniel Och, Och-Ziff and Affiliated Management Entities for Alleged Improper Termination

    Many hedge fund managers incentivize key investment professionals and other employees to remain loyal to the firm by giving them either a profits or equity interest in the firm’s management entities.  See “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  However, such marriages do not always end well, as demonstrated by a recent action brought by a former Och-Ziff employee against Daniel Och, Och-Ziff and affiliated management entities.  The facts alleged in the Complaint offer a rare glimpse into ownership and compensation structures at one of the world’s largest hedge fund management companies.  This article summarizes the factual and legal allegations in the Complaint.  This article also contains a link to the Complaint, which is publicly available but difficult to obtain.  For further insight into a high-level compensation arrangement (and dispute) at a successful hedge fund management company, see “Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager,” The Hedge Fund Law Report, Vol. 4, No. 8 (Mar. 4, 2011).

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  • From Vol. 5 No.14 (Apr. 5, 2012)

    Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act

    Hedge fund managers compensate their employees for services rendered with the expectation that such services will be rendered with competence, integrity and honesty.  However, when employees fail to live up to these expectations, do hedge fund managers have any recourse?  For example, may managers claw back compensation paid to such employees and recoup costs incurred in investigating and defending against securities fraud claims?  A recent decision by the U.S. District Court for the Southern District of New York suggests that, yes, hedge fund managers may in fact have some recourse against rogue employees.

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    PricewaterhouseCoopers Study Describes Recent Trends in and Outlook for Asset Manager Mergers and Acquisitions

    In February 2012, the Asset Management Division of accounting firm PricewaterhouseCoopers LLP released a report entitled “Asset Management M&A Insights: The Way Forward” (Report).  The Report is a compilation of white papers and survey results designed to “provide perspectives on the recent trends and outlook relating to asset management mergers and acquisition activity in the U.S. and major global markets.”  This article summarizes the key topics discussed in the Report, including: an analysis of merger and acquisition (M&A) deals in the asset management arena in the U.S. in 2011; a forecast for U.S. M&A deal activity in 2012; analyses of M&A activity in Europe and Asia; an explanation of the important roles human capital issues play in mergers and acquisitions; and an explanation of the role of various accounting principles, including issues related to consolidation and valuation, in asset management M&A.  Overall, the Report concluded that, in 2011, completed deals were scarce and deal values were relatively low.  While there is no clear indicator that 2012 will be better, the Report points to various factors that may contribute to increased M&A activity in the asset management arena for 2012.  For a discussion of recent litigation involving M&A in the hedge fund arena, see “Federal Court Decision Addresses the Enforceability of an Earnout Provision in the Sale of a Hedge Fund Management Business,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

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  • From Vol. 5 No.9 (Mar. 1, 2012)

    Applicability of New Disclosure Obligations Under ERISA to Hedge Fund Managers

    More and more ERISA-covered benefit plans (especially defined benefit pension plans) are becoming interested in alternative investments, including hedge funds, and assets under management in the hedge fund industry are growing.  The U.S. Department of Labor (DOL) recently reported that the total amount of assets held by private pension plans increased to about $5.5 trillion by the end of the plans’ 2009 plan years (including about $2.2 trillion held by defined benefit pension plans).  Private Pension Plan Bulletin, DOL, Employee Benefits Security Administration (2011).  (The DOL’s numbers do not include the amount of assets in public pension plans and individual retirement accounts.)  And a recent survey conducted by Credit Suisse found that assets under management in hedge funds globally are on track to reach $2.13 trillion by the end of 2012.  Given these numbers and trends, hedge fund managers are increasingly likely to consider marketing their funds to benefit plans as investment opportunities.  However, if ERISA-covered benefit plans (and certain other tax-exempt retirement vehicles) own 25% or more of any class of equity interest in a hedge fund, an undivided portion of all of the underlying assets of the hedge fund becomes “plan assets” subject to ERISA, and the manager of the hedge fund becomes a fiduciary under ERISA to the ERISA-covered benefit plan investors.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010).  This raises a number of issues for such a “covered” hedge fund manager.  One of those issues that will arise this year for the first time is a final rule released by the DOL on February 2, 2012 under ERISA §408(b)(2) regarding fee disclosures by service providers to ERISA plans.  In a guest article, Fred Reish, Bruce Ashton and Gary Ammon, all Partners in the Employee Benefits & Executive Compensation Group at Drinker Biddle & Reath LLP, analyze, with respect to the final rule under ERISA §408(b)(2): covered plans; covered service providers; covered services; disclosure requirements; the effective date for compliance; the definition of compensation for purposes of the rule; how to handle changes in information or status; disclosure errors; and related topics.  This article is relevant to hedge fund managers that have ERISA investors or are considering marketing to such investors.

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  • From Vol. 5 No.8 (Feb. 23, 2012)

    Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two)

    The death, disability or departure of a founder or key employee of a hedge fund manager (succession event) creates a business risk that the manager must proactively address to ensure the long-term viability of the enterprise, to respond to investor concerns and to meet the firm’s regulatory obligations.  A firm must anticipate and address not only personnel considerations, but also the impact of a succession event on ownership, compensation and other legal and operational issues.  This is the second article in a two-part series analyzing key considerations for hedge fund managers aiming to adopt and implement an effective succession plan.  The first article in this series discussed: why succession planning is an imperative for hedge fund managers looking to raise institutional capital and create long-term enterprise value; applicable regulatory requirements; the imperative of commencing succession planning today rather than deferring difficult decisions; examples of prominent hedge fund managers that have implemented succession plans; what types of succession events a succession plan should cover; people decisions, including how to identify roles to be filled and how to identify, incentivize and train successors; and the role of management committees in succession planning.  See “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012).  This article discusses: potential changes in a firm’s ownership and compensation structure designed to incentivize prospective successors to stay with the firm and to address the economics of departing founders or key employees; how to document a succession plan; how to test a succession plan; and how to communicate information about a succession plan with investors.

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  • From Vol. 4 No.46 (Dec. 21, 2011)

    Compensation Survey by Greenwich Associates and Johnson Associates Highlights Trends in Compensation and Best Practices for Hedge Fund Managers and Other Investment Professionals

    In November 2011, Greenwich Associates, an international research-based consulting firm in institutional financial services, and Johnson Associates, a boutique compensation consulting firm specializing in financial services, published their U.S. Asset Management 2011 Compensation Report (Report).  The Report projects compensation levels and trends for hedge fund professionals and other investment professionals for 2011.  The projections are based on historical data gleaned from more than 1,000 interviews with financial professionals in fixed-income and equity investor groups at hedge funds, mutual funds, investment management firms, insurance companies, banks, government agencies and pensions and endowments.  The Report dissects and compares historical compensation data for 2009 and 2010 from various perspectives.  (For another discussion of compensation levels and trends in 2009, see “Infovest21’s Annual Hedge Fund Manager Compensation Survey Reveals Top Paid Manager Positions and Top Factors Affecting Performance,” The Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).)  First, the Report highlights differences in compensation levels among fixed-income and equity investment professionals.  It then contrasts compensation levels for hedge fund professionals versus their counterparts at traditional asset management firms.  It then discusses trends in performance-based compensation and deferrals of compensation.  The Report also reveals trends in compensation for sales professionals and outlines best practices for structuring compensation of sales professionals.  For more on compensation of sales professionals, 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,” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).  This article discusses the data and analysis contained in the Report and outlines the Report’s projections for 2011 compensation levels.

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  • From Vol. 4 No.45 (Dec. 15, 2011)

    Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Three of Four)

    Any asset manager who chooses to open up an office in Singapore will have significant interaction with the Monetary Authority of Singapore (MAS), which acts as Singapore’s unified financial services regulator.  The MAS has confirmed that in the first half of 2012, it will implement a new regulatory structure over asset managers that maintain an investment management office in Singapore.  This article is the third in a four-part series by Maria Gabriela Bianchini, founder of Optionality Consulting.  The first article in this series identified factors that hedge fund managers should consider in determining whether to open an office in Asia and compared the relative merits of Hong Kong and Singapore as locations for an office.  See “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part One of Four),” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).  The second article in this series discussed technical steps and considerations for the actual process of opening an office in either Hong Kong or Singapore.  See “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Two of Four),” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).  This article describes Singapore’s new regulatory structure for hedge fund managers, which is expected to take effect in the first half of 2012, and discusses the application of the new regulations with respect to staffing, compensation, taxation, compliance, regulatory filings and other matters.  Part four will conclude the series with a discussion of Hong Kong.

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  • From Vol. 4 No.35 (Oct. 6, 2011)

    Federal Court Holds That Hedge Fund Marketing and Brokering Hedge Fund Management Company Transactions Are Different Services for Contracting and Compensation Purposes

    The Hedge Fund Law Report previously has reported on a case (which is not the only case of its kind) standing for the incontrovertible proposition that it is preferable for ethical actors to enter into written, as opposed to exclusively oral, hedge fund marketing agreements.  See “Pair of District Court Opinions Illustrates the Difficulty of Enforcing a Purported Oral Agreement Between a Third-Party Marketer and a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  A recent federal district court decision refines the analysis by emphasizing the importance of identifying the contemplated services in the relevant written agreement with as much specificity as possible.  Specifically, the decision indicates that hedge fund marketing – efforts to get people or entities to invest in hedge funds – and brokering transactions between hedge fund management companies are two different categories of services.  See “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).  The same person or entity may do both, but a person or entity that retains another person to perform one of these categories of services does not necessarily retain that person to perform the other category of service.

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  • From Vol. 4 No.20 (Jun. 17, 2011)

    How Much Are In-House Hedge Fund Marketers Paid, and How Will Recent Developments in New York City and California Lobbying Laws Impact the Compensation Levels and Structures of In-House Hedge Fund Marketers (Part Three of Three)

    This is the third article in our three-part series on how recent changes to the New York City and California lobbying laws will impact the compensation and activities of third-party and in-house hedge fund marketers.  The first article in this series described the relevant legal changes in depth and included a chart comparing analogous provisions of the New York City and California laws.  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).  The second article in the series analyzed the implications of the lobbying law changes for third-party hedge fund marketers.  Notably, the second article examined how hedge fund managers may structure new agreements with third-party marketers, or restructure existing agreements, in light of the ban on “contingent compensation” under the New York City and California laws.  That second article also discussed representations, warranties and covenants called for by the revised laws; due diligence consequences of the revised laws; and – most provocatively – why the lobbying law changes may be moot in light of a broader macro trend impacting third-party marketers.  See “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),” The Hedge Fund Law Report, Vol. 4, No. 13 (Apr. 21, 2011).  This article is the third in our lobbying series, and focuses on the implications of the lobbying law changes for in-house hedge fund marketers.  In particular, this article details: the typical compensation structures of in-house hedge fund marketers; how much in-house hedge fund marketers are paid, including specific numbers based on conversations with executive search professionals with relevant experience; whether in-house marketers fall within the scope of the California and New York City lobbying laws; specific strategies for structuring or restructuring the compensation of in-house marketers based on the lobbying law developments; exemptions from the “lobbyist” designation that may be available to in-house marketers; a discussion of relevant guidance provided by the California Fair Political Practices Commission in a recent letter; and the related issue of registration of an in-house hedge fund marketing department as a broker, and of the members of such a department as associated persons of a broker.

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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.12 (Apr. 11, 2011)

    Broadly Defined Terms in a Term Sheet Covering Employment of a General Counsel May Render Hedge Fund Manager Principal Personally Liable for Unpaid Compensation

    Dow Kim sought to launch hedge fund management company Diamond Lake Investment Group with a sterling resume, a high caliber team and great expectations.  But timing worked against Kim.  He launched in late 2007, into a perfect financial storm, when the vast majority of potential hedge fund investors were trying to get their money back rather than trying to deploy it.  A recent decision from New York’s intermediate appellate court held that Kim may have breached a contract and violated New York’s Labor Law by withholding compensation from the person he brought on board as general counsel of the management company.  But the interesting thing about the decision – or one of various interesting things – is that there was no contract.  There was only a term sheet; and that term sheet contained broad definitions of key terms that may render Kim liable for over $2 million in compensation obligations.  This article describes the factual background and legal analysis in the opinion, and makes four observations relevant to the drafting of hedge fund manager employment agreements and term sheets.  At least one other former employee of the short-lived Diamond Lake venture has taken his employment-related grievances to court.  See “After Hedge Fund Folds, Ex-Portfolio Manager Sues Its Founder, Dow Kim, in Federal Court for Fraud and Negligent Misrepresentation in Inducing Him to Join the Venture,” The Hedge Fund Law Report, Vol. 3, No. 32 (Aug. 13, 2010).  See generally “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).

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  • From Vol. 4 No.10 (Mar. 18, 2011)

    Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?

    The hedge fund adviser registration provisions of Dodd-Frank have, deservedly, received considerable attention during the last year from hedge fund managers and other industry participants.  However, there is another big registration question in the hedge fund industry – a question that predates Dodd-Frank by years; that has been discussed in hushed tones, for fear that regulators will overhear; and that may have consequences at least as powerful as the new adviser registration rule.  The question is the title of this article: is the in-house marketing department of a hedge fund manager required to register as a broker?  A closely related question is whether the members of such a department must register as associated persons of a broker.  These questions do not lend themselves to conclusive answers, but this article seeks to provide a framework for analyzing the relevant issues.  In particular, this article discusses: the general broker-dealer registration regime; SEC staff and court interpretations of the term “broker”; registration relief available to issuers and “finders”; the non-exclusive registration safe harbor for associated persons of an issuer; consequences of not registering as a broker if a person or entity is required to do so; specific challenges for hedge fund managers in complying with the safe harbor; how to structure in-house marketer employment agreements to fit within the safe harbor; and structuring alternatives for managers who elect to live with the broker registration regime.  According to our research, while the SEC has brought enforcement actions against various types of entities for operating as unregistered brokers, the SEC has not, to date, brought an action against a hedge fund manager solely for operating its in-house marketing department as an unregistered broker.  However, the SEC’s enforcement division is newly invigorated, with an asset management unit focused specifically on regulating hedge funds via enforcement.  Moreover, the consequences for failing to register as a broker when required to do so can be dramatic.  Finally, the “hushed tones” referenced above have not been entirely successful – we at The Hedge Fund Law Report have anecdotal and written evidence that the issue of broker registration of in-house hedge fund marketing departments is on the SEC’s radar screen.  That is, this article is not alerting the SEC to an issue of which the agency is unaware.  Rather, it is letting hedge fund managers know that they should be prepared – and offering guidance on how to prepare.

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  • From Vol. 4 No.8 (Mar. 4, 2011)

    Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager

    On December 20, 2010, one of the top performing hedge fund managers of 2010, Structured Portfolio Management, LLC (SPM), as well as its affiliates, sued their former Portfolio Manager, Jeffrey Kong, in the District of Stamford, Connecticut Superior Court.  SPM’s complaint, which painted Kong as a disgruntled former employee who merely had access to its confidential investment strategies, sought to enjoin Kong from joining and disclosing SPM trade secrets to Passport Capital LLC, a rival global macro hedge fund manager, and to recover over $10.8 million in distributions and bonuses given to Kong prior to his resignation.  On February 4, 2011, Kong filed counterclaims against SPM.  In his cross-complaint, he took credit for putting SPM “on the map,” hiring its top portfolio team members, and spearheading and adjusting its most successful investment strategies, including those that resulted in the notable returns generated by SPM funds in 2009 and 2010.  Kong also protested SPM’s failure to pay him the industry standard performance fee as a cash bonus, which for those two years, allegedly should have totaled $49 million more than he had received.  Kong also demanded an accounting of his remaining equity stake in SPM, which he believed had a value of more than $25 million.  While the matter has settled, the complaints provide unique insight into high-level compensation arrangements at a successful hedge fund management company, as well as the types of legal allegations that disputes over such compensation arrangements may involve.  As the pace of talent mobility in the hedge fund industry picks up, managers face compensation structuring decisions with increasing frequency, and the stakes of those decisions are considerable.  To get compensation decisions right, it is critical to understand what can go wrong.  Accordingly, this article provides extensive detail on the factual and legal allegations in the SPM and Kong complaints.

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  • From Vol. 4 No.7 (Feb. 25, 2011)

    Who Should Newly Registered Hedge Fund Managers Designate as the Chief Compliance Officer and How Much Are Chief Compliance Officers Paid?

    The Dodd-Frank Act (Dodd-Frank) will require hedge fund managers to appoint a chief compliance officer (CCO) for two reasons – an explicit reason and an implicit reason.  Explicitly, Dodd-Frank will require registration (by July 21, 2011) by hedge fund managers with assets under management in the U.S.: (1) of at least $150 million that manage solely private funds; or (2) between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle (for example, a managed account).  Registered hedge fund managers will be subject to SEC Rule 206(4)-7, which requires, among other things, registered investment advisers to “designate” (note: not “hire”) a CCO to administer their compliance policies and procedures.  Implicitly, Dodd-Frank is not only the cause of major regulatory change, but also the effect of a changed regulatory mindset.  Post-Dodd-Frank, there is more regulation – considerably more – and more vigorous enforcement of new and existing regulation.  Much of that regulation applies with equal force to registered and unregistered hedge fund managers.  Most notably, insider trading and anti-fraud rules apply to hedge fund managers regardless of their registration status.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  Recognizing this, even hedge fund managers beneath the relevant AUM thresholds are considering the appointment of a CCO (if they do not already have one).  For hedge fund managers considering the appointment of a CCO – and even for managers that currently have a CCO but are reevaluating how they staff the role – there are three basic approaches: (1) hire a new internal person to serve exclusively as CCO; (2) add the CCO title and duties to the existing portfolio of a current internal person, such as the general counsel (GC), chief operating officer (COO) or chief financial officer (CFO); or (3) outsource the role to a third-party compliance consulting or similar firm.  Which of these approaches makes sense, individually or in combination, depends on the size, strategy, complexity, resources, history and culture of the management company, among other factors.  In short, deciding who to designate as your CCO is a complex decision, and an increasingly important one.  The CCO is often the last bastion before a major compliance or operational failure, and as recent events demonstrate, those sorts of failures typically pose more franchise risk than bad investment calls.  See “Can the Chief Compliance Officer of a Hedge Fund Manager be Terminated for Investigating a Potential Compliance Violation by the Manager's Principal, CEO or CIO?,” The Hedge Fund Law Report, Vol. 4, No. 2 (Jan. 14, 2011).  The basic purpose of this article is to identify the pros and cons of each of the three foregoing approaches to designating a CCO.  To do so, this article discusses: what Rule 206(4)-7 specifically requires and does not require; the relative benefits and burdens of hiring a dedicated CCO, assigning the role to an existing person and outsourcing the role; hybrid approaches that incorporate the best elements of outsourcing and internal work; counterintuitive insights with respect to the demand for compliance professionals in the current environment; and – perhaps most importantly to anyone in, considering or hiring for a CCO role – specific compensation numbers for compliance professionals at hedge fund managers, employees at hedge fund managers who add a CCO role to other roles and dedicated CCOs, and the “market” for fees payable to outsourced CCO firms.  (We thank David Claypoole, Founder and President of Parks Legal Placement LLC, for providing this detailed insight on CCO compensation numbers.)

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  • From Vol. 4 No.6 (Feb. 18, 2011)

    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)

    Public pension funds represent approximately 16 percent of all institutional investor assets in hedge funds, according to alternative investment data provider Preqin.  However, not all assets invested in hedge funds are equally weighted.  To a hedge fund manager, a dollar invested by a public pension fund generally is more valuable than a dollar invested by a high net worth individual, or most funds of funds, for at least two reasons.  First, that pension fund is likely to stay invested longer, and thus to generate more fees over time.  Second, an investment by a public pension fund often increases the likelihood of other investments because subsequent investors assume, rightly or wrongly, that the public pension fund engaged in rigorous investment and operational due diligence before investing.  Accordingly, public pension funds have long been among the most coveted investors in hedge funds, and that 16 percent figure understates the attention such funds have garnered from in-house and third-party marketers.  However, at least three recent developments have complicated the process of marketing to public pension funds.  The first two of those three developments are discussed in this article.  The third such development is this: an authoritative recent interpretation of New York City’s lobbying law, and recent amendments to California’s lobbying law, likely will require placement agents and other third-party 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.  Most dramatically, both California and New York City 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.  In other words, the lobbying laws of both jurisdictions appear to prohibit – or at least complicate – precisely the types of compensation structures most typically found in placement agent agreements and many in-house marketer agreements.  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).  Of course, the lobbying laws only prohibit or complicate such compensation structures in connection with solicitation activities directed at public pension funds in California or New York City.  However, those jurisdictions contain public pension funds – notably including CalPERS – whose actions are widely followed by other public pension funds and other institutional investors.  See “CalPERS Special Review Foreshadows Seismic Shift in Business Arrangements among Public Pension Funds, Hedge Fund Managers and Placement Agents,” The Hedge Fund Law Report, Vol. 4, No. 1 (Jan. 7, 2011).  This article is the first installment in a three-part series intended to explore the implications of the New York City and California lobbying law developments for various hedge fund industry participants.  Specifically, this article provides the legal basis on which the analyses in parts two and three will be based.  The core of this article is a proprietary, 14-page chart summarizing the key provisions of the New York City and California lobbying laws, and comparing those provisions side-by-side.  For example, column one of the chart lists a provision (e.g., people and entities whose efforts to influence investment decisions may constitute “lobbying” under relevant law), column two describes the provision under New York City law, and column three describes the provision under California law.  The intent of this layout is to enable subscribers to easily compare the way in which the different jurisdictions handle the same concept.  The specific provisions covered by the chart include: primary legal, regulatory and interpretive resources, and links thereto; affected pension funds; definitions of “lobbyist”; definitions of “client” (NY), “external manager” (CA) and “lobbyist employer” (CA); definitions of “lobbying”; people and entities whose efforts to influence investment decisions may constitute “lobbying” under relevant law; exceptions from the definition of “placement agent”; people and entities, contacts with whom may constitute “lobbying” under relevant law; registration requirements for lobbyists; timing and frequency of required filings by lobbyists of statements of registration; filing requirements applicable to clients of lobbyists; periodic filing requirements applicable to lobbyists; prohibitions on contingent compensation; other prohibitions; recordkeeping requirements; the requirement to attend ethics training courses; penalties for violations of lobbying laws; and the public availability of reported data.  Part two of this article series will examine the implications of these lobbying law developments for the activities and compensation of third-party hedge fund marketers, and part three of this series will examine the implications for in-house marketers.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    How Can Liquid Hedge Funds Be Structured to Accommodate Investments in Illiquid Assets?

    During the past decade, an increasing volume of hedge fund dollars has poured into traditional liquid strategies.  As a result, market inefficiencies have narrowed or vanished, and opportunities for arbitrage – and the alpha it can generate – have grown fewer and farther between.  In response, some hedge fund managers that traditionally focused on liquid strategies started investing at least part of their funds’ capital in private equity and other illiquid securities and assets.  However, using liquid fund vehicles to invest in illiquid assets has presented a variety of problems, including those relating to: taxation, liquidity, valuation, manager compensation, strategy drift, due diligence, expectations regarding returns and regulatory scrutiny.  While there has been considerable discussion regarding the convergence of hedge funds and private equity funds, the experience and aftermath of the credit crisis indicate that the convergence discussion should be more refined.  Convergence at the fund level is problematic because illiquids do not fit naturally into a liquid fund.  Convergence at the manager level – for example, the same manager managing both private equity funds and hedge funds – is marginally more palatable, but by and large, institutional investors have demonstrated a preference for managers who stick to their knitting.  In a guest article, Philippe Simoens, Senior Manager in Tax and Strategic Business Services for Weaver, an independent certified public accounting firm, addresses some of the reasons why illiquid assets present problems when housed in liquid funds – even liquid funds purportedly structured to accommodate illiquid investments via mechanisms such as side pockets.  In the course of doing so, this article explains traditional liquid fund structuring and taxation; characteristics and taxation of marketable securities versus private equity; and structures employed by liquid funds to accommodate illiquid assets (including side pockets, lock-ups, gates and redemption suspensions).  The article concludes with thoughts on structuring for managers who traditionally have focused on liquid strategies, but who are exploring illiquid opportunities.

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  • From Vol. 3 No.49 (Dec. 17, 2010)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three)

    Talent has always been mobile in the hedge fund industry.  But at least seven factors are increasing the pace with which hedge fund talent − investment talent (portfolio managers, analysts, traders) as well as non-investment talent (professionals focusing on marketing, operations, law, accounting, compliance and technology) − is moving from proprietary trading desks at investment or commercial banks (prop desks) to a range of other entities, most notably, start-up and existing hedge fund managers.  First, the Volcker Rule generally prohibits U.S. banking institutions and non-U.S. banking institutions with U.S. banking operations from: (1) proprietary trading unrelated to customer-driven business; and (2) sponsoring or investing in hedge funds or private equity funds, or engaging in certain covered transactions with advised or managed hedge funds or private equity funds.  See "Implications of the Volcker Rule – Managing Hedge Fund Affiliations with Banks," The Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010).  Second, many of the investment and commercial banks that house proprietary trading desks have been subject to explicit or implicit restrictions on or reviews of compensation of key personnel.  Third, the availability of hedge fund seed funding has increased.  For example, a December 2010 survey conducted by private fund data provider Preqin found that the number of hedge fund investors expressing an interest in seed investments has almost doubled, from 11 percent in 2009 to 21 percent in 2010.  See also "How to Structure Exit Provisions in Hedge Fund Seeding Arrangements," The Hedge Fund Law Report, Vol. 3, No. 40 (Oct. 15, 2010).  Fourth, many existing hedge fund managers have renegotiated, reset or regained their high water marks.  See "How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?," The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009).  Fifth, many hedge fund industry professionals have no choice: they have been fired from prop desks, and plying their trade at a new institution is their highest value opportunity.  Sixth, according to a Fall 2010 Institutional Investor Survey conducted by Bank of America Merrill Lynch Capital Introductions, institutional investors are considerably more “bullish” on alternative investments than they are about traditional equities and fixed income investments.  Seventh, and finally, there is a considerable volume of dormant savings, particularly in the developing world (especially the so-called BRIC countries) and parts of developed Asia; many of the new funds being launched (by new or existing managers) are intended to tap this well of savings.  See "Local Currency Hedge Funds Expand Marketing and Investment Opportunities, but Involve Currency Hedging and Other Challenges," The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).  Despite these seven factors (and there are likely others) motivating and hastening the movement of talent into and within the hedge fund industry, talent does not move in an entirely free market.  Rather, the mobility of talent is bound up in a web of legal and practical restrictions.  The basic purpose of this article − the first in a three-part series − is to identify relevant legal issues and offer practical suggestions to help talent negotiate the transition from a prop desk to the next hedge fund opportunity.  (The second article in this series will look at talent moves from the bank perspective, and a third article will look at talent moves from the perspective of the hedge fund management company to which the talent moves.)  To serve its purpose, this article discusses the following: the definition of "talent" (we are using the word as shorthand for a variety of typical job descriptions); the working definition of proprietary trading; the various types of entities from which and to which talent may move; which types of entities are likely to be the biggest winners in the movement of talent away from prop desks, and why; examples of recent talent moves from prop desks to other institutions; key legal considerations applicable to all moving hedge fund talent, whether such talent is moving to an existing hedge fund manager or starting its own shop (this discussion includes subtopics such as non-competition agreements, non-solicitation agreements, ownership of performance data and intellectual property, etc.); the key legal considerations specific to talent leaving a prop desk to start a new hedge fund management company; and the chief practical and cultural issues faced by talent that departs a prop desk to start or participate in running a hedge fund management company.

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  • From Vol. 3 No.33 (Aug. 20, 2010)

    Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds

    Given the ever-increasing levels of investment from pension plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) in hedge funds, ERISA considerations can be significant for fund sponsors and managers, and for other service providers to hedge funds and other private funds.  Sometimes, ERISA issues can rise to the level of being significant business considerations.  The exemption under Section 408(b)(2) of ERISA from ERISA’s prohibited transaction rules permits a service provider to an employee benefit plan to receive compensation for the services in the case of “reasonable compensation” for “necessary” services under a “reasonable” arrangement.  Regulations of the U.S. Department of Labor (the “DOL”) promulgated in 1977 had elaborated on the circumstances in which the exemption would be available.  Much has happened since 1977, and there have been recent comprehensive legislative and regulatory proposals to address the level of fee-related disclosure available to fiduciaries and plan participants and beneficiaries.  On the regulatory side, the DOL recently made extensive revisions to the compensation-related information that plan administrators are required to report annually on the “Form 5500,” and has previously issued proposed regulations that would affect the disclosure of fees charged in connection with participant-directed “401(k)” and other plans.  Following its 2007 release of a controversial set of proposed Section 408(b)(2) regulations, the DOL has now issued long-awaited interim final regulations under Section 408(b)(2) requiring increased disclosure of compensation in the case of certain services to pension plans.  Under the new regulations, where they are applicable, an arrangement for providing services to a pension plan will be treated as “reasonable” only if the service provider discloses to the plan specified compensation-related information.  Notwithstanding the major changes from the 2007 proposals, and arguably reflecting the urgency with which the DOL views these issues, the new regulations are not in reproposed form, but rather are interim final regulations.  The effective date of the new regulations is, however, generally delayed until July 16, 2011.  (It is noted that the new regulations do not apply to “welfare” plans, and that future regulations are expected that would address welfare plans.  The new rules also do not apply to individual retirement accounts and similar arrangements.)  Once the rules become effective, they will apply both to future arrangements as well as to arrangements then already in place.  A failure to meet the requirements for the Section 408(b)(2) exemption could cause the payment of compensation to a provider of services to an employee benefit plan to be a prohibited transaction under ERISA and the corresponding provisions of the U.S. tax code.  The consequences of a prohibited transaction can be extremely significant, including, for example, punitive excise taxes, the possibility of fee disgorgement and other potential liabilities on the service provider.  Thus, it may be critical that fiduciaries and other service providers subject to the new rules be in compliance with the new regulations, once they are applicable.  In a guest article, Andrew L. Oringer, a Partner at Ropes & Gray LLP, and Steven W. Rabitz, a Partner at Stroock & Stroock & Lavan LLP, provide a sampling of some of the issues that may be of particular interest to fund sponsors.

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  • From Vol. 3 No.30 (Jul. 30, 2010)

    Heidrick & Struggles Report Details Compensation Numbers and Employment Contract Terms for Hedge Fund Marketing Professionals, Risk Managers and CCOs, and Outlines Industry Trends

    On July 27, 2010, Heidrick & Struggles International, Inc. (Heidrick), a leadership advisory firm providing global executive search and leadership consulting services, released its Report on Hedge Fund Industry Trends for 2010.  “The hedge fund industry is turning on its head – with regulatory and distribution pattern changes having a big impact on talent in the sector,” said Daniel Edwards, co-author of the Report and newly appointed U.S. Hedge Fund Sector Leader for the firm.  (For this and other recent personnel changes at Heidrick, see the People Moves section of this issue of The Hedge Fund Law Report.)  The Report makes general market observations regarding the U.S., European and Asian hedge fund markers; outlines talent trends; reviews hedge fund manager employee contract terms and compensation numbers; and includes sections on launches and liquidations as well as the regulatory outlook.  This article reviews the key take-aways from the Heidrick Report.

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  • From Vol. 3 No.24 (Jun. 18, 2010)

    New York State Courts Side With Elm Ridge Hedge Funds and Founder Ronald Gutfleish in Fee Dispute With Former Manager Douglas DiPasquale

    On May 18, 2010, the New York State Supreme Court, Appellate Division, First Department, affirmed a Manhattan trial court order entering partial summary judgment on behalf of the defendants, Ronald Gutfleish, Elm Ridge Capital Management, LLC (ERCM), Elm Ridge Value Advisors, LLC (ERVA), Elm Ridge Partners, LLC (ERP) and Elm Ridge Management, LLC (ERM), in a separation agreement fee dispute with a former manager, Douglas DiPasquale, the plaintiff.  DiPasquale had resigned as co-managing member of ERCM and ERVA, two firms that advised and managed three hedge funds controlled by Gutfleish, in exchange for a share of future profits from ERCM and ERVA.  Following DiPasquale’s resignation, Gutfleish created ERP and ERM to replace ERVA and ERCM, and ceased payments to DiPasquale.  The New York State courts dismissed DiPasquale’s complaint to the extent that he sought damages from the defendants because they found the separation agreement authorized Gutfleish’s actions.  We detail the background of the action and the courts’ legal analysis.

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  • From Vol. 3 No.21 (May 28, 2010)

    Investments by Hedge Fund Managers in Their Own Funds: Rationale, Amounts, Terms, Disclosure, Duty to Update and Verification

    Corporate and investment management law are replete with doctrines intended to put the interests of investors (principals) ahead of those of managers (agents).  Such doctrines include fiduciary duty, the duty of care, the duty of loyalty and anti-fraud rules.  However, such doctrines routinely run up against human nature.  While generosity, especially in the form of tax-deductible charitable giving, is a noteworthy and laudable trait among the managerial class, selflessness in zero-sum situations – where my loss is your gain – generally is not a defining characteristic of corporate or investment managers.  That’s not why people get into this business.  Yet selflessness among managers is precisely the ideal to which the foregoing doctrines aspire.  The tension between this aspiration and reality is the stuff of daily business news.  In its most tame variety, this tension plays out in the ongoing debates about compensation of executives of public companies.  And in its most extreme incarnation, the tension manifests itself in lurid investment adviser frauds and Ponzi schemes.  Economists call this tension the principal-agent problem.  The problem is that corporate or investment managers have the legal right to decide what to do with assets they do not own, and therefore may take actions that benefit themselves (the managers) but that are not in the best interests of the owners.  The separation of ownership and control is a common feature of public companies, where the equity owned by management is small relative to the equity over which management exercises day-to-day control.  Even in many mutual funds, the management company or individual portfolio manager often only owns a small investment.  By contrast, a distinguishing feature of the hedge fund business model is substantial investment by the hedge fund manager – the individual portfolio manager as well as partners and employees of the management company – in its own funds.  While such investments are not legally required, they are a tradition and an expectation among institutional investors.  Indeed, in its 2009 annual report, the Yale endowment (a pioneer among institutional investors in hedge funds) noted: “An important attribute of Yale’s investment strategy concerns the alignment of interests between investors and investment managers. . . .  [M]anagers invest significant sums alongside Yale, enabling the University to avoid many of the pitfalls of the principal-agent relationship.”  See “Lessons for Hedge Fund Managers on Liquidity, Allocations, Marketing and More from Yale’s 2009 Endowment Report,” The Hedge Fund Law Report, Vol. 3, No. 14 (Apr. 9, 2010).  This article analyzes various aspects of investments by hedge fund managers in their own funds, including: the rationales for such investments from both the investor and manager perspectives; the “market” for the amounts of such investments (as a percentage of the individual manager’s liquid net worth); the concern among investors where the manager has invested too little or too much in its own funds; reinvestment of bonuses in managed funds; the terms of manager investments; when, where and in what level of detail to disclose manager investments and redemptions; whether and in what circumstances managers have a duty to update representations regarding their fund investments; and how investors can verify managers’ representations with respect to their investments.

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  • From Vol. 3 No.9 (Mar. 4, 2010)

    California Appellate Court Affirms $19 Million Arbitration Award Against Russel Bernard, Former Principal of Hedge Fund and Private Equity Fund Manager Oaktree Capital Management

    On February 22, 2010, the California Court of Appeal for the Second District affirmed a Los Angeles Superior Court order confirming an arbitration award against Russel S. Bernard, a former principal at hedge fund and private equity fund manager Oaktree Capital Management, L.P.  In an incentive fee dispute between Bernard and Oaktree, an arbitrator had found that Bernard breached his fiduciary duty to Oaktree when, in his role as fund manager, he stalled the launch of a new fund and appropriated an investment opportunity in order to form a competing private equity fund, Westport Capital Partners.  The arbitrator awarded Oaktree $12.3 million for the management fees it lost from the delayed venture, as well as $6.7 million in attorney’s fees, costs and interest; it also refused Bernard’s demand for payment of incentive fees based on his performance before his resignation.  The appellate court “affirm[ed] the award because [Bernard] did not satisfy the narrow grounds for judicial review of an arbitration award.”  We summarize the background of Oaktree’s action against Bernard and the California appellate court’s legal analysis.

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  • From Vol. 3 No.8 (Feb. 25, 2010)

    Federal District Judge in Texas Dismisses Former Executives’ Employment Contract Dispute Against Hedge Fund Firm D.B. Zwirn & Co. Over Unpaid Bonuses

    Representing a new trend in hedge fund litigation created by the recent financial crisis, various former hedge funds executives have been suing their former employers or partners for unpaid or allegedly unpaid bonuses or other compensation.  See, e.g., “Co-Founder of Hedge Fund Manager Camulos Partners Sues Other Co-Founder for $67 Million in 'Unlawfully Seized' Bonuses and Investments,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010); “New York Appellate Division, First Department, Affirms Dismissal of Breach of Employment Contract Claim Against Hedge Fund Manager Stanfield Capital Partners,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010); “Minnesota Appeals Court Affirms that Repeated Oral Representations Preclude Limitations Defense in Hedge Fund Manager’s Claim for Unpaid Bonuses,” The Hedge Fund Law Report, Vol. 3, No. 2 (Jan. 13, 2010); “Touradji Capital Management Countersues Ex-Hedge Fund Portfolio Managers,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  In this instance, on February 8, 2010, the United States District Court for the Southern District of Texas summarily dismissed a lawsuit over unpaid bonuses brought by plaintiffs Todd A. Dittmann and Susan Chen against their former employer, defendant hedge fund firm D.B. Zwirn & Co., L.P. (DBZ).  The litigation began in February 2009, when Dittmann, and later Chen, filed complaints against DBZ claiming it had breached their respective contracts for employment compensation, and adding causes of action including, among other things, fraud, quasi-contract and violations of the New York State Labor Law.  In rejecting the lawsuit, the District Court concluded that plaintiffs “worked in a high risk industry with the potential for high rewards[,]” received suitable compensation for several years, and that, in 2007, when “DBZ’s business declined through no apparent fault of the Plaintiffs, DBZ reduced their bonuses and ultimately failed to pay, “all in compliance with the terms of the[ir] employment agreement[s].”  We detail the background of the lawsuit and the court’s legal analysis. 

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    What Effect Will the Carried Interest Provision in the Tax Extenders Act Have on Hedge Fund Managers that Are or May Become Publicly Traded Partnerships?

    On December 9, 2009, the U.S. House of Representatives passed legislation that includes a provision that would tax as ordinary income any net income derived with respect to an “investment services partnership interest.”  This carried interest provision in the Tax Extenders Act of 2009, H.R. 4213, would change the tax treatment of the performance allocation that, in years in which a hedge fund has positive investment performance, constitutes the bulk of a hedge fund manager’s revenue.  Currently, most managers structure performance allocations so that all or most of such compensation is taxed as long-term capital gains at a rate of 15 percent.  The carried interest provision would subject such compensation to tax at ordinary income rates, which for hedge fund managers generally would be at a marginal rate of approximately 35 percent.  For more discussion of the Tax Extenders Act, see “Bills in Congress Pose the Most Credible Threat to Date to the Continued Tax Treatment of Hedge Fund Performance Allocations as Capital Gains,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).  The Extenders Act also contains a provision that would effectively cause any publicly traded partnership (PTP) that derives significant income from investment advisory or asset management services to be treated, for tax purposes, as a corporation.  This is because the provision would treat carried interest income as non-qualifying income for purposes of determining whether a PTP meets the 90 percent “good income” test.  That test specifies that partnerships that (1) satisfy the 90 percent good income test (described in more detail in this article) and (2) are not registered under the Investment Company Act of 1940 will, in general, continue to be treated as partnerships and not as Subchapter C corporations for federal income tax purposes.  This article examines the federal tax treatment of the carried interest received by hedge fund managers, as well as the tax treatment of PTPs.  The article also outlines the likely effects of the Extenders Act on the tax treatment of both, and explains tax planning steps that hedge fund managers may take to avoid some of the adverse tax consequences of the bill.

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    Co-Founder of Hedge Fund Manager Camulos Partners Sues Other Co-Founder for $67 Million in “Unlawfully Seized” Bonuses and Investments

    On December 30, 2009, William Seibold, an investor in hedge fund Camulos Partners LP, and an equity interest holder in hedge fund manager Camulos Capital LP and fund general partner Camulos Partners GP LLC, sued the Camulos entities and their controlling individuals for over $67 million in the Delaware Chancery Court.  His complaint alleges that the defendants, through a “calculated scheme and brazen abuse of power,” forced him out of the management partnership and “deprived him of millions of dollars of his investments, compensation and equity.”  His sixteen-count complaint includes claims for statutory theft, conversion, unjust enrichment, breach of contract, tortious interference with contract, breach of fiduciary duty and civil conspiracy.  This article summarizes the primary factual and legal allegations in the complaint.

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    IRS Issues Guidance on Compliance with Section 409A Requirements Applicable to Deferred Compensation Plans of Hedge Fund Managers

    In 2004, as part of the American Jobs Creation Act, Congress amended the Internal Revenue Code to include Section 409A, which generally requires recipients of deferred compensation to elect the time and form of deferred compensation payments in a manner that complies with Section 409A and Sec. 1.409A-1(c) of the Income Tax Regulations.  Failure to elect time and form properly, or utilizing an acceleration of deferred compensation payments, can subject the employee, director, independent contractor or other “service provider,” which may be an individual, corporation, partnership or limited liability company, to an additional 20 percent income tax, accelerated taxation of the deferred payments and heightened interest assessments.  Section 409A was enacted in response to the corporate scandals of the early Naughts, such as Enron, Tyco and WorldCom, and was intended to curb the practice of executives deferring large amounts of compensation and to eliminate the ability of executives to vary the payment schedule by which they received deferred compensation.  In attempting to curb these perceived “evils,” Congress, in enacting Section 409A, created a statute that is hyper-technical in its application, with harsh penalties for noncompliance.  Hedge fund managers, who may be considered “service providers” under the statute, should examine compensation plans that include any form of deferred compensation, including deferral of management or performance fees, for compliance with Section 409A.  Because the penalties for noncompliance are harsh, the Internal Revenue Service (IRS) has issued guidance on correcting plan failures.  In 2008, the IRS provided guidance on operational failures.  However, on January 5, 2010, the IRS issued Notice 2010-6, which provides guidance on correcting document failures.  Both notices provide guidance relevant to hedge fund managers and should be closely examined.  This article examines the scope of Section 409A and Notice 2010-6 and details the applicability of both to hedge funds and hedge fund managers.

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    New York Appellate Division, First Department, Affirms Dismissal of Breach of Employment Contract Claim Against Hedge Fund Manager Stanfield Capital Partners

    On December 22, 2009, the New York State Supreme Court, Appellate Division, First Department, affirmed the decision of a New York County trial court dismissing Richard Johnson’s complaint against his former employer, New York-based hedge fund manager Stanfield Capital Partners, LLC.  Johnson had sued Stanfield for allegedly breaching their employment agreement by failing to pay him millions in additional bonus compensation.  In support of his claims, Johnson represented that he had entered into an “oral” agreement with a member of the firm for an annual formulaic bonus arrangement.  Noting the existence of an “integrated” written employment agreement that called for only discretionary bonuses, the Appellate Division held that the parol evidence rule precluded Johnson from introducing evidence contradicting those terms.  We detail the background of the action, the court’s legal analysis and various additional arguments made by Stanfield (including a Statute of Frauds argument) on which the court did not have occasion to rule (because it found Stanfield’s parol evidence argument sufficient for dismissal).

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    Federal District Court Denies Summary Judgment to J.P. Morgan Chase as to Whether Its Hedge Fund Accounting Business Employees Were Exempt from Fair Labor Standards Act Overtime Pay Requirements

    Plaintiff Damian Hendricks (Hendricks) was a “Fund Accounting Specialist” in the “Hedge Fund Services” business of defendant J.P. Morgan Chase Bank (JPMorgan).  Plaintiff Michael Minzie (Minzie) was a “Fund Accounting Analyst” in that business.  They performed various services in connection with JPMorgan’s preparation of financial statements for hedge fund clients.  Both were paid a weekly salary and were eligible for bonuses.  They claimed on behalf of themselves “and on behalf of other similarly situated individuals” that JPMorgan failed to pay them overtime in violation of the federal Fair Labor Standards Act (FLSA).  Following discovery and depositions, JPMorgan moved for summary judgment, claiming that Hendricks and Minzie were exempt from the FLSA overtime requirements because they were both employed in bona fide professional and administrative capacities.  In a decision that serves as an excellent primer on the applicability, in the hedge fund context, of exemptions from overtime pay under the FLSA and the analogous Connecticut law, the district court denied the motion, holding that there were significant issues of fact as to the nature of the employees’ duties.  We summarize the factual allegations and the court’s decision.

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  • From Vol. 3 No.2 (Jan. 13, 2010)

    Minnesota Appeals Court Affirms that Repeated Oral Representations Preclude Limitations Defense in Hedge Fund Manager’s Claim for Unpaid Bonuses

    On December 29, 2009, the Minnesota Court of Appeals affirmed that a hedge fund manager’s claim for overdue, unpaid bonuses was not barred by the statute of limitations because: (1) the owing party orally acknowledged, and thus extended, the due date for the bonuses; and (2) the owing party was equitably estopped from asserting this defense because the manager reasonably relied on those representations when he spent large sums to build a house.  However, the appellate court reversed a $126,352 award of fees and costs to the hedge fund manager, finding that the lower court abused its discretion in awarding those fees and costs.  This article offers extensive detail on the factual background of the case and the court’s legal analysis.

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  • From Vol. 2 No.52 (Dec. 30, 2009)

    Bills in Congress Pose the Most Credible Threat to Date to the Continued Tax Treatment of Hedge Fund Performance Allocations as Capital Gains

    On December 9, 2009, the U.S. House of Representatives passed the Tax Extenders Act of 2009 (Extenders bill), H.R. 4213.  The bill, if it were to become law, would extend through the end of 2010 a package of tax relief provisions that otherwise would expire at the end of 2009.  Of particular interest to hedge fund managers are several provisions of the Extenders bill included with the goal of raising revenue to offset extended tax relief measures.  Specifically, the bill includes a provision that would tax as ordinary income any net income derived with respect to an “investment services partnership interest.”  The bill defines “investment services partnership interest” as a partnership interest held by a person where it is reasonably expected that the partner or a person related to the partner will provide substantial investment services to the partnership.  The result of this provision would be to change the tax treatment of the performance allocation that constitutes, in up years, the bulk of hedge fund manager revenue.  Currently, most managers structure performance allocations so that all or most of such compensation is taxed as long-term capital gains at a rate of 15 percent.  The Extenders bill would tax such compensation as ordinary income, generally for hedge fund managers at a marginal rate of approximately 35 percent.  In addition, as ordinary income, such compensation would be subject to any applicable self-employment taxes and state and local taxes.  See generally “IRS ‘Managed Funds Audit Team’ Steps Up Audits of Hedge Funds and Hedge Fund Managers, and Investigations of Hedge Fund Tax Compliance Issues,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  As discussed in more detail in this article, the Extenders bill also includes provisions that are similar to the reporting provisions in the proposed Foreign Account Tax Compliance Act of 2009 (FATCA), introduced in the Senate as S. 1934 and in the House (with the same name) as H.R. 3933.  With the support of President Obama and Treasury Secretary Geithner, FATCA was introduced on October 27, 2009 as a means of combating overseas tax havens.  FATCA would affect all foreign financial institutions (FFIs) that invest in U.S. stocks and securities.  Complying FFIs would be required to report financial account information of all U.S. persons to the Internal Revenue Service or subject all payments of U.S. source passive income and gross proceeds from the sale of U.S. securities to a 30 percent withholding tax.  This article details and analyzes the provisions of the Extenders bill and FATCA that are most relevant to hedge fund managers.  Where provisions of the two bills are similar, this article compares specific mechanics.  This article also highlights the differences between the two bills, and discusses, with the benefit of insight from leading practitioners, the implications of the bills for hedge fund manager compensation, tax planning, domicile, structuring, reporting, treatment of so-called “recalcitrant account holders” and more.

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    Infovest21’s Annual Hedge Fund Manager Compensation Survey Reveals Top Paid Manager Positions and Top Factors Affecting Performance

    Infovest21, LLC, an information services company for the hedge fund industry, conducted its eighth annual executive compensation survey of hedge fund managers in the fall of 2009.  The survey aimed to: (1) analyze the compensation structures of hedge fund managers during the current year; and (2) examine major trends as perceived by fund managers.  It analyzed results separately for those managers with assets over $1 billion and those with assets under $1 billion.  This article focuses on the salient findings from the former category, addresses the survey’s approach and methodology and describes the profile of the respondents surveyed (including an analysis of recent cost cutting efforts).  Importantly, this article also details compensation trends for employees at various levels at hedge fund managers, factors affecting compensation and the impact of asset size on the survey findings.

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    Prospectus for Suspended Ellington Financial IPO Details Mechanics of a Hedge Fund Permanent Capital Vehicle

    Only days after Ellington Financial LLC (Ellington), run by Michael Vranos’ hedge-fund firm, Ellington Management Group, LLC (Manager), filed a prospectus with the SEC announcing a planned initial public offering (IPO) to raise cash in order to purchase mortgage-backed bonds, Ellington suspended the IPO due to “market conditions.”  The IPO was premised on the idea that investors would be willing to purchase Ellington shares at a premium, an average of $26 per share, 6.1 percent more than the value of its net assets, or 1.06 times Ellington’s shareholder equity, so that Ellington could invest in potentially underrated home loans in the recovering United States housing market.  While the IPO has ceased, its mechanics and the risk factors discussed in the Ellington prospectus remain particularly interesting for hedge fund managers contemplating a similar issuance of shares to obtain so-called “permanent capital” for the purpose of investing in designated assets.  This article summarizes the material terms and provisions of the Ellington prospectus and the suspended IPO.

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  • From Vol. 2 No.49 (Dec. 10, 2009)

    Stars in Transition: A New Generation of Private Fund Managers

    The economic events of 2008 and 2009 resulted in significant displacement of star talent from market-leading investment banks and similar financial institutions, some of which have ceased to exist.  Some of those stars have moved on to their own ventures, and are launching their own investment management firms to raise hedge or private equity funds.  For most of their careers, some of these individuals, or entire teams of talent, may have thrived in larger institutional environments; however, now many are facing new challenges with practical issues they never had to address, or be bothered with, in the past.  Basic questions can range from something as fundamental and potentially complicated as “do I need to register with the SEC and what rules apply to me?” to something much more basic like “are the terms of this office lease a good deal for me?”  Any manager starting a hedge fund or private equity fund advisory business, whether an experienced veteran or first-timer, will need to think about many issues that could be broadly grouped within the following five categories: (1) seed investors/compensation arrangements; (2) registration requirements for the investment manager and its funds; (3) other regulatory issues impacting private funds; (4) the fund’s offering and operating documents; and (5) the investment manager’s business operations and service providers.  In a guest article, Ira P. Kustin, a Partner in the investment funds practice group at Akin Gump Strauss Hauer & Feld LLP, details the relevant considerations for start-up managers in each of these five categories.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    Hedge Fund Managers Considering Fund Appreciation Rights Compensation Structures to Defer Tax on Performance Compensation and to Better Align Manager and Investor Incentives

    In the public company context, before stock options got a bad name via backdating scandals and unintended consequences (a skewing of incentives towards the short-term, unintended windfalls, etc.), they were seen as a potent tool for mitigating the adverse effects of the oft-bemoaned separation of ownership and control.  Executive compensation debates, however, are not the exclusive province of commentators on public companies.  The credit crisis focused the attention of hedge fund investors on executive compensation at hedge fund managers in a way that good times never could.  See “Addressing (and Resisting) Demands for Changes in Hedge Fund Manager Compensation,” The Hedge Fund Law Report, Vol. 2, No. 16 (Apr. 23, 2009).  As distinct from discussions of executive compensation at public companies, where the chief criticism often relates to the absolute level of compensation, hedge fund manager compensation discussions more often relate to the structure of compensation.  In particular, one of the primary criticisms leveled during the credit crisis was that measuring performance fees over one year failed adequately to reflect the reality of most hedge fund investment strategies, which require more than one year for realization.  Similarly, the idea of measuring performance compensation over a single year has been criticized as incentivizing managers to take undue risks and for potentially rewarding negative performance over multiple years.  In an effort to better align the incentives of managers and investors, hedge fund managers have been evaluating the viability of fund appreciation rights (FARs), which offer a mechanism of manager compensation analogous to stock options.  This article explores this provocative compensation structure, and includes analysis of: the mechanics of FARs; the analogy to call options; how FARs may offer the potential to better align the incentives of managers and investors; the clawback mechanism often built into FARs; a numerical example of how a FARs structure could operate in practice; how FARs can help retain talent, especially in lean years; whether FARs can be used in existing funds in addition to new funds; whether FARs can be used in domestic funds in addition to offshore funds; the tax consequences of FARs; and the market interest in FARs.

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  • From Vol. 2 No.43 (Oct. 29, 2009)

    New Heidrick & Struggles Report Reveals Significant Uptick in Hedge Fund Hiring and Provides Salary Numbers

    Despite a troubled economy, demand for hedge fund professionals has bounced back.  According to a recent report published by Heidrick & Struggles International Inc. (HSII) titled “Hedge Fund Industry Trends,” hedge fund firms dramatically increased their hiring efforts in late August and September 2009 as they sought to rebuild assets under management after the industry’s worst year on record.  Much of that demand centered on hiring sales and marketing executives who can help hedge funds attract new investors.  This article summarizes the most salient findings from the report and focuses largely on the findings as they relate to hedge funds’ increased hiring and marketing efforts.  In particular, our coverage includes details from the HSII report on the “market” for salaries for specific hedge fund positions.

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  • From Vol. 2 No.40 (Oct. 7, 2009)

    How Can Hedge Fund Managers Minimize Tax on Deferred Compensation from Offshore Hedge Funds?

    Hedge fund managers are painfully aware of the U.S. government’s efforts to eliminate the tax benefits associated with their foreign deferred compensation plans.  In 2004, Congress amended the Internal Revenue Code by adding Section 409A, which prohibited the use of foreign trusts in connection with deferred compensation plans.  More recently, in 2008, Congress enacted IRC § 457A, which makes foreign deferred compensation plans fully income taxable as of January 1, 2017.  As a result, the tax bar has been working overtime to develop tax compliant strategies that would mitigate the disastrous effects of Congress’ campaign to increase taxes on hedge fund managers’ income.  Tax attorneys’ efforts have, however, been largely unsuccessful – until now.  In a guest article, Kenneth Rubinstein, Senior Partner at Rubinstein & Rubinstein, LLP, details one strategy that has been developed that will significantly minimize the income tax payable on foreign deferred compensation and blunt the effect of IRC § 457A in a tax compliant manner.  Based on the use of a “hybrid” trust that avoids the prohibitions of IRC § 409A and utilizing the long-standing tax advantages that Congress and the Internal Revenue Code bestow upon life insurance, this strategy will allow early access to the majority of deferred compensation assets on a tax-free basis and eliminate estate tax on plan assets upon the death of the manager.

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  • From Vol. 2 No.35 (Sep. 2, 2009)

    Will Increased Tax Rates and More Onerous Regulation Cause Hedge Fund Managers to Leave London?

    London is one of the world’s premier centers of hedge fund management.  A recent ranking of the world’s 11 most successful hedge fund managers listed two headquartered in London: Winton Capital Management and Brevan Howard Asset Management.  But there has been, for months now, a good deal of talk about an exodus of hedge fund managers from the U.K.  That talk has been fueled by two factors: recent tax law changes and the European Commission’s proposed Alternative Investment Fund Managers Directive (Draft Directive).  We detail the tax law changes, and analyze whether they and the Draft Directive really have the potential to engender the much-discussed flight, or whether such flight constitutes an exaggerated threat.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

    How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?

    Despite solid year-to-date performance, many hedge funds remain below their prior net asset values (NAVs), in many cases achieved during the first half of 2007.  As a technical matter, the governing documents of most hedge funds contain so-called high water mark or loss carry-forward provisions stating that the manager cannot collect a performance fee or allocation until the NAV of the fund exceeds its highest prior level.  But as a practical matter, the performance fee is a critical part of the hedge fund business model.  Among other things, performance fees enable managers to offer the compensation packages required to attract and retain top investment and other talent; and such talent is necessary to offer the incremental advantages in terms of insight and analysis that distinguish one hedge fund from another – that enable one fund to yield alpha while others just deliver beta or losses.  And hedge fund investors recognize this: by and large, they are invested in hedge funds for uncorrelated, absolute returns.  They’re not in hedge funds – at least primarily – to save money on fees.  (Fee saving is what bond and stock index funds are for.)  Investors want their managers incentivized, and thus investors have generally been willing to negotiate alternative arrangements with respect to performance fees or allocations with managers whose funds are below their high water marks.  In a sense, the experience of the past year and a half has demonstrated that high water mark provisions in hedge fund documents do not provide a roadmap for how the relationship between hedge fund managers and investors actually operates.  Rather, such provisions provide a starting position for negotiations between hedge fund managers and investors with respect to performance fees or allocations so long as a manager’s best days remain, at least for the moment, behind him or her.  This article explores what performance fees and allocations are (including a discussion of the tax purpose and effect of mini-master funds); how high water mark provisions affect a manager’s ability to collect such compensation; specific ways in which managers and investors are renegotiating performance fees or allocations in the “shadow” of high water mark provisions; the rationale among managers for seeking, and among investors for consenting to, such revised performance fee or allocation arrangements; and the process for obtaining consent to such revised arrangements, and the circumstances in which negative consent may be viable.

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  • From Vol. 2 No.32 (Aug. 12, 2009)

    Corporate and Financial Institution Compensation Fairness Act of 2009 Threatens Unprecedented Regulation of Hedge Fund Performance Fees

    On July 31, 2009, the U.S. House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 2009 (Act).  The Act consists of two components.  The first component is a “say-on-pay” provision that would, among other things, provide for a separate, non-binding shareholder vote on executive compensation and “golden parachutes” at public companies.  The second component – and the more interesting (and potentially game changing) one for hedge fund managers – provides for “enhanced compensation structure reporting” requirements that would apply to “covered financial institutions” (CFIs), a term that would include, among others, hedge fund managers.  The enhanced compensation structure reporting requirements would require “appropriate Federal regulators” jointly to prescribe, no later than nine months after the date of enactment of the Act, regulations requiring disclosures that would enable the regulators to determine whether a CFI’s incentive compensation (1) “is aligned with sound risk management,” (2) “is structured to account for the time horizon of risk” and (3) meets such other criteria as the regulators may determine to be appropriate to reduce unreasonable incentives for employees of CFIs to take undue risks that could threaten the safety and soundness of the CFI or could have serious adverse effects on economic conditions or financial stability.  The Act also contains a “rule of construction” providing that nothing in the Act shall be construed as requiring the reporting of actual compensation of individuals, and exempts CFIs “with assets of less than” $1 billion.  The hedge fund community has been taken aback by the capacious and ambiguous drafting, and the profound ramifications that the Act, if passed in its current form, could have for hedge fund compensation arrangements.  Read literally, the Act would give regulators unprecedented discretion to substantively regulate the performance-based fees charged by hedge fund managers – one of the bedrocks of the hedge fund business model (albeit a bedrock that is shifting in its precise shape and scope).  The Act still remains to be passed by the Senate, and presented to the President, and even if it becomes law in something like its current form, the undefined terms in the Act likely would assume some specificity through implementing regulations.  As it stands, however, the Act represents a significant government intervention into an area heretofore considered the exclusive province of private agreements.  We discuss the likely effect of the Act on performance fees, base salaries and assets under management; application of the $1 billion exclusion; likely construction of the phrase “sound risk management” and who will construe it; whether the Act will require calculation of performance fees based on performance over a number of years; and what may constitute “inappropriate risks.”

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  • From Vol. 2 No.31 (Aug. 5, 2009)

    What Is a Chief Risk Officer, and Should Hedge Fund Managers Have One?

    “In the wake of the financial crisis, risk governance has emerged as a key topic,” and “[a]t no time in history has there been a greater need for companies to evaluate and strengthen risk governance.”  These statements, from the executive summary of a recent survey conducted by Capital Market Risk Advisors (CMRA) and the Professional Risk Managers’ International Association (PRMIA), reflect the perception of risk shared by many hedge fund managers, in the broader economy and on Capitol Hill.  That survey, titled “Risk Governance: A Benchmarking Survey” (Survey) analyzes, among other things, the role of Chief Risk Officers (CROs) at various types of financial institutions, including hedge funds.  According to the Survey, only about 50 percent of institutional investors have a CRO and hedge fund boards are less likely than boards of other types of institutions to have executive sessions with the CRO.  Many hedge fund managers do not have a CRO at all, which means that the substantive functions of the CRO are performed by someone else (e.g., the Chief Operating Office (COO), Chief Compliance Office (CCO) or portfolio manager), or are not performed at all.  In either case, the Survey and sources interviewed by The Hedge Fund Law Report concurred that there is value in localizing various risk management functions in one person – both in protecting against downside and in identifying areas for upside.  Broadly, a CRO serving in a consultative role, as opposed to merely a control role (we explore the difference in greater detail in this article), can help the fund manager identify underappreciated areas of risk, or areas where risk has been overstated.  A CRO can add value in risk avoidance and risk appreciation.  This article details the substance of a CRO’s typical role at a hedge fund manager; reporting procedures; control versus strategic roles for CROs; trend and exception reports; CRO compensation; and the likelihood that Congress or a regulator will require hedge funds to have CROs or someone performing their substantive functions.

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  • From Vol. 2 No.25 (Jun. 24, 2009)

    Former Employee Sues Hedge Fund Manager Claiming Entitlement to Bonus “In Perpetuity” Based on Capital Introductions

    Accordingly to publicly available court documents, in February 1995, Kimberly Steel entered into an employment agreement with hedge fund manager Watch Hill Management (Watch Hill).  She was employed as “Managing Director, Investor Relations.”  As such, one of her main duties was to solicit investors for Watch Hill.  Her compensation, according to the documents, was based in large part on the amount of money invested by the investors whom she introduced to Watch Hill Fund L.P. (Fund).  At the end of each quarter, she was to receive a bonus equal to a specified percentage of the capital accounts of the investors whom she had introduced.  The agreement also contemplated that if those investors moved to (or invested additional money with) new funds created by Watch Hill’s principals, those investments would also count towards her bonus.  According to the public documents, Watch Hill Management terminated Steel’s employment as of January 28, 2004, and she sued, claiming that she was to receive a bonus “in perpetuity” based on the capital account balances of the limited partners whom she introduced to the Fund.  More recently, a third-party complaint was filed, containing claims arising out of the same facts and circumstances.  We describe the factual and legal allegations of the complaints, which can have relevance for any hedge fund manager structuring compensation arrangements with partners or employees hired or retained to solicit investors.

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  • From Vol. 2 No.23 (Jun. 10, 2009)

    Delaware Court of Chancery Enforces Oral Agreement and Rules that Departing Hedge Fund Founder is Not Entitled to Share of Hedge Fund’s Equity

    Plaintiff Olson was one of three founders of the Viking Global hedge fund.  In accordance with their governing documents, Olson’s membership in the fund was terminated by the two other founders in 2005.  Olson sued his erstwhile partners and the various fund entities, claiming that he was entitled to receive the value of his equity interest in the various entities that comprised the fund business (valued at tens of millions of dollars).  On May 13, 2009, the Delaware Court of Chancery ruled that, prior to forming the fund, the founders had agreed that a departing partner would only be entitled to receive any unpaid compensation from the fund and the remaining value of the partner’s capital account (as opposed to any deferred compensation or compensation for the value of an equity interest).  The court also ruled that the oral agreement was not superseded by the operating agreements of the various fund entities or any other subsequent agreement.  Because of the continuing validity of that agreement, and its applicability to Olson’s departure, the court determined that Olson was not entitled to (1) any further compensation from the fund, (2) the fair value of his partnership interest under the Delaware Revised Uniform Limited Partnership Act or Limited Liability Company Act or (3) any equitable remedy.  We explain the facts and holding of the case, and outline the court’s analysis.

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  • From Vol. 2 No.22 (Jun. 3, 2009)

    Hedge Fund Managers Using “Mini-Master Funds” to Retain Favorable Tax Treatment of Performance-Based Revenue from Offshore Funds

    With the passage last year of legislation eliminating the ability of U.S. hedge fund managers to defer taxes on fee income from their offshore funds, managers are increasingly employing so-called “mini-master funds” to obtain a different kind of favorable tax treatment for the same revenue.  Traditionally, in a master-feeder structure, managers would enter into an investment management agreement with the offshore fund, which in turn would invest substantially all of its assets (from non-U.S. and U.S. tax-exempt investors) in a master fund.  The investment manager would charge the offshore fund a “performance fee” of 20 percent of the gains on its investment in the master fund.  Before last year, managers were able to defer tax on the performance fee by reinvesting it in the offshore fund.  However, Internal Revenue Code Section 457A, adopted as part of the Emergency Economic Stabilization Act of 2008, disallows such fee deferrals and requires hedge fund managers to take all existing deferrals into income by 2017.  Mini-master funds seek to circumvent this rule by converting the performance “fee” into a performance “allocation.”  We explain precisely how mini-masters can accomplish this, and in the course of our discussion explore traditional fee deferrals, the operation of Section 457A, the tax effect of mini-masters, jurisdictional issues and what proposals relating to the taxation of carried interest may mean for the continued utility of mini-masters.  See “IRS Releases Further Guidance Affecting Offshore Hedge Fund And Other Pooled Investment Vehicle Deferrals,” The Hedge Fund Law Report, Vol. 2, No. 6 (Feb. 12, 2009).

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  • From Vol. 2 No.21 (May 27, 2009)

    The Future Will Be Better Tomorrow: The Obama Tax Agenda Is Released

    On May 12, 2009, the Treasury Department released President Obama’s fiscal 2010 tax and revenue proposals in a lengthy book with a green cover.  Accordingly, everyone is calling the list of proposals, the “Green Book.”  President Obama did not desire to raise taxes during the worst recession in the last 80 years.  As a result, most of the revenue proposals would not be effective until 2011, when the current economic crisis is expected to abate.  The Green Book proposals have yet to be introduced as formal legislation.  The current political climate and President Obama’s extraordinary popularity make the introduction and passage of the bulk of the proposals extremely likely.  In a guest article, Mark Leeds and Diana Davis, Shareholder and Counsel, respectively, at Greenberg Traurig LLP, discuss in detail the Green Book, and its potential implications for hedge funds and their managers.

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  • From Vol. 2 No.16 (Apr. 23, 2009)

    Addressing (and Resisting) Demands for Changes in Hedge Fund Manager Compensation

    While the unprecedented market events of 2008 and 2009 have resulted in pressure upon fund liquidity terms and governance provisions, market forces have resulted in requests from some investors for changes to the manner in which hedge fund managers are compensated for their services.  Assuming that market demand will ensure the continued existence of the hedge fund industry, it may be safe also to assume that, in light of recent fund restructurings, as well as the imposition of gates/suspensions, and the use of true or “synthetic” side pockets, some forceful investors will begin to seek certain concessions from fund managers.  Over the past year or so, a small number of investors have indeed begun, in some cases very vocally and publicly, to criticize the incentive compensation structure for hedge fund managers that has developed to date.  In a guest article, Ira Kustin, a Partner at Akin Gump Strauss Hauer & Feld LLP, analyzes the demands for changes in hedge fund managers compensation, including discussions of: reasons why fund managers may resist calls for changes, separation of “new” and “old” funds, adjustments to management fees, adjustments to incentive compensation and complications arising from possible adjustments.

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  • From Vol. 2 No.13 (Apr. 2, 2009)

    Should Hedge Funds Participate in the Public-Private Investment Program?

    On March 23, 2009, the Treasury Department announced the Public-Private Investment Program (PPIP), a collaborative initiative among the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), on the one hand, and private investors, on the other hand, to create $500 billion to $1 trillion in buying power for the purchase from financial institutions of “legacy” (formerly known as “toxic”) loans and securities.  Loans eligible for purchase likely will include primarily residential and commercial mortgages and leveraged loans used to fund buyouts, and eligible securities are likely to include securities backed by eligible loans and certain consumer loans.  The goals of the PIPP include (1) creating a market for currently illiquid assets, thus enabling financial institutions to value and sell those assets, which in turn will enable the institutions to make new loans, raise new capital and repay TARP loans; and (2) reopening the securitization markets, which, at least prior to the credit crisis, generally expanded (some would argue over-expanded) the availability of consumer credit and reduced its cost.  Many of the details of the PPIP remain to be provided.  In the meantime, prior to the provision by the Treasury, Federal Reserve Board or FDIC of further guidance and clarification, hedge and other private fund managers are evaluating the advisability of participation based on the announced parameters of the PPIP.  In particular, hedge fund managers are analyzing the following issues, among others:

     

    1. The scope of the FDIC’s oversight of various aspects of the PPIP, and the role of the Treasury as an equity co-investor and, in the case of the Legacy Securities Program, a lender.
    2. With respect to the Legacy Loans Program, the design of the auctions in which assets will be sold, and the timing of the FDIC’s leverage determinations (i.e., the extent to which the FDIC can, as a practical matter, provide clarity with respect to the amount of leverage it can offer prior to commencement of an auction).
    3. Any limits that may be imposed on hedge fund manager compensation as a result of participation.
    4. How participation may be structured, i.e., whether current funds can invest or whether new dedicated funds have to be organized.
    5. Tax issues, including the structures that will be permitted or required for PPIFs, the ability of tax-exempt or non-U.S. investors to invest in PPIFs via offshore feeder funds (likely structured as non-U.S. corporations) and the characterization of income from PPIFs as ordinary income or capital gain.
    6. Adverse selection issues, i.e., whether banks will only seek to sell their worst assets under the program (and if so whether appropriate pricing can mitigate the gravity of this concern).

     

    Our article addresses each of these issues in detail.

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  • From Vol. 2 No.13 (Apr. 2, 2009)

    IOSCO Report Scrutinizes Hedge Fund Manager Compensation as Group of 20 Prepares to Weigh in on Hedge Fund Regulation

    In March 2009, the International Organization of Securities Commissions (IOSCO) issued its Hedge Funds Oversight Consultation Report (Consultation Report), outlining ideas for enhanced oversight of various aspects of hedge fund investments and hedge fund manager operations.  In particular, the Consultation Report discusses hedge fund manager compensation, identifying what IOSCO deems to be shortcomings in the current compensation structure that could exacerbate various risks to investors and the broader financial system.  IOSCO is an international group of securities regulators organized to promote high and unified standards of market integrity, exchange information among members and provide mutual assistance.  IOSCO itself is not regulator and does not have binding regulatory or legal authority; its authority is limited to its ability to persuade and build consensus.  Nonetheless, the recommendations in the Consultation Report are timely, coming as they do on the heels of requests from pension funds and other institutional investors to renegotiate fees with hedge fund managers and otherwise restructure their relationships.  We discuss the problems identified by IOSCO with respect to hedge fund manager compensation, as well as its proposed principles-based remedies.  We also offer practitioner insight into how hedge fund manager compensation might be regulated, and whether it should be.

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  • From Vol. 2 No.7 (Feb. 19, 2009)

    Climate in Washington Warms to Proposals to Tax Carried Interest as Ordinary Income, as Prospect for Material Revenue from Such Tax Wanes

    In a series of exclusive interviews with members of both houses of Congress from both sides of the aisle, and members of their staffs, The Hedge Fund Law Report has determined that the appetite among Democratic legislators for taxing carried interest as ordinary income remains high, while opposition among Republicans to increasing taxation of carried interest remains equally vigorous.  In this climate of negative returns, the sizes of both management and performance fees are under pressure (primarily from hedge fund investors as opposed to regulators), and many managers will not earn a performance fee until they exceed their “high water mark” – the highest level their funds previously reached – which in many cases appears to be a far-away prospect.  Accordingly, for practical purposes, the level of taxation of hedge fund manager carried interest may be moot for the time being, since for the foreseeable future there will not be any carried interest to tax.  Nonetheless, in this dour economic environment, legislators may look to placate their Main Street constituents with actions targeting “executive compensation,” very broadly understood.  So, even though increasing taxation of carried interest may have only a minor near-term economic benefit, it may have a symbolic resonance.  That is, the setting may be ripe for finalizing a legislative item at precisely the time when it will yield the least revenue.  We bring you insight directly from Capitol Hill, including quotes from Rep. Charles Rangel (via a spokesman), Rep. Elijah Cummings, Senator Orrin Hatch and the office of Senator Mike Crapo.

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  • From Vol. 2 No.6 (Feb. 12, 2009)

    IRS Releases Further Guidance Affecting Offshore Hedge Fund And Other Pooled Investment Vehicle Deferrals

    On January 8, 2009, the Internal Revenue Service issued interim guidance (Notice 2009-8) under Internal Revenue Code Section 457A.  Enacted in October 2008, Section 457A largely eliminates compensation deferrals by nonqualified entities – in general, tax-indifferent non-U.S. corporations or partnerships (U.S. or non-U.S.) with tax-indifferent partners.  In a guest article, Jonathan M. Zorn, Brett A. Robbins and Lucas Rachuba describe the mechanics of the interim guidance – including a discussion of the treatment of deferrals attributable to periods before and after January 1, 2009 – and explain how the interim guidance may impact hedge funds and their managers.

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  • From Vol. 1 No.23 (Oct. 28, 2008)

    The End of Deferral As We Know It: The New Rules Prohibiting the Deferral of Compensation Paid to U.S. Managers By Off-Shore Hedge Funds

    On October 3, 2008, Congress enacted, and President Bush signed, legislation that will curtail deferral of compensation payable by off-shore funds to U.S. managers beginning in 2009, and require that income previously deferred be recognized no later than 2017. In a guest column, Mark Leeds and Yoram Keinan, Partner and Of Counsel, respectively, at Greenberg Traurig, LLP, offer a thorough analysis of the mechanics of the new legislation and what it means for hedge fund managers in structuring their funds and compensation arrangements.

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  • From Vol. 1 No.22 (Oct. 10, 2008)

    New Tax Law Restricts Hedge Fund Fee Deferral Arrangements

    The $700 billion “bailout bill” signed into law on October 3, 2008 contains changes to the U.S. tax code that will effectively eliminate the ability of U.S. hedge fund managers to defer paying tax on fee income from their offshore hedge funds.  The new law, enacted as part of the same bill that contained the Emergency Economic Stabilization Act of 2008, will impose U.S. tax on a current basis on deferred compensation from offshore entities that are not subject to U.S. tax or to a comprehensive non-U.S. income tax, with the principal target being U.S. managers of offshore hedge funds.  In a guest article, Kirkland & Ellis partner Andrew Wright provides a lucid analysis of the relevant provisions of the new law.

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