The Hedge Fund Law Report

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

Articles By Topic

By Topic: Fiduciary Duty

  • From Vol. 11 No.28 (Jul. 12, 2018)

    Former SEC Senior Counsel Offers Her Current Perspective on the SEC and the Private Funds Industry

    Stacey Song recently rejoined Fried Frank’s corporate department as a partner. Based in the firm’s New York office, she will focus on investment advisers, private funds and broker-dealers. Song previously served as a Senior Counsel in the Private Funds Branch of the Division of Investment Management at the SEC where she was the primary expert on legal matters relating to private funds and provided interpretive guidance to other divisions and offices within the SEC, as well as to various industry participants. In connection with her return to Fried Frank, The Hedge Fund Law Report recently interviewed Song about several topics important to private fund managers. This article provides Song’s thoughts on the perspective she gained on the private funds industry and the SEC; collaboration between the industry and Commission staff; and the current regulatory landscape. For additional insight from Fried Frank attorneys, see “Six Common Misconceptions U.S. Fund Managers Have About Marketing in Europe” (Mar. 9, 2017); and “How Does the Amended Custody Rule Change the Balance of Power Between Hedge Fund Managers and Accountants?” (Jan. 27, 2010).

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

    The D.B. Zwirn Saga Continues: SEC Settles With Fund Manager’s CFO Over Fraud Claims

    Daniel B. Zwirn’s high-flying hedge fund management firm, D.B. Zwirn & Co., L.P. (DBZ), went into a death spiral in 2007 after Zwirn disclosed to investors certain improper inter-fund transfers that could have subjected one of the offshore funds to a significant U.S. tax liability and exposed the firm’s poor internal control systems. Zwirn blamed Perry A. Gruss, DBZ’s chief financial officer. The SEC apparently agreed, filing a civil complaint against Gruss in 2011, claiming that he had aided and abetted DBZ’s violations of the anti-fraud provisions of the Investment Advisers Act of 1940. In March 2017, the U.S. District Court for the Southern District of New York (Court) granted summary judgment to the SEC on its most serious charges. More recently, in May 2018, the Court entered a final judgment against Gruss, and the SEC subsequently issued a settlement order. This case highlights the need for fund managers to implement carefully crafted internal controls over critical matters like cash movement procedures and the risks of entrusting a single individual with authority over those functions. This article focuses on the details of the Court’s March 2017 opinion deciding the summary judgment motion and explores the terms of the final judgment and the settlement order. For more on internal controls, see “GLG Partners Settlement Illustrates SEC Views Regarding Valuation Controls at Hedge Fund Managers” (Jan. 16, 2014); and “SEC’s Recent Settlement With a Hedge Fund Manager Highlights the Importance of Documented Internal Controls When Managing Conflicts of Interest Associated With Asset Valuation and Cross Trades” (Jan. 9, 2014).

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  • From Vol. 11 No.23 (Jun. 7, 2018)

    Why Fund Managers Must Review Their Positions on Succession Planning and CCO Outsourcing (Part One of Three)

    The SEC proposed – and recently withdrew – a rule that would have required registered investment advisers to adopt and implement detailed business continuity and transition plans. Despite the rule’s withdrawal, however, the SEC has signaled that it will continue to scrutinize the robustness of advisers’ plans. To the extent that advisers’ business continuity and transition plans cover the departure of key personnel, they generally do so only with respect to founders; yet, from a business and regulatory perspective, they should also cover others, including chief compliance officers (CCOs). The proposed rule would have also required advisers to evaluate third-party service providers’ business continuity and transition plans, including those of outsourced CCOs. This article, the first in a three-part series, discusses the SEC’s proposed rule on business continuity and transition plans; the impact, if any, of the rule’s withdrawal; the importance of CCO succession planning; and the risks of using an outsourced CCO. The second article will examine CCO hiring and onboarding; whether managers should separate their compliance departments from their legal departments; and the risks of high CCO turnover. The third article will evaluate the risks of poor succession planning and provide a roadmap for developing a robust succession plan. See “Pro-Business Environment of New Administration Continues to Have Challenges and Pitfalls for Private Funds” (Sep. 14, 2017).

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  • From Vol. 11 No.23 (Jun. 7, 2018)

    SEC Continues Scrutiny of Undisclosed Fees at Fund Managers

    Although the SEC under Chair Clayton has prioritized protecting retail investors, the agency remains keenly focused on conflicts of interest of every sort, even when the alleged victims are sophisticated investors. In the most recent example of that continuing focus, the SEC issued a settlement order against a private equity manager alleging that the manager failed to disclose to its private equity fund clients that it would receive compensation from a third-party service provider based upon the volume of services that the third party provided to the portfolio companies owned by the manager’s private equity funds. Among other concessions, the manager has agreed to pay a significant amount in disgorgement, interest and penalties. This article details the circumstances leading up to the settlement and the terms of the order. For coverage of other SEC enforcement actions involving improper fee and expense arrangements, see “Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action” (Nov. 12, 2015); “Blackstone Settles SEC Charges Over Undisclosed Fee Practices” (Oct. 22, 2015); and “SEC Enforcement Action Involving ‘Broken Deal’ Expenses Emphasizes the Importance of Proper Allocation and Disclosure” (Jul. 9, 2015).

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  • From Vol. 11 No.20 (May 17, 2018)

    SEC Settles Three Additional Enforcement Actions for Inadequate Share-Class Disclosures

    In connection with the SEC’s continued focus on the selection of mutual fund share classes by investment advisers, the agency recently settled three separate enforcement proceedings with investment advisers. In an effort to maximize the 12b‑1 fees it collected, each respondent allegedly failed to purchase the lowest-cost mutual fund share class for its advisory clients and failed to disclose the conflict of interest presented when purchasing mutual fund share classes for advisory clients. These actions evidence the SEC’s continued focus on conflicts of interest, particularly in connection with share class selection and investor protection. This article details the SEC’s allegations in each of the three proceedings, the alleged compliance failures of the respondents and the terms of the three settlements. For other recent enforcement actions involving mutual fund share class recommendations, see “Ameriprise Settlement Reflects Continued SEC Focus on Conflicts of Interest and Retail Investors” (Apr. 19, 2018); “Recent SEC Settlement Evidences Agency’s Continued Aggressive Enforcement of Conflicts of Interest” (Sep. 21, 2017); and “Advisers Investing Client Assets in Affiliated Funds Could Face SEC Scrutiny for Conflicts of Interest” (Oct. 13, 2016).

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  • From Vol. 11 No.19 (May 10, 2018)

    SEC Emphasizes Investment Adviser Fiduciary Duty and Proposes Enhanced Adviser Regulation

    It is important for investment advisers to understand how the SEC expects them to fulfil their fiduciary duties in order to mitigate the risk of adverse client or regulatory action. The SEC recently issued a release seeking comment on the agency’s proposed interpretation of an investment adviser’s fiduciary duty and its proposal to enhance regulation of advisers through, among other things, licensing, account statement delivery and financial responsibility requirements. This article summarizes the key takeaways from the release. See “What Precisely Is ‘Fiduciary Duty’ in the Hedge Fund Context, and to Whom Is It Owed?” (Jul. 23, 2009).

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  • From Vol. 11 No.9 (Mar. 1, 2018)

    What Does the SEC’s Latest Self-Reporting Initiative Portend for the Future of Enforcement?

    In an effort to align enforcement with efficiency, many regulators are increasingly turning to self-disclosure and cooperation initiatives to incentivize fund managers to come forward and admit bad behavior in exchange for leniency. The SEC recently announced the newest and most narrow of these: the Share Class Selection Disclosure Initiative (SCSD Initiative). By offering favorable settlement terms, the SCSD Initiative is intended to encourage investment advisers to admit failures to properly disclose their selection of mutual fund share classes that paid a fee pursuant to Rule 12b‑1 of the Investment Company Act of 1940 when lower-cost share classes for the same funds were available to clients. See “Recent SEC Settlement Evidences Agency’s Continued Aggressive Enforcement of Conflicts of Interest” (Sep. 21, 2017); and “$97 Million SEC Settlement Highlights Perils of Inaccurate Disclosures and the Agency’s Continued Focus on Conflicts of Interest and Client Overcharges” (May 25, 2017). This initiative serves as a reminder to all fund advisers of the SEC’s focus on conflicts of interest. In addition, due to its narrow nature – including the short timeframe for taking advantage of its benefits and the potential penalties for non-compliance – some may wonder whether the SCSD Initiative signals a retreat from the “regulatory-lite” approach anticipated under the Trump administration. This article analyzes the SCSD Initiative, including its terms and what it could portend for all private fund managers. For more on self-reporting, see “How Fund Managers Can Maintain Work Product Protection During Investigations After the Herrera Decision” (Feb. 22, 2018); and “Newly Revealed CFTC Self-Reporting and Cooperation Regime Could Offer Benefits to Fund Managers, or Lead to Increased Enforcement” (Oct. 19, 2017).

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  • From Vol. 11 No.8 (Feb. 22, 2018)

    Ways the Valeant-Pershing Square Settlement Could Affect Future Insider Trading Lawsuits

    Valeant Pharmaceuticals and Pershing Square recently announced their decision to make a joint $290 million payment to settle litigation arising from alleged insider trading committed in 2014. See “Did Pershing Square and Valeant Violate Insider Trading, Antitrust or Tender Offer Rules in Their Pursuit of Allergan?” (May 2, 2014). Shareholders of Allergan claimed that Pershing Square illegally enriched itself by buying Allergan shares, and earning more than $2 billion in profits, with the knowledge that Valeant planned to initiate a bid for Allergan. Although Valeant ultimately failed in its takeover bid for Allergan, allegations of insider trading and other violations of securities laws have dogged both Valeant and Pershing Square for years. Some observers may be surprised that the insider trading claims against Pershing Square and Valeant were not dismissed. Arguably, the respondents did not technically commit insider trading because they acted without scienter – a key component of insider trading violations as traditionally understood. This article analyzes the Valeant-Pershing Square settlement, together with insights from practitioners with expertise in insider trading law, to help readers understand the settlement’s implications on insider trading law and takeaways for activist investors. For additional analysis of the evolution of insider trading law, see “HFLR Panel Identifies Best Practices for Avoiding Insider Trading Liability in the Aftermath of Martoma” (Jan. 18, 2018).

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  • From Vol. 11 No.7 (Feb. 15, 2018)

    SEC Halts Registration of Cryptocurrency Mutual Funds, Calling for Dialogue Regarding Valuation, Liquidity, Custody, Arbitrage and Manipulation Risk

    Dalia Blass, Director of the SEC Division of Investment Management, has issued a staff letter to the Securities Industry and Financial Markets Association and the Investment Company Institute outlining her Division’s concerns about funds that invest in cryptocurrencies. The letter focuses on registered funds that desire to invest in cryptocurrencies and indicates that, for the time being, the SEC will not register funds that “intend to invest substantially in cryptocurrency and related products.” It also sheds light on the SEC’s general view of this evolving asset class, which may inform its perspective on private fund investments involving cryptocurrencies. This article summarizes the letter and its key takeaways for managers considering launching cryptocurrency funds, as well as any industry participant contemplating investing in cryptocurrencies. For more on investment in cryptocurrencies, see “Opportunities and Challenges Posed by Three Asset Classes on the Frontier of Alternative Investing: Blockchain, Cannabis and Litigation Finance” (Dec. 14, 2017). See also our three-part series on blockchain and the private funds industry: “Basics of the Technology and How the Financial Sector Is Currently Employing It” (Jun. 1, 2017); “Potential Uses by Private Funds and Service Providers” (Jun. 8, 2017); and “Potential Impediments to Its Eventual Adoption” (Jun. 15, 2017).

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  • From Vol. 11 No.2 (Jan. 11, 2018)

    Annual Walkers Fundamentals Seminar Highlights Trends in Investor Sentiment, Governance, Side Letters, Fund Structures, Investment Vehicles and Restructurings

    While the hedge fund industry has generally rebounded from a dismal 2016 with improved performance and net inflows, not all hedge funds have benefitted equally. Investors continue to apply pressure on and shape how hedge fund managers structure their funds and negotiate with investors. A panel at the recent 10th annual Walkers Fundamentals Hedge Fund Seminar hosted by Walkers Global in New York City addressed, among other things, investor sentiment; developments and trends in the use of independent directors, side letters, fund structures and investment vehicles; and fund restructurings. Walkers partner Ashley Gunning introduced the panel, which featured partners Tim Buckley and Rolf Lindsay. This article summarizes the key points presented by the panelists. For coverage of the Walkers Fundamentals Hedge Fund Seminar from prior years, see: 2016 Seminar; 2015 Seminar; 2014 Seminar; 2013 Seminar; 2012 Seminar; 2011 Seminar; and 2009 Seminar.

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  • From Vol. 10 No.48 (Dec. 7, 2017)

    Recent New York Court of Appeals Decision Eases Path for Investor Lawsuits Against Cayman Funds, but Certain Hurdles Remain

    When an offshore fund investor sues in a U.S. court, the defendant may argue that certain claims must be brought derivatively on behalf of the fund, rather than directly by the investor. Cayman law, which frequently governs claims involving offshore hedge funds, presents a number of potential obstacles to derivative claims, however. See “Registered Fund Advisers Delegating to Subadvisers Gain Greater Flexibility From U.S. District Court Ruling to Charge Management Fees” (Mar. 16, 2017); and “Derivative Actions and Books and Records Demands Involving Hedge Funds” (Oct. 17, 2014). Defendants have argued, and some New York courts have held, that a plaintiff’s failure to comply with Rule 12A of the Rules of the Grand Court of the Cayman Islands bars a derivative claim in U.S. courts by depriving the plaintiff of standing, whereas a Massachusetts state trial court found that the rule was merely procedural. Last month, the New York Court of Appeals decided this issue, facilitating lawsuits by Cayman fund investors in the U.S., although significant hurdles remain when bringing claims against hedge fund managers and others. In a guest article, Anne E. Beaumont, partner at Friedman Kaplan Seiler & Adelman, outlines the case history leading up to the Court of Appeals’ ultimate decision, as well as the ruling’s implications for investors, funds and managers. For additional insight from Beaumont, see “How Hedge Fund Managers Can Prepare for the Anticipated ‘End’ of LIBOR” (Aug. 24, 2017); and “Impact on Private Fund Advisers of Obama Administration’s and State Lawmakers’ Actions to Restrict Use of Non-Compete Agreements” (Nov. 10, 2016).

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  • From Vol. 10 No.47 (Nov. 30, 2017)

    Trio of SEC No-Action Letters Addresses Concerns Raised by Decoupling of Research and Commission Payments Under MiFID II

    The recast Markets in Financial Instruments Directive (MiFID II), which takes effect on January 3, 2018, requires the decoupling of payments for broker research from execution services. Money managers, broker-dealers and other market participants have been concerned, however, that complying with these MiFID II provisions could lead to them being out of compliance with U.S. securities laws and regulations. Specifically, (1) broker-dealers are concerned that if they receive payments earmarked specifically for research, they may be deemed to be acting as investment advisers; (2) money managers are concerned that use of a research payment account in accordance with MiFID II would not satisfy the safe harbor for bundled commissions under Section 28(e) of the Securities Exchange Act of 1934; and (3) investment advisers are concerned that they will no longer be able to aggregate orders for registered investment companies with those of other clients. The SEC recently issued three no-action letters that allay the above concerns. This article analyzes the relief provided in each of those letters, along with the applicable rationale. For more on these issues, see MiFID II May Have Significant Ramifications on Research Payments Involving U.S. Managers With Cross-Border Operations” (Jul. 27, 2017).

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  • From Vol. 10 No.38 (Sep. 28, 2017)

    SEC Continues Its Pursuit of Firms That Licensed F‑Squared Indices

    In yet another reminder that fund managers must be scrupulously accurate when making performance claims – and must perform appropriate due diligence when using the track records of third-party advisers – the SEC recently commenced an enforcement action against an investment adviser and its principal (collectively, the Defendants). The SEC’s complaint alleges that the Defendants breached their fiduciary duties and committed fraud by using materially misleading marketing materials created by F‑Squared Investments, Inc. (F‑Squared) for F‑Squared’s “AlphaSector” strategies. Worse, the SEC claims that the Defendants continued to use those materials after the investment adviser’s principal learned that the materials contained fraudulent performance claims, and later sold the business to avoid potential liability for advertising a fraudulent track record. This article summarizes the complaint. For other enforcement actions stemming from third-party advisers licensing F‑Squared’s products, see “SEC Settlements Highlight Need for Managers to Verify Performance Claims of Others Prior to Use” (Sep. 22, 2016); and “Hedge Fund Managers May Be Liable for Performance Claims of Others” (Mar. 3, 2016).

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

    Recent SEC Settlement Evidences Agency’s Continued Aggressive Enforcement of Conflicts of Interest

    The SEC recently released an order instituting administrative cease-and-desist proceedings against an investment adviser, following claims by the Commission that the adviser allowed its representatives to breach their fiduciary duty toward its clients. The conflicts of interest alleged by the SEC in this matter are serious, involving deliberate promotion and marketing of certain classes of shares whose value did not surpass that of other classes of shares that clients could have purchased for a markedly lower price and without having to pay certain marketing fees. This enforcement action affirms the SEC’s continuing commitment to stamping out conflicts of interest, as set forth in the influential 2015 “Conflicts, Conflicts Everywhere” speech delivered by Julie M. Riewe, then Co-Chief of the SEC’s Division of Asset Management. See “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015). To help readers understand the enforcement action and the issues involved, this article analyzes the SEC’s cease-and-desist order and includes insights from legal practitioners at the forefront of interactions between the financial sector and the regulators. For another enforcement action involving inappropriate recommendations of certain mutual fund shares, see “$97 Million SEC Settlement Highlights Perils of Inaccurate Disclosures and the Agency’s Continued Focus on Conflicts of Interest and Client Overcharges” (May 25, 2017).

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  • From Vol. 10 No.35 (Sep. 7, 2017)

    Improper Use by Managers of Fund Cash to Pay Other Funds’ Legal Expenses May Result in Serious Penalties

    In 2010, the SEC commenced an enforcement action in the U.S. District Court for the District of Connecticut (Court) against a hedge fund manager and two investment adviser entities that he controlled. The SEC alleged that the defendants had engaged in securities and investment adviser fraud by ignoring the investment strategy disclosed in certain fund offering documents, inflating the value of certain portfolio securities and diverting money from two of the funds they managed to cover the legal defense costs of three other funds. In August 2017, the Court issued a partial final judgment against the defendants on the SEC’s fraud claims, imposing an injunction, disgorgement totaling almost $8 million and a $5 million civil penalty. This article summarizes the terms of the judgment, drawing on insights from the manager’s hearing testimony and the parties’ submissions related to the SEC’s 2016 motion for summary judgment. See our three-part series on fee and expense allocation practices: “Practices Fund Managers Should Avoid” (Aug. 25, 2016); “Flawed Disclosures to Avoid” (Sep. 8, 2016); and “Preventing and Remedying Improper Allocations” (Sep. 15, 2016).

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

    Fund of Funds Shareholders Lack Standing to Challenge Advisory Fees Paid by Underlying Funds

    Section 36(b) of the Investment Company Act of 1940 permits a registered investment company’s shareholders to sue the fund’s investment adviser for breach of fiduciary duty for charging excessive fees to the company. In a recent decision, the U.S. Court of Appeals for the Eighth Circuit ruled that a shareholder of a fund of funds cannot sue the fund’s adviser for fees paid by an underlying fund to its respective investment adviser. As investors choose to invest through funds of funds, as well as the increasingly popular funds of alternative mutual funds, they need to understand what rights and powers they have – and which they cede – under these approaches. Likewise, managers must remain aware of the extent to which their abilities to charge fees could be challenged by underlying investors in fund of fund complexes. This article summarizes the statutory and factual background of the suit and the Eighth Circuit’s reasoning. For other suits concerning Section 36(b), see “Registered Fund Advisers Delegating to Subadvisers Gain Greater Flexibility From U.S. District Court Ruling to Charge Management Fees” (Mar. 16, 2017); and “In Light of Convergence of Hedge Fund Strategies and Mutual Fund Structures, Mutual Fund Advisory Fee Case Before U.S. Supreme Court May Affect Future Profitability of Hedge Fund Industry” (Sep. 24, 2009).

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  • From Vol. 10 No.29 (Jul. 20, 2017)

    Reading the Regulatory Tea Leaves: Recent White House and Congressional Action and Insights From SIFMA and FINRA Conferences

    There has been a great deal of uncertainty concerning the direction of financial industry regulation. To address this unease, a recent MyComplianceOffice (MCO) presentation – hosted by Joseph Boyhan of MCO and featuring Shearman & Sterling partner Russell D. Sacks and counsel Jennifer D. Morton – offered insight into the status of pending legislation, tax reforms, the fiduciary rule and regulatory priorities. This article examines the points from the presentation that are most relevant to private fund managers. For coverage of another MCO overview of SEC and FINRA enforcement updates, see “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016). For additional insights from Sacks, see “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?”: Part One (Sep. 12, 2013); Part Two (Sep. 19, 2013); and Part Three (Sep. 26, 2013).

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  • From Vol. 10 No.29 (Jul. 20, 2017)

    Recent Changes to Delaware Corporate Law May Affect Transactions by Hedge Fund Managers

    Delaware corporate law has experienced a number of recent changes and trends, including the standard of judicial review in certain merger and acquisition transactions; legislation and court decisions affecting corporate bylaws; and other recent court decisions affecting items such as preferred stock investments, transactions with controlling shareholders and director compensation arrangements. A recent program sponsored by K&L Gates that featured partner Lisa R. Stark examined these topics in depth. The content of this program should be of particular interest to any fund manager or investment adviser that is formed as a Delaware corporation, as well as advisers that pursue activist investment strategies or that invest in the equity of a company’s capital structure. This article highlights the key points from Stark’s presentation. For additional insights from K&L Gates attorneys, see “New Rule Offers Managers a Way to Raise Capital in China” (Apr. 13, 2017); and “What Role Should the GC or CCO Play in the Audit of a Fund’s Financial Statements?” (Feb. 23, 2017).

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

    Steps Hedge Fund Managers May Take Today to Avoid Being Deemed a Fiduciary Under the DOL’s New Fiduciary Rule

    In February 2017, many investment advisers were relieved when President Trump ordered the Department of Labor to evaluate the likely impact of the revised fiduciary rule that, in its current form, expands the range of persons considered “fiduciaries” under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. The initial set of requirements under the fiduciary rule became applicable on June 9, 2017; therefore, hedge fund managers may need to take steps to ensure they are not deemed fiduciaries under the rule in connection with their marketing activities. In a guest article, K&L Gates partner Robert L. Sichel provides an overview of the fiduciary rule, identifies the types of activities that may trigger fiduciary status thereunder, addresses common misconceptions under the rule and provides a roadmap for how a manager can avoid becoming a fiduciary under the rule in connection with its marketing activity. For a discussion of the evaluation of the fiduciary rule ordered by President Trump, see “Despite the DOL Fiduciary Rule’s Uncertain Future Under the Trump Administration, Managers Should Continue Preparing for Its April 2017 Implementation (Part Two of Two)” (Feb. 23, 2017).

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

    Investor Pressure Drives New Performance Compensation Models and Increased Disclosure Obligations for Managers

    As investors grow increasingly aggressive and savvy about striking a reasonable balance between fund managers’ and their own objectives, new terms and provisions are finding their way into fund documents. Old models are increasingly unsustainable as new types of funds change the face of the market and as investors demand not only new fee and compensation arrangements but a slew of disclosures for almost every conceivable event that could significantly affect a fund’s operations and performance. These disclosures include redemptions by fund principals; changes of control or ownership; violations of securities laws; breaches of fiduciary duties; and changes in investment strategies or objectives. Investors and managers must have a nuanced grasp of the radically changing expectations to successfully manage relations with one another, avoid regulatory trouble and realize a fund’s investment objectives. These points came across in a panel discussion at the tenth annual Advanced Topics in Hedge Fund Practices Conference: Manager and Investor Perspectives recently hosted by Morgan Lewis. The panelists were Morgan Lewis partners Richard A. Goldman, Christopher J. Dlutowski and Jedd H. Wider. This article presents the key takeaways from the panel discussion. For additional insights from Goldman, Wider and Dlutowski, see “How Can Private Fund Managers Grant Preferential Rights? Delaware Chancery Court Decision Stresses Need for Fund Document Integration” (Jun. 30, 2016). For coverage of former SEC Chair Christopher Cox’s keynote talk at the conference, see “Hedge Funds’ Image Crisis: Fighting Public Perceptions Against the Backdrop of Potential Financial Sector Reforms” (Jun. 22, 2017).

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

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

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

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  • From Vol. 10 No.18 (May 4, 2017)

    BakerHostetler Panel Analyzes the Trump Effect on the SEC’s Initiatives and Enforcement Efforts

    A recent program presented by BakerHostetler provided timely insight on how the SEC and its enforcement priorities may evolve under the new president’s regulatory agenda, as well as how the new administration may affect the markets in general and private funds in particular. For another look at Trump’s potential effect on the fund industry, see “Ways the Trump Administration’s Policies May Affect Private Fund Advisers” (Mar. 2, 2017). Mark A. Kornfeld, partner at BakerHostetler, moderated the discussion, which featured former SEC Commissioner Troy A. Paredes, founder of Paredes Strategies LLC; Marie Noble, partner, general counsel and chief compliance officer at SkyBridge Capital; and BakerHostetler senior adviser Hon. Michael A. Ferguson and partner Marc D. Powers. This article summarizes the portions of the presentation most relevant to hedge fund managers. See our two-part series on an earlier BakerHostetler conference for additional commentary from Kornfeld and Powers: “Shifts in Enforcement Policies and Tactics As Industry Anticipates New Administration and SEC Chair” (Jan. 5, 2017); and “SEC Use of Administrative Proceedings and Whistleblower Incentives, and Guidance for Fund Managers Facing an Examination” (Jan. 19, 2017). 

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    Ways the Trump Administration’s Policies May Affect Private Fund Advisers

    With a Republican president and Republican-controlled Congress, there is the possibility for comprehensive changes in several areas of concern to private fund managers, including taxation, regulation and enforcement. In his first weeks in office, President Trump issued a series of sweeping, yet sometimes confusing, orders directed at fulfilling some of his campaign promises. A recent seminar presented by the Association for Corporate Growth (ACG) provided insight on the impact of the Trump executive orders regarding the pending fiduciary rule and other regulatory matters; developments at the SEC; the future of the Dodd-Frank Act and other laws that may affect the private fund industry; proposed tax reform; cybersecurity; and political contributions. Scott Gluck, special counsel at Duane Morris, moderated the discussion, which featured Langston Emerson, a managing director at advisory firm The Cypress Group; Basil Godellas, a partner at Winston & Strawn; Ronald M. Jacobs, a partner at Venable; and Michael Pappacena, a managing director at ACA Aponix. This article summarizes their insights. For coverage of other ACG webinars, see “SEC Staff Provides Roadmap to Middle-Market Private Fund Adviser Examinations” (May 16, 2014); and “SEC’s David Blass Expands on the Analysis in Recent No-Action Letter Bearing on the Activities of Hedge Fund Marketers” (Mar. 13, 2014). 

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  • From Vol. 10 No.8 (Feb. 23, 2017)

    Despite the DOL Fiduciary Rule’s Uncertain Future Under the Trump Administration, Managers Should Continue Preparing for Its April 2017 Implementation (Part Two of Two)

    As part of his first 100 days in office, President Donald J. Trump has set his sights on easing some of the existing regulations in the financial sector to ostensibly allow it to flourish. To that end, he issued a presidential memorandum on February 3, 2017 (Presidential Memorandum), ordering the Department of Labor to review the fiduciary duty rule (DOL Fiduciary Rule). This review may lead to a reevaluation of who or what should be officially classified as a fiduciary, with all the legal obligations that classification entails, and may spur a dialogue between regulators and the funds sector. Although legal experts disagree as to the likelihood of the DOL Fiduciary Rule’s ultimate survival, its defeat is far from a fait accompli. Those potentially subject to the DOL Fiduciary Rule can and should continue revising their practices, documents and disclosures where appropriate. This two-part series evaluates the recent orders issued by the Trump administration that target the financial industry, including insights from attorneys specializing in financial regulations, employment and labor law, so that fund managers can respond accordingly. This second article in the series considers the potential ramifications of the proposed changes to the DOL Fiduciary Rule and their impact on hedge fund managers. The first article summarized the Trump administration’s executive order, entitled “Core Principles for Regulating the United States Financial System,” which detailed the financial sector policies of the new administration. For more on how protecting retirement investors has recently been an SEC priority, see “OCIE 2017 Examination Priorities Illustrate Continued Focus on Conflicts of Interest; Branch Offices; Advisers Employing Bad Actors; Oversight of FINRA; Use of Data Analytics; and Cybersecurity” (Jan. 26, 2017); and “SEC Division Heads Enumerate OCIE Priorities, Including Cybersecurity, Fees, Bad Actors and Never-Before Examined Hedge Fund Managers (Part One of Two)” (Apr. 28, 2016).`

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  • From Vol. 9 No.49 (Dec. 15, 2016)

    Recent NY Appeals Court Rulings Clarify How Fund Managers May Pursue Former Employees for Breach of Fiduciary Duty and Improper Use of Performance Record

    In the latest chapter of litigation that began in 2008, the New York State Appellate Court issued two rulings that provide meaningful guidance to industry participants on certain employment-related matters. Specifically, the Appellate Court ruled that a hedge fund manager may pursue two former employees for breach of fiduciary duty, including to recoup certain penalties assessed by the SEC against the firm for violating Rule 105 of Regulation M; misuse of the manager’s performance track record; theft of trade secrets; tortious interference with contract; and defamation. In a guest article, Sean O’Brien, managing partner of O’Brien LLP, along with associates A.J. Monaco and Michael Ahern, provide the litigation history of the case and discuss the claims against the employees and the factual details surrounding such allegations. For additional insights from O’Brien, see “DTSA Provides Hedge Fund Managers With Protection for Proprietary Trading Technology and Other Trade Secrets” (Jun. 23, 2016); and “Can Hedge Fund Managers Contract Out of Default Fiduciary Duties When Drafting Delaware Hedge Fund and Management Company Documents?” (Apr. 4, 2013). For coverage of other employment disputes involving hedge fund managers, see “Quant Fund Manager Moves Aggressively Against Former Employee Who Allegedly Stole Trade Secrets and Other Proprietary Information” (Mar. 21, 2014); and “Highland Capital Management Sues Former Private Equity Chief for Breach of Employment and Buy-Sell Agreements” (May 17, 2012).

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  • From Vol. 9 No.48 (Dec. 8, 2016)

    How Fund Managers May Deploy the Cayman Islands LLC Structure

    Since the introduction of the Cayman Islands Limited Liability Companies Law on July 8, 2016, over 150 Cayman Islands limited liability companies (Cayman Islands LLCs or LLCs) have been registered. See “New Cayman Islands LLC Structure Offers Flexibility to Hedge Fund Managers” (Mar. 10, 2016). In a guest article, Walkers partners Tim Buckley and Melissa Lim, along with senior counsel Andrew Barker, review: (1) some of the key features of Cayman Islands LLCs, including how they differ from their Delaware counterparts and other Cayman Islands entities; (2) how LLCs are currently being used; and (3) possible future developments with respect to LLCs. For additional insight from Lim on the Cayman Islands LLC, see “Despite Fiduciary Duty Questions, Cayman LLCs Can Offer Savings and Other Advantages to Hedge Fund Managers” (Jul. 21, 2016). For further commentary from Buckley, see “Annual Walkers Fundamentals Seminar Discusses How Managers Attract Investors in a Challenging Market by Tailoring Fund Structures and Governance Policies” (Dec. 1, 2016); and “Speakers at Walkers Fundamentals Hedge Fund Seminar Discuss Recent Trends in Hedge Fund Terms, Corporate Governance, Side Letters, FATCA and Cayman Fund Regulation” (Dec. 20, 2012).

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  • From Vol. 9 No.31 (Aug. 4, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part Two of Four)

    This is the second article in our four-part serialization of a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes – in considerable detail and with extensive references to relevant authority – the many substantive considerations associated with employing swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986 (Code), as well as potential penalties for missteps. This article discusses exemptions that could keep swaps from being considered prohibited transactions and explores the extent to which swap counterparties and others would be considered fiduciaries under ERISA, as well as the potential implications of that consideration. To read the first article in this serialization, click here

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  • From Vol. 9 No.30 (Jul. 28, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part One of Four)

    Hedge fund managers and other investment professionals contemplating swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986 (Code) must consider numerous legal issues. To help clarify these complex issues, The Hedge Fund Law Report is serializing a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes – in considerable detail and with extensive references to relevant authority – the many substantive considerations associated with employing swaps on behalf of ERISA plan assets and the potential penalties for missteps. This article, the first in our four-part serialization, discusses fiduciary responsibility and prohibited transactions, including how swaps can constitute prohibited transactions. For more from Rabitz and Oringer, see “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA to Impact Many Hedge Funds” (Aug. 20, 2010). For a prior serialization from Oringer, see our five-part series:“Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse”: Part One (Sep. 4, 2014); Part Two (Sep. 11, 2014); Part Three (Sep. 18, 2014); Part Four (Sep. 25, 2014); and Part Five (Oct. 2, 2014).

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  • From Vol. 9 No.29 (Jul. 21, 2016)

    Despite Fiduciary Duty Questions, Cayman LLCs Can Offer Savings and Other Advantages to Hedge Fund Managers

    On July 13, 2016, the highly anticipated Cayman Islands Limited Liability Companies Law, 2016, came into effect, making the limited liability company (LLC) fully available in that jurisdiction. Widely attributed to the demands of U.S. investors seeking an offshore equivalent to the Delaware LLC, the Cayman LLC has been met with positive reactions from onshore and offshore lawyers, though some have raised concerns about the vehicle’s governance. See “New Cayman Islands LLC Structure Offers Flexibility to Hedge Fund Managers” (Mar. 10, 2016). In an effort to help our readers understand structural, regulatory and registration issues of the Cayman LLC, The Hedge Fund Law Report has interviewed partners of law firms at the forefront of interactions with both the onshore financial sector and the Cayman Islands authorities regarding the law’s development. We present our findings in this article. For analysis of other recent developments in Cayman law, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters” (May 28, 2015); and “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors” (Jan. 24, 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.15 (Apr. 14, 2016)

    Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA

    The Employee Retirement Income Security Act of 1974 (ERISA) imposes a complex regulatory regime onto hedge fund and other private fund managers managing “plan assets.” Two recent developments carry implications for managers under ERISA: the ruling by the U.S. Court of Appeals for the First Circuit about whether a private equity (PE) fund can be treated as a “trade or business” for purposes of the pension funding rules and withdrawal liability under ERISA; and the release of the DOL’s final rule revising the definition of “fiduciary” under ERISA. These were among the ERISA-related topics discussed during a recent segment of the Practising Law Institute’s “Pension Plan Investments 2016: Current Perspectives” seminar. The program 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 program with respect to the foregoing matters. For more on ERISA, see our three-part series on ERISA Considerations for European hedge fund managers: “Liability and Incentive Fee Considerations” (Sep. 24, 2015); “Prohibited Transaction, Reporting and Side Letter Considerations” (Oct. 1, 2015); and “Indicia of Ownership and Bond Documentation Considerations” (Oct. 8, 2015). 

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    RCA Session Highlights Issues Pertaining to the Custody Rule, ERISA, Client Agreements, Fees, Codes of Ethics and Confidentiality

    The first session of the Regulatory Compliance Association’s (RCA) Compliance Program Transparency Series examined key provisions from the CFA Institute’s Asset Manager Code of Professional Conduct (AMCC) and the RCA’s Model Compliance Manual (Manual), which is intended to facilitate implementation of the AMCC. Among the topics covered by the panel were client and fiduciary relationships, including compliance with the custody rule and ERISA as well as best practices for entering into agreements with and charging fees to clients; codes of ethics; and confidentiality. Moderated by Jane Stafford, the RCA’s general counsel, the session featured James G. Jones, a founder and portfolio manager of Sterling Investment Advisors; Michelle Clayman, managing partner and chief investment officer of New Amsterdam Partners; Gerald Lins, general counsel of Voya Investment Management; and Tanya Kerrigan, general counsel and chief compliance officer of Boston Advisors. This article highlights the salient points made on the foregoing issues. For additional insight from RCA programs, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and our coverage of the most recent RCA Compliance, Risk and Enforcement Symposium: “Methods for Hedge Fund Managers to Upgrade Compliance Programs” (Jan. 14, 2016); and “Ways for Hedge Fund Managers to Mitigate Conflicts of Interest” (Jan. 21, 2016).

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  • From Vol. 8 No.44 (Nov. 12, 2015)

    Class Action Lawsuit May Affect Retirement Plan Allocations to Hedge Funds

    Following the 2008 financial crisis, pension managers looked to hedge funds as one way of making up performance losses.  That approach may have backfired for one large corporation whose alternative pension investments stand accused of poor performance.  A former employee is the named plaintiff and class representative in a putative class action against the corporate committees and their members that were responsible for the corporation’s pension investments.  The suit charges that, by investing heavily in “risky and high-cost hedge funds and private equity investments,” and by eschewing more widely accepted pension allocation models, the defendants breached their fiduciary duties to the pension plans, which sustained “massive losses and enormous excess fees.”  This article summarizes the key allegations against the ERISA fiduciaries who elected to invest in hedge funds and other alternative investments.  For more on ERISA fiduciary duties, see the first two parts of our series entitled “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse”: Part One, Vol. 7, No. 33 (Sep. 4, 2014); and Part Two, Vol. 7, No. 34 (Sep. 11, 2014).

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  • From Vol. 8 No.41 (Oct. 22, 2015)

    U.K. Imposes New Statutory Duty of Responsibility on Hedge Fund Senior Managers

    The U.K. government issued a policy paper on October 15, 2015, announcing that it will extend a new Senior Managers and Certification Regime (Senior Managers Regime) to all sectors of the financial services industry, including hedge fund managers and other asset managers.  The Senior Managers Regime will increase the personal responsibility imposed on senior management personnel within hedge fund managers and other financial services firms and will be supported by robust enforcement powers for U.K. regulatory authorities.  It will create a new approval regime for senior managerial staff; include a statutory requirement for senior managers to take reasonable care to prevent regulatory breaches; introduce a new certification regime for certain junior staff; and provide new rules of conduct for senior managers, certified persons and other employees of hedge fund managers and other firms operating within the financial services industry.  This article summarizes the policy paper, setting out the background to and rationale for extending the Senior Managers Regime to hedge fund managers and other financial services firms; outlining the regime’s main features as they will apply to hedge fund managers; and noting the likely impact of the new regime on hedge fund managers.  For more on hedge fund manager employee liability, see “Employees of Hedge Fund Managers May Be Liable for Failing to Prevent Fraud,” The Hedge Fund Law Report, Vol. 8, No. 30 (Jul. 30, 2015); and “U.K. Appellate Court Holds That Hedge Fund Manager Employees May Be Personally Liable,” The Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013). 

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  • From Vol. 8 No.39 (Oct. 8, 2015)

    Investor Suit Against Hedge Fund Manager Illustrates the Perils of Valuing Illiquid Securities

    The SEC remains keenly interested in the valuation practices of private funds, especially with regard to illiquid assets.  See “SEC’s Rozenblit Discusses Operations and Priorities of the Private Funds Unit,” The Hedge Fund Law Report, Vol. 8, No. 37 (Sep. 24, 2015).  Valuing illiquid securities is a fraught activity in the best of times because of the inherent conflict of interest such valuations present.  A manager must have in place an appropriate process for valuing illiquid holdings, must disclose that process to investors and, most importantly, must apply that process fairly and consistently.  Managers vary from these processes at their peril.  See, e.g., SEC Settlement Suggests that Prime Brokers Have Due Diligence and Disclosure Obligations with Respect to Manager-Provided Hedge Fund Valuations,” The Hedge Fund Law Report, Vol. 8, No. 28 (Jul. 16, 2015); and SEC’s Recent Settlement with a Hedge Fund Manager Highlights the Importance of Documented Internal Controls when Managing Conflicts of Interest Associated with Asset Valuation and Cross Trades,” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).  However, a liquidity crisis  which may be caused by a spate of investor redemptions  can exacerbate the manager’s challenges and threaten the very survival of the fund.  The recent investor suit against Boaz Weinstein’s Saba Capital Management, L.P., is evidence of the potential pitfalls surrounding valuation during periods of stress.  The Public Sector Pension Investment Board (Pension Board) charges that it was shortchanged when the defendants altered the method of valuing certain of the fund’s illiquid holdings midstream, resulting in a significant reduction to the fund’s net asset value – and a correspondingly lower redemption payment to the Pension Board.  This article summarizes the Pension Board’s allegations.  For discussion of another investor suit premised in part on improper valuation practices, see “Brockton Retirement Board Files Class Action Lawsuit Against Oppenheimer Fund of Private Equity Funds and Executive Officers for Allegedly False Claims Relating to Fund Performance and Investment Valuations Contained in Fund Marketing Materials,” The Hedge Fund Law Report, Vol. 5, No. 15 (Apr. 12, 2012).

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  • From Vol. 8 No.37 (Sep. 24, 2015)

    Liability and Incentive Fee Considerations Under ERISA for European Hedge Fund Managers (Part One of Three)

    As European hedge fund managers recognize the increasing concentration of investment capital in U.S. pension funds subject to the Employee Retirement Income Security Act of 1974 (ERISA), their appetite for unlocking access to such capital has grown.  This has led a number of European managers to actively seek investment from ERISA plans, notwithstanding the heightened compliance obligations which have traditionally deterred them from accepting ERISA plan assets into their funds.  This article, the first in a three-part series, discusses recent trends in ERISA fundraising by hedge fund managers based in the U.K. and other European jurisdictions and looks at the pertinent issues affecting those managers.  Specifically, it examines key difficulties relating to liability standards and incentive fees and analyzes various approaches to overcoming those issues.  The second article will explore issues relating to prohibited transactions, reporting requirements and side letters under the ERISA regime, and the final article will address concerns relating to indicia of ownership requirements, bond documentation and other overarching issues.  For more on ERISA, see “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 6 (Feb. 12, 2015); and “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence On and Negotiate For Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).

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  • From Vol. 8 No.30 (Jul. 30, 2015)

    Employees of Hedge Fund Managers May Be Liable for Failing to Prevent Fraud

    An investment management firm, along with its affiliate, has filed a claim against its former chief financial officer (CFO), who unwittingly disclosed the firm’s online banking security details to a fraudulent caller, enabling illegitimate transfers from the firm’s bank accounts.  The investment management firm claims that the CFO acted negligently and in breach of his contractual, tortious and fiduciary duties in failing to protect assets in corporate bank accounts.  The CFO, who believed he was providing security details to a member of the anti-fraud team of the investment manager’s private bank, denies failing to uphold the required standard of care, asserting that he was acting honestly, in what he reasonably and genuinely believed to be the best interests of his employer.  This article examines the allegations in the claim, as well as the rebuttals raised by the CFO in his defense.  In addition, the claim raises a number of questions and brings to the fore various issues of relevance to hedge fund managers and their staff, which are discussed in this article.  For another case where employees of a hedge fund manager were held liable for fraudulent actions, see “U.K. Appellate Court Holds That Hedge Fund Manager Employees May Be Personally Liable for Unreasonably Relying on the Representations of a Hedge Fund Manager Principal Regarding Performance and Portfolio Composition,” The Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013).

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  • From Vol. 8 No.27 (Jul. 9, 2015)

    RCA Panel Discusses Pay to Play Rules, GIPS Compliance, Disclosures, Risk Assessments and ERISA Proposals

    Panelists at the recent RCA Enforcement, Compliance & Operations Symposium emphasized the importance of understanding and complying with the various requirements applicable to fund managers.  In particular, speakers discussed compliance with pay to play rules; GIPS compliance and performance reporting; disclosure requirements; and risk assessment requirements.  Additionally, panelists discussed a proposed expansion of the fiduciary definition under ERISA.  This article highlights the key points arising from discussion of the foregoing issues.  For additional coverage of the Symposium, see “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); and “RCA Panel Outlines Keys for Hedge Fund Managers to Implement a Comprehensive Cybersecurity Program,” The Hedge Fund Law Report, Vol. 8, No. 24 (Jun. 18, 2015).

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  • From Vol. 8 No.24 (Jun. 18, 2015)

    Public Pension Plan Investments May Increase the Risk That Hedge Fund Managers May Breach Fiduciary Duties

    Pension funds are significant sources of assets for private fund managers.  Hedge fund managers seeking investments from pension funds face a number of practical and legal concerns – including the possible need to register as a municipal advisor, the complex ERISA regime, pay to play rules and dealing with pension consultants – that may not otherwise arise with respect to individuals or other types of institutional investors.  In addition, as exemplified by a recent SEC order against an investment adviser and two of its principals, public pension plan investors may increase the range of responsibilities for hedge fund managers that, if not adequately discharged, can lead to breach of those managers’ fiduciary duties, with potential serious consequences.  In the order, the SEC claims that the respondents engaged in fraudulent conduct by soliciting several state public pensions to invest in one of their alternative investment fund of funds, even though the fund did not satisfy the criteria established under applicable state law for alternative investments by public pension funds.  This article summarizes the relevant provisions of state law, the alleged misconduct by the respondents and the SEC’s charges.  For more on public pension funds, see “Why and How Do Corporate and Government Pension Plans, Endowments and Foundations Invest in Hedge Funds?,” The Hedge Fund Law Report, Vol. 6, No. 14 (Apr. 4, 2013).

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  • From Vol. 8 No.16 (Apr. 23, 2015)

    SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest

    The SEC has repeatedly emphasized the importance of proper disclosure of conflicts of interest to clients and fund boards.  In a recent speech, Julie M. Riewe, Co-Chief of the Asset Management Unit (AMU) of the SEC’s Enforcement Division, emphasized the continued focus of the AMU on conflicts of interest and postulated that the AMU would recommend a number of conflicts cases for enforcement action, including cases relating to undisclosed business activities.  See “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit,” The Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).  This week, the SEC issued an order charging a registered investment adviser, along with its then-chief compliance officer, with breaching their fiduciary duties by failing to disclose a conflict of interest created by the outside business activity of one of the adviser’s top-performing portfolio managers and failing to disclose a breach of the adviser’s private investment policy by that portfolio manager.  This article provides a discussion of the SEC order and settlement, including the violations that the SEC claimed against the adviser and former chief compliance officer, then highlights the implications of the order for the hedge fund industry.  For another recent SEC enforcement action involving conflicts of interest, see “SEC Settlement Emphasizes the Importance – and Limits – of Fund and Transaction Disclosure,” The Hedge Fund Law Report, Vol. 8, No. 13 (Apr. 2, 2015).

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  • From Vol. 8 No.8 (Feb. 26, 2015)

    Cayman Court of Appeal Overturns Decision Holding Weavering Fund Directors Personally Liable

    Governance of Cayman hedge funds in general, and the duties and qualifications of their directors in particular, have been hot topics in the industry for several years.  See “Cayman Islands Government Introduces Bill That Would Require Registration and Licensing of Certain Hedge Fund Directors,” The Hedge Fund Law Report, Vol. 7, No. 12 (Mar. 28, 2014); and “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  One important source of that concern arose out of the 2009 collapse of Weavering Capital.  In a landmark decision following that collapse, the Cayman Grand Court held the fund’s independent directors personally liable for the fund’s losses by reason of their “wilful neglect” of their duties.  See “Cayman Grand Court Holds Independent Directors of Failed Hedge Fund Weavering Macro Fixed Income Fund Personally Liable for Losses Due to their Willful Failure to Supervise Fund Operations ,” The Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).  The Cayman Court of Appeal has recently overturned that ruling on the ground that, although the directors had breached their duties to the fund, their conduct did not rise to the level of “wilful neglect or default.”  This article summarizes the Court of Appeal’s analysis.

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  • From Vol. 8 No.1 (Jan. 8, 2015)

    K&L Gates Partners Outline Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers (Part Three of Three)

    This article is the third in a three-part series discussing practical insights from a recent presentation on insider trading and compliance priorities by K&L Gates partners Michael W. McGrath, Carolyn A. Jayne and Nicholas S. Hodge.  This article summarizes six noteworthy compliance insights and four recent enforcement themes relevant to hedge fund managers.  The first article in this series provided background on critical aspects of insider trading doctrine (including entity liability and special considerations for CFA charter holders) and described four enforcement patterns bearing directly on hedge fund trading strategies and operations.  The second article detailed eight prophylactic measures that hedge fund managers can implement to avoid insider trading violations and also included a detailed discussion of what McGrath called “the next great undiscovered country for enforcement actions.”  On insider trading, see also “Second Circuit Overturns Newman and Chiasson Convictions, Raising Government’s Burden of Proof in Tippee Liability Insider Trading Cases,” The Hedge Fund Law Report, Vol. 7, No. 47 (Dec. 18, 2014).

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  • From Vol. 7 No.46 (Dec. 11, 2014)

    Schulte Partner Stephanie Breslow Addresses Gates, Side Pockets, Secondaries, Co-Investments, Redemption Suspensions, Funds of One and Fiduciary Duty (Part Two of Two)

    This is the second article in a two-part series covering a presentation by Stephanie R. Breslow at the Practising Law Institute’s annual hedge fund management program.  Breslow is a partner at Schulte Roth & Zabel LLP, co-head of its Investment Management Group and a member of the firm’s Executive Committee.  This article summarizes Breslow’s insights on: (1) compliance challenges for hedge fund managers with respect to the secondary market in hedge fund shares; (2) benefits of investor-level as opposed to fund-level gates; (3) managers’ increasing use of co-investment vehicles rather than side pockets; (4) updating fund provisions regarding calculating NAV after suspension of redemptions; (5) the benefits and drawbacks of funds of one; and (6) fiduciary considerations in the increasingly cautious and institutional current hedge fund industry environment.  The first article in this series discussed Breslow’s comments on gates, side pockets, synthetic side pockets and in-kind distributions, and how those tools evolved both before and during the credit crisis.  For coverage of Breslow’s presentations at PLI hedge fund management programs in prior years, see “Schulte Partner Stephanie Breslow Discusses Tools for Managing Hedge Fund Crises Caused by Liquidity Problems, Poor Performance or Regulatory Issues,” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014); “Schulte Partner Stephanie Breslow Discusses Hedge Fund Liquidity Management Tools in Practising Law Institute Seminar,” The Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012).

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  • From Vol. 7 No.37 (Oct. 2, 2014)

    All-Star Panel at RCA PracticeEdge Session Analyzes Five Key Regulatory Challenges Facing Hedge Fund Managers

    A recent PracticeEdge session presented by the Regulatory Compliance Association (RCA) addressed five key regulatory issues facing hedge fund managers: Broker-dealer registration, the JOBS Act, alternative mutual funds, fiduciary duties and cybersecurity.  Matthew S. Eisenberg, a partner at Finn Dixon & Herling, moderated the discussion.  The speakers included Walter Zebrowski, principal of Hedgemony Partners and RCA Chairman; David W. Blass, at the time of the session, Chief Counsel and Associate Director of the SEC Division of Trading and Markets; Brendan Kalb, General Counsel of AQR Capital Management LLC; Scott D. Pomfret, Regulatory Counsel and Chief Compliance Officer of Highfields Capital Management LP; and D. Forest Wolfe, Chief Compliance Officer and General Counsel of Angelo, Gordon & Co.  As is customary, Blass offered his own opinions, not the official views of the SEC.  (Subsequent to the event, Blass was appointed general counsel of the Investment Company Institute.)  See also “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement? (Part Three of Three),” The Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013); Part Two and Part One.

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  • From Vol. 7 No.36 (Sep. 25, 2014)

    Enforcement Action against Private Equity Fund Manager Highlights Five Aspects of the SEC’s Thinking on Allocation of Expenses

    The SEC recently charged a private equity fund manager with failing to allocate expenses between the two portfolio companies in the manner prescribed by its own expense allocation policy.  The matter is notable for highlighting at least five aspects of the SEC’s thinking on allocation of fund and portfolio company expenses.

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  • From Vol. 7 No.34 (Sep. 11, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Two of Five)

    This is the second article in our five-part serialization of a treatise chapter by Dechert LLP partner Andrew Oringer.  The chapter describes – clearly, comprehensively and with citations to a range of authority that would be immensely time-consuming to compile independently – the ERISA provisions of primary relevance to private funds.  Private fund managers need to understand ERISA if they market to pension funds, and we have yet to encounter a more pithy and pointed route to understanding relevant ERISA concepts (and excluding extraneous concepts) than this chapter.  This second article in the series focuses on fiduciary duty considerations, including delegation, allocation of investment opportunities, varied interests of fund investors, indemnification and insurance, investments in portfolio funds, enforcement-related matters and diversification requirements.  To view the first article in this series, click here.

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  • From Vol. 7 No.34 (Sep. 11, 2014)

    U.S. District Court Denies Class Certification for Investors in Defunct Hedge Fund Parkcentral Global

    The 2008 collapse of hedge fund Parkcentral Global, L.P., which was managed by H. Ross Perot’s money management team, spawned a great deal of litigation.  In one branch of that litigation, certain investors sought certification of a class action in the U.S. District Court for the Northern District of Texas to pursue claims of breach of fiduciary duty against the fund’s investment managers on behalf of all affected investors.  See “Can Hedge Fund Managers Contract Out Of Default Fiduciary Duties When Drafting Delaware Hedge Fund and Management Company Documents?,” The Hedge Fund Law Report, Vol. 6, No. 14 (Apr. 4, 2013).  In a recent decision, the District Court refused to certify a class because it was not impractical for the individual fund investors who suffered losses to join the suit and because common issues of law or fact did not predominate in the case.  This article describes the decision, and is relevant to those on either side of the bar – disgruntled hedge fund investors and their counsel, and those defending or managing the defense of such actions.

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  • From Vol. 7 No.33 (Sep. 4, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part One of Five)

    The Employee Retirement Income Security Act of 1974, as amended (ERISA) is a reactive and remedial statute which has been described as setting forth a “comprehensive and reticulated” scheme to regulate the provision of employee benefits.  It can be extremely complex at times, sometimes even seeming to operate counterintuitively in an attempt to achieve its protective goals.  There may have been a time when hedge fund managers commonly disdained taking investments from pension plans subject to ERISA.  The notion of having to comply with ERISA, of all things, in the case of someone who is not charged with addressing human resources concerns or other benefits-related matters, can be an extremely foreign concept.  Only as investment capital has become increasingly concentrated in pension plans have hedge fund managers more broadly realized that dealing with ERISA might be necessary, or even preferable.  In short, complying with ERISA can dramatically enlarge the pool of money potentially available to a hedge fund manager.  But it can also dramatically enlarge the size and complexity of a manager’s legal and compliance efforts.  In an effort to bring some much needed clarity to one of the most opaque legal areas affecting the investment management business, The Hedge Fund Law Report is serializing a treatise chapter by Andrew L. Oringer, a partner at Dechert LLP and a dean of the ERISA bar.  The chapter describes – in considerable detail and with extensive references to relevant authority – the application of ERISA to hedge and other investment funds.  For hedge fund managers seeking to raise capital from pension plans subject to ERISA, the chapter is essential reading.  This article is the first in our five-part serialization.  See also “RCA PracticeEdge Session Highlights the Key Points of Intersection between ERISA and Hedge Fund Investments and Operations,” The Hedge Fund Law Report, Vol. 7, No. 27 (Jul. 18, 2014).

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  • From Vol. 7 No.31 (Aug. 21, 2014)

    “Best Ideas” Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law (Part Two of Two)

    This is the second article in a two-part series discussing the chief legal concerns raised by hedge fund manager presentations at “best ideas” conferences – conferences at which investment professionals present investment ideas, share convictions and analyze recommendations.  The benefits of presenting at such events include increased visibility and often a charitable component.  The legal pitfalls of presenting at such conferences, however, are various.  The first article in this series discussed issues under Rule 506 of Regulation D, including whether a presentation at a best ideas conference constitutes an offering or general solicitation, as well as Investment Company Act issues.  This article discusses Investment Advisers Act issues, advertising restrictions, fiduciary duty and related considerations and Commodity Exchange Act issues.  The authors of this article series are S. Brian Farmer, Co-Managing Partner of the Investment Management & Private Funds Practice Group at Hirschler Fleischer, and John C. C. Byrne, II.

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  • From Vol. 7 No.27 (Jul. 18, 2014)

    RCA PracticeEdge Session Highlights the Key Points of Intersection between ERISA and Hedge Fund Investments and Operations

    Pension funds are a potentially huge source of capital for hedge fund managers.  However, accepting investments from pension plans governed by the Employee Retirement Income Security Act of 1974 (ERISA) is not without significant risks and drawbacks.  Of greatest concern to a hedge fund manager is that a fund will be deemed a “plan asset fund,” thereby making the manager an ERISA fiduciary and subjecting the fund to ERISA’s strict regulatory regime.  A recent PracticeEdge Session presented by the Regulatory Compliance Association provided an overview of the ERISA regime, with emphasis on when investment funds become subject to the ERISA regime, the consequences of being subject to that regime, the duties of ERISA fiduciaries and certain proposed or pending regulatory changes.  This article summarizes that session.  See also “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence on and Negotiate for Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013); “How Can Hedge Fund Managers Managing Plan Asset Funds Comply with the QPAM and INHAM Exemption Requirements?,” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).

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  • From Vol. 7 No.13 (Apr. 4, 2014)

    Harbinger Group Faces Derivative Class Action Lawsuit Stemming from Alleged Fund-Raising Machinations by Philip Falcone

    Haverhill Retirement System (Haverhill) has commenced a shareholder class action and derivative lawsuit against the directors and controlling shareholders of Harbinger Group Inc. (HGI), a publicly-traded Delaware holding company once controlled by hedge funds managed by defendant Philip A. Falcone.  Haverhill claims that Falcone, facing a liquidity crunch in his hedge funds, arranged to sell a portion of his funds’ HGI shares to defendant Leucadia National Corporation (Leucadia).  In doing so, Haverhill charges that Falcone and the other named defendants had conflicts of interest and engaged in breaches of fiduciary duty, corporate waste and other misconduct when they granted seats on HGI’s board and registration rights for HGI shares to Leucadia in a deal that benefited Falcone and Leucadia, but not HGI.  See also “Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement with Philip A. Falcone and Harbinger Entities,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

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  • From Vol. 7 No.9 (Mar. 7, 2014)

    Co-Investments in the Hedge Fund Context: Fiduciary Duty Concerns, Conflicts and Regulatory Risks (Part Three of Three)

    This is the third article in our series on co-investments in the hedge fund industry.  This article starts by citing evidence of interest among regulators in co-investments, then focuses on the challenging fiduciary duty concerns raised by co-investments, as well as conflicts and regulatory risks that typically arise when structuring or managing co-investments.  The first article in this series discussed the rationales for co-investments from the perspectives of hedge fund managers and investors; negotiating dynamics; and investment strategies in which co-investment are relevant.  The second article in this series described structuring of co-investments, fees, liquidity and relevant insider trading issues.

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  • From Vol. 7 No.8 (Feb. 28, 2014)

    Co-Investments in the Hedge Fund Context: Structuring Considerations and Material Terms (Part Two of Three)

    Co-investments have been a regular feature of private equity investing for decades but historically have played a smaller role in the world of hedge funds.  However, as the range of strategies pursued by hedge funds increases – in particular, as more hedge fund assets are committed to activism, distressed and other illiquid strategies – co-investments are assuming a more prominent place in the hedge fund industry.  In an effort to help hedge fund managers assess the role of co-investments in their investment strategies and operating frameworks, The Hedge Fund Law Report is publishing a three-part series on the structure, terms and risks of hedge fund co-investments.  This article, the second in the series, describes the three general approaches to structuring co-investments; discusses the five factors that most directly affect management fee levels on co-investments; outlines the applicable incentive fee structures; details common liquidity or lockup arrangements; and highlights relevant fiduciary duty and insider trading considerations.  The first article in this series discussed five reasons why hedge fund managers offer co-investments; two reasons why investors may be interested in co-investments; the “market” for how co-investments are handled during the negotiation of initial fund investments; investment strategies that lend themselves to co-investments; and types of investors that are appropriate for co-investments.  See “Co-Investments Enable Hedge Fund Managers to Pursue Illiquid Opportunities While Avoiding Style Drift (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).  The third article will discuss regulatory and other risks in connection with co-investments.

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  • From Vol. 7 No.8 (Feb. 28, 2014)

    Top SEC Officials Discuss Hedge Fund Compliance, Examination and Enforcement Priorities at 2014 Compliance Outreach Program National Seminar (Part Two of Three)

    On January 30, the SEC hosted the 2014 version of its annual Compliance Outreach Program National Seminar for senior professionals at hedge fund managers and other investment advisers.  Panelists at the seminar included senior SEC officials and CCOs from hedge and private equity fund managers.  The seminar provided candid insight from regulators and conveyed best practices developed in the private sector.  This is the second article in a three-part series summarizing the more noteworthy points made at the seminar.  This article covers discussions of SEC priorities by theme and by SEC division and relays insights on nine topics of specific interest to private fund advisers: presence examinations, risk assessments, conflicts, co-investments, allocation of expenses, marketing, custody, allocation of investment opportunities and broker-dealer registration.  The first article discussed SEC Chairman Mary Jo White’s opening remarks and detailed the compliance, examination and enforcement priorities outlined by the heads of relevant SEC divisions.  See “Top SEC Officials Discuss Hedge Fund Compliance, Examination and Enforcement Priorities at 2014 Compliance Outreach Program National Seminar (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).  The third article will focus on private equity compliance issues, valuation and CCO liability.

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  • From Vol. 7 No.6 (Feb. 13, 2014)

    What Are the Duties of Directors of Cayman Islands Hedge Funds, and Should Those Duties Be Codified?

    Corporate governance reform has been on the radar of the Cayman Islands for several years.  The landmark 2011 decision by the Financial Services Division of the Cayman Islands Grand Court, Weavering Macro Fixed Income Fund Limited v. Stefan Peterson and Hans Ekstrom, held that a fund’s directors had willfully neglected their duties to supervise a fund’s operations when they acted as little more than figureheads or rubber stamps of manager actions.  See “The Cayman Islands Weavering Decision One Year Later: Reflections by Weavering’s Counsel and One of the Joint Liquidators,” The Hedge Fund Law Report, Vol. 5, No. 36 (Sep. 20, 2012).  In January 2013, the Cayman Islands Monetary Authority (CIMA) issued proposed rule amendments and proposed revised governance standards – spelled out in the revised Statement of Guidance on fund Governance (Governance SOG) – for hedge funds and their directors.  See “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  In December 2013, CIMA adopted the final Governance SOG.  Cayman directors’ duties have traditionally been derived primarily from common law principles of care, skill and diligence, and good faith, loyalty and other fiduciary duties.  The CIMA governance standards mentioned above were one effort to codify some of those principles with respect to directors of CIMA-regulated entities.  In another step towards governance reform, the Cayman Islands Law Reform Commission recently released an “Issues Paper” exploring the duties of Cayman directors and asking whether there would be any improvement in corporate governance if those duties were enumerated and codified in Cayman statutes.  This article summarizes the key points from the Issues Paper.

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Two of Three)

    This is the second article in a three-part series addressing the evolution of U.S. pension plan management and governance.  This article describes the current governance structures of today’s public pension, focusing on the board of trustees and pension staff; briefly reviews current governance research about public pension trustees, and the importance of both adequate staff infrastructure and effective delegation as features of good governance; and explains the new delegation rule and why it should be a key element of long-term organizational change within the U.S. pension system.  The first article highlighted how growth of public pension plans and fundamental legal or regulatory change, when combined with increasing pension portfolio complexity and the current underfunded status of most U.S. public pension plans, will be the forces defining pension evolution in the twenty-first century.  The first article also included an explanation of why the growth of public pension plans and fundamental legal or regulatory change impacted pension plan evolution through the twentieth century.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).  The third article will focus on what the next phase of pension evolution may look like and also highlight how, at least in one area, governance research can be developed to be a true value-added tool for public pension plans and their trustees, potentially guiding the design of their governance structures and investment infrastructures.  The author of this series is Von M. Hughes, a Managing Director at Pacific Alternative Asset Management Company, LLC.

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  • From Vol. 6 No.37 (Sep. 26, 2013)

    What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part Two of Two)

    It is important for hedge fund managers and investors alike to understand the duties that managers of private funds organized as limited liability companies (LLCs) and limited partnerships (LPs) owe to such funds.  Yet confusion has abounded in this area.  Recently, however, the Delaware courts and legislature have provided helpful guidance.  This two-part series is designed to inform managers and investors about the current state of Delaware law as it relates to the duties owed by hedge fund managers to their funds and investors.  This second installment discusses successful and unsuccessful claims brought pursuant the three available avenues for potential recovery by aggrieved investors: (1) breach of fiduciary duty; (2) breach of contract; and (3) breach of the implied covenant of good faith and fair dealing.  The first installment summarized the development of fiduciary duty law with respect to private investment funds organized as LPs or LLCs in Delaware, as well as issues concerning waiver of fiduciary duties by contract.  See “What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 36 (Sep. 19, 2013).  The authors of this series are Jay W. Eisenhofer and Caitlin M. Moyna, managing director and associate, respectively, at Grant & Eisenhofer P.A.

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  • From Vol. 6 No.37 (Sep. 26, 2013)

    How Can a Hedge Fund That Suffers Losses from Investments in Collateralized Debt Obligations Prove Loss Causation in a Civil Suit?

    On September 3, 2013, the U.S. District Court for the Southern District of New York (Court) dismissed a case brought by Banc of America Securities LLC and Bank of America (BOA) against Bear Stearns Asset Management (BSAM) and others.  The plaintiffs claimed that they suffered billions of dollars in losses caused by a fraud perpetrated by BSAM and three of its former directors.  The fraud related to a “CDO squared” investment, a collateralized debt obligation (CDO) comprised of CDOs constructed out of mortgage-backed securities taken from two of BSAM’s funds.  See “U.S. District Court Approves SEC’s Settlement with Bear Stearns Fund Managers Cioffi and Tannin,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).  The Court’s analysis sheds light on an important issue that investors may face: How can a plaintiff similarly situated to BOA – for instance, a hedge fund that invested in CDOs, CLOs or other structured products – prove loss causation in a civil suit following investment losses?  What is the legal standard applied to expert testimony in such a context?  This article addresses these questions by summarizing the factual background of the case and the Court’s legal analysis.

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  • From Vol. 6 No.36 (Sep. 19, 2013)

    What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part One of Two)

    During the past year, a fascinating and important dispute has arisen among the Delaware judiciary over the duties owed by managers of funds, including hedge funds, organized as limited partnerships (LPs) or limited liability companies (LLCs) (together, LPs and LLCs are often called “alternative entities”).  Some Delaware judges hold the view that traditional fiduciary obligations exist, while others believe that they do not, and that the parties’ duties can be defined solely by contract.  The debate has spilled over from judicial decisions to the pages of the New York Times.  And make no mistake, this is an issue with immense “real-world” consequences.  Alternative entities represent a significant business, and that business has been growing over time.  To help investors understand the scope of fiduciary obligations owed by hedge fund managers to their funds and investors, this article – the first in a two-part series – summarizes the development of fiduciary duty law with respect to private investment funds organized as LPs or LLCs in Delaware, as well as issues concerning waiver of fiduciary duties by contract.  The second installment will discuss examples of successful and unsuccessful claims brought against fiduciaries in the LP and LLC contexts, focusing on three theories of liability: breach of fiduciary duties, breach of contract and breach of the implied covenant of good faith and fair dealing.  The authors of this series are Jay W. Eisenhofer and Caitlin M. Moyna, managing director and associate, respectively, at Grant & Eisenhofer P.A.

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  • From Vol. 6 No.18 (May 2, 2013)

    How Should Hedge Fund Managers Approach the Allocation of Expenses Among Their Firms and Their Funds? (Part One of Two)

    One of the categories of questions most frequently posed by hedge fund managers to outside counsel is: Who should bear the cost of this or that expense – the manager or one or more of its funds?  Generally, the answer is governed by the organizational documents of the manager and its funds, which in turn are drafted in the shadow of legal principles that provide, at best, indirect guidance on allocating expenses.  That is, the SEC and other regulators have not provided specific guidance to hedge fund managers on how to allocate expenses.  This is partly because such guidance would not be practicable – expense types are more various than routine rulemaking can accommodate – and partly so that agencies can reserve enforcement and examination discretion.  At the same time, the stakes of such questions have increased because the costs of operating a hedge fund management business have increased, thanks to Dodd-Frank, the presence examinations initiative and an evolving set of investor expectations more focused on infrastructure, compliance and risk management.  See “Citi Prime Finance Report Dissects the Expenses of Running a Hedge Fund Management Business, Identifying Components, Levels, Trends and Benchmarks,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  In short, hedge fund managers have a growing number and volume of expenses and little in the way of reliable guidance on allocating them.  Hence the frequency of calls to outside counsel on this topic.  In an effort to short-circuit, or at least shorten, some of those calls – to make our in-house counsel subscribers more informed purchasers of legal services; to enable our law firm partner subscribers to deliver lower-margin services more efficiently, the better to focus on higher-margin services; and to refine the due diligence practices of our institutional investor subscribers – The Hedge Fund Law Report is publishing a two-part series on allocation of expenses among hedge fund managers and their funds.  This article, the first in the series, provides an overview of the key issues and challenges inherent in allocation decisions, and outlines various regulatory and other concerns posed by allocation practices.  The second article in the series will provide an overview of approaches used by hedge fund managers in allocating expenses; describe challenges associated with disclosure of expense allocation practices; highlight approaches for addressing the allocation of expenses when disclosures are silent with respect to specific expenses; and discuss key controls designed to ensure that expenses are being allocated in accordance with the manager’s policies and procedures.

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  • From Vol. 6 No.14 (Apr. 4, 2013)

    Can Hedge Fund Managers Contract Out Of Default Fiduciary Duties When Drafting Delaware Hedge Fund and Management Company Documents?

    Most hedge funds and their management entities are organized as Delaware limited liability companies (LLCs) or limited partnerships (LPs).  By statute, the members or partners (partners) of these entities are given “maximum flexibility” to define their respective rights and obligations in the entity’s operating agreement or partnership agreement.  Despite this clearly announced statutory policy favoring freedom of contract, Delaware courts also have developed a body of corporate-style fiduciary duties that prescribe and measure the conduct of the partners of Delaware LPs and LLCs.   The tension between the partners’ contractual rights and obligations, on the one hand, and their fiduciary duties, if any, on the other, is a common and important theme running through the caselaw.  Late last year, the Delaware Supreme Court issued an opinion that sheds new light on the important relationship between contractual and fiduciary duties, and that highlights once again the need for a cautious, detail-oriented approach to negotiating and drafting the agreements that govern hedge funds and their management entities.  That opinion and other recent decisions by Delaware courts raise a number of important questions for practitioners who regularly advise or litigate on behalf of hedge funds and their principals.  In a guest article, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, analyze these developments and provide practical guidance to assist practitioners in drafting and reviewing LLC and LP agreements.

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  • From Vol. 6 No.6 (Feb. 7, 2013)

    Federal Court Opinion Clarifies Two Important Components of the Fiduciary Duty of a Hedge Fund Manager with Benefit Plan Investors

    In a decision of importance to hedge fund managers that have or solicit investments from private pension plans, a federal district court recently analyzed various Employee Retirement Income Security Act (ERISA) issues in connection with a purported class action lawsuit.  The suit was initiated by a pension plan against a manager of a plan assets hedge fund of funds, its managing member, their officers and directors and several funds as a result of losses allegedly caused by an investment in a Ponzi scheme.  Managers of plan asset hedge funds (and in some cases their principals) are subject to heightened regulation pursuant to ERISA, as compared to most hedge fund managers.  For a discussion of regulations impacting plan asset fund managers, see “Speakers at Katten Seminar Outline ERISA Concerns for Managers of Plan Asset Hedge Funds,” The Hedge Fund Law Report, Vol. 5, No. 12 (Mar. 22, 2012); and “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).  The pension plan claimed that the defendants were “fiduciaries” within the meaning of ERISA and that they had breached two essential duties imposed on them as ERISA fiduciaries: They failed to manage the plan’s assets prudently and caused the plan assets fund to engage in prohibited transactions.  The plan also asserted federal securities fraud, breach of contract, breach of fiduciary duty and various state law claims.  The defendants moved to dismiss the pension plan’s complaint for failure to state a cause of action.  This article summarizes the court’s decision, with emphasis on its analysis of the pension plan’s ERISA claims.

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  • From Vol. 6 No.5 (Feb. 1, 2013)

    Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters

    Hedge fund managers intent on attracting institutional capital often feel compelled to entertain requests for preferential treatment via side letters from institutional investors.  But the “cost of capital,” as it were, may increase materially where a side letter is involved.  Such instruments raise regulatory concerns, present business challenges and create operational issues.  See “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  In an effort to identify some of the chief regulatory concerns raised by side letters – and to offer suggestions on how to address those concerns in a way that makes business sense – The Hedge Fund Law Report recently interviewed Christopher Wells, a partner and head of the hedge fund practice at international law firm Proskauer Rose LLP.  Our interview with Wells covered selective disclosure, the role of advisory committees, most favored nation provisions, allocation of costs of administering side letters, ERISA considerations, the role of state “sunshine” laws, considerations specific to sovereign wealth funds and much else.  For additional insight from Wells, see “Managing Risk in a Changing Environment: An Interview with Proskauer Partner Christopher Wells on Hedge Fund Governance, Liquidity Management, Transparency, Tax and Risk Management,” The Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012).  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel on side letters entitled “Navigating the Side Letter Negotiation & Due Diligence Process.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.

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  • From Vol. 5 No.43 (Nov. 15, 2012)

    Schulte Partner Stephanie Breslow Discusses Hedge Fund Liquidity Management Tools in Practising Law Institute Seminar

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

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  • From Vol. 5 No.36 (Sep. 20, 2012)

    The Cayman Islands Weavering Decision One Year Later: Reflections by Weavering’s Counsel and One of the Joint Liquidators

    Last month marks the one-year anniversary of the decision handed down by the Grand Court of the Cayman Islands (Court) against the directors of Weavering Macro Fixed Income Fund, in which both directors were found to have breached their duties and were ordered to pay damages in the amount of USD$111 million.  In the days and weeks which followed, many stakeholders offered their own critique of the decision as well as the “checklist” promulgated by Mr. Justice Andrew Jones QC of the steps which an independent non-executive director of an investment fund should take in order to properly discharge his duties.  Some critiques were lucid and objective dispositions of the decision, and some were not.  Perhaps it was the size of the award, or that it was the first time that directors of a failed Cayman Islands investment fund had been found liable in damages for a fund’s losses, which provoked such interest; but no doubt the views expressed by many were, and are, influenced by personal circumstances.  But what has been the true impact of the decision, and what mark has it left on the laws relating to directors generally?  In this article Mourant Ozannes’ Shaun Folpp, who acted for Weavering with respect to both the first instance proceedings and the recent appeal, and Mr. Ian Stokoe of PwC Corporate Finance and Recovery (Cayman) Limited, one of Weavering’s Joint Official Liquidators, explore these very issues, and reflect on one of the most talked about decisions ever to be handed down by the Court.  For background on the decision, see “Cayman Grand Court Holds Independent Directors of Failed Hedge Fund Weavering Macro Fixed Income Fund Personally Liable for Losses Due to their Willful Failure to Supervise Fund Operations,” The Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).

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  • From Vol. 5 No.34 (Sep. 6, 2012)

    Grant Thornton Broker-Dealer Industry Symposium Focuses on Capital Requirements, Fiduciary Standards, the JOBS Act, the Volcker Rule and Use of Social Media

    On June 19, 2012, Grant Thornton hosted a symposium that highlighted recent regulatory developments impacting brokerage firms, including brokers that have hedge funds as clients.  The aim of the symposium was to arm broker-dealers with valuable information and tools to help them do business in an increasingly regulated industry.  The panelists addressed a number of current issues facing the broker-dealer industry, including: capital requirements for broker-dealers; new fiduciary standards for broker-dealers; the impact of the Jumpstart Our Business Startups (JOBS) Act; regulatory uncertainty surrounding the Volcker Rule; new rule changes impacting broker-dealers; best execution; and the use of social media.  This article summarizes highlights from the symposium on the foregoing topics.  For hedge fund managers, this discussion is relevant for at least two reasons.  First, hedge fund managers routinely interact with broker-dealers in connection with prime brokerage activities, obtaining leverage, borrowing shares to sell short, custody, derivatives transactions and a wide range of other activities.  Second, some hedge fund managers have affiliated broker-dealers.  See “Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).

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  • From Vol. 5 No.34 (Sep. 6, 2012)

    Federal Court Decision Addresses When an Investment Manager Becomes an ERISA Fiduciary

    Investment advisers that become ERISA fiduciaries because the fund is deemed to be a “plan assets” fund subject to ERISA may also be deemed to be a fiduciary with respect to ERISA plans that are investors in that fund.  A recent federal court decision addresses, among other things, circumstances in which an investment manager constitutes a “fiduciary” for ERISA purposes, and whether an ERISA fiduciary is liable for breaches that occurred before it became a fiduciary.  See “Applicability of New Disclosure Obligations under ERISA to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).

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  • From Vol. 5 No.26 (Jun. 28, 2012)

    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

    On June 26, 2012, the SEC filed three separate complaints relating to securities law violations allegedly committed by Philip A. Falcone, his investment advisory firm, Harbinger Capital Partners LLC (Harbinger) and other entities and individuals.  In the first complaint, the SEC charged Falcone, Harbinger and Peter Jenson, a former Managing Director and Chief Operating Officer of Harbinger, with violations of the federal securities laws in relation to the misappropriation of client assets (through the making of a $113.2 million loan from a fund managed by Harbinger to Falcone to pay his personal taxes) and the granting of undisclosed preferential redemption rights to certain investors.  See “Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  In the second complaint, the SEC charged Falcone, Harbinger Capital Partners Offshore Manager, L.L.C. and Harbinger Capital Partners Special Situations GP, L.L.C. with engaging in an illegal short squeeze to manipulate bond prices.  In the third complaint, the SEC charged Harbert Management Corporation, HMC-New York, Inc. and HMC Investors, LLC with control person liability in relation to the alleged market manipulation described in the second complaint.  Separately, the SEC issued an order settling claims with Harbinger related to violations of Rule 105 under Regulation M.  This article details the charges levied by the SEC in the three complaints and details the terms of the settlement with Harbinger related to the Rule 105 violations.

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  • From Vol. 5 No.24 (Jun. 14, 2012)

    Ontario Securities Commission Sanctions Hedge Fund Manager Sextant Capital Management and its Principal for Breach of Fiduciary Duty

    The Ontario Securities Commission recently handed down a decision against an investment fund manager that demonstrates its willingness to levy severe sanctions against managers engaged in fraud with respect to investors.  The decision is notable for its facts and legal analysis as well as its location.  Canada is an increasingly important jurisdiction for hedge fund managers and investors, and this matter provides useful color on the regulatory landscape there.

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  • From Vol. 5 No.9 (Mar. 1, 2012)

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

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

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  • From Vol. 5 No.7 (Feb. 16, 2012)

    Recent Delaware Chancery Court Opinion Clarifies Default Fiduciary Duties Owed By Managers of Limited Liability Companies

    Much confusion has arisen surrounding the scope of fiduciary duties owed by managers of Delaware limited liability companies (LLCs) to other members of the LLC.  Hedge fund managers must understand the scope of such fiduciary duties because they frequently organize LLCs both as hedge funds that they manage as well as the management entities which provide advisory and administrative services to their hedge funds.  As a result, hedge fund managers may owe fiduciary duties not only to hedge fund investors, but also to the other members of their management entities organized as LLCs.  This article describes a recent Delaware Chancery Court opinion that clarifies the default fiduciary duties owed by managers of Delaware LLCs, as well as the scope of the ability of managers to limit or eliminate such duties by contract.

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  • From Vol. 5 No.6 (Feb. 9, 2012)

    Massachusetts Superior Court Dismisses Investors’ Claims Against Hedge Fund Manager Dutchess Capital, its Auditor, Administrator, Principals and Affiliate

    Plaintiffs in this action were investors in two hedge funds managed by Dutchess Capital Management, LLC (Dutchess Capital).  When those investments failed, plaintiffs commenced suit against Dutchess Capital, an affiliate, its principals, its outside auditor and its administrator.  They alleged breach of contract, breach of fiduciary duty, malpractice, fraud and similar claims.  The Court granted defendants’ motion to dismiss, holding that plaintiffs lacked standing to bring certain derivative claims, that the Court lacked jurisdiction over the fund administrator and that the remaining claims were barred by the applicable statutes of limitations.  This article summarizes the Court’s decision.

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  • From Vol. 5 No.3 (Jan. 19, 2012)

    Delaware Chancery Court Sanctions Legendary Investor Michael Steinhardt for Trading in Occam/Calix Shares Based on Confidential Information He Received While Serving as a Representative Plaintiff in a Class Action Against Occam

    In October 2010, plaintiffs Michael Steinhardt (Steinhardt), two hedge funds managed by Steinhardt, Derek Sheeler and Herbert Chen (Chen) commenced a class action lawsuit seeking to enjoin the proposed acquisition of defendant Occam Networks, Inc. (Occam) by Calix, Inc. (Calix) and challenging the fairness of the transaction.  The injunction was denied and the transaction closed in February 2011, but the litigation continued.  During discovery, the defendants learned that Steinhardt and Chen had traded in Occam and Calix shares while subject to a confidentiality order that prohibited trading in shares of Occam and Calix and the use of non-public information discovered in the course of the suit.  The defendants moved for sanctions against them.  The Delaware Chancery Court ruled that Steinhardt had violated his fiduciary duty as a class representative, dismissed him and his funds from the suit with prejudice, and imposed various sanctions on them.  The Court denied the motion as against Chen.  We detail the facts of the case and the Court’s reasoning.

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  • From Vol. 5 No.2 (Jan. 12, 2012)

    New York Court of Appeals Holds that The Martin Act, New York’s “Blue Sky” Law, Does Not Preempt Common Law Claims for Breach of Fiduciary Duty and Gross Negligence

    On December 20, 2011, in an important decision for the investment management community, the New York Court of Appeals ruled that the Martin Act does not preclude overlapping private tort claims brought by individual investors.  See “First Department Decision May Give Aggrieved Hedge Fund Investors an Unexpected and Powerful Avenue of Redress,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).  This article details the background of the action, the court’s legal analysis and the potential implications of the decision for lawsuits by hedge fund investors against hedge fund managers.

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  • From Vol. 4 No.43 (Dec. 1, 2011)

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

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

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  • From Vol. 4 No.31 (Sep. 8, 2011)

    Cayman Grand Court Holds Independent Directors of Failed Hedge Fund Weavering Macro Fixed Income Fund Personally Liable for Losses Due to their Willful Failure to Supervise Fund Operations

    In a judgment with serious implications for those who serve as directors of Cayman Islands hedge funds, the Grand Court of the Cayman Islands has ruled that Stefan Peterson and Hans Ekstrom, who were the independent directors of Weavering Macro Fixed Income Fund Limited (Fund), were personally liable for $111 million of excess redemption payments that had been made by the Fund using a wildly inflated net asset value.  The Court found that those directors had willfully neglected their duties to supervise the operation of the Fund and had served as little more than rubber stamps for the Fund’s founder, Magnus Peterson.  They missed or ignored critical – and obvious – signs that something was seriously amiss with the Fund.  The Court’s judgment, summarized in this article, provides a useful roadmap for the level of engagement, due diligence and oversight required of directors of Cayman Islands hedge funds.  For our original coverage of the Fund’s collapse, see “The Weavering Blow-Up and What It May Mean for Boards of Directors of Cayman Islands Hedge Funds,” The Hedge Fund Law Report, Vol. 2, No. 13 (April 2, 2009).  For a discussion of the role that non-executive directors should play in the governance of offshore hedge funds and the protection of investors, see “The Case In Favor of Non-Executive Directors of Offshore Hedge Funds with Investment Expertise, Fewer Directorships and Independence from the Manager,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010), and a letter to the editor in response, “The Case in Favor of Focused, Experienced and Independent Hedge Fund Directors,” The Hedge Fund Law Report, Vol. 4, No. 3 (Jan. 21, 2011).

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  • From Vol. 4 No.29 (Aug. 25, 2011)

    Delaware Chancery Court Opinion Clarifies the Scope of a Hedge Fund Manager’s Fiduciary Duty to a Seed Investor

    In resolving a contentious lawsuit between a start-up hedge fund manager, Michelle Paige, and her seed investor, the Lerner family, the Delaware Chancery Court issued an opinion on August 8, 2011 that described the scope of a manager’s fiduciary duty to a seed investor, and the circumstances in which a manager viably may prohibit redemption by a seed investor by lowering a gate.  See “Is a Threatening Letter from a Hedge Fund Manager to a Seed Investor Admissible in Litigation between the Manager and the Investor as Evidence of the Manager’s Breach of Fiduciary Duty?,” The Hedge Fund Law Report, Vo. 4, No. 17 (May 20, 2011).  This feature-length article details the background of the action and the Court’s legal analysis.  The opinion is one of the longer statements to date by the Delaware Chancery Court on a hedge fund dispute, and thus provides valuable insight into the Chancery Court’s view of fiduciary duty in the hedge fund context.  In addition, given the factual background, the opinion is particularly relevant to hedge fund managers that have or are seeking seed investors, and to entities that make seed investments in hedge fund managers and hedge funds.  See “Ten Issues That Hedge Fund Seed Investors Should Consider When Drafting Seed Investment Agreements,” The Hedge Fund Law Report, Vo. 4, No. 12 (Apr. 11, 2011).

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  • From Vol. 4 No.26 (Aug. 4, 2011)

    SEC Order against Pegasus Investment Management Suggests That a Hedge Fund Manager Cannot Keep the Proceeds of an Undisclosed “Rental” of Its Trading Volume

    A recent SEC order instituting administrative and cease-and-desist proceedings against a small hedge fund manager confirms the principle that hedge fund investors – not managers – own the assets in funds and any assets generated with those assets, subject to specific exceptions.  The matter also addresses, albeit indirectly and inconclusively, the question of whether hedge funds may agree by contract to permit conduct by the manager that, absent such agreement, would constitute fraud or a breach of fiduciary duty.

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  • From Vol. 4 No.19 (Jun. 8, 2011)

    Houston Pension Fund Sues Hedge Fund Manager Highland Capital Management and JPMorgan for Breach of Fiduciary Duty, Alleging Self-Dealing and Conflicts of Interest

    In 2006 and 2007, plaintiff Houston Municipal Employees Pension System (HMEPS) invested an aggregate $15 million with hedge fund Highland Crusader Fund, L.P. (Fund).  The Fund was sponsored by Highland Capital Management, L.P. (Highland), which also served as the Fund’s investment manager.  The Fund’s general partner was defendant Highland Crusader Fund GP, L.P. (General Partner).  Defendant J.P. Morgan Investor Services Co. (JPMorgan) provided administrative support to the Fund.  The Fund is now in liquidation.  In a lawsuit filed in the Delaware Court of Chancery on May 23, 2011, HMEPS generally claims that, during the credit crisis of 2008, the Highland defendants and their principals “looted” the Fund with the assistance of JPMorgan and engaged in self-dealing by selling themselves high-quality assets from the Fund and leaving the Fund with junk assets.  HMEPS relies in part on a whistleblower complaint filed by a JPMorgan employee who observed “questionable accounting and management practices” at the Fund.  HMEPS claims that Highland, the General Partner and their principals breached their fiduciary duties to the Fund and that JPMorgan aided and abetted that breach.  HMEPS is suing derivatively on behalf of the Fund.  We summarize HMEPS’ specific allegations and Highland’s recent press release in response.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?

    We recently analyzed a decision of an SEC administrative law judge (ALJ) holding that fund-level information, as opposed to portfolio-level information, can constitute material nonpublic information (MNPI) for insider trading purposes.  See “SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  Specifically, the ALJ held that information regarding a major fund redemption, fund management’s decision to increase cash levels and efforts to sell a large portion of the bonds in the fund’s portfolio each constituted MNPI.  Accordingly, the ALJ found that the fund manager’s recommendation to his daughter to sell fund shares while the manager was aware of the foregoing three categories of MNPI constituted insider trading under a tipper-tippee theory.  On the scope of the tipper-tippee theory, see the heading “Insider Trading Law” in “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  As explained in our analysis, while that decision arose in the mutual fund context, it has direct relevance for hedge fund managers and investors.  One of the more provocative questions raised by the decision is: are side letters granting preferential transparency and liquidity terms to one investor ipso facto illegal?  For more on side letters, see “What Is the Legal Effect of a Side Letter That Contains Specific Terms More Favorable Than a Hedge Fund’s General Offering Documentation?,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).

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  • From Vol. 4 No.17 (May 20, 2011)

    Is a Threatening Letter from a Hedge Fund Manager to a Seed Investor Admissible in Litigation between the Manager and the Investor as Evidence of the Manager’s Breach of Fiduciary Duty?

    Hedge fund manager Paige Capital Management, LLC (Fund), had a dispute with seed investor Lerner Master Fund, LLC (Lerner), over Lerner’s demand to withdraw its entire investment.  The Fund’s attorney wrote a letter to Lerner “reminding” Lerner of the potential costs of litigation over Lerner’s withdrawal rights and advising Lerner that, if it did not drop its withdrawal demand, the Fund would invest Lerner’s funds in “high risk, long-term, illiquid, activist securities” and spare no expense in defending the Fund.  This litigation ensued and the Fund sought to block Lerner from introducing the letter as evidence of breach of fiduciary duty by the Fund, claiming that the letter was protected both as a settlement communication and by the privilege for allegedly defamatory statements made in the course of litigation.  We summarize the decision.

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  • From Vol. 4 No.16 (May 13, 2011)

    New York Appellate Division Dismisses Investors’ Complaint Against Corey Ribotsky and Hedge Fund AJW Qualified Partners, Holding that Fund’s Decision to Suspend Redemptions Did Not Constitute a Breach of the Fund’s Operating Agreement or a Breach of Fiduciary Duty

    Plaintiffs are Steven Mizel and his limited partnership which invested, in the aggregate, about $1.6 million with hedge fund AJW Qualified Partners, LLC (Fund).  During the market turmoil of late 2008, plaintiffs sought to redeem their investments in the Fund.  In response to a wave of redemption requests, in October 2008, the Fund froze all redemptions and sought to reorganize.  Plaintiffs brought suit, alleging anticipatory breach of contract by the Fund and breaches of fiduciary duty by the Fund’s manager and its principal, Corey Ribotsky.  The trial court denied the defendants’ motion to dismiss.  The Appellate Division reversed and dismissed the plaintiffs’ complaint in its entirety, holding that the suspension of redemptions was permitted by the Fund’s operating agreement.  We summarize the decision.

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  • From Vol. 4 No.14 (Apr. 29, 2011)

    SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information

    In the vast majority of insider trading cases involving fund management, the material nonpublic information at issue relates to a company whose securities the fund may buy or sell.  However, in a provocative recent initial decision (Decision), an SEC Administrative Law Judge (ALJ) held that information about a fund itself may constitute material nonpublic information for insider trading and breach of fiduciary duty purposes.  This article explains in detail: the factual background of the Decision; the ALJ’s legal analysis; what specific categories of fund-level information may constitute material nonpublic information in the hedge fund management context; the disclosure implications of the potentially expanded scope of material nonpublic information; the interplay between the potentially expanded scope of material nonpublic information and the idea (most notably enunciated in Goldstein v. SEC) that a hedge fund is a manager’s “client”; the implications of the Decision for drafting, negotiating and performing under side letters and managed account agreements; the importance for hedge fund managers of internal investigations; how chief compliance officers (CCOs) can point to the “human toll” in this matter to capture the attention of investment personnel during compliance training; and a new category of monitoring of family relationships to be performed by hedge fund manager CCOs.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    First Department Decision May Give Aggrieved Hedge Fund Investors an Unexpected and Powerful Avenue of Redress

    The Martin Act (New York General Business Law §§ 352-359) prohibits various fraudulent and deceitful practices in the distribution, exchange, sale and purchase of securities.  It authorizes the New York Attorney General to investigate these activities and seek relief against sellers of securities engaged in dishonest or deceptive activities.  For more on the Martin Act in the hedge fund context, see “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009); “Federal Court Dismisses Breach of Fiduciary Duty Claim, but Permits Securities Fraud Claim, Against Alternative Investment Fund and Its Manager and Principals,” The Hedge Fund Law Report, Vol. 2, No. 3 (Jan. 21, 2009).  The Martin Act does not create a private right of action for such violations, however.  See CPC Int’l v. McKesson Corp., 70 N.Y.2d 268 (1987).  Enterprising defendants have used that proposition to argue not only that no private right of action exists, but also that the Martin Act preempts certain private common law claims arising from the conduct covered by the statute.  To date, New York State and a majority of federal courts have found this argument persuasive, and applied it to non-fraud-based common law claims, such as breach of fiduciary duty and negligent misrepresentation.  Hence, many defendants have succeeded in having these claims dismissed.  This has been especially true in the federal courts’ construction of New York law.  However, a recent and notable decision of the Appellate Division, First Department repudiates this trend.

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Cayman Islands Grand Court Rules That Hedge Fund Investor Is Entitled to Court-Supervised Liquidation of Fund, Even Though Fund Managers Were Conducting “Ad Hoc” Liquidation With the Support of a Majority of Fund Investors

    In yet another case that highlights the importance of carefully drafted hedge fund organizational documents, the Cayman Islands Grand Court has granted a request by hedge funds Aris Multi-Strategy Lending Fund Limited and Aris Africa Fund Limited (together, Aris) to have a court-supervised liquidator appointed for hedge fund Heriot African Trade Finance Fund Limited (Heriot or Fund).  In or around March 2009, as a result of the 2008 credit crisis, Heriot’s managers suspended redemptions in the Fund indefinitely.  In June 2009, Aris commenced litigation seeking to wind up the Fund on the grounds that the Fund had failed to file timely financial statements and had failed to comply with its stated investment policy.  Over a year later, it amended that petition to add a critical additional ground for winding up: The Fund had lost its “substratum,” which, under Cayman Islands law, means that the Fund’s business purpose could no longer be carried out.  Heriot, in opposing the winding up order, argued that, with the approval of a majority of its investors, it was already liquidating in an orderly fashion.  The Court ruled that, because Heriot’s organizational documents did not specifically contemplate an informal, self-supervised liquidation process, Aris was entitled to a winding up order and the appointment of a liquidator.  This article summarizes the Court’s decision.  For more on Aris, see "Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris," The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009); "New York State Supreme Court Dismisses Hedge Funds of Funds’ Complaint against Accipiter Hedge Funds Based on Exculpatory Language in Accipiter Fund Documents and Absence of Fiduciary Duty 'Among Constituent Limited Partners,'" The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17. 2010); "New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act," The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).

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  • From Vol. 3 No.44 (Nov. 12, 2010)

    Municipal Securities Rulemaking Board Extends Its Regulatory Reach to Include Hedge Fund Placement Agents

    On November 1, 2010, the Municipal Securities Rulemaking Board (MSRB) filed proposed rule changes with the Securities and Exchange Commission (SEC).  See “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010).  Those proposed rule changes are of interest to the hedge fund community for five primary reasons.  First, they clarify the definition of a “municipal advisor” for purposes of Section 975 of Dodd-Frank.  That definition likely encompasses placement agents providing services to hedge funds and other entities that provide similar services to hedge funds but call themselves something else (such as “finders,” “solicitors” or “cash solicitors”).  Second, the proposed rule changes impose three procedural requirements on municipal advisors.  Third, they impose two substantive requirements on municipal advisors.  Fourth, the MSRB’s Notice 2010-47 (Notice), announcing the filing of the proposed rule changes, includes a roadmap of the MSRB’s rulemaking agenda for “the coming months and years,” including rules that will directly affect hedge fund placement agents.  Fifth, the Notice contains a portentous endnote relating to the “federal fiduciary duty” of municipal advisors, and the entities to whom that duty is owed.  This article discusses each of these five points – and identifies the questions that placement agents have to ask and answer today based on these points.

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  • From Vol. 3 No.43 (Nov. 5, 2010)

    Implications of the DOL’s Proposed Expanded Definition of “Fiduciary” for Hedge Fund Managers, Placement Agents, Valuation Firms and Pension Consultants

    On October 22, 2010, the Department of Labor’s Employee Benefits Security Administration proposed rule amendments that would considerably expand the definition of “fiduciary” for purposes of the Employee Retirement Income Security Act of 1974, as amended (ERISA).  Under current regulation, a person can be deemed a fiduciary for ERISA purposes by reason of rendering investment advice if the person meets a five-part test.  The proposed amendments would replace that five-part test with a two-part test.  Generally, the new two-part test would be easier to satisfy – that is, would capture a wider range of entities and activities – than the old five-part test.  Thus, under the new rule, more entities would qualify (often involuntarily) as ERISA fiduciaries and thereby become subject to a range of duties, at least one of which (the duty of prudence) has been characterized by courts as the “highest known to the law.”  According to the preamble to the proposed rule release in the Federal Register, the DOL proposed the new rule for two primary reasons: to address purported changes in relationships between investment advisers and employee benefit plan clients occasioned by the increasing complexity of investment products and services, and to more efficiently allocate its enforcement resources.  The investment management industry has already voiced skepticism with respect to both rationales.  Regarding the first, commentators have suggested that while investment products and services have become more complex, the fundamental nature of investment advisory relationships has not changed in the 35 years since the current regulation was put in place.  Regarding the second, commentators have suggested that the DOL’s enforcement efforts may be largely moot because if the amendments become effective in their proposed form, many financial services firms – notably, broker-dealers, valuation agents and placement agents – may cease offering services directly or indirectly to employee benefit plans.  Surprisingly, the DOL appears to be cognizant of the potential adverse business consequences of its proposed amendments.  In the rule release, the DOL noted that “plan service providers that fall within the Department’s rule might experience increased costs and liability exposure associated with ERISA fiduciary status.  Consequently, these service providers might charge higher fees to plan clients, or limit or discontinue the availability of their services or products to ERISA plans.”  However, the DOL apparently determined that the benefits of increased enforcement efficiency and a more pervasive fiduciary duty are worth increasing the costs and reducing the choices available to plans.  This article explores the implications of the proposed rule amendments for four categories of hedge fund industry participants: hedge fund managers, placement agents, valuation firms and pension consultants.  The article concludes that the amended rule would have a limited effect on most hedge fund managers, and a potentially direct and adverse effect on placement agents, valuation firms and pension consultants.  However, the proposed amendments also contain exceptions – and this article explains how various hedge fund industry participants may use those exceptions to avoid undesired characterization as an ERISA fiduciary.

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  • From Vol. 3 No.39 (Oct. 8, 2010)

    U.S. District Court Allows ERISA Claims for Breach of Fiduciary Duties to Proceed Against Pension Fund’s Investment Advisers

    Plaintiffs are participants in the Inductotherm Companies Master Profit Sharing Plan (Plan).  Their Complaint, arising out of poor performance of the Plan, alleges 22 separate claims against three sets of defendants: (i) Inductotherm Industries, Inc. and the Plan’s trustees, (ii) investment managers Financial Services Corporation, its wholly-owned subsidiary FSC Securities Corporation (FSC Securities) and the Wharton Business Group (Wharton), and (iii) American International Group (AIG) and certain SunAmerica companies, all of which were alleged to be affiliated with SunAmerica Money Market Fund, in which certain Plan assets were invested.  AIG is also the parent corporation of Financial Services Corporation.  The Complaint includes sixteen claims under the Employee Retirement Income Security Act (ERISA) for breach of fiduciary duties, two common law claims of fraudulent concealment, three claims involving violations of federal and state laws regulating securities, and a claim under the Racketeer Influenced and Corrupt Organizations Act (RICO).  See “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 33 (Aug. 20, 2010); “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).  In a decision that sheds light on how hedge funds that have pension fund investors might fare in lawsuits arising out of poor performance, the District Court held that FSC Securities and Wharton were plan fiduciaries and that the Complaint against them stated valid causes of action for violations of ERISA.  We summarize the Court’s decision, with emphasis on the investment manager defendants.

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  • From Vol. 3 No.38 (Oct. 1, 2010)

    SEC’s Insider Trading Case Against Nelson Obus of Hedge Fund Wynnefield Capital Thrown Out on Summary Judgment Motion Because SEC Failed to Prove that GE Capital Tipper Acted Deceitfully or in Violation of a Confidentiality Duty

    The U.S. District Court for the Southern District of New York has thrown out the SEC’s insider trading case against three individuals, the “tipper,” the “tippee” and the tippee’s superior, who allegedly traded in the securities of SunSource, Inc. (SunSource) after receiving inside information about the potential sale of SunSource.  In early 2001, Allied Capital Corporation (Allied) began exploring the possibility of acquiring SunSource and spinning off one of SunSource’s subsidiaries.  GE Capital was one of several lenders that were approached about the possibility of financing the transaction.  Defendant Thomas Strickland worked for the commercial finance group of GE Capital and was assigned to the SunSource deal team.  Strickland noticed that hedge fund Wynnefield Capital, Inc. (Wynnefield) owned SunSource stock.  In May 2001, Strickland had a conversation about SunSource with defendant Peter Black, an analyst at Wynnefield who happened to have been a college classmate of his.  Black advised his boss, defendant Nelson Obus, of Strickland’s interest in SunSource.  Obus then purchased additional shares of SunSource stock.  After Allied merged with SunSource, the Securities and Exchange Commission (SEC) brought civil insider trading charges against Strickland, Black and Obus.  On the defendants’ motion for summary judgment, the District Court dismissed the case against them.  It reasoned that, in mentioning the SunSource financing to Black, Strickland had not violated any fiduciary duty to GE Capital or SunSource, had not breached any duty of confidentiality to either company and had not acted deceptively.  Therefore, Strickland’s tip did not give rise to liability.  We outline the facts of the case and the Court’s reasoning.

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  • From Vol. 3 No.36 (Sep. 17, 2010)

    In Continuing Saga of Collapse of Hedge Fund Parkcentral Global, Brown Investment Management Sues Fund’s Auditor, Ernst & Young, Claiming Fraud, Negligence and Breach of Fiduciary Duty

    In late 2008, plaintiff Brown Investment Management, L.P. (Brown) and other investors purchased an aggregate $17 million of limited partnership interests in hedge fund Parkcentral Global, L.P. and Parkcentral Global Fund Limited, both of which fed all their invested assets into Parkcentral Global Hub Limited (Fund).  Despite the Fund’s numerous representations that it would not commit more than 5% of its assets to any one of its investment strategies, or lose more than 5% of net asset value in a worst case scenario, the Fund collapsed in 2008 after making a huge unhedged bet on mortgage backed securities.  The investors’ entire $17 million was wiped out within months.  A 2009 class action is pending against various Fund employees and certain entities allegedly controlled by Ross Perot and his family.  Based in part on the allegations made in the class action, Brown and the other investor plaintiffs now accuse the Fund’s auditor, Ernst & Young, L.L.P., of fraud, negligence and other misdeeds arising out of their preparation of the Fund’s financial statements.  We summarize the allegations made in the complaint and the plaintiffs’ legal theories.

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  • From Vol. 3 No.36 (Sep. 17, 2010)

    Connecticut Attorney General Sues Chief Investment Officer of Wesleyan University and Hedge Funds with which CIO was Affiliated for Inappropriate Use of University Resources

    In a complaint filed in the Middlesex Superior Court in Connecticut on August 12, 2010, Connecticut Attorney General Richard Blumenthal accused Thomas Kannam, the former Chief Investment Officer (CIO) of Wesleyan University, along with two hedge fund management companies and one operating company with which Kannam was affiliated, of breach of fiduciary duty and other legal violations.  Specifically, Blumenthal alleged that Kannam violated his fiduciary duty to the University by knowingly causing University Endowment funds to be used for his own personal benefit or the benefit of the hedge fund managers and operating company with which he was affiliated, in contravention of his duty of loyalty to the University.  This article details the factual and legal allegations in Blumenthal’s complaint.  The complaint may have broader relevance within the hedge fund community because of the mobility between employment as an endowment CIO and principal at a hedge fund management company.  That is, for hedge fund managers looking to hire former endowment CIOs, it is important to understand what level of pre-employment affiliation is permissible.  Even for managers who are not looking to hire current or former endowment CIOs, but are merely looking to do business with them in their capacity as CIOs, the complaint helps demarcate the line between permissible and impermissible conduct.

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  • From Vol. 3 No.29 (Jul. 23, 2010)

    Sixth Circuit Rules that a Hedge Fund Adviser Can Owe a Fiduciary Duty Not Only to the Fund, But Also to Fund Investors

    On July 14, 2010, the United States Court of Appeals for the Sixth Circuit upheld a conviction against Mark D. Lay for investment adviser fraud, mail and wire fraud, and for engaging in deceptive and manipulative practices relating to the Ohio Bureau of Workers’ Compensation (OBWC), which was an investor in a hedge fund he managed.  The government accused Lay of ignoring a leverage cap in the OBWC advisory agreement, of failing to disclose how he exceeded that cap to OBWC, and of causing OBWC to lose $212 million as a result.  For his part, Lay argued in the district court and on appeal that in his role as hedge fund adviser, he had a fiduciary duty to the hedge fund, but not to the OBWC, thereby rendering certain jury instructions at his trial improper, and invalidating his conviction on the grounds of insufficient evidence.  On May 13, 2008, the United States District Court for the Northern District of Ohio rejected his motion for judgment of acquittal.  The Court of Appeals affirmed that decision, holding that “Because a hedge fund adviser can, in some circumstances, have a fiduciary relationship with an investor, the jury instructions were correct and sufficient evidence supports Lay’s conviction” for investment adviser fraud.  Concurring in that judgment, one judge dissented in part on the grounds that the government had failed, as a factual matter, to prove mail and wire fraud.  This article summarizes the background of the action, the Court’s legal analysis, and the implications for the scope of a hedge fund manager’s fiduciary duties.

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  • From Vol. 3 No.28 (Jul. 15, 2010)

    Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers

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

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  • From Vol. 3 No.22 (Jun. 3, 2010)

    Primary Legal and Business Considerations in Structuring Hedge Fund Capacity Rights

    Traditionally, hedge funds and private equity funds have used different funding models.  Private equity funds have used a capital on call model, in which investors agree by contract to contribute a certain amount of capital to the fund, and retain possession of that capital until the manager requests it.  Hedge funds, by contrast, have used an immediate funding model, in which investors actually contribute capital to the fund at the time of investment, and the fund’s custodian retains possession of that capital for the duration of the investment.  (But see “Can a Capital On Call Funding Structure Fit the Hedge Fund Business Model?,” The Hedge Fund Law Report, Vol. 2, No. 44 (Nov. 5, 2009).)  However, there is a narrow exception to the immediate funding rule in the hedge fund context.  That exception applies to seed investors and other large, usually early investors in hedge funds (who often simultaneously invest in the hedge fund management entity).  Such investors frequently condition their investments on rights to make additional investments in the fund.  In the hedge fund world, those additional investment rights generally are known as capacity rights.  In effect, investors with capacity rights have the opposite of capital on call.  Instead, they have what might be termed “capital on put.”  Whereas a private equity fund manager has the right to call its investors’ capital, a hedge fund investor with capacity rights has the right to put its capital into the fund.  Capacity rights agreements offer business benefits to managers and investors.  Most notably, they enable start-up managers to bring in anchor investors, and offer anchor investors the opportunity to maximize the value of risky investments with new managers.  But capacity rights agreements also present a variety of legal and practical complications.  The purpose of this article is to highlight some of those complications and, where practicable, offer remedies or solutions.  In particular, this article discusses: the definition of capacity rights; the business rationales for granting (from the manager perspective) or requesting (from the investor perspective) capacity rights; the documents in which such rights are usually memorialized; how such rights are generally structured, including the pros and cons of structuring capacity rights based on dollar amount versus percentage of assets under management (AUM) or total capacity; and various specific concerns raised by capacity rights agreements, including ERISA concerns, concerns relating to most favored nations (MFN) clauses in side letters, the frequently less advantageous economics associated with capital invested pursuant to capacity rights, and fiduciary duty concerns.

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  • From Vol. 3 No.20 (May 21, 2010)

    How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA's More Onerous Prohibited Transaction Provisions? (Part Two of Three)

    This is the second article in a three-part series of articles we are doing on ERISA considerations in the hedge fund context.  Specifically, the first article in this series dealt with how hedge funds and their managers can become − and avoid becoming − subject to ERISA.  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 article deals with the consequences to hedge funds and their managers of becoming subject to ERISA.  And the third article will detail strategies for accepting investments from "benefit plan investors" above 25 percent of any class of equity interests issued by a hedge fund while avoiding many of the more onerous prohibited transaction provisions and other restrictions imposed by ERISA.  In short, the structure of this series is: application, implications, avoidance.  As explained in the first article, the occasion for this series is the gulf between forecasts and experience with respect to inflows into hedge funds globally.  Forecasts suggest that the rate of new investments into hedge funds should be increasing, but experience suggests that fundraising remains a primary challenge for many hedge fund managers, even seasoned managers with good track records.  We think that one explanation for this gulf may involve the nature of the anticipated new assets: many of those assets are likely to come from U.S. corporate pension funds.  Such investors generally employ a long and conscientious pre-investment due diligence process, or from the hedge fund perspective, involve a longer sales cycle.  But when they invest, they invest for the long term.  That is, we think those new assets are out there, and are moving slowly and carefully into hedge funds, focusing on a wider range of considerations when allocating capital, including considerations beyond track record such as transparency, liquidity, risk controls, regulatory savvy and other "non-investment" criteria.  (Most hedge fund blowups have been the result of operational rather than investment failures.)  U.S. corporate pension funds are the quintessential ERISA investor.  Therefore, when competing for allocations from U.S. corporate pension funds, facility with the contours of ERISA (it's an infamously byzantine statute) will be a competitive advantage for hedge fund managers.  The purpose of this series of articles is to help hedge fund managers hone that competitive advantage.  If a hedge fund comes within the jurisdiction of ERISA, the hedge fund and its manager become subject to a series of new obligations and limitations that otherwise would not apply.  Most notably on the obligations side, the manager becomes subject to a more particularized fiduciary duty standard than is imposed by the Investment Advisers Act or Delaware law.  And most notably on the limitations side, the hedge fund (which is deemed to constitute "plan assets" for ERISA purposes) is prohibited from engaging in a series of transactions with so-called "parties in interest."  This article explains the ERISA-specific fiduciary duty, as well as ERISA's per se prohibited transactions, in greater detail.  In addition, on the obligations side, this article details the unique ERISA reporting regime, focusing on the Department of Labor's (DOL) Form 5500 Schedule C (including a discussion of reporting requirements with respect to direct compensation, indirect compensation, eligible indirect compensation and gifts and entertainment); and custody and bonding requirements.  And on the limitations side, this article discusses, in addition to prohibited transactions, limitations imposed on hedge funds and managers with respect to: performance fees; cross trades; principal trades; soft dollars; affiliated brokers; securities issued by the employer who sponsors the relevant ERISA plan; expense pass-throughs; indemnification and exculpation; and placement or finders' fees (and related "pay to play" considerations).  Finally, this article discusses the broad reach of liability and the penalties that may be imposed for violations of ERISA's obligations or limitations, and the cure provisions available for certain breaches.  While this article outlines a seemingly oppressive set of consequences flowing from application of ERISA to a hedge fund and manager, it should be noted that the third article in this series will strike a considerably more optimistic note.  The list of prohibited transactions under ERISA is so long, and the definition of party in interest so broad, that literal compliance with ERISA would actually run contrary to the intent of ERISA, which is to protect retiree money.  That is, a hedge fund manager or other investment manager forced to comply with all of the investment and operational prohibitions of ERISA would not be able to effectively serve the interests of benefit plan investors.  Recognizing this, the DOL has promulgated an extensive series of "class exemptions" that provide relief from the prohibited transaction and other provisions of ERISA, and the DOL from time to time also provides individual exemptions (similar to the SEC's no-action letter process).  Those categories of relief will be the subject of the third article in this series.

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  • From Vol. 3 No.20 (May 21, 2010)

    Investors in Hedge Funds Managed by RAM Capital Resources, LLC Sue RAM, Its Principals and Its Funds Alleging Securities Fraud, RICO Violations and Other Claims Based on Alleged Misrepresentations and Self-Dealing by RAM Principals

    Defendant RAM Capital Resources, LLC (RAM Capital), is a New York-based asset manager that specializes in so-called “PIPE” investments (private investments in public equity).  RAM Capital matched potential investors with PIPE issuers and also formed hedge funds to invest in PIPE offerings.  Defendants Stephen E. Saltzstein (Saltzstein) and Michael E. Fein (Fein) are the principals of RAM Capital.  Saltzstein was introduced to plaintiff Stacy Frati through Saltzstein’s sister, who was a childhood friend of Ms. Frati.  Eventually Ms. Frati and her husband invested $2 million in RAM Capital’s Shelter Island Opportunity Fund, LLC.  On behalf of a client, plaintiff Banco Popolare Luxembourg, S.A. invested $1.5 million with RAM Capital’s Truk International Fund, LP.  In April 2009, plaintiffs requested redemption of their entire interests in those funds, but only $150,000 was eventually returned to Banco Popolare.  This action ensued.  Plaintiffs claim the defendants committed securities fraud, RICO violations and breach of fiduciary duty by allegedly misrepresenting the amount of personal capital they had at stake in their funds, engaging in self-dealing, charging multiple and excessive fees and failing to disclose that they were not registered broker-dealers.  Plaintiffs seek return of their investments, punitive damages, an accounting and other relief.  We detail the plaintiffs’ claims.

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  • From Vol. 3 No.16 (Apr. 23, 2010)

    Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors

    Managed accounts started 2010 as the ostensible antidote to many of the more egregious evils experienced by hedge fund investors over the last two years.  Managed accounts offer transparency, liquidity, control and risk management, whereas during the credit crisis, many hedge funds and other investment vehicles offered opacity, gates, lack of control and increased risk.  While the case for managed accounts is not without valid objections – including administrative cost, allocation issues and other issues discussed more fully below – managed accounts are an increasingly popular method of accessing hedge fund strategies and managers while avoiding the downsides of commingled funds.  According to a February 2010 survey conducted by Preqin, the alternative investment data provider, 16 percent of institutional investors have a current allocation to managed accounts and a further 23 percent of institutional investors are considering an initial allocation to a managed account during 2010.  Similarly, 65 percent of fund of funds managers surveyed by Preqin either operate a managed account currently or are considering doing so during 2010.  Preqin also found that larger investors are more likely to demand, and larger managers are more likely to offer, managed accounts, and that the proportion of fund of funds managers operating managed accounts is greatest in North America (60 percent), followed by Asia and rest of world (including Hong Kong, Singapore, Japan and Israel, at 44 percent) then Europe (40 percent).  Recently, various hedge fund managers have been exploring an alternative structure that effectuates many of the goals of managed accounts, while offering a number of additional benefits and avoiding at least one of the chief downsides.  That alternative structure is the single investor hedge fund – as the name implies, a hedge fund with one outside investor (in addition to the manager’s investment).  To assist hedge fund managers and investors in evaluating whether a single investor hedge fund may be an appropriate alternative to a traditional hedge fund, on the one hand, or a managed account, on the other hand, this article discusses: the definition of a managed account; the six chief benefits and eight primary burdens of managed accounts versus hedge funds; the definition of a single investor hedge fund; the six chief benefits of single investor hedge funds over managed accounts; and the two primary downsides of single investor hedge funds versus managed accounts.

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  • From Vol. 3 No.12 (Mar. 25, 2010)

    Federal District Court Dismisses Lawsuit Brought by San Diego County Employees Retirement Association against Hedge Fund Manager Amaranth Advisors and Related Parties for Securities Fraud, Gross Negligence and Breach of Fiduciary Duty

    On March 29, 2007, the San Diego County Employees Retirement Association (SDCERA) filed a lawsuit against collapsed hedge fund manager Amaranth Advisors LLC (Amaranth) and several related individuals, including the fund manager’s one-time chief energy trader, Brian Hunter, in the U.S. District Court for the Southern District of New York, alleging securities fraud, common law fraud and several other causes of action.  In essence, the plaintiff alleged that the defendants fraudulently induced SDCERA into investing in funds managed by Amaranth, then dissuaded it from withdrawing that investment with a number of misrepresentations upon which SDCERA allegedly relied to its detriment.  The recurring theme in these allegations was that defendant Amaranth represented itself as managing a multi-strategy fund with sophisticated risk management controls when in reality it operated a single-strategy fund making essentially unhedged bets.  On March 15, 2010, District Court Judge Deborah A. Batts granted the defendants’ motions to dismiss each of the several counts of the complaint.  Judge Batts ruled that SDCERA’s claim under federal securities law – that it was fraudulently induced to purchase its interests in the Amaranth fund – was unreasonable as a matter of law; that choice-of-law principles dictated that the issue of common law fraud be decided according to the law of the state of Connecticut, where Amaranth was originally incorporated; that the claims of gross negligence and of breach of fiduciary duty are derivative, not subjects for a direct cause of action, and the plaintiffs failed to satisfy the requirements for a derivative action; and that Amaranth was not itself a party to the contract – which was between the plaintiff and the fund – so the management company was not liable on a breach of contract claim.  This article details the facts of the action and the issue of whether the court had personal jurisdiction over one of the defendants, Brian Hunter, who resides in Calgary, Canada, then analyzes the court’s rationale for its dismissal of each of the counts for failure to state a claim on which relief can be granted.

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  • From Vol. 3 No.10 (Mar. 11, 2010)

    Implications of the Volcker Rule – Managing Hedge Fund Affiliations with Banks

    On January 21, 2010, President Obama proposed to limit the size and scope of banking institutions.  The proposal, named the “Volcker Rule” after its key proponent, Chairman of the President’s Economic Recovery Advisory Board and former Federal Reserve Chairman Paul Volcker, would prohibit depository institutions and their bank holding companies (collectively referred to herein as “BHCs”) from owning, investing in, or sponsoring hedge funds, private equity funds or proprietary trading operations.  If enacted into law, the Volcker Rule would require BHCs to divest their investments in hedge funds and would restrict BHC affiliations and transactions with hedge funds.  Accordingly, hedge fund managers could be faced with managing investor divestitures, including their own investments in the funds they manage, as well as managing limitations on their funds affiliating with BHC service providers going forward.  In a guest article, Genna N. Garver, an Associate at Bracewell & Giuliani LLP; Sanford M. Brown, Managing Partner of Bracewell & Giuliani’s Dallas office; Robert L. Clarke, a Senior Partner at Bracewell & Giuliani and former United States Comptroller of the Currency; and Cheri L. Hoff, a Partner at Bracewell & Giuliani, offer a comprehensive analysis of the implications of the Volcker Rule for hedge fund affiliations with banks.  In particular, the authors provide detailed discussions of: fiduciary duties, the withdrawal process and investor relations issues as they relate to withdrawals by BHC investors in hedge funds; the mechanics of and legal considerations involved in divestitures of hedge fund sponsorship interests; and limitations in the proposed Volcker Rule on the ability of hedge funds to affiliate with BHC service providers, such as BHCs providing prime brokerage services.

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  • From Vol. 3 No.10 (Mar. 11, 2010)

    Identifying and Resolving Conflicts Arising out of Simultaneous Management of Debt and Equity Hedge Funds

    Many hedge fund managers, especially larger ones, manage multiple hedge funds.  Oftentimes, those multiple hedge funds follow different investment strategies.  While management by a single manager of multiple hedge funds offers certain operational economies of scale (e.g., shared office space, personnel and technology), diversification of the manager’s revenue sources and potentially greater overall revenue, it also creates the potential for conflicts between the interests of the funds.  In particular, simultaneous management by a single manager of both debt and equity funds can create a variety of information and business conflicts that challenge the manager’s ability to satisfy its fiduciary duties to both funds and both sets of investors.  This issue is particularly acute now, at a time when many hedge fund managers that previously focused on equity-related strategies have launched distressed debt funds in an effort to make silk purses out of the many sow’s ears left over from the credit crisis.  In effort to assist hedge fund managers in avoiding or navigating these conflicts, this article: discusses fiduciary duty as it relates to the relevant conflicts, both under Delaware law and the Investment Advisers Act; identifies specific examples of the potential conflicts, including five investment issues (e.g., consequences to both the equity and debt funds when a reorganization would benefit the debt but wipe out the equity) and two information issues (e.g., consequences to the equity fund when its manager receives material, non-public information in the course of also managing a debt fund); and evaluates the pros and cons of specific ex ante and ex post remedies for both the information issues and investment issues.

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  • From Vol. 3 No.7 (Feb. 17, 2010)

    New York State Supreme Court Dismisses Hedge Funds of Funds’ Complaint against Accipiter Hedge Funds Based on Exculpatory Language in Accipiter Fund Documents and Absence of Fiduciary Duty “Among Constituent Limited Partners”

    Plaintiffs Aris Multi-Strategy Fund, L.P., and Aris Multi-Strategy Offshore Fund Ltd. (together, Aris) are two funds of funds that invested in Accipiter Life Sciences Fund II (QP), L.P., Accipiter Life Sciences Fund II, L.P., and Accipiter Life Sciences Fund II (Offshore), Ltd. (collectively, Accipiter).  During the summer of 2008, about 60 percent of Accipiter’s investors – excluding Aris – requested redemptions of their interests in Accipiter as of the September 30, 2008 redemption date.  In October, Aris submitted a request to redeem its Accipiter interests effective as of the December 31, 2008 redemption date.  Shortly after Aris’ request, Accipiter announced that it would only honor the September 30, 2008 redemption requests, and that it was suspending all future redemptions so that Accipiter’s funds could liquidate in an orderly fashion.  In a relatively rare move in the hedge fund world, Aris sued Accipiter, its management companies and one of its principals for, among other things, negligence, breach of contract, breach of fiduciary duty and injunctive relief.  The defendants moved to dismiss the complaint for failure to state a cause of action.  The New York State Supreme Court dismissed the entire complaint, determining that the exculpatory language contained in the governing documents was sufficient to bar Aris’ claims.  We summarize the background of the action, Aris’ allegations and the court’s decision.  See also “Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).

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  • From Vol. 3 No.5 (Feb. 4, 2010)

    Institutional Investor Forum Focuses on Hedge Fund Manager Fiduciary Duty, SEC Subpoena Power, Hybrid Hedge Fund Structures, Managed Account Platforms, Codes of Ethics and More

    On January 27, 2010, the Practising Law Institute hosted the Institutional Investor Forum 2010 in New York City.  Among the key topics discussed during the conference were: fiduciary duty and the duties of good faith and fair dealing under Delaware law; exculpation and indemnification concerns in the context of Delaware limited partnerships and limited liability companies; various proposed and current federal and state regulations of hedge fund managers and placement agents; SEC staffing and budgeting; the SEC’s subpoena power when conducting examinations; hybrid fund structures and terms; managed accounts and managed account platforms; and what fraud prevention practices investors look for in hedge fund adviser Codes of Ethics.  This article offers a comprehensive summary of the key points raised and discussed at the conference.

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    Dealing with Mr. Big: Recent Developments in Transactions Involving Controlling Shareholders

    Controlling shareholders of public companies contemplating a sale of the company to a third party sometimes favor private equity bidders over their strategic competitors.  This is because private equity sponsors typically can be more flexible than strategic buyers in structuring transactions that allow the controlling shareholder to retain an equity stake in the surviving entity or to receive other financial benefits that are not shared with the minority shareholders, such as continuing employment with the surviving entity, stock options and other arrangements.  The Delaware Chancery Court’s recent decision in In re John Q. Hammons Hotels Inc. Shareholder Litigation, No. 758-CC (Oct. 2, 2009) provides a road map for parties to structure controlling shareholder sale transactions so that they will be subject to the protections of the business judgment rule, rather than the more rigorous “entire fairness” standard of review.  However, the Chancery Court held in Hammons that a merger between a controlled company and a third party unaffiliated with the controlling shareholder was subject to the entire fairness test because the controlling shareholder received consideration different from that received by the minority shareholders and because the transaction did not include sufficient procedural protections to protect the minority: namely, in addition to the special committee process typically used in going private transactions, there be a condition to the merger that it be approved by holders of a majority of the outstanding shares held by the minority shareholders.  In a guest article, William D. Regner and Dmitriy A. Tartakovskiy, Partner and Associate, respectively, at Debevoise & Plimpton LLP, explore the implications of the Hammons decision on the structuring of controlling shareholder sale transactions.

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  • From Vol. 2 No.51 (Dec. 23, 2009)

    New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act

    Aris Multi-Strategy Fund, LP (Aris LP) and Aris Multi-Strategy Offshore Fund Ltd. (Aris Offshore) (together, Aris or Plaintiffs), two funds of hedge funds managed by Aris Capital Management, LLC, brought an action to recover over $5.13 million allegedly lost by the funds in connection with their investments in underlying hedge funds, the Horizon Funds.  Among other things, Plaintiffs alleged fraud on the part of the Horizon Funds and the indirect owner of the Horizon Funds’ investment manager.  On December 14, 2009, the New York State Supreme Court rejected a motion by the defendants to dismiss the fraud claims, finding that Plaintiff’s complaint (1) contained allegations sufficient to state a cause of action for fraud, and (2) raised factual questions sufficient to survive dismissal under New York Civil Practice Law and Rules Section 3211.  However, the court dismissed tort claims brought by Plaintiffs, finding that such claims were preempted by the Martin Act (New York State’s anti-securities fraud statute).  We detail the factual background of the case, Aris’ legal arguments and the court’s analysis.

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  • From Vol. 2 No.46 (Nov. 19, 2009)

    When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?

    For hedge fund lawyers and compliance professionals who are charged with protecting their institutions from allegations of trading on material, nonpublic information, “Big Boy” provisions, or disclaimers of reliance, are potentially helpful tools.  In the first of a two-part series of guest articles, Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP, discuss the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the Federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no Federal counterpart.  The second article in this series will focus on the usefulness of Big Boy provisions in securities and non-securities transactions and steps that will increase the likelihood a court will enforce a Big Boy provision; the discussion of New York law in that second article will focus on its application in secondary market bank loan transactions.

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  • From Vol. 2 No.40 (Oct. 7, 2009)

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

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

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  • From Vol. 2 No.38 (Sep. 24, 2009)

    In Light of Convergence of Hedge Fund Strategies and Mutual Fund Structures, Mutual Fund Advisory Fee Case before U.S. Supreme Court May Affect Future Profitability of Hedge Fund Industry

    Recent decisions regarding mutual funds, particularly with regard to advisory fee disputes, have taken on heightened importance for the hedge fund community.  This is because of the growing convergence between hedge fund strategies and mutual fund structures.  As previously reported in The Hedge Fund Law Report, investment managers who manage both hedge and mutual funds may have, for somewhat counterintuitive reasons (i.e., reasons other than short term fee considerations), an incentive to favor mutual funds.  See “New Study Offers Surprising Findings on the Incentives Created by Concurrent Management of Hedge and Mutual Funds,” The Hedge Fund Law Report, Vol. 2, No. 23 (Jun. 10, 2009).  Such managers may use the mutual funds to “advertise” their investing prowess to the public and potential hedge fund investors because, with respect to the mutual fund, they have less onerous restrictions with respect to communications with the public, investor solicitations and performance advertising.  Successful mutual fund managers sometimes capitalize on their success by launching hedge funds following similar strategies, but with higher total fees.  Also, an increasing number of mutual funds are employing hedge fund strategies.  As a consequence of this convergence trend, a case now before the U.S. Supreme Court dealing with advisory fees in the mutual fund context has significance for the hedge fund community.  We detail the substantive and procedural history of that case, including the most recent decision from the Seventh Circuit and a dissent from the redoubtable Judge Posner (that could foreshadow the outcome in the U.S. Supreme Court).  We also summarize the arguments advanced by SIFMA, the Independent Directors Council and the Investment Company Institute in amicus briefs.

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  • From Vol. 2 No.34 (Aug. 27, 2009)

    For Hedge Fund Managers, How Would a Statutory Definition of “Fiduciary Duty” Affect the Scope of the Duty and the Standard for Breach?

    In its first meeting, the SEC’s recently convened Investor Advisory Committee identified defining fiduciary duty as one of its discussion topics.  In response, four financial planning and investment advisory industry groups sent a letter to the Investor Advisory Committee opposing a definition of fiduciary duty and supporting the “workability” of the current approach which, according to the letter, involves applying common law principles to specific facts and circumstances.  This debate over whether to define fiduciary duty has been given added relevance by the Obama administration’s proposal on July 10, 2009 of the Investor Protection Act of 2009 (IPA), which would for the first time define fiduciary duty by statute.  See “What Precisely Is ‘Fiduciary Duty’ in the Hedge Fund Context, and To Whom is it Owed?,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009).  For hedge fund managers, there are two primary questions arising out of this debate: (1) to whom is a fiduciary duty owed; and (2) what is the standard for breach of fiduciary duty?  The answers to these questions can dramatically alter the legal landscape in which hedge funds operate.  Accordingly, this article addresses both questions, both under current law and as the law may evolve following passage of the IPA.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

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

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

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  • From Vol. 2 No.32 (Aug. 12, 2009)

    Investors Sue Hedge Fund Managed by N.I.R. Group and Corey Ribotsky in Redemption Dispute

    After a year that saw $155 billion in hedge fund withdrawals, two investors who had invested about $1.6 million with AJW Qualified Partners, LLC (the Fund), a hedge fund managed by N.I.R. Group (N.I.R. or the Manager), filed a lawsuit in a dispute over the Fund’s redemption provisions.  In September 2008, plaintiff Steven Mizel and his limited partnership, Palmetto Partners (Palmetto) sought to redeem their approximately $1.68 million investment in the Fund.  Instead, in October 2008, the Fund allegedly froze all redemption requests and sought to reorganize into a new fund that had a different management compensation structure and more restrictive withdrawal rights.  The Fund also allegedly refused to supply plaintiffs with certain information about the Fund, particularly a list of its members.  Plaintiffs then brought suit in New York State Supreme Court, alleging anticipatory breach of contract by the Fund and breaches of fiduciary duty by the Manager and its principal, Corey S. Ribotsky.  The Hedge Fund Law Report analyzed the relevant pleadings in the case and a related case involving similar allegations brought against Ribtosky by Gerald Tucci.  This article summarizes our analysis.

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  • From Vol. 2 No.31 (Aug. 5, 2009)

    Appellate Division Upholds Dismissal of Complaint by Hedge Funds Holding More than $190 Million of Defaulted Loans Against Credit Suisse, as Arranger of Financing and Administrative and Collateral Agent, for Aiding and Abetting Fraud and Breach of Fiduciary Duty

    In a decision of profound interest to hedge funds that invest in distressed companies and the banks that arrange those loans, New York’s Appellate Division, First Department, has thrown out a claim that defendants Credit Suisse First Boston (USA), Inc. and Credit Suisse Securities (USA) LLC (together, Credit Suisse) aided and abetted a fraud committed by Meridian Automotive Systems, Inc. (Meridian) in a 2004 restructuring of its debt.  Credit Suisse helped to arrange a refinancing of Meridian’s debt.  Plaintiff hedge funds purchased a portion of Meridian’s debt.  Less than one year later, Meridian declared bankruptcy.  Plaintiffs claimed that Credit Suisse knew Meridian was insolvent at the time of the restructuring and failed to disclose it.  The court held that plaintiffs failed to plead a critical element of their claim, i.e., that Credit Suisse had “substantially assisted” Meridian in committing the alleged fraud.  We summarize the court’s reasoning and the cautions it provides for investors and lenders in the distressed debt market.

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  • From Vol. 2 No.29 (Jul. 23, 2009)

    What Precisely Is “Fiduciary Duty” in the Hedge Fund Context, and To Whom is it Owed?

    The concept of fiduciary duty is at the heart of the relationship among hedge fund managers, hedge funds and hedge fund investors.  But until recently, “fiduciary duty” was not defined by any bill or law.  Rather, it was the creature of caselaw, and much of that caselaw dealt with whether and to whom the fiduciary duty is owed, rather than the content of the duty.  That has changed with the Obama administration’s proposal on July 10, 2009 of the Investor Protection Act of 2009 (IPA).  While the IPA has received significant attention because it would impose a fiduciary duty on broker-dealers that provide investment advice (currently, broker-dealers are subject to a less stringent “suitability” standard), for the hedge fund community, the IPA is noteworthy as the first proposed codification of the substance of a fiduciary duty.  In addition, the IPA delegates to the SEC rulemaking authority to define the “client” to whom a fiduciary duty is owed.  This could empower the SEC to resolve an ambiguity that has existed since the D.C. Circuit’s 2006 decision in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006), as to whether a hedge fund manager owes a fiduciary duty to the hedge fund itself, or its underlying investors.  That is, the IPA may enable the SEC to provide by rule that a hedge fund manager owes a fiduciary duty to each investor in a hedge fund, and not just to the hedge fund itself.  For practical purposes, if the IPA were to become law and if the SEC were to provide by rule that a hedge fund manager owes a fiduciary duty to hedge fund investors, it likely would become easier for hedge fund investors to sue managers based on a range of manager conduct.  This is because such a law and rule would more explicitly confer standing on hedge fund investors to challenge various manager actions.  In this article, we explain precisely what “fiduciary duty” means in the hedge fund context, and explore to whom the duty is owed (the answer is by no means straightforward).  We also explore: the practical consequences of identifying either the hedge fund or its investors as the manager’s “client”; Investment Advisers Act Rule 206(4)-8, the anti-fraud rule with a negligence standard; whether fiduciary duty can be waived; the definition of “client” in the Private Fund Investment Advisers Registration Act of 2009; and the executive compensation provisions of the IPA.

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  • From Vol. 2 No.28 (Jul. 16, 2009)

    Investors Allege that Hedge Fund Manager Deliberately Concealed High Number of Redemptions

    On July 8, 2009, a group of investors, including a feeder fund and several charities, accused two hedge funds, Highland Credit Strategies Fund, LP and Highland Credit Strategies Fund, Ltd. (the Funds), their manager, Highland Capital Management (Highland) and affiliated parties of purposefully concealing the high level of redemption requests submitted to the Funds that led to the Funds’ collapse.  This article describes the events that led to the suit and summarizes the legal theories advanced by the investors.

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  • From Vol. 2 No.27 (Jul. 8, 2009)

    SEC Commissioner Aguilar Recommends Tougher Regulation of Hedge Funds and Investment Advisers

    On June 18, 2009, Commissioner Luis A. Aguilar of the Securities and Exchange Commission spoke at the Spring 2009 Hedgeworld Fund Services Conference in New York, New York.  In his speech, Aguilar discussed the causes of the renewed calls to regulate the hedge fund industry, including lack of transparency, the imbalance of power between investors and managers and the potential for impact on the entire capital market.  On June 23, 2009, Commissioner Aguilar also spoke at the International Institute for the Regulation and Inspection of Investment Advisers in Washington, D.C., and announced the SEC’s intention to improve its regulatory regime.  We provide detailed coverage of both speeches.

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  • From Vol. 2 No.27 (Jul. 8, 2009)

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

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

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  • From Vol. 2 No.26 (Jul. 2, 2009)

    Second Circuit Revives Hedge Fund Fraud Claims Against Banc of America Securities

    On June 9, 2009, the United States Court of Appeals for the Second Circuit reinstated hedge fund investors’ claims that Banc of America Securities LLC (BAS) aided and abetted the frauds and breaches of fiduciary duty committed by the manager of funds for which BAS served as prime broker.  It reasoned that the investors had adequately pleaded that BAS’ actions proximately caused their losses.  We detail the factual background and legal analysis of the most recent opinion in a case that The Hedge Fund Law Report has been tracking since last year.  See “Federal Court Permits Suit Concerning Collapsed Lancer Funds to Proceed in Part,” The Hedge Fund Law Report, Vol. 2, No. 5 (Feb. 4, 2009); “Federal Court Bars Investors’ Claims Against Hedge Fund Administrator,” The Hedge Fund Law Report, Vol. 1, No. 28 (Dec. 16, 2008).

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  • From Vol. 2 No.24 (Jun. 17, 2009)

    New York Court Rules that Limited Partners of Collapsed Hedge Fund Cannot Sue Fund’s Outside Legal Counsel for Fraud and Breach of Fiduciary Duty

    In the continuing saga over the 2005 collapse of Wood River Partners, L.P. (the Fund), which suffered huge losses by reason of its highly-concentrated bet on Endwave Corporation (Endwave), New York’s highest court affirmed the dismissal of a complaint filed by limited partners of the Fund against Seward & Kissel, LLP (S&K), which served as outside legal counsel to the Fund.  The Court of Appeals held that the limited partners failed to plead the alleged fraud by S&K with sufficient particularity.  It also ruled that outside counsel to a limited partnership owes a fiduciary duty only to the partnership itself, not to its individual limited partners.  We provide a detailed discussion of the facts of the case and the court’s legal analysis.  The case offers a rare statement on hedge fund law from the highest court of a U.S. state in which many hedge funds are domiciled, and in which the vast majority of hedge funds conduct business.  As such, the case includes important and widely-applicable insights on the scope of a hedge fund manager’s fiduciary duty, and the limits on the potential liability of service providers to hedge funds.

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  • From Vol. 2 No.9 (Mar. 4, 2009)

    Connecticut District Court Rules that Hedge Fund Investor Can Sue Hedge Fund Manager for Imposition of “Involuntary” Lock-Up Period and Improper “Rescinding” of Redemption Notice

    In a lawsuit filed in April 2008, Joseph Umbach, founder of the Mystic line of beverages, accused Carrington Investment Partners, L.P. (the Fund), a billion dollar mortgage-backed securities hedge fund, of “involuntarily” tying up his one million dollar investment in the Fund and improperly “rescinding” a redemption notice he submitted to the Fund’s sole manager, Bruce Rose.  Umbach sought a declaration that the action taken by Carrington and Rose was “an illegal or unenforceable ex post facto” action, and charged that the defendants committed securities fraud, breached their fiduciary duty to him, committed fraud and negligent misrepresentation and breached the terms of their contract.  On February 18, 2009, the United States District Court for the District of Connecticut dismissed Umbach’s request for declaratory judgment, because it found that his remaining claims against the Fund, Carrington Capital Management, LLC (the General Partner) and Bruce Rose, could go forward.  We outline the relevant facts from the complaint and the court’s opinion, and explain the court’s legal analysis.  The case illustrates, among other things, the deference a federal court will give to an agreement between an investor and a hedge fund manager providing the investor with preferential liquidity terms.

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  • From Vol. 2 No.6 (Feb. 12, 2009)

    Ropes & Gray Hosts Teleconference on SEC Enforcement Actions Against Investment Managers, Potential Regulatory Changes in Response to Madoff and Private Plaintiff Claims Against Investment Managers

    On February 4, 2009, global law firm Ropes & Gray LLP hosted a teleconference titled “The Sinking Markets’ Effect on Investment Funds: Litigation and Enforcement Issues Every Investment Fund Executive Should Know.”  The teleconference consisted of four presentations, each by one Ropes partner addressing an overarching question.  Those questions were as follows: (1) Under what theories is the SEC likely to bring claims against unsuccessful and “imprudent” managers?; (2) What impact is the alleged Madoff Ponzi scheme likely to have on future enforcement actions?; (3) What lessons may be learned from the problems at the Reserve Fund, a money-market mutual fund whose value tumbled and “broke the buck,” because of its over-reliance upon commercial paper issued by a Lehman Brothers entity?; and (4) More generally, what is the scope of private liability risk facing funds that have suffered substantial losses, and their managers?  We relate the material points from the various Ropes partners’ answers to these questions.

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  • From Vol. 2 No.6 (Feb. 12, 2009)

    New York Trial Court Permits Action for Misappropriation of Hedge Fund Proprietary Software and Breach of Partnership Agreement To Proceed

    On January 6, 2009, a New York County trial court denied a motion to dismiss a lawsuit brought by Kenneth L. Telljohann and his company, CoVision Capital Group, LLC, against defendants Lawrence Doyle, a hedge fund manager, and his business entity, Tower Capital, Inc. The plaintiffs alleged that Doyle breached their partnership agreement and his fiduciary duty to his partners, and misappropriated the plaintiffs’ hedge fund asset allocation and risk analysis software. Alternatively, the plaintiffs sought to recover the value of the work they had performed on behalf of defendants through claims of unjust enrichment and quantum meruit and to prevent the further misuse of their software through a claim of unfair competition.  We describe the factual background and the court’s legal analysis, and in the process provide insight into how hedge fund managers and their service providers can structure arrangements to avoid disputes over ownership of intellectual property, and the revenue streams from such ownership.

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  • From Vol. 2 No.5 (Feb. 4, 2009)

    Federal Court Permits Suit Concerning Collapsed Lancer Funds to Proceed in Part

    On January 5, 2009, the United States District Court for the Southern District of New York ruled that investors seeking to recover over $550 million in losses stemming from the liquidation of British Virgin Islands-based hedge funds Lancer Offshore, Inc. and OmniFund Ltd. could proceed with certain claims against the funds’ administrators and affiliated parties.  The ruling allows the plaintiffs to continue to press their claim that Citco Group, parent firm of the funds’ administrator, was a “culpable participant,” and hence liable, in the funds’ collapse.  In this follow-up to an article published in our December 16, 2008 issue, we detail the factual background of the case and the court’s holding and legal analysis.

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  • From Vol. 2 No.3 (Jan. 21, 2009)

    Federal Court Dismisses Breach of Fiduciary Duty Claim, but Permits Securities Fraud Claim, Against Alternative Investment Fund and Its Manager and Principals

    On December 22, 2008, the United States District Court for the Southern District of New York held that the Martin Act preempts a breach of fiduciary duty claim brought by an investor against an alternative investment fund, the Goldin Restructuring Fund, L.P.  The court held, however, that the investor’s securities fraud action against the fund pursuant to Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder, could proceed.  We offer a detailed discussion of the case, and, in the process, examine how the federal district court in a key jurisdiction for hedge funds construes securities fraud and breach of fiduciary duty claims against an alternative asset manager.

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  • From Vol. 1 No.20 (Sep. 4, 2008)

    Hedge Fund Manager Sues Former Partner for Fraud and Breach of Contract

    An ex-partner of New York-based hedge fund group K Squared Capital Advisors L.P. has accused his former partner and the group’s manager of fraud, breach of contract, unjust enrichment, breach of fiduciary duty and bad-faith dealings. In a complaint filed in New York State Supreme Court on August 11, 2008, the plaintiff alleges that the defendants falsely attributed income to the plaintiff, leaving him with a significant tax bill. The plaintiff further alleges that the defendants failed to comply with their contractual obligations and provided the plaintiff with falsely low net asset values for funds under management, thus avoiding their obligation to share a portion of incentive fees with the plaintiff.

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  • From Vol. 1 No.18 (Aug. 11, 2008)

    New York Supreme Court Dismisses Hedge Fund Investors’ Claims Against Prime Broker

    On July 23, 2008, Justice Charles E. Ramos of the New York Supreme Court, Commercial Division, dismissed claims brought by investors in hedge fund Wood River Partners, L.P. against the Fund’s prime broker, clearing broker and custodian, UBS Securities, LLC, for allegedly causing the Fund’s collapse. The decision suggests that under New York law, a prime broker, clearing broker or custodian of a hedge fund does not – solely by virtue of serving in any of those roles – owe a fiduciary duty to investors in the fund. The decision also suggests that state law claims based on diminution in value of a hedge fund are properly brought by the fund itself, or derivatively by its investors on behalf of the fund, rather than by investors in the fund. SeeEurycleia Partners, LP v. UBS Securities, LLC, No. 600874/07 (N.Y. Sup. Ct. July 23, 2008).

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  • From Vol. 1 No.15 (Jul. 8, 2008)

    Delaware Chancery Court Rules that Limited Partnership Agreement Permitted General Partner to Make In-Kind Distributions, and that Appropriate Valuation Date of In-Kind Distributions May be Redemption Date Rather than Distribution Date

    On June 13, 2008, the Delaware Chancery Court ruled that the limited partnership agreement of a hedge fund organized as a Delaware limited partnership did not require ratable in-kind distributions, but rather permitted the general partner to make in-kind distributions in its sole discretion. The court also held that the redeeming limited partners might be able to prove that they were entitled to assets equal in aggregate value to the value of their share of the fund at the time of redemption.

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  • From Vol. 1 No.14 (Jun. 19, 2008)

    New York Supreme Court Holds that Ninety Percent Loss in Hedge Fund’s Value Put Investors On Notice of Potential Fraud

    On January 17, 2008, the New York Supreme Court granted a fund manager’s motion to dismiss investors’ fraud and other claims brought in April 2007, holding that a 90% drop in the fund’s value put the investors on notice of the fraud by September 2002 and the applicable statute of limitations expired two years following the date on which the investors knew or should have discovered the fraud.

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  • From Vol. 1 No.8 (Apr. 22, 2008)

    Federal Court Holds that Trader’s Role as Hedge Fund Manager Does Not, by Itself, Create Fiduciary Duty to Fund's Investors

    • Hedge fund trader’s motion to dismiss manager’s breach of fiduciary duty claim denied, since state law requires that parties to a joint venture owe one another such a duty, and allegations that trader recklessly acted to shut the fund down would constitute a breach of such duty.
    • Trader’s motion to dismiss manager’s breach of contract claim also denied, since complaint adequately alleged that trader caused two unsatisfied “day trade calls” that remained unsatisfied during the relevant period.
    • Investor’s claim that trader breached fiduciary duty dismissed because investor failed to show he placed his “trust and confidence” in trader.
    • Investor’s claim that trader tortiously interfered with contract dismissed for failure to allege that trader intended to harm investor.
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  • From Vol. 1 No.6 (Apr. 7, 2008)

    Hedge Fund Service Professionals Do Not Owe Fiduciary Duty to Investors But May be Subject to Liability for Aider and Abettor Claims if Provided by State Statute

    • State appeals court dismissed hedge fund investors’ $200 million lawsuit against fund’s outside counsel for lack of any fiduciary duty owed to investors.
    • State appeals court ruled that preparation of offering memo not a representation, fraudulent or otherwise, to investors.
    • Oregon investor who invested and lost $2.75 million in the fund and filed a separate federal fraud case survived outside counsel’s motion to dismiss because Oregon law grants private right of action against aiders and abettors.
    • Federal case particularly significant because aider and abettor claims against lawyers or accountants in securities fraud cases generally barred under federal law, under recent Stoneridge Supreme Court case.
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  • From Vol. 1 No.1 (Mar. 3, 2008)

    Connecticut Superior Court finds that principals of hedge fund adviser did not breach their fiduciary duties to the partnership or its partners in sale of advisory business

    • Case dealt with the substance of the fiduciary duty owed by a general partner to the partnership and its limited partners.
    • Founders (a limited partnership) owned Forest (a hedge fund adviser) and Forum (a broker-dealer).  A corporation controlled by defendant Boyd was the GP of founders.  Plaintiff Hartley led Forum’s corporate finance department.
    • Founders sold Forum to First Union Bank and Forest to a group controlled by Boyd.  There were no other bidders for either entity, and both entities were sold for multiples of book value.
    • Plaintiff Hartley participated in every partnership meeting at which the sales were discussed, and Founders was advised by an investment bank, law firm and accounting firm.
    • Boyd owed a fiduciary duty to Founders and its LPs, including Hartley.  As such, he had to prove by clear and convincing evidence that he dealt “fairly” with his LPs in the sale.
    • Elements of fairness in this context were: (1) free and frank disclosure, (2) adequate consideration, (3) competent and independent advice and (4) relative sophistication of parties.
    • Court found that Boyd satisfied his fiduciary duty.
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