The Hedge Fund Law Report

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

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By Topic: Side Letters

  • From Vol. 11 No.35 (Sep. 6, 2018)

    An Introduction to Quantitative Investing: Special Risks and Considerations (Part Three of Three)

    Although both quantitative and fundamental strategies expose fund managers to similar risks, a quantitative manager’s heavy dependence on technology and mathematical models means that it must consider and address those risks differently. It must, for example, place greater emphasis on cybersecurity and intellectual property, given that a cyber attack or reproduction of the underlying model are more likely to cripple its trading. In addition, quantitative managers must contend with unique capacity constraints – which inform investor negotiations – and compete with the technology sector for talent. This article, the third in a three-part series, explores the heightened importance of cybersecurity and IP protection for quantitative managers; negotiations with investors over capacity constraints; and methods for quantitative managers to attract and retain talent in the face of stiff competition. The first article provided an overview of quantitative investing and the ways it differs from fundamental investing; discussed the growth of quantitative investing; and evaluated the practical risks and misconceptions of quantitative investing. The second article analyzed regulatory actions and guidance applicable to quantitative managers, as well as the special regulatory risks those managers may face. See our three-part series on how fund managers should structure their cybersecurity programs: “Background and Best Practices” (Mar. 22, 2018); “CISO Hiring, Governance Structures and the Role of the CCO” (Apr. 5, 2018); and “Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties” (Apr. 12, 2018).

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  • From Vol. 11 No.26 (Jun. 28, 2018)

    Advisers Must Disclose Conflicts of Interest and Heed the Terms of Client Agreements, or Risk Stiff SEC Sanctions

    An adviser’s receipt of fees tied to the amount of client assets the adviser invests with a third-party asset manager creates a textbook conflict of interest. A manager recently fell into that trap when it was unable to persuade certain third-party asset managers to pay those fees directly to the manager’s affected clients and, instead, agreed to receive them directly. The manager compounded the problem by failing to disclose that arrangement to its affected clients or to recognize that its advisory agreements with those clients generally prohibited it from receiving compensation from outside managers. This article analyzes the recent SEC settlement order that resulted from those missteps. For another recent SEC action concerning the receipt of undisclosed compensation by an adviser, see “SEC Continues Scrutiny of Undisclosed Fees at Fund Managers” (Jun. 7, 2018).

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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.50 (Dec. 21, 2017)

    Former Senior SEC Attorneys Offer Insight on the Current Regulatory Climate, Adviser Examinations and the Enforcement Referral Process (Part Two of Two)

    President Trump’s executive order on “core principles” enumerated broad regulatory fundamentals pursuant to which the Department of the Treasury provided recommendations on regulation within the investment management industry. See “Reading the Regulatory Tea Leaves: Recent White House and Congressional Action and Insights From SIFMA and FINRA Conferences” (Jul. 20, 2017). While the SEC may follow these recommendations, it is likely that fund managers will continue to face increased examinations and the risk of enforcement action from the agency. These issues, along with practices fund managers can adopt to potentially avoid having routine SEC examinations turn into enforcement actions, were among those discussed at a recent program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA). Moderated by Simpson Thacher partner Olga Gutman, the program featured partners David W. Blass, former Chief Counsel and Associate Director in the SEC Division of Trading and Markets, and Michael J. Osnato, Jr., former Chief of the Complex Financial Instruments Unit of the SEC Division of Enforcement. This two-part series summarizes the panelists’ insights garnered from their experience at the SEC. This second article explores the SEC’s regulatory agenda, and the examination and enforcement referral process. The first article discussed the “zero-tolerance” approach under former Chair Mary Jo White, the direction Chair Jay Clayton intends to take the Commission and the SEC’s enforcement agenda. For more from Simpson Thacher, see “Regulators From the SEC, CFTC and New York Attorney General’s Office Reveal Top Hedge Fund Enforcement Priorities (Part Two of Four)” (Dec. 18, 2014). For coverage of a prior program hosted by MLA, see our two-part series on SEC examinations: “What Hedge Fund Managers Need to Know” (Jun. 16, 2016); and “Fees, Conflicts, Investment Allocations and Other Hot Topics” (Jun. 30, 2016).

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

    HFLR and Seward & Kissel Webinar Explores Trends Identified in Side Letter Study (Part Two of Two)

    As the competition for investor allocations among private fund advisers remains competitive, the bargaining power in side letter negotiations has shifted in favor of the investor. In order to obtain a side letter in the first place, however, allocators must be prepared to make sizeable investments. These findings, which were identified in the Seward & Kissel (S&K) 2016/2017 Hedge Fund Side Letter Study, were discussed in a recent webinar hosted by The Hedge Fund Law Report and S&K. The webinar was moderated by William V. de Cordova, Editor-in-Chief of The Hedge Fund Law Report, and featured commentary on the side letter environment from Steve Nadel, lead author of the S&K side letter study. This article, the second in a two-part series, explores side letter trends identified in, and key takeaways from, the study, and analyzes whether President Trump’s stated pro-business stance will affect the terms offered by managers in side letters. The first article discussed the demographics of investment managers and investors that commonly enter into side letters, and key side letter terms. For additional insights from Nadel on side letters, see “HFLR and Seward & Kissel Webinar Explores Common Issues in Negotiating and Monitoring Side Letters” (Nov. 10, 2016).

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

    HFLR and Seward & Kissel Webinar Explores Key Side Letter Terms (Part One of Two)

    Seward & Kissel (S&K) recently completed its second annual hedge fund side letter study. See “Seward & Kissel Study Finds Reduced Fees and MFN Clauses Remain Most Prevalent Side Letter Terms” (Oct. 5, 2017). To provide fund managers with additional perspectives on the evolution of the side letter landscape over the past year, The Hedge Fund Law Report and S&K hosted a webinar moderated by William V. de Cordova, Editor-in-Chief of The Hedge Fund Law Report, and featuring insights on the side letter environment from Steve Nadel, lead author of the S&K side letter study. This article, the first in a two-part series, discusses the demographics of investment managers and investors that are more inclined to enter into side letters, along with key side letter terms. The second article will explore side letter trends, key takeaways from the study and the effect President Trump’s administration may have on the terms offered by managers in side letters. For coverage of S&K’s 2015/2016 side letter study, see “Seward & Kissel Study Finds MFN Clauses and Reduced Fees Most Prevalent Terms in Side Letters” (Oct. 6, 2016).

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  • From Vol. 10 No.39 (Oct. 5, 2017)

    Seward & Kissel Study Finds Reduced Fees and MFN Clauses Remain Most Prevalent Side Letter Terms

    Side letters remain an important means by which private fund managers can offer appealing terms to prospective investors. Seward & Kissel (S&K) recently completed its second annual study of side letters entered into by its hedge fund manager clients. The Seward & Kissel 2016/2017 Hedge Fund Side Letter Study examines the types of investors that enter into side letters, the amounts they typically invest, the most common side letter terms and details about separately managed accounts. This article examines S&K’s findings, which provide fund managers with valuable insight into the terms requested by institutional investors as well as visibility into the activities of their peers. See “HFLR and Seward & Kissel Webinar Explores Common Issues in Negotiating and Monitoring Side Letters” (Nov. 10, 2016). For coverage of S&K’s 2015/2016 side letter study, see “Seward & Kissel Study Finds MFN Clauses and Reduced Fees Most Prevalent Terms in Side Letters” (Oct. 6, 2016). On Wednesday, October 18, 2017, at 10:00 a.m. EDT, Steve Nadel, lead author of the study and a partner in S&K’s investment management practice, will expand on the topics in this article – as well as other issues relating to side letters – in an upcoming webinar co-produced by The Hedge Fund Law Report and S&K. To register for the webinar, click here.

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  • From Vol. 10 No.27 (Jul. 6, 2017)

    Eight Recommendations for Hedge Fund Managers That Utilize Most Favored Nation Provisions in Side Letters

    The challenging capital-raising environment has generally tilted the balance of power in favor of institutional investors. This has led to an uptick in investor requests for managers and their funds to enter into side letter agreements that grant the investor preferential rights such as reduced fees, greater transparency, enhanced liquidity rights and access to fund investment capacity. In addition to preferential terms, side letter requests now regularly include “Most Favored Nation” (MFN) provisions, which ensure that rights granted to current or future investors are also offered to the investor protected by the MFN. While managers may acquiesce to these demands, dismissing them as “standard” requests, MFN provisions can present numerous pitfalls for fund managers if they are not properly evaluated, prudently negotiated and effectively monitored to ensure compliance. This article, in addition to describing the anatomy of an MFN provision, sets forth eight recommendations for drafting and administering MFN provisions gleaned from conversations with industry experts. For additional commentary on side letter negotiations, see “HFLR and Seward & Kissel Webinar Explores Common Issues in Negotiating and Monitoring Side Letters” (Nov. 10, 2016).

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    Winding Down Funds: How Managers Make the Decision and Communicate It to Investors and Service Providers (Part One of Two)

    A fund manager typically spends most of its time not only contemplating how to maximize returns for investors, but also navigating the array of compliance and regulatory concerns involved in running a private fund. Because the manager is so caught up in thinking about these daily considerations, it may lose sight of the multitude of issues that arise when it comes time to wind down that same fund. If the manager exercises some foresight regarding the fund’s eventual wind-down and puts proper procedures in place, however, the whole process can be both smoother and less fraught with legal and regulatory risks. In a recent interview with The Hedge Fund Law Report, Michael C. Neus, senior fellow in residence with the Program on Corporate Compliance and Enforcement at New York University School of Law and former managing partner and general counsel of Perry Capital, LLC, shared his detailed insights about the various considerations caused by winding down a fund. For additional commentary from Neus, see “Practical Solutions to Some of the Harder Fiduciary Duty and Other Legal Questions Raised by Side Letters” (Feb. 21, 2013). This first article in a two-part series presents Neus’ thoughts on the factors leading to the decision to wind down a fund, which personnel should lead that process and how it should be disclosed to investors and service providers. The second article will explore what types of fees and expenses investors should be charged during the wind-down, as well as how managers can maximize the value of illiquid assets during a liquidation. For more on winding down funds, see “Practical Tips for Fund Managers to Mitigate Litigation Risk From Regulators, Investors and Vendors When Winding Down Funds” (Oct. 27, 2016).

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  • From Vol. 10 No.5 (Feb. 2, 2017)

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

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

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  • From Vol. 9 No.44 (Nov. 10, 2016)

    HFLR and Seward & Kissel Webinar Explores Common Issues in Negotiating and Monitoring Side Letters

    In a challenging fundraising environment, investors have substantial leverage for demanding preferential terms from hedge fund managers. Those terms are often embodied in side letters, which present numerous operational and administrative challenges to managers. See “How Hedge Fund Managers Can Accommodate Heightened Investor Demands for Bespoke Negative Consent, Liquidity, MFN and Other Provisions in Side Letters” (Oct. 13, 2016); and “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two)” (Jun. 13, 2013). A recent program presented by The Hedge Fund Law Report and Seward & Kissel explored issues fund managers commonly face with respect to side letters, including terms most frequently requested by investors, operational concerns when negotiating with investors and administrative issues when handling side letters. The program, “Side Letter Considerations for Fund Managers,” was moderated by William V. de Cordova, Editor-in-Chief of The Hedge Fund Law Report, and featured Seward & Kissel partners Steven B. Nadel and David R. Mulle. This article highlights the key takeaways from the presentation. For additional insight from Nadel, see “29 Top-of-Mind Issues for Investors Conducting Due Diligence on Hedge Fund Managers” (Apr. 4, 2014). For further commentary from Mulle, see “Seward & Kissel Private Funds Forum Offers Practical Steps for Fund Managers to Address HSR Act Enforcement, Tax Reforms, Brexit Uncertainty, MiFID II, Cybersecurity and Side Letters” (Oct. 20, 2016).

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  • From Vol. 9 No.42 (Oct. 27, 2016)

    Former Law Firm Partner and Current Independent Director Provides Perspective on Hedge Fund Governance Issues, Regulatory Matters and Allocator Concerns

    Julian Fletcher recently joined Carne Group Financial Services (Carne) as an independent director in its Cayman Islands office after previously practicing as a partner in Mourant Ozannes’ investment funds group. Fletcher has the vantage point of a former practicing attorney when considering issues, regulations and trends in the hedge fund industry in his new capacity as a fund director. For more on fund directors, see “SEC Chair Outlines Expectations for Fund Directors” (Apr. 7, 2016); “Irish Central Bank Issues Guidance on Fund Director Time Commitments” (Jul. 9, 2015); and “Cayman Court of Appeal Overturns Decision Holding Weavering Fund Directors Personally Liable” (Feb. 26, 2015). In connection with his move to Carne, The Hedge Fund Law Report recently interviewed Fletcher about topics relevant to hedge fund managers, including the future of corporate governance; trends in the structuring of boards of directors of hedge funds; how directors consider different components of a hedge fund’s operations; the future of the Cayman Islands hedge fund industry in light of the introduction of the Cayman LLC vehicle and the decision not to extend the Alternative Investment Fund Managers Directive passport; and critical considerations confronting allocators at this time. For additional analysis from Carne, see “Luxembourg Funds Offer Options for Hedge Fund Managers to Access European and Global Investors” (Feb. 11, 2016); and “Identifying and Addressing the Primary Conflicts of Interest in the Hedge Fund Management Business” (Jan. 17, 2013).

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  • From Vol. 9 No.41 (Oct. 20, 2016)

    Seward & Kissel Private Funds Forum Offers Practical Steps for Fund Managers to Address HSR Act Enforcement, Tax Reforms, Brexit Uncertainty, MiFID II, Cybersecurity and Side Letters

    Years after the financial crisis, private funds in the U.S. and Europe continue to be affected by factors as varied as the trends in enforcement of the Hart-Scott-Rodino Antitrust Improvements Act of 1976; reforms to the U.S. tax code; ongoing uncertainty over Brexit, including whether the U.K. will make a “hard” or “soft” departure from the E.U.; cybersecurity risks; and selective disclosure concerns. These issues were the focus of a segment of the second annual Private Funds Forum co-produced by Bloomberg BNA and Seward & Kissel (S&K) on September 15, 2016. The panel was moderated by S&K partner Robert Van Grover and featured James E. Cofer and David R. Mulle, also partners at S&K; Richard Perry, a partner at Simmons & Simmons; Matthew B. Siano, managing director and general counsel of Two Sigma Investments; and Mark Strefling, general counsel and chief operating officer of Whitebox Advisors. This article highlights the salient points made by the panel. For coverage of the first segment of this forum, see our two-part series: “How Managers Can Mitigate Improper Dissemination of Sensitive Information” (Sep. 22, 2016); and “How Managers Can Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading” (Sep. 29, 2016). On Tuesday, November 1, 2016, at 10:00 a.m. EDT, Mulle and fellow S&K partner Steve Nadel will expand on issues relating to side letters in a complimentary webinar co-produced by The Hedge Fund Law Report and S&K. For more information or to register for the webinar, please send an email to rsvp@hflawreport.com.

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  • From Vol. 9 No.40 (Oct. 13, 2016)

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

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

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  • From Vol. 9 No.39 (Oct. 6, 2016)

    Seward & Kissel Study Finds MFN Clauses and Reduced Fees Most Prevalent Terms in Side Letters 

    Seward & Kissel (S&K) recently completed a study of side letters entered into by its hedge fund manager clients. “The Seward & Kissel 2015/2016 Hedge Fund Side Letter Study” considers the prevalence and features of five common side letter provisions: most favored nation clauses, fee discounts, transparency, preferential liquidity and capacity rights. This article summarizes S&K’s findings. For HFLR coverage of S&K’s annual hedge fund studies, see: 2015 Study (Mar. 31, 2016); 2014 Study (Mar. 5, 2015); 2012 Study (Apr. 11, 2013); and 2011 Study (Feb. 23, 2012). For additional analysis of side letter practices, see “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two)” (Jun. 13, 2013). Steve Nadel, lead author of the study and a partner in S&K’s investment management practice, will expand on the topics in this article – as well as other issues relating to side letters – in an upcoming webinar co-produced by The Hedge Fund Law Report and S&K. Details of the webinar are forthcoming. 

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  • From Vol. 9 No.26 (Jun. 30, 2016)

    How Can Private Fund Managers Grant Preferential Rights? Delaware Chancery Court Decision Stresses Need for Fund Document Integration

    A decision by the Delaware Court of Chancery points to certain issues that private fund general partners and managers must take into account when committing to agreements with investors. The decision exposes false assumptions as to the meaning and enforceability of side letters. Issues brought to light during the proceedings have ramifications for the hedge fund sector more generally, asserted a panel at the Ninth Annual Advanced Topics in Hedge Fund Practices: Manager and Investor Perspectives conference recently hosted by Morgan, Lewis & Bockius. The panel featured Morgan Lewis partners and co-heads of the firm’s global hedge funds practice Richard Goldman and Jedd Wider, as well as partner-elect Christopher Dlutowski. This article highlights the panelists’ key insights relevant to hedge fund and other private fund managers with respect to granting investors preferential rights in light of the Delaware decision, responding to requests for most favored nation status and providing investors with notice of material events. For another ruling affecting side letters, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters” (May 28, 2015). For additional insight from Morgan Lewis partners, see “Becoming a Plan Assets Fund May Limit Hedge and Other Private Funds’ Abilities to Charge Fees” (Apr. 21, 2016); and “Under What Conditions Can a Hedge Fund Manager Present Hypothetical Backtested Performance Results?” (Feb. 1, 2013).

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  • From Vol. 8 No.38 (Oct. 1, 2015)

    Prohibited Transaction, Reporting and Side Letter Considerations Under ERISA for European Hedge Fund Managers (Part Two of Three)

    A growing number of European hedge fund managers are actively seeking injections of capital from U.S. investors subject to the Employee Retirement Income Security Act of 1974 (ERISA).  Hedge fund managers wishing to “cross-over” their funds into the ERISA regulatory sphere must, however, be cognizant of the increased and complex tangle of regulations and compliance obligations which have often deterred European managers from pursuing ERISA assets.  This second article in a three-part series examines particular issues U.K. and other European managers face stemming from prohibited transactions rules and reporting requirements under the ERISA regime and offers approaches to side letters for European managers raising capital from ERISA plans.  The first article analyzed the pertinent issues affecting European managers relating to liability standards and incentive fees.  The final article in the series will address concerns relating to indicia of ownership requirements, bond documentation and other issues.  See also “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Five of Five),” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014); and “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. 8 No.21 (May 28, 2015)

    Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters

    Investment managers, funds and investors – particularly high value investors – often wish to enter into arrangements (side letters) relating to a specific investment conferring rights more beneficial than the raft of rights given to all investors, as an inducement to invest.  However, several cases in the Cayman Islands Grand Court in recent years, as well as a decision of the Cayman Islands Court of Appeal in April 2015, have raised questions as to the enforceability and legality of these side letters.  In a guest article, Christopher Russell and Jeremy Snead of Appleby (Cayman) examine the practical considerations for funds, managers and investors in crafting side letters, including the three fundamental questions that must be considered when entering into a side letter, in light of the Cayman Islands case law.  For additional insight from Russell and Snead, see “How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or At the End of Its Life? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 46 (Dec. 5, 2013); and Part Two of Two, Vol. 6, No. 47 (Dec. 12, 2013); “Pitfalls and Solutions in Trading Shares in Corporate Hedge Funds in Liquidation in the Cayman Islands,” The Hedge Fund Law Report, Vol. 5, No. 41 (Oct. 25, 2012); and “Fund Misrepresentations Inducing Investment: Claims and Remedies Available to Fund Investors and Protections Available to Promoters, Fund Managers and Directors,” The Hedge Fund Law Report, Vol. 5, No. 35 (Sep. 13, 2012).

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  • From Vol. 8 No.10 (Mar. 12, 2015)

    Citing Persistent Losses, Seed Investor BlueCrest Capital Sues Meredith Whitney and Her Hedge Fund for Return of Seed Capital

    In exchange for committing capital to help launch a fund, companies that provide seed or founders’ capital are often granted special redemption rights and economic incentives such as reduced management and performance fees or a share of the fund manager’s fee income.  See “Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss Terms with Institutional Investors, Seeding Arrangements and the Convergence of Mutual Funds and Hedge Funds (Part Four of Four),” The Hedge Fund Law Report, Vol. 8, No. 7 (Feb. 19, 2015).  Structuring such arrangements, however, can be challenging.  A recent dispute between seed investor BlueCrest Capital Opportunities Limited (BlueCrest) and Meredith Whitney’s hedge fund management company illustrates how the interplay of fund organizational documents, seeding agreements and side letters can cause confusion even among the most sophisticated players.  In 2013, BlueCrest seeded a new Whitney fund.  The fund performed poorly, and BlueCrest demanded redemption of its entire seed stake, citing a side letter that said that BlueCrest would not be subject to any lock-ups or other limitations on redemption.  Whitney pushed back, claiming that the separate investment agreement pursuant to which BlueCrest provided seed capital mandated a two-year lockup.  BlueCrest commenced an action in New York State Supreme Court to force Whitney to pay the demanded redemption proceeds and set aside the redemption proceeds pending the litigation.  This article summarizes the background of the dispute, the provisions of the relevant agreements, BlueCrest’s complaint, court hearings with respect to BlueCrest’s requests for a temporary restraining order and preliminary injunction, and the rationale for the court’s decision on the preliminary injunction motion.

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  • From Vol. 8 No.7 (Feb. 19, 2015)

    Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss Terms with Institutional Investors, Seeding Arrangements and the Convergence of Mutual Funds and Hedge Funds (Part Four of Four)

    This is the fourth article in a four-part series covering the Eighth Annual Hedge Fund General Counsel and Compliance Officer Summit, hosted by Corporate Counsel and ALM.  This article summarizes the primary points made at the summit relating to negotiating terms with institutional investors, structuring seeding arrangements and the convergence of mutual funds and hedge funds.  The first article in the series covered regulatory priorities, handling regulatory examinations and cybersecurity preparedness.  The second article discussed CFTC compliance, conflicting regulatory regimes in compliance programs and the regulatory and operational considerations of hedge fund marketing.  The third article covered insider trading, proposed changes to Form 13F and Schedule 13D and employment-related disputes with highly-compensated employees.  The HFLR has covered this annual event in each of the five prior years.  For our previous coverage, see: 2013 Part 3; 2013 Part 2; 2013 Part 1; 2012 Part 2; 2012 Part 1; 2011; 2010; and 2009.

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  • From Vol. 8 No.1 (Jan. 8, 2015)

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

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

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  • From Vol. 7 No.45 (Dec. 4, 2014)

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

    For the last two years, the HFLR has been covering presentations 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.  Her PLI presentations are invariably thorough, relevant, lucid, informed by a unique level of access and experience and delivered with her trademark wit.  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).  Consistent with that tradition, the HFLR is covering Breslow’s presentation at PLI’s 2014 hedge fund management program.  This year’s presentation covered a typically expansive range of topics, including fund-level and investor-level gates, side pockets, synthetic side pockets, in-kind distributions, secondary market trading in hedge fund interests, co-investments, calculating NAV after suspension of redemptions, funds of one and fiduciary duty.  Breslow used the credit crisis as a framing device for her presentation, explaining the applicability and evolution of these concepts before, during and after the crisis.  This article covers the portions of Breslow’s presentation relating to the periods before and during the crisis.

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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.21 (Jun. 2, 2014)

    When and How Can Hedge Fund Managers Close Hedge Funds in a Way that Preserves Opportunity, Reputation and Investor Relationships?  (Part Two of Two)

    This is the second article in our two-part series on best practices for closing hedge funds.  The first article in this series laid out an eight-step framework for executing fund closures, and this article discusses many of the difficult issues that managers encounter when working through that eight-step framework.  In particular, this article analyzes the following themes or issues that regularly come up in connection with closing hedge funds: what happens to the rights and obligations in side letters; holdbacks, reserves and clawbacks; three strategies for handling side pockets and illiquid assets; management and performance fees; litigation, contingent liabilities and indemnification; how to handle an account managed in parallel with a closed fund; whether to include or exclude a closed fund in performance information and advertising; investor relations best practices; and the three most common mistakes hedge fund managers make in closing funds.

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  • From Vol. 6 No.44 (Nov. 14, 2013)

    Cayman Grand Court Enforces Side Letter between Hedge Fund and Beneficial Owner of Fund Shares, Even Though the Letter Was Not Signed by the Shareholder of Record

    The Grand Court of the Cayman Islands, Financial Services Division, recently ruled that a side letter between a Cayman hedge fund and beneficial owner of certain fund shares was enforceable, even though the side letter was not signed by the registered shareholder.  See “Can an Investor Who Invests Through a Nominee Shareholder in a Cayman Islands Hedge Fund Rely on a Side Letter To Which Its Nominee Is Not a Party?,” The Hedge Fund Law Report, Vol. 6, No. 39 (Oct. 11, 2013).  This article summarizes the background of the dispute, the circumstances surrounding the side letter and the reasoning underpinning the Court’s decision.  For more on structuring and negotiating side letters, see “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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  • From Vol. 6 No.41 (Oct. 25, 2013)

    Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part One of Three)

    Sidley Austin LLP recently hosted a conference in its New York office entitled “Private Funds 2013: Developments and Opportunities.”  At the conference, Sidley partners discussed various structuring, regulatory, operational and transactional developments impacting private funds and their managers.  The Hedge Fund Law Report is publishing a three-part series of articles covering the most important insights arising out of the conference.  In this first installment, we summarize the parts of the conference dealing with recent developments in fund structuring, single-investor funds, first loss capital arrangements, side letter terms, hard wiring of feeder funds for ERISA purposes, liquidity terms, fee terms, founder share classes and expense allocations and expense caps.  The second article in the series will discuss recent developments in SEC examinations and enforcement (including a discussion of compliance policy violations, valuation practices, allocation of investment opportunities, insider trading issues, use of political intelligence firms and expert networks, the SEC’s new policy requiring admissions of wrongdoing and best practices for compliance); seeding arrangements; and fund mergers and acquisitions (including a discussion of key terms and negotiating points for such transactions).  The third article will provide an update on regulatory developments impacting fund managers, including recent issues involving commodity pool operator registration and regulation, implementation and compliance with the JOBS Act and derivatives reforms.

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  • From Vol. 6 No.39 (Oct. 11, 2013)

    Can an Investor Who Invests Through a Nominee Shareholder in a Cayman Islands Hedge Fund Rely on a Side Letter To Which Its Nominee Is Not a Party?

    It is a fundamental rule of common law legal systems that, absent statutory intervention, a person who is not a party to a contract, even if the contract is made for that party’s benefit, cannot rely on or enforce the terms of that contract; this is the so-called “privity of contract” rule.   Its origins lie in the common law’s centuries old regard for the notion of bargain, whereby only a party who himself contributes value to an agreement can enforce it, in preference to regard for the intentions of the parties that a third party should benefit.  Many jurisdictions provide a statutory entitlement for a third party to a contract made for its benefit to enforce the benefit of that contract, subject to conditions.  The Cayman Islands have, as yet, no such legislation.  The current position, accordingly, gives rise to issues of the enforceability of side letters between a Cayman Islands fund and an underlying investor who invests through a nominee shareholder, and recent cases reveal a sharp divergence of judicial view – should the court hold the investor to the legal structure it has set up for its own benefit and reasons, and refuse to allow its nominee to enforce a side letter to which it is not a party, or should the court have regard to the perceived commercial reality that the underlying investor and its nominee are effectively one entity, and are to be treated as such, with the consequence that the nominee can enforce the side letter even though not a party to it?  Judicial clashes between observance of legal correctness, and perceived commercial reality, are not uncommon and the common law has over the centuries endeavoured, by various devices, to circumvent the privity of contract rule, in particular by the devices of collateral contracts, trusts of a promise and agency.  These devices are sometimes described as exceptions to the privity rule, but in reality they are not true exceptions, but the application of different legal principles.  Such a judicial clash appears to currently be taking place in the Grand Court of the Cayman Islands as can be seen in the judgments in three recent cases.  In a guest article, Christopher Russell and Sebastian Said, partner and senior associate, respectively, in the Litigation & Insolvency Practice Group of Appleby (Cayman) Ltd, discuss the background and ruling in each of these cases and outline important lessons and recommendations for hedge fund managers arising out of the decisions.

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  • From Vol. 6 No.33 (Aug. 22, 2013)

    Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement with Philip A. Falcone and Harbinger Entities

    A new era in SEC enforcement has begun.  On August 19, 2013, Philip A. Falcone, Harbinger Capital Partners LLC (Harbinger) and other Harbinger entities agreed to a consent settling SEC charges.  The charges related to: (1) an improper loan effected between Falcone and the Harbinger Capital Partners Special Situations Fund; (2) improper arrangements between Falcone, Harbinger Capital Partners Fund I and various large fund investors that provided such investors with undisclosed preferential redemption terms; and (3) improper trading in the distressed high yield bonds issued by Canadian manufacturing company MAAX Holdings, Inc.  The groundbreaking settlement affirms the SEC’s commitment to extracting admissions of wrongdoing as a condition of settlement in select cases involving egregious conduct or significant harm to investors, which stands in direct contrast to its previous policy of allowing defendants to “neither admit nor deny the charges” in settlement agreements.  The settlement has broad implications for hedge fund managers, and it behooves such managers to understand how to address such issues.  This article describes the facts as admitted by the defendants; outlines the sanctions agreed to by the defendants; highlights important issues that hedge fund managers must address in light of the settlement agreement and the SEC’s new settlement policy; and provides practical recommendations for addressing such issues.  For a discussion of the SEC’s enforcement action initiated against the defendants, see “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).

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  • From Vol. 6 No.31 (Aug. 7, 2013)

    Infovest21 White Paper Provides Industry Perspectives on Hedge Fund Fee Pressures, Expense Allocations and Liquidity Terms 

    Drawing on contributions from hedge fund managers, marketers, consultants, attorneys and others, a white paper recently published by Infovest21 detailed hedge fund industry views on topics including fee pressures, expense allocations, liquidity terms and side letters.  This article summarizes the salient points from the white paper.

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  • From Vol. 6 No.25 (Jun. 20, 2013)

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

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

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  • From Vol. 6 No.25 (Jun. 20, 2013)

    PLI Panel Provides Regulator and Industry Perspectives on Ethical and Compliance Challenges Associated with Hedge Fund Investor Relations

    The Practising Law Institute recently sponsored a program entitled “Hedge Fund Compliance and Regulation 2013,” which included a segment entitled “Investor Relations: Ethical Considerations and Compliance Challenges.”  During that session, the expert panel of regulators and industry professionals offered detailed insights on topics related to hedge fund investor relations, including compliance violations unearthed during recent presence examinations of hedge fund managers; strategies for building and maintaining an effective compliance program; views on navigating specific compliance challenges including valuation, conflicts, fees, disclosures and preferential treatment; and potential changes that could arise as a result of the Jumpstart Our Business Startups Act.  This article summarizes key insights from the session.  For our coverage of another session from the program, see “PLI Panel Provides Regulator and Industry Perspectives on SEC and NFA Examinations, Allocation of Form PF Expenses, Annual Compliance Review Reporting and NFA Bylaw 1101 Compliance,” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    Why and How Do Hedge Fund Managers Set Minimum Subscription Amounts? (Part Two of Two)

    Minimum subscription amounts do more than govern the dollar threshold required for access to a hedge fund.  In addition, minimums communicate information about the manager’s strategy and goals; inform the composition of the investor base; enable and limit performance; impact the pace and productivity of marketing; and constrain fund liquidity.  This is the second article in a two-part series digging deeply into the important but often overlooked topic of hedge fund investment minimums.  Generally, this article explores market practice in this area.  Specifically, this article discusses the market for investment minimums and related terms; trends with respect to minimums; application of minimums in different factual contexts; whether investment minimums apply to follow-on investments; and manager practice for enforcing, waiving and modifying minimums.  The first article in this series addressed primary legal, business and investment rationales for setting hedge fund investment minimums.  See “Why and How Do Hedge Fund Managers Set Minimum Subscription Amounts? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 23 (Jun. 6, 2013).

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two)

    On April 18, 2013, the Regulatory Compliance Association held its Regulation, Operations & Compliance 2013 Symposium, at which industry leaders and regulators offered their perspectives on critical issues facing hedge fund managers and investors.  The Hedge Fund Law Report is publishing a two-part series of articles summarizing salient points from panel discussions held during the Symposium.  This article, the first in the series, discusses regulatory and operational challenges implicated by side letters, including dealing with requests for enhanced liquidity and transparency as well as the evaluation of requests for most favored nation provisions.  This article also addresses how hedge fund managers are using funds of one and managed accounts, and the benefits and burdens of each.  The second installment will cover techniques and strategies regulators and prosecutors are using to investigate insider trading; how managers should address high-priority conflicts of interest; the SEC’s whistleblower program; and compliance with the Foreign Account Tax Compliance Act.  For articles covering speeches made and topics discussed during the Symposium, see “SEC Commissioner Aguilar Discusses Insider Trading by Hedge Fund Managers, Valuation and Other Examination and Enforcement Pressure Points,” The Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013); and “OCIE Director Bowden Identifies Five Key Lessons for Hedge Fund Managers from Recent Presence Examinations,” The Hedge Fund Law Report, Vol. 6, No. 21 (May 23, 2013).

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  • From Vol. 6 No.8 (Feb. 21, 2013)

    Mike Neus, Managing Partner and General Counsel of Perry Capital, Discusses Practical Solutions to Some of the Harder Fiduciary Duty and Other Legal Questions Raised by Side Letters

    At their core, side letters are about defining specific rights and obligations with respect to a specific investment.  Accordingly, the legal and practical issues raised by side letters, and best practices for addressing those issues, are often context-specific.  This theme of specificity – the idea that effective solutions must be narrowly tailored to specific problems where side letters are concerned – was a leitmotif in our recent conversation with Michael Neus, Managing Partner and General Counsel of Perry Capital LLC.  We posed some of the harder questions generally raised by side letters to Neus, and his answers – transcribed in this article – were typically nuanced, insightful and informed by current market practice.  In particular, we covered trends in the use of and rights granted in side letters; the advisability of and approach to selective disclosure; concerns related to modification of fund redemption terms through side letters; the impact of different regulatory regimes on side letter drafting; strategies for drafting effective most favored nation provisions; strategies for gracefully declining side letter requests; the approach to using single-investor funds and managed accounts to address side letter requests; strategies for monitoring obligations in side letters; the proper party for executing side letters; and trends in negotiating capacity rights.  See also “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).  Our interview with Neus 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.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.7 (Feb. 14, 2013)

    Peter Tsirigotis of Brown Brothers Harriman Discusses the Operational Challenges Posed by Side Letters

    For hedge fund managers, the panoply of legal and fiduciary duty issues raised by side letters is daunting.  For an insightful discussion of some of these issues, see “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).  Compounding the legal hurdles of side letters are the operational challenges they raise – the need to abide by a patchwork of different promises to different institutions, and the consequent pitfalls in the interstices of those promises.  As SEC examiners and examined managers routinely tell The Hedge Fund Law Report, the most common violations by hedge fund managers are not of external law, but of their own promises and disclosures.  In side letters, therefore, hedge fund managers raise the compliance bar on themselves considerably.  Side letters help raise assets, but they also raise regulatory risk.  Side letters have received considerable attention – including in the HFLR – from the ex ante perspective, that is, from the perspective of a manager negotiating such an instrument.  See, e.g., “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  But side letters have received less attention from the ex post perspective.  There has been, that is, less discussion on how hedge fund managers can live with the deals they strike in side letters.  We recently talked to Peter Tsirigotis, Senior Vice President at Brown Brothers Harriman, to shed some light on this as yet obscure area.  In particular, our conversation with Tsirigotis covered, among other topics: reasons for side letters; categories of side letter rights requested; most favored nation provisions; methods for tracking manager obligations incurred through side letters; technologies used to assist managers in administering side letters; negotiation practices for side letters; and recommendations for protection of confidential information.  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.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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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. 6 No.3 (Jan. 17, 2013)

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

    Regulators are increasingly keen on scrutinizing how fund managers address conflicts of interest.  Norm Champ, then-Deputy Director of the SEC’s Office of Compliance Inspections and Examinations, spoke about conflicts at a May 2012 seminar held at the New York City Bar Association.  See “Davis Polk ‘Hedge Funds in the Current Environment’ Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).  The SEC has indicated that it intends to scrutinize fund managers’ handling of conflicts of interest during “presence examinations” of newly registered managers to be conducted in the next two years.  See “Former SEC Asset Management Unit Co-Chief Robert Kaplan and Former NYS Insurance Superintendent Eric Dinallo, Both Current Debevoise Partners, Discuss the Purpose, Process and Consequences of Presence Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 48 (Dec. 20, 2012).  In addition, the FSA has expressed its own concerns with asset managers’ handling of conflicts of interest by penning a “Dear CEO” letter to asset managers identifying areas where it has particular concerns.  See “FSA Report Warns Investment Managers to Revise Their Compliance Policies and Procedures to Address Key Conflicts of Interest,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  Moreover, regulators have initiated enforcement actions to address conflicts of interest that were not appropriately managed, handled and documented.  The most notable of these actions was levied against Harbinger Capital Partners and its principal, Philip Falcone, in the summer of 2012.  See “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).  Like regulators, hedge fund investors are concerned with conflicts of interest at managers.  See “Use of SSAE 16 (SAS 70) Internal Control Reports by Hedge Fund Managers to Credibly Convey the Quality of Internal Controls, Raise Capital and Prepare for Audits,” The Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).  Left unchecked, conflicts can ripen into legal violations and lost investments.  Accordingly, hedge fund managers must be vigilant in identifying and addressing conflicts.  While the details of conflicts may differ from firm to firm, certain general conflicts pervade the industry.  In a guest article, John Ackerley, a Director with Carne Global Financial Services in the Cayman Islands, provides a checklist of those pervasive conflicts, which are also those that matter most to regulators and investors.  In addition, Ackerley discusses specific measures that hedge fund managers can take to mitigate such conflicts.  Managers can expect questions from regulators and investors on each of the conflicts discussed herein.  Therefore, this article can be useful as a reference point in a mock examination, to prepare for marketing meetings and for other purposes.

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  • From Vol. 6 No.1 (Jan. 3, 2013)

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

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

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  • From Vol. 5 No.48 (Dec. 20, 2012)

    Speakers at Walkers Fundamentals Hedge Fund Seminar Discuss Recent Trends in Hedge Fund Terms, Corporate Governance, Side Letters, FATCA and Cayman Fund Regulation

    On November 8, 2012, international law firm Walkers Global hosted its annual Walkers Fundamentals Hedge Fund Seminar in New York City.  Speakers at this event addressed various issues of current relevance to hedge fund managers, including: recent developments in fund structuring and terms; fund governance; recent Cayman legal developments (including those relating to side letter disputes); implications of the Foreign Account Tax Compliance Act for hedge fund managers; and regulatory developments, including proposed amendments to the Cayman Islands Exempted Limited Partnership Law and the impact of the EU’s Alternative Investment Fund Managers Directive.  This article summarizes noteworthy points discussed during the seminar on each of the foregoing topics.  For our coverage of last year’s Walkers Fundamental Hedge Fund Seminar, see “Speakers at Walkers Fundamentals Hedge Fund Seminar Provide Update on Hedge Fund Terms, Governance Issues and Regulatory Developments Impacting Offshore Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Sixth Annual Hedge Fund General Counsel Summit Highlights SEC Enforcement Priorities, Side Letters, Investment Allocations, Expense Allocations, Trade Errors, Record Retention, Fund Marketing, Secondaries, JOBS Act and STOCK Act (Part One of Two)

    On September 18 and 19, 2012, ALM Events hosted its Sixth Annual Hedge Fund General Counsel Summit (GC Hedge Summit) at the University Club in New York City.  Panelists, including regulators, in-house practitioners and law firm professionals, discussed topics of significant relevance for hedge fund general counsels, including: SEC enforcement priorities relating to hedge funds; the nuts and bolts of a successful hedge fund compliance program (including a discussion of side letters, investment allocations, expense allocations, trade errors and record retention); marketing of hedge funds (including a discussion of compensation of marketing professionals and the Jumpstart Our Business Startups (JOBS) Act); secondary market transactions in fund shares; and the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act) and its implications for the gathering of political intelligence.  Our coverage of the GC Hedge Summit is provided in two installments.  This first installment covers the session addressing the nuts and bolts of a successful compliance program and the session addressing marketing of hedge funds and secondary market transactions in hedge fund shares.  The second article will cover the session discussing the SEC’s enforcement priorities and the session discussing the implications of the STOCK Act for the gathering of political intelligence by hedge fund managers.  See also “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).

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  • From Vol. 5 No.37 (Sep. 27, 2012)

    Cayman Grand Court Rejects Validity of Side Letter Entered Into Between an Investor in Investment Vehicles That Invested in the Matador Fund and a Director of the Matador Fund

    A recent decision handed down by the Grand Court of the Cayman Islands (Court) emphasizes the importance of: (1) ensuring that the correct parties enter into side letters between an investor and a fund; and (2) ensuring that a fund’s governing documents permit the fund to enter into the type of side letter contemplated by the fund and the investor.  This decision follows on the heels of another recent decision handed down by the Court that highlights similar principles.  See “Recent Cayman Grand Court Decision Demonstrates the Practical and Legal Challenges of Investing in Hedge Funds through Nominees,” The Hedge Fund Law Report, Vol. 5, No. 29 (Jul. 26, 2012).

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  • From Vol. 5 No.36 (Sep. 20, 2012)

    How Should Hedge Fund Managers Handle and Document Investor Complaints?

    Not all hedge fund investors are satisfied customers, but not all dissatisfied hedge fund customers sue or seek to arbitrate.  A halfway house between legal action and no action is the investor complaint – an expression of dissatisfaction with some aspect of the investment relationship, which need not relate to performance.  Good performing hedge fund managers can (and do) receive investor complaints, and the most formidable types of complaints frequently relate to matters other than performance, for example, the legality or propriety of conduct of manager personnel.  Adaptive hedge fund managers have developed an infrastructure and style for responding to complaints, and view them as an opportunity to engage investors and other constituencies.  Lesser managers bristle at any whiff of criticism, though that is a bad strategy for all involved; from the investor perspective, part of the job of a hedge fund manager is engaging with reasonable investor inquiries, including justified complaints.  Moreover, given the relatively small size of the hedge fund investor universe (at least compared to the retail investing population), the SEC’s whistleblower bounty program and competition for scarce assets, appropriately calibrated responses to investor complaints can have implications for marketing, reputation and regulatory relations.  In short, navigating the investor complaint process is a relatively novel challenge in the hedge fund industry, but an increasingly important one.  To help hedge fund managers think through the various components of this challenge, this article discusses: what constitutes an investor complaint; who within the management company should receive such complaints; how investor complaints should be investigated and addressed; when to notify the general counsel of an investor complaint; how to determine the appropriate course of action, including whether, when and how to respond to complaints; and how to document a complaint.

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  • From Vol. 5 No.35 (Sep. 13, 2012)

    Fund Misrepresentations Inducing Investment: Claims and Remedies Available to Fund Investors and Protections Available to Promoters, Fund Managers and Directors

    False statements inducing initial or continued investment in Cayman funds are relatively rare, but if they do occur, the financial consequences are often catastrophic for the misled investor and present him with a dilemma – whether to pull out and try to recoup the investment, or to stay in, try to recover what losses are retrievable and take whatever benefits there may be down the line.  Although the decision may be easy enough as a matter of choice in principle, a number of thorny legal issues may arise, such as the right to rescind an allotment of shares, derivative claims and the bar on recovery of reflective loss.  For promoters, managers and directors seeking to avoid such claims, the issue is how to protect themselves from accusations of misleading statements about the fund, and from consequent liability for such statements.  In a guest article, Christopher Russell and Jeremy Snead of Appleby (Cayman) discuss the claims and remedies available to misled fund investors and the protections available to promoters, fund managers and directors that seek to protect themselves from allegations of misrepresentation.

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  • From Vol. 5 No.30 (Aug. 2, 2012)

    Hedge Fund Side Letters: The View from the Fund Director’s Perspective

    Most hedge funds are asked at one time or another by certain investors to provide side letters agreeing to preferential dealing, investment or other strategic terms.  There are clear cases where a side letter would not be acceptable, e.g., it contains plainly egregious terms; has no legitimate purpose; or is clearly contrary to what the hedge fund or hedge fund manager is doing in practice.  In most circumstances, however, there is no black and white answer as to what constitutes an acceptable side letter term or where the line should be drawn.  In crafting a side letter term that is in the best interest of the hedge fund (and in particular, other investors in the fund), there is a difficult balancing act that managers must perform.  On the one hand, the side letter can be used to facilitate a large investment that attracts other strategic investors, which could benefit the fund and the execution of its investment strategy.  On the other hand, side letters generally raise various fiduciary and other concerns that must be addressed.  In a guest article, Victor Murray, an independent accredited director at MG Management Ltd., discusses: side letter disclosure; ERISA considerations relating to side letters; unsavory terms; shareholder actions relating to side letters; lack of statutory provisions; derivative actions; fraud on the minority; and best practices in relation to directors’ review of side letters.

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  • From Vol. 5 No.29 (Jul. 26, 2012)

    Recent Cayman Grand Court Decision Demonstrates the Practical and Legal Challenges of Investing in Hedge Funds through Nominees

    A recent decision of the Grand Court of the Cayman Islands (Court) addressed a range of relevant questions for hedge fund managers and investors, among them: Does a side letter survive a fund restructuring?  Does a side letter entered into between a hedge fund and a beneficial investor bind a nominee through which the beneficial investor subsequently invests?  Is a beneficial investor a party to a hedge fund’s governing documents where it invests through a nominee?  What is the legal status of a side letter entered into prior to (rather than simultaneously with) an investment in a hedge fund?  In short, the decision illustrates the myriad legal and practical challenges faced by investors that invest in hedge funds through nominees; the relevance of the identity of contracting parties; and the scrutiny to which governing documents are subject in the course of hedge fund restructurings.  This feature-length article describes the factual background and legal analysis in the decision, and extracts two key lessons for investors that wish to invest in hedge funds via nominees.  See also “Investing in Cayman Islands Hedge Funds Through a Nominee or Custodian: An Unforeseen Peril,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).

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  • From Vol. 5 No.23 (Jun. 8, 2012)

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

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

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  • From Vol. 5 No.22 (May 31, 2012)

    Eight Recommendations for Hedge Fund Managers That Utilize Most Favored Nation Provisions in Side Letters

    The challenging capital raising environment has generally tilted the typical balance of power in favor of institutional investors.  As a consequence, with increasing frequency, institutional investors are requesting side letters from hedge funds or their managers.  Side letters typically grant the requesting investor preferential rights that are not granted to other investors in the fund’s governing documents; these preferential rights can include special fee reductions, transparency rights, redemption rights, capacity rights, etc.  Additionally, side letter requests now regularly include so-called “Most Favored Nation” (MFN) provisions – which are used by investors to ensure that any rights granted to current or future investors are also offered to the requesting investor.  Requesting investors often demand broad protections in MFN provisions, arguing that they cannot anticipate what rights will be granted to future investors.  While it may be convenient for hedge fund managers to dismiss MFN provisions as “standard” requests from investors, MFN provisions can present numerous pitfalls for fund managers if they are not properly evaluated, appropriately negotiated and effectively monitored to ensure compliance.  This article provides a roadmap for understanding MFN provisions and their implications for a manager’s business, operations and compliance processes.  Specifically, this article describes: the anatomy of an MFN provision; the key terms of an MFN provision; the three principal concerns raised by the use of MFN provisions; and eight recommendations for drafting and administering MFN provisions to mitigate key concerns.

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  • From Vol. 5 No.16 (Apr. 19, 2012)

    Does a Side Letter Granting Preferential Redemption Rights Survive a Hedge Fund Restructuring?

    In the aftermath of the 2008 financial crisis, some hedge fund managers felt compelled to restructure their funds to manage liquidity and to balance the interests of redeeming and continuing investors.  Many such restructurings required investors to either consent to the restructuring or make an election relating to the restructuring.  Nonetheless, many such reorganizations were quickly conceived and may not have considered the survivability of side letters pertaining to the original fund investment.  In dueling complaints recently filed in courts in the Cayman Islands and New York State, a hedge fund and a fund of funds, and their respective managers, initiated litigation focused on the following question: Does a side letter that granted a hedge fund investor, among other things, preferential redemption rights, survive a hedge fund restructuring, or does such a side letter terminate upon the making of a restructuring election by the hedge fund investor?  This article summarizes the complaints, the context and the implications of the litigation for hedge fund managers and investors.  On preferential redemption rights generally, see “Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).

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  • From Vol. 5 No.13 (Mar. 29, 2012)

    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 recently interviewed Christopher M. Wells, a Partner at Proskauer Rose LLP and head of the firm’s Hedge Funds Group.  Wells has decades of experience advising hedge funds and their managers, and a broad-based practice that touches on substantially every aspect of the hedge fund business.  Our interview with Wells was similarly wide-ranging, covering topics including: hedge fund governance; investor demands for heightened transparency; co-investment opportunities; liquidity management issues; side pocketing policies and procedures; holdbacks of redemption proceeds; tax issues, including preparations for compliance with the Foreign Account Tax Compliance Act (FATCA) and the electronic delivery of Schedules K-1; and risk management, including practical steps to prevent style drift and unauthorized trading.  This interview was conducted in conjunction with the Regulatory Compliance Association’s Spring 2012 Regulation & Risk Thought Leadership Symposium.  That Symposium will be held on April 16, 2012 at the Pierre Hotel in New York.  For more information, click here.  To register, click here.  (Subscribers to The Hedge Fund Law Report are eligible for discounted registration.)  Wells is expected to participate in a session at that Symposium focusing on hedge fund governance and related issues.

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  • From Vol. 4 No.44 (Dec. 8, 2011)

    A Step-By-Step Guide to GIPS Compliance for Hedge Fund Managers

    The Hedge Fund Law Report and others have reported on the post-crisis ascendance of non-performance factors in hedge fund due diligence and investment decision-making.  In short, before 2008, hedge fund allocations were driven largely by a manager’s past performance.  After 2008, factors such as transparency, liquidity and robust risk management surpassed performance in the hierarchy of concerns of institutional hedge fund investors.  See “Survey by SEI and Greenwich Associates Identifies the Primary Decision Factors and Concerns of Institutional Investors When Investing in Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 11, 2011).  However, we do not wish to overstate the case or the duration of the trend.  The long-term lesson of the crisis likely will be that robust risk management, appropriate liquidity and transparency and well-developed infrastructure are necessary to justify a hedge fund investment, but not sufficient.  Hedge fund managers without institutional caliber businesses will often be passed over, but as between two managers with good businesses, the deciding factor will often be past performance.  Thus the immediate and important question for hedge fund managers: how can managers present performance information in a manner that maximizes capital raising efforts while complying with relevant law and standards?  An increasingly common answer to this question in the hedge fund community is: by complying with the Global Investment Performance Standards (GIPS), an evolving set of practice standards designed to ensure consistency and uniformity in the presentation of investment performance results.  Compliance with GIPS is ostensibly voluntary, but in practice, more and more institutional hedge fund investors are asking to see GIPS-compliant performance information.  Accordingly, GIPS compliance is becoming a de facto requirement for hedge fund managers, and hedge fund managers are actively seeking to become GIPS compliant.  The main challenge for hedge fund managers is that GIPS were originally designed for a long-only world.  They have been an imperfect fit for managers with complex investment structures, side pockets, illiquid or hard-to-value assets and other typical elements of the hedge fund business.  Sensitive to this, the GIPS Executive Committee recently promulgated guidance specific to alternative investment managers, and service providers have adapted their businesses to help hedge fund managers comply with GIPS and certify such compliance.  However, despite the guidance and available assistance, GIPS compliance remains a challenge for hedge fund managers.  This article aims to assist hedge fund managers in rising to that challenge and surmounting it.  To do so, this article starts by providing a comprehensive overview of GIPS.  The article then identifies five discrete categories of benefits of GIPS compliance and two categories of burdens of compliance.  Next, and most importantly, this article provides a step-by-step process by which hedge fund managers can become GIPS compliant.  In the course of this discussion, this article details the material points from two recent webinars and one recent white paper promulgated by leading GIPS service providers.  Reading this article will enable a hedge fund manager to, among other things: revise its marketing materials to comply with GIPS; organize its front, middle and back offices to collect the data necessary to support a GIPS-compliant presentation; manage service providers with a view to GIPS compliance; ask the right questions of outside counsel; determine whether to engage a specific GIPS compliance service provider; define the scope of any such engagement; and respond effectively to due diligence inquiries on GIPS.

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  • From Vol. 4 No.40 (Nov. 10, 2011)

    Business Issues with Legal Consequences: A Wide-Ranging Interview with Dechert Partner George Mazin about the Most Important Challenges Facing Hedge Fund Managers

    The Hedge Fund Law Report recently had the privilege of interviewing George J. Mazin, a Partner at Dechert LLP, and a deservedly well-regarded member of the hedge fund bar.  As evidenced by the text of our interview, which is included in this issue of The Hedge Fund Law Report, George has an aptitude for identifying the legal consequences of business issues, and explaining them clearly.  He also has the kind of market color that only comes with years – decades – in the trenches, and experience across business cycles.  Our interview was wide-ranging, reflecting the diversity of George’s experience, which in turn reflects the range of legal issues relevant to hedge fund managers.  In particular, our interview covered: valuation considerations in connection with affiliate transactions; valuations based on fraudulent sales and rigged dealer bids; manager overrides of third-party valuations; whether side pockets remain viable in new hedge fund launches; how even non-ERISA hedge funds can analogize the ERISA model of independent pricing; effective valuation testing programs; the interaction between GAAP and the custody rule; GAAP exceptions to audit opinions; use of counterparty confirmations by the SEC; delayed audits; custody of derivatives and limited partnership interests; insider trading policies with respect to market chatter and channel checking; how to grant side letters in light of selective disclosure considerations; how algorithmic or high-speed trading firms can prepare for regulatory examinations; legal considerations in connection with loans from a hedge fund to a manager; best practices in connection with principal trades; and whether side-by-side investing by manager personnel can pass muster under fiduciary duty and related principles.  This interview was conducted in connection with the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, which is taking place today at the Pierre Hotel in New York.

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  • From Vol. 4 No.38 (Oct. 27, 2011)

    SEC Exams of Hedge Fund Advisers: Focus Areas and Common Deficiencies in Compliance Policies and Procedures

    It is a well-known fact that the SEC has significantly fewer examiners than it has registrants to examine.  Nowhere is the SEC more outnumbered than in the investment adviser arena, with approximately 435 examiners compared to more than 11,000 registered investment advisers.  In the first quarter of 2012, advisers with less than $100 million in assets under management will generally transition from SEC registration to state registration.  However, the mandatory registration of private fund advisers with more than $150 million in assets will continue to pose significant resource challenges to SEC examiners.  What’s more, the newly registered private fund advisers will likely be higher risk and more complex firms, which will require more examination resources than those firms moving off the SEC’s rosters.  To help manage this resource imbalance, SEC examinations are becoming much more focused and targeted on high-risk firms and the highest risk activities and practices within those firms; and as a result of various factors discussed in this article, SEC examiners are much better prepared than in the past to scrutinize hedge fund business practices and they have an eager group of well-equipped enforcement staff ready to bring cases – often a series of cases – on the issues where examiners are focusing.  In a guest article, Kimberly Garber – a Founding Principal of boutique compliance firm CORE-CCO, LLC, and former Associate Regional Director in charge of the Examination Program in the Fort Worth Regional Office of the SEC – discusses five risk areas where SEC examiners commonly focus in hedge fund examinations and where compliance policies and procedures are often lacking.  In each area, how comprehensive a firm’s procedures need to be will depend on the risks presented by the firm’s business practices, affiliates and client relationships, and how actively the firm and its personnel engage in each type of activity.  If a firm does not purport to engage in or chooses to prohibit certain activities, its policies and procedures should specify such prohibited practices but also contemplate controls to ensure that employees do not inadvertently or purposefully engage in prohibited activities.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

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

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

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  • From Vol. 4 No.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.16 (May 13, 2011)

    What Is the Legal Effect of a Side Letter That Contains Specific Terms More Favorable Than a Hedge Fund’s General Offering Documentation?

    A question that has arisen in the current climate of hedge fund investor caution in the approach to the terms of investment, and managers being more ready to negotiate the offering terms, is: What is the legal effect of side letters entered into between an investor and the fund (usually through the investment manager) following negotiations as to the terms of a specific investment, which provide for terms more favorable than those offered generally by the fund’s offering documentation?  In a guest article, Christopher Russell and Rachael Reynolds, Partner and Managing Associate, respectively, at Ogier in the Cayman Islands, provide a detailed answer to this question, including a discussion of four principles that should be borne in mind when preparing a side letter to ensure that the letter has legal and binding effect.

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  • From Vol. 3 No.29 (Jul. 23, 2010)

    Hedge Fund Industry Practice for Defining “Class of Equity Interests” for Purposes of the 25 Percent Test under ERISA

    The Hedge Fund Law Report recently published a three-part series on ERISA considerations for hedge fund managers and investors.  The first part of that series explained how hedge funds and their managers can become subject to ERISA; the second part of the series detailed consequences to hedge funds and their managers of becoming subject to ERISA; and the third part provided a roadmap to the prohibited transaction exemptions that enable hedge fund managers to both accept significant ERISA investors in their funds, and operate and invest without many of the constraints imposed by ERISA.  The first article in the series noted that the general rule under ERISA is that when a “benefit plan investor” acquires an equity interest in an entity, other than a public operating company or a registered investment company, all the assets of that entity are deemed to be “plan assets” subject to ERISA, unless an exception applies.  ERISA generally provides three exceptions, one of which – the 25 percent test – is typically relied on by hedge funds.  Under the 25 percent test, if benefit plan investors own less than 25 percent of any class of equity interests issued by a hedge fund, that hedge fund and its manager will not be subject to ERISA.  Accordingly, a threshold question to be addressed by any hedge fund manager that currently has ERISA investors in its funds or is considering accepting investments from ERISA investors is: What constitutes a “class of equity interests” for ERISA purposes?  ERISA does not define the phrase, and the Department of Labor has only defined an “equity interest” as an interest other than debt.  Therefore, like many questions under ERISA, the working definition of class of equity interests is a function of market practice.  The first article in our ERISA series included a survey of market practice on this point as part of a broader discussion.  But in light of the importance of the definition to any ERISA analysis, and in light of the importance of ERISA analysis to hedge fund capital-raising, this article drills down even further on market practice in this area.  Specifically, this article first examines the approaches, concerns and frameworks used by practitioners to define a class of equity interests.  We describe the “conservative” and “broad” views, and identify specific factors relied on by practitioners.  The article then examines whether certain nonintuitive arrangements may constitute a class of equity interests for ERISA purposes, including side letters, side pockets, managed accounts, single investor hedge funds (or “funds of one”), investments (directly or via IRAs) by manager principals and employees and seeding arrangements.  See “Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors,” The Hedge Fund Law Report, Vol. 3, No. 16 (Apr. 23, 2010).

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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.16 (Apr. 23, 2010)

    Impact of Regulatory Reforms on Hedge Funds is Key Focus of PLI’s Hedge Fund Registration and Compliance 2010 Seminar

    As the government and the Securities and Exchange Commission (SEC) push for a number of reforms in the financial markets, the impact on hedge funds is expected to be significant, particularly with the Private Fund Investment Advisers Registration Act of 2009 (House bill) and the Wall Street Reform and Consumer Protection Act of 2009 (Dodd bill) both calling for the mandatory registration of hedge fund managers who meet certain assets under management (AUM) thresholds.  On April 9, 2010, the Practising Law Institute hosted the Hedge Fund Registration and Compliance 2010 seminar in New York City.  Among the key topics discussed during the conference were: fund manager registration; likely changes to the definition of accredited investor; proposed resolution authority; the Volcker Rule; key issues regarding hedge fund marketing; side letters; strategy drift; and soft dollars.  This article offers a comprehensive summary of the key points raised and discussed at the conference.

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  • From Vol. 2 No.52 (Dec. 30, 2009)

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

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

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  • From Vol. 2 No.46 (Nov. 19, 2009)

    How Can Hedge Funds Compete With ETFs for Allocations from Private Bank Wealth Management Programs Given the Growing Popularity of ETFs in Such Programs?

    Up to and even through the credit crisis, private bank clients (chiefly high net worth individuals and family offices) have provided a notable proportion of the assets invested in hedge funds.  However, like other investors in hedge funds during the crisis, private bank clients were dismayed by hedge funds’ illiquidity, lack of transparency and relatively high fees.  At the same time, a new crop of exchange traded funds (ETFs) has arisen purporting to replicate various hedge fund strategies while offering more liquidity, greater transparency and lower fees.  See “Hedge Fund Replication is Gaining in Popularity, but is it a Viable Alternative to Hedge Fund Investing?,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  More traditional ETFs – those that track broad stock and bond indices rather than seeking to replicate hedge fund strategies – also offer the advantages of liquidity, transparency and lower fees.  Not surprisingly, therefore, a number of private bankers recently have redeemed their clients’ hedge fund investments and reallocated the proceeds to ETFs, both of the replication and traditional variety. Indeed, there is some concern in the hedge fund industry that private banks will turn away from hedge funds altogether, primarily in favor of ETFs.  The purpose of this article is to analyze whether that concern is warranted and, to the extent it is, to explore what hedge fund managers can do to counter the trend.  In brief, this article concludes that for a narrow group of strategies, ETFs may well be able to address the goals of private bank clients as well, on average, as hedge funds.  However, for a wide range of hedge fund strategies – especially those that rely more on the decision-making capacity of one or a few portfolio managers as opposed to replicable quantitative models – hedge funds are likely to retain an important role in serving the uncorrelated return and diversification goals of private bank clients.  In particular, this article discusses: what private bank wealth management programs are; the three mechanisms by which private bank clients invest in hedge funds; what ETFs are; how certain new ETFs seek to replicate hedge fund strategies; the growing popularity of ETFs for private bank clients; the benefits and drawbacks of ETFs for private bank clients; the three primary ways in which hedge funds can remain relevant in private bank portfolios in light of the growing popularity of ETFs; and the utility and limits of side letters for private banks.

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  • From Vol. 2 No.41 (Oct. 15, 2009)

    Participants at Third Annual Hedge Fund General Counsel Summit Discuss Adviser Registration, Side Letters, SEC Audits and Enforcement, Fund Restructurings and More

    On October 1, 2009, the Third Annual Hedge Fund General Counsel Summit convened in Old Greenwich, Connecticut, organized by Corporate Counsel and Incisive Media Events.  The one-day conference featured eight panel discussions focusing on topics including the following: changes in the regulatory and enforcement practices of the Securities and Exchange Commission (SEC); the “foregone conclusion” that the U.S. Congress will soon pass a bill requiring the registration of certain hedge fund advisers; how to prepare for an SEC audit; side letter terms and tracking; and hedge fund restructurings in the U.S., Cayman Islands and British Virgin Islands.  A recurring theme among the various panels was the newfound relevance of compliance and robust controls in the hedge fund business, and the concomitant growth in importance within hedge fund managers of the general counsel and chief compliance office (often the same person).  This article discusses the most salient points raised at the conference.

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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.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.30 (Jul. 29, 2009)

    The Evolution of Offshore Investment Funds (Part One of Three): In Interview with The Hedge Fund Law Report, Ogier Partner Colin MacKay Discusses Drafting of Offshore Fund Documents; NAV Adjustments; Clawbacks; Managed Accounts; and Payment-in-Kind Provisions

    During this past spring and summer, global law firm Ogier hosted its Second Annual Ogier Global Investment Funds Seminar, titled “The Evolution of Offshore Investment Funds,” for over 300 hedge fund professionals in New York, Boston, the Cayman Islands, Chicago and San Francisco.  Colin MacKay, one of the presenting partners at the seminar, spoke at length to The Hedge Fund Law Report about the most important issues addressed in the seminar, including: (1) How regulatory developments, recent economic events and caselaw in offshore financial centers is affecting drafting of specific provisions in fund documents (including net asset value adjustments, “clawbacks” of performance fees for subsequent underperformance); (2) Managed accounts, and the amount of assets required to be in a managed account for such an account to be economically viable, in light of the various administrative costs involved in creating and maintaining such an account; (3) Side letters; (4) Liquidity management tools (such as gates, redemption suspensions, payments in kind, etc.), and how the increasing use of such tools is affecting the drafting of payment-in-kind provisions in Cayman and BVI fund documents; (5) Indemnification of fund directors and the evolution of the “gross negligence” standard; (6) Caselaw developments in offshore financial centers (including cases addressing when a redeeming shareholder becomes a creditor of a fund and cases dealing with attempts by liquidators to adjust net asset value); (7) Clawback principles and mechanics; (8) Regulatory developments in offshore financial centers, and in other jurisdictions that may affect funds organized in offshore financial centers (such as the EU’s AIFM Directive); and (9) The relative advantages and disadvantages of various offshore financial centers.  This issue of The Hedge Fund Law Report includes the first of three parts of the full transcript of our interview with MacKay.

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  • From Vol. 2 No.9 (Mar. 4, 2009)

    Trio of Bills Proposed in Connecticut Legislature Would Introduce Substantial State Regulation of Hedge Funds

    In the January 2009 Session of the Connecticut General Assembly, Connecticut lawmakers proposed three bills that would increase the state’s role in the regulation of private investments funds, including hedge funds, with various types of connections to Connecticut.  In particular, lawmakers proposed the following: (1) Connecticut Senate Bill No. 953, “An Act Concerning Hedge Funds,” which generally would raise qualifications for investors in private funds that have offices in Connecticut where employees regularly conduct business on behalf of the funds, and expand disclosure requirements applicable to such funds; (2) Connecticut House Bill No. 6477, “An Act Concerning the Licensing of Hedge Funds and Private Capital Funds,” which generally would require hedge funds established or conducting business in Connecticut to obtain a license from the Connecticut Banking Commissioner; and (3) Connecticut House Bill No. 6480, “An Act Requiring the Disclosure of Financial Information to Prospective Investors in Hedge Funds and Private Capital Funds,” which generally would require hedge funds domiciled in Connecticut and receiving money from Connecticut pension funds to disclose to prospective pension fund investors, upon request, certain financial information.  All three bills have been referred to the Banks Committee of the Connecticut General Assembly.  In addition, at a public hearing held by the Banks Committee on February 24, 2009, Connecticut Attorney General Richard Blumenthal proposed an alternative scheme of state hedge fund regulation.  We provide a detailed analysis of each of the three bills as well as Attorney General Blumenthal’s proposal, including a discussion of industry responses from some of the leading authorities on federal and Connecticut hedge fund regulation.

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  • From Vol. 2 No.5 (Feb. 4, 2009)

    What Has the Asset Managers’ Committee Report to say about Hedge Fund Valuation, Side Letters and PPM Updates?

    As the ground continues to swell, especially in Washington, around the ideas of transparency and accountability in hedge fund practices, the Asset Managers’ Committee of the President’s Working Group on Financial Markets released on January 16, 2009 its final report on best practices for the hedge fund industry.  To complement the detailed discussion of the Asset Managers’ Committee Report included in this issue of The Hedge Fund Law Report (see above), we delve deeper into three areas of the Asset Managers’ Committee Report, in the conviction that they can have a fundamental effect on hedge funds and their managers if the best practices outlined in the Report become law or rule, or acquire, de facto, the force of law or rule: valuation, side letters and private placement memorandum updates.

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  • From Vol. 1 No.9 (Apr. 29, 2008)

    President’s Working Group’s Asset Managers’ and Investors’ Committees Release Best Practices Reports

    • On April 15, 2008, two private sector committees established in September 2007 by the President’s Working Group on Financial Markets released separate yet complimentary sets of best practices for hedge fund asset managers and investors.
    • The Asset Managers’ Committee Report counsels hedge funds to take a comprehensive approach to strengthening practices in “all phase of their business,” emphasizing controls and enhanced procedures in five critical areas: disclosure, valuation, risk management, trading and business operations and compliance, conflicts and business practices.
    • The Investors’ Committee Report contains two parts - a Fiduciary’s Guide for fiduciaries considering an investment in hedge funds on behalf of their principals (e.g., pension funds), and an Investor’s Guide for executing and administering a hedge fund program.
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  • From Vol. 1 No.5 (Mar. 31, 2008)

    Disclosure of Side Letter Terms: Are Some Investors More Equal Than Others?

    • Do undisclosed side letter arrangements constitute fraud or raise potential conflicts?
    • Preferential redemption rights, key man provisions, redemption gate waivers and portfolio transparency rights among potentially material terms often contained in side letters that may be appropriate for disclosure in the PPM.
    • Non-preferred investors may claim that side letters violate fund managers’ fiduciary duty of fair treatment.
    • U.K. regulators lead the way in guidance for disclosure of side letters, requiring that firms disclose the existence of side letters containing material terms.
    • Some hedge fund attorneys advise clients to disclose in the PPM the existence of side letters arrangements or the fact that the fund may enter into such arrangements. However, disclosure has not been tested in court or an administrative proceeding, so it is not certain that hedge fund advisers can disclose their way out of breach of fiduciary duty claims based on preferential rights granted in side letters.
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