Jul. 8, 2008

Managers of Failed Bear Stearns Hedge Fund Charged with Criminal Securities Fraud

On June 18, 2008, the US Attorney for the Eastern District of New York filed an indictment against Ralph Cioffi, 52, and Matthew Tannin, 46, former managers of two failed Bear Stearns hedge funds. Whether or not the government ultimately proves its case, the indictment contains important lessons for hedge fund managers, lawyers, compliance personnel and investors in at least two areas: (1) how to negotiate discussions with investors, lenders and other constituencies during periods of declining performance, and (2) how to use – and not use – e-mail.

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

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

IRS Rules that Long Position in a Swap Referencing a Broad-Based U..S Real Property Index Is Not a U.S. Real Property Interest for FIRPTA Purposes

On June 12, 2008, the IRS published Revenue Ruling 2008-31, holding that a long interest in a swap referencing a broad-based index of U.S. real property is not a U.S. real property interest within the meaning of the Foreign Investment in Real Property Tax Act of 1980. Good news for offshore hedge funds looking for broad-based exposure to U.S. real property; even better news for index publishers.

FASB Proposes Changes to Hedge and Derivative Accounting Rules

In an effort to simplify one of the most complex and criticized financial reporting regimes, the Financial Accounting Standards Board (FASB) is proposing changes to hedge and derivative accounting rules that, if approved, would (1) (according to FASB) greatly improve comparability of financial results for entities that apply hedge accounting, and (2) require application of the fair-value measurement approach to all transactions, a mark-to-market accounting method long favored by the Board.

Hedge Fund Manager Kenneth Pasternak Cleared of Securities Fraud

On June 12, 2008, the US District Court for the District of New Jersey ruled that the SEC failed to prove a securities fraud case brought in 2005 against Kenneth Pasternak, co-founder of Knight Trading Group and current manager of hedge fund Chestnut Ridge Capital. The case, dealing with allegations of breach of Knight’s best execution obligation, provides useful guidance into execution prices that can be charged without violating the best execution obligation, and the various factors that come into play when courts are faced with an allegation of breach of the obligation.