Mar. 30, 2017

Fund Managers Must Address Investors’ Fee and Liquidity Concerns to Maintain Strong Performance in 2017, While Also Preparing for Trump Administration Regulations

By many indices, the hedge fund industry in early 2017 shows strong signs of recovery after a difficult year marked by heavy outflows. Returns are up and optimism abounds in the midst of the pro-business atmosphere fostered by the new administration of President Donald J. Trump. See “Ways the Trump Administration’s Policies May Affect Private Fund Advisers” (Mar. 2, 2017). This positivity is tempered, however, by concerns over whether fund managers can align their interests with investors’ fee and liquidity concerns, as well as whether funds are making use of an appropriate beta hurdle. Further, there is a great deal of uncertainty about the impact of the Trump administration’s emerging policies and priorities on the SEC’s enforcement efforts, the Dodd-Frank Act, carried interest and the Department of Labor’s fiduciary rule. To cast light on these and other critical issues, the Hedge Fund Law Report recently interviewed Steven Nadel, a partner in the investment management practice at Seward & Kissel and lead author of Seward & Kissel’s recently published “2016 New Hedge Fund Study.” See “Lock-Ups and Investor-Level Gates Prevalent in New Hedge Funds” (Mar. 23, 2017). For additional commentary from Nadel, see “HFLR and Seward & Kissel Webinar Explores Common Issues in Negotiating and Monitoring Side Letters” (Nov. 10, 2016); and “Seward & Kissel Partner Steven Nadel Identifies 29 Top-of-Mind Issues for Investors Conducting Due Diligence on Hedge Fund Managers” (Apr. 4, 2014).

New York Appellate Court Affirms Broad Rights of Parties in CDS Transactions to Pursue Their Economic Self-Interests, Despite Adverse Effect on Counterparties

A New York appellate court recently ruled that two related hedge funds are entitled to receive a sum of approximately $22 million – plus prejudgment interest of approximately $68 million – from their counterparty, a large investment bank, in a credit default swap (CDS). The dispute between the parties arose out of a disagreement concerning the value of the reference assets, which in turn led to the bank refusing to return the collateral posted by the hedge funds. In its decision, the court held that the hedge funds’ arm’s-length transaction with the reference assets’ issuer, and their tendency to pursue their self-interest without regard for adverse effects on the counterparty, did not violate standards of good faith and commercial reasonableness. The court’s decision has far-reaching implications for the rights of parties entering into CDS transactions, particularly where some or all of the assets might be susceptible to valuation disputes in uncertain and rapidly fluctuating markets. To help readers understand the case and its impact on derivatives trading, the Hedge Fund Law Report has prepared a summary of the court’s decision and interviewed Fabien Carruzzo, a financial services partner at Kramer Levin Naftalis & Frankel, with expertise in the derivatives and CDS markets. For insights from Carruzzo, see our two-part series on minimum initial and variation margin requirements for over-the-counter derivatives: “Hedge Funds Face Increased Margin Requirements” (Feb. 18, 2016); and “Hedge Funds Face Increased Trading Costs” (Feb. 25, 2016). 

Protecting Attorney-Client Privilege and Attorney Work Product While Cooperating With the Government: Minimizing Cooperation Risks (Part Two of Three)

In exchange for self-reporting and disclosing the facts and circumstances surrounding potential legal violations, the DOJ and SEC offer strong incentives for fund managers to share information about those violations derived from internal investigations. This can include information obtained from relevant witnesses and the identities of potential individual wrongdoers. See “Self-Reporting and Remedying Improper Fee Allocations May Not Be Sufficient for Fund Managers to Avoid SEC Action” (Sep. 15, 2016); and “SEC Enforcement Action Against a Private Equity Fund Manager Partner Calls Into Question the Value of Self-Reporting in the Private Funds Context” (Oct. 13, 2011). Disclosures to the government, however, can seem to conflict with the confidentiality dictates of the attorney-client privilege and the attorney work product doctrine. Consequently, investigating managers that cooperate with the government often face important strategic questions, including how much information to share and whether to include privileged and attorney work product materials in their disclosures to the government. This second installment in the three-part guest series by Eric J. Gorman and Brooke A. Winterhalter, partner and associate, respectively, at Skadden, analyzes these strategic questions and identifies certain steps that managers can take to minimize the risk, or extent, of a waiver of the privilege or work product protection while cooperating with the government. The first installment discussed how managers can establish the attorney-client privilege and attorney work product protection during an internal investigation. The third installment will address strategies for shielding privileged investigation files from discovery in collateral litigation with third parties. For more on establishing and protecting privilege during internal investigations, see “How Hedge Fund Managers Can Protect Privileged Internal Investigations Without Violating SEC Whistleblower Rule 21F-17” (May 21, 2015); and “D.C. Circuit Confirms Applicability of Attorney-Client Privilege to Internal Investigations” (Aug. 7, 2014).

Court to Rule on Novel Issue of Insider Trading Law in Case Against Leon Cooperman and Omega Advisors

In September 2016, the SEC commenced a civil enforcement action against hedge fund manager Leon G. Cooperman and his investment advisory firm, Omega Advisors, Inc. (Omega), charging that Cooperman received and traded on material nonpublic information (MNPI) and committed more than 40 violations of the beneficial ownership reporting requirements under federal securities laws. See “Alleging Dozens of Violations, SEC Charges Leon Cooperman and Omega Advisors With Insider Trading and Failing to Make Regulatory Filings” (Sep. 29, 2016). In response to the defendants’ motion to dismiss the SEC’s complaint for failure to state a claim for insider trading and improper venue for the reporting violations, the U.S. District Court for the Eastern District of Pennsylvania (Court) recently dismissed the reporting violation claims but ruled that the SEC’s insider trading claims could proceed. In its Memorandum accompanying the Order, the Court addressed a novel issue as to whether a defendant could be held liable under the misappropriation theory of insider trading where he entered into an explicit agreement not to trade after he received MNPI but before he traded on it. This article summarizes the Court’s Memorandum. For more on the misappropriation theory of insider trading, see “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part Two of Two)” (Aug. 15, 2013); and “When Does Talking to Corporate Insiders or Advisors Cross the Line Into Tipper or Tippee Liability Under the Misappropriation Theory of Insider Trading?” (Jan. 10, 2013).

K&L Gates Program Warns of Public Disclosure Risks Associated With Accepting State Public Pensions As Investors and Advises on How to Mitigate Them (Part Two of Two)

Many private fund advisers perceive the investments from public pension plans as highly desirable, particularly in a difficult fundraising environment. See “How Emerging Hedge Fund Managers Can Raise Capital in a Challenging Market Without Overstepping Legal Bounds” (Aug. 4, 2016). While the benefits are plentiful, it is important for fund managers to be mindful of federal, state and local regulations surrounding these arrangements. Failure to do so could lead to potential violations of statutory “pay to play” rules, as well as the inadvertent disclosure of proprietary fund information under public record requests and freedom of information (FOI) laws. To apprise fund managers of these issues and help them prepare accordingly, K&L Gates presented a recent program featuring insights from Eric J. Smith, managing director and deputy general counsel at PineBridge Investments, as well as Cary J. Meer and Ruth E. Delaney, partner and associate, respectively, at K&L Gates. This second article in a two-part series covers FOI laws pursuant to which funds could face disclosure issues, as well as ways to protect that information. The first article detailed federal and state pay to play regulations, including restrictions on political contributions and gifts and entertainment. For more on how fund managers can comply with pay to play restrictions, see “The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability” (Oct. 8, 2015); “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them” (Feb. 5, 2015); and “How Can Hedge Fund Managers Participate in the Political Process Without Violating Pay to Play Regulations at the Federal, State, Municipal or Fund Level?” (Oct. 6, 2011).

Deutsche Bank Alternative Investment Survey Explores Hedge Fund Asset Flow Trends; Highlights Greater Allocator Interest in Alternative Beta Strategies (Part One of Two)

Deutsche Bank Global Prime Finance (DB) has released the results of its 15th annual Alternative Investment Survey. The study is compiled from the responses of 460 global allocators representing nearly $2 trillion in hedge fund assets. This article, the first in a two-part series, covers the portions of the study concerning trends in asset flows, including impediments and preferences among allocators. The second article will detail the survey’s results concerning hedge fund fees and fee negotiations, as well as investor allocation preferences. For coverage of previous editions of DB’s annual survey, see our two-part coverage of the 2016 Survey: Part One (Mar. 17, 2016); and Part Two (Mar. 24, 2016); our two-part coverage of the 2015 Survey: Part One (May 21, 2015); and Part Two (Jun. 4, 2015); and our coverage of the 2013 Survey: “Deutsche Bank Survey Describes the Contours of the Nontraditional Hedge Fund Product Market: Investor Appetite, Performance, Marketing, Fees and More” (Jan. 23, 2014). 

Daniel Csefalvay Joins Latham & Watkins in London

Latham & Watkins has hired Daniel Csefalvay as a partner in its London office. Csefalvay advises fund managers, investment banks and trading platforms on cross-border regulatory and compliance issues, as well as mergers and acquisitions. For insight from other Latham & Watkins attorneys, see our three-part series on “How Fund Managers Can Mitigate Prime Broker Risk”: “Preliminary Considerations” (Dec. 1, 2016); “Structural Considerations” (Dec. 8, 2016); and “Legal Considerations” (Dec. 15, 2016). See also our two-part series “Navigating FCA and SEC Cybersecurity Expectations”: Part One (Jan. 7, 2016); and Part Two (Jan. 14, 2016).