Nov. 8, 2018

Primer on Deal-by-Deal Funds: Balancing Deal Uncertainty Issues Against Attractive Carried Interest Opportunities (Part Three of Three)

Uncertain investor funding can make sellers and lenders reluctant to engage with buyers employing a deal-by-deal fund structure, while also exposing sponsors to the risk of absorbing broken deal expenses. On the other hand, the unique treatment of carried interest – by not netting losing investments, in addition to immediately paying it upon selling an investment – presents undeniable upside that may make the risks worth enduring. Weighing these fiscal considerations, among others, against each other is part of the complicated calculus sponsors must perform when deciding whether to adopt the deal-by-deal fund structure. See “Structures and Characteristics of Activist Alternative Investment Funds” (Mar. 12, 2015). This three-part series aims to provide a holistic consideration of the features of the deal-by-deal structure. This final article analyzes the risks of deal uncertainty; ways sponsors can overcome those risks; and the unique management fee and carried interest treatments that can make the deal-by-deal structure a lucrative option to consider. The first article provided an overview of the deal-by-deal fund vehicle and detailed certain investor sentiments toward it. The second article described some of the challenges of the fundraising process, as well as important structural and mechanical considerations when establishing a deal-by-deal fund. See “Interest in Bespoke Fund Structures Surges As Markets Adjust to New Administration and Regulatory Regime” (Mar. 18, 2018).

ISDA 2018 U.S. Resolution Stay Protocol: Should Fund Managers Adhere or Not?

Many fund managers have already received notices from their swap dealer counterparties regarding the implementation of “contractual stay rules” adopted by the U.S. federal banking authorities (QFC Rules). Swap dealers are now urging their counterparties to adhere to the ISDA 2018 U.S. Resolution Stay Protocol (Protocol). Fund managers that do not adhere to the Protocol or take other steps to bring their trading documentation into compliance may not be able to trade certain qualifying financial contracts with their counterparties after January 1, 2019. In this guest article, Michele Navazio, partner at Seward & Kissel, provides an overview of the Protocol and related QFC Rules, with an emphasis on issues that fund managers need to consider in assessing whether to adhere to the Protocol or opt for bilateral amendments to their trading documentation. The relative merits of the two approaches strongly suggest that fund managers should, in almost all cases, choose to adhere to the Protocol. For more on the QFC Rules and Protocol, see “Steps Fund Managers Should Take Now to Ensure Their Trading of Swap, Repo and Securities Lending Transactions Continues Uninterrupted After January 1, 2019” (Oct. 18, 2018). For additional commentary from Navazio, see “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 Three of Three)” (Nov. 14, 2013).

Harbinger Capital Partners Offshore Manager Settles New York Tax Evasion Case for $30 Million

The New York Attorney General and New York City Corporation Counsel recently announced the $30‑million settlement of tax evasion charges against Harbinger Capital Partners Offshore Manager LLC (Offshore Manager), the investment manager for New York-based hedge funds run by Philip A. Falcone. This settlement is the latest chapter in a lawsuit that began when a whistleblower alleged that Offshore Manager and related entities and individuals failed to report and pay New York State and City taxes on income from incentive fees earned from successful trading conducted from a New York City office. This recent settlement is the second related to the whistleblower lawsuit. In April 2017, Harbert Management Corporation, the Alabama-based investment management company that sponsored and organized the hedge funds managed by Offshore Manager, and several related parties agreed to a $40‑million settlement. See “New York State Record Tax Whistleblower Settlement Illustrates Pitfalls of Domestic Tax-Shifting Schemes” (Apr. 27, 2017). This article reviews the allegations against Offshore Manager, examines the terms of the latest settlement agreement and provides insight for hedge fund managers on the key takeaways from this case. For other lawsuits stemming from whistleblower complaints, see “Does the Digital Realty Decision Represent a Sea Change for Whistleblowers or Merely More of the Same?” (Mar. 15, 2018); “Former Employee Files Dodd-Frank Whistleblower Suit Against Vertical Capital” (Dec. 18, 2014); and “In Case of First Impression, U.S. District Court Interprets Private Right of Action Under Whistleblower Provisions of Dodd-Frank Act, Limiting Claims of Dismissed Employee of Hedge Fund Technology Vendor” (Jul. 1, 2011).

Reflections on the Tenth Anniversary of the Financial Crisis: Changes to Compliance Programs, Regulation and Fund Strategies (Part Two of Two)

In the wake of the 2008 global financial crisis, the landscape of the hedge fund industry has changed. Hedge fund managers now face more regulation; more scrutiny from both regulators and investors; and more compliance burdens. As a result, fund managers have been forced to change their structures, practices and compliance programs. In connection with the tenth anniversary of the financial crisis, the Hedge Fund Law Report spoke to Lowenstein Sandler partner Benjamin Kozinn about the 2008 crisis and its impact on the hedge fund space. In this second article in our two-part series, he explores the new focus on compliance programs and chief compliance officers; the present strength of the financial system; changes in hedge fund strategies; the current state of hedge fund regulation; and the future of the hedge fund space. In the first article, Kozinn discussed the causes of the crisis; the role hedge funds played in it; and some of the changes in how fund managers now operate. See “Will Inadequate Policies and Procedures Be the Next Major Focus for SEC Enforcement Actions?” (Nov. 30, 2017).

SEC Sanctions Investment Adviser and Principals for Using Fund Assets to Help an Affiliate and for Using Improper Valuation Adjustments to Boost Returns

The SEC reaffirmed its focus on conflicts of interest and valuation issues in a recent settlement order against an investment adviser that, at relevant times, was controlled by an entity that administers a marketplace lending platform that matches consumer borrowers with investors. The investment adviser and two of its principals allegedly improperly used the assets of a private fund they managed to purchase loans on the platform to help the adviser’s parent company, and they used valuation adjustments to improve the monthly returns of several funds they managed. This article details the SEC’s allegations and the terms of the settlement. See our two‑part series “Ropes & Gray Survey and Forum Consider Credit Fund Structures, Leverage, Conflicts of Interest and Challenging Environment”: Part One (Jul. 19, 2018); and Part Two (Jul. 26, 2018).

Pepper Hamilton Attorney Discusses Fundamental Structuring Issues for Investment Advisers: Taxation, Organizational Expenses, Redemptions, Publicly Traded Partnerships, Performance Fees and Alternative Structures (Part Two of Two)

Pepper Hamilton partner Gregory J. Nowak recently examined in a presentation the key regulatory issues an investment adviser faces when developing its advisory business. This article, the second in a two-part series, summarizes the portions of the program that covered taxation issues, organizational expenses, redemptions, publicly traded partnership rules, performance fees and alternative fund structures. The first article covered separately managed accounts, adviser registration and the applicable federal securities laws. For further commentary from Nowak, see our two-part series on how hedge funds can protect their intellectual property: “Trademarks and Copyrights” (Feb. 23, 2017); and “Trade Secrets and Patents” (Mar. 9, 2017).

Upcoming HFLR Webinar to Explore Trends in the Use of Subscription Credit Facilities

Please join the Hedge Fund Law Report on Thursday, November 15, 2018, at 11:00 a.m. EST for a complimentary webinar discussing key considerations and prevailing trends in the use of subscription credit facilities by private fund managers. The webinar, entitled “Pros, Cons and Trends in the Use of Subscription Credit Facilities,” will be moderated by Rorie Norton of the Hedge Fund Law Report and will feature Thomas Draper, partner at Foley Hoag, and Michael Mascia, partner at Cadwalader. To register for the webinar, click here.

Greenberg Traurig Expands Corporate and Investment Funds Practice With Addition of Peter L. Tsirigotis

Peter L. Tsirigotis has joined Greenberg Traurig’s corporate and investment funds practices as shareholder in its Washington, D.C., and New York City offices. Tsirigotis advises financial institutions, asset managers, investment advisers and institutional investors, helping them develop and maintain financial products while navigating the regulatory landscape. For insight from other Greenberg Traurig attorneys, see our three-part series “Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges”: Part One (Nov. 8, 2013); Part Two (Nov. 14, 2013); and Part Three (Nov. 21, 2013).