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    Mar. 25, 2009

United States Treasury Department Announces Public-Private Investment Program – In Effect, Becomes the World’s Largest Prime Broker

On March 23, 2009, the Treasury Department announced a new Public-Private Investment Program (PPIP), a collaborative initiative among the Treasury Department, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and private investors to create $500 billion to $1 trillion in buying power for the purchase from financial institutions of “legacy” or “toxic” assets.  The idea of the PIPP is that purchasing such assets – primarily real-estate and corporate loans and securities backed by such loans – from financial institutions will fortify the institutions’ balance sheets, thus enabling them to raise new capital and make new loans, and thereby re-opening the spigots of credit in the U.S. economy.  The PPIP seeks to address the challenge of valuation of legacy assets largely by outsourcing valuation to private investment firms and allocating some of the risk of distressed asset purchases to such firms.  Broadly, under the terms of the PPIP, the government will act as a lender to private investors and, to a lesser degree, as a co-investor.  In theory, private investors will determine how best to allocate government capital, and will enjoy some of any upside, with limited downside.  In this sense, the government appears to have become, in effect, the world’s largest prime broker.  We explain the details of the PPIP in a long-form analysis.

Survey Questions: What Do Hedge Fund Market Participants Think of the Public-Private Investment Program?

Subscribers to the Hedge Fund Law Report include many of the leading decision makers in the hedge fund industry.  Accordingly, we would like to hear your views on participation in the PPIP, given what we know about it today, in the form of answers to questions in this survey.  Assuming the responses remain relevant next week – given the pace of regulatory change, the current proposal could be moot by then – we will summarize the responses in the next issue of the Hedge Fund Law Report.  No names will be identified in our summary of responses, unless you affirmatively state that you wish to be identified (and even if you do, you will only be identified if the context warrants).  We thank you in advance for participating in this survey, and we hope that our summary of responses helps clarify the debate over the appropriate structure of collaboration between the investment management industry and the government in working to unfreeze credit markets.

Utah Retirement Systems’ “Summary of Preferred Hedge Fund Terms” Details Fee, Liquidity and Other Fund Terms that Institutional Investors are Requesting – or Demanding – from Hedge Fund Managers

Paradigm shifts, in the financial world and outside of it, are often accompanied by a fundamental document; and the tectonic shift in the hedge fund world – the tipping in favor of investors – has acquired its own emblematic text.  That text is the “Summary of Preferred Hedge Fund Terms” (Summary) recently drafted by Larry Powell, Deputy Chief Investment Officer of the $16 billion Utah Retirement Systems, and it has been making the rounds among hedge fund managers and institutional investors.  Generally, the Summary calls for lower management and performance fees; the recognition of economies of scale in management fee arrangements and the passing on of those economies to investors; restructuring of performance fees so that the timing of payment matches the timing of realization of investments; liquidity that more closely matches the liabilities and time horizons of different investors; more prudent use of leverage; and increased transparency.  We offer a detailed description and discussion of the Summary, and industry reactions to it.

Onerous Customer Agreements Undermine Investor Interest in the TALF, but TALF Trusts Offer a Creative Solution for Hedge Funds Interested in Participating

The first round of the Federal Reserve Bank of New York and the United States Treasury Department’s Term Asset-Backed Securities Loan Facility (TALF) program has launched to a lukewarm reception among investor-borrowers.  According to a statement issued by the Federal Reserve on March 18, 2009, in its first round of funding, the TALF program received only $4.7 billion in requests for loans out of $200 billion in available loan capacity.  Only 19 hedge funds applied for funding.  Market participants attribute the relative lack of interest in part to resistance on the part of investors to the terms of customer agreements that investors are required to enter into with dealers.  According to lawyers who have negotiated such customer agreements, the customer agreements are more restrictive than the Master Loan and Securities Agreement (MLSA) that primary dealers must enter into with the Federal Reserve to participate in the TALF.  The customer agreements are generally dealer-friendly, including unilateral set off rights that favor dealers and broad rights for dealers to inspect investors’ books and records.  We explain the concerns among hedge funds and their advisers relating to the customer agreements.  We also describe TALF Trusts, a creative solution that some hedge fund are employing to circumvent the customer agreements, along with a review of some of the shortcomings of TALF Trusts.

SEC to Seek Third-Party Confirmation of Investor Assets Held by Regulated Firms

In March 9, 2009 letter to Managed Funds Association (MFA), the hedge fund trade association, and the Investment Adviser Association (IAA), Gene A. Gohlke, Associate Director of the SEC’s Office of Compliance Inspections and Examinations, said that in “recent months,” his staff has decided that to verify assets, it will have to request independent confirmation of investor assets from various third parties.  In his letter, Gohlke told the MFA that to confirm the existence of assets managed by the adviser being examined, the staff may contact the following individuals and entities: bank and broker-dealer custodians; account administrators; investors in hedge funds managed by the adviser; advised clients; derivative counterparties; hedge fund administrators and/or managers that are invested in by advised clients; National Securities Clearing Corp., Depository Trust & Clearing Corp.; and auditors for the advisory firm and/or investor accounts.  We outline the salient points from the letter, and provide insight from industry participants into the potential implications of the letter for hedge fund managers.

FSA Publishes Revised Disclosure Rules for Contracts for Difference

The United Kingdom Financial Services Authority (FSA) recently published a Policy Statement (PS09/3), which expands its regime for the disclosure of major shareholdings to include contracts for difference (CfD) and similar financial instruments.  The Policy Statement responds to comments received by the FSA in response to its Consultation Paper (08/17) and includes final rules for the new disclosure regime for CfDs and other similar financial instruments.  We explore the material terms of the new Policy Statement, and discuss similar developments with respect to the disclosure regime applicable to total return equity swaps under United States law.

New York Court Denies Recovery of Hedge Fund Defense Costs Under D&O Liability Policy Because Settlement Resulting in Disgorgement of Profits Was Excluded From Coverage

On March 9, 2009, the New York State Supreme Court for New York County dismissed an action brought by hedge fund Millennium Partners, L.P. (Millennium) against Select Insurance Company (Select) for breach of its directors and officers liability policy.  Millennium initially sought to recover defense costs incurred in settling federal and state securities fraud charges.  Select moved for summary judgment dismissing Millennium’s complaint; the court granted summary judgment to Select and dismissed Millennium’s complaint.  The underlying fraud charges resulted in disgorgement of “improperly acquired funds” by Millennium, which did not constitute a “loss” under the Select policy; because the loss itself fell under a policy exclusion, Millennium could not recover the cost of defending against the charges that led up to the loss.  Our discussion of the case offers insight into questions at the heart of hedge fund manager D&O policies: when will insurers challenge claims for coverage, and how will courts respond to such challenges?

SEC Accuses Brokers and Hedge Fund Advisers of Alleged Bribery Scheme

On March 12, 2009, the SEC filed suit in the United States District Court for the Southern District of New York accusing a broker-dealer firm, Granite Financial Group, LLC, and two brokers, Daniel Schreiber and David Harrison Baker, of allegedly bribing two employees of the hedge fund investment adviser JLF Asset Management LLC, Brian Travis and Nicholas Peter Vulpis, Jr., also named in the suit, in exchange for their routing of hedge fund trades to the brokerage firm.  The SEC charged defendants with various violations of the federal securities laws and sought injunctive relief, disgorgement plus prejudgment interests and civil penalties.  We provide details of the factual allegations and legal charges in the SEC’s complaint.

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