Apr. 9, 2009

Hedge Funds Buffeted by Losses and Redemptions Consider Fund Mergers as an Alternative to Winding Up

Losses and redemptions have combined of late to threaten the viability of many hedge funds managers, especially smaller and mid-sized managers.  In response to that threat, some hedge fund managers have sold their advisory businesses to larger entities.  While selling managers give up a degree of autonomy, they get (or hope to get) an offsetting amount of additional capital (from sale proceeds and new investor sources), operational resources, distribution reach and talent.  In the March 18, 2009 issue of the Hedge Fund Law Report, we explored in depth sales of hedge fund advisory businesses.  See “For Managers Facing Strong Headwinds, Sales of the Advisory Business Offer a Means of Preserving the Franchise While Avoiding Fund Liquidations,” Hedge Fund Law Report, Vol. 2, No. 11 (Mar. 18, 2009).  A related type of transaction – less common in the hedge fund industry and hence less frequently discussed – involves mergers of hedge funds themselves.  Hedge fund mergers have similar goals to sales of advisory businesses (namely, avoiding a wind down and preserving a going concern), but implicate different legal, regulatory and operational considerations.  We explore various aspects of hedge fund mergers, including: investor consent requirements, opt-out rights, asset transfers, due diligence, valuation, treatment of side pockets, operational issues and talent retention.  We also describe a new strategic alternative available to fund managers struggling with losses and redemptions.

Congress Introduces Legislation That Would Tax Offshore Hedge Funds as U.S. Corporations

On March 2, 2009, Senator Carl Levin (D-Michigan) introduced the Stop Tax Haven Abuse Bill of 2009 (the Bill).  A similar bill was introduced in the Senate in 2007 (co-sponsored by then-Senator Barack Obama), but was not acted upon.  The Bill, like its 2007 predecessor, contains numerous provisions generally intended to prevent U.S. taxpayers from holding assets in accounts of financial institutions located in so-called tax havens without disclosing the existence of those accounts to the Internal Revenue Service.  The Bill, however, also contains an onerous provision (Section 103) which would cause hedge funds incorporated outside the United States, but managed from within the United States, to become subject to full U.S. corporate income tax.  In a guest article, Jeremy Naylor, a Partner at White & Case, explains the mechanics of the bill, its potential effect on offshore hedge funds and why Senator Levin’s rationale in proposing the Bill may be at odds with the reality of the current tax law as applied to hedge funds.

Hedge Fund Managers Grapple with Legal and Practical Consequences of Demands from CalPERS, URS and Other Pension Funds for Better Investment Terms and Separate Accounts

While better investment terms cannot completely offset poor hedge fund performance, poor or middling performance can increase the receptivity of managers to restructuring of their relationships with investors – especially large institutional investors.  Accordingly, while the credit crisis has engendered a rash of redemptions, it has also occasioned a series of restructurings of the terms under which significant institutions remain invested in hedge funds or make new investments.  However, while the terms of such restructurings have received significant and deserved attention, topics that have received less attention – but that may be as or more important than the terms themselves – include the mechanics by which the terms are implemented, and the legal considerations that may arise in connection with such implementation.  We explore these operational and legal considerations in detail, including: the relevant language in fund documents; investor consent requirements; liquidity issues; most favored nation provisions; redemption, registration and allocation issues; and cost considerations.

Connecticut Court Denies Appeal by Hedge Fund Firm Promoter Charged with Defrauding Investors

In a decision released on March 17, 2009, the Connecticut Appellate Court denied an appeal from a determination by the Connecticut Banking Commissioner (Commissioner) that the promoter of the hedge fund Criterion Investment Fund I L.P., Eddie Papic, violated various provisions of Connecticut securities laws.  Papic appealed the agency decision to the Connecticut Supreme Court, which affirmed the agency determination.  Papic appealed the latter decision to the Connecticut Appellate Court.  A panel of that Court affirmed the Supreme Court’s decision, finding that the Commissioner’s claims were not preempted by federal securities laws, that the agency findings were supported by substantial evidence and that all requisite administrative procedures had been followed.  The full Connecticut Appellate Court similarly rejected Papic’s claims.  We review in depth the Connecticut Appellate Court’s decision.

Seward & Kissel Attorneys Propose Alternatives to Hedge Fund Taxation Regime in Obama Budget

The delivery of the Obama Administration’s first budget at the end of February heralded the end of an era for the U.S. hedge fund industry.  Among its many proposals to sweep away the era of Reaganomics, the new Administration launched a plan to tax carried interest (also known in the hedge fund context as performance fees) at ordinary income rates.  Peter Pront, a Partner at Seward & Kissel LLP and head of the firm’s Tax Group, and his colleague Ronald Cima, also a Partner in Seward’s Tax Group, recently sat down with the Hedge Fund Law Report to discuss their suggestions on hedge fund tax law changes that they think should be considered by the Obama Administration as alternatives to the Administration’s current proposals.  We report on our conversation with Pront and Cima.

Kaye Scholer Seminar Covers Hedge Fund Structures, Distressed Strategies, the Public-Private Investment Program, Pros and Cons of Prepackaged Bankruptcies and Bankruptcy Code Section 363 Sales

On April 2, 2009, global law firm Kaye Scholer LLP hosted a seminar at its Manhattan office titled “Using Private Equity and Hedge Fund Structures and Strategies to Invest in Distressed Assets.”  The seminar consisted of the following sections: (1) An overview of the core structures and concepts of hedge funds and private equity funds, presented by Timothy A. Spangler, a London-based Kaye Scholer Partner who chairs the firm’s Investment Funds Group; (2) A discussion of laws and accounting principles bearing on the sales and purchases of distressed financial assets, led by Henry Morriello, a New York-based Kaye Scholer Partner, Co-Chair of the firm’s Structured Finance Group and Head of the its Transportation Asset Finance Group, which included an overview of the new Public-Private Investment Program; and (3) A review of bankruptcy laws relevant to hedge fund investments, and of when potential purchasers of distressed assets are better off working through the bankruptcy process rather than around it, delivered by G. Thomas Stromberg, a Kaye Scholer Partner in the firm’s Los Angeles office.  We detail the salient points raised and discussed at the seminar.

SEC Accuses Hedge Fund Manager of Conning Investors out of $5 Million

On March 18, 2009, the SEC commenced an action in the United States District Court for the Northern District of California against hedge fund manager Albert K. Hu, accusing him of misappropriating investor funds.  The SEC charged Hu and the entities he controls with violations of the antifraud provisions of federal securities laws.  The SEC also charged Hu individually with securities laws violations.  The SEC seeks emergency and interim relief, a final judgment permanently enjoining defendants from future violations of the antifraud provisions of the federal securities laws and an order to pay financial penalties and to disgorge ill-gotten gains.  We detail the factual allegations and legal theories advanced by the SEC.