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    Jun. 10, 2009

Representative Michael Capuano Discusses Hedge Fund Regulation with the Hedge Fund Law Report – Expresses More Support for Enhanced Disclosure than for Increased Substantive Regulation

On January 27, 2009, Representatives Michael E. Capuano (D-Mass.) and Michael Castle (R-Del.) introduced the Hedge Fund Adviser Registration Act of 2009 (HFARA).  The HFARA (H.R. 711) would remove Section 203(b)(3) from the Investment Advisers Act of 1940.  The removal of Section 203(b)(3) would effectively require many currently unregistered hedge fund managers to register with the SEC as investment advisers, thereby subjecting them to the various obligations of registered investment advisers, including annual disclosure requirements, advertising and marketing restrictions and recordkeeping requirements.  In February of this year, the Hedge Fund Law Report talked to Rep. Capuano about his rationale for proposing the HFARA.  At that time, he told us: “No one can look me in the eye and tell me they know how many hedge funds there are or how many assets they manage.”  Last week, we talked in greater depth with Rep. Capuano about the rationale behind his proposal to eliminate the private adviser exemption, and his views on hedge fund regulation generally.  His comments offer deeper insight into the intent of the HFARA, and the scope and focus of any law that may result from the bill or others that seek to regulate hedge funds or their managers.

Treasury, Fed and FDIC Officials Discuss Suspension of Legacy Loans Program, Status of Legacy Securities Program and Future of the TALF at SIFMA and PREA’s Public-Private Investment Program Summit

On June 4, 2009, the Securities Industry and Financial Markets Association (SIFMA) and the Pension Real Estate Association (PREA) hosted the Public-Private Investment Program (PPIP) Summit, which featured key speakers from the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC).  The day-long event highlighted some of the key changes to the PPIP, including the recent FDIC announcement that the program for loans was being put on indefinite hold.  In addition, speakers addressed the prospects for the Term Asset-Backed Securities Loan Facility (TALF), and the potential evolution of the securitization market in light of the credit crisis.  We discuss the FDIC’s decision to put the Legacy Loans Program on hold, why banks have been reluctant to sell troubled assets, the structure of and prospects for participation in the Legacy Securities Program and the TALF and concerns with the government as a partner.

Legal Considerations for Investors In and Around the General Motors Bankruptcy, And Similar Distressed Situations Involving Politically Important Stakeholders

On June 1, 2009, troubled automaker General Motors filed for Chapter 11 bankruptcy protection, leaving many lenders – both secured and unsecured – uncertain about how the bankruptcy process will play out, especially in light of the contentious negotiations leading up to and during the Chapter 11 filing by rival automaker Chrysler last month.  GM’s bankruptcy advisers announced that the automaker would be divided into two entities – the “new GM” and the “old GM.”  The latter will house the excess plants and equipment that will eventually be sold off.  The “new GM” will be a nationalized entity.  The automaker would then sell the bulk of its assets to a new company, called Vehicle Acquisitions Holding LLC.  The U.S. government has agreed to provide GM with $30 billion in aid, in addition to the $20 billion the car company already has borrowed from the government, to see it through its restructuring and exit from bankruptcy.  The U.S. government will own a 60 percent equity stake in the new company.  In addition, the Canadian government will put in $9.5 billion for a 12 percent stake.  A majority of the unsecured bondholders in the company have agreed to swap their debt for a 10 percent equity share.  The United Auto Workers Union also has reached an agreement that will give it a 17.5 percent stake.  We explain how the GM bankruptcy is unique, the government’s involvement as a participant in the bankruptcy, considerations for secured, unsecured and debtor-in-possession lenders, consequences of overpayments to secured lenders, cram down risk, dealer litigation and lessons to be drawn from the GM bankruptcy.

New Study Offers Surprising Findings on the Incentives Created by Concurrent Management of Hedge and Mutual Funds

For some time, conventional wisdom has held that where an investment manager manages hedge and mutual funds simultaneously, the manager will have an incentive to favor the hedge fund with better investment opportunities, and to direct the less interesting opportunities to the mutual fund.  The source of this supposed favoritism was fees: since the total fees paid by the hedge fund to the manager are higher than the fees paid by the mutual fund, the manager would stand to collect greater total fees by directing the better opportunities to the hedge fund.  The manager’s fiduciary duty to all of its funds was understood to mitigate this incentive – but not to eliminate it, especially in the closer, harder-to-monitor cases.  However, a new study upends the conventional wisdom.  We detail the findings from that study and what it may mean for hedge fund managers.  We also discuss issues arising from the management by one hedge fund manager of multiple hedge funds with different investor bases – one consisting of outside investors and the other consisting of principals and employees of the manager.

Delaware Court of Chancery Enforces Oral Agreement and Rules that Departing Hedge Fund Founder is Not Entitled to Share of Hedge Fund’s Equity

Plaintiff Olson was one of three founders of the Viking Global hedge fund.  In accordance with their governing documents, Olson’s membership in the fund was terminated by the two other founders in 2005.  Olson sued his erstwhile partners and the various fund entities, claiming that he was entitled to receive the value of his equity interest in the various entities that comprised the fund business (valued at tens of millions of dollars).  On May 13, 2009, the Delaware Court of Chancery ruled that, prior to forming the fund, the founders had agreed that a departing partner would only be entitled to receive any unpaid compensation from the fund and the remaining value of the partner’s capital account (as opposed to any deferred compensation or compensation for the value of an equity interest).  The court also ruled that the oral agreement was not superseded by the operating agreements of the various fund entities or any other subsequent agreement.  Because of the continuing validity of that agreement, and its applicability to Olson’s departure, the court determined that Olson was not entitled to (1) any further compensation from the fund, (2) the fair value of his partnership interest under the Delaware Revised Uniform Limited Partnership Act or Limited Liability Company Act or (3) any equitable remedy.  We explain the facts and holding of the case, and outline the court’s analysis.

District Court Awards Hedge Fund Manager $1.5 Million “Break-Up” Fee Pursuant to Financing Deal’s Letter of Intent

On May 19, 2009, the United States District Court for the Southern District of New York ordered Fair Finance Company, Inc. (FairFin), a financier of retail stores that traded in accounts receivables, to pay FCS Advisors, Inc. d/b/a Brevet Capital Advisors (Brevet), a hedge fund manager, a $1.5 million break-up fee and due diligence expenses based on FairFin’s breach of a letter of intent (LOI).  The LOI stipulated that Brevet would provide FairFin with up to $75 million in financing, and contained an exclusivity provision that required FairFin to pay Brevet $1.5 million if FairFin closed with another party “in lieu of” the financing contemplated in the LOI.  The district court entered summary judgment on behalf of Brevet after finding that no reasonable jury could dispute that Brevet had exercised its option to pursue financing with FairFin, that FairFin violated the exclusivity provision, and that FairFin then closed a similar financing transaction with another financier “in lieu” of a transaction with Brevet.  We explain the facts of the case and the court’s legal analysis.

FINRA Proposes Revised Rumor Rule

On June 1, 2009, FINRA issued Notice 09-29 seeking comment on proposed FINRA Rule 2030, which deals with the circulation of rumors.  The new proposed Rule 2030 replaces a widely criticized earlier proposal, issued as Notice 08-68 on November 18, 2008.  The proposed rule is based on both FINRA Rule 6140(e) and NYSE Rule 435(5) and, if approved, will replace these rules, as well as related interpretive guidance.  In a guest article, Hardy Callott, a Partner at Bingham McCutchen LLP, discusses the proposed revised rumor rule.

Migrating Toward Multi-Prime: Did Your Manager Decrease or Increase Operational Risk?

In the wake of the Bear Stearns and Lehman difficulties, many hedge fund managers have migrated toward a “multi-prime” environment, in which more than one prime broker is utilized by the fund.  On closer examination, a number of hedge funds have failed in their dual objectives of setting up a true multi-prime relationship and reducing their overall operational risk.  Indeed, quite a few hedge fund firms have increased their operational risk without even realizing it.  In a guest article, Holly H. Miller, a Partner at Stone House Consulting, LLC, examines steps that hedge fund managers can take to achieve their objectives and enhance their operational risk profile.

FTI Consulting Inc. Hosts Conference on Structured Finance Securities Litigation

On June 2, 2009, FTI Consulting Inc. hosted the FTI Securities Matters Conference: Structured Finance Securities Litigation.  The four panelists sought to identify themes and trends in the welter of litigation, enforcement actions and arbitration proceedings that have flowed from the credit crisis and its impact upon the securitization process.  We outline the key take-aways from the conference.

Hedge Fund Promoters Lose Appeal in Eleventh Circuit, Must Disgorge $8 Million

In May 2004, two hedge fund promoters settled with the Securities and Exchange Commission (SEC) regarding accusations of fraud in the sale of purported hedge fund interests.  The SEC waited until June 2008 before successfully moving for an order requiring the defendants to disgorge over $8.1 million plus prejudgment interest and to pay $200,000 in civil penalties.  The defendants appealed. On May 19, 2009, the United States Court of Appeals for the Eleventh Circuit upheld the disgorgement order.  We discuss the factual background and the court’s analysis.

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