The alternative investment funds industry is currently facing significant regulatory and legal challenges and, particularly for fund promoters seeking access to European investors, 2009 may well prove to be a watershed. Traditionally, the European (and U.S.) alternative investment funds industry has embraced the offshore jurisdictions as providers of tax-efficient and regulatory “light-touch” domiciles for fund and management structures. The Cayman Islands, in particular, has become the “path of least resistance.”  However, alternative investment funds have recently become subject to hitherto-unseen levels of scrutiny from regulators, politicians, tax authorities and investors, even though much of the resulting criticism has been unwarranted (other than in terms of underperformance). Few participants in the financial services industry seriously believe that the global financial crisis was caused by hedge funds, and this scepticism has been endorsed by more than one regulator. Nevertheless, certain axes are now being held firmly to the grindstone. In this political climate, the future of the “unregulated” offshore jurisdictions is far from certain, and their role as significant financial centers may be substantially altered by forthcoming legislation and regulation, as well as investor demand.  In a guest article, Simon Thomas and Samuel T. Brooks, Partner and Associate, respectively, at Akin Gump Strauss Hauer & Feld LLP, provide a detailed examination of how hedge fund structures are evolving in response to regulatory change, in particular in the European Union.  In particular, Thomas and Brooks examine: the implications for structuring and operations of the Alternative Investment Fund Managers Directive; considerations in connection with an Undertaking for Collective Investment in Transferable Securities (UCITS) structure; incentives for organizing single-strategy hedge funds in various EU jurisdictions; and listings and permanent capital vehicles. Read full article …

The Chapter 11 filing last September 15 of the Lehman Brothers holding entity, and the initiation of insolvency proceedings four days later with respect to the Lehman broker-dealer affiliate, woke hedge fund managers up to previously underappreciated risks – the risks that their prime broker could fail, and that such failure could limit or restrict their funds’ access to assets held at the prime broker.  The near failures of Bear Stearns prior to the Lehman filings, and of Merrill Lynch after the filings (staved off at the last moment by, respectively, J.P. Morgan Chase and Bank of America), only enhanced the perception among hedge fund managers of prime broker fallibility.  Recognizing the ubiquity of counterparty risk concerns among their base of clients and potential clients, and in an effort to win back as many as possible of the assets that fled in late 2008, at least one prime broker is offering a service that incorporates an independent custody concept into a single prime brokerage relationship.  We offer a detailed discussion of this novel approach to prime brokerage, highlighting the specific manner in which such an arrangement can minimize counterparty risk, but also emphasizing the limits of the approach as a risk-mitigation technique, and other potential drawbacks. Read full article …

The SEC recently voted to propose changes to the Advisers Act custody rule.  The SEC initiated this action with the intention of providing additional safeguards when an adviser has custody of client assets.  The proposed changes follow a series of recent enforcement actions involving alleged misappropriation or other misuse of client assets.  The proposed changes would primarily impose two new requirements on registered advisers with custody of client assets.  First, those advisers would need to undergo an annual surprise examination by an independent public accountant to verify client assets.  Second, those advisers who are qualified custodians and self custody client assets or use a related person who is a qualified custodian (rather than an “independent” qualified custodian) would need to obtain a written report from an independent public accountant.  The report would include an opinion as to the qualified custodian’s controls regarding the custody of client assets.  While the proposed changes would impact all registered advisers with custody of client assets, the changes would also have unique application to hedge fund managers.  In a guest article, Terrance J. O’Malley and Jessica Forbes, both Partners at Fried, Frank, Harris, Shriver & Jacobson LLP, examine the proposed changes to the custody rule from the perspective of a hedge fund manager.  Their article begins with a brief review of the rule’s history, then examines the current requirements under the rule and finally describes the proposed changes, including those most relevant to hedge fund managers. Read full article …

On June 17, 2009, the Obama administration released its proposed “rules of the road” for the nation’s regulation of the financial industry.  The proposal aims to restore confidence in the nation’s financial system after last year’s collapses of The Bear Stearns Cos. and Lehman Brothers Holdings Inc., which caused a credit-market seizure, froze bank lending and paralyzed consumer spending.  The proposal generally tightens regulations on many existing institutions already subject to government scrutiny, and brings many products and companies that had operated outside of the banking system under federal control.  The proposed reforms target almost every facet of the financial system, including hedge funds and derivatives.  We provide a comprehensive summary of the proposals, focusing especially on those sections that are most relevant to hedge funds and hedge fund managers. Read full article …

As economic recovery lags and absolute, uncorrelated returns remain hard to come by, litigation funding – an investment strategy that has been popular in the U.K. and Australia for many years – is gaining traction among U.S. hedge funds.  The strategy essentially involves advancing a portion of the costs of a lawsuit in exchange for a multiple of the investment paid out of any damages or settlement.  This article provides a thorough overview of litigation funding, based on interviews with leading practitioners in the field, including discussions of: finding investment opportunities; the unique due diligence process; how litigation funding deals are structured; relevant legal concerns, including champerty and maintenance; attorney-client privilege issues; avoidance of influence on the litigation; the appeal of litigation funding as an investment strategy; and who is investing in the strategy. Read full article …

Confluence Technologies Inc., a provider of fund administration automation, recently published a White Paper titled “Hedge Fund Reporting: The Change Imperative.”  The theme of the paper is that a variety of forces – investor demands for greater transparency; the prospect of increased regulatory oversight; new accounting mandates; and the concerns of asset managers themselves – have placed extraordinary pressure upon hedge fund administration to report more frequently, more thoroughly and with greater flexibility than ever before.  The paper’s authors, Confluence Senior Market Analyst Scott Powell and Director of Marketing Joan Tesla, call this gathering of forces a “perfect storm” for hedge fund administration.  The Hedge Fund Law Report spoke to Scott Powell about the report and some of the issues on which it touches, including (but not limited to): the appropriate level of transparency; the automation of reporting systems; the role of auditing firms; the convergence of U.S. and European accounting standards; the costs of third-party administration; and the new XBRL reporting language.  The full interview is included in this issue of the Hedge Fund Law Report. Read full article …

Accordingly to publicly available court documents, in February 1995, Kimberly Steel entered into an employment agreement with hedge fund manager Watch Hill Management (Watch Hill).  She was employed as “Managing Director, Investor Relations.”  As such, one of her main duties was to solicit investors for Watch Hill.  Her compensation, according to the documents, was based in large part on the amount of money invested by the investors whom she introduced to Watch Hill Fund L.P. (Fund).  At the end of each quarter, she was to receive a bonus equal to a specified percentage of the capital accounts of the investors whom she had introduced.  The agreement also contemplated that if those investors moved to (or invested additional money with) new funds created by Watch Hill’s principals, those investments would also count towards her bonus.  According to the public documents, Watch Hill Management terminated Steel’s employment as of January 28, 2004, and she sued, claiming that she was to receive a bonus “in perpetuity” based on the capital account balances of the limited partners whom she introduced to the Fund.  More recently, a third-party complaint was filed, containing claims arising out of the same facts and circumstances.  We describe the factual and legal allegations of the complaints, which can have relevance for any hedge fund manager structuring compensation arrangements with partners or employees hired or retained to solicit investors. Read full article …

On June 24, 2009, Capital Market Risk Advisors (CMRA) and Risk Fundamentals announced a joint venture combining CMRA’s risk management and risk governance consulting services with Risk Fundamentals’ risk transparency software.  The joint initiative will provide institutional investors, hedge funds and funds of funds with holistic services to address both quantitative and qualitative risks. Read full article …

On June 22, 2009, multi-jurisdictional law firm Conyers Dill & Pearman announced the relocation of corporate attorney Dennis Ryan to the firm’s Dubai office.  Dennis joins from the Cayman Islands office of Conyers where he advised on corporate, finance and investment funds matters.  His relocation is timely as demand for Cayman Islands advice continues to grow across the Middle East and North Africa region. Read full article …