Jan. 21, 2009

Federal Court Dismisses Breach of Fiduciary Duty Claim, but Permits Securities Fraud Claim, Against Alternative Investment Fund and Its Manager and Principals

On December 22, 2008, the United States District Court for the Southern District of New York held that the Martin Act preempts a breach of fiduciary duty claim brought by an investor against an alternative investment fund, the Goldin Restructuring Fund, L.P.  The court held, however, that the investor’s securities fraud action against the fund pursuant to Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder, could proceed.  We offer a detailed discussion of the case, and, in the process, examine how the federal district court in a key jurisdiction for hedge funds construes securities fraud and breach of fiduciary duty claims against an alternative asset manager.

Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators

Partly in response to the generally dismal hedge fund returns of 2008, partly in response to the alleged Madoff Ponzi scheme, hedge fund investors are scrambling for safety.  For some, safety means redeeming and parking the proceeds (when they’re in cash rather than kind) in a safe place – cash or Treasuries in custody accounts, and other sleep-at-night type investments.  Others would like to stay the course in hedge funds, but with new and – from hedge fund managers’ perspective – occasionally onerous conditions.  In this latter category, an increasingly frequent demand from institutional investors is that as a condition of new or remaining investments, hedge fund managers appoint independent administrators, even where the manager was heretofore providing many or all administrative service in-house.  We detail the functions of an administrator, and explore the implications for both hedge fund managers and administrators of the growing chorus of requests from institutional investors to outsource administrative functions.

How Hedge Fund Managers Can Prepare for the Virtual Inevitability of Registration

Despite the fact that the origins of the present economic crisis can be traced largely to subprime mortgage lending and repackaging, that the most severe blow ups with the most wide-ranging ramifications occurred at the most highly regulated institutions, that Bernard Madoff did not manage hedge funds, as such – despite all this, increased hedge fund regulation during the coming year has come to be understood in the industry as a virtual inevitability.  Among the chief anticipated components of any forthcoming regulatory package is likely to be a delegation from Congress to the SEC to require registration of hedge fund advisers.  And most hedge fund law watchers expect any registration rule proposed by the SEC to be crafted with the 2006 Goldstein decision firmly in mind, so that the rule hews closely enough to any mandate from Congress to be entitled to Chevron deference.  (By the same token, any delegation from Congress on this point is likely to be broad enough to accommodate even relatively expansive rulemaking by the SEC.)  In a rule finalized in December 2004, the SEC required certain hedge fund advisers to register with the agency, and in June 2006, the D.C. Circuit Court of Appeals vacated the rule.  After some background on the 2004 rule and registration in general, we offer practical insight on what hedge fund managers can do to prepare for a registration requirement.

How to Prepare for an SEC Investigation: The Pequot Precedent

For more than five years, the SEC has been conducting an on-and-off investigation of potential securities law violations by hedge fund management firm Pequot Capital Management.  The investigation relates to trades that took place nearly eight years ago, and according to people with knowledge of the case, the SEC has recently re-opened its investigation.  Regardless of the ultimate outcome of the SEC’s investigation, the time, expense and distraction involved in the Pequot investigation – or any investigation – can siphon scarce resources away from revenue-generating activities, cause reputational harm, undermine fundraising efforts and otherwise interrupt the management of a hedge fund firm.  The Pequot investigation therefore raises the questions: how can hedge fund managers avoid an SEC investigation?  And, if the SEC initiates an investigation, what is the best way to respond?  We answer these two questions in detail, and conclude with a “to do” list for hedge fund managers seeking to minimize the likelihood of an SEC investigation, or to minimize the gravity and disruption of an investigation once initiated.

Cayman Court Suggests that Hedge Fund Investor does not Have Standing to Liquidate Fund

On December 12, 2008, the Cayman Islands Court of Appeal delivered a Judgment in a case titled In the Matter of Strategic Turnaround Master Partnership, Limited.  The court denied standing to a redeeming investor in Strategic Turnaround Master Partnership, Limited who sought to petition for a wind up of the fund based on the fund’s inability to pay its debts.  However, the court left open the possibility that the investor, Culross Global Ltd., might petition for the same relief under the “just and equitable” doctrine of Cayman Islands insolvency law.  We discuss the facts, legal analysis and implications of the case for hedge funds organized in the Cayman Islands.

Girish Reddy, Founder of Prisma Capital Partners, Discusses Starting a Hedge Fund, the Future of the Hedge Fund Industry and Techniques for Conducting Due Diligence

On January 15, 2009, Girish Reddy, co-founder and managing partner of fund of hedge funds manager Prisma Capital Partners LP, spoke at the Cornell Club’s Cornell Entrepreneur Network event regarding his experiences within several large companies and at Prisma Capital.  We discuss his comments, in particular, on starting a hedge fund, the future of the hedge fund industry and performing thorough due diligence.