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    Aug. 5, 2009

How Can Hedge Funds Get Their Money Out of Lehman Brothers International Europe?

The return of assets to clients of Lehman Brothers International Europe (LBIE) has been a slow, complex process.  Administrators for LBIE have applied to the U.K. High Court for approval of a proposed scheme of arrangement (Scheme) intended to facilitate the process of valuing, recovering and returning client assets.  (A scheme of arrangement is the analogue in a U.K. administration proceeding to a reorganization plan in a U.S. Chapter 11 proceeding.)  See “Should Hedge Funds Purchase Unsecured Debt of Lehman Brothers Holdings Inc.? Key Legal Issues Impacting Returns,” Hedge Fund Law Report, Vol. 2, No. 26 (Jul. 2, 2009).  LBIE is the U.K. broker-dealer affiliate of Lehman Brothers Holdings Inc (LBHI), and served as a prime broker to various hedge funds.  On September 15, 2008, LBHI filed a petition in the United States Bankruptcy Court for the Southern District of New York seeking relief under Chapter 11 of the United States Bankruptcy Code.  Subsequently, 18 additional affiliates of LBHI filed petitions in the United States Bankruptcy Court also seeking relief under Chapter 11.  For more on the LBHI bankruptcy see, “Lehman Brothers Holdings and Certain of its Subsidiaries File for Bankruptcy Protection,” Hedge Fund Law Report, Vol. 1, No. 21 (Sep. 22, 2008).  Also on September 15, 2008, LBIE was placed into administration in the U.K.  The U.K. court has since appointed several partners of PricewaterhouseCoopers (PwC) as joint administrators of the LBIE estate.  When LBIE collapsed, the assets of its hedge fund clients were frozen, and for such hedge funds, retrieving those assets has been a long and tortuous process.  Reportedly, some hedge funds have collapsed based on their inability to recover assets frozen at LBIE.  Others have had difficulty paying redemptions.  And at a minimum, hedge funds with assets frozen at the insolvent broker-dealer have been unable to deploy those assets for investment purposes.  To date, PwC has returned about $13 billion of the $32 billion in clients assets held at LBIE.  The Scheme is intended to improve and expedite the process of returning assets to affected clients.  On July 14, 2009, PwC issued a briefing note outlining the key points of the Scheme.  Our article attempts to cut through the thicket of cross-jurisdictional complexity in an effort to help hedge funds with assets tied up at LBIE answer a simple question: how can they get their money back?  To help answer this question, we discuss the background of the Scheme; Scheme approval process; who is eligible to file claims under the Scheme; how claims will be valued under the Scheme; netting; currency and tax considerations; an opt-out provision in the Scheme; when to expect disbursements; and the relationship of the Scheme to the related U.S. Securities Investor Protection Act proceeding.

What Is a Chief Risk Officer, and Should Hedge Fund Managers Have One?

“In the wake of the financial crisis, risk governance has emerged as a key topic,” and “[a]t no time in history has there been a greater need for companies to evaluate and strengthen risk governance.”  These statements, from the executive summary of a recent survey conducted by Capital Market Risk Advisors (CMRA) and the Professional Risk Managers’ International Association (PRMIA), reflect the perception of risk shared by many hedge fund managers, in the broader economy and on Capitol Hill.  That survey, titled “Risk Governance: A Benchmarking Survey” (Survey) analyzes, among other things, the role of Chief Risk Officers (CROs) at various types of financial institutions, including hedge funds.  According to the Survey, only about 50 percent of institutional investors have a CRO and hedge fund boards are less likely than boards of other types of institutions to have executive sessions with the CRO.  Many hedge fund managers do not have a CRO at all, which means that the substantive functions of the CRO are performed by someone else (e.g., the Chief Operating Office (COO), Chief Compliance Office (CCO) or portfolio manager), or are not performed at all.  In either case, the Survey and sources interviewed by the Hedge Fund Law Report concurred that there is value in localizing various risk management functions in one person – both in protecting against downside and in identifying areas for upside.  Broadly, a CRO serving in a consultative role, as opposed to merely a control role (we explore the difference in greater detail in this article), can help the fund manager identify underappreciated areas of risk, or areas where risk has been overstated.  A CRO can add value in risk avoidance and risk appreciation.  This article details the substance of a CRO’s typical role at a hedge fund manager; reporting procedures; control versus strategic roles for CROs; trend and exception reports; CRO compensation; and the likelihood that Congress or a regulator will require hedge funds to have CROs or someone performing their substantive functions.

The Evolution of Offshore Investment Funds (Part Two of Three): In Interview with the Hedge Fund Law Report, Ogier Partner Colin MacKay Discusses Indemnification; Evolution of the “Gross Negligence” Standard for Directors; Caselaw on When a Redeeming Shareholder Becomes a Creditor of a Hedge Fund and Efforts by Liquidators to Adjust Net Asset Value; and Clawback Principles and Mechanics

During this past spring and summer, global law firm Ogier hosted its Second Annual Ogier Global Investment Funds Seminar, titled “The Evolution of Offshore Investment Funds,” for over 300 hedge fund professionals in New York, Boston, the Cayman Islands, Chicago and San Francisco.  Colin MacKay, one of the presenting partners at the seminar, spoke at length to the Hedge Fund Law Report about the most important issues addressed in the seminar.  Last week, we published the first of three parts of the full transcript.  In that first installment, MacKay discussed, among other things: drafting of offshore fund documents; net asset value (NAV) adjustments; clawbacks; managed accounts; and payment-in-kind provisions.  See “The Evolution of Offshore Investment Funds (Part One of Three): In Interview with the Hedge Fund Law Report, Ogier Partner Colin MacKay Discusses Drafting of Offshore Fund Documents; NAV Adjustments; Clawbacks; Managed Accounts; and Payment-in-Kind Provisions,” Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  This week’s issue of the Hedge Fund Law Report includes part two of the full transcript, in which MacKay discusses indemnification of fund directors and the evolution of the “gross negligence” standard; the most relevant caselaw developments in offshore financial centers (including cases addressing when a redeeming shareholder becomes a creditor of a fund and cases dealing with attempts by liquidators to adjust NAV); and clawback principles and mechanics (including an extensive discussion of why a Cayman court may not enforce a clawback action by a U.S. bankruptcy trustee in circumstances such as the Madoff fraud).

Appellate Division Upholds Dismissal of Complaint by Hedge Funds Holding More than $190 Million of Defaulted Loans Against Credit Suisse, as Arranger of Financing and Administrative and Collateral Agent, for Aiding and Abetting Fraud and Breach of Fiduciary Duty

In a decision of profound interest to hedge funds that invest in distressed companies and the banks that arrange those loans, New York’s Appellate Division, First Department, has thrown out a claim that defendants Credit Suisse First Boston (USA), Inc. and Credit Suisse Securities (USA) LLC (together, Credit Suisse) aided and abetted a fraud committed by Meridian Automotive Systems, Inc. (Meridian) in a 2004 restructuring of its debt.  Credit Suisse helped to arrange a refinancing of Meridian’s debt.  Plaintiff hedge funds purchased a portion of Meridian’s debt.  Less than one year later, Meridian declared bankruptcy.  Plaintiffs claimed that Credit Suisse knew Meridian was insolvent at the time of the restructuring and failed to disclose it.  The court held that plaintiffs failed to plead a critical element of their claim, i.e., that Credit Suisse had “substantially assisted” Meridian in committing the alleged fraud.  We summarize the court’s reasoning and the cautions it provides for investors and lenders in the distressed debt market.

Changing Hedge Fund Landscape Key Focus of Foundation for Accounting Education’s 2009 Hedge Funds and Alternative Investments Conference

On July 29, 2009, the Foundation for Accounting Education presented the 2009 Hedge Funds and Alternative Investments Conference in New York City.  During the one-day event, industry participants discussed the changing landscape for hedge funds, including new demands from investors and the most recent regulatory developments.  A key theme echoed by the participants was that hedge funds need to be better prepared to deal with the changes that are coming, from registration to new valuation policies to increased examinations, not only by the Securities and Exchange Commission (SEC) but by the Internal Revenue Service (IRS) as well.  We detail the key take-aways from the conference, including a discussion of the erosion of trust among hedge fund managers and investors; pressure on hedge fund fees; likely changes in hedge fund regulation; expanded SEC examinations of hedge fund managers and improvements to the training of the SEC’s hedge fund examination staff; and the new IRS Managed Funds Group.

Growing Wave of Credit Default Swap Litigation: Judge Rules Citigroup Did Not Cheat VCG Hedge Fund on Swap and Trims Claims in VCG/Wachovia Litigation

In a pair of recent lawsuits in the United States District Court for the Southern District of New York, VCG Special Opportunities Master Fund, Ltd. (VCG or CDO Plus), an Isle of Jersey, U.K.-registered hedge fund of approximately $50 million in assets and a credit default swaps (CDS) seller previously known as “CDO Plus Master Fund Ltd.,” sued Citibank, N.A. and Wachovia Bank, N.A., both CDS buyers, raising similar claims against each bank.  VCG alleged that both banks had purchased CDS contracts from VCG, each covering a different credit default obligation for the amount of $10 million, and that each had made unwarranted and bad faith demands for additional credit support, i.e., margin calls.  These lawsuits are part of a growing wave of credit default swap litigation and highlight the need for caution in this area.

Direct Access Partners and C3 Offer Hedge Funds Robust Compliance Software in Anticipation of Increased Regulatory Reporting

On August 5, 2009, Direct Access Partners LLC, the institutional agency brokerage firm providing hedge funds with best execution and institutional trading support services, announced that as part of its suite of services, it will make C3’s comprehensive compliance software available.

3rd Annual Hedge Fund General Counsel Summit, October 1, 2009, Greenwich, CT

The troubled economy, recent industry scandals and a new administration calling for increased accountability and regulation is driving the hedge fund industry into a perfect storm.  Hedge fund executives must monitor the winds of change to protect their funds, their reputations and their investors.  The 3rd Annual Hedge Fund General Counsel Summit, taking place on October 1, 2009, in Greenwich, CT, will address these and other concerns by delivering the cutting-edge information and facts essential to success in today’s climate.

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