Sep. 17, 2009

Key Person Provisions in Hedge Fund Documents: Structure, Consequences and Demand from Institutional Investors

Traditionally, the success of a hedge fund manager and its funds under management flows (or fails to flow) directly from the vision, expertise or acumen of one person, or a small group of people.  That person is often, though not invariably, the founder of the manager, and those people are often fellow founding partners, or key hires made subsequent to founding.  In a word, key people are the people that generate revenue, and investors are rightfully concerned about what may happen if key people die, become disabled or cease (voluntarily or involuntarily) to actively participate in the management of the funds in which investors are invested.  To address and mitigate those concerns, key person provisions are often drafted into various fund or manager documents or into side letters; the current trend is toward inclusion of such provisions in fund operating documents, and away from inclusion of such provisions in side letters.  Such provisions take various forms and establish differing mechanics, but generally provide for notification and redemption rights in the event of designated triggering events.  This article explores the substance of key person provisions – how they are drafted and the mechanics they establish; the documents in which they are located; the differing consequences of locating the provisions in different documents; the consequences of triggering such provisions; the demand by institutional investors for such provisions; and the relationship between key person provisions and succession planning.

Convergence of Hedge Fund Strategies and the UCITS Structure in Europe Mirrors Convergence of Hedge Fund Strategies and Mutual Fund Structures in the United States

Undertakings for Collective Investment in Transferable Securities (UCITS) – retail investment funds authorized by one of the member states of the European Union (EU) and thereby passported into the rest of the EU – represent the dominant platform for retail investment funds in Europe.  See “UCITS: An Opportunity for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 2, No. 27 (Jul. 8, 2009).  Collins Stewart, a London-based financial advisory group, recently announced that it plans to launch a fund of funds within the UCITS structure.  This announcement, and a similar announcement from Schroders PLC that it is working with hedge fund managers to launch a range of UCITS funds for sophisticated investors, serve as evidence of the increasing convergence of hedge fund strategies and the UCITS structure.  The convergence mirrors a similar trend in the U.S. in which hedge fund strategies are being offered in mutual fund or exchange-traded fund vehicles.  These trends on both sides of the Atlantic are part of a more overarching trend toward retailization of hedge fund strategies, which heretofore have been the exclusive province of high net worth individuals and sophisticated institutional investors.  Retailization can dramatically change the game for hedge fund managers.  Among other things, it can open up a vast new market for their services.  See “Hedge Fund Managers Launching Mutual Funds in an Effort to Stay a Step Ahead of Regulatory Convergence,” Hedge Fund Law Report, Vol. 2, No. 15 (Apr. 16, 2009).  But at the same time, it can dramatically increase the number and heft of competitors, and can introduce a variety of new conflicts.  See, e.g., “New Study Offers Surprising Findings on the Incentives Created by Concurrent Management of Hedge and Mutual Funds,” Hedge Fund Law Report, Vol. 2, No. 23 (Jun. 10, 2009).  A related trend is so-called hedge fund replication, in which hedge fund strategies are supposed to be reproduced in non-hedge fund, often retail, vehicles.  See “Hedge Fund Replication is Gaining in Popularity, but is it a Viable Alternative to Hedge Fund Investing?,” Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  In this article, we examine retailization on the European side.  In particular, we analyze the promise, limits and mechanics of the UCITS structure; replication as an alternative route to retailization; the likelihood that the onerous Alternative Investment Fund Manager (AIFM) Directive may increase the use of UCITS funds for hedge fund strategies; and how UCITS IV will change structuring and management of UCITS funds, focusing on increased ease of passporting, new rules regarding fund mergers and master-feeder structures and new standards for risk measurement and management.

Are University Endowments Likely to Insource Investment Management Functions Currently Outsourced to Hedge Fund Managers?

In the past year, the values of many university endowments have declined by record amounts.  The negative returns have forced some schools to freeze faculty salaries and slow campus expansion and other improvement plans.  Now, in the wake of the economic downturn, university endowments are picking up the pieces and reexamining their investment strategies.  Harvard Management Co. (HMC), the company that manages Harvard University’s endowment, has announced that it may increase the amount of assets it manages internally and that such a move may involve selling off some holdings in hedge funds.  However, other university endowments are not necessarily following in HMC’s footsteps and are expected to continue outsourcing their investment management processes.  This article examines trends in endowment investment management, and in particular discusses what university endowments are; the history of investments by university endowments in hedge funds (including the story of David Swensen’s successful foray into alternatives); the rationale for insourcing by university endowments of investment management; the pros and cons of insourcing versus outsourcing; and various alternative methods for university endowments to access hedge fund strategies and talent in a manner consistent with the various concerns that, at least in HMC’s case, have led to insourcing.

Motion of the Law Debenture Trust Company May Lead to Additional Recovery for Hedge Funds that Hold Various Categories of Unsecured Tribune Company Debt

The Law Debenture Trust Company (LDTC), representing several groups of prepetition unsecured bondholders in media corporation Tribune Company (Tribune), has filed a motion in federal bankruptcy court seeking additional discovery to investigate the company’s 2007 sale to billionaire investor Samuel Zell, which the creditors claim led to Tribune’s bankruptcy filing in December 2008.  According to the motion, at this point in time, nine months after the bankruptcy filing, there still has not yet been an investigation of the fraudulent conveyance claims nor have any actions been brought.  The delay has made some creditors suspicious and the motion makes several claims of conflicts of interest among the creditors’ committee members and lenders and other parties involved in the buyout.  Legal experts who spoke with the Hedge Fund Law Report noted that because of the rapid collapse of Tribune it is likely that the LBO and related lending transactions will be challenged as fraudulent conveyances.  If such claims are successful, the liens that the LBO banks have would be voided and unsecured creditors would stand to receive a significantly greater recovery in the reorganization than they are currently poised to recover.  In this article, we provide background on the Tribune LBO and subsequent bankruptcy, and detail LDTC’s motion for additional discovery; what fraudulent conveyance claims are generally and what they are in this case; potential subordination of secured creditors; goals of fraudulent conveyance or transfer claims; additional forms of relief that may be available to Tribune’s unsecured creditors; the likelihood of success of LDTC’s claims; the potential impact of LDTC’s action on various categories of unsecured creditors, including hedge funds that purchased Tribune debt subsequent to the Chapter 11 filing; and the impact on recovery by unsecured creditors of the suit by employees of the Los Angeles Times.

The Evolution of Offshore Investment Funds (Part Three of Three): In Interview with the Hedge Fund Law Report, Ogier Partner Colin MacKay Discusses Cross-Border Regulation; Transparency in Various Offshore Financial Centers; Preferred Offshore Financial Centers for Organizing Hedge Funds; Audits and Examinations of Offshore Financial Centers by Global Regulatory Bodies; and How Hedge Fund Managers Can Access Regulatory Findings

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.  In prior issues, we published the first two of three parts of the full transcript.  This week’s issue of the Hedge Fund Law Report includes part three of three of the full transcript, in which MacKay discusses cross-border regulation; the definition of “established operations”; transparency in various offshore financial centers (including the Cayman Islands, BVI, the Channel Islands and Bermuda); which offshore financial centers are more risky for organizing hedge funds; which offshore financial centers hedge funds are likely to migrate to based on their ability to meet international standards of transparency; whether global regulatory bodies such as the Organization for Economic Cooperation and Development and the International Organization of Securities Commissions are merely promulgating standards or whether they are actively examining or auditing the regulatory and tax rules and enforcement of those rules in offshore financial centers; and how hedge funds can access the results of examination and audit work conducted by regulators.

Second Circuit Upholds Attorney Sanctions In Market Manipulation Suit Against Knight Capital and Hedge Funds

A recent increase in court-imposed sanctions on plaintiffs’ counsel signals how judges have become less tolerant of time-consuming and resource-draining lawsuits.  The hedge fund industry, and the counsel it employs, is not immune from such sanctions.  In ATSI Communications, Inc, v. The Shaar Fund, Ltd., three attorneys and their respective law firms attempted to use a post-judgment settlement as a bargaining chip to persuade a judge to drop mandatory sanctions issued against them under the Private Securities Litigation Reform Act of 1995 and Rule 11 of the Federal Rules of Civil Procedure for filing a baseless complaint.  On October 20, 2008, and then again on September 2, 2009, the United States Court of Appeals for the Second Circuit refused their request and affirmed the sanctions order.  We detail the background of the action and the court’s legal analysis.

Preqin Report Reveals Institutional Investors’ Opposition to Proposed Placement Agent Ban in SEC’s Proposed “Pay to Play” Rules

Preqin, an alternative investment research firm, released a report assessing the potential impact of SEC proposed rule release IA-2910, for Advisers Act Rule 206(4)-5 (Proposed Rule), on the private funds industry.  The firm surveyed 50 leading United States institutional investors, and found that the majority support the aim of the Proposed Rule but oppose its ban on placement agents soliciting investments from public pension funds.  This article summarizes the key findings of this report and outlines Preqin’s proposed alternatives to the Proposed Rule.

Trabulse Case Illustrates a Monitor’s Considerable Discretion to Grant, Deny or Modify Investor Claims in the Wake of a Hedge Fund Fraud

On September 26, 2007, the Securities and Exchange Commission (SEC) accused hedge fund manager Alexander James Trabulse, and various entities with which he was associated, including the Fahey Fund, L.P. (the Fahey Fund or the Fund); Fahey Financial Group, Inc.; International Trade & Data; and ITD Trading (Relief Defendants), of defrauding investors by drastically overstating the Fund’s returns and profitability.  Specifically, the SEC alleged that Trabulse sent account statements to investors in the Fund that inflated the Fund’s returns by as much as 200%, while using investor money to purchase cars and finance shopping sprees for his family members.  As a result, the SEC charged him with violating various antifraud provisions of the federal securities laws.  On December 7, 2007, the SEC obtained an order from the United States District Court for the Northern District of California that included (1) a preliminary injunction and (2) appointment of a monitor to oversee the operations of the Relief Defendants.  The SEC enjoined Trabulse from future violations of the federal securities laws and ordered that he pay $250,001 in disgorgement and penalties.  See SEC v. Trabulse, 526 F.Supp.2d 1008 (N.D. Cal. 2007).  The monitor has since allowed 115 claims, in whole or in part, totaling approximately $13.9 million.  This article discussed the claims review process crafted by the monitor, and illustrates the equitable power of a monitor to grant, deny or modify claims made by investors in the wake of a hedge fund fraud.  The case is illustrative precisely because of the typicality of certain of the claims faced by the monitor – including claims involving valuation, inadequate documentation and claimed withdrawals in excess of principal invested.

Jared L. Landaw Promoted to Chief Operating Officer and General Counsel of Barington Capital Group, L.P.

On September 15, 2009, investment firm Barington Capital Group, L.P. announced that Jared L. Landaw had been promoted to Chief Operating Officer and General Counsel.

Deloitte Ireland Announces Appointment of Mike Hartwell as Head of its Investment Management Group

On September 15, 2009, Deloitte Ireland announced the appointment of Mike Hartwell as head of its investment management group.

Fund of Hedge Funds Specialist Eddington Capital Management Names Andrew Popper as its New Chairman

On September 16, 2009, Eddington Capital Management, a fund of hedge funds specialist, announced that it had named Andrew Popper as its new chairman.