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    Mar. 4, 2009

Trio of Bills Proposed in Connecticut Legislature Would Introduce Substantial State Regulation of Hedge Funds

In the January 2009 Session of the Connecticut General Assembly, Connecticut lawmakers proposed three bills that would increase the state’s role in the regulation of private investments funds, including hedge funds, with various types of connections to Connecticut.  In particular, lawmakers proposed the following: (1) Connecticut Senate Bill No. 953, “An Act Concerning Hedge Funds,” which generally would raise qualifications for investors in private funds that have offices in Connecticut where employees regularly conduct business on behalf of the funds, and expand disclosure requirements applicable to such funds; (2) Connecticut House Bill No. 6477, “An Act Concerning the Licensing of Hedge Funds and Private Capital Funds,” which generally would require hedge funds established or conducting business in Connecticut to obtain a license from the Connecticut Banking Commissioner; and (3) Connecticut House Bill No. 6480, “An Act Requiring the Disclosure of Financial Information to Prospective Investors in Hedge Funds and Private Capital Funds,” which generally would require hedge funds domiciled in Connecticut and receiving money from Connecticut pension funds to disclose to prospective pension fund investors, upon request, certain financial information.  All three bills have been referred to the Banks Committee of the Connecticut General Assembly.  In addition, at a public hearing held by the Banks Committee on February 24, 2009, Connecticut Attorney General Richard Blumenthal proposed an alternative scheme of state hedge fund regulation.  We provide a detailed analysis of each of the three bills as well as Attorney General Blumenthal’s proposal, including a discussion of industry responses from some of the leading authorities on federal and Connecticut hedge fund regulation.

Certain Madoff Investors May Find Themselves in an Unusual Dual Role – As Potential Lawsuit Plaintiffs or SIPA Claimants, but also as Potential Clawback Defendants

Various investors in the collapsed investment management business of Bernard L. Madoff Investment Securities LLC (BMIS) may find themselves in an unusual double role, both offensive and defensive.  On the offensive side, those investors are trying to recoup all or part of their investments with BMIS, as potential beneficiaries of the Securities Investors Protection Act (SIPA) proceeding being conducted by court-appointed trustee Irving Picard, a Baker Hostetler partner; as claimants on the limited insurance provided by the Securities Investor Protection Corporation (generally, $500,000 for lost or stolen securities and $100,000 for lost or stolen cash); or as plaintiffs in lawsuits against BMIS, its service providers and others (generally alleging claims in the nature of negligence and breach of fiduciary duty).  On the defensive side, many of those same BMIS investors may be subject to so-called “clawback” lawsuits, that is, generally, actions by the trustee to recover profits paid out to (and in some cases principal invested by) investors within a certain period prior to the filing of the SIPA proceeding, for distribution to other investors.  We describe the specific forms that such clawback actions can take, who can be subject to such actions and whether the trustee would be likely to seek recovery of profits and principal or just profits.  We also discuss the various offensive option available to certain direct and indirect Madoff investors.  In the course of our discussion, we highlight important points raised at the Madoff Litigation Conference hosted by HB Litigation Conferences on February 25, 2009.

The Lehman Bankruptcy and Swap Lessons Learned Negotiating an ISDA Master Agreement in Today’s Market

Recent market events have caused many entities to examine their agreements regarding a variety of relationships they have with brokers and other trading counterparties.  Many over-the-counter derivative trades are documented using the form of Master Agreement of the International Swaps and Derivatives Association Inc. (ISDA), and therefore many entities have been paying particular attention to these ISDA Master Agreements and their related schedules and confirmations.  In a guest article, Thomas H. French and Jack I. Habert, Partner and Special Counsel, respectively, at Willkie Farr & Gallagher LLP, highlight certain provisions of the ISDA Master Agreement that have generated significant interest for counterparties as market conditions have changed in the wake of the Lehman bankruptcy.

Connecticut District Court Rules that Hedge Fund Investor Can Sue Hedge Fund Manager for Imposition of “Involuntary” Lock-Up Period and Improper “Rescinding” of Redemption Notice

In a lawsuit filed in April 2008, Joseph Umbach, founder of the Mystic line of beverages, accused Carrington Investment Partners, L.P. (the Fund), a billion dollar mortgage-backed securities hedge fund, of “involuntarily” tying up his one million dollar investment in the Fund and improperly “rescinding” a redemption notice he submitted to the Fund’s sole manager, Bruce Rose.  Umbach sought a declaration that the action taken by Carrington and Rose was “an illegal or unenforceable ex post facto” action, and charged that the defendants committed securities fraud, breached their fiduciary duty to him, committed fraud and negligent misrepresentation and breached the terms of their contract.  On February 18, 2009, the United States District Court for the District of Connecticut dismissed Umbach’s request for declaratory judgment, because it found that his remaining claims against the Fund, Carrington Capital Management, LLC (the General Partner) and Bruce Rose, could go forward.  We outline the relevant facts from the complaint and the court’s opinion, and explain the court’s legal analysis.  The case illustrates, among other things, the deference a federal court will give to an agreement between an investor and a hedge fund manager providing the investor with preferential liquidity terms.

Financial Crisis to Slow Convergence of Hedge Funds and Private Equity Funds, But Not for Long

Two of the most significant types of alternative investment funds worldwide are hedge funds and private equity funds.  For years, these two alternative investment strategies have been converging.  Although the financial crisis may slow this convergence, the trend will ultimately continue and strengthen – albeit with some important variations across countries.  In a contributed article, Houman B. Shadab, senior research fellow in the Regulatory Studies Program at the Mercatus Center at George Mason University, examines the impact of the financial crisis on convergence, explains the distinction between “strategic” and “structural” convergence, discusses the convergence that already has occurred in distressed debt investing and emphasizes the importance to the pace and shape of convergence of variations in regulatory approaches across jurisdictions.

Update on the Petters Fraud: Polaroid Bankruptcy Trustee Sues to Void Hedge Fund’s Pre-Bankruptcy Receipt of Polaroid Assets

On February 12, 2009, the trustee in the bankruptcy proceeding of Polaroid Corporation, the camera and film company owned by Thomas J. Petters, filed lawsuits in the United States Bankruptcy Court for the District of Minnesota against two hedge fund managers, Acorn Capital Group, LLC and Ritchie Capital Management, LLC, claiming that they exploited Polaroid to extract value from the company shortly before Petters’ alleged fraud was uncovered.  In the actions against Acorn and Ritchie, the trustee asserted that both hedge fund firms used their positions as creditors to conceal losses at Petters’ businesses and to divest Polaroid of assets in the form of liens or other guarantees shortly before the Ponzi scheme collapsed.  We detail the complex allegations in the trustee’s complaints, and in the process offer insight into considerations relevant to hedge funds that have or may obtain investments in or claims with respect to companies in the zone of insolvency.

Regulatory Compliance Association Hosts Teleconference on “Hedge Funds in the Cross-Hairs of Regulatory Reform”; Speakers Address Potential New Regulation and Its Likely Impact, Enforcement and Best Practices

On February 25, 2009, The Regulatory Compliance Association (RCA) hosted a teleconference titled “Hedge Funds in the Cross-Hairs of Regulatory Reform,” as part of its CCO University Outreach Series.  The teleconference focused on four general themes: the near certainty of passage of new legislation focused on hedge funds; the widening scope of civil and even criminal cases brought against hedge fund industry participants by prosecutors and administrative agencies; the potential systemic effects of likely regulatory changes; and the importance of instituting best practices before being required to do so by the government.  We provide a detailed summary of the salient points covered in the teleconference.

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