Oct. 8, 2010

Does Dodd-Frank Enable Certain Hedge Fund Managers to Elect Between Registration with the SEC and CFTC?

The working consensus in the hedge fund industry appears to be that Dodd-Frank will materially expand the range of hedge fund managers required to register with the SEC as investment advisers.  A less-frequently told story, if it has been told at all, is that the plain language of Dodd-Frank may, subject to rulemaking, enable certain hedge fund managers to elect between registration with the SEC and CFTC – a sort of regulatory franchise previously reserved for banking institutions.  Put slightly differently, Dodd-Frank may contain an expansive but as yet under-examined exemption from SEC registration for certain hedge fund managers – an exemption, moreover, that is not based on assets under management.  That exemption – if indeed it is one – is contained in Section 403 of Dodd-Frank.  Here’s how it would work.

New York Supreme Court Suggests that “Big Boy” Provision May Not Shield From Liability a Party that Actively Concealed Information

On May 10, 2010, the Supreme Court of New York County declined to dismiss a complaint brought against Wachovia Capital Markets, LLC d/b/a Wachovia Securities (Wachovia), accounting firm BDO Seidman, LLP, and others for their part in allegedly assisting the massive fraud committed by Le Nature’s, Inc.  Le Nature’s collapsed after taking out $285 million in loans arranged and syndicated by Wachovia from the Plaintiffs, hedge fund manager Harbinger Capital Partners, other hedge fund managers and banks.  The Plaintiffs aim to hold Wachovia liable for its alleged misrepresentations when it induced their investment, notwithstanding the existence of a “Big Boy” provision, or a specific disclaimer of reliance, in their credit agreement.  (For more on “Big Boy” provisions, see “New York State Court Upholds ‘Big Boy’ Provisions and Dismisses Majority of MBIA’s Claims Against Merrill Lynch Relating to CDS Protection Sold by MBIA Referencing CDOs Issued by Merrill,” Hedge Fund Law Report, Vol. 3, No. 17 (Apr. 30, 2010); “Big Boys Don’t Cry: How ‘Big Boy’ Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations,” Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009); “When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?,” Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).)  The Trial Court found that the Plaintiffs’ allegations survived the pleading stage because, accepting their allegations as true, Wachovia “actively prevented any possibility that lenders could have discovered Le Nature’s’ true financial condition by . . . fronting Le Nature’s interest payments” to pre-existing lenders in order to conceal from the Plaintiffs Le Nature’s inability to timely make those interest payments.  Thus, the Court held, even though the sophisticated investors had broad access to Le Nature’s books, the Court could not determine whether the investors “could not have ascertained” Le Nature’s true financial condition “by exercising reasonable diligence” on the existing record.  We detail the background of the action and the Court’s legal analysis.

U.S. District Court Allows ERISA Claims for Breach of Fiduciary Duties to Proceed Against Pension Fund’s Investment Advisers

Plaintiffs are participants in the Inductotherm Companies Master Profit Sharing Plan (Plan).  Their Complaint, arising out of poor performance of the Plan, alleges 22 separate claims against three sets of defendants: (i) Inductotherm Industries, Inc. and the Plan’s trustees, (ii) investment managers Financial Services Corporation, its wholly-owned subsidiary FSC Securities Corporation (FSC Securities) and the Wharton Business Group (Wharton), and (iii) American International Group (AIG) and certain SunAmerica companies, all of which were alleged to be affiliated with SunAmerica Money Market Fund, in which certain Plan assets were invested.  AIG is also the parent corporation of Financial Services Corporation.  The Complaint includes sixteen claims under the Employee Retirement Income Security Act (ERISA) for breach of fiduciary duties, two common law claims of fraudulent concealment, three claims involving violations of federal and state laws regulating securities, and a claim under the Racketeer Influenced and Corrupt Organizations Act (RICO).  See “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds,” Hedge Fund Law Report, Vol. 3, No. 33 (Aug. 20, 2010); “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).  In a decision that sheds light on how hedge funds that have pension fund investors might fare in lawsuits arising out of poor performance, the District Court held that FSC Securities and Wharton were plan fiduciaries and that the Complaint against them stated valid causes of action for violations of ERISA.  We summarize the Court’s decision, with emphasis on the investment manager defendants.

How Can Hedge Fund Managers Mitigate the Reputational Harm of Whistleblower Complaints?

Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act states that where a whistleblower provides “original information” to the SEC that leads to an enforcement action in which the SEC obtains a monetary sanction totaling at least $1 million, the SEC “shall pay an award” to the whistleblower of between 10 and 30 percent of the monetary sanctions imposed in the SEC enforcement action and certain related actions.  See “Can Hedge Fund Managers Use Whistleblower Hotlines to Help Create and Demonstrate a Culture of Compliance?,” Hedge Fund Law Report, Vol. 3, No. 29 (Jul. 23, 2010).  The Dodd-Frank whistleblower provision has the hedge fund industry scared for at least seven reasons, each of which is described in this article.  In short, the Dodd-Frank whistleblower provision has created a new category of exposure for all hedge fund managers, even those with long and laudable track records.  Accordingly, the Hedge Fund Law Report has been talking to a variety of hedge fund industry participants about how to mitigate the potential reputational and other harm that can be caused by whistleblower complaints.  This is an ongoing topic for the industry, and one that we plan to cover continuously: as we obtain new insights, we will share them with you.  The intent of this article is to outline some current thoughts based on conversations with insightful sources, including ideas relating to employment agreements, compliance policies and procedures and exit interviews.

Prime Broker Merlin Securities Develops Spectrum of Hedge Fund Investors; Event Hosted by Accounting Firm Marcum LLP Examines Marketing Implications of the Merlin Spectrum

In August of this year, prime broker Merlin Securities, LLC released a white paper dividing the universe of hedge fund investors into ten categories, and arranging those categories along a spectrum from least to most “institutional.”  By institutional, Merlin was referring to the demand placed on hedge fund managers by each type of investor with respect to assets, operational practices, risk management, track record, reporting and other factors.  On September 23, 2010, at an event hosted by accounting firm Marcum LLP, Ron Suber, Senior Partner at Merlin and an author of the white paper, expanded on the institutional investor spectrum and its implications for hedge fund marketing.  This article outlines the Merlin investor spectrum and details the key takeaways from the Marcum conference with respect to hedge fund marketing, including a discussion of hedge fund seeding by pension funds.  Like any analytical framework, Merlin’s spectrum is intended to help managers clarify their marketing efforts and develop reasonable expectations, rather than to apply without alteration to every factual context.  As discussed more fully below, according to Merlin, it generally would not be realistic for a startup manager to target only pension funds in its marketing efforts; but by the same token, as discussed at the Marcum event, some pension funds have explored or executed hedge fund seeding deals, so startup managers should not rule out marketing to pension funds altogether.  See “How Should Hedge Fund Managers Adjust Their Marketing to Pension Funds in Light of Potential Downward Revisions to Pension Funds’ Projected Rates of Return?,” Hedge Fund Law Report, Vol. 3, No. 11 (Mar. 18, 2010); “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).

Mark Browne Appointed Partner in Mason Hayes+Curran’s Investment Funds Department

On September 28, 2010, Irish law firm Mason Hayes+Curran announced the appointment of Mark Browne as a Partner in its Investment Funds Department.

Conyers Dill Brings New Hires to London, Cayman, Bermuda and Asian Offices

On October 4, 2010, Conyers Dill & Pearman announced the appointment of attorneys in London and Hong Kong as well as the strengthening of its Cayman Islands and Bermuda practices.