Jan. 14, 2011

Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three)

Hedge fund industry talent is increasingly mobile, but the consequences of that mobility impact different institutions differently.  In an article in our issue of December 17, 2010, we discussed the implications of that increasing mobility from the talent perspective.  Specifically, that article, among other things: identified seven discrete reasons for the increasing pace of mobility; defined "talent" (including investment and noninvestment talent); defined "proprietary trading" (to the extent it can be defined); identified the various types of institutions from and to which talent is moving; predicted which entities stand to gain the most from the movement of talent; and offered recent examples of talent moves.  See "Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three)," Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  Working from the foundation of that article, this article discusses the implications of increasing talent mobility from the bank perspective.  (The third and final article in this series will discuss the relevant issues from the perspective of the hedge fund management company to which the talent migrates.)  In particular, this article discusses the key legal, business and cultural issues to be considered by investment or commercial banks in connection with departing hedge fund talent (ideally well before that talent departs), including: eight distinct methods that banks use to protect trade secrets, confidential information and other intellectual property; business considerations that may impact decisions regarding enforcement of intellectual property rights; and the strategic interaction among non-competition provisions (non-competes), non-solicitation provisions (non-solicits), accrued but unpaid compensation and ownership of performance data.  Before continuing, three points should be noted.  First, many of the issues identified in this article are, in certain ways, the mirror images of issues identified in the first article in this series.  That is, when discussing the movement of talent from bank proprietary (prop) trading desks to hedge fund managers, if an issue is relevant to the talent, it is, almost by definition, relevant to the bank; and vice versa.  However, the weighting, implications and consequences of issues are different for the different parties, thus justifying separate discussions.  By analogy, both hedge fund managers and investors are concerned with the general issue of hedge fund money raising, but their specific areas of concern differ markedly.  Second, while the discussion in this article focuses on the relevant issues from the bank perspective, the intended audience for this article is not just banks.  Rather, the article is written in the conviction that the other constituencies − including talent and the hedge fund management companies to which talent moves − can benefit from a deeper understanding of the bank perspective.  Third, as indicated in the outline of the article above, the legal rights of the parties when talent leaves a bank for a hedge fund manager are powerfully determined by the business facts and circumstances.  In other words, the relevant analysis is often a hybrid legal-business analysis, rather than a pure legal analysis.  For example, assume that the head of commodities prop desk is leaving to start a commodities hedge fund manager, and his employment agreement contains a narrowly drawn, well-crafted non-compete.  Will the bank be able to enforce the non-compete?  A pure legal analysis may say yes, but if the bank is exiting the commodities trading business altogether, the legal analysis may be moot.  Of course, the facts always determine legal outcomes; the point here is to suggest that the universe of relevant facts may be broad, and actions outside of the talent's control may bear directly on the parties' legal rights.

Accounting for Uncertain Income Tax Positions for Investment Funds

FIN 48, now included in ASC Topic 740 (Income Taxes) under the Financial Accounting Standards Board’s Codification, was issued in 2006 and after two one-year deferrals became effective for all entities issuing financial statements under Generally Accepted Accounting Principles (GAAP) for years beginning after December 15, 2008.  FIN 48 was issued as an interpretation of FASB Statement 109, Accounting for Income Taxes, with the intent of reducing the diversity of practice in financial accounting for income taxes, including U.S. federal, state and local taxes as well as foreign taxes.  A major component of FIN 48 is that its reach includes all statutory open tax years, not just the accounting reporting year.  This requires that each year is looked at on a cumulative basis.  Entities that report on a non-GAAP basis, such as International Financial Reporting Standards (IFRS), are not subject to FIN 48.  FIN 48 has become a hot topic for fund managers and their auditors.  Given the complicated nature of fund structures, global investment strategies and the variety of financial products that managers invest in, it is an important area, and one to which managers should allocate sufficient resources.  In a guest article, Michael Laveman, a Partner at EisnerAmper LLP, discusses in detail the four-step process for adoption of and compliance with FIN 48.

Can the Chief Compliance Officer of a Hedge Fund Manager be Terminated for Investigating a Potential Compliance Violation by the Manager's Principal, CEO or CIO?

On December 29, 2010, the First Department of the New York State Appellate Division reversed a trial court order and dismissed a breach of implied contract claim brought by Joseph Sullivan, the Chief Compliance Officer of hedge fund manager Peconic Partners LLC, against his former employer and its CEO, William F. Harnisch.  Sullivan had accused Harnisch of terminating his at-will employment in retaliation for his investigation into Harnisch's alleged "front running" scheme.  In dismissing this claim, the Appellate Division recognized that the Peconic Code of Ethics, which Sullivan was required to follow, required "on pains of termination" that he investigate that alleged violation.  Nonetheless, the Appellate Division found that this language did not create a contractual promise not to terminate Sullivan, and that no recognized exception to the employment-at-will doctrine otherwise protected him from termination without cause.  We detail the background of the action and the court's pertinent legal analysis.  Also, we provide a critical analysis of the opinion, discuss its implications for whistleblower law and practice and identify a key provision that must be included in hedge fund manager compliance manuals and codes of ethics in order to protect the chief compliance officer.

Cayman Islands Grand Court Rules That Hedge Fund Investor Is Entitled to Court-Supervised Liquidation of Fund, Even Though Fund Managers Were Conducting “Ad Hoc” Liquidation With the Support of a Majority of Fund Investors

In yet another case that highlights the importance of carefully drafted hedge fund organizational documents, the Cayman Islands Grand Court has granted a request by hedge funds Aris Multi-Strategy Lending Fund Limited and Aris Africa Fund Limited (together, Aris) to have a court-supervised liquidator appointed for hedge fund Heriot African Trade Finance Fund Limited (Heriot or Fund).  In or around March 2009, as a result of the 2008 credit crisis, Heriot’s managers suspended redemptions in the Fund indefinitely.  In June 2009, Aris commenced litigation seeking to wind up the Fund on the grounds that the Fund had failed to file timely financial statements and had failed to comply with its stated investment policy.  Over a year later, it amended that petition to add a critical additional ground for winding up: The Fund had lost its “substratum,” which, under Cayman Islands law, means that the Fund’s business purpose could no longer be carried out.  Heriot, in opposing the winding up order, argued that, with the approval of a majority of its investors, it was already liquidating in an orderly fashion.  The Court ruled that, because Heriot’s organizational documents did not specifically contemplate an informal, self-supervised liquidation process, Aris was entitled to a winding up order and the appointment of a liquidator.  This article summarizes the Court’s decision.  For more on Aris, see "Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris," Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009); "New York State Supreme Court Dismisses Hedge Funds of Funds’ Complaint against Accipiter Hedge Funds Based on Exculpatory Language in Accipiter Fund Documents and Absence of Fiduciary Duty 'Among Constituent Limited Partners,'" Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17. 2010); "New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act," Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).

SEI Poll of Hedge Fund CFOs Highlights Regulatory Challenges, Operational Opportunities and the Bases of Competitive Advantage in the Hedge Fund Business

On January 10, 2011, SEI − a global provider of outsourced asset management, investment processing and investment operations solutions − released the results of a poll conducted at the company's annual hedge fund chief financial officer (CFO) forum.  The poll identified six areas of concern for CFOs, but it also identified opportunities, particularly for managers who have or can obtain scale.  Among other things, the poll provides insight into why a disproportionate volume of recent allocations has gone to larger hedge fund managers.  This article summarizes the results of the poll, and describes the bases of competitive advantage in the hedge fund business.  (They are not what you might think.)

The Investment Funds Amendment Act 2010: Key Changes for Hedge Funds Established in Bermuda, and Their Managers

The Bermuda Investment Funds Amendment Act 2010 (Amendment Act), which received the assent of the Governor General on December 22, 2010, amends the Investment Funds Act 2006 (Act) in making new provisions for the regulation of investment funds in Bermuda.  In a guest article, Neil Henderson, an Associate in the corporate department in the Bermuda office of Conyers Dill & Pearman, describes the changes introduced by the Amendment Act which have particular relevance for hedge funds established in Bermuda, and their managers.

David Sieradzki and David Spotts Join Bracewell & Giuliani’s Broker-Dealer Group

Bracewell & Giuliani LLP recently announced that David S. Sieradzki, formerly a Senior Associate at Milbank, Tweed, Hadley & McCloy, has joined its Washington, D.C. office as a Partner in the broker-dealer and market regulation group.  David A. Spotts, formerly of Global Markets Consulting, also joined the group as Counsel in the firm’s Connecticut and New York offices.

Peter Seuffert Appointed Managing Director of Amber Partners (USA) Inc.

On January 5, 2011, Amber Partners, an independent operational risk certification firm focused on the hedge fund industry, announced that Peter Seuffert has joined the firm as a Managing Director.  For more on Amber, see "New Insurance Products Promise to Protect Investors From Hedge Fund Fraud," Hedge Fund Law Report, Vol. 1, No. 16 (Jul. 22, 2008).