Jun. 23, 2011

Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies

The negative publicity surrounding Chinese companies listed in the United States seemingly has reached a fevered pitch.  In April 2011, the Securities and Exchange Commission, or SEC, acknowledged that it had established a task force to address what it deemed to be abuses by Chinese companies accessing the U.S. markets through the use of reverse merger transactions.  SEC Commissioner Luis Aguilar referred to the proliferation of these companies as a “disturbing trend that seems to have challenging implications for capital formation and investor protection.”  In addition to the SEC, the U.S. national stock exchanges have been taking more aggressive actions against Chinese companies.  During 2011, almost two dozen Chinese companies have seen trading in their securities halted or have been delisted in large part due to accounting irregularities.  Against this backdrop, it has become increasingly difficult for investors in this space to separate the undervalued from the fraudulent.  In a guest article, Cavas S. Pavri, a Member in the Business Law Department of Cozen O’Connor, discusses areas that hedge fund managers should focus on in performing their due diligence on investments in Chinese companies.  Specifically, Pavri discusses, among other things: relevant PCAOB guidance; specific factors to consider in evaluating a Chinese company’s accounting firm; specific factors to consider in assessing a Chinese company’s chief financial officer and accounting staff; what to look for when evaluating the corporate governance of a Chinese company; considerations in connection with “variable interest entity” structures; local financial reporting; SAFE registration; the importance of a prior underwritten offering; and insurance considerations.

SEC Delays Registration Deadline for Hedge Fund Advisers, and Clarifies the Scope and Limits of Registration Exemptions for Private Fund Advisers, Foreign Private Advisers and Family Offices

At an open meeting held on June 22, 2011, the Securities and Exchange Commission adopted and amended rules that will directly affect the registration, reporting and disclosure obligations of U.S. and non-U.S. hedge fund managers.  While the texts of most of those rules or rule amendments remain to be published as of this writing, comments by SEC commissioners at the open meeting outlined the general scope of the final rules and amendments.  Of particular relevance to hedge fund managers, the SEC addressed the following topics at the open meeting: delay of registration and reporting deadlines; who may and must register with the SEC and the states based on assets under management; the private fund adviser exemption; the foreign private adviser exemption; continuing relevance of the Unibanco no-action letter for global hedge fund sub-­advisory relationships; filing, recordkeeping and examination obligations of exempt reporting advisers; and the exemption from registration for family offices.  This article offers more detail on the SEC’s statements on each of the foregoing topics at the open meeting.

CFTC and SEC Propose Rules to Further Define the Term “Eligible Contract Participant”:  Why Should Commodity Pool and Hedge Fund Managers Care?

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act” or “Dodd-Frank”) into law.  Section 721(c) of Title VII of the Dodd-Frank Act made certain changes to the definition of the term “eligible contract participant” (“ECP”).  Subsequently, as part of their efforts to implement Dodd-Frank, the Commodity Futures Trading Commission (the “CFTC”) and the Securities and Exchange Commission (the “SEC” and, together with the CFTC, the “Commissions”) proposed rules to further refine the definition of ECP under the Commodity Exchange Act (“CEA”) (the “Proposed Rules”).  Unless the Commissions withdraw or revise the Proposed Rules before they become effective, the definitional change will negatively affect many commodity pools that engage in over-the-counter (“OTC”) foreign currency (“FX”) transactions.  In a guest article, Steven M. Felsenthal, General Counsel and Chief Compliance Officer of Millburn Ridgefield Corporation, The Millburn Corporation and Millburn International, LLC, and Stephanie T. Green, a legal and compliance intern at The Millburn Corporation: (1) introduce the Proposed Rules as applied to commodity pools engaged in OTC FX transactions; (2) highlight the adverse result of the Proposed Rules; and (3) discuss revisions or alternatives to the Proposed Rules that could help to avoid such adverse results.  While the focus of this article is the adverse results on commodity pools, the same adverse results would apply to any pooled investment vehicle that seeks to trade OTC FX forward contracts, including hedge funds that trade such instruments, because they would likely fall within the definition of commodity pool under Dodd-Frank.

If a Hedge Fund Holder of Defaulted Sovereign Debt Obtains a Judgment Against the Defaulting Sovereign, What Assets Can the Hedge Fund Go After to Satisfy the Judgment?

On May 25, 2011, the United States District Court for the Central District of California denied an ex parte motion of hedge fund NML Capital, Ltd. to place a temporary lien on and prevent the imminent launch of the United States-based Aquarius/SAC-D (Scientific Applications) Satellite.  The Aquarius Satellite represented a collaborative effort between the United States, the Republic of Argentina and other nations.  NML Capital, as holder of previously-suspended Argentina bonds, had sought to utilize a sovereign immunity exception in the Foreign State Immunities Act (FSIA) to execute its billion dollar judgment against Argentina by attaching its interest to Argentina’s part of the Aquarius Satellite.  The District Court rejected the hedge fund’s attempt to impose a temporary protective order or temporary restraining order on that satellite.  We discuss the background of the action and the District Court’s legal analysis as it relates to the rights of hedge funds that hold defaulted sovereign debt to attach and execute their interests against property of the sovereign debtor held in the United States.

SEC’s Fraud Suit Against Principals of Palisades Master Fund for Overvaluation of “Side Pocket,” Misappropriation of Assets and Improper Short-Selling Survives Motion to Dismiss

In October 2010, the Securities and Exchange Commission (SEC) brought civil securities fraud charges against defendants Paul T. Mannion, Jr., and Andrew S. Reckles, and the investment advisers they controlled, claiming that they defrauded investors in hedge fund Palisades Master Fund, L.P. (Fund) by lying to investors about the value of the Fund’s stake in World Health Alternatives, Inc. (WHA), stealing and exercising WHA warrants owned by the Fund, failing to disclose their private sales of WHA stock and concealing a short position in Radyne Corporation at the time that the Fund invested in that corporation’s PIPE offering.  For a detailed summary of the SEC’s complaint, see “SEC Brings Civil Securities Fraud Action Against Principals of Hedge Fund Palisades Master Fund, Alleging Fraud, Self-Dealing, Misuse of Fund Assets and Use of a ‘Side Pocket’ to Misrepresent the Fund’s Value to its Investors,” Hedge Fund Law Report, Vol. 3, No. 42 (Oct. 29, 2010).  The Defendants moved to dismiss the entire complaint on the ground that it failed to state any cause of action against the Defendants.  The District Court generally permitted all counts of the complaint to proceed.  We summarize the factual background and the Court’s legal analysis.

Man Group Announces Appointment of Co-Chief Operating Officers of U.S. Business and Expands Sales Coverage

On June 16, 2011, Man Group announced the appointment of Jordan Allen and Lance Donenberg as Co-Chief Operating officers of Man’s U.S. business.

Weil Establishes European Private Equity Fund Formation Group with Four New Partners

On June 13, 2011, Weil, Gotshal & Manges announced that private funds partners Ed Gander, Nick Benson, Nigel Clark and Jonathan Kandel have resigned from Clifford Chance and accepted an offer to join Weil’s London office to establish a fund formation group.