Sep. 16, 2011

Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?

Generally, two categories of hedge fund managers will be required to register with the SEC as investment advisers by March 30, 2012: (1) managers with assets under management (AUM) in the U.S. of at least $150 million that manage solely private funds; and (2) managers with AUM in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle, such as a managed account.  See “Will Hedge Fund Managers That Do Not Have To Register with the SEC until March 30, 2012 Nonetheless Have To Register in New York, Connecticut, California or Other States by July 21, 2011?,” Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Registration will trigger a range of new obligations.  For example, registered hedge fund managers that do not already have a chief compliance officer (CCO) will have to hire one.  See “To Whom Should the Chief Compliance Officer of a Hedge Fund Manager Report?,” Hedge Fund Law Report, Vol. 4, No. 22 (Jul. 1, 2011).  Also, registered hedge fund managers will have to complete, file and deliver, as appropriate, Form ADV.  See “Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers,” Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).  But perhaps the most onerous new obligation for newly registered hedge fund managers will be the duty to prepare for, manage and survive SEC examinations.  Most hedge fund managers facing a registration requirement for the first time have hired high-caliber people and completed complex forms.  Therefore, hiring a CCO and completing Form ADV will exercise existing skill sets.  But few such managers have experienced anything like an SEC examination.  On the contrary, many such managers have spent years behind a veil of permissible secrecy, disclosing little, rarely disseminating information beyond top employees and large investors and interacting with the government only indirectly.  Examinations will change all that.  The government will show up at your office, often with little or no notice; they will ask to review substantially everything; and a culture of transparency will have to replace a culture of secrecy, where the latter sorts of cultures still exist.  (The SEC does not appreciate secrecy and has any number of ways of demonstrating its lack of appreciation.)  Hedge fund managers facing the new examination reality will have to think about two sets of issues.  The first set of issues relates to examination preparedness, and the Hedge Fund Law Report has written in depth on this topic.  See, e.g., “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011).  The second set of issues relates to examination management and survival, and that is the broad topic of this article.  Specifically, this article addresses a question that hedge fund managers inevitably face in connection with examinations: What should we tell investors and when and how?  To help hedge fund managers identify the relevant subquestions, think through the relevant issues and hopefully plan a disclosure strategy in advance of the commencement of an examination, this article discusses: the three types of SEC examinations and similar events that may trigger a disclosure examination; the five primary sources of a hedge fund manager’s potential disclosure obligation; whether and in what circumstances hedge fund managers must disclose the existence or outcome of the three types of SEC examinations; rules and expectations regarding responses to due diligence inquiries; selective and asymmetric disclosure issues; how hedge fund managers may reconcile the privileged information rights often granted to large investors in side letters with the fiduciary duty to make uniform disclosure to all investors; whether hedge fund managers must disclose deficiency letters in response to inquiries from current or potential investors, and whether such disclosure must be made even absent investor inquiries; whether managers that elect to disclose deficiency letters should disclose the letters themselves or only their contents; best practices with respect to the mechanics of disclosure (including how and when to use telephone and e-mail communications in this context); and whether deficiency letters may be obtained via a Freedom of Information Act request.

How Can Hedge Fund General Counsel Use Project Management to Manage the Cost and Evaluate the Performance of Outside Counsel?

One result of the current economic downturn is a heightened, and probably enduring, price sensitivity among hedge fund general counsel and fund CFOs.  The response from the legal profession has been confined mostly to discussions of “alternative fee arrangements.”  However, discussions regarding the cost of legal services need to go deeper, penetrating how in-house and outside counsel do our work.  The legal profession must address cost, staffing, timing and deliverables; and addressing these issues will yield insight into value.  Fortunately, there is a well-developed tool for addressing these issues – an alternative, if you will, to alternative fee arrangements.  That tool is project management.  Project management has been used effectively across a wide range of businesses for a considerable time, but only recently has made inroads into the legal business.  In the area of hedge fund law specifically, project management has rarely been mentioned.  However, if properly implemented, project management offers hedge fund general counsel the opportunity to save money, comparison shop, budget, plan, manage and evaluate performance with respect to outside counsel.  Accordingly, in a guest article, Jonathan Baum – Principal of Avenir Law, with more than 30 years of experience as a hedge fund, securities, corporate and finance lawyer – offers a detailed discussion of project management generally, and how project management may be applied specifically in the context of engagements by hedge fund general counsel of outside counsel.

How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks in Connection with Leveraged Loan Market Transactions?

On July 27, 2011, compliance software provider Compliance11 hosted a webinar entitled, “Best Practices for use of Expert Networks and the Leveraged Loan Market.”  The purpose of the event was to provide “solutions, tactical input and strategies” designed to avoid insider trading pitfalls when hedge fund managers use expert networks in connection with leveraged loan trades.  For more on this general topic, see “Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement,” Hedge Fund Law Report, Vol. 4, No. 20 (Jun 17, 2011).  The webinar was moderated by Tracey Straub, Vice President of Strategy at Compliance11.  Laurence Herman, General Counsel and Managing Director of Gerson Lehrman Group (GLG), spoke about the use of expert networks, and Tim Houghton, Founding Principal of Cortland Capital Market Services (CCMS), spoke about trading in the leveraged loan market.  See “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  This article summarizes the most important points made during the webinar.  In particular, this article discusses: the ways in which expert networks can diminish the opportunities for inappropriate conveyance of material nonpublic information (MNPI); four recommended steps for hedge fund managers to take prior to engaging an expert network firm or expert; seven best practices for using expert network firms; nine compliance policies and procedures for using experts; whether leveraged loans are “securities” for insider trading purposes; and how to manage MNPI at hedge fund managers that participate in the leveraged loan market.  See “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 Can the Liquidators of Non-U.S. Hedge Funds Access U.S. Bankruptcy Courts to Obtain Ancillary Relief for Fund Investors?

On August 26, 2011, the United States Bankruptcy Court for the Southern District of New York granted a petition by the joint liquidators of Millennium Global Emerging Credit Master Fund Limited (Master Fund) and Millennium Global Emerging Credit Fund Limited (Feeder Fund, collectively the Funds) seeking, inter alia, recognition in the United States of a Bermuda liquidation proceeding as a “foreign main proceeding” or “foreign nonmain proceeding.”  The decision is a noteworthy development on an obscure but important area of law for distressed debt hedge funds.  The case has particular relevance for hedge funds organized in Bermuda, because the Court also reaffirmed that Bermuda has a sophisticated, fair and impartial legal system entitled to recognition and comity in the United States.  For a comparison with the problems of recognition facing Cayman Islands proceedings, see “Delaware Bankruptcy Court Recognizes Cayman Islands Proceeding as ‘Foreign Main Proceeding’ Under Chapter 15 of the U.S. Bankruptcy Code,” Hedge Fund Law Report, Vol. 3, No. 6 (Feb 11, 2010).  For more on the recent changes to the definition of “center of main interests," see “Amendments to Bankruptcy Rule 2019 Recently Approved by the U.S. Supreme Court Add Disclosure Requirements While Protecting Distressed Debt Funds’ Proprietary Trading Strategies,” Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).  This article details the background of the action and the Court’s pertinent legal analysis.

In Second Lawsuit Arising Out of Failed CDO Deal, UBS Is Not Permitted to Pursue Claims Against Hedge Fund Manager Highland Capital Management to the Extent those Claims Could Have Been Brought in its Original Suit

In 2007, UBS Securities LLC and two affiliates (UBS) agreed to finance and serve as placement agents for certain collateralized debt obligations (CDO) that hedge fund manager Highland Capital Management, L.P. (Highland) proposed to issue.  As a result of the 2008 financial crisis, the CDO deal collapsed in December 2008.  UBS then sued Highland in New York State Supreme Court under the indemnification provisions of the CDO deal to recover the losses it allegedly sustained.

Nine Due Diligence Lessons Arising Out of the SEC’s Recent Enforcement Action Against the Manager of a Purported Quantitative Hedge Fund

On August 10, 2011, the SEC filed a complaint (Complaint) against a hedge fund management company and its principal, generally alleging that the defendants solicited a $1 million investment based on five categories of misrepresentations.  The management company purported to manage a hedge fund with a quantitative investment strategy, and the investment came from an individual bond fund portfolio manager at a prominent New York hedge fund management company.  The misrepresentations in this matter highlight a number of pitfalls that hedge fund investors should avoid.  More generally, the matter highlights a number of due diligence points for investors to add to their DDQs – if the points are not there already.  This article describes the factual and legal allegations in the Complaint, then discusses the nine key lessons from the Complaint.

John Quattrocchi Joins SNR Denton’s Private Equity Practice in Dallas

On September 13, 2011, SNR Denton announced that John E. Quattrocchi has joined the firm as a partner in its Private Equity practice in Dallas.  Quattrocchi joins SNR Denton from the Dallas office of Andrews Kurth, LLP, where he had been a partner since 2006.

Samuel E. “Q” Belk IV to Lead Research on Lower-Beta Hedge Funds, Global Macro Managers, Tail Risk Hedging Managers and High-Yield Credit, Bank Debt and Active Currency Managers

On September 13, 2011, Cambridge Associates announced that Samuel E. “Q” Belk IV, 56, has joined the investment consultant as Director of Diversifying Investments.  Belk was most recently a Managing Director at the Dartmouth College Investment Office, where he was responsible for hedge fund and distressed portfolios and private equity.  For more on beta as it relates to hedge fund investments, see “The Space between Alpha and Beta (and Why Hedge Fund Investors Should Care),” Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).