Oct. 27, 2011

The Impact of Asymmetric Information, Trade Documentation, Form of Transfer and Additional Terms of Trade on Hedge Funds’ Trade Risk in European Secondary Loans (Part Two of Two)

Although certain distressed debt investors in the European markets would like to believe that senior secured bonds can provide easier and more liquid access to the rights and influence of senior secured lenders, this is not the current reality.  Though both bonds and bank debt may have “senior secured” preceding their title, the rights and influence afforded to investors can vary significantly among instruments.  While many on the buy side are fighting to bring the senior secured bond structure more in line with bank debt on the premise that a Euro worth of senior secured bonds should be a Euro worth of senior secured bank debt, it remains to be seen when and if this will happen.  In most instances, the ability to quickly access the senior secured facility agreement and ancillary documents as well as steer a borrower’s proposed restructuring will continue to be driven initially by the senior bank debt lenders.  A misstep in trading bank debt while building a portfolio position could therefore shut an investor out from discussions.  This makes for a bitter pill to swallow if the investment strategy behind the debt purchase from the outset is to be active in restructuring talks.  Access by an investor to the traditionally “club” world of European bank debt, especially in middle market private situations, can come with challenges.  This is especially true for investment funds looking to trade across a borrower’s capital structure and seeking liquidity and a quick settlement if things don’t go according to plan.  In Part 1 of this two-part article series, David J. Karp, a Special Counsel at Schulte Roth & Zabel LLP (SRZ), and leader of the firm’s Distressed Debt and Claims Trading Group, Roxanne Yanofsky, an Associate at SRZ, and Erik Schneider, also an Associate at SRZ, examined regulatory and tax issues that may impact on an investor’s recovery; identified certain restrictions in the underlying credit documentation that could prohibit an investor from assuming a direct lender of record position; and discussed perfection issues that may affect a lender’s recovery in a borrower insolvency scenario.  See “Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two),” Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011).  In this article, Part 2 of the series, the authors, joined by their colleague Neil Robson (a Senior Associate in SRZ’s London office) touch upon issues relating to confidential information in the European secondary loan market and trading where a disparity of information exists between syndicate members and restructuring committee members under a credit agreement.  Additionally, the authors discuss the different forms of documentation available for trading bank debt, the various options for purchase of bank debt and the risks associated with each method of settlement.

SEC Exams of Hedge Fund Advisers: Focus Areas and Common Deficiencies in Compliance Policies and Procedures

It is a well-known fact that the SEC has significantly fewer examiners than it has registrants to examine.  Nowhere is the SEC more outnumbered than in the investment adviser arena, with approximately 435 examiners compared to more than 11,000 registered investment advisers.  In the first quarter of 2012, advisers with less than $100 million in assets under management will generally transition from SEC registration to state registration.  However, the mandatory registration of private fund advisers with more than $150 million in assets will continue to pose significant resource challenges to SEC examiners.  What’s more, the newly registered private fund advisers will likely be higher risk and more complex firms, which will require more examination resources than those firms moving off the SEC’s rosters.  To help manage this resource imbalance, SEC examinations are becoming much more focused and targeted on high-risk firms and the highest risk activities and practices within those firms; and as a result of various factors discussed in this article, SEC examiners are much better prepared than in the past to scrutinize hedge fund business practices and they have an eager group of well-equipped enforcement staff ready to bring cases – often a series of cases – on the issues where examiners are focusing.  In a guest article, Kimberly Garber – a Founding Principal of boutique compliance firm CORE-CCO, LLC, and former Associate Regional Director in charge of the Examination Program in the Fort Worth Regional Office of the SEC – discusses five risk areas where SEC examiners commonly focus in hedge fund examinations and where compliance policies and procedures are often lacking.  In each area, how comprehensive a firm’s procedures need to be will depend on the risks presented by the firm’s business practices, affiliates and client relationships, and how actively the firm and its personnel engage in each type of activity.  If a firm does not purport to engage in or chooses to prohibit certain activities, its policies and procedures should specify such prohibited practices but also contemplate controls to ensure that employees do not inadvertently or purposefully engage in prohibited activities.

Proposed Volcker Rule and the Effect on Private Fund Sponsors and Investors

The federal banking agencies and the SEC recently proposed regulations to implement Section 13 of the Bank Holding Company Act, also known as the Volcker Rule, adopted as part of the Dodd-Frank Act.  The Volcker Rule prohibits proprietary trading and private fund investments and sponsorship by banking entities, subject to certain exceptions.  In a guest article, Ropes & Gray LLP Partners Joel Wattenbarger, Jason E. Brown and Mark Nuccio, along with Ropes Associate Alyssa Clough, address the restrictions on investments into private funds and the effect they will have on private fund sponsors, highlight certain issues and potential structuring opportunities that are applicable to private fund sponsors and identify some issues that require further clarification.

Insider Trading – The Long View

Meyer “Mike” Eisenberg has experienced the evolution of insider trading doctrine and enforcement over decades, and from diverse vantage points.  He worked at the SEC during an era when some of the seminal cases were litigated.  Then he experienced the impact of those cases on industry participants in private practice.  And he has taught about the intersection of the cases and their practical import in various academic appointments.  Eisenberg is expected to participate at the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, to be held on November 10, 2011 at the Pierre Hotel in New York.  (Subscribers to the Hedge Fund Law Report are eligible for a registration discount.)  In particular, while each of the expected participants at the upcoming RCA Symposium – including private side and public side thought leaders – will have a firm grasp of current regulatory developments and their impact on hedge fund managers, Eisenberg is unique in his ability to provide what might be called the “long view.”  He has lived insider trading law for decades, from different angles.  He knows how the current crop of cases is similar to and different from what has come before – and how hedge fund managers can put that context into practice; he can credibly discern regulatory trends; and he knows what motivates and matters to regulators.  In anticipation of the RCA Symposium, the Hedge Fund Law Report had the opportunity to interview Eisenberg on insider trading and related topics.  Our interview specifically covered, among other things: Eisenberg’s background; some hoary but still relevant case law; why the SEC may bring an enforcement action where only a small dollar amount is at issue; interaction between OCIE and Enforcement; whether the SEC or private parties may bring aiding and abetting insider trading claims; whether the SEC must prove scienter when it brings a fraud claim against a hedge fund manager under Advisers Act Section 206; what hedge fund managers should do in response to the new use of wiretaps in insider trading investigations; whether the DOJ is likely to use wire fraud charges to “criminalize” activity that does not satisfy the elements of criminal securities fraud; how hedge fund portfolio managers can safely talk to corporate insiders; and compliance policies and procedures hedge fund managers should implement regarding use of consultants, channel checking firms and similar persons.  The full text of our interview with Eisenberg is included in this issue of the Hedge Fund Law Report.

Benefits and Burdens of Redomiciling a Hedge Fund to an EU Jurisdiction

A recent report (Report) lays out the key considerations for hedge fund managers contemplating redomiciliation to the European Union (EU).  The Report is based on interviews of 49 hedge fund managers from 18 different countries, including managers who have redomiciled, managers who are thinking of redomiciling and managers who have no redomiciliation plans.  The Report catalogues the three most significant benefits driving redomiciliation, and other factors that factor into redomiciliation decisions.  The three key benefits and others mentioned in the Report and discussed herein, however, must be weighed against the flexibility and expertise of offshore funds as well as certain investors’ preferences for other, easier ways to allay their concerns.  This article catalogues the findings of the Report; describes redomiciliation mechanics; considers choice of jurisdiction arguments; describes a compromise position that may work for a range of managers that currently have offshore funds; and discusses the pros and cons of certain typically used European structures for hedge fund strategies.  See also “The Implications of UCITS IV Requirements for Asset Management Functions,” Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).

Investors’ Claims Against Investment Advisers Who Recommended Madoff Feeder Fund Survive Motion for Summary Judgment

At the recommendation of the defendant investment advisers, in April 2008, plaintiffs Thomas and Margaret Van Dyke invested over $850,000 in Anchor Hedge Fund Limited (Anchor).  Anchor, in turn, invested its assets with Bernard Madoff.  Plaintiffs’ entire investment was lost in Madoff’s fraud.  Plaintiffs sued Sovereign International Asset Management, Inc., the investment adviser that recommended Anchor, along with its principals.  They alleged fraud under the Investment Advisers Act of 1940 and analogous provisions of Ohio law, breach of contract, negligence and other common law claims.  Plaintiffs’ fraud claims were based in large part on the failure of the defendants to disclose how they were compensated by Anchor.  The parties moved for summary judgment.  We summarize the Court’s ruling on the motions, and its implications for disclosure of fees by hedge fund managers to investors.

Pension Funds and Sovereign Wealth Funds Shift Towards Direct Allocations with a Distinct “Sweet Spot” for Hedge Fund Managers with Between $1.0 Billion and $5.0 Billion Under Management

A June 2011 report summarized the results of a survey (Survey) of pension and sovereign wealth fund investors as well as hedge fund managers.  The Survey had two primary goals: (1) tracking the shift of these investors from funds of funds to direct allocation models; and (2) identifying the predominant characteristics of hedge fund managers who received these newfound direct allocations.  Overall, the Survey found that the shift to direct allocation among these investors has been dramatic.  The managers who have benefited most from this transformation are those with assets under management (AUM) of between $1.0 billion and $5.0 billion, a range the Report dubs the “sweet spot.”  This article details the key findings from the Survey and the key conclusions of the Report, focusing in particular on: the factors leading to direct investing; approaches to direct investing; the three primary vehicles used by pension funds and sovereign wealth funds for direct investing; the manager selection process; criteria used by pension funds and sovereign wealth funds to evaluate direct managers; and the pivotal role of consultants.

Neil Townsend and David Cosgrove Join Willkie’s Private Equity Group

On October 12, 2011, Willkie Farr & Gallagher LLP announced that Neil W. Townsend and David B. Cosgrove have joined the firm as partners.  They will practice in the Corporate and Financial Services Department and Private Equity Practice Group in the firm’s New York office.  For analysis by Willkie published in the HFLR, see “Investment Research and Insider Trading on ‘Outside Information’,” Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011); “The Lehman Bankruptcy and Swap Lessons Learned Negotiating an ISDA Master Agreement in Today’s Market,” Hedge Fund Law Report, Vol. 2, No. 9 (Mar. 4, 2009); and “Impact of Hedge Fund Redemptions Under ERISA,” Hedge Fund Law Report, Vol. 2, No. 2 (Jan. 15, 2009).

Charles W. Garske Joins Okapi Partners

On October 25, 2011, proxy solicitation firm Okapi Partners LLC, announced the addition of Charles W. (Chuck) Garske as Senior Managing Director.  Garske joins Okapi Partners from Georgeson Inc.  For analysis by Okapi published in the HFLR, see “How Will Changes to Proxy Access and Broker Voting Rules Impact Activist Hedge Fund Investors?,” Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).