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    May 3, 2012

Ten Strategies for Preventing Disclosure of Confidential Hedge Fund Data under State Sunshine Laws

Public pension funds are among the most coveted types of investors in hedge funds.  This is so for various reasons.  Public pension funds typically make large investments for the long term.  They often spend considerable time on investment and operational due diligence and only commit capital after scrupulous analysis.  Accordingly, an investment from a credible public pension fund is often more than just a source of capital – it also acts as an imprimatur, a vote of confidence and a letter of recommendation when approaching other investors.  But for hedge fund managers, investments from public pension funds can also have downsides.  One of the more notable downsides is the one-two punch of more information demanded and less control over information provided.  That is, public pension funds often demand from their hedge fund managers – and often receive as a result of their size and concomitant clout – significant transparency into things like portfolio composition, industry concentration, regulatory developments and similar items.  At the same time, public pension funds are typically subject to state “sunshine” laws – laws that generally require government bodies to disclose information about their business and investment activities unless an exemption is available.  For hedge fund managers that want public pension plan investors but do not want to disclose their confidential data, the existence of state sunshine laws would appear to present an unpleasant binary choice: accept pension money (if you can get it) and disclose, or reject pension money and maintain confidentiality.  But the choice need not be so stark.  There are ways to accept public pension plan investors while protecting the confidentiality of competitively sensitive information to a significant degree.  This article outlines ten strategies for doing so and, to contextualize those strategies, discusses: what sunshine laws are; the information typically required to be disclosed pursuant to sunshine laws; some common exemptions from disclosure included in sunshine laws; and the process for challenging a request for disclosure pursuant to sunshine laws.

The Transformation of Third Party Hedge Fund Marketer Contracts and Compensation

Asset raising and marketing are fundamental, life or death activities for hedge fund managers.  If you as a hedge fund manager (or your agents) cannot market effectively, you cannot survive, regardless of your investing prowess.  According to Rothstein Kass’ sixth annual hedge fund industry outlook survey, released in April 2012, “asset raising and marketing are far and away the top issues for funds in 2012, with 53.1 percent of respondents stating those are their biggest concerns.”  Hence the robust pay packages of the top in-house and third party marketers.  See “How Much Are In-House Hedge Fund Marketers Paid?,” Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011).  Marketing in the hedge fund industry is tough for business and legal reasons.  Hedge fund marketing is tough from a business perspective because, among other things: the sales cycle is long; investors have many choices; investors – especially big ones – have considerable bargaining clout; hedge funds are typically relatively liquid (and where they are not, big investors typically negotiate for liquidity); investors rarely provide feedback when they decide to forgo a hedge fund investment, so it is difficult to learn from your mistakes; it is often challenging to clearly articulate a complicated value proposition; etc.  Hedge fund marketing is tough from a legal perspective because the activity is subject to a dense and often opaque patchwork of law, regulation, policy and practice including – but by no means limited to – lobbying laws and rules and related compensation restrictions; performance reporting considerations; due diligence best practices; the JOBS Act and the evolving rules regarding general solicitation and advertising; the AIFMD in Europe; heightened and focused SEC enforcement activity; general contracting and structuring considerations; registration issues; etc.  In an effort to provide guidance to industry participants trying to navigate the business and legal challenges involved in hedge fund marketing, on April 4, 2012, the Third Party Marketers Association hosted a webinar entitled “The Transformation of Third Party Marketer Contracts and Compensation.”  The participants in the webinar were Matthew Eisenberg, a Partner at Finn Dixon & Herling LLP; Laurier W. Beaupre, a Partner at Proskauer Rose LLP; and L. Charles Bartz, a Partner with placement agent BerchWood Partners LLP.  The webinar was moderated by Mike Pereira, Publisher of the Hedge Fund Law Report.  The webinar covered many of the most important issues involved in structuring relationships between hedge fund managers and third party marketers.  This is our first of two articles covering the webinar.  This article summarizes the specific insights and concrete recommendations of the panelists on topics including: the JOBS Act; separate accounts; due diligence; who bears the risk of public plan-level restrictions on compensation; disclosure; looking through funds of funds; and other topics.

Recent ALJ Decision Against Investment Adviser Who Received Undisclosed Compensation from a Hedge Fund Manager It Recommended to Clients Highlights SEC Scrutiny of Forms ADV

An initial decision handed down by Chief Administrative Law Judge Brenda P. Murray (ALJ) on April 20, 2012 highlights the severe penalties that can be imposed on investment advisers and their principals for making materially false Form ADV filings.  The enforcement action in question involved a registered investment adviser and its owner (respondents) that were charged with failing to disclose compensation received from a hedge fund manager that was recommended to the investment adviser’s clients.  For a previous discussion of the initiation of this administrative proceeding, see “An Investment Adviser May Not Call Itself Independent If It Receives Fees from Underlying Managers,” Hedge Fund Law Report, Vol. 4, No. 33 (Sep. 22, 2011).  This article outlines: the factual background in this case; the holdings and legal analysis applied by the ALJ; the sanctions imposed on the respondents; and some lessons learned for investment advisers that file Forms ADV with the SEC.

How Do New Commodities Regulations Impact Hedge Fund Managers with Respect to Registration, Marketing, Trading, Audits and Drafting of Governing Documents?

On February 9, 2012, the U.S. Commodity Futures Trading Commission (CFTC) rescinded an exemption from commodity pool operator (CPO) registration found in CFTC Rule 4.13(a)(4) that was previously heavily relied upon by many hedge fund managers.  The rescission of that exemption also narrowed the availability of an exemption from commodity trading adviser (CTA) registration found in CFTC Rule 4.14(a)(8) which was also relied upon heavily by many hedge fund managers.  As such, many hedge fund managers will need to register as CPOs or CTAs with the CFTC, become members of the National Futures Association (NFA) and become subject to CFTC and NFA regulations.  See “Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do? (Part One of Two),” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  Bearing this in mind, law firm Kleinberg, Kaplan, Wolff & Cohen, P.C. (KKWC) and hedge fund administrator CACEIS jointly hosted a webinar (Webinar) on April 19, 2012 to outline changes in the regulatory regime for CPOs and CTAs.  During the Webinar, Martin D. Sklar, a Member of KKWC, and Darren J. Edelstein, an Associate at KKWC, shared their expertise on numerous topics, including a discussion of the remaining exemptions from CPO and CTA registration for hedge fund managers; the steps taken to register a CPO or a CTA and its respective principals and associated persons; the various CFTC and NFA regulations impacting CPOs and CTAs; and the reporting requirements applicable to registered CPOs and CTAs, including completion and filing of Form CPO-PQR and CTA-PR.  The Hedge Fund Law Report interviewed Sklar and Edelstein following the Webinar to conduct a deeper dive into some of the topics discussed during the Webinar, including a discussion of: the Rule 4.13(a)(3) de minimis exemption; which hedge fund management entities should register as CPOs and CTAs; what marketing, trading and other regulations affect registered CPOs and CTAs; whether and to what extent registered CPOs and CTAs are subject to CFTC and NFA audit; whether hedge fund managers must add additional disclosures or change their subscription documents to allow them to comply with CFTC and NFA regulations; and the biggest challenges hedge fund managers face with respect to registering as a CPO or CTA and becoming subject to CFTC and NFA regulations.

SEC Charges Hedge Fund Manager with Fraud as Part of Its Ongoing Regulatory Scrutiny of Secondary Market Trading in Private Pre-IPO Company Shares

Historically, it has been very difficult for investors to obtain allocations of shares of private companies that are anticipated to conduct an initial public offering of their shares.  To meet this need, a growing secondary market has developed to facilitate secondary market trading in the shares of such private companies, which are often purchased from an issuer’s employees and early investors.  Hedge fund managers have launched funds whose investment strategy is to invest in the shares of these popular private companies.  For the past year, the U.S. Securities and Exchange Commission (SEC) has intensified its scrutiny of this secondary market trading.  As part of that effort, on March 14, 2012, the SEC filed a civil enforcement action against a broker-dealer, an investment adviser and one of their principals who sponsored and managed hedge funds formed to engage in secondary market transactions in the shares of various popular startups, among them, Facebook, Inc., Twitter, Inc. and Zynga Inc.  This article highlights the factual allegations, causes of action and remedies sought by the SEC in its complaint and, in turn, identifies some of the pitfalls that hedge fund managers that employ this trading strategy should avoid.

How Does the SEC Approach Custody Issues in the Course of Examinations of Hedge Fund Managers?

The regulatory scrutiny of custody issues has intensified in recent years due to high-profile scandals involving investment advisers, and the SEC is spending more time on the review of custody issues during examinations of registered investment advisers, including hedge fund managers.  On January 31, 2012, the SEC hosted its annual “Compliance Outreach Program National Seminar” (Seminar).  The Seminar included five sessions.  The fifth session – entitled “Safety and Soundness of Client Assets/Custody” (Session) – discussed the impact of Rule 206(4)-2 under the Advisers Act (Custody Rule) on registered investment advisers, such as hedge fund managers.  The Session began with a discussion of the Custody Rule’s requirements, including a discussion of the 2009 amendments to the Custody Rule.  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures in Light of Amendments to the Custody Rule?,” Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010).  The Session also discussed the SEC’s approach to reviewing custody issues during examinations of investment advisers.  Specifically, the Session explained what an investment adviser should expect with respect to the review of custody issues during an SEC examination and how to prepare for custody reviews in the course of examinations.  This article discusses the foregoing topics and the other key takeaways from the Session.

Goodwin Procter Expands Private Equity Practice with Addition of Ilan S. Nissan and Christian C. Nugent in New York

On May 1, 2012, Goodwin Procter announced that Ilan S. Nissan and Christian C. Nugent joined the firm’s Private Equity Practice as partners in its New York office.

Heidi Lawson Joins Mintz Levin, Enhancing D&O Risk Management Capabilities

Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. recently announced that Heidi Lawson has joined the firm’s Boston office as a member in the Litigation Section.  Lawson focuses on, among other things, D&O insurance for hedge fund managers.  See “Hedge Fund D&O Insurance: Purpose, Structure, Pricing, Covered Claims and Allocation of Premiums Among Funds and Management Entities,” Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011).

Fidelity Investments' Former Deputy General Counsel Stephen Fisher Joins E&Y in Boston

On April 25, 2012, Ernst & Young LLP announced that Stephen D. Fisher, former senior vice president and deputy general counsel of Fidelity Investments, has joined its Asset Management tax practice.  For a recent interview with the Co-Leader of E&Y’s Global Hedge Fund practice, see “Ernst & Young’s Arthur Tully Talks in Depth with Hedge Fund Law Report About Hedge Fund Governance, Succession Planning, Valuation, Form PF and Administrator Shadowing,” Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).

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