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    May 31, 2012

RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part One of Two)

On April 16, 2012, the Regulatory Compliance Association held its Regulation and Risk Thought Leadership Symposium (RCA Symposium) in New York City at the Pierre Hotel.  The RCA Symposium brought together leading practitioners and regulators in a series of panel discussions, each of which offered unique insight on various topics of relevance for hedge fund managers.  This is the first article in a two-part series summarizing the highlights from the RCA Symposium.  This first article discusses the sessions that covered: fund governance issues; interpreting, preparing for and completing Form PF; and enterprise risk management for hedge fund managers.  The second article will discuss sessions that covered: the new paradigm of regulatory enforcement and white-collar prosecution; chief compliance officer and general counsel liability; and re-evaluation of the operating model for third party relationships.

Eight Recommendations for Hedge Fund Managers That Utilize Most Favored Nation Provisions in Side Letters

The challenging capital raising environment has generally tilted the typical balance of power in favor of institutional investors.  As a consequence, with increasing frequency, institutional investors are requesting side letters from hedge funds or their managers.  Side letters typically grant the requesting investor preferential rights that are not granted to other investors in the fund’s governing documents; these preferential rights can include special fee reductions, transparency rights, redemption rights, capacity rights, etc.  Additionally, side letter requests now regularly include so-called “Most Favored Nation” (MFN) provisions – which are used by investors to ensure that any rights granted to current or future investors are also offered to the requesting investor.  Requesting investors often demand broad protections in MFN provisions, arguing that they cannot anticipate what rights will be granted to future investors.  While it may be convenient for hedge fund managers to dismiss MFN provisions as “standard” requests from investors, MFN provisions can present numerous pitfalls for fund managers if they are not properly evaluated, appropriately negotiated and effectively monitored to ensure compliance.  This article provides a roadmap for understanding MFN provisions and their implications for a manager’s business, operations and compliance processes.  Specifically, this article describes: the anatomy of an MFN provision; the key terms of an MFN provision; the three principal concerns raised by the use of MFN provisions; and eight recommendations for drafting and administering MFN provisions to mitigate key concerns.

In What Circumstances Can U.S. and Other Foreign Judgments Be Enforced Against Cayman Islands Hedge Funds?

Parties considering bringing proceedings against Cayman Islands hedge funds in other jurisdictions should ensure that any judgment that might be obtained in a foreign jurisdiction will be recognized and enforced by the Cayman courts.  On the flip side, Cayman-domiciled hedge funds facing claims in foreign jurisdictions will need to consider the safety of ignoring and not participating in those proceedings, on the assumption that any judgment obtained will not be recognized and enforced by the Cayman courts.  In a guest article, Christopher Russell and Joanne Collett, Partner and Senior Associate, respectively, at Appleby, survey the landscape that informs whether Cayman courts will enforce such judgments.  These issues arise in particular in the context of enforceability of judgments obtained by default where the Cayman fund does not participate in the foreign proceedings, and in particular in the context of judgments and orders obtained in insolvency proceedings in light of the increasing trend towards universality of insolvency proceedings.

What Risks – And Opportunities – Does the Euro Zone Crisis Present for Hedge Fund Managers?  An Interview with Richard Frase of Dechert

The euro zone crisis is intensifying, and hedge fund managers must be prepared to address the myriad risks (and prospective opportunities) that are presented by the crisis.  The Hedge Fund Law Report recently interviewed Richard Frase, a Partner at Dechert LLP, who shared his perspective on euro zone risks and how hedge fund managers should prepare themselves to mitigate such risks.  Specifically, the interview covered: European counterparty risks, including risks posed by prime brokers, sub-custodians and trade counterparties; euro-related risks, including a discussion of hedging strategies and approaches with respect to euro-denominated funds or share classes; euro zone-related fund disclosures, including general euro zone economic risk factors, counterparty risks and euro-related risks; approaches to valuing euro-denominated assets; and investment opportunities presented by the euro zone crisis.  This article contains the full text of our interview with Frase.

Rothstein Kass Report Discusses Marketing, Structuring, Tax, Leverage, Due Diligence, Hiring and Other Dominant Concerns for Hedge Fund Managers in a Competitive Capital Raising Environment

The 2012 version of Rothstein Kass’ annual hedge fund industry survey assessed manager sentiment and trends across a wide range of relevant areas, including: structuring and choice of entity; ownership and management of hedge fund firms by women and minorities; seeding; consolidation and chief business concerns among manager principals; use of leverage; the interaction among leverage, tax and capital raising; sources of capital and expectations with respect to investor sentiment; length of the due diligence process; fee and other concessions in exchange for investments; technology; lock-ups; outsourcing; gates; hiring expectations with respect to CCOs, CFOs and CTOs; family office conversions; investor qualification; and Form PF.  This survey results were explained in a report (Report), which also included insight from Rothstein Kass principals.  This article provides a detailed summary of the key points of the Report.

Investors Sue Hedge Fund Manager Harbinger Capital and Philip A. Falcone for Alleged Style Drift

Hedge fund investors have certain fundamental expectations of hedge funds in which they invest, including that the hedge fund will invest assets in accordance with the investment strategies, guidelines and restrictions outlined in the fund offering documents.  In addition, the stated investment strategy informs investors as to whether the hedge fund manager has the requisite expertise to manage the fund, given its investment experience.  Also, investors often want to ensure that they have allocated their assets in accordance with their own asset allocation parameters.  As a result, when hedge fund managers deviate from these investment strategies, fund investors find themselves exposed to risks that they had not anticipated when performing due diligence on the fund and manager.  The SEC has increased regulatory scrutiny of funds to identify style drift and has brought enforcement actions premised on allegations of style drift.  See “Recent SEC Enforcement Action Provides a Dramatic Example of Style Drift in the Hedge Fund Context,” Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).  Investors have also initiated private legal action against fund managers for style drift, as demonstrated by a recent class action complaint brought against Harbinger Capital Partners LLC, Harbinger Holdings, LLC and Philip A. Falcone.  The allegations in the complaint generally arise out of investments by a Harbinger fund in LightSquared Inc.

Three Steps Hedge Fund Managers Can Take to Avoid Liability for Related Party Conflicts of Interest

The interests of hedge fund investors and managers are not always in perfect alignment.  One of the principal conflicts with which investors are concerned is the investment of fund assets in companies in which the manager or one of its affiliates has a financial or other interest; consciously or unconsciously, such interests are thought to color the manager’s judgment.  For this reason, hedge fund investors and regulators expect managers to disclose (in hedge fund offering documents) all material facts necessary to understand the incentives informing a manager’s investment decision-making.  A recent SEC enforcement action demonstrates the agency’s commitment to identifying and interdicting undisclosed conflicts of this nature.  Specifically, the SEC’s action alleges that a registered fund manager invested fund assets in two high-risk private technology companies he founded without disclosing the attendant conflicts of interest to investors, and in contravention of fund offering documents which stated that he would invest fund assets primarily in publicly traded securities.  This article describes the factual allegations, causes of action and remedies sought by the SEC.  This article also provides three recommendations for hedge fund managers aiming to avoid enforcement activity for failing to disclose related party conflicts of interest.

SFC Associates Announces New Affiliates in Hedge Fund Litigation Consulting

On May 30, 2012, SFC Associates, a securities and financial litigation consultancy, announced that it has expanded its hedge fund-related litigation consulting capabilities with the addition of three affiliates: Hugh Cohen, Leon Metzger and Daniel Strachman.

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