Jul. 19, 2012

How Can Hedge Fund Managers Use Founder Share Classes to Raise and Retain Capital?

Early-stage hedge fund managers face significant challenges in raising capital due in large part to the perceived risks related to a limited track record, limited resources, inexperience in running a fund management business, lack of institutional-quality operational infrastructure and lack of an institutional investor base.  Because of such perceived risks, early-stage managers must be particularly resourceful in offering incentives to attract initial investor capital.  One of the most attractive tools that hedge fund managers have at their disposal for this purpose is offering “founder share classes,” which generally give investors preferential investment terms in exchange for taking on some of the perceived risks of investing with an early-stage or emerging manager.  This article explains what founder share classes are and how hedge fund managers can use them to attract and retain early-stage capital.  Specifically, this article discusses: what managers and investors mean when they refer to founder shares; how founder share classes are structured; the key investment terms offered through founder share classes; some of the key advantages and pitfalls of using founder share classes; and some practical recommendations for hedge fund managers wishing to offer founder share classes.

CFTC Expands Relief from Registration for Eligible Commodity Pool Operators and Commodity Trading Advisors through December 31, 2012

On July 13, 2012, the Division of Swap Dealer and Intermediary Oversight of the U.S. Commodity Futures Trading Commission (CFTC) published a no-action letter issued on July 10, 2012 (no-action letter) that grants certain eligible commodity pool operators (CPOs) of newly launched pools and commodity trading advisors (CTAs) relief from having to register with the CFTC through December 31, 2012.  The relief comes on the heels of the CFTC’s February 9, 2012 adoption of a number of rule amendments, including the rescission of the Rule 4.13 exemption from CPO registration relied upon by many hedge fund managers, which became effective on April 24, 2012.  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); “Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do? (Part Two of Two),” Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  This article describes the no-action relief granted to CPOs and CTAs; outlines the steps that CPOs and CTAs must take to claim such exemptive relief; and highlights the ramifications stemming from the no-action relief granted.

Key Legal and Business Considerations for Hedge Fund Managers in Drafting and Negotiating Confidentiality Agreements (Part Three of Three)

Confidentiality or nondisclosure agreements (NDAs) are pervasive in the hedge fund industry, but little understood and inadequately analyzed.  They are often perceived as adhesion contracts or ministerial impasses to trades or deals.  But NDAs can actually affect the economics of deals, the marketability of assets and the flow of material nonpublic information into and out of a management company.  Hedge fund managers should think harder than they typically have about NDAs.  To help them do so, we are publishing this third installment in a three-part series by William G. Frenkel and Michael Y. Sukhman, both partners at Frenkel Sukhman LLP, on key legal and business considerations in drafting and negotiating confidentiality agreements.  This last article in the series covers remedies, damages and liability in connection with NDAs and non-confidentiality provisions typically included in NDAs.  The second article in this series discussed: the scope of permitted disclosure of information obtained pursuant to NDAs; the terms of permitted disclosure; the scope and terms of required disclosure; and four important considerations with respect to the return and destruction of documents.  See “Key Legal and Business Considerations for Hedge Fund Managers in Drafting and Negotiating Confidentiality Agreements (Part Two of Three),” Hedge Fund Law Report, Vol. 5, No. 17 (Apr. 26, 2012).  And the first article in this series focused on: the “market” for duration provisions; events that trigger expiration of confidentiality obligations; four key elements of the definition of confidential information; and four typical carve-outs from the definition of confidential information.  See “Key Legal and Business Considerations for Hedge Fund Managers in Drafting and Negotiating Confidentiality Agreements (Part One of Three),” Hedge Fund Law Report, Vol. 5, No. 15 (Apr. 12, 2012).

When Is a Distressed Debt Trade Considered Consummated?

Trades in distressed debt or bankruptcy claims are often characterized by cursory, and sometimes oral, agreements to enter into a trade, followed by months during which remaining terms are negotiated prior to settlement of the trade.  However, during the period between the initial agreement and the settlement of the trade, the value of the subject assets can fluctuate, sometimes significantly.  This may create certain disincentives for one party to complete the trade, which can lead to litigation.

Second Circuit Panel Upholds $20.6 Million FINRA Arbitration Award Against Prime Broker Goldman Sachs in Connection with Fraudulent Transfers Into and Among Bayou Fund Accounts

The amount of due diligence that hedge fund prime brokers should conduct with respect to the source of funds deposited and maintained in brokerage accounts has been a topic of keen interest for hedge fund managers, investors and prime brokers, particularly in light of the ongoing litigation between the creditors of the defunct Bayou Group funds and the funds’ prime broker, Goldman Sachs Execution & Clearing, P.C. (GSEC).  See “Does a Prime Broker Have a Due Diligence or Monitoring Obligation When Paying With Soft Dollars for a Hedge Fund Customer’s Access to Expert Networks or Other Alternative Research?,” Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  In the latest round of that litigation, a three-judge panel of the U.S. Court of Appeals for the Second Circuit denied GSEC’s appeal of a district court ruling that upheld a $20.6 million arbitration award against GSEC.  See “District Court Suggests That Prime Brokers May Have Expanded Due Diligence Obligations,” Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).  The arbitrators’ decision, seemingly based in part on the theory that GSEC should have identified red flags in connection with the Bayou fraud, was not rendered in “manifest disregard of the law,” suggesting that prime brokers are indeed at risk for such types of claims.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  This article analyzes the Second Circuit’s Summary Order.

Hedge Fund Fletcher International Sues to Prevent Liquidators of Its Feeder Funds from Forcing It into Voluntary Liquidation

On July 2, 2012, days after it filed for bankruptcy relief in New York under Chapter 11 of the U.S. Bankruptcy Code (Bankruptcy Code), Fletcher International, Ltd. (Debtor), a master fund in a master-feeder structure, sued some of its own Cayman Islands-based feeder funds to block liquidators from disrupting its bankruptcy proceedings and forcing an asset sale.  The Debtor is appealing the ruling of the Grand Court of the Cayman Islands, which appointed Ernst & Young as liquidators of the feeder funds after three Louisiana pension funds sued to redeem their interests in the feeder funds.  See “Cayman Grand Court Ruling Supports Proposition That Hedge Fund Managers Do Not Have Unfettered Discretion in Making Distributions In Kind to Investors,” Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  The Debtor generally argues that the Ernst & Young liquidators lack the knowledge of its unique assets necessary to maximize returns for its creditors and shareholders in bankruptcy proceedings.  This article summarizes the factual background and the allegations in the Debtor’s complaint.

Bingham Significantly Expands Investment Management Team in Washington, D.C.

On July 9, 2012, Bingham McCutchen LLP announced that it has expanded its Investment Management Practice Group with the addition of three partners to its Washington, D.C., office: Thomas S. Harman, W. John McGuire and Christopher D. Menconi.

Ernst & Young LLP Adds Partners to Further Expand Its Asset Management Tax Practice

On July 12, 2012, Ernst & Young LLP announced the appointment of Julie Canty and Carlos A. Schmidt as partners in the firm’s Asset Management Tax practice.  For insight from E&Y in an area of growing importance to investment managers, see “Ernst & Young’s 2012 Global Fraud Survey Highlights Significant Challenges in Dealing with Corruption and Bribery Risks,” The FCPA Report, Vol. 1, No. 3 (Jul. 11, 2012).