Aug. 16, 2012

Key Considerations for Hedge Fund Managers in Organizing and Operating Valuation Committees

Among the various conflicts of interest that arise in the hedge fund management business, valuation of portfolio assets may be first among equals.  The specific conflict is this: portfolio managers often play a fundamental role in the valuation of portfolio assets and, at the same time, the compensation of portfolio managers is often tied directly to the valuation of such assets.  Therefore, portfolio managers often have an incentive to assign greater values to portfolio assets.  The higher the valuation, the higher the compensation.  As a general rule, greater difficulty in valuing portfolio assets leads to a more acute valuation conflict.  For a manager that trades exclusively public equity, the valuation conflict would be muted because the value of portfolio assets can be ascertained relatively easily from objective third-party sources.  (Though as the Galleon episode taught, public equity managers have their own issues.  See “Is the ‘Mosaic Theory’ a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?,” Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).)  However, for a manager that trades harder-to-value assets – derivatives, distressed debt, certain real estate and other “hard” assets, etc. – the valuation conflict looms larger.  For assets of uncertain value, a manager can strike its mark within a range of plausible values.  Inasmuch as portfolio managers participate in valuation of such assets and are compensated based on valuation, an actual or apparent conflict exists.  The most obvious way to resolve this conflict would be to remove portfolio managers from the valuation process altogether.  However, the problem with this solution is that, in general, the more difficult to value the asset, the more important the role of portfolio management staff in the valuation process.  As a practical matter, if a smart portfolio manager has spent six months or a year analyzing a complex asset, it is unlikely that a valuation firm or administrator will have greater insight into the value of that asset.  Yes, that portfolio manager’s compensation may be tied directly to the value of the asset.  But, realistically, nobody will know the asset better than the portfolio manager.  (This is one of the reasons why hedge fund managers are increasingly “shadowing” functions performed by their administrators.  See “When and How Should Hedge Fund Managers Shadow Functions Performed by Their Fund Administrators?,” Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).)  So, how can hedge fund managers deploy the unique expertise of investment professionals to arrive at accurate valuations while at the same time mitigating the incentive those professionals have two shade valuations up?  For a growing number of hedge fund managers, the answer to this question is: organize and operate a valuation committee.  But that answer raises as many questions as it resolves.  For example: What exactly is a valuation committee?  Who should be on it?  What should it do?  When should it meet?  And so on.  This article addresses these and related questions.  In the course of doing so, this article provides hedge fund managers with a basic framework for thinking about whether and how to constitute a valuation committee, how to structure the operations of such a committee and mistakes to avoid in organizing and operating committees.

Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part Two of Two)

Over the past several years, U.S. investors have broadened their alternative investment horizons by exploring investment opportunities with Asia-based fund managers.  Asia-based fund managers provide a unique perspective on alternatives which translates to differing investment strategies that appeal to U.S. investors seeking uncorrelated returns or “alpha.”  Nonetheless, Asia-based fund managers that seek to attract U.S. investor capital must recognize the intricate regulations that govern investment manager and fund operations in the U.S. and other jurisdictions, such as the Cayman Islands where many funds are organized to attract U.S. investors.  This is the second article in a two-part series designed to help Asia-based fund managers navigate the challenges of structuring and operating funds to appeal to U.S. investors.  The authors of this article series are: Peter Bilfield, a partner at Shipman & Goodwin LLP; Todd Doyle, senior tax associate at Shipman & Goodwin LLP; Michael Padarin, a partner at Walkers; and Lu Yueh Leong, a partner at Rajah & Tann LLP.  This article describes in detail a number of the key U.S. tax, regulatory and other considerations that Asia-based fund managers are concerned with or should consider when soliciting U.S. taxable and U.S. tax-exempt investors.  The first article described the preferred Cayman hedge fund structures utilized by Asia-based fund managers, the management entity structures, Cayman Islands regulations of hedge funds and their managers and regulatory considerations for Singapore-based hedge fund managers.  See “Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part One of Two),” Hedge Fund Law Report, Vol. 5, No. 31 (Aug. 9, 2012).

CFTC Issues Responses to Frequently Asked Questions Concerning Registration Exemption Eligibility and Compliance Obligations for Commodity Pool Operators and Commodity Trading Advisors

On August 14, 2012, the staff of the Commodity Futures Trading Commission (CFTC) Division of Swap Dealer and Intermediary Oversight issued responses to a number of questions raised by market participants in the aftermath of recent amendments to CFTC rules and regulations, which impacted the registration status and compliance obligations of many commodity pool operators (CPOs) and commodity trading advisors, particularly in light of the elimination of the Rule 4.13(a)(4) CPO registration exemption.  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).  These responses provide answers to registration and compliance questions in a variety of areas.  This article summarizes the guidance that is most pertinent to hedge fund managers.

Real Estate Private Equity Adviser Sues Former Executives Alleging Theft of Trade Secrets

Like private equity advisers, hedge fund managers have increasingly faced the need to zealously guard their trade secrets in an era where technology is both fundamental to proprietary trading strategies and can abet the theft of them.  See, e.g., “Eight Measures That Hedge Fund Managers Can Take to Mitigate the Risk of Theft of Their Trade Secrets,” Hedge Fund Law Report, Vol. 5, No. 21 (May 24, 2012).  A recently filed lawsuit is part of a flurry of recent high profile suits designed to redress – and in some cases criminalize – the theft and misuse of confidential information and proprietary trading strategies.  See “Protecting Hedge Fund Trade Secrets: What a Difference a Year Makes,” Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).  This article summarizes the factual allegations in the complaint in the matter, as well as the causes of action and relief requested.

Acceleration Capital Group 2012 Seed Capital Survey Suggests Difficult Environment for Raising Early Stage Hedge Fund Capital

Acceleration Capital Group (ACG), a division of Arcadia Securities, LLC, has released the results of its 2012 “Seeder Demand” survey.  This article summarizes the ACG survey report, which provides a helpful primer on relevant terms that apply to “seed” capital and a window into how much early stage capital is available and where seeders are likely to deploy that capital.

Tyrus Capital Settles Securities Fraud Case with Brazilian Securities Regulator

Monaco-based hedge fund management firm Tyrus Capital LLP (Tyrus Capital) recently settled a case with Comissão de Valores Mobiliários (CVM), the Brazilian securities regulatory authority.  Tyrus Capital and the CVM reached the settlement in connection with CVM’s investigation into an alleged “fraudulent operation” relating to trading of shares of a Brazilian telecommunications company, GVT (Holding) S.A. (GVT), while Tyrus Capital allegedly possessed nonpublic information about Vivendi’s plans to acquire a controlling stake in GVT.  This article discusses the background of Tyrus Capital, its trading in GVT shares and the details of its settlement with the CVM.  In addition, to provide insight into the thinking and process of the CVM for English-speaking readers, the Hedge Fund Law Report specially commissioned translations of two primary documents: (1) minutes of the CVM’s July 3, 2012 board meeting, at which the Tyrus Capital settlement was discussed (along with many other matters); and (2) an approved commitments document memorializing the CVM’s approval of the Tyrus Capital settlement.  These documents are valuable for U.S., U.K. and other English-speaking hedge fund managers that have or are contemplating investments in Brazil, and who therefore wish to enrich their understanding of the thinking, procedure and enforcement approach of the primary Brazilian securities regulator.  Both documents are included as links in this article.

Marc Luftglass Joins Dechert as Counsel in Financial Services Group

International law firm Dechert LLP announced today that Marc M. Luftglass has joined the firm as counsel in the Financial Services group in New York.  For insight from Dechert on the Euro Zone crisis, see “What Risks – And Opportunities – Does the Euro Zone Crisis Present for Hedge Fund Managers?  An Interview with Richard Frase of Dechert,” Hedge Fund Law Report, Vol. 5, No. 22 (May 21, 2012).

Experienced Derivatives Practitioner Jonathan Lindabury Joins Simpson Thacher

On August 13, 2012, Simpson Thacher & Bartlett LLP announced that Jonathan Lindabury has joined the firm as senior counsel and will work in the firm’s global derivatives practice in New York.  For insight from Simpson partners, see “The Supreme Court Rejects Loss Causation Requirement at Class Certification Stage,” Hedge Fund Law Report, Vol. 4, No. 19 (Jun. 8, 2011).

Corporate Governance Services Firm HighWater Expands to New York with Addition of Matt Auriemma

On August 14, 2012, HighWater Limited, a boutique corporate governance services firm based in the Cayman Islands, announced that it has expanded with a New York-based principal, Matt Auriemma, who will be providing independent director services to investment funds, mostly hedge funds and other alternative investment vehicles.  For more on hedge fund corporate governance, see “Corporate Governance Best Practices for Cayman Islands Hedge Funds,” Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).