Hedge fund managers and investors sometimes view the same topic very differently.  See, e.g., “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  The all-important topic of hedge fund due diligence is no exception to this industry truism.  This divergence of interests, experience and expectations was in evidence at a recent conference entitled “Hedge Fund Due Diligence Master Class,” and hosted by Financial Research Associates LLC (FRA).  But, equally if not more importantly, the FRA event also highlighted areas of shared concern among managers and investors, as well as specific due diligence techniques that benefit both constituencies.  Hedge fund due diligence has become a condition precedent of the initiation and continuation of a relationship between a manager and investor.  It is front and center in terms of importance.  Therefore, the concerns, best practices, due diligence approaches and stories from the trenches shared at the FRA event hold important lessons for investors as well as managers.  The Hedge Fund Law Report is memorializing the key lessons from the event in a two-part series of articles.  This article, the first in the series, addresses key priorities and red flags that investors should look for during the manager diligence process; the tension between increased portfolio transparency and protection of proprietary information; and investor perspectives on enterprise risk management by managers.  The second installment will discuss custody and valuation issues; strategic planning for sustainable due diligence programs; recent regulatory developments and how managers should respond; questions that investors should ask during diligence; and ways in which managers are improving their due diligence processes. Read full article …

This is the second article in our two-part series summarizing the key insights from a provocative recent report by Citi Prime Finance (Citi).  The report describes a massive opportunity for capital raising in so-called “liquid alternative” investment products, including alternative mutual funds, ETFs and UCITS.  At the same time – and not surprisingly – the report discusses a blurring of the lines between traditional, hedge and private equity (PE) fund managers as all three categories of managers pursue strategies that broadly fall under the rubric of “liquid alternatives.”  It’s a large pie indeed, but with many players looking for a piece.  To help managers increase their odds of obtaining a piece, this article provides a comprehensive summary of the portions of the Citi report covering the “convergence” of services provided by traditional, hedge and PE managers; the “credibility gap” faced by firms that seek to operate in the convergence zone; how traditional asset managers and PE firms are turning to hedge fund managers for talent as they seek to offer liquid alternatives; and the challenges and choices facing hedge fund managers as the market for liquid alternatives develops.  Part one of this series summarized the portions of the Citi report covering the shifting role that hedge funds play in an institutional investor’s portfolio; how regulatory changes have affected the hedge fund market and helped to make liquid alternatives more attractive; the growing “retail” demand for liquid alternatives; and Citi’s predictions for the growth of the retail alternative market.  See “Citi Prime Finance Report on Liquid Alternatives Describes a Massive Capital Raising Opportunity for Hedge Fund Managers Willing to Go Retail (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 21 (May 23, 2012). Read full article …

A decision recently handed down by the U.K. High Court of Justice involving a dispute over software created by a co-founder of a hedge fund manager highlights the risk of failing to clearly document intellectual property rights at the inception of a manager’s business.  The decision also emphasizes the importance of clearly delineating, in hedge fund manager partnership and employment agreements, ownership of software and other intellectual property developed or modified by principals, employees or contractors of the manager.  This article summarizes the facts and legal analysis underpinning the court’s decision.  See also “Protecting Hedge Fund Trade Secrets: What a Difference a Year Makes,” Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012). Read full article …

The SEC can request various remedies in civil actions brought against hedge fund managers, including a bar prohibiting the manager from serving as an officer or director of a public company.  Because such a remedy can significantly impact a defendant’s ability to make a living, it is not surprising that such bars are challenged.  A federal district court recently ruled on a hedge fund manager’s challenge to an officer and director bar requested by the SEC in a civil action where the manager has been accused of misusing hedge fund assets to make concentrated investments in a financially-distressed company for which he served as the chairman of the board of directors.  One of the two arguments advanced by the manager was that the statutory bar was not an “appropriate” remedy given the factual allegations.  This article describes the factual background in this case; the legal arguments advanced; and the court’s ruling on the manager’s motion for partial judgment on the pleadings.  For a detailed discussion of the SEC’s complaint in this matter, 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). Read full article …

On May 17, 2013, a federal district court enjoined a hedge fund and its manager (defendants) from continuing to pursue a Financial Industry Regulatory Authority, Inc (FINRA) arbitration against a bank and its affiliated broker-dealer (plaintiffs).  For detailed coverage of the plaintiffs’ complaint in this matter, see “Recent Lawsuit Addresses the Question of When a Hedge Fund Manager Is a Customer of a Broker-Dealer for FINRA Arbitration Purposes,” Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  FINRA Rule 12200 requires FINRA members to arbitrate disputes, in the absence of a written agreement, if requested by “customers.”  The court determined that the defendants were not “customers” of the broker-dealer affiliate, and therefore arbitration was not required.  The decision is likely to curtail the availability of arbitration to hedge funds and their managers seeking to assert claims against certain underwriters of securities.  This article summarizes the factual background of the case and the court’s analysis.  See also “How Hedge Fund Managers Can Use Arbitration Provisions to Prevent Investor Class Action Lawsuits,” Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012). Read full article …

On May 30, 2013, Reed Smith LLP announced the addition of James A. Mercadante as a partner in its firmwide Corporate & Securities Group in the firm’s New York office.  Among other representations, Mercadante has structured “Dutch auctions” and other specialized transactions for secondary market transfers of hedge fund interests.  See “Report Dissects Private Equity Secondaries Market: Buyer and Seller Motivations, Industry Players, Fundraising Trends and 2013 Predictions,” Hedge Fund Law Report, Vol. 6, No. 20 (May 16, 2013). Read full article …