Jun. 27, 2013

CLO 2.0: How Can Hedge Fund Managers Navigate the Practical and Legal Challenges of Establishing and Managing Collateralized Loan Obligations? (Part Two of Two)

CLO deal volumes in 2012 and the first quarter of 2013 clearly indicate that investor appetite for CLO investments has returned.  At the same time, establishing and managing CLOs can present attractive revenue-generating opportunities for fund managers.  Nonetheless, these opportunities are accompanied by new challenges for managers, which are outlined in this two-part series of articles.  This second article in the series presents a brief overview of various legal developments that have altered or may alter the CLO management landscape, including (1) risk retention rules, the Volcker Rule and various Commodity Futures Trading Commission requirements under the Dodd-Frank Act, (2) enhanced registration requirements under the Investment Advisers Act of 1940, (3) the implementation of the Foreign Account Tax Compliance Act provisions of the Internal Revenue Code (Code), and (4) Sections 409A and 457A of the Code.  The first installment of the series touched upon several of the practical challenges CLO managers can expect to encounter in establishing a CLO in the current market environment.  Specifically, the first article addressed a number of common documentation requests by anchor investors in the most senior and subordinated (or equity) classes of the CLO capital structure and explored certain inherent difficulties in obtaining warehouse financing in connection with the ramp up of the CLO portfolio prior to the initial issuance of CLO notes.  See “CLO 2.0: How Can Hedge Fund Managers Navigate the Practical and Legal Challenges of Establishing and Managing Collateralized Loan Obligations (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).  The authors of this series are Greg B. Cioffi and Jeff Berman, both partners in Seward & Kissel’s Structured Finance and Asset Securitization Group, and David Sagalyn, an associate in the group.  See also “Key Legal and Business Considerations for Hedge Fund Managers When Purchasing Collateralized Loan Obligation Management Contracts,” Hedge Fund Law Report, Vol. 3, No. 13 (Apr. 2, 2010).

Key Hedge Fund Tax Developments in the U.K., the European Union, Ireland, Germany, Spain, Australia, India and Puerto Rico

Tax considerations have a powerful impact on hedge fund manager compensation and investor returns.  Accordingly, tax considerations are front and center when managers select domiciles for their funds and management entities; structure funds and related entities; and enter and exit positions.  Hedge fund taxation is inherently complicated and continuously changing; and the complexity is compounded for managers investing and operating globally.  To bring some clarity and coherence to this challenging subject, a recent program examined completed and pending changes to relevant tax laws in the U.K. (including the “reporting fund” regime), the European Union (including the financial transaction tax), Germany, Ireland, Spain, Australia, India and Puerto Rico.  Participants in the program provided detailed explanations of the current state of the tax law in each jurisdiction, how the law is likely to change and best practices for structuring and investing around current and anticipated tax law.  This article memorializes the insights from the program, focusing in particular on practical consequences for hedge fund managers of tax law changes.  For more on tax reporting considerations relevant to hedge fund managers, see “What Critical Issues Must Hedge Fund Managers Understand to Inform Their Preparation of Schedules K-1 for Distribution to Their Investors?,” Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).

How Can Hedge Fund Managers Structure, Negotiate and Implement Expense Caps to Amplify Capital Raising Efforts? (Part Two of Two)

This is the second article in our two-part series on hedge fund expense caps.  This article catalogues the benefits and burdens of caps – from the perspectives of managers and investors – then offers six concrete recommendations to managers for implementing caps in a way that emphasizes the benefits while mitigating the burdens.  The first article in this series defined expense caps and discussed whether expense caps can be offered only to select investors; expenses typically covered by caps; structuring of expense caps; and the levels at which expense caps are set.  See “How Can Hedge Fund Managers Structure, Negotiate and Implement Expense Caps to Amplify Capital Raising Efforts? (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).

PLI Panel Addresses Marketing and Brokerage Issues Impacting Hedge Fund Managers, Including Marketing to State Pension Plans, Capital Introduction and Broker Implications of In-House Marketing Activities

At the Practising Law Institute’s Hedge Fund Compliance and Regulation 2013 program, an expert panel comprised of SEC attorneys and industry practitioners shared insights on topics involving marketing and brokerage issues that impact hedge fund managers.  Among other things, the wide-ranging discussion covered the regulatory perils that accompany marketing to government pension funds, including local, state and federal pay-to-play and lobbying laws; capital introduction programs; the European Union’s Alternative Investment Fund Managers Directive; broker regulations implicated by in-house fund marketing activities; and investment-related regulations impacting broker-dealers and their hedge fund clients, including the Market Access Rule, circuit breakers, the use of dark pools, short selling, securities lending and large trader reporting.  This article summarizes the highlights from the panel discussion that are most pertinent to hedge fund managers.  See also “PLI Panel Provides Regulator and Industry Perspectives on Ethical and Compliance Challenges Associated with Hedge Fund Investor Relations,” Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013); “PLI Panel Provides Regulator and Industry Perspectives on SEC and NFA Examinations, Allocation of Form PF Expenses, Annual Compliance Review Reporting and NFA Bylaw 1101 Compliance,” Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

Recent SEC Settlement with Hedge Fund Manager Highlights the Challenge of Qualifying for the “Separate Accounts” Exception from Rule 105’s Trading Restrictions

In the past five years, the SEC has demonstrated its commitment to stamping out “manipulative” trading activity through numerous prosecutions of investment advisers for violating Rule 105 under Regulation M under the Securities Exchange Act of 1934 (Rule 105), which generally prohibits a person from selling an equity security short that is the subject of a firm commitment public offering and then purchasing such securities from an underwriter or broker participating in the offering if the short sale occurred in the five-day period ending with the pricing of such securities in the offering (restricted period).  See “Touradji Capital Settlement Suggests That Having Employee Training on Rule 105 under Regulation M Without Policies to Prevent Violations Will Not Insulate a Firm From SEC Enforcement,” Hedge Fund Law Report, Vol. 4, No. 46 (Dec. 21, 2011).  The most recent of these enforcement actions, initiated against a large hedge fund manager, has resulted in a settlement order in which the SEC clearly communicated that it is very challenging for traders to qualify for the separate accounts exception from application of Rule 105.  This article describes the factual and legal background of the action, the SEC’s legal analysis and the remedies.  See also “Brookside Settlement Suggests That in Calculating Disgorgement Based on a Rule 105 Violation, the SEC Will Look to the Number of Shares Purchased in a Secondary Offering Rather Than the Number of Shares Sold Short Prior to the Offering,” Hedge Fund Law Report, Vol. 4, No. 22 (Jul. 1, 2011).

SEI Report Sizes, Segments and Maps the Retail Alternatives Market

In a recent report, SEI offered a commanding and comprehensive view of the growing market for retail alternatives such as alternative mutual funds, UCITS and related products.  See “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  The report accomplishes three important things.  First, it sizes and segments the market for retail alternatives – data that can greatly assist in sharpening marketing efforts for such products.  Second, the report catalogues the challenges faced by hedge fund managers launching retail alternative products – challenges relating to investor screening, liquidity management, distribution and fee compression, among others.  Third, the report provides a checklist of structuring and regulatory considerations for hedge fund managers looking to enter the retail alternatives market.  This article summarizes the main action points from the report.  In so doing, this article aims to serve as a reference tool for hedge fund managers looking to enter what, by all accounts, appears to be a sizable, complex and paradigm-shifting market.  See also “Dechert Partners Aisha Hunt and Richard Horowitz Discuss Strategies and Challenges for Hedge Fund Managers Wishing to Enter the Alternative Mutual Fund Space,” Hedge Fund Law Report, Vol. 6, No. 20 (May 16, 2013).

Michele J. Alexander Joins Lowenstein Sandler’s Tax Group

On June 24, 2013, Lowenstein Sandler LLP announced that Michele J. Alexander has joined the firm as a partner in its Business Tax Counseling & Structuring Practice.  For analysis from other Lowenstein attorneys published in the HFLR, see “Tribune Bankruptcy Highlights the Importance of Close Reading of Indenture Agreements by Hedge Funds That Trade Bankruptcy Claims or Distressed Debt,” Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012); “Do Hedge Funds Really Pose a Money Laundering Threat? A Decade of Regulatory False Starts Raises Questions,” Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012).

Experienced Hedge Fund Litigator Named Associate Regional Director for Enforcement in SEC’s New York Office

On June 14, 2013, the Securities and Exchange Commission announced the promotion of Amelia A. Cottrell to Associate Regional Director for Enforcement in the agency’s New York Regional Office.  She has worked on, among other things, the SEC’s insider trading case against hedge fund manager CR Intrinsic.  See “Five Takeaways for Other Hedge Fund Managers from the SEC’s Record $602 Million Insider Trading Settlement with CR Intrinsic,” Hedge Fund Law Report, Vol. 6, No. 12 (Mar. 21, 2013); “U.S. District Court Conditionally Approves CR Intrinsic Settlement with SEC Despite ‘Neither Admit Nor Deny Liability’ Provision,” Hedge Fund Law Report, Vol. 6, No. 17 (Apr. 25, 2013).  She also contributed to the insider trading case against Tiger Asia Management.  See “How Can Hedge Fund Managers Understand and Navigate the Perils of Insider Trading Regulation and Enforcement in Hong Kong and the People’s Republic of China,” Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013); “SEC Settles Insider Trading Action against Tiger Asia Management,” Hedge Fund Law Report, Vol. 5, No. 48 (Dec. 20, 2012).

The Hedge Fund Law Report Will Not Publish an Issue Next Week and Will Resume Its Regular Publication Schedule the Following Week

Please note that the Hedge Fund Law Report will not publish an issue next week, the week starting July 1, 2013 (and including the July 4 holiday), and will resume its regular publication schedule the following week, the week starting July 8, 2013.