Jul. 18, 2013

SEC JOBS Act Rulemaking Creates Opportunities and Potential Burdens for Hedge Funds Contemplating General Solicitation and Advertising

When the JOBS Act (formally the Jumpstart Our Business Startups Act) was signed by President Obama last year, it directed that one of its most transformational provisions – the relaxation of decades-long limits on public offerings of unregistered securities – not go into effect until the Securities and Exchange Commission (SEC) set rules to implement the changes.  After more than a year of delay, the agency’s implementing rules are now here.  But the SEC at the same time proposed a raft of controversial additions to the new rules, ensuring that the politically charged debate around the JOBS Act – in which consumer advocates and certain lobbies (such as that for the mutual fund industry) vigorously oppose the law and its opportunities for private funds while many business groups push for it – will continue.  The awkward compromise offered by that two-step has nods to both sides of the debate.  On the one hand, the SEC rules reflect only one of many changes called for by JOBS Act opponents, that being some increase in procedures to confirm investor qualifications (this addition was expected, although the final guidance is more strongly worded than in the SEC’s original proposal from a year ago).  See “JOBS Act: Proposed SEC Rules Would Dramatically Change Marketing Landscape for Hedge Funds,” Hedge Fund Law Report, Vol. 5, No. 34 (Sep. 6, 2012).  On the other hand, the SEC proposal now asks whether the agency should add a number of new requirements that will cheer the opposition.  Lest there be any mistake that the SEC is flashing a yellow light, the release also says that the agency’s examination staff will be charged with monitoring new offering activity in the private funds industry and that firms that expand their marketing profile should carefully consider their compliance infrastructure before doing so.  On the same day that the SEC adopted the JOBS Act rules, it also adopted new rules that foreclose reliance on Regulation D in the case of securities offerings involving felons and other “bad actors.”  In a guest article, Nathan J. Greene, a partner and Co-Practice Group Leader in the Investment Funds Group at Shearman & Sterling LLP, describes the above-referenced JOBS Act rulemaking in more detail and highlights important implications for hedge fund managers.

An Examination of Exit Rights for Hedge Funds Making Non-Controlling Private Equity Investments

A hedge fund contemplating a non-controlling private equity (PE) investment faces a set of concerns beyond those common to PE investments generally.  These concerns boil down to a simple question: “How will we exit?”  For investor liquidity and other reasons, the exit analysis should be front-of-mind for a hedge fund that is willing to make a PE investment without running the portfolio company show.  The hedge fund should complete the analysis before committing capital.  In a guest article, William Q. Orbe and Scott C. Budlong, a founding partner and partner, respectively, at Richards Kibbe & Orbe LLP, explore a variety of exit-related rights that a non-control private equity investor (the Investor) may wish to obtain – or at least try to obtain – while negotiating and documenting its transaction.  Not all of these concepts fit every situation.  And sometimes the Investor simply won’t have the leverage to get everything it wants.  But familiarity with the contents of the exit-rights toolbox at least will allow the Investor to maximize its negotiating efforts, and to adjust its valuation based on a precise understanding of whatever exit rights are ultimately available.

Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part Two of Two)

Investment consultants play an important and growing role in the investment decision-making processes of institutional investors.  See “Goldman Prime Brokerage Survey Relays the Views of Institutional Investors on Hedge Fund Fees, Manager Selection, Due Diligence, Return Expectations, Liquidity, Managed Accounts, UCITS and Alternative Mutual Funds,” Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).  Therefore, hedge fund managers that seek institutional investors for their hedge funds must understand who investment consultants are, how they operate and how they think, as well as the legal risks and benefits of working with consultants.  This article, the second in a two-part series, analyzes those legal risks and benefits, focusing in particular on pay to play, lobbying, general solicitation, advertising, fiduciary duty, conflicts of interest and related concerns.  The first article in this series provided an overview of the services and service models employed by consultants, discussed how consultants are compensated and explored how consultants think about manager selection.  See “Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 27 (Jul. 11, 2013).

Insurance Dedicated Funds Offer Hedge Fund Exposure Plus Tax, Underwriting and Asset Protection Advantages for Investors

Variable universal life insurance enables policy purchasers to invest the cash values of their policies in different investment products.  A primary benefit of such policies (in addition to the insurance) is that the income the investments generate can grow tax-free, and the death benefit on the policy is not subject to income or capital gains tax.  Because those investments are considered securities, most offerings of variable life insurance are registered with federal and state securities regulators.  Private placement life insurance is variable life insurance that, as its name suggests, is only offered through private placements to sophisticated investors.  Purchasers of private placement life insurance can get exposure to hedge funds through funds known as “insurance dedicated funds” (IDFs).  Because these IDFs may provide tax benefits for investors, they present an opportunity for managers willing to organize such funds to raise capital from investors desiring tax-efficient strategies.  However, managers aiming to organize IDFs face some strategy and liquidity constraints and must be sensitive to other structuring considerations.  To help managers understand IDFs, Kleinberg, Kaplan, Wolff & Cohen, P.C. recently hosted a webinar that provided an overview of the structure of IDFs, their benefits to investors and the requirements for setting up IDFs and assuring favorable treatment.  This article summarizes the key take-aways from that discussion.

Deutsche Bank’s Hedge Fund Consulting Group Provides a Roadmap to Hedge Fund Managers in Navigating the Operational Due Diligence Process

Deutsche Bank’s Hedge Fund Consulting Group recently released a report analyzing the results of a survey of institutional investors on operational due diligence (ODD).  Survey participants included 68 investors that collectively manage or advise $2.13 trillion in total assets, including $764 billion of assets invested in hedge funds.  Among other things, the report discussed the composition of ODD teams; the frequency and duration of ODD visits; how investors approach the ODD process; circumstances in which ODD teams have and use investment veto rights; priority focus areas for investor ODD reviews; operating and allocation preferences (including which expenses investors perceive as acceptable for charging to the fund); and recommendations to managers in preparing for ODD reviews.  The insights from investors captured in the Deutsche Bank report can help hedge fund managers refine their approach to the ODD process.  In turn, a well-informed, coherent and credible approach to ODD can pay dividends to hedge fund managers in the form of increased allocations and more effective marketing.  This article extracts insights from the report that managers can incorporate directly into their responses to due diligence inquiries.  For more on ODD, see “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012); and “FRA Conference Juxtaposes Manager and Investor Perspectives on Hedge Fund Due Diligence (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 23 (Jun. 6, 2013).

WilmerHale and Deloitte Identify Best Legal and Accounting Practices for Hedge Fund Valuation, Fees and Expenses

On June 19, 2013, WilmerHale and Deloitte jointly hosted a webinar entitled “Valuation Issues, SEC Examinations & Enforcement Actions.”  The panel of attorneys and auditors discussed the SEC’s heightened focus on private fund manager practices related to valuation, calculation of fees and allocation of expenses.  Panelists also outlined compliance best practices for hedge fund managers relating to valuation, fees, expenses and other areas on which regulators are focused.  For more on those focus areas, see “OCIE Director Bowden Identifies Five Key Lessons for Hedge Fund Managers from Recent Presence Examinations,” Hedge Fund Law Report, Vol. 6, No. 21 (May 23, 2013).  This article summarizes salient points from the webinar.

Investment Management Attorney Stuart Fross Joins Foley in Boston

On July 16, 2013, Foley & Lardner LLP announced that Stuart Fross has joined the firm as a partner in the Private Equity and Venture Capital Practice in its Boston office.