• |

    Aug. 1, 2013

A Compilation of Important Insights from Leading Law Firm Memoranda on the Implications of the JOBS Act Rulemaking for Hedge Fund Managers

On July 10, 2013, as required under the JOBS Act, the SEC adopted final rules to relax long-standing restrictions on general solicitation and general advertising applicable to securities offered pursuant to Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933.  The rule changes are expected to become effective on September 23, 2013.  The SEC also adopted rule changes that disqualify felons and other bad actors from being able to rely on the Rule 506 safe harbor.  In addition, the SEC proposed amendments to Regulation D, Form D and Rule 156 that would significantly expand filing and other requirements with respect to Rule 506 offerings.  See “SEC JOBS Act Rulemaking Creates Opportunities and Potential Burdens for Hedge Funds Contemplating General Solicitation and Advertising,” Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  Since the SEC published its final and proposed JOBS Act rules, many of the leading law firms with hedge fund practices have issued memoranda describing the rules and their anticipated impact on hedge fund managers.  In an effort to assist our subscribers in understanding the range and diversity of informed opinion on this topic, the Hedge Fund Law Report has compiled and analyzed many such memoranda.  This article embodies our analysis.  In particular, this article provides a detailed summary of the final and proposed JOBS Act rules, then provides a compilation of noteworthy insights and practice points from the memoranda.  In the process, this article conveys the consensus view (and identifies differences of opinion) on questions including: Will more hedge fund issuers engage in general solicitation and advertising following adoption of the JOBS Act rules?  What are the primary hurdles in using Rule 506(c)?  What “speedbumps” are created by proposed Advance Form D?  Should private funds take advantage of the new advertising relief?  And what is the expected impact of the bad actor disqualification rule?  See also “Schulte, Cleary and MoFo Partners Discuss How the Final and Proposed JOBS Act Rules Will Impact Hedge Fund Managers and Their Funds,” Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).

A Roadmap and Recommendations for Hedge Fund Managers Facing Presence Examinations

In the fall of 2012, the SEC unleashed its latest tactic aimed at identifying potential issues and deficiencies for newly registered investment advisers – the “presence examination.”  See “OCIE Warns Newly Registered Hedge Fund Advisers to Watch Out for ‘Presence Examinations,’” Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  These “focused, risk-based” examinations came on the heels of the recent influx of SEC registrants (resulting from Dodd-Frank legislation) and are driven in large part by the limited resources available to the SEC staff.  Namely, of the more than 4,000 private fund advisers registered with the SEC (as of April 2013), more than 1,500 registered since July 21, 2010, representing an increase of more than 50 percent in registered private fund advisers.  Through the Presence Examination initiative, the SEC is looking to reach as many of these new registrants as possible, substituting mini risk-based examinations in lieu of traditional “full-blown” examinations, which have historically proved ineffective at reaching the masses.  As of April 2013, approximately 20 percent of all advisers that have been registered for more than three years had never been examined.  In an April 16, 2013 speech at the 2013 NASAA Public Policy conference, SEC Commissioner Elisse B. Walter noted that the Presence Exam initiative creates a way to “meaningfully engage, assess risk, and establish a presence and credibility” with new registrants, serving as a reminder that “we’re out here, keeping an eye on things.”  Many newly registered private fund managers will face presence examinations in the next two years.  In a guest article, Jillian Timmermans, a Partner and Vice President at Cordium, provides a roadmap and practical recommendations that will help such managers navigate the presence examination process more effectively.

Tax and Structuring Considerations for Funds Organized to Invest in Master Limited Partnerships

Many businesses that operate in the energy and natural resources sector are organized as master limited partnerships (MLPs) due to favorable tax treatment, including income tax deferral for investors in the early years of their MLP investments.  Funds established to own MLPs can provide diversified exposure to the MLP sector for investors.  While many of these funds are organized as registered funds, hedge fund managers willing to establish such registered funds may be positioned to capitalize on the opportunity to attract investors interested in tax-efficient energy and natural resource investing.  See generally “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).  A recent panel discussion sponsored by Ropes & Gray LLP discussed various options that are available to fund managers interested in establishing an MLP-focused fund.  Panelists, including Michael Doherty and Amy Snyder, both partners at Ropes & Gray LLP, as well as guest speaker Robert Prado, a director at PricewaterhouseCoopers LLP, addressed the tax benefits provided by MLPs and tax and structuring considerations for funds seeking to invest in MLPs.  This article summarizes the primary lessons from the panel discussion.

Expert Panel Provides Roadmap for Hedge Fund Managers Looking to Present Performance in Compliance with GIPS

Historically, there has been little uniformity in how hedge fund managers present performance results.  As a result, hedge fund investors have faced difficulty in comparing returns across managers.  At the same time, the Global Investment Performance Standards (GIPS) – a set of voluntary best practices designed to ensure consistency in the presentation of performance results, and one of the few potential sources of uniformity – have lacked meaningful guidance for hedge fund managers.  This changed in 2012, when the GIPS Executive Committee issued the Guidance Statement on Alternative Investment Strategies and Structures (Guidance Statement) to provide hedge fund-specific guidance.  Since then, institutional investors and their consultants have frequently encouraged hedge fund managers to present performance results in compliance with GIPS.  See “Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  Yet despite the Guidance Statement, many hedge fund managers are still struggling to understand and navigate the complexities of GIPS compliance.  Against this backdrop, ACA Compliance Group recently hosted a webinar addressing GIPS compliance, focusing on issues specific to hedge fund managers, such as valuation, construction of GIPS composites, calculation of returns, side pocket reporting and benchmark selection.  Managers that provide more clarity in their performance results may be able to court institutional investors more frequently and effectively.  This article summarizes the main points from the webinar.  For more on the GIPS standards, see “A Step-By-Step Guide to GIPS Compliance for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).

Are Disgorgement Payments to the SEC an Insurable Loss under New York Law?

A recent ruling by New York’s highest court involving an insured broker-dealer’s market timing settlement with the SEC may impact hedge fund managers evaluating SEC settlements requiring disgorgement payments where fund investors, rather than the manager, benefited from manager misconduct.  This article summarizes the factual allegations and legal arguments underpinning the court’s decision in this case.  Managers in such circumstances would also be well-advised to determine whether disgorgement payments would be covered by their directors and officers and errors and omissions insurance policies.  See “Hedge Fund D&O Insurance: Purpose, Structure, Pricing, Covered Claims and Allocation of Premiums Among Funds and Management Entities,” Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011).

Recent Decision Highlights the Perils for Hedge Fund Managers of Failing to Understand Early Redemption Provisions in Bond Indentures

If not carefully understood, early redemption rights contained in bond indentures can become a source of dispute and litigation, as demonstrated by an action recently brought in federal court by an issuer seeking to enforce its right to redeem its notes early and at par.  Although the parties in the case were the issuer and the indenture trustee, the court’s decision nonetheless impacted at least one hedge fund that purchased the notes, possibly believing that the period for the issuer to redeem the notes early at par had elapsed.  This article summarizes the factual background of the case and the court’s decision.  In such scenarios, in addition to the fact that the issuer may, in its discretion, have the right to redeem notes early and at par under issuer-favorable conditions, hedge funds and other investors may suffer other adverse economic consequences.  For example, in early, at-par redemption scenarios, a redeemed hedge fund may have difficulty reinvesting amounts previously invested in the notes at equally attractive entry prices and interest rates.  However, the goals and incentives of hedge funds that invest in fixed income depend on the facts and circumstances of the investment.  Sometimes, for example, managers may want an issuer to redeem depreciated notes at par.  See, e.g., “U.S. Supreme Court Declines to Review District Court Decision Holding that Collective Action by Hedge Funds in Pressing Issuer to Redeem Its Long-Term Notes at Par Did Not Violate Antitrust Laws,” Hedge Fund Law Report, Vol. 6, No. 23 (Jun. 6, 2013).

Derivatives and Structured Finance Partner Dean Naumowicz Joins Latham & Watkins in London

On July 30, 2013, Latham & Watkins announced that Dean Naumowicz has joined the firm’s London office as a partner in the Corporate Department.  Naumowicz has experience advising on derivatives and structured products including credit, equity and commodity transactions.  See “Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations between Hedge Fund Managers and Futures Commission Merchants regarding Cleared Derivative Agreements,” Hedge Fund Law Report, Vol. 6, No. 16 (Apr. 18, 2013); “Structured finance: 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),” Hedge Fund Law Report, Vol. 6, No. 26 (Jun. 27, 2013); “A Practical Guide to the Implications of Derivatives Reforms for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013); “Don Muller and Joshua Satten of Northern Trust Hedge Fund Services Discuss the Impact of OTC Derivatives Reforms on Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).

Most-Read Articles