Aug. 7, 2013

Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two)

Hedge fund compensation discussions have typically focused on upside – on how structuring acumen, tax strategy and legal legerdemain can be used to maximize post-tax compensation to good performers.  See “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  However, in the wake – or in the midst – of unprecedented insider trading and other enforcement in the hedge fund industry, there is a growing recognition among managers that compensation can also be used to mitigate downside.  In particular, hedge fund managers are increasingly exploring, implementing and using employee compensation clawbacks to minimize the ex ante risk of bad acts and mitigate the ex post impact of such acts.  For example, S.A.C. Capital Advisors, LLC (SAC Capital) announced in May 2013 – shortly before various SAC Capital entities were indicted for securities fraud and wire fraud – that it planned to implement a policy allowing the firm to claw back compensation from employees engaged in misconduct.  See “SAC Capital Entities Indicted for Securities Fraud and Wire Fraud in Connection With Employees’ Alleged Insider Trading,” Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).  In October 2012, Morgan Stanley went beyond mere implementation to actual enforcement, suing former FrontPoint Partners, LLC portfolio manager Joseph “Chip” Skowron to recoup compensation paid to Skowron.  Morgan Stanley generally alleged that it had the right to claw back such compensation because of Skowron’s 2011 guilty plea to insider trading and obstruction of justice charges.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Employee compensation clawbacks offer powerful advantages to hedge fund managers, particularly in the current heightened enforcement climate.  They can deter bad acts, preserve reputation and broadcast a manager’s commitment to compliance.  However, clawbacks are not without legal and practical risk, including potential civil and criminal liability for managers that do not properly structure or enforce clawbacks.  To help hedge fund managers in evaluating the utility of clawbacks to their businesses, Hedge Fund Law Report is publishing a two-part series on employee compensation clawbacks in the hedge fund industry.  This article, the first installment, provides an overview of employee clawbacks at hedge fund managers; discusses the types of employees, misconduct and triggering events covered by clawbacks; and highlights the benefits of implementing clawbacks.  The second installment will identify drawbacks of clawbacks; outline legal and other considerations for managers in structuring and enforcing clawbacks; describe documentation of clawbacks; enumerate best practices for structuring clawbacks; and provide sample employee clawback provisions.

DLA Piper Hedge Fund Valuation Webinar Covers Fair Value Methodologies, Valuation Services, Valuing Illiquid Positions and Handling Valuation Inquiries During SEC Examinations

Hedge fund valuation practices are commonly misunderstood, and they are clearly subject to heightened scrutiny by the SEC.  See “SEC Commissioner Aguilar Discusses Insider Trading by Hedge Fund Managers, Valuation and Other Examination and Enforcement Pressure Points,” Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013).  With this in mind, a recent panel discussion hosted by international law firm DLA Piper provided a comprehensive and detailed overview of the valuation deficiencies that have been the subject of recent SEC enforcement actions; outlined valuation best practices for hedge fund managers (including “fair value” valuation methodologies, the use of third-party valuation services and valuation methodologies for illiquid positions); and detailed steps that managers should take to navigate valuation inquiries during SEC examinations.  The expert panel included valuation experts, a former SEC examiner and a former government prosecutor.  This article focuses on the detailed guidance offered by the experienced panel.

Infovest21 White Paper Provides Industry Perspectives on Hedge Fund Fee Pressures, Expense Allocations and Liquidity Terms 

Drawing on contributions from hedge fund managers, marketers, consultants, attorneys and others, a white paper recently published by Infovest21 detailed hedge fund industry views on topics including fee pressures, expense allocations, liquidity terms and side letters.  This article summarizes the salient points from the white paper.

How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part One of Two)

While the core tenets of insider trading law are well-established, the outer bounds of the law are continuously evolving, and the application of established doctrine to hedge fund industry-specific issues remains a challenge for many managers.  This article is the first in a two-part series designed to serve as a guide for hedge fund managers to the laws, regulations and cases that define the scope and contours of relevant insider trading doctrine.  Specifically, this first article discusses important elements of insider trading liability, including what constitutes nonpublic information; what information is considered material; when a fiduciary duty has been breached; and the mosaic theory of insider trading.  The second installment will discuss the misappropriation theory of insider trading; the element of scienter; insider trading consequences of fund investments by affiliates of portfolio companies; special tender offer rules; and penalties.  The author of this article series is Ralph Siciliano, a partner at Tannenbaum Helpern Syracuse & Hirschtritt LLP, and head of the firm’s Governmental and Regulatory Investigations Practice.

Federal Court Disallows Peak Ridge Hedge Fund from Proceeding Against Its Futures Commission Merchant with a Breach of Contract Counterclaim Relating to a Dispute Over Margin Requirements

On July 22, 2013, the United States District Court for the Southern District of New York disallowed Peak Ridge Master SPC LTD o/b/o the Peak Ridge Commodities Volatility Master Fund Segregated Portfolio (Peak Ridge), an energy hedge fund, from proceeding with its breach of contract counterclaim against its futures commission merchant (FCM), Morgan Stanley & Co., Incorporated (Morgan Stanley).  Morgan Stanley sued Peak Ridge in November 2010, alleging that Peak Ridge breached the customer agreement governing its natural gas futures trading account, causing Morgan Stanley to terminate the account and to sue for recovery of $40.6 million in losses it incurred from taking over and liquidating the account.  See “Morgan Stanley Sues Commodities Hedge Fund Peak Ridge for Alleged Failure to Satisfy Margin Calls,” Hedge Fund Law Report, Vol. 3, No. 45 (Nov. 19, 2010).  Peak Ridge counterclaimed for $30 million in damages, arguing that Morgan Stanley breached the customer agreement by wrongfully terminating the trading account; liquidating it in a commercially unreasonable manner; and engaging in an interested transaction with an affiliate.  See “Peak Ridge Hedge Fund Alleges that Morgan Stanley Breached Its Prime Brokerage Agreement with the Fund by, Among Other Things, Tripling Margin Requirements over Ten Months,” Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010). On March 15, 2013, the Court granted in part and denied in part Morgan Stanley’s motion to dismiss Peak Ridge’s counterclaims.  Peak Ridge then filed a motion for reconsideration, claiming that the Court had overlooked a telephone conversation in which Morgan Stanley allegedly gave Peak Ridge the opportunity to cure the margin default that had given rise to Morgan Stanley’s original notice of default.  The Court denied Peak Ridge’s motion for reconsideration.  This article summarizes the Court’s legal analysis and ruling on the motion.  For further discussion on how the Dodd-Frank Act will impact relationships between hedge fund customers and their FCMs, including the likely impact on margin requirements, see “A Practical Guide to the Implications of Derivatives Reforms for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).

Recent U.S. Bankruptcy Court Decision Outlines the Standard for Determining When Creditors, Including Hedge Funds, Will Be Liable for Attorney’s Fees and Punitive Damages When They File Unsuccessful Involuntary Chapter 7 Bankruptcy Petitions

The U.S. Bankruptcy Court for the Southern District of New York recently decided a debtor’s motion for attorney’s fees and punitive damages following the dismissal of involuntary Chapter 7 bankruptcy petitions filed by petitioning creditors, who are affiliates of a hedge fund firm.  Section 303(i) of the U.S. Bankruptcy Code authorizes a court to award debtors such amounts upon dismissal of an involuntary Chapter 7 bankruptcy petition.  The decision is instructive for hedge funds and other creditors in evaluating whether to file such petitions and how to approach the petitioning process in light of the potential for such awards.  This article summarizes the factual background and the Court’s analysis in this case.

Investment Management Partner Michelle Moran Joins Ropes & Gray in London

On August 5, 2013, Ropes & Gray announced that Michelle Moran has joined the London office as a partner in its investment management practice.  For recent coverage of Ropes & Gray materials in the HFLR, see “Tax and Structuring Considerations for Funds Organized to Invest in Master Limited Partnerships,” Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013); “Ropes & Gray Partners Share Insights Gleaned from Successfully Navigating Presence Examinations with Hedge Fund Manager Clients,” Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013).

Sullivan & Cromwell Expands International Private Client Practice to Its London Office

As of August 19, 2013, Sullivan & Cromwell LLP partner Basil Zirinis will move to the firm’s London office.  In addition to international estate and trust planning, family business governance and transition, and trust and estate litigation, Zirinis frequently advises principals of international hedge and private equity funds on sophisticated estate and succession planning strategies.