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    Sep. 19, 2013

How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?  (Part Two of Three)

Effective hedge fund capital raising requires effective marketers, and incentivizing effective marketers requires paying them for performance.  But paying in-house marketers for performance – paying them what the law calls “transaction-based compensation” or a “salesman’s stake” – requires the manager that employs those marketers to register as a broker.  How, then, can hedge fund managers attract, retain and incentivize top-tier marketers while avoiding a broker registration requirement?  This question has been looming over the hedge fund industry for years, but the question has been perceived as more theoretical than practical because of the absence of specific enforcement activity or speeches by SEC officials directly on the topic.  However, this all changed on April 5, 2013, when David W. Blass, Chief Counsel of the SEC’s Division of Trading and Markets, delivered a speech to the American Bar Association, Trading and Markets Subcommittee, generally addressing this topic.  See “Do In-House Marketing Activities and Investment Banking Services Performed by Private Fund Managers Require Broker Registration?,” Hedge Fund Law Report, Vol. 6, No. 16 (Apr. 18, 2013) (analyzing the Blass speech).  The Blass speech was notable for highlighting questions and SEC concerns rather than providing conclusive answers or concrete guidance.  Blass noted, for example, that “[t]he SEC and SEC staff have long viewed receipt of transaction-based compensation as a hallmark of being a broker” – which the industry already knew – but he did not describe the types of compensation structures or scenarios that, in the SEC’s view, could constitute transaction-based compensation.  Nor has any other SEC speech, enforcement action or other category of authority particularized the “transaction-based compensation” analysis in a comprehensive manner.  In the absence of relevant and reliable regulatory guidance, this article – the second in a three-part series – distills best industry practices for determining when compensation paid to in-house hedge fund marketers constitutes transaction-based compensation.  Or, put another way, this article outlines strategies for structuring the compensation of in-house marketers to avoid the transaction-based compensation designation, and thereby avoid a broker registration requirement.  This article also discusses the Rule 3a4-1 issuer safe harbor and describes how managers can operate in-house marketing activities within the “spirit” of the safe harbor to minimize the risk of triggering a broker registration requirement.  The first installment in this series explored the activities that could trigger a broker registration requirement, as well as other factors that bear on the registration analysis, including the time devoted to marketing by an employee, the employee’s job title and the employee’s other responsibilities.  See “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?  (Part One of Three),” Hedge Fund Law Report, Vol. 6, No. 35 (Sep. 12, 2013).  The third installment will examine alternative solutions for managers looking to structure in-house marketing activities in a manner that accomplishes the fundamental business goals (most notably, capital raising) without triggering a broker registration requirement.

Comparing and Contrasting EMIR and Dodd-Frank OTC Derivatives Reforms and Their Impact on Hedge Fund Managers

In response to the role played by over-the-counter (OTC) derivatives in the 2008 financial crisis, the U.S. and the EU each took steps to mitigate risks associated with OTC derivatives trading.  The U.S. reforms were embodied in the Dodd-Frank Act.  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).  Similarly, in 2012, the EU adopted its own OTC Derivatives reforms, known as the European Market Infrastructure Regulation (EMIR).  Implementation of Dodd-Frank’s OTC derivatives regulations and the EMIR regulations continues to take shape, with several important compliance and effective dates on the horizon.  With this in mind, a recent webinar presented by Dechert LLP provided a timely and detailed discussion of: the current state of implementation of EMIR; certain newly-effective EMIR risk mitigation requirements; implementation of Dodd-Frank’s central clearing and trade execution mandates and their extraterritorial application; and the significant similarities and differences between the U.S. and EU derivatives reforms.  This article summarizes the key insights from that webinar.  The speakers were Dechert partners Abigail Bell, Richard Frase and M. Holland West.

What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part One of Two)

During the past year, a fascinating and important dispute has arisen among the Delaware judiciary over the duties owed by managers of funds, including hedge funds, organized as limited partnerships (LPs) or limited liability companies (LLCs) (together, LPs and LLCs are often called “alternative entities”).  Some Delaware judges hold the view that traditional fiduciary obligations exist, while others believe that they do not, and that the parties’ duties can be defined solely by contract.  The debate has spilled over from judicial decisions to the pages of the New York Times.  And make no mistake, this is an issue with immense “real-world” consequences.  Alternative entities represent a significant business, and that business has been growing over time.  To help investors understand the scope of fiduciary obligations owed by hedge fund managers to their funds and investors, this article – the first in a two-part series – summarizes the development of fiduciary duty law with respect to private investment funds organized as LPs or LLCs in Delaware, as well as issues concerning waiver of fiduciary duties by contract.  The second installment will discuss examples of successful and unsuccessful claims brought against fiduciaries in the LP and LLC contexts, focusing on three theories of liability: breach of fiduciary duties, breach of contract and breach of the implied covenant of good faith and fair dealing.  The authors of this series are Jay W. Eisenhofer and Caitlin M. Moyna, managing director and associate, respectively, at Grant & Eisenhofer P.A.

Aite Group Report Identifies the Building Blocks of Institutional Credibility for Hedge Fund Managers: Operational Efficiency, Robust Risk Management, Integrated Technology and More

Aite Group, an independent financial services research and advisory firm, recently released a report detailing the challenges faced by hedge fund managers in achieving credibility with institutional investors.  Based on interviews with 40 executives at global hedge fund managers, each with more than $900 million in assets under management, the report noted that “[f]irms overwhelmingly recognize that clients and prospects have a heightened interest in the stability and reliability of firm operations, and that maintaining systems which will promote client confidence in operations is now essential.”  The report described a credibility gap between hedge fund managers and institutional investors – a gap that can be plugged (albeit with significant effort and expense) via greater operational efficiency, identification and command of regulatory risk, enhanced risk management generally, appropriate and integrated use of technology, judicious outsourcing of selected functions, improved transparency and better information management.  This article provides greater detail on what it takes, according to Aite’s research, for hedge fund managers to establish institutional credibility on a sustainable basis – a prerequisite for effective marketing and capital raising.  See also “Top Ten Operational Risks Facing Hedge Fund Managers and What to Do about Them (Part Three of Three),” Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

Cayman Grand Court Evaluates Whether a Trade Counterparty Is an Undisputed “Creditor” That Is Permitted to Petition for the Liquidation of a Purported Hedge Fund Debtor

Under Cayman law, only a creditor (whose status as such is undisputed) is permitted to petition for the liquidation of a debtor.  The Grand Court of the Cayman Islands, Financial Services Division (Court), recently clarified whether there was ambiguity as to the creditor status of a trade counterparty of a hedge fund where the trade counterparty petitioned the Court to liquidate the hedge fund.  The petitioner was a counterparty of a hedge fund pursuant to various commodities contracts.  The fund failed to take delivery of – or to pay for – copper cathodes that it had contracted to buy from the petitioner.  The petitioner claimed it was a creditor of the fund and petitioned the Court to appoint liquidators for the fund.  The fund challenged the petitioner’s standing as a creditor to bring the winding-up petition.  This article summarizes the background of the case, the legal analysis and the Court’s ruling.

Bondholders, Including Hedge Funds, Win Latest Round in Battle with Republic of Argentina over Payments on Defaulted Sovereign Bonds

The row between bondholders, including hedge funds, and the Republic of Argentina highlights some of the challenges and risks that investors face when investing in sovereign debt.  In October 2012, the U.S. Court of Appeals for the Second Circuit (Court) ruled that Argentina had violated the pari passu clause in its Fiscal Agency Agreement Bonds (FAA Bonds) when it refused to pay holdout FAA Bondholders who had not exchanged their bonds in various exchange offers.  See “Hedge Funds Win Battle to Enforce Argentina’s Defaulted Bonds as Second Circuit Upholds Ruling that Argentina Violated Pari Passu Clause by Paying on New Bonds While Refusing to Pay on Defaulted Bonds,” Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012).  Recently, the Second Circuit handed another victory to those bondholders, upholding the subsequent November 2012 ruling by Judge Griesa of the U.S. District Court for the Southern District of New York (District Court) indicating that if Argentina made any payment on the bonds issued in exchange for the FAA Bonds (Exchange Bonds), it would also have to repay the FAA Bonds in full.  See “U.S. District Court Rules in Favor of FAA Bondholders in Dispute with Argentina in Clarifying the Scope of Its Injunctions Requiring Argentina to Make ‘Ratable’ Payments on FAA Bonds,” Hedge Fund Law Report, Vol. 5, No. 46 (Dec. 6, 2012).  The Court rejected arguments that the District Court’s injunctions would harm Argentina, the holders of Exchange Bonds, the parties involved in facilitating payments on the Exchange Bonds and the capital markets.  However, the Court stayed the enforcement of the injunctions pending Argentina’s appeal to the U.S. Supreme Court.  This article summarizes the arguments advanced by Argentina and other interested parties and the Court’s reasoning in upholding the District Court’s ruling.

Former SEC Official Tram N. Nguyen Joins Stroock’s Private Funds Practice

On September 16, 2013, Stroock & Stroock & Lavan LLP announced the addition of Tram N. Nguyen as a partner in the firm’s Private Funds Practice Group in Washington, D.C.  For analysis from Stroock, see “Repeal of Dodd-Frank Confidentiality Protection for SEC: What Investment Advisers Lost and What Remains,” Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010); “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds,” Hedge Fund Law Report, Vol. 3, No. 33 (Aug. 20, 2010); and “How Can Offshore Hedge Funds Ensure That Section 10(b) Will Apply to Their Transactions in Securities Not Listed on U.S. Exchanges?,” Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012).

Sidley Welcomes New Private Equity Partners in Its Dallas Office

On September 17, 2013, Sidley Austin LLP announced that later this month, Angela Fontana and Kelly Dybala will become members of Sidley’s Private Equity practice in the firm’s Dallas office.  For analysis from Sidley recently published in the HFLR, see “How Can Hedge Fund Managers Understand Recent SEC Developments to Mitigate Enforcement Risk?,” Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013); “Challenges Faced By, Risks Encountered By and Lessons Learned From First Filers of Form PF,” Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).

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