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    Dec. 5, 2013

How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or At the End of Its Life? (Part One of Two)

Investment risk takes many forms, and one often overlooked by many hedge fund investors is: How will I protect my investment in the event that the fund fails or decides to cease doing business?  The fund investors that do not adopt a head-in-the-sand approach have various options available to help them maximize the return of and return on such investments.  This is the first article in a two-part guest article series highlighting the various measures available to investors who have made an investment in a fund that is at one of three distinct stages towards or at the end of its commercial life.  This article addresses investor options during the first two stages: where there are warning signs that the fund may be heading into financial difficulty or when the fund is placed into management wind down.  The second article in the series will address measures available to investors during the third stage: when the fund is placed into formal liquidation, either by the court or by voluntary winding up.  The authors of this series are Christopher Russell, Jonathan Bernstein and Jeremy Snead.  Russell and Snead are, respectively, a partner and an associate in the litigation department of Appleby Cayman; Bernstein is a senior associate in the corporate and investment funds department.

How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part One of Two)

Hedge fund due diligence is a courtship process in which institutional investors and their consultants spend considerable time and resources getting to know a manager’s philosophy, people, processes and performance.  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).  Headline performance numbers (phrased gross or net of fees), statements of strategy and similar routine and comparable data points are necessary but not sufficient to tell a manager’s story, or to convey what is unique in the manager’s value proposition.  See “Can Hedge Fund Managers Use Gross (Rather Than Net) Results in Performance Advertising? (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 42 (Nov. 1, 2013).  Investment and operational due diligence focus not only on what performance the manager achieved, but also on how the manager achieved that performance.  And there is no more comprehensive or persuasive way to convey the “how” of a manager’s processes than to walk investors step-by-step through the lifecycle of actual investments – in other words, to present case studies.  However, the instinct of managers (and their marketing and sales people) to put their best feet forward when presenting case studies is constrained by general and specific prohibitions in the federal securities laws and rules.  Generally, the federal securities laws and rules prohibit materially misleading statements or omissions in communications with investors and potential investors.  Applied to case studies, this general prohibition typically means that managers cannot discuss good investments without also discussing bad investments.  Specifically, Rule 206(4)-1(a)(2) under the Investment Advisers Act of 1940 (Advisers Act) – the so-called “cherry picking” rule – prohibits a manager from disseminating, directly or indirectly, advertisements that refer to specific past profitable recommendations unless the advertisement offers to provide a list of all of the manager’s recommendations for at least the past year.  In short, managers often have a compelling business rationale for telling their stories via case studies (and likely will have more opportunities to do so now that the JOBS Act rules have been finalized), but managers’ ability to present case studies is constrained by a patchwork of law and regulation.  See “A Compilation of Important Insights from Leading Law Firm Memoranda on the Implications of the JOBS Act Rulemaking for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013).  This article is the first in a two-part series designed to untangle that patchwork and enable managers to market via case studies within the scope of applicable authority.  In particular, this article describes the purposes and typical contents of case studies; identifies the types of managers and strategies that use and benefit from case studies; and highlights risks associated with use of case studies in marketing, including a discussion of the cherry picking rule.  The second article in the series will discuss additional risks of using case studies and provide best practices for managers wishing to use case studies in marketing.

ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing, OTC Derivatives Reforms, Insider Trading Best Practices, the JOBS Act, AIFMD and Activist Investing (Part Two of Three)

Hedge fund industry thought leaders recently shared their insights on legal, operational and other issues impacting hedge fund managers during the 7th Annual Hedge Fund General Counsel Summit hosted by ALM Events.  This second installment in our three-part series covering the summit discusses topics including the impact of over-the-counter derivatives reforms on fund managers (including a discussion of new mandatory trade reporting, clearing and execution requirements as well as CFTC cross border rules); opportunities and challenges associated with distressed debt investing (including a discussion of opportunities to participate in Chapter 11 proceedings, considerations in claims trading and risks of distressed debt investing); and best practices to address insider trading risks.  The first installment discussed strategies for handling government investigations and challenges facing chief compliance officers, including dual-hatting and potential supervisory liability.  The third installment will provide regulatory updates on the JOBS Act, the Alternative Investment Fund Managers Directive and new Canadian and U.S. initiatives that will impact activist investing strategies.

Ernst & Young’s 2013 Global Hedge Fund and Investor Survey Describes Trends in Asset Sourcing, Alternative Mutual Funds, Customized Solutions, Staffing, Administrator Shadowing, Expense Pass-Throughs and Outsourcing

Ernst & Young (EY) recently released the results of its seventh annual Global Hedge Fund and Investor Survey.  The survey revealed the perspectives of hedge fund managers and investors on topics including strategic priorities, operating revenues and costs, investor allocations to hedge funds, new products and services, expense pass-throughs, administrator shadowing, outsourcing and predictions for future hedge fund industry trends.  This article summarizes the key findings of the survey.  For coverage of EY’s 2012 survey, see “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).

Annual Thompson Hine Hedge Fund Seminar Offers Insights on Organizing Alternative Mutual Funds, AIFMD, FATCA and the JOBS Act

Thompson Hine LLP recently hosted its ninth annual hedge fund seminar, entitled “Regulatory & Compliance Issues Confronting Hedge Funds Today.”  During the seminar, Thompson Hine partners and other panelists discussed critical issues confronting hedge fund managers, including considerations for organizing and operating alternative mutual funds, as well as the impact on hedge fund managers of the Alternative Investment Fund Managers Directive, the Foreign Account Tax Compliance Act and the JOBS Act.  This article describes salient points on each topic discussed during the seminar.

SEC’s First Deferred Prosecution Agreement with an Individual Underscores Its Commitment to Eliciting Cooperation in Cases Against Hedge Fund Managers

On November 12, 2013, the SEC announced that it had entered into a deferred prosecution agreement (DPA) with Scott Herckis, a former hedge fund administrator who cooperated extensively with the agency in taking action against Berton M. Hochfeld, a hedge fund manager who misappropriated more than $1.5 million from the fund.  Herckis marks the first time the SEC has entered into a DPA with an individual rather than a corporation.  The SEC’s stated goal with respect to DPAs is to encourage individuals and companies to assist the agency with its investigations by voluntarily providing the agency with information about misconduct.  In exchange, the SEC agrees not to prosecute cooperators for their own violations, provided they agree to certain prohibitions and undertakings.  The government’s use of DPAs has been criticized by, among others, Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York, who decries the government’s willingness to refrain from prosecuting those who have participated in wrongdoing in exchange for their cooperation.  This article summarizes the factual background surrounding the DPA, the terms of the DPA, the implications of the SEC’s new approach for hedge fund managers and Rakoff’s critique of the government’s use of DPAs.

Private Equity Lawyer Kirk A. Radke Joining Willkie Farr & Gallagher

On December 5, 2013, Willkie Farr & Gallagher LLP announced that Kirk A. Radke will be joining the firm’s Private Equity Practice Group as a partner in New York.  For insight from Willkie, see “Investment Research and Insider Trading on ‘Outside Information,’” Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011).

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