Feb. 7, 2013

How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital? (Part Two of Two)

Alternative mutual funds present opportunities for hedge fund managers to diversify their product offerings and to attract retail investors.  At the same time, retail investors are clamoring for opportunities to invest with the most talented investment professionals, many of which are attracted to working with hedge fund firms.  However, hedge fund managers that launch alternative mutual funds face significant business challenges and regulatory concerns unique to the registered fund world.  This two-part article series is designed to familiarize hedge fund managers with alternative mutual funds and to help them determine whether it is advisable to launch such funds.  This second article details specific steps necessary to launch an alternative mutual fund; costs and fees associated with launching and operating an alternative mutual fund; distribution of alternative mutual funds; investment restrictions applicable to alternative mutual funds; and a key conflict of interest hedge fund managers face when operating alternative mutual funds and traditional hedge funds side-by-side.  The first installment discussed the structure of alternative mutual funds; the investment strategies typically employed by alternative mutual funds; why hedge fund managers consider launching alternative mutual funds; some drawbacks of launching alternative mutual funds; and the various ways in which hedge fund managers can participate in the alternative mutual fund business.  See “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital? (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

CPO Compliance Series: Registration Obligations of Principals and Associated Persons (Part Three of Three)

Commodity pool operators (CPOs) that are registered, or registering, with the U.S. Commodity Futures Trading Commission (CFTC) and that are, or are becoming, members of the National Futures Association (NFA), need to comply with numerous CFTC and NFA requirements.  One of the key compliance obligations is the requirement for a CPO to (1) list its principals on its registration application with the NFA (Form 7-R) and (2) register its associated persons (APs) with the NFA (Form 8-R) and submit a Form 8-R for each natural person principal so that the NFA can perform a background check.  This article details who or what is a principal and who is an AP; outlines the process for registration of APs and listing of natural person principals; and describes some basic supervisory obligations applicable to APs and principals as employees of the CPO and provides some general guidance on how to comply with those supervisory obligations.  This article is the third of a three-part series of articles that focuses in detail on various compliance obligations of CPOs under CFTC and NFA regulations and guidance.  The first article covered NFA Bylaw 1101, which addresses conducting business with non-NFA members.  See “CPO Compliance Series – Conducting Business with Non-NFA Members (NFA Bylaw 1101) (Part One of Three),” Hedge Fund Law Report, Vol. 5, No. 34 (Sep. 6, 2012).  The second article covered the various prohibitions and guidelines for marketing activities and promotional materials for both CPOs and commodity trading advisors under various CFTC regulations and NFA compliance rules.  See “CPO Compliance Series – Marketing and Promotional Materials (Part Two of Three),” Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012).  For additional coverage of each of these topics and other relevant topics, see “Do You Need to Be a Registered Commodity Pool Operator Now and What Does it Mean If You Do? (Part One of Two),” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  The authors of this article and the other articles in this series are Stephen A. McShea, General Counsel and Chief Compliance Officer of Larch Lane Advisors LLC; Cary J. Meer, a partner at K&L Gates LLP; and Lawrence B. Patent, of counsel at K&L Gates LLP.

Don Muller and Joshua Satten of Northern Trust Hedge Fund Services Discuss the Impact of OTC Derivatives Reforms on Hedge Fund Managers

In an attempt to reduce systemic risk from over-the-counter (OTC) derivatives trading, the Dodd-Frank Act fundamentally changed the mechanics of the execution, clearing, settlement and recording of OTC derivatives trades.  Among other things, the Dodd-Frank Act mandates central clearing and exchange trading for many OTC derivatives.  These reforms will have financial, legal, compliance and operational implications for hedge fund managers.  Among other things, hedge fund managers will need to determine whether they wish to adhere to the August 2012 International Swaps and Derivatives Association, Inc. (ISDA) Dodd-Frank Protocol, which is a supplement that will amend their ISDA agreements with swap dealers and major swap participants.  See “Katten Partner Raymond Mouhadeb Discusses the Purpose, Applicability and Implications of the August 2012 ISDA Dodd-Frank Protocol for Hedge Fund Managers, Focusing on Whether Hedge Funds Should Adhere to the Protocol,” Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  To explain some of the impact of these reforms on hedge fund managers, the Hedge Fund Law Report recently interviewed Don Muller, the Global Head of Middle Office Services at Northern Trust Hedge Fund Services, and Joshua Q. Satten, the Global Head of OTC Structured Products at Northern Trust Hedge Fund Services.  Specifically, our interview covered topics including: historical OTC derivatives trading practices; the impact of central clearing and exchange trading of OTC derivatives transactions; the Dodd-Frank Act OTC derivatives reporting requirements; posting of margin on OTC derivatives trades; changes in collateral practices for OTC derivatives trades; the financial impact of such reforms on hedge fund managers; solutions available to facilitate OTC derivatives trading post-reforms; and the impact of OTC derivatives reforms on hedge fund service providers.

New York Appellate Court Decision Illustrates the Litigation and Publicity Risk Inherent in Sloppy Drafting of Hedge Fund Manager Operating Agreements

Oftentimes, principals of a hedge fund manager find negotiating and documenting their business arrangements to be an uncomfortable task which can result in miscommunications of their intentions as well as haphazard negotiations and sloppy documentation.  A recent case involving a contract dispute between hedge fund manager principals provides lessons on the importance of rigorously and accurately reducing such agreements to writing.  For more on the potential consequences of sloppy drafting, see “Hedge Fund Manager May Be Personally Liable to Third-Party Marketers Based on Ambiguities in Marketing Agreement,” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  In short, a hedge fund principal sued his partner for an unpaid portion of his profit share.  The litigants disagreed concerning the validity and enforceability of various purported oral and written amendments (one of which is alleged to have been forged) to their existing operating agreement and whether the plaintiff’s conduct constituted an implicit waiver of his right to receive the unpaid portion of his profit share pursuant to the existing operating agreement.  This article discusses the factual background in this case as well the decisions and analyses by the state trial and appellate courts.

Federal Court Opinion Clarifies Two Important Components of the Fiduciary Duty of a Hedge Fund Manager with Benefit Plan Investors

In a decision of importance to hedge fund managers that have or solicit investments from private pension plans, a federal district court recently analyzed various Employee Retirement Income Security Act (ERISA) issues in connection with a purported class action lawsuit.  The suit was initiated by a pension plan against a manager of a plan assets hedge fund of funds, its managing member, their officers and directors and several funds as a result of losses allegedly caused by an investment in a Ponzi scheme.  Managers of plan asset hedge funds (and in some cases their principals) are subject to heightened regulation pursuant to ERISA, as compared to most hedge fund managers.  For a discussion of regulations impacting plan asset fund managers, see “Speakers at Katten Seminar Outline ERISA Concerns for Managers of Plan Asset Hedge Funds,” Hedge Fund Law Report, Vol. 5, No. 12 (Mar. 22, 2012); and “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part One of Three),” Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010).  The pension plan claimed that the defendants were “fiduciaries” within the meaning of ERISA and that they had breached two essential duties imposed on them as ERISA fiduciaries: They failed to manage the plan’s assets prudently and caused the plan assets fund to engage in prohibited transactions.  The plan also asserted federal securities fraud, breach of contract, breach of fiduciary duty and various state law claims.  The defendants moved to dismiss the pension plan’s complaint for failure to state a cause of action.  This article summarizes the court’s decision, with emphasis on its analysis of the pension plan’s ERISA claims.

SEC Asset Management Unit Chief Bruce Karpati Addresses Private Equity Enforcement Trends, Initiatives and Priorities

On January 23, 2013, Bruce Karpati, Chief of the Asset Management Unit (AMU) of the SEC’s Division of Enforcement, delivered a speech at the Private Equity International Conference in New York.  In the course of that speech, Karpati addressed: the AMU’s activity in the private equity space; the likely increase in private equity enforcement activity going forward; the Division of Enforcement’s risk analytics initiatives; AMU’s enforcement priorities; recent enforcement actions; and specific pointers for private equity firm COOs and CFOs for reducing enforcement risk.  This article summarizes key points from Karpati’s speech.

Akin Gump Adds Senior Hedge Fund Tax Professional in London

On February 4, 2013, Akin Gump Strauss Hauer & Feld announced that Jon Hanifan has joined the firm to lead its European hedge fund tax advisory team.  For a recent comparative analysis from Akin Gump, see “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012).