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    Apr. 18, 2014

Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation

Private fund management companies, which are typically taxed as partnerships, often wish to incentivize key people with equity or equity-like interests in the management company.  A recent event examined the key elements of partnership taxation and considered the four available means of providing equity interests to employees and other service providers: profits interests, capital interests, options and phantom interests.  The discussion chiefly focused on profits interests, as such interests receive the most favorable tax treatment.  For discussion of another presentation on this topic, see “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers

On March 25 and 26, 2014, at the Princeton Club in New York, Financial Research Associates held the most recent edition of its annual Hedge Fund Due Diligence Master Class.  This article summarizes a series of panels at the event focusing on operational due diligence from the manager perspective.  In particular, this article covers evolving operational due diligence trends, due diligence on emerging hedge fund managers, due diligence on service providers, corporate governance and cybersecurity considerations for hedge fund managers.  A prior article in the HFLR covered an overview presentation at the same event.  See “Seward & Kissel Partner Steven Nadel Identifies 29 Top-of-Mind Issues for Investors Conducting Due Diligence on Hedge Fund Managers,” Hedge Fund Law Report, Vol. 7, No. 13 (Apr. 4, 2014).  And a subsequent article will cover panels at the event focusing on operational due diligence from the investor perspective.

SEC Issues Guidance for Investment Advisers on the Interplay of the Testimonial Rule and Social Media

From the SEC’s perspective, testimonials about investment advisers are misleading for the same reason as cherry picking: because testimonials present positive information without the context of offsetting negative information.  See “How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).  Rule 206(4)-1 under the Investment Advisers Act of 1940 (Act), accordingly, prohibits the use of testimonials by investment advisers.  However, that rule was drafted to cover a static media landscape consisting of print, television and radio; the rule is an imperfect fit with social media, a dynamic, ubiquitous and increasingly commercial channel.  Not surprisingly, the SEC has received a regular clip of questions over the past several years about how the prohibition on testimonials applies to statements about an investment adviser on social media websites.  Last month, the SEC’s Division of Investment Management addressed some of those questions in a Guidance Update.  This article describes the Guidance Update, focusing in particular on the principles in the Guidance Update most relevant to hedge fund managers.  This article concludes with the HFLR’s thoughts on the limited utility of the Guidance Update for hedge fund manager marketing.  See also “Understanding the Regulatory Regime Governing the Use of Social Media by Hedge Fund Managers and Broker-Dealers,” Hedge Fund Law Report, Vol. 5, No. 47 (Dec. 13, 2012).

Best Practices for Hedge Fund Separate Account Risk Management

The Asset Management Group of the Securities Industry and Financial Markets Association (whose members include hedge funds and private equity funds) recently asked its members and other notable asset managers to respond to a survey about separate accounts that they manage.  Among other things, the survey asked respondents to detail their risk management processes and the nature of their approaches toward monitoring counterparty and other risks for separate accounts.  The survey report provides detail on how the surveyed firms monitor counterparty risk for separate accounts; risk metrics typically measured and monitored on an ongoing basis in the course of management of separate accounts by the surveyed firms; and risk management processes (other than counterparty risk management) the surveyed firms typically employ in the management of separate accounts.  This article describes the survey process and the survey findings, focusing in particular on the findings related to risk management for separate accounts.  The survey findings are relevant to hedge fund managers that manage separate accounts in crafting or refining their risk management systems with respect to such accounts.  See also “BNY Mellon Study Identifies Best Risk Management Practices for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 37 (Sep. 27, 2012).

Reed Smith Adds Former General Counsel of UBS Global Asset Management’s Alternative and Quantitative Investments Group

Reed Smith recently welcomed James Hnilo as a partner in its Chicago office.  Hnilo was previously a Chicago-based General Counsel of UBS Global Asset Management’s Alternative and Quantitative Investments hedge fund group.

Prominent Hedge Fund Duo Robert Leonard and Michael Mavrides Join Proskauer in New York

On April 14, 2014, Proskauer announced that Robert Leonard and Michael Mavrides have joined the firm’s Hedge Fund Group as partners in the New York office.  For insight from Mavrides, see “Key Legal and Operational Considerations in Connection with Preparing, Filing and Updating Form PF (Part Two of Three),” Hedge Fund Law Report, Vol. 4, No. 40 (Nov. 10, 2011).

Former CFTC Commissioner Bart Chilton Joins DLA Piper as Senior Policy Advisor in Washington, D.C.

On April 15, 2014, former Commodity Futures Trading Commission Commissioner Bart Chilton joined DLA Piper as a senior policy advisor in its Washington, D.C. office.  For insight from the firm, see “DLA Piper Hedge Fund Valuation Webinar Covers Fair Value Methodologies, Valuation Services, Valuing Illiquid Positions and Handling Valuation Inquiries During SEC Examinations,” Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).

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