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    May 8, 2014

How to Close a Hedge Fund in Eight Steps (Part One of Two)

In concept, hedge funds are “continuously offered” and, unlike their private equity cousins, have no built-in end date.  In practice, however, hedge funds do not last forever.  For various reasons – this article catalogues nine of them – hedge fund managers may wish to close their funds, or may close their funds without wishing to.  More often than not, a hedge fund manager that closes a fund remains in the investment management business, and continues to interact with the same employees, investors and service providers – even if that interaction occurs under a different structure.  Closing a fund is a complex process involving hard legal and business issues, often with an overlay of meaningful personal dynamics.  This article – the first in a two-part series – aims to add some structure to what can be a fraught and unruly process by presenting an eight-step framework for hedge fund closures.  The second article in this series will highlight a number of challenges that managers typically encounter in the course of those eight steps, and suggest best practices for negotiating the challenges.  It should be emphasized that this series is about winding down the business and investment affairs of a hedge fund.  In industry parlance, “closing” also refers to a situation in which a hedge fund is not accepting new investors or investments.  That latter type of “closing” is not the subject of this series, but was the subject of prior articles in the HFLR.  See “Legal and Investment Considerations in Connection with Closing Hedge Funds to New Investors or Investments,” Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010); “Primary Legal and Business Considerations in Structuring Hedge Fund Capacity Rights,” Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).

Private Investment Funds Investing in CLO Equity and CLO Warehouse Facilities

Collateralized loan obligation (CLO) issuance totaled approximately $82 billion in 2013, outpacing 2012 total issuance by more than 50%.  The establishment of private investment funds to invest specifically in CLO securities is likewise on the rise.  This guest article provides a brief overview of CLO transactions, while also outlining certain key issues that funds may wish to consider when investing in CLOs, with a particular focus on investment in the most subordinated tranche of CLO securities, commonly referred to as the CLO “equity.”  The author of this article is Greg B. Cioffi, co-head of Seward & Kissel LLP’s Asset Securitization and CLO Practice Group.  See also “CLO 2.0: How Can Hedge Fund Managers Navigate the Practical and Legal Challenges of Establishing and Managing Collateralized Loan Obligations? (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 26 (Jun. 27, 2013).

Can a Hedge Fund Retroactively Amend Its Partnership Agreement to “Rescind” an Investor’s Redemption Request?

As the subprime mortgage market began to collapse, a hedge fund amended its limited partnership agreement (LPA) to “rescind” a pending redemption request and to impose a prospective lockup of investor funds.  An investor whose redemption request was rescinded by that amendment sued the fund, its general partner and the general partner’s managing member, alleging breach of contract, breach of fiduciary duty and other claims.  A federal court recently ruled on whether the fund breached the LPA because the general partner had no authority to approve an amendment that was “in contravention of” the LPA without the consent of all of the fund’s investors.  This article provides a detailed discussion of the factual and procedural background of this case, and the court’s legal analysis.

Key Accounting and Legal Hurdles in Starting a Hedge Fund Management Business, and How to Surmount Them

According to Citi Prime Finance, hedge fund managers need at least $300 million in AUM to break even.  See “Citi Prime Finance Survey Reveals Levels and Mix of Expenses Incurred by Hedge Fund Managers of Different Sizes, Firm Profitability and Margins, Use of Chargebacks and Impact of Regulations on Expenses,” Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).  According to a paper recently published by Rothstein Kass, “There are plenty of successful funds that launch with $50 million, or even $10 to $20 million, for that matter.”  Who is right?  In a recent interview with the authors of that Rothstein Kass paper, we tackled this question, as well as many others on the accounting and legal mechanics of starting and sustaining a hedge fund management business.

U.S. District Court Rules on Whether a Party to a Repurchase Agreement with a Broker-Dealer That Enters Liquidation Is a “Customer” of the Broker-Dealer under SIPA

Following its collapse in 2008, broker-dealer Lehman Brothers Inc. (Lehman) entered a liquidation proceeding administered by the U.S. Bankruptcy Court for the Southern District of New York (Bankruptcy Court) in accordance with the Securities Investor Protection Act of 1970 (SIPA).  Under SIPA, “customers” of a failed broker-dealer are entitled to special protection in the broker-dealer’s liquidation.  In that regard, several banks that had entered into repurchase agreements with Lehman prior to its collapse sought to have their claims categorized by Lehman’s liquidation trustee as “customer” claims under SIPA.  The trustee refused to do so; and the Bankruptcy Court concurred.  The banks then appealed the Bankruptcy Court’s decision to the U.S. District Court for the Southern District of New York.  This article offers a detailed discussion of the District Court’s decision.  Although broker-dealer liquidations are rare, the Court’s decision should inform the drafting of hedge funds’ prime brokerage and repurchase agreements.  See “Prime Brokerage Arrangements from the Hedge Fund Manager Perspective: Financing Structures; Trends in Services; Counterparty Risk; and Negotiating Agreements,” Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).

K&L Gates Strengthens German Investment Management Practice with Addition of Dr. Till Fock

On May 5, 2014, K&L Gates LLP welcomed Dr. Till Fock as a Berlin-based partner in the firm’s investment management practice.  For insight from K&L Gates, see “K&L Gates Investment Management Seminar Addresses Compliance Obligations for Registered CPOs and CTAs, OTC Derivatives Trading, SEC Examinations of Private Fund Managers and the JOBS Act (Part Two of Two),” Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014); “K&L Gates Seminar Discusses Impact of CFTC Harmonization Rules on Alternative Mutual Funds and Other Registered Investment Companies,” Hedge Fund Law Report, Vol. 6, No. 42 (Nov. 1, 2013); “CPO Compliance Series: Registration Obligations of Principals and Associated Persons (Part Three of Three),” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).

Timothy Becker Joins Choate’s Tax Group

Choate Hall & Stewart LLP recently announced that Timothy Becker has joined the firm as a partner in its Tax Group.  Becker has over 11 years of experience advising private equity funds, venture capital funds and hedge funds, as well as their portfolio companies, on tax and other activities.  See “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014); “Tax Practitioners Discuss Taxation of Foreign Investments and Distressed Debt Investments at FRA/HFBOA Seminar (Part Three of Four),” Hedge Fund Law Report, Vol. 7, No. 4 (Jan. 30, 2014); “Key Hedge Fund Tax Developments in the U.K., the European Union, Ireland, Germany, Spain, Australia, India and Puerto Rico,” Hedge Fund Law Report, Vol. 6, No. 26 (Jun. 27, 2013).

Otterbourg Expands Its Loan Trading Practice with Hiring of John Hanley

On May 5, 2014, Otterbourg P.C. announced that John J. Hanley has joined the firm as a member in the corporate group.  Hanley’s practice focuses on the leveraged loan market, including primary and secondary market and related transactions.  On the secondary market for leveraged loans, see “Should Hedge Funds Include Automatic Termination as a Term of Bank Debt Trades on the New Loan Market Association Forms?,” Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010).  Hanley represents hedge funds, investment banks, trading desks and special purpose vehicles in the purchase and sale of bank loans and other financial claims.  On claims trading, see “What Happens to a Claims Trade If a U.S. Bankruptcy Court and a Foreign Court Disagree on the Validity of the Trade?,” Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013); and “Six Implications for Bankruptcy Claims Traders, Including Hedge Funds, Arising Out of the Third Circuit’s Recent Decision Holding that Claims Subject to Disallowance under Section 502(d) Cannot Be ‘Washed’ through Subsequent Transfers,” Hedge Fund Law Report, Vol. 6, No. 48 (Dec. 19, 2013).

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