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    Feb. 21, 2014

Co-Investments Enable Hedge Fund Managers to Pursue Illiquid Opportunities While Avoiding Style Drift (Part One of Three)

A co-investment offers an investor in a private fund or another investor the opportunity to participate in an investment to the extent that the fund (via its manager) elects not to pursue the entire investment.  Historically, co-investments have been the province of private equity funds, managers and investors.  However, as the range of hedge fund investment strategies has grown to incorporate less liquid approaches, the relevance and use of co-investments has grown as well.  For example, in its 2014 Hedge Fund Manager Survey, Aksia found that nearly one-third of surveyed managers currently offer co-investment opportunities to their investors, and another one-third were considering doing so or would consider doing so if there was sufficient investor demand.  See “Aksia’s 2014 Hedge Fund Manager Survey Reveals Manager Perspectives on Economic Conditions, Derivatives Trading, Counterparty Risk, Financing Trends, Capital Raising, Performance, Transparency and Fees,” Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).  This article is the first in a three-part series analyzing co-investments in the hedge fund context.  In particular, this article discusses five reasons why hedge fund managers offer co-investments; two reasons why investors may be interested in co-investments; the “market” for how co-investments are handled during the negotiation of initial fund investments; investment strategies that lend themselves to co-investments; and types of investors that are appropriate for co-investments.  Subsequent articles in the series will cover structuring of co-investments; common terms (including fees and liquidity); and regulatory and other risks.

A Checklist for Updating Hedge Fund and Service Provider Documents for FATCA Compliance

The Foreign Account Tax Compliance Act (FATCA) established a broad registration, compliance and reporting regime designed to combat tax evasion by providing the IRS with information about U.S. accounts held at foreign financial institutions (FFIs).  The regime imposes 30% withholding on payments to FFIs that have failed to register with the IRS and provide information on U.S. account holders.  The first step in FATCA compliance is for FFIs to register with the IRS and obtain a global intermediary identification number, without which the FFI will be subject to withholding as of July 1 of this year.  In that regard, the April 25 deadline for inclusion in the initial IRS list of registered FFIs is fast approaching, and hedge fund managers with offshore funds or that have non-U.S. investors need to assure that they are fully compliant with FATCA.  A recent presentation covered the critical steps that funds should be taking to prepare for FATCA’s July 1 effective date and the compliance mechanisms they will need to implement to assure compliance with FATCA.  This article summarizes the key takeaways from that presentation.  See also “Understanding the Intricacies for Private Funds of Becoming and Remaining FATCA-Compliant,” Hedge Fund Law Report, Vol. 6, No. 35 (Sep. 12, 2013); and “What Impact Will FATCA Have on Offshore Hedge Funds and How Should Such Funds Prepare for FATCA Compliance?,” Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

SEC No-Action Letter Suggests That There May Be Circumstances in which Recipients of Transaction-Based Compensation Do Not Have to Register as Brokers

In combination with other facts and circumstances, the receipt of transaction-based compensation may trigger a requirement on the part of the recipient to register with the SEC as a broker.  For hedge fund managers, this requirement has been considered problematic because in-house marketing professionals may be construed as brokering securities (i.e., fund interests) and receiving compensation that is based in whole or in part on transaction volumes.  For years, this was a quiet concern among managers, but the topic acquired urgency last April when David W. Blass, Chief Counsel of the SEC’s Division of Trading and Markets, addressed it in a speech.  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).  Since then, managers have been working to determine whether they, their in-house marketing departments or certain members of those departments need to register with the SEC as brokers, or how they should change their compensation or other practices to avoid a broker registration requirement.  See “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement? (Part Three of Three),” Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013).  A recent SEC no-action letter provides further insight into the SEC’s evolving thinking on this topic.  See “Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?,” Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).

Top SEC Officials Discuss Hedge Fund Compliance, Examination and Enforcement Priorities at 2014 Compliance Outreach Program National Seminar (Part One of Three)

On January 30, the SEC hosted the 2014 version of its annual Compliance Outreach Program National Seminar for senior professionals at hedge fund managers and other investment advisers.  Panelists at the seminar included senior SEC officials and CCOs from hedge and private equity fund managers.  The seminar provided first-person insight into the concerns of regulators with direct jurisdiction over hedge fund managers, and also highlighted private sector best practices.  This is the first article in a three-part series summarizing the more noteworthy points made at the seminar.  This article covers SEC Chairman Mary Jo White’s opening remarks, then details the compliance, examination and enforcement priorities outlined by the heads of the relevant SEC divisions.  See also “SEC Provides Recommendations for Establishing an Effective Risk Management Program for Hedge Fund Managers at Its Compliance Outreach Program National Seminar,” Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012); “Trading Practices Session at SEC’s Compliance Outreach Program National Seminar Addresses Need for Holistic Compliance Procedures Dealing with Allocations, Best Execution and Cross Trades,” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).

Can a Hedge Fund Holding Secured Debt Credit Bid Up to the Face Amount of the Debt Or Only Up to the Amount Paid for the Debt?

The right of a secured creditor to bid the secured debt it holds to purchase the collateral securing that debt from the debtor in a Chapter 11 proceeding (a credit bid) is now firmly established.  See “U.S. Supreme Court Resolves Circuit Split and Affirms Secured Creditors’ Right to Credit Bid Under Chapter 11 Plan,” Hedge Fund Law Report, Vol. 5, No. 25 (Jun. 21, 2012); and “Seventh Circuit Holds that Secured Lenders Must Have the Opportunity to Credit Bid in Asset Sales Under a Chapter 11 Plan,” Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  However, when the secured creditor purchased that debt at a steep discount, as is often the case in distressed debt transactions executed by hedge funds, issues may arise as to whether the creditor is entitled to credit bid up to the face amount of the debt it holds, or only a portion of that amount.  A U.S. District Court recently addressed this issue, and its analysis has implications for hedge funds that invest in secured credit.

Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Three of Three)

This is the third installment in our three-part series addressing the evolution of U.S. pension plan management and governance.  This installment focuses on what the next phase of pension evolution may look like and also highlights how, at least in one area, governance research can be developed to be a true value-added tool for public pension plans and their trustees, potentially guiding the design of their governance structures and investment infrastructures.  The first installment highlighted how growth of public pension plans and fundamental legal or regulatory change, when combined with increasing pension portfolio complexity and the current underfunded status of most U.S. public pension plans, will be the forces defining pension evolution in the twenty-first century.  The first installment also included an explanation of why the growth of public pension plans and fundamental legal or regulatory change impacted pension plan evolution through the twentieth century.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part One of Three),” Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).  The second installment described the current governance structures of today’s public pension, focusing on the board of trustees and pension staff; briefly reviewed current governance research about public pension trustees, and the importance of both adequate staff infrastructure and effective delegation as features of good governance; and explained the new delegation rule and why it should be a key element of long-term organizational change within the U.S. pension system.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Two of Three), Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).  The author of this series is Von M. Hughes, a Managing Director at Pacific Alternative Asset Management Company, LLC.

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