Apr. 2, 2015

Investment Allocation Conflicts Arising Out of Simultaneous Management of Hedge Funds and Alternative Mutual Funds Following the Same Strategy (Part One of Three)

Managers that simultaneously manage hedge funds and alternative mutual funds (or liquid alternative funds) have a fiduciary duty to manage each fund in the best interests of that fund’s investors.  In addition, Section 17(d) and Rule 17d-1 under the Investment Company Act of 1940 (the ’40 Act) require joint enterprises involving a mutual fund and certain affiliates to be fair to the mutual fund.  See “SEC and FSA Impose Heavy Fines on Investment Manager for Failing to Address Conflicts of Interest Associated with Side by Side Management of a Registered Fund and a Hedge Fund,” Hedge Fund Law Report, Vol. 5, No. 21 (May 24, 2012).  However, simultaneous management is rife with potential conflicts, such as an incentive for the manager to allocate trades to the hedge fund over the mutual fund in certain circumstances (including in order to earn higher fees in the hedge fund), thereby benefiting the manager and hedge fund investors to the detriment of the mutual fund investors.  This article, the first in a three-part series, provides an overall assessment of conflicts of interest in simultaneous management; outlines the conflicts inherent in allocation of investments between a hedge fund and an alternative mutual fund following the same strategy; and discusses leverage limits, liquidity issues and diversification requirements applicable to alternative mutual funds.  The second article in this series will discuss other conflicts arising out of simultaneous management of a hedge fund and alternative mutual fund, including cross transactions, soft dollar allocations, valuations, reporting, operational conflicts and marketing conflicts.  The third article will address ways to mitigate such conflicts of interest.  See also “Eight Important Regulatory and Operational Differences Between Managing Hedge Funds and Alternative Mutual Funds,” Hedge Fund Law Report, Vol. 7, No. 44 (Nov. 20, 2014).

RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence

As institutional investors seek better returns or mitigation of downside risk in their portfolios, they frequently turn to hedge funds.  A recent program sponsored by the Regulatory Compliance Association provided an overview of the basic due diligence steps that such investors take with regard to investments with hedge fund managers, and focused on alignment of interests, indemnification provisions, liquidity, investor consent and the issues raised when investing through or alongside separate accounts.  The program was moderated by Scott Sherman, a Managing Director at Blackstone and Senior RCA Fellow from Practice.  The other speakers were Maura Harris, a Senior Vice President at The Permal Group; Nicole M. Tortarolo, an Executive Director at UBS A.G.; and David Warsoff, Executive Director at J.P. Morgan Alternative Asset Management.  For more on investor due diligence, see “Operational Due Diligence from the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits,” Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).  For fund managers’ perspectives on investor due diligence, see “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014).  For more on due diligence from the Regulatory Compliance Association, see “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices,” Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  This month, the RCA will be hosting its Regulation, Operations and Compliance (ROC) Symposium in Bermuda.  For more on ROC Bermuda 2015, click here; to register for it, click here.  For a discussion of another RCA program, see “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them,” Hedge Fund Law Report, Vol. 8, No. 5 (Feb. 5, 2015).

U.K. Supreme Court Resolves Ambiguity in Standard LMA Terms for Sales of Loan Participations

A recent decision by the U.K. Supreme Court has resolved an ambiguity in the Loan Market Association Standard Terms and Conditions for Par Trade Transactions.  This article summarizes the facts underlying the dispute, the relevant provisions of the LMA terms and the Supreme Court’s reasoning.  For more on loan transactions governed by the LMA terms, see “The Impact of Asymmetric Information, Trade Documentation, Form of Transfer and Additional Terms of Trade on Hedge Funds’ Trade Risk in European Secondary Loans (Part Two of Two),” Hedge Fund Law Report, Vol. 4, No. 38 (Oct. 27, 2011); “Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two),” Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011); and “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).

FRA Compliance Master Class Highlights Operational and Regulatory Issues for Hedge Fund Managers Considering Launching Alternative Mutual Funds

Seeking to access a vast source of capital that is not readily accessible by traditional hedge funds, hedge fund managers have been launching or contemplating the launch of alternative mutual funds.  Aside from the opportunity to expand the manager’s investor base, launching an alternative mutual fund allows a hedge fund manager to expand and diversify its product offering.  In the U.S., such funds are governed by the Investment Company Act of 1940 and, as such, must meet a broad array of regulatory and compliance requirements.  See “The First Steps to Take When Joining the Rush to Offer Registered Liquid Alternative Funds,” Hedge Fund Law Report, Vol. 7, No. 42 (Nov. 6, 2014).  For a general discussion of ways that hedge fund managers can enter the retail alternatives space, see “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  Speakers at FRA LLC’s Private Investment Funds Compliance Master Class – including Marie Noble, partner, general counsel and CCO at SkyBridge Capital; and Robert Schwartz, general counsel and CCO at Loeb King Capital Management – discussed issues to consider when converting a hedge fund strategy to a mutual fund structure, due diligence of mutual fund service providers, alternative mutual fund compliance and marketing.  This article highlights the key points discussed on each of the foregoing topics.  For additional coverage of this conference, see “Five Steps That CCOs Can Take to Avoid Supervisory Liability, and Other Hedge Fund Manager CCO Best Practices,” Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For a discussion of another kind of conversion, see “Legal Mechanics of Converting a Hedge Fund Manager to a Family Office,” Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).

SEC Settlement Emphasizes the Importance – and Limits – of Fund and Transaction Disclosure

A recent SEC settlement emphasizes the importance that the SEC places on proper documentation of transactions and disclosure of conflicts of interest to investors in hedge funds, even if those transactions and conflicts do not actually result in material financial loss to investors.  This article provides a detailed discussion of the settlement, then highlights the implications for the hedge fund industry arising out of the SEC’s order.  For more on transactions between hedge fund managers and funds, see “When and How Can Hedge Fund Managers Engage in Transactions with Their Hedge Funds?,” Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  For more on loans from hedge funds to managers, see “Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement with Philip A. Falcone and Harbinger Entities,” Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).