Jun. 4, 2015

Modified High Water Mark Provisions May Reduce Risk and Enable Hedge Fund Managers to Retain Talent (Part One of Two)

Following a market downturn or period of bad performance, traditional high water mark provisions – which prevent hedge fund managers from receiving incentive or performance fees until prior losses are recouped – can result in additional pressure on hedge fund managers, even after those managers have begun to turn fund performance around.  Managers may not be able to subsist entirely on management fees and may risk losing key investment personnel without incentive compensation.  To alleviate some of this financial pressure, certain managers may consider using modified high water mark provisions, allowing them to receive lower amounts of incentive compensation during periods when the fund remains below the high water mark.  Seward & Kissel’s 2014 New Hedge Fund Study noted that all of the funds analyzed included some type of high water mark, and 7.4% of funds in the study included a modified high water mark.  See “Seward & Kissel New Hedge Fund Study Identifies Trends in Investment Strategies, Fees, Liquidity Terms, Fund Structures and Strategic Capital Arrangements,” Hedge Fund Law Report, Vol. 8, No. 9 (Mar 5, 2015).  This article, the first in a two-part series, analyzes elements of modified high water mark provisions and explores the benefits of such modified high water marks.  The second article will discuss the industry prevalence of and investor reception to modified high water marks and examine issues that hedge fund managers should consider before implementing a modified high water mark.

How Hedge Fund Managers Can Meet Insurance Requirements Under AIFMD

The alternative investment fund managers directive (AIFMD) imposes specific requirements for hedge fund managers and others marketing to investors in Europe to maintain either adequate capital or professional indemnity/errors & omissions insurance (PI) sufficient to cover certain potential claims.  While alternative investment fund managers (AIFMs) in the E.U. have many AIFMD-compliant products to choose from, PI policies purchased locally by many U.S. and other non-E.U. AIFMs may not meet AIFMD requirements.  In a guest article, Simon Holt, Senior Underwriter – Financial Institutions at Pioneer Underwriting Limited, examines the requirements for PI insurance under AIFMD; the availability of such insurance to AIFMs; common areas where insurance policies fall short of the AIFMD requirements; and AIFMD-compliant insurance solutions available to U.S. AIFMs.  See also “Passports, Platforms and Private Placement: Options for Marketing Funds in Europe in the Post-AIFMD Era,” Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015).

NFA Conference Addresses Examination Processes, Training and Compliance Best Practices for Swap Dealers and Major Swap Participants (Part One of Two)

Under Dodd-Frank, registered swap dealers (SDs) and major swap participants (MSPs) are required to become members of a registered futures association, such as the NFA or the CFTC.  In addition, Section 4s of the Commodity Exchange Act requires registered SDs and MSPs to meet specific requirements with regard to, among other things, capital and margin; reporting and recordkeeping; daily trading records; business conduct standards; documentation standards; trading duties; and designation of a chief compliance officer.  Registered member firms will be examined by the NFA for compliance with multiple substantive regulatory requirements (Section 4s Implementing Regulations).  During the recent NFA Member Regulatory Conference held in New York City, members of the NFA and other industry experts discussed best practices in compliance training, testing and monitoring, and SD and MSP reporting requirements.  This article, the first in a two-part series, highlights the main points regarding the NFA’s examination process and NFA expectations concerning member training programs, compliance monitoring and testing.  The second article will review upcoming examination focus areas; NFA investigations; the Section 4s Implementing Regulation review process; and filings required from SDs and MSPs.  For more on SDs and MSPs, see “CFTC Extends Annual Report Deadline for Futures Commission Merchants, Registered Swap Dealers and Major Swap Participants,” Hedge Fund Law Report, Vol. 8, No. 14 (Apr. 9, 2015).

A Roadmap to the SEC’s Proposed Changes to Form ADV

On May 20, the SEC proposed a number of significant changes to Form ADV and the rules under the Investment Advisers Act of 1940 (Advisers Act).  The changes to Form ADV have three primary goals: to fill in perceived data gaps; to facilitate “umbrella registration” for multiple private fund advisers that operate as part of a single advisory business; and to make certain technical and clarifying amendments.  The changes to the Advisers Act rules primarily expand certain of the “books and records” provisions and make certain technical amendments.  This article summarizes the proposed changes.  For more on Form ADV, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates:  An Interview with Proskauer Partner Robert Leonard,” Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015).

Deutsche Bank Alternative Investment Survey Explores Fee and Liquidity Trends, the Landscape for Investment Intermediaries and Early Stage Investment Terms (Part Two of Two)

Deutsche Bank Global Prime Finance (DB) has released the results of its 13th annual Alternative Investment Survey.  This article, the second of two-part coverage, summarizes the portions of the survey that address fee and liquidity trends; trends among intermediaries; and early stage investing and seeding.  The first article described the survey methodology and demographics and summarized the portions of the survey that deal with allocations to alternative investments in general, and to hedge funds in particular; allocation plans by strategy and region; and investor preferences regarding hedge fund track record, minimum size, and initial and target investment ticket sizes.  For coverage of DB’s November 2013 survey, see “Deutsche Bank Survey Describes the Contours of the Nontraditional Hedge Fund Product Market: Investor Appetite, Performance, Marketing, Fees and More,” Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).  For more on fees, liquidity terms and early stage investments, see “Sidley Partners Discuss Evolving Hedge Fund Fee Structures, Seed Deal Terms, Single Investor Hedge Funds, Risk Aggregators, Expense Allocations, Co-Investments and Fund Liquidity (Part One of Two),” Hedge Fund Law Report, Vol. 7, No. 36 (Sep. 25, 2014).

Marketplace Lending Attracts Growing Interest from Institutional Investors

Peer-to-peer or “marketplace” lending is rapidly growing; although the sector did not exist only a few years ago, marketplace lenders issued $5.5 billion of loans in 2014.  As the marketplace lending industry grows, it is attracting a wider range of participants, including new platform operators, new types of borrowers and new sources of capital, with institutional investors potentially playing a critical role in shaping the industry.  Richards Kibbe & Orbe (RK&O) has released the results of its inaugural survey analyzing marketplace lending.  This article summarizes the results of the survey.  For additional insight from RK&O, see “The Newman/Chiasson Decision Continues to Have Implications for Insider Trading Compliance,” Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015); and “Puffery or Securities Fraud? Litvak Conviction Sheds Light on Permissible Bounds of Bond Sales Talk and the Evidentiary Power of Bloomberg Chats,” Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).

SRZ Expands Litigation Practice with Former SEC Division of Enforcement Official

SRZ recently announced the addition of Charles J. Clark as a litigation partner, resident in the firm’s Washington, D.C. office.  At SRZ, he will represent public companies, financial institutions, private funds and their senior executives in securities-related enforcement proceedings before the SEC, DOJ, FINRA, CFPB and other federal and state law enforcement and regulatory authorities.  For HFLR articles authored by SRZ partners, see “Ten Recommendations to Help Hedge Fund Managers Conduct Successful Internal Investigations,” Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013); and “Hedge Fund Names: What a Hedge Fund Manager Should Do Before It Starts Using a Name,” Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).  For additional insight from SRZ partners, see “Schulte Partner Stephanie Breslow Addresses Gates, Side Pockets, Secondaries, Co-Investments, Redemption Suspensions, Funds of One and Fiduciary Duty,” Hedge Fund Law Report, Vol. 7, No. 45 (Dec. 4, 2014); “Hedge Fund Industry Experts Discuss Presence Examinations Priorities, SEC Investigations and How an Admission in an SEC Settlement May Affect Insurance Coverage,” Hedge Fund Law Report, Vol. 7, No. 26 (Jul. 11, 2014); and “Can Activist Hedge Fund Managers Provide Special Compensation to Nominees That Are Elected to the Board of a Target? An Interview with Marc Weingarten, Co-Head of the Global Shareholder Activism Practice at Schulte Roth & Zabel,” Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).

Justin Gardner Joins Kirkland & Ellis in London

Justin Gardner has recently joined the London office of Kirkland & Ellis as of counsel. Gardner is responsible for establishing and maintaining the Knowledge and Learning Platform for the private funds group in London.  For additional insight from Kirkland & Ellis, see “Portability and Protection of Hedge Fund Investment Track Records,” Hedge Fund Law Report, Vol. 4, No. 40 (Nov. 10, 2011); and “New Tax Law Restricts Hedge Fund Fee Deferral Arrangements,” Hedge Fund Law Report, Vol. 1, No. 22 (Oct. 10, 2008).