Jul. 23, 2015

Tax Court Decision Upholding “Investor Control” Doctrine May Nullify Tax Benefits for Some Policyholders Investing in Hedge Funds through Private Placement Life Insurance

Many hedge funds and other investments whose returns are based on short-term trading are tax inefficient.  Good gross returns can be reduced 50% or more by income taxes (including state and local income taxes).  For over 20 years, investors, including hedge fund investors, have used private placement life insurance (PPLI) and private placement variable annuities to eliminate or defer income tax on hedge fund and other tax-inefficient earnings and, with proper estate planning, reduce or eliminate estate tax as well.  PPLI can provide a large tax-free death benefit for a cost that is often much less than the tax savings gained.  After 30 years of uncertainty and speculation, a recent Tax Court decision confirmed the validity of the “investor control” doctrine, potentially allowing the IRS to impose taxes on investment returns from PPLI and annuities.  In a guest article, Jeffrey S. Bortnick and Philip S. Gross, partners at Kleinberg, Kaplan, Wolff & Cohen, discuss this significant Tax Court decision and its potential ramifications on the hedge fund industry.  For further insight from Gross, see “The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees,” Hedge Fund Law Report, Vol. 7, No. 24 (Jun. 19, 2014); and “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).  For more from KKWC, see “Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement,” Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015).

Seward & Kissel Private Funds Forum Analyzes Trends in Hedge Fund Seeding Arrangements and Fee Structures (Part One of Two)

A hedge fund manager must keep abreast of current trends in hedge fund structures and terms in order to raise capital from investors, anticipate prospective changes in the marketplace and adapt accordingly.  At the recent Seward & Kissel Private Funds Forum, panelists examined key capital raising and fund structuring trends in the hedge fund industry.  This article, the first of a two-part series, summarizes the panelists’ discussion of seeding arrangements and fee structures as well as ERISA and taxation considerations upon hedge fund structuring.  The second article will explore the use of special fund structures, activist strategies and alternative mutual funds.  For additional insight from the firm, 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).  For more on hedge fund seeding arrangements, see “Report Offers Insights on Seeding Landscape, Available Talent, Seeding Terms and Players,” Hedge Fund Law Report, Vol. 8, No. 1 (Jan. 8, 2015); and “New York City Bar’s ‘Hedge Funds in the Current Environment’ Event Focuses on Hedge Fund Structuring, Private Fund Examinations, Compliance Risks and Seeding Arrangements,” Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).

Licensing and International Regulation of Singapore-Based Hedge Fund Managers (Part Two of Two)

As hedge fund managers looking to establish a presence in Asia consider Singapore, they must be aware of licensing requirements imposed by Singapore as well as the impact of external regulatory regimes on such entities.  Morgan Lewis offered an overview of the regulation of managers and fund distribution in Singapore – as well as how other countries’ regulatory regimes affect hedge fund managers established there – as part of the first presentation in its “Going Global” series on forming and operating hedge fund management companies outside the U.S.  Moderated by Morgan Lewis partner Timothy W. Levin, the discussion featured partners Joo Khin Ng, Wai Ming Yap, Daniel Yong and William Yonge.  This second article in our two-part series addresses the main points raised during the presentation with respect to Singapore licensing requirements; “dual-hatting” arrangements; product distribution; and the impact of U.S. and U.K. regulatory regimes on Singapore-based managers.  The first article summarized Singapore corporate structures; employment laws; tax laws; and regulation of financial services activities.  For more on the licensing and regulatory issues involved in establishing a Singapore-based manager, see “Singapore Monetary Authority Proposes New Rules to License Larger Hedge Fund Management Firms,” Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010); and “Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part Two of Two),” Hedge Fund Law Report, Vol. 5, No. 32 (Aug. 16, 2012).

SEC Settlement Suggests that Hedge Fund Managers Have Responsibility for Counterparties’ Reporting Obligations

The SEC recently settled an enforcement action against a registered investment adviser that allegedly provided inaccurate daily trade files to four prime brokers, leading to violations of federal securities laws.  Resulting from operational issues that persisted for almost six years, over half a billion shares were listed inaccurately in prime brokers’ ledgers, and sales of millions of shares were reported inaccurately by prime brokers on blue sheets provided to the SEC and the Financial Industry Regulatory Authority.  In a settlement illustrating the importance of broker-dealer records to the hedge fund industry, the SEC clarified a core component of regulatory investigations as well as a substantial risk to the integrity of the investigative process.  Consequently, hedge fund managers may bear some responsibility for the accurate reporting and compliance obligations of their counterparties.  This article summarizes the background to the order; highlights the SEC’s findings; and discusses the lessons to be learned from the case.  For another recent SEC settlement regarding prime brokers, see “SEC Settlement Suggests that Prime Brokers Have Due Diligence and Disclosure Obligations with Respect to Manager-Provided Hedge Fund Valuations,” Hedge Fund Law Report, Vol. 8, No. 28 (Jul. 16, 2015).  For more on prime brokerage generally, 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).

SEC Enforcement Action Shows Hedge Fund Managers May Be Liable for Failing to Adequately Support Their CCOs

A recent SEC enforcement action asserts the imperative of having an effective and empowered chief compliance officer (CCO) as well as effective compliance policies and procedures – and actually following those procedures. The SEC alleged that an investment adviser and several of its principals failed to provide sufficient support and resources to its CCO, which led to certain compliance failures by the firm.  The SEC also claimed that the adviser neglected to seek best execution for clients by failing to move eligible clients into a certain share class.  This article summarizes the facts giving rise to the enforcement action; the SEC’s specific charges; and the settlement terms.  This settlement comes at a time when there is the sense in the industry that CCOs are increasingly in the SEC’s cross-hairs.  See “SEC Commissioner Issues Statement Supporting Hedge Fund Manager Chief Compliance Officers,” Hedge Fund Law Report, Vol. 8, No. 28 (Jul. 16, 2015); and “SEC Commissioner Speaks Out Against Trend Toward Strict Liability for Compliance Personnel,” Hedge Fund Law Report, Vol. 8, No. 25 (Jun. 25, 2015).  For a general discussion of CCO duties and potential liabilities, 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); and “Dechert Partners and Venor Capital General Counsel Describe the Scope of Supervisory Liability for Hedge Fund Manager Personnel,” Hedge Fund Law Report, Vol. 7, No. 26 (Jul. 11, 2014).

PwC White Paper Explores Hedge Fund Manager M&A Activity

PwC recently issued a white paper on asset manager merger and acquisition activity.  The paper enumerates various factors that affect M&A activity; examines the types of acquisitions and investments asset managers are seeking; provides an overview of recent M&A and IPO activity; and discusses asset manager valuations and accounting rule changes that may affect certain elements of asset manager M&A transactions.  This article summarizes the key takeaways from the PwC paper.  For coverage of PwC’s 2012 study on this topic, see “PricewaterhouseCoopers Study Describes Recent Trends in and Outlook for Asset Manager Mergers and Acquisitions,” Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).  See also “Experts Offer Advice on Initiating and Structuring M&A Transactions in the Asset Management Industry (Part One of Two),” Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015).

Proskauer Welcomes Private Investments Lawyer Niamh Curry to New York Office

Proskauer recently announced that Niamh A. Curry has joined the firm’s private investment funds group as a partner in New York.  Her practice focuses on the structuring and formation of international and domestic private investment funds, including hedge funds, private equity funds, hybrid funds and funds of funds, as well as the purchase of portfolios of stakes in private investment funds and unlisted companies.  For insight from Proskauer partners, 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); “Proskauer Partner and SEC Enforcement Division Veteran Ronald Wood Explains the Implications for Hedge Fund Managers of Structure and Staffing Changes at the SEC,” Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013); and “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters,” Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

Gawain Hughes Joins Morgan Lewis in London

Morgan Lewis recently announced the addition of investment management lawyer Gawain Hughes to its London office.  He advises leading institutional fund managers, administrators and investors on all aspects of fund formation, investment and regulation in the U.K., Europe and beyond, with a particular focus on the private equity funds, real estate and infrastructure sectors.  For insight from the firm, see “How to Structure a Singapore-Based Hedge Fund Manager (Part One of Two),” Hedge Fund Law Report, Vol. 8, No. 28 (Jul. 16, 2015); and “Licensing and International Regulation of Singapore-Based Hedge Fund Managers (Part Two of Two),” in this issue.