Aug. 6, 2015

ESMA Recommends Extension of the AIFMD Passport for Hedge Fund Managers and Funds in Certain Non-E.U. Jurisdictions

While E.U. hedge fund managers are able to market their funds throughout Europe via AIFMD’s passport mechanism, that option is currently unavailable to non-E.U. managers wishing to market in Europe.  Instead, non-E.U. alternative investment fund managers and non-E.U. alternative investment funds (AIFs) are subject to the national private placement regime of each Member State where the AIF is marketed or managed.  ESMA published its “Advice to the European Parliament, the Council and the Commission on the application of the AIFMD passport to non-E.U. AIFMs and AIFs” on July 30, 2015.  This article examines the assessment criteria and methodology adopted by ESMA; highlights the key commentary regarding the six jurisdictions assessed; summarizes stakeholder feedback; and discusses certain implications of the advice.  See “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); “Navigating the Patchwork of National Private Placement Regimes: A Roadmap for Marketing in Europe by Non-EU Hedge Fund Managers That Are Not Authorized Under the AIFMD,” Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014); and “Application of the AIFMD to Non-EU Alternative Investment Fund Managers (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).  For more on marketing under AIFMD, see “Four Approaches to Fund Marketing and Distribution Under the AIFMD,” Hedge Fund Law Report, Vol. 7, No. 21 (Jun. 2, 2014); and “What Is the Difference Between Marketing and Reverse Solicitation Under the AIFMD?,” Hedge Fund Law Report, Vol. 7, No. 42 (Nov. 6, 2014). 

Practical Consequences of the Use of Benchmarks to Measure Hedge Fund Performance by Pension Funds and Institutional Investors (Part Two of Two)

Hedge funds seek absolute returns and, unlike mutual funds, are not legally required to identify a benchmark or report performance against certain indices.  However, as pension funds and other institutional investors evaluate hedge funds’ performance, either explicitly or implicitly, against benchmarks, hedge fund managers themselves may also provide benchmarked performance information.  The first article in our two-part series explored the extent to which, and the means by which, pension funds and institutional investors employ benchmarks in their assessments of hedge fund performance.  This article examines the practical consequences of subjecting hedge funds to performance benchmarks, including whether this practice could cause hedge funds to shift away from their traditional absolute returns-based performance emphasis, toward a focus on benchmarked results; whether hedge fund managers have themselves been influenced to publish benchmarked performance information and the implications of doing so; and the parameters surrounding the use of benchmarks for hedge fund performance evaluation.  For discussion of another practice of measuring hedge fund performance, see “Legal Risks for Hedge Fund Managers of Using Target Returns (Part Two of Two),” Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015).

New York Appeals Court Rules on Applicability of New York Labor Law to Hedge Fund Incentive Compensation

A recent decision by New York’s Appellate Division, First Department (Manhattan) is of great significance to hedge fund managers doing business in the state.  The ruling is important to hedge fund managers because it applies to the type of incentive-based compensation that is often made available to many financial industry employees – which typically depends on the overall success of the business or a team of employees – and determines whether such compensation merits the special protections provided by the Labor Law.  In a guest article, Sean R. O’Brien and Sara A. Welch, managing partner and counsel, respectively, at O’Brien LLP, discuss the Court’s decision in light of the Labor Law, as well as the ramifications of the ruling on the hedge fund industry.  For more from O’Brien and Welch, see also “Hedge Fund Incentive Compensation Not Subject to Wage Claim under New York Labor Law,” Hedge Fund Law Report, Vol. 7, No. 14 (Apr. 11, 2014); and “How Can Hedge Fund Managers Protect Themselves Against Trade Secrets Claims?,” Hedge Fund Law Report, Vol. 7, No. 19 (May 16, 2014).  For commentary on other rulings relating to hedge fund employee compensation, see “New York Court Assesses the Validity of a Former Portfolio Manager’s Claim against a Fund Management Company for Unvested Performance Compensation,” Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015); “New York Federal District Court, Applying ‘Faithless Servant’ Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading,” Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014); and “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

Hedge Funds Are Required to Disclose Basket Option Contracts and Basket Contracts

The IRS has recently set its sights on “basket option contracts” and “basket contracts,” suspecting that certain hedge funds and other taxpayers have improperly used those structures to defer recognition of ordinary income and short-term gains on assets within the basket, and to claim long-term capital gains treatment on exercise of the option or termination of the contract.  IRS Notice 2015-47 deems basket option contracts to be “listed transactions.”  IRS Notice 2015-48 deems basket contracts to be “transactions of interest.”  The Notices apply to transactions in effect on or after January 1, 2011; taxpayers who were parties to basket option contracts or basket contracts on or after that date will have to report them retroactively, even for years for which they have already filed returns.  This article summarizes the key provisions of each Notice.  For more on taxation of options, see “Tax Practitioners Discuss Taxation of Options and Swaps and Impact of Proposed IRS Regulations,” Hedge Fund Law Report, Vol. 8, No. 7 (Feb. 19, 2015).  For a discussion of other strategies that investors have used to seek long-term gains treatment on investments, see “Tax Practitioners Discuss Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles at FRA/HFBOA Seminar (Part Four of Four),” Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).  The IRS has previously targeted certain swaps.  See “IRS Directive and HIRE Act Undermine Tax Benefits of Total Return Equity Swaps for Offshore Hedge Funds,” Hedge Fund Law Report, Vol. 3, No. 12 (Mar. 25, 2010).

Citi Survey Examines Adaptation and Evolution of Hedge Funds for Institutional Portfolios (Part Two of Three)

As institutional investor portfolio construction has evolved over the past 50 years from a basic split between equities and bonds to more complex allocations in a diverse group of investments, hedge fund managers have adapted to such evolution, offering products tailored to the changing appetites of institutional investors.  In its sixth annual asset management Industry Evolution Report, Citi Business Advisory Services (Citi) examines these “convergence products” and their availability to investors and fund managers.  This article, the second in a three-part series, addresses Citi’s assessment of investment managers’ adaptation of their products to investors’ needs and the evolution of hedge funds following the global financial crisis.  The first article discussed the methodology employed by Citi in conducting its survey; tracked the evolution of modern portfolio theory; examined portfolio weaknesses exposed by the global financial crisis; and reviewed the alignment by investors of their portfolios to certain risk factors.  The third article will explore how asset managers may tailor their product offerings and marketing efforts to meet the evolving needs of institutional investors and how they may offer “institutional” portfolio construction to retail investors.  For coverage of Citi’s 2014 survey, see “Citi Survey Highlights Opportunities for Hedge Fund Managers as Institutional Investors Seek to Optimize Their Portfolios (Part Two of Two),” Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014).

State Pension Fund Study Challenges Assumptions Regarding Active Management and Alternative Investments

Hedge fund managers and other alternative investment managers frequently target state pension funds for investment, with the understanding that, in exchange for the fees paid by those pension funds, the hedge funds or alternative investments will deliver superior returns.  However, in its study of state pension funds with fiscal years ending June 30, 2014, the Maryland Public Policy Institute challenges that assumption.  This article summarizes the results of the study.  For more about pension plan investments, see “Pension Plan Gatekeepers Increasingly Serving as Competitors to Alternative Investment Managers,” Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014); and “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Three of Three),” Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).

K&L Gates Strengthens Investment Management Practice in Boston

The Boston office of K&L Gates recently added Kenneth Holston as of counsel in the firm’s investment management, hedge funds and alternative investments practice.  Holston will counsel investment clients on a variety of regulatory, compliance and corporate matters, including hedge fund formation; legislative and industry developments, such as Dodd-Frank and the European Market Infrastructure Regulation (EMIR); and futures, prime brokerage and clearing agreements.  For insight from the firm, see “K&L Gates-IAA Panel Addresses Cyber Insurance Plans for Investment Advisers (Part Two of Two),” Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); “K&L Gates Partners Outline Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers (Part Three of Three),” Hedge Fund Law Report, Vol. 8, No. 1 (Jan. 8, 2015); and “Key Investment and Operational Restrictions Imposed on Alternative Mutual Funds by the Investment Company Act of 1940 (Part Two of Two), Vol. 7, No. 25 (Jun. 27, 2014). 

Investment Management Lawyer John J. Mahon Joins Schulte Roth & Zabel in D.C.

On August 5, 2015, Schulte Roth & Zabel (SRZ) announced the addition of John J. Mahon as a partner in its investment management group, resident in the firm’s Washington, D.C. office.  Mahon advises private equity firms and other financial sector participants in a wide range of capital markets and securities law matters and has counseled on the establishment and operation of business development companies, registered closed-end funds and other similar public and private vehicles that comply with complex regulatory structures, such as the Investment Company Act of 1940, the Investment Advisers Act of 1940 and the Dodd-Frank Act.  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 commentary from SRZ partners, see “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).