Sep. 3, 2015

How Hedge Fund Managers Should Respond to Tax Regulator Attacks on “Disguised Management Fees” (Part Two of Two)

In an effort to limit arrangements in which hedge fund managers and other private fund managers receive interests in funds in exchange for waiving management fees (thereby deferring recognition of income and changing its character), tax regulators in the United States recently proposed regulations to treat some investment fund management fee waivers and other payments in lieu of management fees as “disguised payments for services,” with immediate income tax consequences.  The U.S. tax authorities are not the only ones trying to strip the disguises from management fees.  In the United Kingdom, the Finance Act 2015 introduced disguised management fee rules to combat creative strategies to convert what is in economic substance a management fee – calculated by reference to funds under management and taxed as income at the rate of 45% – to capital gains taxable at 28%.  A new bill will also change the taxation of “good carry.”  In a guest article, the second in a two-part series, George J. Schutzer and Timothy Jarvis of Squire Patton Boggs outline proposed actions in the U.K. and suggest steps for hedge fund managers and others to take in response to the rules in place and the proposed new rules in the U.S. and the U.K.  The first article described common management fee waiver provisions and explained how the U.S. proposals would limit fee waivers that would be respected for tax purposes.  For more on proposals that could affect the taxation of hedge fund managers and their employees, see “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two),” Hedge Fund Law Report, Vol. 8, No. 16 (Apr. 23, 2015); and “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships,” Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).

Can Emerging Hedge Fund Managers Use Technology to Satisfy Business Continuity Requirements and Mitigate Third-Party Risk?

Hedge fund firms are investing in sophisticated and robust infrastructures and information technology (IT) services to stay ahead of competition and drive growth in a changing marketplace.  However, challenges await, particularly for startup firms with budget restrictions, tight timelines and short resumes.  New launches in 2015 and beyond will have to raise their standards to ensure IT systems and technology support structures are in place to give firms an edge where perhaps other operational areas cannot.  In this guest article, Vinod Paul of Eze Castle Integration examines considerations for emerging hedge fund managers in establishing technology infrastructure – including components to ensure resiliency of the manager’s business – and discusses ways an emerging manager can avoid common startup pitfalls.  In a previously published companion article, Marni Pankin of Marcum provided a checklist for emerging managers to follow when launching a hedge fund in order to meet various operational, accounting, compliance and regulatory requirements.  For more on technology considerations for hedge fund managers, see “Aite Group Report Identifies the Building Blocks of Institutional Credibility for Hedge Fund Managers: Operational Efficiency, Robust Risk Management, Integrated Technology and More,” Hedge Fund Law Report, Vol. 6, No. 36 (Sep. 19, 2013).

In Third Point Settlement, FTC Takes Narrow View of “Investment Only” Exemption to Hart-Scott-Rodino Premerger Notification Requirements

A recent settlement with the Federal Trade Commission (FTC) clarifies the applicability of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act) to certain investment fund activities.  Relying on an exemption for acquiring voting securities solely for investment purposes (that does not result in the acquirer owning more than 10% of the target’s voting securities), Third Point LLC (Third Point) and three funds that it manages acquired shares of an issuer in excess of the HSR Act thresholds.  The FTC and DOJ brought this enforcement action, claiming that the exemption did not apply because of particular actions with respect to board or management representation at the issuer.  This article summarizes the relevant provisions of the HSR Act, the specific charges against Third Point and its funds, as well as the terms of – and FTC rationale for – the settlement.  For more activity by Third Point, see “How Can a Hedge Fund Manager Dislodge a Poison Pill at a Public Company?,” Hedge Fund Law Report, Vol. 7, No. 12 (Mar. 28, 2014).  For analysis of other issues affecting activist investing, see “Top SEC Officials, Law Firm Partners and In-House Counsel Discuss Private Fund Enforcement Priorities, Tender Offer Rules Applicable to Activist Investing, Valuation Challenges, Personal Trade Monitoring and Compliance Testing (Part Four of Four),” Hedge Fund Law Report, Vol. 8, No. 3 (Jan. 22, 2015); “Practitioners Discuss U.S. and Canadian Shareholder Activism and Activist Tools,” Hedge Fund Law Report, Vol. 7, No. 45 (Dec. 4, 2014); and “Did Pershing Square and Valeant Violate Insider Trading, Antitrust or Tender Offer Rules in Their Pursuit of Allergan?,” Hedge Fund Law Report, Vol. 7, No. 17 (May 2, 2014).

Luxembourg Financial Regulator Issues Guidance on AIFMD Marketing and Reverse Solicitation

The Luxembourg Commission de Surveillance du Secteur Financier (CSSF) recently updated its Frequently Asked Questions document (FAQ) on the application of AIFMD in Luxembourg.  The FAQ includes helpful guidance and clarifications relating to the definition of marketing and reverse solicitation for hedge fund managers operating or marketing funds in Luxembourg.  In addition, the CSSF set out further information regarding credit institutions and investment firms, depositaries and Annex IV reporting.  This article summarizes the new guidance.  See also “What Is the Difference Between Marketing and Reverse Solicitation Under the AIFMD?,” Hedge Fund Law Report, Vol. 7, No. 42 (Nov. 6, 2014).  For more on AIFMD, see “ESMA Opinion Highlights Issues Regarding the Functioning of the AIFMD Passport,” Hedge Fund Law Report, Vol. 8, No. 32 (Aug. 13, 2015); and “ESMA Recommends Extension of the AIFMD Passport for Hedge Fund Managers and Funds in Certain Non-E.U. Jurisdictions,” Hedge Fund Law Report, Vol. 8, No. 31 (Aug. 6, 2015).

Downplaying Liquidity Risk While a Hedge Fund Sells Assets and Seeks Loans to Ensure Liquidity May Trigger an Enforcement Action

A recent SEC settlement emphasizes the importance for hedge fund managers of adequately disclosing risks to investors.  The SEC alleged that two affiliated registered investment advisers touted the soundness of several hedge funds, even as those funds sold assets and sought loans to provide liquidity.  This article summarizes the SEC’s order against the investment advisers, including the alleged marketing misrepresentations that gave rise to the specific violations charged by the SEC.  For discussion of another recent enforcement action against one of the investment advisers, see “Failure to Regularly Audit Compliance and Surveillance Systems May Carry Significant Consequences,” Hedge Fund Law Report, Vol. 8, No. 33 (Aug. 27, 2015).  For another recent enforcement action involving misrepresentations to investors, see “Public Pension Plan Investments May Increase the Risk That Hedge Fund Managers May Breach Fiduciary Duties,” Hedge Fund Law Report, Vol. 8, No. 24 (Jun. 18, 2015).