Apr. 21, 2016

A Bipartisan Problem for Private Funds: How Current Regulations Complicate IRS Audits of Partnerships (Part One of Two)

The procedural rules governing federal income tax audits and judicial proceedings of partnerships and other entities classified as partnerships for federal income tax purposes were amended last November under the Bipartisan Budget Act of 2015 (2015 Budget Act). Scheduled to take effect in 2018, this new “streamlined audit approach” is expected to make it easier for the Internal Revenue Service to audit large partnerships, including hedge funds and other private funds. In a two-part guest series, David A. Roby, Jr., a partner at Sutherland Asbill & Brennan, explores the new approach and its implications for hedge fund and other private fund managers. This first part discusses current partnership tax principles and audit procedures and explores the reasons for revising the applicable rules. The second article will examine the revised partnership audit rules under the 2015 Budget Act and their impact on hedge funds and other private funds. For more on the streamlined audit approach, see “How to Draft Key Hedge Fund Documents to Take New Partnership Rules Into Account” (Feb. 11, 2016). For insight from Roby’s colleague John Walsh, see “Current and Former Regulators Advise Hedge Fund Managers on How to Prepare for SEC Exams” (Feb. 18, 2016); “Insights on SEC Priorities for 2015” (Apr. 23, 2015); and “Three Steps in Responding to an SEC Examination Deficiency Letter and Other Practical Guidance for Hedge Fund Managers” (Feb. 13, 2014).

New Luxembourg RAIF Structure Facilitates Access to AIFMD Passport and Marketing to E.U. Investors for Non-E.U. Hedge Fund Managers (Part One of Two)

The Luxembourg funds market is steadily growing and offers numerous options for U.S. managers looking to access European investors. In addition to Undertakings for Collective Investments in Transferable Securities vehicles and specialized investment funds, Luxembourg has recently unveiled a new structure – the Reserved Alternative Investment Fund (RAIF) – that will provide a flexible new avenue for U.S. managers to market their funds into the E.U. At a recent presentation, the Association of the Luxembourg Fund Industry (ALFI) provided a comprehensive overview of the business, tax and regulatory ramifications of the RAIF. This article, the first in a two-part series, summarizes the panel’s discussion of the Luxembourg funds landscape and the key features of RAIFs. The second article will explore opportunities presented by RAIFs for U.S. managers – including hedge fund, real estate and private equity managers – as well as tax considerations of the new fund structure. For additional insights from ALFI, see “Luxembourg Funds Offer Options for Hedge Fund Managers to Access European and Global Investors” (Feb. 11, 2016); and “NICSA/ALFI Program Considers Impact of AIFMD on U.S. Fund Managers” (Sep. 25, 2014).

District Court Order Threatens Confidentiality of Compliance Monitor Reports

Reports of compliance monitors retained in accordance with corporate settlements have generally been kept out of public view – until now. Finding that a compliance monitor’s report is a judicial record and the public has a First Amendment right to see it, Judge John Gleeson of the Eastern District of New York granted, in large part, the pro se request of an HSBC mortgage customer to unseal the first annual report of the compliance monitor HSBC retained in connection with its $1.9 billion settlement with the DOJ. The matter is stayed pending appeal. As settlements frequently require engaging a compliance monitor, this decision carries implications for any hedge fund manager or other investment adviser entering into such a settlement. For SEC enforcement actions resulting in monitorships, see “Repeat Custody Rule Offenders Face Severe SEC Sanctions” (Dec. 10, 2015); “Inadequate Disclosure of Expense Allocations May Carry Unintended Consequences” (May 14, 2015); and “SEC Settlement Emphasizes the Importance – and Limits – of Fund and Transaction Disclosure” (Apr. 2, 2015).

U.K. Treasury to Amend Private Fund Limited Partnership Structure to Address Consultation Responses

In July 2015, the U.K. Treasury issued a consultation paper seeking comment on proposed revisions to the U.K. Limited Partnerships Act 1907 that would create a new type of entity known as a Private Fund Limited Partnership (PFLP). The new PFLP structure would ease certain administrative requirements applicable to limited partnerships and would provide a “white list” of permissible limited partner activities. The Treasury recently issued a summary of consultation responses revealing broad support for the proposals. This article examines the Treasury’s planned changes in response to those comments. For a discussion of the proposals, see “U.K. Treasury Proposes Limited Partnership Reforms to Boost Competitiveness of Private Fund Structures” (Aug. 27, 2015).

Becoming a Plan Assets Fund May Limit Hedge and Other Private Funds’ Abilities to Charge Fees

One of the decisions faced by hedge funds and other private funds that accept “plan assets” subject to the Employee Retirement Income Security Act of 1974 (ERISA) is whether to cross the 25% threshold and become subject to ERISA. But taking that step is fraught with complex obligations and may significantly impact management and deferred performance fees. A recent segment of the “Pension Plan Investments 2016: Current Perspectives” seminar hosted by the Practising Law Institute (PLI) addressed issues for funds crossing the 25% threshold, including compensation practices for fiduciaries as well as management and performance fee structures of plan assets funds. The program, “Current Topics in Private Equity and Alternative Investments,” was moderated by Arthur H. Kohn, a partner at Cleary Gottlieb Steen & Hamilton; and featured Jeanie Cogill, a partner at Morgan, Lewis & Bockius; David M. Cohen, a partner at Schulte Roth & Zabel; and Steven W. Rabitz, a partner at Stroock & Stroock & Lavan. This article summarizes the key takeaways from the seminar with respect to the above matters. For additional commentary from this PLI program, see “Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA” (Apr. 14, 2016). For more on ERISA, see our two-part series on “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors”: Part One (Feb. 5, 2015); and Part Two (Feb. 12, 2015).

Institutional Investors Increasingly Concerned by Risk of Marketplace Lending Regulation

The maturing peer-to-peer or “marketplace” lending sector continues to attract interest from institutional investors. Those investors have become more optimistic and less uncertain as the industry evolves, resulting in a sharp uptick in sector investment in 2015. Despite this optimism and growth, new concerns have emerged, such as those regarding regulatory risks in light of institutional investors’ lack of knowledge about industry regulation. Richards Kibbe & Orbe (RK&O) and Wharton FinTech have released the results of their second annual survey analyzing marketplace lending (Survey). This article summarizes the key findings of the Survey. For coverage of last year’s survey, see “Marketplace Lending Attracts Growing Interest From Institutional Investors” (Jun. 4, 2015). For additional insight from Scott Budlong, a partner at RK&O and one of the co-authors of the Survey, see our two-part “Succession Planning Series”: “A Blueprint for Hedge Fund Founders Seeking to Pass Along the Firm to the Next Generation of Leaders” (Nov. 21, 2013); and “Selling a Hedge Fund Founder’s Interest to an Outside Investor” (Jan. 16, 2014).

Proskauer Welcomes David Miller

Proskauer recently added David Miller as a partner in the tax department, resident in the New York office. Miller advises clients – including in banking, finance, private equity, health care, life sciences, real estate, technology, consumer products, entertainment and energy – on a broad range of domestic and international corporate tax issues. See “Hedge Funds Organized as Delaware LLCs May Be Transparent for U.K. Tax Purposes” (Jul. 16, 2015). For insight from Proskauer partners, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates: An Interview With Proskauer Partner Robert Leonard” (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” (Mar. 14, 2013); and “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters” (Feb. 1, 2013).