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    Jan. 21, 2016

Going Private: Factors to Consider When Closing a Hedge Fund to Outside Investors (Part One of Three)

In late 2015, BlueCrest Capital Management announced that it would be returning outside capital and transitioning to a private investment partnership, managing only assets of its partners and employees. In doing so, BlueCrest has joined the growing ranks of hedge fund managers who, for a number of reasons, have decided to close their funds to outside investment and convert into a private structure. Historically, hedge fund managers weary of investor demands; increased regulatory and compliance requirements; and potential publicity issues have typically converted to family office structures. See “Legal Mechanics of Converting a Hedge Fund Manager to a Family Office” (Dec. 1, 2011). However, there are options beyond a family office for taking a hedge fund private. This article, the first in a three-part series, explores the “going private” trend and the factors a hedge fund manager should consider when deciding to convert a hedge fund, as well as the options available once that decision has been made. The second article will examine the operational considerations a hedge fund manager faces when converting its hedge fund, including ongoing regulatory obligations and staffing concerns. The third article will detail the mechanics for taking a hedge fund private, including redemption of outside investors and costs of conversion.

The New Section 871(m) Regulations: Withholding Law Applicable to Non-U.S. Hedge Funds (Part One of Two)

Non-U.S. hedge funds may be subject to two kinds of United States federal income taxes. Funds that are engaged in a U.S. trade or business are subject to U.S. federal income tax on their net income that is effectively connected with their U.S. trade or business. Funds that are not engaged in a U.S. trade or business are generally subject to a 30% tax imposed on gross payments of U.S.-source fixed, determinable, annual or periodic income (FDAP). Most offshore funds take precautions to ensure that they are not engaged in a U.S. trade or business. However, all funds that invest in U.S. debt and equity – as well as in derivatives that reference U.S. debt and equity – may be subject to withholding tax on FDAP. In this two-part series, John Kaufmann of Greenberg Traurig discusses certain ways in which final and temporary regulations recently promulgated under Internal Revenue Code Section 871(m) increase the scope of FDAP withholding, and lists traps for the unwary created by these regulations. This article addresses the current law and the issues that the new Section 871(m) regulations are intended to address. The second article will explain the scope of the new regulations and the potential complications that they have created. For insight from Kaufmann’s colleague, Scott MacLeod, see “Tax, Structuring, Compliance and Operating Challenges Raised by Hedge Funds Offered Exclusively to Insurance Companies” (Oct. 30, 2014).

RCA Compliance, Risk and Enforcement Symposium Examines Ways for Hedge Fund Managers to Mitigate Conflicts of Interest

Every hedge fund manager and investment adviser faces potential conflicts of interest, and the SEC has warned that, unless eliminated or properly mitigated, conflicts of interest are a significant concern. See “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016). Failure to properly address conflicts of interest can result in significant SEC enforcement penalties, such as the recent $20 million penalty against Guggenheim Partners. See “SEC Settlement With Investment Adviser Highlights Perils of Undisclosed Conflicts of Interest” (Aug. 27, 2015). Consequently, a primary focus of investment managers’ compliance efforts must be identifying and mitigating conflicts of interest, as well as developing and implementing related compliance policies and procedures. Among various topics discussed during the recent Regulatory Compliance Association (RCA) Compliance, Risk and Enforcement Symposium, panelists explored common conflicts of interest, including expense allocations, allocation of investment opportunities, affiliated transactions and valuation. This article highlights the salient points made on these issues. For additional insight from RCA programs, see “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers” (Jul. 2, 2015); and “All-Star Panel at RCA PracticeEdge Session Analyzes Five Key Regulatory Challenges Facing Hedge Fund Managers” (Oct. 2, 2014).

Hedge Funds and Others May Be Eligible to Collect Proceeds From $1.86 Billion CDS Antitrust Settlement

On January 11, 2016, Quinn Emanuel announced the $1.86 billion settlement of a class action lawsuit alleging that, since 2008, major banks had conspired with the International Swaps and Derivatives Association and financial information services firm Markit Group to limit transparency and competition in the credit default swaps (CDS) market by thwarting attempts to create an exchange for trading CDS. The plaintiffs estimated that the defendants’ conduct inflated bid/ask spreads on CDS by 20% on average, amounting to damages between eight and twelve billion dollars. The U.S. District Court for the Southern District of New York has issued an order establishing a class of plaintiffs, identifying covered CDS transactions and preliminarily approving the settlement. Market participants covered by the class action plaintiffs – including hedge funds, pension funds, asset managers and other institutional investors that purchased certain CDS – have a limited time to opt out of the settlement class before final approval of the settlement. This article documents the history of the litigation and the plaintiffs’ claims, and summarizes the settlement terms. For coverage of another antitrust suit involving financial market participants, see “Federal Antitrust Suit Against Ten Prominent Private Equity Firms Based on Allegations of ‘Club Etiquette’ Not to Jump Announced Deals Survives Summary Judgment Motion” (Apr. 11, 2013).

Despite His “Bad Acts,” Issuers Beneficially Owned by Steven A. Cohen Are Not Precluded From Private Offerings Based on the Bad Actor Rule

Steven A. Cohen, the billionaire founder of S.A.C. Capital Advisors, LLC, has settled SEC charges that he failed reasonably to supervise Matthew Martoma, a portfolio manager who engaged in insider trading in shares of two pharmaceutical companies. The SEC charged that “Cohen received information that should have caused him to take prompt action to determine whether an employee under his supervision was engaged in unlawful conduct and to prevent violations of the federal securities laws. Cohen failed to take reasonable steps to investigate and prevent such a violation.” See “SEC Charges Steven A. Cohen With Failing to Supervise Employees Who Allegedly Engaged in Insider Trading” (Jul. 25, 2013). This article summarizes the terms of the settlement and the related SEC no-action letter regarding the ability of entities beneficially owned by Cohen and his funds to continue to rely on Rule 506(b) or (c) of Regulation D for private placements despite the “bad actor” rule set forth in Rule 506(d). See also “Defense White Paper Refutes SEC’s Allegations That Steven A. Cohen Failed to Supervise Employees Accused of Insider Trading and Provides a Behind-the-Scenes Look at SAC Capital’s Compliance Program and Culture” (Jul. 25, 2013).

Annual Walkers Fundamentals Seminar Spotlights Trends in Fund Structures, Strategies, Fees and Governance

Walkers Global recently held its Fundamentals Hedge Fund Seminar in New York City, where experts addressed various issues relevant to the hedge fund industry, including the structures of new hedge funds and the typical terms being negotiated with investors, as well as trends in new fund strategies and fund governance. This article summarizes the key points discussed at the conference on each of these topics. For the HFLR’s coverage of Walkers Fundamentals Hedge Fund Seminars from prior years, see: 2014 Seminar; 2013 Seminar; 2012 Seminar; 2011 Seminar; and 2009 Seminar.

K&L Gates Bolsters Investment Management Practice in New York and Pittsburgh

K&L Gates recently added to its investment management, hedge funds and alternative investments practice with Derek Steingarten as a partner in New York and Brian Vargo as a partner in Pittsburgh. Steingarten’s client base spans seasoned and startup investment managers; hedge funds; funds-of-funds; open- and closed-end mutual funds; and fund directors. Vargo advises investment management firms and private and registered funds on matters relating to organization, governance and operations, including compliance with securities and commodities laws and regulations. For insight from the firm, see “K&L Gates-IAA Panel Addresses Cyber Insurance Plans for Investment Advisers (Part Two of Two)” (Jul. 2, 2015); and “K&L Gates Partners Outline Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers (Part Three of Three)” (Jan. 8, 2015).

Edward Klees Joins Hirschler Fleischer

Hirschler Fleischer last week announced the expansion of its investment management practice with the addition of partner Edward H. Klees. Klees focuses his practice on legal and regulatory issues impacting institutional investor operations and governance; investment custody issues; investment legal reviews and negotiations; and fund formation. For insight from Hirschler Fleischer, see our two-part series “‘Best Ideas’ Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law”: Part One (Aug. 7, 2014); and Part Two (Aug. 21, 2014).

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