Jul. 28, 2016

Implications of New Margin Requirements for TBA Transactions, Specified Pool Transactions and Certain Forward Transactions

FINRA Rule 4210 sets forth the margin requirements that determine the amount of collateral investors are required to maintain in their margin accounts for a wide range of securities transactions. The SEC recently approved amendments to that rule to establish margin requirements for To Be Announced transactions (including adjustable rate mortgage transactions), Specified Pool Transactions and certain forward-settling U.S. government agency mortgage-backed securities transactions. The change is important for hedge fund managers trading in those securities both because of the new requirements for posting initial and variation margin and because managers will have to enter into new agreements (or modify existing agreements) with their FINRA-member broker-dealers to govern such transactions. This article highlights the new requirements that are relevant to private fund managers. For a discussion of margin requirements on swaps and derivatives, see “Hedge Funds Face Increased Margin Requirements Under Final Swap Rules (Part One of Two)” (Feb. 18, 2016); and “Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations Between Hedge Fund Managers and Futures Commission Merchants Regarding Cleared Derivative Agreements” (Apr. 18, 2013). For margin requirements in Europe, see “Europe Approves Hedge Fund Use of CFTC-Authorized Central Counterparties Under EMIR” (Mar. 31, 2016).

Implications of Lehman Brothers Decision on Hedge Fund Managers Trading CDOs

On June 28, 2016, Judge Shelley Chapman of the U.S. Bankruptcy Court for the Southern District of New York authored an opinion in the case of Lehman Brothers Special Financing Inc. v. Bank of America National Association. This decision, which holds that certain market-standard provisions in structured finance transactions are enforceable when the swap counterparty’s default is due to the bankruptcy of that counterparty, provides hedge fund managers and others trading collateralized debt obligations (CDOs) and other structured products with greater certainty than prior rulings relating to the collapse of Lehman Brothers. The Hedge Fund Law Report recently interviewed Schulte Roth & Zabel partner Paul Watterson about Judge Chapman’s decision and its ramifications for hedge fund managers. Specifically, Watterson addressed the significance of the decision in light of prior case law, the implications of the decisions for hedge fund managers trading CDOs and the specific provisions managers should include in CDO documentation to take advantage of this holding. For more on the Lehman Brothers collapse, see “Lesson From Lehman Brothers for Hedge Fund Managers: The Effect of a Bankruptcy Filing on the Value of the Debtor’s Derivative Book” (Jul. 12, 2012); and “How Can Hedge Funds Get Their Money Out of Lehman Brothers International Europe?” (Aug. 5, 2009).

A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part One of Four)

Hedge fund managers and other investment professionals contemplating swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986 (Code) must consider numerous legal issues. To help clarify these complex issues, the Hedge Fund Law Report is serializing a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes – in considerable detail and with extensive references to relevant authority – the many substantive considerations associated with employing swaps on behalf of ERISA plan assets and the potential penalties for missteps. This article, the first in our four-part serialization, discusses fiduciary responsibility and prohibited transactions, including how swaps can constitute prohibited transactions. For more from Rabitz and Oringer, see “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA to Impact Many Hedge Funds” (Aug. 20, 2010). For a prior serialization from Oringer, see our five-part series:“Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse”: Part One (Sep. 4, 2014); Part Two (Sep. 11, 2014); Part Three (Sep. 18, 2014); Part Four (Sep. 25, 2014); and Part Five (Oct. 2, 2014).

U.S. Managers Marketing to U.K. Investors Could Face Ballooning Reporting Burdens Under Proposed Rule

On July 4, 2016, the U.K. Financial Conduct Authority (FCA) published its Quarterly Consultation Paper No. 13 (Consultation), proposing amendments to the FCA Handbook of particular relevance to U.S. hedge fund managers marketing feeder funds to British investors under Article 42 of the Alternative Investment Fund Managers Directive (AIFMD). If adopted, Chapter 10 of the Consultation would increase the reporting obligations of a subset of alternative investment fund managers located outside of the European Economic Area (EEA) that market non-EEA feeder alternative investment funds to U.K. investors. Specifically, certain hedge fund managers would be required to provide transparency reporting for their master funds, in addition to their feeder funds. This article examines the impact of AIFMD on the U.K.’s national private placement regime (NPPR), the current transparency reporting requirements applicable to U.S. hedge fund managers availing themselves of that NPPR and the impact the Consultation would have on those reporting requirements. For more on AIFMD, see our two-part series on compliance by hedge fund managers: “Increased Compliance Burden” (Apr. 28, 2016); and “AIFMD’s Depository Requirement” (May 5, 2016).  

How Hedge Fund Managers Can Navigate Dual AIFMD and CFTC Compliance (Part Two of Two)

Both the Alternative Investment Fund Managers Directive (AIFMD) and the regulations of the U.S. Commodity Futures Trading Commission (CFTC) regulate hedge fund and other private fund managers. Depending on where a hedge fund manager is located and what investors it solicits, the manager may be subject to AIFMD and also required to register with the CFTC. Consequently, that manager would need to ensure that it is able to comply with both regimes. See “Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss CFTC Compliance, Conflicting Regulatory Regimes and Best Marketing Practices (Part Two of Four)” (Jan. 29, 2015). A recent program sponsored by the Futures Industry Association (FIA) provided an overview of the intersection of AIFMD and CFTC regulations, along with other regulatory issues. Michael Sorrell, an associate general counsel at the FIA, moderated the discussion, which featured Fried Frank partners Gregg Beechey, William J. Breslin and David S. Mitchell. This article, the second in a two-part series, summarizes the speakers’ key insights with respect to the intersection of CFTC regulation with AIFMD, as well as the impact on AIFMD of the U.K.’s vote to leave the E.U. The first article addressed the current options available to U.S. managers to market their funds in the E.U. For additional insight from Fried Frank partners, see “Application to Hedge Fund Managers of the Internal Control Report Requirement of the Amended Custody Rule” (Feb. 11, 2010); and “Hedge Fund Manager Fiduciary Duty, SEC Subpoena Power, Hybrid Hedge Fund Structures, Managed Account Platforms, Codes of Ethics and More” (Feb. 4, 2010).

Hedge Fund Managers Must Ensure Portfolios and Valuation Comport With Investor Disclosures or Risk SEC Fraud Action

The SEC recently commenced an enforcement action against a hedge fund manager, along with its founder and CEO, for misleading investors about the nature and value of the assets held by its funds. The respondents had promised investors that the funds they managed would purchase legal fee receivables from law firms in settled cases. However, the cease-and-desist order instituted by the SEC alleges that a substantial portion of investor money was actually used to purchase receivables from cases that were unsettled or where collection was subject to ongoing litigation risk. The respondents also allegedly manipulated the value of the receivables they purchased. This case highlights the need for hedge fund managers to ensure the investments held in their portfolios, as well as the valuation of those investments, are in line with disclosures made to investors. This article outlines the SEC’s allegations and the relief requested. For more on litigation funding, see “How Can Hedge Funds Mitigate the Risks of Investments in Litigation? An Interview with Kenneth A. Linzer” (Jun. 21, 2012); and “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns” (Jun. 24, 2009).

The Hedge Fund Law Report Makes Significant Editorial Hires

The Hedge Fund Law Report has added a pair of Associate Editors – Kara Bingham and Rorie Norton – to its fast-growing Manhattan-based team. Both new editors are experienced lawyers with extensive expertise in fund formation and regulatory compliance. Bingham comes to the HFLR from 400 Capital Management, where she was general counsel and chief compliance officer. Norton joins from Kleinberg, Kaplan, Wolff & Cohen, a law firm specializing in hedge funds, where he practiced law as an associate. The HFLR encourages readers to contact Bingham at kbingham@hflawreport.com or +1 (212) 574-7868 and Norton at rnorton@hflawreport.com or +1 (212) 686-5316 to discuss what they are seeing and hearing in the industry.

Oren Gertner Joins Davis Polk’s Investment Management Practice

Davis Polk has bolstered its investment management practice in New York with the hiring of Oren Gertner, who joins the firm as counsel. Gertner advises clients on the structuring, formation, offering and management of private equity funds, debt funds, buyout funds, real estate funds, funds-of-funds and managed accounts. For commentary by Davis Polk attorneys, see “Davis Polk ‘Hedge Funds in the Current Environment’ Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities” (Jun. 14, 2012); and our two-part series on hedge fund managers pursuing activist strategies: “Filing Obligations and Other Operational Considerations” (May 5, 2016); and “Settlement, Prospects, Shareholder Engagement and Proxy Access Considerations” (May 12, 2016).