Articles By Topic
By Topic: Marketing
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From Vol. 6 No.20 (May 16, 2013)
How Can Hedge Fund Managers Effectively Raise Capital from Single-Family Offices, Multi-Family Offices and High Net Worth Individuals?
A law firm and an accounting firm hosted a seminar earlier this year on strategies and risks of hedge fund marketing focused on family offices and high net worth individuals. The primary purpose of the seminar was to highlight workable, battle-tested strategies for raising capital from both sets of investors. The secondary purpose of the seminar was to offer practical advice on navigating regulatory risks posed by hedge fund marketing generally. This article discusses the salient points discussed during the seminar. For related insight, see “Why and How Do Family Offices and Foundations Invest in Hedge Funds?,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).
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From Vol. 6 No.19 (May 9, 2013)
Rothstein Kass 2013 Hedge Fund Outlook Highlights Managers’ Perspectives on Performance and Economic Trends, Leverage, Capital Raising Strategies, Due Diligence, Staffing, Operational Changes and Regulatory Concerns
International services firm Rothstein Kass recently released a report detailing findings from its survey of 358 professionals at hedge fund managers regarding performance and economic outlook, use of leverage, capital raising concerns and strategies (including seed deals, use of separately managed accounts and fee breaks), investor due diligence, staffing issues and regulatory priorities. This article summarizes the key takeaways from the survey. For an article summarizing the 2012 version of this annual Rothstein Kass report, see “Rothstein Kass Report Discusses Marketing, Structuring, Tax, Leverage, Due Diligence, Hiring and Other Dominant Concerns for Hedge Fund Managers in a Competitive Capital Raising Environment,” The Hedge Fund Law Report, Vol. 5, No. 22 (May 31, 2012).
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From Vol. 6 No.18 (May 2, 2013)
Three Recommendations to Help Hedge Fund Managers Avoid False GIPS Compliance Claims in Marketing Materials
Hedge fund managers engaged in raising capital are increasingly looking to present their performance results in compliance with the Global Investment Performance Standards (GIPS). GIPS provide prospective investors with additional assurances about the integrity of such performance results. At the same time, with the passage of the Jumpstart Our Business Startups Act, the SEC has become increasingly concerned about public advertising by private fund managers and has made it a priority to review performance advertising presentations during presence examinations of hedge fund managers. See “OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers at the RCA’s Compliance, Risk & Enforcement 2012 Symposium,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013); and “How Can Hedge Fund Managers Identify and Navigate Pitfalls Associated with the JOBS Act’s Rollback of the Ban on General Solicitation and Advertising?,” The Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013). In a development that may foreshadow heightened scrutiny in this area, the SEC has initiated administrative proceedings against an investment adviser and its principal for allegedly falsely claiming that the investment adviser’s performance results complied with advertising guidelines set forth in GIPS. Although compliance with the GIPS standards are voluntary, the SEC has made clear that managers who advertise GIPS compliance, but whose advertisements and marketing materials do not actually provide all of the information required by GIPS, are subject to sanction under the anti-fraud provisions and advertising rules contained in the Investment Advisers Act of 1940. This article summarizes the SEC’s factual and legal allegations in this case and provides three recommendations for hedge fund managers interested in reducing the risk of false GIPS compliance claims. For an article that identifies some of the hedge fund specific issues related to GIPS-compliant performance presentations, see “A Step-By-Step Guide to GIPS Compliance for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).
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From Vol. 6 No.16 (Apr. 18, 2013)
Do In-House Marketing Activities and Investment Banking Services Performed by Private Fund Managers Require Broker Registration?
In an April 5, 2013 speech delivered before the American Bar Association, Trading and Markets Subcommittee, David W. Blass, Chief Counsel of the SEC’s Division of Trading and Markets, cautioned private fund managers that certain in-house marketing and investment banking activities may require the manager or its personnel to register as a broker with the SEC. The speech was in response to certain practices identified by the SEC staff during presence examinations of newly-registered advisers. See “SEC’s OCIE Director, Carlo di Florio, Discusses Examination Strategies and Expectations for Impending Examinations of Private Equity Advisers,” The Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012). Blass highlighted two groups of practices that raise regulatory concerns: (1) the marketing of fund securities by a manager’s in-house personnel; and (2) “purported investment banking or other broker activities” related to a fund’s portfolio companies. For more on the broker registration consequences of the former practice, see “Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011). This article provides an overview of broker registration issues pertinent to hedge fund managers; summarizes key takeaways from Blass’ speech; and helps hedge fund managers understand and analyze their activities within the broker registration framework.
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From Vol. 6 No.15 (Apr. 11, 2013)
SEI Study Offers a Reality Check to Hedge Fund Managers on What Actually Works When Marketing to Institutional Investors
Financial and asset management services provider SEI has released its sixth annual survey of institutional hedge fund investors. While hedge fund investors are “generally maintaining, and even somewhat increasing,” their hedge fund allocations, SEI cites “rising investor dissatisfaction” with hedge fund performance, which, going forward, could be further hindered by the “institutionalization” of the hedge fund space in response to more intensive investor due diligence and greater demands for transparency. Moreover, as the line between hedge funds and other products offering hedge fund strategies continues to blur, it becomes more difficult for managers to distinguish their funds and convince investors that they offer good value. See “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013). This article summarizes key points from the survey. For more on the expectations of fund managers and investors, see “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012). For a general look at institutional investors’ priorities and perspectives on alternative investments, see “Natixis Global Asset Management Survey Reveals Institutional Investors’ Attitudes Towards Market Volatility, Risk Management, Portfolio Construction, Investment Concerns, Alternative Investments and Investment Priorities,” The Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012).
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From Vol. 6 No.13 (Mar. 28, 2013)
Four Recommendations for Private Fund Managers Wishing to Mitigate the Risks of Using Unregistered Brokers to Introduce Prospective Investors to Their Funds
Two recently-issued SEC orders settling administrative and cease-and-desist proceedings (Orders) demonstrate the regulatory risks private fund managers face in using unregistered brokers to introduce prospective investors to their funds. One of those Orders was against a private equity fund manager and its former senior managing partner, and the other was against a third party consultant retained by the private equity fund manager to introduce potential investors to its funds. The private equity fund manager paid the consultant a percentage of the capital commitments of investors he introduced, resulting in millions of dollars in compensation for him. See generally “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010). Importantly, this case demonstrates that the SEC is willing to pursue not just unregistered brokers who engage in impermissible marketing activities on behalf of investment funds, but also the fund managers themselves if they are found to assist an unregistered broker or ignore warning signs that the unregistered broker is engaging in misconduct. This article summarizes the alleged misconduct, causes of action and the remedies agreed upon in the settlement. In addition, this article provides four recommendations for fund managers wishing to mitigate the risks of using unregistered brokers in introducing prospective investors to their funds.
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From Vol. 6 No.13 (Mar. 28, 2013)
Why and How Do Sovereign Wealth Funds Invest in Hedge Funds?
Investments from sovereign wealth funds (SWFs) can be attractive to hedge fund managers because such investments typically represent significant and sticky assets. Understanding the character, investment processes, objectives and allocation preferences of SWFs can increase a manager’s likelihood of receiving an allocation from this investor type, thereby growing assets, fees and clout. For insight on refining a marketing approach vis-à-vis another important hedge fund investor type, see “Rothstein Kass Study Explains the ‘Consultative’ Approach to Marketing to Single-Family Offices and the Importance of That Approach for Smaller Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011). With these dynamics in mind, a recent report discusses trends in SWF growth and asset allocation preferences. In particular, the report provides insight into SWF allocations to hedge funds and other alternative investment vehicles and the investment preferences of SWFs by economic sector. This article summarizes the key findings of the report. For a direct discussion of how hedge fund managers can hone their marketing efforts to attract SWF investments, see “Specific Steps that Hedge Fund Managers Can Take to Increase the Likelihood of an Investment from a Sovereign Wealth Fund,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).
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From Vol. 6 No.10 (Mar. 7, 2013)
How Can Hedge Fund Managers Identify and Navigate Pitfalls Associated with the JOBS Act’s Rollback of the Ban on General Solicitation and Advertising?
The Jumpstart Our Business Startups Act (JOBS Act) provisions allowing general solicitation and general advertising in private offerings (JOBS Act Marketing Provisions), upon becoming effective, will profoundly change how hedge fund managers can market their funds. Before taking advantage of the JOBS Act Marketing Provisions, however, hedge fund managers should be aware of a number of potential pitfalls. First, hedge fund managers may be prohibited from engaging in general solicitation and general advertising if they rely on exemptions from registration under certain Commodity Futures Trading Commission rules, or under certain state and federal investment adviser laws. Second, hedge fund managers that are able to take advantage of the provisions need to be aware of several potential compliance issues under the Investment Advisers Act of 1940, including issues that arise when using social media, publicly available websites and publicly advertised performance history. In a guest article, Adam Gale, a Member in the New York office of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., identifies potential regulatory pitfalls associated with reliance on the JOBS Act Marketing Provisions and provides some recommendations to address compliance issues in connection with reliance on the JOBS Act Marketing Provisions.
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From Vol. 6 No.9 (Feb. 28, 2013)
U.K. Appellate Court Holds That Hedge Fund Manager Employees May Be Personally Liable for Unreasonably Relying on the Representations of a Hedge Fund Manager Principal Regarding Performance and Portfolio Composition
The best hedge fund managers are often great salespeople, and a good bit of their sales efforts are often directed internally – in particular, at persuading non-investment professionals to buy into their view of the world. This is fine so long as that view is compelling and legitimate. But this becomes problematic for all involved when that view is fraudulent. A recent U.K. appellate court decision indicates that employees of hedge fund managers may be liable in cases where they accept at face value – and relay to third parties – representations from a manager principal that they knew or should have known to be false. “He told me so” is not a valid defense to a suit for negligence; and employees with limited authority can be hit with effectively unlimited liability.
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From Vol. 6 No.5 (Feb. 1, 2013)
Under What Conditions Can a Hedge Fund Manager Present Hypothetical Backtested Performance Results?
Hedge fund managers (particularly early-stage managers) that lack a robust track record to demonstrate their investment prowess may use hypothetical backtested performance results to show how their investment strategies would have performed on an historical basis. However, the SEC and investors strictly scrutinize the use of hypothetical backtested performance results by hedge fund managers because such results do not represent actual performance data. The concern is that hypothetical results may reflect rosy assumptions as opposed to real results, and potential investors may not be sufficiently apprised of the difference. In an expression of such concern, the SEC recently entered into a consent order with an investment adviser and its principal to settle an enforcement action in connection with the misleading use of hypothetical backtested performance results. The results at issue purported to show how the performance of the manager’s investment portfolios would have compared to designated benchmarks. This article summarizes the factual background, legal violations and settlement terms in this case. The article also describes prior SEC enforcement actions that were based on other impermissible practices in connection with the use of hypothetical backtested performance results. For another example of an SEC action premised on the use of misleading performance advertising, see “SEC Charges Hedge Fund Manager and Its Founder with Securities and Investment Adviser Fraud Based on ‘Cherry Picking’ of Trades,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).
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From Vol. 6 No.2 (Jan. 10, 2013)
SEC Continues Its Crackdown on Misleading Representations of “Skin in the Game” by Hedge Fund Managers
In many situations, the interests of hedge fund managers and investors diverge. See generally “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012). Recognizing this – and recognizing the insufficiency of the law to effectively mitigate the divergence – managers and investors have developed tools to align interests. One such tool is the pay-for-performance concept embodied in the performance fee or allocation common to hedge fund structures. See “SEC Adopts Final Rules Governing the Payment of Performance Fees to Registered Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012). Another tool is manager co-investment or “skin in the game.” The idea here is for the manager to put his money where his mouth is by making the same investments as investors. Indeed, many hedge fund PPMs contain language to the effect that the principals of the management company have invested a “substantial portion of their net worth” in the funds. See “Investments by Hedge Fund Managers in Their Own Funds: Rationale, Amounts, Terms, Disclosure, Duty to Update and Verification,” The Hedge Fund Law Report, Vol. 3, No. 21 (May 28, 2010). However, from time to time, a manager’s claims with respect to skin in the game are at odds with the facts. The SEC is attuned to the potential dissonance between representations and reality, particularly in hedge fund marketing materials. In June of last year, the SEC settled administrative proceedings against a hedge fund manager alleging, among other things, misleading statements regarding skin in the game. See “SEC Sanctions Quantek Asset Management and its Portfolio Manager for Misleading Investors About ‘Skin in the Game’ and Related-Party Transactions,” The Hedge Fund Law Report, Vol. 5, No. 23 (Jun. 8, 2012). The SEC recently settled another administrative action based on similar allegations, this time in connection with investments in collateralized debt obligations (CDOs). This article describes relevant factual and legal points from the more recent settlement. For a discussion of another matter involving overlapping facts, see “Implications of the Second Circuit’s Decision to Reinstate Breach of Contract and Gross Negligence Claims Brought against a CDO Manager,” The Hedge Fund Law Report, Vol. 5, No. 33 (Aug. 23, 2012).
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From Vol. 6 No.1 (Jan. 3, 2013)
Why and How Do Family Offices and Foundations Invest in Hedge Funds?
Family offices and foundations are an important source of investment capital for hedge funds and funds of funds (together, funds), particularly funds whose managers have a track record, well-developed infrastructure and the ability to demonstrate staying power. See “Prime Broker Merlin Securities Develops Spectrum of Hedge Fund Investors; Event Hosted by Accounting Firm Marcum LLP Examines Marketing Implications of the Merlin Spectrum,” The Hedge Fund Law Report, Vol. 3, No. 39 (Oct. 8, 2010). However, family offices and foundations have specific objectives in investing in hedge funds and specific concerns with their hedge fund investments. Understanding these objectives and concerns is important to hedge fund managers because effective fund marketing should be a refined process rather than a blunt instrument. Marketing that raises long-term dollars invariably caters to the specific circumstances of an investor rather than generally (or only) touting the achievements of the manager. This is particularly true in marketing to family offices – entities that often have a range of objectives including but not limited to absolute returns. See “New Rothstein Kass Study Explains the ‘Consultative’ Approach to Marketing to Single-Family Offices and the Importance of That Approach for Smaller Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011). To help hedge fund managers enrich their understanding of the goals and concerns of family offices and foundations, this article describes the pertinent findings from a December 2012 survey of family offices and foundations conducted by Infovest21. In particular, this article discusses the survey findings on topics including fund fees, allocation criteria, role of assets under management in manager selection, transparency and related topics.
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From Vol. 5 No.42 (Nov. 9, 2012)
Annual Thompson Hine Hedge Fund Seminar Focuses on Implications for Hedge Fund Managers of the JOBS Act, Form PF and Form CPO-PQR
On October 4, 2012, Thompson Hine LLP hosted its annual Hedge Fund Seminar, which this year was entitled, “The JOBS Act and Dodd-Frank – Two Years Later.” Speakers at the event addressed the impact of Form PF and Form CPO-PQR as well as the anticipated impact of the Jumpstart Our Business Startups (JOBS) Act on hedge fund managers. In addition, the speakers discussed the building blocks of a culture of compliance at hedge fund management companies. This article summarizes the most salient points raised at the seminar.
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From Vol. 5 No.36 (Sep. 20, 2012)
Preqin Study Reveals Institutional Investors’ Latest Views and Expectations on Hedge Fund Terms
Effective hedge fund marketing requires a thorough understanding of the target audience, which increasingly consists of institutional investors. To deepen the appreciation of hedge fund managers for the concerns, goals and expectations of institutional investors, alternative investment data firm Preqin Ltd. recently published a study on institutional investors’ views on hedge fund fee terms, transparency, liquidity and other aspects of the manager-investor relationship. This article highlights the key findings of the study.
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From Vol. 5 No.18 (May 3, 2012)
The Transformation of Third Party Hedge Fund Marketer Contracts and Compensation (Part One of Two)
Asset raising and marketing are fundamental, life or death activities for hedge fund managers. If you as a hedge fund manager (or your agents) cannot market effectively, you cannot survive, regardless of your investing prowess. According to Rothstein Kass’ sixth annual hedge fund industry outlook survey, released in April 2012, “asset raising and marketing are far and away the top issues for funds in 2012, with 53.1 percent of respondents stating those are their biggest concerns.” Hence the robust pay packages of the top in-house and third party marketers. See “How Much Are In-House Hedge Fund Marketers Paid?,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011). Marketing in the hedge fund industry is tough for business and legal reasons. Hedge fund marketing is tough from a business perspective because, among other things: the sales cycle is long; investors have many choices; investors – especially big ones – have considerable bargaining clout; hedge funds are typically relatively liquid (and where they are not, big investors typically negotiate for liquidity); investors rarely provide feedback when they decide to forgo a hedge fund investment, so it is difficult to learn from your mistakes; it is often challenging to clearly articulate a complicated value proposition; etc. Hedge fund marketing is tough from a legal perspective because the activity is subject to a dense and often opaque patchwork of law, regulation, policy and practice including – but by no means limited to – lobbying laws and rules and related compensation restrictions; performance reporting considerations; due diligence best practices; the JOBS Act and the evolving rules regarding general solicitation and advertising; the AIFMD in Europe; heightened and focused SEC enforcement activity; general contracting and structuring considerations; registration issues; etc. In an effort to provide guidance to industry participants trying to navigate the business and legal challenges involved in hedge fund marketing, on April 4, 2012, the Third Party Marketers Association hosted a webinar entitled “The Transformation of Third Party Marketer Contracts and Compensation.” The participants in the webinar were Matthew Eisenberg, a Partner at Finn Dixon & Herling LLP; Laurier W. Beaupre, a Partner at Proskauer Rose LLP; and L. Charles Bartz, a Partner with placement agent BerchWood Partners LLP. The webinar was moderated by Mike Pereira, Publisher of The Hedge Fund Law Report. The webinar covered many of the most important issues involved in structuring relationships between hedge fund managers and third party marketers. This is our first of two articles covering the webinar. This article summarizes the specific insights and concrete recommendations of the panelists on topics including: the JOBS Act; separate accounts; due diligence; who bears the risk of public plan-level restrictions on compensation; disclosure; looking through funds of funds; and other topics.
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From Vol. 5 No.15 (Apr. 12, 2012)
What Concerns Do Mobile Devices Present for Hedge Fund Managers, and How Should Those Concerns Be Addressed? (Part One of Three)
Mobile devices, such as smartphones and tablet computers, have significantly enhanced the ability of hedge fund managers and their personnel to conduct business more effectively and efficiently by, among other things, facilitating performance of job functions outside of the office. However, such productivity gains come at a cost. The ability to remotely access firm networks and information via mobile devices magnifies the risk of losing some control over access to firm information and firm systems. Such loss of control can, in turn, create additional perils, most notably, security concerns for hedge fund managers who closely guard any informational advantage they have over competitors. Additionally, such loss of control over access may heighten risks that a firm’s network is compromised, which can cause significant damage to a firm’s operations. As such, it is imperative for hedge fund managers to keep up with the ever-growing risks that arise from the rapidly evolving mobile device technology landscape and to adopt policies and solutions designed to minimize the loss of control over access to firm information and systems. This is the first article in a three-part series designed to address the concerns raised by mobile devices and to outline policies and procedures as well as technology solutions that can help hedge fund managers mitigate the risks posed by the use of mobile devices. This first article provides an overview of the use of mobile devices and how hedge fund managers have historically addressed the use of mobile devices. In particular, this article surveys the various risks for hedge fund managers raised by mobile devices, including security risks, risks related to unauthorized trading and risks related to the downloading of malware and viruses. This article also addresses concerns relating to retention and archiving of books and records, and advertising and communications. The second and third installments in this three-part series will discuss principles and detail best practices for establishing mobile device policies and procedures as well as specific mobile device solutions and technologies designed to address the risks catalogued in this article.
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From Vol. 5 No.15 (Apr. 12, 2012)
Brockton Retirement Board Files Class Action Lawsuit Against Oppenheimer Fund of Private Equity Funds and Executive Officers for Allegedly False Claims Relating to Fund Performance and Investment Valuations Contained in Fund Marketing Materials
The Jumpstart Our Business Startups Act may portend good news for hedge funds that seek to raise capital from investors. However, hedge fund managers should approach their investor solicitation efforts with caution, particularly in light of the increasing scrutiny from both regulators and investors with respect to fund performance and valuation. A recent example of this scrutiny is a class action lawsuit initiated on March 26, 2012 by a Massachusetts retirement fund, Brockton Retirement Board (Brockton), against a private equity fund of funds manager and related entities. The Complaint generally alleges that the Defendants made false and misleading statements in marketing materials. This article summarizes the factual allegations in the Complaint, the causes of action and the remedies sought by Brockton. For a similar story of alleged failure by a fund of funds manager to perform claimed due diligence, see “Federal Court Decision Holds That a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).
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From Vol. 5 No.14 (Apr. 5, 2012)
Implications of the JOBS Act for Hedge Fund Managers
The President is expected to sign into law today the Jumpstart Our Business Startups (JOBS) Act, which could represent a positive development for many small businesses, including hedge funds, that generally seek to raise their profile within the capital markets and specifically seek to raise capital. While it may still be premature to prognosticate the impact that the JOBS Act will have on hedge fund marketing and advertising because the SEC has not provided details regarding its anticipated rulemaking, hedge fund managers and their compliance staff should nonetheless be cognizant of the potential implications of this legislation on their businesses. This article surveys some of these potential implications.
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From Vol. 5 No.8 (Feb. 23, 2012)
Hedge Fund Manager May Be Personally Liable to Third-Party Marketers Based on Ambiguities in Marketing Agreement
A recent court decision highlights the pitfalls of sloppily drafted agreements covering third-party marketing arrangements in the hedge fund context. This article summarizes that opinion, which is relevant to hedge fund managers, third-party marketers and others engaged in hedge fund capital raising. See “How Much Are In-House Hedge Fund Marketers Paid, and How Will Recent Developments in New York City and California Lobbying Laws Impact the Compensation Levels and Structures of In-House Hedge Fund Marketers (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011).
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From Vol. 5 No.5 (Feb. 2, 2012)
Marketing Hedge Funds to European Union Investors in the Post-AIFMD Era
On January 26, 2012, K&L Gates LLP (K&L) hosted a webinar entitled, “Marketing Hedge and Private Funds in Europe” (Webinar). The purpose of the event was to provide information about the European Union (EU) Alternative Investment Fund Managers Directive (AIFMD), a new law that significantly impacts, among other things, the marketing of hedge funds and other private funds in Europe so that fund managers can proactively evaluate their fund structuring and marketing options. The Webinar principally focused on: (1) structures for accessing European retail, institutional and other investors via public and private offering; (2) the impact that the AIFMD is anticipated to have beginning in 2013; (3) the survival of the current private placement regime after the AIFMD becomes effective; (4) advantages and disadvantages of establishing EU-domiciled funds and EU-authorized subsidiary operations; (5) the process of becoming EU-regulated; (6) consequences of a collapse of the euro or a country’s departure from the euro zone; and (7) points of consideration for managers with euro-denominated share classes or underlying euro swaps and other exposures. The Webinar was conducted by K&L partners Martin Cornish and Mark Perlow. This article provided a comprehensive synopsis of the Webinar.
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From Vol. 5 No.4 (Jan. 26, 2012)
Survey by SEI and Greenwich Associates Highlights the Importance to Hedge Fund Investors of a Clearly Articulated, Comprehensible and Credible Value Proposition
In October 2011, SEI Knowledge Partnership (SEI) and Greenwich Associates conducted their fifth annual survey of institutional hedge fund investors. On January 25, 2012, they released a report summarizing part one of the results of that survey (Report), including current trends affecting the hedge fund industry, including institutional hedge fund allocations, objectives, performance and preferences in investment strategies and vehicles. The Report, entitled “The Shifting Hedge Fund Landscape, Part I of II: Institutions Put Fund Managers to the Test,” identifies a deepening commitment to hedge funds on the part of institutional investors, and foreshadows increased institutional allocations. At the same time, however, the Report finds that institutions keep creating new challenges and requirements for hedge fund managers. Notably, the Report also details what hedge fund managers must do in order to maintain investor confidence. Part two of the survey will explore investors’ chief concerns regarding hedge fund investing, as well as the continuing evolution of institutional standards for hedge fund evaluation, selection and monitoring. This article summarizes the findings of the Report and the key takeaways for hedge fund managers. See also “SEI Report Describes the Growth Opportunity for Hedge Fund Managers in Regulated Alternative Funds,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).
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From Vol. 5 No.3 (Jan. 19, 2012)
Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Four of Four)
This article is the fourth in a four-part series by Maria Gabriela Bianchini, founder of Optionality Consulting. The first article in this series identified factors that hedge fund managers should consider in determining whether to open an office in Asia and compared the relative merits of Hong Kong and Singapore as locations for an office. See “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part One of Four),” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011). The second article in this series discussed technical steps and considerations for the actual process of opening an office in either Hong Kong or Singapore. See “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Two of Four),” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011). The third article in this series described the practical impact of Singapore’s new regulatory regime on hedge fund managers. See “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Three of Four),” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15 2012). This article series concludes with a discussion of topical regulatory issues regarding opening an office in Hong Kong.
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From Vol. 4 No.44 (Dec. 8, 2011)
A Step-By-Step Guide to GIPS Compliance for Hedge Fund Managers
The Hedge Fund Law Report and others have reported on the post-crisis ascendance of non-performance factors in hedge fund due diligence and investment decision-making. In short, before 2008, hedge fund allocations were driven largely by a manager’s past performance. After 2008, factors such as transparency, liquidity and robust risk management surpassed performance in the hierarchy of concerns of institutional hedge fund investors. See “Survey by SEI and Greenwich Associates Identifies the Primary Decision Factors and Concerns of Institutional Investors When Investing in Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 11, 2011). However, we do not wish to overstate the case or the duration of the trend. The long-term lesson of the crisis likely will be that robust risk management, appropriate liquidity and transparency and well-developed infrastructure are necessary to justify a hedge fund investment, but not sufficient. Hedge fund managers without institutional caliber businesses will often be passed over, but as between two managers with good businesses, the deciding factor will often be past performance. Thus the immediate and important question for hedge fund managers: how can managers present performance information in a manner that maximizes capital raising efforts while complying with relevant law and standards? An increasingly common answer to this question in the hedge fund community is: by complying with the Global Investment Performance Standards (GIPS), an evolving set of practice standards designed to ensure consistency and uniformity in the presentation of investment performance results. Compliance with GIPS is ostensibly voluntary, but in practice, more and more institutional hedge fund investors are asking to see GIPS-compliant performance information. Accordingly, GIPS compliance is becoming a de facto requirement for hedge fund managers, and hedge fund managers are actively seeking to become GIPS compliant. The main challenge for hedge fund managers is that GIPS were originally designed for a long-only world. They have been an imperfect fit for managers with complex investment structures, side pockets, illiquid or hard-to-value assets and other typical elements of the hedge fund business. Sensitive to this, the GIPS Executive Committee recently promulgated guidance specific to alternative investment managers, and service providers have adapted their businesses to help hedge fund managers comply with GIPS and certify such compliance. However, despite the guidance and available assistance, GIPS compliance remains a challenge for hedge fund managers. This article aims to assist hedge fund managers in rising to that challenge and surmounting it. To do so, this article starts by providing a comprehensive overview of GIPS. The article then identifies five discrete categories of benefits of GIPS compliance and two categories of burdens of compliance. Next, and most importantly, this article provides a step-by-step process by which hedge fund managers can become GIPS compliant. In the course of this discussion, this article details the material points from two recent webinars and one recent white paper promulgated by leading GIPS service providers. Reading this article will enable a hedge fund manager to, among other things: revise its marketing materials to comply with GIPS; organize its front, middle and back offices to collect the data necessary to support a GIPS-compliant presentation; manage service providers with a view to GIPS compliance; ask the right questions of outside counsel; determine whether to engage a specific GIPS compliance service provider; define the scope of any such engagement; and respond effectively to due diligence inquiries on GIPS.
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From Vol. 4 No.43 (Dec. 1, 2011)
Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation
Changing investor expectations and heightened regulation of hedge fund marketing has ushered in a new era for hedge fund managers seeking to raise capital. Hedge fund managers must continuously keep abreast of the issues that will impact their ability to effectively raise capital, particularly from institutional investors. Additionally, recent regulatory developments have created new challenges for fund managers that use third party marketers to assist in raising capital. This “New Normal” was the backdrop of the 2011 annual conference of the Third Party Marketers Association (3PM) in Boston on October 26 and 27, 2011. This article focuses on the most important points for hedge fund managers that were discussed during the conference. The article begins with a discussion of how fund managers can enhance their marketing efforts to raise more capital by understanding various aspects of the capital raising cycle, including the changing request for proposal (RFP) process, product positioning, the investor due diligence process and the manager selection process. The article then moves to a discussion of the regulatory challenges facing hedge fund managers using third party marketers, including a discussion of third party marketer due diligence of fund managers and appropriate compensation arrangements for third party marketers in light of lobbying law changes and pay to play regulations. The final section discusses impending and existing rules that will have a significant impact on hedge fund marketing.
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From Vol. 4 No.42 (Nov. 23, 2011)
Recent Enforcement Action Highlights SEC’s Concern with Preferential Redemption Rights Granted to Favored Hedge Fund Investors
Hedge fund investors are demanding greater liquidity where liquidity is practicable. See “What Do Hedge Fund Investors Want in Terms of Liquidity and Transparency?,” The Hedge Fund Law Report, Vol. 4, No. 39 (Nov. 3, 2011). Some managers are addressing such demands by launching more liquid funds. See our recent interview with Dechert Partner George Mazin (question on bifurcation in post-crisis hedge fund launches along liquidity lines). Other managers are addressing such demands by launching moderately liquid hedge funds but granting certain investors preferential redemption rights, often via side letters. See “Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011). The former approach passes regulatory muster. To an increasing degree, the latter approach does not. Regulators are concerned that any asymmetry in the redemption rights granted to hedge fund investors that otherwise are getting the same material terms may conflict with the manager’s uniform fiduciary duty to all fund investors. See “Delaware Chancery Court Opinion Clarifies the Scope of a Hedge Fund Manager’s Fiduciary Duty to a Seed Investor,” The Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011). Top SEC officials have expressed this concern with increasing volume of late, most recently at this week’s Practising Law Institute program on hedge funds. A recent enforcement action illustrates a factual scenario in which the SEC’s legal concern may give rise to causes of action against a hedge fund manager. Practically, this action will help hedge fund managers define the scope of accommodation that permissibly may be granted to a significant investor that demands greater liquidity than other investors. See “How Can Liquid Hedge Funds Be Structured to Accommodate Investments in Illiquid Assets?,” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011). Theoretically, this action is part of a growing body of regulatory statements and authority suggesting that uniform liquidity for similarly situated hedge fund investors is in the nature of an inalienable investor right. This article details the factual and legal allegations in the order and discusses the implications of the order for hedge fund liquidity, brokerage activity by hedge fund managers and principal transactions.
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From Vol. 4 No.35 (Oct. 6, 2011)
Federal Court Holds That Hedge Fund Marketing and Brokering Hedge Fund Management Company Transactions Are Different Services for Contracting and Compensation Purposes
The Hedge Fund Law Report previously has reported on a case (which is not the only case of its kind) standing for the incontrovertible proposition that it is preferable for ethical actors to enter into written, as opposed to exclusively oral, hedge fund marketing agreements. See “Pair of District Court Opinions Illustrates the Difficulty of Enforcing a Purported Oral Agreement Between a Third-Party Marketer and a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010). A recent federal district court decision refines the analysis by emphasizing the importance of identifying the contemplated services in the relevant written agreement with as much specificity as possible. Specifically, the decision indicates that hedge fund marketing – efforts to get people or entities to invest in hedge funds – and brokering transactions between hedge fund management companies are two different categories of services. See “Buying a Majority Interest in a Hedge Fund Manager: An Acquirer’s Primer on Key Structuring and Negotiating Issues,” The Hedge Fund Law Report, Vol. 4, No. 17 (May 20, 2011). The same person or entity may do both, but a person or entity that retains another person to perform one of these categories of services does not necessarily retain that person to perform the other category of service.
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From Vol. 4 No.20 (Jun. 17, 2011)
How Much Are In-House Hedge Fund Marketers Paid, and How Will Recent Developments in New York City and California Lobbying Laws Impact the Compensation Levels and Structures of In-House Hedge Fund Marketers (Part Three of Three)
This is the third article in our three-part series on how recent changes to the New York City and California lobbying laws will impact the compensation and activities of third-party and in-house hedge fund marketers. The first article in this series described the relevant legal changes in depth and included a chart comparing analogous provisions of the New York City and California laws. See “Recent Developments in New York City and California Lobbying Laws May Impact the Activities and Compensation of In-House and Third-Party Hedge Fund Marketers (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011). The second article in the series analyzed the implications of the lobbying law changes for third-party hedge fund marketers. Notably, the second article examined how hedge fund managers may structure new agreements with third-party marketers, or restructure existing agreements, in light of the ban on “contingent compensation” under the New York City and California laws. That second article also discussed representations, warranties and covenants called for by the revised laws; due diligence consequences of the revised laws; and – most provocatively – why the lobbying law changes may be moot in light of a broader macro trend impacting third-party marketers. See “How Can Hedge Fund Managers Structure the Compensation of Third-Party Marketers in Light of the Ban On ‘Contingent Compensation’ Under New York City and California Lobbying Laws? (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 13 (Apr. 21, 2011). This article is the third in our lobbying series, and focuses on the implications of the lobbying law changes for in-house hedge fund marketers. In particular, this article details: the typical compensation structures of in-house hedge fund marketers; how much in-house hedge fund marketers are paid, including specific numbers based on conversations with executive search professionals with relevant experience; whether in-house marketers fall within the scope of the California and New York City lobbying laws; specific strategies for structuring or restructuring the compensation of in-house marketers based on the lobbying law developments; exemptions from the “lobbyist” designation that may be available to in-house marketers; a discussion of relevant guidance provided by the California Fair Political Practices Commission in a recent letter; and the related issue of registration of an in-house hedge fund marketing department as a broker, and of the members of such a department as associated persons of a broker.
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From Vol. 4 No.20 (Jun. 17, 2011)
Does a Hedge Fund Manager’s Contractual Obligation to Pay Fees to a Third-Party Marketer Survive the Closing or Restructuring of the Manager?
In 2005, plaintiffs Hedge Fund Capital Partners, LLC and Cyprian Consulting LLC entered into an “introduction agreement” with hedge fund manager Thor Asset Management, Inc. (Thor). In exchange for referrals of prospective investors, Thor promised to pay plaintiffs 20 percent of any management and performance fees earned by Thor from investors introduced by plaintiffs. Relations soured when, in 2009, Thor’s principals formed co-defendant Systematic Alpha Management, LLC (SAM) and SAM apparently took over Thor’s operations. Plaintiffs sued, claiming that SAM was Thor’s “alter ego” and that Thor and SAM had failed to pay the full amount of introduction fees owed under plaintiffs’ agreement with Thor. They claimed that, among other things, Thor failed to pay any fees at all on certain introductions, failed to pay fees on subsequent investments made by investors introduced by plaintiffs and shifted investors into new funds to avoid paying fees to plaintiffs. SAM moved to dismiss the entire complaint for failure to state a cause of action. The trial court denied SAM’s motion in its entirety and the Appellate Division affirmed the order in part. We summarize the plaintiffs’ claims and the subsequent proceedings.
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From Vol. 4 No.19 (Jun. 8, 2011)
How Can Hedge Fund Managers Avoid Criminal Securities Fraud Charges When Allocating Trades Among Multiple Funds and Accounts?
All hedge fund managers that manage multiple funds and accounts – which is to say, the vast majority of hedge fund managers – have to draft, implement and enforce policies and procedures governing the allocation of trades among those funds and accounts. Where those funds and accounts follow explicitly different strategies, the appropriate approach to allocations is relatively straightforward. For example, if a manager manages an equity long/short fund and a credit fund, equities go to the equity fund and bonds go to the credit fund. But where multiple funds and accounts may be eligible to invest in the same security, the appropriate approach to allocations is more challenging. For example, if a manager manages an equity long/short fund and an activist fund and purchases a block of public equity, how and when should the manager determine how to allocate the block between the two funds? While the specifics of an allocations policy will depend on the manager’s fund structures and strategies, some general principles and proscriptions apply. As for principles, an allocations policy should be equitable, should take into account the size and strategies of various funds, should provide a mechanism for correcting allocation errors and should give the manager an appropriate degree of discretion in making allocation determinations. As for proscriptions, the boundaries of “appropriate discretion” in this context generally are set by the anti-fraud provisions of the federal securities laws and principles of fiduciary duty. In other words, you cannot allocate trades in a manner that constitutes securities fraud. How might trade allocations constitute securities fraud? A recent SEC order (Order) answers that question; and a prior criminal indictment (Indictment, and together with the Order, the Charging Documents) and plea arising out of the same facts raises the frightening prospect that in more egregious circumstances, fraudulent trade allocation practices may constitute criminal securities fraud. This article explains the facts and legal violations that led to the Order, Indictment and plea, then discusses the implications of this matter for hedge fund managers in the areas of trade allocations, marketing, disclosure on Form ADV and creation and maintenance of books and records. In particular, this article discusses: why the cherry-picking scheme at issue in this matter was not just a bad legal decision, but also a bad business decision; two types of cherry-picking; whether and in what circumstances cherry-picking may lead to criminal liability; how the sometimes purposeful vagary of criminal indictments can subtly expand the reach of white collar criminal liability; whether disclosure can cure trade allocation practices that are otherwise fraudulent; the compliance utility of technology; conflicts of interest inherent in one person serving as chief compliance officer and in other roles; whether post-trade allocations are ever permissible; how hedge fund managers can test the sufficiency of their trade allocation policies; how trade allocation policies interact with the transparency rights sometimes granted to larger hedge fund investors; and the idea of “cross-fund transparency.”
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From Vol. 4 No.18 (Jun. 1, 2011)
Is a Hedge Fund Manager Required to Disclose the Existence or Substance of SEC Examination Deficiency Letters to Investors or Potential Investors?
Following an examination of a registered hedge fund manager by the SEC staff, the staff typically issues a deficiency letter to the manager listing compliance shortcomings identified by the staff during the examination. See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011). Quickly, comprehensively and conclusively remedying compliance shortcomings identified in a deficiency letter should be a first order of business for any hedge fund manager – that is the easy part, a point that few would dispute. However, considerably more ambiguity surrounds the question of whether and to what extent hedge fund managers must disclose to investors and potential investors various aspects of SEC examinations – including their existence, scope, focus and outcome. More particularly, hedge fund managers that receive deficiency letters routinely ask: must we disclose the fact of receipt of this deficiency letter or its contents to investors or potential investors? And does the answer depend on whether potential investors have requested information about or contained in a deficiency letter in due diligence or in a request for proposal (RFP)? The answers to these questions generally have been governed by a “materiality” standard – the same standard that, at a certain level of generality, governs all disclosure questions. The consensus guidance has been: disclose whatever is material. But this is more of a reframing of the question than an answer. The practical question in this context is how to assess materiality in the interest of disclosing adequately, avoiding anti-fraud or breach of fiduciary duty claims and ensuring best investor relations practices. A recently issued SEC order (Order) settling administrative proceedings against a registered investment adviser provides limited guidance on the foregoing questions. This article describes the facts recited in the Order, the SEC’s legal analysis and how that analysis can inform decision-making of hedge fund managers considering whether and to what extent to disclose the existence or substance of deficiency letters to investors or potential investors. This analysis has particular relevance for hedge fund managers seeking to grow institutional assets under management by responding to RFPs.
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From Vol. 4 No.15 (May 6, 2011)
PerTrac’s Eighth Annual “Sizing the Hedge Fund Universe” Study Identifies Trends Regarding AUM, Domicile, Currency and Performance Information Reporting for Single Manager Hedge Funds, Funds of Funds and Commodity Trading Advisors
In its recently released study entitled “Sizing the 2010 Hedge Fund Universe” (Study), software and services provider PerTrac analyzed information from ten leading global hedge fund databases to identify trends with respect to assets under management, domicile, currency and performance information reporting by single manager hedge funds, funds of funds and commodity trading advisors. The Study generally found that the overall number of entities that existed and reported performance information to databases increased during 2010 over 2009, but that the growth was unevenly distributed among the types of entities under analysis. Moreover, the Study highlighted the significant number of small managers, and thus, from a regulatory perspective, implicitly emphasized the increased importance of state-level hedge fund adviser registration. See “Connecticut Welcomes You! Federal Financial Regulatory Reform Restores Connecticut’s Authority over Hedge Fund Advisers,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010). This article summarizes the key findings of the Study. Also, where relevant, this article includes links to other articles in The Hedge Fund Law Report offering concrete guidance to managers on the legal and regulatory implications of the business trends identified by the Study. See, e.g., “Who Should Newly Registered Hedge Fund Managers Designate as the Chief Compliance Officer and How Much Are Chief Compliance Officers Paid?,” The Hedge Fund Law Report, Vol. 4, No. 7 (Feb. 25, 2011).
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From Vol. 4 No.13 (Apr. 21, 2011)
How Can Hedge Fund Managers Structure the Compensation of Third-Party Marketers in Light of the Ban On “Contingent Compensation” Under New York City and California Lobbying Laws? (Part Two of Three)
An authoritative recent interpretation of New York City’s lobbying law and recent amendments to California’s lobbyist law likely will require placement agents and other third-party hedge fund marketers, in-house hedge fund marketers and, in some cases, hedge fund managers themselves, to register as lobbyists. Such registration will impose new obligations and prohibitions on hedge fund marketers and managers. See “Recent Developments in New York City and California Lobbying Laws May Impact the Activities and Compensation of In-House and Third-Party Hedge Fund Marketers (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011). Most dramatically, both California and New York City will prohibit a registered lobbyist from receiving contingent compensation, that is, compensation that is calculated by reference to the success of the lobbyist’s efforts in persuading a public pension fund to invest in a hedge fund. Success-based compensation is the primary mechanism used to compensate and incentivize hedge fund marketers. Accordingly, the legal change in California and the interpretive change in New York will fundamentally alter the economics of hedge fund marketing. Or to set the stage in simpler terms: Hedge fund marketers will be required to register as lobbyists; hedge fund marketers are paid by commission; lobbying laws prohibit the payment of commissions to lobbyists; so how will hedge fund marketers be paid going forward? This is the second article in a three-part series intended to address that question. The first article included a comprehensive chart detailing the provisions relevant to hedge fund managers and marketers of the New York City and California lobbying laws. This article examines how hedge fund managers can structure or restructure their arrangements with third-party hedge fund marketers in light of the ban on contingent compensation. Specifically, this article discusses: the relevant provisions of the New York City Administrative Code and the California Code; trends in other states and municipalities; typical components, levels and structures of compensation of third-party hedge fund marketers (all of which were analyzed in depth in a prior article in the HFLR); four specific strategies that hedge fund managers can use to structure new arrangements with third-party marketers, and the benefits and burdens of each; three of the more challenging scenarios that hedge fund managers may face in restructuring existing agreements with third-party marketers, and the relevant legal considerations in each scenario; whether the New York City and California lobbying laws contain grandfathering provisions; special lobbying law considerations for funds of funds; and changes to representations, warranties, covenants and due diligence necessitated by the changes to the lobbying law. The article concludes with a discussion of a “bigger issue” that has the potential to render the foregoing discussion largely moot. (The third article in this series will examine related issues with respect to in-house hedge fund marketers.)
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From Vol. 4 No.12 (Apr. 11, 2011)
GIPS Committee Provides Eagerly-Anticipated Guidance on Presentation of Hedge Fund Performance Information for Master-Feeder Structures, Side Pockets, Illiquid Assets and Other Assets, Strategies and Structures
As established by the CFA Institute in 1999, the “Global Investment Performance Standards” (GIPS) for the presentation of investment performance information aims to create ethical, global and industry-wide methods of communicating investment results to prospective clients. On March 15, 2011, the GIPS Executive Committee released its “Exposure Draft of the Guidance Statement on Alternative Investment Strategies and Structures” (Guidance Statement) in an effort to provide dedicated guidance to firms that manage hedge funds, funds-of-funds, master-feeder funds and other alternative investment strategies so they may better understand and meet the GIPS standards. The Executive Committee decided to produce these standards due to the perception among many alternative investment firms that the lack of such guidance complicated compliance with GIPS. Accordingly, the GIPS standards, which focus on the underlying GIPS principles of “fair representation and full disclosure,” provide a framework that substantially all hedge fund and other private fund managers can apply to a variety of assets, structures and strategies. The exposure draft is open for public comment until June 15, 2011. This article provides a comprehensive summary of the exposure draft, focusing on the items most relevant to presentation of hedge fund performance information.
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From Vol. 4 No.11 (Apr. 1, 2011)
Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers
Many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register by July 21, 2011 – that is, in just under four months – unless the SEC extends the registration deadline. Rule 203-1 under the Investment Advisers Act of 1940 (Advisers Act) currently provides that to apply for registration with the SEC as an investment adviser, a hedge fund manager must complete Form ADV, file Part 1A of Form ADV and file the brochure(s) required by Part 2A of Form ADV electronically with the Investment Adviser Registration Depository (IARD). Last July, the SEC finalized amendments to Part 2 of Form ADV and related rules under the Advisers Act. Those amendments were long in the making – a decade, by some counts – and they have changed Part 2 significantly. Most notably, Part 2 is now entirely narrative, publicly filed and deeper and broader in terms of the categories of required disclosure (including disciplinary history). So, hedge fund managers will have to register as investment advisers and registered investment advisers must file Form ADV, Part 2. Therefore, registered hedge fund managers will have to file Form ADV, Part 2. For managers, this has been an expensive syllogism. Many have hired compliance consultants with the goal of saying no more and no less than is required in their Part 2s. Recently, the staff of the SEC’s Division of Investment Management (Division) offered assistance in this collective benchmarking effort by publishing “Staff Responses to Questions About Part 2 of Form ADV” (Staff Responses). The Staff Responses include a series of commonly asked questions and answers to those questions. But the questions are broad and the answers are terse, in some cases, limited to a single, oracular word. While better than no statement from the Division, the Staff Responses raise as many questions as they answer. In particular, the Staff Responses say nothing about the background and context of the answers; provide no guidance on the interaction among and application of the answers; and fail to highlight the extent to which certain answers render others largely moot. This article seeks to fill in the blanks left by the Staff Responses. It does so by discussing: the legal and regulatory authority supporting some of the more relevant answers; where those answers fit into the more general patchwork of hedge fund regulation; the interaction among the answers; and the application of the answers to offshore advisers to offshore hedge funds. The article also offers guidance on implementing certain answers and highlights what certain of the answers do not cover.
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From Vol. 4 No.11 (Apr. 1, 2011)
CalPERS “Special Review” Includes Details of Misconduct and Recommendations That May Fundamentally Alter the Hedge Fund Placement Agent Business
In 2009, the California Public Employees’ Retirement System (CalPERS) – the largest state pension fund in the country, with about $228 billion in assets held for the benefit of over 1.6 million California public employees, retirees and their families – discovered that exorbitant fees had been paid by certain of its external money managers to placement agents. CalPERS retained the law firm of Steptoe & Johnson LLP to investigate whether the payment of these fees compromised the interests of its participants and beneficiaries. The Steptoe investigation focused on placement agents that allegedly used their connections with certain members of CalPERS’ Board of Administration (Board), executive staff and senior officers to obtain excessive fees from money managers and others who wished to obtain access to CalPERS contracts. As previously reported in The Hedge Fund Law Report, in December 2010, the law firm issued a series of twelve preliminary recommendations to CalPERS’ Board and its executive staff for its immediate consideration in remedying the harm to its beneficiaries and participants caused by the improper use of placement agents. See “CalPERS Special Review Foreshadows Seismic Shift in Business Arrangements among Public Pension Funds, Hedge Fund Managers and Placement Agents,” The Hedge Fund Law Report, Vol. 4, No. 1 (Jan. 7, 2011). Since that time, CalPERS has effectively adopted each of these recommendations. Then, on March 14, 2011, Steptoe & Johnson issued the “Report of the CalPERS Special Review.” This Report detailed, subject to limitations requested by law enforcement agencies and allegations for which the law firm could not obtain sufficient corroboration, the apparent misconduct and ethical breaches committed by former CalPERS Board members and employees. The Report also offered four additional recommendations to prevent a recurrence. As a result of its size and experience with hedge funds, CalPERS is a trendsetter for other public pension funds and institutional investors with respect to hedge fund investment terms and governance, placement agent relationships and related matters. Accordingly, the Report, like the previously issued recommendations, is of broad interest to hedge fund managers, investors and service providers. See generally “Lessons for Hedge Fund Managers on Liquidity, Allocations, Marketing and More from Yale’s 2009 Endowment Report,” The Hedge Fund Law Report, Vol. 3, No. 14 (Apr. 9, 2010). Indeed, the Report acknowledges that CalPERS’ experience “was apparently no different . . . than that of a number of other public pension funds.” This article summarizes: the findings of the Report; the four key recommendations made in the Report; and the terms of letter agreements entered into with respect to fees between CalPERS and some of its more prominent external money managers, including Apollo Global Management.
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From Vol. 4 No.11 (Apr. 1, 2011)
Survey by SEI and Greenwich Associates Identifies the Primary Decision Factors and Concerns of Institutional Investors When Investing in Hedge Funds
A survey of 97 institutional investors and 14 investment consultants conducted by SEI Knowledge Partnership in collaboration with Greenwich Associates last October, and released earlier this year, identifies the hierarchy of considerations and concerns of institutional investors when investing in hedge funds. One notable finding of the survey – especially for a publication, like the HFLR, focused on regulation – is the view of most institutional investors with respect to regulation. That view is discussed in this article. In addition, this article discusses the survey’s findings on the following topics: statistics with respect to hedge fund returns, assets under management, launches and liquidations during the last three years; plans with respect to hedge fund allocations during 2011; objectives of institutional investors when investing in hedge funds; most significant challenges in hedge fund investing; experience with and perceptions of liquidity; the 16 factors that investors consider most important when selecting among managers; four key takeaways for hedge fund managers from the survey findings; breakdown of hedge fund allocations by institutional investor type; trends with respect to fees; the role of consultants; the success rate of negotiations on liquidity terms; and trends with respect to the resources dedicated by institutional investors and consultants to hedge fund due diligence and monitoring.
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From Vol. 4 No.10 (Mar. 18, 2011)
Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?
The hedge fund adviser registration provisions of Dodd-Frank have, deservedly, received considerable attention during the last year from hedge fund managers and other industry participants. However, there is another big registration question in the hedge fund industry – a question that predates Dodd-Frank by years; that has been discussed in hushed tones, for fear that regulators will overhear; and that may have consequences at least as powerful as the new adviser registration rule. The question is the title of this article: is the in-house marketing department of a hedge fund manager required to register as a broker? A closely related question is whether the members of such a department must register as associated persons of a broker. These questions do not lend themselves to conclusive answers, but this article seeks to provide a framework for analyzing the relevant issues. In particular, this article discusses: the general broker-dealer registration regime; SEC staff and court interpretations of the term “broker”; registration relief available to issuers and “finders”; the non-exclusive registration safe harbor for associated persons of an issuer; consequences of not registering as a broker if a person or entity is required to do so; specific challenges for hedge fund managers in complying with the safe harbor; how to structure in-house marketer employment agreements to fit within the safe harbor; and structuring alternatives for managers who elect to live with the broker registration regime. According to our research, while the SEC has brought enforcement actions against various types of entities for operating as unregistered brokers, the SEC has not, to date, brought an action against a hedge fund manager solely for operating its in-house marketing department as an unregistered broker. However, the SEC’s enforcement division is newly invigorated, with an asset management unit focused specifically on regulating hedge funds via enforcement. Moreover, the consequences for failing to register as a broker when required to do so can be dramatic. Finally, the “hushed tones” referenced above have not been entirely successful – we at The Hedge Fund Law Report have anecdotal and written evidence that the issue of broker registration of in-house hedge fund marketing departments is on the SEC’s radar screen. That is, this article is not alerting the SEC to an issue of which the agency is unaware. Rather, it is letting hedge fund managers know that they should be prepared – and offering guidance on how to prepare.
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From Vol. 4 No.6 (Feb. 18, 2011)
Recent Developments in New York City and California Lobbying Laws May Impact the Activities and Compensation of In-House and Third-Party Hedge Fund Marketers (Part One of Three)
Public pension funds represent approximately 16 percent of all institutional investor assets in hedge funds, according to alternative investment data provider Preqin. However, not all assets invested in hedge funds are equally weighted. To a hedge fund manager, a dollar invested by a public pension fund generally is more valuable than a dollar invested by a high net worth individual, or most funds of funds, for at least two reasons. First, that pension fund is likely to stay invested longer, and thus to generate more fees over time. Second, an investment by a public pension fund often increases the likelihood of other investments because subsequent investors assume, rightly or wrongly, that the public pension fund engaged in rigorous investment and operational due diligence before investing. Accordingly, public pension funds have long been among the most coveted investors in hedge funds, and that 16 percent figure understates the attention such funds have garnered from in-house and third-party marketers. However, at least three recent developments have complicated the process of marketing to public pension funds. The first two of those three developments are discussed in this article. The third such development is this: an authoritative recent interpretation of New York City’s lobbying law, and recent amendments to California’s lobbying law, likely will require placement agents and other third-party marketers, in-house hedge fund marketers and, in some cases, hedge fund managers themselves, to register as lobbyists. Such registration will impose new obligations and prohibitions on hedge fund marketers. Most dramatically, both California and New York City prohibit a registered lobbyist from receiving contingent compensation, that is, compensation that is calculated by reference to the success of the lobbyist’s efforts in persuading a public pension fund to invest in a hedge fund. In other words, the lobbying laws of both jurisdictions appear to prohibit – or at least complicate – precisely the types of compensation structures most typically found in placement agent agreements and many in-house marketer agreements. See “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010). Of course, the lobbying laws only prohibit or complicate such compensation structures in connection with solicitation activities directed at public pension funds in California or New York City. However, those jurisdictions contain public pension funds – notably including CalPERS – whose actions are widely followed by other public pension funds and other institutional investors. See “CalPERS Special Review Foreshadows Seismic Shift in Business Arrangements among Public Pension Funds, Hedge Fund Managers and Placement Agents,” The Hedge Fund Law Report, Vol. 4, No. 1 (Jan. 7, 2011). This article is the first installment in a three-part series intended to explore the implications of the New York City and California lobbying law developments for various hedge fund industry participants. Specifically, this article provides the legal basis on which the analyses in parts two and three will be based. The core of this article is a proprietary, 14-page chart summarizing the key provisions of the New York City and California lobbying laws, and comparing those provisions side-by-side. For example, column one of the chart lists a provision (e.g., people and entities whose efforts to influence investment decisions may constitute “lobbying” under relevant law), column two describes the provision under New York City law, and column three describes the provision under California law. The intent of this layout is to enable subscribers to easily compare the way in which the different jurisdictions handle the same concept. The specific provisions covered by the chart include: primary legal, regulatory and interpretive resources, and links thereto; affected pension funds; definitions of “lobbyist”; definitions of “client” (NY), “external manager” (CA) and “lobbyist employer” (CA); definitions of “lobbying”; people and entities whose efforts to influence investment decisions may constitute “lobbying” under relevant law; exceptions from the definition of “placement agent”; people and entities, contacts with whom may constitute “lobbying” under relevant law; registration requirements for lobbyists; timing and frequency of required filings by lobbyists of statements of registration; filing requirements applicable to clients of lobbyists; periodic filing requirements applicable to lobbyists; prohibitions on contingent compensation; other prohibitions; recordkeeping requirements; the requirement to attend ethics training courses; penalties for violations of lobbying laws; and the public availability of reported data. Part two of this article series will examine the implications of these lobbying law developments for the activities and compensation of third-party hedge fund marketers, and part three of this series will examine the implications for in-house marketers.
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From Vol. 4 No.3 (Jan. 21, 2011)
2010 Greenwich Associates Global Custodian Prime Brokerage Study Discusses Counterparty Risk Concerns, Sources of Assets, Balance Spreading, Leverage Levels, Separately Managed Accounts and Hedge Fund Staffing Benchmarks
In the 2010 Greenwich Associates Global Custodian Prime Brokerage Study, institutional financial services consulting and research firm Greenwich Associates offered insight on the relationship between hedge funds and prime brokers, high water marks, counterparty risk concerns among hedge fund managers, hedge fund money raising, spreading of hedge fund cash and non-cash balances, use by hedge funds of leverage and separately managed accounts and hedge fund manager staffing. The insights in the study were based on interviews with over 1,800 hedge fund managers across North America, Europe and Asia-Pacific. This article summarizes the key findings of the study.
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From Vol. 3 No.49 (Dec. 17, 2010)
Pair of District Court Opinions Illustrates the Difficulty of Enforcing a Purported Oral Agreement Between a Third-Party Marketer and a Hedge Fund Manager
On October 20, 2009 and November 9, 2010, the U.S. District Court for the Northern District of Illinois issued two opinions benefiting hedge fund manager Whitecap Advisors, LLC, in breach of contract litigation brought by third-party hedge fund marketer Coburn Group, LLC. In the lawsuit, Coburn Group had accused Whitecap of breaching its oral agreement to continue to pay its commission for so long as the investors it introduced to Whitecap maintained investments with it. Whitecap, in turn, had challenged Coburn Group’s claim that such an agreement existed, and claimed, alternatively, that they had entered a “pay-as-you-go” arrangement that it terminated following repeated unsuccessful attempts by both parties to reach a memorialized contract. When Coburn Group moved for summary judgment, the District Court found that material issues of fact existed that necessitated a jury trial. When Whitecap moved, days later, to preclude Coburn Group from introducing evidence at that trial of damages to Coburn Group that may arise in the future, the District Court agreed that such evidence would be inappropriate given the speculative nature of such damages, and granted Whitecap’s motion. This action is particularly significant because not many legal opinions address the relationship between hedge fund managers and placement agents or third-party marketers. This article details the background of the instant action and the court’s pertinent legal analysis. For more on the relationships between hedge fund managers and placement agents or third-party marketers, see “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010); “Indemnification Provisions in Agreements between Hedge Fund Managers and Placement Agents: Reciprocal, But Not Necessarily Symmetrical,” The Hedge Fund Law Report, Vol. 3, No. 41 (Oct. 22, 2010).
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From Vol. 3 No.44 (Nov. 12, 2010)
Municipal Securities Rulemaking Board Extends Its Regulatory Reach to Include Hedge Fund Placement Agents
On November 1, 2010, the Municipal Securities Rulemaking Board (MSRB) filed proposed rule changes with the Securities and Exchange Commission (SEC). See “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010). Those proposed rule changes are of interest to the hedge fund community for five primary reasons. First, they clarify the definition of a “municipal advisor” for purposes of Section 975 of Dodd-Frank. That definition likely encompasses placement agents providing services to hedge funds and other entities that provide similar services to hedge funds but call themselves something else (such as “finders,” “solicitors” or “cash solicitors”). Second, the proposed rule changes impose three procedural requirements on municipal advisors. Third, they impose two substantive requirements on municipal advisors. Fourth, the MSRB’s Notice 2010-47 (Notice), announcing the filing of the proposed rule changes, includes a roadmap of the MSRB’s rulemaking agenda for “the coming months and years,” including rules that will directly affect hedge fund placement agents. Fifth, the Notice contains a portentous endnote relating to the “federal fiduciary duty” of municipal advisors, and the entities to whom that duty is owed. This article discusses each of these five points – and identifies the questions that placement agents have to ask and answer today based on these points.
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From Vol. 3 No.40 (Oct. 15, 2010)
Two Recent Matters Suggest That Law Firms Should Stick to Practicing Law Rather Than Trying to Intermediate Hedge Fund Investments
From time to time, business-minded hedge fund lawyers look at their client bases and networks and say to themselves: “I know a lot of hedge funds managers looking for investors and a lot of institutions looking to invest in hedge funds. Wouldn’t I be helping everybody – myself included – if I connected those hedge fund managers and investors?” Two recent matters answer this question with a resounding “no.” This article describes the two matters, and their application to law firms with hedge fund manager or investor clients.
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From Vol. 3 No.39 (Oct. 8, 2010)
Prime Broker Merlin Securities Develops Spectrum of Hedge Fund Investors; Event Hosted by Accounting Firm Marcum LLP Examines Marketing Implications of the Merlin Spectrum
In August of this year, prime broker Merlin Securities, LLC released a white paper dividing the universe of hedge fund investors into ten categories, and arranging those categories along a spectrum from least to most “institutional.” By institutional, Merlin was referring to the demand placed on hedge fund managers by each type of investor with respect to assets, operational practices, risk management, track record, reporting and other factors. On September 23, 2010, at an event hosted by accounting firm Marcum LLP, Ron Suber, Senior Partner at Merlin and an author of the white paper, expanded on the institutional investor spectrum and its implications for hedge fund marketing. This article outlines the Merlin investor spectrum and details the key takeaways from the Marcum conference with respect to hedge fund marketing, including a discussion of hedge fund seeding by pension funds. Like any analytical framework, Merlin’s spectrum is intended to help managers clarify their marketing efforts and develop reasonable expectations, rather than to apply without alteration to every factual context. As discussed more fully below, according to Merlin, it generally would not be realistic for a startup manager to target only pension funds in its marketing efforts; but by the same token, as discussed at the Marcum event, some pension funds have explored or executed hedge fund seeding deals, so startup managers should not rule out marketing to pension funds altogether. See “How Should Hedge Fund Managers Adjust Their Marketing to Pension Funds in Light of Potential Downward Revisions to Pension Funds’ Projected Rates of Return?,” The Hedge Fund Law Report, Vol. 3, No. 11 (Mar. 18, 2010); “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).
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From Vol. 3 No.36 (Sep. 17, 2010)
Three Significant Legal Pitfalls for Hedge Fund Marketers, and How to Avoid Them
Until recently, the generally held perception was that the worst a hedge fund marketer could do is fail to raise money. But then came the credit crisis, a raft of new regulations, a newly enlarged and invigorated SEC and a tectonic shift in the hedge fund investor base in favor of more public and private pension funds and other retirement plans. In this fraught new operating environment, hedge fund marketers can do more than fail to benefit the fund: they can affirmatively harm the fund and manager. In particular, marketers can, in different contexts: jeopardize fees; render ideal investors off-limits; subject a manager to complex regulatory schemes from which the manager would otherwise be exempt; and give investors the right to rescind their investments. This article details three significant legal pitfalls that can give rise to these and other harms, and suggests ways to avoid them.
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From Vol. 3 No.35 (Sep. 10, 2010)
What Is the “Market” for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?
Historically, hedge fund managers have retained placement agents and other third-party intermediaries to identify investors, obtain investments and for related purposes. Hedge fund managers’ use of placement agents is likely to continue and even increase for two simple reasons: because such use is permitted, and because it can add value. On the first point, the fact that hedge fund managers can use placement agents is only news because between August 2009 and June 2010, the continued viability of that use was in doubt. In short, in August 2009, the SEC proposed a pay to play rule that would have prohibited hedge fund managers from using placement agents (or “third-party solicitors,” “solicitors,” “finders” or “pension consultants”) to obtain investments from public pension funds. Given the importance of public pension funds in the hedge fund investor base – according to Preqin, public pension funds comprise approximately 17 percent of all institutional hedge fund investors – many in the hedge fund industry thought that the proposed ban marked the beginning of the end of the use by hedge fund managers of placement agents. See, e.g., “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009). However, the final pay to play rule, adopted by the SEC on June 30, 2010, did not prohibit hedge fund managers from using placement agents to solicit investments from public pension funds, but rather permitted such use so long as the relevant placement agent is a registered investment adviser or registered broker-dealer. See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010). Along similar lines, on September 2, 2010, the SEC adopted a temporary rule (Rule 15Ba2-6T under the Securities Exchange Act of 1934) requiring municipal advisors to register with the SEC by October 1, 2010 (i.e., within three weeks). This rule does not prohibit the use by hedge fund managers of “finders,” “solicitors” or other previously unregistered entities to obtain investments from public pension funds, but it may require such entities to register with the SEC. See “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” below, in this issue of The Hedge Fund Law Report. In short, while the legal and regulatory environment for placement agents has become more complex, their activities are, in general, still legally permitted. And on the second point – the idea that placement agents can add value – there are two categories of rationales for this idea: micro rationales and macro rationales. The micro rationales – the specific categories of services that placement agents are well-positioned to provide to hedge fund managers – are detailed below. As for the macro rationales, four trends suggest that placement agents will play an increasingly important role in the allocation of capital to hedge funds. First, a disproportionate volume of recent inflows have gone to larger managers. Second, according to Preqin, 29 percent of institutional investors plan to invest more capital in hedge funds over the next 12 months than they did during the previous 12 months, and 46 percent of investors plan to increase their hedge fund allocations in the next three to five years. Third, according to Preqin, 37 percent of institutional investors plan to direct any hedge fund allocations in the short to medium term to a mixture of new and existing managers, and 23 percent of institutional investors plan to invest in new managers only (that is, new to the investor, though not necessarily new to the market, i.e., not necessarily startup managers). Fourth, according to Preqin, “firm reputation” is tied with “track record” as the second most important factor for institutional investors when making hedge fund allocations. The point: capital is likely to flow into hedge funds over the next five years, but if you are anything other than a large, established manager, the competition for capital is likely to remain fierce. And importantly in an industry where performance is easily measured, readily comparable and frequently updated, even “large, established managers” can stumble in terms of size and stature, and find themselves pounding the proverbial fundraising pavement once again. In light of the anticipated importance of placement agents in steering capital into hedge funds over the next (at least) five years, this article seeks to shed light on a relatively obscure topic: the “market” for fees and other terms in agreements between hedge fund managers and placement agents. Specifically, this article first identifies seven distinct reasons why a manager may hire a placement agent, then details the most important terms of, and issues in connection with, placement agent agreements, including the following: fee structures and levels; declining fees; duration of engagements and sunset provisions; carve-outs for the manager’s pre-existing relationships; exclusivity; licensing, registration and representations with respect to both; indemnification; insurance; and the pay to play overlay.
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From Vol. 3 No.7 (Feb. 17, 2010)
Barclays Capital Report Says Mid-Sized Hedge Funds Attract the Most Money from Investors and Hedge Funds Saw $150 Billion Inflows in First Nine Months of 2009
A December 2009, Barclays Capital’s Prime Services Division report on the hedge fund industry, entitled “Raising the Game,” found that hedge funds attracted $150 billion in new assets in the first nine months of this year. Despite that inflow, the report stated that assets under management (AUM) remain an average of 32 percent below peak levels two years ago. Even so, hedge fund managers surveyed for the report representing a combined total of $387 billion of AUM, or approximately one third of the industry, expressed optimism regarding future inflows. Notably, the survey also found that hedge funds are devoting more resources to differentiate themselves as a result of the financial crisis. See also “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009). This article details the most salient findings of the report and their implications.
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From Vol. 2 No.50 (Dec. 17, 2009)
How Can Start-Up Hedge Fund Managers Use Past Performance Information to Market New Funds?
Recent market dislocations have given rise in the hedge fund industry, as in other industries, to an increasing crescendo of entrepreneurship. According to data from Hedge Fund Research Inc., 224 hedge funds launched worldwide during the third quarter of this year, while 190 closed in the same period – the first time since early 2008 that the number of new launches exceeded the number of closures. While compensation has come down on average, especially at firms under their high water marks, so has the opportunity cost of casting out on one’s own. See “How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009). In short, for star traders on broker-dealer prop desks, second chairs, co-managers and trusted lieutenants, the climate for hedge fund entrepreneurship is unusually fertile. See “As Banks Close Prop Desks and Traders Move to Hedge Funds, Hedge Fund Managers Focus on Permissible Scope of Use of Confidential Information,” The Hedge Fund Law Report, Vol. 2, No. 18 (May 7, 2009). While hedge fund entrepreneurs face all of the usual issues involved in entrepreneurship – employment matters, office leases, professional services fees, etc. – they also face certain issues unique to the hedge fund industry. See “Stars in Transition: A New Generation of Private Fund Managers,” The Hedge Fund Law Report, Vol. 2, No. 49 (Dec. 10, 2009). Chief among those unique issues are the legal and regulatory limitations on what a hedge fund entrepreneur can communicate to potential investors in the new funds or management entity with respect to prior performance. Specifically, despite the ubiquity of the disclaimer stating that past performance does not guarantee future results, there remains no more reliable predictor of future results than past performance. Accordingly, new investors are keenly interested in past performance, and for any hedge fund entrepreneur that seeks to create a viable business, the question is not whether to communicate past performance, but how. The short answer is: carefully. Few topics are as central to marketing discussions when launching a new hedge fund management company and new hedge funds, and few topics are as fraught with legal risk. In an effort to help hedge fund entrepreneurs navigate the thicket of relevant regulation, this article analyzes in depth the laws, rules, regulatory pronouncements (in particular, no-action letters) and market practices governing the permissible and impermissible uses of past performance data when launching new funds or managers. While the authority is complex and fact-specific, this article extracts and drills down on five broad principles that new managers would be well-advised to keep in mind during (and even after) new fund or manager launches. Within those five broad principles, this article describes concrete strategies that managers can follow to stay within the rules governing the use of past performance information in marketing efforts. This article also details the key points from the seminal Clover Capital no-action letter.
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From Vol. 1 No.17 (Aug. 1, 2008)
SEC Issues No-Action Letter Suggesting Hedge Fund Advisers Are Exempt From Cash Solicitation Arrangement Disclosure Requirements
On Tuesday, July 15, 2008, the SEC Division of Investment Management issued a no-action letter stating that “[w]e believe that Rule 206(4)-3 generally does not apply to a registered investment adviser’s cash payment to a person solely to compensate that person for soliciting investors or prospective investors for, or referring investors or prospective investors to, an investment pool managed by the adviser.” Even though the letter appears to be a positive development for hedge fund managers that contract with third-party solicitors to solicit fund investors, managers should still be cognizant of the actual or potential conflicts of interest that may be inherent in solicitation arrangements. Advisers Act Rule 206(4)-3(b) may still provide useful guidance as to the content and substance of appropriate disclosure of solicitation arrangements.
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