The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Articles By Topic

By Topic: Administrators

  • From Vol. 10 No.6 (Feb. 9, 2017)

    Why Funds Should Confirm Clear Contractual Obligations and Liabilities With Their Administrators

    In recent years – following the Madoff scandal and the corresponding increase in regulatory scrutiny of hedge funds – investors have increasingly pressured managers to hire third-party fund administrators. See “Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators” (Jan. 21, 2009). Administrators add an extra layer of review and verification to mitigate the insularity and lack of oversight that allowed Madoff’s fraud to flourish undetected for decades. Notwithstanding the critical role that administrators play in the financial services industry, they are not subject to the same level of regulatory oversight as other service providers, such as a fund’s prime broker or auditor. Accordingly, when an administrator’s processes break down, causing losses directly to the fund and indirectly to its investors, the fund’s only option may be to pursue a civil action against the administrator. The success of such a claim will then depend on not only the facts of the case, but also the provisions setting forth the administrator’s obligations and liabilities contained in the agreement between the fund and the administrator. In a guest article, Lisa Solbakken, a partner at Arkin Solbakken, provides insight on the proper role of the administrator, details ongoing litigation in which funds allege that their administrators breached their contractual duties to the funds and offers advice on how funds should approach the negotiation of their administration agreements. For more on administrator liability, see “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016). 

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  • From Vol. 9 No.36 (Sep. 15, 2016)

    How Fund Managers Can Prevent or Remedy Improper Fee and Expense Allocations (Part Three of Three)

    In recent years, the SEC has targeted perceived fee and expense improprieties by private fund managers, with each enforcement action causing managers to fortify their internal practices in an attempt to avoid similar regulatory scrutiny. This increased SEC focus has also caused managers to proactively remedy improper fee or expense allocations revealed by their newly enhanced policies and procedures. This final article in our three-part series provides practical guidance about preventative measures fund managers can take to ensure fees and expenses are properly allocated, as well as post-violation efforts they can perform to remedy any improper allocations. Taken together, these can help managers ensure their procedures meet industry standards and may mitigate the severity of any future SEC sanctions. The first article in this series detailed trends in the types of expense allocations most aggressively scrutinized by the SEC. The second article in the series examined the role of inadequate disclosure and failed policies and procedures in causing expense allocation violations and provided steps managers can take to buttress each of those areas. For more on expense allocations, see “Fees, Conflicts, Investment Allocations and Other Hot Topics Hedge Fund Managers Should Expect During an SEC Examination (Part Two of Two)” (Jun. 30, 2016); and our two-part series entitled “How Should Hedge Fund Managers Approach the Allocation of Expenses Among Their Firms and Their Funds?”: Part One (May 2, 2013); and Part Two (May 9, 2013).

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  • From Vol. 9 No.35 (Sep. 8, 2016)

    “Gatekeeper” Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry

    Fund administrators have been the target of several recent SEC enforcement actions and civil lawsuits by investors that seek to make administrators liable for the misconduct of fund managers and their principals. These aggressive enforcement actions and civil lawsuits are the first of their kind to argue that administrators serve in a gatekeeper role. For more on the SEC’s focus on another category of gatekeepers, see “How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?” (Aug. 19, 2011). In a guest article, Marc Powers and Jonathan Forman, partner and senior associate, respectively, at BakerHostetler, review recent SEC enforcement actions and civil lawsuits against administrators as gatekeepers and outline implications of these actions for hedge fund administrators, managers and investors. For additional insight from Powers, see “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act” (Mar. 5, 2015); and “Chapter 15 of the Bankruptcy Code Presents Litigation Risks and Liability for Creditors, Counterparties, Service Providers and Others Doing Business With Bankrupt Offshore Hedge Funds” (Oct. 3, 2013). For coverage of fund managers shadowing administrators, see “Certain Hedge Fund Managers Are Moving from Full to Partial Shadowing of Administrator Functions” (Sep. 12, 2013); and “When and How Should Hedge Fund Managers Shadow Functions Performed by Their Fund Administrators?” (Mar. 8, 2012).

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  • From Vol. 9 No.26 (Jun. 30, 2016)

    Expanded “Gatekeeper” Responsibilities May Impact Relationship Between Hedge Funds and Service Providers

    The Dodd-Frank Act expanded the SEC’s authority and oversight of the fund industry, in part by subjecting previously unregistered advisers to registration requirements. Two recent SEC enforcement actions have further increased this authority, finding that a service provider to hedge funds – not itself subject to fiduciary or other obligations under the Investment Advisers Act of 1940 (Advisers Act) – was responsible for Advisers Act violations by two of its clients. On June 16, 2016, the SEC announced the resolution of two enforcement actions against a private fund administrator that, by missing various red flags raised by activities of its private fund clients, allegedly caused those clients to violate antifraud provisions of the Advisers Act. This article analyzes the facts that led up the SEC’s allegations, resolution of the enforcement actions and potential industry implications. For more on the SEC’s focus on gatekeepers, see “How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?” (Aug. 19, 2011).

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  • From Vol. 6 No.46 (Dec. 5, 2013)

    Ernst & Young’s 2013 Global Hedge Fund and Investor Survey Describes Trends in Asset Sourcing, Alternative Mutual Funds, Customized Solutions, Staffing, Administrator Shadowing, Expense Pass-Throughs and Outsourcing

    Ernst & Young (EY) recently released the results of its seventh annual Global Hedge Fund and Investor Survey.  The survey revealed the perspectives of hedge fund managers and investors on topics including strategic priorities, operating revenues and costs, investor allocations to hedge funds, new products and services, expense pass-throughs, administrator shadowing, outsourcing and predictions for future hedge fund industry trends.  This article summarizes the key findings of the survey.  For coverage of EY’s 2012 survey, 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).

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  • From Vol. 6 No.35 (Sep. 12, 2013)

    Certain Hedge Fund Managers Are Moving from Full to Partial Shadowing of Administrator Functions

    Since the 2008 financial crisis, hedge fund managers have faced conflicting pressures from investors.  On one hand, heightened pressures on fees have prompted some managers to outsource certain back- and middle-office functions to third-party service providers.  On the other hand, the crisis and concurrent frauds caused investors to demand that managers implement more rigorous controls over fund operations, custody of assets and reporting.  To provide investors an additional level of comfort, managers that outsource delineated functions to administrators typically replicate, or “shadow,” those functions in-house, enabling them to verify the quality of the administrator’s work.  However, this duplication of effort is costly and time-consuming.  Moreover, shadowing may distract managers from effectively performing other essential functions, especially investment management and investor relations.  Consequently, some managers have moved towards “partial shadowing” – monitoring and assuring the quality of certain outsourced work without replicating that work in-house.  A recent panel discussion sponsored by the Regulatory Compliance Association provided an overview of the current climate for administrator shadowing and addressed the pros and cons of a move toward partial shadowing.  This article summarizes the key takeaways from that discussion.

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    How Should Hedge Fund Managers Select Accountants, Prime Brokers, Independent Directors, Administrators, Legal Counsel, Compliance Consultants, Risk Consultants and Insurance Brokers for Their Funds?

    This article discusses what hedge fund managers should look for in the companies that provide accounting, brokerage, directorial, administration, legal, consulting, risk management and technology services to a fund.  To do so, this article focuses on questions that hedge fund managers should ask and issues they should address when retaining or changing service providers.

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  • From Vol. 6 No.23 (Jun. 6, 2013)

    TheCityUK Report Discusses Trends in Hedge Fund Manager Locations, Fund Domiciles, Performance, Strategies, Investors, Secondary Market Transactions and Service Providers

    TheCityUK (TCUK), an association of representatives from the U.K. financial services sector and other businesses, recently released a report providing an overview of recent trends in the global hedge fund industry, broken down by geography, with a focus on the role of managers and funds based in the U.K.  Specifically, the report provided a geographical breakdown of funds and managers; a snapshot of fund performance and investment strategies; a synopsis of fund manager concerns; recent information on secondary market transactions in hedge fund interests; and perspectives on the use of hedge fund service providers.  This article summarizes the primary insights from the report.

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  • From Vol. 6 No.17 (Apr. 25, 2013)

    Roundtable Addresses Trends in Hedge Fund Operational Due Diligence, Fund Expenses, Administrator Shadowing, Business Continuity Planning and Cloud Computing

    At a recent roundtable, hedge fund investor due diligence experts offered their perspectives on evolving hedge fund manager operations and investor due diligence practices.  The panelists addressed various specific topics, including: the impact of regulations on investor due diligence processes; investor responses to increased insider trading risks; scrutiny of fund expenses; administrator shadowing; business continuity planning for hedge fund managers; and the benefits and risks of cloud computing services.  These investor perspectives can provide useful information for hedge fund managers looking to refine their capital raising efforts.  This article highlights the salient points discussed on each of the foregoing topics.

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  • From Vol. 6 No.16 (Apr. 18, 2013)

    Clive Snowdon Joins Moore Group

    On April 15, 2013, hedge fund administrator Moore Group announced that Clive Snowdon has been appointed Group Managing Director.  See “Who Are the Top Ten Hedge Fund Administrators by Assets Under Administration?,” The Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012).

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  • From Vol. 5 No.38 (Oct. 4, 2012)

    Who Are the Top Ten Hedge Fund Administrators by Assets Under Administration?

    eVestment/HFN recently released the results of its eleventh survey of hedge fund administrators, covering the first half of 2012, and discussing relevant dynamics in the alternative investment fund administrator industry.  This article summarizes the findings of the survey.

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  • From Vol. 5 No.29 (Jul. 26, 2012)

    Corgentum Survey Illustrates the Views of Hedge Fund Investors on the Roles, Duties, Risks and Performance of Service Providers

    Corgentum Consulting, LLC, a specialist consulting firm that performs operational due diligence reviews of fund managers, recently conducted a survey asking hedge fund investors five questions about their views on service providers, including questions concerning the functions provided by service providers and the risks associated with them.  This article describes the survey findings.

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  • From Vol. 5 No.23 (Jun. 8, 2012)

    RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part Two of Two)

    On April 16, 2012, the Regulatory Compliance Association held its Regulation and Risk Thought Leadership Symposium (RCA Symposium) in New York City at the Pierre Hotel.  The RCA Symposium brought together leading practitioners and regulators in a series of panel discussions, each of which offered unique insight on various topics of relevance for hedge fund managers.  This is the second article in a two-part series summarizing the highlights from the RCA Symposium.  This second article discusses the sessions covering: the new paradigm of regulatory enforcement and white-collar prosecution; chief compliance officer and general counsel liability; and re-evaluation of the operating model for third party relationships.  The first article discussed the sessions covering: fund governance issues; interpreting, preparing for and completing Form PF; and enterprise risk management for hedge fund managers.  See “RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 22 (May 31, 2012).

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  • From Vol. 5 No.20 (May 17, 2012)

    Amber Partners White Paper Highlights Key Due Diligence Points for Hedge Fund Investors Evaluating Hedge Fund Portfolio Composition and Valuation

    Valuation is one of the key focal areas for many hedge fund investors because a hedge fund manager that utilizes poor valuation practices can present significant investment and operational risks.  At the same time, assessing valuation risk is often one of the most difficult tasks that a hedge fund investor faces in conducting an operational due diligence review.  This is due, in part, to the myriad investment strategies employed by hedge fund managers and the differing levels of transparency provided by hedge fund managers, which, in turn, lead to varying approaches in the presentation of portfolio information.  In April 2012, Amber Partners published a White Paper (Amber White Paper) that supplies hedge fund investors with a roadmap for assessing the level of valuation risk posed by a hedge fund manager.  Specifically, the Amber White Paper provides guidance to investors on how to evaluate the composition of a hedge fund portfolio as well as the manager’s controls over the month-end valuation process.  In addition to providing guidance to hedge fund investors, managers can also glean important lessons from the Amber White Paper on how to avoid valuation pitfalls and institute best-of-breed valuation practices.  This article details the recommendations described in the Amber White Paper.  See also “Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    Use of SSAE 16 (SAS 70) Internal Control Reports by Hedge Fund Managers to Credibly Convey the Quality of Internal Controls, Raise Capital and Prepare for Audits

    An “institutional” quality infrastructure is becoming a prerequisite for hedge fund managers looking to raise capital from sophisticated investors.  But institutional is a difficult quality to define with precision in the hedge fund industry, a function of, among other things, the relative youth of the industry, asymmetry in the size and structure of management companies and the reluctance on the part of managers to disclose information.  As used by hedge fund investors, consultants, managers, regulators, service providers and others, institutional is more of a conclusion than a characteristic.  Managers are said to be institutional when they have fund directors with substance, gray hair in key operational roles, best-of-breed technology, brand name service providers, top tier investment talent and high caliber personnel focused on aspects of the business other than investing.  But a manager may be institutional without some of these elements, and even a manager with these elements can have holes in its processes that undermine the veneer of competence.  So how can investors reliably assess the institutional caliber of a manager, and how can managers credibly demonstrate their level of institutionalization?  Along similar lines, how can investors make institutional apples to apples comparisons when hedge fund management businesses are radically different in terms of size, structure, strategy and operations?  One method is to focus on the robustness of a manager’s internal controls, since robust internal controls are a necessary – though not sufficient – element of an institutional quality infrastructure.  Unlike other indicia of institutionalization, the robustness of internal controls can be measured at a single manager and compared across managers.  Such measurement can be accomplished by having an independent auditor conduct an internal control audit and issue an internal control report in accordance with Statement on Standards for Attestation Engagements No. 16 (SSAE 16), which replaced the long-standing Statement on Auditing Standards 70 (SAS 70).  While SSAE 16s have been in use in other industries for some time, they are a relatively new technique in the hedge fund industry.  However, in a climate of heightened regulator and investor scrutiny of non-investment aspects of the hedge fund business, SSAE 16s offer one of the most objective available barometers of institutionalization.  This article provides an introduction to the SSAE 16 audit process as applied to the hedge fund industry, including a description of the SSAE 16 audit and the corresponding internal control report; provides guidance regarding fund service providers a hedge fund manager should request an internal control report from and what should be covered in such internal control reports; outlines the reasons why hedge fund managers may consider obtaining an SSAE 16 audit on themselves, including a discussion of key benefits and costs of obtaining an internal control audit and report; describes the process for hedge fund managers to obtain an internal control audit and report; addresses who should pay for the internal control audit and report; addresses how often a hedge fund manager should obtain an internal control audit and report; identifies the challenges hedge fund managers face in obtaining an internal control audit and report; and explores whether there are any suitable alternatives to the internal control audit and report.

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    Ernst & Young’s Arthur Tully Talks in Depth with The Hedge Fund Law Report About Hedge Fund Governance, Succession Planning, Valuation, Form PF and Administrator Shadowing

    Ernst & Young’s (E&Y) recently published “Coming of Age: Global Hedge Fund Survey 2011” (Survey) highlighted a host of operational issues that hedge fund managers have recently grappled with, including issues related to corporate governance, succession planning and shadowing of fund administrators.  See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  We recently interviewed Arthur Tully, the Co-Leader of E&Y’s Global Hedge Fund practice, on various topics covered by the Survey, including: issues related to valuation of investments; independent reconciliation of investment positions; reconciliation and documentation of differences in NAV calculations; independent administration considerations for UCITS funds; and how to gather the data necessary to complete Form PF.  See “Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).  In this follow-up interview, Tully shares his insight and experience on additional topics of pressing importance to hedge fund managers, including best practices for hedge fund corporate governance; compensation structures for effective succession planning; valuation issues (including a discussion of the biggest mistakes made in valuing assets); project management in the Form PF context; and administrator shadowing (including common functions shadowed by hedge fund managers).  This article contains the full text of our second interview with Tully.  Tully is expected to expand on these and related topics during a session focusing on hedge fund governance at the Regulatory Compliance Association’s Spring 2012 Regulation & Risk Thought Leadership Symposium.  That Symposium will be held on April 16, 2012 at the Pierre Hotel in New York.  For more information, click here.  To register, click here.  (Subscribers to The Hedge Fund Law Report are eligible for discounted registration.)

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  • From Vol. 5 No.10 (Mar. 8, 2012)

    When and How Should Hedge Fund Managers Shadow Functions Performed by Their Fund Administrators?

    In 2007, hedge fund managers administered roughly 75 percent of U.S.-based hedge funds in house.  Today – for reasons including the credit crisis, high profile frauds and the institutionalization of the hedge fund investor base – the majority of the hedge fund industry outsources to administrators in some capacity.  But outsourcing of administrative functions in the hedge fund industry is not like outsourcing in any other industry.  A typical outsourcing arrangement is a classic division of labor: Party A pays Party B to perform specific tasks because Party B can perform them more cheaply or efficiently, or because Party A’s time would be spent more productively on other tasks.  See “Primary Legal and Practical Considerations for Hedge Fund Managers Looking to Outsource Their Operational Functions,” The Hedge Fund Law Report, Vol. 4, No. 33 (Sep. 22, 2011).  By contrast, outsourcing of administrative functions in the hedge fund industry is not so much a division of labor as a duplication of it.  To a degree that likely would surprise observers outside of the industry, hedge fund managers often continue to perform administrative functions even after those functions are outsourced to an administrator.  In hedge fund industry parlance, this duplication of administrative efforts is known as “shadowing.”  According to a recent Ernst & Young survey, shadowing is “expensive and unique to the hedge fund industry,” widespread and “a business model that might not make economic sense.”  See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  So why do hedge fund managers shadow their administrators?  That is the fundamental question that this article addresses.  In particular, this article discusses: what hedge fund administrators do; what administrator shadowing is; the functions most commonly shadowed by hedge fund managers; reasons why managers shadow their administrators; the benefits and costs of administrator shadowing; whether funds or managers typically bear the costs of shadowing; the circumstances that make shadowing of an administrator most attractive for managers; the different methods managers can use to shadow administrators; and the challenges managers face when shadowing their administrators.

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  • From Vol. 5 No.6 (Feb. 9, 2012)

    Massachusetts Superior Court Dismisses Investors’ Claims Against Hedge Fund Manager Dutchess Capital, its Auditor, Administrator, Principals and Affiliate

    Plaintiffs in this action were investors in two hedge funds managed by Dutchess Capital Management, LLC (Dutchess Capital).  When those investments failed, plaintiffs commenced suit against Dutchess Capital, an affiliate, its principals, its outside auditor and its administrator.  They alleged breach of contract, breach of fiduciary duty, malpractice, fraud and similar claims.  The Court granted defendants’ motion to dismiss, holding that plaintiffs lacked standing to bring certain derivative claims, that the Court lacked jurisdiction over the fund administrator and that the remaining claims were barred by the applicable statutes of limitations.  This article summarizes the Court’s decision.

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  • From Vol. 5 No.2 (Jan. 12, 2012)

    Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice

    Ernst & Young recently released the provocative results of its annual hedge fund survey entitled, “Coming of Age: Global Hedge Fund Survey 2011.”  The survey polled hedge fund managers and investors on a range of relevant topics, notably including valuation and the use of administrators.  See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Many of our subscribers are profoundly interested in the topics of valuation and administrators.  Accordingly, we recently interviewed Arthur Tully, the Co-Leader of E&Y’s Global Hedge Fund Practice, to dig deeper into the survey results on these two topics, and to go beyond the survey to explore Tully’s extensive experience in these areas.  Our interview covered a range of topics on which HFLR subscribers have requested additional insight, including: the level of comfort that investors should take in an administrator’s valuation of Level 3 assets; the level of interest on the part of investors in independent reconciliation of a hedge fund’s investment positions to custodians and prime brokers; who pays for “shadowing” of an administrator by a hedge fund manager and alternatives to shadowing that can provide the same level of comfort to investors; how managers can reconcile and document differences between their calculations of NAV and administrators’ calculations of NAV; independent administration considerations for UCITS funds; the interaction between valuation firms and administrators; hedge fund manager valuation committees; the roles of the board of directors and chief compliance officer in the valuation process; what SEC examiners are looking for with respect to valuation; and how to gather the data necessary to complete Form PF.  The full text of our interview with Tully is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence

    Ernst & Young (E&Y) recently released the 2011 edition of its annual hedge fund survey entitled, “Coming of Age: Global Hedge Fund Survey 2011” (Report).  The Report conveys and compares the views of hedge fund managers and investors on topics including succession, independent board oversight, use of administrators, expense pass-throughs and due diligence.  This article summarizes the more salient findings from the Report.  One of the Report’s many interesting insights is that managers frequently receive little in the way of feedback when a potential investor declines an investment.  The Report partially fills this “feedback gap” by offering generalized insight on what matters most to investors.  For example, managers may be surprised to learn that the absence of a robust and reliable succession plan may have played as much or more of a role in a lost investment as performance or even operational issues.  (The HFLR will be covering succession planning for hedge fund managers in an upcoming issue.)  More generally, the depth of the disparity in perception between managers and investors on a range of topics, as found by the Report, is at times startling.  The Report therefore offers a sobering reality check for both managers and investors.  Both sides need one another, albeit for different reasons, and the lifecycle of an investment can be significantly more productive if expectations and assumptions are better aligned.

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  • From Vol. 4 No.46 (Dec. 21, 2011)

    Deloitte’s Fourth Annual Fund Administration Survey Identifies the Challenges Facing the Hedge Fund Administration Business

    Hedge fund managers are looking to fund administrators to provide a growing variety of administrative, accounting, custodial and asset confirmation services.  See “Application to Hedge Fund Managers of the Internal Control Report Requirement of the Amended Custody Rule,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  The evolving hedge fund industry, changing regulatory landscape and heightened investor demands for greater and more timely information reporting have ratcheted up expectations for fund administrators, and fund administrators are striving to meet these heightened expectations.  See “Hedge Fund Administration Faces a ‘Perfect Storm’: An Interview with Confluence Technologies Senior Market Analyst Scott Powell,” The Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009).  Recently, Deloitte LLP (Deloitte) published a report in which 70 third party fund administrators from 11 countries were surveyed on the biggest challenges they face (Deloitte Survey).  As indicated by fund administrator respondents, the biggest challenges fall into several general categories: regulatory changes; cost containment; implementation of streamlined processes and new technology; and pressure on fees.  This article discusses the findings from the Deloitte Survey.  The survey findings can, among other things, help hedge fund managers select administrators, enable administrators to better focus their resources and assist investors in performing due diligence on administrators.  See “Legal, Operational and Risk Considerations for Institutional Investors When Performing Due Diligence on Hedge Fund Service Providers,” The Hedge Fund Law Report, Vol. 3, No. 27 (Jul. 8, 2010).

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  • From Vol. 4 No.19 (Jun. 8, 2011)

    Houston Pension Fund Sues Hedge Fund Manager Highland Capital Management and JPMorgan for Breach of Fiduciary Duty, Alleging Self-Dealing and Conflicts of Interest

    In 2006 and 2007, plaintiff Houston Municipal Employees Pension System (HMEPS) invested an aggregate $15 million with hedge fund Highland Crusader Fund, L.P. (Fund).  The Fund was sponsored by Highland Capital Management, L.P. (Highland), which also served as the Fund’s investment manager.  The Fund’s general partner was defendant Highland Crusader Fund GP, L.P. (General Partner).  Defendant J.P. Morgan Investor Services Co. (JPMorgan) provided administrative support to the Fund.  The Fund is now in liquidation.  In a lawsuit filed in the Delaware Court of Chancery on May 23, 2011, HMEPS generally claims that, during the credit crisis of 2008, the Highland defendants and their principals “looted” the Fund with the assistance of JPMorgan and engaged in self-dealing by selling themselves high-quality assets from the Fund and leaving the Fund with junk assets.  HMEPS relies in part on a whistleblower complaint filed by a JPMorgan employee who observed “questionable accounting and management practices” at the Fund.  HMEPS claims that Highland, the General Partner and their principals breached their fiduciary duties to the Fund and that JPMorgan aided and abetted that breach.  HMEPS is suing derivatively on behalf of the Fund.  We summarize HMEPS’ specific allegations and Highland’s recent press release in response.

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    The Investment Funds Amendment Act 2010: Key Changes for Hedge Funds Established in Bermuda, and Their Managers

    The Bermuda Investment Funds Amendment Act 2010 (Amendment Act), which received the assent of the Governor General on December 22, 2010, amends the Investment Funds Act 2006 (Act) in making new provisions for the regulation of investment funds in Bermuda.  In a guest article, Neil Henderson, an Associate in the corporate department in the Bermuda office of Conyers Dill & Pearman, describes the changes introduced by the Amendment Act which have particular relevance for hedge funds established in Bermuda, and their managers.

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  • From Vol. 3 No.31 (Aug. 6, 2010)

    Delaware Chancery Court Rules that Countersuit for Indemnification by Manager of Fund Administration Holdings, LLC, May Proceed against those Members of the Fund who Sued Him for Intentional Withholding of Distributions

    On June 30, 2010, the Delaware Chancery Court denied a motion to dismiss counterclaims brought by James P. Kelly, the managing member of Fund Administration Holdings, LLC (FAH), as against members of FAH who had sued him.  Kelly had intentionally withheld payments from the sale of fund assets to those members after they had assisted another firm, State Street Bank and Trust Company (State Street), in unrelated litigation against him.  After the members sued Kelly, he counterclaimed for indemnification, breach of a non-disparagement clause, and release under FAH’s operating agreement.  The court, though “skeptical” of Kelly’s position in seeking indemnification, felt “constrained” to permit his claims to go forward due to ambiguities in the operating agreement.  We detail the background of the action and the court’s legal analysis.

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  • From Vol. 3 No.19 (May 14, 2010)

    NICSA’s "Trends in Hedge Fund Operations" Seminar Focuses on Liquidity, Managed Accounts, Third-Party Administration, Due Diligence, GIPS Standards and Related Topics

    On April 28, 2010, the National Investment Company Service Association, a not-for-profit trade association providing educational programming and information exchange within the operations sector of the worldwide investment industry, sponsored a webinar entitled "Trends in Hedge Fund Operations."  Speakers at the webinar focused on a range of issues of current relevance to hedge fund operations, including: fund-level and investor-level gates; side pockets; the frequency of use of managed accounts; the use of independent, third-party administrators; in-house administration; hybrid arrangements between third-party and in-house administration, including the use of agreed-upon procedures letters; investor due diligence and audit trends; GIPS standards; and the evolution of hedge fund technology.  This article summarizes the key points discussed during the webinar.

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  • From Vol. 3 No.15 (Apr. 16, 2010)

    State Claims Against Directors and Administrators of Hedge Funds Managed by Lancer Management Group Survive SLUSA Challenge

    Investors sought to recover losses stemming from the liquidation of two British Virgin Islands-based hedge funds (Funds) in which they held shares.  In the most recent decision in the ongoing litigation involving the failed hedge funds managed by Lancer Management Group, LLC (Lancer), the United States District Court for the Southern District of New York ruled that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) did not preempt state claims against the directors and administrators of the Funds for allegations of material misstatements in connection with the purchase or sale of a covered security.  This was because the court ruled that the shares issued by the Funds were not “covered securities” under the SLUSA. Rather, the securities were merely held in portfolios.  We detail the background of the allegations and the court’s legal analysis.  See also “Pension Committee Case Highlights Obligations of Hedge Fund Managers to Preserve Documents and Information in Anticipation of Litigation,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).

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  • From Vol. 3 No.2 (Jan. 13, 2010)

    How Can Hedge Fund Managers Maintain the Efficiency Advantages of In-House Administration While Addressing the Valuation, Transparency and Conflicts Concerns of Institutional Investors?

    Financial industry scandals uncovered during the past year and a half have led to calls from regulators and institutional investors for the unbundling of services that, in some cases, have been performed under the roof of a single hedge fund manager.  On the regulatory side, the most salient example is the recently amended custody rule.  As the SEC said in its adopting release, although the amendments do not require the use of an independent custodian, the SEC “encourage[s] custodians independent of the adviser to maintain client assets as a best practice whenever feasible.”  (We covered the custody rule amendments last week, and will have significantly more to say about them in coming weeks.  See “SEC Adopts Investment Adviser Custody Rule Amendments,” The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).)  On the institutional investor side, the most noteworthy development along these lines has been the increasing volume and frequency of calls for independent hedge fund administration.  See “Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators,” The Hedge Fund Law Report, Vol. 2, No. 3 (Jan. 21, 2009).  The basic idea underlying calls for such unbundling is that the provision of administration, custody and similar services by third parties will diminish the ability of hedge fund managers to engage in fraud and, in less extreme scenarios, will mitigate conflicts of interest.  For example, if Custodian X has custody of the assets of Fund Y and sends account statements to investors in Fund Y, the manager of Fund Y will have a difficult time persuading those investors that the fund contains assets that do not exist.  Similarly, if Administrator X calculates the net asset value (NAV) of Fund Y and shares that NAV with investors in Fund Y on a monthly basis, the manager of Fund Y will have a difficult time selling inflated NAV figures to investors.  While the case for third-party administration is plausible – and indeed various leading hedge fund managers have acceded to demands from institutional investors for third-party administration – there remain compelling counterarguments in favor of in-house administration.  Two of the most compelling such arguments involve cost and complexity.  That is, third-party administration generally is paid for by the fund, so in-house administration can save costs.  Also, some managers, especially those with more complex strategies, have invested significantly in the people, processes, technology and infrastructure that comprise their in-house administrative function.  From the perspective of such managers, converting to third-party administration would constitute a step down in terms of expertise and would undermine the value in a large, long-term investment.  (While some of that value can, in theory, be recouped by selling the in-house administrative unit as a separate entity, the unit may be so integrated into the manager’s operations that such a spin out is not practicable.)  Since money-raising remains challenging, and calls for third-party administration remain stentorian, this article aims to elucidate the pros and cons of third-party administration versus in-house administration for various categories of hedge fund managers.  Specifically, this article discusses: what specific services hedge fund administrators perform; typical fees for administrators; relevant considerations when selecting a third-party administrator; the case for in-house administration; the case against in-house administration; and the treatment of administration under the EU’s proposed AIFM Directive and in Luxembourg.  Perhaps most importantly, this article highlights a compromise solution that may enable hedge fund managers to perform in-house administration while addressing the underlying concerns that cause institutional investors to demand third-party administration.

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  • From Vol. 2 No.52 (Dec. 30, 2009)

    Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris

    An article in last week’s issue of The Hedge Fund Law Report detailed a ruling by the New York State Supreme Court permitting a lawsuit by funds managed by Aris Capital Management (Aris) to proceed against hedge funds in which the Aris funds had invested and the managers of those investee funds.  See “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).  That lawsuit is one of various suits brought by Aris and its managed funds against hedge funds or managers in which the Aris funds have invested.  The Aris suits allege a variety of claims in a variety of circumstances, but collectively are noteworthy for their mere existence.  In the hedge fund world, there has been a conspicuous absence during the past two years of legal actions by hedge fund investors against hedge fund managers, despite the coming-to-fruition of circumstances that industry participants thought, pre-credit crisis, would augur an uptick in litigation: the imposition of gates, suspensions of redemptions, mispricing of securities, large losses, etc.  Jason Papastavrou, Founder and Chief Investment Officer of Aris, appears to have broken ranks with what seems like an unspoken agreement in the hedge fund world to avoid the courthouse steps, and he has done so with a considerable degree of thoughtfulness, for specific reasons and with particularized goals.  In an interview with The Hedge Fund Law Report, Papastavrou and Apostolos Peristeris, COO, CCO and GC of Aris, discuss certain of their lawsuits, why they brought them, what they seek to gain from them and what the relevant managers might have done differently to have avoided the suits.  They also discuss: seven explanations for the reluctance on the part of most hedge fund investors to sue managers; the fund of funds redemption process; how their lawsuits have affected their due diligence process; in-house administration; background checks; the importance of face-to-face meetings; side letters; how Aris investors have reacted to the lawsuits; and Aris’ transition to a managed accounts model from a fund of funds model.

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  • From Vol. 2 No.28 (Jul. 16, 2009)

    State Street Vision Report on Hedge Funds Predicts a Migration to Third-Party Administration, Custody and Specialized Services, and a Comprehensive Reconsideration of Financial Regulation

    On July 1, 2009, State Street Corporation released two papers on alternative investments as part of its Vision series of thought-leadership reports.  The papers examine two components of alternative investments, hedge funds and private equity, and their future prospects amid the global economic downturn.  According to State Street, both industries will likely adapt to the changed investment environment caused by the financial crisis and continue to provide significant long-term opportunities for institutional investors.  Our article examines the report on the hedge fund industry, entitled “Alternatives: New Views of the Hedge Fund Industry.”  In particular, our article addresses the potential ramifications of two trends identified by the report: (1) a migration to third-party administration, custody and specialized services; and (2) a comprehensive reconsideration of financial regulation.

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  • From Vol. 2 No.25 (Jun. 24, 2009)

    Hedge Fund Administration Faces a “Perfect Storm”: An Interview with Confluence Technologies Senior Market Analyst Scott Powell

    Confluence Technologies Inc., a provider of fund administration automation, recently published a White Paper titled “Hedge Fund Reporting: The Change Imperative.”  The theme of the paper is that a variety of forces – investor demands for greater transparency; the prospect of increased regulatory oversight; new accounting mandates; and the concerns of asset managers themselves – have placed extraordinary pressure upon hedge fund administration to report more frequently, more thoroughly and with greater flexibility than ever before.  The paper’s authors, Confluence Senior Market Analyst Scott Powell and Director of Marketing Joan Tesla, call this gathering of forces a “perfect storm” for hedge fund administration.  The Hedge Fund Law Report spoke to Scott Powell about the report and some of the issues on which it touches, including (but not limited to): the appropriate level of transparency; the automation of reporting systems; the role of auditing firms; the convergence of U.S. and European accounting standards; the costs of third-party administration; and the new XBRL reporting language.  The full interview is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 2 No.5 (Feb. 4, 2009)

    Federal Court Permits Suit Concerning Collapsed Lancer Funds to Proceed in Part

    On January 5, 2009, the United States District Court for the Southern District of New York ruled that investors seeking to recover over $550 million in losses stemming from the liquidation of British Virgin Islands-based hedge funds Lancer Offshore, Inc. and OmniFund Ltd. could proceed with certain claims against the funds’ administrators and affiliated parties.  The ruling allows the plaintiffs to continue to press their claim that Citco Group, parent firm of the funds’ administrator, was a “culpable participant,” and hence liable, in the funds’ collapse.  In this follow-up to an article published in our December 16, 2008 issue, we detail the factual background of the case and the court’s holding and legal analysis.

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  • From Vol. 2 No.3 (Jan. 21, 2009)

    Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators

    Partly in response to the generally dismal hedge fund returns of 2008, partly in response to the alleged Madoff Ponzi scheme, hedge fund investors are scrambling for safety.  For some, safety means redeeming and parking the proceeds (when they’re in cash rather than kind) in a safe place – cash or Treasuries in custody accounts, and other sleep-at-night type investments.  Others would like to stay the course in hedge funds, but with new and – from hedge fund managers’ perspective – occasionally onerous conditions.  In this latter category, an increasingly frequent demand from institutional investors is that as a condition of new or remaining investments, hedge fund managers appoint independent administrators, even where the manager was heretofore providing many or all administrative service in-house.  We detail the functions of an administrator, and explore the implications for both hedge fund managers and administrators of the growing chorus of requests from institutional investors to outsource administrative functions.

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  • From Vol. 1 No.28 (Dec. 16, 2008)

    Federal Court Bars Investors’ Claims Against Hedge Fund Administrator

    Hedge fund investors sued hedge funds’ prime broker and custodian, their former administrator and their former auditor for fraud, alleging that that the defendants should have known that the funds’ manager was actively engaged in fraud, and that the defendants should have warned plaintiff investors.  We detail the precise allegations, the applicable legal standards, the outcome and the potential implications of the case for future investor suits against third party hedge fund service providers.

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