The Hedge Fund Law Report

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

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By Topic: Gates

  • From Vol. 7 No.1 (Jan. 9, 2014)

    Schulte Partner Stephanie Breslow Discusses Tools for Managing Hedge Fund Crises Caused by Liquidity Problems, Poor Performance or Regulatory Issues

    The Practising Law Institute’s (PLI) Hedge Fund Management 2013 program included a session entitled “Managing Hedge Funds in Crisis,” which was presented by Stephanie R. Breslow, a partner at Schulte Roth & Zabel LLP, co-head of the firm’s Investment Management Group and a member of its Executive Committee.  Breslow discussed the various tools that managers have at their disposal to address crises impacting their funds, such as a run on liquidity, and how those tools have changed over time, particularly after the 2008 financial crisis.  This article summarizes the key takeaways from her presentation.  For a general discussion of post-crisis liquidity and crisis management tools, see “Structuring, Valuation, Fee Calculation and Other Legal and Accounting Considerations in Connection with Hedge Fund General Redemption Provisions, Lock-Up Periods, Side Pockets, Gates, Redemption Suspensions and Special Purpose Vehicles,” The Hedge Fund Law Report, Vol. 3, No. 43 (Nov. 5, 2010); “What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?,” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011); and “IOSCO Report Discusses Appropriate Use and Disclosure of Hedge Fund Redemption Suspensions, Gates and Side Pockets,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).

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  • From Vol. 5 No.43 (Nov. 15, 2012)

    Schulte Partner Stephanie Breslow Discusses Hedge Fund Liquidity Management Tools in Practising Law Institute Seminar

    “Liquidity” describes the frequency with which investors can get their money back from a hedge fund.  Typically, the governing documents of a hedge fund contain default liquidity provisions and a set of mechanisms the manager can use to vary those default provisions.  For example, the default provisions may say that investors can redeem from the fund quarterly, but the documents may also permit the manager to reduce, delay or recharacterize redemption requests.  Conceptually, liquidity management tools are motivated by investment and equitable considerations: it is difficult to execute an investment program on a fickle capital base, and a manager’s fiduciary duty flows to all investors in a commingled vehicle.  In practice, however, investors are rarely happy to hear that they cannot get their money back.  Prior to the 2008 financial crisis, liquidity management tools in hedge fund governing documents were effectively viewed as boilerplate: present, but rarely used.  Then credit markets seized up, liquidity dried up and everybody needed cash – investors for their own investors or beneficiaries, managers to satisfy redemptions, banks to remain solvent, etc.  Managers blew the dust off long dormant provisions in governing documents and actually imposed gates, suspended redemptions and use other heretofore unthinkable techniques to manage liquidity.  The financial crisis has passed, but liquidity management remains an important topic in the hedge fund industry.  Liquidity issues are often micro rather than macro, and, in any case, post-crisis documents have been drafted with a view to the next macro event.  Recognizing the ongoing importance of liquidity management in hedge fund governance, Stephanie R. Breslow presented a session on the topic at the Practising Law Institute’s September 5, 2012 “Hedge Funds 2012” event.  Breslow is a partner in the New York office of Schulte Roth & Zabel LLP, co-head of Schulte’s Investment Management Group and a member of the firm’s Executive Committee.  Breslow’s session focused on, among other topics: developments in fund liquidity terms since the 2008 financial crisis; tools available to a fund manager for managing liquidity risk, including the right to suspend redemptions, fund-level gates, investor-level gates, side pockets and in-kind distribution of assets; duties owed by a fund manager in the context of a liquidity crisis; the evolution in fund manager attitudes towards secondary market transactions in fund interests and shares; and why fund investors have not pushed for the right to remove fund managers in fund governing documents during liquidity crises.  This article summarizes key points from Breslow’s session.

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  • From Vol. 5 No.37 (Sep. 27, 2012)

    Cayman Grand Court Rejects Validity of Side Letter Entered Into Between an Investor in Investment Vehicles That Invested in the Matador Fund and a Director of the Matador Fund

    A recent decision handed down by the Grand Court of the Cayman Islands (Court) emphasizes the importance of: (1) ensuring that the correct parties enter into side letters between an investor and a fund; and (2) ensuring that a fund’s governing documents permit the fund to enter into the type of side letter contemplated by the fund and the investor.  This decision follows on the heels of another recent decision handed down by the Court that highlights similar principles.  See “Recent Cayman Grand Court Decision Demonstrates the Practical and Legal Challenges of Investing in Hedge Funds through Nominees,” The Hedge Fund Law Report, Vol. 5, No. 29 (Jul. 26, 2012).

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  • From Vol. 5 No.26 (Jun. 28, 2012)

    SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation

    On June 26, 2012, the SEC filed three separate complaints relating to securities law violations allegedly committed by Philip A. Falcone, his investment advisory firm, Harbinger Capital Partners LLC (Harbinger) and other entities and individuals.  In the first complaint, the SEC charged Falcone, Harbinger and Peter Jenson, a former Managing Director and Chief Operating Officer of Harbinger, with violations of the federal securities laws in relation to the misappropriation of client assets (through the making of a $113.2 million loan from a fund managed by Harbinger to Falcone to pay his personal taxes) and the granting of undisclosed preferential redemption rights to certain investors.  See “Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  In the second complaint, the SEC charged Falcone, Harbinger Capital Partners Offshore Manager, L.L.C. and Harbinger Capital Partners Special Situations GP, L.L.C. with engaging in an illegal short squeeze to manipulate bond prices.  In the third complaint, the SEC charged Harbert Management Corporation, HMC-New York, Inc. and HMC Investors, LLC with control person liability in relation to the alleged market manipulation described in the second complaint.  Separately, the SEC issued an order settling claims with Harbinger related to violations of Rule 105 under Regulation M.  This article details the charges levied by the SEC in the three complaints and details the terms of the settlement with Harbinger related to the Rule 105 violations.

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  • From Vol. 4 No.42 (Nov. 23, 2011)

    Speakers at Walkers Fundamentals Hedge Fund Seminar Provide Update on Hedge Fund Terms, Governance Issues and Regulatory Developments Impacting Offshore Hedge Funds

    On November 8, 2011, international law firm Walkers Global (Walkers) held its Walkers Fundamentals Hedge Fund Seminar in New York City.  Speakers at this event addressed various topics of current relevance to the hedge fund industry, including: recent trends in offshore hedge fund structures; hedge fund fees and fee negotiations; fund lock-ups; fund-level and investor-level gates; fund wind-down petitions and the appointment of fund liquidators; corporate governance issues; D&O insurance; fund manager concerns with Form PF; and offshore regulatory developments, such as proposed legislation requiring registration of certain master funds in the Cayman Islands, the EU’s Alternative Investment Fund Manager (AIFM) Directive and the British Virgin Islands (BVI) Securities & Investment Business Act (SIBA).  This article summarizes the key points discussed at the conference relating to each of the foregoing topics and others.

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  • From Vol. 4 No.29 (Aug. 25, 2011)

    Delaware Chancery Court Opinion Clarifies the Scope of a Hedge Fund Manager’s Fiduciary Duty to a Seed Investor

    In resolving a contentious lawsuit between a start-up hedge fund manager, Michelle Paige, and her seed investor, the Lerner family, the Delaware Chancery Court issued an opinion on August 8, 2011 that described the scope of a manager’s fiduciary duty to a seed investor, and the circumstances in which a manager viably may prohibit redemption by a seed investor by lowering a gate.  See “Is a Threatening Letter from a Hedge Fund Manager to a Seed Investor Admissible in Litigation between the Manager and the Investor as Evidence of the Manager’s Breach of Fiduciary Duty?,” The Hedge Fund Law Report, Vo. 4, No. 17 (May 20, 2011).  This feature-length article details the background of the action and the Court’s legal analysis.  The opinion is one of the longer statements to date by the Delaware Chancery Court on a hedge fund dispute, and thus provides valuable insight into the Chancery Court’s view of fiduciary duty in the hedge fund context.  In addition, given the factual background, the opinion is particularly relevant to hedge fund managers that have or are seeking seed investors, and to entities that make seed investments in hedge fund managers and hedge funds.  See “Ten Issues That Hedge Fund Seed Investors Should Consider When Drafting Seed Investment Agreements,” The Hedge Fund Law Report, Vo. 4, No. 12 (Apr. 11, 2011).

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  • From Vol. 4 No.25 (Jul. 27, 2011)

    Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices

    The United States District Court for the Southern District of New York recently issued judgments in favor of three bankrupt hedge funds in fraudulent conveyance actions against investors that redeemed within two years of the funds’ bankruptcy filings.  The hedge funds were members of the Bayou group of hedge funds, which – as the hedge fund industry knows well – was a fraud that collapsed in August 2005, resulting in bankruptcy filings by the Bayou funds and related entities in May 2006.  These judgments are very important for hedge fund investors because they illustrate what appears to be a direct conflict between bankruptcy law and hedge fund due diligence best practices.  In short, hedge fund due diligence best practices currently counsel in favor of redemption at the first whiff of fraud on the part of a manager.  However, bankruptcy law appears to require a hedge fund investor to undertake a “diligent investigation” when it obtains facts that put it on inquiry notice of insolvency of the fund or a fraudulent purpose on the part of the manager.  The immediacy of a prompt redemption is directly at odds with the delay inherent in a diligent investigation.  How can hedge fund investors reconcile the practical goal of prompt self-help with the legal obligation of a diligent investigation?  To help answer that question, this feature length article surveys the factual and procedural history of the Bayou matters, then analyzes the arguments and outcome in the recent Bayou trial.  The primary question at the trial was whether certain investors that redeemed from the Bayou funds could keep their redemption proceeds based on “good faith” defenses to the Bayou estate’s fraudulent conveyance actions.  In the absence of a court opinion, The Hedge Fund Law Report analyzed the 142-page transcript of the closing arguments, as well as the motion papers filed by the parties and four prior bankruptcy court and district court opinions.  This article embodies the results of our analysis.  The article concludes by identifying five ways in which hedge fund investors may reconcile hedge fund due diligence best practices with the seemingly draconian outcome in these recent Bayou judgments.

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  • From Vol. 4 No.17 (May 20, 2011)

    Is a Threatening Letter from a Hedge Fund Manager to a Seed Investor Admissible in Litigation between the Manager and the Investor as Evidence of the Manager’s Breach of Fiduciary Duty?

    Hedge fund manager Paige Capital Management, LLC (Fund), had a dispute with seed investor Lerner Master Fund, LLC (Lerner), over Lerner’s demand to withdraw its entire investment.  The Fund’s attorney wrote a letter to Lerner “reminding” Lerner of the potential costs of litigation over Lerner’s withdrawal rights and advising Lerner that, if it did not drop its withdrawal demand, the Fund would invest Lerner’s funds in “high risk, long-term, illiquid, activist securities” and spare no expense in defending the Fund.  This litigation ensued and the Fund sought to block Lerner from introducing the letter as evidence of breach of fiduciary duty by the Fund, claiming that the letter was protected both as a settlement communication and by the privilege for allegedly defamatory statements made in the course of litigation.  We summarize the decision.

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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)

    IOSCO Report Discusses Appropriate Use and Disclosure of Hedge Fund Redemption Suspensions, Gates and Side Pockets

    On March 8, 2011, the International Organization of Securities Commissions (IOSCO) Technical Committee issued a draft Consultation Report entitled “Principles on Suspensions of Redemptions in Collective Investment Schemes.”  The report focuses on all open-ended collective investment schemes (CIS), including hedge funds, which offer a continuous redemption right, without regard to the type of investor to which the CIS is offered (i.e., institutional or retail).  The report proposes general principles to inform regulatory regimes in their oversight of CIS, and to guide fund managers in deciding if, when and how to suspend investor redemptions.  The report addresses basic management of liquidity risk, permissible reasons for suspension and the actions a CIS should take following a decision to suspend.  It emphasizes three basic principles, and offers guidance relating to alternative liquidity tools available in certain jurisdictions.  This article discusses the most important points of the consultation report, focusing in particular on the points most relevant to hedge fund managers.

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  • From Vol. 4 No.6 (Feb. 18, 2011)

    What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?

    Gates are provisions in hedge fund governing documents that permit the fund manager to limit the volume of assets redeemed on a given redemption date.  The general purpose of gates is to slow the pace of redemptions in down markets and to enable managers to avoid selling assets at temporarily depressed prices.  The goal of such devices is to protect long-term fund investors who, in the absence of gates, might be left with a less liquid and less valuable portfolio.  Historically, for purposes of determining whether a gate was triggered, the volume of assets sought to be redeemed on a given redemption date was measured at the fund level (fund-level gate).  More recently, some hedge fund documents have provided for measurement at the capital account level, on an investor-by-investor basis (investor-level gate).  Even more recently – and, admittedly, in just a few cases of which we are aware – managers have launched hedge funds with a novel provision that combines elements of fund-level and investor-level gates.  The market has taken to calling such provisions “hybrid gates.”  This article explains the mechanics and goals of hybrid gates.  In particular, this article discusses: how redemptions are reduced above the gate threshold in the context of fund-level gates; how the pro rata reduction amount is calculated; current practice with respect to priority of carried-forward excess redemptions; whether carried-forward excess redemptions remain subject to fund profit and loss; discounts or penalties for redemptions above a gate threshold; operation of investor-level gates; and examples of hedge funds that have implemented investor-level gates.  With that background, the article explains (using a numerical example) how hybrid gates work and why managers may consider using them.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    How Can Liquid Hedge Funds Be Structured to Accommodate Investments in Illiquid Assets?

    During the past decade, an increasing volume of hedge fund dollars has poured into traditional liquid strategies.  As a result, market inefficiencies have narrowed or vanished, and opportunities for arbitrage – and the alpha it can generate – have grown fewer and farther between.  In response, some hedge fund managers that traditionally focused on liquid strategies started investing at least part of their funds’ capital in private equity and other illiquid securities and assets.  However, using liquid fund vehicles to invest in illiquid assets has presented a variety of problems, including those relating to: taxation, liquidity, valuation, manager compensation, strategy drift, due diligence, expectations regarding returns and regulatory scrutiny.  While there has been considerable discussion regarding the convergence of hedge funds and private equity funds, the experience and aftermath of the credit crisis indicate that the convergence discussion should be more refined.  Convergence at the fund level is problematic because illiquids do not fit naturally into a liquid fund.  Convergence at the manager level – for example, the same manager managing both private equity funds and hedge funds – is marginally more palatable, but by and large, institutional investors have demonstrated a preference for managers who stick to their knitting.  In a guest article, Philippe Simoens, Senior Manager in Tax and Strategic Business Services for Weaver, an independent certified public accounting firm, addresses some of the reasons why illiquid assets present problems when housed in liquid funds – even liquid funds purportedly structured to accommodate illiquid investments via mechanisms such as side pockets.  In the course of doing so, this article explains traditional liquid fund structuring and taxation; characteristics and taxation of marketable securities versus private equity; and structures employed by liquid funds to accommodate illiquid assets (including side pockets, lock-ups, gates and redemption suspensions).  The article concludes with thoughts on structuring for managers who traditionally have focused on liquid strategies, but who are exploring illiquid opportunities.

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  • From Vol. 2 No.22 (Jun. 3, 2009)

    Northern Trust Announces New Feature to Enable Funds of Funds to Assess the Impact of Gates on Their Liquidity In Real Time

    On May 21, 2009, Northern Trust announced that it had enhanced its offering to funds of hedge funds (FoHF) clients with a new feature that enables FoHF managers to assess the impact of gates on their liquidity in real time.

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  • From Vol. 1 No.29 (Dec. 24, 2008)

    Stigma Fades as Use of Gates Becomes More Common

    Since the onset of the credit crisis, the imposition of gates limiting redemptions from hedge funds has become increasingly common.  However, there was a time, not too long ago, when the lowering of a gate was a hedge fund industry taboo – a sign of imminent and irrevocable decline.  We explain what gates are, explore the rationale for lowering them in times of stress and discuss the increasing frequency of use of gates (and the concomitant fading of the old stigma).

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