The Hedge Fund Law Report

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

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By Topic: Subscription Agreements

  • From Vol. 8 No.6 (Feb. 12, 2015)

    Citi Survey Finds Large Drop in Hedge Fund Profitability from 2013 to 2014, Highlighting the Importance of Management Fee Revenue and Its Impact on Product Strategy and Management Company Valuations (Part One of Two)

    Citi Business Advisory Services (Citi) recently issued the results of its 2014-15 Annual Hedge Fund Operating Metrics Survey (formerly called The Hedge Fund Business Expense Survey), which focused on hedge fund management fee revenues, operating expenses, operating margins, performance fee income and overall profitability.  In this article, the first of two, we summarize Citi’s methodology, survey demographics and its findings with regard to hedge fund profitability in both 2013 and 2014.  The second article will cover the growing importance of management fees for hedge fund managers and how deriving a greater portion of total profits from management fees may improve a fund manager’s valuation.  For coverage of Citi’s 2013 survey, see “Citi Prime Finance Survey Reveals Levels and Mix of Expenses Incurred by Hedge Fund Managers of Different Sizes, Firm Profitability and Margins, Use of Chargebacks and Impact of Regulations on Expenses,” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).  For another recent perspective on hedge fund management company expenses, see “Ernst & Young’s 2014 Global Hedge Fund and Investor Survey Considers Growth Areas for Hedge Fund Managers, Related Costs and Challenges, Operating Expenses and Cybersecurity,” The Hedge Fund Law Report, Vol. 8, No. 2 (Jan. 15, 2015).

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  • From Vol. 5 No.26 (Jun. 28, 2012)

    How Hedge Fund Managers Can Use Arbitration Provisions to Prevent Investor Class Action Lawsuits

    As can be expected during an economic downturn, hedge fund managers were not impervious to investor dissatisfaction following the 2008 financial crisis.  In some instances, this dissatisfaction resulted in litigation.  A recent trend is for investors to threaten to bring their claims as a class action, which not only carries the possibility of exponentially increasing potential damages, but also harming the reputation of the manager and its ability to raise capital in the future.  Nearly all fund governing documents contain arbitration provisions that require any and all claims relating to investment accounts to be arbitrated in private, confidential proceedings.  However, most arbitration provisions contained in fund governing documents are silent on the availability of class arbitration, and this issue is significant for hedge fund managers to consider both retrospectively and prospectively in drafting their governing documents.  While the issue of the permissibility of class actions in arbitration has been the subject of recent judicial scrutiny, reported cases have not yet applied the issue to the hedge fund industry.  In a guest article, Joshua G. Hamilton and Adam M. Sevell, partner and associate, respectively, at Paul Hastings, consider the interplay of recent court opinions dealing with the limitations on class action arbitrations and whether class actions should be permitted in the context of disputes between an investor, on the one hand, and a hedge fund and its manager, on the other hand, and offer some best practices for hedge fund managers seeking to preclude class arbitration.

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  • From Vol. 5 No.9 (Mar. 1, 2012)

    Hedge Fund Investor Accuses Paulson & Co. of Gross Negligence and Breach of Fiduciary Duty Stemming from Losses on Sino-Forest Investment

    Hugh F. Culverhouse, an investor in hedge fund Paulson Advantage Plus, L.P., has commenced a class action lawsuit against that fund’s general partners, Paulson & Co. Inc. and Paulson Advisers LLC.  Culverhouse alleges that those entities were grossly negligent in performing due diligence in connection with the fund’s investment in Sino-Forest Corporation, whose stock collapsed after an independent research firm cast serious doubt on the value of its assets and the viability of its business structure.  Culverhouse seeks monetary and punitive damages for alleged breach of fiduciary, gross negligence and unjust enrichment.  This article does two things.  First, it offers a comprehensive summary of the Complaint.  This summary, in turn, is useful because lawsuits by investors against hedge fund managers are rare, and particularly rare against a name as noteworthy as Paulson.  Disputes between investors and managers are almost always negotiated privately, but such negotiation occurs in the “shadow” of relevant law.  This article outlines what the relevant law may be.  Second, this article contains links to various governing documents of Paulson Advantage Plus, L.P., including the fund’s private offering memorandum, limited partnership agreement and subscription agreement.  Regardless of the merits of Culverhouse’s claim, Paulson remains a well-regarded name in the hedge fund industry.  According to LCH Investments NV, Paulson & Co. Inc. has earned its investors $22.6 billion since its founding in 1994.  Those kinds of earnings can – and have – purchased highly competent legal advice, which translates into workably crafted governing documents.  Accordingly, the governing documents of the Paulson fund are useful precedents for large or small hedge fund managers looking to assess the “market” for terms in such documents or best practices for drafting specific terms.  Thus, we provide links to the governing documents.  See also “Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies,” The Hedge Fund Law Report, Vol. 4, No. 21 (Jun. 23, 2011).

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  • From Vol. 5 No.9 (Mar. 1, 2012)

    SEC Adopts Final Rules Governing the Payment of Performance Fees to Registered Hedge Fund Managers

    On February 15, 2012, the SEC issued a final release in which it adopted rule amendments (final rule amendments) to Rule 205-3 under the Investment Advisers Act of 1940 (Advisers Act), which governs the payment of performance-based compensation to registered investment advisers by qualified clients.  On May 10, 2011, the SEC issued a notice of intent to issue order (May 10 Notice) to modify the assets under management and net worth dollar thresholds informing the qualified client definition and to make additional amendments to Rule 205-3.  On July 12, 2011, the SEC issued an order (July 12 Order) that raised the qualified client dollar thresholds.  For a discussion of the May 10 Notice and the July 12 Order, see “SEC Order Increasing the Dollar Threshold for ‘Qualified Client’ Status Further Chips Away at the Utility of the 3(c)(1) Fund Structure,” The Hedge Fund Law Report, Vol. 4, No. 28 (Aug. 19, 2011).  The final rule amendments codified the change in the qualified client dollar thresholds by amending the definition of qualified client contained in Rule 205-3(d) and adopted rules that are substantially similar to those proposed in the May 10 Notice.  Nonetheless, there are some important differences between the final rule amendments and the rule proposals.  This article discusses the final rule amendments in detail as well as the implications for hedge fund managers, particularly those that operate hedge funds that rely on the exclusion from registration of the hedge fund as an investment company contained in Section 3(c)(1) of the Investment Company Act of 1940.

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  • From Vol. 4 No.23 (Jul. 8, 2011)

    How Can Hedge Fund Managers Collect the Investor Information Required to Comply with the Prohibition on “Spinning” in FINRA Rule 5131?

    FINRA Rule 5131 seeks to ensure public confidence in the initial public offering (IPO) process by prohibiting allocations by broker-dealers of new issues to accounts (including hedge funds) in which a past, current or prospective investment banking client of the broker-dealer holds a beneficial interest – a practice known as “spinning.”  Rule 5131 imposes direct prohibitions on broker-dealers and indirect obligations on hedge fund managers.  That is, to avoid violations of Rule 5131 when allocating new issues to a hedge fund, broker-dealers need information about investors in the hedge fund.  Specifically, broker-dealers need to know whether any investor in the hedge fund is an executive officer or director of a public company or covered non-public company, or if any investor is materially supported by such an executive officer or director.  (All of these terms are discussed in detail in this article.)  However, such information is typically only available to the hedge fund manager.  Therefore, to comply with Rule 5131, broker-dealers – including prime brokers – will ask hedge fund managers for relevant investor information.  In order to provide broker-dealers with sufficient responses, hedge fund managers will have to collect such information from their existing and new investors.  The primary administrative and compliance issue here is that the information required to comply with Rule 5131 is not information that hedge fund managers typically have collected from investors.  As a result, hedge fund managers and other industry participants have been wondering what the scope of required information is, how to collect it, how frequently and what to do with it.  See “New FINRA IPO Allocation Rule Will Require Hedge Funds That Invest in ‘New Issues’ to Revisit Their Compliance Policies and Procedures and Fund Structures,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  With the goal of addressing these questions and more generally helping hedge fund managers comply with their obligations under Rule 5131, this article discusses: the mechanics of Rule 5131, including a discussion of the various defined terms in the rule; the relevance of hedge fund size and strategy in the application of Rule 5131; remedies that may be imposed on hedge fund managers for violations of Rule 5131; how hedge fund managers may revise their subscription documents, questionnaires and annual certifications; the viability and advisability of a negative consent process; the extent to which hedge fund managers are required to investigate investor representations regarding corporate affiliations; an investor’s duty to update representations regarding corporate affiliations; how beneficial ownership is measured for Rule 5131 purposes; the categories of relationships between a broker-dealer and a company that may implicate Rule 5131; and how to calculate the beneficial ownership of a fund of funds in an underlying hedge fund where an investor in the fund of funds is a restricted person under Rule 5131.  This article concludes with an analysis of the elements of two sets of questionnaires and annual certifications provided to The Hedge Fund Law Report by two leading law firm hedge fund practice groups.  We provide a step-by-step analysis of what is included in these forms.  The purpose of this analysis is to enable hedge fund managers to draft new questionnaires and certifications or to revise existing questionnaires and certifications to reflect best practices.

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  • From Vol. 4 No.14 (Apr. 29, 2011)

    U.S. District Court Dismisses All Federal Securities Fraud Claims Brought by Investors Against Hedge Fund Manager RAM Capital Resources, LLC, its Principals and the Funds it Sponsored, Holding that Disclaimers in Subscription Agreements Preclude Reliance on Certain Alleged Misrepresentations

    Defendant RAM Capital Resources, LLC (RAM Capital), is a New York based asset manager and hedge fund sponsor.  Defendants Stephen E. Saltzstein (Saltzstein) and Michael E. Fein (Fein) are RAM Capital’s principals.  Saltzstein was introduced to plaintiff Mario Frati through Saltzstein’s sister, who was a childhood friend of Mario Frati’s wife.  The Fratis invested $2 million in RAM Capital’s Shelter Island Opportunity Fund, LLC.  Plaintiff Banco Popolare (Luxembourg), S.A., on behalf of Mr. Frati’s mother, invested $1.5 million with RAM Capital’s Truk International Fund, LP.  When plaintiffs’ redemption demands were not satisfied, plaintiffs brought suit.  Their complaint, as amended, alleges federal securities fraud, common law fraud, breach of fiduciary duty, unjust enrichment and breach of contract.  Plaintiffs claim the defendants misrepresented, among other things, that plaintiffs could redeem their investments after six months and that RAM Capital’s principals were “heavily invested” in the sponsored funds.  Defendants allegedly also wrongfully omitted to tell plaintiffs that RAM Capital, Saltzstein and Fein were under investigation by the Securities and Exchange Commission and that they were not registered broker-dealers.  See “Investors in Hedge Funds Managed by RAM Capital Resources, LLC Sue RAM, its Principals and its Funds Alleging Securities Fraud, RICO Violations and Other Claims Based on Alleged Misrepresentations and Self-Dealing by RAM Principals,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  Defendants moved to dismiss the entire complaint for failure to state a claim.  We summarize the Court’s decision on defendants’ motion to dismiss.

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  • From Vol. 4 No.5 (Feb. 10, 2011)

    New FINRA IPO Allocation Rule Will Require Hedge Funds That Invest in “New Issues” to Revisit Their Compliance Policies and Procedures and Fund Structures

    On September 29, 2010, the SEC approved new FINRA Rule 5131, New Issue Allocations and Distributions.  Paragraph (b) of Rule 5131 generally prohibits “spinning” – that is, the practice in which FINRA members (substantially all SEC-registered broker-dealers) allocate new issues to officers and directors of current, and certain past or prospective, investment banking clients.  As FINRA noted in Regulatory Notice 10-60, “[b]ecause such persons are often in a position to hire members on behalf of the companies they serve, allocating new issues to such persons creates the appearance of impropriety and has the potential to divide the loyalty of the agents of the company (i.e., the executive officers and directors) from the principal (i.e., the company) on whose behalf they must act.”  The rule will become effective on May 27, 2011.  For hedge funds that invest in new issues, Rule 5131(b) presents a range of compliance and structuring challenges.  Although the rule directly governs the relationships between broker-dealers and corporate officers and directors, hedge funds often serve as the vehicle through which such corporate officers and directors invest in new issues.  Therefore, the brunt of the compliance burden of Rule 5131(b) will, in many cases, devolve to hedge fund managers.  The purpose of this article is to help hedge fund managers design or recalibrate their compliance programs to accommodate new Rule 5131(b), and to highlight some fund structuring options that may be relevant.  Specifically, this article discusses: the general rule imposed by Rule 5131(b); the specific prohibitions included in Rule 5131(b); the de minimis exception to the prohibitions (which is relevant for hedge funds); and – most importantly – compliance and structuring strategies for hedge fund managers.

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  • From Vol. 3 No.10 (Mar. 11, 2010)

    Florida District Court Dismisses Class Action Suit Against Hedge Fund Palm Beach Capital Because Forum Selection Clause in Subscription Agreement Called For Jurisdiction in Cayman Islands, Even Though the Fund Did Not Sign the Subscription Agreement

    Plaintiffs were investors in hedge fund Palm Beach Offshore (Fund), which was organized in the Cayman Islands.  The Fund became insolvent when the Tom Petters multi-billion dollar Ponzi scheme, in which the Fund had made a substantial investment, collapsed in 2008.  See “Update on the Petters Fraud: Polaroid Bankruptcy Trustee Sues to Void Hedge Fund’s Pre-Bankruptcy Receipt of Polaroid Assets,” The Hedge Fund Law Report, Vol. 2, No. 9 (Mar. 4, 2009).  Plaintiffs commenced a class action lawsuit against the Fund’s manager, its principals, its auditors and an outside administrator, alleging breach of fiduciary duty, negligence, unjust enrichment, fraud, negligent misrepresentation and conversion.  The Fund manager and principals moved to dismiss on the grounds that a forum selection clause contained in the subscription agreement required suit to be brought only in the Cayman Islands.  Plaintiffs argued that the forum selection clause was unenforceable because (i) the Fund had not signed the subscription agreement that contained the clause, (ii) the forum selection clause was obtained through fraud and (iii) enforcement was against public policy.  The court rejected all three of plaintiffs’ arguments and dismissed the suit as against the manager and its principals, holding that the clause was enforceable.  We summarize the facts of the case and the Court’s reasoning.

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  • From Vol. 2 No.20 (May 20, 2009)

    Connecticut District Court Dismisses Complaint Against Hedge Fund Manager and Investment Adviser for Lack of Venue

    On April 22, 2009, the United States District Court for the District of Connecticut dismissed a complaint by BNY AIS Nominees Limited (BNY AIS) on behalf of the shareholders of the hedge fund Stewardship Credit Arbitrage Fund, Ltd. (the Hedge Fund) against Marlon Quan (Quan), the Hedge Fund’s managing director and Stewardship Investment Advisors, LLC (SIA), the Hedge Fund’s investment adviser, for improper venue.  The Hedge Fund’s subscription agreement required disputes under the agreement to be resolved in the Bermuda.  The District Court dismissed the complaint, holding that even though the defendants were not parties to the subscription agreement, they were so closely related to the Hedge Fund as to be entitled to the benefits of the forum selection clause.  We detail the facts, analysis and holding of the case.

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  • From Vol. 2 No.17 (Apr. 30, 2009)

    Massachusetts Trial Court Rules that Integration Clause in Subscription Agreement does not Protect Hedge Fund Manager from Fraudulent Misrepresentation Claims

    On January 30, 2009, the Massachusetts Superior Court ruled that Edward Marram, as trustee for Geo-Centers, Inc. Profit Sharing Plan & Trust (the Plan), which had invested $2 million of its assets with the defendant hedge fund, Kobrick Offshore Fund (Kobrick or the Fund), could proceed with the various securities fraud claims it had originally brought against Kobrick.  The court also granted sanctions to Kobrick with respect to the plaintiff’s discovery failure; permitted the Plan to amend its complaint; dismissed all of Kobrick’s counterclaims; and dismissed all claims against third party defendants who allegedly provided negligent advice to the Plan.  The parties were ordered to attempt to resolve the action through mediation.  The court’s key substantive holding was that an integration clause in a subscription agreement does not protect a hedge fund manager defendant from suit based on separate oral or written misrepresentations.  We provide a detailed discussion of the court’s analysis.

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