Articles By Topic
By Topic: Seeding
-
From Vol. 6 No.20 (May 16, 2013)
Seeding, Strategic Stakes and the Evolving Market for Third-Party Investments in Hedge Fund Management Businesses
Hedge fund managers may seek parties to acquire strategic stakes in their businesses or revenue streams for various reasons, including the desire to expand or monetize their businesses. To help hedge fund managers understand the current market for such arrangements, a recent report provided a thorough look at hedge fund seeding, identified seven discrete seeding models and described recent merger and acquisition activity in the hedge fund space. The report also provided an overview of recent fund launches and closures. This article summarizes the key takeaways from the report. See also “How to Structure Exit Provisions in Hedge Fund Seeding Arrangements,” The Hedge Fund of Law Report, Vol. 3, No. 40 (Oct. 15, 2010).
Read Full Article … -
From Vol. 6 No.19 (May 9, 2013)
Rothstein Kass 2013 Hedge Fund Outlook Highlights Managers’ Perspectives on Performance and Economic Trends, Leverage, Capital Raising Strategies, Due Diligence, Staffing, Operational Changes and Regulatory Concerns
International services firm Rothstein Kass recently released a report detailing findings from its survey of 358 professionals at hedge fund managers regarding performance and economic outlook, use of leverage, capital raising concerns and strategies (including seed deals, use of separately managed accounts and fee breaks), investor due diligence, staffing issues and regulatory priorities. This article summarizes the key takeaways from the survey. For an article summarizing the 2012 version of this annual Rothstein Kass report, see “Rothstein Kass Report Discusses Marketing, Structuring, Tax, Leverage, Due Diligence, Hiring and Other Dominant Concerns for Hedge Fund Managers in a Competitive Capital Raising Environment,” The Hedge Fund Law Report, Vol. 5, No. 22 (May 31, 2012).
Read Full Article … -
From Vol. 5 No.32 (Aug. 16, 2012)
Acceleration Capital Group 2012 Seed Capital Survey Suggests Difficult Environment for Raising Early Stage Hedge Fund Capital
Acceleration Capital Group (ACG), a division of Arcadia Securities, LLC, has released the results of its 2012 “Seeder Demand” survey. This article summarizes the ACG survey report, which provides a helpful primer on relevant terms that apply to “seed” capital and a window into how much early stage capital is available and where seeders are likely to deploy that capital.
Read Full Article … -
From Vol. 5 No.27 (Jul. 12, 2012)
SEC Charges Fund Manager Jason Konior and His Firms with Operating a Pyramid Scheme Using a Purported “First Loss” Trading Program
On May 24, 2012, the SEC brought charges in Manhattan federal court against New York-based hedge fund manager Jason J. Konior and his firms, Absolute Fund Advisors, LLC and Absolute Fund Management, LLC, alleging that the defendants violated federal securities laws by operating a pyramid scheme disguised as a “first loss” trading program. This article summarizes the factual background and causes of action contained in the complaint.
Read Full Article … -
From Vol. 5 No.23 (Jun. 8, 2012)
SEC Sanctions Quantek Asset Management and its Portfolio Manager for Misleading Investors About “Skin in the Game” and Related-Party Transactions
Investments by hedge fund managers in their own funds and related party transactions (such as loans from a fund to a manager) exist at opposite sides of the incentive spectrum. The former – so-called “skin in the game” – is typically thought to align the interests of investors and managers while the latter is seen as pitting the interests of investors and managers in direct conflict. Investors want to know about both, for obviously different reasons. A May 29, 2012 SEC Order Instituting Administrative and Cease-And-Desist Proceedings against Quantek Asset Management LLC (Quantek), Javier Guerra, Bulltick Capital Markets Holdings, LP (Bulltick) and Ralph Patino highlights these and other investor considerations. This article summarizes the SEC’s factual and legal allegations against Quantek, Bulltick, Guerra and Patino, and the settlement among the parties. The SEC’s action follows private actions against the same or similar parties. See, e.g., “Fund of Hedge Funds Aris Multi-Strategy Fund Wins Arbitration Award against Underlying Manager Based on Allegations of Self-Dealing,” The Hedge Fund Law Report, Vol. 4, No. 39 (Nov. 3, 2011); “British Virgin Islands High Court of Justice Rules that Minority Shareholder in Feeder Hedge Fund that had Permanently Suspended Redemptions Was Not Entitled to Appointment of a Liquidator,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).
Read Full Article … -
From Vol. 5 No.1 (Jan. 5, 2012)
Legal and Operational Due Diligence Best Practices for Hedge Fund Investors
In the wake of the financial crisis in late 2008, many investors were left trapped in suspended, gated or otherwise illiquid hedge funds. Unfortunately, for many investors who had historically taken a passive role with respect to their hedge fund investments, it took a painful lesson to learn that control over fundamental fund decisions was in the hands of hedge fund managers. Decisions such as the power to suspend or side pocket holdings were vested in managers either directly or through their influence over the board of directors of the fund. In these situations, which were not uncommon, leaving control in the hands of the manager rather than a more independent board gave rise to a conflict of interest. Managers were in some cases perceived to be acting in their own self-interest at the expense, literally and figuratively, of the fund and, consequently, the investors. The lessons from the financial crisis of 2008 reinforced the view that successful hedge fund investing requires investors to approach the manager selection process with a number of considerations in mind, including investment, risk, operational and legal considerations. Ideally, a hedge fund investment opportunity will be structured to sufficiently protect the investor’s rights (i.e., appropriate controls and safeguards) while providing an operating environment designed to maximize investment returns. Striking such a balance can be challenging, but as many investors learned during the financial crisis, it is a critical element of any successful hedge fund program. The focus on hedge fund governance issues has intensified in the wake of the financial crisis, with buzz words such as “managed accounts,” “independent directors,” “tri-party custody solutions” and “transparency” now dominating the discourse. Indeed, investor efforts to improve corporate governance and control have resulted in an altering of the old “take it or leave it” type of hedge fund documents, which have become more accommodative towards investors. In short, in recent years investors have become more likely to negotiate with managers, and such negotiations have been more successful on average. In a guest article, Charles Nightingale, a Legal and Regulatory Counsel for Pacific Alternative Asset Management Company, LLC (PAAMCO), and Marc Towers, a Director in PAAMCO’s Investment Operations Group, identify nine areas on which institutional investors should focus in the course of due diligence. Within each area, Nightingale and Towers drill down on specific issues that hedge fund investors should address, questions that investors should ask and red flags of which investors should be aware. The article is based not in theory, but in the authors’ on-the-ground experience conducting legal and operational due diligence on a wide range of hedge fund managers – across strategies, geographies and AUM sizes. From this deep experience, the authors have extracted a series of best practices, and those practices are conveyed in this article. One of the main themes of the article is that due diligence in the hedge fund arena is an interdisciplinary undertaking, incorporating law, regulation, operations, tax, accounting, structuring, finance and other disciplines, as well as – less tangibly – experience, judgment and a good sense of what motivates people. Another of the themes of the article is that due diligence is a continuous process – it starts well before an investment and often lasts beyond a redemption. This article, in short, highlights the due diligence considerations that matter to decision-makers at one of the most sophisticated allocators of capital to hedge funds. For managers looking to raise capital or investors looking to deploy capital intelligently, the analysis in this article merits serious consideration.
Read Full Article … -
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).
Read Full Article … -
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.
Read Full Article … -
From Vol. 4 No.12 (Apr. 11, 2011)
Ten Issues That Hedge Fund Seed Investors Should Consider When Drafting Seed Investment Agreements
While the interests of hedge fund seed investors and the managers in whom they invest frequently diverge, it is relatively rare for such a divergence of interests to wind up in court. See “How to Structure Exit Provisions in Hedge Fund Seeding Arrangements,” The Hedge Fund Law Report, Vol. 3, No. 40 (Oct. 15, 2010). When it does, the results can be illuminating for the wide range of hedge fund industry participants that participate in the seeding process – whether as investors, recipients of investments or service providers to either. See “Primary Legal and Business Considerations in Hedge Fund Seeding Arrangements,” The Hedge Fund Law Report, Vol. 2, No. 38 (Sep. 24, 2009). Accordingly, this article offers a detailed discussion of a recent decision by the Superior Court of Massachusetts involving two individual seed investors in a prominent hedge fund management business. According to the plaintiffs’ allegations, the manager – i.e., the recipient of seed funding – engaged in a “shell game” of fund restructurings with the goal of stripping the seed investors of their right to a portion of net management fees. The investors protected their rights via arbitration and this lawsuit, but with difficulty, acrimony, publicity and expense. This article explains the factual background and legal claims in the dispute, and illustrates how seed investors may revise their form documents and approaches in light of the lessons of this dispute. In particular, the arbitration award imposed provisions on the parties, mostly to the benefit of the seed investors, that effectively served as ex post amendments to the seed investment agreement. Those provisions should have been included ex ante in this matter – and should be included, or at least considered, by seed investors in every seed investment deal. We explain what those provisions are and why they matter to seed investors. More generally, we derive practical lessons from the legal analysis and factual missteps in this matter that are relevant to anyone involved or contemplating involvement in a hedge fund seeding transaction. See also “Massachusetts Courts Approve of Accounting Firm Rothstein Kass’ Role as Award Arbiter in Hedge Fund Management Fee Dispute,” The Hedge Fund Law Report, Vol. 3, No. 18 (May 7, 2010).
Read Full Article … -
From Vol. 3 No.49 (Dec. 17, 2010)
Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three)
Talent has always been mobile in the hedge fund industry. But at least seven factors are increasing the pace with which hedge fund talent − investment talent (portfolio managers, analysts, traders) as well as non-investment talent (professionals focusing on marketing, operations, law, accounting, compliance and technology) − is moving from proprietary trading desks at investment or commercial banks (prop desks) to a range of other entities, most notably, start-up and existing hedge fund managers. First, the Volcker Rule generally prohibits U.S. banking institutions and non-U.S. banking institutions with U.S. banking operations from: (1) proprietary trading unrelated to customer-driven business; and (2) sponsoring or investing in hedge funds or private equity funds, or engaging in certain covered transactions with advised or managed hedge funds or private equity funds. See "Implications of the Volcker Rule – Managing Hedge Fund Affiliations with Banks," The Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010). Second, many of the investment and commercial banks that house proprietary trading desks have been subject to explicit or implicit restrictions on or reviews of compensation of key personnel. Third, the availability of hedge fund seed funding has increased. For example, a December 2010 survey conducted by private fund data provider Preqin found that the number of hedge fund investors expressing an interest in seed investments has almost doubled, from 11 percent in 2009 to 21 percent in 2010. See also "How to Structure Exit Provisions in Hedge Fund Seeding Arrangements," The Hedge Fund Law Report, Vol. 3, No. 40 (Oct. 15, 2010). Fourth, many existing hedge fund managers have renegotiated, reset or regained their high water marks. See "How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?," The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009). Fifth, many hedge fund industry professionals have no choice: they have been fired from prop desks, and plying their trade at a new institution is their highest value opportunity. Sixth, according to a Fall 2010 Institutional Investor Survey conducted by Bank of America Merrill Lynch Capital Introductions, institutional investors are considerably more “bullish” on alternative investments than they are about traditional equities and fixed income investments. Seventh, and finally, there is a considerable volume of dormant savings, particularly in the developing world (especially the so-called BRIC countries) and parts of developed Asia; many of the new funds being launched (by new or existing managers) are intended to tap this well of savings. See "Local Currency Hedge Funds Expand Marketing and Investment Opportunities, but Involve Currency Hedging and Other Challenges," The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010). Despite these seven factors (and there are likely others) motivating and hastening the movement of talent into and within the hedge fund industry, talent does not move in an entirely free market. Rather, the mobility of talent is bound up in a web of legal and practical restrictions. The basic purpose of this article − the first in a three-part series − is to identify relevant legal issues and offer practical suggestions to help talent negotiate the transition from a prop desk to the next hedge fund opportunity. (The second article in this series will look at talent moves from the bank perspective, and a third article will look at talent moves from the perspective of the hedge fund management company to which the talent moves.) To serve its purpose, this article discusses the following: the definition of "talent" (we are using the word as shorthand for a variety of typical job descriptions); the working definition of proprietary trading; the various types of entities from which and to which talent may move; which types of entities are likely to be the biggest winners in the movement of talent away from prop desks, and why; examples of recent talent moves from prop desks to other institutions; key legal considerations applicable to all moving hedge fund talent, whether such talent is moving to an existing hedge fund manager or starting its own shop (this discussion includes subtopics such as non-competition agreements, non-solicitation agreements, ownership of performance data and intellectual property, etc.); the key legal considerations specific to talent leaving a prop desk to start a new hedge fund management company; and the chief practical and cultural issues faced by talent that departs a prop desk to start or participate in running a hedge fund management company.
Read Full Article … -
From Vol. 3 No.40 (Oct. 15, 2010)
How to Structure Exit Provisions in Hedge Fund Seeding Arrangements
Some legal arrangements are meant to last in perpetuity. Other legal arrangements begin with an explicitly finite life. And yet other arrangements commence with the goal of perpetuity, but only achieve a limited duration. Hedge fund seeding arrangements fall – or should fall – into the second category: in the better-structured seeding deals, the mechanics of exit provisions are comprehensively described in the deal documents, and understood by the parties prior to the formal commencement of the relationship. See “Primary Legal and Business Considerations in Hedge Fund Seeding Arrangements,” The Hedge Fund Law Report, Vol. 2, No. 38 (Dec. 10, 2009). Conceptually, seeding exit provisions should balance the goals of hedge fund managers and seed investors. Managers generally want control and unencumbered revenue streams, and seed investors generally want a return on their investments. Importantly, over time, these goals need not conflict with one another: seeding exits can be structured in a manner that facilitates a graceful exit by the seed investor, and that maintains the entrepreneurial spirit necessary for continued success by the manager. The intent of this article is to explain the structure, rationale and context of a number of exit provisions that have actually been used, according to our sources, in seeding deals. To do so, this article discusses: what types of entities are engaged in hedge fund seeding; the services typically provided by seed investors to hedge fund managers, and the extent to which those services are similar to those provided by prime brokers; the categories of consideration typically provided by hedge fund managers to seed investors; variations on hedge fund seeding arrangements (including “foundership,” founder share classes and acceleration capital); the business case for seeding; the adverse selection argument (and some powerful rebuttals to it); rationales for exiting seeding arrangements, from both the manager and investor perspectives (including a discussion of the seeding provisions of the Volcker Rule); nine distinct approaches to seeding exit structures (including put/call agreements); and considerations in connection with funding buyouts.
Read Full Article … -
From Vol. 3 No.40 (Oct. 15, 2010)
District Court Requires Fund of Funds Manager PAAMCO to Pay 40 Percent of Annual Net Profits to Seed Investor
On August 27, 2010, the U.S. District Court for the Southern District of New York granted summary judgment on behalf of Franklin Realty Co., and Franklin Realty Holdings, LLC (Plaintiff), the venture investment entity of S. Donald Sussman, in their contract dispute with PAAMCO Founders Co., LLC (Defendant), f/k/a Pacific Alternative Asset Management Co. It found no dispute that, under the terms of their Revolving Credit Agreement (RCA), Franklin was entitled to the greater of 10 percent of the outstanding loan or 40 percent of PAAMCO’s net profits. It rejected PAAMCO’s defense of criminal usury because the principal on the loan was not absolutely repayable, and Franklin would not necessarily receive more than the 25 percent legal rate of interest in New York. It also rejected PAAMCO’s defense that Franklin fraudulently induced a separate agreement that allowed Franklin to convert the RCA into a 40 percent membership interest in PAAMCO on the grounds that PAAMCO had failed to offer admissible evidence of a material misrepresentation. We detail the background of the instant action and the Court’s legal analysis.
Read Full Article … -
From Vol. 3 No.22 (Jun. 3, 2010)
Primary Legal and Business Considerations in Structuring Hedge Fund Capacity Rights
Traditionally, hedge funds and private equity funds have used different funding models. Private equity funds have used a capital on call model, in which investors agree by contract to contribute a certain amount of capital to the fund, and retain possession of that capital until the manager requests it. Hedge funds, by contrast, have used an immediate funding model, in which investors actually contribute capital to the fund at the time of investment, and the fund’s custodian retains possession of that capital for the duration of the investment. (But see “Can a Capital On Call Funding Structure Fit the Hedge Fund Business Model?,” The Hedge Fund Law Report, Vol. 2, No. 44 (Nov. 5, 2009).) However, there is a narrow exception to the immediate funding rule in the hedge fund context. That exception applies to seed investors and other large, usually early investors in hedge funds (who often simultaneously invest in the hedge fund management entity). Such investors frequently condition their investments on rights to make additional investments in the fund. In the hedge fund world, those additional investment rights generally are known as capacity rights. In effect, investors with capacity rights have the opposite of capital on call. Instead, they have what might be termed “capital on put.” Whereas a private equity fund manager has the right to call its investors’ capital, a hedge fund investor with capacity rights has the right to put its capital into the fund. Capacity rights agreements offer business benefits to managers and investors. Most notably, they enable start-up managers to bring in anchor investors, and offer anchor investors the opportunity to maximize the value of risky investments with new managers. But capacity rights agreements also present a variety of legal and practical complications. The purpose of this article is to highlight some of those complications and, where practicable, offer remedies or solutions. In particular, this article discusses: the definition of capacity rights; the business rationales for granting (from the manager perspective) or requesting (from the investor perspective) capacity rights; the documents in which such rights are usually memorialized; how such rights are generally structured, including the pros and cons of structuring capacity rights based on dollar amount versus percentage of assets under management (AUM) or total capacity; and various specific concerns raised by capacity rights agreements, including ERISA concerns, concerns relating to most favored nations (MFN) clauses in side letters, the frequently less advantageous economics associated with capital invested pursuant to capacity rights, and fiduciary duty concerns.
Read Full Article … -
From Vol. 2 No.38 (Sep. 24, 2009)
Primary Legal and Business Considerations in Hedge Fund Seeding Arrangements
Over the last ten years it has become increasingly difficult for an emerging fund manager to start a hedge fund with minimal assets under management, establish a track record and use that record to attract additional capital. With increased regulation on the horizon and its attendant compliance costs, not to mention investor wariness in the face of current economic conditions, the barrier to entry for hedge fund managers likely will increase even more. One way for a manager to break through this barrier is to enter into an agreement with a seed investor. In a typical seeding arrangement, the hedge fund manager or seedee receives start-up capital from a seed investor or seedor, typically a banking or other financial entity or else a fund of funds whose strategy is to invest in promising emerging managers. In return, the seedor participates (more often than not though a contractual right to a portion of the revenues of the seedee rather than a direct ownership interest). As a result, the seedor’s and the seedee’s interests appear to be aligned. Each benefits from an increase in the manager’s assets under management and positive performance. Yet, the seedor and the seedee have different expectations from a seeding arrangement. These expectations color how the two parties look at the terms of the seeding arrangement. In a guest article, Janet R. Murtha, a Partner at Warshaw Burstein Cohen Schlesinger & Kuh, LLP, explores the primary legal and business issues that frequently arise in seeding arrangements from the perspectives of both sides. In particular, from the perspective of seedees, she examines: objectives; the term of a seed commitment; capacity rights; and other matters. And from the perspective of seedors, she analyzes: objectives; reputational concerns and related due diligence; and back office concerns and related due diligence. Finally, she explains the economics of seeding transactions and the use and structuring of put and call provisions.
Read Full Article …