The Hedge Fund Law Report

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

Articles By Topic

By Topic: Employment

  • From Vol. 7 No.21 (Jun. 2, 2014)

    Aligning Employee and Investor Interests under the Volcker Rule

    The Volcker Rule limits the extent to which bank-affiliated asset managers and their employees may invest in hedge funds that they sponsor.  As a result, such managers need to ensure that any arrangements that allow for employee participation, including compensation arrangements, comply with the final Volcker Rule.  In a guest article, Tram N. Nguyen and Steven W. Rabitz, both partners at Stroock & Stroock & Lavan LLP, examine the different options that managers have under the final Volcker Rule in designing such arrangements.

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  • From Vol. 7 No.20 (May 23, 2014)

    Six Privacy-Related Topics to Be Covered by a Hedge Fund Manager’s Compliance Policies and Procedures (Part Three of Three)

    This is the final article in our three-part series on employee privacy issues relevant to hedge fund managers.  The first article in this series made the case, using examples, for why hedge fund managers should care about employee privacy.  See “How Can Hedge Fund Managers Reconcile Effective Monitoring of Electronic Communications with Employees’ Privacy Rights? (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 13 (Apr. 4, 2014).  The second article in this series identified the five primary sources of employee privacy rights.  See “Three Best Practices for Reconciling the Often Conflicting Sources of Privacy Rights of Hedge Fund Manager Employees (Part Two of Three),” The Hedge Fund Law Report, Vol. 7, No. 14 (Apr. 11, 2014).  This article discusses six topics that hedge fund managers should cover in their compliance policies and procedures under the general rubric of employee privacy.  The overarching aim of this series is to assist managers in calibrating and communicating their employees’ expectations of privacy – particularly in connection with electronic communications – in a manner consistent with best practices, relevant law and expectations of SEC examiners.

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  • From Vol. 7 No.19 (May 16, 2014)

    How Can Hedge Fund Managers Protect Themselves Against Trade Secrets Claims?

    Hedge fund management firms, courts and commentators have devoted significant attention to the steps that hedge fund managers can take to protect the confidential information and trade secrets that belong to the firm, including how to protect information that is at risk when employees depart.  In that context, the focus is largely upon potential claims that a hedge fund manager might possess against a departing employee – or the potential grounds that governmental authorities might have to pursue the former employee in such a situation.  See “Recent Developments Affecting the Protection of Trade Secrets by Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013); “Protecting Hedge Funds’ Trade Secrets: What a Difference a Year Makes,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012); “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies,” The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).  In a guest article, Sean R. O’Brien, Sara A. Welch and A.J. Monaco – Managing Partner, Counsel and Associate, respectively, at O’Brien LLP – consider the other edge of that sword, addressing the following questions: What exposure do hedge fund managers have when new employees arrive and bring with them information that they do not own, and what can hedge fund managers do to reduce the likelihood that they will be the subject of a theft of trade secrets or other similar claim when employees join them?  As set forth in this article, a hedge fund manager’s exposure to such claims can be significant, but at the same time there are a number of relatively simple steps hedge fund managers can take during the hiring process and otherwise to markedly reduce the risk of trade secret claims.

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  • From Vol. 7 No.15 (Apr. 18, 2014)

    Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation

    Private fund management companies, which are typically taxed as partnerships, often wish to incentivize key people with equity or equity-like interests in the management company.  A recent event examined the key elements of partnership taxation and considered the four available means of providing equity interests to employees and other service providers: profits interests, capital interests, options and phantom interests.  The discussion chiefly focused on profits interests, as such interests receive the most favorable tax treatment.  For discussion of another presentation on this topic, see “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

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  • From Vol. 7 No.14 (Apr. 11, 2014)

    Hedge Fund Incentive Compensation Not Subject to Wage Claim under New York Labor Law

    A recent decision by a New York court interpreting the State’s Labor Law is of great significance to hedge fund managers doing business in the State.  The ruling is important to hedge fund firms because it recognizes that incentive-based compensation to financial industry employees – which typically depends on the overall success of the business (or at least of a team of employees) and not on the performance of a single employee – is not the sort of compensation that merits protection under the Labor Law.  In a guest article, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, discuss the claims, the ruling and the ramifications and lessons of the decision.

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  • From Vol. 7 No.13 (Apr. 4, 2014)

    How Can Hedge Fund Managers Reconcile Effective Monitoring of Electronic Communications with Employees’ Privacy Rights? (Part One of Three)

    Information is the raw material out of which hedge fund managers fashion their finished products – compelling investment ideas and, one hopes, absolute returns.  As such, managers and their personnel are continuously engaged in collecting, refining and transmitting information, that is, communicating.  Today, the vast majority of such communications occur electronically – via e-mail, chat, text, social media and similar channels.  From an investment perspective, this increases opportunities but at the same time competition.  From a compliance perspective, the proliferation of electronic communications has dramatically expanded the range of opportunities for legal and regulatory violations.  Hedge fund managers are not unique among businesses in contending with the compliance challenges raised by electronic communications, but many of the specific compliance challenges faced by hedge fund managers are industry-specific.  Accordingly, The Hedge Fund Law Report is undertaking a three-part series intended to identify the specific compliance challenges for hedge fund managers raised by electronic communications and to outline best practices for surmounting those challenges.  This article – the first in the series – catalogues six reasons why hedge fund managers need to monitor electronic communications of employees and highlights two settings in which procedures other than electronic communication monitoring are most effective.  Subsequent articles in the series will discuss the sources of employees’ privacy rights, factors bearing on the reasonableness of an employee’s expectation of privacy, the benefits and limits of specific policies regarding electronic communication monitoring and best practices in this area.  See also “Key Elements of Electronic Communications Policies and Procedures for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    New York Federal District Court, Applying “Faithless Servant” Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading

    On December 19, 2013, the United States District Court for the Southern District of New York allowed Morgan Stanley to recoup more than $31 million paid in compensation to a former portfolio manager who admitted to insider trading.  Morgan Stanley originally sued former FrontPoint Partners, LLC portfolio manager Joseph F. “Chip” Skowron III (Skowron) in October 2012 to recoup compensation paid to him.  Morgan Stanley based its allegation of the right to claw back such compensation upon Skowron’s 2011 guilty plea to insider trading and obstruction of justice charges.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  After prevailing on some of its claims and losing on others, Morgan Stanley moved for partial summary judgment, based on New York’s “faithless servant” doctrine.  This article summarizes the faithless servant doctrine and the Court’s analysis.

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  • From Vol. 6 No.48 (Dec. 19, 2013)

    In Messy Hedge Fund Employment Dispute, Highland Capital Accuses Former Executive’s Counsel of Extortion and Other Criminal Acts in Connection with Possession and Threatened Use of Highland’s Confidential and Proprietary Information

    In a nasty divorce from its one-time general counsel and senior executive Patrick Daugherty, hedge fund manager Highland Capital Management, L.P. (Highland) has taken the gloves off and sued Daugherty’s counsel, Looper Reed & McGraw, P.C. (Looper).  Highland claims that, at the termination of his employment, Daugherty misappropriated more than 60,000 documents containing Highland’s confidential and proprietary information.  It further accuses Looper of improperly obtaining and using that information to assist Daugherty in his effort to “extort” more than $2 million from Highland.  This case underscores the need for hedge fund managers to take strong prophylactic measures to prevent the theft of such information, including any trade secrets, prior to an employee’s departure.  See “Recent Developments Affecting the Protection of Trade Secrets by Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013); “Measures Hedge Fund Managers Can Implement to Maximize Protection of Their Trade Secrets,” The Hedge Fund Law Report, Vol. 5, No. 46 (Dec. 6, 2012).  The case also argues in favor of pre-employment background checks of hedge fund manager employees.  See “Six Critical Questions to Be Addressed by Hedge Fund Managers That Outsource Employee Background Checks (Part Three of Three),” The Hedge Fund Law Report, Vol. 6, No. 40 (Oct. 17, 2013).  This article summarizes the factual and legal allegations in Highland’s petition, including a discussion of protective measures employed by Highland designed to protect its confidential information.  Highland previously sued Daugherty over his possession and use of that information.  See “Highland Capital Management Sues Former Private Equity Chief for Breach of Employment and Buy-Sell Agreements,” The Hedge Fund Law Report, Vol. 5, No. 20 (May 17, 2012).  For a discussion of another action involving a hedge fund business divorce, see “Delaware Chancery Court, Criticizing Both Sides in Contentious Litigation, Awards $4.662 Million to Camulos Capital Hedge Fund Founder in Payment for His Fund Interest,” The Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012).

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Citi Prime Finance Report Distills the Four Pillars of “People Alpha” at Hedge Fund Managers

    Most hedge fund managers believe that people are their primary resource and that absolute, uncorrelated returns are a function of top talent.  Citi Prime Finance has coined a new and pithy term for this view – “people alpha” – and, in a recent report, outlined the building blocks of a robust human capital infrastructure at hedge fund managers.  Specifically, Citi’s report distilled best practices among hedge fund managers (based on interviews) in four critical human resources areas: talent acquisition, talent retention, employee learning and development and performance measurement and management.  This article summarizes key insights from the Citi report.  See also “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

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  • From Vol. 6 No.41 (Oct. 25, 2013)

    Recent Developments Affecting the Protection of Trade Secrets by Hedge Fund Managers

    The past few years have seen a significant and highly public move by the Department of Justice and other government entities to pursue prosecutions of the criminal laws governing the theft of trade secrets, including the theft of trade secrets from hedge fund managers.  In articles published in The Hedge Fund Law Report in December 2010 and April of 2012, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, examined the significant government resources being committed to these efforts, as well as the fast-changing legal framework that applied to them.  See “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading,” The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010); and “Protecting Hedge Funds’ Trade Secrets: What a Difference a Year Makes,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).  Another year has wrought equally significant developments in this critical area.  In this guest article, O’Brien and Welch return to the pages of the HFLR to examine these developments and explain their implications for hedge fund managers.

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  • From Vol. 6 No.33 (Aug. 22, 2013)

    How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?

    The competition for key talent among hedge fund managers is fierce, and many have resorted to offering their key employees a stake in the manager’s business to attract the best and the brightest.  “Equity” compensation has become so prevalent that more than one-quarter of hedge fund manager employees have reported owning an equity interest in their firms.  See “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  The forms of equity compensation that hedge fund managers can offer include profits interests, capital interests, options and phantom income in the firm.  Each of these options has economic and other ramifications, both for the offering firm and the offeree.  A recent program provided an overview of the various forms of equity participation that a hedge fund manager can offer its personnel.  Among other things, the panelists discussed the intricacies of profits interests; the current status of carried interest legislation; four different types of equity compensation that managers can offer personnel (including profits interests, capital interests, options and phantom income); tax consequences of becoming a “partner” as a result of the receipt of equity participation in the firm; and the applicability of Section 409A of the Internal Revenue Code to various forms of equity compensation offered by managers.  This article summarizes the key takeaways from the program.

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part Two of Two)

    Employee compensation clawbacks can help hedge fund managers deter bad acts, preserve reputation and demonstrate a commitment to compliance.  However, compensation clawbacks are only effective if properly structured, carefully drafted and consistently enforced.  This is the second article in a two-part series designed to help hedge fund managers think through the pros and cons of implementing compensation clawbacks.  In particular, this article starts by exploring some of the cons, including those relating to federal employment and tax law; state wage, labor and tax law; whistleblower issues; and logistical concerns.  This article then identifies four best practices for structuring and implementing clawbacks, and concludes with an appendix including three sample clawback provisions provided by sources and actually used by hedge fund managers, and one definition of “cause” used in connection with a clawback provision.  The first installment in this series provided an overview of employee clawbacks at hedge fund managers; discussed the types of employees, misconduct and triggering events covered by clawbacks; and highlighted the benefits of implementing clawbacks.  See “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).

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  • From Vol. 6 No.31 (Aug. 7, 2013)

    Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two)

    Hedge fund compensation discussions have typically focused on upside – on how structuring acumen, tax strategy and legal legerdemain can be used to maximize post-tax compensation to good performers.  See “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  However, in the wake – or in the midst – of unprecedented insider trading and other enforcement in the hedge fund industry, there is a growing recognition among managers that compensation can also be used to mitigate downside.  In particular, hedge fund managers are increasingly exploring, implementing and using employee compensation clawbacks to minimize the ex ante risk of bad acts and mitigate the ex post impact of such acts.  For example, S.A.C. Capital Advisors, LLC (SAC Capital) announced in May 2013 – shortly before various SAC Capital entities were indicted for securities fraud and wire fraud – that it planned to implement a policy allowing the firm to claw back compensation from employees engaged in misconduct.  See “SAC Capital Entities Indicted for Securities Fraud and Wire Fraud in Connection With Employees’ Alleged Insider Trading,” The Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).  In October 2012, Morgan Stanley went beyond mere implementation to actual enforcement, suing former FrontPoint Partners, LLC portfolio manager Joseph “Chip” Skowron to recoup compensation paid to Skowron.  Morgan Stanley generally alleged that it had the right to claw back such compensation because of Skowron’s 2011 guilty plea to insider trading and obstruction of justice charges.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Employee compensation clawbacks offer powerful advantages to hedge fund managers, particularly in the current heightened enforcement climate.  They can deter bad acts, preserve reputation and broadcast a manager’s commitment to compliance.  However, clawbacks are not without legal and practical risk, including potential civil and criminal liability for managers that do not properly structure or enforce clawbacks.  To help hedge fund managers in evaluating the utility of clawbacks to their businesses, The Hedge Fund Law Report is publishing a two-part series on employee compensation clawbacks in the hedge fund industry.  This article, the first installment, provides an overview of employee clawbacks at hedge fund managers; discusses the types of employees, misconduct and triggering events covered by clawbacks; and highlights the benefits of implementing clawbacks.  The second installment will identify drawbacks of clawbacks; outline legal and other considerations for managers in structuring and enforcing clawbacks; describe documentation of clawbacks; enumerate best practices for structuring clawbacks; and provide sample employee clawback provisions.

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  • From Vol. 6 No.9 (Feb. 28, 2013)

    U.K. Appellate Court Holds That Hedge Fund Manager Employees May Be Personally Liable for Unreasonably Relying on the Representations of a Hedge Fund Manager Principal Regarding Performance and Portfolio Composition

    The best hedge fund managers are often great salespeople, and a good bit of their sales efforts are often directed internally – in particular, at persuading non-investment professionals to buy into their view of the world.  This is fine so long as that view is compelling and legitimate.  But this becomes problematic for all involved when that view is fraudulent.  A recent U.K. appellate court decision indicates that employees of hedge fund managers may be liable in cases where they accept at face value – and relay to third parties – representations from a manager principal that they knew or should have known to be false.  “He told me so” is not a valid defense to a suit for negligence; and employees with limited authority can be hit with effectively unlimited liability.

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  • From Vol. 6 No.6 (Feb. 7, 2013)

    New York Appellate Court Decision Illustrates the Litigation and Publicity Risk Inherent in Sloppy Drafting of Hedge Fund Manager Operating Agreements

    Oftentimes, principals of a hedge fund manager find negotiating and documenting their business arrangements to be an uncomfortable task which can result in miscommunications of their intentions as well as haphazard negotiations and sloppy documentation.  A recent case involving a contract dispute between hedge fund manager principals provides lessons on the importance of rigorously and accurately reducing such agreements to writing.  For more on the potential consequences of sloppy drafting, see “Hedge Fund Manager May Be Personally Liable to Third-Party Marketers Based on Ambiguities in Marketing Agreement,” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  In short, a hedge fund principal sued his partner for an unpaid portion of his profit share.  The litigants disagreed concerning the validity and enforceability of various purported oral and written amendments (one of which is alleged to have been forged) to their existing operating agreement and whether the plaintiff’s conduct constituted an implicit waiver of his right to receive the unpaid portion of his profit share pursuant to the existing operating agreement.  This article discusses the factual background in this case as well the decisions and analyses by the state trial and appellate courts.

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  • From Vol. 5 No.44 (Nov. 21, 2012)

    U.K. High Court of Justice Rules on Request by Hedge Fund Manager Affiliates to Search Computers of Two Former Employees

    Most hedge fund management companies are built on a foundation of confidential and proprietary information – strategies, technologies, positions, plans, investor and prospect lists, etc.  To add value, employees must be given access to some or all of that confidential information, which of course invites the prospect that employees will walk away with it.  Managers take various steps to prevent theft of confidential information, including legal and technology precautions.  See “Protecting Hedge Fund Trade Secrets: What a Difference a Year Makes,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).  However, confidential information can be hard to secure absolutely and difficult to monitor.  Thus, with some frequency, litigation over ownership of and access to confidential information follows the voluntary or involuntary departure of employees from hedge fund managers.  See “Eight Measures That Hedge Fund Managers Can Take to Mitigate the Risk of Theft of Their Trade Secrets,” The Hedge Fund Law Report, Vol. 5, No. 21 (May 24, 2012).  This article discusses a recent example of such litigation.

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Four Recommendations for Hedge Fund Managers Designed to Minimize Risk and Damage from Employment Discrimination Lawsuits

    Employment discrimination suits can be the source of significant embarrassment and potentially reputational harm for hedge fund managers, even if the allegations are not proven to be true.  Furthermore, such suits can sap the morale of firm personnel (particularly those who may be similarly situated to the complainant) and harm the firm’s employee recruiting efforts.  It is therefore imperative that fund managers take seriously and proactively address any concerns about discrimination before they reach the courts, which occurred recently when a global private equity fund of funds manager and several of its employees were sued by a former principal/senior employee for discrimination, wrongful termination and defamation.  This article discusses the factual background, allegations and requested relief in the complaint.  Additionally, the article provides some best practices for fund managers designed to assist them in proactively minimizing risks and damage from employment discrimination lawsuits.

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  • From Vol. 5 No.25 (Jun. 21, 2012)

    Icahn Enterprises Employment Agreement with Top Executive Highlights Measures Hedge Fund Managers Can Take to Retain and Incentivize Top Talent

    Most hedge fund managers would agree that their most valuable asset is their talent.  Not surprisingly, therefore, managers spend significant time and effort trying to incentivize and retain key employees.  As in other areas of law and business, precedent is a helpful guide – especially precedent created and used by people at the top of the field.  Employment agreements used by top managers can be enlightening benchmarks when structuring compensation, retention mechanisms and similar provisions.  The problem is, such employment agreements are hard to get a hold of – except when they are publicly filed.

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  • From Vol. 5 No.20 (May 17, 2012)

    Highland Capital Management Sues Former Private Equity Chief for Breach of Employment and Buy-Sell Agreements

    On April 11, 2012, Highland Capital Management, L.P. (Highland) sued its former Head of Private Equity Investing, Patrick Daugherty, in Texas state court for breach of contract, breach of fiduciary duties, tortious interference with its business relationships and defamation.  This article summarizes: the allegations; the specific provisions of the employment and related agreements alleged to have been breached; Highland’s causes of action; and the remedies requested in the Complaint.

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  • From Vol. 5 No.17 (Apr. 26, 2012)

    District Court Decision Suggests That Overly Broad Restrictive Covenants Will Not Be Enforced in Employment Agreements in the Wealth Management Industry

    Ideally, hedge fund managers and employees should be able to negotiate employment agreements that align the interests of the manager with those of the employee.  However, the interests of managers and employees will almost inevitably conflict in the context of certain typical employment agreement provisions.  Most notably, restrictive covenants, such as non-competition, non-solicitation and confidentiality clauses, highlight the diverging interests of managers and employees.  On one hand, hedge fund managers wish to include restrictive covenants in employment agreements to protect their confidential and proprietary information and to protect investments in employee development.  On the other hand, employees wish to limit the scope of such covenants to provide them with the widest universe of employment opportunities following departure from a manager.  While the laws governing restrictive covenants vary from state to state, generally, such laws have been interpreted by courts to balance these competing interests.  For a comprehensive discussion of relevant law and practice, see “Schulte Roth & Zabel Partners Discuss Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).  Where such covenants have been found to be overly restrictive, courts have typically refused to enforce them.  A recent District Court decision addresses the permissible scope of a restrictive covenant in an employment agreement between a wealth management firm and an employee of the firm where the employee was terminated involuntarily without cause.

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  • From Vol. 5 No.14 (Apr. 5, 2012)

    Former Employee Seeks Over $150 Million in Damages from Daniel Och, Och-Ziff and Affiliated Management Entities for Alleged Improper Termination

    Many hedge fund managers incentivize key investment professionals and other employees to remain loyal to the firm by giving them either a profits or equity interest in the firm’s management entities.  See “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  However, such marriages do not always end well, as demonstrated by a recent action brought by a former Och-Ziff employee against Daniel Och, Och-Ziff and affiliated management entities.  The facts alleged in the Complaint offer a rare glimpse into ownership and compensation structures at one of the world’s largest hedge fund management companies.  This article summarizes the factual and legal allegations in the Complaint.  This article also contains a link to the Complaint, which is publicly available but difficult to obtain.  For further insight into a high-level compensation arrangement (and dispute) at a successful hedge fund management company, see “Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager,” The Hedge Fund Law Report, Vol. 4, No. 8 (Mar. 4, 2011).

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  • From Vol. 5 No.14 (Apr. 5, 2012)

    Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act

    Hedge fund managers compensate their employees for services rendered with the expectation that such services will be rendered with competence, integrity and honesty.  However, when employees fail to live up to these expectations, do hedge fund managers have any recourse?  For example, may managers claw back compensation paid to such employees and recoup costs incurred in investigating and defending against securities fraud claims?  A recent decision by the U.S. District Court for the Southern District of New York suggests that, yes, hedge fund managers may in fact have some recourse against rogue employees.

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    PricewaterhouseCoopers Study Describes Recent Trends in and Outlook for Asset Manager Mergers and Acquisitions

    In February 2012, the Asset Management Division of accounting firm PricewaterhouseCoopers LLP released a report entitled “Asset Management M&A Insights: The Way Forward” (Report).  The Report is a compilation of white papers and survey results designed to “provide perspectives on the recent trends and outlook relating to asset management mergers and acquisition activity in the U.S. and major global markets.”  This article summarizes the key topics discussed in the Report, including: an analysis of merger and acquisition (M&A) deals in the asset management arena in the U.S. in 2011; a forecast for U.S. M&A deal activity in 2012; analyses of M&A activity in Europe and Asia; an explanation of the important roles human capital issues play in mergers and acquisitions; and an explanation of the role of various accounting principles, including issues related to consolidation and valuation, in asset management M&A.  Overall, the Report concluded that, in 2011, completed deals were scarce and deal values were relatively low.  While there is no clear indicator that 2012 will be better, the Report points to various factors that may contribute to increased M&A activity in the asset management arena for 2012.  For a discussion of recent litigation involving M&A in the hedge fund arena, see “Federal Court Decision Addresses the Enforceability of an Earnout Provision in the Sale of a Hedge Fund Management Business,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

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  • From Vol. 5 No.8 (Feb. 23, 2012)

    Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two)

    The death, disability or departure of a founder or key employee of a hedge fund manager (succession event) creates a business risk that the manager must proactively address to ensure the long-term viability of the enterprise, to respond to investor concerns and to meet the firm’s regulatory obligations.  A firm must anticipate and address not only personnel considerations, but also the impact of a succession event on ownership, compensation and other legal and operational issues.  This is the second article in a two-part series analyzing key considerations for hedge fund managers aiming to adopt and implement an effective succession plan.  The first article in this series discussed: why succession planning is an imperative for hedge fund managers looking to raise institutional capital and create long-term enterprise value; applicable regulatory requirements; the imperative of commencing succession planning today rather than deferring difficult decisions; examples of prominent hedge fund managers that have implemented succession plans; what types of succession events a succession plan should cover; people decisions, including how to identify roles to be filled and how to identify, incentivize and train successors; and the role of management committees in succession planning.  See “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012).  This article discusses: potential changes in a firm’s ownership and compensation structure designed to incentivize prospective successors to stay with the firm and to address the economics of departing founders or key employees; how to document a succession plan; how to test a succession plan; and how to communicate information about a succession plan with investors.

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  • From Vol. 5 No.7 (Feb. 16, 2012)

    Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part One of Two)

    Many hedge fund managers may be surprised to learn that they are mortal.  But managers are being reminded of this unpleasant fact with increasing frequency by institutional investors requesting robust succession plans.  In one view, succession planning is part and parcel of the frequently cited “institutionalization” of the hedge fund industry.  By definition, institutions are not about any one person.  They may have a charismatic founder – a Sam Walton or a Ross Perot – but they can survive the death, disability or departure of that founder, and even thrive following such an event.  But more fundamentally, succession planning is about going from good to great.  A good hedge fund manager can generate consistent returns over an extended period.  A great hedge fund manager can create an institution that generates consistent returns over an extended period.  In other words, a good hedge fund manager is a good investor, but a great hedge fund manager is a good investor and a good businessperson.  Paradoxically, greatness in the hedge fund business – as in any business – requires the ability to render yourself somewhat irrelevant.  Service partnerships like hedge fund managers are inherently fragile because their primary asset is their talent and talent can be fickle, fleeting and, absent contractual restrictions, mobile.  See “Schulte Roth & Zabel Partners Discuss Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).  Moreover, talent at the top that is insufficiently diffused throughout the organization can result in a top heavy hedge fund manager, and one that is therefore easily toppled.  Accordingly, investors in hedge funds and acquirers of hedge fund management businesses want concrete evidence that a manager has mitigated the business risk.  A considered, workable and realistic succession plan is the best evidence that a manager has thought ahead.  Reasoning backwards, a succession plan is more than just a defensive document: it offers franchise value to acquirers, predictability to investors and long-term value to the founder and his or her heirs.  See also “Key Person Provisions in Hedge Fund Documents: Structure, Consequences and Demand from Institutional Investors,” The Hedge Fund Law Report, Vol. 2, No. 37 (Sep. 17, 2009).  This is the first article in a two-part series that will outline key considerations for hedge fund managers seeking to develop and implement a succession plan.  This feature-length article discusses: why succession planning is an imperative for hedge fund managers looking to raise institutional capital and create long-term enterprise value; applicable regulatory requirements; the imperative of commencing succession planning today rather than deferring difficult decisions; examples of prominent hedge fund managers that have implemented succession plans; what types of succession events a succession plan should cover; people decisions, including how to identify roles to be filled and how to identify, incentivize and train successors; and the role of management committees in succession planning.  The second article in this series will discuss potential changes in a firm’s ownership and compensation structure designed to incentivize prospective successors to stay with the firm and to address the economics of departing founders or key employees; buyout and sunset provisions and the role of insurance; how to document and test the succession plan; how to communicate information about a manager’s succession plan with investors; and considerations with respect to redemption rights.

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  • From Vol. 4 No.46 (Dec. 21, 2011)

    Compensation Survey by Greenwich Associates and Johnson Associates Highlights Trends in Compensation and Best Practices for Hedge Fund Managers and Other Investment Professionals

    In November 2011, Greenwich Associates, an international research-based consulting firm in institutional financial services, and Johnson Associates, a boutique compensation consulting firm specializing in financial services, published their U.S. Asset Management 2011 Compensation Report (Report).  The Report projects compensation levels and trends for hedge fund professionals and other investment professionals for 2011.  The projections are based on historical data gleaned from more than 1,000 interviews with financial professionals in fixed-income and equity investor groups at hedge funds, mutual funds, investment management firms, insurance companies, banks, government agencies and pensions and endowments.  The Report dissects and compares historical compensation data for 2009 and 2010 from various perspectives.  (For another discussion of compensation levels and trends in 2009, see “Infovest21’s Annual Hedge Fund Manager Compensation Survey Reveals Top Paid Manager Positions and Top Factors Affecting Performance,” The Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).)  First, the Report highlights differences in compensation levels among fixed-income and equity investment professionals.  It then contrasts compensation levels for hedge fund professionals versus their counterparts at traditional asset management firms.  It then discusses trends in performance-based compensation and deferrals of compensation.  The Report also reveals trends in compensation for sales professionals and outlines best practices for structuring compensation of sales professionals.  For more on compensation of sales professionals, see “Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation,” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).  This article discusses the data and analysis contained in the Report and outlines the Report’s projections for 2011 compensation levels.

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  • From Vol. 4 No.46 (Dec. 21, 2011)

    U.S. Court of Appeals Finds That a Private Fund Manager and One of its Portfolio Companies May Constitute a Single Employer with Regard to Liability for Unfair Labor Practices

    During the relevant period, investment manager Oaktree Capital Management, L.P. (Oaktree) indirectly owned TBR Property, L.L.C. (TBR), which operates the Hawaiian resort property known as the Turtle Bay Resort (Resort).  The collective bargaining agreement covering certain of the Resort’s employees expired in November 2003.  While a new contract was being negotiated, TBR and its third party resort manager barred certain union representatives from the Resort and refused to collect union dues from the employees.  As a result, the National Labor Relations Board (NLRB) brought unfair labor practice charges against Oaktree, TBR and the manager.  An administrative law judge found all three defendants liable, holding that Oaktree and TBR constituted a “single employer” and that, as a result, Oaktree was jointly and severally liable for the violations.  A panel of the NLRB upheld the administrative law judge’s decision.  An appeal was taken to the U.S. Court of Appeals for the Fifth Circuit.  We summarize the Court’s decision and reasoning, and highlight the criteria the NLRB used in making its determination.  The decision is relevant to hedge fund managers following control-oriented, private equity style strategies.

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  • From Vol. 4 No.42 (Nov. 23, 2011)

    Schulte Roth & Zabel Partners Discuss Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements

    Restrictive covenants, including non-competition clauses, are commonly misunderstood, and such misunderstandings can cause problems not only for employees, but also employers.  When hedge fund managers hire new employees, these types of restrictions are often included in employment agreements or in partnership agreements (or side letters), often when an employee or partner is granted an interest in the fund manager’s profits.  Additionally, they can be found in purchase agreements when a fund manager sells some or all of its business.  See “Buying a Majority Interest in a Hedge Fund Manager: An Acquirer’s Primer on Key Structuring and Negotiating Issues,” The Hedge Fund Law Report, Vol. 4, No. 17 (May 20, 2011).  When properly drafted and applied, restrictive covenants can protect an employer against harm created by the theft or misuse of valuable proprietary firm information.  When improperly drafted or applied, such restrictive covenants may not be enforced and will not provide the desired protection.  In addition, fund managers hiring new employees who may be subject to restrictive covenants should take certain precautions to avoid allegations that they aided or abetted a breach of a restrictive covenant which can cause reputational harm, among other things.  On November 10, 2011, Ronald E. Richman and Holly H. Weiss (SRZ Partners), both partners at Schulte Roth & Zabel LLP, hosted a seminar entitled “Restrictive Covenant Issues for Investment Managers” (Seminar) in which they discussed a variety of issues relevant to hedge fund managers, including the different types of restrictive covenants, common misconceptions about restrictive covenants, how to properly draft restrictive covenants, how restrictive covenants are analyzed by the courts, what happens once a dispute involving restrictive covenants arises and best practices for hedge fund manager employers looking to hire prospective employees.  For the most part, Richman and Weiss focused on restrictive covenants in the employment arena.  This article summarizes the issues discussed by the SRZ Partners and includes additional guidance relevant for hedge fund managers dealing with restrictive covenants.

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  • From Vol. 4 No.41 (Nov. 17, 2011)

    U.S. District Court Evaluates FINRA Arbitration Decision in High-Stakes Severance Dispute Between UBS and Former Portfolio Manager

    Plaintiff Stephen P. Finkelstein (Finkelstein) was a portfolio manager for Dillon Read Capital Management (Fund), a hedge fund operated and owned by defendants UBS Global Asset Management (US) Inc. and UBS Securities LLC (together, UBS).  In early 2007, Finkelstein received a bonus in the amount of $25 million based on the Fund’s 2006 performance.  During the financial crisis that unfolded during 2007, the Fund showed losses of more than $300 million attributable to Finkelstein’s trades.  Finkelstein’s trading authority was suspended.  UBS closed the Fund and eventually terminated Finkelstein.  UBS had an ERISA-governed severance plan in place and adopted a “Supplemental Program” for Fund employees who might not otherwise be eligible for bonuses due to the timing of the Fund’s closure.  Eligible employees could receive a bonus equal to 25% of their 2006 bonus.  Finkelstein put in a claim for a bonus in the amount of $6.25 million, which UBS denied based on the huge trading losses incurred by the Fund as of April 2007.  Finkelstein submitted the claim to arbitration through FINRA Dispute Resolution.  The arbitration panel denied his claim.  Finkelstein then commenced an action in U.S. District Court seeking to overturn the arbitration decision.  We summarize the District Court’s decision with respect to Finkelstein’s claim and the Court’s legal analysis.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    Opus Trading Fund Accuses Former Trader That Joined Competitor of Breach of Contract and Misappropriation of Proprietary Information

    In a complaint filed on March 28, 2011 in New York County Supreme Court, trading and investment firm Opus Trading Fund, LLC (plaintiff) accused a former Opus trader, David Kleinman (defendant), of violating the confidentiality and non-competition clauses of his employment agreement by accepting employment with a competitor that follows a similar trading strategy.  For more on the legal and practical issues relating to confidentiality and non-competition clauses in employment agreements for hedge fund investment talent, see “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),” Vol. 3, No. 49 (Dec. 17, 2010).  In addition to illustrating the types of legal disputes that can arise when trading talent moves from one firm to another, this matter also illustrates the importance of protecting sensitive information with technology.  This article summarizes the factual and legal allegations in the complaint, with emphasis on the security measures Opus implemented to protect its digital property.  For discussions of other disputed talent moves and hedge fund employment disputes, see, e.g., “Broadly Defined Terms in a Term Sheet Covering Employment of a General Counsel May Render Hedge Fund Manager Principal Personally Liable for Unpaid Compensation,” The Hedge Fund Law Report, Vol. 4, No. 12 (Apr. 11, 2011); “Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager,” The Hedge Fund Law Report, Vol. 4, No. 8 (Mar. 4, 2011); “Hedge Fund Research and Advisory Firm Aksia LLC Sues Two Former Employees for Misappropriation and Destruction of Confidential Business Information,” The Hedge Fund Law Report, Vol. 3, No. 4 (Jan. 27, 2010); “New York Trial Court Permits Action for Misappropriation of Hedge Fund Proprietary Software and Breach of Partnership Agreement To Proceed,” The Hedge Fund Law Report, Vol. 2, No. 6 (Feb. 12, 2009); “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading Strategies,” The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).

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  • From Vol. 4 No.12 (Apr. 11, 2011)

    Broadly Defined Terms in a Term Sheet Covering Employment of a General Counsel May Render Hedge Fund Manager Principal Personally Liable for Unpaid Compensation

    Dow Kim sought to launch hedge fund management company Diamond Lake Investment Group with a sterling resume, a high caliber team and great expectations.  But timing worked against Kim.  He launched in late 2007, into a perfect financial storm, when the vast majority of potential hedge fund investors were trying to get their money back rather than trying to deploy it.  A recent decision from New York’s intermediate appellate court held that Kim may have breached a contract and violated New York’s Labor Law by withholding compensation from the person he brought on board as general counsel of the management company.  But the interesting thing about the decision – or one of various interesting things – is that there was no contract.  There was only a term sheet; and that term sheet contained broad definitions of key terms that may render Kim liable for over $2 million in compensation obligations.  This article describes the factual background and legal analysis in the opinion, and makes four observations relevant to the drafting of hedge fund manager employment agreements and term sheets.  At least one other former employee of the short-lived Diamond Lake venture has taken his employment-related grievances to court.  See “After Hedge Fund Folds, Ex-Portfolio Manager Sues Its Founder, Dow Kim, in Federal Court for Fraud and Negligent Misrepresentation in Inducing Him to Join the Venture,” The Hedge Fund Law Report, Vol. 3, No. 32 (Aug. 13, 2010).  See generally “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).

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  • From Vol. 4 No.8 (Mar. 4, 2011)

    Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager

    On December 20, 2010, one of the top performing hedge fund managers of 2010, Structured Portfolio Management, LLC (SPM), as well as its affiliates, sued their former Portfolio Manager, Jeffrey Kong, in the District of Stamford, Connecticut Superior Court.  SPM’s complaint, which painted Kong as a disgruntled former employee who merely had access to its confidential investment strategies, sought to enjoin Kong from joining and disclosing SPM trade secrets to Passport Capital LLC, a rival global macro hedge fund manager, and to recover over $10.8 million in distributions and bonuses given to Kong prior to his resignation.  On February 4, 2011, Kong filed counterclaims against SPM.  In his cross-complaint, he took credit for putting SPM “on the map,” hiring its top portfolio team members, and spearheading and adjusting its most successful investment strategies, including those that resulted in the notable returns generated by SPM funds in 2009 and 2010.  Kong also protested SPM’s failure to pay him the industry standard performance fee as a cash bonus, which for those two years, allegedly should have totaled $49 million more than he had received.  Kong also demanded an accounting of his remaining equity stake in SPM, which he believed had a value of more than $25 million.  While the matter has settled, the complaints provide unique insight into high-level compensation arrangements at a successful hedge fund management company, as well as the types of legal allegations that disputes over such compensation arrangements may involve.  As the pace of talent mobility in the hedge fund industry picks up, managers face compensation structuring decisions with increasing frequency, and the stakes of those decisions are considerable.  To get compensation decisions right, it is critical to understand what can go wrong.  Accordingly, this article provides extensive detail on the factual and legal allegations in the SPM and Kong complaints.

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  • From Vol. 4 No.5 (Feb. 10, 2011)

    Former Employee of Hedge Fund Manager Vinya Capital Loses Bid to Enforce Alleged Oral and Written Modifications of Employment Contract

    The U.S. District Court for the Southern District of New York has granted summary judgment to hedge fund manager Vinya Capital, L.P. (Vinya), dismissing the claims of its former employee Bleron Baraliu (Baraliu) for unpaid bonuses and other incentive compensation.  Baraliu began working for Vinya as a foreign exchange trader in August 2004.  He left Vinya in December 2005.  Baraliu and Vinya had entered into a written “at-will” employment agreement that specified both guaranteed compensation and the possibility of discretionary bonuses.  Addenda to that agreement modified the compensation structure but retained the prospect of discretionary bonuses.  Baraliu claimed that one written addendum to his employment contract awarded him a 2.5% limited partnership interest in Vinya.  He also claimed that, in exchange for remaining with Vinya, Vinya had orally promised him a $500,000 bonus and the right to buy an additional 7.5% limited partnership interest in Vinya.  The District Court granted Vinya’s motion for summary judgment, holding that the written addendum never became binding on Vinya and that the merger clause in the employment agreement barred his claims based on Vinya’s oral promises.  We summarize the contracts in question and the Court’s reasoning.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three)

    This is the third installment in our three-part series on the movement of talent from bank proprietary (prop) trading desks to hedge fund managers.  The series focuses on the legal and business considerations raised by such moves, and highlights the different considerations faced by the different constituencies.  The first article in the series focused on the talent perspective, that is, the considerations that investment and non-investment personnel should address when moving from a bank to a hedge fund manager.  See “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),” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  The second article in the series focused on the bank perspective, and demonstrated that while banks face many of the same issues as talent in this context, banks often face those issues from a different perspective, and weight those issues differently.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 2 (Jan. 14, 2011).  This article focuses on the perspective of the hedge fund manager to which talent moves.  While the legal and business issues faced by such recipient managers are complex, at a broad level, they can be broken down into a simple binary question: Are your hiring decisions motivated by the goal of buying talent or access?  Generally, if you are looking to buy talent, you are okay, but if you are looking to buy access, you are in trouble.  Put slightly differently, while a variety of legal disciplines govern the relationships between hedge fund managers and their employees, the unifying theme among those disciplines is ensuring that business success or failure is based on merit commercialized on a level playing field.  If this sounds too pious to be plausible, read on – and also read some of our cautionary tales of recent access-buying in the hedge fund arena.  To illustrate this general idea, this article discusses the following categories of considerations for hedge fund managers receiving talent: avoiding insider trading violations based on material, non-public information possessed by incoming talent; the three-step process for avoiding liability for aiding and abetting a breach by a new employee of that employee’s employment or post-employment covenants with his or her former bank employer, including non-competition agreements (non-competes), non-solicitation agreements (non-solicits), termination, severance and option agreements; special considerations in connection with the movement of teams (as opposed to individuals); avoiding liability for unauthorized use by an incoming employee of trade secrets or other intellectual property owned by a former bank employer; use of data regarding employee performance at a prior bank employer; avoiding pay-to-play violations; and what to look for when performing background checks.

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three)

    Hedge fund industry talent is increasingly mobile, but the consequences of that mobility impact different institutions differently.  In an article in our issue of December 17, 2010, we discussed the implications of that increasing mobility from the talent perspective.  Specifically, that article, among other things: identified seven discrete reasons for the increasing pace of mobility; defined "talent" (including investment and noninvestment talent); defined "proprietary trading" (to the extent it can be defined); identified the various types of institutions from and to which talent is moving; predicted which entities stand to gain the most from the movement of talent; and offered recent examples of talent moves.  See "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)," The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  Working from the foundation of that article, this article discusses the implications of increasing talent mobility from the bank perspective.  (The third and final article in this series will discuss the relevant issues from the perspective of the hedge fund management company to which the talent migrates.)  In particular, this article discusses the key legal, business and cultural issues to be considered by investment or commercial banks in connection with departing hedge fund talent (ideally well before that talent departs), including: eight distinct methods that banks use to protect trade secrets, confidential information and other intellectual property; business considerations that may impact decisions regarding enforcement of intellectual property rights; and the strategic interaction among non-competition provisions (non-competes), non-solicitation provisions (non-solicits), accrued but unpaid compensation and ownership of performance data.  Before continuing, three points should be noted.  First, many of the issues identified in this article are, in certain ways, the mirror images of issues identified in the first article in this series.  That is, when discussing the movement of talent from bank proprietary (prop) trading desks to hedge fund managers, if an issue is relevant to the talent, it is, almost by definition, relevant to the bank; and vice versa.  However, the weighting, implications and consequences of issues are different for the different parties, thus justifying separate discussions.  By analogy, both hedge fund managers and investors are concerned with the general issue of hedge fund money raising, but their specific areas of concern differ markedly.  Second, while the discussion in this article focuses on the relevant issues from the bank perspective, the intended audience for this article is not just banks.  Rather, the article is written in the conviction that the other constituencies − including talent and the hedge fund management companies to which talent moves − can benefit from a deeper understanding of the bank perspective.  Third, as indicated in the outline of the article above, the legal rights of the parties when talent leaves a bank for a hedge fund manager are powerfully determined by the business facts and circumstances.  In other words, the relevant analysis is often a hybrid legal-business analysis, rather than a pure legal analysis.  For example, assume that the head of commodities prop desk is leaving to start a commodities hedge fund manager, and his employment agreement contains a narrowly drawn, well-crafted non-compete.  Will the bank be able to enforce the non-compete?  A pure legal analysis may say yes, but if the bank is exiting the commodities trading business altogether, the legal analysis may be moot.  Of course, the facts always determine legal outcomes; the point here is to suggest that the universe of relevant facts may be broad, and actions outside of the talent's control may bear directly on the parties' legal rights.

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Can the Chief Compliance Officer of a Hedge Fund Manager be Terminated for Investigating a Potential Compliance Violation by the Manager's Principal, CEO or CIO?

    On December 29, 2010, the First Department of the New York State Appellate Division reversed a trial court order and dismissed a breach of implied contract claim brought by Joseph Sullivan, the Chief Compliance Officer of hedge fund manager Peconic Partners LLC, against his former employer and its CEO, William F. Harnisch.  Sullivan had accused Harnisch of terminating his at-will employment in retaliation for his investigation into Harnisch's alleged "front running" scheme.  In dismissing this claim, the Appellate Division recognized that the Peconic Code of Ethics, which Sullivan was required to follow, required "on pains of termination" that he investigate that alleged violation.  Nonetheless, the Appellate Division found that this language did not create a contractual promise not to terminate Sullivan, and that no recognized exception to the employment-at-will doctrine otherwise protected him from termination without cause.  We detail the background of the action and the court's pertinent legal analysis.  Also, we provide a critical analysis of the opinion, discuss its implications for whistleblower law and practice and identify a key provision that must be included in hedge fund manager compliance manuals and codes of ethics in order to protect the chief compliance officer.

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  • 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.

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  • From Vol. 3 No.32 (Aug. 13, 2010)

    After Hedge Fund Folds, Ex-Portfolio Manager Sues Its Founder, Dow Kim, in Federal Court for Fraud and Negligent Misrepresentation in Inducing Him to Join the Venture

    On June 30, 2010, Michael Pasternak filed suit in the U.S. District Court for the Southern District of New York against his former employer Dow Kim, founder of failed hedge fund start-up Diamond Lake Investment Group.  Pasternak accuses Kim of fraud in the inducement and negligent misrepresentation because Kim allegedly provided false information to Pasternak regarding capital commitments to the fund in order to induce Pasternak to join – commitments which never materialized due in part to the ensuing global economic crisis.  Pasternak now seeks damages of over $6 million to reflect the opportunity cost of a simultaneous job offer he declined to pursue.  His complaint provides an insider’s look at the launch of a hedge fund on the eve of the crisis.  We summarize the details of the complaint and the relief sought.

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  • From Vol. 3 No.24 (Jun. 18, 2010)

    New York State Courts Side With Elm Ridge Hedge Funds and Founder Ronald Gutfleish in Fee Dispute With Former Manager Douglas DiPasquale

    On May 18, 2010, the New York State Supreme Court, Appellate Division, First Department, affirmed a Manhattan trial court order entering partial summary judgment on behalf of the defendants, Ronald Gutfleish, Elm Ridge Capital Management, LLC (ERCM), Elm Ridge Value Advisors, LLC (ERVA), Elm Ridge Partners, LLC (ERP) and Elm Ridge Management, LLC (ERM), in a separation agreement fee dispute with a former manager, Douglas DiPasquale, the plaintiff.  DiPasquale had resigned as co-managing member of ERCM and ERVA, two firms that advised and managed three hedge funds controlled by Gutfleish, in exchange for a share of future profits from ERCM and ERVA.  Following DiPasquale’s resignation, Gutfleish created ERP and ERM to replace ERVA and ERCM, and ceased payments to DiPasquale.  The New York State courts dismissed DiPasquale’s complaint to the extent that he sought damages from the defendants because they found the separation agreement authorized Gutfleish’s actions.  We detail the background of the action and the courts’ legal analysis.

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  • From Vol. 3 No.17 (Apr. 30, 2010)

    Private Equity Fund Manager Sues JPMorgan Private Asia for Specific Performance of SpinOut Agreement or Nearly $31 Million

    On April 19, 2010, Varun Kumar Bery, the former head of JPMorgan’s Private Capital Asia Corp., (JPM), a subsidiary of JPMorgan Chase & Co., filed suit against JPM, claiming that Bery had been terminated without cause and that JPM had breached a spinout agreement which would have allowed him to keep the private equity team and platform that he managed.  Bery is suing his former employer for injunctive relief, including specific performance of a spinout agreement, and damages “in the region of US$30.8 million” for breach of express and implied contract.  This article summarizes the background of Bery’s action, the allegations and the relief sought.

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  • From Vol. 3 No.13 (Apr. 2, 2010)

    Delaware Court Dismisses Hedge Fund Steel Partners Japan Strategic Holdings’ Counterclaims Against Former Consultant Who Started a Competing Japanese Hedge Fund

    In 2001, two Japanese investment bankers, Kenzo Kuroda, the plaintiff, and Yusuke Nishi, formed a relationship with the individual defendants, Thomas J. Niedermeyer, Jr. and Warren G. Lichtenstein.  The defendants had created a complex web of corporate entities with the intent to target Japanese publicly traded companies through an aggressive hedge fund investment strategy.  Kuroda and Nishi joined as non-managing members of one entity, defendant Steel Partners Japan Strategic Holdings, LLC (SPJS), the general partner for hedge funds: SPJS Fund, L.P., (Feeder Fund) and SPJS Fund (Offshore), L.P. (Master Fund).  They also co-owned SPJ-KK, a Japanese firm they formed to provide consulting services to SPJ Asset Management (SPJAM), the investment manager for the Funds.  In 2006, Kuroda left SPJS and formed a competing investment fund.  Kuroda demanded full payment for amounts due him as a member of SPJS, and the defendants refused.  Kuroda sued for those sums, and brought claims based on defendants’ purported disparagement of him and of his new business.  On April 15, 2009, the Delaware Chancery Court dismissed all of his claims against the defendants, except for one sounding in breach of contract.  Kuroda v. SPJS Holdings, L.L.C., et al., 971 A.2d 872 (Del.Ch. 2009).  Two weeks later, the defendants brought counterclaims under the SPJS LLC agreement of misappropriation of trade secrets, breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing and breach of contract.  They did not assert counterclaims based on violations of the consulting agreement between SPJ-KK and SPJAM because that contract mandated arbitration in Japan.  On March 16, 2010, the Chancery Court granted the plaintiff’s motion to dismiss the counterclaims.  We summarize the series of events leading up to the instant action and the Chancery Court’s legal analysis.

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  • From Vol. 3 No.9 (Mar. 4, 2010)

    Camulos Strikes Back with Counterclaims Against William Seibold and His Competing Investment Company

    On December 30, 2009, William Seibold, an investor in hedge fund Camulos Partners LP, and an equity interest holder in hedge fund manager Camulos Capital LP and fund general partner Camulos Partners GP LLC, sued Camulos entities and controlling individuals for over $67 million in the Delaware Chancery Court.  His complaint alleged that the defendants, through a “calculated scheme and brazen abuse of power,” forced him out of the management partnership and “deprived him of millions of dollars of his investments, compensation and equity.”  See “Co-Founder of Hedge Fund Manager Camulos Partners Sues Other Co-Founder for $67 Million in ‘Unlawfully Seized’ Bonuses and Investments,” The Hedge Fund Law Report, Vol. 3, No. 4 (Jan. 27, 2010).  On January 19, 2010, Camulos and its entities struck back with scathing counterclaims against Seibold, alleging that he committed multiple and serious breaches of fiduciary duty and contract, misappropriation of  proprietary information, investor-poaching, and gleaned confidential information from Camulos as he planned to create a competing investment firm.  This article summarizes the primary factual and legal allegations of Camulos’ counterclaims.

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  • From Vol. 3 No.8 (Feb. 25, 2010)

    Federal District Judge in Texas Dismisses Former Executives’ Employment Contract Dispute Against Hedge Fund Firm D.B. Zwirn & Co. Over Unpaid Bonuses

    Representing a new trend in hedge fund litigation created by the recent financial crisis, various former hedge funds executives have been suing their former employers or partners for unpaid or allegedly unpaid bonuses or other compensation.  See, e.g., “Co-Founder of Hedge Fund Manager Camulos Partners Sues Other Co-Founder for $67 Million in 'Unlawfully Seized' Bonuses and Investments,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010); “New York Appellate Division, First Department, Affirms Dismissal of Breach of Employment Contract Claim Against Hedge Fund Manager Stanfield Capital Partners,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010); “Minnesota Appeals Court Affirms that Repeated Oral Representations Preclude Limitations Defense in Hedge Fund Manager’s Claim for Unpaid Bonuses,” The Hedge Fund Law Report, Vol. 3, No. 2 (Jan. 13, 2010); “Touradji Capital Management Countersues Ex-Hedge Fund Portfolio Managers,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  In this instance, on February 8, 2010, the United States District Court for the Southern District of Texas summarily dismissed a lawsuit over unpaid bonuses brought by plaintiffs Todd A. Dittmann and Susan Chen against their former employer, defendant hedge fund firm D.B. Zwirn & Co., L.P. (DBZ).  The litigation began in February 2009, when Dittmann, and later Chen, filed complaints against DBZ claiming it had breached their respective contracts for employment compensation, and adding causes of action including, among other things, fraud, quasi-contract and violations of the New York State Labor Law.  In rejecting the lawsuit, the District Court concluded that plaintiffs “worked in a high risk industry with the potential for high rewards[,]” received suitable compensation for several years, and that, in 2007, when “DBZ’s business declined through no apparent fault of the Plaintiffs, DBZ reduced their bonuses and ultimately failed to pay, “all in compliance with the terms of the[ir] employment agreement[s].”  We detail the background of the lawsuit and the court’s legal analysis. 

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    Co-Founder of Hedge Fund Manager Camulos Partners Sues Other Co-Founder for $67 Million in “Unlawfully Seized” Bonuses and Investments

    On December 30, 2009, William Seibold, an investor in hedge fund Camulos Partners LP, and an equity interest holder in hedge fund manager Camulos Capital LP and fund general partner Camulos Partners GP LLC, sued the Camulos entities and their controlling individuals for over $67 million in the Delaware Chancery Court.  His complaint alleges that the defendants, through a “calculated scheme and brazen abuse of power,” forced him out of the management partnership and “deprived him of millions of dollars of his investments, compensation and equity.”  His sixteen-count complaint includes claims for statutory theft, conversion, unjust enrichment, breach of contract, tortious interference with contract, breach of fiduciary duty and civil conspiracy.  This article summarizes the primary factual and legal allegations in the complaint.

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    Hedge Fund Research and Advisory Firm Aksia LLC Sues Two Former Employees for Misappropriation and Destruction of Confidential Business Information

    Aksia LLC is a hedge fund advisory business that provides strategy and portfolio-level research and advisory services to institutional investors that invest in hedge funds.  Defendants Sarah Cole and Corissa Mastropieri worked for Aksia’s “Americas advisory services team” servicing institutional clients and developing new business.  Aksia’s complaint alleges that, in connection with the defendants’ move to work for an Aksia competitor in London, the defendants solicited each other to leave Aksia, stole confidential business information and other company property, tampered with company records and interfered with Aksia’s relations with its clients.  The complaint illustrates how Aksia used forensic investigations of the defendants’ computers to document the defendants’ alleged preparation for their move to an Aksia competitor.  In addition to money damages, Aksia seeks, among other things, to enjoin the defendants from using the confidential information they allegedly took and from working for that competitor.  This article summarizes Aksia’s allegations and the relief it is seeking.

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    IRS Issues Guidance on Compliance with Section 409A Requirements Applicable to Deferred Compensation Plans of Hedge Fund Managers

    In 2004, as part of the American Jobs Creation Act, Congress amended the Internal Revenue Code to include Section 409A, which generally requires recipients of deferred compensation to elect the time and form of deferred compensation payments in a manner that complies with Section 409A and Sec. 1.409A-1(c) of the Income Tax Regulations.  Failure to elect time and form properly, or utilizing an acceleration of deferred compensation payments, can subject the employee, director, independent contractor or other “service provider,” which may be an individual, corporation, partnership or limited liability company, to an additional 20 percent income tax, accelerated taxation of the deferred payments and heightened interest assessments.  Section 409A was enacted in response to the corporate scandals of the early Naughts, such as Enron, Tyco and WorldCom, and was intended to curb the practice of executives deferring large amounts of compensation and to eliminate the ability of executives to vary the payment schedule by which they received deferred compensation.  In attempting to curb these perceived “evils,” Congress, in enacting Section 409A, created a statute that is hyper-technical in its application, with harsh penalties for noncompliance.  Hedge fund managers, who may be considered “service providers” under the statute, should examine compensation plans that include any form of deferred compensation, including deferral of management or performance fees, for compliance with Section 409A.  Because the penalties for noncompliance are harsh, the Internal Revenue Service (IRS) has issued guidance on correcting plan failures.  In 2008, the IRS provided guidance on operational failures.  However, on January 5, 2010, the IRS issued Notice 2010-6, which provides guidance on correcting document failures.  Both notices provide guidance relevant to hedge fund managers and should be closely examined.  This article examines the scope of Section 409A and Notice 2010-6 and details the applicability of both to hedge funds and hedge fund managers.

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    New York Appellate Division, First Department, Affirms Dismissal of Breach of Employment Contract Claim Against Hedge Fund Manager Stanfield Capital Partners

    On December 22, 2009, the New York State Supreme Court, Appellate Division, First Department, affirmed the decision of a New York County trial court dismissing Richard Johnson’s complaint against his former employer, New York-based hedge fund manager Stanfield Capital Partners, LLC.  Johnson had sued Stanfield for allegedly breaching their employment agreement by failing to pay him millions in additional bonus compensation.  In support of his claims, Johnson represented that he had entered into an “oral” agreement with a member of the firm for an annual formulaic bonus arrangement.  Noting the existence of an “integrated” written employment agreement that called for only discretionary bonuses, the Appellate Division held that the parol evidence rule precluded Johnson from introducing evidence contradicting those terms.  We detail the background of the action, the court’s legal analysis and various additional arguments made by Stanfield (including a Statute of Frauds argument) on which the court did not have occasion to rule (because it found Stanfield’s parol evidence argument sufficient for dismissal).

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    Federal District Court Denies Summary Judgment to J.P. Morgan Chase as to Whether Its Hedge Fund Accounting Business Employees Were Exempt from Fair Labor Standards Act Overtime Pay Requirements

    Plaintiff Damian Hendricks (Hendricks) was a “Fund Accounting Specialist” in the “Hedge Fund Services” business of defendant J.P. Morgan Chase Bank (JPMorgan).  Plaintiff Michael Minzie (Minzie) was a “Fund Accounting Analyst” in that business.  They performed various services in connection with JPMorgan’s preparation of financial statements for hedge fund clients.  Both were paid a weekly salary and were eligible for bonuses.  They claimed on behalf of themselves “and on behalf of other similarly situated individuals” that JPMorgan failed to pay them overtime in violation of the federal Fair Labor Standards Act (FLSA).  Following discovery and depositions, JPMorgan moved for summary judgment, claiming that Hendricks and Minzie were exempt from the FLSA overtime requirements because they were both employed in bona fide professional and administrative capacities.  In a decision that serves as an excellent primer on the applicability, in the hedge fund context, of exemptions from overtime pay under the FLSA and the analogous Connecticut law, the district court denied the motion, holding that there were significant issues of fact as to the nature of the employees’ duties.  We summarize the factual allegations and the court’s decision.

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  • From Vol. 2 No.46 (Nov. 19, 2009)

    Touradji Capital Management Countersues Ex-Hedge Fund Portfolio Managers

    As previously detailed in the Hedge Fund Law Report, Gentry Beach (Beach), and Robert Vollero (Vollero, and collectively, the plaintiffs), two former employees of Touradji Capital Management, LP (Touradji Capital), filed a lawsuit a year ago in New York State Supreme Court against Touradji Capital and its founder Paul Touradji (collectively, the defendants).  See “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  In that lawsuit, Beach and Vollero, each of whom has since started his own hedge fund management firm, asserted that the defendants owed them almost $50 million in bonuses and profit sharing, and that Touradji had threatened Beach’s welfare.  The defendants have now vehemently struck back.  On November 4, 2009, they filed a countersuit against Beach and Vollero, claiming that, while employed by Touradji Capital, the two breached their fiduciary duties to the firm, and that after they left, they committed unfair competition, tortiously interfered with Touradji Capital’s business relationships, stole its trade secrets and defamed the firm.  The defendants’ counterclaims seek more than $250 million in damages.  This article summarizes the allegations in Touradji’s counter-attack.  It also discusses the withdrawal by Amaranth LLC and Amaranth Advisors L.L.C. of a summons filed on September 18 in New York state court against Touradji.  That summons alleged, among other things, breach of a confidentiality agreement Touradji and Amaranth had signed in advance of the transfer of Amaranth’s base metals portfolio to Touradji.

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  • From Vol. 2 No.39 (Oct. 1, 2009)

    New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action

    In January 2009, two portfolio managers formerly employed by Touradji Capital Management, LP, a hedge fund manager with approximately $3.5 billion under management (Touradji Capital or the Fund), sued the Fund and its principal and founder, Paul Touradji (Touradji), alleging several causes of action based on the defendants’ alleged failure to pay tens of millions of dollars of compensation to them over their tenure at Touradji Capital.  The defendants moved to dismiss the complaint for failure to state a cause of action.  The New York State Supreme Court allowed plaintiffs’ claims for breach of contract and intentional infliction of emotional distress to proceed, but dismissed all other claims.  We describe the factual background and the court’s legal analysis.

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