The Hedge Fund Law Report

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

Articles By Topic

By Topic: Fiduciary Duty

  • From Vol. 10 No.8 (Feb. 23, 2017)

    Despite the DOL Fiduciary Rule’s Uncertain Future Under the Trump Administration, Managers Should Continue Preparing for Its April 2017 Implementation (Part Two of Two)

    As part of his first 100 days in office, President Donald J. Trump has set his sights on easing some of the existing regulations in the financial sector to ostensibly allow it to flourish. To that end, he issued a presidential memorandum on February 3, 2017 (Presidential Memorandum), ordering the Department of Labor to review the fiduciary duty rule (DOL Fiduciary Rule). This review may lead to a reevaluation of who or what should be officially classified as a fiduciary, with all the legal obligations that classification entails, and may spur a dialogue between regulators and the funds sector. Although legal experts disagree as to the likelihood of the DOL Fiduciary Rule’s ultimate survival, its defeat is far from a fait accompli. Those potentially subject to the DOL Fiduciary Rule can and should continue revising their practices, documents and disclosures where appropriate. This two-part series evaluates the recent orders issued by the Trump administration that target the financial industry, including insights from attorneys specializing in financial regulations, employment and labor law, so that fund managers can respond accordingly. This second article in the series considers the potential ramifications of the proposed changes to the DOL Fiduciary Rule and their impact on hedge fund managers. The first article summarized the Trump administration’s executive order, entitled “Core Principles for Regulating the United States Financial System,” which detailed the financial sector policies of the new administration. For more on how protecting retirement investors has recently been an SEC priority, see “OCIE 2017 Examination Priorities Illustrate Continued Focus on Conflicts of Interest; Branch Offices; Advisers Employing Bad Actors; Oversight of FINRA; Use of Data Analytics; and Cybersecurity” (Jan. 26, 2017); and “SEC Division Heads Enumerate OCIE Priorities, Including Cybersecurity, Fees, Bad Actors and Never-Before Examined Hedge Fund Managers (Part One of Two)” (Apr. 28, 2016).`

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  • From Vol. 9 No.49 (Dec. 15, 2016)

    Recent NY Appeals Court Rulings Clarify How Fund Managers May Pursue Former Employees for Breach of Fiduciary Duty and Improper Use of Performance Record

    In the latest chapter of litigation that began in 2008, the New York State Appellate Court issued two rulings that provide meaningful guidance to industry participants on certain employment-related matters. Specifically, the Appellate Court ruled that a hedge fund manager may pursue two former employees for breach of fiduciary duty, including to recoup certain penalties assessed by the SEC against the firm for violating Rule 105 of Regulation M; misuse of the manager’s performance track record; theft of trade secrets; tortious interference with contract; and defamation. In a guest article, Sean O’Brien, managing partner of O’Brien LLP, along with associates A.J. Monaco and Michael Ahern, provide the litigation history of the case and discuss the claims against the employees and the factual details surrounding such allegations. For additional insights from O’Brien, see “DTSA Provides Hedge Fund Managers With Protection for Proprietary Trading Technology and Other Trade Secrets” (Jun. 23, 2016); and “Can Hedge Fund Managers Contract Out of Default Fiduciary Duties When Drafting Delaware Hedge Fund and Management Company Documents?” (Apr. 4, 2013). For coverage of other employment disputes involving hedge fund managers, see “Quant Fund Manager Moves Aggressively Against Former Employee Who Allegedly Stole Trade Secrets and Other Proprietary Information” (Mar. 21, 2014); and “Highland Capital Management Sues Former Private Equity Chief for Breach of Employment and Buy-Sell Agreements” (May 17, 2012).

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  • From Vol. 9 No.29 (Jul. 21, 2016)

    Despite Fiduciary Duty Questions, Cayman LLCs Can Offer Savings and Other Advantages to Hedge Fund Managers

    On July 13, 2016, the highly anticipated Cayman Islands Limited Liability Companies Law, 2016, came into effect, making the limited liability company (LLC) fully available in that jurisdiction. Widely attributed to the demands of U.S. investors seeking an offshore equivalent to the Delaware LLC, the Cayman LLC has been met with positive reactions from onshore and offshore lawyers, though some have raised concerns about the vehicle’s governance. See “New Cayman Islands LLC Structure Offers Flexibility to Hedge Fund Managers” (Mar. 10, 2016). In an effort to help our readers understand structural, regulatory and registration issues of the Cayman LLC, The Hedge Fund Law Report has interviewed partners of law firms at the forefront of interactions with both the onshore financial sector and the Cayman Islands authorities regarding the law’s development. We present our findings in this article. For analysis of other recent developments in Cayman law, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters” (May 28, 2015); and “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors” (Jan. 24, 2013).

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  • From Vol. 9 No.16 (Apr. 21, 2016)

    Becoming a Plan Assets Fund May Limit Hedge and Other Private Funds’ Abilities to Charge Fees

    One of the decisions faced by hedge funds and other private funds that accept “plan assets” subject to the Employee Retirement Income Security Act of 1974 (ERISA) is whether to cross the 25% threshold and become subject to ERISA. But taking that step is fraught with complex obligations and may significantly impact management and deferred performance fees. A recent segment of the “Pension Plan Investments 2016: Current Perspectives” seminar hosted by the Practising Law Institute (PLI) addressed issues for funds crossing the 25% threshold, including compensation practices for fiduciaries as well as management and performance fee structures of plan assets funds. The program, “Current Topics in Private Equity and Alternative Investments,” was moderated by Arthur H. Kohn, a partner at Cleary Gottlieb Steen & Hamilton; and featured Jeanie Cogill, a partner at Morgan, Lewis & Bockius; David M. Cohen, a partner at Schulte Roth & Zabel; and Steven W. Rabitz, a partner at Stroock & Stroock & Lavan. This article summarizes the key takeaways from the seminar with respect to the above matters. For additional commentary from this PLI program, see “Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA” (Apr. 14, 2016). For more on ERISA, see our two-part series on “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors”: Part One (Feb. 5, 2015); and Part Two (Feb. 12, 2015).

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  • From Vol. 9 No.15 (Apr. 14, 2016)

    Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA

    The Employee Retirement Income Security Act of 1974 (ERISA) imposes a complex regulatory regime onto hedge fund and other private fund managers managing “plan assets.” Two recent developments carry implications for managers under ERISA: the ruling by the U.S. Court of Appeals for the First Circuit about whether a private equity (PE) fund can be treated as a “trade or business” for purposes of the pension funding rules and withdrawal liability under ERISA; and the release of the DOL’s final rule revising the definition of “fiduciary” under ERISA. These were among the ERISA-related topics discussed during a recent segment of the Practising Law Institute’s “Pension Plan Investments 2016: Current Perspectives” seminar. The program was moderated by Arthur H. Kohn, a partner at Cleary Gottlieb Steen & Hamilton; and featured Jeanie Cogill, a partner at Morgan, Lewis & Bockius; David M. Cohen, a partner at Schulte Roth & Zabel; and Steven W. Rabitz, a partner at Stroock & Stroock & Lavan. This article summarizes the key takeaways from the program with respect to the foregoing matters. For more on ERISA, see our three-part series on ERISA Considerations for European hedge fund managers: “Liability and Incentive Fee Considerations” (Sep. 24, 2015); “Prohibited Transaction, Reporting and Side Letter Considerations” (Oct. 1, 2015); and “Indicia of Ownership and Bond Documentation Considerations” (Oct. 8, 2015). 

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    RCA Session Highlights Issues Pertaining to the Custody Rule, ERISA, Client Agreements, Fees, Codes of Ethics and Confidentiality

    The first session of the Regulatory Compliance Association’s (RCA) Compliance Program Transparency Series examined key provisions from the CFA Institute’s Asset Manager Code of Professional Conduct (AMCC) and the RCA’s Model Compliance Manual (Manual), which is intended to facilitate implementation of the AMCC. Among the topics covered by the panel were client and fiduciary relationships, including compliance with the custody rule and ERISA as well as best practices for entering into agreements with and charging fees to clients; codes of ethics; and confidentiality. Moderated by Jane Stafford, the RCA’s general counsel, the session featured James G. Jones, a founder and portfolio manager of Sterling Investment Advisors; Michelle Clayman, managing partner and chief investment officer of New Amsterdam Partners; Gerald Lins, general counsel of Voya Investment Management; and Tanya Kerrigan, general counsel and chief compliance officer of Boston Advisors. This article highlights the salient points made on the foregoing issues. For additional insight from RCA programs, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and our coverage of the most recent RCA Compliance, Risk and Enforcement Symposium: “Methods for Hedge Fund Managers to Upgrade Compliance Programs” (Jan. 14, 2016); and “Ways for Hedge Fund Managers to Mitigate Conflicts of Interest” (Jan. 21, 2016).

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  • From Vol. 8 No.44 (Nov. 12, 2015)

    Class Action Lawsuit May Affect Retirement Plan Allocations to Hedge Funds

    Following the 2008 financial crisis, pension managers looked to hedge funds as one way of making up performance losses.  That approach may have backfired for one large corporation whose alternative pension investments stand accused of poor performance.  A former employee is the named plaintiff and class representative in a putative class action against the corporate committees and their members that were responsible for the corporation’s pension investments.  The suit charges that, by investing heavily in “risky and high-cost hedge funds and private equity investments,” and by eschewing more widely accepted pension allocation models, the defendants breached their fiduciary duties to the pension plans, which sustained “massive losses and enormous excess fees.”  This article summarizes the key allegations against the ERISA fiduciaries who elected to invest in hedge funds and other alternative investments.  For more on ERISA fiduciary duties, see the first two parts of our series entitled “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse”: Part One, Vol. 7, No. 33 (Sep. 4, 2014); and Part Two, Vol. 7, No. 34 (Sep. 11, 2014).

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  • From Vol. 8 No.35 (Sep. 10, 2015)

    J.P. Morgan Analyst, Friends and Family Hit with Civil and Criminal Charges for Insider Trading

    Insider trading remains a key area of interest for the SEC and DOJ.  Even though recent court decisions have scaled back – at least for the time being – those agencies’ expansive views of liability for trading on inside tips, every emerging fact pattern helps hedge fund managers understand the continually evolving insider trading doctrine.  See “Government Petition to Supreme Court for Review of Newman/Chiasson Reversal Provides Insight into Prosecutorial View of Insider Trading,” The Hedge Fund Law Report, Vol. 8, No. 32 (Aug. 13, 2015).  The SEC recently filed charges against a J.P. Morgan analyst and two friends who allegedly traded on material nonpublic information regarding pending acquisitions.  The analyst, who worked in the J.P. Morgan division that advised on those acquisitions, allegedly provided information to a close friend; that friend and another friend then allegedly traded on that information, individually and through brokerage accounts of family members, reaping nearly $600,000 in illicit trading profits.  The DOJ is pursuing parallel criminal charges against all three defendants.  This article summarizes the alleged insider trading scheme, the SEC’s specific charges and the relief it is seeking.  For more on the current insider trading enforcement climate, see “Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement,” The Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015).

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  • From Vol. 8 No.30 (Jul. 30, 2015)

    Employees of Hedge Fund Managers May Be Liable for Failing to Prevent Fraud

    An investment management firm, along with its affiliate, has filed a claim against its former chief financial officer (CFO), who unwittingly disclosed the firm’s online banking security details to a fraudulent caller, enabling illegitimate transfers from the firm’s bank accounts.  The investment management firm claims that the CFO acted negligently and in breach of his contractual, tortious and fiduciary duties in failing to protect assets in corporate bank accounts.  The CFO, who believed he was providing security details to a member of the anti-fraud team of the investment manager’s private bank, denies failing to uphold the required standard of care, asserting that he was acting honestly, in what he reasonably and genuinely believed to be the best interests of his employer.  This article examines the allegations in the claim, as well as the rebuttals raised by the CFO in his defense.  In addition, the claim raises a number of questions and brings to the fore various issues of relevance to hedge fund managers and their staff, which are discussed in this article.  For another case where employees of a hedge fund manager were held liable for fraudulent actions, see “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 Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013).

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  • From Vol. 8 No.1 (Jan. 8, 2015)

    K&L Gates Partners Outline Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers (Part Three of Three)

    This article is the third in a three-part series discussing practical insights from a recent presentation on insider trading and compliance priorities by K&L Gates partners Michael W. McGrath, Carolyn A. Jayne and Nicholas S. Hodge.  This article summarizes six noteworthy compliance insights and four recent enforcement themes relevant to hedge fund managers.  The first article in this series provided background on critical aspects of insider trading doctrine (including entity liability and special considerations for CFA charter holders) and described four enforcement patterns bearing directly on hedge fund trading strategies and operations.  The second article detailed eight prophylactic measures that hedge fund managers can implement to avoid insider trading violations and also included a detailed discussion of what McGrath called “the next great undiscovered country for enforcement actions.”  On insider trading, see also “Second Circuit Overturns Newman and Chiasson Convictions, Raising Government’s Burden of Proof in Tippee Liability Insider Trading Cases,” The Hedge Fund Law Report, Vol. 7, No. 47 (Dec. 18, 2014).

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  • From Vol. 7 No.46 (Dec. 11, 2014)

    Schulte Partner Stephanie Breslow Addresses Gates, Side Pockets, Secondaries, Co-Investments, Redemption Suspensions, Funds of One and Fiduciary Duty (Part Two of Two)

    This is the second article in a two-part series covering a presentation by Stephanie R. Breslow at the Practising Law Institute’s annual hedge fund management program.  Breslow is a partner at Schulte Roth & Zabel LLP, co-head of its Investment Management Group and a member of the firm’s Executive Committee.  This article summarizes Breslow’s insights on: (1) compliance challenges for hedge fund managers with respect to the secondary market in hedge fund shares; (2) benefits of investor-level as opposed to fund-level gates; (3) managers’ increasing use of co-investment vehicles rather than side pockets; (4) updating fund provisions regarding calculating NAV after suspension of redemptions; (5) the benefits and drawbacks of funds of one; and (6) fiduciary considerations in the increasingly cautious and institutional current hedge fund industry environment.  The first article in this series discussed Breslow’s comments on gates, side pockets, synthetic side pockets and in-kind distributions, and how those tools evolved both before and during the credit crisis.  For coverage of Breslow’s presentations at PLI hedge fund management programs in prior years, see “Schulte Partner Stephanie Breslow Discusses Tools for Managing Hedge Fund Crises Caused by Liquidity Problems, Poor Performance or Regulatory Issues,” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014); “Schulte Partner Stephanie Breslow Discusses Hedge Fund Liquidity Management Tools in Practising Law Institute Seminar,” The Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012).

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  • From Vol. 7 No.37 (Oct. 2, 2014)

    All-Star Panel at RCA PracticeEdge Session Analyzes Five Key Regulatory Challenges Facing Hedge Fund Managers

    A recent PracticeEdge session presented by the Regulatory Compliance Association (RCA) addressed five key regulatory issues facing hedge fund managers: Broker-dealer registration, the JOBS Act, alternative mutual funds, fiduciary duties and cybersecurity.  Matthew S. Eisenberg, a partner at Finn Dixon & Herling, moderated the discussion.  The speakers included Walter Zebrowski, principal of Hedgemony Partners and RCA Chairman; David W. Blass, at the time of the session, Chief Counsel and Associate Director of the SEC Division of Trading and Markets; Brendan Kalb, General Counsel of AQR Capital Management LLC; Scott D. Pomfret, Regulatory Counsel and Chief Compliance Officer of Highfields Capital Management LP; and D. Forest Wolfe, Chief Compliance Officer and General Counsel of Angelo, Gordon & Co.  As is customary, Blass offered his own opinions, not the official views of the SEC.  (Subsequent to the event, Blass was appointed general counsel of the Investment Company Institute.)  See also “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement? (Part Three of Three),” The Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013); Part Two and Part One.

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  • From Vol. 7 No.36 (Sep. 25, 2014)

    Enforcement Action against Private Equity Fund Manager Highlights Five Aspects of the SEC’s Thinking on Allocation of Expenses

    The SEC recently charged a private equity fund manager with failing to allocate expenses between the two portfolio companies in the manner prescribed by its own expense allocation policy.  The matter is notable for highlighting at least five aspects of the SEC’s thinking on allocation of fund and portfolio company expenses.

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  • From Vol. 7 No.34 (Sep. 11, 2014)

    U.S. District Court Denies Class Certification for Investors in Defunct Hedge Fund Parkcentral Global

    The 2008 collapse of hedge fund Parkcentral Global, L.P., which was managed by H. Ross Perot’s money management team, spawned a great deal of litigation.  In one branch of that litigation, certain investors sought certification of a class action in the U.S. District Court for the Northern District of Texas to pursue claims of breach of fiduciary duty against the fund’s investment managers on behalf of all affected investors.  See “Can Hedge Fund Managers Contract Out Of Default Fiduciary Duties When Drafting Delaware Hedge Fund and Management Company Documents?,” The Hedge Fund Law Report, Vol. 6, No. 14 (Apr. 4, 2013).  In a recent decision, the District Court refused to certify a class because it was not impractical for the individual fund investors who suffered losses to join the suit and because common issues of law or fact did not predominate in the case.  This article describes the decision, and is relevant to those on either side of the bar – disgruntled hedge fund investors and their counsel, and those defending or managing the defense of such actions.

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  • From Vol. 7 No.13 (Apr. 4, 2014)

    Harbinger Group Faces Derivative Class Action Lawsuit Stemming from Alleged Fund-Raising Machinations by Philip Falcone

    Haverhill Retirement System (Haverhill) has commenced a shareholder class action and derivative lawsuit against the directors and controlling shareholders of Harbinger Group Inc. (HGI), a publicly-traded Delaware holding company once controlled by hedge funds managed by defendant Philip A. Falcone.  Haverhill claims that Falcone, facing a liquidity crunch in his hedge funds, arranged to sell a portion of his funds’ HGI shares to defendant Leucadia National Corporation (Leucadia).  In doing so, Haverhill charges that Falcone and the other named defendants had conflicts of interest and engaged in breaches of fiduciary duty, corporate waste and other misconduct when they granted seats on HGI’s board and registration rights for HGI shares to Leucadia in a deal that benefited Falcone and Leucadia, but not HGI.  See also “Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement with Philip A. Falcone and Harbinger Entities,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

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  • From Vol. 7 No.6 (Feb. 13, 2014)

    What Are the Duties of Directors of Cayman Islands Hedge Funds, and Should Those Duties Be Codified?

    Corporate governance reform has been on the radar of the Cayman Islands for several years.  The landmark 2011 decision by the Financial Services Division of the Cayman Islands Grand Court, Weavering Macro Fixed Income Fund Limited v. Stefan Peterson and Hans Ekstrom, held that a fund’s directors had willfully neglected their duties to supervise a fund’s operations when they acted as little more than figureheads or rubber stamps of manager actions.  See “The Cayman Islands Weavering Decision One Year Later: Reflections by Weavering’s Counsel and One of the Joint Liquidators,” The Hedge Fund Law Report, Vol. 5, No. 36 (Sep. 20, 2012).  In January 2013, the Cayman Islands Monetary Authority (CIMA) issued proposed rule amendments and proposed revised governance standards – spelled out in the revised Statement of Guidance on fund Governance (Governance SOG) – for hedge funds and their directors.  See “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  In December 2013, CIMA adopted the final Governance SOG.  Cayman directors’ duties have traditionally been derived primarily from common law principles of care, skill and diligence, and good faith, loyalty and other fiduciary duties.  The CIMA governance standards mentioned above were one effort to codify some of those principles with respect to directors of CIMA-regulated entities.  In another step towards governance reform, the Cayman Islands Law Reform Commission recently released an “Issues Paper” exploring the duties of Cayman directors and asking whether there would be any improvement in corporate governance if those duties were enumerated and codified in Cayman statutes.  This article summarizes the key points from the Issues Paper.

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  • From Vol. 6 No.37 (Sep. 26, 2013)

    What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part Two of Two)

    It is important for hedge fund managers and investors alike to understand the duties that managers of private funds organized as limited liability companies (LLCs) and limited partnerships (LPs) owe to such funds.  Yet confusion has abounded in this area.  Recently, however, the Delaware courts and legislature have provided helpful guidance.  This two-part series is designed to inform managers and investors about the current state of Delaware law as it relates to the duties owed by hedge fund managers to their funds and investors.  This second installment discusses successful and unsuccessful claims brought pursuant the three available avenues for potential recovery by aggrieved investors: (1) breach of fiduciary duty; (2) breach of contract; and (3) breach of the implied covenant of good faith and fair dealing.  The first installment summarized the development of fiduciary duty law with respect to private investment funds organized as LPs or LLCs in Delaware, as well as issues concerning waiver of fiduciary duties by contract.  See “What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 36 (Sep. 19, 2013).  The authors of this series are Jay W. Eisenhofer and Caitlin M. Moyna, managing director and associate, respectively, at Grant & Eisenhofer P.A.

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  • From Vol. 6 No.36 (Sep. 19, 2013)

    What Is the Current State of Delaware Law on the Scope of Fiduciary Duties Owed by Hedge Fund Managers to Their Funds and Investors? (Part One of Two)

    During the past year, a fascinating and important dispute has arisen among the Delaware judiciary over the duties owed by managers of funds, including hedge funds, organized as limited partnerships (LPs) or limited liability companies (LLCs) (together, LPs and LLCs are often called “alternative entities”).  Some Delaware judges hold the view that traditional fiduciary obligations exist, while others believe that they do not, and that the parties’ duties can be defined solely by contract.  The debate has spilled over from judicial decisions to the pages of the New York Times.  And make no mistake, this is an issue with immense “real-world” consequences.  Alternative entities represent a significant business, and that business has been growing over time.  To help investors understand the scope of fiduciary obligations owed by hedge fund managers to their funds and investors, this article – the first in a two-part series – summarizes the development of fiduciary duty law with respect to private investment funds organized as LPs or LLCs in Delaware, as well as issues concerning waiver of fiduciary duties by contract.  The second installment will discuss examples of successful and unsuccessful claims brought against fiduciaries in the LP and LLC contexts, focusing on three theories of liability: breach of fiduciary duties, breach of contract and breach of the implied covenant of good faith and fair dealing.  The authors of this series are Jay W. Eisenhofer and Caitlin M. Moyna, managing director and associate, respectively, at Grant & Eisenhofer P.A.

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  • From Vol. 6 No.18 (May 2, 2013)

    When Can Hedge Fund Investors Bring Suit Against a Service Provider for Services Performed on Behalf of the Fund?

    A federal district court recently considered whether claims brought by investors in a bankrupt hedge fund against a lender for allegedly aiding and abetting the fund manager’s breach of fiduciary duty and fraud against the hedge fund should be permitted to proceed.  The fundamental question at issue was whether the investors’ claims were direct claims that should be permitted to proceed or derivative claims that should have been brought by the hedge fund and therefore should be dismissed.  For another discussion of derivative suits in the hedge fund context, see “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PricewaterhouseCoopers LLP,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  This article summarizes the factual and procedural background of the case as well as the court’s legal analysis and decision.

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  • From Vol. 6 No.14 (Apr. 4, 2013)

    Can Hedge Fund Managers Contract Out Of Default Fiduciary Duties When Drafting Delaware Hedge Fund and Management Company Documents?

    Most hedge funds and their management entities are organized as Delaware limited liability companies (LLCs) or limited partnerships (LPs).  By statute, the members or partners (partners) of these entities are given “maximum flexibility” to define their respective rights and obligations in the entity’s operating agreement or partnership agreement.  Despite this clearly announced statutory policy favoring freedom of contract, Delaware courts also have developed a body of corporate-style fiduciary duties that prescribe and measure the conduct of the partners of Delaware LPs and LLCs.   The tension between the partners’ contractual rights and obligations, on the one hand, and their fiduciary duties, if any, on the other, is a common and important theme running through the caselaw.  Late last year, the Delaware Supreme Court issued an opinion that sheds new light on the important relationship between contractual and fiduciary duties, and that highlights once again the need for a cautious, detail-oriented approach to negotiating and drafting the agreements that govern hedge funds and their management entities.  That opinion and other recent decisions by Delaware courts raise a number of important questions for practitioners who regularly advise or litigate on behalf of hedge funds and their principals.  In a guest article, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, analyze these developments and provide practical guidance to assist practitioners in drafting and reviewing LLC and LP agreements.

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  • From Vol. 5 No.43 (Nov. 15, 2012)

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

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

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  • From Vol. 5 No.34 (Sep. 6, 2012)

    Grant Thornton Broker-Dealer Industry Symposium Focuses on Capital Requirements, Fiduciary Standards, the JOBS Act, the Volcker Rule and Use of Social Media

    On June 19, 2012, Grant Thornton hosted a symposium that highlighted recent regulatory developments impacting brokerage firms, including brokers that have hedge funds as clients.  The aim of the symposium was to arm broker-dealers with valuable information and tools to help them do business in an increasingly regulated industry.  The panelists addressed a number of current issues facing the broker-dealer industry, including: capital requirements for broker-dealers; new fiduciary standards for broker-dealers; the impact of the Jumpstart Our Business Startups (JOBS) Act; regulatory uncertainty surrounding the Volcker Rule; new rule changes impacting broker-dealers; best execution; and the use of social media.  This article summarizes highlights from the symposium on the foregoing topics.  For hedge fund managers, this discussion is relevant for at least two reasons.  First, hedge fund managers routinely interact with broker-dealers in connection with prime brokerage activities, obtaining leverage, borrowing shares to sell short, custody, derivatives transactions and a wide range of other activities.  Second, some hedge fund managers have affiliated broker-dealers.  See “Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).

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  • From Vol. 5 No.24 (Jun. 14, 2012)

    Ontario Securities Commission Sanctions Hedge Fund Manager Sextant Capital Management and its Principal for Breach of Fiduciary Duty

    The Ontario Securities Commission recently handed down a decision against an investment fund manager that demonstrates its willingness to levy severe sanctions against managers engaged in fraud with respect to investors.  The decision is notable for its facts and legal analysis as well as its location.  Canada is an increasingly important jurisdiction for hedge fund managers and investors, and this matter provides useful color on the regulatory landscape there.

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  • From Vol. 5 No.9 (Mar. 1, 2012)

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

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

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  • From Vol. 5 No.7 (Feb. 16, 2012)

    Recent Delaware Chancery Court Opinion Clarifies Default Fiduciary Duties Owed By Managers of Limited Liability Companies

    Much confusion has arisen surrounding the scope of fiduciary duties owed by managers of Delaware limited liability companies (LLCs) to other members of the LLC.  Hedge fund managers must understand the scope of such fiduciary duties because they frequently organize LLCs both as hedge funds that they manage as well as the management entities which provide advisory and administrative services to their hedge funds.  As a result, hedge fund managers may owe fiduciary duties not only to hedge fund investors, but also to the other members of their management entities organized as LLCs.  This article describes a recent Delaware Chancery Court opinion that clarifies the default fiduciary duties owed by managers of Delaware LLCs, as well as the scope of the ability of managers to limit or eliminate such duties by contract.

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  • From Vol. 5 No.6 (Feb. 9, 2012)

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

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

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  • From Vol. 5 No.3 (Jan. 19, 2012)

    Delaware Chancery Court Sanctions Legendary Investor Michael Steinhardt for Trading in Occam/Calix Shares Based on Confidential Information He Received While Serving as a Representative Plaintiff in a Class Action Against Occam

    In October 2010, plaintiffs Michael Steinhardt (Steinhardt), two hedge funds managed by Steinhardt, Derek Sheeler and Herbert Chen (Chen) commenced a class action lawsuit seeking to enjoin the proposed acquisition of defendant Occam Networks, Inc. (Occam) by Calix, Inc. (Calix) and challenging the fairness of the transaction.  The injunction was denied and the transaction closed in February 2011, but the litigation continued.  During discovery, the defendants learned that Steinhardt and Chen had traded in Occam and Calix shares while subject to a confidentiality order that prohibited trading in shares of Occam and Calix and the use of non-public information discovered in the course of the suit.  The defendants moved for sanctions against them.  The Delaware Chancery Court ruled that Steinhardt had violated his fiduciary duty as a class representative, dismissed him and his funds from the suit with prejudice, and imposed various sanctions on them.  The Court denied the motion as against Chen.  We detail the facts of the case and the Court’s reasoning.

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  • From Vol. 4 No.36 (Oct. 13, 2011)

    Hedge Fund Healey Alternative Investment Partnership’s Complaint Against Royal Bank of Canada for Failure to Pay Full Cash Settlement Value of Equity Barrier Call Option Agreement Survives Bank’s Motion to Dismiss

    Plaintiff Hedge Fund Healey Alternative Investment Partnership (Fund) purchased a cash-settled equity barrier call option from defendants Royal Bank of Canada and RBC Dominion Securities Corporation (together, Bank).  The option agreement referenced a basket of financial assets, including interests in hedge funds.  However, the Bank was not obligated to own those assets.  In September 2008, the Bank’s monthly report on the option agreement showed its value to be almost $22 million.  The Fund formally terminated the option agreement as of June 30, 2009.  The Bank paid about $9.16 million to the Fund, but refused to pay any further amounts, claiming that it was unable to value certain hedge fund interests, particularly hedge fund investments held in side pockets.  The Fund sued the bank, claiming breach of contract, breach of fiduciary duty and breach of the covenant of good faith and fair dealing.  The Bank moved to dismiss for failure to state a cause of action.  This article provides a comprehensive summary of the factual background and the District Court’s legal analysis.

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  • From Vol. 4 No.29 (Aug. 25, 2011)

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

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

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  • From Vol. 4 No.26 (Aug. 4, 2011)

    SEC Order against Pegasus Investment Management Suggests That a Hedge Fund Manager Cannot Keep the Proceeds of an Undisclosed “Rental” of Its Trading Volume

    A recent SEC order instituting administrative and cease-and-desist proceedings against a small hedge fund manager confirms the principle that hedge fund investors – not managers – own the assets in funds and any assets generated with those assets, subject to specific exceptions.  The matter also addresses, albeit indirectly and inconclusively, the question of whether hedge funds may agree by contract to permit conduct by the manager that, absent such agreement, would constitute fraud or a breach of fiduciary duty.

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  • From Vol. 4 No.19 (Jun. 8, 2011)

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

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

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  • From Vol. 4 No.17 (May 20, 2011)

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

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

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  • From Vol. 4 No.16 (May 13, 2011)

    New York Appellate Division Dismisses Investors’ Complaint Against Corey Ribotsky and Hedge Fund AJW Qualified Partners, Holding that Fund’s Decision to Suspend Redemptions Did Not Constitute a Breach of the Fund’s Operating Agreement or a Breach of Fiduciary Duty

    Plaintiffs are Steven Mizel and his limited partnership which invested, in the aggregate, about $1.6 million with hedge fund AJW Qualified Partners, LLC (Fund).  During the market turmoil of late 2008, plaintiffs sought to redeem their investments in the Fund.  In response to a wave of redemption requests, in October 2008, the Fund froze all redemptions and sought to reorganize.  Plaintiffs brought suit, alleging anticipatory breach of contract by the Fund and breaches of fiduciary duty by the Fund’s manager and its principal, Corey Ribotsky.  The trial court denied the defendants’ motion to dismiss.  The Appellate Division reversed and dismissed the plaintiffs’ complaint in its entirety, holding that the suspension of redemptions was permitted by the Fund’s operating agreement.  We summarize the decision.

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  • From Vol. 4 No.14 (Apr. 29, 2011)

    SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information

    In the vast majority of insider trading cases involving fund management, the material nonpublic information at issue relates to a company whose securities the fund may buy or sell.  However, in a provocative recent initial decision (Decision), an SEC Administrative Law Judge (ALJ) held that information about a fund itself may constitute material nonpublic information for insider trading and breach of fiduciary duty purposes.  This article explains in detail: the factual background of the Decision; the ALJ’s legal analysis; what specific categories of fund-level information may constitute material nonpublic information in the hedge fund management context; the disclosure implications of the potentially expanded scope of material nonpublic information; the interplay between the potentially expanded scope of material nonpublic information and the idea (most notably enunciated in Goldstein v. SEC) that a hedge fund is a manager’s “client”; the implications of the Decision for drafting, negotiating and performing under side letters and managed account agreements; the importance for hedge fund managers of internal investigations; how chief compliance officers (CCOs) can point to the “human toll” in this matter to capture the attention of investment personnel during compliance training; and a new category of monitoring of family relationships to be performed by hedge fund manager CCOs.

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  • From Vol. 3 No.29 (Jul. 23, 2010)

    Sixth Circuit Rules that a Hedge Fund Adviser Can Owe a Fiduciary Duty Not Only to the Fund, But Also to Fund Investors

    On July 14, 2010, the United States Court of Appeals for the Sixth Circuit upheld a conviction against Mark D. Lay for investment adviser fraud, mail and wire fraud, and for engaging in deceptive and manipulative practices relating to the Ohio Bureau of Workers’ Compensation (OBWC), which was an investor in a hedge fund he managed.  The government accused Lay of ignoring a leverage cap in the OBWC advisory agreement, of failing to disclose how he exceeded that cap to OBWC, and of causing OBWC to lose $212 million as a result.  For his part, Lay argued in the district court and on appeal that in his role as hedge fund adviser, he had a fiduciary duty to the hedge fund, but not to the OBWC, thereby rendering certain jury instructions at his trial improper, and invalidating his conviction on the grounds of insufficient evidence.  On May 13, 2008, the United States District Court for the Northern District of Ohio rejected his motion for judgment of acquittal.  The Court of Appeals affirmed that decision, holding that “Because a hedge fund adviser can, in some circumstances, have a fiduciary relationship with an investor, the jury instructions were correct and sufficient evidence supports Lay’s conviction” for investment adviser fraud.  Concurring in that judgment, one judge dissented in part on the grounds that the government had failed, as a factual matter, to prove mail and wire fraud.  This article summarizes the background of the action, the Court’s legal analysis, and the implications for the scope of a hedge fund manager’s fiduciary duties.

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  • From Vol. 3 No.10 (Mar. 11, 2010)

    Identifying and Resolving Conflicts Arising out of Simultaneous Management of Debt and Equity Hedge Funds

    Many hedge fund managers, especially larger ones, manage multiple hedge funds.  Oftentimes, those multiple hedge funds follow different investment strategies.  While management by a single manager of multiple hedge funds offers certain operational economies of scale (e.g., shared office space, personnel and technology), diversification of the manager’s revenue sources and potentially greater overall revenue, it also creates the potential for conflicts between the interests of the funds.  In particular, simultaneous management by a single manager of both debt and equity funds can create a variety of information and business conflicts that challenge the manager’s ability to satisfy its fiduciary duties to both funds and both sets of investors.  This issue is particularly acute now, at a time when many hedge fund managers that previously focused on equity-related strategies have launched distressed debt funds in an effort to make silk purses out of the many sow’s ears left over from the credit crisis.  In effort to assist hedge fund managers in avoiding or navigating these conflicts, this article: discusses fiduciary duty as it relates to the relevant conflicts, both under Delaware law and the Investment Advisers Act; identifies specific examples of the potential conflicts, including five investment issues (e.g., consequences to both the equity and debt funds when a reorganization would benefit the debt but wipe out the equity) and two information issues (e.g., consequences to the equity fund when its manager receives material, non-public information in the course of also managing a debt fund); and evaluates the pros and cons of specific ex ante and ex post remedies for both the information issues and investment issues.

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  • From Vol. 2 No.34 (Aug. 27, 2009)

    For Hedge Fund Managers, How Would a Statutory Definition of “Fiduciary Duty” Affect the Scope of the Duty and the Standard for Breach?

    In its first meeting, the SEC’s recently convened Investor Advisory Committee identified defining fiduciary duty as one of its discussion topics.  In response, four financial planning and investment advisory industry groups sent a letter to the Investor Advisory Committee opposing a definition of fiduciary duty and supporting the “workability” of the current approach which, according to the letter, involves applying common law principles to specific facts and circumstances.  This debate over whether to define fiduciary duty has been given added relevance by the Obama administration’s proposal on July 10, 2009 of the Investor Protection Act of 2009 (IPA), which would for the first time define fiduciary duty by statute.  See “What Precisely Is ‘Fiduciary Duty’ in the Hedge Fund Context, and To Whom is it Owed?,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009).  For hedge fund managers, there are two primary questions arising out of this debate: (1) to whom is a fiduciary duty owed; and (2) what is the standard for breach of fiduciary duty?  The answers to these questions can dramatically alter the legal landscape in which hedge funds operate.  Accordingly, this article addresses both questions, both under current law and as the law may evolve following passage of the IPA.

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  • From Vol. 2 No.29 (Jul. 23, 2009)

    What Precisely Is “Fiduciary Duty” in the Hedge Fund Context, and To Whom is it Owed?

    The concept of fiduciary duty is at the heart of the relationship among hedge fund managers, hedge funds and hedge fund investors.  But until recently, “fiduciary duty” was not defined by any bill or law.  Rather, it was the creature of caselaw, and much of that caselaw dealt with whether and to whom the fiduciary duty is owed, rather than the content of the duty.  That has changed with the Obama administration’s proposal on July 10, 2009 of the Investor Protection Act of 2009 (IPA).  While the IPA has received significant attention because it would impose a fiduciary duty on broker-dealers that provide investment advice (currently, broker-dealers are subject to a less stringent “suitability” standard), for the hedge fund community, the IPA is noteworthy as the first proposed codification of the substance of a fiduciary duty.  In addition, the IPA delegates to the SEC rulemaking authority to define the “client” to whom a fiduciary duty is owed.  This could empower the SEC to resolve an ambiguity that has existed since the D.C. Circuit’s 2006 decision in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006), as to whether a hedge fund manager owes a fiduciary duty to the hedge fund itself, or its underlying investors.  That is, the IPA may enable the SEC to provide by rule that a hedge fund manager owes a fiduciary duty to each investor in a hedge fund, and not just to the hedge fund itself.  For practical purposes, if the IPA were to become law and if the SEC were to provide by rule that a hedge fund manager owes a fiduciary duty to hedge fund investors, it likely would become easier for hedge fund investors to sue managers based on a range of manager conduct.  This is because such a law and rule would more explicitly confer standing on hedge fund investors to challenge various manager actions.  In this article, we explain precisely what “fiduciary duty” means in the hedge fund context, and explore to whom the duty is owed (the answer is by no means straightforward).  We also explore: the practical consequences of identifying either the hedge fund or its investors as the manager’s “client”; Investment Advisers Act Rule 206(4)-8, the anti-fraud rule with a negligence standard; whether fiduciary duty can be waived; the definition of “client” in the Private Fund Investment Advisers Registration Act of 2009; and the executive compensation provisions of the IPA.

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  • From Vol. 2 No.24 (Jun. 17, 2009)

    New York Court Rules that Limited Partners of Collapsed Hedge Fund Cannot Sue Fund’s Outside Legal Counsel for Fraud and Breach of Fiduciary Duty

    In the continuing saga over the 2005 collapse of Wood River Partners, L.P. (the Fund), which suffered huge losses by reason of its highly-concentrated bet on Endwave Corporation (Endwave), New York’s highest court affirmed the dismissal of a complaint filed by limited partners of the Fund against Seward & Kissel, LLP (S&K), which served as outside legal counsel to the Fund.  The Court of Appeals held that the limited partners failed to plead the alleged fraud by S&K with sufficient particularity.  It also ruled that outside counsel to a limited partnership owes a fiduciary duty only to the partnership itself, not to its individual limited partners.  We provide a detailed discussion of the facts of the case and the court’s legal analysis.  The case offers a rare statement on hedge fund law from the highest court of a U.S. state in which many hedge funds are domiciled, and in which the vast majority of hedge funds conduct business.  As such, the case includes important and widely-applicable insights on the scope of a hedge fund manager’s fiduciary duty, and the limits on the potential liability of service providers to hedge funds.

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  • From Vol. 1 No.8 (Apr. 22, 2008)

    Federal Court Holds that Trader’s Role as Hedge Fund Manager Does Not, by Itself, Create Fiduciary Duty to Fund's Investors

    • Hedge fund trader’s motion to dismiss manager’s breach of fiduciary duty claim denied, since state law requires that parties to a joint venture owe one another such a duty, and allegations that trader recklessly acted to shut the fund down would constitute a breach of such duty.
    • Trader’s motion to dismiss manager’s breach of contract claim also denied, since complaint adequately alleged that trader caused two unsatisfied “day trade calls” that remained unsatisfied during the relevant period.
    • Investor’s claim that trader breached fiduciary duty dismissed because investor failed to show he placed his “trust and confidence” in trader.
    • Investor’s claim that trader tortiously interfered with contract dismissed for failure to allege that trader intended to harm investor.
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