The Hedge Fund Law Report

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

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By Topic: Managed Accounts

  • From Vol. 8 No.13 (Apr. 2, 2015)

    RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence

    As institutional investors seek better returns or mitigation of downside risk in their portfolios, they frequently turn to hedge funds.  A recent program sponsored by the Regulatory Compliance Association provided an overview of the basic due diligence steps that such investors take with regard to investments with hedge fund managers, and focused on alignment of interests, indemnification provisions, liquidity, investor consent and the issues raised when investing through or alongside separate accounts.  The program was moderated by Scott Sherman, a Managing Director at Blackstone and Senior RCA Fellow from Practice.  The other speakers were Maura Harris, a Senior Vice President at The Permal Group; Nicole M. Tortarolo, an Executive Director at UBS A.G.; and David Warsoff, Executive Director at J.P. Morgan Alternative Asset Management.  For more on investor due diligence, see “Operational Due Diligence from the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and On-Site Visits,” The Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).  For fund managers’ perspectives on investor due diligence, see “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014).  For more on due diligence from the Regulatory Compliance Association, see “RCA Session Covers Transparency, Liquidity and Most Favored Nation Provisions in Hedge Fund Side Letters, and Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  This month, the RCA will be hosting its Regulation, Operations and Compliance (ROC) Symposium in Bermuda.  For more on ROC Bermuda 2015, click here; to register for it, click here.  For a discussion of another RCA program, see “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them,” The Hedge Fund Law Report, Vol. 8, No. 5 (Feb. 5, 2015).

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two)

    On April 18, 2013, the Regulatory Compliance Association held its Regulation, Operations & Compliance 2013 Symposium, at which industry leaders and regulators offered their perspectives on critical issues facing hedge fund managers and investors.  The Hedge Fund Law Report is publishing a two-part series of articles summarizing salient points from panel discussions held during the Symposium.  This article, the first in the series, discusses regulatory and operational challenges implicated by side letters, including dealing with requests for enhanced liquidity and transparency as well as the evaluation of requests for most favored nation provisions.  This article also addresses how hedge fund managers are using funds of one and managed accounts, and the benefits and burdens of each.  The second installment will cover techniques and strategies regulators and prosecutors are using to investigate insider trading; how managers should address high-priority conflicts of interest; the SEC’s whistleblower program; and compliance with the Foreign Account Tax Compliance Act.  For articles covering speeches made and topics discussed during the Symposium, see “SEC Commissioner Aguilar Discusses Insider Trading by Hedge Fund Managers, Valuation and Other Examination and Enforcement Pressure Points,” The Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013); and “OCIE Director Bowden Identifies Five Key Lessons for Hedge Fund Managers from Recent Presence Examinations,” The Hedge Fund Law Report, Vol. 6, No. 21 (May 23, 2013).

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Sixth Annual Hedge Fund General Counsel Summit Highlights SEC Enforcement Priorities, Side Letters, Investment Allocations, Expense Allocations, Trade Errors, Record Retention, Fund Marketing, Secondaries, JOBS Act and STOCK Act (Part One of Two)

    On September 18 and 19, 2012, ALM Events hosted its Sixth Annual Hedge Fund General Counsel Summit (GC Hedge Summit) at the University Club in New York City.  Panelists, including regulators, in-house practitioners and law firm professionals, discussed topics of significant relevance for hedge fund general counsels, including: SEC enforcement priorities relating to hedge funds; the nuts and bolts of a successful hedge fund compliance program (including a discussion of side letters, investment allocations, expense allocations, trade errors and record retention); marketing of hedge funds (including a discussion of compensation of marketing professionals and the Jumpstart Our Business Startups (JOBS) Act); secondary market transactions in fund shares; and the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act) and its implications for the gathering of political intelligence.  Our coverage of the GC Hedge Summit is provided in two installments.  This first installment covers the session addressing the nuts and bolts of a successful compliance program and the session addressing marketing of hedge funds and secondary market transactions in hedge fund shares.  The second article will cover the session discussing the SEC’s enforcement priorities and the session discussing the implications of the STOCK Act for the gathering of political intelligence by hedge fund managers.  See also “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).

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  • From Vol. 5 No.30 (Aug. 2, 2012)

    Considerations for Hedge Fund Managers Looking to Join Managed Account Platforms (Part One of Two)

    Following the 2008 financial crisis, hedge fund investors expressed concerns relating to a lack of liquidity, transparency and control in investing in comingled funds.  This led to an increase in the popularity of separately managed accounts, which address these concerns while allowing investors to access the investment acumen of talented hedge fund managers.  Capitalizing on the popularity of managed accounts, financial institution sponsors have built managed account platforms that provide investors with access to a variety of managers.  The platform sponsor vets participating managers, serves as a gatekeeper of the platform and provides other services.  These managed account platforms have grown in popularity, particularly with institutional investors.  As such, many hedge fund managers have considered joining such platforms as a route to increased assets under management and visibility in the institutional investor community.  This is the first article in a two-part series designed to describe what managed account platforms are and to highlight the various considerations that hedge fund managers should evaluate in determining whether to offer their services through such platforms.  This first article surveys managed account platforms, including describing the various structures for managed account platforms; the evolution of managed account platforms; and the process for adding a hedge fund manager to a managed account platform.  The second article in the series will discuss why investors find managed account platforms attractive as a method for allocating capital; considerations for hedge fund managers evaluating whether to offer their services through a managed account platform; how managers should consider which platforms to join; and certain key issues to negotiate with a platform sponsor.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Legal and Operational Due Diligence Best Practices for Hedge Fund Investors

    In the wake of the financial crisis in late 2008, many investors were left trapped in suspended, gated or otherwise illiquid hedge funds.  Unfortunately, for many investors who had historically taken a passive role with respect to their hedge fund investments, it took a painful lesson to learn that control over fundamental fund decisions was in the hands of hedge fund managers.  Decisions such as the power to suspend or side pocket holdings were vested in managers either directly or through their influence over the board of directors of the fund.  In these situations, which were not uncommon, leaving control in the hands of the manager rather than a more independent board gave rise to a conflict of interest.  Managers were in some cases perceived to be acting in their own self-interest at the expense, literally and figuratively, of the fund and, consequently, the investors.  The lessons from the financial crisis of 2008 reinforced the view that successful hedge fund investing requires investors to approach the manager selection process with a number of considerations in mind, including investment, risk, operational and legal considerations.  Ideally, a hedge fund investment opportunity will be structured to sufficiently protect the investor’s rights (i.e., appropriate controls and safeguards) while providing an operating environment designed to maximize investment returns.  Striking such a balance can be challenging, but as many investors learned during the financial crisis, it is a critical element of any successful hedge fund program.  The focus on hedge fund governance issues has intensified in the wake of the financial crisis, with buzz words such as “managed accounts,” “independent directors,” “tri-party custody solutions” and “transparency” now dominating the discourse.  Indeed, investor efforts to improve corporate governance and control have resulted in an altering of the old “take it or leave it” type of hedge fund documents, which have become more accommodative towards investors.  In short, in recent years investors have become more likely to negotiate with managers, and such negotiations have been more successful on average.  In a guest article, Charles Nightingale, a Legal and Regulatory Counsel for Pacific Alternative Asset Management Company, LLC (PAAMCO), and Marc Towers, a Director in PAAMCO’s Investment Operations Group, identify nine areas on which institutional investors should focus in the course of due diligence.  Within each area, Nightingale and Towers drill down on specific issues that hedge fund investors should address, questions that investors should ask and red flags of which investors should be aware.  The article is based not in theory, but in the authors’ on-the-ground experience conducting legal and operational due diligence on a wide range of hedge fund managers – across strategies, geographies and AUM sizes.  From this deep experience, the authors have extracted a series of best practices, and those practices are conveyed in this article.  One of the main themes of the article is that due diligence in the hedge fund arena is an interdisciplinary undertaking, incorporating law, regulation, operations, tax, accounting, structuring, finance and other disciplines, as well as – less tangibly – experience, judgment and a good sense of what motivates people.  Another of the themes of the article is that due diligence is a continuous process – it starts well before an investment and often lasts beyond a redemption.  This article, in short, highlights the due diligence considerations that matter to decision-makers at one of the most sophisticated allocators of capital to hedge funds.  For managers looking to raise capital or investors looking to deploy capital intelligently, the analysis in this article merits serious consideration.

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  • From Vol. 4 No.7 (Feb. 25, 2011)

    HedgeMark Names George Arnett, III as Executive Vice President and General Counsel

    On February 8, 2011, managed accounts platform provider HedgeMark International, LLC announced that George “Tres” Arnett, III has joined the company as Executive Vice President and General Counsel.

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  • From Vol. 4 No.3 (Jan. 21, 2011)

    2010 Greenwich Associates Global Custodian Prime Brokerage Study Discusses Counterparty Risk Concerns, Sources of Assets, Balance Spreading, Leverage Levels, Separately Managed Accounts and Hedge Fund Staffing Benchmarks

    In the 2010 Greenwich Associates Global Custodian Prime Brokerage Study, institutional financial services consulting and research firm Greenwich Associates offered insight on the relationship between hedge funds and prime brokers, high water marks, counterparty risk concerns among hedge fund managers, hedge fund money raising, spreading of hedge fund cash and non-cash balances, use by hedge funds of leverage and separately managed accounts and hedge fund manager staffing.  The insights in the study were based on interviews with over 1,800 hedge fund managers across North America, Europe and Asia-Pacific.  This article summarizes the key findings of the study.

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  • From Vol. 3 No.16 (Apr. 23, 2010)

    Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors

    Managed accounts started 2010 as the ostensible antidote to many of the more egregious evils experienced by hedge fund investors over the last two years.  Managed accounts offer transparency, liquidity, control and risk management, whereas during the credit crisis, many hedge funds and other investment vehicles offered opacity, gates, lack of control and increased risk.  While the case for managed accounts is not without valid objections – including administrative cost, allocation issues and other issues discussed more fully below – managed accounts are an increasingly popular method of accessing hedge fund strategies and managers while avoiding the downsides of commingled funds.  According to a February 2010 survey conducted by Preqin, the alternative investment data provider, 16 percent of institutional investors have a current allocation to managed accounts and a further 23 percent of institutional investors are considering an initial allocation to a managed account during 2010.  Similarly, 65 percent of fund of funds managers surveyed by Preqin either operate a managed account currently or are considering doing so during 2010.  Preqin also found that larger investors are more likely to demand, and larger managers are more likely to offer, managed accounts, and that the proportion of fund of funds managers operating managed accounts is greatest in North America (60 percent), followed by Asia and rest of world (including Hong Kong, Singapore, Japan and Israel, at 44 percent) then Europe (40 percent).  Recently, various hedge fund managers have been exploring an alternative structure that effectuates many of the goals of managed accounts, while offering a number of additional benefits and avoiding at least one of the chief downsides.  That alternative structure is the single investor hedge fund – as the name implies, a hedge fund with one outside investor (in addition to the manager’s investment).  To assist hedge fund managers and investors in evaluating whether a single investor hedge fund may be an appropriate alternative to a traditional hedge fund, on the one hand, or a managed account, on the other hand, this article discusses: the definition of a managed account; the six chief benefits and eight primary burdens of managed accounts versus hedge funds; the definition of a single investor hedge fund; the six chief benefits of single investor hedge funds over managed accounts; and the two primary downsides of single investor hedge funds versus managed accounts.

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  • From Vol. 3 No.5 (Feb. 4, 2010)

    How Can Hedge Fund Managers Structure Managed Accounts to Remain Outside the Purview of the Amended Custody Rule’s Surprise Examination Requirement?

    Under the amended custody rule, a registered hedge fund manager that has custody of client assets is required to undergo an annual surprise examination unless it is eligible for one or more of three exceptions from the surprise examination requirement.  Generally, an adviser is deemed to have custody under the amended rule in any of four circumstances: if (1) it maintains physical custody of client funds or securities; (2) it has the authority to obtain client funds or securities, for example, by deducting advisory fees from a client’s account or otherwise withdrawing funds from a client’s account; (3) it acts in a capacity that gives it legal ownership of or access to client funds or securities (for example, where it acts as general partner of a limited partnership); or (4) client funds or securities are held directly or indirectly by a “related person” of the adviser.  However, even if an adviser is deemed to have custody for any of the foregoing reasons, it would not be subject to the annual surprise examination requirement if it were eligible for any of the following three exceptions: (1) if it is deemed to have custody solely based on its fee deduction authority; (2) to the extent it advises pooled investment vehicles that deliver annual audited financial statements (prepared by an independent, PCAOB-registered accountant) to investors in the pool within 120 days of the end of the pool’s fiscal year (180 days for funds of funds); or (3) if it is deemed to have custody solely based on custody by a “related person” and that related person is “operationally independent” of the adviser.  For a thoroughgoing discussion of the mechanics of the amended custody rule, see “How Does the Amended Custody Rule Change the Balance of Power Between Hedge Fund Managers and Accountants?,” The Hedge Fund Law Report, Vol. 3, No. 4 (Jan. 27, 2010).  Accordingly, most registered hedge fund managers would not be subject to the surprise examination requirement, with respect to hedge funds under management, because they would be eligible for the “pooled investment vehicle” exception.  However, to the extent a hedge fund manager also manages managed accounts, the manager would not be eligible for the pooled investment vehicle exception with respect to those managed accounts.  There are at least two reasons for this: (1) the typical managed account only has one investor, and thus is not “pooled” within the meaning of the amended custody rule; and (2) generally, hedge fund managers do not distribute audited financial statements to managed account investors (though such investors often conduct their own audits of the account).  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures in Light of Amendments to the Custody Rule?,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010).  Therefore, a hedge fund manager may only avoid the annual surprise examination requirement with respect to any managed accounts under management if: (1) it is not deemed to have custody of the funds or securities in the managed accounts; or (2) it is eligible for an exception from the surprise examination requirement other than the pooled investment vehicle exception.  The problem is, many managed accounts are structured and operated in ways that would cause their managers to be deemed to have custody and would render their managers ineligible for any exception.  For example, if a hedge fund manager has authority to deduct fees from the managed account and custodies the managed account assets at an affiliate of the manager that is not operationally independent of the manager, the manager would not be eligible for any exception.  See “SEC Adopts Investment Adviser Custody Rule Amendments,” The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).  Given the intrusiveness, expense and potential reputational harm arising out of surprise examinations, this article examines how managed accounts may be structured so that the manager will not be deemed to have custody of the assets in the account.  (The urgency of such avoidance is compounded by the growing chorus of calls from institutional investors for exposure to hedge fund strategies via managed accounts.)  In particular, the remainder of this article details: precisely what a managed account is (including the use of segregated portfolio companies in the Cayman Islands); the benefits of managed accounts; the drawbacks of managed accounts; how managed accounts can be structured and documented to avoid imputing custody of the assets in the account to the manager, or to ensure that the manager remains eligible for the fee deduction exception to the surprise examination requirement; the special case of private securities and illiquid assets; and special purpose vehicle considerations.

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