The Hedge Fund Law Report

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

Articles By Topic

By Topic: Mandatory Redemptions

  • From Vol. 5 No.29 (Jul. 26, 2012)

    The Nuts and Bolts of FATCA Compliance: An Interview with James Wall of J.H. Cohn Concerning Due Diligence, Document Collection, Reporting and Other Operational Challenges

    The Foreign Account Tax Compliance Act (FATCA) has that unfortunate combination of qualities that strikes fear into the hearts of hedge fund managers and investors: ambiguity and significant penalties.  FATCA is set to become effective as of January 1, 2013, but final rules have not yet been promulgated by the U.S. Department of the Treasury.  At the same time, sizable financial penalties can be imposed for noncompliance.  Accordingly, the hedge fund industry is paying close attention to FATCA developments.  Given the serious ramifications of non-compliance with FATCA and the significant uncertainty regarding the details of final regulations, The Hedge Fund Law Report conducted an interview with James K. Wall, a Principal and International Tax Director at J.H. Cohn LLP, concerning FATCA and its implications for hedge fund managers and investors.  Our interview with Wall covered various topics, including key questions hedge fund managers still face relating to FATCA compliance; due diligence and compliance measures that hedge fund managers must take; operational challenges in becoming FATCA compliant; whether the hedge fund or the manager should be responsible for bearing costs and expenses in connection with FATCA compliance; dealing with recalcitrant investors; policies and procedures that hedge fund managers should consider adopting for FATCA compliance; what to communicate to fund investors about FATCA; and whether fund governing documents must be amended to include FATCA-related provisions.  This article contains the transcript of our interview with Wall.  See also “U.S. Releases Helpful FATCA Guidance, But the Law Still Remains,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

    Read Full Article …
  • From Vol. 3 No.17 (Apr. 30, 2010)

    Mandatory Redemptions Enable Hedge Fund Managers to Control Regulatory and Reputational Risks, Contain Costs and Accommodate Maturation of Investor Base

    Mandatory redemption provisions are provisions in hedge fund documents that generally permit a manager to eject an investor from the fund, in whole or in part, in the manager’s sole discretion, and against the investor’s will.  At first blush, such provisions would appear to have utility only in the best of times, when the demand for hedge fund capacity exceeds the supply.  But as discussed more fully below, a hedge fund manager has a continuous obligation, regardless of the marketing or investment climate, to control the composition of its investor base.  This is because the types of investors in the hedge fund – regardless of investment strategy or outcome – can have a material effect on the fund and the manager.  On the fund side, the types of investors in the fund can affect the fund’s regulatory status (in particular under the Employee Retirement Income Security Act of 1974 (ERISA) and the Investment Company Act) and costs.  And on the manager side, the types of investors in the fund can affect the manager’s time, reputation and flexibility in portfolio management.  A mandatory redemption provision provides a contractual basis for acting on the conclusion that the burdens to the fund or manager (regulatory, cost, reputational, etc.) of keeping an investor outweigh the benefits (fees, relationships, etc.) of keeping that investor.  In effect, mandatory redemption provisions are to a hedge fund investor base as a standard investment management agreement is to a hedge fund investment portfolio: both give a hedge fund manager considerable discretion to act in the best interests of the fund, even where those interests diverge from the interests of one investor.  We recognize that capital raising remains a paramount challenge and an urgent imperative for hedge fund managers – especially for startup managers, but even for established ones.  See “Why Does Capital Raising for Distressed Debt Hedge Funds Remain Particularly Challenging Despite the Recent and Anticipated Positive Performance of the Strategy?,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009); “How Can Start-Up Hedge Fund Managers Use Past Performance Information to Market New Funds?,” The Hedge Fund Law Report, Vol. 2, No. 50 (Oct. 1, 2009); “How Should Hedge Fund Managers Adjust Their Marketing to Pension Funds in Light of Potential Downward Revisions to Pension Funds’ Projected Rates of Return?,” The Hedge Fund Law Report, Vol. 3, No. 11 (Mar. 18, 2010).  Nonetheless, just as you cannot buy insurance after a storm hits, so a hedge fund manager would have difficulty interpolating a mandatory redemption provision into fund documents once the rationale for such a redemption crystallizes.  Instead, the time to consider and draft provisions in hedge fund documents is before they become necessary.  Put another way, hedge fund documents – and they are not alone among legal documents in this regard – generally should be drafted to accommodate worst-case scenarios and low-probability events.  The advisability of this approach was borne out during the credit crisis, when gate and liquidating trust provisions – quiescent in fund documents for years before the crisis – were suddenly put into practice.  See “Steel Partners’ Restructuring and Redemption Plan: Precedent or Anomaly?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  Thus the timing of this discussion.  To assist hedge fund managers in appreciating the range of circumstances in which mandatory redemption provisions may be useful, this article first catalogues eleven distinct rationales for using such provisions.  Notably, all of these rationales can apply in good times or bad.  That is, the breadth of these rationales indicates that mandatory redemption provisions are not just tools to be used when investors are beating down the door.  The article then describes a practice that we call “reverse due diligence.”  While the use of this phrase in the hedge fund context may be novel, this practice it describes is not, and it should be an ongoing activity at hedge fund managers.  The article then discusses the mechanics of mandatory redemption provisions in hedge fund governing documents, including the drafting of such provisions, triggering events, notice requirements and fee considerations, including suggesting (for the benefit of institutional investors) the novel (as far as we have been able to determine) possibility of a “reverse redemption fee.”  Finally, the article examines the interaction of mandatory redemption provisions and side pockets, and discusses alternatives to mandatory redemptions that may effectuate similar goals.

    Read Full Article …