The Hedge Fund Law Report

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

Articles By Topic

By Topic: Liquidations

  • From Vol. 10 No.11 (Mar. 16, 2017)

    Considerations When Winding Down Funds: Navigating Illiquid Assets, Unanticipated Windfalls and Fees and Expenses During Liquidation (Part Two of Two)

    Once a manager decides to wind down a fund, it must navigate myriad considerations and decisions during the process. The manager needs to disclose the wind-down to investors at the outset without triggering liabilities to service providers or diminishing asset values, and the fund needs to retain appropriate personnel and working capital to perform a wind-down that could take months or even years to complete. To address these and other issues that arise when winding down a fund, The Hedge Fund Law Report recently interviewed Michael C. Neus, senior fellow in residence with the Program on Corporate Compliance and Enforcement at New York University School of Law and former managing partner and general counsel of Perry Capital, LLC. This second article in our two-part series analyzes how illiquid assets should be treated during a wind-down; what fees can and should responsibly be charged to investors; and how managers should allocate an unanticipated windfall received after the wind-down is completed. The first article in the series described the roles that a fund’s general counsel and chief compliance officer play in the wind-down, as well as best practices for communicating the decision to wind down to service providers and investors. For more on considerations when winding down a fund in the Cayman Islands, see “How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or at the End of Its Life? (Part One of Two)” (Dec. 5, 2013); and our two-part series on navigating the loss of a fund’s substratum requirement: “Analysis of the Conflicting Cayman Islands Standards” (Jan. 5, 2017); and “Steps to Ensure a Fund’s Soft Wind-Down Does Not Result in a Winding-Up Order” (Jan. 12, 2017).

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    Winding Down Funds: How Managers Make the Decision and Communicate It to Investors and Service Providers (Part One of Two)

    A fund manager typically spends most of its time not only contemplating how to maximize returns for investors, but also navigating the array of compliance and regulatory concerns involved in running a private fund. Because the manager is so caught up in thinking about these daily considerations, it may lose sight of the multitude of issues that arise when it comes time to wind down that same fund. If the manager exercises some foresight regarding the fund’s eventual wind-down and puts proper procedures in place, however, the whole process can be both smoother and less fraught with legal and regulatory risks. In a recent interview with The Hedge Fund Law Report, Michael C. Neus, senior fellow in residence with the Program on Corporate Compliance and Enforcement at New York University School of Law and former managing partner and general counsel of Perry Capital, LLC, shared his detailed insights about the various considerations caused by winding down a fund. For additional commentary from Neus, see “Practical Solutions to Some of the Harder Fiduciary Duty and Other Legal Questions Raised by Side Letters” (Feb. 21, 2013). This first article in a two-part series presents Neus’ thoughts on the factors leading to the decision to wind down a fund, which personnel should lead that process and how it should be disclosed to investors and service providers. The second article will explore what types of fees and expenses investors should be charged during the wind-down, as well as how managers can maximize the value of illiquid assets during a liquidation. For more on winding down funds, see “Practical Tips for Fund Managers to Mitigate Litigation Risk From Regulators, Investors and Vendors When Winding Down Funds” (Oct. 27, 2016).

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  • From Vol. 10 No.2 (Jan. 12, 2017)

    Loss of Substratum: Steps to Ensure a Fund’s Soft Wind-Down Does Not Result in a Winding-Up Order (Part Two of Two)

    Conflicting cases in the Cayman Islands mean that funds intending to operate during a soft wind-down are susceptible to an investor petition for a court-appointed liquidator to commence a winding-up of the fund due to loss of substratum (i.e., its purpose for existence). For more on soft wind-downs of Cayman funds, see “Cayman Hedge Funds, Soft Wind-Downs and Disclosure” (Feb. 25, 2011). Fund managers and their advisers are forced to navigate conflicting statements in the case law on this issue, while recent cases have further highlighted the need for the Cayman Islands Court of Appeal to finally resolve this issue. In this guest article, the second in a two-part series, Tony Heaver-Wren and Sebastian Said, partner and counsel, respectively, at Appleby (Cayman), detail the competing Cayman standards for considering a fund’s business when identifying loss of substratum, as well as practical steps that fund managers can take to avoid having a court reach such a determination when conducting a soft wind-down. The first article set forth the history of the Cayman Islands law on loss of substratum, as well as the divergent standards – the “impossibility test” and the “non-viability test” – currently being used by the Cayman Islands courts. For Cayman court considerations concerning loss of substratum, see “Cayman Islands Grand Court Rules That Investor in Hedge Fund Wyser-Pratte EuroValue Fund Is Entitled to Court-Imposed Liquidation of Fund, Even Though Fund Is Solvent, but Gives Fund Time to Complete Liquidation on Its Own” (Nov. 19, 2010).

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  • From Vol. 10 No.1 (Jan. 5, 2017)

    Loss of Substratum: Analysis of the Conflicting Cayman Islands Standards (Part One of Two)

    In two recent winding-up petitions issued against investment funds on the just and equitable basis, the Financial Services Division of the Grand Court of the Cayman Islands has revisited the controversial question of the appropriate test for winding up a company on the grounds of loss of substratum (i.e., loss of the purpose for purpose for its existence). Considered in the context of earlier Cayman authorities on the test for loss of substratum, the law is now in a considerable state of confusion and is therefore ripe for clarification by the Cayman Islands Court of Appeal – particularly because of its significance for Cayman’s financial services industry. In this guest article, the first in a two-part series, Tony Heaver-Wren and Sebastian Said, partner and counsel, respectively, at Appleby (Cayman), describe the history of the Cayman Islands loss of substratum and the competing current approaches – the “impossibility test” and the “non-viability test” – being used by the courts. The second article will analyze how the impossibility test can be properly applied in the context of a fund proposing a soft wind-down, and how the potentially valid policy factors identified by courts concerning its usage can appropriately be addressed. For additional insight from Appleby (Cayman) attorneys, see “Changes to Redeeming Investor Distribution Priority and Other Ramifications of the Primeo Appellate Decision for Cayman Islands Hedge Funds” (Sep. 15, 2016); “How Can Service Providers to Cayman Islands Hedge Funds Enforce Rights to Contracts to Which They Are Not Parties?” (Jun. 19, 2014); and the two-part series entitled “How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or at the End of Its Life?”: Part One (Dec. 5, 2013); and Part Two (Dec. 12, 2013).

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  • From Vol. 9 No.42 (Oct. 27, 2016)

    Practical Tips for Fund Managers to Mitigate Litigation Risk From Regulators, Investors and Vendors When Winding Down Funds

    As private funds wind down – typically because of poor performance, investor attrition or fallout from regulatory enforcement actions – it is critically important for fund principals to approach the closure thoughtfully and methodically in order to minimize any potential issues. This includes understanding and honoring the requirements in fund documentation and other contracts; carefully managing communications with investors; promptly notifying investors when the fund liquidation commences; assessing liquidity in preparation for pending redemptions; and identifying which employees can and should be incentivized to remain with the fund through its wind-down. These points were made in a recent session at the Tenth Annual Hedge Fund General Counsel and Compliance Summit, hosted by Corporate Counsel and ALM. The panel featured Patricia Arciero-Craig, general counsel and secretary of Gleacher & Company, Inc.; Cynthia A. Marian, head of legal and compliance of Marto Capital LP; Finbarr O’Connor, managing director and private funds advisory practice leader of Berkeley Research Group, LLC; and Michael R. Schwenk, general counsel and chief compliance officer of NWI Management LP. This article presents key takeaways from the panel discussion. For coverage of the opening session of the conference, see “How Hedge Fund Managers Can Accommodate Heightened Investor Demands for Bespoke Negative Consent, Liquidity, MFN and Other Provisions in Side Letters” (Oct. 13, 2016).

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  • From Vol. 9 No.37 (Sep. 22, 2016)

    AIMA Survey Identifies Key Ways That Managers Align With Investors, Including Alternative Fee Structures, Skin in the Game and Customized Investment Solutions

    The Alternative Investment Management Association (AIMA) recently released a paper reviewing the nature of relationships between hedge fund managers and their investors. AIMA’s report explores a number of methods that managers are using to strengthen their relationships with investors, including by employing alternative fee structures, investing significant capital in their funds and offering customized investment solutions. This article examines these and other key takeaways from the report. For additional insight from AIMA, see “Basel III Raises Prime Brokerage Costs for Hedge Fund Managers” (Feb. 18, 2016); “Structures and Characteristics of Activist Alternative Investment Funds” (Mar. 12, 2015); and “Key Drivers of the Bifurcation of the Hedge Fund Industry Between Larger and Smaller Managers” (May 24, 2012).

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  • From Vol. 7 No.34 (Sep. 11, 2014)

    How May Investors in Cayman Islands Hedge Funds In Liquidation Protect Their Interests If Dissatisfied with the Liquidators’ Conduct of the Liquidation?

    Investors are rarely happy to learn that the Cayman Islands hedge fund in which they have invested is entering liquidation.  That dissatisfaction can be exacerbated by the conduct of the liquidator.  Causes of such dissatisfaction include lack of transparency, delay, cost, fire sales, failure to bring claims, failure on the part of the liquidators to consider a restructuring, etc.  However, the Cayman corporate liquidation process is structured to protect shareholders and creditors in liquidations, and the Cayman liquidation framework provides safeguards relating to court and voluntary liquidations.  In a guest article, Christopher Russell and Paul Kennedy, partner and associate, respectively, in the Litigation and Insolvency practice group at Appleby, Cayman Islands, enumerate specific strategies whereby investors in liquidating Cayman hedge funds that are not satisfied with the conduct of the liquidator may protect their interests.  See also “When and How Can Hedge Fund Managers Close Hedge Funds in a Way that Preserves Opportunity, Reputation and Investor Relationships?  (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 21 (Jun. 2, 2014).

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  • From Vol. 7 No.18 (May 8, 2014)

    How to Close a Hedge Fund in Eight Steps (Part One of Two)

    In concept, hedge funds are “continuously offered” and, unlike their private equity cousins, have no built-in end date.  In practice, however, hedge funds do not last forever.  For various reasons – this article catalogues nine of them – hedge fund managers may wish to close their funds, or may close their funds without wishing to.  More often than not, a hedge fund manager that closes a fund remains in the investment management business, and continues to interact with the same employees, investors and service providers – even if that interaction occurs under a different structure.  Closing a fund is a complex process involving hard legal and business issues, often with an overlay of meaningful personal dynamics.  This article – the first in a two-part series – aims to add some structure to what can be a fraught and unruly process by presenting an eight-step framework for hedge fund closures.  The second article in this series will highlight a number of challenges that managers typically encounter in the course of those eight steps, and suggest best practices for negotiating the challenges.  It should be emphasized that this series is about winding down the business and investment affairs of a hedge fund.  In industry parlance, “closing” also refers to a situation in which a hedge fund is not accepting new investors or investments.  That latter type of “closing” is not the subject of this series, but was the subject of prior articles in the HFLR.  See “Legal and Investment Considerations in Connection with Closing Hedge Funds to New Investors or Investments,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010); “Primary Legal and Business Considerations in Structuring Hedge Fund Capacity Rights,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or At the End of Its Life? (Part Two of Two)

    This is the second article in a two-part series on how a hedge fund investor can maximize the protection of its investment in a fund at three distinct stages towards and at the end of its commercial life.  This article addresses measures available to investors during the third stage: when the fund is placed into formal liquidation, either by a court or by voluntary winding up.  The first installment addressed measures available to investors during the first two stages: where there are warning signs that the fund may be heading into financial difficulty or when the fund is placed into management wind down.  See “How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or At the End of Its Life? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 46 (Dec. 5, 2013).  The authors of this series are Christopher Russell, Jonathan Bernstein and Jeremy Snead.  Russell and Snead are, respectively, a partner and an associate in the litigation department of Appleby Cayman; Bernstein is a senior associate in the corporate and investment funds department.

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  • From Vol. 6 No.46 (Dec. 5, 2013)

    How Can Investors in Cayman Hedge Funds Maximize Protection of Their Investments When the Fund Is Near or At the End of Its Life? (Part One of Two)

    Investment risk takes many forms, and one often overlooked by many hedge fund investors is: How will I protect my investment in the event that the fund fails or decides to cease doing business?  The fund investors that do not adopt a head-in-the-sand approach have various options available to help them maximize the return of and return on such investments.  This is the first article in a two-part guest article series highlighting the various measures available to investors who have made an investment in a fund that is at one of three distinct stages towards or at the end of its commercial life.  This article addresses investor options during the first two stages: where there are warning signs that the fund may be heading into financial difficulty or when the fund is placed into management wind down.  The second article in the series will address measures available to investors during the third stage: when the fund is placed into formal liquidation, either by the court or by voluntary winding up.  The authors of this series are Christopher Russell, Jonathan Bernstein and Jeremy Snead.  Russell and Snead are, respectively, a partner and an associate in the litigation department of Appleby Cayman; Bernstein is a senior associate in the corporate and investment funds department.

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  • From Vol. 6 No.36 (Sep. 19, 2013)

    Cayman Grand Court Evaluates Whether a Trade Counterparty Is an Undisputed “Creditor” That Is Permitted to Petition for the Liquidation of a Purported Hedge Fund Debtor

    Under Cayman law, only a creditor (whose status as such is undisputed) is permitted to petition for the liquidation of a debtor.  The Grand Court of the Cayman Islands, Financial Services Division (Court), recently clarified whether there was ambiguity as to the creditor status of a trade counterparty of a hedge fund where the trade counterparty petitioned the Court to liquidate the hedge fund.  The petitioner was a counterparty of a hedge fund pursuant to various commodities contracts.  The fund failed to take delivery of – or to pay for – copper cathodes that it had contracted to buy from the petitioner.  The petitioner claimed it was a creditor of the fund and petitioned the Court to appoint liquidators for the fund.  The fund challenged the petitioner’s standing as a creditor to bring the winding-up petition.  This article summarizes the background of the case, the legal analysis and the Court’s ruling.

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  • From Vol. 6 No.13 (Mar. 28, 2013)

    BVI Court Rules on the Validity of the Appointment of Hedge Fund Liquidators by a Hedge Fund Manager Subject to SEC and CFTC Enforcement Actions

    The Eastern Caribbean Supreme Court (Court) in the High Court of Justice in the British Virgin Islands (BVI) recently opined on the validity of the appointment of BVI liquidators for several BVI-domiciled hedge funds made by a manager that has been separately charged by the SEC and the U.S. Commodity Futures Trading Commission with defrauding investors.  The challenge to the liquidators’ appointment came from a U.S.-court-appointed receiver of the hedge funds.  This article summarizes the factual background, legal analysis and holdings by the Court in this matter.  For a discussion of the waterfall provisions applicable to BVI hedge fund insolvency proceedings, see “BVI Court of Appeal Rules on Priority of Redeemed Investors Versus Remaining Investors in a Hedge Fund Liquidation,” The Hedge Fund Law Report, Vol. 6, No. 12 (Mar. 21, 2013).

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    BVI Court of Appeal Rules on Priority of Redeemed Investors Versus Remaining Investors in a Hedge Fund Liquidation

    The Court of Appeal of the Eastern Caribbean Supreme Court recently ruled on whether investors in a hedge fund, who had given notice of redemption but who had not been paid in full at the time the fund went into liquidation, have priority in the liquidation over fund investors who had not redeemed their shares prior to the liquidation.  This article recounts the relevant facts of the case and summarizes the Court’s decision and reasoning.  For a discussion of the trial court’s decision, see “British Virgin Islands High Court Issues Landmark Decision Affecting the Distribution Rights of Redeemed Versus Continuing Investors in a Liquidating Hedge Fund,” The Hedge Fund Law Report, Vol. 5, No. 47 (Dec. 13, 2012).

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  • From Vol. 5 No.47 (Dec. 13, 2012)

    British Virgin Islands High Court Issues Landmark Decision Affecting the Distribution Rights of Redeemed Versus Continuing Investors in a Liquidating Hedge Fund

    On November 16, 2012, the Commercial Division of the High Court in the British Virgin Islands issued a landmark decision bearing on the distribution rights of redeemed versus continuing investors in a hedge fund in liquidation.  Among other things, the decision provides insight to a hedge fund investor who must evaluate whether to redeem its investment in a fund that is expected to liquidate in the near future.  This article summarizes the factual background and legal analysis of the decision.  See also “Seventh Circuit Approves Federal Receiver’s Hedge Fund Liquidation Plan Subordinating Priority Rights of Redeeming Investors,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).

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  • From Vol. 5 No.41 (Oct. 25, 2012)

    Pitfalls and Solutions in Trading Shares in Corporate Hedge Funds in Liquidation in the Cayman Islands

    When redemptions in the shares of hedge funds are suspended, including in situations where the determination of net asset value is suspended, trading in those fund shares nonetheless commonly occurs in a secondary market, with investors typically seeking to exit a fund position to cap their losses, and more speculative investors seeking to purchase positions in the hope of a better return if the fund emerges from its financial difficulties.  However, in the Cayman Islands, if the fund’s difficulties give rise to a voluntary liquidation, any transfer of shares made after the commencement of the liquidation will be void unless sanctioned by the liquidators.  Sellers, buyers and liquidators need to know how transfers of hedge fund shares made after the commencement of a voluntary liquidation may be preserved.  In a guest article, Christopher Russell and Jeremy Snead, partner and associate, respectively, at Appleby (Cayman), highlight the pitfalls associated with such transactions and solutions for preserving these arrangements.

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  • From Vol. 5 No.37 (Sep. 27, 2012)

    Cayman Grand Court Rejects Validity of Side Letter Entered Into Between an Investor in Investment Vehicles That Invested in the Matador Fund and a Director of the Matador Fund

    A recent decision handed down by the Grand Court of the Cayman Islands (Court) emphasizes the importance of: (1) ensuring that the correct parties enter into side letters between an investor and a fund; and (2) ensuring that a fund’s governing documents permit the fund to enter into the type of side letter contemplated by the fund and the investor.  This decision follows on the heels of another recent decision handed down by the Court that highlights similar principles.  See “Recent Cayman Grand Court Decision Demonstrates the Practical and Legal Challenges of Investing in Hedge Funds through Nominees,” The Hedge Fund Law Report, Vol. 5, No. 29 (Jul. 26, 2012).

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  • From Vol. 5 No.19 (May 10, 2012)

    Cayman Grand Court Ruling Supports Proposition That Hedge Fund Managers Do Not Have Unfettered Discretion in Making Distributions In Kind to Investors

    The 2008 financial crisis raised investor concerns related to the discretion that hedge funds and their managers often maintained with respect to decisions impacting investor redemptions.  In some circumstances, hedge funds invoked gates or suspended redemptions that delayed distribution of redemption proceeds that were to be delivered pursuant to fund governing documents.  In other circumstances, hedge funds paid redemption proceeds “in kind” as opposed to making cash payments.  While hedge fund governing documents often give hedge funds and their managers broad discretion in making distributions in kind, a recent decision handed down by the Grand Court of the Cayman Islands supports the proposition that hedge funds do not have unfettered discretion to make in kind distributions to investors and that a favorable valuation assigned by a fund to an in kind distribution of redemption proceeds may not insulate it from a claim that the fund is insolvent and should be liquidated.

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  • From Vol. 5 No.12 (Mar. 22, 2012)

    To What Extent Can a Hedge Fund Manager Hold Back Redemption Proceeds for Contingent Liabilities?

    Contingent or unforeseen liabilities can present numerous problems for hedge fund managers because it can be extremely difficult to determine the amount of such liabilities as well as the timing of payments to cover any such liabilities.  This is why many hedge fund managers have historically built into their fund governing documents the right to “hold back” amounts that would otherwise be distributed to fund investors to account for such liabilities.  Unfortunately, although the fund documents may give a hedge fund manager unfettered discretion in exercising its right to hold back distributions, its fiduciary obligations may trump such rights, particularly if it is determined that the hedge fund manager is not acting in accord with its obligation of good faith and fair dealing owed to all fund investors in making distributions.  A hedge fund manager’s decisions as to how to address contingent liabilities can be particularly difficult when a fund is in liquidation, where there may be only limited resources to cover contingent or unforeseen liabilities.  A recently-filed complaint has initiated a lawsuit relating to the amount of discretion hedge fund or hedge fund of funds managers have to hold back distributions to a single investor where there are contingent liabilities arising out of such investor’s investment in a liquidating hedge fund.  This article summarizes the complaint in that case.

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  • From Vol. 4 No.42 (Nov. 23, 2011)

    Speakers at Walkers Fundamentals Hedge Fund Seminar Provide Update on Hedge Fund Terms, Governance Issues and Regulatory Developments Impacting Offshore Hedge Funds

    On November 8, 2011, international law firm Walkers Global (Walkers) held its Walkers Fundamentals Hedge Fund Seminar in New York City.  Speakers at this event addressed various topics of current relevance to the hedge fund industry, including: recent trends in offshore hedge fund structures; hedge fund fees and fee negotiations; fund lock-ups; fund-level and investor-level gates; fund wind-down petitions and the appointment of fund liquidators; corporate governance issues; D&O insurance; fund manager concerns with Form PF; and offshore regulatory developments, such as proposed legislation requiring registration of certain master funds in the Cayman Islands, the EU’s Alternative Investment Fund Manager (AIFM) Directive and the British Virgin Islands (BVI) Securities & Investment Business Act (SIBA).  This article summarizes the key points discussed at the conference relating to each of the foregoing topics and others.

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  • From Vol. 4 No.29 (Aug. 25, 2011)

    Failure to Follow Investment Guidelines, Manipulative Trading and Misleading Investors Leads British FSA to Impose Steep Civil Penalties and Ban Principals of Defunct Hedge Fund Manager Mercurius Capital from Securities Industry

    From July 2006 through January 2008, the manager of Cayman Islands hedge fund Mercurius International Fund Limited (Fund) repeatedly violated the Fund’s investment guidelines by over-concentrating investments in thinly-traded companies.  When the values of those investments began to drop, the Fund’s director and chief executive officer, Michiel Visser (Visser), and its chief financial and compliance officer, Oluwole Modupe Fagbulu (Fagbulu), engaged in market manipulation to inflate artificially the Fund’s net asset value (NAV), engaged in sham trades to increase NAV and conceal money borrowed at exorbitant rates and concealed all these machinations, and the Fund’s perilous financial position, from existing and prospective investors.  The Fund collapsed in January 2008 and is now in liquidation.  The British Financial Services Authority (FSA) charged Visser and Fagbulu with market manipulation and other violations of the Financial Services and Markets Act of 2000.  It banned the defendants from the securities industry and imposed steep financial penalties on them.  Visser and Fagbulu appealed to the Upper Tribunal of the British Tax and Chancery Chamber.  We summarize the Tribunal’s decision.

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  • From Vol. 4 No.19 (Jun. 8, 2011)

    If a Hedge Fund Goes into Liquidation between the Time of an Investor’s Subscription and Issuance of Fund Shares to that Investor, Who Owns the Money Paid for the Fund Shares?

    Although both an investor and a hedge fund manager have a common interest in completing the subscription process, intervening events – for example, a petition for the winding up and liquidation of the fund before the process is complete – necessarily require a determination of the point in time at which the investor’s subscription monies cease to be its own, and fall within the ambit of the fund’s own assets.  In particular, if the fund is placed into liquidation after receipt of the investor’s subscription monies, but before issuing and registering the shares subscribed for, the question becomes: Would the investor be entitled to the return of the subscription monies, or entitled only to a pro-rated distribution in the liquidation which may become payable to it either as a creditor or member?  In a guest article, Christopher Russell and Shaun Folpp, Partner and Managing Associate, respectively, at Ogier, Cayman Islands, address this question.  In the process, Russell and Folpp discuss “Quistclose” trusts, constructive trusts and the extensive case law relevant to the ownership of subscription monies after liquidation but before the issuance of shares.

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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)

    When Does the SEC Acquire the Right to Freeze the Assets of a Hedge Fund or Appoint a Receiver over a Hedge Fund?

    As previously reported in The Hedge Fund Law Report, on March 24, 2011, the SEC brought a civil enforcement action against Marlon Quan, and the firms he managed, Acorn Capital Group, LLC (ACORN) and Stewardship Investment Advisors, LLC (SIA), in the U.S. District Court for the District of Minnesota.  The SEC accused Quan of using his hedge funds to facilitate a Ponzi scheme orchestrated by Thomas J. Petters by funneling hundreds of millions of dollars of investor money to Petters, while falsely assuring investors of actions taken to protect their investments.  See “SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  The SEC filed the action on that date in order to stop the imminent distribution of approximately $14 million in settlement funds – obtained from the Petters’ bankruptcy and receivership estates – to certain of Quan’s offshore hedge funds, and to prevent Quan from allegedly dispersing more assets to individuals associated with him.  The SEC did so, it said, to protect the interests of investors in Quan’s onshore hedge funds.  Thus, the SEC also named as “relief defendants” (defined as persons or entities who received ill-gotten funds or assets as a result of the illegal acts of the defendants) the company that held the settlement funds on behalf of Quan’s associated entities, Asset Based Resource Group (ABRG), and Florene Quan, Quan’s wife who allegedly received certain properties from Quan for nominal value.  See, by way of background, “Connecticut District Court Dismisses Complaint Against Hedge Fund Manager and Investment Adviser for Lack of Venue,” The Hedge Fund Law Report, Vol. 2, No. 20 (May 20, 2009).  After filing the complaint, the SEC immediately filed a motion to obtain an order freezing the assets of all named defendants, appointing a receiver over certain of Quan’s onshore entities and ABRG, and enjoining Quan, Acorn and SIA from further violations of securities laws.  A Bermuda court-appointed liquidator, who took over Quan’s offshore hedge funds, successfully moved to intervene for the limited purpose of being heard regarding the disbursement of settlement proceeds and to object to the appointment of a receiver over ABRG.  We detail the background of the action and the Court’s legal analysis.  For more on receivers in the hedge fund context, see “Seventh Circuit Approves Federal Receiver’s Hedge Fund Liquidation Plan Subordinating Priority Rights of Redeeming Investors; Agrees That Equity Mandates That All Investors, Redeeming and Not, Be Treated Equally Where Fund Lacks Sufficient Assets to Make Them Whole,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Cayman Islands Grand Court Rules That Hedge Fund Investor Is Entitled to Court-Supervised Liquidation of Fund, Even Though Fund Managers Were Conducting “Ad Hoc” Liquidation With the Support of a Majority of Fund Investors

    In yet another case that highlights the importance of carefully drafted hedge fund organizational documents, the Cayman Islands Grand Court has granted a request by hedge funds Aris Multi-Strategy Lending Fund Limited and Aris Africa Fund Limited (together, Aris) to have a court-supervised liquidator appointed for hedge fund Heriot African Trade Finance Fund Limited (Heriot or Fund).  In or around March 2009, as a result of the 2008 credit crisis, Heriot’s managers suspended redemptions in the Fund indefinitely.  In June 2009, Aris commenced litigation seeking to wind up the Fund on the grounds that the Fund had failed to file timely financial statements and had failed to comply with its stated investment policy.  Over a year later, it amended that petition to add a critical additional ground for winding up: The Fund had lost its “substratum,” which, under Cayman Islands law, means that the Fund’s business purpose could no longer be carried out.  Heriot, in opposing the winding up order, argued that, with the approval of a majority of its investors, it was already liquidating in an orderly fashion.  The Court ruled that, because Heriot’s organizational documents did not specifically contemplate an informal, self-supervised liquidation process, Aris was entitled to a winding up order and the appointment of a liquidator.  This article summarizes the Court’s decision.  For more on Aris, see "Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris," The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009); "New York State Supreme Court Dismisses Hedge Funds of Funds’ Complaint against Accipiter Hedge Funds Based on Exculpatory Language in Accipiter Fund Documents and Absence of Fiduciary Duty 'Among Constituent Limited Partners,'" The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17. 2010); "New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act," The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).

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  • From Vol. 3 No.50 (Dec. 29, 2010)

    Seventh Circuit Approves Federal Receiver’s Hedge Fund Liquidation Plan Subordinating Priority Rights of Redeeming Investors; Agrees That Equity Mandates That All Investors, Redeeming and Not, Be Treated Equally Where Fund Lacks Sufficient Assets to Make Them Whole

    On December 1, 2010, the U.S. Court of Appeals for the Seventh Circuit affirmed a pro rata distribution plan for the liquidation of a family of investment vehicles, akin to hedge funds, over the objections of investors who claimed that their pre-receivership redemption requests gave them creditor-priority over non-redeeming investors.  The appeal arose out of an enforcement action by the U.S. Securities and Exchange Commission (SEC) against the collapsed management firm, Wealth Management LLC, and its six investment vehicles.  The U.S. District Court for the Eastern District of Wisconsin had appointed a receiver to take over and liquidate the defendants.  The objectors, non-parties to that action, claimed that the receiver’s liquidation plan illegally failed to recognize their rights, as equity investors who sought to redeem their shares prior to the funds’ collapse, to have their interests converted into corporate debt with liquidation priority over other non-redeeming equity investors.  The Circuit Court agreed with the District Court, ruling that the liquidation plan, which subordinated their interests in order to treat all investors equally, only needed to allocate receivership property in a manner that is “fair and reasonable” to all investors, and that state law did not govern the distribution.  We detail the background of the action and the Court’s pertinent legal analysis.

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  • From Vol. 3 No.45 (Nov. 19, 2010)

    Protection Against Court Winding Up of Cayman Islands Hedge Funds in Management Wind Down

    Many investment funds that have come to the end of their commercial life will conclude that the interests of their investors are best served by the closing down of the fund, conducted by its management, including the investment manager, with the return to the investors of their due share of the assets of the fund after settlement of liabilities; such closing down is usually effected by the distribution to investors of cash or assets, or by the assignment of shares in a special purpose vehicle set up by the fund to take illiquid or other assets of the fund, or by a combination of these.  Funds will typically achieve this by a combination of redemptions (voluntary and compulsory), in cash or in specie, and the imposition and lifting of suspensions of redemptions and gating provisions as necessary.  Such wind down schemes, to be valid and enforceable, will require compliance with the contractual entitlement of the fund to adopt and impose the scheme under the fund’s constitutional documentation, i.e., the fund’s articles of association and offering memoranda.  Funds which have ceased to operate as active investment vehicles have recently attracted the attention of the first instance courts of the Cayman Islands (and the British Virgin Islands and Bermuda), in the context of petitions to wind up a fund which is in management wind down.  This kind of informal wind down will usually be effected and managed by the fund’s board of directors and the investment manager.  A source of discontent amongst investors may be the level of fees charged by the investment manager during the wind down period which, whilst accepted to be at a level appropriate when the fund was operating as a going concern and taking in new investors, is perceived to be disproportionately and unjustifiably high in a wind down.  It may also be perceived that any wind down managed by the investment manager inherently provides an incentive (conscious or unconscious) for the investment manager to prolong the wind down process for the purpose of earning continuing fees.  A trend is emerging from a number of recent cases before the first instance courts of the Cayman Islands (which may be followed in other jurisdictions) that it is open to the court, almost as a matter of course, to impose a compulsory winding up order in respect of an investment fund merely because it has ceased to operate as an active investment vehicle, even if it is in a process of a management-conducted winding down.  In a guest article, Christopher Russell and Shaun Folpp, Partner and Senior Associate, respectively, at Ogier, Cayman Islands, analyze and critique this trend, and detail its implications for the drafting of constitutional documents of Cayman Islands hedge funds.

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  • From Vol. 3 No.45 (Nov. 19, 2010)

    Cayman Islands Grand Court Rules that Investor in Hedge Fund Wyser-Pratte EuroValue Fund Is Entitled to Court-Imposed Liquidation of Fund, Even Though Fund Is Solvent, but Gives Fund Time to Complete Liquidation On Its Own

    In another case that has its roots in the market meltdown and liquidity crisis of 2008, the Grand Court of the Cayman Islands has ruled that, in principle, an investor in hedge fund Wyser-Pratte EuroValue Fund Ltd. (Fund) is entitled to judicial liquidation of the Fund.  However, because the Fund had already substantially completed the liquidation process by the time of the hearing of the liquidation petition, the Court declined to issue an immediate order appointing liquidators.  Petitioner, Fund investor AIFAM Event Driven Fund Trust (Investor), sought to redeem all its Fund shares, effective June 20, 2008.  In response to numerous redemption requests, the Fund imposed a gate on redemptions, limiting them to 10% of net asset value.  In September 2008, the Fund froze redemptions entirely.  The freeze remained in effect indefinitely.  In March 2010, the Fund proposed to liquidate over a two-year period.  Dissatisfied with that plan, the Investor filed a petition for court-supervised liquidation of the Fund.  Unbeknownst to the Investor, the Fund had already adopted a revised plan that would have substantially concluded the liquidation by the end of 2010 and, significantly, provided that the Fund manager would not be paid management fees after 2010.  The Grand Court agreed with the Investor’s argument that, under the circumstances, it was entitled to a court-appointed liquidator.  However, by the time of the hearing of the Investor’s petition, the Fund had already completed a substantial portion of its liquidation, and was poised to complete the liquidation within a few weeks.  As a result, the Grand Court decided not to appoint a liquidator to give the Fund time to make good on its promises.  We summarize the facts of the case and the Grand Court’s reasoning.  See also “Protection Against Court Winding Up of Cayman Islands Hedge Funds in Management Wind Down,” above, in this issue of The Hedge Fund Law Report.

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  • From Vol. 3 No.35 (Sep. 10, 2010)

    New York State Supreme Court Rules that Liquidating Trustee of Defunct Hedge Fund Lipper Convertibles, L.P. has Right to Claw Back Withdrawals Made to Sylvester Stallone and Other Investors Who Withdrew Their Interests in the Fund at a Time When the Fund’s Assets Were Grossly Overvalued Due to Fraud

    Defendants Sylvester Stallone and other individuals and institutional investors invested in Lipper Convertibles, L.P. (Fund), a hedge fund formed by Lipper & Company, L.P.  From January 2001 through January 2002 the defendants withdrew as limited partners from the Fund and received payouts based on the net asset value of the Fund as of the time of their respective withdrawals, as calculated by the Fund’s general partner.  In March 2002, an internal review by the Fund revealed that the Fund’s assets had been dramatically overstated due to the fraudulent actions of its portfolio manager and the apparent neglect or complicity of the Fund’s auditor.  The Fund’s assets were then written down to about 53 percent of their prior values.  The write-downs prompted the Fund’s collapse and its subsequent Court-monitored liquidation.  The Court eventually appointed Richard A. Williamson (Williamson) to act as the Fund’s liquidating trustee in place of the Fund’s general partner.  Among the many lawsuits spawned by the Fund’s collapse were those by Williamson against about sixty Fund investors who had withdrawn prior to the Fund’s collapse and who had received distributions based on the Fund’s fraudulently inflated net asset values.  Williamson sought to claw back distributions made to those investors on the theory that the withdrawing investors had been unjustly enriched at the expense of other innocent investors who had not withdrawn from the Fund.  The eight investors in this action countered by alleging, among other things, that Williamson stood in the shoes of the Fund and that, because the Fund was at fault by virtue of its own fraud, the Fund was not entitled to claw back investor distributions.  The Court ruled that the claw backs were proper.  We outline the background of the lawsuit and summarize the parties’ arguments and the Court’s reasoning.

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