The Hedge Fund Law Report

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

Articles By Topic

By Topic: Winding Up

  • From Vol. 10 No.14 (Apr. 6, 2017)

    Avoiding Common Pitfalls Under the Custody Rule: Custody Determination, Auditor Independence and Liquidation Audits (Part Two of Two)

    The crux of Rule 206(4)-2 under the Investment Advisers Act of 1940 (Advisers Act), commonly referred to as the “custody rule,” is the protection of client and investor assets. There are several areas, however, where an adviser can run afoul of the custody rule. In this second installment of a two-part series, we review the auditor-independence requirement and discuss two additional hazards that may result in non-compliance with the custody rule: failing to realize when the adviser has custody and liquidation audits. The first article detailed options for fund managers to comply with the rule; discussed the frequency with which custody is reviewed during SEC examinations; and identified common weaknesses relating to inadvertent custody, as well as preparation and delivery of audited financial statements. For a discussion of SEC enforcement actions and corresponding penalties involving violations of the custody rule, see “Failure by Investment Advisers to Ensure Accurate Client Billing May Lead to SEC Enforcement Action and Penalties” (Feb. 2, 2017); “Repeat Custody Rule Offenders Face Severe SEC Sanctions” (Dec. 10, 2015); and “SEC Sanctions Two Private Fund Managers for Custody Rule Violations, Including Imposing Statutory Bars on Their Chief Compliance Officers” (Nov. 8, 2013).

    Read Full Article …
  • 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).

    Read Full Article …
  • 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).

    Read Full Article …
  • 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).

    Read Full Article …
  • 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).

    Read Full Article …
  • 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).

    Read Full Article …
  • From Vol. 9 No.36 (Sep. 15, 2016)

    Changes to Redeeming Investor Distribution Priority and Other Ramifications of the Primeo Appellate Decision for Cayman Islands Hedge Funds

    On July 19, 2016, the Cayman Islands Court of Appeal (CICA) delivered an important decision in the litigation between liquidators of the Herald Fund SPC and the Primeo Fund, each of which were directly or indirectly feeder funds in the Ponzi scheme run by Bernard Madoff. The CICA’s ruling changes the law on priorities in insolvencies, clarifying where redeemed investors rank relative to outside creditors. However, the decision also calls into question the scope and application of the Cayman Islands statute governing redemptions by fund investors. It is vital for managers of – and investors in – Cayman Islands hedge funds facing liquidity problems to consider the CICA’s findings going forward. In a guest article, Jeremy Walton and Paul Kennedy, partner and senior associate, respectively, at Appleby (Cayman), provide an overview of the history and holding of the case, analysis of potential issues created by the ruling and practical advice for hedge fund managers and investors in light of the decision. For additional commentary from Appleby attorneys, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters” (May 28, 2015); and “How May Investors in Cayman Islands Hedge Funds in Liquidation Protect Their Interests If Dissatisfied With the Liquidators’ Conduct of the Liquidation?” (Sep. 11, 2014). For coverage of another hedge fund forced to liquidate due to its investment in Madoff feeder funds, see “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” (Mar. 28, 2013).

    Read Full Article …
  • From Vol. 8 No.35 (Sep. 10, 2015)

    Redeemed Investors Have Priority With Respect to Payment from Liquidating Cayman Islands Hedge Fund

    A recent decision of the Grand Court of the Cayman Islands has provided much-needed clarity on the rights of redeemed but unpaid investors in an insolvency scenario and the circumstances in which a liquidator of a Cayman Islands company may alter investors’ rights to receive distributions.  The decision confirms that investors who have been redeemed pursuant to the company’s articles of association are entitled to be paid those redemption proceeds ahead of unredeemed investors, and that distributions to unredeemed investors must be made in accordance with Cayman Islands law.  In a guest article, Peter Hayden, Rocco Cecere and Christopher Levers of Mourant Ozannes discuss the ruling, including the case’s background, matters considered by the Court and the impact of the decision on the hedge fund industry.  For additional insight from the firm, 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); and “Cayman Islands Developments Impacting Fund Governance, Master Fund Registration and the Insolvency Regime: An Interview with Neal Lomax, Simon Dickson and Simon Thomas of Mourant Ozannes,” The Hedge Fund Law Report, Vol. 5, No. 23 (Jun. 8, 2012).  For discussion of other recent Cayman Islands cases, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters,” The Hedge Fund Law Report, Vol. 8, No. 21 (May 28, 2015); and “Cayman Court of Appeal Overturns Decision Holding Weavering Fund Directors Personally Liable,” The Hedge Fund Law Report, Vol. 8, No. 8 (Feb. 26, 2015).

    Read Full Article …
  • 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.

    Read Full Article …
  • 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.

    Read Full Article …
  • 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.

    Read Full Article …
  • From Vol. 5 No.5 (Feb. 2, 2012)

    How Safe Is It to Ignore Foreign Tax Claims or Judgments Against Cayman Islands Hedge Funds in the Context of a Winding Up of the Fund?

    Cayman Islands hedge funds are subject to no Cayman Islands tax of any nature, but they may become liable to foreign tax claims – for example through trading swaps – or they may become subject to judgments for tax imposed against them in other jurisdictions.  How should such claims and judgments be regarded by liquidators in the context of winding up the fund, whether in a liquidation imposed by the court, or in a voluntary liquidation?  Must effect be given to such claims or judgments, or can such claims and judgments simply be ignored, and the winding up completed without regard to them?  Or should the winding up only be completed once the tax claim or judgment has been abandoned by the foreign tax authority, or only with Cayman court sanction that the claim or judgment be disregarded for the purposes of the winding up?  In a guest article, Christopher Russell, Partner and head of the litigation and insolvency department of Ogier, Cayman Islands, and Shaun Folpp, a Managing Associate in the litigation and insolvency department of Ogier, Cayman Islands, address these and related questions.

    Read Full Article …
  • 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.

    Read Full Article …
  • 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.

    Read Full Article …