The Hedge Fund Law Report

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

Articles By Topic

By Topic: Redemptions

  • From Vol. 10 No.15 (Apr. 13, 2017)

    Credit Suisse Investor Survey Finds Steady Demand for Hedge Funds and Growing Demand for Less-Liquid Products

    Credit Suisse Capital Services (CS) recently released the results of its 2017 hedge fund industry survey covering anticipated asset flows by strategy and region; hedge fund selection and redemption drivers; fees; industry risks; early stage investing; and non-traditional hedge fund products. Among the survey’s key findings is that steady growth in allocations to hedge funds is coinciding with rising interest in non-traditional products (e.g., illiquid credit/direct lending and alternative mutual funds). This corroborates other industry survey findings and should put traditional fund managers on notice as they pursue their fundraising efforts. This article summarizes CS’ key findings. For coverage of past CS investor surveys, see “Despite Significant Redemptions, Credit Suisse Survey Finds Investors Remain Committed to Hedge Funds” (Aug. 4, 2016); “Growing Demand by Hedge Fund Investors for Managed Accounts, Long-Only Funds and Alternative Mutual Funds” (Apr. 7, 2016); and “Investor Appetite for Alternative Investment Vehicles and Strategy Preferences” (Aug. 27, 2015).

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

    FCA Outlines Priorities of Liquidity and Fair Practices for Open-End Funds Investing in Illiquid Assets

    Open-end funds that invest in illiquid assets, such as buildings and infrastructure, are quite appealing, as well as seriously risky, to investors. They offer the potential for higher returns than certain other funds, but there are also problems and dangers inherent in their structure and strategy. These risks flow in part from a tension between the fund’s ostensible long-term investment objectives and the propensity for some investors to redeem, regardless of the liquidity available to the fund at a given moment or the effect of those redemptions on remaining investors. All of these points come across in a discussion paper recently published by the U.K. Financial Conduct Authority (FCA) assessing the risks when consumers turn to open-end investment funds to gain exposure to illiquid assets and outlining several liquidity management mechanisms that funds can use. This article analyzes, and presents insights from partners of law firms at the forefront of interactions between the global funds industry and regulatory agencies on, the issues outlined in the discussion paper and the potential for further regulation of open-end funds that invest in illiquid assets. For discussion of another recent FCA statement on liquidity issues, see “FCA Expects Hedge Fund Managers to Focus on Liquidity Risk” (Mar. 3, 2016). 

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  • From Vol. 10 No.2 (Jan. 12, 2017)

    Hedge Fund Platinum Partners and Principals Face Civil and Criminal Proceedings From SEC and DOJ Over Alleged Fraudulent Valuation Practices and Liquidity Misrepresentations

    The SEC has initiated an enforcement proceeding against Platinum Management (NY) LLC, Platinum Credit Management, L.P. and seven individuals, alleging that they improperly inflated the value of illiquid fund assets, made material misrepresentations to investors to hide the liquidity crisis faced by the firm’s flagship fund and orchestrated a scheme to defraud third-party bondholders of one of the fund’s portfolio companies. In a parallel investigation, the DOJ has brought an eight-count indictment against seven individual defendants for securities fraud, investment adviser fraud and conspiracy. The SEC complaint asserts 11 counts of securities and investment adviser fraud against the defendants. This article discusses the alleged fraudulent conduct, along with the specific SEC and DOJ charges. For additional coverage of the SEC’s recent attention to valuation of illiquid assets, see “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016); and “SEC Division Heads Enumerate Enforcement Priorities, Including Conflicts of Interest, Valuation, Performance Advertising and CCO Liability (Part Two of Two)” (May 5, 2016). For more on regulatory concerns over liquidity, see “FSOC Report Focuses on Liquidity, Leverage and Other Risks Facing Hedge Fund and Asset Managers” (Apr. 28, 2016).

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  • From Vol. 9 No.42 (Oct. 27, 2016)

    The Current State of Direct Lending by Hedge Funds: Fund Structures, Tax and Financing Options

    A decrease in bank lending to small- and middle-market companies has created opportunities for private fund managers that wish to engage in direct lending. A recent program presented by Dechert explored the current growth in direct lending, focusing on fund structures and strategies, tax implications and debt financing for direct lending funds. The program featured Dechert partners Matthew K. Kerfoot and Russel G. Perkins. This article summarizes the speakers’ key insights. See our three-part series on hedge fund direct lending: “Tax Considerations for Hedge Funds Pursuing Direct Lending Strategies” (Sep. 22, 2016); “Structures to Manage the U.S. Trade or Business Risk to Foreign Investors” (Sep. 29, 2016); and “Regulatory Considerations of Direct Lending and a Review of Fund Investment Terms” (Oct. 6, 2016). For additional insight from Kerfoot, see “Dechert Panel Discusses Recent Hedge Fund Fee and Liquidity Terms, the Growth of Direct Lending and Demands of Institutional Investors” (Jun. 14, 2016); and “Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations Between Hedge Fund Managers and Futures Commission Merchants Regarding Cleared Derivative Agreements” (Apr. 18, 2013). 

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  • From Vol. 9 No.39 (Oct. 6, 2016)

    Hedge Funds As Direct Lenders: Regulatory Considerations of Direct Lending and a Review of Fund Investment Terms (Part Three of Three)

    As lending to U.S. companies has increased in popularity as an investment strategy among hedge and private equity funds, some have voiced concerns about the lack of regulation of these alternative corporate lenders as compared to the capital requirements imposed on traditional lenders. This is in stark contrast to the European alternative lending market, where substantial and varied barriers imposed by some jurisdictions create challenges for alternative lenders originating loans on a cross-border basis. Whether U.S. regulators will adopt a European-style regulatory model of alternative lending to U.S. companies remains to be seen. This final article in a three-part series provides an overview of the current regulatory environment surrounding direct lending by alternative lenders and outlines common fee and liquidity terms of direct lending funds. The first article discussed the prevalence of hedge fund lending to U.S. companies and the primary tax considerations to hedge fund investors associated with this strategy. The second article examined how direct lending can constitute engaging in a “U.S. trade or business” and explored structures and strategies available to minimize this risk to investors in an offshore fund. See also “Permanent Capital Structures Offer Managers Funding Stability and Access to Capital While Granting Investors Liquidity and Access to Managers” (Apr. 9, 2015).

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  • From Vol. 9 No.39 (Oct. 6, 2016)

    Seward & Kissel Study Finds MFN Clauses and Reduced Fees Most Prevalent Terms in Side Letters 

    Seward & Kissel (S&K) recently completed a study of side letters entered into by its hedge fund manager clients. “The Seward & Kissel 2015/2016 Hedge Fund Side Letter Study” considers the prevalence and features of five common side letter provisions: most favored nation clauses, fee discounts, transparency, preferential liquidity and capacity rights. This article summarizes S&K’s findings. For HFLR coverage of S&K’s annual hedge fund studies, see: 2015 Study (Mar. 31, 2016); 2014 Study (Mar. 5, 2015); 2012 Study (Apr. 11, 2013); and 2011 Study (Feb. 23, 2012). For additional analysis of side letter practices, see “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)” (Jun. 13, 2013). Steve Nadel, lead author of the study and a partner in S&K’s investment management practice, will expand on the topics in this article – as well as other issues relating to side letters – in an upcoming webinar co-produced by The Hedge Fund Law Report and S&K. Details of the webinar are forthcoming. 

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  • 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).

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  • From Vol. 9 No.33 (Aug. 25, 2016)

    Barclays Survey Suggests Hedge Funds Fell Short of Investor Expectations Due to Industry Growth, Position Crowding and Macro Conditions

    Barclays Capital Solutions Group recently took the pulse of the hedge fund industry, compiling survey responses from 340 hedge fund investors and other relevant data. Its report includes three main components: an overview of hedge fund industry performance, with a focus on the possible causes of recent underperformance; an exploration of investor sentiment; and an outlook on the industry for 2016. This article outlines the insights from the report most applicable to hedge fund managers, including with respect to hedge fund performance and the reasons for industry underperformance; strategy preferences of investors; prevalence of fee discounts; and investor criteria for selecting managers. For coverage of other surveys from Barclays, see “Options for Hedge Fund Managers in Alternative Mutual Fund Space” (Apr. 11, 2014); “Family Office Perspectives on Hedge Fund Allocation Percentages, Strategies, Liquidity, Fees, Track Record and Investor Base” (Nov. 14, 2013); and “Increased Financing Costs for Hedge Funds Due to Regulatory Changes Affecting Prime Broker Financing” (Oct. 18, 2012).

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  • From Vol. 9 No.31 (Aug. 4, 2016)

    Despite Significant Redemptions, Credit Suisse Survey Finds Investors Remain Committed to Hedge Funds

    Credit Suisse Capital Services (CS) recently issued its “Mid-Year Survey of Hedge Fund Investor Sentiment” (Mid-Year Survey) – a follow-up to CS’s annual global hedge fund investor survey (2016 Annual Survey). See “Credit Suisse Survey Reveals Growing Demand by Hedge Fund Investors for Managed Accounts, Long-Only Funds and Alternative Mutual Funds” (Apr. 7, 2016). The Mid-Year Survey focuses on hedge fund investor redemptions and reallocations in the first half of 2016, future allocation plans and strategy preferences. Among the survey findings, CS found a slight decrease in redemptions from the 2016 Annual Survey, a wide distribution in the driving factors behind investor redemptions and a substantial disparity in the types of investment strategies preferred among investors based on their geographic location. CS also found that investors remain committed to hedge funds, with the majority intending to redeploy redemption proceeds. This article summarizes the key findings of the Mid-Year Survey. For coverage of previous CS investor surveys, see “Investor Appetite for Alternative Investment Vehicles and Strategy Preferences” (Aug. 27, 2015); “Factors in Institutional Investors’ Investment and Redemption Decisions, Appetite for Alternative UCITS and Anticipated 2015 Hedge Fund Investments by Strategy and Region” (Mar. 27, 2015); and “Allocation Preferences of Hedge Fund Investors, With Particular Attention on Preferences of Pension Funds and Insurance Companies” (Mar. 14, 2013).

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  • From Vol. 9 No.20 (May 19, 2016)

    Preparing for Contingent Liabilities: How an Alternative to Hedge Fund Contingency Reserves May Offer More Equitable Investor Treatment (Part Two of Two)

    The power to establish reserves for contingent liabilities and other potential fund obligations may be deployed whenever a fund manager foresees a possible future event that could adversely affect the fund. Depending on the outcome of that possible future event (as well as fund policies on adjusting net asset value), contributing, redeeming or “status quo” investors may bear a higher proportion of such contingency reserve. In this two-part guest series, S. Brian Farmer and Alina A. Grinblat, partner and associate, respectively, at Hirschler Fleischer, explore the drawbacks of hedge fund contingency reserves and suggest an alternative structure. In the first article, they explained how hedge fund contingency reserves operate in practice, illustrating how reserves can affect fund shareholders and the unequal treatment that can result. This second article analyzes hedge fund manager motivations in establishing reserves and proposes an alternative structure that may avoid consequent investor inequality. For additional insight from Farmer, see our series on “The Use of Benchmarks to Measure Hedge Fund Performance by Pension Funds and Institutional Investors”: Part One (Jul. 30, 2015); and Part Two (Aug. 6, 2015).

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  • From Vol. 9 No.19 (May 12, 2016)

    Preparing for Liability: How Hedge Fund Contingency Reserves Can Lead to Inequitable Investor Treatment (Part One of Two)

    Hedge fund governing documents generally give the manager broad discretion to establish reserves for contingent liabilities and other items that may ultimately become fund obligations. However, depending on the hedge fund manager’s practice, establishing and releasing contingency reserves may result in inequitable treatment of investors redeeming, subscribing or simply remaining in the fund. In this two-part guest series, S. Brian Farmer and Alina A. Grinblat, partner and associate, respectively, at Hirschler Fleischer, address hedge fund contingency reserves. In this first article, they explain how the reserves operate in practice, highlighting the effect on shareholders in the fund and the unequal treatment that can result. The second article will analyze hedge fund manager motivations for establishing reserves and propose an alternative structure that may avoid investor inequality resulting from those reserves. For additional insight from Farmer, see our two-part series “‘Best Ideas’ Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law”: Part One (Aug. 7, 2014); and Part Two (Aug. 21, 2014).

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    Credit Suisse Survey Reveals Growing Demand by Hedge Fund Investors for Managed Accounts, Long-Only Funds and Alternative Mutual Funds

    Credit Suisse Capital Services (CS) recently released the results of its 2016 hedge fund investor survey. CS asked hedge fund investors about industry risks, trends and the drivers of investments and redemptions; appetite for non-traditional hedge fund investment vehicles; anticipated allocations; and performance expectations. Among the survey findings, CS found growing demand for alternatives to direct hedge fund investments, such as managed accounts, long-only funds and alternative mutual funds offered by hedge fund managers. This article examines key takeaways from the survey. For more on alternative mutual funds, see our three-part series on conflicts arising out of simultaneous management of hedge funds and alternative mutual funds: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015). For coverage of past CS investor surveys, see “Investor Appetite for Alternative Investment Vehicles and Strategy Preferences” (Aug. 27, 2015); “Factors in Institutional Investors’ Investment and Redemption Decisions, Appetite for Alternative UCITS and Anticipated 2015 Hedge Fund Investments by Strategy and Region” (Mar. 27, 2015); and “Allocation Preferences of Hedge Fund Investors, With Particular Attention on Preferences of Pension Funds and Insurance Companies” (Mar. 14, 2013).

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  • From Vol. 8 No.36 (Sep. 17, 2015)

    Implementation of Hedge Fund Audit Holdbacks (Part Two of Two)

    Audit holdback provisions allow a fund to retain a portion of a withdrawing investor’s redemption proceeds for a period of time – typically until the fund’s annual audit is completed – to guard against adjustments to the fund’s net asset value (NAV) after the investor has redeemed.  However, when establishing an audit holdback, a hedge fund manager must carefully balance the overall liquidity of the underlying investments and the likelihood of subsequent adjustments to the NAV against the interests of investors and market practice.  This article, the second in a two-part series, discusses the prevalence of holdbacks in the hedge fund industry; investor response to these provisions; and considerations for hedge fund managers in crafting audit holdback terms.  The first article analyzed the mechanics of audit holdbacks; considered common variables found in such provisions; and evaluated potential alternatives to audit holdback structures.  For more on holdbacks, see “The Evolution of Offshore Investment Funds (Part One of Three): In Interview with The Hedge Fund Law Report, Ogier Partner Colin MacKay Discusses Drafting of Offshore Fund Documents; NAV Adjustments; Clawbacks; Managed Accounts; and Payment-in-Kind Provisions,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).

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  • From Vol. 8 No.35 (Sep. 10, 2015)

    Operational Considerations of Hedge Fund Audit Holdbacks (Part One of Two)

    When an investor seeks to redeem from a hedge fund, the fund manager must often expeditiously pay the investor’s redemption proceeds based on the then-current net asset value (NAV) of the fund.  See “Structuring, Valuation, Fee Calculation and Other Legal and Accounting Considerations in Connection with Hedge Fund General Redemption Provisions, Lock-Up Periods, Side Pockets, Gates, Redemption Suspensions and Special Purpose Vehicles,” The Hedge Fund Law Report, Vol. 3, No. 43 (Nov. 5, 2010).  However, despite a manager’s best efforts to value the fund appropriately, adjustments to the fund’s NAV after the fact may result in corresponding revisions to the redemption proceeds to which the redeeming investor actually was entitled.  To guard against such situations, hedge funds typically employ audit holdback provisions so that the fund can retain a portion of a redeeming investor’s redemption proceeds until the fund’s annual audit is finalized.  This article, the first in a two-part series, analyzes the mechanics of audit holdbacks; considers common variables in such provisions; and evaluates potential alternatives to audit holdback structures.  The second article will discuss the prevalence of holdbacks in the hedge fund industry; investor response to such provisions; and considerations for hedge fund managers in crafting audit holdback terms.  For more on holdbacks, see “Soft Lock-Ups Help Hedge Fund Managers Reconcile the Goals of Stable Capital and Investor Liquidity,” The Hedge Fund Law Report, Vol. 3, No. 45 (Nov. 19, 2010).

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  • 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).

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  • From Vol. 8 No.20 (May 21, 2015)

    Dechert Global Alternative Funds Symposium Highlights Trends in Hedge Fund Expense Allocations, Fees, Redemptions and Gates

    In the dynamic and ever-changing hedge fund industry, it is vital for hedge fund managers to understand current trends with respect to fund structures and terms in order to best market to and raise capital from investors and anticipate likely changes in the hedge fund marketplace.  Recent trends have managers rethinking the kinds of expenses that should be appropriately allocated to funds; the structures of gates and redemption provisions; and acceptable fee terms for their funds.  Navigating these trends was a key issue discussed during the Dechert Alternative Funds Symposium recently held in New York City.  This article summarizes the salient points raised on the foregoing topics.  See also “Evolving Hedge Fund Fee Structures, Seed Deal Terms, Single Investor Hedge Funds, Risk Aggregators, Expense Allocations, Co-Investments and Fund Liquidity (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 36 (Sep. 25, 2014).

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  • From Vol. 8 No.12 (Mar. 27, 2015)

    Credit Suisse Hedge Fund Survey Considers Factors in Institutional Investors’ Investment and Redemption Decisions, Appetite for Alternative UCITS and Anticipated 2015 Hedge Fund Investments by Strategy and Region

    Credit Suisse (CS) recently released the results of its 2015 Global Survey of Hedge Fund Investor Appetite and Activity.  With responses from nearly 400 institutional investors, the survey provides insight into the factors that drive such investors’ decisions to invest in hedge funds and redeem their interests in those funds; their appetite for alternative UCITS; their predictions and allocation plans with regard to the hedge fund industry, and their perspectives on the overall market.  This article summarizes the key takeaways from the CS survey report.  For coverage of a prior CS hedge fund survey, see “Credit Suisse Survey Reveals Allocation Preferences of Hedge Fund Investors, With Particular Attention on Preferences of Pension Funds and Insurance Companies,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).  For coverage of a recent survey that focuses on manager perspectives, see “Ernst & Young’s 2014 Global Hedge Fund and Investor Survey Considers Growth Areas for Hedge Fund Managers, Related Costs and Challenges, Operating Expenses and Cybersecurity,” The Hedge Fund Law Report, Vol. 8, No. 2 (Jan. 15, 2015).

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  • From Vol. 8 No.10 (Mar. 12, 2015)

    Citing Persistent Losses, Seed Investor BlueCrest Capital Sues Meredith Whitney and Her Hedge Fund for Return of Seed Capital

    In exchange for committing capital to help launch a fund, companies that provide seed or founders’ capital are often granted special redemption rights and economic incentives such as reduced management and performance fees or a share of the fund manager’s fee income.  See “Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss Terms with Institutional Investors, Seeding Arrangements and the Convergence of Mutual Funds and Hedge Funds (Part Four of Four),” The Hedge Fund Law Report, Vol. 8, No. 7 (Feb. 19, 2015).  Structuring such arrangements, however, can be challenging.  A recent dispute between seed investor BlueCrest Capital Opportunities Limited (BlueCrest) and Meredith Whitney’s hedge fund management company illustrates how the interplay of fund organizational documents, seeding agreements and side letters can cause confusion even among the most sophisticated players.  In 2013, BlueCrest seeded a new Whitney fund.  The fund performed poorly, and BlueCrest demanded redemption of its entire seed stake, citing a side letter that said that BlueCrest would not be subject to any lock-ups or other limitations on redemption.  Whitney pushed back, claiming that the separate investment agreement pursuant to which BlueCrest provided seed capital mandated a two-year lockup.  BlueCrest commenced an action in New York State Supreme Court to force Whitney to pay the demanded redemption proceeds and set aside the redemption proceeds pending the litigation.  This article summarizes the background of the dispute, the provisions of the relevant agreements, BlueCrest’s complaint, court hearings with respect to BlueCrest’s requests for a temporary restraining order and preliminary injunction, and the rationale for the court’s decision on the preliminary injunction motion.

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  • From Vol. 8 No.3 (Jan. 22, 2015)

    How Do Regulatory Investigations Affect the Hedge Fund Audit Process, Investor Redemptions, Reporting of Loss Contingencies and Management Representation Letters?

    A fund’s financial auditors are charged with taking reasonable steps to assure that the fund’s financial statements are free from material misstatements.  A regulatory investigation or allegation of misconduct against a fund or its manager can delay completion of an audit, lead to a qualified audit opinion or even derail the audit and lead to resignation of the auditor.  In that regard, a recent PracticeEdge session offered by the Regulatory Compliance Association (RCA) considered the steps a fund manager should take when faced with a regulatory investigation or allegation of misconduct, how to develop an effective response plan, and the impact that the matter will have on the annual audit process and the firm’s financial statements.  See also “Is This an Inspection or an Investigation? The Blurring Line Between Examinations of and Enforcement Actions Against Private Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012).  In April of this year, 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.

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  • From Vol. 7 No.36 (Sep. 25, 2014)

    Sidley Partners Discuss Evolving Hedge Fund Fee Structures, Seed Deal Terms, Single Investor Hedge Funds, Risk Aggregators, Expense Allocations, Co-Investments and Fund Liquidity (Part One of Two)

    Sidley Austin recently hosted its annual private funds event in New York City.  This article is the first in a two-part series covering that event.  This article highlights the most useful points made during a discussion entitled “Hedge Fund Terms and Trends,” featuring Sidley partners Benson R. Cohen, Janelle Ibeling, William D. Kerr and Christopher P. Lokken.  The partners addressed registered funds; challenges presented by single investor or single relationship hedge funds; use of and resistance by managers to risk aggregators; seed deal terms and trends; structures for aligning fund liquidity with investment duration; expense allocations; developments in fund structuring; and the impact of the Volcker Rule on hedge fund investments by bank aggregator platforms.  The discussion also provided a uniquely candid and relevant discussion of evolving fee structures and models for hedge funds and other entities used to offer alternative investment strategies.  Sidley sees and structures hedge funds and related vehicles across a wide range of strategies, sizes and geographies.  Accordingly, insight from Sidley partners on fees is generally relevant to hedge fund managers launching new products or justifying or amending fee structures on existing products.  The Hedge Fund Law Report previously covered Sidley’s 2013 private funds conference in three parts.  See Part One, Part Two and Part Three.

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  • From Vol. 7 No.18 (May 8, 2014)

    Can a Hedge Fund Retroactively Amend Its Partnership Agreement to “Rescind” an Investor’s Redemption Request?

    As the subprime mortgage market began to collapse, a hedge fund amended its limited partnership agreement (LPA) to “rescind” a pending redemption request and to impose a prospective lockup of investor funds.  An investor whose redemption request was rescinded by that amendment sued the fund, its general partner and the general partner’s managing member, alleging breach of contract, breach of fiduciary duty and other claims.  A federal court recently ruled on whether the fund breached the LPA because the general partner had no authority to approve an amendment that was “in contravention of” the LPA without the consent of all of the fund’s investors.  This article provides a detailed discussion of the factual and procedural background of this case, and the court’s legal analysis.

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    Stanley Druckenmiller’s Counsel Provides a Tutorial for Negotiating Exculpation, Indemnification, Redemption, Withdrawal and Amendment Provisions in Hedge Fund Governing Documents

    Gerald Kerner, general counsel of Duquesne Family Office LLC, and former general counsel of famed investor Stanley Druckenmiller’s Duquesne Capital Management, L.L.C., recently drafted a white paper, the general thesis of which is that hedge fund investors pay insufficient attention to certain “boilerplate” terms in fund documents – terms that, in practice, can have important consequences for the economics of an investment.  In the first instance, the white paper recommends that hedge fund investors negotiate such boilerplate provisions – and walk if the manager refuses to engage in productive dialogue.  The white paper then offers specific recommendations for hedge fund investors when negotiating exculpation, indemnification, redemption, withdrawal, amendment and other provisions.  The white paper incorporates the wisdom accumulated by Kerner over years negotiating the deployment of capital by one of the hedge fund industry’s leading lights.  Its insights can tangibly impact the way investors approach negotiating with managers, and vice versa; the white paper, therefore, is illuminating reading for both constituencies.  This article summarizes the recommendations in the white paper.

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  • From Vol. 6 No.34 (Aug. 29, 2013)

    How and When Should Hedge Fund Managers Value Securities Used to Satisfy Redemption Requests In Kind?

    Hedge fund governing documents frequently permit hedge fund managers to satisfy redemption requests in cash or in kind.  To pay redemptions in cash, managers typically use cash in the fund or – in the absence of sufficient cash on hand – sell securities to generate cash.  To pay redemptions in kind, managers typically deliver to investors portfolio securities or interests in a special purpose vehicle established to hold and gradually liquidate portfolio assets.  Managers typically use the in-kind distribution mechanism in declining or liquidity-constrained markets because sales of assets into such markets would occur at a discount, thus generating less cash than sales of the same assets over longer time horizons.  While redeeming investors are rarely enthusiastic about receiving assets rather than cash, an important argument in favor of in-kind redemptions is that they can preserve value for non-redeeming investors and thereby enable a manager to satisfy its fiduciary obligation to the fund.  Not surprisingly, redemptions in kind were a recurring theme during the credit crisis.  See “Steel Partners’ Restructuring and Redemption Plan: Precedent or Anomaly?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  Some of the harder questions raised by redemptions in kind relate to valuation.  For example, if a manager agrees as of December 31 of a given year (the “as of date”) to distribute a certain number and type of securities to a redeeming investor, but only distributes those securities months or years later (e.g., because of a suspension of redemptions), who bears the risk of a decline in value of the securities between the as of date and the actual distribution date – the fund or the investor?  In other words, would the manager in this scenario be required to distribute more securities to the investor so that the investor receives in securities the dollar value of its fund interest on the as of date?  Or would the investor be required to internalize the decline in value of a fixed number of securities?  The answers to these questions depend on the governing documents of the fund, other relevant documents (e.g., side letters) and external law.  A recent decision from New York’s intermediate appellate court illuminates these questions and offers guidance to hedge fund managers in drafting in-kind distribution rights in fund documents and side letters.  See also “Schulte Partner Stephanie Breslow Discusses Hedge Fund Liquidity Management Tools in Practising Law Institute Seminar,” The Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012).

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  • From Vol. 6 No.10 (Mar. 7, 2013)

    SEC Charges Hedge Fund Manager and its Principals with Defrauding Investors in Connection With an Undisclosed Restructuring of Feeder Funds to Favor Largest Investor

    A recently filed SEC enforcement action – along with a criminal indictment based on the same facts – demonstrates the continued focus of regulators and prosecutors on undisclosed preferential treatment of certain hedge fund investors.  See, e.g., “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).

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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.30 (Aug. 2, 2012)

    Hedge Fund Side Letters: The View from the Fund Director’s Perspective

    Most hedge funds are asked at one time or another by certain investors to provide side letters agreeing to preferential dealing, investment or other strategic terms.  There are clear cases where a side letter would not be acceptable, e.g., it contains plainly egregious terms; has no legitimate purpose; or is clearly contrary to what the hedge fund or hedge fund manager is doing in practice.  In most circumstances, however, there is no black and white answer as to what constitutes an acceptable side letter term or where the line should be drawn.  In crafting a side letter term that is in the best interest of the hedge fund (and in particular, other investors in the fund), there is a difficult balancing act that managers must perform.  On the one hand, the side letter can be used to facilitate a large investment that attracts other strategic investors, which could benefit the fund and the execution of its investment strategy.  On the other hand, side letters generally raise various fiduciary and other concerns that must be addressed.  In a guest article, Victor Murray, an independent accredited director at MG Management Ltd., discusses: side letter disclosure; ERISA considerations relating to side letters; unsavory terms; shareholder actions relating to side letters; lack of statutory provisions; derivative actions; fraud on the minority; and best practices in relation to directors’ review of side letters.

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  • From Vol. 5 No.26 (Jun. 28, 2012)

    SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation

    On June 26, 2012, the SEC filed three separate complaints relating to securities law violations allegedly committed by Philip A. Falcone, his investment advisory firm, Harbinger Capital Partners LLC (Harbinger) and other entities and individuals.  In the first complaint, the SEC charged Falcone, Harbinger and Peter Jenson, a former Managing Director and Chief Operating Officer of Harbinger, with violations of the federal securities laws in relation to the misappropriation of client assets (through the making of a $113.2 million loan from a fund managed by Harbinger to Falcone to pay his personal taxes) and the granting of undisclosed preferential redemption rights to certain investors.  See “Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  In the second complaint, the SEC charged Falcone, Harbinger Capital Partners Offshore Manager, L.L.C. and Harbinger Capital Partners Special Situations GP, L.L.C. with engaging in an illegal short squeeze to manipulate bond prices.  In the third complaint, the SEC charged Harbert Management Corporation, HMC-New York, Inc. and HMC Investors, LLC with control person liability in relation to the alleged market manipulation described in the second complaint.  Separately, the SEC issued an order settling claims with Harbinger related to violations of Rule 105 under Regulation M.  This article details the charges levied by the SEC in the three complaints and details the terms of the settlement with Harbinger related to the Rule 105 violations.

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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.16 (Apr. 19, 2012)

    Does a Side Letter Granting Preferential Redemption Rights Survive a Hedge Fund Restructuring?

    In the aftermath of the 2008 financial crisis, some hedge fund managers felt compelled to restructure their funds to manage liquidity and to balance the interests of redeeming and continuing investors.  Many such restructurings required investors to either consent to the restructuring or make an election relating to the restructuring.  Nonetheless, many such reorganizations were quickly conceived and may not have considered the survivability of side letters pertaining to the original fund investment.  In dueling complaints recently filed in courts in the Cayman Islands and New York State, a hedge fund and a fund of funds, and their respective managers, initiated litigation focused on the following question: Does a side letter that granted a hedge fund investor, among other things, preferential redemption rights, survive a hedge fund restructuring, or does such a side letter terminate upon the making of a restructuring election by the hedge fund investor?  This article summarizes the complaints, the context and the implications of the litigation for hedge fund managers and investors.  On preferential redemption rights generally, see “Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).

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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. 5 No.3 (Jan. 19, 2012)

    What Legal Ammunition Is Available to Investors to Challenge Aggressive Liquidity Management by Hedge Fund Managers?

    In August 2008 – at the height of the credit crisis – funds managed by Eden Rock Capital Management sought to redeem from funds managed by Stillwater Capital.  Stillwater refused to honor such redemption requests and allegedly engaged in a series of transactions intended to hinder such redemptions.  In March 2011, the Eden Rock funds sued Stillwater, the Stillwater funds and Stillwater’s successor, alleging fraudulent conveyance, fraud, breach of contract and related claims.  See “Investment Manager Eden Rock Financial Sues Hedge Fund Stillwater Capital and Gerova Financial Group in New York State Supreme Court,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  The New York State Supreme Court recently ruled on Eden Rock’s claims.  This article summarizes the factual background – focusing on the redemption dispute – and the Court’s decision.  The experience of the crisis – in particular, the combustible combination of investors seeking liquidity and managers unwilling to part with it – has already influenced hedge fund structuring, due diligence, side letters and many other aspects of the hedge fund business.  But even in non-crisis times, micro factors will result in occasional, fund-specific illiquidity that is hard to predict at the time of an investment.  Accordingly, it is important for hedge fund managers and investors to understand the viability of various legal claims available to contest liquidity management mechanisms.  While the liquidity management mechanisms at issue in this matter are complicated and unlikely to be reproduced verbatim, the matter nonetheless illuminates how a court will evaluate claims in the nature of fraudulent conveyance, fraud and breach of contract as applied to typical hedge fund structures and redemption-related disputes.

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  • From Vol. 4 No.42 (Nov. 23, 2011)

    Recent Enforcement Action Highlights SEC’s Concern with Preferential Redemption Rights Granted to Favored Hedge Fund Investors

    Hedge fund investors are demanding greater liquidity where liquidity is practicable.  See “What Do Hedge Fund Investors Want in Terms of Liquidity and Transparency?,” The Hedge Fund Law Report, Vol. 4, No. 39 (Nov. 3, 2011).  Some managers are addressing such demands by launching more liquid funds.  See our recent interview with Dechert Partner George Mazin (question on bifurcation in post-crisis hedge fund launches along liquidity lines).  Other managers are addressing such demands by launching moderately liquid hedge funds but granting certain investors preferential redemption rights, often via side letters.  See “Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  The former approach passes regulatory muster.  To an increasing degree, the latter approach does not.  Regulators are concerned that any asymmetry in the redemption rights granted to hedge fund investors that otherwise are getting the same material terms may conflict with the manager’s uniform fiduciary duty to all fund investors.  See “Delaware Chancery Court Opinion Clarifies the Scope of a Hedge Fund Manager’s Fiduciary Duty to a Seed Investor,” The Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011).  Top SEC officials have expressed this concern with increasing volume of late, most recently at this week’s Practising Law Institute program on hedge funds.  A recent enforcement action illustrates a factual scenario in which the SEC’s legal concern may give rise to causes of action against a hedge fund manager.  Practically, this action will help hedge fund managers define the scope of accommodation that permissibly may be granted to a significant investor that demands greater liquidity than other investors.  See “How Can Liquid Hedge Funds Be Structured to Accommodate Investments in Illiquid Assets?,” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).  Theoretically, this action is part of a growing body of regulatory statements and authority suggesting that uniform liquidity for similarly situated hedge fund investors is in the nature of an inalienable investor right.  This article details the factual and legal allegations in the order and discusses the implications of the order for hedge fund liquidity, brokerage activity by hedge fund managers and principal transactions.

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  • From Vol. 4 No.29 (Aug. 25, 2011)

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

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

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  • From Vol. 4 No.25 (Jul. 27, 2011)

    Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices

    The United States District Court for the Southern District of New York recently issued judgments in favor of three bankrupt hedge funds in fraudulent conveyance actions against investors that redeemed within two years of the funds’ bankruptcy filings.  The hedge funds were members of the Bayou group of hedge funds, which – as the hedge fund industry knows well – was a fraud that collapsed in August 2005, resulting in bankruptcy filings by the Bayou funds and related entities in May 2006.  These judgments are very important for hedge fund investors because they illustrate what appears to be a direct conflict between bankruptcy law and hedge fund due diligence best practices.  In short, hedge fund due diligence best practices currently counsel in favor of redemption at the first whiff of fraud on the part of a manager.  However, bankruptcy law appears to require a hedge fund investor to undertake a “diligent investigation” when it obtains facts that put it on inquiry notice of insolvency of the fund or a fraudulent purpose on the part of the manager.  The immediacy of a prompt redemption is directly at odds with the delay inherent in a diligent investigation.  How can hedge fund investors reconcile the practical goal of prompt self-help with the legal obligation of a diligent investigation?  To help answer that question, this feature length article surveys the factual and procedural history of the Bayou matters, then analyzes the arguments and outcome in the recent Bayou trial.  The primary question at the trial was whether certain investors that redeemed from the Bayou funds could keep their redemption proceeds based on “good faith” defenses to the Bayou estate’s fraudulent conveyance actions.  In the absence of a court opinion, The Hedge Fund Law Report analyzed the 142-page transcript of the closing arguments, as well as the motion papers filed by the parties and four prior bankruptcy court and district court opinions.  This article embodies the results of our analysis.  The article concludes by identifying five ways in which hedge fund investors may reconcile hedge fund due diligence best practices with the seemingly draconian outcome in these recent Bayou judgments.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    Fifth Circuit Rules that Hedge Fund Limited Partnership Agreement Was Unambiguous and that Portfolio Manager’s Departure Did Not Trigger Investors’ Withdrawal Rights

    Plaintiffs were investors in hedge fund Tuckerbrook/SB Global Special Situations Fund, L.P. (Fund).  Sumanta Banerjee (Banerjee) was a 50% owner and managing member of the Fund’s general partner and served as the Fund’s portfolio manager.  The Fund’s limited partnership agreement permitted withdrawal in the event Banerjee ceased to be “directly or indirectly involved in the activities of” the Fund’s general partner.  The Fund terminated Banerjee’s employment as portfolio manager in March, 2008, and plaintiffs promptly requested redemption of their Fund interests.  The Fund refused and the investors sued.  The U.S. District Court granted summary judgment dismissing the investors’ complaint, ruling that Banerjee was in fact still “involved” with the general partner even though he was no longer portfolio manager.  The U.S. Court of Appeals for the Fifth Circuit recently affirmed the District Court’s decision.  We summarize the factual background of Court of Appeals’ decision, including relevant language from the limited partnership agreement, and the Court’s legal analysis.  For a discussion of the District Court’s opinion, on which the Fifth Circuit relied heavily, see “Texas District Court Rules that Hedge Fund Limited Partners’ Withdrawal Rights Were Not Triggered by Termination of Fund Principal's Employment with the Fund, where Principal Continued to Exert Influence Over the Fund as 50 Percent Owner of the Fund's General Partner,” The Hedge Fund Law Report, Vol. 3, No. 13 (Apr. 2, 2010).

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  • From Vol. 4 No.17 (May 20, 2011)

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

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

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  • From Vol. 4 No.16 (May 13, 2011)

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

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

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  • From Vol. 4 No.15 (May 6, 2011)

    What Are the Legal and Practical Effects of a Discrepancy between the Provisions of a Cayman Hedge Fund’s Articles of Association and Offering Documentation?

    Before the recent global economic crisis impacted the hedge fund world, it was not uncommon for even sophisticated investors to subscribe for shares in corporate offshore vehicles without having first scrutinized in detail the offering memorandum, the Articles of Association and the other governing documentation of the fund.  The change in the economic climate has given rise to a heightened awareness of the need to review carefully, and in some cases to seek to negotiate, the terms of subscription.  It has also caused those who have suffered investment losses to scrutinize subscription terms carefully in order to consider whether, based on the terms upon which they invested and the terms of the Articles of Association of the fund, they have grounds for bringing proceedings to recover damages from the fund or its directors, or other service providers.  A number of the disputes that have arisen in the last few years between Cayman funds and their investors have been caused by apparent material differences in key provisions in fund documents, in particular the offering memoranda and the Articles of Association – for example, the fund’s rights to suspend redemptions, delay payment of redemption proceeds, side-pocket illiquid positions and to set aside reserves for contingent liabilities post declaration of net asset value.  The question arises: What is the effect of a provision in the offering documentation which appears to be inconsistent with the wording of the Articles?  Does the provision in the offering documentation constitute an enforceable right of the fund (for example, to suspend payment of redemption proceeds if such a provision is not provided for in the Articles) or a shareholder (for example, to require adherence by the fund to an investment policy specified in the offering document but not contained within the Articles)?  Or does such an inconsistency constitute a misrepresentation of the terms of the Articles, which may give rise to a cause of action against the fund or its directors at the suit of an investor who relied on the misrepresentation in deciding to invest or remain invested in the fund?  In a guest article, Christopher Russell and Rachael Reynolds, Partner and Managing Associate, respectively, at Ogier in the Cayman Islands, address the foregoing questions and others, and discuss relevant guidance provided by the UK Privy Council in an important recent decision.

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  • From Vol. 4 No.14 (Apr. 29, 2011)

    Investment Manager Eden Rock Financial Sues Hedge Fund Stillwater Capital and Gerova Financial Group in New York State Supreme Court for Fraudulent Conveyance, Fraud and Breach of Contract in Connection with Plan to Achieve Liquidity in Stillwater Funds

    Plaintiffs Eden Rock Finance Fund, L.P., Eden Rock Finance Master Limited and Eden Rock Unleveraged Finance Master Limited (together, Eden Rock) had invested about $29 million with defendant hedge funds Stillwater Asset Backed Offshore Fund Ltd. (Stillwater Offshore) and Stillwater Asset Backed Fund II, LP (Stillwater Onshore), both of which were feeder funds for Stillwater Asset Backed Fund LP (Master Fund).  Commencing in August 2008, Eden Rock sought to redeem all of its interests in the Stillwater funds.  Although Stillwater repeatedly promised Eden Rock redemption in cash, no redemption payments were ever made.  In December 2009, Stillwater Offshore proposed to redeem Eden Rock’s interests in that fund by a payment in kind.  It purported to issue to Eden Rock participation certificates in the underlying assets held by the Master Fund.  It also promised that Eden Rock would receive a 10% return of principal from those assets, in liquid funds, each quarter.  No principal was ever returned.  In January 2010, all the assets of the Master Fund were acquired by defendant Gerova Financial Group Ltd. (Gerova), a publicly traded company, in exchange for an indeterminate number of Gerova’s shares.  Those shares were supposed to be registered for public trading in the U.S. but, in fact, they were never registered.  In addition, an audit of the acquired portfolio revealed accounting irregularities and Gerova’s auditors refused to issue an opinion as to the value of the acquired assets.  After management upheavals at Gerova, the New York Stock Exchange suspended trading in its shares in February 2011.  Eden Rock has now sued Gerova, Stillwater Onshore, Stillwater Offshore and various affiliates.  We summarize Eden Rock’s allegations.

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  • From Vol. 4 No.10 (Mar. 18, 2011)

    IOSCO Report Discusses Appropriate Use and Disclosure of Hedge Fund Redemption Suspensions, Gates and Side Pockets

    On March 8, 2011, the International Organization of Securities Commissions (IOSCO) Technical Committee issued a draft Consultation Report entitled “Principles on Suspensions of Redemptions in Collective Investment Schemes.”  The report focuses on all open-ended collective investment schemes (CIS), including hedge funds, which offer a continuous redemption right, without regard to the type of investor to which the CIS is offered (i.e., institutional or retail).  The report proposes general principles to inform regulatory regimes in their oversight of CIS, and to guide fund managers in deciding if, when and how to suspend investor redemptions.  The report addresses basic management of liquidity risk, permissible reasons for suspension and the actions a CIS should take following a decision to suspend.  It emphasizes three basic principles, and offers guidance relating to alternative liquidity tools available in certain jurisdictions.  This article discusses the most important points of the consultation report, focusing in particular on the points most relevant to hedge fund managers.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    British Virgin Islands High Court of Justice Rules that Minority Shareholder in Feeder Hedge Fund that had Permanently Suspended Redemptions Was Not Entitled to Appointment of a Liquidator

    In a break with Cayman Islands jurisprudence on the availability of court-supervised fund liquidations, the British Virgin Islands High Court of Justice has refused to appoint liquidators for a hedge fund that has permanently suspended redemptions and is in the process of liquidating in a soft wind-down, ruling that the fund had not lost its “substratum” for purposes of the Business Companies Act of 2004.  Plaintiff Aris Multi-Strategy Lending Fund, Ltd. (Aris), a fund of funds, had invested about $11 million with defendant Quantek Opportunity Fund, Ltd. (Fund).  The Fund was a feeder fund that invested all of its assets in non-party Quantek Master Fund SPC (Master Fund).  Following the liquidity crisis of 2008, the Fund and the Master Fund suspended all redemptions and the calculation of net asset value.  The Fund adopted a reorganization plan pursuant to which it planned to distribute the proceeds from the liquidation of the Master Fund’s portfolio in three installments over a period of three years.  Apparently dissatisfied with the pace of liquidation, Aris commenced an action seeking court-supervised liquidation of the Fund.  The only substantial issue before the Court was whether Aris was entitled to the appointment of liquidators for the Fund on the grounds that the Fund had “lost its substratum.”  Aris has been aggressive in taking fund managers to task through litigation.  For summaries of litigation by Aris against domestic funds, see “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).  Aris’ founder has previously discussed with The Hedge Fund Law Report the issues raised in contemplating litigation against fund managers.  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).

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  • From Vol. 4 No.7 (Feb. 25, 2011)

    Cayman Hedge Funds, Soft Wind-Downs and Disclosure

    The expression “soft wind-down” is used in the corporate hedge fund context to describe the operating state where a fund is still under the control of its directors and where the investment manager is conducting an orderly realisation of the portfolio with a view to redeeming out all remaining investors.  The fund is not formally in liquidation – a specific statutory process in Cayman where the directors’ powers cease and liquidators assume control with a view to shutting the company down.  Over the past several years, a number of hedge funds have been faced with large numbers of redemption requests with the consequence that the economic viability of those funds has come into question.  Faced with little alternative, those funds have imposed suspensions and instituted soft wind-downs.  For some funds, the duration and conduct of the soft wind-down procedures has proved unsatisfactory to investors with the result that a number have ended up in court.  In recent decisions, the Cayman court has indicated that it will grant an order to place a corporate hedge fund into formal liquidation on the statutory grounds of it being “just and equitable” if the fund has lost its sub-stratum.  Put another way, an open ended hedge fund which has represented to investors that they will get periodic liquidity should not be implementing an indefinite suspension of redemptions coupled with a long term soft wind-down in the absence of proper disclosure.  In a guest article, Tim Frawley, a Partner at Maples and Calder, offers a detailed discussion of: the definition of “disclosure” in the hedge fund context; the rationale for disclosure; the evolution of the purpose of hedge fund offering documents; Cayman Islands statutory and common law with respect to misrepresentation and disclosure; considerations in connection with disclosing the possibility of a soft wind-down; and recent Cayman and BVI caselaw bearing on disclosure considerations.

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  • From Vol. 4 No.6 (Feb. 18, 2011)

    What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?

    Gates are provisions in hedge fund governing documents that permit the fund manager to limit the volume of assets redeemed on a given redemption date.  The general purpose of gates is to slow the pace of redemptions in down markets and to enable managers to avoid selling assets at temporarily depressed prices.  The goal of such devices is to protect long-term fund investors who, in the absence of gates, might be left with a less liquid and less valuable portfolio.  Historically, for purposes of determining whether a gate was triggered, the volume of assets sought to be redeemed on a given redemption date was measured at the fund level (fund-level gate).  More recently, some hedge fund documents have provided for measurement at the capital account level, on an investor-by-investor basis (investor-level gate).  Even more recently – and, admittedly, in just a few cases of which we are aware – managers have launched hedge funds with a novel provision that combines elements of fund-level and investor-level gates.  The market has taken to calling such provisions “hybrid gates.”  This article explains the mechanics and goals of hybrid gates.  In particular, this article discusses: how redemptions are reduced above the gate threshold in the context of fund-level gates; how the pro rata reduction amount is calculated; current practice with respect to priority of carried-forward excess redemptions; whether carried-forward excess redemptions remain subject to fund profit and loss; discounts or penalties for redemptions above a gate threshold; operation of investor-level gates; and examples of hedge funds that have implemented investor-level gates.  With that background, the article explains (using a numerical example) how hybrid gates work and why managers may consider using them.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    How Can Liquid Hedge Funds Be Structured to Accommodate Investments in Illiquid Assets?

    During the past decade, an increasing volume of hedge fund dollars has poured into traditional liquid strategies.  As a result, market inefficiencies have narrowed or vanished, and opportunities for arbitrage – and the alpha it can generate – have grown fewer and farther between.  In response, some hedge fund managers that traditionally focused on liquid strategies started investing at least part of their funds’ capital in private equity and other illiquid securities and assets.  However, using liquid fund vehicles to invest in illiquid assets has presented a variety of problems, including those relating to: taxation, liquidity, valuation, manager compensation, strategy drift, due diligence, expectations regarding returns and regulatory scrutiny.  While there has been considerable discussion regarding the convergence of hedge funds and private equity funds, the experience and aftermath of the credit crisis indicate that the convergence discussion should be more refined.  Convergence at the fund level is problematic because illiquids do not fit naturally into a liquid fund.  Convergence at the manager level – for example, the same manager managing both private equity funds and hedge funds – is marginally more palatable, but by and large, institutional investors have demonstrated a preference for managers who stick to their knitting.  In a guest article, Philippe Simoens, Senior Manager in Tax and Strategic Business Services for Weaver, an independent certified public accounting firm, addresses some of the reasons why illiquid assets present problems when housed in liquid funds – even liquid funds purportedly structured to accommodate illiquid investments via mechanisms such as side pockets.  In the course of doing so, this article explains traditional liquid fund structuring and taxation; characteristics and taxation of marketable securities versus private equity; and structures employed by liquid funds to accommodate illiquid assets (including side pockets, lock-ups, gates and redemption suspensions).  The article concludes with thoughts on structuring for managers who traditionally have focused on liquid strategies, but who are exploring illiquid opportunities.

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  • From Vol. 4 No.3 (Jan. 21, 2011)

    Strategic Turnaround Judgment Provides Welcome Guidance for the Hedge Fund Industry on the Suspension of Redemptions

    Among the most debated issues in the funds industry over the last two years are the questions to what extent, and when, can a fund suspend redemptions, and what is the effect on a redeeming investor of a suspension imposed by the fund after the investor’s redemption notice has expired?  The recent judgment of the Judicial Committee of the Privy Council in Culross Global SPC Limited v Strategic Turnaround Master Partnership Limited provides helpful and authoritative guidance about how provisions in a fund’s contractual documentation addressing redemptions and suspensions of redemptions should be interpreted, and how to determine which of the various documents constituting the investment agreement between a fund and its investor should take priority if the documents contain inconsistent provisions.  In a guest article, Jeremy Walton, a Partner and the Litigation and Insolvency Practice Group Head at Appleby in the Cayman Islands: outlines the facts of the Strategic Turnaround matter; discusses the lower court decisions and the Privy Council’s legal analysis; identifies five practice points for hedge fund industry participants arising out of the Privy Council’s judgment; highlights issues that remain unresolved even after the Privy Council’s judgment; and explores whether the decision may be a Pyrrhic victory for hedge fund investors.

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  • From Vol. 4 No.1 (Jan. 7, 2011)

    High Court Governing Cayman Islands Hedge Fund Rules That Funds Cannot Retroactively Suspend Payment of Redemption Proceeds After Their Due Date Absent Express Authority in Fund Governing Documents

    In December 2008, the Cayman Islands Court of Appeal, faced with a case arising out of a redemption request by a hedge fund investor, held that, depending on the terms of a Cayman fund’s governing articles, it may suspend redemptions of investors who have submitted their redemption notices, even after the redemption date has passed.  See “Cayman Court Suggests that Hedge Fund Investor does not Have Standing to Liquidate Fund,” The Hedge Fund Law Report, Vol. 2, No. 3 (Jan. 20, 2009).  On December 13, 2010, that decision, which created uncertainty as to the rights of investors following redemption requests, was overruled by the Judicial Committee of the Privy Council in London.  The case presented the question of whether an investor in a hedge fund, Strategic Turnaround Master Partnership Limited (STMP), who had requested redemption and had not received payment by the agreed-upon redemption date for payment, had standing to petition for a winding up of the fund for its failure to pay its debts to creditors, or whether it merely remained a prospective creditor and shareholder who remained bound by the fund’s governing documents.  In deciding in favor of the investor, the Privy Council established that, absent clearly expressed provisions in a fund’s governing articles to the contrary, a redemption occurs on the intended redemption date – not on the date of payment of redemption proceeds – and, as a result, the investor becomes an actual creditor at that time.  We detail the background of this important action, the Privy Council’s legal analysis and the implications of this judgment for hedge fund managers and investors.

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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.22 (Jun. 3, 2010)

    Interview with Gemini Strategies’ President Steven Winters on the Split of the Gemini Master Fund into Continuing and Redeeming Funds

    In the mist of the liquidity crisis of 2008, Steven Winters, President of Gemini Strategies and Portfolio Manager of the Gemini Master Fund Ltd (an investor in small-cap and micro-cap U.S. companies), took a novel approach to a substantial wave of redemption requests.  Rather than using any of the typical liquidity management tools such as gates, redemption suspensions or payments in kind, Winters and his advisers split the fund into a continuing fund and a redeeming fund.  The move enabled the fund to return cash to redeeming investors, generate considerable returns and retain relationships.  It was a creative structure and a good outcome, and can offer a model for any hedge fund faced with heavy redemptions (which can happen even when the macro environment is positive).  The Hedge Fund Law Report recently discussed with Winters the background, rationale, mechanics and outcome of the split.  The full transcript of that interview is included in this issue of The Hedge Fund Law Report.

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  • 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.

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  • From Vol. 3 No.14 (Apr. 9, 2010)

    Cayman Islands Court of Appeal Refuses to Allow an Investor in Hedge Fund Camulos Partners to Commence a Winding-Up Proceeding to Pursue its Unpaid Redemption Demand Because the Investor has Alternative Available Remedies

    The Cayman Islands Court of Appeal recently rejected a bid by a hedge fund investor to pressure the fund into paying out a redemption demand by forcing the fund into liquidation.  It rejected the investor’s liquidation petition as an abuse of process.  Kathrein & Co. (Investor) was an investor in hedge fund Camulos Partners Offshore Limited (Fund), which was organized under the laws of the Cayman Islands.  In July 2008, the Investor sought to redeem its entire interest in the Fund.  The redemption request had an effective date of September 30, 2008.  In early September, the Fund announced a plan of reorganization and subsequently suspended all redemptions in the Fund.  The Investor then commenced an action against the Fund seeking a declaration of its rights to receive the full value of its redemption proceeds.  The Fund opposed that action.  When the Investor learned that the Fund was going to begin distributing cash to all other investors in the Fund (but not to the Investor), the Investor filed a winding-up petition to force liquidation of the Fund.  On appeal, the Court of Appeal determined that the Investor was not entitled to petition for liquidation of the Fund.  It ruled that, because the Investor had other viable alternatives to seek payment of its claim for its redemption proceeds, the petition for liquidation was an impermissible abuse of process.  Consequently, the Court dismissed the liquidation petition.  We summarize the procedural jousting and the reasoning behind the Court’s decision.

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  • From Vol. 3 No.13 (Apr. 2, 2010)

    Texas District Court Rules that Hedge Fund Limited Partners’ Withdrawal Rights Were Not Triggered by Termination of Fund Principal’s Employment with the Fund, where Principal Continued to Exert Influence Over the Fund as 50 Percent Owner of the Fund’s General Partner

    Plaintiffs were investors in hedge fund Tuckerbrook/SB Global Special Situations Fund, L.P. (Fund), a fund of funds.  Sumanta Banerjee (Banerjee) was a 50 percent owner of the Fund’s general partner and was employed as its portfolio manager.  The Fund’s limited partnership agreement permitted withdrawal in the event Banerjee ceased to be “directly involved” with the Fund’s general partner or the Fund.  The Fund terminated Banerjee’s employment in March, 2008, and plaintiffs promptly requested redemption of their Fund interests.  The Fund refused and this litigation ensued.  The U.S. District Court for the Southern District of Texas ruled that the Fund and its co-defendants were entitled to summary judgment dismissing plaintiffs’ complaint because the evidence showed clearly that, even though Banerjee was no longer employed by the general partner, he continued to exert substantial influence over the Fund and its operations after the termination of his employment through his ownership interest in the Fund’s general partner.  We describe the facts and circumstances surrounding the lawsuit and explain the rationale for the Court’s decision.

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  • From Vol. 3 No.8 (Feb. 25, 2010)

    British Virgin Islands Court Finds that Western Union, which Sought Redemption of its Reserve Fund Shares Prior to a Redemption Freeze, is a Creditor of the Fund and May Appoint a Liquidator, Over Opposition of Hedge Fund Manager Caxton Associates

    Respondent Reserve International Liquidity Fund, Ltd. (Fund) is a “money market daily liquidity fund” organized under the laws of the British Virgin Islands (BVI).  Applicant Western Union International Limited (WU) owned approximately 298 million shares of the Fund (i.e., approximately $298 million of holdings).  On September 15, 2008, Lehman Brothers filed for bankruptcy and the 2008 liquidity crisis accelerated.  On that day, WU submitted redemption requests for its entire interest in the Fund, which still had a net asset value of $1 per share.  Days later, the Fund and its affiliate, The Reserve Primary Fund, “broke the buck” and suspended redemptions and the daily calculation of net asset values.  Litigation against the Fund in the United States commenced within weeks by various investors seeking redemptions of their interests and determination of the value of those interests.  WU commenced an action in the BVI seeking liquidation of the Fund under BVI law.  The fundamental issue considered by the court was determining when WU’s redemption of its Fund shares was completed and when, therefore, a shareholder became a creditor of the Fund with respect to the redemption proceeds, which would then entitle the shareholder to apply for the appointment of a liquidator.  WU argued that its redemption was complete on the date of its redemption request, and that it became a creditor of the Fund on that date.  The BVI High Court of Justice agreed, relying heavily on the language contained in the Fund’s Articles of Association.  We summarize the Court’s reasoning and the implications of this decision.

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  • From Vol. 3 No.7 (Feb. 17, 2010)

    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”

    Plaintiffs Aris Multi-Strategy Fund, L.P., and Aris Multi-Strategy Offshore Fund Ltd. (together, Aris) are two funds of funds that invested in Accipiter Life Sciences Fund II (QP), L.P., Accipiter Life Sciences Fund II, L.P., and Accipiter Life Sciences Fund II (Offshore), Ltd. (collectively, Accipiter).  During the summer of 2008, about 60 percent of Accipiter’s investors – excluding Aris – requested redemptions of their interests in Accipiter as of the September 30, 2008 redemption date.  In October, Aris submitted a request to redeem its Accipiter interests effective as of the December 31, 2008 redemption date.  Shortly after Aris’ request, Accipiter announced that it would only honor the September 30, 2008 redemption requests, and that it was suspending all future redemptions so that Accipiter’s funds could liquidate in an orderly fashion.  In a relatively rare move in the hedge fund world, Aris sued Accipiter, its management companies and one of its principals for, among other things, negligence, breach of contract, breach of fiduciary duty and injunctive relief.  The defendants moved to dismiss the complaint for failure to state a cause of action.  The New York State Supreme Court dismissed the entire complaint, determining that the exculpatory language contained in the governing documents was sufficient to bar Aris’ claims.  We summarize the background of the action, Aris’ allegations and the court’s decision.  See also “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).

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  • From Vol. 2 No.44 (Nov. 5, 2009)

    Investors Win Court-Imposed Liquidation of Cayman Islands Hedge Fund of Funds Matador Investments

    Matador Investments Ltd. (Matador or the Fund) is a fund of funds organized under the laws of the Cayman Islands.  Following a request by investors for redemption of their interests in Matador, the Fund first imposed a “gate” on redemptions (to stretch out redemption payments over time), and later imposed a complete freeze on redemptions.  The investors brought an action against the Fund seeking a judicial liquidation of the Fund on the ground that, following their redemption requests, they had become unpaid “creditors” of the Fund.  See “How Will the New Cayman Islands Insolvency Regime Affect the Winding-Up of Cayman Islands Hedge Funds?,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  Matador, relying on the recent Strategic Turnaround decision, argued that until the redemptions were paid in full, the investors were still bound by the Fund’s governing documents, which permitted both gates and freezes on redemptions.  The court disagreed, appointed a liquidator, and directed the Fund to commence winding up its affairs.  We explain the parties’ arguments and how the court distinguished the Matador investors from those in the Strategic Turnaround case.

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  • From Vol. 2 No.34 (Aug. 27, 2009)

    Steel Partners’ Restructuring and Redemption Plan: Precedent or Anomaly?

    At the end of 2008, hedge fund manager Steel Partners LLC (Steel Partners) adopted a novel and controversial approach in response to requests to redeem approximately 38 percent of the net assets in its Steel Partners II family of funds (Steel Partners II Funds).  In a nutshell, Steel Partners proposed a restructuring plan in which investors could receive a cash distribution and either (1) shares (of limited or no liquidity) in a new publicly-traded entity that would hold the funds’ assets, or (2) a pro rata distribution of the funds’ (largely illiquid) holdings.  Certain limited partners sued to enjoin that plan and demanded an “orderly liquidation” of the funds.  On June 19, 2009, the Delaware Chancery Court denied the plaintiffs’ demand for a preliminary injunction.  See “Delaware Chancery Court Permits Hedge Fund Manager Steel Partners to Restructure Fund and Redeem Certain Limited Partnership Interests,” The Hedge Fund Law Report, Vol. 2, No. 26 (Jul. 2, 2009).  In light of the legal imprimatur of the Delaware Chancery Court, the following question has been floating around the hedge fund community: is the Steel Partners approach a precedent or an anomaly?  Based on original research and interviews with market participants, The Hedge Fund Law Report has concluded that the answer is likely the latter: the Steel Partners approach, while legally plausible, is practically and optically cumbersome, and unlikely to be imitated precisely (though parts of the approach may inform responses to heavy redemption requests by similarly situated managers).  In fact, quite apart from serving as a precedent for an anti-redemption technique, the Steel Partners case may induce hedge fund investors to demand language in the governing documents of future funds prohibiting such techniques.  We describe the Steel Partners redemption plan; discuss the legal challenge to it; identify three reasons why it is unlikely to serve as a precedent; and offer insight into how the plan and the reactions to it may affect drafting of future fund documents.

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  • From Vol. 2 No.32 (Aug. 12, 2009)

    Investors Sue Hedge Fund Managed by N.I.R. Group and Corey Ribotsky in Redemption Dispute

    After a year that saw $155 billion in hedge fund withdrawals, two investors who had invested about $1.6 million with AJW Qualified Partners, LLC (the Fund), a hedge fund managed by N.I.R. Group (N.I.R. or the Manager), filed a lawsuit in a dispute over the Fund’s redemption provisions.  In September 2008, plaintiff Steven Mizel and his limited partnership, Palmetto Partners (Palmetto) sought to redeem their approximately $1.68 million investment in the Fund.  Instead, in October 2008, the Fund allegedly froze all redemption requests and sought to reorganize into a new fund that had a different management compensation structure and more restrictive withdrawal rights.  The Fund also allegedly refused to supply plaintiffs with certain information about the Fund, particularly a list of its members.  Plaintiffs then brought suit in New York State Supreme Court, alleging anticipatory breach of contract by the Fund and breaches of fiduciary duty by the Manager and its principal, Corey S. Ribotsky.  The Hedge Fund Law Report analyzed the relevant pleadings in the case and a related case involving similar allegations brought against Ribtosky by Gerald Tucci.  This article summarizes our analysis.

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  • From Vol. 2 No.30 (Jul. 29, 2009)

    Investors Demand More Specificity in Hedge Fund Governing Documents Regarding Circumstances in which Liquidity Management Tools May Be Used

    The credit crisis witnessed unprecedented deployment of liquidity management tools that, prior to the crisis, lay dormant in fund documents – tools such as fund-level gates, investor-level gates, hard and soft lock-ups, rolling redemption periods, holdbacks, redemption suspensions and side pockets.  The stigma previously attached to use of such tools faded as survival became the paramount imperative.  See “Stigma Fades as Use of Gates Becomes More Common,” The Hedge Fund Law Report, Vol. 1, No. 29 (Dec. 24, 2008).  In addition, managers sought to stem the tide of outflows to ensure that remaining investors were not left with the least liquid assets, and to facilitate the execution of longer-term investment strategies.  See “Investors in Hedge Fund Strategies Increasingly Demanding Separate Accounts to Avoid Gates and Other Consequences of Commingled Investment Vehicles,” The Hedge Fund Law Report, Vol. 2, No. 9 (Feb. 26, 2009).  The constituent documents of funds being launched today reflect the experience of the past year and a half.  At least for the time being, investors still have the upper hand in many cases in negotiating capacity with hedge fund managers, and many of those investors are demanding more specific liquidity provisions in fund documents.  In particular, investors are asking for – and in many cases getting – more specificity with respect to the circumstances in which liquidity management techniques may be employed, and the particular techniques that may be employed in specific circumstances.  The old approach was to vest essentially plenary discretion in the manager to lower a gate, suspend redemptions, etc. in a wide variety of circumstances.  The new drafting reflects an effort to enumerate the circumstances in which liquidity may be curtailed.  At the same time, investors and managers continue to recognize the impracticability of describing every circumstance in which liquidity restrictions may be prudent.  So while the drafting of liquidity management provisions is getting more precise, it still leaves room – albeit less room – for manager discretion.  We discuss relevant standards promulgated by the Hedge Fund Standards Board, and changes to those standards to reflect the trend toward more specific liquidity management disclosure, offer practitioner insight on the rationale for the trend and – importantly – provide actual language from the PPMs of two recently-launched hedge funds that reflect the new, more specific drafting.

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  • From Vol. 2 No.28 (Jul. 16, 2009)

    Investors Allege that Hedge Fund Manager Deliberately Concealed High Number of Redemptions

    On July 8, 2009, a group of investors, including a feeder fund and several charities, accused two hedge funds, Highland Credit Strategies Fund, LP and Highland Credit Strategies Fund, Ltd. (the Funds), their manager, Highland Capital Management (Highland) and affiliated parties of purposefully concealing the high level of redemption requests submitted to the Funds that led to the Funds’ collapse.  This article describes the events that led to the suit and summarizes the legal theories advanced by the investors.

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  • From Vol. 2 No.26 (Jul. 2, 2009)

    Delaware Chancery Court Permits Hedge Fund Manager Steel Partners to Restructure Fund and Redeem Certain Limited Partnership Interests

    After the 2008 market collapse, the Steel Partners II family of hedge funds (Steel Partners) was flooded with redemption requests.  Because the funds were locked into long-term investments, the funds’ manager proposed a restructuring plan under which the investors could receive a cash distribution and either (1) shares in a new publicly-traded entity that would hold the funds’ assets, or (2) a pro rata distribution of the funds’ securities holdings.  Certain limited partners sued to enjoin that plan and demanded an “orderly liquidation” of the funds.  Relying heavily on the fact that Steel Partners’ offering documents specifically contemplated temporary freezes on redemptions and permitted mandatory redemptions and distributions of assets in kind, the Delaware Chancery Court denied the plaintiffs’ demand for a preliminary injunction.  We explain the restructuring plan in detail, and explain the court’s analysis.

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  • From Vol. 2 No.21 (May 27, 2009)

    How Can Hedge Fund Managers Prevent or Mitigate Revocations of Redemption Requests?

    In the scramble for liquidity starting in summer 2007 and persisting, in varying degrees, through today, the perception and use of redemption requests has evolved.  Traditionally, hedge fund managers and investors understood redemption requests as irrevocable; and the constituent documents of most hedge funds reflect that understanding, requiring the manager to process any redemption request properly received from an investor.  However, fund documents also generally grant the manager – in its discretion and consistent with its fiduciary duty to the fund and all of its investors – discretion to grant a request by an investor to revoke its redemption request.  During the credit crisis, some investors have been taking advantage of such provisions in fund documents by submitting “preemptive” redemption requests.  That is, they have been submitting requests for full or partial redemptions for each redemption period, then withdrawing those redemption requests before the redemption is effectuated.  The specific purpose of such preemptive redemption requests is to avoid getting caught in a gate, or to submit redemption requests before the manager suspends redemptions.  The general goal of such requests is to maximize a claim on liquidity in a time of illiquidity and market dislocation.  However, while the ability to submit such requests is good for the investor that reserves the right to redeem, it is bad for the manager and other investors.  In effect, the ability to submit preemptive redemption requests gives the requester an option on redemption.  But like any option, this one has a cost.  In this case, the cost is borne not by requester, but by the other fund investors.  And that cost has at least three components: (1) reduced liquidity for other investors (who may be caught by a gate if total redemption requests in any period exceed a certain threshold of net asset value, usually around 15 percent); (2) costs in connection with preparing to meet the redemption, such as administrative and valuation fees, brokerage commissions, etc.; and (3) opportunity costs, which consist of the manager selling at inopportune times to raise the cash required to pay redemptions, or missing good investment opportunities while sitting on that cash.  In economic parlance, investors submitting preemptive redemption requests are internalizing the liquidity benefits of such requests while externalizing the various costs of such requests to other fund investors.  Since fund managers have a legal fiduciary duty to act in the best interests of the fund and all of its investors, and a practical duty to avoid, to the extent possible, operational structures that inhibit their ability to manage their funds, managers have been looking for credible ways to prevent or mitigate revocations of redemption requests.  We detail four specific strategies that managers are using to discourage revocation of redemption requests, and another approach to redemptions that may render all of those techniques unnecessary.

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  • From Vol. 2 No.15 (Apr. 16, 2009)

    Hedge Fund Managers Using Special Purpose Vehicles to Minimize Adverse Effects of Redemptions on Long-Term Investors

    When a hedge fund is invested in illiquid assets, redemptions from that fund can adversely affect various constituencies, including non-redeeming investors, redeeming investors, the manager and even those who have day-to-day dealings with the assets.  Managers have various tools available to them for preventing or delaying redemptions, or mitigating the adverse outcomes that can flow from them.  Such tools include fund-level gates, investor-level gates, hard and soft lock-ups, rolling redemption periods, holdbacks, redemption suspensions and side pockets.  In addition, pension funds and other institutional investors are increasingly demanding access to hedge fund strategies via separate accounts, in an effort to minimize the mismatch between the time horizons of different investors in commingled vehicles.  With growing frequency, however, managers are employing a different strategy to effectuate redemptions – at least, redemptions of a sort – while avoiding many of the adverse outcomes normally associated with redemptions.  That strategy involves the use of special purpose vehicles (SPVs) – essentially, separate entities to which a fund can transfer illiquid assets, or economic exposure to illiquid assets, and which can issue interests that are transferred to redeeming investors in lieu of cash or the assets themselves.  In effect, managers formerly had been limited to three options when faced with redemptions: give nothing (i.e., impose a suspension, gate or holdback); give cash; or give in kind.  The use of SPVs introduces a fourth option: give interests in a new entity organized solely to house illiquid assets – if you will, a sort of “bad bank” for illiquid hedge fund assets.  More than anything, SPVs offer managers a way to control the timing of the disposition of currently illiquid assets, and to avoid forced sales into distressed markets.  We provide a comprehensive analysis of the use of SPVs in the redemption context, including a discussion of what SPVs are and how they work, what synthetic SPVs are and the contexts in which they can be used, a comparison with side pockets, recent examples, fee considerations and more.

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  • From Vol. 2 No.13 (Apr. 2, 2009)

    Can a Hedge Fund Make Redemption Payments “In Kind” by way of the Issue of “Participation Interests” in its own Illiquid Assets, and What is the Status of a Redeeming Investor who has not Received any Payment at All?

    Hedge funds incorporated in Bermuda, the Cayman Islands, and the British Virgin Islands face substantial legal challenges in 2009, especially in meeting liquidity needs for redeeming investors.  Many hedge fund assets and investments have declined both in value and in liquidity.  Some assets are hard to value.  Other investments are illiquid.  Many investors have been seeking to withdraw their investments in hedge funds and to have their shares redeemed for value.  There is unlikely, however, to be enough cash or liquid assets available to pay all of them, at the same time.  There are a variety of defensive strategies potentially available to hedge funds holding illiquid assets when faced with a rush of redemption requests and requests for payment.  In a guest article, Alex Potts of Conyers Dill & Pearman details various of those strategies, and offer a comprehensive discussion of the evolving caselaw regarding redemptions from hedge funds organized in the British Virgin Islands and the Cayman Islands.

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  • From Vol. 2 No.9 (Mar. 4, 2009)

    Connecticut District Court Rules that Hedge Fund Investor Can Sue Hedge Fund Manager for Imposition of “Involuntary” Lock-Up Period and Improper “Rescinding” of Redemption Notice

    In a lawsuit filed in April 2008, Joseph Umbach, founder of the Mystic line of beverages, accused Carrington Investment Partners, L.P. (the Fund), a billion dollar mortgage-backed securities hedge fund, of “involuntarily” tying up his one million dollar investment in the Fund and improperly “rescinding” a redemption notice he submitted to the Fund’s sole manager, Bruce Rose.  Umbach sought a declaration that the action taken by Carrington and Rose was “an illegal or unenforceable ex post facto” action, and charged that the defendants committed securities fraud, breached their fiduciary duty to him, committed fraud and negligent misrepresentation and breached the terms of their contract.  On February 18, 2009, the United States District Court for the District of Connecticut dismissed Umbach’s request for declaratory judgment, because it found that his remaining claims against the Fund, Carrington Capital Management, LLC (the General Partner) and Bruce Rose, could go forward.  We outline the relevant facts from the complaint and the court’s opinion, and explain the court’s legal analysis.  The case illustrates, among other things, the deference a federal court will give to an agreement between an investor and a hedge fund manager providing the investor with preferential liquidity terms.

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  • From Vol. 2 No.5 (Feb. 4, 2009)

    Icahn-Affiliated Entity Challenges Effort by Steel Partners to Convert Hedge Fund Investment into Publicly-Listed Vehicle

    On January 13, 2009, ACF Master Trust, an employee benefit plan for ACF Industries LLC that is affiliated with Carl Icahn, filed a lawsuit against Steel Partners II (Offshore) Ltd., a Cayman Islands based hedge fund and others, alleging fraud and breach of contract based on a reorganization of one of the fund’s investments allegedly undertaken in response to the fund’s recent losses and the ensuing wave of redemptions.  Our discussion includes details of the specific PPM provisions at issue and the mechanics of the reorganization, as well as a summary of the allegations and defenses based on a review of the pleadings.

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  • From Vol. 1 No.15 (Jul. 8, 2008)

    Delaware Chancery Court Rules that Limited Partnership Agreement Permitted General Partner to Make In-Kind Distributions, and that Appropriate Valuation Date of In-Kind Distributions May be Redemption Date Rather than Distribution Date

    On June 13, 2008, the Delaware Chancery Court ruled that the limited partnership agreement of a hedge fund organized as a Delaware limited partnership did not require ratable in-kind distributions, but rather permitted the general partner to make in-kind distributions in its sole discretion. The court also held that the redeeming limited partners might be able to prove that they were entitled to assets equal in aggregate value to the value of their share of the fund at the time of redemption.

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  • From Vol. 1 No.7 (Apr. 15, 2008)

    Gates Provide Safety Valves for Hedge Funds and Investors

    • A gate is a provision in a fund’s governing documents authorizing the adviser to suspend redemptions when redemption requests as of a certain date exceed a stated threshold of the fund’s net assets (usually from 15 to 25%).
    • By putting a damper on withdrawals, gates protect the interests of both fund managers and non-redeeming investors.
    • Consensus among investment professionals appears to be that gates are more palatable to investors than longer lockup periods.
    • Even with a gate, a fund manager needs to be a good communicator in order to have the best chance of convincing investors to hang in there during tough times.
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