The Hedge Fund Law Report

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

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By Topic: ERISA

  • From Vol. 10 No.9 (Mar. 2, 2017)

    Ways the Trump Administration’s Policies May Affect Private Fund Advisers

    With a Republican president and Republican-controlled Congress, there is the possibility for comprehensive changes in several areas of concern to private fund managers, including taxation, regulation and enforcement. In his first weeks in office, President Trump issued a series of sweeping, yet sometimes confusing, orders directed at fulfilling some of his campaign promises. A recent seminar presented by the Association for Corporate Growth (ACG) provided insight on the impact of the Trump executive orders regarding the pending fiduciary rule and other regulatory matters; developments at the SEC; the future of the Dodd-Frank Act and other laws that may affect the private fund industry; proposed tax reform; cybersecurity; and political contributions. Scott Gluck, special counsel at Duane Morris, moderated the discussion, which featured Langston Emerson, a managing director at advisory firm The Cypress Group; Basil Godellas, a partner at Winston & Strawn; Ronald M. Jacobs, a partner at Venable; and Michael Pappacena, a managing director at ACA Aponix. This article summarizes their insights. For coverage of other ACG webinars, see “SEC Staff Provides Roadmap to Middle-Market Private Fund Adviser Examinations” (May 16, 2014); and “SEC’s David Blass Expands on the Analysis in Recent No-Action Letter Bearing on the Activities of Hedge Fund Marketers” (Mar. 13, 2014). 

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  • From Vol. 10 No.8 (Feb. 23, 2017)

    Despite the DOL Fiduciary Rule’s Uncertain Future Under the Trump Administration, Managers Should Continue Preparing for Its April 2017 Implementation (Part Two of Two)

    As part of his first 100 days in office, President Donald J. Trump has set his sights on easing some of the existing regulations in the financial sector to ostensibly allow it to flourish. To that end, he issued a presidential memorandum on February 3, 2017 (Presidential Memorandum), ordering the Department of Labor to review the fiduciary duty rule (DOL Fiduciary Rule). This review may lead to a reevaluation of who or what should be officially classified as a fiduciary, with all the legal obligations that classification entails, and may spur a dialogue between regulators and the funds sector. Although legal experts disagree as to the likelihood of the DOL Fiduciary Rule’s ultimate survival, its defeat is far from a fait accompli. Those potentially subject to the DOL Fiduciary Rule can and should continue revising their practices, documents and disclosures where appropriate. This two-part series evaluates the recent orders issued by the Trump administration that target the financial industry, including insights from attorneys specializing in financial regulations, employment and labor law, so that fund managers can respond accordingly. This second article in the series considers the potential ramifications of the proposed changes to the DOL Fiduciary Rule and their impact on hedge fund managers. The first article summarized the Trump administration’s executive order, entitled “Core Principles for Regulating the United States Financial System,” which detailed the financial sector policies of the new administration. For more on how protecting retirement investors has recently been an SEC priority, see “OCIE 2017 Examination Priorities Illustrate Continued Focus on Conflicts of Interest; Branch Offices; Advisers Employing Bad Actors; Oversight of FINRA; Use of Data Analytics; and Cybersecurity” (Jan. 26, 2017); and “SEC Division Heads Enumerate OCIE Priorities, Including Cybersecurity, Fees, Bad Actors and Never-Before Examined Hedge Fund Managers (Part One of Two)” (Apr. 28, 2016).`

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  • From Vol. 10 No.7 (Feb. 16, 2017)

    Malta’s New Notified AIF Vehicle Facilitates Quick Market Launches Without Requiring Regulatory Pre-Approval or Burdensome Ongoing Oversight

    In 2016, the Malta Financial Services Authority (MFSA) undertook a consolidation of its funds regime. This effort resulted in the addition of the notified alternative investment fund (Notified AIF) to Malta’s extensive range of fund structures. A Notified AIF is unique because it enables the timely launch of an alternative investment fund as long as it meets certain conditions to be “notified” to the MFSA by the AIF’s alternative investment fund manager. Under the Notified AIF framework, the MFSA focuses on regulating the product provider – in this case, the fund manager – rather than the fund product, which is what facilitates the launch of a Notified AIF without requiring pre-authorization by the MFSA. In a guest article, Dr. Yanika Fino, an associate at GANADO Advocates, describes the requirements for forming a Notified AIF, the types of funds that are eligible to use this vehicle and some of the pros and cons associated with pursuing this structure. For more on launching funds in Malta, see “What Malta Can Offer the Hedge Fund Industry: An Interview With the Chairman of FinanceMalta” (Jan. 26, 2017); and “European Alternative Funds: The Alternatives” (Jun. 24, 2009).

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  • From Vol. 9 No.46 (Nov. 24, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part One of Four)

    Hedge fund managers and other investment professionals contemplating swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986 must consider numerous legal issues. To help clarify these complex issues, The Hedge Fund Law Report is serializing a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes – in considerable detail and with extensive references to relevant authority – the many substantive considerations associated with employing swaps on behalf of ERISA plan assets and the potential penalties for missteps. This article, the first in our four-part serialization, discusses fiduciary responsibility and prohibited transactions, including how swaps can constitute prohibited transactions. For more from Rabitz and Oringer, see “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA to Impact Many Hedge Funds” (Aug. 20, 2010). For a prior serialization from Oringer, see our five-part series:“Happily Ever After? – Investment Funds That Live With ERISA, For Better and For Worse”: Part One (Sep. 4, 2014); Part Two (Sep. 11, 2014); Part Three (Sep. 18, 2014); Part Four (Sep. 25, 2014); and Part Five (Oct. 2, 2014).

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  • From Vol. 9 No.33 (Aug. 25, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part Four of Four)

    This is the final installment in our four-part serialization of a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes the substantive considerations – as well as potential penalties for missteps – associated with employing swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986, and includes references to a wide range of relevant authority. This article examines issues relating to cleared swaps, collateral, rehypothecation and swap execution facilities. The third article in the serialization described implications of funds reaching the 25 percent threshold of plan investment; considerations for fund managers when facing governmental plans; and credit-related issues. The second article discussed exemptions that could keep swaps from being considered prohibited transactions and explored the extent to which swap counterparties and others would be considered fiduciaries under ERISA, as well as the potential implications of that consideration. The first article explored fiduciary responsibility and prohibited transactions generally.

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  • From Vol. 9 No.32 (Aug. 11, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part Three of Four)

    This is the third article in our four-part serialization of a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes the substantive considerations – as well as potential penalties for missteps – associated with employing swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986, and includes references to a wide range of relevant authority. This third article in the serialization describes implications of funds reaching the 25% threshold of plan investment; considerations for fund managers when facing governmental plans; and credit-related issues. The second article discussed exemptions that could keep swaps from being considered prohibited transactions and explored the extent to which swap counterparties and others would be considered fiduciaries under ERISA, as well as the potential implications of that consideration. The first article explored fiduciary responsibility and prohibited transactions generally.

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  • From Vol. 9 No.31 (Aug. 4, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part Two of Four)

    This is the second article in our four-part serialization of a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes – in considerable detail and with extensive references to relevant authority – the many substantive considerations associated with employing swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986 (Code), as well as potential penalties for missteps. This article discusses exemptions that could keep swaps from being considered prohibited transactions and explores the extent to which swap counterparties and others would be considered fiduciaries under ERISA, as well as the potential implications of that consideration. To read the first article in this serialization, click here

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  • From Vol. 9 No.30 (Jul. 28, 2016)

    A “Clear” Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans (Part One of Four)

    Hedge fund managers and other investment professionals contemplating swap transactions for employee benefit plans, certain other similar plans and “plan assets” entities subject to the fiduciary provisions of the Employee Retirement Income Security Act of 1974 (ERISA) or the corresponding provisions of Section 4975 of the Internal Revenue Code of 1986 (Code) must consider numerous legal issues. To help clarify these complex issues, The Hedge Fund Law Report is serializing a treatise chapter by Steven W. Rabitz, partner at Stroock & Stroock & Lavan, and Andrew L. Oringer, partner at Dechert. The chapter describes – in considerable detail and with extensive references to relevant authority – the many substantive considerations associated with employing swaps on behalf of ERISA plan assets and the potential penalties for missteps. This article, the first in our four-part serialization, discusses fiduciary responsibility and prohibited transactions, including how swaps can constitute prohibited transactions. For more from Rabitz and Oringer, see “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA to Impact Many Hedge Funds” (Aug. 20, 2010). For a prior serialization from Oringer, see our five-part series:“Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse”: Part One (Sep. 4, 2014); Part Two (Sep. 11, 2014); Part Three (Sep. 18, 2014); Part Four (Sep. 25, 2014); and Part Five (Oct. 2, 2014).

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  • From Vol. 9 No.16 (Apr. 21, 2016)

    Becoming a Plan Assets Fund May Limit Hedge and Other Private Funds’ Abilities to Charge Fees

    One of the decisions faced by hedge funds and other private funds that accept “plan assets” subject to the Employee Retirement Income Security Act of 1974 (ERISA) is whether to cross the 25% threshold and become subject to ERISA. But taking that step is fraught with complex obligations and may significantly impact management and deferred performance fees. A recent segment of the “Pension Plan Investments 2016: Current Perspectives” seminar hosted by the Practising Law Institute (PLI) addressed issues for funds crossing the 25% threshold, including compensation practices for fiduciaries as well as management and performance fee structures of plan assets funds. The program, “Current Topics in Private Equity and Alternative Investments,” was moderated by Arthur H. Kohn, a partner at Cleary Gottlieb Steen & Hamilton; and featured Jeanie Cogill, a partner at Morgan, Lewis & Bockius; David M. Cohen, a partner at Schulte Roth & Zabel; and Steven W. Rabitz, a partner at Stroock & Stroock & Lavan. This article summarizes the key takeaways from the seminar with respect to the above matters. For additional commentary from this PLI program, see “Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA” (Apr. 14, 2016). For more on ERISA, see our two-part series on “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors”: Part One (Feb. 5, 2015); and Part Two (Feb. 12, 2015).

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  • From Vol. 9 No.15 (Apr. 14, 2016)

    Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA

    The Employee Retirement Income Security Act of 1974 (ERISA) imposes a complex regulatory regime onto hedge fund and other private fund managers managing “plan assets.” Two recent developments carry implications for managers under ERISA: the ruling by the U.S. Court of Appeals for the First Circuit about whether a private equity (PE) fund can be treated as a “trade or business” for purposes of the pension funding rules and withdrawal liability under ERISA; and the release of the DOL’s final rule revising the definition of “fiduciary” under ERISA. These were among the ERISA-related topics discussed during a recent segment of the Practising Law Institute’s “Pension Plan Investments 2016: Current Perspectives” seminar. The program was moderated by Arthur H. Kohn, a partner at Cleary Gottlieb Steen & Hamilton; and featured Jeanie Cogill, a partner at Morgan, Lewis & Bockius; David M. Cohen, a partner at Schulte Roth & Zabel; and Steven W. Rabitz, a partner at Stroock & Stroock & Lavan. This article summarizes the key takeaways from the program with respect to the foregoing matters. For more on ERISA, see our three-part series on ERISA Considerations for European hedge fund managers: “Liability and Incentive Fee Considerations” (Sep. 24, 2015); “Prohibited Transaction, Reporting and Side Letter Considerations” (Oct. 1, 2015); and “Indicia of Ownership and Bond Documentation Considerations” (Oct. 8, 2015). 

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    RCA Session Highlights Issues Pertaining to the Custody Rule, ERISA, Client Agreements, Fees, Codes of Ethics and Confidentiality

    The first session of the Regulatory Compliance Association’s (RCA) Compliance Program Transparency Series examined key provisions from the CFA Institute’s Asset Manager Code of Professional Conduct (AMCC) and the RCA’s Model Compliance Manual (Manual), which is intended to facilitate implementation of the AMCC. Among the topics covered by the panel were client and fiduciary relationships, including compliance with the custody rule and ERISA as well as best practices for entering into agreements with and charging fees to clients; codes of ethics; and confidentiality. Moderated by Jane Stafford, the RCA’s general counsel, the session featured James G. Jones, a founder and portfolio manager of Sterling Investment Advisors; Michelle Clayman, managing partner and chief investment officer of New Amsterdam Partners; Gerald Lins, general counsel of Voya Investment Management; and Tanya Kerrigan, general counsel and chief compliance officer of Boston Advisors. This article highlights the salient points made on the foregoing issues. For additional insight from RCA programs, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and our coverage of the most recent RCA Compliance, Risk and Enforcement Symposium: “Methods for Hedge Fund Managers to Upgrade Compliance Programs” (Jan. 14, 2016); and “Ways for Hedge Fund Managers to Mitigate Conflicts of Interest” (Jan. 21, 2016).

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  • From Vol. 8 No.46 (Nov. 26, 2015)

    Liability and Incentive Fee Considerations Under ERISA for European Hedge Fund Managers (Part One of Three)

    As European hedge fund managers recognize the increasing concentration of investment capital in U.S. pension funds subject to the Employee Retirement Income Security Act of 1974 (ERISA), their appetite for unlocking access to such capital has grown.  This has led a number of European managers to actively seek investment from ERISA plans, notwithstanding the heightened compliance obligations which have traditionally deterred them from accepting ERISA plan assets into their funds.  This article, the first in a three-part series, discusses recent trends in ERISA fundraising by hedge fund managers based in the U.K. and other European jurisdictions and looks at the pertinent issues affecting those managers.  Specifically, it examines key difficulties relating to liability standards and incentive fees and analyzes various approaches to overcoming those issues.  The second article explores issues relating to prohibited transactions, reporting requirements and side letters under the ERISA regime, and the final article addresses concerns relating to indicia of ownership requirements, bond documentation and other overarching issues.  For more on ERISA, see “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 6 (Feb. 12, 2015); and “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence On and Negotiate For Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).

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  • From Vol. 8 No.39 (Oct. 8, 2015)

    Indicia of Ownership and Bond Documentation Considerations Under ERISA for European Hedge Fund Managers (Part Three of Three)

    As their appetite for investment from U.S. investors subject to the Employee Retirement Security Act of 1974 (ERISA) grows, European hedge fund managers must remain aware of the increased and complex tangle of regulations and compliance obligations that are imposed on hedge funds and managers that fall under ERISA’s ambit.  This final article in our three-part series analyzes various approaches to ERISA’s indicia of ownership requirements for U.K. and other European hedge fund managers; discusses concerns relating to bond documentation; and examines overarching issues affecting European managers choosing to manage ERISA assets.  The first article explored issues relating to liability standards and incentive fees for European managers operating under the ERISA regime, while the second article analyzed specific concerns regarding the prohibited transactions rules, reporting requirements and side letters.  See also “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Three of Three),” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014); and “Applicability of New Disclosure Obligations Under ERISA to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).

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  • From Vol. 8 No.38 (Oct. 1, 2015)

    Prohibited Transaction, Reporting and Side Letter Considerations Under ERISA for European Hedge Fund Managers (Part Two of Three)

    A growing number of European hedge fund managers are actively seeking injections of capital from U.S. investors subject to the Employee Retirement Income Security Act of 1974 (ERISA).  Hedge fund managers wishing to “cross-over” their funds into the ERISA regulatory sphere must, however, be cognizant of the increased and complex tangle of regulations and compliance obligations which have often deterred European managers from pursuing ERISA assets.  This second article in a three-part series examines particular issues U.K. and other European managers face stemming from prohibited transactions rules and reporting requirements under the ERISA regime and offers approaches to side letters for European managers raising capital from ERISA plans.  The first article analyzed the pertinent issues affecting European managers relating to liability standards and incentive fees.  The final article in the series will address concerns relating to indicia of ownership requirements, bond documentation and other issues.  See also “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Five of Five),” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014); and “RCA PracticeEdge Session Highlights the Key Points of Intersection between ERISA and Hedge Fund Investments and Operations,” The Hedge Fund Law Report, Vol. 7, No. 27 (Jul. 18, 2014).

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  • From Vol. 8 No.37 (Sep. 24, 2015)

    Liability and Incentive Fee Considerations Under ERISA for European Hedge Fund Managers (Part One of Three)

    As European hedge fund managers recognize the increasing concentration of investment capital in U.S. pension funds subject to the Employee Retirement Income Security Act of 1974 (ERISA), their appetite for unlocking access to such capital has grown.  This has led a number of European managers to actively seek investment from ERISA plans, notwithstanding the heightened compliance obligations which have traditionally deterred them from accepting ERISA plan assets into their funds.  This article, the first in a three-part series, discusses recent trends in ERISA fundraising by hedge fund managers based in the U.K. and other European jurisdictions and looks at the pertinent issues affecting those managers.  Specifically, it examines key difficulties relating to liability standards and incentive fees and analyzes various approaches to overcoming those issues.  The second article will explore issues relating to prohibited transactions, reporting requirements and side letters under the ERISA regime, and the final article will address concerns relating to indicia of ownership requirements, bond documentation and other overarching issues.  For more on ERISA, see “Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 6 (Feb. 12, 2015); and “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence On and Negotiate For Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).

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  • From Vol. 8 No.29 (Jul. 23, 2015)

    Seward & Kissel Private Funds Forum Analyzes Trends in Hedge Fund Seeding Arrangements and Fee Structures (Part One of Two)

    A hedge fund manager must keep abreast of current trends in hedge fund structures and terms in order to raise capital from investors, anticipate prospective changes in the marketplace and adapt accordingly.  At the recent Seward & Kissel Private Funds Forum, panelists examined key capital raising and fund structuring trends in the hedge fund industry.  This article, the first of a two-part series, summarizes the panelists’ discussion of seeding arrangements and fee structures as well as ERISA and taxation considerations upon hedge fund structuring.  The second article will explore the use of special fund structures, activist strategies and alternative mutual funds.  For additional insight from the firm, see “Seward & Kissel New Hedge Fund Study Identifies Trends in Investment Strategies, Fees, Liquidity Terms, Fund Structures and Strategic Capital Arrangements,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015).  For more on hedge fund seeding arrangements, see “Report Offers Insights on Seeding Landscape, Available Talent, Seeding Terms and Players,” The Hedge Fund Law Report, Vol. 8, No. 1 (Jan. 8, 2015); and “New York City Bar’s ‘Hedge Funds in the Current Environment’ Event Focuses on Hedge Fund Structuring, Private Fund Examinations, Compliance Risks and Seeding Arrangements,” The Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).

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  • From Vol. 8 No.27 (Jul. 9, 2015)

    RCA Panel Discusses Pay to Play Rules, GIPS Compliance, Disclosures, Risk Assessments and ERISA Proposals

    Panelists at the recent RCA Enforcement, Compliance & Operations Symposium emphasized the importance of understanding and complying with the various requirements applicable to fund managers.  In particular, speakers discussed compliance with pay to play rules; GIPS compliance and performance reporting; disclosure requirements; and risk assessment requirements.  Additionally, panelists discussed a proposed expansion of the fiduciary definition under ERISA.  This article highlights the key points arising from discussion of the foregoing issues.  For additional coverage of the Symposium, see “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); and “RCA Panel Outlines Keys for Hedge Fund Managers to Implement a Comprehensive Cybersecurity Program,” The Hedge Fund Law Report, Vol. 8, No. 24 (Jun. 18, 2015).

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  • From Vol. 8 No.6 (Feb. 12, 2015)

    Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors (Part Two of Two)

    Pension funds represent a significant source of capital for private fund managers, but if a fund is deemed a “plan assets fund,” ERISA’s strict regulatory regime applies.  Understanding how ERISA works, as well as the exceptions available to those who do not want to be subject to ERISA as a manager of “plan assets,” is crucial for managers.  At a recent New York City Bar event, ERISA practitioners from Simpson Thacher & Bartlett LLP; Proskauer Rose LLP; Skadden, Arps, Slate, Meagher & Flom LLP; and Wachtell, Lipton, Rosen & Katz discussed these issues and other ERISA-related developments applicable to organizing and operating private equity and hedge funds.  This article, the second in a two-part series, addresses drafting plan documents, ERISA-related liability, controlled groups and common control concepts as applied to private equity funds, and implications of the Sun Capital case.  The first article in the series summarized insights from panelists on identifying benefit plan investors and exemptions available to fund managers under ERISA.  See also “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Five of Five),” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014); “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence on and Negotiate for Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).

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  • From Vol. 8 No.5 (Feb. 5, 2015)

    Structuring Private Funds to Avoid ERISA While Accommodating Benefit Plan Investors (Part One of Two)

    Private fund managers need to understand what ERISA is, why ERISA matters and what exceptions are available to managers who do not want to be subject to ERISA as a manager of “plan assets.”  At a recent event, ERISA practitioners from Simpson Thacher & Bartlett LLP; Proskauer Rose LLP; Skadden, Arps, Slate, Meagher & Flom LLP; and Wachtell, Lipton, Rosen & Katz discussed these issues and other ERISA-related developments applicable to organizing and operating private equity and hedge funds.  This article, the first in a two-part series, summarizes insights from panelists on identifying benefit plan investors and exemptions available to fund managers under ERISA.  The second installment will address drafting plan documents, ERISA-related liability and implications of the Sun Capital case.  See also “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Five of Five),” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014); and “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence on and Negotiate for Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).

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  • From Vol. 7 No.37 (Oct. 2, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Five of Five)

    This is the final installment in our five-part serialization of a treatise chapter by Dechert LLP partner Andrew Oringer.  The chapter analyzes ERISA as it applies to private fund managers, references relevant authority and highlights critical compliance issues.  This article discusses trust requirements, custody, ERISA’s bonding rules, reporting of investments and direct filings with the Department of Labor, reporting issues (relating to compensation, hard-to-value assets and gifts and entertainment) and prime brokers.  The fourth article in this series addressed self-dealing issues relating to fee structures, certain special issues for plans of financial institutions, services for multiple funds, payment or reimbursement of expenses, employer securities and employer real property and certain miscellaneous exceptions (including foreign exchange and cross trading).  The third article focused on prohibited transactions, qualified professional asset managers, the “service provider” exemption and the exemption for compensation for services.  The second article covered fiduciary duty considerations, including delegation, allocation of investment opportunities, varied interests of fund investors, indemnification and insurance, investments in portfolio funds, enforcement-related matters and diversification requirements.  And the first article discussed the “plan assets” rules and rules for the delegation and allocation of fiduciary responsibility.

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  • From Vol. 7 No.36 (Sep. 25, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Four of Five)

    This is the fourth article in our five-part serialization of a treatise chapter by Dechert LLP partner Andrew Oringer.  The chapter details the ERISA provisions of primary relevance to private fund managers and references relevant authority.  This article continues the discussion of prohibited transactions initiated in part three.  In particular, this article addresses self-dealing issues relating to fee structures, certain special issues for plans of financial institutions, services for multiple funds, payment or reimbursement of expenses, employer securities and employer real property and certain miscellaneous exceptions (including foreign exchange and cross trading).  The third article in the series focused on prohibited transactions, qualified professional asset managers, the “service provider” exemption and the exemption for compensation for services.  The second article in the series covered fiduciary duty considerations, including delegation, allocation of investment opportunities, varied interests of fund investors, indemnification and insurance, investments in portfolio funds, enforcement-related matters and diversification requirements.  The first article in the series discussed the “plan assets” rules and rules for the delegation and allocation of fiduciary responsibility.

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  • From Vol. 7 No.35 (Sep. 18, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Three of Five)

    This is the third article in our five-part serialization of a treatise chapter by Dechert LLP partner Andrew Oringer.  The chapter describes the ERISA provisions of chief relevance to private fund managers, and includes references to a wide range of relevant and, in some cases, obscure authority.  This third article in the series focuses on prohibited transactions, qualified professional asset managers, the “service provider” exemption and the exemption for compensation for services.  The second article in the series covered fiduciary duty considerations, including delegation, allocation of investment opportunities, varied interests of fund investors, indemnification and insurance, investments in portfolio funds, enforcement-related matters and diversification requirements.  The first article in the series discussed the “plan assets” rules and rules for the delegation and allocation of fiduciary responsibility.

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  • From Vol. 7 No.34 (Sep. 11, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Two of Five)

    This is the second article in our five-part serialization of a treatise chapter by Dechert LLP partner Andrew Oringer.  The chapter describes – clearly, comprehensively and with citations to a range of authority that would be immensely time-consuming to compile independently – the ERISA provisions of primary relevance to private funds.  Private fund managers need to understand ERISA if they market to pension funds, and we have yet to encounter a more pithy and pointed route to understanding relevant ERISA concepts (and excluding extraneous concepts) than this chapter.  This second article in the series focuses on fiduciary duty considerations, including delegation, allocation of investment opportunities, varied interests of fund investors, indemnification and insurance, investments in portfolio funds, enforcement-related matters and diversification requirements.  To view the first article in this series, click here.

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  • From Vol. 7 No.33 (Sep. 4, 2014)

    Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part One of Five)

    The Employee Retirement Income Security Act of 1974, as amended (ERISA) is a reactive and remedial statute which has been described as setting forth a “comprehensive and reticulated” scheme to regulate the provision of employee benefits.  It can be extremely complex at times, sometimes even seeming to operate counterintuitively in an attempt to achieve its protective goals.  There may have been a time when hedge fund managers commonly disdained taking investments from pension plans subject to ERISA.  The notion of having to comply with ERISA, of all things, in the case of someone who is not charged with addressing human resources concerns or other benefits-related matters, can be an extremely foreign concept.  Only as investment capital has become increasingly concentrated in pension plans have hedge fund managers more broadly realized that dealing with ERISA might be necessary, or even preferable.  In short, complying with ERISA can dramatically enlarge the pool of money potentially available to a hedge fund manager.  But it can also dramatically enlarge the size and complexity of a manager’s legal and compliance efforts.  In an effort to bring some much needed clarity to one of the most opaque legal areas affecting the investment management business, The Hedge Fund Law Report is serializing a treatise chapter by Andrew L. Oringer, a partner at Dechert LLP and a dean of the ERISA bar.  The chapter describes – in considerable detail and with extensive references to relevant authority – the application of ERISA to hedge and other investment funds.  For hedge fund managers seeking to raise capital from pension plans subject to ERISA, the chapter is essential reading.  This article is the first in our five-part serialization.  See also “RCA PracticeEdge Session Highlights the Key Points of Intersection between ERISA and Hedge Fund Investments and Operations,” The Hedge Fund Law Report, Vol. 7, No. 27 (Jul. 18, 2014).

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  • From Vol. 7 No.27 (Jul. 18, 2014)

    RCA PracticeEdge Session Highlights the Key Points of Intersection between ERISA and Hedge Fund Investments and Operations

    Pension funds are a potentially huge source of capital for hedge fund managers.  However, accepting investments from pension plans governed by the Employee Retirement Income Security Act of 1974 (ERISA) is not without significant risks and drawbacks.  Of greatest concern to a hedge fund manager is that a fund will be deemed a “plan asset fund,” thereby making the manager an ERISA fiduciary and subjecting the fund to ERISA’s strict regulatory regime.  A recent PracticeEdge Session presented by the Regulatory Compliance Association provided an overview of the ERISA regime, with emphasis on when investment funds become subject to the ERISA regime, the consequences of being subject to that regime, the duties of ERISA fiduciaries and certain proposed or pending regulatory changes.  This article summarizes that session.  See also “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence on and Negotiate for Investments in Their Funds?,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013); “How Can Hedge Fund Managers Managing Plan Asset Funds Comply with the QPAM and INHAM Exemption Requirements?,” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).

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  • From Vol. 7 No.23 (Jun. 13, 2014)

    Pension Plan Gatekeepers Increasingly Serving as Competitors to Alternative Investment Managers

    On May 21, 2014, Rep. George Miller, Senior Democratic Member of the House Committee on Education and the Workforce, sent a letter to Labor Department Secretary Thomas Perez expressing concerns about a “growing trend” in which pension consultants are “recommending” themselves to manage the assets of their pension plan clients.  See also “Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).

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  • From Vol. 7 No.7 (Feb. 21, 2014)

    Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Three of Three)

    This is the third installment in our three-part series addressing the evolution of U.S. pension plan management and governance.  This installment focuses on what the next phase of pension evolution may look like and also highlights how, at least in one area, governance research can be developed to be a true value-added tool for public pension plans and their trustees, potentially guiding the design of their governance structures and investment infrastructures.  The first installment highlighted how growth of public pension plans and fundamental legal or regulatory change, when combined with increasing pension portfolio complexity and the current underfunded status of most U.S. public pension plans, will be the forces defining pension evolution in the twenty-first century.  The first installment also included an explanation of why the growth of public pension plans and fundamental legal or regulatory change impacted pension plan evolution through the twentieth century.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).  The second installment described the current governance structures of today’s public pension, focusing on the board of trustees and pension staff; briefly reviewed current governance research about public pension trustees, and the importance of both adequate staff infrastructure and effective delegation as features of good governance; and explained the new delegation rule and why it should be a key element of long-term organizational change within the U.S. pension system.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Two of Three), The Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).  The author of this series is Von M. Hughes, a Managing Director at Pacific Alternative Asset Management Company, LLC.

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Two of Three)

    This is the second article in a three-part series addressing the evolution of U.S. pension plan management and governance.  This article describes the current governance structures of today’s public pension, focusing on the board of trustees and pension staff; briefly reviews current governance research about public pension trustees, and the importance of both adequate staff infrastructure and effective delegation as features of good governance; and explains the new delegation rule and why it should be a key element of long-term organizational change within the U.S. pension system.  The first article highlighted how growth of public pension plans and fundamental legal or regulatory change, when combined with increasing pension portfolio complexity and the current underfunded status of most U.S. public pension plans, will be the forces defining pension evolution in the twenty-first century.  The first article also included an explanation of why the growth of public pension plans and fundamental legal or regulatory change impacted pension plan evolution through the twentieth century.  See “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).  The third article will focus on what the next phase of pension evolution may look like and also highlight how, at least in one area, governance research can be developed to be a true value-added tool for public pension plans and their trustees, potentially guiding the design of their governance structures and investment infrastructures.  The author of this series is Von M. Hughes, a Managing Director at Pacific Alternative Asset Management Company, LLC.

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  • From Vol. 7 No.3 (Jan. 23, 2014)

    Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part One of Three)

    As U.S. pension plans increasingly represent an important and sticky source of assets for hedge fund managers, it is imperative for managers to understand the evolution of pension plan organization and management as well as the legal obligations borne by pension plan trustees when delegating investment decision-making to, among others, hedge fund managers.  Understanding these parameters of prudent delegation can help managers respond more effectively to the needs of pension plans and their trustees, which will be essential in their quest to raise and retain capital from such pension plans.  To aid in this understanding, we are publishing this three-part series addressing the evolution of U.S. pension plan management and governance.  Part one highlights how growth of public pension plans and fundamental legal or regulatory change, when combined with increasing pension portfolio complexity and the current underfunded status of most U.S. public pension plans, will be the forces defining pension evolution in the twenty-first century.  For the reader’s reference, part one also includes, as Appendix A, an explanation of why the growth of public pension plans and fundamental legal or regulatory change impacted pension plan evolution through the twentieth century.  Part two will describe the current governance structures of today’s public pension, focusing on the board of trustees and pension staff; briefly review current governance research about public pension trustees, and the importance of both adequate staff infrastructure and effective delegation as features of good governance; and explain the new delegation rule and why it should be a key element of long-term organizational change within the U.S. pension system.  Part three will focus on what the next phase of pension evolution may look like and also highlight at least how, in one area, governance research can be developed to be a true value-added tool for public pension plans and their trustees, potentially guiding the design of their governance structures and investment infrastructures.  The author of this series is Von M. Hughes, a Managing Director at Pacific Alternative Asset Management Company, LLC.

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    How Can Hedge Fund Managers Managing Plan Asset Funds Comply with the QPAM and INHAM Exemption Requirements?

    Hedge funds that accept investments from pension plans need to be cognizant of the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and its “plan asset” regulations.  Specifically, if a benefit plan investor owns more than 25 percent of any class of a fund’s equity securities, the fund could be deemed a “plan asset fund” subject to ERISA, including its prohibition against transactions with “parties in interest.”  As a result, many managers of plan asset funds rely on an exemption from ERISA’s prohibited transaction rules for “qualified professional asset managers” (QPAM).  A recent panel reviewed the requirements of the QPAM exemption and the related exemption for “in-house asset managers” (INHAM), emphasizing the requirement that INHAMs and certain QPAMs conduct an annual audit of their compliance with the exemptions.  This article summarizes the key take-aways from that discussion.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    First Circuit Holds that Private Equity Fund May Be Liable for Unfunded Pension Obligations of Portfolio Company

    Private equity funds often exercise significant management control over, and effect changes to management and operations of, portfolio companies.  On July 24, 2013, the U.S. Court of Appeals for the First Circuit ruled that, as a result of those “hands on” activities, a private equity fund may constitute a “trade or business” within the meaning of the Employee Retirement Income Security Act of 1974, as amended by the Multiemployer Pension Plan Amendment Act of 1980.  As such, a private equity fund could potentially face liability for the unfunded pension obligations of a portfolio company.

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  • From Vol. 6 No.25 (Jun. 20, 2013)

    What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence On and Negotiate For Investments in Their Funds?

    Pension and other plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) have sought out hedge fund investments as a way of achieving more attractive risk-adjusted returns.  However, ERISA plan trustees must be careful to fulfill their fiduciary duties and comply with other ERISA requirements when investing plan assets in hedge funds.  Because such regulations can be daunting, a recent program provided a roadmap for ERISA plans considering making investments in alternative investment funds.  Specifically, the program provided both general insights into key criteria that ERISA plans consider when evaluating hedge fund managers as well as specific insights concerning the types of provisions that ERISA plans negotiate for in hedge fund subscription documents and side letters.  The program was instructive not only for ERISA plan investors, but also for managers who seek to raise assets from ERISA plan investors.  This article summarizes the key takeaways from the program.  See also “Application of the QPAM and INHAM ERISA Class Exemptions to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 46 (Dec. 6, 2012).

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    How Should Hedge Fund Managers Approach the Identification, Prevention, Detection, Handling and Correction of Trade Errors? (Part Three of Three)

    Trade errors can cause substantial harm to hedge fund managers and their investors.  Such errors can, among other adverse consequences, undermine investors’ confidence in a manager’s trade execution capability; cause a manager to miss investment opportunities; and divert investment and operating resources in the course of correcting errors.  As such, managers, investors and regulators are theoretically aligned in their shared interest in avoiding trade errors.  As a practical matter, however, there is no regulatory roadmap to best practices for trade error prevention, detection and remediation.  SEC guidance has been sparse on this topic; and industry practice has largely filled the vacuum left by the dearth of authority.  Accordingly, in the area of trade errors (as in other areas, such as principal transactions), hedge fund managers are left to divine industry practice – and, further, to conform relevant practice to the specifics of their businesses.  How can hedge fund managers do this?  To begin to answer this hard and multifaceted question, The Hedge Fund Law Report has been publishing a three-part series on preventing, detecting, resolving and documenting trade errors.  This third installment in the series discusses the allocation of losses and gains resulting from trade errors among a manager and its clients; limitations on the allocation of trade error losses; documentation of trade errors; whether managers can obtain insurance to cover losses resulting from trade errors; and common mistakes managers make in handling trade errors.  The first article in the series discussed the challenge of defining a trade error; a manager’s legal obligations relating to the handling of trade errors; and the policies and procedures that managers should consider to prevent, detect, resolve and document trade errors.  See “How Should Hedge Fund Managers Approach the Identification, Prevention, Detection, Handling and Correction of Trade Errors? (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013).  The second article in the series outlined various measures to prevent trade errors; detect trade errors after execution; report trade errors once identified; resolve trade errors; and calculate losses resulting from trade errors.  See “How Should Hedge Fund Managers Approach the Identification, Prevention, Detection, Handling and Correction of Trade Errors? (Part Two of Three),” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).

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  • From Vol. 6 No.9 (Feb. 28, 2013)

    Department of Labor Advisory Opinion Facilitates Continued Access to the Swaps Market by Plan Asset Hedge Funds

    The Dodd-Frank Act established a comprehensive new regime of central clearing and trade execution requirements for certain over the counter swap transactions.  In anticipation of the effectiveness of that new regime, the Securities Industry and Financial Markets Association (SIFMA) requested an advisory opinion from the U.S. Department of Labor (DOL) on the applicability of the Employee Retirement Income Security Act of 1974 (ERISA) to certain elements of the central clearing of swaps entered into by pension plans and other entities deemed to hold “plan assets,” including hedge funds deemed to be “plan asset funds” (ERISA plans).  SIFMA was concerned that margin held by clearing members might be considered “plan assets” and that clearing members might be deemed ERISA fiduciaries or “parties in interest” to an ERISA plan subject to ERISA’s prohibited transaction rules.  In response, the DOL recently issued an advisory opinion (Opinion) addressing these issues.  The Opinion impacts plan asset hedge funds, which are subject to ERISA’s substantive provisions.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).  This article summarizes the Opinion and its implications for ERISA plans, including plan asset hedge funds.

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  • From Vol. 6 No.6 (Feb. 7, 2013)

    Federal Court Opinion Clarifies Two Important Components of the Fiduciary Duty of a Hedge Fund Manager with Benefit Plan Investors

    In a decision of importance to hedge fund managers that have or solicit investments from private pension plans, a federal district court recently analyzed various Employee Retirement Income Security Act (ERISA) issues in connection with a purported class action lawsuit.  The suit was initiated by a pension plan against a manager of a plan assets hedge fund of funds, its managing member, their officers and directors and several funds as a result of losses allegedly caused by an investment in a Ponzi scheme.  Managers of plan asset hedge funds (and in some cases their principals) are subject to heightened regulation pursuant to ERISA, as compared to most hedge fund managers.  For a discussion of regulations impacting plan asset fund managers, see “Speakers at Katten Seminar Outline ERISA Concerns for Managers of Plan Asset Hedge Funds,” The Hedge Fund Law Report, Vol. 5, No. 12 (Mar. 22, 2012); and “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010).  The pension plan claimed that the defendants were “fiduciaries” within the meaning of ERISA and that they had breached two essential duties imposed on them as ERISA fiduciaries: They failed to manage the plan’s assets prudently and caused the plan assets fund to engage in prohibited transactions.  The plan also asserted federal securities fraud, breach of contract, breach of fiduciary duty and various state law claims.  The defendants moved to dismiss the pension plan’s complaint for failure to state a cause of action.  This article summarizes the court’s decision, with emphasis on its analysis of the pension plan’s ERISA claims.

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  • From Vol. 6 No.4 (Jan. 24, 2013)

    K&L Gates Investment Management Seminar Provides Guidance for Hedge Fund Managers on Social Media, Pay to Play Rules, ERISA Rule Changes, AIFMD, SEC Examination and Enforcement Priorities, Form PF, the JOBS Act, CPO Regulation and FATCA

    On December 5, 2012, international law firm K&L Gates held its 2012 Investment Management Conference in New York.  Speakers at the conference provided guidance on various regulatory developments impacting hedge funds, including: the use of social media; pay to play rules; rule changes under the Employee Retirement Income Security Act of 1974 (ERISA) impacting managers of plan assets; the E.U. Alternative Investment Fund Managers Directive (AIFMD); SEC examination and enforcement priorities; Form PF; the JOBS Act; regulation of commodity pool operators (CPOs); and the Foreign Account Tax Compliance Act (FATCA).  This article highlights the key points discussed at the conference on each of the foregoing topics.

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  • From Vol. 5 No.46 (Dec. 6, 2012)

    Application of the QPAM and INHAM ERISA Class Exemptions to Hedge Fund Managers

    The Employee Retirement Income Security Act of 1974 (ERISA) and the plan asset regulations generally provide that when a “benefit plan investor” acquires an equity interest in an entity, other than a public operating company or a registered investment company, all of the assets of that entity are deemed to be “plan assets” subject to ERISA and related provisions of the Internal Revenue Code of 1986 (IRC), unless an exception applies.  However, investments by benefit plan investors in a hedge fund would generally not constitute plan assets (thereby subjecting the hedge fund and its manager to ERISA and related IRC provisions) unless such benefit plan investors own 25% or more of any class of equity securities issued by the fund.  See “Applicability of New Disclosure Obligations under ERISA to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).  Once subject to ERISA, a fund and its manager may not engage in certain specified “prohibited transactions,” including transactions with “parties in interest,” which may include the fund’s brokers and counterparties pursuant to Section 406(a) of ERISA.  Many fund managers rely on a class exemption for funds that are managed by a “qualified professional asset manager” (QPAM).  A recent panel, including participants from FTI Consulting and K&L Gates, reviewed the QPAM exemption and the parallel exemption for an “In-House Asset Manager” (INHAM).  The panel described the conditions for reliance on the QPAM and INHAM class exemptions and also focused on the audit requirement that is an important component of the exemption when a QPAM or INHAM manages its own retirement plan.  This article summarizes the key points from the panel discussion.

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  • From Vol. 5 No.34 (Sep. 6, 2012)

    Federal Court Decision Addresses When an Investment Manager Becomes an ERISA Fiduciary

    Investment advisers that become ERISA fiduciaries because the fund is deemed to be a “plan assets” fund subject to ERISA may also be deemed to be a fiduciary with respect to ERISA plans that are investors in that fund.  A recent federal court decision addresses, among other things, circumstances in which an investment manager constitutes a “fiduciary” for ERISA purposes, and whether an ERISA fiduciary is liable for breaches that occurred before it became a fiduciary.  See “Applicability of New Disclosure Obligations under ERISA to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).

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  • From Vol. 5 No.33 (Aug. 23, 2012)

    How Can Hedge Fund Managers Capture the Upside of ERISA Investments While Mitigating Costs Related to Potential ERISA Liability?

    Generally, if a “benefit plan investor” owns 25 percent or more of any class of equity interests issued by a hedge fund, the fund and its manager will become subject to certain provisions of the Employee Retirement Income Security Act of 1974 (ERISA).  See “Hedge Fund Industry Practice for Defining ‘Class of Equity Interests’ for Purposes of the 25 Percent Test under ERISA,” The Hedge Fund Law Report, Vol. 3, No. 29 (Jul. 23, 2010).  For hedge fund managers, there are benefits and burdens to accepting an investment that will subject them to ERISA.  The chief benefits are that ERISA investors tend to be sizable, serious, long-term investors.  The chief burden is the complex regulatory regime with which ERISA managers must contend, and the consequent expansion of potential liability and administrative and other costs.  See “Applicability of New Disclosure Obligations under ERISA to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).  Hedge fund managers soliciting benefit plan investors therefore seek to capture the upside of ERISA investments while mitigating the potential liability and related costs.  One of the more effective ways in which savvy managers do so is by purchasing fiduciary liability insurance.  But fiduciary liability insurance is a complex product, and structuring an appropriate policy requires an involved legal and business analysis.  The intent of this article is to provide hedge fund managers with a checklist of issues to consider when evaluating the purchase of fiduciary liability insurance and when actually purchasing and structuring such insurance.  In particular, this article details: what fiduciary liability insurance is; the rationale for purchasing such insurance; how such insurance is typically structured; what types of claims and costs are typically covered; the distinction between fiduciary liability insurance and errors and omissions (E&O) coverage; typical premium pricing; the allocation of premiums among management entities and funds; notable fiduciary liability insurance carriers; and the interaction between such insurance and indemnification provisions in manager and fund governing documents.

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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.12 (Mar. 22, 2012)

    Speakers at Katten Seminar Outline ERISA Concerns for Managers of Plan Asset Hedge Funds

    On January 31, 2012, Katten Muchin Rosenman LLP (Katten) hosted a seminar entitled, “25% Solutions: How to Manage ERISA Plan Assets in a Hedge Fund” in New York City.  Speakers at this event addressed: the implications of the Employee Retirement Income Security Act of 1974 (ERISA) for alternative investment fund managers managing plan asset funds; the plan asset regulations and the exception for comingled investment funds with less than 25% ownership by benefit plan investors; how the 25% calculation should be performed; and special concerns for managers managing hedge funds offering different share classes, fund of funds and funds utilizing a master-feeder structure.  This feature-length article summarizes the key points discussed at the seminar on each of the foregoing topics, and provides a self-contained tutorial on ERISA considerations for hedge fund managers.

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  • From Vol. 5 No.9 (Mar. 1, 2012)

    Applicability of New Disclosure Obligations Under ERISA to Hedge Fund Managers

    More and more ERISA-covered benefit plans (especially defined benefit pension plans) are becoming interested in alternative investments, including hedge funds, and assets under management in the hedge fund industry are growing.  The U.S. Department of Labor (DOL) recently reported that the total amount of assets held by private pension plans increased to about $5.5 trillion by the end of the plans’ 2009 plan years (including about $2.2 trillion held by defined benefit pension plans).  Private Pension Plan Bulletin, DOL, Employee Benefits Security Administration (2011).  (The DOL’s numbers do not include the amount of assets in public pension plans and individual retirement accounts.)  And a recent survey conducted by Credit Suisse found that assets under management in hedge funds globally are on track to reach $2.13 trillion by the end of 2012.  Given these numbers and trends, hedge fund managers are increasingly likely to consider marketing their funds to benefit plans as investment opportunities.  However, if ERISA-covered benefit plans (and certain other tax-exempt retirement vehicles) own 25% or more of any class of equity interest in a hedge fund, an undivided portion of all of the underlying assets of the hedge fund becomes “plan assets” subject to ERISA, and the manager of the hedge fund becomes a fiduciary under ERISA to the ERISA-covered benefit plan investors.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010).  This raises a number of issues for such a “covered” hedge fund manager.  One of those issues that will arise this year for the first time is a final rule released by the DOL on February 2, 2012 under ERISA §408(b)(2) regarding fee disclosures by service providers to ERISA plans.  In a guest article, Fred Reish, Bruce Ashton and Gary Ammon, all Partners in the Employee Benefits & Executive Compensation Group at Drinker Biddle & Reath LLP, analyze, with respect to the final rule under ERISA §408(b)(2): covered plans; covered service providers; covered services; disclosure requirements; the effective date for compliance; the definition of compensation for purposes of the rule; how to handle changes in information or status; disclosure errors; and related topics.  This article is relevant to hedge fund managers that have ERISA investors or are considering marketing to such investors.

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  • From Vol. 4 No.41 (Nov. 17, 2011)

    U.S. District Court Evaluates FINRA Arbitration Decision in High-Stakes Severance Dispute Between UBS and Former Portfolio Manager

    Plaintiff Stephen P. Finkelstein (Finkelstein) was a portfolio manager for Dillon Read Capital Management (Fund), a hedge fund operated and owned by defendants UBS Global Asset Management (US) Inc. and UBS Securities LLC (together, UBS).  In early 2007, Finkelstein received a bonus in the amount of $25 million based on the Fund’s 2006 performance.  During the financial crisis that unfolded during 2007, the Fund showed losses of more than $300 million attributable to Finkelstein’s trades.  Finkelstein’s trading authority was suspended.  UBS closed the Fund and eventually terminated Finkelstein.  UBS had an ERISA-governed severance plan in place and adopted a “Supplemental Program” for Fund employees who might not otherwise be eligible for bonuses due to the timing of the Fund’s closure.  Eligible employees could receive a bonus equal to 25% of their 2006 bonus.  Finkelstein put in a claim for a bonus in the amount of $6.25 million, which UBS denied based on the huge trading losses incurred by the Fund as of April 2007.  Finkelstein submitted the claim to arbitration through FINRA Dispute Resolution.  The arbitration panel denied his claim.  Finkelstein then commenced an action in U.S. District Court seeking to overturn the arbitration decision.  We summarize the District Court’s decision with respect to Finkelstein’s claim and the Court’s legal analysis.

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  • From Vol. 4 No.6 (Feb. 18, 2011)

    Department Of Labor Defers Until 2012 Effective Date of New ERISA Regulations on Fee Disclosure That Can Impact Hedge Funds That Have or Target Private Pension Funds and Other ERISA Investors

    The exemption under Section 408(b)(2) of ERISA from ERISA’s prohibited transaction rules permits a service provider to an employee benefit plan (including a hedge fund manager) to receive “reasonable compensation” for “necessary” services under a “reasonable” arrangement.  Regulations of the U.S. Department of Labor (DOL) promulgated in 1977 elaborated on the circumstances in which the exemption would be available.  Much has happened since 1977, and there have been recent comprehensive legislative and regulatory proposals to address the level of fee-related disclosure available to fiduciaries and plan participants and beneficiaries.  On the regulatory side, the DOL recently made extensive revisions to the compensation-related information that plan administrators are required to report annually on the “Form 5500,” and has previously issued proposed regulations that would affect the disclosure of fees charged in connection with participant-directed “401(k)” and other plans.  On Form 5500, see “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA's More Onerous Prohibited Transaction Provisions? (Part Two of Three),” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  Following its 2007 release of a controversial set of proposed Section 408(b)(2) regulations, on July 16, 2010, the DOL issued long-awaited interim final regulations under Section 408(b)(2) requiring increased disclosure of compensation in the case of certain services to pension plans.  Under the new regulations, where they are applicable, an arrangement for providing services to a pension plan will be treated as “reasonable” only if the service provider discloses to the plan specified compensation-related information.  See “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 33 (Aug. 20, 2010).  The effective date of the new regulations was scheduled to be July 16, 2011.  However, on February 11, 2011, the DOL announced that it intends to extend the applicability date for the new disclosure rules under Section 408(b)(2) to January 1, 2012.

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  • From Vol. 3 No.43 (Nov. 5, 2010)

    Implications of the DOL’s Proposed Expanded Definition of “Fiduciary” for Hedge Fund Managers, Placement Agents, Valuation Firms and Pension Consultants

    On October 22, 2010, the Department of Labor’s Employee Benefits Security Administration proposed rule amendments that would considerably expand the definition of “fiduciary” for purposes of the Employee Retirement Income Security Act of 1974, as amended (ERISA).  Under current regulation, a person can be deemed a fiduciary for ERISA purposes by reason of rendering investment advice if the person meets a five-part test.  The proposed amendments would replace that five-part test with a two-part test.  Generally, the new two-part test would be easier to satisfy – that is, would capture a wider range of entities and activities – than the old five-part test.  Thus, under the new rule, more entities would qualify (often involuntarily) as ERISA fiduciaries and thereby become subject to a range of duties, at least one of which (the duty of prudence) has been characterized by courts as the “highest known to the law.”  According to the preamble to the proposed rule release in the Federal Register, the DOL proposed the new rule for two primary reasons: to address purported changes in relationships between investment advisers and employee benefit plan clients occasioned by the increasing complexity of investment products and services, and to more efficiently allocate its enforcement resources.  The investment management industry has already voiced skepticism with respect to both rationales.  Regarding the first, commentators have suggested that while investment products and services have become more complex, the fundamental nature of investment advisory relationships has not changed in the 35 years since the current regulation was put in place.  Regarding the second, commentators have suggested that the DOL’s enforcement efforts may be largely moot because if the amendments become effective in their proposed form, many financial services firms – notably, broker-dealers, valuation agents and placement agents – may cease offering services directly or indirectly to employee benefit plans.  Surprisingly, the DOL appears to be cognizant of the potential adverse business consequences of its proposed amendments.  In the rule release, the DOL noted that “plan service providers that fall within the Department’s rule might experience increased costs and liability exposure associated with ERISA fiduciary status.  Consequently, these service providers might charge higher fees to plan clients, or limit or discontinue the availability of their services or products to ERISA plans.”  However, the DOL apparently determined that the benefits of increased enforcement efficiency and a more pervasive fiduciary duty are worth increasing the costs and reducing the choices available to plans.  This article explores the implications of the proposed rule amendments for four categories of hedge fund industry participants: hedge fund managers, placement agents, valuation firms and pension consultants.  The article concludes that the amended rule would have a limited effect on most hedge fund managers, and a potentially direct and adverse effect on placement agents, valuation firms and pension consultants.  However, the proposed amendments also contain exceptions – and this article explains how various hedge fund industry participants may use those exceptions to avoid undesired characterization as an ERISA fiduciary.

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  • From Vol. 3 No.41 (Oct. 22, 2010)

    U.S. District Court Allows ERISA and Federal Securities Fraud Claims to Proceed Against Hedge Fund Manager Beacon Associates, Investment Adviser Ivy Asset Management and Pension Manager J.P. Jeanneret Associates

    From 1995 through 2008, hedge fund Beacon Associates (Beacon) fed approximately 71 percent of its assets, or about $164 million, to Bernard L. Madoff Investment Securities LLC.  By the time Madoff’s scheme collapsed, Beacon had withdrawn only $26 million.  The Plaintiffs in this action are Beacon investors who claim that the Defendants violated various federal and state securities laws, state common law and the Employee Retirement Income Security Act (ERISA).  The Defendants include investment adviser Ivy Asset Management, LLC (Ivy) and its principals, Bank of New York, which acquired Ivy in 2000, Beacon and its principals, Beacon’s auditor, pension adviser J.P. Jeanneret Associates (JPJA) and JPJA’s principal.  The Defendants moved to dismiss all of the Plaintiffs’ claims.  The District Court permitted certain federal securities fraud claims to proceed against Ivy, Beacon, JPJA and their respective principals, permitted certain ERISA claims for breach of fiduciary duties of loyalty and prudence to proceed against those same Defendants and dismissed the remainder of the complaint.  We summarize the Court’s decision with emphasis on the Court’s ERISA analysis.

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  • From Vol. 3 No.39 (Oct. 8, 2010)

    U.S. District Court Allows ERISA Claims for Breach of Fiduciary Duties to Proceed Against Pension Fund’s Investment Advisers

    Plaintiffs are participants in the Inductotherm Companies Master Profit Sharing Plan (Plan).  Their Complaint, arising out of poor performance of the Plan, alleges 22 separate claims against three sets of defendants: (i) Inductotherm Industries, Inc. and the Plan’s trustees, (ii) investment managers Financial Services Corporation, its wholly-owned subsidiary FSC Securities Corporation (FSC Securities) and the Wharton Business Group (Wharton), and (iii) American International Group (AIG) and certain SunAmerica companies, all of which were alleged to be affiliated with SunAmerica Money Market Fund, in which certain Plan assets were invested.  AIG is also the parent corporation of Financial Services Corporation.  The Complaint includes sixteen claims under the Employee Retirement Income Security Act (ERISA) for breach of fiduciary duties, two common law claims of fraudulent concealment, three claims involving violations of federal and state laws regulating securities, and a claim under the Racketeer Influenced and Corrupt Organizations Act (RICO).  See “Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 33 (Aug. 20, 2010); “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).  In a decision that sheds light on how hedge funds that have pension fund investors might fare in lawsuits arising out of poor performance, the District Court held that FSC Securities and Wharton were plan fiduciaries and that the Complaint against them stated valid causes of action for violations of ERISA.  We summarize the Court’s decision, with emphasis on the investment manager defendants.

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  • From Vol. 3 No.36 (Sep. 17, 2010)

    Three Significant Legal Pitfalls for Hedge Fund Marketers, and How to Avoid Them

    Until recently, the generally held perception was that the worst a hedge fund marketer could do is fail to raise money.  But then came the credit crisis, a raft of new regulations, a newly enlarged and invigorated SEC and a tectonic shift in the hedge fund investor base in favor of more public and private pension funds and other retirement plans.  In this fraught new operating environment, hedge fund marketers can do more than fail to benefit the fund: they can affirmatively harm the fund and manager.  In particular, marketers can, in different contexts: jeopardize fees; render ideal investors off-limits; subject a manager to complex regulatory schemes from which the manager would otherwise be exempt; and give investors the right to rescind their investments.  This article details three significant legal pitfalls that can give rise to these and other harms, and suggests ways to avoid them.

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  • From Vol. 3 No.33 (Aug. 20, 2010)

    Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds

    Given the ever-increasing levels of investment from pension plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) in hedge funds, ERISA considerations can be significant for fund sponsors and managers, and for other service providers to hedge funds and other private funds.  Sometimes, ERISA issues can rise to the level of being significant business considerations.  The exemption under Section 408(b)(2) of ERISA from ERISA’s prohibited transaction rules permits a service provider to an employee benefit plan to receive compensation for the services in the case of “reasonable compensation” for “necessary” services under a “reasonable” arrangement.  Regulations of the U.S. Department of Labor (the “DOL”) promulgated in 1977 had elaborated on the circumstances in which the exemption would be available.  Much has happened since 1977, and there have been recent comprehensive legislative and regulatory proposals to address the level of fee-related disclosure available to fiduciaries and plan participants and beneficiaries.  On the regulatory side, the DOL recently made extensive revisions to the compensation-related information that plan administrators are required to report annually on the “Form 5500,” and has previously issued proposed regulations that would affect the disclosure of fees charged in connection with participant-directed “401(k)” and other plans.  Following its 2007 release of a controversial set of proposed Section 408(b)(2) regulations, the DOL has now issued long-awaited interim final regulations under Section 408(b)(2) requiring increased disclosure of compensation in the case of certain services to pension plans.  Under the new regulations, where they are applicable, an arrangement for providing services to a pension plan will be treated as “reasonable” only if the service provider discloses to the plan specified compensation-related information.  Notwithstanding the major changes from the 2007 proposals, and arguably reflecting the urgency with which the DOL views these issues, the new regulations are not in reproposed form, but rather are interim final regulations.  The effective date of the new regulations is, however, generally delayed until July 16, 2011.  (It is noted that the new regulations do not apply to “welfare” plans, and that future regulations are expected that would address welfare plans.  The new rules also do not apply to individual retirement accounts and similar arrangements.)  Once the rules become effective, they will apply both to future arrangements as well as to arrangements then already in place.  A failure to meet the requirements for the Section 408(b)(2) exemption could cause the payment of compensation to a provider of services to an employee benefit plan to be a prohibited transaction under ERISA and the corresponding provisions of the U.S. tax code.  The consequences of a prohibited transaction can be extremely significant, including, for example, punitive excise taxes, the possibility of fee disgorgement and other potential liabilities on the service provider.  Thus, it may be critical that fiduciaries and other service providers subject to the new rules be in compliance with the new regulations, once they are applicable.  In a guest article, Andrew L. Oringer, a Partner at Ropes & Gray LLP, and Steven W. Rabitz, a Partner at Stroock & Stroock & Lavan LLP, provide a sampling of some of the issues that may be of particular interest to fund sponsors.

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  • From Vol. 3 No.32 (Aug. 13, 2010)

    Dodd-Frank May Impose New Obligations on Managers of Large Hedge Funds and Plan Asset Hedge Funds that Enter into Swaps

    Placement agents, in-house marketers, data providers and others interviewed by The Hedge Fund Law Report have identified two salient trends in the current hedge fund capital raising environment: the “race to the top” and the growing importance of ERISA money.  As discussed below, both trends highlight the importance to the hedge fund industry of a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank or the Act), enacted on July 21, 2010, relating to swaps with “special entities.”  On the first trend: The race to the top refers to the fact – good for larger managers, not so good for smaller and start-up managers – that the lion’s share of recent inflows have gone to the largest hedge funds.  According to data provider Hedge Fund Research, Inc., 93 percent of the $9.5 billion of net inflows into hedge funds in the second quarter of 2010 went to funds managed by managers with more than $5 billion in assets under management (AUM).  And that capital raising advantage is only enhancing the current distribution of assets in favor of larger managers.  According to HFR, as of June 30, 2010, managers with $5 billion or more in AUM managed approximately 60 percent of total industry assets of $1.6 trillion.  Moreover, HFR data as of June 30 showed that while 342 hedge funds with $1 billion or more in AUM comprised just 4.9 percent of the total number of hedge funds globally, they accounted for 76.1 percent of total industry AUM.  While a full analysis of the reasons for this race to the top is beyond the scope of this article, a few of the reasons are discussed herein.  However, investors racing to the top may miss many of the more interesting hedge fund investment opportunities.  According to research published by PerTrac Financial Solutions in February 2007 and updated to incorporate 2009 data, smaller, younger hedge funds appear to perform better, over longer periods, than larger, older funds.  And on the second trend: The Hedge Fund Law Report has and continues to analyze the growing importance of ERISA investors in hedge funds.  See, for example, The Hedge Fund Law Report’s three-part series on ERISA considerations for hedge fund managers and investors.  The story here is essentially as follows: private sector pension funds are the most important category of ERISA investor.  According to data provider Preqin, as of late 2009, private sector pension funds represented 14 percent of institutional investors in hedge funds and constituted the largest group of investors actively considering their first investment in hedge funds in 2010.  Moreover, survey data released by Preqin on August 10, 2010 indicates that 29 percent of institutional investors plan to allocate more capital to hedge funds in the next 12 months while just 15 percent are looking to redeem, meaning the balance of inflows into hedge funds over the next year is expected to be positive.  Preqin also found that 37 percent of institutional investors are planning to invest in new hedge funds in the next 12 months.  Many of those new investments, often with new managers, will come from private sector pension funds and other ERISA investors.  Accordingly, more hedge fund managers (by number and AUM) will become subject to ERISA in the near term.  In anticipation of that trend, we have provided managers with a roadmap for accepting ERISA money without materially undermining their investment and operational discretion.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).  In light of the importance of the race to the top and ERISA money to hedge fund capital raising, any legal provision that directly impacts larger hedge funds and hedge funds subject to ERISA (Plan Asset Hedge Funds) is of central importance to the industry.  Dodd-Frank contains precisely such a provision.  Specifically, Dodd-Frank will require a “swap dealer” or “major swap participant” that enters into a swap with a “special entity” to: (1) have a reasonable basis to believe that the special entity has an independent representative that, among other things, has sufficient knowledge to evaluate the transaction and risks; and (2) comply with certain business conduct standards.  As explained more fully below, the definition of “major swap participant” in Dodd-Frank may include large hedge funds, and the definition of “special entity” in Dodd-Frank may include Plan Asset Hedge Funds.  See “Hedge Fund Industry Practice for Defining ‘Class of Equity Interests’ for Purposes of the 25 Percent Test under ERISA,” The Hedge Fund Law Report, Vol. 3, No. 29 (Jul. 23, 2010).  To help explain the application of this “swaps and special entities” provision of Dodd-Frank to hedge fund managers, swap dealers and others, this article: defines the relevant terms, including a discussion of the extent to which those definitions may include hedge funds and hedge fund managers; offers examples of applications of the special entities provision in the hedge fund context; explains the mechanics of the “reasonable basis test” included in the statute; describes the business conduct standards; then analyzes the elements of the statutory reasonable basis test, including a potential “de facto best execution” standard included in the test.

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  • From Vol. 3 No.29 (Jul. 23, 2010)

    Hedge Fund Industry Practice for Defining “Class of Equity Interests” for Purposes of the 25 Percent Test under ERISA

    The Hedge Fund Law Report recently published a three-part series on ERISA considerations for hedge fund managers and investors.  The first part of that series explained how hedge funds and their managers can become subject to ERISA; the second part of the series detailed consequences to hedge funds and their managers of becoming subject to ERISA; and the third part provided a roadmap to the prohibited transaction exemptions that enable hedge fund managers to both accept significant ERISA investors in their funds, and operate and invest without many of the constraints imposed by ERISA.  The first article in the series noted that the general rule under ERISA is that when a “benefit plan investor” acquires an equity interest in an entity, other than a public operating company or a registered investment company, all the assets of that entity are deemed to be “plan assets” subject to ERISA, unless an exception applies.  ERISA generally provides three exceptions, one of which – the 25 percent test – is typically relied on by hedge funds.  Under the 25 percent test, if benefit plan investors own less than 25 percent of any class of equity interests issued by a hedge fund, that hedge fund and its manager will not be subject to ERISA.  Accordingly, a threshold question to be addressed by any hedge fund manager that currently has ERISA investors in its funds or is considering accepting investments from ERISA investors is: What constitutes a “class of equity interests” for ERISA purposes?  ERISA does not define the phrase, and the Department of Labor has only defined an “equity interest” as an interest other than debt.  Therefore, like many questions under ERISA, the working definition of class of equity interests is a function of market practice.  The first article in our ERISA series included a survey of market practice on this point as part of a broader discussion.  But in light of the importance of the definition to any ERISA analysis, and in light of the importance of ERISA analysis to hedge fund capital-raising, this article drills down even further on market practice in this area.  Specifically, this article first examines the approaches, concerns and frameworks used by practitioners to define a class of equity interests.  We describe the “conservative” and “broad” views, and identify specific factors relied on by practitioners.  The article then examines whether certain nonintuitive arrangements may constitute a class of equity interests for ERISA purposes, including side letters, side pockets, managed accounts, single investor hedge funds (or “funds of one”), investments (directly or via IRAs) by manager principals and employees and seeding arrangements.  See “Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors,” The Hedge Fund Law Report, Vol. 3, No. 16 (Apr. 23, 2010).

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  • From Vol. 3 No.24 (Jun. 18, 2010)

    How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three)

    This is the third of three articles in a series intended to acquaint – or reacquaint – hedge fund managers, investors, service providers and others with the basic principles and prohibitions of, and exemptions from, the Employee Retirement Income Security Act of 1974 (ERISA).  The first article in this series explained how hedge fund managers can become – or avoid becoming – subject to ERISA.  That article focused primarily on the “25 percent test,” which generally provides that if benefit plan investors (e.g., corporate pension funds) own less than 25 percent of any class of equity interests issued by a hedge fund, the hedge fund manager will not be subject to ERISA.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010).  The second article in the series detailed the consequences to a hedge fund manager of becoming subject to ERISA, which can happen, for example, if a large non-ERISA investor redeems, causing the proportionate ownership of benefit plan investors to exceed 25 percent of a class of equity interests.  Those consequences most notably include the imposition of a heightened fiduciary duty and a prohibition on many transactions between the hedge fund and “parties in interest” to a benefit plan invested in the hedge fund.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Two of Three),” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  As that second article noted, ERISA’s list of prohibited transactions is so long, and ERISA’s definition of “party in interest” (and the parallel definition of “disqualified person” under the Internal Revenue Code) so expansive, that strict compliance by investment managers with ERISA’s prohibited transaction provisions would undermine the basic purpose of ERISA; broadly, that purpose is to ensure the ethical, unconflicted and competent management of retiree money.  Accordingly, Congress (by statute) and the Department of Labor (by regulation and other action) have created a series of exemptions from the prohibited transaction provisions.  These exemptions enable a hedge fund to accept investments from benefit plan investors above the 25 percent threshold and to engage in many transactions that otherwise would be prohibited by ERISA.  That is, many hedge fund managers heretofore have taken the view that a fund can have significant ERISA money or a manager can have unfettered investment discretion, but not both.  But the prohibited transaction exemptions, properly understood and implemented, come close to reconciling that dichotomy.  To assist hedge fund managers in obtaining ERISA assets while retaining investment discretion, this article provides a comprehensive roadmap to the prohibited transaction exemptions most relevant to hedge fund managers.  Specifically, this article discusses: ERISA’s definition of “party in interest”; prohibited transactions under ERISA by category; typical hedge fund transactions that would (absent statutory and regulatory relief) be prohibited by ERISA; the conditions required to be satisfied for a hedge fund manager to qualify as a qualified professional asset manager (QPAM); the impact of the financial regulation overhaul bills on hedge fund managers’ eligibility for the QPAM exemption; the conditions required to be satisfied for a transaction to be eligible for the QPAM exemption; the impact of ERISA’s anti-self-dealing provisions on the timing of disposition of investments in private equity funds and hybrid funds; the service provider exemption; the eleven conditions that must be satisfied for performance compensation to comply with ERISA; the cross trading exemption; the foreign exchange transaction exemption; the electronic communication networks exemption; the block trading exemption; individual exemptions, including a discussion of a recent individual exemption granted to Ivy Asset Management Corporation in connection with a proposed sale of shares of offshore hedge funds owned by a hedge fund of funds; and a provocative provision included in the Restoring American Financial Stability Act of 2010, passed by the U.S. Senate on May 20, 2010, that threatens to undermine the ability of certain hedge funds to enter into swaps with prime brokers.

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  • From Vol. 3 No.20 (May 21, 2010)

    How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA's More Onerous Prohibited Transaction Provisions? (Part Two of Three)

    This is the second article in a three-part series of articles we are doing on ERISA considerations in the hedge fund context.  Specifically, the first article in this series dealt with how hedge funds and their managers can become − and avoid becoming − subject to ERISA.  See "How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA's More Onerous Prohibited Transaction Provisions? (Part One of Three)," The Hedge Fund Law Report, Vol. 3, No. 19 (May 14, 2010).  This article deals with the consequences to hedge funds and their managers of becoming subject to ERISA.  And the third article will detail strategies for accepting investments from "benefit plan investors" above 25 percent of any class of equity interests issued by a hedge fund while avoiding many of the more onerous prohibited transaction provisions and other restrictions imposed by ERISA.  In short, the structure of this series is: application, implications, avoidance.  As explained in the first article, the occasion for this series is the gulf between forecasts and experience with respect to inflows into hedge funds globally.  Forecasts suggest that the rate of new investments into hedge funds should be increasing, but experience suggests that fundraising remains a primary challenge for many hedge fund managers, even seasoned managers with good track records.  We think that one explanation for this gulf may involve the nature of the anticipated new assets: many of those assets are likely to come from U.S. corporate pension funds.  Such investors generally employ a long and conscientious pre-investment due diligence process, or from the hedge fund perspective, involve a longer sales cycle.  But when they invest, they invest for the long term.  That is, we think those new assets are out there, and are moving slowly and carefully into hedge funds, focusing on a wider range of considerations when allocating capital, including considerations beyond track record such as transparency, liquidity, risk controls, regulatory savvy and other "non-investment" criteria.  (Most hedge fund blowups have been the result of operational rather than investment failures.)  U.S. corporate pension funds are the quintessential ERISA investor.  Therefore, when competing for allocations from U.S. corporate pension funds, facility with the contours of ERISA (it's an infamously byzantine statute) will be a competitive advantage for hedge fund managers.  The purpose of this series of articles is to help hedge fund managers hone that competitive advantage.  If a hedge fund comes within the jurisdiction of ERISA, the hedge fund and its manager become subject to a series of new obligations and limitations that otherwise would not apply.  Most notably on the obligations side, the manager becomes subject to a more particularized fiduciary duty standard than is imposed by the Investment Advisers Act or Delaware law.  And most notably on the limitations side, the hedge fund (which is deemed to constitute "plan assets" for ERISA purposes) is prohibited from engaging in a series of transactions with so-called "parties in interest."  This article explains the ERISA-specific fiduciary duty, as well as ERISA's per se prohibited transactions, in greater detail.  In addition, on the obligations side, this article details the unique ERISA reporting regime, focusing on the Department of Labor's (DOL) Form 5500 Schedule C (including a discussion of reporting requirements with respect to direct compensation, indirect compensation, eligible indirect compensation and gifts and entertainment); and custody and bonding requirements.  And on the limitations side, this article discusses, in addition to prohibited transactions, limitations imposed on hedge funds and managers with respect to: performance fees; cross trades; principal trades; soft dollars; affiliated brokers; securities issued by the employer who sponsors the relevant ERISA plan; expense pass-throughs; indemnification and exculpation; and placement or finders' fees (and related "pay to play" considerations).  Finally, this article discusses the broad reach of liability and the penalties that may be imposed for violations of ERISA's obligations or limitations, and the cure provisions available for certain breaches.  While this article outlines a seemingly oppressive set of consequences flowing from application of ERISA to a hedge fund and manager, it should be noted that the third article in this series will strike a considerably more optimistic note.  The list of prohibited transactions under ERISA is so long, and the definition of party in interest so broad, that literal compliance with ERISA would actually run contrary to the intent of ERISA, which is to protect retiree money.  That is, a hedge fund manager or other investment manager forced to comply with all of the investment and operational prohibitions of ERISA would not be able to effectively serve the interests of benefit plan investors.  Recognizing this, the DOL has promulgated an extensive series of "class exemptions" that provide relief from the prohibited transaction and other provisions of ERISA, and the DOL from time to time also provides individual exemptions (similar to the SEC's no-action letter process).  Those categories of relief will be the subject of the third article in this series.

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  • From Vol. 3 No.19 (May 14, 2010)

    How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA's More Onerous Prohibited Transaction Provisions? (Part One of Three)

    The hedge fund industry is at an interesting juncture.  Various studies suggest that assets under management (AUM) by hedge funds globally are poised to rebound dramatically from their 2009 nadir over the coming four years and beyond.  For example, an April 2010 survey by Credit Suisse's Prime Services business of institutional investors representing approximately $1 trillion projected that the hedge fund industry will grow from an estimated $1.64 trillion in AUM at the end of 2009 to $1.97 trillion by the end of 2010.  Similarly, an April 2009 survey by BNY Mellon and Casey Quirk forecast that global hedge fund AUM would reach $2.6 trillion by the end of 2013.  At the same time, we at The Hedge Fund Law Report have talked to an appreciable number of hedge fund managers − including startup managers and established managers with admirable track records − who have noted that the fundraising environment remains challenging.  In other words, a significant volume of assets is poised to move into (in some cases, back into) hedge funds, but that move has just begun.  Why this disjunction between survey results (suggesting large imminent inflows) and anecdotal evidence on the ground (suggesting that those inflows remain in the offing)?  One answer may be the nature of the new or returning investors.  According to the BNY Mellon-Casey Quirk study and other studies, a substantial portion of the near-term net inflows are expected to come, directly or via funds of funds, from corporate pension funds and other institutional investors subject to the Employee Retirement Income Security Act of 1974 (ERISA).  This is patient, judicious and sticky money: ERISA investors generally engage in lengthy and rigorous due diligence and take a relatively long time to make an investment decision.  But once they invest, they tend to stick around.  In short, the gulf between projected and actual inflows into hedge funds is consistent with survey findings suggesting that ERISA investors will comprise a growing proportion of an increasing hedge fund asset base, and it is consistent with the deliberate investment approach of many ERISA investors.  One key take-away for hedge fund managers who want a piece of the new asset pie: avoiding ERISA may no longer be a viable option.  However, the purpose of this article (and two companion articles to follow) is to illustrate why becoming subject to ERISA may no longer be such a bad outcome.  That is, heretofore, hedge fund managers generally have balanced the fee and long-term commitment benefits of accepting "substantial" ERISA investments, on the one hand, with the operational and investment restrictions and compliance and administrative burdens imposed by ERISA, on the other hand.  Many managers have concluded that the burdens outweigh the benefits, and thus have scrupulously kept investments by benefit plan investors below 25 percent of any class of equity interests issued by their hedge funds, thereby avoiding application of ERISA.  However, a robust list of "class exemptions" from the prohibited transaction provisions and other restrictions of ERISA offers to mitigate the operational and investment burdens imposed by ERISA on hedge fund and managers.  Notably, the Qualified Professional Asset Manager (QPAM) exemption and the service provider exemption permit hedge fund managers to engage in many transactions that otherwise would be prohibited by ERISA.  In short, the various class exemptions enable a hedge fund manager to exceed the 25 percent threshold while avoiding many of the more onerous provisions of ERISA.  If The Hedge Fund Law Report were inclined to use cute titles, we might have called this article series: "Class Exemptions or: How I Learned to Stop Worrying and Love ERISA."  As indicated, this article is the first in a three-part series.  This article discusses the general rules under ERISA, the plan asset regulations thereunder and relevant sections of the Internal Revenue Code (IRC) governing when a hedge fund may be deemed to hold plan assets thereby subjecting the fund and its manager to ERISA.  Importantly, this article also discusses the three exceptions to the general rule, focusing on the one exception typically relied upon by hedge funds to remain outside of the ambit of ERISA: the 25 percent test.  In particular, this article provides detail on the definition of "benefit plan investor," and how that definition was narrowed (and thus how hedge fund ERISA capacity was expanded) by the Pension Protection Act of 2006 (PPA); the treatment by a hedge fund of benefit plan investors in hedge funds of funds or insurance company general accounts that invest in the hedge fund; the formula for calculating the percentage ownership of benefit plan investors; the treatment of investments by manager personnel when calculating that formula; the potentially counterintuitive method of defining a "class" of equity interests for ERISA purposes, including discussions of the implications in this context of side pockets and side letters; when and how to recalculate the 25 percent test; the interaction of the 25 percent test and secondary market transfers of hedge fund interests; and disclosure and mandatory redemption considerations.  The second article in this series, to be published in next week's issue of The Hedge Fund Law Report, will discuss the most important consequences to a hedge fund manager of becoming subject to ERISA and the repercussions for a hedge fund manager of violating the fiduciary duty, prohibited transactions or other provisions of ERISA.  And the third article in this series will detail ten class exemptions and other exemptions that hedge fund managers may use to avoid the various operating and investment restrictions of ERISA, as well as potential changes to ERISA and the rules thereunder.

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  • From Vol. 2 No.27 (Jul. 8, 2009)

    Class Action Suit Against Hedge Fund that Invested in Madoff Feeder Fund Highlights the Standard of Care to which ERISA Fiduciaries are Held

    On February 12, 2009, the Pension Fund for Hospital and Health Care Employees (Fund) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Austin Capital Management Ltd. (Austin) for millions of dollars of losses due to allegedly improper investments in securities controlled by Bernard L. Madoff and his company.  Specifically, the complaint claimed that Austin “directed significant amounts of investment, estimated at present to be $184 million, into Madoff-related securities, virtually all of which were lost when the Ponzi scheme became known in December 2008.”  As a result, the complaint alleged that Austin failed to prudently invest the Fund’s assets, in violation of the Employee Retirement Income Security Act of 1974 (ERISA).  Then, on June 12, 2009, Spector Roseman Kodroff & Willis, P.C. (SRKW), a Philadelphia-based law firm, filed a second class action against Austin for more losses due to improper investments in securities controlled by Madoff.  This suit, brought on behalf of the Pittsburgh-based Board of Trustees of the Steamfitters Local 449 Retirement Security Fund and a nationwide class of similar funds, similarly alleged that Austin failed to prudently invest the benefit funds’ assets, in violation of ERISA.  These class actions are two of the many suits that have been brought in recent months against the “feeder funds” that contributed to Madoff’s Ponzi scheme, or funds that invested in such feeder funds.  The case highlights three issues relevant to hedge funds: (1) the question of when an alleged class of plaintiffs bringing suit against a hedge fund will be certified by a court; (2) the standard of care applicable to ERISA fiduciaries; and (3) the standard for consolidation and transfer of MDL cases.  The article analyzes each of those issues in detail.

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  • From Vol. 2 No.19 (May 13, 2009)

    401(k) Plans Offer a Powerful Distribution Channel for Hedge Fund Managers Willing to Tackle ERISA, Liquidity and Non-Discrimination Concerns

    Traditionally, the investment options available to participants in 401(k) plans have been staid and sleepy, consisting primarily of stock and bond mutual funds, money market funds and similar products.  However, since around 2005, 401(k) plan sponsors have been offering hedge funds or hedge fund strategies as alternative investment options for plan participants.  Inclusion of hedge funds can benefit both sides.  For participants, it can expand the range of investment and diversification opportunities.  For hedge fund managers, it can offer a potentially far-reaching distribution channel and access to a large and largely untapped market.  But offering hedge funds in 401(k) plans raises legal and practical issues, for both hedge fund managers and plan sponsors.  On the legal side, hedge fund managers are concerned that the 401(k) plan or its participants can be construed by the Department of Labor as “benefit plan investors.”  If such investors hold more than 25 percent of any class of equity interests offered by one of the manager’s funds, the manager can be subject to the Employee Retirement Income Security Act of 1974 (ERISA).  Plan sponsors have to contend with non-discrimination rules, which generally require participants at different income levels in the same plan to receive the same investment options.  At many companies, certain employees would qualify as “accredited investors” and “qualified purchasers,” and thus would be eligible to invest in most hedge funds, while other employees would not qualify.  Plan sponsors that wish to offer hedge funds have to figure out how to do so without discriminating against the employees who would not qualify, outside of the plan, to invest in hedge funds.  Plan sponsors also have to be cognizant of unrelated business taxable income issues.  On the practical side, hedge fund managers and plan sponsors have to contend with potential discrepancies in the liquidity offered to plan participants and investors in the relevant hedge fund.  This article explores structures and approaches being used by plan sponsors and hedge fund managers to address or mitigate the various legal and practical hurdles involved in including hedge funds or hedge fund strategies in 401(k) plans.  In the course of our discussion, we offer specific strategies for addressing ERISA concerns and the liquidity mismatch between 401(k) plans and most hedge funds, and thereby provide the beginning of a roadmap for managers interested in vastly expanding the scope of their distribution into retail or quasi-retail channels.

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  • From Vol. 2 No.2 (Jan. 15, 2009)

    Impact of Hedge Fund Redemptions Under ERISA

    Many hedge funds avoid regulation under the Employee Retirement Income Security Act of 1974, as amended, by maintaining participation by “benefit plan investors” below 25% of the value of each class of equity interest issued by the fund.  For such funds, it is important not to lose sight of the requirements for satisfying the 25% test, in light of an unprecedented number of redemption requests due to general turmoil in the financial markets.  In a guest article, Willkie Farr & Gallagher LLP provides timely and important reminders on how to remain in compliance with the 25% test, even in the presence of substantial redemptions by benefit plan investors and non-benefit plan investors.

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  • From Vol. 1 No.9 (Apr. 29, 2008)

    MFA Comments on Proposed Rule Affecting Disclosures Required Under ERISA

    • Proposed rule would require employee benefit plan service providers, such as hedge fund advisers, to disclose information allowing plan fiduciaries to assess the “reasonableness” of provider fees and any potential conflicts of interest.
    • MFA asked the DOL to clarify that the proposed rule does not apply to privately-offered pooled investment vehicles that do not constitute ERISA plan assets.
    • MFA recommended that the rule’s conflict of interest disclosure provision be modified to require disclosure only of objectively material conflicts of which a service provider is aware.
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