The Hedge Fund Law Report

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

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By Topic: Placement Agents

  • From Vol. 10 No.12 (Mar. 23, 2017)

    K&L Gates Program Addresses State and Local Lobbying; Pay to Play; and Gifts and Entertainment Limitations (Part One of Two)

    Private fund advisers that seek investments from public pension plans enter a minefield of federal, state and local rules, and those that think that compliance with the “pay to play” rules under the Investment Advisers Act of 1940 affords sufficient protection may be sadly mistaken. States, municipalities and even individual government pension plans have a wide array of rules regarding lobbying, political contributions and gifts and entertainment. Further, sensitive information provided to public pension plans in the course of the investment management relationship may be subject to disclosure under public records and freedom of information (FOI) laws. A recent program presented by K&L Gates offered valuable insights into those state and local rules. The program featured Cary J. Meer and Ruth E. Delaney, partner and associate, respectively, at K&L Gates; and Eric J. Smith, managing director and deputy general counsel at PineBridge Investments. This article, the first in a two-part series, covers the portions of the program devoted to lobbyist regulation; political contributions; and gifts and entertainment. The second article will discuss state “sunshine” and FOI laws. For additional insight from Meer, see “How Hedge Fund Managers Can Prepare for SEC Remote Examinations (Part Two of Two)” (May 19, 2016); “Practical Guidance for Hedge Fund Managers on Raising Capital in Australia, the Middle East and Asia” (Oct. 30, 2014); and “Impact of CFTC Harmonization Rules on Alternative Mutual Funds and Other Registered Investment Companies” (Nov. 1, 2013).

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  • From Vol. 9 No.43 (Nov. 3, 2016)

    Current Trends in Operational Due Diligence and Background Checks

    Operational due diligence is an important part of the investment process. Investors are concerned not only with a manager’s performance but also with the security and stability of its operations. At the recent Third Party Marketers Association (3PM) 2016 Annual Conference, marketers and operational due diligence professionals offered insights into the types of operational due diligence they conduct and how hedge fund managers can prepare for due diligence inquiries. Although the presentation was geared toward third-party marketers, its lessons apply equally to investors because the process by which a third-party marketer investigates a potential client is analogous to how an investor evaluates a hedge fund manager with which it is considering investing. Introduced by Steven Jafarzadeh and moderated by Mark Sullivan, both managing directors and partners at alternative asset placement agent platform Stonehaven, LLC, the program featured Lauri Martin Haas, founder and principal of operational due diligence firm PRISM LLC, and Kenneth S. Springer, founder and president of business investigations firm Corporate Resolutions Inc. This article highlights the key takeaways from the panel. For coverage of another 3PM annual conference, see “Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation” (Dec. 1, 2011). For additional insight from Springer, see “Can Hedge Fund Managers Use Whistleblower Hotlines to Help Create and Demonstrate a Culture of Compliance?” (Jul. 23, 2010); and “Implications for Hedge Funds of New Whistleblower Initiatives by FINRA and the SEC: An Interview With Kenneth Springer of Corporate Resolutions Inc.” (Mar. 11, 2009).

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  • From Vol. 9 No.40 (Oct. 13, 2016)

    How Developments With California’s Pension Plan Disclosure Law, the SEC’s Rules and FINRA’s CAB License May Impact Hedge Fund Managers and Third-Party Marketers

    Hedge fund managers and many service providers have faced a wave of new regulatory requirements since the 2008 global financial crisis. This is particularly true for third-party marketers engaged by hedge fund managers to solicit clients and fund investors, which may be subject to a barrage of regulations at the federal, state and local level depending on the nature of their business. To explore some of the latest regulatory challenges faced by funds and their marketers, The Hedge Fund Law Report recently interviewed Susan E. Bryant, counsel at Verrill Dana LLP, and Richard M. Morris, partner at Herrick, Feinstein LLP. This article sets forth the participants’ thoughts on a host of issues, including new disclosure requirements for state pension plan investors; recent enforcement trends; and new rules adopted by the SEC, FINRA, Municipal Securities Rulemaking Board (MSRB) and state regulators. On Thursday, October 20, 2016, from 10:30 a.m. to 11:30 a.m. EDT, Morris and Bryant will expand on the topics in this article – as well as other issues that affect hedge fund managers and third-party marketers – during a panel moderated by Kara Bingham, Associate Editor of the HFLR, at the Third Party Marketers Association (3PM) 2016 Annual Conference. For more information on the conference, click here. To take advantage of the HFLR’s $300 discount when registering for the conference, click the link available in the article. For prior coverage of a conference sponsored by 3PM, see “Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation” (Dec. 1, 2011).

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  • From Vol. 6 No.26 (Jun. 27, 2013)

    PLI Panel Addresses Marketing and Brokerage Issues Impacting Hedge Fund Managers, Including Marketing to State Pension Plans, Capital Introduction and Broker Implications of In-House Marketing Activities

    At the Practising Law Institute’s Hedge Fund Compliance and Regulation 2013 program, an expert panel comprised of SEC attorneys and industry practitioners shared insights on topics involving marketing and brokerage issues that impact hedge fund managers.  Among other things, the wide-ranging discussion covered the regulatory perils that accompany marketing to government pension funds, including local, state and federal pay-to-play and lobbying laws; capital introduction programs; the European Union’s Alternative Investment Fund Managers Directive; broker regulations implicated by in-house fund marketing activities; and investment-related regulations impacting broker-dealers and their hedge fund clients, including the Market Access Rule, circuit breakers, the use of dark pools, short selling, securities lending and large trader reporting.  This article summarizes the highlights from the panel discussion that are most pertinent to hedge fund managers.  See also “PLI Panel Provides Regulator and Industry Perspectives on Ethical and Compliance Challenges Associated with Hedge Fund Investor Relations,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013); “PLI Panel Provides Regulator and Industry Perspectives on SEC and NFA Examinations, Allocation of Form PF Expenses, Annual Compliance Review Reporting and NFA Bylaw 1101 Compliance,” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    In Second Lawsuit Arising Out of Failed CDO Deal, UBS Is Not Permitted to Pursue Claims Against Hedge Fund Manager Highland Capital Management to the Extent those Claims Could Have Been Brought in its Original Suit

    In 2007, UBS Securities LLC and two affiliates (UBS) agreed to finance and serve as placement agents for certain collateralized debt obligations (CDO) that hedge fund manager Highland Capital Management, L.P. (Highland) proposed to issue.  As a result of the 2008 financial crisis, the CDO deal collapsed in December 2008.  UBS then sued Highland in New York State Supreme Court under the indemnification provisions of the CDO deal to recover the losses it allegedly sustained.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    How Can Hedge Fund Managers Structure the Compensation of Third-Party Marketers in Light of the Ban On “Contingent Compensation” Under New York City and California Lobbying Laws? (Part Two of Three)

    An authoritative recent interpretation of New York City’s lobbying law and recent amendments to California’s lobbyist law likely will require placement agents and other third-party hedge fund marketers, in-house hedge fund marketers and, in some cases, hedge fund managers themselves, to register as lobbyists.  Such registration will impose new obligations and prohibitions on hedge fund marketers and managers.  See “Recent Developments in New York City and California Lobbying Laws May Impact the Activities and Compensation of In-House and Third-Party Hedge Fund Marketers (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011).  Most dramatically, both California and New York City will prohibit a registered lobbyist from receiving contingent compensation, that is, compensation that is calculated by reference to the success of the lobbyist’s efforts in persuading a public pension fund to invest in a hedge fund.  Success-based compensation is the primary mechanism used to compensate and incentivize hedge fund marketers.  Accordingly, the legal change in California and the interpretive change in New York will fundamentally alter the economics of hedge fund marketing.  Or to set the stage in simpler terms: Hedge fund marketers will be required to register as lobbyists; hedge fund marketers are paid by commission; lobbying laws prohibit the payment of commissions to lobbyists; so how will hedge fund marketers be paid going forward?  This is the second article in a three-part series intended to address that question.  The first article included a comprehensive chart detailing the provisions relevant to hedge fund managers and marketers of the New York City and California lobbying laws.  This article examines how hedge fund managers can structure or restructure their arrangements with third-party hedge fund marketers in light of the ban on contingent compensation.  Specifically, this article discusses: the relevant provisions of the New York City Administrative Code and the California Code; trends in other states and municipalities; typical components, levels and structures of compensation of third-party hedge fund marketers (all of which were analyzed in depth in a prior article in the HFLR); four specific strategies that hedge fund managers can use to structure new arrangements with third-party marketers, and the benefits and burdens of each; three of the more challenging scenarios that hedge fund managers may face in restructuring existing agreements with third-party marketers, and the relevant legal considerations in each scenario; whether the New York City and California lobbying laws contain grandfathering provisions; special lobbying law considerations for funds of funds; and changes to representations, warranties, covenants and due diligence necessitated by the changes to the lobbying law.  The article concludes with a discussion of a “bigger issue” that has the potential to render the foregoing discussion largely moot.  (The third article in this series will examine related issues with respect to in-house hedge fund marketers.)

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers

    Many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register by July 21, 2011 – that is, in just under four months – unless the SEC extends the registration deadline.  Rule 203-1 under the Investment Advisers Act of 1940 (Advisers Act) currently provides that to apply for registration with the SEC as an investment adviser, a hedge fund manager must complete Form ADV, file Part 1A of Form ADV and file the brochure(s) required by Part 2A of Form ADV electronically with the Investment Adviser Registration Depository (IARD).  Last July, the SEC finalized amendments to Part 2 of Form ADV and related rules under the Advisers Act.  Those amendments were long in the making – a decade, by some counts – and they have changed Part 2 significantly.  Most notably, Part 2 is now entirely narrative, publicly filed and deeper and broader in terms of the categories of required disclosure (including disciplinary history).  So, hedge fund managers will have to register as investment advisers and registered investment advisers must file Form ADV, Part 2.  Therefore, registered hedge fund managers will have to file Form ADV, Part 2.  For managers, this has been an expensive syllogism.  Many have hired compliance consultants with the goal of saying no more and no less than is required in their Part 2s.  Recently, the staff of the SEC’s Division of Investment Management (Division) offered assistance in this collective benchmarking effort by publishing “Staff Responses to Questions About Part 2 of Form ADV” (Staff Responses).  The Staff Responses include a series of commonly asked questions and answers to those questions.  But the questions are broad and the answers are terse, in some cases, limited to a single, oracular word.  While better than no statement from the Division, the Staff Responses raise as many questions as they answer.  In particular, the Staff Responses say nothing about the background and context of the answers; provide no guidance on the interaction among and application of the answers; and fail to highlight the extent to which certain answers render others largely moot.  This article seeks to fill in the blanks left by the Staff Responses.  It does so by discussing: the legal and regulatory authority supporting some of the more relevant answers; where those answers fit into the more general patchwork of hedge fund regulation; the interaction among the answers; and the application of the answers to offshore advisers to offshore hedge funds.  The article also offers guidance on implementing certain answers and highlights what certain of the answers do not cover.

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  • From Vol. 4 No.1 (Jan. 7, 2011)

    CalPERS Special Review Foreshadows Seismic Shift in Business Arrangements among Public Pension Funds, Hedge Fund Managers and Placement Agents

    Over the course of 2010 and into 2011, the California Public Employees’ Retirement System (CalPERS) has been investigating and addressing whether the interests of CalPERS participants and beneficiaries were compromised by the payment of placement agent fees and related activities.  See “Three Significant Legal Pitfalls for Hedge Fund Marketers, and How to Avoid Them,” The Hedge Fund Law Report, Vol. 3, No. 36 (Sep. 17, 2010).  However, what started as a review arising out of the well-publicized placement agent scandals of 2009 has expanded in scope to include a special review of the organization and operation of CalPERS itself; the “fitness” of CalPERS employees and its external investment managers; and the fee arrangements among CalPERS, its external investment managers and placement agents.  See “Indemnification Provisions in Agreements between Hedge Fund Managers and Placement Agents: Reciprocal, But Not Necessarily Symmetrical,” The Hedge Fund Law Report, Vol. 3, No. 41 (Oct. 22, 2010).  In a report dated December 2010, Steptoe & Johnson LLP, the law firm leading the special review, summarizes its observations and recommendations in the foregoing areas.  The report indicates that CalPERS has already implemented many of Steptoe’s recommendations, and Steptoe expects CalPERS to implement those of the recommendations it has not yet implemented.  The Steptoe report is important for all hedge fund managers, for the following reasons.  For those managers fortunate enough to have CalPERS as a current investor, the report foreshadows likely demands from CalPERS in the areas of fees, use and compensation of placement agents, conflicts of interest, gifts and travel, employment of former CalPERS board members and staff, public disclosure of information provided to CalPERS, location and lavishness of annual meetings and other topics.  Even for hedge fund managers that do not count CalPERS as a current investor, the report is relevant.  (For a discussion of when to approach certain types of investors, see “Prime Broker Merlin Securities Develops Spectrum of Hedge Fund Investors; Event Hosted by Accounting Firm Marcum LLP Examines Marketing Implications of the Merlin Spectrum,” The Hedge Fund Law Report, Vol. 3, No. 39 (Oct. 8, 2010).)  Here is why: CalPERS is the largest public pension fund in the U.S.  As of January 5, 2011, the total CalPERS fund market value was $226.5 billion, with about 14 percent, or $31.7 billion, allocated to “private equity” and other “alternative investments.”  Like Yale among endowments, CalPERS among pension funds has been and continues to be a trendsetter with respect to the terms under which institutional investors allocate capital to hedge funds.  See “Lessons for Hedge Fund Managers on Liquidity, Allocations, Marketing and More from Yale’s 2009 Endowment Report,” The Hedge Fund Law Report, Vol. 3, No. 15 (Apr. 9, 2010).  That is, other institutional investors look to the actions of CalPERS as precedents in the areas of terms, fees, governance, risk management, manager selection, due diligence, mitigation of conflicts of interest and others.  Indeed, the Steptoe report is cognizant of CalPERS’ stature as an institutional investor, noting that CalPERS can, by adopting the recommendations in the report, “set a standard for other public pension funds to follow.”  (By the same token, the report takes CalPERS to task for inadequately using its “purchasing power” – our phrase, not the report’s – to negotiate lower fees with external managers.  However, the report also notes that CalPERS has recently improved in this area and obtained over $200 million in fee concessions from external managers in various asset classes.)  Given the importance of CalPERS as an investor in hedge funds, the terms it demands from external managers are likely to be demanded by other investors of comparable bargaining power (or requested by investors of lesser bargaining power).  Similarly, the concerns identified by CalPERS are likely to make their way into due diligence questionnaires of other investors.  Accordingly, this article offers a comprehensive review of the Steptoe report, along with commentary on how the report’s recommendations may alter the relationship among public pension funds, hedge fund managers and placement agents.  One of the more dramatic recommendations in the report would involve shifting a greater percentage of the compensation of external managers to performance fees, and away from management fees.  We discuss (among other things) the implications of this recommendation, and how – especially for smaller or start-up managers – this revised approach to fees can make it difficult to “keep the lights on.”

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  • From Vol. 3 No.49 (Dec. 17, 2010)

    Pair of District Court Opinions Illustrates the Difficulty of Enforcing a Purported Oral Agreement Between a Third-Party Marketer and a Hedge Fund Manager

    On October 20, 2009 and November 9, 2010, the U.S. District Court for the Northern District of Illinois issued two opinions benefiting hedge fund manager Whitecap Advisors, LLC, in breach of contract litigation brought by third-party hedge fund marketer Coburn Group, LLC.  In the lawsuit, Coburn Group had accused Whitecap of breaching its oral agreement to continue to pay its commission for so long as the investors it introduced to Whitecap maintained investments with it.  Whitecap, in turn, had challenged Coburn Group’s claim that such an agreement existed, and claimed, alternatively, that they had entered a “pay-as-you-go” arrangement that it terminated following repeated unsuccessful attempts by both parties to reach a memorialized contract.  When Coburn Group moved for summary judgment, the District Court found that material issues of fact existed that necessitated a jury trial.  When Whitecap moved, days later, to preclude Coburn Group from introducing evidence at that trial of damages to Coburn Group that may arise in the future, the District Court agreed that such evidence would be inappropriate given the speculative nature of such damages, and granted Whitecap’s motion.  This action is particularly significant because not many legal opinions address the relationship between hedge fund managers and placement agents or third-party marketers.  This article details the background of the instant action and the court’s pertinent legal analysis.  For more on the relationships between hedge fund managers and placement agents or third-party marketers, see “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010); “Indemnification Provisions in Agreements between Hedge Fund Managers and Placement Agents: Reciprocal, But Not Necessarily Symmetrical,” The Hedge Fund Law Report, Vol. 3, No. 41 (Oct. 22, 2010).

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  • From Vol. 3 No.44 (Nov. 12, 2010)

    Municipal Securities Rulemaking Board Extends Its Regulatory Reach to Include Hedge Fund Placement Agents

    On November 1, 2010, the Municipal Securities Rulemaking Board (MSRB) filed proposed rule changes with the Securities and Exchange Commission (SEC).  See “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010).  Those proposed rule changes are of interest to the hedge fund community for five primary reasons.  First, they clarify the definition of a “municipal advisor” for purposes of Section 975 of Dodd-Frank.  That definition likely encompasses placement agents providing services to hedge funds and other entities that provide similar services to hedge funds but call themselves something else (such as “finders,” “solicitors” or “cash solicitors”).  Second, the proposed rule changes impose three procedural requirements on municipal advisors.  Third, they impose two substantive requirements on municipal advisors.  Fourth, the MSRB’s Notice 2010-47 (Notice), announcing the filing of the proposed rule changes, includes a roadmap of the MSRB’s rulemaking agenda for “the coming months and years,” including rules that will directly affect hedge fund placement agents.  Fifth, the Notice contains a portentous endnote relating to the “federal fiduciary duty” of municipal advisors, and the entities to whom that duty is owed.  This article discusses each of these five points – and identifies the questions that placement agents have to ask and answer today based on these points.

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  • From Vol. 3 No.41 (Oct. 22, 2010)

    Indemnification Provisions in Agreements between Hedge Fund Managers and Placement Agents: Reciprocal, But Not Necessarily Symmetrical

    In a recent article, we argued that the use of placement agents by hedge fund managers – especially smaller and start-up managers – is likely to continue and grow in the near term, for both macro and micro reasons.  At the macro level, we identified four rationales for this anticipated trend: (1) many new investments are going to larger managers; (2) many institutional investors plan to increase their hedge fund allocations in the next three to five years; (3) a noteworthy percentage of institutional investors plan to increase their allocations to new managers; and (4) manager reputation weighs heavily in the allocation decision-making of institutional investors.  And at the micro level, we suggested that the use of placement agents by hedge fund managers will continue and grow because placement agents provide a range of potentially valuable services to managers, including: marketing and sales expertise; division of labor between portfolio management and marketing; credibility; contacts and access; strategic and other services; geographic and cultural expertise; and the ability to avoid the question of whether the manager’s in-house marketing department must register with the SEC as a broker.  For a fuller discussion of each of these points, see “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010).  Another point we made in that article – and a large part of the reason why we have undertaken this article – is that while the business case for the use by hedge fund managers of placement agents is compelling, the recent regulatory attention focused on placement agent activities and hedge fund marketing more generally is unprecedented.  See, e.g., “Three Significant Legal Pitfalls for Hedge Fund Marketers, and How to Avoid Them,” The Hedge Fund Law Report, Vol. 3, No. 36 (Sep. 17, 2010); “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” The Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010); “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010); “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).  Accordingly, hedge fund managers are increasingly sensitive to the prospect that retaining placement agents can involve burdens as well as benefits.  At best, placement agents can dramatically increase assets under management, revenues and profits.  But at worst, placement agents can materially expand the range and severity of liabilities to which hedge fund managers are exposed.  At the same time, marketing and selling hedge fund interests can expose placement agents to liability.  In short, the exposure created by the relationship is reciprocal, but not necessarily symmetrical: in most cases, and as explained more fully below, placement agents have more opportunities to harm managers than vice versa.  Sophisticated hedge fund managers and placement agents recognize that their relationships may create these reciprocal, asymmetrical liabilities, and, to the extent possible, seek to allocate the burden of such liabilities ex ante, by contract.  Specifically, the indemnification provisions included in agreements between hedge fund managers and placement agents theoretically aim to allocate a particular category of liability to the party best situated to avoid it.  (Practically, they often allocate more liabilities to the party with less bargaining power.)  By allocating (in theory) liabilities to the “least cost avoider,” indemnification provisions also seek to affect behavior in a manner that mitigates the likelihood of loss.  The idea is that a party is more likely to take precautions against a loss if it is required to internalize the cost of that loss; and the party best situated to take such precautions is the party that can do so at the lowest cost. This article explores a question that frequently arises in the negotiation of agreements between hedge fund managers and placement agents: who should indemnify whom?  Or more particularly – since the answer is not so absolute – for what categories of potential liability should placement agents indemnify managers, and vice versa?  To answer that question, this article discusses: the activities of placement agents that can give rise to claims (by regulators or investors) against or can otherwise adversely affect managers; the activities of managers that can give rise to claims against or can otherwise adversely affect placement agents; how indemnification provisions in placement agent agreements are drafted to incorporate the various categories of potential liability; other mechanics of indemnification provisions (including the relevant legal standard, term, advancement of attorneys fees and clawbacks); the inevitable insufficiency of indemnification; the consequent heightened importance of due diligence and monitoring (including a discussion of ten best compliance practices and procedures for broker-dealers); and the interaction in this context among indemnification, directors and officers (D&O) insurance and errors and omissions (E&O) insurance.

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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.35 (Sep. 10, 2010)

    What Is the “Market” for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?

    Historically, hedge fund managers have retained placement agents and other third-party intermediaries to identify investors, obtain investments and for related purposes.  Hedge fund managers’ use of placement agents is likely to continue and even increase for two simple reasons: because such use is permitted, and because it can add value.  On the first point, the fact that hedge fund managers can use placement agents is only news because between August 2009 and June 2010, the continued viability of that use was in doubt.  In short, in August 2009, the SEC proposed a pay to play rule that would have prohibited hedge fund managers from using placement agents (or “third-party solicitors,” “solicitors,” “finders” or “pension consultants”) to obtain investments from public pension funds.  Given the importance of public pension funds in the hedge fund investor base – according to Preqin, public pension funds comprise approximately 17 percent of all institutional hedge fund investors – many in the hedge fund industry thought that the proposed ban marked the beginning of the end of the use by hedge fund managers of placement agents.  See, e.g., “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).  However, the final pay to play rule, adopted by the SEC on June 30, 2010, did not prohibit hedge fund managers from using placement agents to solicit investments from public pension funds, but rather permitted such use so long as the relevant placement agent is a registered investment adviser or registered broker-dealer.  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).  Along similar lines, on September 2, 2010, the SEC adopted a temporary rule (Rule 15Ba2-6T under the Securities Exchange Act of 1934) requiring municipal advisors to register with the SEC by October 1, 2010 (i.e., within three weeks).  This rule does not prohibit the use by hedge fund managers of “finders,” “solicitors” or other previously unregistered entities to obtain investments from public pension funds, but it may require such entities to register with the SEC.  See “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” below, in this issue of The Hedge Fund Law Report.  In short, while the legal and regulatory environment for placement agents has become more complex, their activities are, in general, still legally permitted.  And on the second point – the idea that placement agents can add value – there are two categories of rationales for this idea: micro rationales and macro rationales.  The micro rationales – the specific categories of services that placement agents are well-positioned to provide to hedge fund managers – are detailed below.  As for the macro rationales, four trends suggest that placement agents will play an increasingly important role in the allocation of capital to hedge funds.  First, a disproportionate volume of recent inflows have gone to larger managers.  Second, according to Preqin, 29 percent of institutional investors plan to invest more capital in hedge funds over the next 12 months than they did during the previous 12 months, and 46 percent of investors plan to increase their hedge fund allocations in the next three to five years.  Third, according to Preqin, 37 percent of institutional investors plan to direct any hedge fund allocations in the short to medium term to a mixture of new and existing managers, and 23 percent of institutional investors plan to invest in new managers only (that is, new to the investor, though not necessarily new to the market, i.e., not necessarily startup managers).  Fourth, according to Preqin, “firm reputation” is tied with “track record” as the second most important factor for institutional investors when making hedge fund allocations.  The point: capital is likely to flow into hedge funds over the next five years, but if you are anything other than a large, established manager, the competition for capital is likely to remain fierce.  And importantly in an industry where performance is easily measured, readily comparable and frequently updated, even “large, established managers” can stumble in terms of size and stature, and find themselves pounding the proverbial fundraising pavement once again.  In light of the anticipated importance of placement agents in steering capital into hedge funds over the next (at least) five years, this article seeks to shed light on a relatively obscure topic: the “market” for fees and other terms in agreements between hedge fund managers and placement agents.  Specifically, this article first identifies seven distinct reasons why a manager may hire a placement agent, then details the most important terms of, and issues in connection with, placement agent agreements, including the following: fee structures and levels; declining fees; duration of engagements and sunset provisions; carve-outs for the manager’s pre-existing relationships; exclusivity; licensing, registration and representations with respect to both; indemnification; insurance; and the pay to play overlay.

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  • From Vol. 3 No.35 (Sep. 10, 2010)

    Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks

    While prudence has for some time dictated that hedge fund managers only use registered broker-dealers to solicit investments from public pension funds, the law has not entirely kept pace with prudence.  That is, the term “broker” is defined in Section 3(a)(4) of the Securities Exchange Act of 1934 (Exchange Act) to mean a “person engaged in the business of effecting transactions in securities for the account of others.”  In a series of no-action letters, the SEC has adopted a broad understanding of the term “broker.”  Generally, absent an exemption, any entity that receives commissions or other transaction-based compensation in connection with securities-based activities is required, in the SEC’s view, to register as a broker-dealer.  However, the SEC has recognized a narrow exception to the broker-dealer registration requirement for so-called “finders” (although it is the activities of such entities, rather than their name, that determines the presence or absence of a registration obligation).  Generally, finders are entities that are compensated via a flat or hourly fee for bringing parties together for a potential securities transaction, but that do not receive commissions or other transaction-based compensation for such match-making.  Many of the intermediaries embroiled in the 2009 pay to play scandals styled themselves “finders” or “solicitors” whose activities did not require registration as a broker-dealer.  See “What Do the Regulatory and Industry Responses to the New York Pension Fund ‘Pay to Play’ Scandal Mean for the Future of Hedge Fund Marketing?,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  In part in response to those scandals – or more specifically, to the unregistered status of many of the participants in those scandals – the Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 15B of the Securities Exchange Act of 1934 to require registration with the SEC by “municipal advisors.”  On September 2, 2010, the SEC adopted temporary Rule 15Ba2-6T under the Exchange Act, which will require registration with the SEC by municipal advisors on Form MA-T by October 1, 2010 (i.e., within three weeks).  Notably, Dodd-Frank explicitly exempts from the municipal advisor registration requirement registered broker-dealers, registered investment advisers and Commodity Trading Advisers registered with the CFTC.

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  • From Vol. 3 No.30 (Jul. 30, 2010)

    How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New “Pay to Play” Rule?

    On July 1, 2010, the SEC adopted Rule 206(4)-5 (Rule) under the Investment Advisers Act of 1940 (Advisers Act).  See “SEC Adopts Pay to Play Rules for Investment Advisers; Total Placement Agency Ban Avoided,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  The Rule generally seeks to curtail pay to play practices in the selection by state investment funds, most notably public pension funds, of hedge fund managers and other investment advisers.  Broadly, the Rule does this in three ways: (1) by limiting donations by principals of investment advisers and others with an economic stake in winning public fund business to election campaigns of public officials who may directly or indirectly influence the selection of the adviser to manage a public fund; (2) by prohibiting payments by investment advisers to any person for soliciting government entities for advisory services unless that person is (a) a registered investment adviser subject to the Rule or a registered broker dealer subject to a similar rule to be promulgated by FINRA, or (b) a principal or employee of the adviser; and (3) by revising Advisers Act Rule 204-2 (the recordkeeping rule) to require investment advisers with government clients, or advisers to hedge funds with government entity investors, to maintain records regarding political contributions by the adviser and its covered associates.  According to private fund data provider Preqin, public pension funds represent approximately 17 percent of all institutional hedge fund investors, with an average allocation of six percent of total assets to hedge funds.  The Rule governs the process by which hedge fund managers seek advisory business from this important constituency.  Accordingly, the Rule is of fundamental importance to a wide range of hedge fund managers, for whom the Rule creates a range of new compliance and marketing challenges.  The purpose of this article is to identify and provide guidance with respect to many of those new challenges.  In particular, the descriptive section of this article provides an overview of the mechanics of the Rule.  The analytic section of this article addresses areas in which hedge fund managers should revisit their policies and procedures in light of the Rule, including policies and procedures relating to: political contributions; monitoring contributions; preclearance of contributions; due diligence on placement agents; compliance training with respect to contributions; prescreening of new employees; acquisitions of hedge fund management firms; state, local and fund-specific rules relating to pay to play arrangements; sub-advisers and funds of funds; and mandatory redemptions.  The analytic section also includes a discussion of the implications of the Rule for lobbying by hedge fund managers.  See “Hedge Funds Increasing Lobbying Efforts, Focusing On Shaping Regulations Rather Than Preventing Them,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  The article concludes with a note on potential constitutional challenges to the Rule.  One of the more important points made by this article is that while the Rule has garnered significant attention, it is just part of a patchwork of federal, state, local and fund-specific rules governing the process by which hedge fund managers solicit investment advisory business from government entities.

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  • From Vol. 3 No.28 (Jul. 15, 2010)

    SEC Adopts Pay to Play Rules for Investment Advisers; Total Placement Agency Ban Avoided

    As previously reported in The Hedge Fund Law Report, on August 3, 2009, the Securities and Exchange Commission (SEC) proposed its “pay to play” rules for investment advisers in Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended (the Act).  See “SEC Proposes ‘Pay to Play’ Rules for Investment Advisers,” Vol. 2, No. 32 (Aug. 12, 2009).  On June 30, 2010, the SEC adopted Rule 206(4)-5 to protect public pension plans by deterring investment advisers from participating in “pay to play” practices, that is, practices wherein politicians encourage financial contributions from any person, political action committee or company, including hedge funds, in exchange for the chance to be selected as investment adviser for those plans.  The new rule has three essential elements, each of which is detailed in this article.  In a departure from the prior version of the rule circulated for public comment, the rule does not include an outright ban on investment advisers compensating a third-party solicitor to obtain governmental entities as advisory clients, provided, however, that the solicitor must register with the SEC and/or the Financial Industry Regulatory Authority (FINRA) (as an investment adviser or broker-dealer), and remain subject to pay to play restrictions.  In other words, the new rule allows hedge fund managers to continue using registered placement agents in the United States.  We summarize the key provisions of the new pay to play rule, focusing on those applicable to hedge fund managers and placement agents.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance

    As a result of the recent “pay to play” scandals in New York, California and other states, the SEC, New York Attorney General Andrew Cuomo and certain state pension fund managers have restricted or prohibited hedge fund managers from using placement agents when marketing to state pension fund managers.  See “What Do the Regulatory and Industry Responses to the New York Pension Fund ‘Pay to Play’ Scandal Mean for the Future of Hedge Fund Marketing?,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  Prior to the pay to play scandals, placement agents often served an important intermediary role between investment managers and the trustees of state retiree money: they understood the investment goals of pension funds and the investment competencies of particular managers, and they added value by connecting goals with appropriate competencies.  However, the regulatory and industry responses to the pay to play scandals – still perceived in various quarters as unduly draconian – have all but eliminated placement agents from hedge fund manager marketing efforts, at least to the extent those efforts are directed at state pension funds, and at least for now.  At the same time, pension funds are expected to contribute a growing proportion of the assets under management by hedge funds in the next few years.  So who or what is going to fill the hedge fund marketing void that has opened up in the post-placement agent era?  In an effort to answer that question, this article revisits the New York State pension kickback case then discusses: the reduction in the use of placement agents by state pension funds in New York and California; the SEC’s recently proposed rule regarding placement agents; the move by pension funds away from allocations to funds of funds in favor of direct investments in hedge funds; specific examples of pension funds that have moved to single manager allocations; what precisely pension funds are looking for in allocating capital to single managers; specific steps that hedge fund managers can take to market to pension fund managers without relying on placement agents; considerations with respect to in-house marketing teams and prime broker capital introduction services; due diligence by pension funds; and background checks.

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  • From Vol. 2 No.40 (Oct. 7, 2009)

    Second Circuit Rules that Contract Dispute between Hedge Fund Manager and its Placement Agent Over Proper Arbitration Venue Does Not Permit Federal Intervention

    As previously reported in The Hedge Fund Law Report, placement agents in the hedge fund industry face an uncertain future after the New York pension fund kickback scandal and the Securities and Exchange Commission’s new proposed pay to play rules.  See, e.g., “What Do the Regulatory and Industry Responses to the New York Pension Fund ‘Pay to Play’ Scandal Mean for the Future of Hedge Fund Marketing?,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009); “How Has the New York Pension Fund Kickback Scandal Changed the Landscape for Placement Agents, and for Hedge Fund Managers who Use Them?,” The Hedge Fund Law Report, Vol. 2, No. 17 (Apr. 30, 2009).  As a result, new court decisions interpreting the interaction of placement agents and hedge fund managers, including their contractual rights, have increased significance for hedge fund industry participants.  This article describes the facts and legal analysis of one such notable decision, issued September 22, 2009 by United States Court of Appeals for the Second Circuit.

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  • From Vol. 2 No.37 (Sep. 17, 2009)

    Preqin Report Reveals Institutional Investors’ Opposition to Proposed Placement Agent Ban in SEC’s Proposed “Pay to Play” Rules

    Preqin, an alternative investment research firm, released a report assessing the potential impact of SEC proposed rule release IA-2910, for Advisers Act Rule 206(4)-5 (Proposed Rule), on the private funds industry.  The firm surveyed 50 leading United States institutional investors, and found that the majority support the aim of the Proposed Rule but oppose its ban on placement agents soliciting investments from public pension funds.  This article summarizes the key findings of this report and outlines Preqin’s proposed alternatives to the Proposed Rule.

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  • From Vol. 2 No.30 (Jul. 29, 2009)

    What Do the Regulatory and Industry Responses to the New York Pension Fund “Pay to Play” Scandal Mean for the Future of Hedge Fund Marketing?

    New York’s so-called “pay to play” scandal – in which state officials conditioned investments of state pension money in hedge and private equity funds on payments by the funds’ managers to the officials or their affiliates – has yielded a range of regulatory and industry responses, of varying degrees of severity.  At the most draconian is New York Attorney General Andrew Cuomo’s Code of Conduct (Code), to which three alternative investment managers have thus far agreed in settlement of pay to play charges.  The Code bans the use of placement agents altogether, but is not yet law and has not yet been adopted by any industry group as a best practice.  (However, it has been adopted by the New York State Teachers’ Retirement System.)  Somewhat less severe is a recently proposed SEC rule intended to curtail pay to play practices.  That rule generally provides that an investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser to manage money for state or local governments would be barred for two years from providing advisory services for compensation, either directly or through a fund.  A yet more measured response to the pay to play scandal ­– and in the view of many on the hedge fund side, a more practicable one – has come from CalPERS and other pension funds.  These pension funds have required increased disclosure and transparency with respect to compensation arrangements between investment managers seeking to manage pension assets and any placement agents or third party marketers acting on behalf of such managers.  Finally, lurking in the background has been Investment Advisers Act Rule 206(4)-3, which generally requires disclosure of the compensation arrangement between a registered investment adviser and a placement agent, to any “client” of the adviser that was solicited by the placement agent.  The application of this rule in the pay to play scandal is subtle, as explained more comprehensively in this article.  The regulatory responses have changed the game of hedge fund marketing.  The difficult (though apparently improving) investment climate for hedge funds has made marketing more difficult as a practical matter, and the regulatory responses to the pay to play scandal have made marketing more treacherous as a legal matter.  Therefore, this article provides background on the scandal and the various settlements; offers details of Cuomo’s Code; addresses the likelihood that other states will follow New York’s lead; discusses actions by pension funds in response to the scandal, the SEC’s recently proposed anti-pay to play rule and Rule 206(4)-3; and, importantly, explores the future of hedge fund marketing without placement agents, or with harsh restrictions on their activities.

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  • From Vol. 2 No.17 (Apr. 30, 2009)

    How Has the New York Pension Fund Kickback Scandal Changed the Landscape for Placement Agents, and for Hedge Fund Managers who Use Them?

    Placement agents long have served as a conduit between hedge fund managers and institutional investors.  Placement agents provide managers with a range of marketing services, including introductions to capital sources, honing of marketing materials and presentations and explanations of how managers’ strategies can address investors’ goals.  However, that arrangement has come under pressure, in light of a sweeping indictment filed by the New York State Attorney General Andrew Cuomo and a parallel civil complaint filed by the SEC, both alleging that certain New York State officials conspired to condition access to investments by the state’s pension fund on the payment of kickbacks to state officials or their associates.  In addition, at least one former hedge fund manager has pleaded guilty to paying kickbacks in exchange for state investments in a hedge fund he managed.  The pay-to-play allegations raise a series of potentially game-changing questions for placements agents and hedge fund managers that use them.  At the most extreme, they give rise to the prospect that other state pension funds will follow New York’s lead in banning the use of placement agents, and that other significant private equity and hedge fund managers will cease using placement agents.  This would cause a secular shift in the placement agency business – in effect, would convert it from a business that in large part serves established managers in ongoing fundraising efforts to a business that primarily serves smaller, start-up managers.  A less draconian – and more certain and immediate – effect of the events will be to cause managers to scrutinize their placement agent relationships (current and new) significantly more closely, and to build more robust protections into their agreements with placement agents.  We explore the implications of the pay-to-play allegations for hedge fund managers and investors, and placement agents.

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  • From Vol. 1 No.29 (Dec. 24, 2008)

    Madoff: the SEC’s Complaint and What it May Mean for Private Fund Placement Agents

    On December 11, 2008, the Securities and Exchange Commission brought a civil action against Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC (BMIS), a broker dealer and investment adviser registered in both capacities with the SEC, in the United States District Court for the Southern District of New York, alleging that Madoff and BMIS committed fraud through the investment advisory activities of BMIS.  We detail the complaint and discuss a topic that has not yet received significant attention – the implications of the Madoff scandal for private fund placement agents.

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  • From Vol. 1 No.24 (Nov. 12, 2008)

    Finally, Some Good News for Private Fund Placement Agents

    Private fund managers who are registered investment advisers may now have greater flexibility in entering into and disclosing arrangements with finders who solicit and refer prospective fund investors. However, that flexibility is dependent upon the finder solely soliciting for a private fund rather than for other investment arrangements (such as managed accounts) that the manager may offer. In a guest article, Debevoise & Plimpton partner Kenneth J. Berman analyzes the recently-issued SEC staff interpretive letter clarifying the application of the cash solicitation fee rule under the Investment Advisers Act of 1940.

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