The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 3, No. 20 (May 21, 2010) Print IssuePrint This Issue

  • 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 Lender to Shareholder: How to Make Your Equity Work Harder for You

    Scenario: You hold bank debt or bonds in a company that is being restructured, whether through a Chapter 11 bankruptcy reorganization or an out-of-court restructuring.  As part of the restructuring, you (as well as the company’s other creditors) are being asked to reduce (or extinguish entirely) the principal amount of debt you hold, but as an incentive to agree to the proposal, you are being offered equity securities in the newly restructured company.  Alternatively, you are receiving a cash payout on your debt, and you are being offered the right to subscribe for new equity in the company in a rights offering.  As part of either deal, you are presented with a suite of documents setting out your various rights with respect to the company and the other shareholders, almost always prepared by the lead lender’s attorneys and similar to venture capital agreements with the lead lender taking the role of the lead investor.  Question: If you will be a minority shareholder in the newly restructured company, what rights should you expect, and what can you get?  Some lenders will approach this type of scenario with the view “I’m getting x¢ on the dollar in new debt more than I paid, and the equity is just the icing on the cake.”  Others will make the (usually incorrect) assumption that they will be able to freely trade their new equity in the same way as the debt they previously held or the new debt they are receiving.  In a guest article, Jahangier Sharifi and Catherine Rossouw, Partner and Associate, respectively, at Richards Kibbe & Orbe LLP, provide lenders who are being offered minority shareholder positions in restructured companies with a checklist of rights to look for and of pitfalls to avoid when negotiating the terms of these equity documents.  Their article has three parts.  Section 1 discusses possible restrictions on liquidity that may limit your ability to get the most value out of your new equity.  Section 2 outlines the basic protections and control rights that you should ask for in your equity documents as a minority shareholder.  Section 3 highlights the key takeaways for lenders when negotiating equity documents.

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  • Richards Kibbe & Orbe LLP and ACA Compliance Group Webcast Highlights Developments in SEC Examinations of Registered Investment Advisers, and How to Prepare for a Surprise Visit from the SEC

    Hedge fund advisers represent a significant priority for the Securities and Exchange Commission (SEC) in its rulemaking, enforcement and examination efforts.  For hedge fund managers registered with the SEC as investment advisers, the SEC’s examination program has become increasingly important; and significantly more hedge fund managers are likely to be required to register with the SEC in light of the Senate's passage of the Financial Stability Bill.  Pursuant to Section 204 of the Investment Advisers Act of 1940 (the Advisers Act), the books and records of any registered investment adviser (RIA) may undergo compliance examinations by SEC staff.  These examinations aim to protect investors by determining whether RIAs are complying with the law, adhering to the disclosures that they have provided to their clients and maintaining appropriate compliance programs to ensure compliance with the law.  If the SEC examines an RIA, the RIA must provide examiners with access to all requested advisory records that it maintains.  The RIA must also provide the SEC with access to the written policies and procedures required by law to prevent violations of federal securities laws.  The policies and procedures, once implemented, should prevent violations from occurring, detect violations that have occurred and promptly correct any past violations.  The RIA should also prepare for the examination staff to review communications with investors for consistency and accuracy.  The failure of this examination program to detect several high-profile investment adviser frauds, including the Ponzi scheme perpetrated by Bernard Madoff, has led to criticism of the SEC and increased the significance of the examination itself.  On April 22, 2010, Richards Kibbe & Orbe LLP partner Eva Marie Carney co-presented a webcast entitled “SEC Examinations of Investment Advisers” with Joel Sauer of the ACA Compliance Group.  The webcast focused on some of the most important developments in RIA examinations.  It addressed topics such as how to prepare for the visit, asset verification tests, e-mail requests, common exam deficiencies, and the SEC’s enhanced subpoena powers.  It also addressed various “polling questions” or hypotheticals as tutorials for the audience.  This article summarizes the salient details of the presentation, including a step-by-step analysis of how an RIA can best prepare for and effectively manage an SEC examination, and the most common areas of focus during the examination.

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  • Investors in Hedge Funds Managed by RAM Capital Resources, LLC Sue RAM, Its Principals and Its Funds Alleging Securities Fraud, RICO Violations and Other Claims Based on Alleged Misrepresentations and Self-Dealing by RAM Principals

    Defendant RAM Capital Resources, LLC (RAM Capital), is a New York-based asset manager that specializes in so-called “PIPE” investments (private investments in public equity).  RAM Capital matched potential investors with PIPE issuers and also formed hedge funds to invest in PIPE offerings.  Defendants Stephen E. Saltzstein (Saltzstein) and Michael E. Fein (Fein) are the principals of RAM Capital.  Saltzstein was introduced to plaintiff Stacy Frati through Saltzstein’s sister, who was a childhood friend of Ms. Frati.  Eventually Ms. Frati and her husband invested $2 million in RAM Capital’s Shelter Island Opportunity Fund, LLC.  On behalf of a client, plaintiff Banco Popolare Luxembourg, S.A. invested $1.5 million with RAM Capital’s Truk International Fund, LP.  In April 2009, plaintiffs requested redemption of their entire interests in those funds, but only $150,000 was eventually returned to Banco Popolare.  This action ensued.  Plaintiffs claim the defendants committed securities fraud, RICO violations and breach of fiduciary duty by allegedly misrepresenting the amount of personal capital they had at stake in their funds, engaging in self-dealing, charging multiple and excessive fees and failing to disclose that they were not registered broker-dealers.  Plaintiffs seek return of their investments, punitive damages, an accounting and other relief.  We detail the plaintiffs’ claims.

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