The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 3, No. 25 (Jun. 25, 2010) Print IssuePrint This Issue

  • How Can a Hedge Fund Investor Pledge Its Hedge Fund Interest as Collateral for a Loan Without Obtaining the Consent of the Hedge Fund’s Manager or General Partner?

    Loans secured by limited partnership and limited liability company interests are an important source of liquidity for investors and of revenue for lenders.  However, the constitutional documents of hedge funds often provide that a holder of a hedge fund interest may not pledge its interest without the prior consent of the hedge fund’s general partner, manager or another party (the “required assenter”), which is an obstacle to the lender taking security over the hedge fund interest.  Consequently, where an investor as pledgor pledges its hedge fund interest to a secured party as security for a loan, the transaction parties need to obtain the consent of the required assenter to the investor’s pledge of the hedge fund interest, although under some circumstances provisions of the Uniform Commercial Code as in effect in certain jurisdictions may allow the investor to create a security interest despite the failure to obtain the required assenter’s consent.  Many required assenters refuse to consent or agree to provide only a limited consent that does not fully protect the secured party’s interests.  Fortunately, where the hedge fund interest is transferred in compliance with the fund’s governing documents by the investor to a securities intermediary, which becomes the legal owner of the fund interest, the secured party may take a security interest in the securities account, the security entitlements relating to the financial assets credited to such securities account and the investor’s indirect pro rata property interest in the financial assets credited to such securities account, in each case, without obtaining the required assenter’s consent, even when consent to a pledge of the fund interest is required by the applicable fund documents.  In a guest article, Sabrena Silver, a Partner at Linklaters LLP, and Scott E. Waxman, a Partner at Potter Anderson & Corroon LLP, detail the specific legal and business mechanics whereby a hedge fund investor may pledge its hedge fund interest as collateral for a loan, even where the hedge fund documents require such consent but the hedge fund’s general partner, manager or another relevant party refuses to grant it. 

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  • Registered Direct Offerings Enable Hedge Funds to Make Advantageously-Structured Investments in Public Equity While Avoiding the Illiquidity and Other Downsides of PIPEs

    Investment structuring can profoundly affect investment outcomes – an insight that accounts, in large part, for the growing participation by hedge funds as investors in registered direct offerings (RDOs).  As explained in more detail below, an RDO involves the sale by a public company of registered securities via a placement agent to institutional investors, such as hedge funds.  Since the securities purchased in an RDO are registered, the purchaser can sell them immediately.  By contrast, the securities purchased in a private investment in public equity (PIPE) are restricted and generally cannot be sold for 60 to 90 days following the purchase.  The illiquidity of PIPEs can adversely affect investment returns.  For example, assume hedge fund A purchased 10,000 shares of common stock of Company X in an RDO on January 1, 2010 for $50 per share and sold those shares a week later for $51.  Hedge fund A would have a pre-tax profit of $10,000.  Now assume that hedge fund A purchased those same 10,000 shares of common stock of Company X in a PIPE on January 1, 2010 for the same $50 per share.  And assume that during the two months following the purchase, the fortunes of Company X declined, such that as of March 1, 2010, the price of Company X common stock had fallen to $35 per share.  Under the terms of most PIPEs, hedge fund A would be legally prohibited from selling the shares it purchased in the PIPE during those two months, and would watch without recourse as its investment in Company X lost $150,000.  Efforts by hedge funds to offset such losses via short sales have often backfired, resulting in allegations of insider trading and violations of Regulation M.  See “Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009); “SEC Obtains Permanent Injunction Against Hedge Fund Colonial Fund LLC for Illegal Short Sales; Opinion Addresses Fund Manager’s Faulty Internal Compliance and Accounting Systems,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009); “District Court Preserves PIPE Insider Trading Claims Against Gryphon Hedge Fund,” The Hedge Fund Law Report, Vol. 2, No. 15 (Apr. 16, 2009).  Beyond liquidity, RDOs offer additional benefits to hedge funds, some relative to PIPEs and others independently.  With the goal of helping hedge funds evaluate whether RDOs offer an attractive investment structure and opportunity, this article details the mechanics of RDOs; includes statistics on RDO and PIPE activity; catalogs 13 distinct benefits to hedge funds of participating in RDOs; and identifies and discusses insider trading concerns in connection with RDOs.

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  • Minnesota District Court Allows Majority of Securities Fraud Action to Proceed Against Individuals and Entities that Were Affiliated with Defunct Hedge Fund Paramount Partners as Sales Agents

    In April 2009, Steven B. Cummings and a number of other investors sued hedge fund Paramount Partners, LP (Fund), its general partner Crossroad Capital Management, LLC (Crossroad), adviser/affiliate Capital Solutions Management, LP (CSM), sales agent Capital Solutions Distributors, LLC (CSD), and the respective principals of those four entities.  They alleged securities fraud, violations of various provisions of federal and Minnesota law and various common law claims arising out of the sale of limited partnership interests in the Fund.  See “Investors in Hedge Fund Paramount Partners Sue Fund, General Partner and Fund Advisers for Securities Fraud and Violation of Minnesota Law,” The Hedge Fund Law Report, Vol. 2, No. 16 (Apr. 23, 2009).  A 2009 SEC investigation revealed that, of the $10.8 million invested in the Fund over its life, investors had withdrawn $1.2 million, the Fund’s general partner Crossroad had received $2.1 million, and the Fund’s principal, John W. Lawton, had withdrawn another $900,000 directly from the Fund.  The remaining $6.6 million was either lost in trading or otherwise unaccounted for.  Defendant CSM became a minority owner of the Fund’s general partner in 2006.  CSM’s subsidiary, CSD, became the Fund’s “exclusive distributor.”  They were compensated based on the amount of capital they raised for the Fund.  CSM and CSD and their principals moved to dismiss portions of the Plaintiffs’ complaint on the ground that certain claims were time-barred and that the remainder of the complaint failed to state a cause of action against them.  The Court agreed that certain federal securities fraud claims were time-barred and that the Plaintiffs had not stated a cause of action for consumer fraud under Minnesota law.  The Court permitted all other federal and state causes of action to proceed.  We outline the court’s reasoning, with emphasis on the portions of the decision most relevant to the hedge fund industry.

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  • Federal District Court Refuses to Dismiss Suit Against Hedge Fund MB Investment Partners’ Controlling Persons for Ponzi Scheme Committed by MB’s President and Co-Managing Partner, Mark Bloom

    On June 10, 2010, the United States District Court for the Eastern District of Pennsylvania took the first step in dealing with the legal fallout to the hedge funds connected with disgraced hedge fund manager and convict Mark Bloom.  Bloom, as President, Co-Managing Partner, Chief Marketing Officer, and Director of hedge fund MB Investment Partners, Inc. (MB), used his influence in that firm to obtain investors for his personal investment vehicle, North Hills Management, LLC and North Hills, LP, and enhanced stock index funds through which he operated a Ponzi scheme.  Seeking restitution, a number of Bloom’s victims (Plaintiffs) brought suit against Bloom, MB, Centre MB Holdings, LLC (CMB), which owned MB and controlled its operations, Center Partners Management (CPM), which owned CMB and shared directors with MB, Robert Machinist, the Chairman, COO, Co-Managing Partner and a Director of MB, Ronald Altman, a Partner, Senior Managing Director and Portfolio Manager at MB, and seven other directors on MB’s board (Defendants).  The District Court refused to dismiss the causes of action against the officers and directors of MB, including those based on “Controlling Person Liability” under Section 20(a) of the Securities Exchange Act of 1934, as amended, and based on “negligent supervision” for their failure to properly supervise and uncover the fraud committed by Bloom, and through him, MB.  It did, however, dismiss all claims against portfolio manager Altman, notwithstanding allegations that he failed to perform due diligence in recommending the victims invest with Bloom.  We detail the background of the action and the Court’s legal analysis.

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  • Prisma Capital Partners Appoints Anne Wynne as General Counsel

    On June 22, 2010, alternative investment manager Prisma Capital Partners LP announced the appointment of Anne Wynne as General Counsel, where she will coordinate all legal activities on behalf of the firm.  For more on Prisma and the thinking of one of its founders, see “Girish Reddy, Founder of Prisma Capital Partners, Discusses Starting a Hedge Fund, the Future of the Hedge Fund Industry and Techniques for Conducting Due Diligence,” The Hedge Fund Law Report, Vol. 2, No. 3 (Jan. 21, 2009).

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  • Former DLA Piper Private Equity Head Joins Kaye Scholer as Managing Partner of the Firm’s London Office

    On June 24, 2010, Kaye Scholer LLP announced that Andrew B. Harris, the well-regarded private equity, mergers and acquisitions and corporate finance lawyer, has joined the firm as Managing Partner of its London office.

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  • William Ferri Promoted to Global Head of Alternative & Quantitative Investments at UBS Global Asset Management

    UBS has promoted William Ferri to head of hedge funds to replace the outgoing Joe Scoby, who is a 23-year veteran of UBS and is scheduled to retire from the Swiss bank on June 30, 2010.

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