The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 3, No. 28 (Jul. 15, 2010) Print IssuePrint This Issue

  • Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers

    Can there be circumstances in which it makes business and legal sense for a hedge fund manager to cause one of its managed hedge funds to lend money or other assets to the manager?  The visceral response from most hedge fund legal and compliance professionals generally – and from those surveyed by The Hedge Fund Law Report on this question specifically – is: rarely, if at all.  However, this is a question that merits attention from hedge fund managers for at least three reasons.  First, even if loans from funds to managers are imprudent or prohibited in most circumstances, there may be some circumstances in which such loans may be permissible; and in a still-tight credit environment for most hedge funds and managers, it is important to be aware of the risks and benefits of all credit options.  Second, it is more important to understand why such loans may be ill-advised than merely to understand that such loans may be ill-advised, in particular because the explanation touches on many other aspects of the hedge fund-manager relationship (including fiduciary duty, principal trading and others).  Third, a wide range of transactions, some of them nonintuitive, may constitute loans from a hedge fund to a manager.  For example, if an affiliate of the manager lends securities to the fund and that loan is secured by cash, does the “loan” of securities from the affiliate to the fund constitute a “loan” of cash from the fund to the manager?  As discussed more fully below, the SEC’s standard document request letter for investment adviser examinations asks for documentation of loans from funds to advisers, and registered hedge fund managers will be subject to such examinations.  Therefore, it is important for hedge fund managers to appreciate the full range transactions that may constitute loans for examination purposes.  The goal of this article is to provide a fuller answer to that initial question – can there be circumstances in which it makes business and legal sense for a hedge fund manager to cause one of its managed hedge funds to lend money or other assets to the manager?  To do so, this article begins by enumerating examples of circumstances in which a hedge fund may make or be construed to have made a loan to its manager.  As indicated, some of those circumstances may be indirect, roundabout or non-obvious, and our point is not to provide an exhaustive list, but rather to suggest that many fact patterns that do not look like loans may be deemed (by the SEC or investors) to be loans.  The article then goes on to address the chief legal concerns in connection with loans from funds to advisers, including concerns relating to fiduciary duty, SEC examinations, ERISA, principal trading, advisory boards, commodity pool operators, disclosure and manager defaults.  The article includes concrete suggestions for structuring loans from hedge funds to managers in a way that may, in appropriate circumstances, pass muster with regulators and investors.

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  • Massachusetts High Court Rules that Website and Single E-Mail Communication to Massachusetts Resident Confer Personal Jurisdiction Over Philip Goldstein’s Hedge Fund Company in Administrative Proceeding

    Massachusetts’ highest court has dealt a blow to activist investor Philip Goldstein’s efforts to broaden the ability of hedge funds to disseminate information about their operations and performance.  Plaintiff Bulldog Investors General Partnership (Bulldog) had operated a website containing information about its investment products.  A visitor to the site could register and receive “more specific information” about Bulldog’s funds.  In November 2006, Massachusetts resident Brendan Hickey (Hickey) registered with the site.  A Bulldog employee then sent Hickey a single e-mail with detailed information about Bulldog’s funds and offered to discuss the funds by telephone.  As a result, in January 2007, the Securities Division of the office of the Secretary of the Commonwealth (Secretary) filed a complaint against Bulldog and certain employees and affiliates, accusing them of offering non-exempt, unregistered securities.  Bulldog contested the proceeding, arguing that the Secretary did not have personal jurisdiction over the named respondents, that the information provided did not constitute an “offer” under Massachusetts law and that the enforcement action violated the respondents’ rights to free speech.  The Supreme Judicial Court upheld the determination by the Secretary and lower court that jurisdiction was proper and that Bulldog’s e-mail to Hickey constituted an “offer” of unregistered securities under Massachusetts law.  Bulldog’s free speech claims are being heard in a separate proceeding.  We summarize the facts that gave rise to the administrative proceeding and the Court’s reasoning.

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  • 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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  • New York Court of Appeals Affirms Summary Dismissal of Fraud Action by Investors in Lipper Convertibles Hedge Fund Against Its Accountant PricewaterhouseCoopers

    On June 29, 2010, the New York Court of Appeals affirmed a trial court decision to enter summary judgment on behalf of accounting firm PricewaterhouseCoopers, LLC (PwC) in ongoing litigation over its part in a fraud committed by its client, hedge fund Lipper Convertibles, LP (the fund).  The fund had intentionally overstated its assets using improper methods for valuing securities.  PwC, tasked with auditing these financial statements, fraudulently attested to their accuracy and their conformity with generally accepted accounting principles (GAAP).  Those disclosures, in turn, induced the Plaintiffs to invest in the fund, which resulted in extensive litigation once the fraud was discovered and the investors lost millions.  The Court of Appeals terminated the fraud aspect of the litigation against PwC by the investors because an overlapping, independent action against PwC, litigated by the fund’s Trustee in bankruptcy for the benefit of all investors, provided them with a direct remedy for the damages they claimed to have suffered.  We summarize the background of the action and the Court’s legal analysis.

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  • Appaloosa Management L.P. Settles SEC Allegations of Reg M Violations in Connection with Short Sales

    In a Settlement Order (Order) dated July 2, 2010, hedge fund management firm Appaloosa Management L.P. agreed to pay approximately $1.3 million to settle SEC charges that the firm violated rules barring the purchase of shares in a public offering following a short sale of shares of the same issuer.  The case involved Appaloosa’s participation in a follow-on offering by Wells Fargo & Co. after Appaloosa had sold short more than one million Wells Fargo shares.  The SEC found that the firm violated Rule 105 of Regulation M of the Securities Exchange Act of 1934 (Rule 105) by making short sales during the Rule 105 restricted period preceding its participation in a public offering by Wells Fargo & Co.  According to the Order, Appaloosa made disgorgeable profits of $842,500 through the purchase of shares in the offering and the short sales.  Without admitting or denying the SEC’s findings, Appaloosa agreed to adopt, implement and maintain written compliance policies and procedures to prevent future violations of Rule 105.  In addition, it agreed to disgorge $842,500 in profits and pay a civil penalty of $421,250 plus prejudgment interest of $40,773.  This article summarizes the case background and the SEC’s findings and details agreed-upon remedial action as set forth in the Order.

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  • John Finley, Head of M&A at Simpson Thacher, to Join Blackstone as Chief Legal Officer

    On July 7, 2010, The Blackstone Group announced that John G. Finley will join the firm, effective September 1, 2010, as a Senior Managing Director and Chief Legal Officer.  Finley will also serve on Blackstone’s Executive Committee.  Finley is currently a partner at Simpson Thacher & Bartlett, where he is head of the global mergers and acquisitions group.

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  • Katten Muchin Adds Ricardo J. Hollingsworth as New York-Based Financial Services Partner

    On June 28, 2010, Katten Muchin Rosenman LLP announced that Ricardo J. Hollingsworth has joined the Firm as a Partner in its New York Financial Services Practice.

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