The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 3, No. 40 (Oct. 15, 2010) Print IssuePrint This Issue

  • How to Structure Exit Provisions in Hedge Fund Seeding Arrangements

    Some legal arrangements are meant to last in perpetuity.  Other legal arrangements begin with an explicitly finite life.  And yet other arrangements commence with the goal of perpetuity, but only achieve a limited duration.  Hedge fund seeding arrangements fall – or should fall – into the second category: in the better-structured seeding deals, the mechanics of exit provisions are comprehensively described in the deal documents, and understood by the parties prior to the formal commencement of the relationship.  See “Primary Legal and Business Considerations in Hedge Fund Seeding Arrangements,” The Hedge Fund Law Report, Vol. 2, No. 38 (Dec. 10, 2009).  Conceptually, seeding exit provisions should balance the goals of hedge fund managers and seed investors.  Managers generally want control and unencumbered revenue streams, and seed investors generally want a return on their investments.  Importantly, over time, these goals need not conflict with one another: seeding exits can be structured in a manner that facilitates a graceful exit by the seed investor, and that maintains the entrepreneurial spirit necessary for continued success by the manager.  The intent of this article is to explain the structure, rationale and context of a number of exit provisions that have actually been used, according to our sources, in seeding deals.  To do so, this article discusses: what types of entities are engaged in hedge fund seeding; the services typically provided by seed investors to hedge fund managers, and the extent to which those services are similar to those provided by prime brokers; the categories of consideration typically provided by hedge fund managers to seed investors; variations on hedge fund seeding arrangements (including “foundership,” founder share classes and acceleration capital); the business case for seeding; the adverse selection argument (and some powerful rebuttals to it); rationales for exiting seeding arrangements, from both the manager and investor perspectives (including a discussion of the seeding provisions of the Volcker Rule); nine distinct approaches to seeding exit structures (including put/call agreements); and considerations in connection with funding buyouts.

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  • District Court Requires Fund of Funds Manager PAAMCO to Pay 40 Percent of Annual Net Profits to Seed Investor

    On August 27, 2010, the U.S. District Court for the Southern District of New York granted summary judgment on behalf of Franklin Realty Co., and Franklin Realty Holdings, LLC (Plaintiff), the venture investment entity of S. Donald Sussman, in their contract dispute with PAAMCO Founders Co., LLC (Defendant), f/k/a Pacific Alternative Asset Management Co.  It found no dispute that, under the terms of their Revolving Credit Agreement (RCA), Franklin was entitled to the greater of 10 percent of the outstanding loan or 40 percent of PAAMCO’s net profits.  It rejected PAAMCO’s defense of criminal usury because the principal on the loan was not absolutely repayable, and Franklin would not necessarily receive more than the 25 percent legal rate of interest in New York.  It also rejected PAAMCO’s defense that Franklin fraudulently induced a separate agreement that allowed Franklin to convert the RCA into a 40 percent membership interest in PAAMCO on the grounds that PAAMCO had failed to offer admissible evidence of a material misrepresentation.  We detail the background of the instant action and the Court’s legal analysis.

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  • Two Recent Matters Suggest That Law Firms Should Stick to Practicing Law Rather Than Trying to Intermediate Hedge Fund Investments

    From time to time, business-minded hedge fund lawyers look at their client bases and networks and say to themselves: “I know a lot of hedge funds managers looking for investors and a lot of institutions looking to invest in hedge funds.  Wouldn’t I be helping everybody – myself included – if I connected those hedge fund managers and investors?”  Two recent matters answer this question with a resounding “no.”  This article describes the two matters, and their application to law firms with hedge fund manager or investor clients.

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  • Hudson Bay Names Former SEC Assistant Regional Director Scott Black as General Counsel and Chief Compliance Officer

    On October 13, 2010, Hudson Bay Capital Management LP announced that Scott Black has joined the alternative investment management firm as General Counsel and Chief Compliance Officer.  Black joins Hudson Bay from the SEC, where he was an Assistant Regional Director in the Division of Enforcement in the Commission’s New York Regional Office.

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  • Regulatory Compliance Association to Host Annual Fall Asset Management Thought Leadership Symposium on November 3, 2010 at Marriott Marquis in New York City

    A new paradigm is poised to emerge within the asset management industry – driven by the forces of worldwide financial regulatory reform (e.g., Dodd-Frank and the AIFM Directive), market turmoil, industry consolidation and escalating allocator demands.  Sections of Dodd-Frank will directly target hedge funds, private equity funds, investment advisers, investment companies and others, as well as impact various financial instruments, such as derivatives, and various markets.  More importantly, the breadth of the sweeping regulatory reform will affect prime brokers, administrators, auditors and other industry participants, which in turn will produce collateral implications for asset managers.

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  • Throgmorton Adds Corporate Finance Veteran to its Board and Appoints Head of Legal

    On October 12, 2010, Throgmorton UK Ltd announced the addition of corporate financier Roger Looker to its Board as a non-executive director and the appointment of Adam Hewitson as the firm’s internal legal counsel.  Throgmorton is a UK firm providing business, financial and administrative outsourcing to the hedge fund, private equity and corporate finance sectors.

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  • James Capezzuto Named Associate Regional Director for Examinations in SEC New York Regional Office

    On October 14, 2010, the Securities and Exchange Commission announced the selection of James A. Capezzuto as Associate Regional Director for Examinations in the agency’s New York Regional Office.  Capezzuto succeeds Norm Champ, who was appointed Deputy Director of the SEC’s Office of Compliance, Inspections and Examinations in June of this year.

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