The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 3, No. 45 (Nov. 19, 2010) Print IssuePrint This Issue

  • Soft Lock-Ups Help Hedge Fund Managers Reconcile the Goals of Stable Capital and Investor Liquidity

    What do hedge fund liquidity management tools (lock-ups, gates, suspensions and the like) and garbage dumps have in common?  Both categories are characterized by a “not in my backyard” mentality.  In the dump context, people want the benefit of a faraway dump (the ability to use and dispose of goods), but do not want the burden of a nearby dump (pollution, nuisance, olfactory offense).  Similarly, in the hedge fund liquidity management context, investors want the benefit of judiciously-deployed liquidity management tools (the greater returns that often come from a less liquid portfolio), but do not want the burden of investor-level illiquidity (an inability to get your money back when you want it).  Indeed, a large part of the tension between hedge fund managers and investors during the credit crisis arose out of precisely this “liquidity management NIMBYism.”  By and large, investors did not object to declining performance, per se.  Rather, they objected to the inability to get their money back, roughly on demand; and investors objected more strongly where they, in turn, had their own investors demanding to redeem.  Managers and investors sought to structure around the potential liquidity problems of commingled hedge funds by turning with increasing frequency, in the wake of the crisis, to managed accounts and single investor hedge funds.  See “Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors,” The Hedge Fund Law Report, Vol. 3, No. 16 (Apr. 23, 2010); “How Can Hedge Fund Managers Structure Managed Accounts to Remain Outside the Purview of the Amended Custody Rule’s Surprise Examination Requirement?,” The Hedge Fund Law Report, Vol. 3, No. 5 (Feb. 4, 2010).  However, by most accounts, the use of managed accounts and single investor hedge funds has not been as prevalent as anticipated in late 2009.  Rather, hedge fund managers have been finding creative ways to accommodate the liquidity needs of investors in the classic commingled hedge fund structure.  One such method is the so-called “soft” lock-up.  In a typical hedge fund investment, the investor cannot get its capital back or “redeem” – that is, the investor’s capital is “locked up” – for a period following the date of investment.  That period is specified in the governing documents of the fund, and generally is one to three years.  (Following expiration of the initial lock-up, the investor generally may redeem its initial capital commitment – plus or minus any gains or losses and net of applicable fees and holdbacks – periodically, e.g., monthly, quarterly, semiannually, annually or biennially.  Generally, investors must provide written notice of intent to redeem 30 to 90 days prior to a scheduled redemption date.)  Traditionally, that initial one- to three-year period during which capital could not be redeemed was known simply as the “lock-up” period.  Now, with the advent of “soft” lock-ups, that traditional approach is known as a “hard” lock-up period.  A soft lock-up works much like a hard lock-up, but with one key difference: an investor can redeem during the soft lock-up period by paying a redemption penalty to the fund.  This article discusses: the mechanics of and rationale for traditional or “hard” lock-ups; the interaction between the liquidity of a hedge fund’s strategy and the length of a lock-up; the practical and fiduciary duty considerations in connection with granting waivers from hard lock-ups; the interplay between secondary market transactions and lock-ups; holdbacks; three methods for calculating soft lock-up redemption penalties, including accounting and tax considerations; the three chief rationales for soft lock-ups; variations on the lock-up structure; and empirical data on institutional investor tolerance for soft lock-ups versus hard lock-ups, and lock-ups generally, and the marketing implications of this data.

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  • Protection Against Court Winding Up of Cayman Islands Hedge Funds in Management Wind Down

    Many investment funds that have come to the end of their commercial life will conclude that the interests of their investors are best served by the closing down of the fund, conducted by its management, including the investment manager, with the return to the investors of their due share of the assets of the fund after settlement of liabilities; such closing down is usually effected by the distribution to investors of cash or assets, or by the assignment of shares in a special purpose vehicle set up by the fund to take illiquid or other assets of the fund, or by a combination of these.  Funds will typically achieve this by a combination of redemptions (voluntary and compulsory), in cash or in specie, and the imposition and lifting of suspensions of redemptions and gating provisions as necessary.  Such wind down schemes, to be valid and enforceable, will require compliance with the contractual entitlement of the fund to adopt and impose the scheme under the fund’s constitutional documentation, i.e., the fund’s articles of association and offering memoranda.  Funds which have ceased to operate as active investment vehicles have recently attracted the attention of the first instance courts of the Cayman Islands (and the British Virgin Islands and Bermuda), in the context of petitions to wind up a fund which is in management wind down.  This kind of informal wind down will usually be effected and managed by the fund’s board of directors and the investment manager.  A source of discontent amongst investors may be the level of fees charged by the investment manager during the wind down period which, whilst accepted to be at a level appropriate when the fund was operating as a going concern and taking in new investors, is perceived to be disproportionately and unjustifiably high in a wind down.  It may also be perceived that any wind down managed by the investment manager inherently provides an incentive (conscious or unconscious) for the investment manager to prolong the wind down process for the purpose of earning continuing fees.  A trend is emerging from a number of recent cases before the first instance courts of the Cayman Islands (which may be followed in other jurisdictions) that it is open to the court, almost as a matter of course, to impose a compulsory winding up order in respect of an investment fund merely because it has ceased to operate as an active investment vehicle, even if it is in a process of a management-conducted winding down.  In a guest article, Christopher Russell and Shaun Folpp, Partner and Senior Associate, respectively, at Ogier, Cayman Islands, analyze and critique this trend, and detail its implications for the drafting of constitutional documents of Cayman Islands hedge funds.

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  • U.K. Chancery Court Holds That, Under European Union Intellectual Property Law, Financial Services Company “OCH Capital” Infringed the Trademarks of European Hedge Fund Manager Och-Ziff Capital Management

    On October 20, 2010, a Judge of the United Kingdom High Court of Justice, Chancery Division, ruled that OCH Capital, LLP infringed two trademarks, “OCH-ZIFF” and “OCH” registered by hedge fund Och-Ziff Management Europe, Ltd. and its manager, OZ Management LP (collectively Och-Ziff or Claimants), and that OCH Capital committed “passing off,” the European equivalent of “unfair competition.”  Specifically, it found that, by using the sign “OCH Capital,” and derivations thereof, in the course of its trade in the financial services industry, OCH Capital created confusion in the marketplace with the Och-Ziff trademarks, and caused damage to, and took unfair advantage of, the Och-Ziff Group’s established reputation in the same industry.  The Court also held OCH Capital, its founder, Thomas Tadeus Antoni Ochocki, and its management firm, Union Investment Management Ltd. jointly liable.  We detail the background of the action and the Court’s legal analysis.

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  • Cayman Islands Grand Court Rules that Investor in Hedge Fund Wyser-Pratte EuroValue Fund Is Entitled to Court-Imposed Liquidation of Fund, Even Though Fund Is Solvent, but Gives Fund Time to Complete Liquidation On Its Own

    In another case that has its roots in the market meltdown and liquidity crisis of 2008, the Grand Court of the Cayman Islands has ruled that, in principle, an investor in hedge fund Wyser-Pratte EuroValue Fund Ltd. (Fund) is entitled to judicial liquidation of the Fund.  However, because the Fund had already substantially completed the liquidation process by the time of the hearing of the liquidation petition, the Court declined to issue an immediate order appointing liquidators.  Petitioner, Fund investor AIFAM Event Driven Fund Trust (Investor), sought to redeem all its Fund shares, effective June 20, 2008.  In response to numerous redemption requests, the Fund imposed a gate on redemptions, limiting them to 10% of net asset value.  In September 2008, the Fund froze redemptions entirely.  The freeze remained in effect indefinitely.  In March 2010, the Fund proposed to liquidate over a two-year period.  Dissatisfied with that plan, the Investor filed a petition for court-supervised liquidation of the Fund.  Unbeknownst to the Investor, the Fund had already adopted a revised plan that would have substantially concluded the liquidation by the end of 2010 and, significantly, provided that the Fund manager would not be paid management fees after 2010.  The Grand Court agreed with the Investor’s argument that, under the circumstances, it was entitled to a court-appointed liquidator.  However, by the time of the hearing of the Investor’s petition, the Fund had already completed a substantial portion of its liquidation, and was poised to complete the liquidation within a few weeks.  As a result, the Grand Court decided not to appoint a liquidator to give the Fund time to make good on its promises.  We summarize the facts of the case and the Grand Court’s reasoning.  See also “Protection Against Court Winding Up of Cayman Islands Hedge Funds in Management Wind Down,” above, in this issue of The Hedge Fund Law Report.

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  • Morgan Stanley Sues Commodities Hedge Fund Peak Ridge for Alleged Failure to Satisfy Margin Calls

    On November 8, 2010, Morgan Stanley & Co. Incorporated filed suit against commodities hedge fund Peak Ridge Master SPC LTD (Peak Ridge), claiming $40.6 million in damages resulting from losses stemming from bad bets on natural gas.  According to Morgan Stanley, the losses resulted from Peak Ridge’s inability to meet contractually required margin calls, which Morgan Stanley had tripled over a period of ten months leading up to Peak Ridge’s alleged default due to the increasing level of risk the fund had taken on since it began trading through Morgan Stanley’s futures commission merchant (FCM) unit.  Morgan Stanley took control of the fund’s positions from June 10, 2010, and undertook several transactions in the following two weeks “in order to reduce risk and stabilize the book in an orderly fashion.”  We review the background of the action and the main points in Morgan Stanley’s Complaint.

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  • Harneys Enhances Litigation and Investment Funds Practices

    On November 15, 2010, international offshore law firm Harneys announced two new recruits to the firm’s litigation and investment funds practices.  Philipp Neumann joined the firm’s investment funds department in the British Virgin Islands while James Noble joined the litigation and insolvency team in the Cayman Islands.

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