The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 4, No. 12 (Apr. 11, 2011) Print IssuePrint This Issue

  • Ten Issues That Hedge Fund Seed Investors Should Consider When Drafting Seed Investment Agreements

    While the interests of hedge fund seed investors and the managers in whom they invest frequently diverge, it is relatively rare for such a divergence of interests to wind up in court.  See “How to Structure Exit Provisions in Hedge Fund Seeding Arrangements,” The Hedge Fund Law Report, Vol. 3, No. 40 (Oct. 15, 2010).  When it does, the results can be illuminating for the wide range of hedge fund industry participants that participate in the seeding process – whether as investors, recipients of investments or service providers to either.  See “Primary Legal and Business Considerations in Hedge Fund Seeding Arrangements,” The Hedge Fund Law Report, Vol. 2, No. 38 (Sep. 24, 2009).  Accordingly, this article offers a detailed discussion of a recent decision by the Superior Court of Massachusetts involving two individual seed investors in a prominent hedge fund management business.  According to the plaintiffs’ allegations, the manager – i.e., the recipient of seed funding – engaged in a “shell game” of fund restructurings with the goal of stripping the seed investors of their right to a portion of net management fees.  The investors protected their rights via arbitration and this lawsuit, but with difficulty, acrimony, publicity and expense.  This article explains the factual background and legal claims in the dispute, and illustrates how seed investors may revise their form documents and approaches in light of the lessons of this dispute.  In particular, the arbitration award imposed provisions on the parties, mostly to the benefit of the seed investors, that effectively served as ex post amendments to the seed investment agreement.  Those provisions should have been included ex ante in this matter – and should be included, or at least considered, by seed investors in every seed investment deal.  We explain what those provisions are and why they matter to seed investors.  More generally, we derive practical lessons from the legal analysis and factual missteps in this matter that are relevant to anyone involved or contemplating involvement in a hedge fund seeding transaction.  See also “Massachusetts Courts Approve of Accounting Firm Rothstein Kass’ Role as Award Arbiter in Hedge Fund Management Fee Dispute,” The Hedge Fund Law Report, Vol. 3, No. 18 (May 7, 2010).

    Read full article …
  • Investments by Family Offices in Hedge Funds through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part Two of Two)

    Variable insurance policies are an often utilized structure through which family offices and other high net worth investors invest in hedge funds and other private investment funds.  One of the primary advantages of investing in hedge funds and other private investment funds through variable insurance policies is the deferral of income taxes.  However, policy holders must first satisfy two important tests – the “diversification rules” and the “investor control” rules – in order for the policies to qualify for favorable income tax treatment.  This article is the second in a two-part series.  The first article in this series described the mechanics of investing in an insurance dedicated fund through variable insurance policies and offered a roadmap for satisfying the two tests to ensure the variable insurance policies maintain their tax-advantaged status.  See “Investments by Family Offices in Hedge Funds through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).  This article describes in detail a recent restructuring transaction in which the authors participated (the “Transaction”) and provides the key terms in the Transaction documents applicable to the diversification and investor control rules.

    Read full article …
  • Broadly Defined Terms in a Term Sheet Covering Employment of a General Counsel May Render Hedge Fund Manager Principal Personally Liable for Unpaid Compensation

    Dow Kim sought to launch hedge fund management company Diamond Lake Investment Group with a sterling resume, a high caliber team and great expectations.  But timing worked against Kim.  He launched in late 2007, into a perfect financial storm, when the vast majority of potential hedge fund investors were trying to get their money back rather than trying to deploy it.  A recent decision from New York’s intermediate appellate court held that Kim may have breached a contract and violated New York’s Labor Law by withholding compensation from the person he brought on board as general counsel of the management company.  But the interesting thing about the decision – or one of various interesting things – is that there was no contract.  There was only a term sheet; and that term sheet contained broad definitions of key terms that may render Kim liable for over $2 million in compensation obligations.  This article describes the factual background and legal analysis in the opinion, and makes four observations relevant to the drafting of hedge fund manager employment agreements and term sheets.  At least one other former employee of the short-lived Diamond Lake venture has taken his employment-related grievances to court.  See “After Hedge Fund Folds, Ex-Portfolio Manager Sues Its Founder, Dow Kim, in Federal Court for Fraud and Negligent Misrepresentation in Inducing Him to Join the Venture,” The Hedge Fund Law Report, Vol. 3, No. 32 (Aug. 13, 2010).  See generally “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).

    Read full article …
  • U.S. District Court Rules on Statute of Limitations Issues in Civil Insider Trading Action against Prominent Hedge Fund Managers Sam and Charles Wyly, and Their Advisers

    In July 2010, the Securities and Exchange Commission (SEC) commenced a civil enforcement action against investor-entrepreneurs Samuel Wyly and Charles J. Wyly, Jr., their attorney Michael C. French, and one of their brokers, Louis J. Schaufele III.  The SEC alleges that the defendants committed various securities laws violations, including insider trading, through “a labyrinth of offshore trusts and subsidiary entities” that enabled them to conceal their true holdings and trading in various public companies.  The defendants moved to dismiss certain of the SEC’s causes of action for insider trading and securities fraud on the grounds that those claims were barred by the applicable statutes of limitations and that they failed to state claims upon which relief could be granted.  The U.S. District Court for the Southern District of New York has denied the defendants’ motion in its entirety and ruled that equitable tolling principles apply to the statute of limitations governing the civil penalty provisions of the Securities Exchange Act.  As a result, the applicable limitations period did not begin to run until the SEC had reason to know of the alleged fraud.  We provide a detailed summary of the Court’s decision, with an emphasis on the statute of limitations ruling.

    Read full article …
  • GIPS Committee Provides Eagerly-Anticipated Guidance on Presentation of Hedge Fund Performance Information for Master-Feeder Structures, Side Pockets, Illiquid Assets and Other Assets, Strategies and Structures

    As established by the CFA Institute in 1999, the “Global Investment Performance Standards” (GIPS) for the presentation of investment performance information aims to create ethical, global and industry-wide methods of communicating investment results to prospective clients.  On March 15, 2011, the GIPS Executive Committee released its “Exposure Draft of the Guidance Statement on Alternative Investment Strategies and Structures” (Guidance Statement) in an effort to provide dedicated guidance to firms that manage hedge funds, funds-of-funds, master-feeder funds and other alternative investment strategies so they may better understand and meet the GIPS standards.  The Executive Committee decided to produce these standards due to the perception among many alternative investment firms that the lack of such guidance complicated compliance with GIPS.  Accordingly, the GIPS standards, which focus on the underlying GIPS principles of “fair representation and full disclosure,” provide a framework that substantially all hedge fund and other private fund managers can apply to a variety of assets, structures and strategies.  The exposure draft is open for public comment until June 15, 2011.  This article provides a comprehensive summary of the exposure draft, focusing on the items most relevant to presentation of hedge fund performance information.

    Read full article …
  • SEC Anticipates Extension of Compliance Dates for Hedge Fund Adviser Registration and Mid-Sized Adviser Deregistration

    In a letter dated April 8, 2011 to the President of the North American Securities Administrators Association, Robert Plaze, Associate Director of the SEC’s Division of Investment Management (Division), indicated that the SEC “will consider providing additional time” for hedge fund managers affected by two key registration provisions to comply with those provisions.  The letter does not constitute formal SEC action and the conservative course for hedge fund managers is to proceed with preparations for relevant registration requirements until the SEC issues formal guidance.  However, the letter appears to indicate a recognition on the part of the Division that the increasingly imminent July 21, 2011 compliance date threatens to yield unintended consequences for hedge fund managers and investors, and the SEC itself.

    Read full article …
  • New York Appellate Court Requires Insurers to Indemnify Hedge Fund-Controlled Company for Attorneys’ Fee Award against Company in a Shareholder Derivative Action

    Plaintiffs in shareholder derivative actions often seek, and courts are empowered to award, a variety of remedies – including an award of attorneys’ fees to a prevailing plaintiff.  In a recent decision, the New York Appellate Division, First Department, reaffirmed insurance protection to a corporate policyholder, in which private investment funds had invested, facing the threat of paying attorneys’ fees in a derivative suit.  The Appellate Division held that – notwithstanding the fact that no other damages were awarded in the underlying derivative suit – the derivative plaintiffs’ attorneys’ fees constituted a “Loss” for which the policyholder was entitled to reimbursement from its insurers.  The decision is an important win for policyholders because it represents the first time a New York appellate court has recognized that an underlying plaintiff’s attorneys’ fees awarded in a securities or derivative action are indemnifiable under the terms of the insured defendant’s insurance policy.  In so doing, the Appellate Division placed New York law in line with decisions that are favorable to policyholders on this issue in jurisdictions across the country.  In a guest article, Jared Zola and Andrew N. Bourne, Partner and Associate, respectively, at Dickstein Shapiro LLP, describe the facts and holding of the decision and its implications for hedge funds involved on either side of a derivative suit.

    Read full article …
  • Sanjay Wadhwa Named Associate Regional Director for Enforcement in SEC’s New York Regional Office

    On April 1, 2011, the SEC announced that Sanjay Wadhwa has been promoted to Associate Regional Director for Enforcement in the agency’s New York Regional Office.

    Read full article …