The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 4, No. 14 (Apr. 29, 2011) Print IssuePrint This Issue

  • Legal Considerations for Hedge Fund Managers that Use Social Media

    In late 2010, the SEC sent a “sweep” letter (the “Sweep Letter”) to a number of registered investment advisers requesting information on their involvement with social media and related recordkeeping practices.  The Sweep Letter appears to signal heightened regulatory awareness that social media websites such as Facebook and LinkedIn are increasingly being used by investment advisers to connect with clients.  Use of these sites by hedge fund and other private fund advisers may present regulatory issues, however, under the advertising rules of the Investment Advisers Act of 1940 (the “Advisers Act”) and the exemptions for private placements under the Securities Act of 1933.  With the repeal of the private adviser exemption from Advisers Act registration still on track for July, social media compliance by advisers to hedge funds and private funds can present important compliance issues.  In a guest article, Diana E. McCarthy and Andrew E. Seaberg, Partner and Associate, respectively, at Drinker Biddle & Reath LLP, detail: the specific items requested in the Sweep Letter; existing regulatory guidance on social media use (including guidance with respect to testimonials and supervision); advertising issues raised by social media; how hedge fund managers can develop a robust social media policy; personal use of social media and related compliance policies; and business use of social media and related compliance policies.

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  • SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market

    Recently, during Congressional testimony, Robert Khuzami, the Director of the SEC’s Division of Enforcement (Enforcement Division), faced tough questions regarding the SEC’s response to the Madoff scandal.  In response, Khuzami revealed an investigative initiative concerning hedge funds.  The Enforcement Division is now focusing on hedge funds that outperform “market indexes by 3% and [are] doing it on a steady basis.”  Khuzami referred to such performance as “aberrational,” and stated that Enforcement is “canvassing all hedge funds” for such “aberrational performance.”  This initiative raises a number of questions.  Should skilled portfolio managers (and their investors) bear the burden and costs of an SEC investigation just because they have returned more than the market?  How and why did the Enforcement Division determine to set the threshold at three percent?  Does the three percent threshold reflect “aberrational” performance, as Khuzami suggests?  What is considered outperformance on a “steady basis”?  Will the Enforcement Division focus on performance on a quarterly basis, or over one year, three years, or longer periods?  In a guest article, Fredric Firestone, Eugene Goldman and Michael Ungar – all Partners in the White Collar & Securities Defense Practice Group at McDermott Will & Emery LLP, based in Washington, D.C., and all Enforcement Division alumni – address these and related questions, and explain the implications of the new enforcement initiative for hedge fund managers.

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  • SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information

    In the vast majority of insider trading cases involving fund management, the material nonpublic information at issue relates to a company whose securities the fund may buy or sell.  However, in a provocative recent initial decision (Decision), an SEC Administrative Law Judge (ALJ) held that information about a fund itself may constitute material nonpublic information for insider trading and breach of fiduciary duty purposes.  This article explains in detail: the factual background of the Decision; the ALJ’s legal analysis; what specific categories of fund-level information may constitute material nonpublic information in the hedge fund management context; the disclosure implications of the potentially expanded scope of material nonpublic information; the interplay between the potentially expanded scope of material nonpublic information and the idea (most notably enunciated in Goldstein v. SEC) that a hedge fund is a manager’s “client”; the implications of the Decision for drafting, negotiating and performing under side letters and managed account agreements; the importance for hedge fund managers of internal investigations; how chief compliance officers (CCOs) can point to the “human toll” in this matter to capture the attention of investment personnel during compliance training; and a new category of monitoring of family relationships to be performed by hedge fund manager CCOs.

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  • U.S. District Court Dismisses All Federal Securities Fraud Claims Brought by Investors Against Hedge Fund Manager RAM Capital Resources, LLC, its Principals and the Funds it Sponsored, Holding that Disclaimers in Subscription Agreements Preclude Reliance on Certain Alleged Misrepresentations

    Defendant RAM Capital Resources, LLC (RAM Capital), is a New York based asset manager and hedge fund sponsor.  Defendants Stephen E. Saltzstein (Saltzstein) and Michael E. Fein (Fein) are RAM Capital’s principals.  Saltzstein was introduced to plaintiff Mario Frati through Saltzstein’s sister, who was a childhood friend of Mario Frati’s wife.  The Fratis invested $2 million in RAM Capital’s Shelter Island Opportunity Fund, LLC.  Plaintiff Banco Popolare (Luxembourg), S.A., on behalf of Mr. Frati’s mother, invested $1.5 million with RAM Capital’s Truk International Fund, LP.  When plaintiffs’ redemption demands were not satisfied, plaintiffs brought suit.  Their complaint, as amended, alleges federal securities fraud, common law fraud, breach of fiduciary duty, unjust enrichment and breach of contract.  Plaintiffs claim the defendants misrepresented, among other things, that plaintiffs could redeem their investments after six months and that RAM Capital’s principals were “heavily invested” in the sponsored funds.  Defendants allegedly also wrongfully omitted to tell plaintiffs that RAM Capital, Saltzstein and Fein were under investigation by the Securities and Exchange Commission and that they were not registered broker-dealers.  See “Investors in Hedge Funds Managed by RAM Capital Resources, LLC Sue RAM, its Principals and its Funds Alleging Securities Fraud, RICO Violations and Other Claims Based on Alleged Misrepresentations and Self-Dealing by RAM Principals,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  Defendants moved to dismiss the entire complaint for failure to state a claim.  We summarize the Court’s decision on defendants’ motion to dismiss.

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  • Massachusetts Securities Division Proposes Regulation on the Use by Hedge Fund Managers of Expert Networks

    On April 20, 2011, the Massachusetts Securities Division (Division) proposed regulations that would impose new conditions on the use of “matching or expert network services” by Massachusetts-registered hedge fund managers or unregistered hedge fund managers operating in Massachusetts.  In the proposing release, the Division stated: “The rise of expert network firms, and the number of abuses which have been addressed by regulators, make it clear that additional measures are required to ensure that confidential information is not being accessed and traded upon.”  By way of evidence of “the number of abuses which have been addressed by regulators,” the Division’s proposing release cites the Division’s own recently filed complaint against Risk Reward Capital Management Corp., the allegations of which remain to be proven.  See “Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).  This article describes relevant Massachusetts regulation and how the proposed regulation would change the current regulatory regime.  This article concludes with a critique of the proposed resolution, generally suggesting that it is overbroad, redundant of current law, redundant of current practice and incomplete.

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  • Investment Manager Eden Rock Financial Sues Hedge Fund Stillwater Capital and Gerova Financial Group in New York State Supreme Court for Fraudulent Conveyance, Fraud and Breach of Contract in Connection with Plan to Achieve Liquidity in Stillwater Funds

    Plaintiffs Eden Rock Finance Fund, L.P., Eden Rock Finance Master Limited and Eden Rock Unleveraged Finance Master Limited (together, Eden Rock) had invested about $29 million with defendant hedge funds Stillwater Asset Backed Offshore Fund Ltd. (Stillwater Offshore) and Stillwater Asset Backed Fund II, LP (Stillwater Onshore), both of which were feeder funds for Stillwater Asset Backed Fund LP (Master Fund).  Commencing in August 2008, Eden Rock sought to redeem all of its interests in the Stillwater funds.  Although Stillwater repeatedly promised Eden Rock redemption in cash, no redemption payments were ever made.  In December 2009, Stillwater Offshore proposed to redeem Eden Rock’s interests in that fund by a payment in kind.  It purported to issue to Eden Rock participation certificates in the underlying assets held by the Master Fund.  It also promised that Eden Rock would receive a 10% return of principal from those assets, in liquid funds, each quarter.  No principal was ever returned.  In January 2010, all the assets of the Master Fund were acquired by defendant Gerova Financial Group Ltd. (Gerova), a publicly traded company, in exchange for an indeterminate number of Gerova’s shares.  Those shares were supposed to be registered for public trading in the U.S. but, in fact, they were never registered.  In addition, an audit of the acquired portfolio revealed accounting irregularities and Gerova’s auditors refused to issue an opinion as to the value of the acquired assets.  After management upheavals at Gerova, the New York Stock Exchange suspended trading in its shares in February 2011.  Eden Rock has now sued Gerova, Stillwater Onshore, Stillwater Offshore and various affiliates.  We summarize Eden Rock’s allegations.

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  • Bob Contri Named Head of Deloitte’s Financial Services Industry Group

    On April 25, 2011, Deloitte announced the appointment of Bob Contri as leader of its financial services industry group in the United States.

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