The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 4, No. 39 (Nov. 3, 2011) Print IssuePrint This Issue

  • Anti-Bribery Compliance for Private Fund Managers

    Managing the risks inherent in dealing with foreign officials should be a top priority for managers of hedge funds and private equity funds.  This is especially true in the current climate of expansive government interpretations of anti-bribery laws, new incentives for whistleblowers and the recent government scrutiny of the inner workings of fund managers.  It has become standard fare for fund managers to have regular interactions with foreign officials or their representatives in the ordinary course of raising capital and making investments.  There is nothing inherently wrong with such interactions.  Still, those dealings need to be informed by a heightened sensitivity to the possible appearance that something of value was given to a foreign official in connection with a particular investment or transaction.  The risk is that, regardless of the intent of the fund manager, certain conduct may be viewed in hindsight as an effort to improperly influence the actions of a foreign official.  As a result, a fund manager needs to focus on more than just the substance of the transaction and needs to consider both how the transaction might be perceived and the record that is being created.  As cross-border investments continue apace, fund managers can protect themselves by having adequate policies and procedures in place to identify potential bribery risks and to prevent violations from occurring.  Aggressive enforcement of the Foreign Corrupt Practices Act (FCPA) by U.S. authorities and the comprehensive overhaul of anti-corruption laws in the U.K., culminating in the new Bribery Act 2010 (Bribery Act), highlight the importance of implementing effective anti-corruption compliance policies and procedures.  In these circumstances, fund managers must do more than assure themselves that they are not acting with a corrupt intent; they also need to be alert to the risk of misunderstandings and to be diligent in creating a record of compliance.  In a guest article, Paul A. Leder and Sarah P. Swanz, partner and counsel, respectively, in the Washington D.C. office of Richards Kibbe & Orbe LLP, outline steps to take to identify and manage the compliance risks faced by fund managers both directly (through their own dealings with foreign officials) and indirectly (through investments in operating companies that operate overseas).  Specifically, Leder and Swanz identify conduct at the fund manager level that can put the manager at risk; discuss the importance of strong internal controls and compliance programs to mitigate corruption risks; and highlight categories of conduct at the portfolio company level that can put the manager at risk.  The authors then make specific suggestions for identifying potential bribery risks and managing such risks.  They conclude with a case study of a criminal prosecution that demonstrates the potential exposure for managers when making foreign investments.

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  • Key Legal and Operational Considerations in Connection with Preparing, Filing and Updating Form PF (Part One of Three)

    Rightly or wrongly, a consensus has emerged among global regulators that private funds – most notably, hedge funds and private equity funds – may collectively pose a risk to the global financial system.  The often cited evidence of this view includes the 1998 collapse of Long Term Capital Management and the 2008 financial crisis.  Neither, of course, conclusively demonstrates that private funds pose systemic risk, and we at The Hedge Fund Law Report have not seen persuasive evidence of the thesis.  In fact, we have seen persuasive evidence to the contrary, namely, that the collective buying power of private funds mitigates systemic risk by providing, if you will, a “buyer of penultimate resort.”  (The taxpayer remains the buyer of last resort.)  When the going gets tough, it is hedge and private equity funds that typically buy the distressed assets, receive novations of derivatives and provide rescue funding to institutions teetering on the brink.  See “Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act,” The Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).  But perception, demagoguery and skewed incentives often affect the shape of legislation and regulation more powerfully than evidence or economic reality.  The perception of risk in the private funds industry has given us the reality of Form PF.  Form PF generally calls for voluminous disclosure by private fund managers to regulators of fund, investor, counterparty, credit and other information.  It calls for a level of disclosure that is unprecedented in the U.S. hedge fund industry.  The form is legally complex and operationally challenging.  On the legal side, its novelty means that there is no direct market practice to assess the form’s application or to guide completion.  On the operational side, its novelty means that managers and service providers do not have dedicated systems in place to create, organize, scrub, update and secure the relevant data.  See “Technical and Operational Considerations for Hedge Fund Managers in Connection with Preparing, Filing and Updating Form PF,” The Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011).  To bring some clarity to the complexity, on October 25, 2011, Advise Technologies and The Hedge Fund Law Report co-sponsored a seminar on Form PF.  The seminar consisted of two panels, the first focusing on legal questions raised by the form, and the second focusing on operational considerations in connection with the form.  On October 26, 2011 – the day after our seminar – the SEC adopted Rule 204(b)-1 under the Investment Advisers Act of 1940 requiring periodic reporting by private fund managers on Form PF.  In other words, we discussed proposed Form PF at the seminar and a day later the SEC adopted final Form PF.  However, as detailed in this article, most of the changes from the proposed form to the final form involved thresholds and timing provisions.  While the seminar covered thresholds and timing provisions, the more important discussion at the seminar focused on market color, relevant practice, context and lore.  The final rule did not change any of that; and that is precisely the information that you as a hedge fund manager, investor or service provider need to grapple successfully with Form PF.  Moreover, the final rule says nothing about operations – what you actually have to do to prepare, file and update the form – and that was an important focus of the seminar.  In recognition of the ongoing relevance of the discussion at the seminar, The Hedge Fund Law Report is publishing a three-part series on changes to Form PF and the key legal and operational points made by seminar participants.  This article – the first part of the three-part series – provides a line-by-line comparison of proposed Form PF and final Form PF, including the instructions and the form itself.  To do so, this article links to a redline prepared by Advise Technologies highlighting the differences between the proposed and final instructions and forms.  The second article in this series will summarize the key legal points made at the seminar, and the third article in this series will summarize the key operational points made at the seminar.  Taken together, the three parts of this series are intended to help HFLR subscribers determine whether they have to file Form PF, what they have to file, how they can go about filing and how their obligations have changed from the proposed rule to the final rule.

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  • Bondholders of Bankrupt Icelandic Bank Kaupthing Singer and Friedlander Battle with Other Bank Creditors over Competing Claims

    This case pits the creditors of failed bank Kaupthing Singer and Friedlander Limited (KSF) against holders of bonds issued by KSF subsidiary Singer & Friedlander Funding plc (Funding).  Both of those entities are now in administration (bankruptcy) in the UK.  KSF had guaranteed Funding’s bonds and sought to use a claim for indemnification from Funding under that guarantee to offset other amounts it owed to Funding.  The UK Supreme Court ruled on whether the rule against double proof takes precedence over a conflicting equitable principle.  We summarize the Supreme Court’s decision.  For a deep discussion of the chief regulatory, tax, documentation, insider trading and other legal and business issues impacting hedge funds’ trade risk in European secondary loans, see Part One and Part Two of the two-part article series recently published in the HFLR by attorneys at Schulte Roth & Zabel LLP.

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  • Can an Arbitration Provision Signed by a Hedge Fund Manager, but Not by a Hedge Fund Director, Bind a Hedge Fund?

    On September 29, 2011, Judge Elizabeth A. Kovachevich of the United States District Court for the Middle District of Florida issued an order (Order) compelling arbitration of 23 of the “clawback” actions brought by the receiver (Receiver) of Arthur Nadel’s fraudulent hedge funds to recover false profits from the funds’ investors.  Following the discovery that Nadel was running a massive Ponzi scheme, the Receiver filed numerous such fraudulent conveyance actions against investors in an attempt to claw back any money withdrawn in excess of the investors’ capital contributions.  On the differing treatment in bankruptcy between capital invested in a Ponzi scheme and withdrawals in excess of such capital contributions, see “Two Recent Federal Court Decisions Clarify the Differing Treatment under SIPA of Returned Principal and Fictitious Profits,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  Certain of the investors demanded that the suits against them be arbitrated as opposed to litigated.  The Court ruled on the investors’ demands, and in doing so, addressed the question of whether the existence of an arbitration provision in a hedge fund document signed by a manager is sufficient, absent extraordinary circumstances, to force the fund to attack the validity of that document in front of an arbitrator as opposed to a judge.

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  • What Do Hedge Fund Investors Want in Terms of Liquidity and Transparency?

    In the aftermath of recent high profile hedge fund scandals and the 2008 financial crisis, hedge fund investors have raised their expectations with respect to the degree of fund liquidity and portfolio transparency demanded from fund managers.  Heightened transparency offers investors an opportunity to more closely evaluate the risks and conflicts of interest attendant to their fund investments.  See “Eight Corporate Governance Steps That Hedge Fund Managers Should Consider in Response to Concerns Expressed by Institutional Investors,” The Hedge Fund Law Report, Vol. 4, No. 35 (Oct. 6, 2011).  More preferential fund liquidity terms offer fund investors better opportunities to exit their investments, which can be a valuable tool particularly in times of financial market dislocation.  See “How Can Hedge Fund of Funds Managers Manage a ‘Liquidity Mismatch’ Between Their Funds and Underlying Hedge Funds?,” The Hedge Fund Law Report, Vol. 2, No. 40 (Oct. 7, 2009).  Fund managers must be attentive to the nuanced demands of these investors, particularly in light of the heightened competition in the challenging capital raising environment.  Private fund data provider Preqin recently published two reports in which institutional investors were surveyed to ascertain their views on fund liquidity and transparency.  The first study, conducted in June 2011 (Transparency Study), details changing expectations and satisfaction levels with respect to the level of transparency being offered by fund managers; the categories of transparency being requested by institutional investors; and how and how often hedge fund managers should communicate with institutional investors.  The second study, conducted in September 2011 (Liquidity Study), details institutional investor preferences when it comes to fund liquidity terms; institutional investor expectations with respect to the length of lock-up and redemption periods; the trade-offs between illiquidity and other fund terms (such as fees) that investors are willing to make; and whether institutional investors are willing to invest with managers that imposed gates during or shortly after the credit crisis.  A fund manager’s ability to understand and adequately address the concerns of institutional investors on these two fronts can go a long way towards helping fund managers retain existing institutional investors and towards attracting new ones.  See “Certain Hedge Funds Are Using Enhanced Liquidity as a Marketing Tool,” The Hedge Fund Law Report, Vol. 2, No. 22 (Jun. 3, 2009).

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  • Fund of Hedge Funds Aris Multi-Strategy Fund Wins Arbitration Award against Underlying Manager Based on Allegations of Self-Dealing

    According to press reports, on September 28, 2011, Javier Guerra, the portfolio manager of Quantek Asset Management, LLC (QAM) and Quantek Opportunity Fund, LP (Partnership or Feeder Fund), resigned from the Partnership’s Board of Directors as a result of a loss in arbitration to fund of hedge funds investor Aris Multi-Strategy Fund (Aris).  The arbitration panel reportedly concluded that QAM fraudulently induced Aris to invest in the Feeder Fund and ordered Guerra to pay $1 million in damages; Aris had invested $15 million in the Feeder Fund.  This article details the relevant factual and legal allegations in publicly available court documents, and includes links to those documents.  For more on litigation involving Aris, see “New York State Supreme Court Dismisses Hedge Funds of Funds’ Complaint against Accipiter Hedge Funds Based on Exculpatory Language in Accipiter Fund Documents and Absence of Fiduciary Duty ‘Among Constituent Limited Partners,’” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010); “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).  For more on the views of Aris’ principals with respect to litigation by hedge fund investors against hedge fund managers, see “Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers?,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).

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  • More Hedge Funds Are Employing Environmental, Social and Governance Investment Criteria

    An October 2011 report (Report) by The Forum for Sustainable and Responsible Investment found that while hedge funds have historically comprised only a small proportion of the total number of alternative investment vehicles incorporating environmental, social and governance (ESG) investment criteria, the number of hedge funds employing ESG criteria increased markedly in 2011 over 2010, and hedge funds accounted for a greater share of ESG alternative funds in 2011 than in prior years.  Other categories of alternative funds employing ESG criteria – and thus following what the Report called a sustainable and responsible investing (SRI) strategy – include private equity, venture capital and real estate funds.  This brief article summarizes the portions of the Report relating to hedge funds.

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  • Andrew Bowden to Lead National Investment Adviser/Investment Company Exam Program at OCIE

    On October 21, 2011, the Securities and Exchange Commission announced that Andrew J. Bowden was appointed as Associate Director to lead the National Investment Adviser/Investment Company Examination Program in the SEC’s Office of Compliance Inspections and Examinations (OCIE).  OCIE conducts the SEC’s national examination program for hedge fund advisers and other investment advisers, investment companies, broker-dealers, self-regulatory organizations, clearing agencies, transfer agents and credit rating agencies to fulfill its mission of promoting compliance, preventing fraud, monitoring risk and informing SEC policy.  See “SEC Exams of Hedge Fund Advisers: Focus Areas and Common Deficiencies in Compliance Policies and Procedures,” Vol. 4, No. 38 (Oct. 27, 2011).

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