The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 5, No. 11 (Mar. 16, 2012) Print IssuePrint This Issue

  • Hedge Fund Names: What a Hedge Fund Manager Should Do Before It Starts Using a Name

    Although the pace of new hedge fund formation these days is nowhere near that of several years ago, new funds are still being formed at a fairly healthy clip.  Whether as a result of investment banks spinning off their proprietary trading operations due to the Dodd-Frank regime or as a result of successful traders leaving funds that are stuck below their high-water marks, new funds are being formed and new managers will need to come up with names for their management companies and funds.  In the wake of last decade’s exponential growth in the industry, they will find that most of the obvious sources of names (e.g., trees, birds, constellations and mythological entities) are already being used.  Other names, although no longer in use, have been so tarnished by their past use in the investment management field (whether due to scandal or simply poor performance) that they are no longer viable candidates for a new manager.  This makes selecting a name for a new management company or fund increasingly difficult and presents a greater risk now than ever before.  It also makes obtaining trademark protection for a name increasingly important.  Complicating the name selection issue is the fact that trademark rights exist on a country-by-country basis, which means that a given name might be available for use and registration in one country but not in another.  With the globalization of financial markets and the rise of multi-jurisdictional hedge fund managers, new managers must consider name rights outside the United States and may have to devise intricate use and registration strategies internationally to ensure their ability to use their name and prevent others from adopting similar names across many countries.  In a guest article, David Nissenbaum and Scott Kareff, Partner and Special Counsel, respectively, at Schulte Roth & Zabel LLP, discuss various topics related to hedge fund name selection, including: the importance of trademark registration for hedge funds; specific disputes that can arise as a result of name selection; ten lessons that can be learned from prior name disputes; and the value of name searches, including a discussion of the name search process and its inherent limitations.

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  • Use of SSAE 16 (SAS 70) Internal Control Reports by Hedge Fund Managers to Credibly Convey the Quality of Internal Controls, Raise Capital and Prepare for Audits

    An “institutional” quality infrastructure is becoming a prerequisite for hedge fund managers looking to raise capital from sophisticated investors.  But institutional is a difficult quality to define with precision in the hedge fund industry, a function of, among other things, the relative youth of the industry, asymmetry in the size and structure of management companies and the reluctance on the part of managers to disclose information.  As used by hedge fund investors, consultants, managers, regulators, service providers and others, institutional is more of a conclusion than a characteristic.  Managers are said to be institutional when they have fund directors with substance, gray hair in key operational roles, best-of-breed technology, brand name service providers, top tier investment talent and high caliber personnel focused on aspects of the business other than investing.  But a manager may be institutional without some of these elements, and even a manager with these elements can have holes in its processes that undermine the veneer of competence.  So how can investors reliably assess the institutional caliber of a manager, and how can managers credibly demonstrate their level of institutionalization?  Along similar lines, how can investors make institutional apples to apples comparisons when hedge fund management businesses are radically different in terms of size, structure, strategy and operations?  One method is to focus on the robustness of a manager’s internal controls, since robust internal controls are a necessary – though not sufficient – element of an institutional quality infrastructure.  Unlike other indicia of institutionalization, the robustness of internal controls can be measured at a single manager and compared across managers.  Such measurement can be accomplished by having an independent auditor conduct an internal control audit and issue an internal control report in accordance with Statement on Standards for Attestation Engagements No. 16 (SSAE 16), which replaced the long-standing Statement on Auditing Standards 70 (SAS 70).  While SSAE 16s have been in use in other industries for some time, they are a relatively new technique in the hedge fund industry.  However, in a climate of heightened regulator and investor scrutiny of non-investment aspects of the hedge fund business, SSAE 16s offer one of the most objective available barometers of institutionalization.  This article provides an introduction to the SSAE 16 audit process as applied to the hedge fund industry, including a description of the SSAE 16 audit and the corresponding internal control report; provides guidance regarding fund service providers a hedge fund manager should request an internal control report from and what should be covered in such internal control reports; outlines the reasons why hedge fund managers may consider obtaining an SSAE 16 audit on themselves, including a discussion of key benefits and costs of obtaining an internal control audit and report; describes the process for hedge fund managers to obtain an internal control audit and report; addresses who should pay for the internal control audit and report; addresses how often a hedge fund manager should obtain an internal control audit and report; identifies the challenges hedge fund managers face in obtaining an internal control audit and report; and explores whether there are any suitable alternatives to the internal control audit and report.

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  • Ernst & Young’s Arthur Tully Talks in Depth with The Hedge Fund Law Report About Hedge Fund Governance, Succession Planning, Valuation, Form PF and Administrator Shadowing

    Ernst & Young’s (E&Y) recently published “Coming of Age: Global Hedge Fund Survey 2011” (Survey) highlighted a host of operational issues that hedge fund managers have recently grappled with, including issues related to corporate governance, succession planning and shadowing of fund administrators.  See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  We recently interviewed Arthur Tully, the Co-Leader of E&Y’s Global Hedge Fund practice, on various topics covered by the Survey, including: issues related to valuation of investments; independent reconciliation of investment positions; reconciliation and documentation of differences in NAV calculations; independent administration considerations for UCITS funds; and how to gather the data necessary to complete Form PF.  See “Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).  In this follow-up interview, Tully shares his insight and experience on additional topics of pressing importance to hedge fund managers, including best practices for hedge fund corporate governance; compensation structures for effective succession planning; valuation issues (including a discussion of the biggest mistakes made in valuing assets); project management in the Form PF context; and administrator shadowing (including common functions shadowed by hedge fund managers).  This article contains the full text of our second interview with Tully.  Tully is expected to expand on these and related topics during a session focusing on hedge fund governance at the Regulatory Compliance Association’s Spring 2012 Regulation & Risk Thought Leadership Symposium.  That Symposium will be held on April 16, 2012 at the Pierre Hotel in New York.  For more information, click here.  To register, click here.  (Subscribers to The Hedge Fund Law Report are eligible for discounted registration.)

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  • Second Circuit Clarifies When Offshore Hedge Funds Can Make Section 10(b) Securities Fraud Claims in Connection with “Domestic Transactions” with Conduct and Effects in the United States

    Offshore hedge funds should no longer assume that the federal securities laws will universally provide them with protection with respect to their securities transactions that have conduct and effects in the United States.  Recent caselaw makes clear that offshore hedge funds do not have unfettered rights to state claims for relief under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) with respect to all such transactions.  Thus, an offshore hedge fund’s failure to understand the scope of protection afforded pursuant to Section 10(b) can lead to legal risk if securities fraud should occur, particularly as it relates to domestic transactions in securities other than those listed on domestic exchanges.  A recent Second Circuit opinion clarifies the scope of transactions that will constitute “domestic transactions” in such unlisted securities.  This article summarizes the facts of the case and the Court’s reasoning in its opinion.

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  • PricewaterhouseCoopers Study Describes Recent Trends in and Outlook for Asset Manager Mergers and Acquisitions

    In February 2012, the Asset Management Division of accounting firm PricewaterhouseCoopers LLP released a report entitled “Asset Management M&A Insights: The Way Forward” (Report).  The Report is a compilation of white papers and survey results designed to “provide perspectives on the recent trends and outlook relating to asset management mergers and acquisition activity in the U.S. and major global markets.”  This article summarizes the key topics discussed in the Report, including: an analysis of merger and acquisition (M&A) deals in the asset management arena in the U.S. in 2011; a forecast for U.S. M&A deal activity in 2012; analyses of M&A activity in Europe and Asia; an explanation of the important roles human capital issues play in mergers and acquisitions; and an explanation of the role of various accounting principles, including issues related to consolidation and valuation, in asset management M&A.  Overall, the Report concluded that, in 2011, completed deals were scarce and deal values were relatively low.  While there is no clear indicator that 2012 will be better, the Report points to various factors that may contribute to increased M&A activity in the asset management arena for 2012.  For a discussion of recent litigation involving M&A in the hedge fund arena, see “Federal Court Decision Addresses the Enforceability of an Earnout Provision in the Sale of a Hedge Fund Management Business,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

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  • Two Delaware Chancery Court Decisions Help Define the Scope of Liability for Private Fund Portfolio Company Directors

    Hedge and private equity fund managers whose employees serve as directors of portfolio companies should understand the scope of potential liability with respect to their service as a company director and how they can shield themselves from such liability.  The Delaware Chancery Court has, within the past two years, issued two separate decisions in a single case that will help define company director liability.  This article details these two decisions.

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  • U.K.’s FSA Issues Latest Biannual Report Assessing Possible Sources of Systemic Risk from Hedge Funds

    On February 29, 2012, the U.K. Financial Services Authority (FSA) released its latest biannual report entitled “Assessing the possible sources of systemic risk from hedge funds” (Report).  The Report detailed the results of two separate surveys conducted by the FSA in September 2011 and October 2011: the Hedge Fund Survey (HFS) and the Hedge Funds as Counterparties Survey (HFACS).  These surveys were designed to “assess potential systemic risks to financial stability from hedge funds including the nature of bank and prime broker interactions with this segment of the financial system.”  Among other things, the surveys assessed the gross exposures of hedge funds in the markets in which they trade as well as their use of different types of leverage in their trading activities.  Importantly, the FSA is likely to share the results of such surveys with other global regulatory authorities that oversee the activities of hedge fund managers, and such results may ultimately impact the type and amount of disclosures that hedge fund managers are required to make with respect to their hedge funds, including disclosures required by Form PF and pursuant to the EU Alternative Investment Fund Managers Directive.  This article highlights the key findings of the Report.

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  • DLA Piper Expands Global Investment Funds Practice with Addition of Richard Reilly

    On March 13, 2012, DLA Piper announced that Richard Reilly has joined the firm’s global Investment Funds practice as a partner.

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  • Ogier Cayman Appoints Richard de Lacy QC to Lead Litigation Practice

    On March 15, 2012, Ogier announced the appointment of Richard de Lacy QC to the role of partner and head of the firm’s Cayman litigation practice, effective March 19, 2012.

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  • Mark Diamond Joins Rimon’s Private Investment Funds Group in San Francisco

    Rimon P.C. recently welcomed Mark Diamond, a financial services attorney with 30 years of experience in hedge funds and asset management, as a member of its Private Investment Funds Group in Rimon’s San Francisco office.

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