The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 5, No. 40 (Oct. 18, 2012) Print IssuePrint This Issue

  • Key Considerations for Hedge Fund Managers in Evaluating the Use of Cloud Computing Solutions (Part One of Two)

    Investors increasingly expect hedge fund managers to have best-of-breed technology and applications designed to, among other things, conduct business effectively and efficiently, facilitate compliance with applicable regulations and investor demands; and safeguard the firm’s information.  These expectations pose a significant challenge for many hedge fund managers because of the significant cost required to implement and maintain a robust technological infrastructure.  Cloud solutions have helped to partially alleviate this burden on hedge fund managers by making numerous applications and functions available online, thus reducing or eliminating the need for a firm to establish and maintain heavy technological infrastructure, with all of the associated capital costs, personnel costs and real estate costs concomitant to such infrastructure.  Cloud solutions also present benefits other than cost savings as described in more detail in this article.  While particularly attractive for smaller hedge fund managers wishing to minimize the amount of launch capital spent on technology, cloud solutions have also become attractive to larger, more well-established managers seeking cost savings and other benefits.  This article is the first in a two-part series discussing cloud computing solutions for hedge fund managers.  This article defines cloud computing services; outlines key differences between different types of cloud computing solutions; describes the functions available through cloud solutions; and highlights the benefits and risks of using cloud solutions.  The second article in this series will discuss how to evaluate the various cloud computing solutions and providers; describe best practices in creating and implementing policies and procedures for using cloud solutions; and identify common mistakes made by hedge fund managers in selecting and using cloud solutions.

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  • Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions

    In the current political environment, high income U.S. persons are likely to see their income tax rates on investment income rise and their ability to deduct investment-related expenses further curtailed.  Consequently, such investors and their advisors are likely to become more concerned about the difference between pre-tax and after-tax returns from competing investment alternatives.  It is generally known that hedge funds are somewhat tax-inefficient investments for U.S. high income individual investors.  Some funds often employ trading strategies that generate attractive pre-tax returns, but often generate income taxed at the highest rates.  Although the mutual fund industry has rolled out many new funds for the general public that are marketed as “tax managed” or “tax efficient” funds, the same trend has not been as evident in the hedge fund world.  This fact is a bit unusual since, as discussed in this article, individual investors in hedge funds organized as tax partnerships face a much greater risk of tax inefficiency than investors that invest in shares of corporations that are mutual funds (regulated investment companies under the Internal Revenue Code).  Given the increasing competition for assets under management as well as the factors described above, hedge fund managers should engage in tax planning throughout the tax year to make their funds more tax-efficient and should consult with their tax advisors with respect to the tax changes which will surely come in the future.  In some cases, fund managers should reconsider the structures of their funds that are available to such U.S. individual investors.  In a guest article, A.J. Alex Gelinas, a tax partner at Sadis & Goldberg LLP, analyses tax changes relevant to hedge fund managers and investors that are about to go into effect, or that are likely to go into effect in the future as Congress faces the need to increase tax revenues, and the effect such tax law changes may have on the marketing of hedge funds to U.S. high income individuals.  The article provides concrete tax structuring suggestions and also serves as a comprehensive overview of fundamental principles of tax structuring for hedge funds.

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  • Sixth Annual Hedge Fund General Counsel Summit Highlights SEC Enforcement Priorities, Side Letters, Investment Allocations, Expense Allocations, Trade Errors, Record Retention, Fund Marketing, Secondaries, JOBS Act and STOCK Act (Part Two of Two)

    On September 18 and 19, 2012, ALM Events hosted its Sixth Annual Hedge Fund General Counsel Summit (GC Hedge Summit) at the University Club in New York City.  Panelists, including regulators, in-house practitioners and law firm professionals, discussed topics of significant relevance for hedge fund general counsels, including: SEC enforcement priorities relating to hedge funds; the nuts and bolts of a successful hedge fund compliance program (including a discussion of side letters, investment allocations, expense allocations, trade errors and record retention); marketing of hedge funds (including a discussion of compensation of marketing professionals and the Jumpstart Our Business Startups (JOBS) Act); secondary market transactions in fund shares; and the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act) and its implications for the gathering of political intelligence.  See “JOBS Act: Proposed SEC Rules Would Dramatically Change Marketing Landscape for Hedge Funds,” The Hedge Fund Law Report, Vol. 5, No. 34 (Sep. 6, 2012).  Our coverage of the GC Hedge Summit is provided in two installments.  The first installment covered the sessions addressing the nuts and bolts of a successful compliance program, marketing of hedge funds and secondary market transactions in hedge fund shares.  See “Sixth Annual Hedge Fund General Counsel Summit Highlights SEC Enforcement Priorities, Side Letters, Investment Allocations, Expense Allocations, Trade Errors, Record Retention, Fund Marketing, Secondaries, JOBS Act and STOCK Act (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  This second article covers the session discussing the SEC’s enforcement priorities and the session discussing the implications of the STOCK Act for the gathering of political intelligence by hedge fund managers.  In particular, this article includes a comprehensive summary of the keynote address by Bruce Karpati, Co-Chief of the Asset Management Unit of the SEC’s Division of Enforcement.

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  • Barclays Predicts Increased Financing Costs for Hedge Funds Due to Regulatory Changes Affecting Prime Broker Financing

    A September 2012 Barclays report predicts that the cost of prime broker financing for hedge funds is likely to increase as regulatory changes increase prime brokers’ costs of funding.  The Barclays report outlines hedge funds’ historical sources of leverage and the ways that prime brokers borrow to finance their lending to hedge funds; summarizes pending regulatory changes that may affect prime broker financing; and discusses the implications of those changes for hedge funds.  This article summarizes key takeaways from the Barclays report.

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  • Six Steps That Hedge Fund Managers Should Take to Protect Their Confidential Information When Using or Evaluating Dark Pools

    The desire of hedge fund managers to zealously protect their confidential information can be at odds with the reality of the need to execute on their investment strategies, particularly when it comes to executing large trades.  As such, many hedge fund managers have begun directing trades (directly or indirectly through broker-dealers) through dark pools to protect important trading information, such as indications of interest on large trades, from misuse by other market participants.  Nonetheless, a recently settled enforcement action brought by the Securities and Exchange Commission demonstrates that hedge fund managers should be cautious about which dark pools are being used to execute their trades and how dark pool operators access and use fund and manager information.  This article summarizes the SEC’s order in the matter and provides six practical recommendations for hedge fund managers seeking to conduct due diligence (either directly or indirectly through broker-dealers) on the dark pool operators used to execute their trades.

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  • Top Ten Operational Risks Facing Hedge Fund Managers and What to Do about Them (Part One of Three)

    Operational risk has become a centerpiece of investor due diligence and a focal point of regulatory interest.  See “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Operational excellence is more difficult to discern than good performance; performance can be quantified and compared across managers while operations are often unique to a manager’s business practices and investment strategies.  At the same time, operational failures typically pose a greater threat than investment shortcomings.  Everyone understands that generating returns requires assuming risk, but it is often difficult to articulate a coherent explanation for operational shortcomings.  In short, in the area of hedge fund manager operations, best practices are critical, but challenging to identify.  Recognizing that the supply of best practices information on hedge fund manager operations generally falls short of the demand for it, SEI recently published the first of a series of papers entitled “Top 10 Operational Risks: A Survival Guide for Investment Management Firms.”  In a three-part series, The Hedge Fund Law Report is summarizing the key takeaways from the full Guide.  This first installment addresses a hedge fund manager’s attitude and approach towards operational risk; the need for effective oversight of firm functions; and the imperative of appropriate training and staffing to minimize operational risks.

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  • Walkers Appoints Ingrid Pierce as Global Managing Partner

    On October 15, 2012, international financial law firm Walkers announced that Ingrid Pierce has been appointed as Global Managing Partner of the firm.  See “Speakers at Walkers Fundamentals Hedge Fund Seminar Provide Update on Hedge Fund Terms, Governance Issues and Regulatory Developments Impacting Offshore Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).

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  • Andrew Calamari Named Director of SEC’s New York Regional Office

    On October 17, 2012, the Securities and Exchange Commission announced that Andrew M. Calamari has been named Director of the agency’s New York Regional Office.  For insights from Calamari’s colleagues, see “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012); and “SEC’s OCIE Director, Carlo di Florio, Discusses Examination Strategies and Expectations for Impending Examinations of Private Equity Advisers,” The Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).

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