The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 2, No. 45 (Nov. 11, 2009) Print IssuePrint This Issue

  • The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance

    As a result of the recent “pay to play” scandals in New York, California and other states, the SEC, New York Attorney General Andrew Cuomo and certain state pension fund managers have restricted or prohibited hedge fund managers from using placement agents when marketing to state pension fund managers.  See “What Do the Regulatory and Industry Responses to the New York Pension Fund ‘Pay to Play’ Scandal Mean for the Future of Hedge Fund Marketing?,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  Prior to the pay to play scandals, placement agents often served an important intermediary role between investment managers and the trustees of state retiree money: they understood the investment goals of pension funds and the investment competencies of particular managers, and they added value by connecting goals with appropriate competencies.  However, the regulatory and industry responses to the pay to play scandals – still perceived in various quarters as unduly draconian – have all but eliminated placement agents from hedge fund manager marketing efforts, at least to the extent those efforts are directed at state pension funds, and at least for now.  At the same time, pension funds are expected to contribute a growing proportion of the assets under management by hedge funds in the next few years.  So who or what is going to fill the hedge fund marketing void that has opened up in the post-placement agent era?  In an effort to answer that question, this article revisits the New York State pension kickback case then discusses: the reduction in the use of placement agents by state pension funds in New York and California; the SEC’s recently proposed rule regarding placement agents; the move by pension funds away from allocations to funds of funds in favor of direct investments in hedge funds; specific examples of pension funds that have moved to single manager allocations; what precisely pension funds are looking for in allocating capital to single managers; specific steps that hedge fund managers can take to market to pension fund managers without relying on placement agents; considerations with respect to in-house marketing teams and prime broker capital introduction services; due diligence by pension funds; and background checks.

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  • Hedge Fund Managers Considering Fund Appreciation Rights Compensation Structures to Defer Tax on Performance Compensation and to Better Align Manager and Investor Incentives

    In the public company context, before stock options got a bad name via backdating scandals and unintended consequences (a skewing of incentives towards the short-term, unintended windfalls, etc.), they were seen as a potent tool for mitigating the adverse effects of the oft-bemoaned separation of ownership and control.  Executive compensation debates, however, are not the exclusive province of commentators on public companies.  The credit crisis focused the attention of hedge fund investors on executive compensation at hedge fund managers in a way that good times never could.  See “Addressing (and Resisting) Demands for Changes in Hedge Fund Manager Compensation,” The Hedge Fund Law Report, Vol. 2, No. 16 (Apr. 23, 2009).  As distinct from discussions of executive compensation at public companies, where the chief criticism often relates to the absolute level of compensation, hedge fund manager compensation discussions more often relate to the structure of compensation.  In particular, one of the primary criticisms leveled during the credit crisis was that measuring performance fees over one year failed adequately to reflect the reality of most hedge fund investment strategies, which require more than one year for realization.  Similarly, the idea of measuring performance compensation over a single year has been criticized as incentivizing managers to take undue risks and for potentially rewarding negative performance over multiple years.  In an effort to better align the incentives of managers and investors, hedge fund managers have been evaluating the viability of fund appreciation rights (FARs), which offer a mechanism of manager compensation analogous to stock options.  This article explores this provocative compensation structure, and includes analysis of: the mechanics of FARs; the analogy to call options; how FARs may offer the potential to better align the incentives of managers and investors; the clawback mechanism often built into FARs; a numerical example of how a FARs structure could operate in practice; how FARs can help retain talent, especially in lean years; whether FARs can be used in existing funds in addition to new funds; whether FARs can be used in domestic funds in addition to offshore funds; the tax consequences of FARs; and the market interest in FARs.

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  • Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs

    In November 2007, Scott Friestad, Associate Director of the SEC’s Enforcement Division, announced that trading abuses would be a priority for the then-newly-launched Hedge Fund Working Group.  He defined “trading abuse” to include abuses of private investments in public equity (PIPE) transactions, as well as insider trading and improper short sales under Regulation M.  But the advertised crackdown was already underway.  For example, that September, the SEC had initiated an enforcement action against Robert A. Berlacher and others alleging that the defendants had engaged in unlawful insider trading in connection with the Radyne ComStream Inc. PIPE offering of 2004, by selling short Radyne securities prior to the public announcement of the PIPE.  As an alternative theory of liability, the SEC also alleged that the trading violated Section 5 of the Securities Act of 1933 (Securities Act).  Section 5 generally requires that every offer or sale of securities must be either registered or exempt from registration.  The SEC claimed in Berlacher and analogous cases that the use of PIPE shares after the effective date of the relevant registration statement to cover short sales made prior to the effective date of the relevant registration statement effectively constituted an unregistered sale of securities that required registration.  The SEC has since suffered a series of setbacks in connection with PIPEs, especially with respect to its Section 5 theory of liability.  The various dismissals of claims under Section 5 are, in turn, part of a broader pattern of setbacks for the SEC in its enforcement efforts in connection with PIPEs, and the decisions that have resulted from this effort have affected the practices of issuers, placement agents and investors.  This article reviews the mechanics of PIPE transactions and the informal confidentiality arrangements traditionally entered into by PIPE issuers and investors.  The article then surveys the insider trading caselaw applicable to investors in PIPEs (many of whom are hedge funds); the insider trading claims against Mark Cuban, which were dismissed in July of this year, including insights from the lawyer who successfully represented Cuban in that matter; the changing dynamics of the PIPE marketplace, including the entry of more sophisticated issuers, and the concomitant new emphasis on the terms of confidentiality and standstill agreements; and the materiality of PIPEs in any insider trading analysis.

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  • SEC Sues Hedge Fund CFO and Venture Capital Fund CFO Alleging Insider Trading In Tempur-Pedic and Acxiom Stock

    On October 30, 2009, the Securities and Exchange Commission (SEC) commenced a civil enforcement action against a group of seven individuals who allegedly engaged in insider trading in the securities of Tempur-Pedic International, Inc. (Tempur) and Acxiom Corporation (Acxiom).  Defendant King Chuen Tang (Chen Tang) was Chief Financial Officer of an unnamed hedge fund.  He allegedly conveyed confidential information about Tempur to five co-defendants, and traded on that information for his own account, through funds that he controlled, and through accounts held in the names of friends and family members.  His brother-in-law, defendant Ronald Yee, was Chief Financial Officer of a venture capital fund.  He is said to have been the tipper who provided Chen Tang with non-public information about Acxiom.  The SEC is seeking a permanent injunction, disgorgement of profits and civil penalties against the seven defendants involved in the scheme.  It is also seeking disgorgement of profits and an accounting from the investment funds controlled by the defendants and from the friends and family members of the defendants in whose names the illicit trades were conducted.  We summarize the details of the scheme, as pleaded in the SEC’s complaint, and the SEC’s legal allegations.

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  • New York Court of Appeals Holds that State Champerty Statute Cannot Curb Rights of Distressed Debt Buyers to Sue to Enforce Contracts

    On October 15, 2009, the New York Court of Appeals decided that purchasers of distressed debt instruments, who buy them for the purpose of collecting damages by means of a lawsuit against the debtor, may do so without violating the New York champerty statute if they possess a pre-existing proprietary interest in the instrument.  The court issued its ruling in response to a request from the United States Court of Appeals for the Second Circuit for clarification as to the proper interpretation of the New York champerty statute, New York Judiciary Law Section 489.  We discuss the facts and the holding of the case, which has important implications for hedge funds that trade distressed debt.  In particular, the case enhances the certainty of property rights for distressed debt traders, and has the potential to expand liquidity in the distressed debt trading market.  It also may incentivize entry into that market, thereby undermining, at the margin, one of the competitive advantages of existing players, namely, the relative scarcity of specialized investors.  On the other hand, new entrants without the experience of existing players may offer interesting opportunities for incumbents with presumptive advantages in terms of experience, contacts and infrastructure.

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  • Maurice Allen and Michael Goetz to Open London Office of Ropes & Gray; Law Firm’s U.K. Presence Will Focus on Private Equity and Debt

    On October 22, 2009, Ropes & Gray LLP announced that leading finance lawyers Maurice Allen and Michael Goetz will join the firm and spearhead the launch of its London office in January 2010.

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  • Liongate Capital Management Announces Opening of Office in Dubai

    On November 10, 2009, fund of hedge funds manager Liongate Capital Management announced the opening of its Dubai office and the award of a license by the Dubai Financial Services Authority to operate from the Dubai International Financial Centre.

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