The Hedge Fund Law Report

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

Recent Issue Headlines

Vol. 2, No. 46 (Nov. 19, 2009) Print IssuePrint This Issue

  • How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?

    All hedge fund managers, in a manner of speaking, are in the information business – the business of collecting, analyzing and acting on a significant volume of complex information.  At a similar level of generality, many of the federal securities laws and rules govern the use that may and may not be made of certain categories of information.  At one end of the spectrum of permissibility is material, nonpublic information.  Generally, hedge fund managers may not trade securities based on such information where it is obtained from someone with a fiduciary duty to the issuer of those securities.  At the other end of the spectrum is public information, such as that gleaned from public filings such as annual or quarterly reports.  Somewhere in the middle is so-called “market color,” generally understood to refer to information that is more specific to a company, industry or market than public information, but that does not rise to the level of material, nonpublic information.  In other words, if information is market color, a hedge fund manager can trade on it, whereas if information crosses the line from market color to inside information, a manager cannot trade on it.  However, the distinction is easier to draw in hindsight, and the line is often blurry.  Moreover, as recent insider trading charges have demonstrated, the practical standard of proof in the court of institutional investor opinion is significantly lower than in a civil or administrative proceeding: insider trading charges alone, even if unproven, are sufficient to unravel a hedge fund business that may have taken years to build.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009); “SEC Sues Hedge Fund CFO and Venture Capital Fund CFO Alleging Insider Trading in Tempur-Pedic and Acxion Stock,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009); “A Pequot Postmortem: What is Headline Risk and How Can it be Avoided or Mitigated?,” The Hedge Fund Law Report, Vol. 2, No. 24 (Jun. 17, 2009).  At the same time, many traders, analysts and others at hedge fund managers have to determine on a day-to-day basis whether certain categories of information they receive, alone or in combination with other information possessed by them or their firms, constitutes market color that may be acted upon, or material, nonpublic information that may not be acted upon.  Given that distinguishing between market color and inside information can have profound consequences, is infamously difficult and is a labor routinely practiced by many in the hedge fund industry, this article seeks to provide guidance in making that distinction in various contexts.  In particular, this article discusses: the definition of market color; who provides market color and the channels via which it is provided; the interaction of soft dollars and market color; factors to consider in determining whether and when a particular piece of information crosses the line from market color to inside information; and regulatory precedents that may provide insight into how the SEC may treat market color.

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  • How Can Hedge Funds Compete With ETFs for Allocations from Private Bank Wealth Management Programs Given the Growing Popularity of ETFs in Such Programs?

    Up to and even through the credit crisis, private bank clients (chiefly high net worth individuals and family offices) have provided a notable proportion of the assets invested in hedge funds.  However, like other investors in hedge funds during the crisis, private bank clients were dismayed by hedge funds’ illiquidity, lack of transparency and relatively high fees.  At the same time, a new crop of exchange traded funds (ETFs) has arisen purporting to replicate various hedge fund strategies while offering more liquidity, greater transparency and lower fees.  See “Hedge Fund Replication is Gaining in Popularity, but is it a Viable Alternative to Hedge Fund Investing?,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  More traditional ETFs – those that track broad stock and bond indices rather than seeking to replicate hedge fund strategies – also offer the advantages of liquidity, transparency and lower fees.  Not surprisingly, therefore, a number of private bankers recently have redeemed their clients’ hedge fund investments and reallocated the proceeds to ETFs, both of the replication and traditional variety. Indeed, there is some concern in the hedge fund industry that private banks will turn away from hedge funds altogether, primarily in favor of ETFs.  The purpose of this article is to analyze whether that concern is warranted and, to the extent it is, to explore what hedge fund managers can do to counter the trend.  In brief, this article concludes that for a narrow group of strategies, ETFs may well be able to address the goals of private bank clients as well, on average, as hedge funds.  However, for a wide range of hedge fund strategies – especially those that rely more on the decision-making capacity of one or a few portfolio managers as opposed to replicable quantitative models – hedge funds are likely to retain an important role in serving the uncorrelated return and diversification goals of private bank clients.  In particular, this article discusses: what private bank wealth management programs are; the three mechanisms by which private bank clients invest in hedge funds; what ETFs are; how certain new ETFs seek to replicate hedge fund strategies; the growing popularity of ETFs for private bank clients; the benefits and drawbacks of ETFs for private bank clients; the three primary ways in which hedge funds can remain relevant in private bank portfolios in light of the growing popularity of ETFs; and the utility and limits of side letters for private banks.

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  • When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?

    For hedge fund lawyers and compliance professionals who are charged with protecting their institutions from allegations of trading on material, nonpublic information, “Big Boy” provisions, or disclaimers of reliance, are potentially helpful tools.  In the first of a two-part series of guest articles, Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP, discuss the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the Federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no Federal counterpart.  The second article in this series will focus on the usefulness of Big Boy provisions in securities and non-securities transactions and steps that will increase the likelihood a court will enforce a Big Boy provision; the discussion of New York law in that second article will focus on its application in secondary market bank loan transactions.

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  • How Will Registration and Reporting Impact Hedge Fund Managers? An Interview with Todd Groome, Non-Executive Chairman of the Alternative Investment Management Association

    On November 3, 2009, the Alternative Investment Management Association (AIMA) reiterated its support for the registration of hedge fund managers operating in the U.S. and for the reporting of systemically relevant information by larger managers to national authorities in the interest of financial stability.  The following day, the Financial Services Committee of the U.S. House of Representatives, by a vote of 41 to 28, approved a bill that would impose a registration mandate, The Private Fund Investment Advisers Act of 2009, sponsored by Rep. Paul Kanjorski (D-PA).  See “U.S. House of Representatives Holds Hearings on Hedge Fund Adviser Registration,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009); “House Subcommittee Considers Bill Requiring U.S. Hedge Fund Advisers with Over $30 Million in Assets Under Management to Register with SEC,” The Hedge Fund Law Report, Vol. 2, No. 41 (Oct. 15, 2009).  The Hedge Fund Law Report recently interviewed Todd Groome, who since December 2008 has served as Non-Executive Chairman of the AIMA.  (Before assuming his current role, Groome was an Advisor in the Monetary and Capital Markets Department of the International Monetary Fund (IMF).)  Our interview focused on topics including: the range of appropriate information for financial reports to national authorities; the capacity of administrators to analyze and act on that information; the disproportionate costs of compliance with reporting requirements for smaller managers; the need to preserve the confidentiality of the information (in its pre-aggregated form) that may be reported by managers; the sources of systemic risk and how to mitigate it; the sharing of information among national authorities; the development of an official multi-national information template; the threat of a tax-driven flight of talent and capital from London; sound practices for hedge fund administrators; the continued viability of an in-house administration option; and the policy or politics behind last year’s bans on short selling in the financial services industry in both the U.S. and the U.K.  The first half of the full transcript of that interview is included in this issue of The Hedge Fund Law Report.  The remainder of the full transcript will be included in a subsequent issue.

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  • Touradji Capital Management Countersues Ex-Hedge Fund Portfolio Managers

    As previously detailed in the Hedge Fund Law Report, Gentry Beach (Beach), and Robert Vollero (Vollero, and collectively, the plaintiffs), two former employees of Touradji Capital Management, LP (Touradji Capital), filed a lawsuit a year ago in New York State Supreme Court against Touradji Capital and its founder Paul Touradji (collectively, the defendants).  See “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  In that lawsuit, Beach and Vollero, each of whom has since started his own hedge fund management firm, asserted that the defendants owed them almost $50 million in bonuses and profit sharing, and that Touradji had threatened Beach’s welfare.  The defendants have now vehemently struck back.  On November 4, 2009, they filed a countersuit against Beach and Vollero, claiming that, while employed by Touradji Capital, the two breached their fiduciary duties to the firm, and that after they left, they committed unfair competition, tortiously interfered with Touradji Capital’s business relationships, stole its trade secrets and defamed the firm.  The defendants’ counterclaims seek more than $250 million in damages.  This article summarizes the allegations in Touradji’s counter-attack.  It also discusses the withdrawal by Amaranth LLC and Amaranth Advisors L.L.C. of a summons filed on September 18 in New York state court against Touradji.  That summons alleged, among other things, breach of a confidentiality agreement Touradji and Amaranth had signed in advance of the transfer of Amaranth’s base metals portfolio to Touradji.

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  • Another Hedge Fund Manager, Former Jefferies Group Manager Joseph Contorinis, Indicted for Insider Trading

    On November 6, 2009, the United States Attorney’s Office for the Southern District of New York announced the indictment of Joseph Contorinis, a former Jefferies Group, Inc. hedge fund portfolio manager, on charges of conspiracy and securities fraud relating to his alleged participation in an insider trading conspiracy ring.  See United States v. Contorinis, Case No. 09 Maj 289 (S.D.N.Y., filed Nov. 5, 2009).  According to the indictment, Contorinis, who acted as managing director and portfolio manager for the Jefferies Paragon Fund, allegedly received material, nonpublic information from UBS Investment Bank investment banker Nicos Stephanou (Stephanou), regarding merger and acquisition activity that led to Contorinis making profits of about $7 million for his hedge fund.  The indictment capped a series of insider trading cases announced since the beginning of November by the U.S. Attorney’s Office.  On November 5, 2009, the U.S. Attorney’s Office announced the indictment of fourteen other individuals for insider trading as part of a widening investigation of the alleged insider trading scheme by Galleon Group founder Raj Rajaratnam, a scheme federal law enforcement officials describe as the largest ever hedge fund-related insider trading conspiracy.  For more background on the Galleon Group insider trading case, see “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  We detail the allegations in the Contorinis indictment and a related action.

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  • Ernst & Young Survey Reveals Hedge Fund Industry Has “Weathered the Storm”

    A new survey published by Ernst & Young, entitled “Global hedge fund survey: Weathering the storm” has concluded that the 2009 global downturn has forced hedge fund managers to respond swiftly and dramatically to the demands of investors.  The survey, based on one hundred telephone interviews with the largest hedge funds in the United States, Europe and Asia, and representing roughly half the industry, found that significant changes to fund governance, administration and investor reporting over the last year has enhanced investor confidence without adding significant costs.  The fund managers polled also observed the rapid improvements to transparency and governance as proof that the industry can effectively respond to the needs of investors.  These observations stand in stark contrast to managers’ concerns regarding increased regulatory oversight, which they view as imprecise, of less utility to investors and overly expensive.  This article details the survey findings and its analysis of the Draft EU Directive, and discusses implications for the hedge fund industry in the year to come.

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  • Alternative Investment Management, LLC Appoints Susan Potok Harrison as Director of Investor Relations

    On November 17, 2009, Alternative Investment Management, LLC, a New York-based independent investment management firm, announced that it had appointed Susan Potok Harrison as Director of Investor Relations.

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