Private Investment Funds – Page 13

Model Due Diligence Questionnaire for Hedge Fund Investors

The Managed Funds Association put together a Model Due Diligence Questionnaire for Hedge Fund Investors (.pdf). This questionnaire was designed to identify the kinds of questions that a potential investor may wish to consider before investing in a Hedge Fund. The questions that may help amplify on or provide additional details to the disclosure in a Hedge Fund’s offering documents.

Sound Practices for Hedge Fund Managers

The Managed Funds Association updated its Sound Practices for Hedge Fund Managers (.pdf) in November, 2007 in response to the initial drafts of the President’s Working Group on Financial Markets.

The objectives of Sound Practices are to:

Strengthen business practices of the hedge fund industry through a strong framework of internal policies and practices

Encourage individualized assessment and application of recommendations

Enhance market discipline in the global financial marketplace

Sound Practices, which was originally published in 2000 and is now in its fourth edition, provides peer-to-peer recommendations for establishing standards of excellence in virtually every aspect of business. The recommendations included in Sound Practices are divided among the seven topics listed below:

Management, Trading, and Information Technology Controls

Responsibilities to Investors

Determination of Net Asset Value

Risk Management

Regulatory Controls

Trading Relationship Management, Monitoring, and Disclosure

Business Continuity, Disaster Recovery, and Crisis Management

What is a Hedge Fund?

The President’s Working Group on Financial Markets Report of the Asset Managers’ Committee uses this as a definition of “hedge fund.”

By “hedge fund” we mean a pooled investment vehicle that generally meets most, if not all, of the following criteria: (i) it is not marketed to the general public (i.e., it is privately offered), (ii) its investors are limited to high net worth individuals and institutions, (iii) it is not registered as an investment company under relevant laws (e.g., U.S. Investment Company Act of 1940), (iv) its assets are managed by a professional investment management firm that is compensated in part based upon investment performance of the vehicle, (v) its primary investment objective is investing in a liquid portfolio of securities and other investment assets, and (vi) it has periodic but restricted or limited investor redemption rights. (This description is based in part on the definition in the Managed Funds Association’s 2007 Sound Practices for Hedge Fund Managers.) Although hedge funds may invest in private equity and real estate, this Report is not addressed to the specific considerations of private equity or real estate funds. We use the terms “alternative asset manager” and “manager” to refer to the entity that establishes the investment profile and strategies for the hedge fund and makes the investment decisions on its behalf.

Draft SEC Filings Can Be Protected From Discovery

In a January 9, 2009 order, Magistrate Judge Morton Denlow of the US District Court for the Northern District of Illinois ruled that Aon was not required to produce an email seeking comments on draft disclosure language for Aon’s Form 10-K because it was protected by the attorney-client privilege. Magistrate’s Opinion and Order in Roth v. Aon

The ruling is part of a securities class action suit against Aon. The plaintiffs were seeking an email with with a draft portion of Aon’s 10-K. In rejecting the plaintiff’s request, Judge Denlow recognized that the process of preparing SEC filings involves legal judgments throughout, even where the disclosure in question concerns operational rather than legal matters. Judge Denlow lays out the eight prong test for attorney-client privilege:

“(1) Where legal advice of any kind is sought (2) from a professional legal adviser in his capacity as such, (3) the communications relating to that purpose, (4) made in confidence (5) by the client, (6) are at his instance permanently protected (7) from disclosure by himself or by the legal adviser, (8) except the protection be waived.”

Judge Denlow goes on to point out that the inclusion of non-lawyers as recipients of the email did not waive the attorney-client privilege so long as all other recipients were employees of Aon.

Judge Denlow also rejected the argument that because the final 10-k was a public document that drafts should not subject to the privilege.

A key take-away is that communications to be protected by the attorney-client privilege must only be exchanged among in-house or outside counsel and company employees. Including outsiders, such as the company’s auditors or other consultants, as recipients could waive the privilege. You should also label these drafts as preliminary drafts and as confidential attorney/client privilege.

Although this ruling is based on SEC filings, you should be able to apply the same analysis to private placement memorandum and other documents related to private investment fund-raising.

New York State Bar Position on Carried Interest

Besides the position of Professor Bankman on carried interest, the New York State bar submitted a very detailed report and recommendations to the House Committee on Oversight and Government Reform: New York State Bar Tax Section Report on Carried Interest and Fee Deferral Legislation (.pdf) September, 2008

Joseph Bankman Testimony on Hedge Fund Tax Treatment

The House Committee on Oversight and Government Reform held a hearing on hedge funds and the financial market on November 13, 2008. Among those testifying was Professor Joseph Bankman, the Ralph M. Parsons Professor of Law and Business at Stanford Law School: Testimony of Joseph Bankman.

Professor Bankman points out that the carried interest of a private equity fund sponsor is typically taxed as capital gains (assuming the underlying assets are held long enough). professor Bankman points out his dislike of the tax advantages and proposes a legislative change:

The Alternative Minimum Tax Relief Act of 2008 contained a provision that would have taxed carry at ordinary income rates. That Act passed the House of Representatives in June, 2008, but died in the Senate. Thus, carry remains tax-favored. I recommend that Congress eliminate the tax advantage given to carry by again passing a measure similar to that contained in the Alternative Minimum Tax Relief Act of 2008. I recommend, though, that such a measure be amended to address the concerns expressed in the New York State Bar Association Report on Proposed Carried Interest and Deferred Fee Legislation.

Thanks to the Hedge Fund Law Blog for pointing out this resource: Hedge Fund Taxation – Law School Professor Perspective.

Starting a Green Real Estate Fund

Lisa Michelle Galley of the Our Green Journey blog and Galley Eco Capital posts her notes from a panel of green real estate fund managers about why investors and development partners want these funds and the do’s and dont’s for building a green fund.

Does commercial real estate need pure green real estate funds?

Green real estate funds align capital more clearly with mission
JV development partners are seeking a green fund’s concentrated expertise.
Green funds benefit from the superior financial performance of green assets.

Best practices for building a green real estate fund

Your team must have sustainability expertise.
Pay attention to both the leasing team and lease structure
Establish the right partnerships
Proper reporting is crucial.

Ohio Retirement System Lobbyist

map_ohio Ohio requires registration and annual filings if you are a Retirement System Lobbyist. See Ohio Revised Code §101.90. According to the law, it seems that any replacement agent hired by an investment fund is subject to registration if that agent discussed an investment offering with the Ohio retirement system.

Retirement system lobbyist means any person engaged to influence retirement system decisions or to conduct retirement system lobbying activity as one of the person’s main purposes on a regular and substantial basis. Retirement system lobbyist does not include an elected or appointed officer or employee of a federal or state agency, or political subdivision who attempts to influence or affect retirement system decisions in a fiduciary capacity as a representative of the officer’s or employee’s agency or political subdivision.

Engaged means to make any arrangement whereby an individual is employed or retained for compensation to act for or on behalf of an employer to actively advocate.

Compensation means a salary, gift, payment, benefit, subscription, loan, advance, reimbursement, or deposit of money or anything of value; or a contract, promise, or agreement, whether or not legally enforceable, to make compensation.

Employer means any person who, directly or indirectly, engages a retirement system lobbyist.

Retirement System Decisions means a decision of a retirement system regarding the investment of retirement system funds. Retirement system decision also includes the decision by a board of a retirement system to award a contract to an agent or an investment manager Retirement system lobbying activity means contacts made to promote, oppose, reward, or otherwise influence the outcome of a retirement system decision by direct communication with a member of a board of a state retirement system, a state retirement system investment official, or an employee of a state retirement system whose position involves substantial and material exercise of discretion in the investment of retirement system funds.

You are required to submit a report three times a year (due May 31, September 30 and January 31) using Form 1010.93 AGT (.pdf) The Office of the Legislative Inspector General launched the Ohio Lobbying Activity Center (OLAC). The OLAC is an online filing system that allows registered Agents/Lobbyists and their Employers to electronically register their lobbying engagements and file their tri-annual Activity and Expenditure Reports.

See:

Strategies for Responding to Liquidity Needs of Investors in Real Estate Funds

Goodwin Procter put together a great piece on Strategies for Responding to Liquidity Needs of Investors in Real Estate Funds.

As a result of the current economic downturn and global economic credit crisis, some investors find themselves over-allocated to investments in private real estate funds because their private real estate investments have not been written down in value to the same degree as their public investments (the so-called “denominator effect”). In addition, many large pension plans, foundations and endowments have suffered well-publicized losses in the public equity markets.

These pressures facing such investors are compounded by the fact that the virtual shutdown of the credit markets has dramatically reduced the volume of real estate transactions in the marketplace, which in turn has reduced the amount of distributions that real estate funds are able to make to their investors. Despite these liquidity constraints on investors, the current reduction in cash flows and sale proceeds means that many real estate funds may encounter an even greater than expected need to call capital from investors in the near term in order to fund operating costs and debt service, and to complete development or capital improvement projects.

New York Public Pension Funds’ Regulation No. 85

The Superintendent of Insurance of the State of New York promulgated the Second amendment to Part 136 of Chapter IX of Title 11 of the Official Compilation of Codes, Rules and Regulations of the State of New York (Regulation No. 85) (.pdf) in October 0f 2008. The regulation is intended to have the business of the state retirement systems comply with these principles:

the retirement system and the fund shall operate under a strong governance framework with a rigorous system of internal controls;
the retirement system and the fund shall maintain a high level of operational transparency;
the Comptroller shall adhere to and manage the retirement system and the fund with the highest ethical, professional and conflict of interest standards;
the Comptroller shall have a fiduciary responsibility to act for the sole benefit of the retirement system’s members and beneficiaries; and
the retirement system and the fund shall be managed in the most efficient and effective manner possible.

The regulation requires investment managers to promptly disclose any conflict of interest that “reasonably be expected to impair the investment manager’s, or consultant or advisor’s ability to render unbiased and objective advice”. [11 NYCRR 136-2.4(c)(1)(i)].

The regulation also requires investment advisers to file an annual statement with the following language:

“ALL INVESTMENT MANAGERS, AND CONSULTANTS OR ADVISORS OWE THE COMPTROLLER A FIDUCIARY DUTY. THIS MEANS THAT INVESTMENT MANAGERS, OR CONSULTANTS OR ADVISORS MUST DISCLOSE TO THE COMPTROLLER INFORMATION ABOUT MATERIAL CONFLICTS OF INTEREST. FAILURE TO TRUTHFULLY COMPLETE THIS STATEMENT MAY RESULT IN CRIMINAL OR CIVIL LIABILITIES”. [11 NYCRR 136-2.4(c)(1)(ii)]

The regulation also requires an investment manager to disclose the payments made to any placement agent or intermediary that assists the investment manager in obtaining investments by the Fund.[11 NYCRR 136-2.4(d)]

The New York State Comptroller, Thomas P. DiNapoli, also releases monthly reports that disclose in detail investments and transactions, hiring of fund managers, and the involvement of placement agents: Disclosure of Investments & Transactions.