A New Statutory Exemption for Private Resales of Restricted Securities Enacted

A New Statutory Exemption for Private Resales of Restricted Securities Enacted
Frenkel Sukhman LLP
February 6, 2016

On December 4, 2015, President Obama signed into law The Fixing America’s Surface Transportation Act (the “FAST Act”), which establishes a new statutory exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”), for private resales of restricted securities buried among other securities and non-securities law provisions. New Section 4(a)(7) of the Securities Act exemption codifies a private resale exemption similar (but not identical) to the informal “Section 4(a)(1-1/2)” private resale exemption which was developed over time by the securities bar through court rulings and SEC no-action letters.

The new Section 4(a)(7) provides an exemption from registration for certain private resale transactions meeting the following requirements:

• Each purchaser is an “accredited investor” as defined in Rule 501 under the Securities Act;
• No “general solicitation” or “general advertising” is used in connection with the offer or sale;
• The seller is not the issuer or a subsidiary of the issuer;
• The securities are not part of an unsold allotment to, or a subscription or participation by, an underwriter of the security or a redistribution;
• The securities have been authorized and outstanding for at least 90 days prior to the date of the resale; and
• Certain information has been provided by the seller to the purchaser.

Mandatory information disclosure is one key element in which the Rule 4(a)(7) exemption differs from the informal 4-1/2 exemption and the one which would likely be most difficult to implement in transactions involving startup or small companies due to the requirement of preparing GAAP financials.  All issuers who are not reporting companies under the Securities Exchange Act of 1933 (the “Securities Exchange Act”) would also need to consider using confidentiality agreements to protect their proprietary information and address issues raised by material non-public information if they agree to cooperate with the transferor of restricted securities and permit disclosure of such information to the transferee.  In the case of a transaction involving the securities of a non-reporting issuer, among certain other categories, the seller and the prospective purchaser are entitled to receive from the issuer, at the request of the seller, current information about the issuer, including, but not limited to:

• the issuer’s name;
• the issuer’s address;
• the title and class of the security to be sold;
• the par value of the security;
• the total number of shares outstanding as of the end of the issuer’s most recent fiscal year;
• the name and address of the transfer agent or other person responsible for the transfer of such security;
• the nature of the issuer’s business;
• the names of the issuer’s officers and directors;
• the names of any person that will receive commission or other remuneration in connection with the sale;
• the issuer’s most recent balance sheet and profit and loss statement and similar financial statement for the two preceding fiscal years during which the issuer has been in business, prepared in accordance with GAAP; and
• if the seller is an affiliate, a statement regarding the nature of the affiliation accompanied by a certification from the seller that it has no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.

The new Section 4(a)(7) exemption is not available if the seller, or any person who will receive a commission or other remuneration in connection with offering or selling the securities, is subject to the “bad actor” disqualification under Rule 506(d) under the Securities Act or statutory disqualification under Section 3(a)(39) of the Securities Exchange Act. In addition, the new exemption is available only for securities of an issuer “engaged in business” and not in an organizational stage or in bankruptcy or receivership, and not a “blank check”, “blind pool” or “shell company” or special purpose acquisition company.

Any securities acquired in accordance with the Section 4(a)(7) exemption will be deemed to have been acquired in a transaction not involving a public offering and will be deemed to be “restricted securities” within the meaning of Rule 144 under the Securities Act and “covered securities” for state securities law (“blue sky”) purposes. The resale transaction will not be deemed to be a “distribution” for purposes of Section 2(a)(11) of the Securities Act.

The new Section 4(a)(7) exemption is presumably not exclusive of other available resale exemptions (i.e. pursuant to Rule 144, Rule 144A or Rule 904). The statutory safe harbor the new rule offers presents certain advantages over the conditions of those exemptions but has its own burdensome limitations not imposed by the other rules. Its enactment promises to give holders of restricted securities a wider choice in structuring exit transactions and possibly bring about greater liquidity to secondary markets. However, every resale situation must be analyzed on the basis of its own facts and circumstances to determine which exemption would fit the parties to the transaction best, including in light of the contractual requirements for transfer imposed by the currently existing private placement documentation. Finally, it is not entirely clear whether a seller may still rely on the common law exemption known as Section 4(a)(1-1/2) in the event it does not comply with Section 4(a)(7) or other statutory exemptions. There is no legislative history on point and the SEC has not addressed this issue yet.

Issuers should consider updating their organizational documents in connection with the provisions governing securities compliance requirements for permitted transfers in order to accommodate resales of restricted securities pursuant to the new exemption.  Although issuers are not parties to secondary securities transactions, they have normally imposed certain contractual requirements (including legal opinion from a securities counsel to the transferor with respect to the availability of an exemption from registration for the proposed transaction) as conditions to recognizing the transfer.  With the possibility for a greater involvement of issuers in the resale process due to the informational requirements of the new statutory exemption, it is in the issuers’ interest to define clearly the rights and obligations of all parties concerned.

Frenkel Sukhman LLP advises its fund and other clients in the financial services and other industries on securities law compliance issues and represents issuers and holders of restricted securities in private placement issuance and resale transactions on the regular basis.

CYBER SECURITY BECOMES A FOCUS FOR FINANCIAL REGULATORS: Contracts with Vendors and Service Providers Under Scrutiny



Frenkel Sukhman LLP

May 1, 2015

Investment funds, broker/dealers, and other financial service companies face serious cyber security threats to the safety of their confidential and proprietary information and, indirectly, even more dramatic threats to their operations, both from within their organizations and from the outside.   While preparing to combat these threats is a good business practice in itself, such companies should pay heed to the fact that regulators have begun to address their obligations in data protection, making institutional information security preparedness a discrete compliance and potentially legal issue.  Following last year’s well-publicized cyberattacks on JPMorgan and other banks, the regulatory interest in strengthening protection against cyber criminals has received a new impetus, from the U.S. Treasury Department down to state financial regulators.

The Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) issued a National Exam Program Risk Alert (“Risk Alert”) on February 3, 2015, providing observations derived from the sweep examinations in 2014 of over 100 registered broker-dealers and investment advisers that were undertaken to assess their cybersecurity practices and preparedness. The Risk Alert does not provide substantive requirements in the subject of cyber security preparedness. However, it signals that cybersecurity is one of OCIE’s top 2015 exam priorities, and that all SEC registrants will want to review their preparedness for a cyber exam.  As part of its cyber sweep initiative OCIE staff tested the level of preparedness of the examined firms by reviewing certain practices and procedures. These included written information security policies and procedures, periodic audits to assess compliance, risk assessments, mapping technology resources, encryption and password techniques and cybersecurity insurance.

It is noteworthy that most registrants reported cyber attacks (majority of which arose from malware and fraudulent e-mails) directly or through one or more vendors. Although most registrants’ policies require cybersecurity risk assessments of vendors with access to their proprietary information and operations, only some have such requirements for vendors. Even fewer (24%) investment advisers do so according to the OCIE initiative’s findings.   The inclusion of certain questions in OCIE examinations regarding contracts with vendors and business partners and requests for the description of contractual information security requirements and sample copies seem to indicate that the SEC encourages its registrants to take a more active position in negotiating stronger contractual protection in dealings with IT service firms and other vendors who have access to their networks and data. The odds are that many firms will experience one or more instances of unauthorized access to their computer systems and that their data and/or operations will be compromised as a result.

Financial Industry Regulatory Authority (FINRA) published a detailed report, “Report on Cybersecurity Practices” on the same date as the SEC, identifying effective practices for dealing with cybersecurity threats by its members, a result of its own targeted examinations and initiatives.  The FINRA report focuses on third-party vendor risks as well and calls for efforts to closely research and evaluate third-party vendors, preferably before they are engaged and periodically thereafter. Member firms are requested to review due diligence procedures for selecting vendors, and procedures to approve and monitor vendor access to firm networks, customer data and other sensitive information. As part of the due diligence review, copies of the vendors’ written information security plans and certifications of compliance with applicable standards should be obtained. Vendor contracts should be reviewed for inclusion of appropriate terms on security measures, including incident response notification procedures and cyber insurance coverage.

In May 2014, the New York State Department of Financial Services (“NYSDFS”) published a report titled “Report on Cyber Security in the Banking Sector” that described the findings of its survey of more than 150 banking organizations and isolated the industry’s reliance on third-party service providers for critical banking functions as a continuing challenge. NYSDFS has announced that it will be scrutinizing cyber-security as an integral part of its bank examinations, and is asking banks to prepare responses to a specific set of questions and information-requests on their security practices and procedures for purposes of the examinations.  NYSDFS is also considering cyber security requirements for financial institutions that would specifically apply to their relationships with third-party service providers.

While the Risk Alert should not be viewed as a summary of industry norms or best practices for the SEC registrants, it is a useful document that provides a glimpse into the regulator’s mindset.  Given that cybersecurity is one of OCIE’s top 2015 exam priorities for all SEC registrants regardless of their form, investment advisers as well as broker/dealers should review their preparedness for a cyber exam and make such improvements as may be needed on the basis of the review. One of the key areas for such improvements is contractual relationships with its key vendors and third party IT service, data and other technical or content providers.  Upgrading the firms’ contractual protection may take a significant amount of time and effort as it is likely to require negotiation with several third parties whose counsel may not be aware of the new regulatory attention bestowed on cyber security and the need to assume at least some of the responsibility for the improvements.  Different types of contracts will require different amendments depending on the nature of services, the service provider’s access to the client’s data, computer systems and operations, and other factors.

Along with internal preparedness for cyber attacks, bolstering the financial institution’s legal position vis-à-vis third party service providers is one of the principal tools in fending off potential civil litigation, regulatory inquiries and administrative enforcement action and protecting against resulting financial and reputational harm.  The results of the OCIE study show that 88% of the broker-dealers and 74% of investment advisers surveyed have already been victims of some form of a cyber attack so both the risk to financial institutions’ information security and the risk of attendant legal and regulatory repercussions are very real.


Frenkel Sukhman LLP advises its fund and other clients in the financial services and other industries on cyber security issues and helps them to minimize regulatory and legal exposure from cyber security threats with its attorneys drafting, reviewing and negotiating service, outsourcing, licensing and other agreements on the regular basis.



       The Non-Profit Revitalization Act of 2013 (the “Act”), signed into law on December 18, 2013, effects an array of significant structural and definitional changes to the organization and operation of domestic and foreign not-for-profit (“NFP”) corporations in New York.  These include new corporate governance rules, streamlined administrative and procedural filing requirements and expanded state oversight power, some of which are summarized below.  NFP corporations should note the Act’s July 1, 2014 effective date and review and consider making conforming amendments to their bylaws, policies and other corporate documents.

Categories of NFP Corporations Streamlined

The four categories of New York NFP corporations (A, B, C, and D – as based on their specific purpose) are eliminated and replaced with two basic classes:

  • Charitable, which includes corporations organized for charitable, educational, religious, scientific, literary, or cultural purposes, or for the prevention of cruelty to children or animals; and
  • Non-charitable, which includes corporations organized for civic, patriotic, political, social, fraternal, athletic, agricultural, horticultural, or animal husbandry purposes, or for the purpose of operating a professional, commercial, industrial, trade, or service association.

Type A and certain Type D corporations formed prior to July 1, 2014 will be automatically deemed “non-charitable” corporations while Type B and Type C corporations will be deemed “charitable.”

Restrictions on Board Chairmanship and Committee Composition

The Act requires (as of January 1, 2015) greater separation between a NFP corporation’s management and board by prohibiting an employee of the corporation from serving as the chairperson of the board or holding any other title with similar responsibilities.  The Act also eliminates the distinction between standing and special committees; provides that committees of the NFP corporation which include non-directors do not have the authority to bind the corporation; and imposes an affirmative duty on any committee authorized by the board to purchase or dispose of real estate to report promptly to the board but not later than at the next scheduled meeting of the board.

Relaxed Requirements for Real Estate Transactions

A purchase, sale, mortgage or lease of real property can now be approved by a majority vote of the board or a majority vote of a committee (instead of a two-thirds vote previously required), unless the transaction involves all or substantially all of the assets of the NFP corporation (but not if the board has more than 21 members).

Related Party Transaction Approval Process

Under the Act, a NFP corporation’s board may not enter into a “related party” transaction unless it has determined that the transaction is fair, reasonable and in the corporation’s best interests.  A “related party” is newly defined as any director, officer or key employee of the organization or an affiliate; any relative of such individual; and any entity in which such individual has a 35% or greater ownership interest or, in the case of a partnership or professional corporation, a greater than 5% direct or indirect ownership interest. The Attorney General may challenge a related party transaction and impose a penalty on the corporation or its directors in the case of willful and intentional misconduct in addition to other statutory remedies.

Executive Compensation Approval Process

The Act imposes new procedural requirements on boards of NFP corporations in their review of executive compensation packages, barring persons who may benefit from such compensation from participating in any board or committee deliberation or vote concerning the compensation, except to the extent the board or committee requests that they present information or answer questions.  Directors who vote for, or concur in, a compensation arrangement without following these procedural requirements may be jointly and severally liable to the corporation.

Whistleblower and Conflict of Interest Policy Requirements

Under the Act, NFP corporations with over $1 million in annual revenues and 20 or more employees must adopt a whistleblower policy to protect against retaliation persons who report suspected improper conduct.  The Act also requires adoption of a conflict of interest policy that requires directors, officers and key employees to act in the organization’s best interests and specifies minimum required components of the policy.  Each director must submit a statement regarding potential conflicts of interest prior to election to the board and annually thereafter.

AG Approval of Certain Corporate Transactions

The Act simplifies the process for applying for approval of merger or consolidation plans, changes in corporate purposes and asset dispositions by applying for an order of approval directly from the Attorney General without the need to petition the Supreme Court.  If the Attorney General disapproves the application or determines that court review is appropriate, then judicial review of the decision may be sought.

Financial Reporting Changes

The Act clarifies and increases the revenue thresholds for nonprofits that must make annual financial reports to the Attorney General.  All NFP corporations must file unaudited financial statements, regardless of how little annual gross revenue is earned, but those with annual gross revenue between $250,000 and $500,000 must also file audited financial reports and an independent CPA’s review report, and those with greater than $500,000 in annual gross revenue, must file annual financial statements along with an independent CPA’s audit report and opinion letter.

Audit Oversight Requirement Imposed

The “independent directors” of a NFP corporation with annual revenues in excess of $500,000 that is required to register with New York State to conduct charitable solicitations must oversee the organization’s accounting and financial reporting and the audit of its financial statements. The Act defines an “independent director” as someone who is not (or whose relative is not) an employee of the nonprofit for the past three years and does not have another type of financial relationship with the nonprofit, as specifically defined in the Act.  This function may also be performed by the corporation’s audit committee composed of independent directors.  Moreover, NFP corporations with annual revenues greater than $1,000,000 that are required to register with New York State to conduct charitable solicitations are subject to certain additional audit oversight requirements, including review and discussion with the independent auditor of the scope and planning of the audit prior to its commencement, any material risks and weaknesses in internal controls identified by the auditor, any restrictions on the scope of the auditor’s activities, significant disagreements between the auditor and management, and the adequacy of the nonprofit’s accounting and financial reporting processes.  The performance and independence of the auditor must also be reviewed on an annual basis.

Simplified Corporate Governance Requirements

The Act enables NFP corporations to conduct board votes and other actions via e-mail, conduct board meetings via videoconference, and delegate the approval of small transactions to committees.


Although the Act still requires NFP corporations to furnish a list of directors and officers upon demand from a member of the not-for profit or a law enforcement agency, it eliminates the requirement to disclose their home addresses.


Frenkel Sukhman LLP has been assisting its not-for-profit corporate clients with formation, fundraising and other activities, compliance, and financing and other transactions and its attorneys would be pleased to answer any questions you may have about the Act and its impact on NFP corporations.

Revised LMA Standard Terms and Conditions for Bank Debt Trades Go Live This Week

March 6, 2014

The Loan Market Association (“LMA”) published a revised version (“Revised T&C”) of the LMA Standard Terms and Conditions for Par and Distressed Trade Transactions (Bank Debt/Claims) as part of its “Plainer English” project. These Revised T&C went live this past Monday, March 3, 2014 (“Effective Date”). All LMA trades entered into prior to the Effective Date will be on the basis of the former LMA Terms and Conditions (in effect from 2012), and all trades entered into on or after the Effective Date will be on the basis of the Revised T&C.

While Revised T&C may require some changes in how market participants negotiate and draft trading documents, most are minor in scope and significance while others simply serve to clarify the existing market practices.

Some of the examples of these changes are as follows:

• Obligations under the credit documents travel together with rights to the credit assets purchased.
• Delayed settlement compensation payable by Seller after payment default is due irrespective of whether or not the Obligor is in payment default. Seller has the right to demand repayment by the Buyer if the Obligor defaults and does not pay the scheduled payment within any applicable grace period, and it is up to the Seller to demand repayment from the Buyer.
• Transfer costs are to be split between multiple entities managed by the same investment manager so that each party, unless otherwise agreed, only pays one half of one transfer fee in total.
• Unless otherwise specified in the trade confirmation, the seller and the buyer act as principals so that it is no longer necessary to indicate in the trade confirmation whether a party is acting as a principal or an agent.
• A bankruptcy or insolvency proceeding against a buyer or seller that is required by law or regulation to not be publicly disclosed does not constitute an insolvency event and does not result in termination of the trade.
• English choice of forum is accepted by the seller and the buyer and neither will argue to the contrary.
• Documents may be signed electronically. Originals of documents are only required to be delivered upon request.

Various other LMA secondary trading form documents, such as the Bank Debt Trade Confirmation, Participation Agreements and User Guide have been similarly amended.

Frenkel Sukhman LLP has been assisting its fund and other clients with documenting and negotiating bank debt and claims trading documents in par and distressed debt transactions and would be pleased to assist you with your debt or claims trading transactions if you are in need of legal counsel.

U.S. Fund Managers to File BEA Form BE-11 for Foreign Funds and Portfolio Holdings

Among various federal filings U.S.-based private fund managers have to make, questionnaires generated by the little-known unit of the U.S. Department of Commerce, Bureau of Economic Analysis (“BEA”), have maintained a low profile.  This is likely to change this year with the renewed interest on the part of BEA as well as other federal agencies with jurisdiction over U.S. fund managers in disclosure and enforcement matters.

BEA is responsible for the administration of several annual surveys, which are mailed to the previously identified “U.S. Reporters.”  However, the U.S. law requires every entity subject to the provisions of the International Investment and Trade in Services Survey Act to self-report and make necessary filings with BEA even if they have not previously received initial requests to return completed surveys from BEA.  One of such annual surveys relates to the equity investments made by U.S. entities in foreign entities (while others relate to foreign investment in U.S. entities).

Many U.S. fund managers with non-U.S. master (or other) funds, foreign equity portfolio interests and certain other foreign holdings may be subject to this filing obligation.  Investment managers newly registered with the U.S. Securities and Exchange Commission (“SEC”) under the amended registration requirements of the 1940 Advisers Act will need to ramp up their compliance with all applicable U.S. filing requirements, including those imposed by BEA.  In particular, they will need to determine urgently whether or not they, as investment managers, or their U.S. feeder funds or special purpose vehicles may be required to file Form BE-11, the 2011 Annual Survey of U.S. Direct Investment Abroad.

To answer whether a filing of Form BE-11 is obligatory, a fund manager that is a U.S. person, would need to determine whether it owns, directly or indirectly, at least 10% of the voting securities of a “foreign affiliate” if such foreign affiliate meets certain thresholds.  These thresholds are based on the foreign affiliate’s assets, sales or net income being greater than $60 million (positive or negative) for majority or minority-owned foreign affiliates.  If the assets, sales or net income are greater than $25 million, but not greater than $60 million (positive or negative) for foreign affiliates established or acquired by the U.S. reporter in the most recent or current fiscal year, an exemption may apply.

One of the difficulties of making this determination lies in the nature of private investment funds as Form BE-11 as are all other annual surveys utilized by BEA seem to have been conceived with a view toward conventional operating companies with direct foreign investments rather than asset managers and other financial intermediaries.  The concept of sales, for example, translates only roughly into management fees.  Further, a variety of different foreign forms of business organization commonly used in investment fund structures, complicates the application of the definition of foreign ownership.  Generally, limited partnership interests are not considered “voting securities.”  Hence, a U.S. entity holding limited partnership interests in a foreign limited partnership (such as a Cayman master fund, for example) would not need to file Form BE-11.  However, a U.S. general partner of such foreign entity would be deemed to hold voting securities in that entity and will be required to file absent an exemption.  Those foreign master funds that are organized as corporations or stock companies with various classes of shares may present special problems in determining U.S. control of their voting securities.  The same approach would apply to foreign portfolio companies held by U.S. fund entities to the extent there is greater than 10% ownership of such companies’ voting securities.

Form BE-11 was due to be filed on May 31 of this year; however an extension request could be filed to apply for more time to make this filing.  BEA provides a ready-made Extension Request Form for this purpose.  Filers expecting to file fewer than 50 forms (each per foreign affiliate) may request an extension to June 29, 2012 while those expecting to file up to 100 forms may request an extension to July 31, 2012 and those expecting to file more than 100 forms may request an extension to August 31, 2012.  We understand that BEA’s policy is to grant extension requests which have been timely filed but BEA will consider late requests with an explanation for delay as well.  BEA also provides a form to declare exemption from the obligation to file Form BE-11 (Claim for Not Filing) in the event a U.S. entity received a request from BEA for a BE-11 survey but believes to qualify for an exemption from reporting.  Those fund managers who have never filed Form BE-11 with BEA and believe that they qualify as a “U.S. reporter” subject to the BEA reporting regime should contact their legal counsel for advice on how to proceed in order to avoid penalties and other enforcement actions on the part of the Commerce Department and/or the SEC.

In the past months, Form BE-11 and other BEA annual surveys have been highlighted to many fund managers, both registered under the 1940 Advisers Act and exempt, as a result of informal notification that the Department of Commerce may begin to enforce penalties against persons failing to make these filings.  It has been reported that so far BEA’s intent has not been punitive in that it is only asking U.S. reporters to file going forward and is not requiring them to file forms for prior years.  The foreign affiliates’ data collected is used by the U.S. government to monitor, among other matters, exports/imports and employment abroad by U.S. persons and is given limited confidential treatment (solely for statistical and analytical purposes).  However, BEA is legally empowered to impose fines and other penalties.  Moreover, with the increased interest in regulation of the alternative investments industry and expanded information sharing among federal agencies, compliance with BEA’s filing requirements should become a prerogative for all U.S. fund managers who fall into the definition of a U.S. reporter under the law.

Frenkel Sukhman LLP has been assisting its fund and other clients with filing BE-11 and other BEA surveys and reports and would be pleased to assist you with your BEA filing obligations, if any.

New Reporting Requirements for Newly-Registered and Exempt Investment Advisers

As a result of the implementation of new registration requirements adopted by the U.S. Securities and Exchange Commission (SEC) implementing certain provisions of The Private Fund Investment Advisers Registration Act of 2010 (“Title IV”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), some 3,000 advisers were required to register with the SEC in early 2012.  Those of these newly registered investment advisers are now subject to a wide range of reporting obligations, including on Form PF, the rules (the “Rules”) for which were newly adopted by the SEC in late 2011 to help monitor systemic risk in the U.S. financial system.  The Rules, however, apply not only to those financial institutions that are “too big to fail” but also to much smaller private fund advisors which have never been subject to SEC registration or this level of regulatory oversight and which now have to provide much greater disclosure to the regulators.  Moreover, the new private fund adviser exemption under the Rules, while exempting some advisers from registration with the SEC (often at the cost of state registration), no longer completely frees such exempt advisers, regardless of the size of their AUM, from reporting requirements, preventing them from “flying under the radar” as far as public disclosure of their investment operations is concerned.

The key innovation and, for many, a serious hurdle, in the new reporting requirements for all SEC-registered investment advisers is Form PF.  With respect to newly registered advisers, many of which managed relatively small funds, in particular, the Rules will require so-called “smaller” investment advisers (managing between $150 million and $1.5 billion in AUM) to report extensive information to the SEC on Form PF about the private funds they advise.  Form PF is designed to supplement Form ADV, which was also revised in 2011 to include substantial information about private funds advised by reporting advisers.  Although Form PF has been significantly streamlined from the original version as it appeared in the SEC Proposing Release,  it continues to represent an arduous task for smaller advisers without organizational resources to manage the new reporting process.

The information requested on Form PF is quite detailed and extensive and may require advisers to alter their compliance policies and procedures and, possibly, even to revise their recordkeeping systems.  It calls for disclosure about the management company, the assets under management and fund performance.  As adopted, however, Form PF generally permits advisers to rely on existing systems to provide information, a notable difference compared to the requirements proposed earlier.  In particular, Form PF removed the proposed requirement that submitting officials of the adviser certify, under penalty of perjury, the information contained therein.  An adviser is not required to update information that was provided in good faith at the time of submitting Form PF even if such information was subsequently revised for recordkeeping, risk management, or investor reporting purposes.  Although reporting advisers may only have to submit Form PF to the SEC on a quarterly or annual basis, much of the required information may need to be gathered monthly.

Smaller advisers are only required to complete Section 1 of Form PF, which calls for the provision of general identifying information, assets under management, size, leverage and performance information for each private fund and also basic information on hedge funds. Advisers must also provide information about related persons and their large trader identification numbers. With respect to each private fund, advisers must provide gross and net assets, derivative positions, borrowings, concentration of equity holders, investments in private funds and parallel managed accounts, performance information (with the same frequency with which the advisers already calculate performance), beneficial ownership, assets and liabilities, investment strategies (including use of high-frequency strategies) and counterparty exposures.  Although information submitted on Form PF is nonpublic and not subject to Freedom of Information Act requests, it is not completely confidential.  The SEC may use the information in enforcement actions and it may be accessed by various federal departments and agencies.

Advisers potentially subject to Form PF reporting have some time to review their structures and determine their status and subsequent reporting requirements (advisers to smaller funds with less than $1.5 billion in assets will make the first Form PF filings on April 30, 2013 assuming calendar fiscal year).  Nonetheless, because of the substantial reporting requirements, advisers should begin reviewing Form PF now to ensure that their internal systems are appropriately designed to capture necessary information before their applicable deadline looms close.  The advisers solely to private funds with less than $150 million in AUM, venture capital funds and family offices, among others, will not be required to file Form PF, provided that such advisers satisfy the definitional requirements under the Rules.  

Advisers to funds that qualify as venture capital funds under the definition contained in Rule 203(I)-1, and are therefore excluded from the definition of “investment adviser,” do not have any obligations to file Form PF.  Qualifying for this exemption has been made somewhat easier in the Rules as compared with the original SEC proposal largely due to the use of a 20% basket for non-qualifying investments and abandoned requirement for management involvement in portfolio companies.  Still, venture capital fund advisers would need to determine whether the funds they manage meet the new requirements under the Rules or under the grandfathering provisions of the Rules.  Similarly, advisers that qualify as “family offices” under Section 202(a)(11)(G) and the recently adopted Rule 202(a)(11)(G)-1 do not have any obligations with respect to Form PF.  Although not every “family office” would automatically qualify under this rule, advisers should carefully consider its requirements and, if necessary, take steps to alter their structure or operations to qualify for the Section 202(a)(11)(G) exception or for other Section 202(a)(11) exceptions in order to avoid Form PF filing obligations.  Foreign SEC-registered advisers with minimal U.S. assets under management may be able to reorganize those U.S. assets into a separate fund that is offered only to U.S. investors, which could avoid Form PF filing requirements (if it has less than $150 million of U.S. assets under management) regardless of the total AUM of such advisers.

It should be noted that, apart from Form PF, the SEC has imposed certain reporting requirements applicable even to the investment advisers exempt from registration under the Rules, such as those advisers with less than $25 million in AUM.  For example, exempt advisers, must comply with the reporting requirements by filing reports with the SEC through completing specific items on Part IA of Form ADV (but not Part II) and filing amendments to Form ADV.   These reports are publicly available on the SEC website.  The value of assets under management is to be calculated by reference to Form ADV and is generally equal to the fair market value of the assets of the qualifying private funds, plus the amount of uncalled capital commitments.  In a change from the quarterly calculation originally proposed, advisers are required to determine the value of assets that they manage on an annual basis.  Recordkeeping obligations of exempt investment advisers are yet to be specifically addressed by the SEC.

“Gardening Leave” Should Not Involve Lunching or Other Social Activities with Your Former Colleagues

While the term “gardening leave” or “garden leave” is thought to be an English import to the New World, some U.S. fund managers and other financial institutions have been using gardening leave provisions in their employment agreements in all but a name.  Under a “gardening leave” clause the employee is required to give the employer a certain notice prior to departure from the firm following which the employee is placed on a salaried leave of absence and is forbidden to work for competitors and to engage in certain other activities.  The name for this contractual device originates in the idea that the employee is paid to stay at home and tend to a garden rather than engage in a conduct the employer might find objectionable.  One basic distinction between gardening leave provisions and restrictive covenants following separation is that the terminated employee (whether by his or her own volition or by the employer) technically remains in an employment status during the period of the leave and continues to be compensated as before but is subject to greatly reduced (if not completely eliminated) job duties and lack of access to the employer’s offices, facilities, and personnel.

A case involving just this kind of clause is currently pending before the London High Court.  The employee in that case is Fahim Imam-Sadeque, the former head of sales for the UK, Middle East and Australia for BlueBay Asset Management, one of Europe’s largest specialist managers of fixed-income credit and alternative products, managing assets of more than £24billion.  Mr. Imam-Sadeque reportedly left the firm in December 2011 after having signed an agreement that was said to contain a gardening leave for a period of six months from the date he gave notice in July 2011 after he had accepted an offer to join a competitor, Goldbridge Capital Partners, as head of sales and marketing from January 2012.  As a reward for staying home in his English garden, during the term of the leave he was entitled to continued salary and to other compensation, including fund shares worth £1.7million.  While he continued to be a BlueBay employee, he was subject to a range of the common restrictive covenants, such as non-competition, non-solicitation and non-poaching.  It is the latter restriction that Mr. Imam-Sadeque reportedly violated in the course of having lunch with a current BlueBay employee, Damian Nixon, whom he sought out in a number of emails.

While we do not know what actually transpired during this December lunch, BlueBay clearly interpreted it as more than an exchange of season’s greetings and refused to turn over the accrued compensation, including deferred fund shares to Mr. Imam-Sadeque, claiming a breach  of the anti-poaching provisions of his contract.  BlueBay also claimed Mr. Imam-Sadeque had allowed Goldbridge to issue inaccurate and misleading references to himself and other BlueBay staff, with Goldbridge saying he no longer worked for BlueBay when he did so.  Not surprisingly, Mr. Imam-Sadeque has brought suit against BlueBay claiming that he did nothing wrong by having lunch with Mr. Nixon, and that BlueBay is wrongfully withholding his deferred compensation.

The lesson of this pending case, regardless of its outcome, which is more likely than not will turn on the employer’s ability to secure Mr. Nixon’s (its current employee) cooperation as a witness, is that gardening leaves serve a useful purpose for both the employer and the employee but should not be abused by either.  Employers can obtain a stronger legal protection by way of restrictive covenants when they continue paying the departing employee and in exchange get the privilege of counting him or her as a current (if not active) employee during the term of the leave because most legal challenges to the validity and enforceability of such restrictive covenants lose their potency precisely due to continued consideration being paid by the employer and the unambiguous employment status of the departing employee.  Furthermore, gardening leaves can offer greater protection against misappropriation of the employer’s confidential information and trade secrets because employees on leave are effectively kept away from the most current information, being denied access to the employer’s offices, files or networks as well as its employees, suppliers, customers, investors, and other counter-parties and as current employees are generally subject to greater control by the employer than former employees.  Employees also benefit by having a paid leave with full insurance coverage and often other benefits once they serve a termination notice on their employer before they completely sever the ties with the old employer and get to start with a new employer (or a new career in gardening or elsewhere).

However, once either party overreaches, the bargain of certainty and predictability is lost, and the courts are liable to step in with their own vision of what is just and fair in a given fact pattern.  U.K. courts have generally enforced gardening leave provisions with both injunctions against prohibited employee conduct and by upholding the employer’s right to withhold contractual compensation in the event of a material breach by the employee.  A typical U.K. Service Agreement for investment fund professionals and managers uses a fairly broad language for its anti-poaching clause of the garden leave provisions, such as:

“The Employee covenants with the Company that the Employee will not directly or indirectly on Employee’s own account or on behalf of or in conjunction with any person for a period of __ months after the Termination Date induce or attempt to induce any employee to whom this paragraph applies to leave the employment of the Company (whether or not this would be a breach of contract by such employee).”

It may also be possible to use more specific language prohibiting any contact by the employee who gave termination notice with any of the employer’s employees, directors, officers, investors, customers, suppliers, and service providers, re-defining the employee’s duties and obligations and so on.  It is unknown at this point whether the BlueBay employment agreement in question contained such language, but conceivably even the less-specific language reproduced above may subject the former employee to liability when sufficient evidence is introduced as to his or her attempts to poach the company’s employees or to violate the no-contact provisions of the contract.  What is clear is that any employee who voluntarily signs a contract with such provisions should steer clear of the employer’s business and employees until the gardening leave is over to protect his or her entitlement to deferred compensation and to avoid litigation.

In the U.S., gardening leave clauses are used more rarely than in the U.K. and almost exclusively with executive management and professional positions, including those in the financial services industry.  They are sometimes called “sitting out” clauses.  As in the U.K., courts in the U.S. generally find them valid and enforceable because the continued compensation dispenses with the challenge based on the lack of a “safety net” for the employee and gardening leave provisions are therefore a safer bet for the employer than pure post-separation restrictive covenants where no additional compensation is paid to the severed employee.  However, the reasonableness test still applies, and the period of the leave as well as the need for and the scope of the employer’s protection may still be scrutinized by a court.  U.S. employers rarely go beyond the 6 months term, and 2-3 months terms are more typical.  In addition, a number of cases raise special concerns with the availability of specific performance to enforce the garden leave which provides for some limited services to be continued to be performed for the benefit of the former employer during the transitional period (as opposed to an injunction against an employee who accepts an employment offer from a competitor and attempts to commence new employment during the period of the garden leave) as an involuntary servitude.  Money damages (including a setoff of deferred compensation) are much less controversial as a legal remedy and should serve as sufficient deterrent against potential violations on the part of competitors and former employees alike.  New York courts consistently rejected plaintiffs’ arguments that the employment exclusion effect of properly drafted garden leaves may make it difficult to resume work due to lost skills.  In addition, the scale of compensation typically granted hedge fund and private equity fund executives makes it very difficult for the executives in between jobs to get the sympathy of a judge or a jury in the absence of a truly despicable conduct on the part of the employer.

It should be remembered that there has been limited guidance from U.S. courts on the pure U.K.-style gardening leave provisions, and U.S. employers should exercise caution in including such provisions into U.S. employment or separation agreements and seek advice of U.S. counsel on their effect under local state law.  We have been involved in preparation, negotiation and litigation of such agreements on behalf of both hedge and private equity fund employers and their employees and would be pleased to assist you with your legal needs in this area.

Washington Mutual Decision Offers Key Lessons on Treatment of Confidential Information

Since Judge Walrath issued in September 2011 her now (in)famous decision in the Washington Mutual chapter 11 cases pending in the US Bankruptcy Court for the District of Delaware, much has been written about the current and potential impact of that decision.  Recent developments in that case have cast doubt on whether there will in fact be a significant long-term impact.  However, it remains clear that Judge Walrath’s decision does contain several key lessons with respect to treatment of confidential information that are well worth remembering, regardless of the fate of other aspects of that decision.

First, a brief note regarding the most recent developments in the WaMu case.  In December of 2011, the dissenting shareholders reached a settlement with the creditors allowing the Court to ultimately move forward with this (seventh!) plan of reorganization.  Then, last week, Judge Walrath confirmed the plan of reorganization, withdrawing a portion of her September ruling which granted equity holders the opportunity to pursue claims against certain major noteholders (which happened to be four large hedge funds which specialize in distressed debt investing) (the “Funds”) on the theory of insider trading.

Now, a look at the September 2011 decision.  The (rather complicated) facts which gave rise to Judge Walrath’s September decision are, very briefly, as follows.  WaMu and JP Morgan Chase (“JMP”) were engaged in on-going settlement discussions regarding the ownership of certain $4 billion held by JPM.  These settlement discussions took place over the course of some 12 months.  The Funds were directly involved in many of the discussions, and, periodically, were subject to confidentiality agreements in connection with these discussions, which restricted the Funds’ trading activities with respect to the Debtor’s securities (unless appropriate ethical walls were established).  The Funds’ understanding was that, upon the expiration of each such period of restriction, the Debtor would publicly disclose all material information, thereby allowing the Funds to become unrestricted and continue their trading activities.

In practice, however, the Debtor, upon at least two occasions when settlement talks with JPM broke down, did not release to the public either the fact that such settlement discussions had taken place or any details of those discussions to which the Funds had been privy.  On the other hand, several of the Funds (who had not established any ethical walls) resumed their trading activities, on at least two such separate occasions, with the understanding that (a) the applicable confidentiality agreements had expired and (b) the material information regarding the settlement discussions had been disclosed to the public by the Debtor.

Based on these facts, Judge Walrath found that there were sufficient allegations that the Funds (which did not restrict their trading) may have traded on the basis of material non-public information in violation of applicable securities laws to warrant further discovery.  The Court further ruled that the little-known remedy of equitable disallowance could be imposed to disallow the claims of the Funds if the facts supporting insider trading claims were established (vs. equitable subordination, which the Court ruled was not available as a remedy).  The Court also specifically rejected the Funds’ contention that, having strict internal policies prohibiting insider trading, the Funds acted in reliance on JPM’s obligation under the confidentiality agreements to disclose the material non-public information at the conclusion of each of the confidentiality periods.

What, then, given the recent confirmation of the Chapter 11 plan, and Judge Walrath’s withdrawal of the insider trading aspect of her September 2011 decision, are the lessons of this case?  There are certain notable aspects of Judge Walrath’s rulings with respect to bankruptcy law which may arguably have some lasting effect in bankruptcy proceedings (or, at least, academic interest) (such as her ruling regarding the availability of equitable disallowance or that the Funds may have owed a duty to other members of the two classes of the Debtor’s debt structure in which the Funds held blocking positions).  However, the indisputable lessons of this case pertain to the treatment and use of confidential information and the administration of confidentiality agreements and the attendant obligations.  In particular, the WaMu case reminds us that

  1. Having policies in place is necessary but not sufficient – the key is in the implementation of those policies. Whether the answer is to have ethical walls to prevent the confidential information from reaching the traders (which, admittedly, is practicable for only the largest organizations) or to restrict all trading activity pertaining to a particular name, the policy on appropriate use of confidential (i.e., non-public) information must be vigilantly enforced.
  2. When acting on the basis of (or just with the knowledge of) confidential (read “inside”) information, one takes the risk of that information being material in the eyes of the SEC or a court.  Here, the Funds were apparently of the opinion that the information regarding the ongoing settlement discussions with JPM was not material to the Debtor / plan of reorganization.  Judge Walrath found otherwise.
  3. It is a fine idea to provide in an NDA that, on the expiration or termination of the NDA, the disclosing party will make public the confidential information provided, thereby “cleansing” the recipient and enabling the recipient to trade the relevant securities.  However, just having that contractual right (or even obligation on the part of the disclosing party) is not necessarily sufficient. The recipient must then confirm that the relevant confidential (or inside / non-public) information has actually been made public by the disclosing party prior to placing any trades.  Indeed, contractually, the recipient may additionally want to obtain the right to disclose publicly the relevant information in the event that the disclosing party fails to do so in a timely fashion or, as seems to have been the case in WaMu, there is a difference of opinion as to what portion of the confidential / non-public information should be made public.

Avoid the Urge to Overreach in Restrictive Covenants in Employment Agreements

A recent (September 2011) New York case, Novus Partners v. Vainchenker, illustrates the difficulty of enforcing overly broad restrictive covenants in the employment context relevant to hedge funds and other private fund entities.  In this case, an employee of a hedge fund research company left to work for a competitor and was promptly accused by his former employer of violating confidentiality, non-competition and non-solicitation clauses of his employment agreement among other claims.  After suing both the ex-employee and his new employer (who was sent a notice apprising it of its new employee’s breach of contract), the plaintiff was faced with a challenge from the defendants by way of a motion to dismiss that attacked the legal sufficiency of the agreements signed by the ex-employee.

As we all know, employers like to protect themselves against this very situation with what they view as “iron-clad” contractual provisions that they offer to employees as part of their employment package and that employees (short of very few executive-level employees) tend not to negotiate.  Which is all well and good.  We certainly encourage our employer clients to arm themselves with the appropriately-drafted restrictive covenants at every stage of interaction with employees, independent contractors and service providers (normally when they enter into employment or service agreements and, upon termination, in separation or termination agreements).  However, care must be taken not to have our defensive instincts get the better of us.  New York courts, as well as courts in other states, scrutinize restrictive covenants when they are being used against former employees and may refuse to enforce them when they are seen as overly broad, unreasonable or (probably rare in the investment fund industry given the scale of typical compensation packages) unconscionable.  

Failure to follow the basic principles may make it more difficult (read expensive) to enforce these covenants or may make them completely unenforceable.  In fact, the latter is what happened in this case, where on a motion to dismiss the plaintiff (former employer) was ordered to re-plead one of its claims for the sin of seeking to enforce an overly broad non-solicitation clause related to the employer’s clients. 

So the lessons of this case for the investment fund industry employers can be summed up as follows:

  1. Geographic limitations not crucial in the context of investment management industry.   These are not terribly relevant for the alternative investments industry, which is spread widely across the major financial centers of the globe.    Most of the successful challenges to these have to do with the duration (the 1 year term here was not viewed by this court as excessive) and with the scope (apparently the nature of the hedge fund research services offered by the former employer here was sufficiently specialized not to cause offence).
  2. Scope of non-solicitation limited to clients directly known to ex-employee.  With respect to the language of the non-solicitation clause the judge held that the clause must be limited to those clients of the former employer with whom the defendant ex-employee had some contact in his prior job.  While we do not advise to limit non-solicitation clauses so that they only prohibit solicitation of those clients with whom the employee has had a business relationship in every instance, the given employee’s direct exposure to the employer’s clients and the nature of the client list should be consider.  In this case, the judge noted that the ex-employee never had much of an exposure to many of his former employer’s clients.  The judge also stated that the restriction as drafted would effectively prevent the ex-employee from soliciting any of the hedge funds for the fear of unwittingly violating this clause.  On the other hand, the court found the defendant ex-employee’s effort to induce another employee of the plaintiff employer to leave and go work at his new employer a clear violation of the non-solicitation clause. 
  3. Broad confidentiality language subject to scrutiny.  While the benefit of a well-drafted confidentiality clause is clear in this context the plaintiff employer did face a challenge from the ex-employee (and the court) related to the over-broad language of the NDA in question.  This issue comes up quite often in our practice when we try to convince our (employer) clients to be reasonable when it comes to the scope of what constitutes confidential information to be protected against disclosure and/or misuse by their employees.  The simple reason for being cautious here is that when it comes to matching facts of the case to the contractual obligation you don’t want to be arguing that just because everything you deem confidential deserves to be protected b.  For example, while the judge here allowed the claim based on the confidentiality clause to proceed, the court spoke derisively of the extent of protection afforded to client lists when a business’s customers can be easily determined.  Proprietary software, on the other hand, was easily classifiable as a trade secret and deserving of legal protection.    

The reason for the additional scrutiny given to these restrictive covenants is that in ruling on these claims a variety of equitable considerations come into play.   The key to a smooth and cost-efficient enforcement lies in customizing these clauses to the specific circumstances of each employer’s business and each employee’s position.  Using a balanced approach in drafting restrictive covenants serves to deprive former employees of the ability to challenge their validity as a tactic to delaying or avoiding enforcement.  This is one situation where employers should not be using “one size fits all” standard form agreements.  As counsel to both employers and employees in the private fund industry we regularly negotiate restrictive covenants in the employment context and review them for potential employers considering a hire subject to these restrictions.  After all, given the entrepreneurial spirit in this industry, employees of the yesteryear often become future employers and so the cycle of relying on the enforceability of restrictive covenants to protect one’s business continues.

Counterparty Risk Returns with MF Global, Jefferies

The ghosts of Lehman Brothers and Bear Stearns returned late in this year in the guise of MF Global’s bankruptcy filing and a precipitous drop in Jefferies’ stock prices.  While these two may turn out to have little in common, from the perspective of investment fund managers to whom these institutions serve as prime brokers or custodians and, to a lesser extent, clearing brokers, the message is clear.  The risk of having your funds’ assets tied up for prolonged periods of time in a bankruptcy or some other insolvency process is quite real (as is a possible risk of loss of such assets to the extent they have become the subject of third parties’ security claims or simply have been misappropriated by your counterparty).  

Hedge funds have been on notice at least since 2008 that the text of the prime brokerage agreements they enter into can have momentous significance when things begin to go very wrong with their prime brokers (whether because they get caught up in a tidal wave of a financial crisis or for more localized reasons of financial mismanagement).  The failure of MF Global, in particular, has highlighted loopholes in the Australian regulatory system which allowed it to use client funds to hedge its own positions with full consent of the Australian regulator.  Whereas in the United Kingdom, we understand it is illegal to use clients’ money for any of the provider’s own activities, including hedging, the Australian OTC derivatives rules prevent brokers from using client funds to trade on their own account but allow trades with clients’ funds to hedge positions.  This includes margining, guaranteeing, securing, transferring, adjusting or settling dealings in derivatives by the licensee, including hedging positions taken by other clients.  As a result, the Australian government may be unable to take action if investors’ funds have been pooled together by MF Global and used for hedging purposes. 

Some of the same lessons of the Lehman bankruptcy apply today.  We advise our fund clients to negotiate their prime brokerage agreements carefully, especially with respect to the prime broker’s re-hypothecation rights and rights to transfer client assets to affiliates and sub-contractors.  Prime broker’s recourse against funds’ assets should be limited (preferably to those assets posted as collateral against loans in margin accounts) rather than left as blanket authority.  What has now emerged from the MF Global scandal underscores the necessity to restrict the powers of prime brokers to make use of the clients’ collateral as much as possible in order to prevent funds’ assets from being used in the prime broker’s own proprietary transactions and from being transferred out of the U.S. jurisdiction. 

Some of our clients have conducted a review of the insolvency laws in the major jurisdictions where their prime brokers are located to understand better the legal treatment of the funds’ assets in the event of the prime broker’s bankruptcy and to adjust the mix of their assets held by prime brokers accordingly.  The counterparty’s insolvency risk can also be managed through master netting arrangements to reduce the clients’ exposure although their enforceability varies from one jurisdiction to another.  In some situations, it may be prudent to request a special, segregated treatment of the client’s assets by having them held by a third party custodian and/or to request registration of the client’s securities in the fund’s name rather than in “street” name, though counterparties are reluctant to agree to such arrangement. 

We also advise our clients to negotiate the “boilerplate” clauses with vigilance to the extent they relate to the issues we highlighted above, including in the assignment clauses where we insist that any such assignments be limited to the prime broker’s affiliates that are licensed U.S. broker/dealers.  Once the funds leave the U.S., foreign laws and regulations make their well-being in the hands of foreign affiliates of the U.S. prime broker somewhat uncertain, as this latest case with MF Global amply demonstrates.  The protections of the U.S. regulatory regime do not normally extend to non-U.S. affiliates of U.S. prime brokers, and such entities are often utilized for margin or securities lending and as custodians outside of the U.S.

We realize that in the last few years the prime brokerage industry has become the game of a few, largest (though not necessarily strongest) financial institutions who resist vehemently any changes to their form agreements (which, incidentally, underwent few changes since 2008 to reflect the new realities of the marketplace).  Prudent risk management practices dictate that fund managers as fiduciaries avoid selecting weaker prime brokers, and so their business has been flowing to the few strongest banks with the healthiest balance sheets and reserves, resulting in the ever-growing obstinacy on their part to negotiate terms of their prime brokerage agreements characteristic of any oligopoly. 

However, it is incumbent on the fund manager to request reasonable assurances with respect to their managed assets when negotiating with these banks because any bank, no matter how big and strong today, may end up insolvent tomorrow.  In fact, accepting their standard forms without negotiation is not, in our opinion, the best practice to follow for investment managers.  And, to the extent a fund manager elects to deal with those smaller banks and brokers that lack market power, it ought to extract even greater legal protection for its investors’ assets from such counterparties to compensate for the higher risk of insolvency.  Gone are the days when default, cross-default and cross-acceleration provisions are thought to apply only to clients of banks.  Today, it is vital that as many of those be made mutual as possible.  Finally, in anticipation of a bank or broker succumbing to a potential crisis it is useful to include prime broker’s cooperation clauses to help transition to a different bank and to move the funds’ assets promptly that would be triggered by the client’s request (based on some early warning sign) rather than waiting for the prime broker’s default to occur before taking action.

Needless to say, prime brokerage agreements are not the only ones where counterparty risk of the service provider has to be addressed through contractual protections.  Agreements for any custodial arrangement, fund administration, collateralized borrowing (where the funds’ assets are the subject of a security interest) and even certain trading activities (such as under the ISDA regime with respect to swaps and derivatives) should be scrutinized to provide for the adequate contractual mechanisms to minimize counterparty risk.  Further, counterparty risk in dealing with third parties as principals rather than service providers can be extraordinarily high in certain transactions, such as participation agreements, contracts for difference and repurchase agreements (more on these in our future blog postings).  The economic risk with respect to any single transaction, however, tends to be significantly smaller than in typical global prime brokerage and custodial relationships where most, if not all, of managed assets may be placed so these should naturally be the priority in getting counsel to review and to help negotiate the appropriate safeguards. 

As counsel to hedge funds and private equity funds, we have helped many of our clients achieve a greater sense of security with respect to the assets they manage in the hands of prime brokers, fund administrators and custodial agents and other service providers to the private investment fund industry.