All posts tagged investment fund

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.

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:

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).
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.
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.

Beyond Confidentiality: the private equity bidders’ experience with Yahoo!

A lesson from the recently reported Yahoo! sale process: carefully review and negotiate your NDAs! As Yahoo! illustrates, confidentiality agreements can reach well beyond mere confidentiality and can affect not only the process but the potential outcome of a sale.

Confidentiality agreements, as we all know, are the life blood of private equity and, generally, M&A transactions. In a typical NDA, the recipient agrees to keep information confidential and to limit its use to the transaction under consideration. However, not infrequently, the disclosing party will include additional restrictions on the recipient which go well beyond confidentiality. Common examples include non-circumvention (e.g., with respect to a particular target or subject), non-solicitation of employees, and no contact with the acquisition target (or borrower, if the transaction involves debt) as well as its customers, suppliers, vendors, etc.

These restrictive provisions are designed to protect the legitimate business interests of the target company by preventing, for instance, damaging rumors and employee and customer defections. They may also serve to protect the interests of the broker or introducing party with respect to a particular opportunity. Occasionally, however, the disclosing party may seek to include in the NDA a provision which is primarily designed to influence the sale process. As has been widely reported, Yahoo! included just such a provision—no “cross talk” as it has been described—into the NDAs circulated to potential private equity bidders.

As reported, this no cross-talk provision precludes the potential bidders from speaking to each other regarding the potential transaction (presumably, whether or not confidential information is disclosed in the course of such conversations). What is Yahoo!’s possible motivation for including such a provision in the NDA? It is, almost certainly, a business consideration – the desire to influence the bidding process and, indeed, the likely outcome of the sale. Given Yahoo!’s market capitalization of $20 billion, if the bidders are not able to discuss potential co-investment agreements, it makes it much less likely that any private equity bidder would be able to make an offer for 100% of the equity. Not surprisingly, many potential private equity bidders balked at this restriction. The one private equity sponsor who has reportedly agreed to this restriction in the NDA is TPG Capital which, as reported, is specifically interested in a minority stake.

From our perspective, as buy-side counsel, we strongly encourage our private equity and hedge fund clients to review and negotiate all NDAs, whether in M&A, private equity, distressed debt, real estate or other contexts. As this case amply illustrates, the restrictions contained in many confidentiality agreements go well beyond confidentiality and may significantly impact one’s ability to evaluate and consummate a potential transaction (and, indeed, influence what kind of transaction or bidder is likely to succeed).

The Funds' Counsel Blog

All posts tagged investment fund

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

Avoid the Urge to Overreach in Restrictive Covenants in Employment Agreements

Beyond Confidentiality: the private equity bidders’ experience with Yahoo!

Frenkel Sukhman LLP

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