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Investment Funds News

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    • PA U L , W E I S S , R I F K I N D , W H A R TO N & G A R R I S O N L L P Investment Funds News M A R K E T A N D L E G A L U P D A T E pmofkd==OMMV Separately Managed Accounts M A R C O V. M A S O T T I A N D J Y O T I S H A R M A I N S I D E : Demand Increasing for Separately Managed Accounts Faced with gates, suspension events and other redemption restrictions in pooled investment vehi- cles, investors are increasingly approaching investment managers to establish separately managed pÉé~ê~íÉäó=j~å~ÖÉÇ=^ÅÅçìåíë== accounts (“SMAs”). SMAs are individualized investment portfolios that are separately managed for each `~êêáÉÇ=fåíÉêÉëí=mêçéçëÉÇ investor by an investment manager. Historically, given the administrative burdens involved in managing iÉÖáëä~íáçå an SMA (including additional reporting obligations), investment managers were inclined to establish SMAs for only their largest clients, such as pension funds, endowments and funds of funds. However, j~å~ÖÉãÉåí=mêçÑáíë=fåíÉêÉëíë==== investment managers now seem willing to organize SMAs for smaller investors as they watch investor e~åÇäáåÖ=j~ëë=oÉÇÉãéíáçåë===== capital dissipate through redemptions and face an increasingly difficult fund raising environment. An SMA offers an investment manager the opportunity to accommodate each client’s specific needs with- aÉÑ~ìäíáåÖ=iáãáíÉÇ=m~êíåÉêë out the same level of conflicting obligations to other clients and, as a result, an investment manager may dÉåÉê~ä=m~êíåÉê=c~Åáäáí~íáçå=çÑ offer an investor preferential reporting, liquidity or economic terms without the same level of concern p~äÉë=çÑ=iáãáíÉÇ=m~êíåÉê=fåíÉêÉëíë about “most favored nations” provisions with other investors. In light of these considerations and the current climate, a growing number of SMAs are being established by investment managers for contribu- fãéäáÅ~íáçåë=çÑ=c^p=NRT="c~áê tions of as little as $50 to $100 million. s~äìÉ"= ^ÅÅçìåíáåÖ=çå=mêáî~íÉ cìåÇë Structure oÉÅÉåí=iáíáÖ~íáçå=^ÑÑÉÅíáåÖ=mêáî~íÉ An SMA is typically structured as either an “Investment Account” or a “Separate Vehicle.” cìåÇë In the case of an Investment Account, an investor typically contributes cash, securities and/or other assets into an account established on behalf of the investor for management by the mêçéçëÉÇ=iÉÖáëä~íáçå=^ÑÑÉÅíáåÖ mêáî~íÉ=cìåÇë investment manager, or the investor extends direct discretionary authority to the investment manager in respect of existing assets. The relationship between the investor and the investment manager is governed by an Investment Management Agreement. Paul, Weiss Investment Funds Group In the case of a Separate Vehicle, the investment manager creates a special purpose investment qÜÉ=ÑìåÇë=Öêçìé=ÑçÅìëÉë=çå=íÜÉ=çêÖ~åáò~íáçåI=ÑìåÇ ê~áëáåÖ= ~åÇ= ã~áåíÉå~åÅÉ= çÑ= éêáî~íÉ= áåîÉëíãÉåí vehicle with the investor as the sole limited partner or shareholder. The investment manager ÑìåÇë=çÑ=ÉîÉêó=íóéÉI=áåÅäìÇáåÖ=Äìóçìí=ÑìåÇëI=ÜÉÇÖÉ typically controls and manages the Separate Vehicle under the terms of the constituent ÑìåÇëI= îÉåíìêÉ= Å~éáí~ä= ÑìåÇëI= ÜóÄêáÇ= ÑìåÇëI= documents of the Separate Vehicle (including an Investment Management Agreement), and the ÇáëíêÉëëÉÇ= ÑìåÇëI= ãÉòò~åáåÉ= ÑìåÇëI= ëéçåëçêëÜáé Separate Vehicle maintains direct ownership of the assets. ÑìåÇëI= áåÑê~ëíêìÅíìêÉ= ÑìåÇëI= ÅçJáåîÉëíãÉåí= ÑìåÇë ~åÇ= ÑìåÇë= çÑ= ÑìåÇëK= qÜÉ= ÑìåÇë= Öêçìé= áë= ~äëç From the perspective of the investment manager, an SMA structured as a Separate Vehicle may áåîçäîÉÇ= áå= ~ÅèìáêáåÖI= ãÉêÖáåÖ= ~åÇ= ~ÇîáëáåÖ= be preferable to an SMA structured as an Investment Account for a number of reasons. áåîÉëíãÉåí= ã~å~ÖÉãÉåí= ÄìëáåÉëëÉëK= få= ~ÇÇáíáçåI (continued on page 2) íÜÉ= ÑìåÇë= Öêçìé= êÉéêÉëÉåíë= ~= ÇáîÉêëÉ= Öêçìé= çÑ ÇçãÉëíáÅ=~åÇ=ÑçêÉáÖå=áåîÉëíçêë=áå=ÅçååÉÅíáçå=ïáíÜ íÜÉáê=áåîÉëíãÉåíë=áå=éêáî~íÉ=áåîÉëíãÉåí=ÑìåÇëK= © 2009 Paul, Weiss, Rifkind, Wharton & Garrison LLP. In some jurisdictions, this brochure may be considered attorney advertising. Past represenations are no guarantee of future outcomes. N E W Y O R K W A S H I N G T O N D C L O N D O N T O K Y O B E I J I N G H O N G K O N G
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Separately Managed Accounts S E P A R AT E V E H I C L E INVESTMENT ACCOUNT (continued from page 1) Control: qÜÉ=áåîÉëíãÉåí=ã~å~ÖÉê=íóéáÅ~ääó qÜÉ=áåîÉëíçê=íÉÅÜåáÅ~ääó=çïåë=íÜÉ Commonly Negotiated Terms: Åçåíêçäë=íÜÉ=pÉé~ê~íÉ=sÉÜáÅäÉI= ~ëëÉíë=~åÇ=íóéáÅ~ääó=åÉÖçíá~íÉë=~ ïÜáÅÜ=éêçîáÇÉë=íÜÉ=áåîÉëíãÉåí= ÖêÉ~íÉê=ÇÉÖêÉÉ=çÑ=Åçåíêçä=çîÉê=íÜÉ Investment Mandate and Fees ã~å~ÖÉê=ïáíÜ=~=ÖêÉ~íÉê=ÇÉÖêÉÉ=çÑ ã~å~ÖÉãÉåíI=Çáëéçëáíáçå=~åÇ In general, an investor and investment man- Åçåíêçä=çîÉê=íÜÉ=ã~å~ÖÉãÉåíI= äáèìáÇ~íáçå=çÑ=íÜÉ=~ëëÉíë=Åçãé~êÉÇ= Çáëéçëáíáçå=~åÇ=äáèìáÇ~íáçå=çÑ=íÜÉ íç=~=pÉé~ê~íÉ=sÉÜáÅäÉK ager will negotiate the investment mandate of the ~ëëÉíë=Åçãé~êÉÇ=íç=~å=fåîÉëíãÉåí SMA. In many cases, the investor negotiates ^ÅÅçìåíK detailed written investment guidelines to ensure Performance qÜÉ=éÉêÑçêã~åÅÉJÄ~ëÉÇ=ÅçãéÉåJ qÜÉ=éÉêÑçêã~åÅÉJÄ~ëÉÇ= that the investments are consistent with the liq- Allocation: ë~íáçå=íç=íÜÉ=áåîÉëíãÉåí=ã~å~ÖÉê ÅçãéÉåë~íáçå=íç=íÜÉ=áåîÉëíãÉåí uidity and return characteristics associated with ã~ó=ÄÉ=ëíêìÅíìêÉÇ=~ë=~å=?~ääçÅ~J ã~å~ÖÉê=áë=íóéáÅ~ääó=ëíêìÅíìêÉÇ== íáçå?=íç=í~âÉ=~Çî~åí~ÖÉ=çÑ=íÜÉ=Å~éáJ ~ë=~=ÑÉÉ=E~åÇ=åçí=~ë=~å=?~ääçÅ~íáçå?F the investor's investment objective. In addition, í~ä=Ö~áåë=í~ñ=ê~íÉK ~åÇ=íÜÉêÉÑçêÉ=í~ñÉÇ=~í=çêÇáå~êó the fees associated with an SMA often include áåÅçãÉ=ê~íÉëK both management fees and incentive fees (or incentive “allocation” with respect to an SMA Indemnification: qÜÉ=áåÇÉãåáÑáÅ~íáçå=éêçíÉÅíáçå=áë qÜÉ=áåÇÉãåáÑáÅ~íáçå=éêçíÉÅíáçå=áë ÖÉåÉê~ääó=ÅçåëáëíÉåí=ïáíÜ=~=éççäÉÇ çÑíÉå=äÉëë=çê=ãçêÉ=äáãáíÉÇ=íÜ~å=íÜÉ structured as a Separate Vehicle). The investor áåîÉëíãÉåí=ÑìåÇ=EáKÉKI=ÖÉåÉê~ääóI éêçíÉÅíáçå=áå=~=pÉé~ê~íÉ=sÉÜáÅäÉK== may bear an annual management fee equal to a áåÇÉãåáÑáÅ~íáçå=êÉä~íáåÖ=íç=~åó=Åä~áãë få=ÅÉêí~áå=Å~ëÉëI=íÜÉ=áåîÉëíçê=ïáää certain percentage (often between 0.5% and 2%) çíÜÉê=íÜ~å=Ñçê=Öêçëë=åÉÖäáÖÉåÅÉI êÉÑìëÉ=íç=~ÖêÉÉ=íç=áåÇÉãåáÑó=íÜÉ Ñê~ìÇ=çê=ïáääÑìä=ãáëÅçåÇìÅíFK áåîÉëíãÉåí=ã~å~ÖÉê=~åÇ=áíë=êÉä~íÉÇ of the net asset value of the assets attributable to éÉêëçåëK==jçêÉçîÉêI=íÜÉ=áåîÉëíãÉåí the SMA. If the investor terminates the SMA or ã~å~ÖÉê=ã~ó=ÄÉ=êÉèìáêÉÇ=íç makes withdrawals from the SMA within a certain áåÇÉãåáÑó=íÜÉ=áåîÉëíçê=áå=ÅçååÉÅJ íáçå=ïáíÜ=íÜÉ=ã~å~ÖÉê∞ë=ÄêÉ~ÅÜÉë period of time after formation (for example, 12 çê=~ÅíáçåëK to 18 months), the investment manager may be entitled to an additional management fee equal to Tax Structure: qÜÉ=áåîÉëíãÉåí=ã~å~ÖÉê=Ü~ë= qÜÉ=áåîÉëíãÉåí=ã~å~ÖÉê=ëáãéäó ÑäÉñáÄáäáíó=íç=ëíêìÅíìêÉ=íÜÉ=pÉé~ê~íÉ Éëí~ÄäáëÜÉë=~å=~ÅÅçìåí=çå=ÄÉÜ~äÑ=çÑ the management fee (calculated based on the sÉÜáÅäÉ=áå=~=í~ñJÉÑÑáÅáÉåí=çê= íÜÉ=áåîÉëíçê=ïáíÜçìí=~äï~óë=Ü~îáåÖ original contributions to the SMA) that would ~Çî~åí~ÖÉçìë=ã~ååÉê=íç=~ÇÇêÉëë íÜÉ=ÄÉåÉÑáí=çê=ÑäÉñáÄáäáíó=íç=Éëí~ÄäáëÜ have been payable by the investor for such period íÜÉ=ÇáîÉêëÉ=åÉÉÇë=çÑ=íÜÉ=áåîÉëíçêK íÜÉ=~ÅÅçìåí=áå=~=í~ñJÉÑÑáÅáÉåí=çê ~Çî~åí~ÖÉçìë=ã~ååÉêK of time had the SMA not been terminated or withdrawals not been made. The investor may also bear an annual incentive fee or allocation Expenses: qÜÉ=ÉñéÉåëÉë=ÄçêåÉ=Äó=íÜÉ=áåîÉëíçê qÜÉ=ÉñéÉåëÉë=ÄçêåÉ=Äó=íÜÉ=áåîÉëíçê ~êÉ=ÖÉåÉê~ääó=ÅçåëáëíÉåí=ïáíÜ=íÜÉ ~êÉ=çÑíÉå=ãçêÉ=äáãáíÉÇ=íÜ~å=íÜÉ equal to a certain percentage (say 5% to 20%) of ÉñéÉåëÉë=áå=~=éççäÉÇ=áåîÉëíãÉåí ÉñéÉåëÉë=ÄçêåÉ=Äó=~å=áåîÉëíçê=áå=~ the net profits of the SMA. The incentive fee or ÑìåÇK pÉé~ê~íÉ=sÉÜáÅäÉK allocation is typically subject to a “high water mark” and, in some cases, a hurdle rate or pre- Counterparty qÜÉ=áåîÉëíãÉåí=ã~å~ÖÉê=íóéáÅ~ääó qÜÉ=áåîÉëíãÉåí=ã~å~ÖÉê=ã~ó=åçí ferred return (which may be linked to a relevant Arrangements: Ü~ë=ÇáëÅêÉíáçå=íç=åÉÖçíá~íÉ= Ü~îÉ=ÇáëÅêÉíáçå=íç=åÉÖçíá~íÉ ~êê~åÖÉãÉåíë=ïáíÜ=éêáãÉ=ÄêçâÉêë ~êê~åÖÉãÉåíë=ïáíÜ=éêáãÉ=ÄêçâÉêë benchmark). ~åÇ=çíÜÉê=íê~ÇáåÖ=~êê~åÖÉãÉåíëK ~åÇ=çíÜÉê=íê~ÇáåÖ=~êê~åÖÉãÉåíëK qÜÉ=áåîÉëíçê=ã~ó=ÄÉ=áåîçäîÉÇ=áå åÉÖçíá~íáåÖ=íÜÉëÉ=~êê~åÖÉãÉåíë=~åÇ The Investor's Perspective: ã~ó=ÇÉã~åÇ=íÜ~í=~=ÅÉêí~áå=éêáãÉ Transparency and Liquidity ÄêçâÉê=çê=çíÜÉê=ÅçìåíÉêé~êíó=áë ìëÉÇK Advantages From the perspective of an investor, an SMA offers the investor its own tailored fund with greater transparency and fewer restrictions on performance of the portfolio, the net asset value Alternative Form liquidity. With respect to transparency, reports of the SMA and related information. With Given the current economic climate and the provided to an investor are often customized to respect to liquidity, an SMA may offer an investor issues that both investors and investment man- satisfy the specific needs of the investor. An daily, weekly or monthly liquidity terms (without agers are confronting, an SMA offers an alterna- investment manager and an investor generally lengthy notice periods, gate provisions, lock-up tive investment form for which both investors agree on precisely the type of information that periods and other similar features typical of and investment managers are showing increasing will be provided to the investor on a daily, hedge funds). In many cases, an investor is able willingness and demand. Investors and invest- weekly, monthly, quarterly or annual basis. The to withdraw all or any portion of the assets from ment managers should familiarize themselves investment manager may be required to report to the SMA upon prior notice to the investment with the potential structures of an SMA and the investor all transactions involving the invest- manager (anywhere from 5 to 90 days depending commonly negotiated terms. ment assets, a list of all accounts, the investment on the nature of the investment assets). P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 2
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Carried Interest Proposed Legislation D AV I D W. M AY O A N D L E E J . H E P N E R In his fiscal year 2010 budget proposal, with this change in taxation, we will continue to There is some uncertainty concerning the President Obama called for the taxation of car- monitor any further legislative developments application of this proposal to a typical invest- ried interests in investment funds as ordinary with respect to the President's proposal. ment fund structure. Many investment funds, income starting in 2011. In addition, two pend- particularly in New York City, are currently ing pieces of legislation in New York could sub- New York State Nonresident structured in such a way that one entity acts as the stantially increase the taxes payable on carried Income Tax investment manager and receives management interests held by certain New York State man- Under current law, a nonresident of New fees, while the carried interest is actually allocated agers. The first, Governor David A. Paterson's York State is subject to New York State income to the fund's general partner. Since the carried Executive Budget Bill, would impose New York's tax on the nonresident’s New York source interest is not received by the entity providing nonresident personal income tax on income from income. Thus, under current law, a nonresident investment management services, it is possible carried interest received for performing invest- partner in an entity that manages an investment that for funds with this structure, carried interest ment management services in New York State. fund is subject to New York State personal allocations to nonresident managers will remain The other, a bill introduced by Assemblyman income tax on his share of management fee non-New York source income and therefore Micah Kellner, would subject certain carried income arising out of management services per- exempt from New York State income tax. interest received in connection with investment formed in New York. The nonresident partner’s management services to the New York City share of the carried interest allocations made to New York City Unincorporated Unincorporated Business Tax (“UBT”). If the general partner, however, is not taxed as New Business Tax enacted, both New York bills would take effect as York source income. That income, generally The New York City UBT is a 4% tax of January 1, 2009. consisting of interest, dividends, and capital imposed on the business income of every unin- gains, is not earned in connection with a New corporated business conducted, in whole or in Federal Income Tax York trade or business, and is not considered part, in New York City. The UBT is currently Under current law, the receipt of a partner- imposed on management fees earned by fund ship carried interest in exchange for services is The President's budget proposal, managers. Income and gains generated from generally not a taxable event for U.S. federal buying and selling property for one’s own income tax purposes. Rather, the recipient of the submitted to Congress on account are exempt from the tax because such carried interest recognizes income and gain with February 26, 2009, contains a activity does not constitute an unincorporated respect to such interest only when he or she single line item that calls for the business. The character of the income and gains receives proportionate allocations of partnership arising out of an unincorporated entity’s self- income and gain. The character of any income taxation of carried interest as trading is retained when allocated to partners of and gain in the hands of a partnership is retained ordinary income. the entity. This is true regardless of how the when allocated to its partners. Therefore, divi- interest in the unincorporated entity was acquired dends and long-term capital gains realized by the New York source income. Therefore, it is not and regardless of whether the distributive share is partnership, for example, are taxed to the holder taxable in New York to nonresidents. proportionate to a partner's capital interest in the of a carried interest at the current federal rates Governor Paterson’s proposal would amend entity. Thus, carried interest in an investment for dividends and long-term capital gains, and not the New York Tax Law to require nonresident fund is generally exempt from the UBT. as ordinary income. partners to include in their New York source Assemblyman Kellner’s bill would modify President Obama’s budget proposal, submit- income any income, gain, loss, and deduction the trading exception by providing that any ted to Congress on February 26, 2009, contains a attributable to “investment management services income or gain realized in connection with an single line item that calls for the taxation of car- performed in exchange for consideration to a “investment management services interest,”other ried interest as ordinary income. While the pro- partnership or other entity.” As a result, income than any portion of the interest received as a posal indicates that this change would take place attributable to carried interests, in addition to result of a capital contribution, will not be eligi- in 2011, it provides no details as to how ordinary management fees, may be taxable to nonresidents ble for the trading exemption if held by an unin- income treatment would be achieved. The legis- providing investment management services in corporated business whose assets exceed $10 mil- lation resulting from this proposal could, among New York. Governor Paterson's proposal lion. In general, carried interest in an investment other things, treat all carried interest allocations defines “investment management services” as: fund constitutes an “investment management as ordinary income notwithstanding the underly- advising a business as to the value of any proper- services interest,” which the Budget Bill defines ing character of the income or gain (which was ty; advising a business as to the advisability of as “any interest in a business which is held by any the approach taken in legislation considered in investing in, purchasing, or selling any property; person if such person provides, directly or indi- the House of Representatives in the past two managing, acquiring, or disposing of any proper- rectly, in the active conduct of a trade or busi- years), or it could take a different approach, such ty; arranging financing with respect to acquiring ness, a substantial quantity of any of ” certain as taxing the initial grant of a carried interest. To property; and related support services. For this financial management services, which are sub- best determine whether adjustments to invest- purpose, “property” includes stock, debt, deriva- stantially the same as those enumerated in the ment fund structures may be required to deal tives, commodities, and real estate. Budget Bill. P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 3
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Recent Litigation Management Profits Interests: Affecting Private Funds To Waive or Not to Waive in Light of Recently Proposed Tax Legislation Distributions in Kind pÅÜìëë=îK=mÉåÑáÉäÇ=m~êíåÉêëK = = = R O B E RT M . H I R S H A N D S T E P H A N I E R . M C C AV I T T lå= cÉÄêì~êó= QI= OMMVI= íÜÉ= aÉä~ï~êÉ `Ü~åÅÉêó= `çìêí= ÅçåÑáêãÉÇ= ~= ÑìåÇ Under President Obama’'s fiscal year 2010 ital contributions and profits be converted into ëéçåëçêDë= ~Äáäáíó= íç= çîÉêêáÇÉ= pÉÅíáçå NTJSMR=çÑ=aorim^=áå=íÜÉ=ÑìåÇ=é~êíåÉêJ budget proposal, carried interest would be taxed capital gains (assuming that the private equity ëÜáé= ~ÖêÉÉãÉåíK= råÇÉê= pÉÅíáçå= as ordinary income beginning in 2011. No statu- fund earns capital gains). Management fee waiv- NTJSMRI=ìåäÉëë=çíÜÉêïáëÉ=éêçîáÇÉÇ=Ñçê tory language has yet been released, but based on er programs are viewed as an effective tool to áå=~=é~êíåÉêëÜáé=~ÖêÉÉãÉåíI=~==é~êíåÉêJ statutory language proposed in 2007 and 2008 defer taxation of management fees and effective- ëÜáé= ã~ó= ÅçãéÉä= ~= é~êíåÉê= íç= ~ÅÅÉéí that may be used as a model for the administra- ly convert management fee income to capital ~å=áåJâáåÇ=ÇáëíêáÄìíáçåI=Äìí=ïáíÜ=êÉëéÉÅí tion's proposal, net income allocated to a fund’s gains. íç=É~ÅÜ=çÑ=íÜÉ=ÑìåÇDë=~ëëÉíëI=åçí=áå=~å general partner or any of its affiliates with Under the proposed legislation described ~ãçìåí= ÉñÅÉÉÇáåÖ= ëìÅÜ= é~êíåÉêDë= respect to what has been referred to under cer- above, all profits associated with a management éêç=ê~í~=ëÜ~êÉ=áå=íÜÉ=Å~éáí~ä=çÑ=íÜÉ=é~êíJ tain of such proposals as an “investment servic- profits interest would be taxable at the higher åÉêëÜáéK= få= çêÇÉê= íç= çîÉêêáÇÉ= pÉÅíáçå= es partnership interest” would generally be taxed ordinary income tax rates - both the notional NTJSMRI= íÜÉ= ä~åÖì~ÖÉ= áå= íÜÉ= é~êíåÉêJ ëÜáé= ~ÖêÉÉãÉåí= íÜ~í= ïçìäÇ= éÉêãáí= íÜÉ at ordinary income tax rates, even if such net capital contributions and the long term profits ÑìåÇ= íç= ÇáëíêáÄìíÉ= ãçêÉ= íÜ~å= ~= äáãáíÉÇ income is an allocation of a share of long-term thereon. Accordingly, although the waiver may é~êíåÉêDë= é~êíåÉêëÜáé= éÉêÅÉåí~ÖÉ= çÑ capital gains that would otherwise be taxed at the still defer taxes, it would not have the effect of ~åó= ÑìåÇ= ~ëëÉí= ãìëí= ÄÉ= ëìÑÑáÅáÉåíäó lower capital gains rates. An “investment servic- converting management fee income to capital ÉñéäáÅáíK es partnership interest” includes any interest in a gains under such a proposal. On the other hand, partnership that is held by any person who pro- if the management team receives the manage- Side Letters vides (directly or indirectly) a substantial quantity ment fee income currently, pays ordinary income rãÄ~ÅÜ= îK= `~êêáåÖíçå= fåîK= m~êíåÉêëK = = = = of investment advisory and/or management tax on such income, and invests those after-tax lå=cÉÄêì~êó=NUI=OMMVI=íÜÉ=rKpK=aáëíêáÅí services to the partnership. The proposals gen- dollars (plus any required additional capital to `çìêí= Ñçê= íÜÉ= = aáëíêáÅí= çÑ= `çååÉÅíáÅìí erally contained an exception for capital interests fund their capital obligation to the private equity ÇÉÅäáåÉÇ= íç= Çáëãáëë= Åä~áãë= Äó= ~å acquired upon the contribution of invested capi- fund), profits earned on this cash investment áåîÉëíçê= êÉä~íáåÖ= íç= ~= ëáÇÉ= äÉííÉê= éìêéçêíáåÖ=íç=ï~áîÉ=~åó=äçÅâJìé=çÑ=íÜÉ tal, which would not include any type of loan would remain eligible for long-term capital gains áåîÉëíçêDë= Å~éáí~äK= få= ÇÉåóáåÖ= made to a partner, directly or indirectly, by any treatment. Accordingly, the new tax proposal, if ÇÉÑÉåÇ~åíëD= ãçíáçå= íç= ÇáëãáëëI= íÜÉ other partner or by the partnership. enacted, would significantly impact the overall `çìêí= = êÉàÉÅíÉÇ= íÜÉ= ÇÉÑÉåÇ~åíëD= ~êÖìJ It is expected that any carried interest legis- analysis of whether it makes sense in existing pri- ãÉåíë= Ä~ëÉÇ= ìéçå= ?ãÉêÖÉê= Åä~ìëÉë? lation would also tax income from management vate equity funds to continue to utilize manage- Åçåí~áåÉÇ= áå= íÜÉ= é~êíåÉêëÜáé= ~ÖêÉÉJ fee waiver programs, also known as “manage- ment fee waiver programs, as the possibility of a ãÉåíI= éêçîáÇáåÖ= íÜ~íW= = ?xqzÜÉ= ~ääÉÖÉÇ= ment profits interests.” A management profits higher effective tax rate must be added to the ãáëêÉéêÉëÉåí~íáçåë= êÉä~íÉ= íç= íÜÉ= páÇÉ interest is an indirect profits interest in a private analysis of the other features of the management iÉííÉê=~åÇ=áíë=ÉÑÑÉÅí=çå=mä~áåíáÑÑDë=~Äáäáíó equity fund that members of the investment fee waiver program (tax deferral, the ability in íç=ïáíÜÇê~ï=Üáë=áåîÉëíãÉåí=K=K=K=qÜÉëÉ management team receive in connection with a effect to satisfy a capital commitment with pre- Å~ååçí= ÄÉ= ÇáëÅä~áãÉÇ= Äó= íÜÉ= áåíÉÖê~J íáçå= Åä~ìëÉë= áå= íÜÉ= xm~êíåÉêëÜáéz waiver of current management fees. The limited tax dollars (which reduces economic exposure to ^ÖêÉÉãÉåí= ~åÇ= pìÄëÅêáéíáçå partners of the private equity fund contribute the private equity fund) and the need for the pri- ^ÖêÉÉãÉåíI= ÄÉÅ~ìëÉ= íÜÉ= páÇÉ= iÉííÉê amounts equal to the waived management fees to vate equity fund to earn profits). Since decisions ï~ë= ~ãÄáÖìçìë= ~åÇ= ÅçåíêçääÉÇ= íÜÉ fund what are in effect capital contributions to with respect to the utilization of these programs ^ÖêÉÉãÉåí= ÄÉíïÉÉå= íÜÉ= mä~áåíáÑÑ= ~åÇ private equity fund investments on a pre-tax basis in existing private equity funds (including the aÉÑÉåÇ~åíëK' = qÜÉ= ÇÉÅáëáçå= äÉ~îÉë= áå (i.e., notional capital contributions) on behalf of application of waived management fees to new èìÉëíáçå= íç= ïÜ~í= ÉñíÉåí= ~= Åçìêí= ã~ó the management team. Upon realization of an investments) may be made currently, it would be ~Çãáí= ÉîáÇÉåÅÉ= çÑ= çê~ä= ~ÖêÉÉãÉåíë= íç investment, the management team generally will timely for management teams to begin the áåíÉêéêÉí= íÜÉ= íÉêãë= çÑ= ~= ëáÇÉ= äÉííÉê receive an amount equal to its notional capital overall analysis now. ïÜÉêÉ= ~å= áåîÉëíçê= Åä~áãë= íÜ~í= áí= ï~ë contributions in such investment and propor- ãáëäÉÇ= Äó= ~= ÑìåÇ= ã~å~ÖÉêK= qÜÉ= If you are interested in receiving numerical ÇÉÅáëáçå=~äëç=ÜáÖÜäáÖÜíë=íÜÉ=áãéçêí~åÅÉ tionate profits thereon, in each case, only to the examples that illustrate the economic result of making an çÑ= áåÅäìÇáåÖ= ~= ãÉêÖÉê= Åä~ìëÉ= áå= ~= ëáÇÉ extent that the fund has available profits realized election versus not making an election under the current äÉííÉê=~ÖêÉÉãÉåí=ê~íÜÉê=íÜ~å=êÉäóáåÖ=çå on the investment. Under the current tax law, it tax proposals, please contact Stephanie R. McCavitt at ~= é~êíåÉêëÜáé= ~ÖêÉÉãÉåí= çê= ëìÄëÅêáéJ is intended that the return of these notional cap- 212-373-3558. íáçå=~ÖêÉÉãÉåí=ãÉêÖÉê=Åä~ìëÉK= P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 4
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV SEC Speaks: Handling Mass Redemptions Custodial Controls JENNIFER A. SPIEGEL a Priority As the hedge fund industry grapples with an redemptions was a PIK made through a newly unprecedented volume of redemption requests, organized SPV. An SPV may be used to isolate hedge fund sponsors are struggling to satisfy and manage down assets to be liquidated in con- aìêáåÖ= íÜÉ= êÉÅÉåí= ?pb`= péÉ~âë?= these requests while still complying with their nection with satisfying redemptions of redeem- ÅçåÑÉêÉåÅÉ= áå= t~ëÜáåÖíçåI= aK`KI fund documents and fiduciary duties, and ing investors. The redeeming investors then ^ëëçÅá~íÉ= aáêÉÅíçê= dÉåÉ= dçÜäâÉ= çÑ= íÜÉ preserve enough of their assets and investor cap- receive a PIK in the form of an interest in the pb`Dë= lÑÑáÅÉ= çÑ= `çãéäá~åÅÉI= fåëéÉÅíáçåë ital to remain a viable presence in the industry. SPV in satisfaction of their redemption requests. ~åÇ= bñ~ãáå~íáçåë= El`fbF= åçíÉÇ= íÜ~í= ÅìëJ Below we note some issues that have arisen with Although an attractive mechanism that may íçÇó= ~åÇ= ë~ÑÉíó= çÑ= ÅäáÉåí= ~ëëÉíë= ïáää= ÄÉ= ~ respect to hedge fund redemptions. (Readers enable a fund to avoid a fire sale of assets, many ëéÉÅá~ä=ÑçÅìë=çÑ=íÜÉ=pb`=ÇìêáåÖ=OMMV=~åÇ should be aware that this is a succinct summary fund sponsors discovered that there are numer- OMNM=Éñ~ãáå~íáçåëK==bñ~ãáåÉêë=ïáää=ÑçÅìë of an article that Bloomberg Law Reports™ will ous potential pitfalls associated with such SPVs, çå= ~ÇîáëÉêëD= Åçãéäá~åÅÉ= ~åÇ= çéÉê~íáåÖ be publishing in the near future. ) ranging from compliance with fund redemption éêçÅÉÇìêÉë=ïáíÜ=êÉëéÉÅí=íç=ÅìëíçÇóI=ïÜáÅÜ provisions, fiduciary issues, conflicts of interest ÜÉ=ë~áÇ=ëÜçìäÇ=ÄÉ=ÇÉëáÖåÉÇ=íç=ÉåëìêÉ=íÜ~í Gates and Suspensions and valuation issues. Some of these issues have ÅäáÉåí=~ëëÉíë=~êÉ=éêçíÉÅíÉÇ=Ñêçã=íÜÉÑí=~åÇ Gates and suspension provisions are two been the subject of litigation in the United States ãáëìëÉK= = ^ãçåÖ= çíÜÉê= íÜáåÖëI= Éñ~ãáåÉêë ïáää= ÄÉ= ëÉäÉÅíáåÖ= ~= ë~ãéäÉ= çÑ= íÜÉ= standard features of a hedge fund that enable the and Bermuda. Éñ~ãáåÉÇ= ÑáêãDë= ÅäáÉåíë= ~åÇ= Åçåí~ÅíáåÖ investment manager to preserve the value of the íÜÉã= ÇáêÉÅíäó= íç= îÉêáÑó= íÜÉáê= ~Çîáëçêó fund and prevent a sudden exodus of capital Impact of Recent Redemptions ~ÅÅçìåí= Ä~ä~åÅÉë= J= ~= éê~ÅíáÅÉ= íÜ~í= ëçãÉ when faced with mass redemptions. A gate on Hedge Fund Terms ~ÇîáëÉêë= ~êÉ= ÅçåÅÉêåÉÇ= ÅçìäÇ= ÅêÉ~íÉ= enables the fund to limit redemptions as of any As a result of the recent wave of redemp- êÉéìí~íáçå~ä= áëëìÉë= Ñçê= íÜÉã= ìåäÉëë= íÜÉ date, while a suspension provision precludes tions, fund sponsors are keenly aware of the pb`= ã~âÉë= ÅäÉ~ê= íç= ëìÅÜ= áåîÉëíçêë= íÜ~í redemptions altogether as of such date. Each importance of matching the redemption terms of íÜÉ= êÉèìÉëí= áë= ~= êçìíáåÉ= êÉèìÉëí= ~åÇ= plays a different role in a fund's strategy with their fund documents to the liquidity of the ëáÖå~äë= åç= éçíÉåíá~ä= ïêçåÖÇçáåÖ= Äó= íÜÉ respect to handling redemptions and the exact assets held by the fund. Many have also had occa- ~ÇîáëÉêK==i~ëí=ïÉÉâI=íÜÉ=pb`=~ÇîáëÉÇ=íÜ~í language of their drafting can lead to very differ- sion to revisit and clarify partnership agreement "íÜÉëÉ= ~ÅÅçìåí= ÅçåÑáêã~íáçå= êÉèìÉëíë ent consequences. provisions affecting redemptions, which may ëÜçìäÇ=åçí=ÄÉ=ÅçåëáÇÉêÉÇ=~ë=~å=áåÇáÅ~íáçå have been either ambiguous or did not provide Äó=íÜÉ=`çããáëëáçå=çê=áíë=ëí~ÑÑ=íÜ~í=~åó=îáçJ Payments in Kind (PIKs) and ä~íáçåë= çÑ= ä~ï= Ü~îÉ= çÅÅìêêÉÇI= åçê= ëÜçìäÇ the full range of flexibility that the fund sponsor Special Purpose Vehicles (SPVs) íÜÉëÉ= êÉèìÉëíë= ÄÉ= ÅçåëíêìÉÇ= ~ë= ~å Many funds have the ability to satisfy a would have liked. Although every fund sponsor undoubtedly ~ÇîÉêëÉ=êÉÑäÉÅíáçå=ìéçå=íÜÉ=~ÇîáëÉê=çê=~åó redemption through a PIK - distributing an hopes that it will never again have to face such a éÉêëçå=çê=Éåíáíó=~ëëçÅá~íÉÇ=ïáíÜ=~=ÑáêãK" investment held by the fund to the investor. However, there are many practical obstacles a period of volatility and massive redemptions, fund faces when making a PIK, as well as poten- investors can expect that fund sponsors that have its own liquidity dependent to the same tial obstacles posed by Delaware’s Revised survive this crisis will fine-tune their fund docu- extent on other investors' redemptions and thus Uniform Limited Partnership Act and some ments to incorporate features enabling them to may not be motivated to submit a redemption thorny fiduciary duty considerations. The exact handle mass redemptions without being forced to request solely to secure its place in the redemp- partnership agreement language with respect to liquidate assets at depressed prices. These fea- tion line. However, these investor-level gates can PIKs will be critical in defining the full extent of tures may include explicit provisions in the part- obviously limit the ability of an investor to with- a fund's flexibility to make PIKs. nership agreement to use SPVs, as well as individ- draw a large percentage of its capital at any one One form of PIK that was widely imple- ual investor-level gates. An investor that is subject time and will necessarily impact an investor's liq- mented during the period of 2008 year-end only to an individual investor-level gate will not uidity management and initial decision to invest. Because many investors have been uncom- E L E C T R O N I C F O R M D F I L I N G M A N D AT O R Y A S O F M A R C H 1 6 fortable having their liquidity rights affected so dramatically by the redemption decisions of ^ë=~=êÉãáåÇÉêI=~ë=çÑ=j~êÅÜ=NSI=OMMVI=cçêã=aë=ãìëí=ÄÉ=ÑáäÉÇ=ÉäÉÅíêçåáÅ~ääó=íÜêçìÖÜ=íÜÉ=pb`Dë other investors, investors will likely continue to bad^o=ëóëíÉãK==^ää=ÑìåÇë=ãìëí=Ü~îÉ=~=`Éåíê~ä=fåÇÉñ=hÉó=E`fhF=åìãÄÉê=~åÇ=`fh=`çåÑáêã~íáçå=`çÇÉ show a growing interest in “separately managed E```F=áå=çêÇÉê=íç=ÑáäÉ=ÉäÉÅíêçåáÅ~ääóK=mäÉ~ëÉ=ëÉÉ=çìê=cÉÄêì~êó=NUI=OMMV=ÅäáÉåí=~äÉêí=ÉåíáíäÉÇ=?bäÉÅíêçåáÅ accounts.” cçêã=a=cáäáåÖ=j~åÇ~íçêó=~ë=çÑ=j~êÅÜ=NS?=Ñçê=ÑìêíÜÉê=áåÑçêã~íáçå=çå=íÜáë=íçéáÅK= Please see "Separately Managed Accounts" by Marco V. Masotti and Jyoti Sharma on page 1. P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 5
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Defaulting Limited Partners R O B E RT M . H I R S H , M I T C H E L L L . B E R G A N D J I L L M . S I LV E R M A N Prolonged troubles in the economy have Most partnership agreement default provi- default on a call for an investment. This initial increased the potential for limited partner sions afford the general partner very broad dis- default puts the general partner on notice that the defaults in private equity funds. Most fund spon- cretion over which remedies, if any, are exercised. fund may need to secure additional capital in sors are already aware of the more obvious issues Thus, while the increased pressure on a general order to be able to complete an anticipated related to defaults, including the general partner's partner to exercise remedies might at first appear investment. fiduciary duties in connection with its exercise of to limit a general partner’s freedom, it may in fact remedies, the enforceability of remedies in differ- enable them to exercise their discretion more lib- Aggregation of Partnerships ent jurisdictions, and the potential for regulatory erally. This is because general partners that might and AIVs with Respect to problems that arise as the total size of a fund otherwise have been lenient on a defaulting part- Default Remedies changes and the percentage interest of some lim- ner in order to maintain a good relationship will General partners sometimes establish alter- ited partners increases. This article addresses now have a justification for much stricter treat- native investment vehicles (commonly known as three more subtle issues that have not previously ment - the other limited partners are watching “AIVs”) for investments that could create adverse been fully explored relating to a very common and holding them accountable. This enables gen- tax consequences for certain limited partners private equity fund default remedy - the general eral partners to enforce the default remedies and/or the general partner if they were made partner's ability to reduce a defaulting limited under the partnership agreement, including by directly by the main fund. Many of these partner's capital account and share the forfeited reducing a limited partner’s capital account, with- arrangements, drafted before the heightened sen- portion with non-defaulting limited partners. out being seen as unnecessarily punitive. sitivity to defaults, do not aggregate the AIV and the main fund for purposes of imposing default Effect on Other Limited Partners Calling Temporary Cash Funds remedies. Thus, a default by a limited partner on of General Partner Discretion Limited partners that are invested in numer- a capital call to an AIV would lead only to a As defaults grow more common, all limited ous private equity funds, but that suddenly face a reduction in its capital account in the AIV, and partners are paying more attention to the poten- diminished supply of available capital, may strate- not a reduction in its capital account in the main tial remedies that a general partner has under the gize over which funds’ capital calls they will fund. Consider, however, a situation where some default on and which they will honor. Obviously, limited partners have invested in all investments partnership agreement. Non-defaulting limited where a partner has funded the majority of its through the partnership, but others hold half of partners in particular are becoming increasingly commitment to the fund, the threat of losing half their investments through the partnership, and aware that they could benefit from the general of its capital account will probably be significant half through the AIV. If a limited partner with partner's exercise of some of these remedies. For enough to discourage the limited partner from investments in the AIV defaults on a capital call example, if a limited partner defaults, the general deliberately defaulting in that fund. However, by the partnership, the general partner could then partner may cause it to forfeit as much as 50% of where a general partner has not yet called any reduce such limited partner's capital account in its capital account balance, with the non-default- capital, or where the capital accounts are minimal, the partnership, but would have no ability to ing limited partners succeeding to the forfeited the prospect of a capital account forfeiture may reduce such limited partner's capital account in portion. This can be quite a windfall for a non- not be especially ominous for limited partners. As the AIV. Despite the AIV having been put in defaulting limited partner when a large institu- a result, one way to deter defaults might be for place for tax and not other reasons, a defaulting tional partner defaults. the general partner to call a certain amount of limited partner with all of its investments held In some cases, limited partners have even capital in advance to be held as “Temporary through the partnership will forfeit more of its written to a general partner to “remind” the gen- Cash.” Many partnership agreements contain capital than a defaulting limited partner who eral partner of their expectation that the general provisions permitting such calls to be made with- invests primarily through the AIV, even when the partner will strictly enforce its remedies against out reference to a specific investment, but rather economic magnitude of the default is exactly the defaulting limited partners, including by imposing to be held in reserve and used if and when the same for both limited partners - an odd result. a capital account forfeiture and shift. Historically, general partner identifies an investment. Because The equitable fix would be to cross default the general partners may have shied away from exer- capital called as Temporary Cash would increase interests in the AIV with the interests in the main cising the full extent of their rights against a a limited partner's capital account by the called fund; however, before introducing a cross default, defaulting limited partner in order to preserve an amount, the potential loss for a limited partner one must consider several issues, including the existing relationship with the defaulting partner. who later defaults is that much greater. An added tax effect of such aggregation, the potentially dif- However, now that limited partners are aware benefit of this approach is that it can enable a ferent results under the law governing the main that they can potentially benefit from the default general partner to anticipate a default by a specif- fund and the law governing the AIV and, finally, of another partner, they may pressure general ic limited partner prior to calling capital for an how the benefit of a capital account forfeiture is partners to exercise the full extent of their discre- investment. For example, if a general partner shared among limited partners of the main fund tion under the default provisions of the partner- makes a call for Temporary Cash and a partner and the AIV. ship agreement. defaults, it is likely that that same partner will also P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 6
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Proposed Legislation General Partner Facilitation of Sales Affecting Private Funds of Limited Partner Interests kçí= äçåÖ= ~ÑíÉê= pb`= `Ü~áêã~å= j~êó JENNIFER A. SPIEGEL pÅÜ~éáêçDë= pÉå~íÉ= `çåÑáêã~íáçå= eÉ~êáåÖëI áå= ïÜáÅÜ= ëÜÉ= Å~ääÉÇ= Ñçê= áããÉÇá~íÉ= ÑÉÇÉê~ä Given the volume of potential limited part- ner interests are available for sale, even if it lim- äÉÖáëä~íáçå=íç=êÉÖìä~íÉ=ÜÉÇÖÉ=ÑìåÇëI=ëÉîÉê~ä ner defaults this year, general partners are under- its this announcement to pre-screened accred- äÉÖáëä~íáîÉ= éêçéçë~äë= ïÉêÉ= áåíêçÇìÅÉÇ= áå standably very keen to help their limited partners ited and otherwise qualified transferees. `çåÖêÉëë=~åÇ=~í=íÜÉ=pí~íÉ=äÉîÉäK==_Éäçï=~êÉ in any way possible to avoid a default through a Participating in the Sale Discussion. If the ëìãã~êáÉë= çÑ= ëçãÉ= çÑ= íÜçëÉ= éêçéçë~äëK secondary sale of the limited partner interests. general partner takes the lead in structuring or ^äíÜçìÖÜ= ãçëí= çÑ= íÜÉëÉ= éêçéçë~äë= ~êÉ However, a general partner needs to consider a negotiating the business terms of the transfer, áåíÉåÇÉÇ=íç=í~êÖÉí=ÜÉÇÖÉ=ÑìåÇëI=~ë=ÅìêêÉåíJ äó=Çê~ÑíÉÇI=ã~åó=ïçìäÇ=~ééäó=íç=~ää=íóéÉë=çÑ number of factors when facilitating sales of lim- including, especially, the price (which could éêáî~íÉ=ÑìåÇëI=áåÅäìÇáåÖ=éêáî~íÉ=Éèìáíó=ÑìåÇëK ited partner interests, including whether it is act- arise subtly when the general partner is asked to ing as a broker. This concern is in addition to all weigh in on what constitutes “market terms” of the other concerns that any secondary transfer for sales of interests in today’s market), it may eÉÇÖÉ= cìåÇ= qê~åëé~êÉåÅó= ^ÅíK = = = raises (publicly traded partnership issues, fiduci- be effecting transactions in the securities of pÉå~íçêë= `ÜìÅâ= dê~ëëäÉó= ~åÇ= `~êä ary issues, eligibility of the transferee, Investment others. iÉîáå=Ü~îÉ=áåíêçÇìÅÉÇ=äÉÖáëä~íáçå=ÉåíáJ Company Act issues, Investment Advisers Act Soliciting Potential Purchasers. A general íäÉÇ= íÜÉ= ?eÉÇÖÉ= cìåÇ= qê~åëé~êÉåÅó issues (has the transferee become a “client”?), partner should be careful that whether through ^Åí= çÑ= OMMV?= ïÜáÅÜ= éêçîáÇÉë= íÜ~í confidentiality, etc). advertising or otherwise, it is not actively solic- ÑìåÇë=íÜ~í=ë~íáëÑó=íÜÉ=êÉèìáêÉãÉåíë=çÑ Although there is no bright line guidance for iting potential transferees or purchasers for the pÉÅíáçå= PEÅFENF= çê= PEÅFETF= çÑ= íÜÉ when a general partner's role in a secondary pur- sale of a limited partner interest. fåîÉëíãÉåí= `çãé~åó= ^Åí= ~åÇ= íÜ~í chase amounts to “effecting transactions in the Ü~îÉ= ~ëëÉíëI= çê= ~ëëÉíë= ìåÇÉê= ã~åJ securities for the account of others” and subjects Low Risk General Partner ~ÖÉãÉåíI=çÑ=ARM=ãáääáçå=çê=ãçêÉI=ã~ó the general partner to potential regulation as a Activities çåäó= êÉã~áå= ÉñÉãéí= Ñêçã= êÉÖìä~íáçå broker-dealer under the Securities Exchange Act Reviewing Transferee Eligibility. A general ~ë= ~å= áåîÉëíãÉåí= Åçãé~åó= áÑ= íÜÉ of 1934, set forth below are some general prelim- partner's due diligence review regarding the ÑìåÇW= = EáF= êÉÖáëíÉêë= ïáíÜ= íÜÉ= pb`X= EááF inary guidelines general partners should consider transferee to ascertain such transferee’s compli- ÑáäÉë= ~å= ~ååì~ä= ÇáëÅäçëìêÉ= Ñçêã= ïáíÜ when facilitating transfers of limited partner ance with investor eligibility is a necessary func- íÜÉ= pb`X= EáááF= ã~áåí~áåë= ëìÅÜ= Äççâë interests. tion in connection with any fund’s compliance ~åÇ=êÉÅçêÇë=~ë=íÜÉ=pb`=ã~ó=êÉèìáêÉX This is preliminary guidance only, and each of these and should not in and of itself raise broker- EáîF=ÅççéÉê~íÉë=ïáíÜ=pb`=êÉèìÉëíë=Ñçê áåÑçêã~íáçå= çê= Éñ~ãáå~íáçåX= ~åÇ= EîF factors will need to be assessed in light of its degree and dealer concerns. Éëí~ÄäáëÜÉë=~å=~åíáJãçåÉó=ä~ìåÇÉêáåÖ frequency. A general partner should seek the advice of Providing Fund Information. Prospective éêçÖê~ã= ~åÇ= êÉéçêíë= ëìëéáÅáçìë counsel before taking it upon itself to track down buyers transferees will obviously want to diligence lim- íê~åë~ÅíáçåëK=mäÉ~ëÉ=ëÉÉ=çìê=g~åì~êó for the fund interests of limited partners that it fears may ited partner interests as thoroughly as possible. PMI=OMMV=ÅäáÉåí=~äÉêí=ÉåíáíäÉÇ= ?pÉå~íÉ default. The provision by the general partner of recent _áää= tçìäÇ= oÉèìáêÉ= mêáî~íÉ= cìåÇë= íç quarterly reports and a private placement mem- oÉÖáëíÉê= ~åÇ= j~âÉ= aáëÅäçëìêÉë?= Ñçê High Risk General Partner orandum (with appropriate disclaimers) to ÑìêíÜÉê=áåÑçêã~íáçå=çå=íÜáë=íçéáÅK Activities prospective transferees should also be an Receiving Compensation in Connection acceptable activity. Note that the prospective eÉÇÖÉ=cìåÇ=^ÇîáëÉê=oÉÖáëíê~íáçå=^Åí = = = = with a Sale. If the general partner receives any transferee should be subject to a confidentiali- çÑ= OMMVK= oÉéêÉëÉåí~íáîÉë= jáÅÜ~Éä = = form of compensation in connection with the ty agreement and the general partner should be `~éì~åç= ~åÇ= jáÅÜ~Éä= `~ëíäÉ= Ü~îÉ sale of a limited partner interest, this could be careful about providing any information that áåíêçÇìÅÉÇ= äÉÖáëä~íáçå= ÉåíáíäÉÇ= íÜÉ a “bad fact” in analyzing the general partner’s has not already been provided to (or that is ?eÉÇÖÉ= cìåÇ= ^ÇîáëÉê= oÉÖáëíê~íáçå activities in the context of potential broker- being shared simultaneously with) existing lim- ^Åí= çÑ= OMMV?= ïÜáÅÜ= ÇÉäÉíÉë= íÜÉ= ?éêáJ dealer regulation. General partners should note ited partners. î~íÉ=~ÇîáëÉê?=ÉñÉãéíáçå=Ñêçã=pÉÅíáçå that compensation may take subtle forms, such Putting Seller and Buyer in Touch. Passively OMPEÄFEPF= çÑ= íÜÉ= ^ÇîáëÉêë= ^ÅíK= = ^ë= ~ as the release of unrelated claims or an overly putting in contact (i) a selling limited partner êÉëìäíI=ãçëí=ÅìêêÉåíäó=ÉñÉãéí=éêáî~íÉ broad indemnification of the general partner who has, on its own initiative, contacted the ÑìåÇ=~ÇîáëÉêë=ïáíÜ=çîÉê=AOR=ãáääáçå=áå (including with respect to claims unrelated to general partner and (ii) an interested buyer who ~ëëÉíë=ìåÇÉê=ã~å~ÖÉãÉåí=ïçìäÇ=ÄÉ êÉèìáêÉÇ= íç= êÉÖáëíÉê= ïáíÜ= íÜÉ= pb`= ~ë the transfer). has, on its own initiative, contacted the general áåîÉëíãÉåí= ~ÇîáëÉêëI= ã~âáåÖ= íÜÉã Advertising the Sale of Limited Partner partner expressing an interest in purchasing a ëìÄàÉÅí=íç=~ää=çÑ=íÜÉ=éêçîáëáçåë=çÑ=íÜÉ Interests. A general partner could be consid- limited partner interest should not raise ^ÇîáëÉêë=^ÅíK=======(continued on page 8) ered to be holding itself out as a broker if it issues. facilitates sales by announcing that limited part- P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 7
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Proposed Legislation Affecting Private Funds Implications of FAS 157 “Fair Value” (continued from page 7) mÉåëáçå=pÉÅìêáíó=^Åí=çÑ=OMMVK = = = Accounting on Private Funds oÉéêÉëÉåí~íáîÉ=`~ëíäÉ=Ü~ë=áåíêçÇìÅÉÇ=äÉÖJ áëä~íáçå= ÉåíáíäÉÇ= íÜÉ= ?mÉåëáçå= pÉÅìêáíó= ^Åí S T E P H A N I E R . M C C AV I T T A N D J E N N I F E R A . S P I E G E L çÑ=OMMV?=íÜ~í=ïçìäÇ=~ãÉåÇ=qáíäÉ=f=çÑ=bofp^ íç=êÉèìáêÉ=ÇáëÅäçëìêÉ=çÑ=éä~å=áåîÉëíãÉåíë=áå Beginning last year, for the first time, private Market Comparables vs ÜÉÇÖÉ= ÑìåÇë= áå= íÜÉ= ~ååì~ä= êÉéçêí= çÑ= É~ÅÜ funds were faced with implementing a methodol- Discounted Cash Flow ("DCF") ÇÉÑáåÉÇ= ÄÉåÉÑáí= éÉåëáçå= éä~åK= = qÜÉ= ÇáëÅäçJ ogy to comply with the requirement to “fair value” Private equity funds and hedge funds that ëìêÉ=ïçìäÇ=ëéÉÅáÑáÅ~ääó=áåÅäìÇÉ=~=ëÅÜÉÇìäÉ their investments pursuant to Financial hold non-public investments, which has become áÇÉåíáÑóáåÖ= É~ÅÜ= ÜÉÇÖÉ= ÑìåÇ= áå= ïÜáÅÜ= íÜÉ Accounting Standards Board Statement 157 (“FAS increasingly common in recent years, will éä~å=áåîÉëíë=~ë=çÑ=íÜÉ=ÉåÇ=çÑ=íÜÉ=éä~å=óÉ~ê 157”), which became effective for fiscal years undoubtedly have difficulty identifying compara- ÅçîÉêÉÇ= Äó= íÜÉ= ~ååì~ä= êÉéçêí= ~åÇ= íÜÉ beginning after November 15, 2007. The difficul- ble investments in the current market. Securities ~ãçìåí=áåîÉëíÉÇ=áå=É~ÅÜ=ÑìåÇK= ty in assigning fair values to hard-to-value assets, of a public company that operates in the same which historically have been valued at cost, is fur- market sector as a privately-held portfolio compa- eÉÇÖÉ=cìåÇ=píìÇó=^ÅíK= = = = ther exacerbated by the current credit crisis and ny may have suffered a significant decline in value oÉéêÉëÉåí~íáîÉ=`~ëíäÉ=Ü~ë=áåíêçÇìÅÉÇ=äÉÖJ in the current turbulent stock market, which may áëä~íáçå= ÉåíáíäÉÇ= íÜÉ= ?eÉÇÖÉ= cìåÇ= píìÇó resulting global market disruptions. This mark-to- not be indicative of the value that should be attrib- market requirement raises various concerns for ^Åí?= íÜ~í= ïçìäÇ= êÉèìáêÉ= íÜÉ= mêÉëáÇÉåíDë utable to the private investment. Thus, a private both private equity funds and hedge funds. tçêâáåÖ= dêçìé= çå= cáå~åÅá~ä= j~êâÉíë= íç fund sponsor must first decide whether it should ÅçåÇìÅí=~=ëíìÇó=çå=íÜÉ=ÜÉÇÖÉ=ÑìåÇ=áåÇìëJ consider the value of public companies in valuing Overview of FAS 157 its own private investments. Other observable íêóK==qÜÉ=êÉéçêí=áë=íç=áåÅäìÇÉ=êÉÅçããÉåÇ~J In general, FAS 157 provides guidelines that íáçåë= ïáíÜ= êÉëéÉÅí= íç= EáF= äÉÖáëä~íáçå= êÉä~íáåÖ inputs may not be available to begin with due to prioritize the type of data required to be used to íç=~ééêçéêá~íÉ=ÇáëÅäçëìêÉ=êÉèìáêÉãÉåíë=Ñçê the lack of comparable private transactions in the mark-to-market investments under U.S. Generally current stagnant marketplace. As a result, fund ÜÉÇÖÉ= ÑìåÇëX= EááF= íÜÉ= íóéÉ= çÑ= áåÑçêã~íáçå Accepted Accounting Principles (“GAAP”) and sponsors may use less favored valuation approach- ÜÉÇÖÉ=ÑìåÇë=ëÜçìäÇ=ÇáëÅäçëÉ=íç=êÉÖìä~íçêë requires detailed financial statement disclosure es, such as a DCF approach. Reliance on DCF, ~åÇ=íç=íÜÉ=éìÄäáÅX=EáááF=ÉÑÑçêíë=íÜÉ=ÜÉÇÖÉ=ÑìåÇ concerning such valuation. Under the guidelines, which emphasizes a company's potential for long- áåÇìëíêó= çê= êÉÖìä~íçêë= çÑ= Ñáå~åÅá~ä= áåëíáíìJ investments must be valued using the price that term cash flow when analyzing its value, could íáçåë= ëÜçìäÇ= ìåÇÉêí~âÉ= íç= áãéêçîÉ= éê~ÅJ would be received in the market to sell the invest- enable a fund sponsor to avoid reflecting large íáÅÉëX=~åÇ=EáîF=çîÉêëáÖÜí=êÉëéçåëáÄáäáíáÉë=íÜ~í ment based on market data (observable inputs). losses associated with the sudden decrease in asset ãÉãÄÉêë= çÑ= íÜÉ= tçêâáåÖ= dêçìé= ëÜçìäÇ Only if there is little, or no, market activity, or values since September 2008. DCF can also help Ü~îÉ=çîÉê=íÜÉ=ÜÉÇÖÉ=ÑìåÇ=áåÇìëíêóI=~åÇ=íÜÉ when relevant market data is unavailable, is man- avoid the “choppy” results that many have feared ÇÉÖêÉÉ=~åÇ=ëÅçéÉ=çÑ=ëìÅÜ=çîÉêëáÖÜíK a mark-to-market approach would introduce to agement allowed to rely on its own assumptions otherwise smooth private equity returns. píçé=q~ñ=e~îÉå=^ÄìëÉ=^ÅíK== = = = = (unobservable inputs). FAS 157 introduces a hier- Nonetheless, whether a comparables or DCF pÉå~íçê= iÉîáå= Ü~ë= áåíêçÇìÅÉÇ= íÜÉ= ?píçé archy of three levels of inputs, with observable approach is used, a fund sponsor must take care to q~ñ=e~îÉå=^ÄìëÉ=^Åí?=ïÜáÅÜ=áë=áåíÉåÇÉÇ=íç inputs or quoted prices for identical assets being include appropriate disclosure regarding the par- ëíçé= çÑÑëÜçêÉ= í~ñ= Ü~îÉå= ~åÇ= í~ñ= ëÜÉäíÉê the preferred source of valuation. Because this ticular approach it implements to fair value the ~ÄìëÉëI= ~åÇ= íÜ~í= ïçìäÇI= áÑ= Éå~ÅíÉÇI approach to fair value measurement assumes fund's assets. ÅÜ~åÖÉ= ëìÄëí~åíá~ääó= íÜÉ= í~ñ= íêÉ~íãÉåí= çÑ orderly transactions between market participants, åçåJrKpK=ÜÉÇÖÉ=ÑìåÇë=~åÇ=äáâÉäó=çíÜÉê=åçåJ it will be difficult to apply in times of market dis- One Investment, Multiple rKpK=Åçêéçê~íáçåë=íÜ~í=~êÉ=ã~å~ÖÉÇ=áå=íÜÉ ruption where transactions are often distressed or Valuations råáíÉÇ=pí~íÉëK==^=Åçãé~åáçå=Äáää=ï~ë=áåíêçJ forced. The SEC and the FASB have acknowl- Investments may be valued very differently by ÇìÅÉÇ= áå= íÜÉ= rKpK= eçìëÉ= çÑ edged that the determination of fair value will different fund sponsors as one fund sponsor may oÉéêÉëÉåí~íáîÉë= Äó= çîÉê= QM= jÉãÄÉêë= äÉÇ require challenging judgment calls during this peri- consider a public comparable in valuing while Äó= oÉéêÉëÉåí~íáîÉë= iäçóÇ= açÖÖÉíí= ~åÇ od of market uncertainty; however, requests to another fund sponsor determines no comparable oçë~=aÉi~ìêçK=qÜÉ=píçé=q~ñ=e~îÉå=^ÄìëÉ postpone its application were rejected. exists. For an institutional investor holding the same investment through different fund sponsors, ^Åí= áë= ~å= áãéêçîÉÇ= îÉêëáçå= çÑ= äÉÖáëä~íáçå this means it could have multiple valuations for the áåíêçÇìÅÉÇ= áå= íÜÉ= ä~ëí= `çåÖêÉëëK= qÜÉ= Äáää What Does This Mean for Private Ü~ë=ÄÉÉå=ëíêÉåÖíÜÉåÉÇ=ïáíÜ=íÜÉ=~ÇÇáíáçå=çÑ Funds? same investment in its portfolio. The existence of multiple valuations can undermine investor confi- íÜêÉÉ= åÉï= éêçîáëáçåë= íÜ~í= ïçìäÇW= EáF= íêÉ~í The requirement to mark-to-market illiquid dence, which is already in short supply. ÑçêÉáÖå= Åçêéçê~íáçåë= ã~å~ÖÉÇ= ~åÇ= ÅçåJ investments raises various issues, particularly in the íêçääÉÇ= áå= íÜÉ= råáíÉÇ= pí~íÉë= ~ë= ÇçãÉëíáÅ midst of the current credit crisis when comparable Unrealized Losses Åçêéçê~íáçåë= Ñçê= áåÅçãÉ= í~ñ= éìêéçëÉëX= investments and observable inputs are likely Many private equity funds take unrealized EááF= ÅÜ~åÖÉ= íÜÉ= rKpK= ïáíÜÜçäÇáåÖ= í~ñ= íêÉ~íJ unavailable. The following are some issues private losses into account when distributing proceeds of ãÉåí=çÑ=Éèìáíó=ëï~é==(continued on page 9) funds may be grappling with: an investment to investors only (continued on page 9) P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 8
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Implications of FAS 157 “Fair Value” Accounting on Private Funds Proposed Legislation Affecting Private Funds (continued from page 8) (continued from page 8) é~óãÉåíë= íÜ~í= ~êÉ= ~= ëìÄëíáíìíÉ= Ñçê= ÇáîáJ if the unrealized losses represent a significant and Performance; Fundraising ÇÉåÇë= çå= ëíçÅâë= çÑ= rKpK= áëëìÉêëX= ~åÇ= EáááF permanent decline in value. Some private equity A fund sponsor raising a new fund must Éñé~åÇ= íÜÉ= í~ñ= êÉíìêå= êÉéçêíáåÖ= êÉèìáêÉJ funds, however, define the concept of unrealized decide whether to report its performance based on ãÉåíë=Ñçê=é~ëëáîÉ=ÑçêÉáÖå=áåîÉëíãÉåí=ÅçêJ loss based on GAAP. Depending on the relevant éçê~íáçåë= Emcf`ëF= íç= áåÅäìÇÉ= rKpK= éÉêëçåë its GAAP-based financial statements or based on definitions used in the partnership agreement's ïÜç=ÇçåDí=çïå= ~= mcf`I= Äìí=Ü~îÉ=ÑçêãÉÇI an alternative set of financial statements that do ëÉåí= ~ëëÉíë= íçI= êÉÅÉáîÉÇ= ~ëëÉíë= ÑêçãI= çê distribution provisions, fair value accounting may not contain mark-to-market valuations, but that ÄÉåÉÑáíÉÇ=Ñêçã=~=mcf`K== require those funds to take into account unrealized disclose such value differences. During stable mäÉ~ëÉ= ëÉÉ= çìê= j~êÅÜ= RI= OMMV= ÅäáÉåí losses that previously would not have affected dis- markets, GAAP-based financial statements could ~äÉêí= ÉåíáíäÉÇ= ?iÉîáå= _áää= tçìäÇ= `Ü~åÖÉ tributions of investment proceeds. This in turn have the effect of arguably overstating the value of q~ñ~íáçå= çÑ= kçåJrKpK= eÉÇÖÉ= cìåÇë= ~åÇ can affect the fund’s “IRR” calculation and delay investments that have not been sold, while in the líÜÉê= kçåJrKpK= `çêéçê~íáçåë?= Ñçê= ÑìêíÜÉê the receipt of carried interest distributions by the current market they will potentially understate áåÑçêã~íáçå=çå=íÜáë=íçéáÅK fund sponsor. such values, resulting in additional “paper losses” Similarly, hedge funds with “side pocketed” which could unsettle an already anxious investor mêçéçëÉÇ=_áää=íç=aÉíÉÅíI=aÉíÉêI = = = = illiquid investments typically take only realized aáëÅçìê~ÖÉ=lÑÑëÜçêÉ=q~ñ=bî~ëáçåK= = = = = base. It may be difficult to determine which ^ë= ~å= ~äíÉêå~íáîÉ= íç= pÉå~íçê= iÉîáå∞ë= ÄáääI losses into account when striking a fund-wide net approach provides the most appropriate picture of pÉå~íÉ= cáå~åÅÉ= `çããáííÉÉ= `Ü~áêã~å= j~ñ asset value for purposes of calculating the man- the performance of a fund's investments. _~ìÅìë=áë=ÅìêêÉåíäó=ÅáêÅìä~íáåÖ=~=?îÉêó=éêÉäáãJ agement fee and annual incentive allocations. áå~êó= Çê~Ñí?= çÑ= äÉÖáëä~íáçå= áåíÉåÇÉÇ= íç Taking unrealized losses into consideration could Disclosure; Operative Documents ÉåÜ~åÅÉ=íÜÉ=íê~åëé~êÉåÅó=çÑ=çÑÑëÜçêÉ=~ÅíáîáJ decrease fee and incentive income unless the fund Fund sponsors must disclose in their finan- íó=~åÇ=íç=ÖáîÉ=íÜÉ=fop=ÄÉííÉê=íççäë=íç=ÇÉíÉêI sponsor is comfortable with “NAV Divergence.” cials which category of “input” they relied upon to ÇÉíÉÅí=~åÇ=ÇáëÅçìê~ÖÉ=çÑÑëÜçêÉ=~ÄìëÉë=~åÇ See “NAV Divergence” below. value their assets. They may also consider includ- åçåÅçãéäá~åÅÉK==qÜÉ=Çê~Ñí=ÑçÅìëÉë=çå=ÅçãJ ing disclosure in their offering documents regard- éäá~åÅÉI=éêáã~êáäó=íÜêçìÖÜ=áåÑçêã~íáçå=êÉéçêíJ Defaults ing their implementation of FAS 157. In addition, áåÖI=ÉñíÉåÇáåÖ=ÅÉêí~áå=ëí~íìíÉë=çÑ=äáãáí~íáçåë Private equity fund investors with limited cap- ~åÇ= ÑáåÉëLéÉå~äíáÉëK= = få= ëìãã~êóI= íÜÉ= éêçJ fund sponsors may consider including provisions éçë~äW==EáF=êÉèìáêÉë=ÉåíáíáÉë=íê~åëÑÉêêáåÖ=ÑìåÇë ital resources available given current market condi- in their operative fund documents that set forth çÑÑëÜçêÉ= EçíÜÉê= íÜ~å= çå= ÄÉÜ~äÑ= çÑ= éìÄäáÅäó tions may make calculated decisions as to which of the framework they intend to use for their valua- íê~ÇÉÇ=Åçãé~åáÉëF=íç=êÉéçêí=íç=íÜÉ=fop=íÜÉ their investments to default on based on valuations tion methodology and include an investor ~ãçìåí=~åÇ=ÇÉëíáå~íáçåL~ÅÅçìåí=áåÑçêã~íáçå reported. Prior to the implementation of FAS acknowledgement as to such procedures. çÑ= íÜÉ= ÑìåÇë= íê~åëÑÉêêÉÇX= EááF= ÉñíÉåÇë= íÜÉ 157, this information would not have been avail- ëí~íìíÉ=çÑ=äáãáí~íáçåë=Ñêçã=íÜêÉÉ=íç=ëáñ=óÉ~êë able to these investors. Default considerations NAV Divergence Ñçê=í~ñ=êÉíìêåë=êÉéçêíáåÖI=çê=íÜ~í=ëÜçìäÇ=Ü~îÉ may place an additional strain on a firm's valuation Some funds, hedge funds in particular, have êÉéçêíÉÇI= ÅÉêí~áå= áåíÉêå~íáçå~ä= íê~åë~ÅíáçåëI methodology. already implemented what accountants refer to as íç= ÖáîÉ= íÜÉ= fop= ãçêÉ= íáãÉ= íç= ÇÉíÉÅí= ~åÇ Éñ~ãáåÉ= çÑÑëÜçêÉ= ~ÅíáîáíóX= EáááF= = êÉèìáêÉë= íÜÉ “NAV divergence” - the use of one value for pur- cçêÉáÖå=_~åâ=^ÅÅçìåí=oÉéçêíë=Ec_^oF=Ñçêã Secondary Sales poses of subscriptions, redemptions and manage- íç=ÄÉ=ÑáäÉÇ=ïáíÜ=íÜÉ=áåÅçãÉ=í~ñ=êÉíìêåI=íìêåJ The decision to buy or to sell a fund interest ment fee and incentive allocation calculations and áåÖ=íÜÉ=c_^o=áåíç=í~ñ=êÉíìêå=áåÑçêã~íáçå=~åÇ in the secondary market will also be made based the use of another value, an FAS-compliant value, ã~âáåÖ=áí=É~ëáÉê=Ñçê=íÜÉ=fop=íç=ÉåÑçêÅÉ=c_^o on investment value information. Therefore, the for purposes of financial statements and creation ÑáäáåÖ=êÉèìáêÉãÉåíëX=EáîF=êÉèìáêÉë=éêÉé~êÉêë=íç approach taken to value investments and the val- of reserves. Although this practice pre-dates the ~ëâ= ~= ëÉêáÉë= çÑ= ÇìÉ= ÇáäáÖÉåÅÉ= èìÉëíáçåë= íç ues assigned to those investments will affect not arrival of FAS 157, it may come under stricter ÇÉíÉêãáåÉ=ïÜÉíÜÉê=~å=c_^o=ëÜçìäÇ=ÄÉ=ÑáäÉÇX only decisions made by a fund’s current investors - scrutiny as fund sponsors and investors struggle to EîF=ÉåÜ~åÅÉë=íÜÉ=éÉå~äíó=Ñçê=~=ÑçêÉáÖå=íêìëíDë whether to redeem or sell in the secondary market grasp the full effects of FAS 157. Ñ~áäìêÉ=íç=ÑáäÉI=é~êíáÅìä~êäó=ïÜÉå=íÜÉ=Åçêéìë=çÑ - but will also affect the decisions of potential sec- íÜÉ= íêìëí= áë= ìåâåçïåI= Äó= Éëí~ÄäáëÜáåÖ= ~ ANMIMMM=ãáåáãìã=éÉå~äíóX=EîáF=ïáíÜ=êÉëéÉÅí ondary market purchasers. This valuation issue Investment Advisers Act íç=íê~åëÑÉêë=Ñêçã=ÑçêÉáÖå=íêìëíëI=Éñé~åÇë=íÜÉ could add additional complexity to the secondary Rule 206(4)-(8) of the Investment Advisers íóéÉë=çÑ=éêçéÉêíó=ÅçåëáÇÉêÉÇ=íç=ÄÉ=~=ÇáëíêáJ market which is growing rapidly to address exist- Act of 1940 prohibits investment advisers from Äìíáçå= EÉKÖKI= ~êíïçêâ= ~åÇ= àÉïÉäêóFX= EîááF= ÇçìJ ing investors' needs for immediate liquidity. making false or misleading statements to investors ÄäÉë=~ééäáÅ~ÄäÉ=ÑáåÉë=~åÇ=éÉå~äíáÉë=çå=ìåÇÉêJ and prospective investors in private funds. é~óãÉåíë= ~ííêáÄìí~ÄäÉ= íç= ÅÉêí~áå= çÑÑëÜçêÉ Investment Allocations Distributing misleading financial statements could íê~åë~ÅíáçåëX=~åÇ=EîáááF=ãçÇáÑáÉë=~=éêçîáëáçå=áå Institutional investors, such as pension funds fall within this rule. Because the rule also applies to íÜÉ=OMMU=eÉêçÉë=^Åí=íÜ~í=êÉèìáêÉë=çÑÑëÜçêÉ and funds of funds, will now base their own misleading “conduct”, a fee calculation - without ÉåíáíáÉë=íÜ~í=ÜáêÉ=ïçêâÉêë=íç=éÉêÑçêã=ëÉêîáÅÉë investment allocations (for current and future any corresponding statement - based on an éìêëì~åí= íç= ~= ÖçîÉêåãÉåí= Åçåíê~Åí= íç= ÄÉ years) in part on valuations received from their íêÉ~íÉÇ=~ë=^ãÉêáÅ~å=ÉãéäçóÉêë=Äó=Éëí~ÄäáëÜJ improper valuation could also be caught by the áåÖ=~=êìäÉ=íÜ~í=~í=äÉ~ëí=NMM=Üçìêë=çÑ=ëÉêîáÅÉ=~ fund investments. Therefore, mark-to-market val- rule. Importantly, the rule does not require any ãçåíÜ= ÅçåëíáíìíÉë= ~å= ÉãéäçóÉÉK= = qÜÉ uations will likely affect certain investors' own specific intent or knowledge of the improper val- pÉå~íÉ=cáå~åÅÉ=`çããáííÉÉ=ëí~ÑÑ=áë=ÅìêêÉåíäó investment allocations, as well as what they report uation. As a result, a fund sponsor relying on val- êÉèìÉëíáåÖ=ÅçããÉåíë=çå=íÜÉ=Çê~Ñí=éêçéçë~äK on their financial statements to their investors. uations provided in the (continued on page 10) (continued on page 10) P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 9
    • fksbpqjbkq=crkap=kbtp pmofkd==OMMV Implications of FAS 157 “Fair Value” Accounting on Private Funds Proposed Legislation Affecting Private Funds (continued from page 9) (continued from page 9) `çååÉÅíáÅìí=eÉÇÖÉ=cìåÇ=iÉÖáëä~íáçåK = = = financials of its portfolio companies could run FASB Proposes Additional `çååÉÅíáÅìí= ä~ïã~âÉêë= êÉÅÉåíäó= áåíêçJ afoul of the rule if those valuations are incorrect. Guidance Fund sponsors should be mindful of this risk FASB recently announced two proposals ÇìÅÉÇ= íÜêÉÉ= Äáääë= íÜ~í= ïçìäÇ= ÄêáåÖ= ëáÖåáÑáJ when working with portfolio companies, auditors relating to FAS 157 intended to address issues Å~åí= ÅÜ~åÖÉë= íç= `qDë= äçåÖJëí~åÇáåÖ and valuation experts to establish their valuation associated with (i) measuring the fair value of secu- Ü~åÇëJçÑÑ= ~ééêç~ÅÜ= íç= êÉÖìä~íáåÖ= ÜÉÇÖÉ techniques, methodologies and policies. ÑìåÇëK==qÜÉ=Äáääë=ïçìäÇ=~ééäó=íç=~åó=ÜÉÇÖÉ rities in markets that have become inactive and may As FAS 157 begins to be implemented by pri- ÑìåÇ= íÜ~í= Ü~ë= ~å= çÑÑáÅÉ= áå= `q= ïÜÉêÉ reflect distressed transactions and (ii) reflecting vate funds this year, we expect that additional issues ÉãéäçóÉÉë=êÉÖìä~êäó=ÅçåÇìÅí=ÄìëáåÉëë=çå impairment of value in the current economic crisis. and concerns will arise, which will be fueled by the ÄÉÜ~äÑ= çÑ= ~= ÜÉÇÖÉ= ÑìåÇK= = péÉÅáÑáÅ~ääóI difficulties in applying the guidelines in practice as The comment period for these proposals ends on April 1, 2009. pÉå~íÉ=_áää=VRP=éêçîáÇÉë=íÜ~íW==EáF=ëí~êíáåÖ well as ever-changing market conditions. áå=OMNNI=ÜÉÇÖÉ=ÑìåÇë=ã~ó=åçí=Ü~îÉ=áåÇáJ This newsletter contains general information îáÇì~ä= áåîÉëíçêë= ïÜç= Ü~îÉ=äÉëë=íÜ~å=AOKR Investment Funds News Editors: only and is not intended to and does not contain ãáääáçå=áå=áåîÉëíãÉåí=~ëëÉíë=çê=áåëíáíìíáçå~ä Marco V. Masotti and Karen J. Hughes any legal advice. áåîÉëíçêë=ïÜç=Ü~îÉ=äÉëë=íÜ~å=AR=ãáääáçå=áå *IRS Circular 230 disclosure: To ensure ~ëëÉíëX= EááF= ÜÉÇÖÉ= ÑìåÇ= ã~å~ÖÉêë= ãìëí Please contact funds@paulweiss.com to be added compliance with requirements imposed by the to our mailing list or for further information. ÇáëÅäçëÉ= ÅÉêí~áå= ÅçåÑäáÅíë= çÑ= áåíÉêÉëí= íç IRS, we inform you that any U.S. federal tax advice contained in this document is not intend- áåîÉëíçêë= ~åÇ= éêçëéÉÅíáîÉ= áåîÉëíçêëX= EáááF ed or written to be used, and cannot be used, for ÜÉÇÖÉ= ÑìåÇ= ã~å~ÖÉêë= ãìëí= ÇáëÅäçëÉ= íç the purpose of (i) avoiding penalties under the É~ÅÜ=áåîÉëíçê=E~F=~åó=ã~íÉêá~ä=ÅÜ~åÖÉ=áå=áíë Internal Revenue Code or (ii) promoting, market- ing or recommending to another party any áåîÉëíãÉåí=ëíê~íÉÖó=~åÇ=íÜÉ=ÇÉé~êíìêÉ=çÑ transaction or matter that is contained in this ~åó= ÉãéäçóÉÉ= ïÜç= ÉñÉêÅáëÉë= ëáÖåáÑáÅ~åí document. Åçåíêçä= çîÉê= íÜÉ= áåîÉëíãÉåí= ëíê~íÉÖóI= EÄF www.paulweiss.com © 2009 Paul, Weiss, Rifkind, Wharton & Garrison LLP íÜÉ= ÉñáëíÉåÅÉ= çÑ= ~åó= ëáÇÉ= äÉííÉêëI= ~åÇ= EÅF ~åó= ã~àçê= äáíáÖ~íáçå= áåîçäîáåÖ= íÜÉ= ÑìåÇ= çê INVESTMENT FUNDS GROUP OFFICES & C O N TA C T S ÖçîÉêåãÉåí~ä= áåîÉëíáÖ~íáçå= çÑ= íÜÉ= ÑìåÇX NEW YORK ~åÇ=EáîF=ëí~êíáåÖ=áå=OMNMI=ÜÉÇÖÉ=ÑìåÇ=ã~åJ NOUR=^îÉåìÉ=çÑ=íÜÉ=^ãÉêáÅ~ë Robert M. Hirsh Marco V. Masotti ~ÖÉêë= ãìëí= ÇáëÅäçëÉI= áå= ïêáíáåÖI= íç= É~ÅÜ kÉï=vçêâI=kv=NMMNVJSMSQ ONOJPTPJPNMU ONOJPTPJPMPQ áåîÉëíçê= íÜÉ= ÑÉÉ= ëÅÜÉÇìäÉ= íç= ÄÉ= é~áÇ= Äó qÉäW=ONOJPTPJPMMM êÜáêëÜ]é~ìäïÉáëëKÅçã ãã~ëçííá]é~ìäïÉáëëKÅçã íÜÉ=ÜÉÇÖÉ=ÑìåÇ=~åÇ=~=Ñáå~åÅá~ä=ëí~íÉãÉåí c~ñW=ONOJTRTJPVVM=Ec~ñF Mitchell L. Berg Yvonne Y.F. Chan íÜ~í=Ü~ë=ÄÉÉå=~ìÇáíÉÇ=Äó=~å=áåÇÉéÉåÇÉåí ONOJPTPJPMQU ONOJPTPJPORR ~ÅÅçìåíáåÖ=ÑáêãK==qÜÉ=`q=gçáåí=`çããáííÉÉ ãÄÉêÖ]é~ìäïÉáëëKÅçã óÅÜ~å]é~ìäïÉáëëKÅçã çå=_~åâë=~ééêçîÉÇ=pÉå~íÉ=_áää=VRPX=ÜçïJ Stephanie R. McCavitt Jennifer A. Spiegel ÉîÉêI= íÜÉ= Äáää= Ü~ë= åçí= ÄÉÉå= ãçîÉÇ= íç= Ñìää ONOJPTPJPRRU ONOJPTPJPTQU pÉå~íÉ= ÅçåëáÇÉê~íáçåK= = pÉå~íÉ= _áääë= SQTT ëãÅÅ~îáíí]é~ìäïÉáëëKÅçã àëéáÉÖÉä]é~ìäïÉáëëKÅçã ~åÇ= SQUM= éêçîáÇÉI= êÉëéÉÅíáîÉäóI= íÜ~í LONDON ÜÉÇÖÉ=ÑìåÇ=ã~å~ÖÉêë=~åÇ=?éêáî~íÉ=Å~éáí~ä ^äÇÉê=`~ëíäÉ Mark S. Bergman David K. Lakhdhir ÑìåÇ?=ã~å~ÖÉêë=ïçìäÇ=ÄÉ=êÉèìáêÉÇ=íç=ÄÉ NM=kçÄäÉ=píêÉÉí EQQJOMF=TPSTJNSMN EQQJOMF=TPSTJNSMO äáÅÉåëÉÇ= íç= ÅçåÇìÅí= ÄìëáåÉëë= áå= `qI= ~åÇ içåÇçå=b`Os=Tgr ãÄÉêÖã~å]é~ìäïÉáëëKÅçã Çä~âÜÇÜáê]é~ìäïÉáëëKÅçã íÜ~í= ÜÉÇÖÉ= ÑìåÇë= ~åÇ= ?éêáî~íÉ= Å~éáí~ä råáíÉÇ=háåÖÇçã ÑìåÇë?= ïáíÜ= `q= éÉåëáçå= ÑìåÇ= áåîÉëíçêë qÉäW=EQQJOMF=TPSTJNSMM c~ñW=EQQJOMF=TPSTJNSRM= ïçìäÇ= ~äëç= ÄÉ= êÉèìáêÉÇ= íç= ÇáëÅäçëÉ ÇÉí~áäÉÇ=éçêíÑçäáç=áåÑçêã~íáçå=íç=ëìÅÜ=éÉåJ HONG KONG ëáçå=ÑìåÇë=ìéçå=êÉèìÉëíK==^í=íÜáë=íáãÉI=íÜÉ NOíÜ=cäççê= John E. Lange `q= gçáåí= `çããáííÉÉ= çå= _~åâë= Ü~ë= åçí eçåÖ=hçåÖ=`äìÄ=_ìáäÇáåÖ EUROF=OUQSJMPPP í~âÉå= ~åó= ÑìêíÜÉê= ~Åíáçå= êÉÖ~êÇáåÖ= _áääë P^=`Ü~íÉê=oç~ÇI=`Éåíê~ä àä~åÖÉ]é~ìäïÉáëëKÅçã SQTT=~åÇ=SQUMK==aìêáåÖ=~=ÜÉ~êáåÖ=çå=íÜÉ eçåÖ=hçåÖ qÉäW=EUROF=ORPSJVVPP éêçéçëÉÇ= äÉÖáëä~íáçå= ÅçåÇìÅíÉÇ= Äó= íÜÉ c~ñWEUROF=ORPSJVSOO _~åâë= `çããáííÉÉ= çÑ= íÜÉ= `q= dÉåÉê~ä ^ëëÉãÄäóI= _~åâë= `çããáííÉÉ= `Ü~áêã~åI TOKYO pÉå~íçê= oçÄÉêí= aìÑÑ= ~åÇ= `q= ^ííçêåÉó cìâçâì=pÉáãÉá=_ìáäÇáåÖ Kaye N. Yoshino dÉåÉê~ä= _äìãÉåíÜ~ä= ëí~íÉÇ= íÜ~í= cÉÇÉê~ä OJO=rÅÜáë~áï~áÅÜç=OJÅÜçãÉ EUNJPF=PRVTJSPMP `ÜáóçÇ~JâìI=qçâóç=NMMJMMNN âóçëÜáåç]é~ìäïÉáëëKÅçã êÉÖìä~íáçå=çÑ=ÜÉÇÖÉ=ÑìåÇë=ï~ë=éêÉÑÉê~ÄäÉI g~é~å Äìí= íÜÉó= ÑÉÉä= íÜ~í= ëí~íÉ= êÉÖìä~íáçå= ïáää= ÄÉ qÉäW=EUNJPF=PRVTJUNMN åÉÅÉëë~êó=íç=Ñáää=íÜÉ=êÉÖìä~íçêó=îçáÇ=áå=íÜÉ c~ñW=EUNJPF=PRVTJUNOM ~ÄëÉåÅÉ=çÑ=cÉÇÉê~ä=~ÅíáçåK= P A U L , W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N L L P 10