This month’s Eurekahedge Report reports on a somewhat flat month for the industry. Negative returns in April affected most regional hedge funds as market sentiment became more risk-averse leading to declines across global markets. After a short few months of strong growth, attention returned to European debt issues, soft US economic data and slowing Chinese growth.

There were a few positive numbers to be found, however. the Eurekahedge North American Hedge Fund Index finished the month with positive returns of 0.08%, beating the S&P 500. Managers with positive returns banked on upbeat corporate earnings and the end of April saw a surge caused by speculation of further stimulus from the US Federal Reserve.

Emerging market hedge funds were up 0.54% in the month, bucking the trend from other regions and the underlying markets. Similarly, a 0.51% return by the Mizuho-Eurekahedge Asia Pacific Index showed that the larger asset managers in the region were able to manage volatility in the underlying markets. The index has also notched up strong returns by the end of April 2012 with gains of 5.47%.

Our special report this month focuses on Latin American hedge funds; a sector that has experienced tremendous growth in the last decade jumping from US$2.7 billion to US$58.9 billion in AUM. Latin American hedge funds have also started the year strong attracting US$1.2 billion in 1Q 2012 with gains of US$1.9 billion in perfor

Highlights from this month’s report:

• The asset-weighted Mizuho-Eurekahedge Top 100 Index increased 0.28% in April 2012, signaling a better month for larger funds.
• Hedge funds attracted US$10.4 billion during the month of April.
• Assets in North American hedge funds have increased by nearly US$40 billion since the start of the year.
• Relative value and fixed income hedge funds are a bright light in the industry – they have now witnessed five consecutive months of positive returns with gains of 5.91% and 4.56% respectively.
• Launch activity remained strong in 2012 with more than 150 funds launched worldwide as at the end of April 2012.
• Assets in distressed debt hedge funds were back above US$60 billion.
• The Eurekahedge Latin American Hedge Fund Index saw a surge of 6.45% at end-April 2012.

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The Investment Adviser Oversight Act of 2012 (HR 4624) was introduced yesterday in Congress, according to FrontLine Compliance. The bill provides for the formation of a registered national investment adviser association which would serve as an advisory industry SRO.

In summary, the bill calls for the following:

• The creation of an advisory industry SRO with full rule-making and examination authority over SEC and state registered advisers

• The SRO would be registered with the SEC and report to the SEC for approval regarding its program – similar to how FINRA currently reports to the SEC

• The SRO would have authority over both registered entities and the associated persons of such entities, again like FINRA

• Exemptions for SRO registration are contained in the bill and include certain exemptions for state registered advisers that reside in states with formal examination programs that allow for state exams once every four years

• The bill strives for a balance between SEC, state, and SRO regulation of advisers

FINRA, the primary broker-dealer industry SRO, has long been a proponent of an adviser SRO and has been lobbying Congress for its formation. In opposition, the Investment Adviser Association (IAA), an industry trade group for advisers, has increased its lobbying efforts to oppose the new bill. For now, it appears that the bill may be brought to the house floor for vote as early as May 2012.

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The latest edition (Q1 2012) of the AIMA Journal can be downloaded here.

This issue contains:

· Address from Andrew Baker: “In defence of hedge funds: institutional investors are giving a vote of confidence”

· Government & Regulatory Affairs Developments

· How do the Proposed FATCA Regulations Impact Alternative Investment Managers? By Oscar Teunissen, Rebecca E. Lee, Dominick Dell’Imperio, Steve Nauheim and Rebecca McGerty, PwC

· Taking the best route offshore. By Ingrid Pierce, Partner, Walkers

· SFC gets tough on Takeovers Code disclosures. By Greg Heaton, Partner, Deacons

· A Year of Opportunity, by Adam Wallace, Head of Alternative Investment Services, Asia Pacific, JP Morgan Worldwide Securities Services

· The UK Reporting Fund Regime, by Tim Levett, Consultant, and Marie Barber, Member, Kinetic Partners LLP

· Irish China A Funds — Some Key Elements to Consider, by Stephen Carty, Partner, Maples and Calder (Dublin office)

· The Top Five Things Every Buyside Firm Should Know About Recovery and Resolution Plans, by Michael Beaton, Managing Director, Document Risk Solutions Ltd

· Emerging Hedge Fund Managers: Brighter Outlook for 2012 by John McCann, Managing Director of Trinity Fund Administration Limited

· FX Options Update, by CME Group

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On February 27, 2012, the Delaware Court of Chancery enjoined the sale of BankAtlantic, the sole banking subsidiary of BankAtlantic Bancorp (BBX), to Branch Bank & Trust (BB&T). BBX had planned to sell $3.4 billion in deposits and $3.1 billion in performing loans and other assets to BB&T, keeping BankAtlantic’s criticized assets for itself in a “good bank/bad bank” transaction.

Plaintiffs, including Wells Fargo Bank, National Association as Institutional Trustee of two Delaware statutory trusts (represented by Seward & Kissel LLP), brought suit to enjoin the sale, claiming that the sale violated the contractual rights of holders of some $333 million of trust preferred securities (TruPS ) issued by BBX.

The agreements governing the TruPS provided that any acquirer of all or substantially all of the assets of BBX would have to assume BBX’s TruPS obligations. The proposed transaction between BBX and BB&T, however, contemplated no such assumption by BB&T. Had the transaction been consummated, the only assets retained by BBX to pay the TruPS would have been criticized assets such as nonperforming loans and real-estate owned property. After the transaction, BBX would leave the banking business and no longer be a bank holding company.

BBX contended that the sale of BankAtlantic did not constitute a sale of substantially all of its property because the assets to be retained by BBX had a book value of more than $600 million. The court found BBX’s argument to be “illogical and counter-factual.” BBX further argued that the sale should not be enjoined in any event, because there would have been sufficient assets to pay the TruPS obligations.

After highly accelerated discovery, the Chancery Court conducted a three day trial of the issues raised by Plaintiffs. In its opinion, the court found that “by the most conservative measure [BBX] will convey 85-90% of its assets, and the transaction will change fundamentally the nature of [BBX]’s business.” The court concluded that the proposed sale would therefore breach BBX’s obligations to the TruPS holders.

This decision is significant because it sends a message to all Banks with trust preferred securities (TruPS) that they cannot infringe on the rights of the TruPS holders when trying to restructure.

The court further found that the TruPS holders would be irreparably harmed by the sale. Because the proposed sale would breach the agreements governing the TruPS, the TruPS obligations would be accelerated, and BBX would not be able to pay off the accelerated debt. Further, the personal consideration for BBX’s senior executives would receive in the proposed sale — more than $10 million — would also breach the agreements governing the TruPS. In addition, the radical change in BBX’s business brought about by the sale would fundamentally alter the risk shouldered by the TruPS holders. The court held that BBX’s “officers and directors cannot extract value over time to benefit themselves and the equity through a transaction that violates clear contractual rights in the Indentures.” Affirming that “[p]arties who enter into contracts are entitled to enforce their rights,” the Chancery Court permanently enjoined the proposed transaction.

Before regulatory changes significantly limited the favorable capital treatment afforded to TruPS, banks had issued some $60 billion of these securities, and over 1,800 banks placed TruPS into TruPS collateralized debt obligations (CDOs). Indeed, banks themselves have purchased some $12 billion in TruPS CDOs, making them a significant investor in bank industry debt. By protecting the rights of TruPS investors, the Chancery Court’s decision may have a significant impact on how troubled TruPS issuers seek to resolve their difficulties.

The case is In re BankAtlantic Bankcorp, Inc. Litigation, Consol. C.A. No. 7068-VCL (Del. Ch.). Seward & Kissel’s team members were Mark Hyland, Greg Cioffi, Jeffrey Berman, Jeffrey Dine, David Sagalyn, Benay Josselson, Celinda Metro and Ryan Suser.

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Despite higher investment levels, overall private equity activity fell during the fourth quarter of 2011, according to the Private Equity Index (PE Index) released today by the Private Equity Growth Capital Council (PEGCC). Strong Q4 investment activity held the Index above its 10-year moving average and higher than its 2010 average level.

As of December 31, 2011, the PE Index registered at 103.9, which is 7.4 points below its revised level of the previous quarter. This decline was primarily driven by muted fundraising and exit activity. Despite this quarterly decline, private equity activity has increased on an annual basis. On average, the PE Index registered at 110.4 in 2011 compared to 96.8 in 2010. Some key observations about private equity activity in fourth quarter of 2011 include:

· Global private equity investment increased from $63 billion in 2011-Q3 to $99 billion.

· Equity contributed by sponsors in leveraged buyout deals increased from 39% in 2011-Q3 to 42%.

· Commitments to global buyout funds fell from $31 billion in 2011-Q3 to $18 billion.

· Global callable capital reserves (“dry powder”) for buyout funds fell to $367 billion.

· U.S. private equity exits fell from $23 billion in 2011-Q3 to $20 billion.

“While private equity activity declined slightly last quarter, on an annual basis most industry fundamentals in 2011, including investment activity, were at their most favorable levels since 2008,” said Bronwyn Bailey, PEGCC Vice President of Research. “We are optimistic that, with more stable financial markets, private equity will continue to make critical investments that will contribute to U.S. economic recovery and growth in 2012,” Bailey concluded.

Designed to provide an accurate snapshot of the state of the private equity market at any given point in time, the PE Index is a composite measure of global private equity activity based on three key factors: the dollar value of total private equity-backed investment, fundraising, and exits (portfolio company IPOs or sales to corporations or other investors). The Index measures 100 when all three components are at their 10-year moving average. These three factors collectively capture the most fundamental elements of the private equity market.

The Private Equity Index is calculated using data provided by Thomson Reuters, Pitchbook and Preqin. The Council updates the PE Index at the end of each quarter.

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The Committee convened in closed session at the Hay Adams Hotel at 11:30 a.m. All Committee members were present. Assistant Secretary for Financial Markets Mary Miller, Deputy Assistant Secretary (DAS) for Federal Finance Matthew Rutherford and Director of the Office of Debt Management Colin Kim welcomed the Committee. Other members of Treasury staff present were Fred Pietrangeli, Jennifer Imler, Amar Reganti, David Chung, Ernest Zhu, Brian Zakutansky, and Alfred Johnson. Federal Reserve Bank of New York members Dina Marchioni and Mark Cabana were also present.

DAS Rutherford began with a review of the fiscal situation noting that the economy posted a 2.8 percent growth rate in the fourth quarter of 2011. Rutherford presented a series of charts showing recent trends in receipts, outlays, and deficits. DAS Rutherford noted that the Administration’s new budget numbers are expected to be released in early February 2012.

Director Kim proceeded to discuss Treasury’s marketable debt portfolio. Using OMB deficit projections from the September 2011 report, “Living Within Our Means and Investing in the Future” and assuming no changes to the current issuance strategy, Treasury looks to be under financed in FY2012. With the same assumptions, Treasury would be over financed from FY2013 to FY2016. Any financing shortfalls in FY2012 are expected to be made up with increased bill issuance.

Director Kim next reviewed several debt metrics. As of December 30, the average maturity of the portfolio was approximately 62.4 months. In the chart presentation showing the projections for Treasury’s weighted average maturity, Director Kim adjusted future note and bond issuance on a pro-rata basis to match financing needs. The projections show that average maturity continues to extend.

Director Kim emphasized that the average maturity projections and the associated underlying assumptions for future issuance were hypothetical and not meant to convey future debt management policy or an average maturity target. He reiterated that Treasury will remain flexible in the conduct of debt management policy.

Director Kim then turned to demand characteristics within the primary market for Treasury securities. He noted that bid-to-cover ratios for TIPS auctions were at high levels across most maturity points. Director Kim noted that Treasury plans to gradually increase the size of TIPS issuance in 2012. This year, Treasury will issue approximately $150 billion of TIPS. The majority of the incremental new issuance will likely be at the 5- and 10-year tenors.

He also noted that bid-to-cover ratios remained at healthy levels for all Treasury securities, with particularly high demand for 4-week bills. The elevated bid-to-cover ratios in 4-week bill auctions in late December were related to the rule that bounds bill auction stop-out rates at zero. The question was asked if it made sense for Treasury to permit bids and awards at negative interest rates in marketable Treasury bill auctions. DAS Rutherford noted that there were operational issues associated with such a rule change, but that the hurdles were not insurmountable. It was the unanimous view of the committee that Treasury should modify auction regulations to permit negative rate bidding and awards in Treasury bill auctions as soon as feasible. Rutherford noted that any decision on this policy change would likely be made at the May refunding.

The Committee next turned to the question in the charge regarding Floating Rate Notes (FRNs).
Treasury continually seeks ways to minimize borrowing costs, better manage its liability profile, enhance market liquidity, and expand the investor base in Treasury securities. Market participants and the Committee have previously suggested that FRNs could help Treasury meet these objectives. Treasury asked the Committee to comment on the viability of such a product, along with the optimal maturity, reference index, reset frequency, payment period, and distribution mechanism. Treasury requested a specific recommendation for the structure of a Treasury FRN and for the Committee to help determine whether such a security would be additive to Treasury’s current mix of products.

The presenting member opened by discussing the demand backdrop for U.S. Treasuries, noting structural declines of high-quality assets over the last five years. Furthermore, regulatory changes could result in incremental Treasury demand. Additionally, money market funds may have demand for a Treasury FRN, especially if the final maturity were two years or less. The Committee member also noted that other short-end investors that are not constrained by money market fund regulations, such as securities lenders, municipalities, GSEs and corporations, would be a source of potential demand.

Turning next to the arguments in support of FRNs and the estimated benefits of Treasury issuing such securities, the presenting member revisited the case for extending the average maturity of Treasury’s debt portfolio. The Committee member stated that FRN issuance would reduce Treasury’s roll over burden. In addition, FRN issuance, in lieu of fixed-rate term issuance, would allow Treasury to avoid paying an interest rate risk premium. This product would allow the U.S. government to extend the maturity of its funding while reducing interest expense, depending on what securities would be replaced by FRN issuance.

The presenter discussed how the cost savings of FRNs would depend on the pricing spread versus the cost of maturity extension and the interest rate risk premium. The Committee member noted that the cost of maturity extension can be determined by using an asset swap spread of term Treasury debt over bills. In near-zero asymmetric rate regimes the member noted that interest rate risk premium can be approximated by observing the sum of at-the-money interest rate caplet costs for the tenor of the FRN.

Next, the presenting member discussed choices of reference indices and sample structures. The member noted that the majority of the floating rate securities issued by the GSEs are indexed to either LIBOR or the federal funds rate. The size of this market currently stands at $152 billion. Moreover, the majority of corporate FRNs are also linked to LIBOR. The presenter noted that LIBOR would be disadvantageous to Treasury as it would subject the government’s financing costs to bank funding risks.

The Committee member noted that issuance in the FRN market primarily occurred at maturities of 5-years and under. Additionally, the presenter stated that a higher reset frequency will result in shorter interest rate duration and lower price volatility. This characteristic may make the asset more attractive for stable-value buyers. The presenter went on to recommend that Treasury floor the coupons at zero.

In conclusion, the presenting member noted that the examination of alternative forms and structures of debt issuance is consistent with Treasury’s mission of financing the government at the lowest cost over time. It was suggested that Treasury begin by issuing a 2-year FRN with a floating rate index reset daily. This would appeal to both money market participants and investors looking for a stable-value asset.

An active discussion ensued. One member noted that FRNs would be a more cost effective way to extend maturity. Another member stressed the importance of this program becoming both large and liquid to appeal to a broad investor base. One member asked what distribution mechanism would best fit this issuance: an auction or a window. The discussion concluded with the Committee unanimously favoring FRN issuance, while noting that more work remains to be done to explore various structural considerations.

The meeting adjourned at 1:00 p.m.

The Committee reconvened at the Department of the Treasury at 6:00 p.m. All Committee members except Walter J. Muller and Stephen Rodosky were present. The Chairman presented the Committee report to Secretary Geithner.

A brief discussion followed the Chairman’s presentation but did not raise significant questions regarding the report’s content.

The Committee then reviewed the financing for the remainder of the January through March quarter (see attached).

The meeting adjourned at 6:30 p.m.

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Private fund adviser registration is here, meaning a whole new world of compliance risk has become a reality. Successful registration means more than just filling out a form and the March 2012 deadline is fast approaching.

Remember, in order to be registered by the deadline, you must file by February. If you haven’t already taken the steps necessary to protect your firm, you’re out of time.

Hedge fund compliance firm NRS has put together some tools to help your firm prepare for registration:

• The NRS Private Fund Registration and Compliance Intelligence Center, a collection of 15 insightful, easy-to-understand articles and how-tos designed to help your firm find its footing when it comes to registration tasks and strategies.

• Back by popular demand, a free Webinar entitled “Private Fund Registration and Compliance: What you need to know now”. Limited to the first 100 respondents, this online seminar is hosted by Mederic Daigneault, NRS’s Director of Hedge Fund Services, and will provide answers to frequently asked questions regarding registration requirements, timelines and the specifics of an ongoing compliance program.

NRS also recommends that you build your compliance program and complete registration documents now even if you don’t file until the 11th hour, avoiding the risk of operating as an unregistered investment adviser.

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By Jay Gould –  (Pillsbury Winthrop Shaw Pittman LLP) - On October 18, 2011, the SEC released a notice of FINRA’s filing of Proposed Rule 5123 (the “Proposed Rule”) which would require FINRA members and associated persons to: 1) provide to investors disclosure documents in connection with private placements prior to sale and 2) file with FINRA such disclosure documents within 15 days after the date of first sale and any subsequent amendments. These proposed changes would significantly affect fund managers who offer or sell their funds that are exempt from registration pursuant to Section 3(c)(1) of the Investment Company Act through third party marketers, nearly all of which are required to be registered as broker-dealers.

Pre-sale requirement to provide disclosure documents to investors

The Proposed Rule would require FINRA members and associated persons that offer or sell private placements or participate in the preparation of private placement memoranda (“PPM”), term sheets or other disclosure documents in connection with such private placements, to provide such disclosure documents to investors prior to sale. The disclosure documents must describe the anticipated use of offering proceeds, the amount and type of offering expenses, and the amount and type of offering compensation. Much of this information is currently captured in the Form D filing that most fund managers file with the SEC, but under the Proposed Rule, would go directly to investors in connection with the sale of fund interests.

As a practical matter, this likely means increased scrutiny of hedge fund and other private fund offerings by FINRA, as well as the likelihood that third party marketers that sell on behalf of hedge funds may request greater or more enhanced indemnification from fund managers in the placement agency agreement between the third party marketer and the fund manager. Accordingly, fund managers who use third party marketers to market their funds must keep their fund documents updated, taking into account all changes to fund strategies, material performance issues (to the extent applicable), regulatory changes and management personnel changes, to name a few.

Post-sale requirement to notice file with FINRA

The Proposed Rule would also require each FINRA member and associated person to notice file with FINRA by filing the PPM, term sheet or other disclosure documents no later than 15 days after the date of first sale. In addition, any amendments to such disclosure documents or disclosures required by the Proposed Rule would have to be filed no later than 15 days after such documents are provided to any investor or prospective investor. To the extent these documents are provided to investors, they would also be subject to the strict liability standard of Rule 206(4)-8 under the Investment Advisers Act to which all fund managers are already subject. Accordingly, fund managers must be careful to keep all of their documents current under the materiality standards of state and Federal securities laws.

Offerings Exempted from the Proposed Rule

The Proposed Rule would exempt several types of private placements including offerings sold only to any one or more of the following purchasers:

· institutional accounts, as defined in NASD Rule 3110(c)(4);

· qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act; (Accordingly, 3(c)(7) funds would be exempt from the Proposed Rule.)

· qualified institutional buyers, as defined in Securities Act Rule 144A;

· investment companies, as defined in Section 3 of the Investment Company Act;

· an entity composed exclusively of qualified institutional buyers, as defined in Securities Act Rule 144A;

· banks, as defined in Section 3(a)(2) of the Securities Act; and

· employees and affiliates of the issuer.

In addition, the Rule would exempt the following types of offerings:

· offerings of exempted securities, as defined by Section 3(a)(12) of the Exchange Act;

· offerings made pursuant to Securities Act Rule 144A or SEC Regulation S;

· offerings of exempt securities with short term maturities under Section 3(a)(3) of the Securities Act;

· offerings of subordinated loans under Exchange Act Rule 15c3-1, Appendix D;

· offerings of “variable contracts” as defined in Rule 2320(b)(2);

· offerings of modified guaranteed annuity contracts and modified guaranteed life insurance policies, as referenced in Rule 5110(b)(8)(E);

· offerings of non-convertible debt or preferred securities by issuers that meet the eligibility criteria for incorporation by reference in Forms S-3 and F-3;

· offerings of securities issued in conversions, stock splits and restructuring transactions that are executed by an already existing investor without the need for additional consideration or investments on the part of the investor;

· offerings of securities of a commodity pool operated by a commodity pool operator as defined under Section 1a(11) of the Commodity Exchange Act; and

· offerings filed with FINRA under Rules 2310, 5110, 5121 and 5122.

Confidential treatment

Documents and information filed with FINRA pursuant to the Proposed Rule would be given confidential treatment. FINRA would use such documents and information solely for the purpose of determining compliance with FINRA rules or other applicable regulatory purposes, although presumably such documents would be available to the SEC in connection with examinations and enforcement proceedings of hedge fund managers. In addition, FINRA would afford confidential treatment to any comment or similar letters by FINRA and thus could not be discoverable by a litigant through a legal action.

A full text of the SEC Notice is available here (PDF).

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Exempt reporting advisers (“ERAs”) must prepare and file Form ADV Part 1A with the SEC and comply with certain other reporting and recordkeeping requirements under the Investment Advisers Act of 1940 (“Advisers Act”), such as §204A (insider trading prohibitions), §206 (anti-fraud provisions) and Rule 206(4)-5 (pay-to-play rules).

ERAs are investment advisers to hedge funds and private equity funds that avoid full SEC registration by relying on either Rule 203(m)-1 under the Advisers Act (applicable to investment advisers solely to hedge funds and private equity funds with aggregate AUM in the US under $150 million) or Rule 203(l)-1 under the Advisers Act (applicable to investment advisers that solely manage venture capital funds).

Form ADV Part 1A for ERAs became available on November 7, 2011. ERAs are required to complete several items of Part 1A of Form ADV, including providing detailed information regarding each fund advised, and file it with the SEC no later than March 30, 2012. Going forward, an ERA to a newly formed fund should file within 60 days from the date that such fund is formed.

Whether an investment adviser is considered an ERA will depend upon where the investment adviser is located. Connecticut- and California-based investment advisers to hedge funds and private equity funds with AUM under $150 million, and New York-based investment advisers to hedge funds and private equity funds with AUM between $25 million and $150 million, generally will be considered ERAs. Please contact us as soon as possible to determine whether your investment advisory firm will be considered an ERA.

For investment advisers currently registered with the SEC, the transition process to ERA status will include: 1) filing Form ADV-W (select “filing as an ERA” as the reason for withdrawing), and; 2) filing an initial Form ADV Part 1A as an ERA. Existing IARD entitlements will remain valid.

Although the SEC has indicated that ERAs will not be subject to routine examinations by SEC staff, ERAs are subject to SEC examinations for cause, such as when prompted by a tip, a complaint, or a referral from another agency or organization.

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