Program Philippe Benedict, Stephanie Breslow, Ida Wurczinger Draim

Tab 1 | Main Program Philippe Benedict, Stephanie Breslow, Ida Wurczinger Draim, David Efron, Marc Elovitz, Steven Fredman, Kenneth Gerstein, Udi Grofman, Michael Littenberg, Kelli Moll, Richard Morvillo, David Nissenbaum, Richard Presutti, Paul Roth, Howard Schiffman, Gary Stein, André Weiss

Guest Speaker | Jeffrey H. Aronson, Centerbridge Partners, L.P.

Tab 2 | Compliance Spotlight David Cohen, Ida Wurczinger Draim, Marc Elovitz, David Momborquette, Neil Robson

Tab 3 | Current Issues in Distressed Investing Adam Harris, David Karp, Eleazer Klein, Kurt Rosell

Tab 4 | Investing in Financial Institutions Mary Marks, Omoz Osayimwese, John Pollack, Joseph Vitale

Tab 5 | Crisis Management: Handling Government Investigations Harry Davis, David Nissenbaum, Martin Perschetz, Ronald Richman

Tab 6 | Running a Multi-Jurisdictional Adviser Nick Fagge, Christopher Hilditch, Daniel Hunter, Scott Kareff, Shlomo Twerski

Tab 7 | Structuring and Restructuring Your Management Company Kim Baptiste, David Griffel, Udi Grofman, Jason Kaplan, Holly Weiss

Tab 8 | The Impact of Derivatives Regulation on Private Funds Kristin Boggiano, Ron Feldman, Dominique Padilla Gallego, Craig Stein

Tab 9 | AML, FCPA and OFAC: The Intersection of Three Key Risk Areas Betty Santangelo, Sung-Hee Suh, Peter White Tab 1: Main Program

Introduction Paul Roth

Management Company Capital Transactions Philippe Benedict, Steven Fredman, Richard Presutti, André Weiss

Sources of Capital: Capital Markets, Seeding Arrangements and Registered Funds Kenneth Gerstein, Michael Littenberg, David Nissenbaum

Managing Compliance Strategically Ida Wurczinger Draim, Marc Elovitz, Kelli Moll, Richard Morvillo

Relationships with Investors Stephanie Breslow, Josh Dambacher, David Efron

Managing Regulatory Exposure Udi Grofman, Howard Schiffman, Gary Stein 2A Conversation0 with Jeffrey H. Aronson | Centerbridge Partners, L.P. 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Philippe Benedict New York Office +1 212.756.2124 [email protected]

Philippe Benedict is a partner in the Tax and Financial Services Groups at Schulte Roth & Zabel. His practice focuses on the tax aspects of investment funds, mergers and acquisitions, international transactions, real estate transactions and financial instruments.

Philippe has been involved in many major transactions involving sales or spinoffs of investment fund managers. He recently advised Credit Suisse Group AG in connection with its acquisition of a stake in York Capital Management and represented fund manager FrontPoint Partners in connection with its spinoff from Morgan Stanley. He also advised Claren Road Asset Management with regard to the sale of a majority stake to The Carlyle Group.

A frequent speaker at prominent industry events, Philippe was invited to present on the subject of “Compensation in the Post-Deferral Era” at McLagan’s Winter 2010 Hedge Fund Roundtable and spoke on “Current and Expected Changes in the Investment Management Business” at a 2010 SRZ Breakfast Briefing. He also recently co-authored “New Paradigm in Asset Manager M&A: Financial Institution Alliances with Hedge Fund Managers,” which appeared in The Hedge Fund Journal.

Philippe attended New York University School of Law, where he was awarded an LL.M. in taxation and a J.D. While attending NYU for his J.D., he was the recipient of a Gruss Fellowship and served on the staff of the Journal of International Law and Politics. He obtained his B.S., summa cum laude, from Adelphi University.

Stephanie R. Breslow New York Office +1 212.756.2542 [email protected]

Stephanie R. Breslow is a partner and co-head of the Investment Management Group k 7" 1. 1nk as well as a member of the Financial Services Group and the Executive Committee at Schulte Roth & Zabel. Her practice includes investment management, partnerships and securities, with a focus on the formation of liquid-securities funds (hedge funds, hybrid funds) and private equity funds (LBO, mezzanine, distressed, real estate, venture), as well as providing regulatory advice to investment managers and broker- dealers. She also represents fund sponsors and institutional investors in connection with seed capital investments in fund managers and acquisitions of interests in investment management businesses, and represents funds of funds and other institutional investors in connection with their investment activities.

A sought-after speaker on fund formation and operation and compliance issues, Stephanie regularly publishes books and articles on the latest trends in these areas. She recently co-authored Private Equity Funds: Formation and Operation published by the Practising Law Institute, contributed a chapter on “Hedge Funds in Private Equity” for inclusion in Private Equity 2005-2006 (PLC Cross-border Handbooks) and wrote New York and Delaware Business Entities: Choice, Formation, Operation, Financing and Acquisitions and New York Limited Liability Companies: A Guide to Law and Practice, both published by West Publishing Co.

Currently the secretary of the Investment Funds Committee of the International Bar Association, Stephanie is also a founding member and former chair of the Private Investment Fund Forum, a former member of the Steering Committee of the Wall Street Fund Forum and a member of the Board of Directors of 100 Women in Hedge Funds.

Stephanie was named one of The Hedge Fund Journal’s 50 Leading Women in Hedge Funds and is listed in Chambers USA, Chambers Global: The World’s Leading Lawyers, The Legal 500 U.S., Best Lawyers in America, America’s Leading Lawyers, Who’s Who Legal: The International Who’s Who of Business Lawyers (which ranked her one of the world’s “Top Ten Private Equity Lawyers”), IFLR Best of the Best USA (Investment Funds), IFLR Guide to the World’s Leading Investment Funds Lawyers, IFLR Guide to the World’s Leading Women in Business Law (Investment Funds), IFLR Guide to the World’s Leading Private Equity Lawyers, and the PLC Cross-border Private Equity Handbook, among other leading directories. Stephanie earned her J.D. from Columbia University School of Law, where she was a Harlan Fiske Stone Scholar, and her B.A., cum laude, from Harvard University.

Ida Wurczinger Draim Washington DC Office +1 202.729.7462 [email protected]

Ida Wurczinger Draim is a partner in the Investment Management, Litigation and Regulatory & Compliance Groups at Schulte Roth & Zabel. Her practice focuses on securities and commodities futures compliance counseling and the representation of securities industry and corporate clients in regulatory investigations and proceedings. Ida is known for her expertise in investment adviser and broker-dealer compliance and her highly effective representation of industry clients before the SEC, NYSE, FINRA, CFTC, NFA and other regulatory authorities.

Some of the areas that Ida regularly addresses on behalf of investment adviser clients include conflicts of interest, Form ADV disclosure, third-party marketing arrangements, soft dollar practices, personal trading compliance, principal and agency trades, advertising, and trading restrictions and prohibitions. In the broker-dealer context, Ida deals with Regulations NMS and SHO, best execution, dark pools, prime brokerage functions, institutional and retail sales practices, insider trading and rumors, marketing materials, short sale restrictions and statutory disqualifications.

In addition to compliance counseling and regulatory representation, Ida is an active speaker and writer, most recently co-authoring the chapter “Protecting Your Firm Through Policies and Procedures, Training and Testing” in the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. She also recently authored the “Trade Reporting and Compliance” chapter in Complinet’s Practitioner’s Guide for Broker-Dealers.

Ida has experienced securities regulation from both sides. After several years as a securities litigation associate with a Wall Street law firm, Ida joined the SEC, first serving as staff attorney in the Division of Enforcement and then as special counsel to SEC Chairman John Shad. Ida is a member of the FINRA Board of Arbitrators and Board of Mediators and, for 10 years (ending January 2009), served as a member of the Nasdaq Listing Qualifications Panel. She is also a former chair of the Corporation, Finance and Securities Law Section of the District of Columbia Bar. Recognized by The Best Lawyers in America in the area of securities law, Ida received her J.D. from Harvard Law School and her B.A., cum laude, from Rutgers University.

David J. Efron New York Office +1 212.756.2269 [email protected]

David J. Efron is a partner in the Investment Management and Regulatory & Compliance Groups at Schulte Roth & Zabel. He practices in the areas of domestic and offshore hedge funds, including fund formations and restructurings. Additionally, he advises hedge fund managers on structure, compensation and various other matters relating to their management companies, and structures seed capital and joint venture arrangements. David also represents hedge fund managers in connection with SEC regulatory issues and compliance-related matters.

A published author on subjects relating to investment management, David is a sought- after speaker for hedge fund industry conferences and seminars and a frequent guest lecturer at New York–area law schools. Most recently, David spoke on “Key Issues Facing CFOs” at SEI’s Alternative Investment Fund CFO Forum.

David has been recognized by The Legal 500 U.S. as “an extraordinarily capable attorney. He has a mastery of the pertinent matters, but he also brings a pragmatic approach.” He received his LL.M. degree in securities regulation, with distinction, from Georgetown University Law Center, his J.D. from Syracuse University College of Law and his B.A. from Vassar College.

Marc E. Elovitz New York Office +1 212.756.2553 [email protected]

Marc E. Elovitz is a partner in the Investment Management, Litigation and Regulatory & Compliance Groups at Schulte Roth & Zabel, where he heads up the firm’s regulatory compliance work in the private investment funds area. He advises hedge funds, private equity funds and funds of funds on compliance with the Investment Advisers Act of 1940 and other federal, state and self-regulatory organization requirements. He works with fund managers to design and implement compliance programs tailored to the business, operations and risks specific to each manager. He guides clients through the SEC adviser registration process and regularly provides strategic and practical advice to managers undergoing SEC examinations. Marc provides guidance to clients on securities trading matters and represents them in regulatory investigations and enforcement actions, arbitrations and civil litigation.

Recently, Marc has been leading macro-level compliance infrastructure reviews with fund managers, identifying the material risks specific to each particular firm and evaluating the compliance programs in place to address those risks. He also regularly leads training sessions for portfolio managers and analysts on complying with insider trading and market manipulation laws.

Marc is a frequent speaker at hedge fund industry conferences and seminars and recently spoke at the Goldman Sachs Annual Hedge Fund Conference and will be speaking in March about SEC Regulatory Developments at ACA’s Annual Compliance Conference and at the Private Investment Funds Committee Seminar at the International Bar Association in London. He recently co-authored articles entitled “SEC Investigations After Dodd-Frank” and “Dodd-Frank Becomes Law: Key Issues for Private Fund Managers” and the chapter “Protecting Your Firm Through Policies and Procedures, Training and Testing” in the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. He also co-authored the “Market Manipulation” chapter in the leading treatise, Federal Securities Exchange Act of 1934 (Matthew Bender) and wrote the chapter on “The Legal Basis of Investment Management in the U.S.” for the upcoming Oxford University Press book The Law of Investment Management.

Marc is a member of the Private Investment Funds Committee of the New York City Bar Association, the ABA Hedge Funds Subcommittee and the Steering Committee of the Managed Funds Association’s Outside Counsel Forum. Marc attended New York University School of Law, from which he was awarded his J.D., and earned his B.A., with honors, from Wesleyan University.

Steven J. Fredman New York Office +1 212.756.2567 [email protected]

Steven J. Fredman is a partner and co-head of the Investment Management Group and a member of the Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. He concentrates his practice in the areas of investment funds (domestic and offshore), investment advisers and broker-dealers, the acquisition and related financing of investment management firms, and securities regulation. Steve has structured and organized private investment partnerships and offshore funds, including general equity, arbitrage, global investment, private equity, distressed company, small cap and funds of funds, and has counseled on issues relating to partnership law, new product development and other matters. He has structured and organized investment advisers and broker-dealers, handled the registration of commodity pool operators and commodity trading advisors, and provided ongoing advice to investment advisers on securities laws, rules, regulations and information. He has also represented clients in connection with the acquisition and sale of investment management firms or their assets.

Steve is a frequent speaker, having most recently spoken at University of Pennsylvania Law School’s Institute of Law and Economics on hedge fund compensation structures. He also recently co-authored “New Paradigm in Asset Manager M&A: Financial Institution Alliances with Hedge Fund Managers,” published in The Hedge Fund Journal. He is a past member of the American Bar Association’s Committee on Partnership and the New York City Bar Association’s Committee on Art Law. He was awarded his J.D. from Georgetown University Law Center, where he was an editor of Law and Policy in International Business, and earned his B.A. from Columbia University, where he was Phi Beta Kappa.

Kenneth S. Gerstein New York Office +1 212.756.2533 [email protected]

Kenneth S. Gerstein, a partner in the Investment Management, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, focuses his practice on representing investment advisers, broker-dealers and banks in connection with the organization and operation of investment funds, including mutual funds, hedge funds, closed-end investment companies, business development companies and bank collective investment funds. He also represents these firms in connection with the development of other types of investment-related products and services. Ken has worked with clients in developing novel hybrid fund products, including registered hedge funds and registered hedge funds of funds. He also advises clients on a broad range of securities regulatory and compliance matters, and represents mutual fund independent directors.

Ken is a frequent author and speaker on issues related to investment funds and investment advisers, having appeared at conferences sponsored by the Practising Law Institute, ALI-ABA, the Investment Company Institute and other organizations. He is a member of the American Bar Association’s Committee on the Federal Regulation of Securities and its Subcommittee on Investment Companies and Investment Advisers, and has been a member of the New York City Bar Association’s Committee on Investment Management Regulation. Prior to entering private practice, Ken served as special counsel in the SEC’s Division of Investment Management in Washington, D.C. Ken obtained an LL.M. from Georgetown University Law Center, a J.D. from the James E. Beasley School of Law at Temple University, where he was a member of the Temple Law Quarterly, and a B.S. in economics from the Wharton School of the University of Pennsylvania.

Udi Grofman New York Office +1 212.756.2298 [email protected]

Udi Grofman is a partner in the Investment Management, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, where he concentrates on securities law, investment funds and regulatory compliance. Udi’s experience includes structuring financial services and investment management firms, hedge funds, private equity funds, hybrid funds and funds of funds, and scalable platforms for fund sponsors; and structuring and negotiating seed and strategic investments and relationships. In addition, he regularly advises investment management firms and their principals on regulatory compliance, crisis and risk management, and other operational issues. Udi also advises on mergers, acquisitions and reorganizations of investment management firms, and on restructuring proprietary trading desks into independent investment management firms.

A speaker and authority on hedge fund trends, Udi spoke about “The Emerging Regulatory Framework: What to Expect in 2010 and Beyond” at the Bank of America/ Merrill Lynch Global Hedge Fund Conference. He is listed as a leading lawyer in Who’s Who Legal – The International Who’s Who of Private Funds Lawyers and The Legal 500 United States has recognized him as one of the hedge fund industry’s “finest talents,” noting that he has been referred to by clients as “the single sharpest lawyer I’ve come across in the space” and “an extraordinary lawyer with a very sound and expansive knowledge of the law as well as very good judgment.” Udi graduated with an LL.M. from New York University School of Law and an LL.B., magna cum laude, from Tel Aviv University School of Law.

Michael R. Littenberg New York Office +1 212.756.2524 [email protected]

Michael R. Littenberg, a partner in the Business Transactions and Financial Services Groups, has more than 20 years of experience representing issuers, underwriters, promoters, security holders, boards and board committees in capital markets transactions and ongoing securities law compliance matters. He represents clients in registered, Regulation D, Rule 144A and Regulation S offerings, including offerings of voting and non-voting common stock, LLC units and limited partnership interests, American Depositary Receipts and restricted depositary units, preferred and convertible preferred stock, trust preferred securities, secured and unsecured, senior and subordinated high-yield debt securities, senior and subordinated investment- grade debt securities, commercial paper, medium-term notes and equity-linked notes. Michael has advised issuers, underwriters and promoters on a significant number of “permanent capital” offerings, including offerings by SPACs, externally and internally managed vehicles that invest in credit assets, real estate investment trusts, business development companies, offshore listed vehicles, MTN issuers, special purpose vehicles and credit derivative product companies.

Michael is a frequent speaker at conferences and seminars, has authored numerous articles and is frequently quoted as an expert in the business and specialty press on securities law topics. He received his J.D., magna cum laude, from Tulane University Law School, where he was an editor of the Tulane Law Review, and his B.S. from Indiana University.

Kelli L. Moll New York Office +1 212.756.2557 [email protected]

Kelli L. Moll is a partner in the Investment Management and Regulatory & Compliance Groups at Schulte Roth & Zabel, where her areas of concentration include the formation and ongoing operation of hedge funds and private equity funds, and counseling investment advisers. Kelli has represented numerous hedge funds and their managers in connection with fund formations, compensation and vesting arrangements, spin- offs of proprietary trading groups, the acquisition of trading groups, seed capital arrangements, private equity co-investments and registration and compliance under the Investment Advisers Act of 1940.

Kelli lectures extensively on hedge funds. Most recently, she spoke on “Marketing Hurdles for Private Fund Managers” at the ACA 2010 Compliance Conference, “Performance Advertising: Protecting Your Firm in a Competitive Marketing Environment” at the SRZ Investment Management Alumni Roundtable and “The Changing Landscape of the Investor-Manager Relationships: Negotiating with Sizeable Investors” at the SRZ Investment Management Hot Topics. Kelli has also authored numerous articles on issues affecting investment funds and their managers.

A member of the American Bar Association, Kelli earned her J.D. from Loyola University Chicago School of Law, where she was both a staff editor of The Business Lawyer and case editor of the Loyola Consumer Law Reporter. She also obtained a B.A. in finance from the University of Illinois at Urbana-Champaign.

Richard J. Morvillo Washington DC Office +1 202.729.7479 [email protected]

Richard J. Morvillo, a partner in the Litigation, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, has, for more than 30 years, made the focus of his practice SEC enforcement, related white-collar criminal matters and private securities litigation. A former branch chief with the SEC’s Division of Enforcement, Rich represents corporations, corporate executives, brokerage firms, investment advisors, accounting firms, auditors, law firms, hedge funds and individual investors in connection with SEC, PCAOB, NYSE, FINRA, Congressional, state attorneys general and grand jury investigations; SEC litigation; and complex securities cases.

In addition to litigating a number of SEC enforcement cases to a successful judgment and defending numerous class actions and shareholder derivative suits in federal courts throughout the country, Rich has conducted many internal investigations for corporations and advised members of numerous special committees of boards of directors as to their rights and obligations regarding the handling and evaluation of corporate transactions, internal investigations and shareholder litigation. He recently authored the chapter “Breach of Duty: Misappropriation Theory” in the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. He is a frequent speaker at professional seminars and served as the co- chair of two PLI annual programs: “Internal Investigations” and “Auditor Liability.”

Chambers USA called Rich “one of the deans of the securities enforcement bar.” He is also listed as a leading litigator in numerous other peer-review publications, including Benchmark Litigation, The Best Lawyers in America, Ethisphere: Attorneys Who Matter, Washington DC Super Lawyers, The Legal Times (which named him one of Washington’s “Top 10 Securities Lawyers”) and Washingtonian Magazine. He has served on the adjunct faculty of Georgetown University School of Law, teaching a course in “Professional Responsibility in Corporate and Securities Practice.” Rich received his J.D. from Fordham University School of Law and his A.B. from Colgate University.

David Nissenbaum New York Office +1 212.756.2227 [email protected]

David Nissenbaum is a partner in the Investment Management and Financial Services Groups at Schulte Roth & Zabel, where his practice focuses on corporate, bank regulation and securities matters. He primarily represents institutional and entrepreneurial investment managers, financial services firms and private investment funds in all aspects of their business.

David’s expertise is in structuring and advising investment management and financial services firms; structuring and forming hedge, private equity, structured finance and hybrid funds, funds of funds and scalable platforms for fund sponsors; counseling principals on firm structures, partner and senior employee terms and regulatory matters; structuring and negotiating seed and strategic investments, spin-offs, lift-outs and acquisitions; restructuring proprietary trading desks into investment management businesses; counseling on identification and management of conflicts of interest; and advising on all aspects of U.S. banking laws that affect investment and financial services firms and investment funds, including investments in banking organizations, bank-sponsored funds and investments in funds by banking organizations.

David is a sought-after writer and speaker in his areas of expertise. “Just Like Starting Over: A Blueprint for the New Wall Street Firm” and “Hedge Fund Outlook 2010,” which he authored for The Deal, and “Federal Reserve Provides Greater Flexibility for Non-Controlling Investment in Banks and Bank Holding Companies” are among his publications, and he has spoken in recent months about disclosure documentation, domicile considerations, and current and expected changes in the investment management business.

Richard A. Presutti New York Office +1 212.756.2063 [email protected]

Richard A. Presutti, a partner in the Business Transactions and Financial Services Groups at Schulte Roth & Zabel, practices primarily in the areas of private equity, mergers and acquisitions, leveraged buyouts and transactional matters specific to the investment management community. Rick received his J.D., cum laude, from Tulane University Law School and his B.S. from Bentley College. His selected representations include: Private Equity/M&A Transactions • Represented Blue Bird in a joint venture with Girardin Minibus to create Micro Bird • Represented Chrysler in the sale of its assets to Fiat • Represented Merrill Lynch in the sale of its senior ABS CDO portfolio to an affiliate of Loan Star Funds • Represented Cerberus in the sale of Peguform Luxembourg Holding to Polytec • Represented Chrysler in the sale of Tritec Motors to Fiat Powertrain • Represented Sport Brands International in its series of sales of Fila Luxembourg, Cloudveil Mountain Works and Motionwear • Represented Veritas Capital in its acquisition of Aeroflex Incorporated • Represented Cerberus Capital Management in the acquisition of 80.1% of Chrysler Holding from Daimler • Represented a consortium of Cerberus Capital Management, Citigroup, Aozora Bank and PNC Bank in the acquisition of 51% of GMAC LLC from General Motors Corporation • Represented Cerberus Capital Management in a series of bus industry acquisitions, including North American Bus Industries, Blue Bird and Optima Bus • Represented Cerberus Capital Management and Blackacre Capital Management in their acquisition of LNR Property Corporation • Represented Veritas Capital in its acquisition of DynCorp International • Represented Cerberus Capital Management in its acquisition of the assets of Georgia Pacific’s distribution division • Represented First Data Corporation in its acquisition of a majority interest in NYCE Corporation • Represented Cerberus Capital Management in its acquisition of the worldwide operations of the Alamo and National car rental brands Investment Adviser/M&A Transactions • Represented Beach Point Capital Management LP in a management buyback of the alternative business of Post Advisory Group LLC • Represented Dolomite Capital Management LP in its sale of a majority interest to the Ashmore Group • Represented Bayview Asset Management in its sale of a minority interest to The Blackstone Group • Represented Arlon Capital in its purchase of a minority interest in Monarch Alternative Capital (f/k/a QDRA) and Monarch’s spin-off from Quadrangle

Paul N. Roth New York Office +1 212.756.2450 [email protected]

Paul N. Roth is a founding partner of Schulte Roth & Zabel, a member of the Executive Committee, chair of the Investment Management Group and a member of the Regulatory & Compliance Group. Paul’s extensive private investment funds practice includes the representation of hedge funds, private equity funds, offshore funds, investment advisers and broker-dealers in connection with fund formations and compliance, securities regulation, mergers and acquisitions (domestic and cross- border) and other financial transactions.

Paul is a frequent speaker and author on issues concerning private fund managers. He serves as a special adviser to the Board of Directors of the Managed Funds Association (MFA), as an adviser to the Alternative Investment Management Association (AIMA) and is a former member of the Legal Advisory Board to the National Association of Securities Dealers (NASD). He chairs the Subcommittee on Hedge Funds of the American Bar Association’s Committee on Federal Securities Regulation and is a former chair of the New York City Bar Association’s Committee on Securities Regulation.

Paul has been recognized as a leading fund lawyer by The Best Lawyers in America, Chambers Global, Chambers USA, The Legal 500 United States, The IFLR Best of the Best USA (Investment Funds), The IFLR Guide to the World’s Leading Investment Funds Lawyers, The IFLR Guide to the World’s Leading Private Equity Lawyers, The IFLR Guide to the World’s Leading Capital Markets Lawyers, The International Who’s Who of Private Funds Lawyers, the Lawdragon 500 Leading Lawyers in America, the PLC Cross-border Investment Funds Handbook, Who’s Who in American Law and Who’s Who in America. He was recently named to HFMWeek’s annual list of the 50 most influential people in hedge funds.

Paul is a member of the Boards of Directors of the NAACP Legal Defense and Educational Fund, Citizens Committee for New York City, the Advisory Board of the RAND Center for Corporate Ethics and Governance, and a fellow of the New York Bar Foundation and the Phi Beta Kappa Society. Paul graduated with his J.D., cum laude, from Harvard Law School, after which he was awarded a Fulbright Fellowship to study law in The Netherlands. He also earned his A.B., magna cum laude and Phi Beta Kappa, from Harvard College.

Howard Schiffman Washington DC Office +1 202.729.7461 [email protected]

Howard Schiffman is a partner in the Litigation and Regulatory & Compliance Groups at Schulte Roth & Zabel. Nationally known in the area of securities litigation and regulatory developments, Howard’s practice ranges from investigations and enforcement proceedings brought by various exchanges and government agencies, including the SEC, the DOJ and FINRA, to a diverse array of civil litigation, including securities class actions and arbitrations. He has also served as special internal investigative counsel to public companies.

A corporate problem solver, Howard is adept at dispute containment and resolution as well as at arguing to a jury. He counsels clients, including major financial institutions and investment banks, leading Nasdaq market-makers, institutional and retail brokerage firms and their registered representatives, trade execution and clearing firms, prime brokers, national accounting firms, hedge funds, and public and private companies and their senior officers in risk analysis and litigation avoidance. Still, with his extensive trial experience and solid record of success in numerous SEC enforcement actions, SRO proceedings and FINRA arbitrations, Howard has the confidence to take a case to trial when necessary. Within the last year, he obtained defense verdicts in two arbitrations and recently won a significant award for Royal Bank of Scotland in connection with the sale of LaSalle Bank.

Howard began his career as a trial attorney with the SEC Division of Enforcement and has long been at the forefront of securities litigation and regulatory developments, including his representation of hedge funds in connection with SEC investigations into market manipulation and trading on rumors.

He is a member of American Bar Association sections on litigation, corporation, finance and securities law, and is a director (and former president) of the Association of Securities and Exchange Commission Alumni Inc. Howard was included in the Washingtonian’s “800 Top Lawyers” listing (a ranking of “Washington’s best — the top one percent”) and has been recognized by Chambers USA: America’s Leading Lawyers for Business as a leading individual in the securities regulation area. Howard received his J.D., cum laude, from Fordham University School of Law, where he was a member of the Fordham Law Review, and his B.A., cum laude, from Colgate University.

Gary Stein New York Office +1 212.756.2441 [email protected]

Gary Stein is a partner in the Litigation and Regulatory & Compliance Groups at Schulte Roth & Zabel, where he focuses on white-collar criminal defense and securities regulatory matters, complex commercial litigation, internal investigations, anti-money laundering issues, civil and criminal forfeiture proceedings and appellate litigation. He represents public companies, financial institutions, hedge funds and individuals as subjects, victims and witnesses in federal and state criminal investigations and regulatory investigations by the SEC, SROs and state attorneys general. He has conducted numerous internal investigations involving potential violations of the Foreign Corrupt Practices Act, financial statement fraud, money laundering and other matters, and advises companies on compliance with the FCPA and anti-money laundering and OFAC regulations.

As a former assistant U.S. attorney and chief appellate attorney in the Southern District of New York, Gary investigated, prosecuted, tried and represented the government on appeal in numerous white-collar criminal cases involving money laundering, fraudulent investment schemes, bank fraud, insider trading, art theft, illegal kickbacks, terrorist financing and other financial crimes. His civil litigation experience includes claims of fraud and breach of contract, securities class actions and derivative actions, contests over corporate control, and disputes arising from the sale of businesses. He has handled more than 150 appeals in federal and state courts involving issues of both criminal law and procedure and complex commercial law. He successfully argued 15 appeals in the U.S. Court of Appeals for the Second Circuit.

An accomplished public speaker and writer, Gary has presented on risk management and crisis management issues at global conferences and seminars. He recently co- authored the “Scienter/Trading ‘on the Basis of’” chapter in the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. In 2008, he won a Burton Award for Achievement in Legal Writing for co-authoring “The Foreign Corrupt Practices Act: Recent Cases and Enforcement Trends,” which appeared in the Journal of Investment Compliance. A member of the board of directors of The Legal Aid Society and the board of editors of Business Crimes Bulletin, Gary obtained his J.D. from New York University School of Law, where he was senior articles editor of the New York University Law Review, and his B.A. from New York University.

André Weiss New York Office +1 212.756.2431 [email protected]

André Weiss, a senior partner in the Business Transactions and Financial Services Groups at Schulte Roth & Zabel, represents private investment funds, banks and other financial institutions, and real estate and other businesses in connection with strategic and private equity acquisitions, with a sub-specialty in alternative asset management acquisitions. Asset management deals André has led include:

• Sale of Highbridge Capital Management LLC to JPMorgan Chase • Sale of a minority interest in Ospraie Management LP to Lehman Brothers • Sale of a minority interest in D.E. Shaw & Co. to Lehman Brothers • Sale of a minority interest in York Capital Management LLC to Credit Suisse Group AG • Sale of Claren Road Asset Management LLC to The Carlyle Group • Sale of a substantial non-controlling interest in Sterling Stamos Capital Management LP to Merrill Lynch • Sale of a minority interest in GSO Capital Partners LP to Merrill Lynch • Sale of GSO Capital Partners LP to The Blackstone Group • Sale of Delaware Management Co. to Castle Harlan Inc. • Sale of Delaware Management Co. to Lincoln National Corp. • Sale of Weiss Peck & Greer LLC to Robeco Asset Management • Sale of Ivy Asset Management Corp. to The Bank of New York Co. • Sale of Boston Partners Asset Management to Robeco Asset Management • Sale of Cyllenius Capital Management LP to BlackRock Inc. • Sale of Harbor Capital Management and its related transfer agent and broker- dealer entities to Robeco Asset Management • Sale of Sage Capital Management LLC to Robeco Asset Management • Sale of HPB Management LLC to BlackRock Inc. • Sale to Proxima USA, owned by Banco Bilbao Vizcaya Argentaria SA, of the VegaPlus investment management platform in the United States • Transfer of the management of the D.B. Zwirn & Co. managed assets to Fortress Investment Group LLC • Transfer of the control of the Gabriel and Ariel (Merkin) managed assets to court-ordered receivership

A frequent public speaker and author, André recently co-authored “New Paradigm in Asset Manager M&A: Financial Institution Alliances with Hedge Fund Managers,” which was published in The Hedge Fund Journal. He is a member of the New York State Bar Association and the New York City Bar Association. A former staff attorney for the Securities and Exchange Commission, Division of Market Regulation and former secretary of Toys “R” Us, André received his J.D., cum laude, from Syracuse University College of Law, where he was an editor of the Syracuse Law Review, and his B.A. from New York University.

Guest Speaker Jeffrey H. Aronson Co-Founder and Managing Principal Centerbridge Partners, L.P.

Jeffrey H. Aronson is Co-Founder and Managing Principal of Centerbridge Partners, L.P., a private investment firm based in New York City with approximately $13 billion of capital under management. The Firm is focused on private equity, distressed securities and credit investing. Mr. Aronson has been an active investor in distressed securities for more than 20 years and has been deeply involved in many U.S. and overseas restructurings. Prior to founding Centerbridge with Mark T. Gallogly in October 2005, Mr. Aronson was a partner at Angelo, Gordon & Co., a leading alternative investment firm, where he led all of the firm’s distressed securities and leveraged loan efforts. Before joining Angelo, Gordon in 1989, Mr. Aronson served as Senior Corporate Counsel at L.F. Rothschild & Co. and he began his career as a securities attorney with the law firm of Stroock & Stroock & Lavan. Mr. Aronson graduated with honors from Johns Hopkins University, where he serves as a trustee, and has a J.D. from New York University School of Law.

Notes:

Management Company Capital Transactions Philippe Benedict, Steven Fredman, Richard Presutti, Andre Weiss

Philippe Benedict Partner, Tax and Financial Services +1 212.756.2124 | [email protected]

Steven Fredman Partner, Investment Management, Financial Services and Regulatory & Compliance +1 212.756.2567 | [email protected]

Richard Presutti Partner, Business Transactions and Financial Services +1 212.756.2063 | [email protected]

André Weiss Partner, Business Transactions and Financial Services +1 212.756.2431 | [email protected]

Notes:

Investments in Alternative Asset Managers

• Anticipating future tax increases -- Expected tax rate increase in 2013 -- Even if “carried interest” legislation does not pass, potential sellers should consider monetizing their positions before 2013, when ordinary income and long-term capital gains tax rates are scheduled to rise and a 3.8% Medicare tax on investment income begins to apply -- Sellers should consider structuring their transactions in order to be paid the initial purchase price and one or more earn-out installments before 2013 in order to take advantage of the current tax rates -- Sellers should be careful about making capital contributions to their firms within the 12-month period preceding a sale, as such contributions may turn a portion of their holding periods from long term to short term • Buyer’s motivation -- First and foremost, to make a good investment return; therefore the focus is on fund managers who have recovered from 2008 -- Second, to provide exclusive or preferred products to customers -- In some instances, to diversify business breadth with complementary businesses • Seller’s motivation -- Take money off the table with capital gains tax treatment -- To fund working capital needs -- To establish a mark on valuation in connection with establishment of employee equity plan -- To begin the process of institutionalizing the organization • Tax motivations -- Sellers currently recognize capital gains on a sale of the goodwill underlying their businesses. Proposed “carried interest” legislation would recharacterize 50% - 75% of certain gains as ordinary income. Sellers may want to analyze their structures in light of this proposed legislation.

• Tax motivations (continued) -- Buyers generally can amortize their purchase price over 15 years, depending on the allocation of purchase price among assets acquired (directly and indirectly) and, in the case of a non-corporate target, the making of Section 754 elections by the target • Growing complexity of regulatory environment -- Manager may be able to piggyback on buyer’s compliance infrastructure to address increasingly rigorous compliance obligations

Notes:

Financial vs. Strategic Investments

• Financial investment motivations -- Generally under 20% investments focusing on passive investments targeting high annual returns and exit opportunities • Strategic investment motivations -- Generally over 30% investments with long-term commercial relationship expectations focusing on annual returns and strategic opportunities to grow the manager, with exit matters constituting a negotiating item rather than part of the business plan

Notes:

Financial Investments

• Economics -- Net profits deal: investor shares in net profits after all or substantially all of the manager’s expenses -- Gross profits deal: investor shares in gross revenue without regard for the manager’s expenses -- Modified gross profits deal: investor shares in gross revenues after deduction for only certain specified expenses, or expenses capped at a percentage of revenues • Economics drives governance -- Need for closer oversight by buyer if expense structure is less pressing in gross revenue deal than in net income deal -- A buyer’s involvement and oversight with respect to decisions impacting expenses do not equate to involvement in the investment process • Tax challenges -- In order for a seller to qualify for capital gains treatment, what is sold must be a capital asset. A net deal is more likely to be respected as a sale of a capital asset. • Exit strategies in financial investments -- Sale by financial investor of position it acquired: investor will want free transferability while the manager will want control over who its future partner could be, which may be in the form of right of first refusal, right of first offer, list of (or defined term for) prohibited transferees or limitation on transfer of investor’s information and/or governance rights -- Sale of all or larger portion of the manager: manager will want an ability to drag the investor in a follow- on majority sale transaction while the investor will want to control its obligation to participate in the sale -- IPO: the investor will want registration rights in the event the manager goes public, and the manager will want to limit the information it needs to disclose publicly in the event the investor entity is, or goes, public

Notes:

Strategic Investments

• Trend toward deals with well under 100% ownership where significant economics remain with seller -- Buyers have become uncomfortable with owning 100% in the later years, once the earn-out expired -- Retention and incentivization in the later years are now entrenched in the buyer’s focus • Full partnership with asset manager in the net income economics as opposed to revenue or modified revenue participation -- Principal concern is how the numbers can be used to increase or decrease the earn-out with affiliate transactions, including salaries to sellers, gathering the most attention • Irrespective of number of shares, sellers will retain by contract investment control over their funds and managed accounts -- Without retained investment control, investors will redeem at the first opportunity or withhold consent -- Focus of negotiations will be on retention of control over matters that are not directly the investment function but could nonetheless impact investment performance, including hiring, firing, compensation, etc. • Client consent and satisfaction -- If a transaction will result in a shift of a sufficient percentage of ownership, client consent may be required by law or pursuant to advisory, partnership or other agreements -- Under the Investment Advisers Act, a 25% shift in equity ownership is presumed to result in a change of control -- SEC has not addressed what type of consent is sufficient in the context of a change in control of a hedge fund manager -- Practice ranges from the manager seeking consent from the general partner (which raises obvious conflict issues) to the manager seeking consent from investors, with non-consenting investors getting a withdrawal right (an option that would not be practical for a private equity fund or a fund with side pocketed investments)

Notes:

Elements of Strategic Investments

• Long term earn-outs -- Virtually all alternative asset manager acquisitions involve earn-outs that extend from three to five years with payouts possibly extending beyond five years -- Earn-outs have run anywhere from 25% - 75% of total anticipated purchase price -- More often than not the earn-out is capped -- There may be differing layers on the earn-out – i.e., a portion based on AUM, on management fees, on incentive fees/allocations and net income, each as defined -- Most frequent formula is based on EBITDA or adjusted income -- Tension between conditioning payment on future services and recognizing capital gains on receipt of the earn-out. Buyers also may not want to report earn-outs as compensation for tax or financial accounting/GAAP purposes. -- Proportionality of earn-out share and initial proceeds among the sellers -- Part of the earn-out will be recharacterized as interest. Additionally, to the extent that an individual’s expected share of the earn-out exceeds $5 million, the excess will be subject to an annual nondeductible interest charge. • Retention by sellers of complete day-to-day operational/investment control • Long-term non-competes -- Non-competes in a sale context are enforceable for a longer term than a typical employment context and often include a non-solicit of clients and employees -- May be tied to the term of the earn-out, if any, and often range from one to five years or longer • Reinvestment of sales of proceeds in seller funds -- Frequently a large after-tax percentage of the closing purchase price is required to remain invested in the seller manager’s products through the earn-out period or beyond

• Reinvestment of sales of proceeds in seller funds (continued) -- Withdrawals may be made if a seller departs involuntarily with respect to such seller’s portion -- Reinvestment serves two purposes: as a mechanism for retention of the seller and as a tool for clients to reflect shared exposure with the seller • Distribution arrangements -- Is distribution arrangement exclusive? Does manager have existing distribution arrangement with other parties in place? -- Compensation structure — one-time payment or continuous stream based on fees generated by the introduced investor -- If an investor is solicited for Fund A but invests in Fund B, does the buyer/distributor earn a fee? • Platform -- We frequently refer to these alternative asset manager acquisitions as joint ventures or marriages and the partnership or LLC agreement as the pre-nup -- If so, is the marriage monogamous: can the buyers develop similar relationships with other managers in the same space? -- Generally, with limitations and conditions, buyers are willing to restrict their ability to associate themselves with competitors of the seller manager for at least the earn-out period or longer

Notes:

Preparing for the Relationship

• Detailed term sheet -- Buyers, and especially sellers, must understand the very personalized nature of these deals and be willing to work through complex economic terms and governance issues -- Investment managers want to preserve the entrepreneurial culture of their firm, and steer clear of the bureaucratic issues and regulatory impositions that may be part of a large institution -- Taking the time to work through the transaction issues in a detailed term sheet helps both sides understand and work through these issues at a business level without getting bogged down in dense transaction documents • Building trust and integration -- Critical that groups within each firm take the time before the closing to get to know each other -- Focus in advance on integration of operations, systems and compliance • Keeping employees happy -- Generally, non-sellers (e.g., employees) share in the purchase price through a “purchase price bonus pool.” The tax impact of these arrangements needs to be examined from a tax and accounting perspective. • Adjusting to becoming an employee -- At the outset of an engagement by a targeted fund, we caution the principals on a potentially individual cultural matter -- Most of these principals (or at least the most senior) haven’t been employees for years. At the closing, that status changes. -- The principals should be comfortable with their day-to-day reporting and the day-to-day reports at the buyer must develop a sensitivity that will be different than the standard employer/employee relationship

New Paradigm in Asset Manager M&A Financial institution alliances with hedge fund managers

PHILIPPE BENEDICT, STEVEN FREDMAN, CHRISTOPHER HARRISON, JOSEPH VITALE AND ANDRÉ WEISS, SCHULTE ROTH & ZABEL

Changing dynamics in acquisitions acquisitions of alternative asset managers (including the earn-out is highly contingent); that interest is not We are experiencing a rebound in alternative asset the frequently misunderstood restrictions of the deductible by non-corporate sellers. manager acquisitions linked to an ongoing global Volcker Rule) and developing tax legislation that repositioning within the financial industry. This could impact these transactions. Earn-out formulae generally capture both AUM (or development follows a several year lull in alternative management fee) growth as well as the impact of asset management acquisitions attributable to the Retaining talent incentive fees/allocations. Earn-out structures that economic crisis and the concurrent short-term decline Agreeing to a price is the initial step in negotiating an are based on both income streams motivate the in the approbation of alternative asset managers. alternative asset manager acquisition. Valuations of sellers to focus on investment returns, not only AUM Financial institutions are seeking sizeable investments alternative asset managers are difficult, particularly growth. They have become a useful tool in satisfying in, and sometimes control of, alternative asset given the volatility of incentive-based returns and investors in funds managed by targets that the sellers managers. fluctuations in markets and investor redemptions in share an ongoing interest in preventing performance recent years. Valuations have to take into account compression as AUM expands. Earn-out formulae These financial institutions – including banks, private the reliance of asset management businesses also frequently credit the sellers with most or all of equity buyers (for their own accounts, not their funds) upon a relatively small number of highly talented the benefit of the buyer’s post-closing distribution and other substantial alternative asset managers – individuals, as well as the need to continuously efforts and any integration into the buyer’s existing are seeking immediate attractive returns, and incentivise and, from time to time, replace or platform. supplementary revenue streams that do not require augment them. Because of the narrow pool of talent leveraged trading in the financial institution’s own and the opportunities that successful portfolio Long-term non-competes capital. These transactions often present an attractive managers have to participate in other organizations Sellers are generally required to enter into long-term opportunity to leverage their global distribution or to start-up their own firms, acquirers need to non-compete arrangements. While non-competes do networks, by guiding investors into alternative asset establish an incentive and retention program that not deter retirement, they remove any motivation for products in which the buyer not only benefits from ensures the longevity of the target. a seller to leave the target business in order to pursue distribution fees but also shares in the manager’s other opportunities. equity upside as its business grows. The earn-out The long-term earn-out has become the primary Unlike non-competes in the employment context, Buyers are typically seeking targets with superior method to address valuation and longevity concerns non-compete arrangements designed to protect current and historic track records that the buyers’ and is now the hallmark of alternative asset the buyer of a significant business can frequently distribution network can effectively market, and acquisitions. Frequently less than half of the total be relied upon to sustain long-term non-competes. that have a pedigree that satisfies the institutions’ anticipated purchase price is paid at closing. The We expect that courts would sustain long-term non- reputational standards. Managers that have not remainder, which may or may not be capped, is based competes by sellers of alternative asset managers recovered from the financial crisis or that have on one or more measures of performance – most because the purchase price is based on the goodwill experienced larger than average net withdrawals or frequently, total or average EBITDA or management of the target business which is inexorably tied to the redemptions are, to some extent, being left behind in fees – covering a three to seven year period post- sellers’ capability and reputation. As a companion 1 these developments. closing. concept, the sellers and other employees may be required to be stripped of the right to utilize the Alternative asset managers, in turn, are looking to The most obvious method for retaining sellers in performance track record of the target company and expand, stabilise and diversify their investor base and the target business – making the earn-out payment enter into long-term confidentiality and employee assets under management through a relationship contingent on seller retention or compliance with and investor non-solicitation arrangements, all of with a buyer with a well-suited distribution non-compete obligations – may not give the sellers which further limits their ability to compete through network. The owners of the target frequently have the anticipated tax treatment with respect to the any venture outside of the target company. most of their wealth invested in their alternative transaction, and is therefore not common in practice. asset management businesses and also seek these Current US federal tax law generally treats the net Reinvestment by sellers transactions in order to monetise a portion of their profits from properly structured earn-out payments Requiring significant percentages of the sellers’ equity. With reduced public interest in alternative as capital gains to the sellers and eligible for long- after-tax sale proceeds to be reinvested in the asset manager IPOs, owners of these managers term capital gains treatment for assets or interests manager’s funds for several years is another mainstay exploit these transactions to grow and institutionalise held over one year, to the extent of the goodwill in of asset manager acquisitions. That reinvestment their businesses, with equity structures that maintain the sellers’ business. further incentivizes sellers to commit themselves to permanent equity for the founders while incentivising the business after the initial purchase price is paid the next generation of investment professionals with There are two exceptions to this general principle. because a sizeable portion of the initial payment equity stakes. First, a relatively small portion of the earn-out will be at risk in the business. Fund investors also payment will be deemed to be interest income appreciate the alignment of interest created by that This article describes the challenges presented by because of the deferred nature of such payment. obligation. these transactions and some of the structures and Second, to the extent that a seller’s share of the earn- methods used to balance the competing interests of out exceeds $5 million, the excess may be subject to Partial sales the buyers and selling equity holders. We also discuss an annual interest charge, so long as the potential Financial buyers and sellers are becoming increasingly the challenges of client consents, the impact of bank for the earn-out remains outstanding (possibly even if reluctant to purchase and sell 100% of the equity of

1 November 2010

the target business. On the one hand, buyers are bear significant reputational exposure to the target. events, strategic developments or personnel changes motivated to leave the sellers with sufficient equity At a minimum, the buyer will demand broad veto on either or both sides. in the business to motivate the sellers beyond the rights over fundamental business decisions. Where earn-out period and provide a pool of available the buyer acquires voting control, the sellers will Of course, the original contract is binding, and equity that the sellers are motivated to share with likewise require vetoes over fundamental business frequently sets the framework for third stage the other professionals who continue to operate the decisions to protect themselves from the buyer negotiation – but the original contract cannot target manager. Similarly, sellers often seek to retain forcing changes which impact their ability to hit the create working satisfaction or commitment if the substantial ownership of the target manager in order earn-out targets. foundation of the alignment dissipates. Frequently, to benefit from permanent equity in the business stage three is driven by fear that one or more sellers, as it grows under the new relationship as well as to Dueling veto rights present a risk of deadlock on having significantly increased his or her wealth in the express their confidence to the buyer. key business decisions. Such situations are normally transaction, would rather go his or her own way. avoided in standard deal-making in favour of a Platform for growth resolution process that allows the decision of one Where sellers retain significant equity in the target Sellers often rely on access to the institutional buyer’s party or the other to govern or allow one party an company, the transaction essentially becomes distribution network to add stable institutional exit right. In asset manager acquisitions, however, a permanent strategic alliance, premised on an investors to the targets’ investment products, which the logic is different. In a deadlock, the selling ongoing mutually beneficial business relationship. in turn promotes the value of their permanent partners by default continue to operate the business Therefore, in advising clients what to anticipate in the equity. A variety of techniques protect their interests in the ordinary course during the initial earn-out governance/partnership negotiations, we frequently in maintaining a premier, if not exclusive, position period. suggest to clients that they develop the mindset of in the buyer’s distribution platform. For example, negotiating a prenuptial agreement. If the marriage rather than prohibiting a buyer from acquiring or Where buyers commit an exclusive portion of their works, no one cares what the agreement provides, distributing for a competing asset manager, the platform and distribution capabilities to the target, but if there is a difference of opinion, a deadlock or a parties may agree to accelerate the earn-out, or the dynamics vary. There, the buyer’s dependence falling out, the agreement takes on special meaning. portions of it, or provide the sellers with a limited on the target creates a greater need for the buyer to right to call back their equity, in those circumstances. have input on target operational or strategic matters, The core of the governance/partnership agreement is These types of protections are obviously more critical at least in the case of significant adverse events or a the process of dealing with the “what ifs” (e.g., what where the sellers are relying on growth to hit long- sustained period of poor performance. if there is a deadlock on significant issues, what if the term earn-out targets. platform relationship ceases to be mutually beneficial, Stage two: post-earn-out what if there is a crisis at the target or at the buyer Three stages of governance Where the buyer has acquired a majority of the that makes the alliance difficult, and what if the buyer Next to negotiations over purchase price, including business, governance typically transitions to the revises its strategic direction in favor of a competitor the earn-out, dividing up and sharing governance buyer after the earn-out period. The sellers relinquish of the target). These are not easy topics to address at rights is the most challenging and intricate aspect some veto rights, but nevertheless maintain more the time that the relationship is in its infancy, and, in of reaching an agreement in alternative asset control than in a typical majority acquisition because fact, not all arrangements address these issues. management acquisitions. The competing interests of of the need to assure investors in target products buyers and sellers typically come together in practice that the management team they are counting on At times, the governance negotiations detour into through a complicated set of checks and balances continues to manage investment matters. As a result, negotiations of exit scenarios that can take varied that shift over time with changes in the parties’ the selling partners continue to run the day-to-day forms, including buy-sells, puts and calls, and earn- interests and leverage. operations, but will no longer have the right to block out acceleration. Where the parties need clarity and all decisions of the buyer, if the buyer decides to move certainty to predict the outcome of these events, Stage one: pre-earn-out the business in a new direction. the parties dedicate the effort up front to work out The balance of governance rights tends to favor the a resolution. In our experience, however, the actual sellers during the initial earn-out stage, even where Sellers that retain a meaningful portion of the equity circumstances giving rise to the exit have invariably a majority or 100% of the target has been sold to will negotiate for economic rights and minority proven to be different than the ones that were the buyer. Sellers insist on and frequently attain a protections in the post earn-out period. In many specifically contemplated. high degree of – if not complete – control over the instances, these minority protections resemble the day-to-day operations and other matters that could minority rights that the buyer bargained to have Challenges of client consents impact their ability to obtain the earn-out portion during the earn-out period. Determining whether client consents to the of the purchase price. This governance dynamic is transaction are required involves an in-depth, “facts- further justified by sellers pointing out that although Stage three: renegotiation and-circumstances” analysis. The preferred method a substantial portion of the target equity has In our experience, the original transaction terms do of obtaining those consents can turn into a strategic been transferred, the full purchase price (i.e., the not typically survive significant changes in personnel decision. earn-out) has yet to be paid. As sellers remain the and market cycles. Nearly every arrangement key relationship with the investors in the target’s undergoes renegotiation within approximately three If the target manager is registered as an investment products, investor comfort with the sellers’ authority years of closing (during the earn-out period), and adviser under the Investment Advisers Act of 1940, to manage the day-to-day investment process is vital some even earlier. The sellers may outperform the a change of control and deemed assignment of to obtaining investor consent where required and to metrics contemplated by the earn-out and make the manager’s advisory contracts with its funds the success of the business going forward. themselves invaluable to the business, and demand and managed accounts may be presumed to occur an expansion of the potential earn-out payments. under Advisers Act rules and related SEC no-action Even where the buyer has not yet paid most of the The sellers may underperform, the earn-out may be letters. Minority acquisitions can trigger a change of purchase price, it has made a significant investment out of reach, and the buyer may need to bring in and control depending on a number of factors, including and may have control and therefore responsibility for compensate fresh talent to turn around the business. the percentage of equity being sold and the control the target from a regulatory perspective or at least Platform commitments may not survive market rights the buyer is obtaining. In fact, a change in

2 November 2010

control may occur even though target management on the percentage of equity the banking entity can its affiliates, on the other hand, will be quantitatively continues to control day-to day operations. acquire, the voting or other governance rights the limited and qualitatively non-material. The specifics banking entity can have, or the other commercial of such limitations are determined by the legal staff Fund documents of a private investment fund rarely relationships the parties can maintain. Following a of the Federal Reserve Board on a case-by-case basis provide a blueprint for how to obtain consents to control deal, however, the target will become subject and are designed to prevent the banking entity a change of control, and the SEC has not directly to various federal banking laws, and the federal from gaining influence through the combination of addressed how client consents should be obtained banking regulators can hold the banking entity substantial ownership and commercial relationships. in the private investment fund context. A variety responsible for the target’s compliance with those of practices have developed, which range from: and all other applicable laws. As part of the required commitments, the banking obtaining “negative” consents, in which the entity also agrees to limit its representation on the transaction goes forward with notice to investors Accordingly, prior to entering into a control deal, manager’s board (to no more than one, or possibly who are permitted to withdraw from the funds an asset manager should understand the effect two, voting members and one, or possibly two, if they object; obtaining “affirmative” consents federal banking law would have on its business. For non-voting observers), forgo any rights that would from the percentage of investors that would be example, the manager’s funds could, depending on enable it to exercise a controlling influence over required to amend the fund documents; obtaining their structure, become subject to certain investment the manager’s management or policies (such as consent of independent directors (for offshore funds, limitations that apply on a consolidated basis to the all veto or consent rights, except in very limited where independent boards are in place); or simply banking entity and all of its affiliates (which would circumstances), refrain from taking any actions to obtaining the consent of the general partner of the include a controlled manager and its controlled pressure management (such as soliciting proxies, funds (which is somewhat riskier, since the general funds). If such limitations apply, they may affect the proposing directors in opposition to those nominated partner is controlled by the sellers). The approach investment strategy of the funds and, in any event, by management, or threatening to dispose of taken depends on several factors, including the risk would require the funds to provide the banking entity stock). While such commitments generally prevent tolerance of the buyer and the sellers, the existence with real-time position transparency. the acquirer from playing a role in the business of of periodic withdrawal rights of investors, and the the manager, properly structured deals should, timing constraints of the transaction. In turn, since a control deal renders the acquiring nonetheless, provide the banking entity with ways to banking entity potentially responsible for the protect its economic interest in the target manager. Bank acquisitions and impact of Volcker target’s legal compliance, a banking entity should Contrary to some erroneous press reports, the first determine what rights it will need, or what Potential US tax law changes “Volcker Rule” contained in the recently enacted requirements it will want to impose on the manager, Sales of asset managers have become increasingly Dodd-Frank Wall Street Reform and Consumer to get comfortable with this potential liability. For more complicated from a US federal income tax Protection Act does not prohibit banks or their example, the acquirer will need to determine what standpoint. The three areas described below may affiliates from acquiring equity, even controlling level of involvement it will want in the compliance have significant implications on asset manager interests, in alternative asset managers. While the activities of the target and what mechanisms it will transactions, and have driven many managers to seek Volcker Rule will eventually impose severe limits need to ensure that compliance issues are adequately and, if feasible, close deals before year-end. on the ability of “banking entities”2 to invest addressed. proprietary money in hedge funds and private Carried interest legislation equity funds, the statute explicitly permits banking “Non-control” deals The antagonism on “Main Street” and in the entities to continue to sponsor and manage funds. Because of the regulatory issues a control deal political arena towards private investment funds has Accordingly, since the Volcker Rule does not generally creates for both parties, they may seek to structure generated several legislative proposals over the past prohibit such activity, even if conducted directly by the transaction as a non-controlling investment few years that target private investment funds and banking entities, it does not prevent banking entities instead. In order for a banking entity’s equity stake would affect alternative asset manager acquisitions. from investing in, or acquiring, third-party managers in a manager to qualify as non-controlling, the The proposed “carried interest” legislation would, if who, themselves, engage in such activities. banking entity must hold less than 25% of any class enacted, deprive private investment fund managers of the manager’s voting securities and less than one and their owners of favorable tax treatment in a Moreover, investments by banking entities in third- third of its total equity. Under certain circumstances, number of areas that they have enjoyed virtually party managers may offer certain unique benefits to however, a banking entity may need to reduce its from their inception. In particular, the US Congress both parties. From the standpoint of the manager, an holding to as little as five percent of the target’s has focused on the taxation of performance-based investment by a banking entity allows the manager voting securities or 25% of its equity in order to avoid compensation earned by alternative asset managers to benefit from the significant distribution capabilities being deemed to control the manager. from advising funds that are treated as partnerships of most banking entities and enables the manager to for US tax purposes. Alternative asset managers of market its funds to the banking entity’s client base. Depending on the size of the banking entity’s such funds typically divide their operations into two From the banking entity’s standpoint, an investment proposed interest, the banking entity may also be or more separate businesses. One company provides in a third-party manager will likely be the only way, required to make certain “passivity commitments” to asset management services and generates fee income post-Volcker, for it to participate in the profits of funds the Federal Reserve Board in order to avoid a control for such services. Another entity earns performance- it does not sponsor itself. determination. Such commitments are normally based compensation in the form of a profits interest required for non-controlling investments consisting in such funds (the so-called “carried interest”). When a banking entity acquires equity in a target of 10% or more of any class of the target’s voting asset manager, the parties must either structure securities or 25% or more of its total equity, but, The US House of Representatives has passed the deal as a “controlling” or “non-controlling” under certain circumstances, may be required for legislation that the US Senate is currently investment under federal banking law. even smaller investments. considering, which would change the tax treatment of the sale of “investment services partnership “Control” deals In making such commitments, the banking entity interests.” While there is some ambiguity as to what The benefits of structuring the transaction as a agrees that all other business relationships between it constitutes an “investment services partnership controlling investment are that no limits are placed and its affiliates, on the one hand and the target and interest,” our view is that the term generally does

3 November 2010

not include the sale of a management company; for married individuals and $200,000 for others), it would, however, include the sale of the entity and that tax is not deductible. It applies to interest, FOOTNOTES receiving the carried interest. dividends and capital gains from investments and may also apply to the gains realized on the sale 1. Typically the buyer acquires equity in Specifically, two critical items are under attack. First, of asset managers. This tax creates additional the manager, so that the buyer and the proposed legislation limits the ability of fund motivation for asset managers to sell their firms prior sellers who retain equity are “partners” managers to pass through to themselves, in respect to 2013, including negotiating for the payment of in every economic sense. Alternatives of their carried interest, the capital gains treatment any earn-out to be made no later than 31st December have arisen over the years, however, in enjoyed by investors in these funds – treating 75% 2012. which the buyer’s equity is not equivalent of the carried interest as ordinary income from the to a percentage of net income. For provision of services (even if such carried interest Closing thoughts example, buyers may purchase a unique would otherwise have been treated as capital gains), Alternative asset management acquisitions are class of equity, a share of revenues or a except that only 50% would be treated as ordinary complex joint venture transactions, and, not share of revenues minus some but not income for profits attributable to assets that were surprisingly, negotiations are often protracted. all operating expenses. Revenue shares held for at least five years. In addition, the amount Where banks are involved, dealing with federal create greater freedom for the sellers treated as ordinary income would carry with it self- banking regulation adds to the hurdles and extends in operating the business post-closing, employment tax (currently at 2.9%). the duration of the pre-closing process. We have because the buyer need not insist on the experienced a number of transactions in which over same types of controls over budget and Second, and more directly impacting sales of one year was expended on the courtship and the expense matters, but do not result in a managers, the legislation applies the same re- legal negotiations. “partnership” in the sense of the buyer characterisation rules to a sale of an entity receiving and sellers sharing the opportunities and carried interest. As a result, asset managers would We have found that a sometimes neglected key to risks of a business proportionally. The tax bear a much higher tax burden from selling the the success of these negotiations is starting off with and structural issues presented by these goodwill they create if they earn carried interest than the proper mindset and preparation. The principals types of investments are beyond the do sellers of businesses generally. should expend the effort towards understanding scope of this article. what they are seeking from the relationship, what Needless to say, the currently targeted 1st January they might be willing to sacrifice and what goals 2. Defined as US banks, or foreign banks 2011 effective date for the proposed legislation are fundamental, and what the other side is seeking with a US banking presence, and all their seems to have encouraged increased alternative from the relationship and how each party’s goals can affiliates. asset manager acquisition activity with a 31st be made compatible with the other’s. During this December 2010 target closing. In addition, asset effort, hopefully a relationship of trust develops that managers may be more inclined to seek a higher can be instrumental in overcoming the inevitable percentage of upfront payments in 2010, as any earn- hurdles that rear up during the negotiations. While, ABOUT THE AUTHORS out payments made after 2010 may be subject to the as with all complex deals, the devil will be in the re-characterisation rules. Moreover, the allocation of details, the mutual understanding of goals and the purchase price between the management company development of a relationship will be necessary to The authors of this article: Messrs. Benedict and the carried interest recipient will take on a more find solutions. (Tax), Fredman (Investment Management), significant role for future sales. Harrison (Business Transactions - M&A), It should go without saying, but in our experience the Vitale (Bank Regulatory), and Weiss Expiration of Bush tax cuts parties should not permit the negotiations to become (Business Transactions - M&A) are members Unless the US Congress enacts new legislation, the overheated or hostile. In a typical acquisition, heated of the Schulte Roth & Zabel team that current top marginal individual tax rate for ordinary negotiations are considered almost perfunctory; represented the buyer or sellers on certain income and short-term capital gains will increase there, after all, the closing is an ending. In perpetual of the hallmark alternative asset manager from 35% to 39.6% in 2011, and the current top joint venture transactions, the closing, like a acquisitions completed by Schulte Roth marginal individual tax rate for long-term capital wedding, is the beginning. What occurs beforehand & Zabel over the past several years, gains will increase from 15% to 20% in 2011. While should be a foundation for the future, not a heated including the JPMorgan/Highbridge and there has been recent activity in Washington effort to win points, which are in abundant supply. Blackstone/GSO transactions, as well as the indicating that legislators may try to extend the recently announced acquisition of a non- current tax rates, it is difficult to tell at this point Complementary to the uptick in alternative asset controlling minority stake by Credit Suisse whether they will extend tax rates at all and whether manager acquisitions, a number of banks are in York Capital Management. The authors any extension would apply to individuals in the spinning off or considering spinning off alternative acknowledge the assistance of David Griffel highest tax brackets. As a result, asset managers may asset managers. This is being spurred by the (Tax) in preparing this article. try to finalize sales before the end of 2010 and also legislation relating to controlled hedge fund structure as much of the consideration as upfront relationships as well as changes in strategies by payments to be made by 31st December 2010. some banks. Here they are impelled by their boards, shareholders and the difficulty that some banks Medicare tax on investment income had with their internal hedge fund-like trading The healthcare reform legislation enacted earlier strategies or with their owned alternative asset this year included a new tax on investment income managers. Ultimately, we expect these spin-offs that is effective starting in calendar year 2013. The to be followed by the creation of new strategic law imposes a 3.8% tax on individuals’ investment alliances of the separated asset managers and other income over a specified amount ($250,000 generally institutions. THFJ

4 Sources of Capital: Capital Markets, Registered Funds and Seeding Arrangements

Notes:

Sources of Capital: Capital Markets, Registered Funds and Seeding Arrangements Kenneth Gerstein, Michael Littenberg, David Nissenbaum

Kenneth Gerstein Partner, Investment Management, Financial Services and Regulatory & Compliance +1 212.756.2533 | [email protected]

Michael Littenberg Partner, Business Transactions and Financial Services +1 212.756.2524 | [email protected]

David Nissenbaum Partner, Investment Management and Financial Services + 1 212.756.2227 | [email protected]

Notes:

SgeWNM GMk 1NIJtlx

ikNK1 COyYIN

• Background -- Hedge fund managers look for new sources of capital for various reasons -- Access broader distribution channels and types of investors -- Funds registered under the Investment Company Act of 1940 (“1940 Act”) • Growing interest in alternative investments among financial intermediaries and retail investors • Financial advisors seeking lower volatility asset classes/strategies post-market meltdown • Recent developments: -- $12 billion net flows to long/short mutual funds in first eight months of 2010 (Morningstar) -- 119 mutual funds in Morningstar Long/Short Category (49 launched after 2008) -- Growing number of private fund managers have launched registered funds -- Some examples: AQR Funds, Ramius Dynamic Replication Fund, and recent filings by Avenue Capital and Blackstone/GSO (closed-end credit funds) -- Unregistered public vehicles -- Modest activity in non-1940 Act registered permanent capital vehicles and special purpose acquisition companies (“SPACs”) -- More stable market has led to renewed interest in non-1940 Act registered permanent capital vehicles -- Diversification of business lines and income streams • Business stability • Manager is a more attractive target for M&A -- Permanent capital vehicles • Provides stable asset base and eliminates managing around cash flows. May result in limited ability to remove external manager • Solves liquidity and concentration problems that cannot be addressed in hedge fund structure

Notes:

U.S. 40 Act Registered

Closed-End Mutual Funds Funds

BDCs Registered Funds of Hedge Funds

• Registered funds -- Available structures: -- Closed-end funds — issue non-redeemable shares. Liquidity provided by exchange listing or periodic repurchase offers. -- Mutual funds (open-end funds) — issue redeemable shares. Daily liquidity at NAV. -- Business development companies (BDCs) — like closed-end funds. Not 1940 Act registered, but subject to most 1940 Act provisions. • Attractive for credit-oriented investment programs • Offer greater flexibility than a registered fund in terms of ability to use leverage and ability to receive performance-based compensation (without limitation on who may invest in the product) -- Registered funds of hedge funds — many organized in past 10 years. Structured as closed-end funds. -- Key benefits: -- No limit on number of investors -- No investor qualification requirements, unless there is performance-based compensation or fund is privately offered -- Ability to make public offering of shares/interests to investors, which facilitates distribution through more retail channels -- Ability to be taxed under Subchapter M of the Internal Revenue Codes, which allows for simplified tax reporting to investors using 1099s rather than K-1s

Notes:

U.S. Not 40 Act Registered

Specialized Credit SPACs Vehicles

Finance , MTNs Companies

• 1940 Act exempt products -- Diverse mix of products geared toward different investment strategies and investor bases and that rely on a variety of 1940 Act exemptions -- Some of these products have been registered under the Securities Act of 1933 (the “1933 Act”), while others have been sold offshore under Reg. S or in the United States under Rule 144A -- Fairly few deals have been done, so there is less of a market standard for these products -- Several U.S. and European managers have organized European-listed permanent capital vehicles that were sold to offshore investors -- Vehicles often structured as Guernsey entities and were listed in London or on Euronext -- As offshore vehicles, products could be sold to both offshore retail and offshore institutional investors -- These vehicles can be offered in private placements to “qualified purchasers” in the United States -- Real estate investment trusts (“REITs”) are an option for a U.S.-based permanent capital vehicle that is not registered under the 1940 Act. Primary investment focus must be real estate, mortgages and other real estate-related securities for 1940 Act exclusion to be available. -- From 2005 through 2008, there were many offerings of SPACs, including SPACs sponsored by well- known private fund managers -- SPACs are a type of blind pool formed to purchase an operating company -- Several hundred SPACs were launched with some raising several hundred million dollars -- There also have been specialized vehicles set up to invest in various credit strategies, such as CDO equity and municipal obligations, as well as deals structured as finance companies. These vehicles have for the most part been tailored to the specific goals of the manager and have varied widely from issuer to issuer. -- One manager established a medium term note program to raise “quasi-permanent” investment capital for its funds

• 1940 Act exempt products (continued) -- Although the market for new products of these types has been largely dormant since late 2008, we are seeing some signs of life again in the market for these products -- Some smaller SPAC deals completed during the past year have had structures intended to address perceived product deficiencies. Rather than shareholders getting a vote on the initial business combination, they have the ability to opt out via a mandatory issuer tender offer. To the extent that there is a mini-renaissance in SPACs in 2011, there is likely to be a premium on quality, experienced management teams. -- It is unlikely there will be any one “hot” product • The potential products in the offing are generally tailored to meet the managers’ particular goals • Many managers are in the stealth R&D phase with investment banks, and we will probably see some products file with the SEC and/or launch over the next few months -- Most likely candidates are products set up to invest in a variety of different credit strategies and possibly MTNs • If there is a successful launch, other issuers that want to tap this market will need to be fairly far along in the process so that they can access the market before the window closes

Notes:

Offshore

• Offshore vehicles -- UCITS -- Funds organized to meet European Union Undertakings for Collective Investment in Transferable Securities framework. UCITS III is in effect until July 2011. • EU Directives establish a common regulatory regime for collective investment schemes and enable a Europe-wide distribution of such products • UCITS III allows for the creation and distribution of investment fund products throughout the EU to both retail and institutional investors • Primary advantage is that it allows the investment fund to passport in a variety of EU member states after it has registered in one EU member state -- Offering UCITS to U.S. investors • U.S. managers may offer UCITS products to eligible U.S. investors. The manager must be an SEC-registered investment adviser, will be subject to capital requirements and must comply with UCITS regulations, including risk monitoring requirements, the Eligible Asset Directive and any requirements imposed by the local regulatory authorities. • The offering must comply with U.S. securities laws (privately placed to accredited investors and qualified purchasers) • May not be offered to U.S. retail investors. As a result, communications must be tailored so as not to be regarded as a general solicitation or general advertising of the UCITS in the United States. -- Liquidity and investment restrictions • Must provide investors with at least bi-monthly liquidity • Prohibited from effecting short sales of securities • May only invest in a prescribed list of eligible assets • No more than 10% of NAV may be invested in any one transferable security • May employ synthetic leverage up to 100% of NAV through use of derivatives; short term borrowing limited to 10% of NAV

• Offshore vehicles (continued) -- Risk management procedures • Regulations require that the Risk Management Process (“RMP”) must incorporate a daily calculation of Value at Risk (“VaR”) of the fund • Periodic stress tests on investment products • Reviewing and supporting the arrangement and procedures for the valuation of OTC derivatives • Disclosure requirements -- Offshore listed vehicles -- European mutual funds -- London Stock Exchange listed funds -- Listed management companies

Notes:

Key Product Structuring Issues

• Implications of 1940 Act registration -- Public reporting on a quarterly basis showing all investment positions (with 60-day lag) -- Limitations on use of leverage applicable to borrowings and other transactions in which a fund has a potential payment obligation beyond the cost of its investment (e.g., futures contracts, writing options, swaps) -- Mutual funds can borrow only from banks subject to 300% asset coverage requirement (i.e., can borrow up to 50% of its capital) and all other leveraged positions must be fully “covered” by segregating cash and liquid securities -- Generally, closed-end funds are subject to a 300% asset coverage requirement (or 200% in the case of preferred stock) -- May impact feasibility of using registered funds for highly leveraged investment programs. However, in many cases, swaps and other instruments with embedded leverage can be used to work around 1940 Act limitations. -- Fund Governance — requirement to have “independent directors” and certain actions (e.g., increase in advisory fee) require shareholder approval. Independent directors must approve advisory agreement and, after initial two-year term, must annually approve renewal of the advisory agreement. -- Other 1940 Act requirements • Providing liquidity (open-end vs. closed-end; listed vs. trading at a discount) -- Registered funds with illiquid assets must be structured as closed-end funds since mutual funds (open- end funds) cannot invest more than 15% of their assets in illiquid securities -- Closed-end funds listed on an exchange provide daily liquidity, but frequently trade at discounts from NAV -- Some closed-end funds are not exchange-traded and provide liquidity by making repurchase offers to investors • U.S. tax treatment -- A registered fund can qualify as a “regulated investment company” under Subchapter M of the Internal Revenue Code if it satisfies a quarterly diversification requirement and an annual source of income requirement, and there will be no tax at the entity level if the fund makes required distributions to investors -- Fund with concentrated investment program may not be able to meet diversification requirements -- Fund with non-securities based investments (e.g., investments in non-financial futures contracts) may not be able to meet the requirement that 90% of gross income is derived from investments in securities

• U.S. tax treatment (continued) -- Fund with illiquid assets may not be able to generate cash needed to make required distributions -- Publicly traded partnership considerations for funds taxed as partnerships • Performance-based compensation -- Closed-end funds and mutual funds must restrict sales/transfer so that all investors are “qualified clients” (i.e., net worth of more than $1.5 million) to charge traditional incentive allocation/fee based on net profits -- BDC can generally have a 20% performance fee without any restriction on who may invest -- A registered fund has option of using a “fulcrum fee” under which there is an asset-based fee that is subject to increase and decrease based on the performance of the fund relative to the performance of a relevant index over a specified measurement period -- Other products -- Generally speaking, the specialized credit vehicles and offshore listed vehicles have not been limited with respect to performance-based compensation -- Promoters of SPACs are compensated through an equity promote rather than performance fees • Logistics in raising capital -- Public offerings provide easier access to broader distribution channels/sources, but can present various hurdles -- Need for underwriter/syndicate -- Market climate for product type -- SEC registration process -- Lead time for launching products • SEC comments • Frequently complex regulatory considerations for products seeking to rely on exclusions from the 1940 Act -- Managers with broker-dealer distribution relationships for their private funds have successfully used those relationships for distributing registered funds without underwritten offerings -- Private offerings • Potential conflicts -- Side-by-side management of registered funds and private funds -- Trade allocation conflicts from differing fee structures and/or investment strategies -- Need procedures to address the conflicts -- 1940 Act prohibition of “joint enterprises” applicable to investment in private offerings -- Restricts ability to negotiate deal terms where both registered funds and private funds invest -- Potentially restricts use of side letters by registered funds of hedge funds -- Potential impact of new products on existing investor/client base • Administration and compliance requirements -- Registered funds and products sold in public offerings have to develop compliance programs to assure compliance with federal securities laws and regulations -- Public investor base creates need for expanded investor services

Notes:

Seed and Acceleration Capital

• Seed and acceleration capital deals -- These are issuances of equity in the manager or special additional profits interests in the funds (sharing the revenues) granted to initial investors who make significant investments -- Few new managers have started up in the last 12 – 18 months without a seed deal -- Market conditions favor seeders, but seeders need to be prepared for lower AUM growth rates -- Current market for key terms -- Profit share or revenue deal, or fee discount -- Lockup -- Most favored nation -- Restrictive covenants for key persons -- Exit for the seeder

Traditional Traditional U.S. Publicly U.S. Non-Publicly U.S. Open-End Hedge Fund Private Traded Closed-End Traded Closed-End Fund Equity Fund Fund Fund (Mutual Fund)

Description/ Invests in any Invests in securities Invests in equities, Invests in equities, Invests in equities, Typical security; may use that are not listed on debt, cash-equivalents debt, cash-equivalents debt, cash-equivalents Investment leverage and an exchange and related interests and related interests and related interests Program sophisticated trading strategies (Also, typical structure for registered funds of hedge funds)

Significant None None Incentive Incentive Incentive Restrictionson compensation not compensation compensation Investments/ possible (except for permitted if investors permitted if investors Compensation “fulcrum fee”) are “qualified clients” are “qualified clients” Generally, use of Generally, use of Leveraged positions leverage subject to leverage subject to must be covered by 300% asset coverage 300% asset coverage cash and/or liquid requirement requirement securities (and may borrow only from banks and subject to 300% asset coverage requirement) Illiquid investments limited to 15% of assets

Typical Type Limited Partnership or Limited Partnership or Corporation or Trust Corporation, Trust, LLC Corporation or Trust of Entity LLC (domestic); LLC (domestic); (domestic) or Limited Partnership (domestic) Limited Partnership Limited Partnership (domestic) or Corporation or Corporation (offshore) (offshore)

Entity General Partner or General Partner or Board of Directors or Board of Directors, Board of Directors or Governance Managing Member Managing Member Trustees Trustees or Managers Trustees (in addition to (domestic); Board (domestic); Board of Investment of Directors, often Directors (offshore) Manager) independent (offshore)

Manner Shares/interests by Shares/interests by Shares by public Shares/interests/units Shares by public or of Offering private placement private placement offering by public or private private offering offering Shares sold daily Continuous offering at NAV is possible

Target/Permitted U.S. AIs/QPs and U.S. AIs/QPs and U.S. and possibly U.S. and possibly U.S. and possibly Investors non-U.S. non-U.S. non-U.S. non-U.S. non-U.S.

Tax Partnership/ Partnership No corporate tax if No corporate tax if No corporate tax if Considerations pass-through (pass-through Subchapter M Subchapter M Subchapter M treatment treatment) qualification qualification qualification (domestic) and requirements met requirements met requirements met PFIC (offshore) and income is and income is and income is distributed distributed distributed annually annually annually Partnership/pass- through treatment available

U.S. Investment Exception under Exception under Registered as Registered as Registered as Company Act Section 3(c)(1) or Section 3(c)(1) or investment company investment company investment company Registration 3(c)(7) 3(c)(7)

U.S. Investment Required Required Required Required Required Adviser Registration

Select Numerous examples Numerous examples Avenue Income Credit ACAP Strategic Fund; Altegris Managed Examples Strategies Fund; Goldman Sachs Credit Futures Strategy Fund; Blackstone/GSO Strategies Fund; Ramius Dynamic Long-Short Credit Advantage Advisers Replication Fund; Income Fund Xanthus Fund; AQR Funds (both in registration) Campbell Multi-Strategy Trust

Liquidity Typically 1-2 yr. Typically 7-10 yr. Exchange traded/daily Discretionary issuer Daily redemptions of Terms lockup; quarterly term, no redemptions; liquidity repurchase offers or shares at NAV liquidity; transfers transfers require periodic repurchase require approval approval offers at specified interval

PriPrivatevate In vInvestmentestment Fun Fundsds Se Seminarminar | 20 | 20 | | © ©20 201111 Schu Schultelte Ro Rothth & Z&ab Zabelel LL LLPP Comparison of Selected Vehicles and Structures for Alternative Investment Products

U.S. Business Offshore Listed U.S. Listed Specialized U.S. Listed Special UCITS Development Public Fund Real Estate Credit Vehicle Purpose Acquisition Company Investment Trust Company

Invests in equity and Invests in equities, Invests in real estate Buys or originates Makes buyout Invests in certain debt of private debt, cash-equivalents and mortgage credit assets investments but raises eligible assets set operating companies; and related interests interests money and then looks forth by EU Directives similar to venture for opportunities; not capital or mezzanine used to hold debt funds portfolios

20% performance None 80%+ assets in Generally no limits Generally must Leverage limited; fee is permitted real estate and/or on compensation invest capital 10% diversification mortgage interests within 12—24 months requirement; no direct 70%+ of assets (including certain Investment program of raise shorting permitted must generally be qualifying may be affected by invested in U.S. mortgage-backed requirements of ICA private operating securities) exemption companies

Corporation or Trust Corporation Corporation Limited Corporation Public Limited (domestic) (offshore) (domestic) Partnership or (domestic) Company; LLC Contractual Fund; Investment Company with fixed capital

Board of Directors or Board of Directors Board of Directors Board of Directors or Board of Directors Board of Directors Trustees Managers

Shares by public Shares by private Shares by public Interests/units by Shares by public Shares/units by or private offering placement (U.S.); offering private placement or offering public offering in EU; Shares/interests by public offering private placement public offering in U.S. (non-US.)

U.S. and possibly U.S. QPs & QIBs and U.S. and possibly Private deals—QPs; Primarily U.S. U.S. Als & QPs and non-U.S. non-U.S. (public) non-U.S. public deals—U.S. and non-U.S. possibly non-US.

No corporate tax if Partnership No corporate tax if Disregarded entity, Corporate taxation Usually a PFIC Subchapter M (pass-through income is distributed Partnership qualification treatment) or annually or PFIC requirements met PFIC and income is distributed annually Partnership/pass- through treatment available (if not publicly traded)

No exception or Exception under Exception under Varies Section 3(a)(1)(C) Exception under exemption; elects Section 3(c)(7) Section 3(c)(5)(c) operating company Section 3(c)(7) to be regulated as a BDC

Required May be required if Not required Generally required Not applicable Generally required manager is U.S.-based

Apollo Investment; Third Point Numerous examples Numerous examples Numerous examples Marshall Wace; Kohlberg Capital Brevan Howard; GLG Corp; American Capital, Ltd; Ares Capital

Exchange Exchange traded Typically exchange Private or OTC or Typically exchange Redemptions at traded/daily traded exchange traded traded least semi-monthly; liquidity or private gates permitted equity fund structure only in limited (if privately offered) circumstances

Notes:

Managing Compliance Strategically Ida Wurczinger Draim, Marc Elovitz, Kelli Moll, Richard Morvillo

Ida Wurczinger Draim Partner, Investment Management, Litigation and Regulatory & Compliance +1 202.729.7462 | [email protected]

Marc Elovitz Partner, Investment Management, Litigation and Regulatory & Compliance +1 212.756.2553 | [email protected]

Kelli Moll Partner, Investment Management and Regulatory & Compliance +1 212.756.2557 | [email protected]

Richard Morvillo Partner, Litigation, Financial Services and Regulatory & Compliance +1 202.729.7479 | [email protected]

An IfdapratedApproachto Cafnptanco Notes:

Consultants and Other Service Providers Outside Legal CCO/General C..... I Portfolio Managers Independent Senior Chief valuation Management Financial Agents Investor Officer Relations Chief Oparatlnj Officer

• To be most effective, a firm’s compliance program should be integrated -- Identify and involve the relevant people at your firm -- Use your outside advisors • Identify and address: -- Tone from the top -- Integration of compliance systems and operations -- Communication systems and reporting • Avoid segmented responsibilities resulting in no one person either internally or among the firm’s external advisers having the “whole” picture of the firm’s activities

-TA 5, r- - LD -, F-T iT' 11 - I . Notes:

offim

• Current focus on paid research consultants -- U.S. Attorney’s Office: arrests, raids and subpoenas -- SEC subpoenas -- Media scrutiny -- Investor diligence • Steps for managers to address the issues -- Identify relevant personnel: Senior Management, General Counsel, Chief Compliance Officer, Investor Relations and Outside Counsel -- Understand the role paid research consultants play in the investment process -- What types of people are consulted? • Academics • Industry experts • Self-employed • Employees of competitors, suppliers or distributors of company at issue • Employees of company at issue • Consultant for company at issue (e.g., doctor in clinical trial) • Steps for managers to address the issues -- What types of information are being gathered? • Background on industry • General industry trends • Specifics of company at issue: manufacturing data, forecasts, new products or business developments or M&A activity

• What lines can be drawn in the use of paid research consultants? -- Limits on numbers of consultations with particular person -- Restrictions on communications with different categories of employees -- Increased oversight for certain categories of employees -- Requirements regarding proof of authorization of consultant’s employees -- Restrictions on consultation in period prior to earnings announcements • What types of monitoring can be implemented? -- Pre-approval processes to reduce risks -- Chaperone calls -- Randomly choose calls to sit in on -- Review emails and notes from consultations -- Follow up on significant or unusual trades where there was recent consultation • What types of training can be used? -- Tailored to particular sectors -- Separate from general compliance and code of ethics training for all employees -- Tone from the top

M7, F7 Notes:

• Comprehensive disclosure regime -- Advisers Act Rule 206(4)-8 (the “Hedge Fund Anti-Fraud Rule”) -- Goals: accuracy, consistency, compliance with SEC guidance -- Step one: creation of comprehensive list of all avenues of disclosure • Regime’s approach -- Broad vetting process -- Review of substantive content by relevant business personnel -- Example: senior portfolio managers review description of trade allocation policies -- Result: tailored, specific disclosures -- Centralized pre-approval -- Sign-off by legal and/or compliance prior to first use -- Selective disclosure not controlled by individual portfolio managers -- Tracking of disclosures -- System for recording approval/dissemination of various disclosures -- Result: documentation of process, more efficient updating -- Periodic review and updating -- Frequency of review -- Means of updating -- Creation of a duty to update through voluntary disclosure

Notes:

IndepenCCnt Senior Chief Valgation Management Financial Agents Inveftor Officer

• Identifying, managing and disclosing conflicts of interest is an integral part in carrying out a manager’s fiduciary duties to its clients -- Not solely the role of internal legal and compliance -- Senior management and other key business heads should be involved -- Conflicts may change as the manager’s business evolves • Addressing conflicts of interest -- A manager should seek to eliminate or reduce risk to the extent practicable -- Disclosure of a conflict of interest may not be sufficient if the conflict creates a breach of fiduciary duty issue • Tailor disclosures information to the specific risks of the manager’s business • Conflicts of interest that typically exist and require detailed disclosure include, but are not limited to: -- Personal trading -- Allocation of investments -- Valuation issues -- Soft dollar arrangements -- Expense allocation -- Affiliated transactions -- Side letter agreements -- Different proprietary investments -- Different fee arrangements among investment products

M Integrated Approach: Proposed Whlstleblower Rules Notes:

• The benefits of blowing the whistle on you are tempting -- Under proposed rules, whistleblowers who report to the SEC “original information” that leads to “successful” SEC investigations and related actions will get 10% – 30% of the total monetary sanctions if they exceed $1 million • You want to encourage whistleblowers to come to you first -- Promote good compliance as a part of the firm’s culture -- Encourage employees to come forward and convince them that they will be rewarded for their assistance -- Show employees that you are prepared to review the complaint fully and objectively -- Help them understand that coming to you will not jeopardize their chances of recovery under the whistleblower program • If a whistleblower comes to you, do a really good job of investigating the complaint -- You have limited time to evaluate it before deciding whether to contact the government -- The SEC is not only going to look only at the complaint, but also will look at how you handled it and what you did once you became aware of it

Notes:

Relationships with Investors Stephanie Breslow, David Efron

ZOOM ANNUAL PF#XrE NefflWOffFUN08813ANARismwrewww

Stephanie Breslow Partner, Investment Management and Financial Services + 1 212.756.2542 | [email protected]

David Efron Partner, Investment Management and Regulatory & Compliance +1 212.756.2269 | [email protected]

Notes:

Where is the Market?

• Performance gains and investor inflows have combined to create a $120 billion increase in hedge fund assets in Q3 2010, according to Hedge Fund Research -- The capital increase reflects a combination of both performance-based gains and new capital inflows, bringing total assets invested in the hedge fund industry to $1.77 trillion as of Q3 2010 -- Investors allocated a net $19 billion of new capital to the hedge fund industry in the third quarter, the largest quarterly capital inflow since Q4 2007 -- Hedge fund performance was slightly lower than the stock market, with the average fund up 10.4% through year end • Movement to larger and more established managers is motivated by: -- Stability of investors and employee team -- Good operational controls -- Asset allocators are gatekeepers; care about avoiding embarrassment and care less about maximizing upside • $5 billion is sweet spot, $1 billion is minimum to be “established” -- Funds with over $5 billion AUM attracted 61.33% of all new money, while those in the $1 to $5 billion range attracted 25.9% of all asset flows -- According to Hedge Funds Review, hedge fund launches in Q3 2010 increased to 260, up from 201 in the previous quarter. Over the last 12 months, 1,945 funds have launched, the highest total since Q2 2008. However, this includes new funds created by existing managers, and many truly new funds are small. • New managers face a slower, harder road -- Often require seed money, which increases startup cost and adds another barrier to entry -- Can’t assume “take it or leave it” approach with fund documents

• New managers face a slower, harder road (continued) -- Registration will add to startup costs -- Fundraising can be slow and launch timing uncertain -- Even existing managers may be tempted to offer special terms to reach critical mass — according to Hedge Funds Review, the average incentive fee fell by 11 basis points to 19%, the second largest quarterly decline in incentive fees since 2008. The average management fees remained at 1.58%. This does not take into account fee sharing arrangements with seed providers. • It used to be that new managers who were hungry were perceived to have an advantage, and investors wanted to come in at the ground floor -- First year returns -- Hungry managers -- Capacity • Today there is more focus on: -- Avoiding embarrassment -- Diversified investor base of loyal “sticky money” -- Top quality service providers (often not as available to smaller managers) -- Established track record -- Less volatility of returns

Notes:

Diligence: Communications with Investors

• Heightened concern about regulatory inquiries -- Madoff -- Insider trading • Enhanced investor due diligence -- Background checks extend beyond the principals -- Service providers all contacted, and asked for verification of employment and subjective assessments • Smarter due diligence -- Investors more savvy about who is a qualified service provider -- More savvy about back office -- Diligence takes longer, so launches take longer • Not wanting to be surprised • How to communicate with your investors -- Delivering bad news -- Timing; level playing field -- Selective transparency -- Reacting to media coverage -- Litigation considerations • Relationship management hot topics -- Investors more sophisticated about other managers -- Don’t want to be outlier — e.g., PIKS with fees • Sensitive to past actions of the manager, such as: -- Forced restructuring -- Extended suspensions -- Aggressive expense allocation

Notes:

Evolution of Fund Terms

• Liquidity terms -- More sophisticated matching of investment program and liquidity (match between assets and liabilities). Investors willing to accept “appropriate” liquidity terms but not willing to accept locked up capital where underlying portfolio does not require it. -- Fund level gates in new funds are rare. Investor level gates are increasingly common, especially with distressed and credit investment programs with illiquidity in underlying portfolio. • Side pockets -- Increased pressure from investors to prohibit side pocket investments in new funds and to prohibit new side pocket investments in existing funds • Fees -- Increased pressure on management fee rates, with 1.5% more typical for new funds. 20% incentive fee with cumulative “high water mark” still the norm for new funds. -- Common for new funds to have variable pricing, i.e., multiple classes with different fee rates based on different liquidity terms offered -- Few new funds have adopted clawback, multi-year incentive fee or modified “high water mark” features • Negotiation of fund terms -- More managers proactively engaging in discussions and negotiations with one or more large, strategic investors in establishing terms for new funds • Side letters -- More side letters covering more areas, including greater transparency rights and notice of, and redemption upon, expanded list of key events -- Investors seeking clarity on “what if” scenarios like redemption gate mechanics, suspensions and distributions in kind/use of SPVs • Platform investors -- More separate, dedicated fund classes established to accommodate “conduit” vehicles, distribution and other platform arrangements for placement agents, consultants and financial institutions • Managed accounts -- Fewer investor requests for “traditional” managed accounts. Also, fewer investor requests for single investor funds (with the exception of certain large sovereign wealth funds and state plans).

Notes:

Managing Regulatory Exposure Udi Grofman, Howard Schiffman, Gary Stein

Udi Grofman Partner, Investment Management, Financial Services and Regulatory & Compliance +1 212.756.2298 | [email protected]

Howard Schiffman Partner, Litigation and Regulatory & Compliance +1 202.729.7461 | [email protected]

Gary Stein Partner, Litigation and Regulatory & Compliance +1 212.756.2441 | [email protected]

Notes:

A Regulatory Problem Emerges

• The problem could be internally discovered -- Flagged by compliance • The problem could emerge from a government inquiry • The problem could be raised by a whistleblower allegation • When the problem is discovered consider: -- Pros and cons of conducting an internal inquiry or internal investigation -- Scope of investigation -- Speed of investigation

Notes:

Managing the Problem Internally

• Limit knowledge on “need-to-know” basis -- Consider who handles the matter internally and involvement of legal department and/or outside counsel in fact-finding efforts and resolution discussions • Manage affected employee(s) strategically • Preserve e-mails and documents -- Consider scope of document preservation notice • Protect the attorney-client privilege -- Involvement of counsel in meetings and on e-mails -- Sharing of information with third parties

Notes:

Managing the Problem Externally

• Plan your communication strategy -- “Stress test” this strategy -- Designate authorized personnel to handle communications • Investors and prospective investors -- Is disclosure required? -- Form of disclosure (e.g., oral, written, supplement to PPM) -- How disclosure is made now could impact disclosure obligations in the future -- Pay attention to previously-made statements and side letters • Analyze selective disclosure issues -- Pay attention to confidentiality considerations and to attorney-client privilege • Investors in the management company/general partner • Auditor • Offshore directors • Administrator, “street” and counterparties • Media -- Pros and cons of proactive engagement -- Pros and cons of “no comment” strategy

Notes:

Taking Steps to Fix the Problem

• Potentially culpable employees -- Separate counsel -- Reasons and timing for introducing separate counsel -- Indemnification -- Analyze whether insurance coverage is available and who pays the deductible -- Termination/suspension -- Consider impact of termination/suspension on containment • Changes to policies and procedures -- Improving policies and procedures might be advisable even in light of concerns regarding the policies and procedures being deficient

Notes:

Dealing with the Government

• Information demands from government: -- Informal inquiries -- SEC subpoena or Grand Jury subpoena -- Search warrant -- Importance of first conversation with regulator: consider timing, context and goals -- Different considerations apply to different regulators • Consider pros and cons of self-reporting

Speakers David Cohen Ida Wurczinger Draim Marc Elovitz David Momborquette 2Neil Robson 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

David M. Cohen New York Office +1 212.756.2141 [email protected]

David M. Cohen is a partner in the Employment & Employee Benefits, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. His practice focuses on matters related to fiduciary responsibility, the Employee Retirement Income Security Act of 1974 (ERISA) and qualified plans.

David speaks and writes widely on ERISA and benefit fund–related issues, including authoring ERISA compliance guides for broker-dealers for the Practising Law Institute and recently presenting on “Legal Issues Concerning Alternative Investments: Focus on Hedge Funds” at the International Foundation of Employee Benefits Plans 56th U.S. Annual Employee Benefits Conference. In recognition of his accomplishments, he was selected for inclusion in The Best Lawyers in America and in New York Super Lawyers, a listing of outstanding attorneys in the New York metro area.

Prior to joining SRZ, David held positions in both the private sector (as vice president and assistant general counsel of a major investment firm) and government service (with the Department of Labor Employee Benefits Security Administration’s Divisions of Regulatory Coordination and Exemptions). David earned a J.D. from The George Washington University Law School and a B.A. from Columbia University.

Ida Wurczinger Draim Washington DC Office +1 202.729.7462 [email protected]

Marc E. Elovitz New York Office +1 212.756.2553 [email protected]

David K. Momborquette New York Office +1 212.756.2268 [email protected]

\-- David K. Momborquette is a partner in the Litigation, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. His practice focuses on complex commercial litigation and regulatory matters primarily for financial services industry clients, including hedge funds, funds of funds and private equity funds. David has substantial experience in both private securities litigation and securities regulatory matters, including class action litigation and investor disputes, as well as investigations by the SEC, the NYSE, FINRA and state attorneys general offices.

Recent representations include representing an inter-dealer broker in certain arbitrations and related civil actions arising from the hiring of brokers by a competitor, representing an investment manager in connection with a fund wind-down and related regulatory and investor disputes, representing an investment fund in connection with a civil action seeking to enjoin proxy solicitation, counseling a private equity fund in connection with a shareholder action brought to enjoin a proposed merger and counseling a securities firm in connection with a civil action arising from the hiring of a CDO group.

David has written extensively on securities regulation and frequently presents on regulatory compliance and enforcement issues. He recently appeared at two separate SRZ Investment Management Hot Topics events, speaking on “Private Equity Investment Adviser Registration” and “Managing Compliance Strategically.” He also recently authored the chapter “Big Boy Letters” in the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute.

David was awarded his J.D. from Boston University School of Law, where he was notes editor of the Boston University Law Review, a G. Joseph Tauro Scholar and an Edward F. Hennessey Scholar; he also earned his B.A. from Boston University.

Neil Robson London Office +44 (0) 20 7081 8037 [email protected]

Neil Robson is a senior associate in the Investment Management, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. He has extensive experience providing regulatory advice to funds and managers regarding Financial Services Authority (FSA) authorization and compliance; cross-border issues in the financial services sector, market abuse, anti-money laundering and regulatory capital requirements; formations and buyouts of financial services groups and structuring and marketing of investment funds; agreements with customers, custodians and service providers; and outsourcing arrangements.

Neil provides non-contentious regulatory advice and assistance to banking, investment management, brokerage and other clients to ensure that they remain compliant with FSA rules and U.K. regulation. He also advises on a wide range of other U.K. financial services regulatory and M&A matters.

Neil is a frequent author of SRZ Client Alerts on FSA policies and codes and also recently co-authored “Bribery Act 2010” published in The Hedge Fund Journal. In addition, he has written on regulatory matters for various other professional trade publications and speaks frequently at conferences attended by attorneys and financial services professionals on developments in U.K. financial services regulation, including MiFID, short selling and market abuse. He recently took part in the HFMWeek Legal Summit, speaking on issues related to alternative investment fund managers. Neil graduated from BPP Law School and earned an M.A. and B.A. from University College London, as well as a diploma from Birkbeck College at the University of London.

Notes:

New Reporting Obligations

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Private fund reporting -- Proposed amendments to ADV Part 1 — Item 7B and Section 7B of Schedule D -- New information about each fund not currently reported on Part 1 -- Strategy -- Master-feeder -- Investment Company Act exemption relied on -- Any foreign regulatory registrations -- Gross and net asset value -- Summary of fund’s investments • Asset and liability classes • Fair value hierarchy (Level 1, Level 2 and Level 3) -- Minimum investment amount -- Number and type of beneficial owners -- Fund’s service providers • Auditors • Prime brokers • Custodians • Administrators • Marketers • Changes to AUM reporting -- New concept of “Regulatory Assets Under Management” -- No exclusion for assets that are: -- Family

• Changes to AUM reporting (continued) -- Proprietary -- No-fee -- Uncalled capital commitments specifically included -- No deductions for: -- Borrowings -- Accrued fees or expenses -- “Regulatory AUM” under Part 1 may differ from AUM reported in Part 2 • Additional proposed ADV changes -- Advisers to disclose whether its own assets (not AUM) total $1 billion at fiscal year end -- Exact number of employees disclosed, not just a range -- New types of clients added to list: -- Business development companies -- Insurance companies -- Other investment adviser and pension and profit-sharing plans subject to ERISA -- Amount of regulatory AUM attributable to each type of client -- Percentage of clients that are not U.S. persons -- Increased disclosure of other business activities -- Increased disclosure of information about related persons -- Whether all soft dollar benefits qualify under 28(e) • New ADV Part 2 -- Disclosures of investment strategies and risks -- “Significant” investment strategies -- “Material” risks of each strategy -- “Frequent trading” -- “Unusual risks” -- Mandatory disclosure of risk of loss -- Plain English -- Overinclusiveness vs. underinclusiveness • Systemic risk reporting -- Rule proposals expected early 2011 -- Statute requires that recordkeeping cover: -- AUM and use of leverage (including off-balance sheet) -- Counterparty credit risk exposure -- Trading and investment positions -- Valuation policies and practices -- Types of assets held -- Side arrangement or side letters -- Trading practices, and -- Other information requested

Notes:

U.K. Reporting

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Acquisitions of U.K. publicly-listed securities (both U.K. companies and non-U.K. companies) -- U.K. regulated markets -- London Stock Exchange plc — full list (or AIM) -- Also: EDX London Ltd., ICE Futures Europe, LIFFE Administration and Management, PLUS Markets plc and London Metal Exchange Ltd. -- Entering into contracts for difference (“CfDs”), total return swaps or other instruments with similar economic effect to shares -- Public disclosure requirements — to issuer (and, if issuer is U.K. company, to FSA) -- U.K. issuer — disclosure threshold is 3% and every whole percentage above that -- Non-U.K. issuer — disclosure thresholds at 5%, 10%, 15%, 20%, 2/5%, 30%, 50% and 75% -- Timing — disclose within two trading days (U.K. issuers) or four trading days (non-U.K. issuers) -- SEC-registered advisers (under Investment Advisers Act of 1940) benefit from U.K. investment managers exemption -- Disclose at 5%, 10% and every whole percentage above that (aggregate holdings of all funds for which the adviser/manager has discretionary investment authority) • Short sales of U.K. publicly-listed securities -- Rights issue period -- Disclosure if holding a net short position of 0.25%, and ongoing disclosure at each 0.1% thereafter, upwards or downwards -- Disclosure to Regulatory Information Service -- U.K. financial sector company -- Disclosure thresholds and process as above

• Other considerations -- Mandatory offers under Takeover Code (30% or greater holding) -- FSA consent required for holdings of 10% or more in FSA authorized issuers (acquisition without consent is a criminal offense) • EU disclosure requirements -- Transparency Directive -- New pan-European short selling regime

Notes:

New Issue Offerings

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• FINRA Rule 5130 and new Rule 5131 -- Apply to FINRA member firms (i.e., broker-dealers) -- Restrict their ability to allocate initial public offerings of equity securities -- Foreign offerings included (NASD Notice to Members 03-79, n.16) • FINRA Rule 5130 -- Purpose: bona fide public offering, no allocations for future business -- Prohibits allocation to accounts with restricted person beneficial owners -- Definition of “restricted person” -- Definition of “beneficial ownership” -- Includes deferred compensation if invested in account -- Broker-dealer must obtain annual representations from fund managers -- Look-through to fund investors, fund of funds investors -- Calculation of restricted person ownership of account -- De minimis exemption (restricted person participation at or below 10%) -- Options for effecting a “carve-out” of restricted person participation -- Restricted person participation at secondary market price • New FINRA Rule 5131 -- Becomes effective on May 27, 2011 -- Purpose: no kickbacks, spinning or flipping (FINRA Notice to Members 10-60) -- Prohibits broker-dealers from conditioning an allocation upon receipt of excessive compensation for other services

• New FINRA Rule 5131 (continued) -- Prohibits broker-dealers from allocating new issues to accounts whose beneficial owners include executive officers or directors of companies that were IB clients in past 12 months or become such in next three months, or the immediate family members of such officers and directors -- Exemption where aggregate ownership by officers, directors and family members with respect to any one company does not exceed 25% -- Is not triggered where fund has no individual (as opposed to entity) investors -- Broker-dealer may rely upon annual representations from fund managers

Notes:

Marketing Your Funds

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Marketing and advertising compliance is a key component of any sound compliance program -- In the past, the SEC has focused enforcement resources on investment adviser marketing and has imposed significant sanctions on individuals and firms for misleading or otherwise improper advertising -- Review of marketing materials likely to be a focus in adviser examination • Applicable legal standards -- Section 206 of the Investment Advisers Act -- Investment Advisers Act Rule 206(4)-1 -- Basic rule governing advertisement by investment advisers -- Four specific categories of misleading advertising and one catchall provision prohibiting the use of any advertisement which contains any untrue statement of a material fact, or which is otherwise false or misleading -- Federal and state general anti-fraud provisions -- Dodd-Frank -- Revised “accredited investor” definition -- SEC no-action letters -- The leading source of guidance regarding the legal standards governing marketing and advertising by investment advisers -- Clover Capital Mgmt. Inc., SEC No-Action Letter (Oct. 28, 1986) • Advisers Act Rule 206(4)-1 defines “advertisement” -- “[A]ny notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities” -- Electronic communications and websites may constitute an “advertisement”

• Advisers Act Rule 204-2(a)(16) recordkeeping requirements -- Pursuant to this rule, an adviser must maintain all accounts, books, internal working papers and other documents necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts or securities recommendations in any notice, circular, advertisement, newspaper article, investment letter, bulletin or other communication circulated or distributed to 10 or more persons • Consistency among marketing materials, fund documents and actual practice is critical -- During examinations, the SEC often looks for inconsistencies between marketing materials and other fund documents, and between written materials and actual practice -- A manager’s failure to comply with its own policies and procedures is often cited as a deficiency • Overall impression of marketing materials matters -- The SEC also will review a manager’s marketing materials to ensure that the overall impression that they give investors is not misleading even if the relevant materials contain only accurate representations • How to best avoid violations -- Identify relevant materials -- Continuously monitor use of marketing materials -- Periodic reviews and updates -- Document any revisions

Notes:

Form 5500: Report from the Field

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Not many plans made requests • Expect more requests for 2010 • Format of requests from plan varied widely • Managers typically made up own response form — answered all the questions • Focus on proprietary soft dollars received versus soft dollar bank accounts

Notes:

Counting: Still Important

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Manager responsibility — manager liability • Counting fund of funds — proportionate vs. all or nothing • Excluding manager and manager affiliate money • Still no definition of class

Notes:

Transitioning to a Plan Asset Fund

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Talk with clients first • Review and revise offering memo • Review and revise prime brokerage agreements • Review administration agreement — revise if necessary • Review and revise ISDAs, MSLAs, option agreements • Review and revise any other counterparty agreements • Review valuation policies — revise if necessary • Review impact of charge in status on investments and investment strategy -- Review asset-backed securities and private placement for ERISA restrictions • Obtain investment manager appointment from existing ERISA investors

Notes:

New DOL Rules

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• New ERISA section 408(b)(2) regulations regarding compensation -- No impact on non-plan asset funds -- Offering memo for plan asset fund probably complies with disclosure rules as currently drafted • New definition of “fiduciary” under ERISA section 3(21) -- Minimal impact on plan asset funds -- Could potentially raise issues regarding valuation of hard to value securities; dealings with counterparties • Potential impact on non-plan asset funds -- Should be none but open questions on marketing of fund, valuation of hard to value securities • Pushing back in plan asset world — counterparties are not fiduciaries to sophisticated hedge fund managers • Pushing back in the non-plan asset world — letting DOL know they have gone too far

Notes:

Pay to Play

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• SEC Rule 206(4)-5 -- Purpose is to address use of political contributions to influence public officials who direct public plan advisory business/investments -- Applies to political “contributions” made on or after March 14, 2011 -- Both SEC-registered and exempt private advisers must comply -- SEC has proposed that exempt foreign advisers, private fund and venture capital advisers be required to comply -- Prohibits contributions by adviser or its “covered associates” in excess of: -- $150 per election per “official” of a “government entity” where government entity is a current client/investor or becomes one within two years -- $350 cap per election/official applies if the contributor is entitled to vote for the recipient -- Bans solicitation/coordination of contributions, including “bundling” -- Bans circumvention through indirect contributions -- Two-year “look back” for newly-hired or promoted employees (six months if non-marketing position) -- Violation triggers a two-year “time out” where adviser cannot receive any compensation from the government entity client/investor for two years -- Returned contributions exception -- Recordkeeping requirements for SEC-registered advisers -- Effective Sept. 13, 2011, will ban use of unregistered third parties to solicit government entity business • Various states and localities have laws and regulations that overlap with the SEC Rule -- New York State Executive Order -- California Lobbyist Law • Compliance policies and procedures -- Who and what is covered? -- Total ban vs. pre-clearance? -- Reporting of contributions -- “New hire” procedures

Notes:

European Marketing

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• At present -- National private placement exemptions (“NPPRs”) must be used • From 2013 to 2015 -- NPPRs must be used -- Cooperation and information sharing agreement must exist between the SEC and the regulator of the EU country into which the marketing is to take place -- The third country where the fund is established must not be listed as a non-cooperative state by the Financial Action Task Force, and -- Fund must publish an annual report and make the appropriate disclosures to investors and regulators, as is required by the AIFM Directive • From 2015 to 2018 -- Either: -- NPPRs must be used -- Cooperation and information sharing agreement must exist between the SEC and the regulator of the EU country into which the marketing is to take place -- The third country where the fund is established must not be listed as a non-cooperative state by the Financial Action Task Force, and -- The fund must publish an annual report and make the appropriate disclosures to investors and regulators, as is required by the AIFM Directive -- Or: -- The U.S. adviser becomes registered with or authorized by the regulator of the EU country in which it intends to conduct the majority of its marketing and can thereby gain a pan-European passport -- U.S. adviser would have to comply with the full AIFM Directive regime

• From 2015 to 2018 (continued) -- Cooperation and information sharing agreement must exist between the SEC and the regulator of the EU country into which the marketing is to take place -- The third country where the fund is established must not be listed as a non-cooperative state by the Financial Action Task Force, and -- The third country where the fund is established must have signed an agreement with the EU country where the marketing is to take place as regards the sharing of information for tax matters (in accord with Article 26 of the OECD Model Tax Convention) • From 2018 -- Potential for the NPPRs to be abolished, leaving only the registration and passport regime as the sole option for non-EU advisers to market into the EU

Notes:

Paid Research Consultants

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• The current context — mosaic theory, channel checks and best practices -- SEC has stated about research analysts: -- “The value to the entire market of these efforts cannot be gainsaid; market efficiency in pricing is significantly enhanced by such initiatives to ferret out and analyze information.” In re Dirks, 1981 Fed. Sec. L. Rep. (Jan. 22, 1981) -- “Analysts can provide a valuable service in sifting through and extracting information that would not be significant to the ordinary investor to reach material conclusions. Regulation Fair Disclosure — SEC Release No. 43154 (2000) -- U.S. attorney, Southern District of New York in October 2010: -- “Illegal insider trading is rampant” -- “Many of the people who are going to such lengths to obtain inside information for a trading advantage are already among the most advantaged, privileged, and wealthy insiders in modern finance” -- “Material non-public information is akin to a performance-enhancing drug that provides the illegal ‘edge’ to outpace their rivals and make even more money” -- “Recordings [wiretaps] are the absolute best evidence, and so we will not shrink from using them” • Using distributors and suppliers as paid research consultants -- Sources of confidentiality -- Common law and contractual duties to employer • Duty not to disclose confidential or proprietary information • Duty not to engage in activities that have the potential to create a conflict of interest with employer without prior authorization

• Using distributors and suppliers as paid research consultants (continued) -- Contractual duties to customers or clients not to disclose confidential or proprietary information • May be very strict: some companies do not want suppliers to even identify fact that they are a supplier to a particular company or for a particular product -- Timing and number of contacts -- Numerous contacts close to release of quarterly results -- Relationship of consultant’s employer to client/customer -- Sole or primary supplier/distributor vs. immaterial/noncritical component -- Types of information disclosed — potentially material -- Actual, undisclosed sales figures -- Sales forecasts -- Forecasts regarding purchase or shipping orders -- Information regarding alternative suppliers for products -- Information regarding new products • Confirming existence of new products • New product features • Release date of new products

Speakers Adam Harris David Karp Eleazer Klein 2Kurt Rosell 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Adam C. Harris New York Office +1 212.756.2253 [email protected]

Adam C. Harris is a partner in the Business Reorganization Group at Schulte Roth & Zabel, where his practice covers corporate restructurings, workouts and creditors’ rights litigation. Adam’s practice has a particular focus on the representation of investment funds and financial institutions in distressed situations, including both in-court and out-of-court restructurings, and distressed acquisitions by third-party investors or exiting creditors through “credit bid” or similar strategies. In addition to representing creditors and acquirers in distressed situations, Adam has also represented Chapter 11 debtors, as well as portfolio companies in out-of-court exchange offers, debt repurchases and other capital restructurings.

A speaker and author on bankruptcy and restructuring issues, Adam recently co- authored the chapter “Out of Court Restructurings, the Bankruptcy Context and Creditors’ Committees” for the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. Adam, who is listed in both Chambers USA and Best Lawyers in America, received his J.D., magna cum laude, from Georgetown University School of Law and his B.A. from Emory University.

David J. Karp New York Office +1 212.756.2175 [email protected]

David J. Karp is a special counsel in the Business Reorganization Group at Schulte Roth & Zabel, where his practice focuses on corporate restructuring, special situations and distressed investments, distressed mergers and acquisitions, and the bankruptcy aspects of structured finance. David leads the firm’s Distressed Debt and Claims Trading Group, which provides advice in connection with U.S., European and emerging market debt and claims trading matters.

Among his broad work in reorganization and distressed investments, David has represented debtors, ad hoc and official committees, and individual secured and unsecured creditors. David’s recent representations include an investment bank in connection with the sale of a distressed CDO portfolio, a private equity fund in connection with the proposed acquisition of a substantial portion of the assets and the Chapter 11 cases of Delphi Corporation and its affiliates, a secured lender in connection with the acquisition of Philadelphia Newspapers LLC, and bondholders in connection with the Chapter 11 cases of Visteon Corp.

David has also represented investment funds and private equity funds in connection with distressed investments in Centro Properties Group, Charter Communications, Cinram International Inc., Delta Air Lines Inc., General Motors Corp., Idearc Inc., Kaupthing Bank hf., Landsbanki Íslands hf., Las Vegas Sands Corp., Lear Corp., Lehman Brothers Holdings Inc. and its affiliated debtors; Pacific Ethanol Inc., Penton Media Inc., Quality Home Brands Holdings LLC, Quinn Group Ltd., SemGroup Corp., Stallion Oilfield Services Ltd., Tribune Co., Tropicana Entertainment LLC and Young Broadcasting Inc.

David is an author and speaker on various distressed investing topics. He recently co-wrote “Champerty Clarified” for activist distressed debt and claims investors, published in Bankruptcy Strategist, and spoke on “Basic Issues for Distressed Bank Debt Market Participants” at the SRZ Distressed Investing: Capital Structure Analysis and Debt Trading seminar. A member of the American Bankruptcy Institute, the Loan Syndications and Trading Association and the Loan Market Association, David earned his J.D. from Fordham University School of Law and his B.S. from Cornell University.

Eleazer Klein New York Office +1 212.756.2376 [email protected]

Eleazer Klein, a partner in the Business Transactions, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, practices in the areas of securities law, mergers and acquisitions, and regulatory compliance. Ele is best known for his expertise, since the early 1990s, in the development and implementation of alternative investment structures for private equity investments and, specifically, the structuring and negotiating of private investments in public equity, or PIPEs, and related products including Registered Direct offerings, Convertible 144A offerings, Reverse Mergers, Equity Lines and SPACs.

Ele currently works on approximately 200 PIPE or PIPE market–related transactions every year for some of the largest private investment groups and investment banks in the U.S. and abroad. In addition, Ele advises clients on restructurings, reorganizations, initial public offerings and secondary offerings, venture capital financing, indenture defaults and interpretation, and activist investing, as well as counseling clients in the regulatory areas of short-selling, Sections 13 and 16, Rule 144, insider trading and Regulation M/Rule 105.

Because of his extensive PIPEs experience, Ele is a co-author of the “Private Investments in Public Equity Securities (‘PIPES’)” chapter in the Insider Trading Law and Compliance Answer Book, to be published this year by the Practising Law Institute; he is also a contributing author to PIPEs: A Guide to Private Investments in Public Equity, published by Bloomberg Press, which is a leading treatise in the PIPEs arena. In addition, he has become a leading source for business journalists and business news organizations, and a much-sought-after speaker by sponsors of PIPEs, SPACs and regulatory conferences. Ele was a moderator at DealFlow Media’s 2010 PIPEs conference, spoke on “Trends in PIPE Transactions” at The International PIPEs Conference 2010 in Shanghai and presented on “Effectively Valuing PIPEs” at the FRA 10th Annual Valuation of Hard-to-Value Securities and Portfolios conference.

Listed in New York Super Lawyers, Ele received his J.D. from Yale Law School, where he was senior editor of The Yale Law Journal, and his B.S., summa cum laude, from Brooklyn College.

Kurt F. Rosell New York Office +1 212.756.2099 [email protected]

Kurt F. Rosell is a partner in the Tax Group at Schulte Roth & Zabel, where his practice focuses on the tax aspects of mergers and acquisitions, leveraged buyouts and other private equity transactions; international transactions; the formation of private equity funds; executive compensation; and bankruptcy and workout transactions. At recent speaking engagements, Kurt has addressed topics pertaining to the current economic downturn, such as “M&A in Bankruptcy” and “Tax Aspects of Investments in Distressed Situations.”

Listed in The Best Lawyers in America and New York Super Lawyers, Kurt earned his LL.M. in taxation from New York University School of Law, his J.D. from Columbia Law School, where he was a senior editor of the Columbia Law Review and a Harlan Fiske Stone Scholar, and his B.A., magna cum laude and Phi Beta Kappa, from Wake Forest University.

Notes:

Valuation

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Three generally acceptable valuation methodologies have unique considerations when being applied in a distressed situation: discounted cash flow, comparable companies analysis and precedent transactions analysis -- The more methods used, the more persuasive, particularly if the results are in the same ballpark -- Valuation methods based on speculative activities, such as bond trading or pink sheets may be unpersuasive to the court -- Expert credibility is critical, given the malleability of valuation methods -- Result-dependent compensation packages may limit expert’s credibility -- Courts will be wary of any perceived evasiveness or inconsistencies • Valuation adjustments may be necessary during the case if conditions change • Valuation challenges need to be brought to the court’s attention as soon as they are ripe for a decision • A court might negatively view unwillingness to back up a valuation argument with cash • Net operating losses/Section 382 -- Section 382 of the Tax Code was enacted to prevent “loss trafficking.” Unfortunately, it applies in many situations in which no loss trafficking occurs or is possible. -- The statute applies if a corporation that has net operating losses (or “built-in losses”) experiences an “ownership change.” An ownership change occurs if any one shareholder (or group of shareholders) increases its (or their) ownership of the stock of the loss corporation by more than 50 percentage points during a “testing period.” The test is based on ownership by shareholders who own at least 5% of the corporation’s stock, with all smaller shareholders treated as a single shareholder. -- So, if one shareholder of a loss corporation increases his ownership from 5% of a corporation’s stock to 55.1%, an ownership change occurred. In addition, if 10 separate shareholders, acting independently, each increase their ownership from 0% to 5.1% of a loss corporation’s stock, the loss corporation experienced an ownership change.

• Net operating losses/Section 382 (continued) -- Similarly, if one or a group of shareholders who each own at least 5% of a loss corporation’s stock and together own more than 50% of the corporation’s stock sell that stock in the market to other shareholders, an ownership change has occurred -- The main point is that a loss corporation can undergo an ownership change as a result of acquisitions of stock by shareholders who end up owning at least 5% of the corporation’s stock or sales of stock by shareholders who already own more than 5% -- In many cases, an important asset of an issuer of distressed securities is its net operating losses. Trading in the equity securities of the issuer can result in the occurrence of an ownership change under Section 382. As a result, in cases in which an issuer files for bankruptcy protection and has significant NOLs, the issuer will generally request that the bankruptcy court issue an equity trading order. -- The equity trading order will generally require a prospective purchaser of more than a specified number of shares of the bankrupt corporation’s stock (generally, a number somewhat less than 5% of the corporation’s stock) to notify the corporation of its intent to purchase shares in excess of the specified threshold. The prospective purchaser is not permitted to buy stock in excess of the threshold without the permission of the corporation. In addition, the trading order will require that shareholders who own shares in excess of the threshold at the time the order is issued, obtain the approval of the corporation before they sell any shares. -- Issues: -- Be aware of the existence of the trading order so you don’t inadvertently violate it. The orders are extremely common. -- An important issue exists as to whether investment funds managed by a common manager are treated as a single shareholder or as separate shareholders for purposes of determining how many shares of the bankrupt corporation’s stock the funds own. In the past, the Internal Revenue Service has ruled that commonly managed funds are treated as separate shareholders if the funds can make certain representations. There have been indications, though, that the IRS may be changing its view in this regard. The situation is far from clear. -- Assuming that the commonly managed funds filed Schedule 13D or 13G with respect to their purchases, the form in which those Schedules were filed can be important -- If a prospective shareholder desires to buy shares in excess of the specified threshold, timing is often key. The issuer is usually more likely to approve purchases early in the process rather than later. The same holds true for applications to sell by existing 5% shareholders.

Notes:

Rights Offering

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• In a rights offering, creditors of one or more particular classes of debt are granted the right to subscribe to post reorganization equity as part of the plan of reorganization • Subscribing creditors have to be (i) eligible to receive the securities and (ii) holders as of record date set by the bankruptcy court • Rights offering trading issues: -- Prior to record date, subscription rights travel with debt. If a trade settles before record date, then the buyer will be able to directly subscribe as record date holder. -- After record date, purchase of debt does not automatically include right to subscribe, as only record date holders can directly subscribe -- For trades that might settle after record date, buyer should include right to subscribe as part of trade terms and negotiate side letter to subscribe through its seller or seller’s seller • Backstop issues in rights offerings: -- Certain creditors (typically those holding a large percentage of the outstanding debt) may agree to backstop the rights offering (i.e., purchase any securities that are not subscribed for in the rights offering) for a fee -- If the debtor is a public company, Section 13(d) group issues may arise if the backstop parties own any equity or equity-linked security of the company. A group is formed “when two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer” (Rule 13d-5(b)(1)). The backstop may be an agreement to acquire securities or, if, for example, there are standstill provisions prohibiting sales of the securities, an agreement to hold securities. -- Section 13(d) group members are deemed to beneficially own any securities owned by the other group members. This can subject the backstop parties to reporting obligations under Section 13(d) (if the group is over 5% beneficial ownership) and profit disgorgement provisions under Section 16 (if the group is over 10% beneficial ownership).

• Backstop issues in rights offerings: (continued) -- If a Schedule 13D (rather than the short form Schedule 13G) is required to be filed because parties are not passive, sensitive information may be required to be disclosed. This information includes 60-day trading history, disclosure of holdings of other securities, including debt and derivative securities, and plans and proposals with respect to the issuer. A Schedule 13D also involves more frequent amendment obligations (e.g., any material change from the information previously reported). -- If the backstop parties are subject to Section 16, this could have disastrous consequences on the group members’ ability to trade. Section 16(b) requires insiders to pay to the issuer any profit derived from any sale and purchase or purchase and sale of the issuer’s securities within a period of less than six months and Section 16(c) prohibits insiders from executing short sales with respect to the issuer’s equity securities.

Notes:

Post-Emergence Equity Governance

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• The governance issues that arise with respect to the post-emergence entity vary depending on whether the issuer will be private or public post-emergence • If the issuer is public pre-emergence, but will have a smaller shareholder base post-emergence, the issuer may choose to “go dark” post-emergence to avoid the cost associated with being a public company. In order to go dark, the issuer will have to make certain filings with the SEC to delist and deregister its securities. After going dark, the issuer will no longer have to file reports with the SEC. • Governance of private post-reorganization entity: if the issuer will be private post-emergence, the debt holders that will be post-emergence shareholders will negotiate for, among other things, minority protections, drag-along rights, tag-along rights and consent/veto rights over fundamental or extraordinary transactions. Certain larger shareholders may also negotiate for seats on the board of directors or board of managers of the issuer. • Governance of public post-reorganization entity: if the issuer will be public post-emergence, the debt holders that will be post-emergence shareholders may negotiate for board seats. Board seats provide access to material, non-public information which will restrict trading ability outside of certain open trading windows (typically around the filing of the issuer’s Form 10-Qs or Form 10-Ks). If the shareholder’s beneficial ownership exceeds 5% and the shareholder has a board seat, it will likely have to file on the more onerous Schedule 13D rather than Schedule 13G. A board seat may subject the shareholder to the Section 16 profit disgorgement rules based on a “director-by-deputization” theory. • Those that will have a control interest in the post-emergence entity should also consider that controlling stockholders have special fiduciary duties to the minority stockholders under Delaware law (e.g., sales of control blocks by controlling stockholders are subject to the “entire fairness” test under Delaware law). Affiliate transactions between controlling stockholders and the company may be subject to enhanced scrutiny by directors and stockholders and, in extreme cases, by Delaware courts.

Notes:

LSTA vs. LMA Trading Issues

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• “Trade is a trade” concept: -- Two debt trading platforms: LSTA governed by New York law and LMA governed by English law -- Bank debt trades and claims trades can become binding when parties orally agree on material terms. What constitutes material terms is more clear in the context of widely traded bank debt on LSTA or LMA standard terms (i.e., price, face amount of debt and credit facility tranche). -- No requirement under New York statute of frauds exemption that trade be memorialized in writing -- Trade can be binding when certain material terms are missing -- Alternatively, parties can enter into a binding preliminary agreement to negotiate together in good faith in an effort to reach a final agreement. While this preliminary agreement does not create an obligation to close the ultimate transaction, courts have found that it does bar a party from “renouncing the deal, abandoning the negotiations, or insisting on conditions that do not conform to the preliminary agreement.” Bear Stearns Inv. Products, Inc. v. Hitachi Automotive Products (USA), Inc.1 • New York law “true participation” vs. English law debtor/creditor participation: -- In a loan participation, an investor purchases an interest based on a lender’s right to payment under a loan. Unlike an assignment of such interest, a participant does not become a lender of record and is not entitled to receive payments directly from the borrower. -- The decision to settle a trade by participation and whether to settle such a participation on LSTA or on LMA documents results in significantly different levels of counterparty credit risk and, in the event of a counterparty’s insolvency, result in significantly different recoveries -- Whether the underlying participation agreement is governed by English or New York law may determine a participant’s ownership interest in these payments

1 401 B.R. 598 (S.D.N.Y. 2009)

• New York law “true participation” vs. English law debtor/creditor participation: (continued) -- The relationship between the parties to a English law governed participation agreement is generally that of debtor and creditor and does not include any transfer of ownership in the actual payments of the underlying borrower -- New York law participations can be structured as so-called true participations that entitle the participant to an ownership interest in the proceeds paid by a borrower to a lender of record -- In a true participation, the participant has an actual ownership interest in the payments the lender of record receives from the borrower for the participant, which can isolate the payment stream from the participant’s counterparty’s potential bankruptcy estate

Notes:

Claims Trading Risk Allocation

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Three types of risk: -- Counterparty credit risk — risk seller becomes insolvent -- Recovery risk — risk related to the amount of the ultimate distribution -- Notional amount risk — risk that the face amount of the claim is reduced also known as impairment (not to be confused with the Bankruptcy Code definition of impairment) • Notional amount risk impairment of claim caused by: -- Creditor’s bad acts -- Fraud/insider trading -- Non-compliance with procedural/substantive requirements -- Inconsistency with debtor’s books and records -- Inclusion of unmatured interest, such as OID, or -- Preferential transfers to creditor • Impairment risk allocation in transfer documentation -- Recourse — buyer retains a put right for impaired amount of claim -- Non-recourse — impairment risk transferred to buyer subject to seller’s representations, warranties and indemnities, but may be risk equivalent of recourse, depending on drafting -- As-is — limited representations and warranties -- Hold back — purchasers holds back or pays part of purchase price in escrow subject to final determination of claim and claim amount

• Treatment of “market discount” (continued) -- A significant tax issue in distressed debt trading is the uncertain treatment of market discount. For debt securities issued at par (or close to it), market discount is the excess of the face amount of the debt and the purchase price a buyer paid for it in the secondary market. So, if an investor buys a $1,000 note that was issued at par for $600, the $400 excess of the face amount of the note over the purchase price is market discount for tax purposes. -- In general, the application of the market discount rules has two tax consequences. First, any payments received on the note are treated as ordinary income up to the amount of the accrued market discount on the note. Second, any gain recognized on a sale of the note (or as a result of a modification of the terms of the note that is treated as a sale for tax purposes, as described below) is also treated as ordinary income up to the amount of the accrued market discount. -- The market discount rules were enacted to address discounts that arises as a result of changes in prevailing market interest rates rather than changes in the creditworthiness of the issue of the debt. For example, if an “A” rated corporation issues five-year debt at par at 6% (the prevailing rate for issuers of similar quality at the time) and rates later increase to 8%, the previously issued debt will trade at a discount even if the creditworthiness of the issuer is unchanged. In that situation, the purchaser of the note in the secondary market at the time when rates have increased is in a similar position to an investor who purchases a note at original issuance with OID. The market discount rules were intended to treat the secondary market purchaser in a manner similar to the initial purchaser who purchases a note with OID. -- Unfortunately, the market discount rules are not limited to situations in which a decline in the market value of an issuer’s debt is attributable to an increase in prevailing interest rates. On their face, the rules apply to any purchase of outstanding debt at a discount, even if the full amount of the discount is attributable to a decline in the issuer’s creditworthiness. -- Under a literal (and possibly correct) reading of the market discount rules to debt trading at a deep discount as a result of a decline in the credit quality of the issuer, market discount accrues ratably over the remaining life of the debt. The rules would apply even if it is clear that the full principal amount of the debt will never be paid. The result would be that, if the issuer’s prospects improve and the value of the debt increases, any gain recognized by the seller would be treated as capital gains. In addition, if the issuer does pay some, but not all the principal amount of the debt and the debt remains outstanding, the principal payment would generally be treated as income in whole or in part. -- A more troubling issue can arise in the case of a modification of the terms of the debt in connection with a workout or reorganization of the issuer. In many cases, the modification of the terms will result in the deemed exchange of the existing debt for a hypothetical new debt. If neither the existing nor the new debt is traded on an “established securities market,” the issue price of the new debt will be the stated principal amount of the debt. -- So, to take the example of a holder who purchases a $1,000 face amount note in the market for $600, after which the terms of the note are modified in a manner that creates a deemed exchange for tax purposes, the holder would recognize gain of $400 (the excess of the face amount of the note over the holder’s tax basis in the note) and the gain would be treated as ordinary income under the market discount rules. That result would occur even though the holder had not received any cash as a result of the modification of the terms of the note. -- Note that the definition of an “established securities market” is by no means clear

Notes:

Icelandic Claims Trading Framework

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Iceland’s three major banks (Glitnir, Kaupthing, Landsbanki)2 collapsed in October 2009. The three banks had aggregate debt obligations of approximately $75 billion, over six times Iceland’s GDP at the time. • Despite difficulties related to Icelandic insolvency infrastructure, major market participants have developed a framework that allows for an active claims trading market in Icelandic bank claims. This framework relies on the existing trade documentation and settlement practices and legal knowledge base, both of which had developed among secondary debt and claims trading participants in the United States and Europe over the past decade. • Icelandic insolvency infrastructure issues: -- Unclear claims classification and priority of claim -- Domestic tax issues -- Lack of agreed upon claims transfer mechanics, and -- Unclear official guidance • These issues resulted in extended settlement times, limited liquidity, and caused uncertainty in the marketplace. Some of these issues were addressed by amendments to the Icelandic insolvency laws, other issues are still being addressed (i.e., what is an appropriate role for a creditors committee). • An efficient and liquid Icelandic bank claims market required a market standard for the legal claims trade documentation. The market had to decide between LMA and U.S.-style documentation: -- The advantage of the LMA’s documentation was that the LMA already had a claims trading platform and the documents were familiar to the European participants

2 Glitnir Bank hf., Landsbanki Islands hf. and Kaupthing Bank hf

• An efficient and liquid Icelandic bank claims market required a market standard for the legal claims trade documentation. The market had to decide between LMA and U.S.-style documentation: (continued) -- One of the LMA documentation’s disadvantages was that they transfer claims under English insolvency law, not Icelandic insolvency law. Claims transfer requirements are different depending on the jurisdiction. This would necessitate substantial revisions to the LMA’s documents to address the unique features of Icelandic bank claims. Additionally, the transfer documentation had to address certain Icelandic tax issues. -- U.S.-style documentation’s advantages was that they could easily be adopted to Icelandic claims. Additionally, given the uncertainty relating to Icelandic insolvency laws and its treatment of claims, U.S.-style documents would allow for purchase price holdbacks and other provisions that could clearly delineate and allocate risk among buyers and sellers. -- However, U.S.-style documents were relatively unfamiliar to market participants in Europe and required substantial negotiation for each trade • LMA documentation prevailed because: -- The vast majority of the original claimholders (and thus majority of claim sellers) were located in Europe, they preferred application of English or Icelandic law to the trades, they were more familiar with the LMA than the U.S.-style documents -- Sell-side participants resisted the U.S.-style documents even though it allows buyers and sellers to allocate notional amount risk among them, because they viewed this allocation as too “buyer-friendly”

Notes:

Post-Reorganization Equity Trading

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Bankruptcy Code Section 1145 exempts securities issued in exchange for, or principally for, claims against the debtor from Securities Laws’ registration requirement (“Plan Securities”).3 • Plan securities issued pursuant to a plan are deemed to be issued in a public offering. Generally, plan securities are freely tradable on any exchange. However, if equity is issued for cash and not principally in exchange for the claim, then Bankruptcy Code section will not apply. • But plan securities are not freely tradable by an “underwriter” which is an entity that: -- Purchases claims with a view to distribute plan securities -- Offers to sell plan securities for holders of post-reorganization equity -- Offers to buy plan securities from holders with a view to distribute the plan securities, or -- Is an issuer or affiliate of the issuer (i.e., the debtor) • “Ordinary trading transaction” allows underwriters not affiliated with the debtor to freely sell their plan securities. SEC no-action letters clarify that a trade may be an ordinary trading transaction, if:4 -- Issuer is a reporting company (files SEC reports) -- The trade is executed on either a national exchange or in the over-the-counter market, and -- Does not involve: -- A concerted action by recipients of the plan securities or by a distributor on their behalf -- The use of informational documents used to market the plan securities, and -- Special compensation to brokers and dealers in connection with the sale of the plan securities

3 11 U.S.C. § 1145 4 See, e.g., AWS Reorg., Inc. (Oct. 27, 1997); UNR Industries (July 11, 1989); Manville Corporation (Aug. 28, 1986)

• Practical trading considerations -- After emergence and particularly in the case of privately-held companies, there is a lack of market consensus around how an instrument will trade or even what rights will trade with the shares -- Accordingly, there is often disagreement over transfer procedures of a particular company’s post- reorganization equity, and the procedures can vary between different post-reorganization companies. For instance: -- Some companies require an opinion of counsel, stating that the security is not subject to securities laws -- Some companies require seller certifications to this effect and some companies require no opinion of counsel or certification whatsoever

Schulte Roth & Zabel’s Distressed Debt and Claims Trading Group has extensive experience representing broker- dealers, hedge funds, investment banks, CLOs and private equity funds on a wide range of U.S., European and emerging markets debt and claims trading matters.

We advise clients in structuring, preparing and negotiating deal-specific .`' 1 transaction documentation including: “big boy” letters, trade confirmations, distressed and par loan purchase and sale agreements, claim assignment agreements, debt and claim participation and sub-participation agreements, collateral annexes, netting letters, proceeds letters, confidentiality agreements, purchase agreements for the sale of private debt securities, and bid documentation in connection with debt auctions. In addition, through our relationships with many of the most significant participants in the distressed debt and claims trading market, including large agent banks and market makers, as well as our active involvement with the Loan Syndications and Trading Association (LSTA) and Loan Market Association (LMA), we are able to quickly gain access to information for clients, move trades along expeditiously, and steer the closing process past potential bottlenecks. The Distressed Debt and Claims Trading Group often plays a central role in transactions with a trading component while working closely with the firm’s other practice groups, including the distressed investing, business transactions, finance, investment management, business reorganization, structured products, litigation and tax groups.

We regularly handle the following types of transactions:

• Purchase and sale of U.S., European and emerging market distressed debt: We utilize the standard documentation of both the LSTA and the LMA, as well as the experience and legal knowledge of the distressed debt trading markets, to effectively advise our clients regarding their transactions and guide these transactions to successful and timely closings.

• Purchase and sale of bankruptcy claims: We have extensive experience in the bankruptcy claims arena, including assisting clients with the filing of bankruptcy claims, assisting clients that hold claims in negotiations with debtor companies, conducting diligence into the validity of bankruptcy claims, advising on the variety of recourse options available in structuring a bankruptcy claim sale and the negotiation of the terms of the assignment of claim agreement.

• Structure of auction of distressed debt: In the area of bank debt auctions, we collect bids, assist our clients in evaluating bids, and have successfully guided our clients through multiple rounds of bidding and all steps of the settlement process.

• Transfer of distressed debt in connection with equity rights offerings: We coordinate the purchase of bank debt and bonds that are granted subscription rights under plans of reorganization to purchase shares of a borrower’s post- reorganization equity. We organize the exercise of our clients’ subscription rights via the use of negotiated side letters, proceeds letters and other legal documents.

• Transfer of when-issued equity of companies emerging from bankruptcy: We are knowledgeable about the many details needed to effect a transfer of when- issued equity in a company whose shares are not yet listed on an exchange and have successfully negotiated stock purchase agreements that help shield both the buyer and seller from the risks that could be associated with the purchase and sale of a relatively illiquid asset. Representative Transactions • Lead role in debt buyback and tender offer: • Negotiation of bulk sale of loan portfolio: We played the lead role in a debt buyback and We negotiated the bulk sale of our client’s loan tender offer in connection with amendment portfolio, including the sale of equity together to a financing facility on behalf of a borrower with the debt and coordination with Agents client. We negotiated key details of the buyback and trustees to ensure that all of the individual with lenders so that the buyback would close transactions were settled properly. comtemporaneously as an amendment to the financing facility. Our unique structure allowed our • Structured and led club participation of bankruptcy client to buy the debt without breaching terms in claims: We represented the purchasers of economic the existing financing facility. participations and syndication of partial rights to multi-billion dollar bankruptcy claims. • Purchase and sale of non-traditional claims: We represented a purchaser in an auction of claims in a liquidating investment fund and related due diligence.

Representative credits and claims traded by our clients include: AbitibiBowater Inc., Aleris International Inc., American Axle & Manufacturing Inc., Aveos Holding Co., Capmark Financial Group Inc., Carey International Inc., Centro Properties Group, Charter Communications, Cinram International Inc., Citadel Broadcasting Corp., Clear Channel Communications Inc., Consolidated Container Co. LLC, Dana Holding Corp., Delphi Corp., Delta Air Lines Inc., Dex Media West LLC, FairPoint Communications Inc., Ford Motor Co., Freedom Communications Inc., Freescale Semiconductor Inc., Generac Holdings Inc., General Growth Properties Inc., General Motors Corp., Georgia Gulf Corp., Hawker Beechcraft Corp., Hexion Specialty Chemicals Inc., Idearc Inc., Kaupthing Bank hf., Landsbanki Íslands hf., Las Vegas Sands Corp., Lear Corp., Lee Enterprises, Lehman Brothers Holdings Inc. (and its affiliated U.S., U.K. and Bermuda debtors), Pacific Ethanol Inc., Penton Media Inc., Pope & Talbot Ltd., Quality Home Brands Holdings LLC, Quinn Group Ltd., SemGroup Corp., Simmons Bedding Co., Spectrum Brands Inc., Stallion Oilfield Services Ltd., Tribune Co., Tropicana Entertainment LLC, Univision Communications Inc., United Air Lines Inc., US Airways Group Inc., Visteon Corp., Xerium Technologies Inc. and Young Broadcasting Inc.

For more information, please contact:

Adam C. Harris David J. Karp Partner, Business Reorganization Special Counsel, Business Reorganization +1 212.756.2253 | [email protected] +1 212.756.2175 | [email protected]

Schulte Roth & Zabel LLP Schulte Roth & Zabel LLP Schulte Roth & Zabel International LLP New York Washington, DC London 919 Third Avenue 1152 Fifteenth Street, NW, Suite 850 Heathcoat House, 20 Savile Row New York, NY 10022 Washington, DC 20005 London W1S 3PR +1 212.756.2000 +1 202.729.7470 +44 (0) 20 7081 8000 +1 212.593.5955 fax +1 202.730.4520 fax +44 (0) 20 7081 8010 fax www.srz.com

The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions. ® is the registered trademark of Schulte Roth & Zabel LLP. 01.11 Tab 4: Investing in Financial Institutions

Speakers Mary Marks Omoz Osayimwese John Pollack 2Joseph Vitale 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Mary K. Marks New York Office +1 212.756.2546 [email protected]

Mary K. Marks is a special counsel in the Business Transactions, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. She practices in the areas of antitrust and competition counseling, with a focus on complying with and obtaining clearance under the Hart-Scott-Rodino Act and global merger control and foreign investment laws for U.S. and multinational acquisitions, divestitures and joint ventures. Mary advises transaction parties with respect to permissible pre-clearance and pre- closing activities. She also counsels clients regarding coordination and information sharing activities, and has been invited to participate in FTC discussions regarding HSR practice issues and, in particular, how the HSR rules apply to private investment firms.

Mary represents investment funds and corporate clients in transactions involving, among other sectors, telecommunications, food services, insurance, financial services, pharmaceuticals, pulp and paper goods, forests, supermarkets, automobile manufacturers, housewares, real estate and computer software. She has published articles on competition issues surrounding mergers; one article, to be published in the first quarter of 2011, explains compliance and disclosure under the new HSR regulations. She also recently appeared as a moderator at two American Bar Association Antitrust Section programs on the U.S. Supreme Court case American Needle v. NFL concerning antitrust issues facing joint ventures and other competitor collaborations.

Mary is vice chair of the ABA Antitrust Section’s Pricing Conduct Committee and serves as editor of the section’s newsletter, The Price Point. She has also been nominated to the NYSBA Antitrust Section’s Executive Committee for 2011-2012. She earned her J.D. from Georgetown University Law Center, where she was on the staff of the Georgetown Journal of Legal Ethics, and her B.B.A., magna cum laude, from the University of Notre Dame.

Omoz Osayimwese New York Office +1 212.756.2075 [email protected]

Omoz Osayimwese is a partner in the Investment Management and Financial Services Groups at Schulte Roth & Zabel, where he focuses his practice on the representation of sponsors and investors in the formation and structuring of private equity funds, hedge funds and hybrid funds. Omoz has extensive experience representing sponsors and investors in funds employing real estate, buyout, credit, distressed investment, activist, multi-strategy and long-short equity strategies. He also represents hedge fund managers and investors in the negotiation of seed capital transactions and advises sponsors of private equity firms in the structuring of complex carry-sharing arrangements among principals and employees.

Omoz’s recent representations include counseling institutional sponsors and boutique firms in the formation of private equity funds, hedge funds and hybrid funds; working with lead investors on their investments in private equity funds; representing hedge fund managers and investors in seed capital arrangements; counseling investment managers in joint venture arrangements; and advising investment managers and investors in the formation of special purpose acquisition and co-investment vehicles.

A regular speaker about current developments related to private investment funds, Omoz recently spoke on “Private Equity Investment Adviser Registration” at the SRZ Investment Management Hot Topics seminar. Omoz received his J.D. from University of Michigan Law School and his B.A., with highest honors, from Michigan State University.

John M. Pollack New York Office +1 212.756.2372 [email protected]

John M. Pollack, a partner in the Business Transactions and Financial Services Groups at Schulte Roth & Zabel, practices in the areas of public and private mergers, acquisitions, divestitures, restructurings, recapitalizations, co-investments, tender and exchange offers, distressed transactions and securities law matters. His clients include private investment funds as well as U.S. and foreign publicly traded companies.

John recently worked as counsel to Veritas Capital Fund Management LLC on the acquisition of Lockheed Martin Corp.’s Enterprise Integration Group business. He also worked on the merger of DynCorp International Inc. with an affiliate of Cerberus Capital Management LP, a transaction that was selected by The Deal as one of 2010’s “Private Equity Deals of the Year.” In addition, he was named to BTI Consulting Group’s BTI Client Service All-Star Team for 2010.

A member of the New York State Bar Association, John is also part of The George Washington University Law School’s board of advisors as well as an advisory board member of its Center for Law, Economics & Finance. He graduated magna cum laude with his J.D. and B.A. from The George Washington University Law School and The George Washington University, with the former bestowing upon him high honors, Order of the Coif and an award for Highest Overall Proficiency in Securities Law.

Joseph P. Vitale New York Office +1 212.756.2485 [email protected]

Joseph P. Vitale is a partner in the Bank Regulatory, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. He focuses his practice on the representation of financial institutions and money service businesses with respect to: chartering; regulatory compliance; financial transactions; mergers, acquisitions and reorganizations; responses to formal and informal regulatory actions; litigations and claims; and legislative and regulatory developments. Joseph advises entities, including private investment funds, seeking to acquire banks or other licensed financial or money service providers. He practices before the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Housing Finance Board, and the banking agencies of all 50 states, the District of Columbia and Puerto Rico.

A recent highlight of Joseph’s practice was his representation of the majority owners of a Fortune 500 mortgage and consumer finance conglomerate in connection with the institution’s conversion into the nation’s 14th largest bank holding company, a complex transaction that included a related $2 billion private recapitalization and the acquisition of $5 billion in public funds through the TARP. Joseph is admitted to federal and state courts for the District of Columbia and the State of New York, as well as the U.S. Court of Federal Claims, where, among other matters, he co-litigated a breach-of-contract claim on behalf of a former thrift institution which, after an eight-week trial, resulted in a $96 million judgment against the U.S. government.

A featured speaker at mergermarket’s recent Financial Services M&A Symposium, Joseph is a frequent speaker and is often quoted as an expert in the business and specialty press on issues related to bank regulations and compliance. He recently co-authored “New Paradigm in Asset Manager M&A: Financial Institution Alliances with Hedge Fund Managers” and “Dodd-Frank Becomes Law: Key Issues for Private Fund Managers,” both of which appeared in The Hedge Fund Journal. He received his J.D. from Georgetown University Law Center and his A.B. from the College of the Holy Cross.

Notes:

State of the Market & Outlook for 2011

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Open bank deals likely to exceed FDIC-assisted deals in 2011 -- While the FDIC “troubled bank” list continues to grow (860 as of end of Q3 2010), the focus is on resolving pre-failure • Several factors would seem to suggest serious upswing in M&A activity -- Enactment of Dodd-Frank and stabilizing market conditions lessen uncertainty -- Remaining TARP recipients looking for buyers to cut ties with the U.S. Treasury -- Significant consolidation expected -- Many consider the United States severely overbanked • 8,000 U.S. banks roughly equal to total in all of Europe -- Thousands of weakened, but non-“troubled banks” present potentially attractive opportunities for healthier strategic buyers -- Institutions will seek greater economies of scale to offset increased cost of doing business caused by Dodd-Frank and Basel III • Even strategic deals likely to present opportunities for private investment funds -- Many potential buyers will need to raise capital to fund acquisitions • Many private investment firms have become interested recently in investing in banks, banking holding companies and other financial institutions. Factors behind this upswing include: -- Multiples are currently at historic lows and are expected to rise -- The debt markets are improving, and -- Private investment firms are more willing to invest in attractively valued banks on the premise that performance will improve over time

• However, certain factors exist that have impeded the upswing, including: -- A focus on due diligence where government loss-sharing is not available, and -- Concern among certain regulators regarding private investment firms and a preference for traditional bank buyers -- This regulatory concern should be expected. Regulators are charged with the safety and soundness of the banking industry and there is a perception that the primary goal of private investment firms is to realize a short-term profit on their investment and influence the operations of the bank along such lines, even though it may not be in the best interests of the bank and its customers. Understanding and planning for such sensitivity is essential. • There will likely be more transparency into fund investments in future HSR filings because new rules expected in the next few months require disclosure of 5% investments of associates under common management

Regulation of Financial Institutions Notes:

Other Licensed Banks Financial Service Providers

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR ' z-s1nw1e aocn a zaoei ILP

• What’s similar? -- Target subject to significant regulation and regulatory oversight -- Required vetting process by regulator(s) for potential control parties and significant interest holders • What’s different? -- Banks: control parties (except for individuals) subject to significant ongoing regulation and regulatory oversight, effecting worldwide activities of both the control parties and their affiliates -- Other licensed financial service providers: following initial vetting process, control parties not typically regulated

Notes:

LAW and THE LAW

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• The law governing control of banks is very complex (and, in many cases, non-intuitive) -- Federal law implicated in all cases, involving one or more of four (soon to be three) different federal agencies -- Both federal and state law implicated for investments in state banks • Written law just the starting point -- Statutes and regulation provide significant discretion to regulators -- Many rules developed through precedent -- Some publicly available (if you know where to look), others known only to those who practice regularly in this area

Notes:

Voting EquityEquity

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR Izo a zaoei a

• Entities that “control” a bank must become a bank holding company (“BHC”). BHCs and their affiliates (including, in the case of a fund, its manager, any commonly controlled funds, and any (non-human)1 investors who are deemed to control the fund under the thresholds detailed in the above chart) must comply with: -- Activity and investment restrictions -- Capital requirements -- Reporting requirements and regulatory examination • To avoid the foregoing, your investment must be (i) less than 25% of any class of the bank’s voting stock, (ii) less than one-third of the bank’s total equity, and (iii) deemed otherwise “noncontrolling” • Regulatory control is the ability to significantly influence, not the ability to direct (so it exists well below operational control) • Control determined on a “totality of the circumstances” basis, examining a variety of factors, including: -- Percentage of total equity and voting rights (see above chart) -- Board representation (see Doing the Deal: Special Governance Rights) -- Consent/Veto rights or other covenants (see Doing the Deal: Special Governance Rights) -- Other business relationships with target (material relationships typically not allowed) • Investors acquiring 10% or more (or, in many recent cases, 5% or more) of any class of a bank’s voting stock or between 25% and one-third of its total equity will be required to make certain “passivity commitments” designed to ensure that the investor remains passive -- Such passivity commitments will apply to the investor and its affiliates (including, in the case of a fund, its manager, any commonly controlled funds and any investors who are deemed to control the fund under the thresholds detailed in the above chart)

1 Individuals who are deemed to control a fund that becomes a BHC would not be subject to any ongoing regulation, but would be required to go through a regulatory vetting process, involving significant personal disclosure (on a confidential basis)

Notes:

Aggregation

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• All affiliated parties (including funds controlled by the same advisor) holding investments in the same bank will be aggregated for the purpose of determining control -- Example: If a fund acquires 24% of a bank’s voting stock, and an affiliated fund acquires 1%, then will both be deemed to control the bank • Even unaffiliated parties may be aggregated together, if they are deemed to be “acting in concert” -- Any joint activity or known parallel action to attempt to influence a bank’s management or policies (whether or not pursuant to an expressed agreement) will constitute acting in concert -- Certain parties will automatically be presumed to be acting in concert, including parties with significant other business relationships (such as two fund groups that have significant investments with one another or in the same portfolio companies) -- This presumption is subject to rebuttal

Structuring Options Notes:

Investment Through Fund (No AIV) Th

Investors Investors Investors

Fund Fund AIV

Investment Investment Investment

Ime ttmeMs -T_rf' r,7771 I=

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR ' zon slnwIe aocn a zaoei «P

• Alternative Investment Vehicles (“AIVs”) are entities established by a private equity fund sponsor under the governing agreement of a private equity fund (the “Main Fund”) for purposes of making an investment that would otherwise create or result in a regulatory or tax issue if made through the Main Fund • An investment made through an AIV reduces investors’ unfunded or uncalled capital commitments to the Main Fund as if such investment had been made through the Main Fund (instead of through the AIV) • Investors’ percentage interests in an AIV may be lower than their percentage interests in the Main Fund to the extent that having such lower percentages would mitigate or eliminate a regulatory or tax issue • An AIV need not make the entire investment in question and sometimes only a portion of an investment is made through an AIV with the remaining portion of the investment made through the Main Fund

Simple vs. Complex Notes:

Simple Ownership Structure Complex Ownership Structure m 0

4W 00

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR I, -o -a..i..

• The laws and regulation governing investments in banks were designed with relatively simple structures in mind, not the complex “spider web” structures involved in many fund investments (including, most importantly, the fact that control of a fund does not, typically, lie with its investors) -- Solving for this requires “fitting a square peg into a round hole,” which requires not only knowing the law, but understanding the perspectives, sensitivities and objectives of: -- Banking regulators -- Private investment fund managers -- Fund investors

Notes:

Other Licensed Financial Service Providers

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Acquiring a “controlling” or significant interest in a (non-bank) federal or state-licensed financial service provider typically requires the satisfaction of a regulatory process -- Triggering thresholds vary by type of license and jurisdiction -- Thresholds may apply to percentage of equity, voting rights or both -- Analysis usually limited to objective thresholds -- Process varies by type of license and jurisdiction -- Prior approval required in some cases, post-acquisition notice in others -- Level of disclosure required varies, including whether officers and directors of fund or its advisor will be required to participate • Investors holding an interest in a fund above the applicable threshold may also be required to participate • In general, process consists solely of a one-time vetting, not ongoing regulation

Notes:

Antitrust Regulation

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Extensive antitrust regulation -- United States -- Federal Reserve Board -- U.S. Department of Justice, Antitrust Division -- U.S. Federal Trade Commission -- States Attorneys General -- Outside the United States (if parties have foreign subs OR investments) -- Canada -- EU -- Ireland -- Jersey -- Others -- Coordination among regulators • Substantive concerns -- Remedies must address greatest common denominator -- Competing definitions of relevant market -- In the United States, deal structure often affects HSR review, but not substantive analysis • Timing concerns -- Regulators showing concern for deal timing without sacrificing any substantive criteria -- Parties must be reasonable and upfront about remedies -- Usually advisable to informally consult with regulators before deal is announced

Doing the Deal: Solo Investments Notes:

General Partner

Investors

Investment Fund Bank

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR zo aocn a zaoei P

• Structure consists of a single fund (or group of affiliated funds) making a stand-alone investment • Investment negotiated directly with target • To avoid becoming a BHC, investment must be no more than 24.9% of any class of voting stock and no more than 33.3% of total equity (depending on the totality of the circumstances, the actual thresholds may be lower)

Notes:

Doing the Deal: Qualifying as Regulatory Capital

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Often times what is of paramount importance to the target (and accordingly dictates the transaction) is that the capital being invested qualifies as regulatory capital. Whether investment meets this objective will depend on a number of factors, including: -- The type of instrument (e.g., common equity vs. convertible preferred equity vs. a hybrid) -- The terms of the instrument (e.g., cumulative vs. non-cumulative dividends, preemptive rights, anti- dilution rights and similar rights) -- The post-closing rights of the investor (i.e., its “special governance rights”) -- The terms of any indemnification or other down-side relief being provided by the target in the transaction • For an investment to count toward a bank’s regulatory capital, among other things: -- There should be no put options or mandatory redemption or similar features associated with the instrument -- Any provisions for dividends and redemptions by banking organizations must be contingent on the prior approval of the board and, in most cases, the regulator -- No restrictions should be placed on the usage of the funds or that would deter the bank’s ability to raise capital in the future (subject to certain exceptions) -- For example, the Federal Reserve staff has expressed concern about the “reset” provisions granted in certain capital raising transactions. “Reset” provisions enable investors to claw back some of their investment if the financial institution raises further equity at a share price below the original investment. • The terms that work for regulatory capital treatment are constantly changing and evolving. It is important to understand the current lay-of-the-land when negotiating such terms.

Notes:

Doing the Deal: Special Governance Rights

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Usually, the investor will seek to obtain governance rights in connection with the transaction. Unlike investments in non-regulated companies, the investor’s ability to obtain these rights in a bank may be limited. • Assuming the investor is required to enter into a passivity agreement: -- In terms of board rights, the greater the investor’s interest, the more difficult it will be to obtain board rights while at the same time preserving the “non-control” nature of the investment. If you will own more than 24.9% of the bank’s equity (regardless of voting power), no more than two board seats will be allowed, and most likely only one board seat will be permitted. -- In terms of consent rights concerning the post-closing operation of the bank, such rights must be limited to fundamental decisions such as dissolution and materially adverse changes to the rights and preferences of the investor’s interest and should not give the investor veto powers over particular investments or management decisions. Examples of problematic provisions include consent rights over (i) the hiring, firing and compensation of management, (ii) the entry into new lines of business, (iii) capital raises (other than more senior capital or pari passu capital), and (iv) M&A transactions. -- In terms of access to management, the investor can obtain a right to communicate with the target’s management and customary access rights, but final decisions must rest with the bank’s directors and management • If the investor is acquiring an equity position large enough to require a passivity agreement, the default rule is that no post-closing business relationships between the bank and the investor will be permitted. However, relationships may be allowed if limited in scope/nature, on market terms, non- exclusive and terminable without penalty by the target.

Notes:

Doing the Deal: Investing Alongside Others

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Typically, in multi-investor transactions, the investors will enter into an interim consortium agreement and post-closing governance arrangements. For the most part, the interim consortium agreements and post-closing governance agreements are similar to other non-financial institution transactions. As discussed above, the ability to obtain special governance rights is more limited than in non-financial institution transactions. Accordingly, it will be of added comfort to an investor to be pari passu with any lead investor in the transaction. • Investors need to be mindful of the aggregation concept in terms of how they conduct themselves vis-à-vis other investors pre-signing and pre-closing. Aggregation may result if two or more investors are determined to be acting in concert, i.e., taking parallel action. Investing together in a transaction could be argued by a regulator to evidence that the parties are acting in concert. The regulator understands that a level of pre-closing interaction and coordination among investors will be necessary to get a deal closed (e.g., customary interaction for purposes of drafting, negotiating and finalizing investment and governance documentation). However, too much pre-closing interaction can be problematic. • We generally recommend that investors make their own investment decisions, conduct separate due diligence reviews, have their own separate legal counsel and be careful about the degree of communication with other investors

Doing the Deal: Club Transaction Structure Notes:

Fund A Fund B Fund C Fund D Fund E

/tC t1Q11 vm

.e-1 d, e.t tyomany

Investment by each fund below control threshold

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR I, -o -a....

• Structure consists of multiple, unaffiliated funds (or fund groups), each taking a noncontrolling interest (so as to avoid becoming BHCs), but in the aggregate the consortium (or “club”) acquires a controlling share of the target (typically 100%) • Typically, an acquisition vehicle is formed to facilitate the investment and own the target -- Acquisition vehicle must become BHC -- Management of acquisition vehicle recruited by club members, but must be unaffiliated with each (should be individuals with banking experience) -- Management of acquisition vehicle negotiates transaction with target on behalf of club • Club members must take special care not to be deemed to be acting in concert -- Independent investment decision -- Separate legal counsel -- Avoid ex parte communications with other club members -- Post transaction, manage investment and vote stock independent of all other club members. NO COORDINATION.

Doing the Deal: Blind Pool Investments Notes:

Acquisition V6111I

L?Pil3 [o falcetlatbe Invesimlenf. M- t become a BHC.

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR Izo Hen a zaoei a

• Structure similar to club deal, but deal devised and led by independent management team (who receive equity in return) -- Each investor “blind” to identity of other investors (each recruited by placement agent) • Historically, each investor limited to <5% or, in some cases, <10% • Investors more likely to include both funds and non-funds than club deal • In general, structure reduces regulatory concerns -- Limits on investment size and control by management designed to eliminate control issues -- “Blind” nature designed to eliminate concerted action issues

Doing the Deal: Hybrid Structures Notes:

A--/Lead

A"ulsltlan Vehicle`

s[o falcetlatbe Invesimlenf. Ma become a BHC.

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR Izo Hen a zaoei a

• Combination of club deal and blind pool -- Primarily structured like blind pool, except one or more lead investors (10% – 24.9%) are in the know and act like club members • In general, hybrid deals have evolved due to the regulator issues faced by true club deals and the difficulty in putting together true blind pools

Notes:

Doing the Deal: Exits

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Investors acquiring 5% or more of any class of voting stock in a deal involving FDIC-assistance are subject to a three-year lock-up. Such investors may not sell any portion of their interest within that period, unless they obtain the prior approval of the FDIC. • Aside from the special holding rules discussed above, in the non-control investment context, there are no specific regulatory impediments to an exit. However, if investors develop a reputation of making quick exits in problem banks, they may develop a reputation with the regulator that they’re only in it for the short haul which may make dealing with the regulator more challenging for future transactions. • The most logical exit is either the public or private sell-down of the investment, although of course the investor may also exit if the target bank sells itself to a third party • Registration rights are important and the investor will want to require target to file a resale shelf registration statement and have it declared effective as soon as possible after closing. The investor may want to demand reasonable liquidated damages if timetable for effectiveness of registration statement is not met.

Speakers Harry Davis David Nissenbaum Martin Perschetz 2Ronald Richman 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Harry S. Davis New York Office +1 212.756.2222 [email protected]

Harry S. Davis is a partner in the Litigation, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. His practice focuses on complex commercial litigation and regulatory matters for financial services industry clients, including hedge funds, funds of funds, private equity funds, prime and clearing brokers, auditors and administrators.

Harry has substantial experience in both securities regulatory matters and private litigation, including investigations by the SEC, U.S. attorney’s offices, the Department of Justice, the CFTC, the FTC, state attorneys general, state securities regulators and self-regulatory organizations.

Harry has litigated numerous cases in federal and state courts throughout the United States, including his recent successful representation of a prime broker in a hotly contested and high-profile fraudulent transfer trial brought by the bankruptcy trustee of a failed hedge fund. Over the course of his career, Harry has represented clients in investigations and litigations involving allegations of insider trading, market manipulation, market timing and late trading, alleged securities law violations concerning PIPEs, short-swing profits, securities and common law fraud, advertising, breach of fiduciary duty and breach of contract, among other claims. To prevent minor issues from growing into bigger problems, he provides litigation and compliance counseling to many of the firm’s clients, and conducts internal investigations.

A prolific author and highly sought speaker, Harry recently served as the editor of the Insider Trading Law and Compliance Answer Book, to be published this year by the Practising Law Institute, and authored two chapters: “Introduction to the Law of Insider Trading” and “Materiality.” He also co-authored “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment” for The Hedge Fund Law Report’s Feb. 17, 2010, issue and “Clearing Broker Liability and Responsibilities” in Broker-Dealer Regulation, published by the Practising Law Institute. He also recently spoke on “Hedge Funds: Tracking the Progress of Reform” at The Financial Times Global Financial Forum as well as “An In-Depth Look at Recent Trading Revisions and Compliance” at the FRA Hedge Fund Compliance Summit.

Harry graduated with a J.D., magna cum laude, from Cornell Law School, where he was associate editor of the Cornell Law Review, and was awarded his B.A., with departmental honors, from Johns Hopkins University.

David Nissenbaum New York Office +1 212.756.2227 [email protected]

Martin L. Perschetz New York Office +1 212.756.2247 [email protected]

Martin L. Perschetz is a partner and co-chair of the Litigation Group, a member of the Regulatory & Compliance Group and a member of the Executive Committee at Schulte Roth & Zabel. He concentrates his practice in the areas of white-collar criminal defense, SEC enforcement, securities litigation and accountant’s liability. With the firm for almost 25 years, Marty was previously an assistant U.S. attorney for the Southern District of New York, where he was chief of the Major Crimes Unit and led a team of prosecutors in the investigation and prosecution of federal criminal cases involving a wide variety of complex business and tax frauds.

Marty has represented a wide array of clients in significant matters involving federal and state prosecutors, the SEC, the NYSE and FINRA, as well as in large and complex private civil litigation and in corporate internal investigations. His clients in securities and financial statement matters have included PricewaterhouseCoopers LLP and Big Four accounting firm auditors; investment funds Millennium Partners and The Clinton Group; and former senior officials at Merck, Vivendi Universal, Kmart Corp. and other large companies.

Marty recently co-authored the chapter “Scienter/Trading ‘on the Basis of’” for the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. He has also recently spoken on “Recent Developments in Civil Litigation” for the PLI program on Auditor Liability in the Current Environment 2010: How to Protect Yourself.

The AmLaw Daily named Marty a “Litigator of the Week” for his successful work defending the former CFO of Vivendi Universal. Believed to be the largest federal securities class action ever to proceed to a jury verdict, the case involved numerous complex issues under the antifraud provisions of the federal securities laws, and under U.S. and French Generally Accepted Accounting Principles. Marty has also been recognized by Benchmark Litigation: The Definitive Guide to America’s Leading Litigation Firms & Attorneys, The Best Lawyers in America and New York Super Lawyers. Marty received his J.D. from the State University of New York at Buffalo Law School, where he was case and comment editor of the Buffalo Law Review, and a B.A., with honors, from the University of Maryland.

Ronald E. Richman New York Office +1 212.756.2048 [email protected]

Ronald E. Richman is a partner and co-head of the Employment & Employee Benefits Group and a member of the Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. Ron concentrates his practice on the litigation of employment and employee benefits cases in federal and state courts throughout the United States. He litigates cases involving trade secrets, non- competition, non-solicit and breach of confidentiality, breach of loyalty issues and represents private equity funds and hedge funds in employment and employment contact disputes. He defends employee benefit plans, fiduciaries and employers in class actions and in cases brought by individual plaintiffs. He represents employee benefit plans before the U.S. Department of Labor, the Pension Benefit Guaranty Corporation and the Internal Revenue Service in connection with novel issues of law concerning plan mergers, terminations, spin-offs, fiduciary duties and prohibited transactions, and various aspects of withdrawal liability and mass withdrawal liability. Ron also represents employers (particularly hedge and private equity funds), employees and partners with respect to executive compensation and partnership issues.

Ron frequently speaks and writes on employee benefit and employment topics. He recently spoke on “Developments 401(k) Stock Drop Crisis” at the Legal Education Institute and “Plan Mergers in Troubled Economic Times” at the International Foundation of Employee Benefits Plans 56th U.S. Annual Employee Benefits Conference and “Social Networking in the Legal World, the Good, Bad, and the Ugly” at The Computer Forensic Show.

A fellow of the American College of Employee Benefits Counsel and a member of the CPR Employment Dispute Committee of the CPR Institute for Dispute Resolution, Ron received a J.D. from Columbia University School of Law, where he was a Harlan Fiske Stone Scholar and the recipient of the Emil Schlesinger Labor Law Prize, and a B.S. from the Industrial and Labor Relations School at Cornell University.

Notes:

The Importance of Proper Preparedness

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Preparedness is more important than ever in the current enforcement environment -- Recent high profile raids by the FBI and subpoenas from the SEC and USAO against firms allegedly engaged in insider trading -- Intense focus on information obtained from expert networks and consultants • Implications for your business and your funds -- Survival -- Reputation -- Redemptions -- Future investors -- Portfolio management -- Brain drain

Notes:

First Signs of Crisis

SEC Subpoenas or Informal Inquiries

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• A crisis may arise in a number of ways, each presenting unique challenges -- Execution of a search warrant -- Service of a grand jury subpoena by federal or state prosecutors -- SEC subpoena or informal inquiry -- Inquiries by other federal or state regulators -- Learning from your own compliance programs or from current or former employees that a problem may exist

Notes:

Simultaneous First Steps

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Selection of counsel • Legal representation for employees • Document preservation • Communication with employees

Notes:

Simultaneous First Steps: Selection of Counsel

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Essential that at the first indication of a problem, the very first step should be to retain an attorney with specialized knowledge and expertise • Factors to consider -- Experience of counsel in dealing with the government -- Experience of counsel with the specific type of issues presented -- Experience of counsel in related litigation -- Private civil litigation may arise from a government investigation -- Experience of counsel with the industry • Who does counsel represent? -- Funds, management company, both -- Principals of the fund -- Employees: whether counsel represents employees personally or only the company depends on the facts and circumstances.

Notes:

Simultaneous First Steps: Legal Representation for Employees

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• What to do when an employee wants his or her own lawyer -- Outside counsel must give so-called Upjohn warnings when speaking to employees, warning the employee that counsel represents the company and not the employee individually. A common response to this is for the employee to ask for their own lawyer, although many may wish to appear as “team players” and use the company’s lawyer. • Key issues -- Employees have no “Fifth Amendment” rights to remain silent in connection with interviews or an internal investigation by employers, and in most situations — absent an employment contract to the contrary — you are free to terminate an employee who does not cooperate fully. -- Attorneys do have some ethical requirements besides the Upjohn warnings: if the employee asks the attorney if the employee should retain independent counsel, the company attorney should inform the employee that the company attorney cannot advise the employee as to whether to retain his or her own counsel, but should answer truthfully whether there is a conflict • Best practices -- Allowing employees access to their own attorneys (and paying for those attorneys) will often encourage employees to cooperate. To prevent their attorneys from over asserting themselves in the investigation, may want to consider allowing them to attend interviews with their client, but request that they not speak during such interviews. • Indemnifications -- By fund or management company -- Additional considerations

Notes:

Simultaneous First Steps: Document Preservation

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Work with counsel to send a litigation hold to all relevant employees. This memorandum should inform them of what documents are to be retained, and emphasize the importance of not deleting or destroying any relevant documents. -- It is important to give counsel an understanding of your electronic data systems and ensure that electronic data is not inadvertently deleted or made difficult to restore or access • Important that all documents that are possibly relevant to the investigation be preserved • Deleting questionable data risks severe consequences, usually worse than the actual data that had been deleted -- In some situations, any destroyed evidence may be inferred to have been adverse to you -- In more serious cases, obstruction of justice charges may arise from destruction of documents • Need to inform and remind employees of the need to preserve documents, and warn them of both the civil liability implications of failing to preserve all relevant documents and the criminal exposure associated with document destruction

Notes:

Simultaneous First Steps: Communication with Employees

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Important to communicate essentials to employees as necessary: document retention, attorney representation issues, and importance of not talking to the press or to regulators (without doing so in conjunction with the firm’s attorney) • Handling the “office rumor mill” -- Need to make decisions about how much information regarding the government’s investigation as well as your own internal investigation should be conveyed to personnel. As a general rule, best not to comment on pending investigations or personnel issues. However, in some high-profile situations it may be appropriate to issue a carefully considered preemptive statement to prevent rumors from building. -- Should keep employees with knowledge of the investigation to a minimum, both to prevent rumors and to control whistleblower risks • Non-cooperating employees -- May face both employees who will not cooperate in an internal investigation, and those who cooperate internally but refuse to cooperate once the government is more closely involved • Dealing with employees who have engaged in wrongdoing -- Can usually terminate employees immediately after wrongdoing is discovered: at-will employees may be terminated for nearly any reason, and employees with contracts will usually have a clause allowing such individuals to be terminated for “Cause” as a result of misconduct. Acting too quickly may expose the company to potential liability later, however. • Tell employees that if they are contacted by regulators, they should have no substantive conversation with the regulators before speaking with the company’s attorney • Former key employees

Notes:

First Substantive Communication with Regulators: Version One vs. Version Two

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• First substantive conversation may be very different depending on whether your first awareness of the crisis results from a regulatory inquiry or has been discovered internally -- If the government is already involved, then the conversation will be shaped in response to government’s earlier search warrant, subpoena or other communication -- If triggered by an internal alert, the conversation will be to inform the regulator that you have discovered an issue, to provide relevant background information and to explain what you have done in response already • Don’t talk to regulators before you speak to counsel • An “all-important” conversation that sets the tone of your relationship with the regulators • Important to carefully plan all communications with regulators. That is doubly important with respect to the first substantive discussion. -- Before making the initial call, consider what you hope to accomplish and what you will say • Need to take into account what regulator you are dealing with: the Department of Justice, New York Attorney General and SEC all have different ways to deal with situations. This is especially an area where experienced counsel can provide guidance.

Notes:

Disclosure and Communication: Investors, Counterparties and Press

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• All internal communications should be handled through counsel. Other communications are not privileged, and could eventually be discoverable. Also, these communications may be inaccurately reflected in non-privileged notes, memos or other documents. Note that external communications — those with investors, counterparties, the press, etc. — will not be privileged and, therefore, the government will be able to learn the details of those communications. • Disclosure to investors -- Need to determine if disclosure is required. If not required, need to decide whether voluntary disclosure is appropriate. -- If making disclosure (required or voluntary), need to decide the medium -- Telephone calls: more personal, but if the investor asks follow-up questions, this may raise risks of selective disclosure, so should be done carefully and under advice of counsel -- Letters or e-mail: although this ensures a clear record of what was disclosed, it also increases the chances that the information will be provided to others (such as the press) -- Responding to inquiries about whether you are under investigation with a statement that “we do not comment on pending investigations” is ideal. However, if you have previously responded to such questions with a denial, a “no comment” response may be considered misleading. -- Due diligence questionnaires (DDQs) often inquire as to whether you are under investigation or have received a regulatory subpoena or inquiry. If you have a form DDQ response, need to examine it and determine whether or not it is appropriate. • Communication with counterparties: prime brokers, ISDA agreement obligations, lenders and other counterparties • Dealing with the press -- Should already have a policy in place stating that employees should not speak to the press directly, and should direct any media inquiries to a designated public relations person. If don’t have a press policy, then should enact one immediately.

Notes:

Internal Investigations: The Short Version

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Should be conducted by outside counsel, not internal staff • An internal investigation allows an opportunity to cooperate with the government, which may significantly reduce penalties and other sanctions or even dissuade authorities from bringing an action at all • Before conducting an internal investigation, need to create a plan and consider the speed and scope of the investigation -- Speed is important, because the government will act much more favorably if the company is the first to report any wrongdoing. Your employees have a strong incentive, both as possible bounties and reduced sentences, to report before you do. -- Scope is also important, and thoroughness may be essential to the government in considering your cooperation to be sufficient. Thoroughness is also key to protection against defamation suits by employees found to have engaged in wrongdoing who later claim that your investigation failed to find exculpatory information. You should work with counsel before the investigation begins to create a specific work plan to determine what the investigation should cover, and follow the plan carefully to ensure that nothing is missed. • Need to carefully consider anything that is put in writing. Even documents covered by privilege may be acquired by the government if they ask you to waive privilege.

Notes:

Self-Reporting

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• What to do if your internal investigation reveals potential problems? • Pros and cons of self-reporting -- Need to evaluate whether disclosure will do more harm than good in your particular circumstance -- While self-reporting may create risk, reporting problems before a regulator discovers them independently may result in lesser penalties or sanctions -- Also need to consider that if you discover a problem, fail to report it, and the government later uncovers the issue, this may result in harsher penalties if it appears that you attempted to “cover up” the problem • If you choose to self-report, you must carefully plan the reporting -- Self-reporting offers a chance to present the situation on your own terms, so important to make full use of this opportunity

Notes:

Whistleblower Issues

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Always a consideration, but Dodd-Frank has provided both additional protections and incentives for whistleblowers. It also expands the scope of who is considered a whistleblower, to include all those who provide information regarding “potential” violations, encouraging potential whistleblowers to act at the first suspicion of wrongdoing. • As discussed above, whistleblower considerations are especially important in an internal investigation. Any employee who obtains information may decide to go to the government in exchange for a bounty, the amount of which is now governed by statute (i.e., Section 922 of Dodd- Frank amended the Securities Exchange Act of 1934 to provide for bounty awards of 10% to 30% of the amount of monetary sanctions when such sanctions exceed $1,000,000). Employees who have engaged in wrongdoing have a greater incentive to approach the government, as their cooperation may result in reduced fines and penalties or other leniency. All of this would reduce the value of your company’s cooperation and may make employees more likely to take their concerns directly to the government rather than to senior management or legal and compliance personnel within your firm.

Notes:

Dealing with the Government on an Ongoing Basis

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Communicating with the government during the investigation • Negotiating with the government • Decision to settle or fight -- Before choosing to settle, need to carefully consider its impact on redemptions, the future of the fund and potential civil liability • Whether to contact regulators other than your primary contact -- A number of issues must be considered: such contact may risk causing additional harm by attracting the attention of other authorities. On the other hand, it may provide benefits given for cooperation, and may be necessary to determine the full extent of potential liability.

www.hflawreport.com Volume 3, Number 7 February 17, 2010 Insider Trading Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment

By Harry S. Davis, Richard Morvillo and Justin Mendelsohn, Schulte Roth & Zabel LLP

As the Securities Exchange Commission (the “SEC”) and prohibited.6 And the penalties for insider trading are very federal prosecutors continue their crackdown on what they serious. In addition to required disgorgement of up to three perceive to be “systemic” insider trading within the hedge times any profit earned (or any loss avoided) as a result of the fund industry,1 now more than ever it is critical for all illegal trading, the SEC can seek penalties of up to $5 million industry participants to be aware of the line between good for individuals and $25 million for entities, prosecutors can research, including entirely lawful information-gathering, seek up to twenty years in jail and, for investment advisers and impermissible insider trading. This article examines (whether or not they are registered), the SEC can obtain a some of the commonly misunderstood areas of the law of lifetime bar from the industry, not to mention the significant insider trading in the context of the current, unprecedented reputational damage that comes from mere allegations of regulatory environment. Understanding the subtleties in insider trading. the statutory framework is fundamental to protecting your firm because, as we have all observed, mere allegations of Although an understanding of the most basic rules relating to insider trading can wipe out a multi-billion dollar hedge fund insider trading is of course vital to any market participant, it 2 operation through massive investor redemptions. is particularly important for hedge fund managers and their professional staff to understand the details in this evolving At the most fundamental level, the prohibition against insider area of the law and to consult regularly with experienced trading bars the trading of securities on the basis of material, counsel in order to stay on the right side of the line and non-public information.3 The reach of the law, however, protect yourselves and your firm. And that is true now more extends well-beyond those who actually make or even profit than ever. Because so much of the law of insider trading from tainted trades. For instance, one who shares material, depends upon the facts and circumstances of each individual non-public information (the “tipper”) with those who then case, this article is not designed to provide a comprehensive trade based on that information (the “tippee”) can be liable analysis of the law. Rather it is intended to give a broad for insider trading even where the tipper does not make overview and to answer some frequently asked questions and any trades, earns no profits and avoids no losses.4 It does dispel some important misconceptions. not matter whether the tipper trades in the security; both parties may be held liable. What’s more, it is illegal to even The Current Regulatory Environment recommend the purchase or sale of securities on the basis of material, non-public information.5 Assisting someone who is Both the SEC and the Department of Justice have authority engaged in any of the above-mentioned activities is likewise to bring insider trading cases and the agencies are currently

www.hflawreport.com Volume 3, Number 7 February 17, 2010

working in concert with an unprecedented tenacity to tactics such as the utilization of “cooperating witnesses” to bring new cases, especially cases involving the hedge fund voluntarily record telephone and other conversations with community. The enhanced coordination between the “targets” of governmental investigations, court ordered agencies and their subsequent aggressive posture is hardly wiretaps obtained by federal prosecutors and extensive data- surprising; the recently appointed Director of the SEC’s mining by the SEC’s Office of Market Intelligence. As Enforcement Division, Robert Khuzami, his deputy, Lorin a result of these changes, firms are receiving increasingly L. Reisner, as well as the Director of the SEC’s Northeast broad subpoenas that require the disclosure of wide-ranging Regional Office, George S. Canellos, are all former federal information, such as all communications with other hedge prosecutors with the United States Attorney’s Office for the funds and documentation of all trades over longer time Southern District of New York. periods than has been the norm in prior investigations. At the same time, the number of formal Enforcement Upon taking office, Mr. Khuzami announced several new investigations opened in 2009 more than doubled from the initiatives, many of which indicate that the Division of previous year.11 Enforcement is focused on hedge funds and potential insider trading. For example, an Asset Management Unit has been In this environment, it is critical for those in the hedge fund established to focus exclusively on investment advisers, industry to be aware not only of the general prohibitions investment companies, hedge funds and private equity funds against insider trading, but also those areas of the law that and the Office of Market Intelligence has been created to are less commonly understood. The following sections are monitor incoming tips and complaints to the SEC. These designed to assist hedge fund compliance officers and in- units will be used to “ferret out” those “funds whose business house lawyers as well as business people to navigate these model consisted of vigorous attempts to collect information perilous regulatory waters. Of course, as this is an evolving from corporate insiders and to utilize that information to area of the law and the SEC, federal prosecutors and other trade.”7 Each of these units is headed by senior enforcement securities regulators are seeking to expand the boundaries lawyers with years of SEC experience.8 every day, consultation with experienced securities regulatory

counsel is essential. Additionally, several procedural and structural changes

designed to streamline management and internal processes Defining an “Insider” at the Division of Enforcement have been implemented, including the redeployment of all branch chiefs to It is obvious that the term “insider” encompasses officers, investigative work9 and the delegation of the power to issue directors and employees of the company that issued the formal orders of investigation (and the associated subpoena securities (the “Issuer”). But those people are not the only power) to senior officers throughout the Division, as corporate “insiders” to whom the prohibition against insider opposed to the old protocol that required prior Commission trading applies. Indeed, any person (or entity) who, by approval.10 These efficiency-minded measures have been reason of his or her fiduciary relationship with the Issuer, has accompanied by the use of new and aggressive investigatory access to material, non-public information is considered an

www.hflawreport.com Volume 3, Number 7 February 17, 2010 insider under the law.12 That includes the Issuer’s auditors, The Broad Scope of What Constitutes attorneys, bankers, and other advisors, who are often a “Trade in Securities” referred to as “temporary insiders.” All “insiders” (including A “trade in securities” is another phrase that has a much more “temporary insiders”) who are aware of material, non-public expansive meaning than the general public, or even some information about the Issuer have a duty to either disclose all financial industry participants, may appreciate. “Securities” material, non-public information to the entire marketplace is a broadly-defined term that includes virtually anything 13 or refrain from trading. that someone might be interested in trading.16 Thus, in addition to the obvious trading of stocks and bonds, a “trade What may be less obvious is that certain of the company’s in securities” also encompasses shorting stocks, puts, calls, security holders, broker-dealers and securities analysts may derivatives, and the manipulation of programmed trades. become temporary insiders when they come into possession of material, non-public information as a result of a close SEC Enforcement Director Robert Khuzami has recently association or relationship with the company or its insiders.14 emphasized that the SEC will be scouring trades outside For example, in Ferraioli v. Cantor, the U.S. District Court the traditional markets to detect insider trading. “The days for the Southern District of New York held that a controlling of insider trading scrutiny being focused almost solely on stockholder was an insider and was necessarily precluded the equity markets are now gone,” Khuzami warned at a 17 from acting on undisclosed material information.15 recent conference on hedge fund regulation in New York. According to Khuzami, the SEC will “roll back the curtain on those markets and look at patterns across all markets.”18 It is thus important to recognize that, depending on the In fact, the SEC brought its first insider trading case relating facts and circumstances, you or your firm may become an to credit default swaps in May, when it brought an action insider, even unwillingly. At that point, a duty may arise against a Deutsche Bank AG salesman on claims that he and it may be unlawful to trade in the security at issue wrongfully conveyed information on a bond sale to a hedge- while in possession of material, non-public information. fund money manager.19 That case is currently in discovery Furthermore, it is necessary to have an appreciation of after the defendants’ motion to dismiss on the basis that the whether an outside source of information is in fact an insider SEC had no jurisdiction over the swaps was dismissed in in order to avoid “tippee” liability. One must set aside the December 2009. The court in that case refused to dismiss paradigm of the traditional insiders and determine how the the SEC’s complaint and sent the case forward to the material information was discovered. If material information discovery phase. In doing so, the court held that it would is conveyed by an insider, and such information was not look beyond the face of the swaps to determine whether they disclosed to the public, you may be restricted from trading in were securities-based swaps and therefore within the SEC’s that security. purview under Section 10(b) of the Securities Exchange Act of 1934.20

www.hflawreport.com Volume 3, Number 7 February 17, 2010

It is difficult to overemphasize the breadth of what may through publicly available information as well as other work constitute a “trade in securities”. Loan participations may that you have done on the company (but which does not even be swept under the classification depending on the include obtaining any material, non-public information). facts of the case. In this context, the Supreme Court has On Friday, your analyst finishes developing an investment adopted the Second Circuit’s “family resemblance” approach thesis and a model in which he believes that Company X to determine whether a particular instrument qualifies as is undervalued by the market and its stock price is likely to 21 a security. Under this test, a note is presumed to be a rise as the market realizes Company X’s true potential. As security because the word “note” is included in the statutory the firm’s portfolio manager, you consider the analyst’s view definition of “security”, and that such a presumption may over the weekend and decide to build a sizeable position be rebutted only by showing that the note bears a strong in Company X’s shares starting the following Monday. resemblance to a judicially enumerated list of instruments Unbeknownst to you, over the weekend – after you have which are not securities. made your decision to buy Company X’s stock on the basis

of your analyst’s thoughtful and painstaking analysis but Factors the courts consider include: (i) the motivations before your firm has purchased those shares – one of your that would prompt a reasonable buyer to enter into the firm’s other professionals talks with a senior executive at transaction; (ii) the plan of distribution of the instrument; Company X, who tells her that the company is in the final (iii) the reasonable expectations of the investing public; and (iv) whether some other factor, such as the existence of stages of negotiating a merger with its largest competitor. another regulatory scheme, significantly reduces the risk of On Monday you would still like to build the same position the instrument.22 And while many industry participants in Company X’s stock as you did over the weekend and remain of the view that loan participations are unlikely to it is still based upon your analyst’s work prior to learning be swept within the ambit of “security” – the SEC has yet to this obviously material, non-public information about the bring an insider trading case involving the trading of bank company’s merger plans. Can you do so? The answer is debt – the issue is not free from doubt in every case. NO! Why? Because even though the information about the Company’s merger plans is not the reason for your desire Because the SEC has clearly announced its intention to to buy Company X’s stock, your firm is now “aware” of pay closer attention to non-equity markets in its campaign material, non-public information about Company X and against insider trading, hedge funds should expect the the SEC takes the view that any trade made while “aware” rules to be applied to an ever expanding swath of financial of material, non-public information is a trade made “on the products. basis of” that information (even if the information did not really motivate your firm to trade). The Meaning of a Trade Which Is “On the Basis of” Material, Non-Public Information As you can see from this hypothetical, what it means Consider the following scenario: your fund has spent for a trade to be “on the basis of” material, non-public countless hours researching and analyzing Company X information is not intuitive and represents an area of the

www.hflawreport.com Volume 3, Number 7 February 17, 2010

law filled with misconceptions. Simply put, you don’t have sales, and delegate those decisions to a person who did not to actually use the information you receive in trading for a possess material, non-public information. Also, the purchase trade to be “on the basis of” that information. Indeed, the or sale at issue must be “pursuant to the contract, instruction, SEC adopted a rule dealing directly with this point. Under or plan,” meaning that the individual or entity that entered SEC Rule 10b5-1, a trade is “on the basis of” material, into the contract did not alter or deviate from it, or engage non-public information if anyone in your organization is in a corresponding or hedging transaction with respect to the “aware” of the information at the time of the trade (unless a securities.26 safe harbor applies).23 Importantly, the time for measuring “awareness” is “when the person made the purchase or sale” The second safe harbor involves the implementation not when the person decided to make the purchase or sale.24 of effective policies and procedures designed to prevent It is also significant to note that awareness of material, non- individuals who make investment decisions from acquiring public information by any one individual within your firm is material, non-public information from other parts of the imputed to everyone at your firm (again, subject to the safe firm. Such policies and procedures are often referred to harbors discussed below).25 As a result, looking back to the as “information barriers,” an “ethics wall,” or a “Chinese hypothetical fund’s desired purchase of Company X’s shares, Wall”. In order for an entity to rely on the “information the desired trade would likely violate the insider trading barrier” safe harbor in Rule 10b5-1, the entity must show laws, even though the material, non-public information that: (i) the individual who made the investment decision was obtained by a different person than either the analyst on behalf of the entity was not aware of the material, non- (who came up with the investment recommendation) or the public information; and (ii) the entity had implemented portfolio manager (who made the decision to trade) and even reasonable policies and procedures, in light of the nature of though the information was obtained only after the decision the entity’s business, to ensure that those making investment to trade had been made. This is because the firm became decisions on its behalf would not violate the insider trading aware of the material, non-public information before the laws.27 In addition, those policies and procedures must be trade was made. in place before anyone in your firm becomes “aware” of material, non-public information, meaning that you cannot As noted above, there are several safe harbors to the rule that wall someone off from the rest of the firm after she becomes awareness of information equates to a subsequent trade being aware of material, non-public information (only before “on the basis of” that information. First, an individual or she becomes aware of that information). It is important to entity may adopt a “10b5-1 Trading Plan,” which must (i) note that the SEC contemplates fairly draconian separation specify the “amount” of securities to be purchased or sold, between “public teams” and “private teams” for information and the “price” and “date” of the purchase or sale; (ii) include barriers to be deemed effective and this can often be difficult a written formula for determining the amount; or (iii) forbid (but certainly not impossible) to implement in practice in a the individual or entity to exercise any subsequent influence hedge fund environment. over how, when, and whether to conduct the purchases or

www.hflawreport.com Volume 3, Number 7 February 17, 2010

Determining Whether Information is “Material” Regulation FD prohibits Issuers from selectively disclosing material, non-public information to securities professionals A significant number of insider trading cases turn on the (or anyone else) without making simultaneous public issue of whether the non-public information received is disclosure of the same information. In essence, Regulation actually “material.” It is therefore vital to understand how FD is the flip side of insider trading: Regulation FD the courts have interpreted this element. Information precludes Issuers from selectively disclosing material, non- is “material” if there is a “substantial likelihood that the public information while the laws against insider trading disclosure of [that information] would have been viewed preclude the recipient of such information (as well as the by the reasonable investor as having significantly altered corporate insider) from trading in securities while aware of the ‘total mix’ of information made available.”28 Another that information. Because insider trading and Regulation formulation frequently used is that information is material if FD are so closely related, Reg FD cases can offer guidance a reasonable investor would consider it important in making on insider trading law and vice versa, particularly for an investment decision.29 Materiality “does not require proof firms struggling with the process of determining whether of substantial likelihood that disclosure of the omitted fact information is material. would have caused the reasonable investor to change his

[position]. What the standard does contemplate is a showing An early Regulation FD investigation emphasizes the of a substantial likelihood that, under all the circumstances, importance of knowledgeable business people in making the omitted fact would have assumed actual significance in materiality determinations and not just leaving it to the deliberations of the reasonable shareholder.”30 the lawyers. In 2002, the SEC released its Report of Investigation in the Matter of Motorola, regarding its Whether information is material often depends on the investigation into whether Motorola Inc. (“Motorola”) facts and circumstances of each particular case. Examples violated Regulation FD when one of its senior officials of information that is often viewed as material include: selectively disclosed information about the company’s 31 32 restatement of financials, earnings information, quarterly sales and orders during private telephone 33 mergers and acquisitions and impending bankruptcy conversations with selected sell-side analysts.35 Before 34 filings. Significantly, the determination of whether a the conversations occurred, the senior Motorola officials piece of information is indeed material typically requires a sought legal advice from in-house counsel, who approved collaborative effort between the business people who best the selective disclosures on the basis that the information in understand the Issuer and the market for its securities and question was not materially different from information the their lawyers. company had already made public. According to counsel, the original public disclosure that Motorola’s sales and orders The question of materiality is similarly central to Regulation were experiencing “significant weakness” was not materially FD, another rule promulgated by the SEC pursuant to the different from the private disclosure of what officials Securities Exchange Act of 1934 relating to how publicly understood the term “significant” to mean: a change of 25 traded companies can dispense market information. percent or more.

www.hflawreport.com Volume 3, Number 7 February 17, 2010

Although the SEC acknowledged that the Motorola “mosaic” can include any public information about the issuer officials acted in good faith, the Commission concluded whose securities that you seek to trade as well as immaterial that counsel’s determination was erroneous. What is more, information that may not be public. The idea is that you according to the SEC, the senior officials should have known are piecing together an investment thesis from information that the information was material notwithstanding counsel’s that is either public or is not material and it is the totality of legal advice to the contrary. Ultimately, the SEC decided not that information – and not any one piece of information in to bring an enforcement action, but strongly cautioned the isolation – which motivates you to trade. Thus, even if the business people involved. last piece of a puzzle is non-public information, so long as that piece of information – by itself – is not material, there Matter of Motorola teaches that business people can neither is no insider trading violation if you trade based upon the remove themselves from the decision of what is deemed whole picture that you have created.38 The mosaic theory is material nor protect themselves by simply relying on the grounded in the notion that each piece of information that advice of counsel, at least in the Regulation FD context.36 you obtain must be analyzed in isolation to determine if it Because materiality is based upon what a “reasonable constitutes material, non-public information. If it is, then investor” would consider important when making an you may not trade without running the risk of violating investment decision, the SEC emphasized in Motorola the prohibition against insider trading. If each piece of the important role of business people in making this information is either immaterial or public, then you are determination. free to trade in the issuer’s securities even though it is the accumulation of all those disparate pieces of information Some of the factors that are relevant to determining if together with your own analysis which is material to your information is material include: the probability that the decision to invest in the company.39 event will occur; the potential impact on the market if the event does occur; the credibility of the source of the Putting together a mosaic is good research, not insider information; and the likely market reaction. But it is also trading. It is what good analysts do, both on the sell always important to consider how the SEC will view the side (resulting in research reports and investment information with the benefit of hindsight. recommendations) and on the buy side (resulting in trading decisions). Care must be taken, however, to ensure that each The “Mosaic Theory” and its Relationship piece of the “mosaic” is either public or immaterial and that to “Materiality” it is the broader picture – and not one piece of information The “mosaic theory” involves putting together lots of in isolation – which motivates you to trade the issuer’s disparate pieces of information with your own analysis into securities. an investment thesis which then motivates you to trade a security.37 It is a little bit like putting together a jigsaw Does the “mosaic theory” allow a firm to trade based puzzle. The pieces of information that you include in your on analysis that incorporates both material, non-public

www.hflawreport.com Volume 3, Number 7 February 17, 2010

information and public or non-material information? Harry S. Davis is a partner in the litigation group at Schulte Roth & Absolutely NOT! Indeed, this is one of the most common Zabel LLP. Throughout his 20 year career, Mr. Davis’ practice has misconceptions of insider trading law. A mosaic may include: focused on regulatory investigations, enforcement actions and litigation (1) public information; (2) non-public information which is on behalf of hedge funds, broker-dealers and other financial services not material; and (3) your own analysis and evaluation BUT industry clients. Richard Morvillo is a partner in the Washington, it may NOT include any material, non-public information.40 D.C. office of Schulte Roth & Zabel LLP. Mr. Morvillo is nationally Thus, analysts may gather disparate pieces of nonmaterial recognized as one the leading lawyers in SEC investigations, information or material, but public, information from a enforcement actions and related white collar and private securities variety of sources and create a “mosaic” from which material, litigation, and has extensive experience in insider trading cases and non-public information may be deduced. Decisions whether other regulatory matters. He is also a former branch chief in the SEC’s or not to trade based on this resulting “mosaic” may likely be outside the reach of insider trading liability. Nevertheless, Enforcement Division. Justin Mendelsohn is an associate in Schulte it is important to consult counsel in order to keep your firm Roth & Zabel’s litigation group. on the correct side of the line which separates good research from insider trading. 1 Robert Khuzami, Director, Division of Enforcement, SEC, Conclusion Address at the Bloomberg Washington Summit (November 12, 2009). Securities regulators as well as criminal prosecutors have 2 See Susan Pulliam and Gregory Zuckerman, Galleon Clients made clear that bringing cases to stop insider trading Abandon Ship, The Wall Street Journal, October 21, 2009 within the hedge fund industry is a top priority and that (explaining that The Galleon Group would begin to wind they believe this is a significant problem meriting their down its hedge funds in wake of around $1.3 billion in attention. As such, it is imperative that the hedge fund redemption requests); Andrew Ross Sorkin, ed. Galleon to industry clearly understand the “do’s and don’ts” and Begin Winding Down Funds, DealBook, N.Y. Times, gain a fulsome understanding of the law in this evolving October 21, 2009 (same). area. Comprehensive and properly tailored policies and 3 15 U.S.C. § 78j(b). Civil insider trading enforcement procedures, trade testing, strong compliance, a serious tone cases are brought by the SEC pursuant to Section 10(b) at the top and proper training are critical to protecting your of the Securities Exchange Act of 1934 and Rule 10b-5 firm in this environment. And because so much of the law promulgated thereunder; the United States Attorneys’ of insider trading turns on the facts and circumstances of Offices bring criminal insider trading cases pursuant to the each situation, consulting regularly with experienced counsel same statute. The most critical difference between a civil is essential too. insider trading case and one which merits criminal

www.hflawreport.com Volume 3, Number 7 February 17, 2010

prosecution is the degree of misconduct involved (which 15 281 F. Supp. 354, 356 (S.D.N.Y. 1967). can be very subjective) and the burden of proof (criminal 16 See 15 U.S.C. § 77b(a)(1). cases require proof beyond a reasonable doubt whereas civil 17 David Scheer and Joshua Gallu, “SEC to Focus on cases require a mere preponderance of the evidence). Derivatives as Insider Probes Expand,” Bloomberg News, 4 15 U.S.C. § 78j(b); 15 U.S.C. § 78t(b). Nov. 23, 2009, available at http://www.bloomberg.com/apps/ 5 15 U.S.C. § 78j(b); 15 U.S.C. § 78t(a). news?pid=20601087&sid=avw9gnboEVfc&pos=3. 6 15 U.S.C. § 78j(b); 15 U.S.C. § 78t(b). 18 Id. 7 See note 1, supra. 19 SEC v. Rorech, No. 09 CV 4329 (S.D.N.Y. filed May 5, 8 The Asset Management Unit is led by Bruce Karpati 2009). and Robert Kaplan. Mr. Karpati was the head of the 20 Securities and Exchange Commission v. Rorech, 09 Civ. SEC’s Hedge Fund Working Group, and is an Assistant 4329, New York Law Journal, December 11, 2009. Regional Director and former Branch Chief at the SEC. 21 Reves v. Ernst & Young, 494 U.S. 56, 65 (1990). Mr. Kaplan is an Assistant Director of the SEC’s Division 22 Id. at 66. of Enforcement and formerly served as Assistant Chief 23 17 C.F.R. § 240.10b5-1; see also United States v. Royer, Litigation Counsel and Senior Counsel in the Enforcement 549 F.3d 886, 889 (2d Cir. 2008) (holding that a person Division. The Office of Market Intelligence will be led by need not “use” information to meet the “on the basis of” Thomas Sporkin. Mr. Sporkin was a former Deputy Chief requirement). in the Office of Internet Enforcement at the SEC. Press 24 See note 20, supra. Release, SEC, SEC Names New Specialized Unit Chiefs and 25 See Donald C. Langevort, 18 Insider Trading Regulation, Head of New Office of Market Intelligence, January 13, 2010, Enforcement, and Prevention § 3:15 (2006). available at http://www.sec.gov/news/press/2010/2010-5. 26 17 C.F.R. § 240.10b5-1(c). htm. 27 Id. 9 Robert Khuzami, Director, Division of Enforcement, 28 TSC Industries v. Northway, 426 U.S. 438 (1976). SEC, Speech by SEC Staff: My First 100 Days as Director of 29 Basic, Inc. v. Levinson, 485 U.S. 224 (1988). Enforcement (Aug. 5, 2009). 30 Id. 10 Stephen Taub, “George Canellos Talks Tough/The Message 31 In re Atlas Worldwide Holdings, Inc. Securities Litigation, is Going Out,” Absolute Return (Oct. 2009). 324 F. Supp. 2d 474, 487 (S.D.N.Y. 2004). 11 Jason S. Flemmons, Associate Chief Accountant, Division 32 Elkind v. Liggett & Meyers, Inc., 635 F.2d 156 (2d Cir. of Enforcement, SEC, Speech by SEC Staff: Remarks Before 1980). the 2009 AICPA National Conference on Current SEC and 33 United States v. O’Hagan, 521 U.S. 642 (1997). PCAOB Developments, December 8, 2009. 34 S.E.C. v. Luldiner, SEC Lit. Release No. 13,638 (C.D. Cal. 12 S.E.C. v. Texas Gulf Sulpher Co., 401 F.2d 833, 848 (1968). May 18, 1983). 13 Id. 35 Report of Investigation Pursuant to Section 21(a) of the 14 See e.g., In re Cady, Roberts & Co., 40 SEC 907 (1961). Securities Exchange Act of 1934: Motorola Inc., Release No.

www.hflawreport.com Volume 3, Number 7 February 17, 2010

34-46898 (November 25, 2002), at Section III. 37 See Elkind v. Liggett & Myers, Inc., 635 F. 2d 156, 165 (2d 36 Relying on advice of counsel in an insider trading Cir. 1980). investigation or enforcement action may still help persuade 38 See Selective Disclosure and Insider Trading, Securities Act the trier of fact that the defendant did not have scienter Release No. 33-7881, Exchange Act Release No. 34-43154 (an intent to deceive), which is required to bring an (August 15, 2000), at Section II.B.3. insider trading case. Alternatively, it might be helpful in 39 See id. persuading the government to pursue the case civilly but 40 Id. not criminally.

Speakers Nick Fagge Christopher Hilditch Daniel Hunter Scott Kareff 2Shlomo Twerski 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Nick Fagge London Office +44 (0) 20 7081 8009 [email protected]

Nick Fagge is a special counsel in the Tax Group at Schulte Roth & Zabel. In his practice, he principally advises investment management clients on the structuring of U.K. management companies, covering all relevant partnership and tax issues. Nick also advises more widely on U.K. and international tax issues relating to the taxation of private investment funds, their U.K. investors and managers.

Nick is a Chartered Tax Adviser and associate of the Chartered Institute of Taxation, the leading body in the U.K. for taxation professionals dealing with all aspects of taxation. He is also a member of the Tax Committee of the Alternative Investment Management Association. He has written and spoken about U.K., EU and international tax issues for various publications and engagements, particularly in regards to how changes in tax codes and regulations affect hedge funds and their U.K. managers. Nick graduated from Corpus Christi College at the University of Oxford and completed his legal training at the College of Law in Guildford, England.

Christopher Hilditch London Office +44 (0) 20 7081 8002 [email protected]

Christopher Hilditch is a partner in the Investment Management, Financial Services and Regulatory & Compliance Groups as well as the head of the London office at Schulte Roth & Zabel. He advises a wide range of institutional and entrepreneurial managers on structuring and establishing investment funds, especially hedge funds and funds of hedge funds, and other innovative products. On an ongoing basis, he advises promoters and managers on operational issues, including prime brokerage arrangements, investment transactions and relations with investors. He also advises on regulatory issues affecting funds and their managers, as well as on corporate, securities and partnership law issues.

Chris is a frequent speaker on hedge fund and related topics and a regular contributor to a variety of industry publications. Recent articles include “Bribery Act 2010,” written for The Hedge Fund Journal as well as various SRZ Client Alerts on topics ranging from FSA telephone taping rules to new EU fund-manager directives. Recent speaking engagements include discussing “Recent Developments of Hedge Fund Regulation from a Global Point of View” at the ALFI European Alternative Investment Fund Conference and “Pan-European Short Selling Regime” for a Citibank client conference call.

Listed as a leading hedge fund lawyer in Chambers UK, The Legal 500 UK, PLC Cross- border Investment Funds Handbook, The International Who’s Who of Private Fund Lawyers and The Expert Guide to the Word’s Leading Mutual Fund Lawyers, Chris is a member of the Law Society, the City of London Solicitors Company, the International Bar Association and the Sound Practices Committee of the Alternative Investment Management Association (AIMA), and has participated in a number of ad hoc industry committees. Chris graduated with an M.A., with honors, from Oxford University and attended law school at the College of Law, Guildford, England.

Daniel F. Hunter New York Office +1 212.756.2201 [email protected]

Daniel F. Hunter, a partner in the Investment Management Group at Schulte Roth & Zabel, concentrates his practice on the design, structure and regulation of alternative investment products, including hedge funds, hybrid funds and private equity funds. He regularly advises funds that invest in distressed debt, asset-backed securities and bank loans. Dan also provides day-to-day regulatory, operational, M&A and restructuring advice to his fund clients, and advises funds regarding the receipt or allocation of seed capital.

Dan authored “The Changing Face of Capital Introduction” for the MFA Reporter and spoke on “Disclosure Issues in Connection with Side Pockets and Side Letters,” at a West LegalWorks’ New Frontiers in Hedge Fund Due Diligence conference. Prior to joining SRZ in 2007, Dan was associated with several AmLaw 100 firms and held non- legal positions at Salomon Smith Barney (investment banking), Altavista Company (strategic alliances) and Medscape (business development). Dan received his J.D. from the University of Michigan Law School, where he was articles editor of the University of Michigan Journal of Law Reform and his A.B., cum laude and with high honors in history, from the University of Michigan.

Scott M. Kareff New York Office +1 212.756.2132 [email protected]

Scott M. Kareff is a special counsel in the Intellectual Property, Sourcing & Technology Group at Schulte Roth & Zabel and leads the firm’s trademark practice for private investment funds. His transactional experience includes intellectual property and information technology work in connection with mergers and acquisitions and commercial lending transactions, including due diligence and negotiation of IP and IT provisions; transitional services agreements and other ancillary agreements; and negotiation of IP and technology licenses and IT agreements, including software and outsourcing agreements.

In the areas of counseling and prosecution, Scott has represented clients on trademark, copyright and right of publicity enforcement matters; domain name infringement and ICANN dispute resolution; trademark clearance; trademark and copyright prosecution; and sweepstakes and online privacy issues.

Scott has written and spoken on trademark issues and trademark challenges for the hedge fund industry, is currently the vice chair of the American Bar Association Intellectual Property Law Section’s Special Committee on IP Security Interests and is a past member of the International Trademark Association’s editorial board. He earned his J.D./M.S.F.S., magna cum laude, from Georgetown University Law Center, where he was associate editor of the Georgetown Law Journal. He was awarded his B.A., with distinction, from Cornell University.

Shlomo C. Twerski New York Office +1 212.756.2510 [email protected]

Shlomo C. Twerski, a partner in the Tax Group at Schulte Roth & Zabel, focuses his practice on the tax aspects of onshore and offshore investment funds, registered investment companies and business development companies, private equity partnerships, real estate and corporate transactions, restructurings and workouts, securitizations, and existing and emerging financial instruments.

Shlomo regularly speaks at industry conferences and events. As part of a series of presentations concerning the impact of the current economic downturn on the alternative investment industry, Shlomo has recently addressed such topics as “Tax Considerations for 2010” and “Registered Funds and UCITS: Reaching New Capital and Markets” for various SRZ seminars.

A member of the Tax Section of the New York State Bar Association, Shlomo earned his J.D. from Hofstra University School of Law, where he was an articles editor of the Hofstra Law Review.

Notes:

Establishing a Foreign Presence

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Reasons why many of our clients have established a foreign office -- Talent search in Europe and elsewhere -- Opportunity search in emerging markets -- Trading in given time zones -- Raising capital in Europe and Asia • Opening a foreign office requires careful jurisdiction by jurisdiction analysis • Using U.K. as a proxy for other foreign offices

Notes:

Selecting the Ideal Structure: Objectives

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Tax in the local jurisdiction is the main consideration when deciding on the most suitable form of legal entity to carry on business in that jurisdiction -- Relevant tax issues might include: -- Tax liabilities of the local entity itself (“entity level” taxation) -- Availability of foreign tax credits where profits taxed locally are also subject to U.S. taxation -- Taxation of the personnel engaged in the local business (including local payroll and social security taxes)

Model of U.K. Office Notes: t

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR I a «a

• In the U.K., the form of business entity most often established for a discretionary management or investment advisory business is a limited liability partnership (“LLP”) • The LLP itself is not subject to tax in the U.K. Instead, the members (partners) of the LLP are taxed upon their respective allocated shares of profits of the LLP. • Key personnel engaged in the U.K. business become members (partners) of the LLP and are compensated in the form of a share of profits of the LLP. They are not employees. • Compensating key personnel as members of the LLP (and not employees) avoids the LLP being chargeable to Employers’ National Insurance Contributions in respect of the compensation of these key personnel (currently a 12.8% charge) • A “corporate member” — U.K. limited company — which is a wholly-owned subsidiary of the U.S. management company is often included as a member of the LLP • Use of a corporate member allows profits of the LLP which are to be retained in the U.K. business or repatriated to the U.S. to be allocated to the corporate member where they will suffer a lower corporate rate of tax (currently 28%) • Both LLP and corporate member “check-the-box” to elect to be treated as pass-through entities for U.S. tax purposes. This ensures that foreign tax credits should be available to offset U.S. tax liabilities on profits that have also suffered U.K. taxation in the hands of the members of the LLP (whether the key personnel or the corporate member).

Notes:

Checking Your Name

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Trademark rights exist on a country-by-country basis (“territoriality principle”) • A name can be “available” in one country but not in another • A name can be “available” for some purposes (for use as a company name), but not others (for trademark registration) • Similar names in fields that you would consider distinct from a business standpoint could be problematic in the trademark context • “Availability” of a name as a trademark is usually not a “yes/no” issue. Trademark rights are heavily dependent on facts and circumstances and involve degrees of risk. • Start-up funds should check name availability in all potential countries of interest during the formation process • Existing managers who are expanding to new countries may have less flexibility if they encounter a name problem in a new country • Consider the meaning/connotation of your name in foreign languages when expanding internationally • As in the United States, the Trademark Office in many countries may translate your name into the local language to determine if you can trademark it • Avoid embarrassing or negative cultural meanings of translated words

Notes:

Trademarking Your Name

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Benefits of trademark registration: -- Deters other managers -- Provides ammunition in the event a dispute does arise -- Establishes rights in the absence of advertising and public recognition • The Madrid System of International Trademark Registration: “one-stop shopping” -- Advantages: -- “Check-the-box” in over 80 countries, including all of the European Union, Switzerland, China, Japan, Singapore and Australia, but not Hong Kong or India -- If no substantive refusals or third-party objections are raised, there is no need to engage local counsel -- Administrative efficiency and cost savings over separate national registrations -- Disadvantages: -- “Central attack” during the first five years. Can be saved by “transformation” (Madrid Protocol only) -- Enforcement of rights: generally easier with national trademark registrations than with international registrations • Choices — which name(s) to trademark: -- Protect your core name, not your entire organization chart -- Typical registration strategy -- Make sure you use what you register • Scams: private registries, monitoring services, domain name scams -- The con: the correspondence looks like it comes from a governmental agency and is filled with information that is specific to you and your trademark -- The tell: you have designated an attorney (or service provider) to correspond with Governmental Trademark Offices (or domain name registrars) but the solicitation is addressed to you

Notes:

Getting Licensed in the U.K....

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Most fund management and associated activities require authorization • This includes investment management, trading, advice and marketing • Exemption available for intra-group research and analysis • Criminal offense to undertake any regulated activity without the requisite authorization • Detailed and lengthy process for authorization — allow six months • Minimum capitalization requirements

Notes:

...and Europe

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• AIFMD -- Text of AIFMD agreed November 2010; likely to have force of law around May 2011 -- Required to be implemented and to have effect two years later (May 2013) -- Applies to managers domiciled in Europe providing: -- Management services (management, administration, marketing) to … -- Alternative investment funds (any fund not authorized as a UCITS) -- There can only be one AIFM -- EU office of U.S. manager unlikely to be an AIFM -- Access to EU markets for U.S. managers under AIFMD: -- Until May 2013: no change to current regime -- May 2013 – May 2015: • Can market EU funds in accordance with national private placement regimes. Some additional requirements on manager. • Can market non-EU funds on same basis, provided that the fund jurisdiction also meets certain requirements around information sharing, AML and model tax treaties -- May 2015 – May 2018: • If manage an EU fund, must be authorized and comply with all the Directive’s requirements • For a non-EU fund, can elect either to use national private placement regimes (as above) or alternatively comply with all the Directive’s requirements and obtain passport • From May 2018: national private placement regimes may be removed in which case only option would be to be authorized and comply with all the Directive’s requirements

• Private placement rules -- Each country must be looked at individually -- Generally not possible to market private funds publicly -- Different rules may apply to closed-end funds than open-end funds -- Some countries have private placement regimes for hedge funds; others do not -- Some examples: -- France • No private placement regime. French investors should only be communicated with offshore France on an unsolicited basis. -- Germany • Limited marketing to institutional investors, experienced high net worth investors and to a “restricted circle of investors” otherwise known to the promoter. No filing requirements. Appropriate disclaimer should be included on marketing materials. -- Italy • In theory, it is possible to register a hedge fund for sale, but this is not done. Approaches to Italian investors should be made offshore Italy. Draft law may allow limited approaches to professional investors. -- Spain • Limited marketing to investors who subscribe at least €50,000 ($72,000). No general solicitation and all materials should be individually addressed. No filing requirements. Appropriate disclaimer should be included on marketing materials. Note most hedge funds tax inefficient for Spanish investors. -- Switzerland • Limited marketing to “qualified investors” — banks, securities dealers, asset managers and high net worth individuals (investments to the value of approximately $2 million). No filing requirements. Appropriate disclaimer should be included on marketing materials. -- United Kingdom • Limited marketing to professional investors and to high net worth companies and trusts. Exemptions for marketing to high net worth individuals and sophisticated investors difficult to use in practice. No filing requirements. Appropriate disclaimer should be included on marketing materials.

Notes:

Connecting to Your Foreign Office: U.S. Regulations

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Associate with U.S. adviser -- To what degree control is shared, U.S. investor capital is allocated among PMs and investment decision impacts U.S. capital are all critical components of understanding U.S. oversight and making the proper SEC registration and exemption decisions -- Most managers will have few choices once they grow above $150 million, their principal office is located in the U.S., and investment decisions made in the offshore office affect U.S. capital -- Form ADV now has a narrative format which may take longer to complete and updating rules will require managers to be more on top of updates • Separate from U.S. adviser -- It is possible for non-U.S. based advisers and theoretically possible for U.S. based advisers to separate the offices for purposes of SEC regulation -- Dodd-Frank Act has added great uncertainty in this area and almost certainly will increase the U.S. regulatory burden on foreign managers by causing many to register with the SEC -- Foreign private adviser exemption -- Private funds exemption for non-U.S. adviser • Consequently, compliance costs will increase for many non-U.S. managers even though the laws were not enacted in their home jurisdiction

Notes:

Paying Your People

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Regulated firms in European jurisdictions are likely to be subject to regulatory rules governing the remuneration of their key staff • In the U.K., these rules will include the FSA’s Remuneration Code and potentially also (when implemented) the remuneration provisions of the AIFM Directive • The “proportionality” principle included in the FSA Remuneration Code limits the application of the Remuneration Code • Firms are classified into four categories; most U.K. management and advisory firms will be “category 4” firms • Category 4 firms are not obliged to apply the provisions of the FSA Remuneration Code that require the deferral of compensation or the payment of a portion of compensation in shares or share-equivalent instruments • Category 4 firms will be subject to the provisions of the FSA Remuneration Code that require firms to identify and notify their “code staff,” to have a remuneration policy and to pay guaranteed bonuses only in limited circumstances • Detailed rules governing remuneration pursuant to the remuneration provisions of the AIFMD have not yet been formulated • AIFMD contains the same “proportionality principle” as the FSA Remuneration Code • The various sets of regulatory rules have a common source in the EU’s Capital Requirements Directive 3 • The hope is, therefore, that the remuneration provisions of the AIFMD (once implemented) will be similarly restricted in their application to fund management firms as the FSA’s Remuneneration Code

Notes:

Staying in Compliance

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• It will be necessary to comply with local rules and regulations • To the extent possible, harmonize compliance procedures; where different standards apply, apply the higher standard to all • In the event of inconsistent rules, it will be necessary to consider implications • Global reporting lines will need to be considered and CCO will need to understand local rules, even if not local compliance officer • Personal account dealing practices may differ in different jurisdictions and give rise to personnel issues

Notes:

Running Your Business

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Multiple trading books or one? • Lines of reporting • Indemnification of sub-advisers • Insurance coverage

Notes:

Protecting Your Name: Offense VS. Defense

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Playing offense: -- You have full trademark protection and a new manager starts using your name. At issue is whether they will be able to continue using their name (and whether they will have to pay monetary damages). • Playing defense: -- You lack full trademark protection and a pre-existing manager objects to your name. At issue is whether you will be able to continue using your name (and whether you will have to pay monetary damages). • The kickoff — trademark disputes typically start as a result of: -- Publicity in the trade -- Marketing efforts/tips from investors -- Trademark filings/websites — detected by (legitimate) watch monitoring service • The game — dispute process: -- “Cease and desist” or “demand” letter and subsequent correspondence -- Likelihood of confusion factors -- Common settlement terms

Notes:

Hiring and Firing

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Immigration requirements may require local hires and/or make transferring personnel difficult • Potential hires may be subject to long notice periods in existing position • Local employment rules may give local staff additional protections; in particular, concept of “employee at will” may not exist and formal (and lengthy) procedures may need to be complied with in the event of termination • Expectations of working hours and holidays may differ (and there may be statutory requirements). Other cultural differences may make integration difficult. • Enforceability of restrictive covenants may be different in the U.S.

Notes:

Maximizing Tax Efficiency

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• It will be important to ensure that having a subadviser in another jurisdiction does not expose the funds being managed to tax in that jurisdiction (on the basis that the funds’ profits are being generated by the activities of the subadviser in that jurisdiction) • In some jurisdictions, it is necessary for the subadviser to comply with the terms of an exemption in order to avoid the funds which they manage becoming subject to tax in that jurisdiction • For example, the U.K. requires managers exercising investment discretion in the U.K. on behalf of trading funds to comply with the terms of the U.K.’s investment manager exemption (“IME”) in order that the funds should not be subject to U.K. taxation • The U.K. IME has a number of specific requirements that managers and funds must comply with in order to ensure the availability of the exemption. Three of the most significant requirements are: -- The fund must generally be a “widely held” collective fund with a majority of external, unrelated investors -- The compensation received by the U.K. manager/subadviser for its U.K. activities must represent a “customary rate” for the services being provided from the U.K. -- There are restrictions on the proportion of the fund’s total capital that can be invested by principals or persons otherwise connected with the management companies

Notes:

Getting Your License: Hong Kong, Singapore and Australia

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Securities and Futures Commission (“SFC”) in Hong Kong -- Managers wishing to carry out investment management activities from Hong Kong are generally required to obtain a TYPE 9 license -- Exemptions are narrow, however, there are other licenses for just providing research -- License process can be time-consuming and may be difficult to fulfill the competency requirements -- Speed up process in situations where: -- The fund manager is regulated by an overseas regulator such as the FSA or SEC -- They have a good compliance record, and -- They service “professional investors” as defined under Hong Kong law -- Annual financial statement filing requirements • Monetary Authority in Singapore (“MAS”) -- Generally required to hold a capital markets service license in order to conduct fund management -- Proposal subject to legislation (Consultation Paper April 27, 2010 put out by MAS): new exemption from registration for managers with less than S$250 million as Singapore looks to attract start-up hedge fund managers; notice required to MAS; must have fewer than 30 clients (of which 15 can be funds) -- Need licensed custodian -- Executive director based in Singapore -- Need a physical office in Singapore -- Need minimum capital base of S$250,000 and at least two Singapore professionals, whether registered or exempt -- Many questions still open regarding MAS proposal

• Australia -- Many clients trigger the registration requirement when they conduct marketing activities in Australia -- AFS license regime -- You may need your own license or use a local AFS license holder -- Passport relief requires foreign manager (i.e., U.S. manager) to be regulated in home jurisdiction -- Dodd-Frank will actually allow more U.S. managers to manage Australian capital without having their own AFC license (by maintaining an exemption rather than a license)

I. Introduction

A. The Hedge Fund Explosion/Retrenchment1 1999: 2,500 Hedge Funds 2003: 6,000 Hedge Funds 2006: 8,000 Hedge Funds 2009: 9,400 Hedge Funds

B. Are There Any (Good) Names Left?

With the exponential growth the hedge fund field witnessed in the last decade, most of the obvious sources for management company and fund names (e.g., trees, birds, constellations, mythological entities) have already been taken or are no longer viable (i.e., have been tarnished due to a prior scandal or merely poor performance). This makes selecting a name for a new management company or fund increasingly difficult.

Name issues are usually addressed during the fund formation process, when counsel conducts availability searches and typically proceeds to file trademark registrations.

C. Established Funds Can Also Benefit from Trademarking Their Names

But even established management companies and funds can benefit from trademark registration if they have not previously trademarked their names. Benefits of registration include deterring new funds from adopting confusingly similar names and providing legal weapons in the event of a name dispute.

D. Multi-Jurisdictional Advisers Face Increased Name Risk

Because trademark rights exist on a country-by-country basis, multi-jurisdictional advisers must secure name rights in multiple countries. This task is challenging enough for new managers, who must do separate availability searches and pursue trademark registrations across multiple jurisdictions, increasing the likelihood that a proposed name will not be available. This task is even more challenging for managers that originally operated in a single country, then decide to establish offices in other jurisdictions. Because these managers are already committed to their existing name, they have less leeway if that name is not available in the new international jurisdiction.

E. Cross-Border Name Disputes Have Been on the Rise

With the increase in multi-jurisdictional advisers, we have seen an increase in cross-border name disputes. This makes securing trademark rights internationally even more important.

II. Trademark Selection: Selecting a Name (That You Can Trademark) A. Pick a “Strong” Mark

B. Mark Hierarchy 1. Strong Marks Are Preferable Candidates: Trademarks denote the source of goods and services, and not the goods and services themselves. The greater a mark’s tendency to denote only the source of goods and services, the more protection from unauthorized use the mark receives. Marks may be categorized as:

1 Definitive data is difficult to find with respect to how many fund managers there are or have been at any given time. These figures are estimates derived from various hedge fund industry publications. Although the trend has clearly been upward over the last decade, looking at the numbers alone does not reflect the spike in fund liquidations that has occurred since the financial crisis and the fall of Lehman Brothers in September 2008.

• “Fanciful” (i.e., coined) and “arbitrary” marks are the strongest marks because they relay nothing in particular about the nature or quality of the marked goods or services. • “Suggestive” marks are weaker because they tend to imply the nature or quality of the marked goods or services. • “Descriptive” marks are weakest because they explicitly reference the nature or quality of the marked goods or services. Included within the classification of descriptive marks are laudatory terms that attribute a characteristic of superiority to the goods (e.g., GOLD MEDAL) and geographic terms that suggest an association between the geographic region and the product or service identified by the mark e.g.( , HAWAIIAN PUNCH).

Note: A generic designation will never be protected as a trademark because public policy requires that competitors be able to identify freely the nature of their services.

Tension usually exists between the marketing executives, who want to use marks that readily identify the nature of those goods and services they must sell, and the trademark attorneys, who want to clear and protect strong marks. C. Names as Marks May or May Not Be Protected 1. If a mark is recognized by the public “primarily merely as a surname,” the mark generally will not receive trademark protection. Should the mark later acquire secondary meaning (and, hence, no longer be primarily merely a surname), it can receive trademark protection. The name of a living individual cannot be registered as a trademark without the individual’s written consent.

2. There is no absolute right to use your own surname as a trademark. If confusion is likely to occur, you could be forced to use a disclaimer or to use your full name to distinguish the sources sufficiently. In extreme cases, if the likelihood of confusion cannot be abated, you could be forced to cease use as a trademark completely. You can always use your name to refer to you.

D. Avoid Using Misleading Marks: A mark can be misleading if it suggests a quality or characteristic of the product or service that is not true.

E. Avoid using words such as guaranteed, safe, insured and other terms that suggest protection of or benefits to clients. Terms like this should be evaluated carefully prior to their incorporation into marks.

F. Letter marks are strong, but difficult to clear.

III. Trademark Clearance A. Determining a Mark’s Availability for Use: What We Look For 1. Avoid “Confusingly Similar” Marks

• A mark generally will infringe an existing mark if the two marks are “confusingly similar.” A confusingly similar mark is one that is likely to cause a substantial portion of the relevant consuming public to believe mistakenly that the existing mark’s owner (the “senior user”) is the source of the newcomer’s (the “junior user”) goods and services or that the senior user and the junior user are affiliated in some way or that the senior user has somehow authorized, licensed or sponsored the junior user’s goods and services. • Generally, a mark will be available for use only if it is not “confusingly similar” to any other valid marks used earlier. • Whether a mark would be deemed “confusingly similar” to an existing mark depends on several factors including:

(i) The degree of similarity between the two marks; (ii) The similarity of the respective goods and services of the senior user and the junior user; (iii) The likelihood that the senior user will “bridge the gap” (i.e., offer the junior user’s type of goods and services) (note that when the senior and junior user offer the same goods and services, there is no gap to bridge); (iv) The “strength” of the senior user’s mark (i.e., how effectively that mark denotes the senior user exclusively as the source of its goods or services); and (v) The sophistication of the consumers to which the respective goods or services are (or will be) marketed, and the care exercised by such consumers when selecting the goods and services. 2. Using a Mark Similar (But Not Too Similar) to Those Already in Use: The Dilution Effect • To the extent that similar marks used by unaffiliated parties coexist without causing confusionin the marketplace, the trademark protection afforded those parties’ respective marks is narrow in scope. A newcomer seeking to adopt yet another similar mark would be more likely to do so safely because the existing marks are “diluted” (i.e., weakened). • Dilution is a double-edged sword, however: to the extent that the newcomer later asserts its own diluted mark against a junior mark no more similar to the newcomer’s mark than are the existing marks, the newcomer would have considerable difficulty asserting its rights successfully. B. Determining a Mark’s Availability for Use: How We Look 1. Research is required to determine whether a proposed mark is available for use (i.e., whether it is “clear”).

• A “first level” (or “knock-out”) search of the Trademark Office records is conducted to determine whether any marks which are the subject of existing federal trademark registrations or applications could preclude the proposed mark’s use. One or more confusingly similar references revealed during this search phase generally would end the availability inquiry, and the process would be repeated for an alternate mark. • If no knock-out reference is revealed, a “second level” (or “common law”) search is conducted to determine whether any other existing trademark rights preclude use of the proposed name. The second level search is necessary because trademark rights generally arise from use of a mark, and not merely from trademark registrations or applications. A second level search retrieves references from a variety of public databases and corporate listings. If no conflicting rights are revealed during this search phase, the mark generally is clear for use.

Note: References are commonly retrieved with information insufficient to determine whether they represent conflicting rights. In such instances, investigation of the reference’s use of a mark is appropriate.

Also Mark availability searches necessarily are limited by the quality of information reviewed. Thus, the risk always remains however slight that valid third party rights not revealed during the searches could be violated by virtue of using the mark. And Mark availability searches are time sensitive. There is an unavoidable time lag between the date the search is run and the date of the information in the databases searched. Generally, this time lag is about two to three weeks, but this can be enough to cause a problem.

Also, you cannot rely on a “stale” search to clear a mark. For example, if you do a search in January, then decide not to use the name, only to return to the name in May, you will need to do a new search.

IV. Trademark Registration A. Benefits of Federal Registration: Once a mark is cleared for use, apply to register it with the Trademark Office. Federal trademark registration is a cost-effective means to protect the exclusive right to use the mark. Registration generally confers the following benefits, among others: 1. Constructive notice nationwide of the trademark owner’s claim of ownership.

2. Right to sue in federal court for trademark infringement.

3. Provides prima facie evidence of validity of the mark, of registration of the mark, of registrant’s ownership of the mark, and of registrant’s exclusive right to use the mark.

4. A Principal Register registration, upon obtaining incontestable status, is conclusive evidence of the validity of the mark, of registration of the mark, of registrant’s ownership of the mark, and of registrant’s exclusive right to use the registered mark for the goods/services identified in the registration, subject to limited exceptions and defenses.

5. The right to use the registration notice®.

6. A Principal Register registration may be filed with U.S. Customs Service to prevent importation of infringing foreign goods.

7. Registration can be used as a basis for obtaining registration in foreign countries.

B. Registration Procedure: A federal trademark application for registration of a mark can be filed before use of the mark has commenced “in commerce” (an “intent to use” application) or after such use has commenced (a “use-based” application). Ultimately, however, a mark must be used in commerce before a registration can issue. 1. “Use in commerce” includes interstate commerce and commerce with foreign nations. The Trademark Office will examine the mark to determine whether it is entitled to registration. It typically takes at least seven months to complete this initial exam. The Trademark Office might reject the application for one or more reasons (e.g., the mark is confusingly similar to one or more marks which are the subject of existing registrations and applications). The applicant can rebut the Trademark Office’s findings. If the Trademark Office is persuaded, it will retract its objections. If not, the applicant may be forced to appeal the rejection or abandon the application without prejudice to rights in the underlying mark.

2. Under U.S. law, marks with meanings in foreign languages will be translated into their English equivalents in determining whether the marks are similar for the “confusingly similar” or “likelihood of confusion” test.

3. Upon approval of the application, the Trademark Office will “publish” it in the Official Gazette. Third parties who believe they would be harmed by registration of the mark may “oppose” (i.e., challenge) such registration. An opposition is an administrative litigation adjudicated by the Trademark Office’s Trademark Trial and Appeal Board.

4. Absent a third party challenge, the applicant will have to submit acceptable specimens demonstrating how it has used the mark in connection with the goods and services recited in the application. Once the applicant has done this, the application will pass to registration.

C. The Madrid System of International Trademark Registration 1. As of Nov. 30, 2010, 85 countries, including the United States, are parties to the Madrid Protocol and/ or the Madrid Agreement (collectively, the “Madrid System”). This means that U.S. managers can seek trademark protection for their names in many of the most important international jurisdictions through the U.S. Patent and Trademark Office.

2. In addition to the United States, members of the Madrid System include the European Union (and all of its 27 member states except for Malta), Switzerland, China, Singapore, Japan and Australia.

3. Significantly, Hong Kong and India are not parties to the Madrid System. Consequently, trademark registration must be sought in those countries via local counsel.

4. Advantages of Using the Madrid System

Securing international trademark registrations via the Madrid System is generally less expensive and offers administrative convenience over obtaining separate registrations in each country. If no substantive issues are raised by the trademark offices in the international jurisdictions selected, the trademark owner can obtain an international registration without engaging local counsel.

5. Disadvantages of Using the Madrid System

The main drawback is that, within the first five years after filing, if there should be a problem with the home country trademark application or registration such that it fails (known as a central attack), the corresponding applications and registrations in the rest of the countries designated under Madrid will also fail. Under the Madrid Protocol, to which the United States is a party, the risk of a central attack can be mitigated by converting the International Registration filings in the rest of the countries into national filings (known as transformation), but this is cumbersome and expensive. Transformation is not available under the Madrid Agreement.

Another drawback is that it is generally easier to enforce rights in a country with a national registration rather than an International Registration.

D. Beware of Common Trademark and Domain Name Scams 1. Once you have filed in the United States or internationally for trademark registration you are likely to receive unsolicited “offers” relating to your trademarks.

2. These mailings typically look like they have been issued by government agencies and make it seem like you are paying official registration fees.

3. Read the fine print: typically it will reveal that the offer is to include your trademark on a private registry and that payment of the fee is voluntary.

4. The tell: legitimate correspondence from the relevant trademark office concerning registrations fees gets sent to your designated attorney. By contrast, the scammers send these solicitations directly to the trademark owner.

5. Another common scam is from Asian Domain Name Registrars who claim that a third party is trying to register a domain name that the solicitor “noticed” is identical or similar to your trademark filing.

V. Trademark Disputes A. Trademark disputes typically erupt upon fund launch or expansion into a new jurisdiction or from the trademark registration process. 1. Publicity surrounding fund launch could spur complaints from pre-existing managers with similar names

2. Marketing efforts could bring you to the attention of an existing manager

3. Filing for trademark applications is a public act (trademark owners typically engage “trademark watch” services to notify them of new trademark filings and even the creation of a new website using a given name).

B. Disputes are typically commenced by sending a “cease and desist” letter demanding that the “junior” user stop using the “senior” user’s name 1. Often disputes can be managed and resolved via an exchange of lawyer’s letters setting forth arguments why infringement is or is not present

2. In some cases a senior user will require certain concessions from the junior user

3. If the junior user in a given country has superior rights in another country of interest to the senior user, this could pave the way for a global co-existence agreement.

C. Typical settlement concessions include: 1. Requiring the junior user to modify its name to distinguish it from the senior user (may or may not involve modification to the “dominant” portion of the manager’s name).

2. Requiring the junior user to refrain from using the mark in connection with a specific field of use (e.g., private equity, venture capital, real estate).

3. Requiring the junior user to refrain from using the mark in certain countries.

4. Requiring the junior user from refraining from seeking trademark registrations for its name.

D. Litigation can ALMOST ALWAYS be avoided if the junior user is willing to change its name. 1. Changing a manager’s name may be an insignificant nuisance or may be completely unacceptable depending on the manager’s circumstances.

2. Most trademark infringement cases in the hedge fund area revolve around whether or not the junior user will be able to continue using its name or not (injunctive relief).

3. But monetary awards, consisting of the Plaintiff’s losses and the Defendant’s profits from using the infringing mark, are possible and can be significant.

APPENDIX A: Trademark Cases Involving Financial Services

Examples of financial services trademarks deemed confusingly similar:

LANE CAPITAL MANAGEMENT LANE CAPITAL MANAGEMENT for hedge fund management for retail stocks and bonds (fixed income arbitrage using mortgage-backed (investment advisory services primarily to securities, U.S. Government securities, options, individuals who seek to invest personal funds swaps and futures) in stocks and bonds for long term growth)

LEXINGTON MANAGEMENT CORPORATION LEXINGTON CAPITAL PARTNERS for management and marketing of mutual funds for retail brokerage services

K2 ADVISORS K2 CAPITAL MANAGEMENT and for hedge fund management (fund of funds) K2 VOLATILITY FUND For investment management, advisory and broker-dealer services

DREYFUS Lion logo ROYAL BANK OF CANADA Lion logo for mutual funds, investment advisory services, for wholesale banking fund management

THE FUND OF FUNDS FIRST AMERICAN FUND OF GROWTH FUNDS for mutual fund investment business for mutual fund services

POPULAR BANK BANCO POPULAR for commercial banking services for commercial banking services

Examples of financial services trademarks deemed not confusingly similar:

HAVEN CAPITAL MANAGEMENT HAVENS ADVISORS, HAVENS PARTNERS, for investment advisory services and mutual fund HAVENS ASSOCIATES management for advisory and management services in risk arbitrage, hedging, and distressed security investment strategies

FRANKLIN RESOURCES, INC. FRANKLIN CREDIT MANAGEMENT for mutual funds, REIT management and for a finance company dealing primarily in consumer financing troubled loans

APPENDIX B: Using Your Trademark Properly

Trademarks must denote the sources of goods and services, not the goods and services themselves. If the public comes to view a mark as the generic term for the goods or services, the mark could be deemed “abandoned” and hence no longer entitled to protection from unauthorized use.

A trademark owner can help strengthen its mark and ensure its longevity by using it properly.

1. Trademarks should appear in BOLD CAPITALIZED form, or at least in Initial Capital letters. Trademarks should always be used as proper adjectives, and never as nouns or verbs.

Example: One can be said to “use a XEROX copier,” but one should not be said to “xerox a report” or “distribute xeroxes.”

2. Additional emphasis can be placed on a mark’s trademark status by using the word “brand” adjacent to the mark.

Example: FROSTED FLAKES brand cereal.

3. Unless the mark itself is a possessive form, it should not be used in possessive form.

Example: BEN & JERRY’S ice cream (proper)

My TOSHIBA’s power cord (improper)

4. Do not use singular marks in plural form or vice-versa.

Example: One can sell NIKE tennis shoes, but should not sell “NIKEs.”

One can use a BAGGIES plastic bag, but not “a BAGGIE”.

5. If the mark is federally registered, it should bear the ® symbol to denote same. If it is not, it should only bear the TM symbol (or SM for a service mark).

6. Never vary the spelling of the mark or abbreviate it. Instead, use it in a consistent form to reinforce the public’s recognition of it as a mark.

APPENDIX C: Hierarchy of Marks

BRAND GOODS/SERVICES STRENGTH KODAK Film fanciful APPLE Computers arbitrary COPPERTONE suntan lotion suggestive PARK ‘N FLY airport parking services descriptive (must acquire secondary meaning to be protected) APPLE Apples generic (never protected)

Speakers Kim Baptiste David Griffel Udi Grofman Jason Kaplan 2Holly Weiss 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Kim E. Baptiste New York Office +1 212.756.2317 [email protected]

.of, Kim E. Baptiste is a partner in the Individual Client Services Group at Schulte Roth dc2h & Zabel. His practice focuses on estate planning, trusts, charitable foundations, tax planning and estate administration.

A speaker on estate planning issues, Kim was most recently invited to speak on “Estate Planning Opportunities in Today’s Environment” at wealth management firm Convergent’s annual symposium in Washington, D.C. Kim is a fellow of the American College of Trust and Estate Counsel and a member of its Business Planning Committee, a member of the New York State Bar Association and a past member of the NYSBA Tax Section’s Executive Committee and a past co-chair of the Committee on Taxation of Trusts and Estates. He is also an adjunct professor in the Graduate Tax Program of the NYU School of Law and was selected for inclusion by New York Super Lawyers, which lists the top five percent of attorneys, by state and practice area, as selected by their peers.

Kim obtained an LL.M. in taxation from New York University School of Law, a J.D. from Boston University School of Law, where he served as note and case editor on the Boston University Law Review, and his A.B. from Yale University.

David S. Griffel New York Office +1 212.756.2428 [email protected]

David S. Griffel is a special counsel in the Tax and Financial Services Groups at Schulte Roth & Zabel, where he concentrates on tax issues related to the formation and operation of onshore and offshore investment funds and their investment managers; tax considerations related to employee and executive compensation, including deferred compensation programs; and partnership taxation.

David has spoken on tax issues related to running investment management firms and their funds. A member of the American Bar Association and the New York State Bar Association, he graduated with an LL.M. in taxation and a J.D., magna cum laude, from New York University School of Law, where he was the executive editor of the Environmental Law Journal, a Florence Allen Scholar and a member of the Order of the Coif. Prior to that, he was awarded an A.B., cum laude, from Harvard University, where he was the sports editor of The Harvard Crimson.

Udi Grofman New York Office +1 212.756.2298 [email protected]

Jason S. Kaplan New York Office +1 212.756.2760 [email protected]

Jason S. Kaplan is a partner in the Investment Management and Regulatory & Compliance Groups at Schulte Roth & Zabel, where he concentrates in the area of investment management and advises on general corporate, securities and compliance issues for investment advisers and investment funds.

Jason’s practice focuses on advising managers of hedge, private equity and hybrid funds regarding the structure of their businesses and on day-to-day operational, securities, corporate and compliance issues; structuring and negotiating seed and strategic investments and relationships; and advising investment managers with respect to regulatory and compliance issues.

Among recent writing and speaking engagements, Jason co-authored “Dodd-Frank Becomes Law: Key Issues for Private Fund Managers” published in The Hedge Fund Journal and spoke on “The Upcoming Spring Registration with the SEC for Hedge Funds” at the HFCFO General Membership Meeting (Southern Connecticut Chapter). Jason earned his J.D. from Fordham University School of Law, where he was a member of the Fordham Law Review, and his B.S. from the University of Michigan.

Holly H. Weiss New York Office +1 212.756.2515 [email protected]

Holly H. Weiss is a partner in the Employment & Employee Benefits and Financial Services Groups at Schulte Roth & Zabel, where she focuses her practice on the representation of employers in all aspects of employment law and employee relations. Holly handles disputes involving statutory employment discrimination claims, ERISA claims, executive compensation, employment agreements, restrictive covenants and common law tort and contract claims in federal and state courts, before administrative and government agencies and in arbitral forums. She advises employers on employment law compliance, human resources matters, hiring and termination, and litigation avoidance; negotiates employment agreements, separation agreements and other employment-related agreements; provides training; and conducts investigations.

Holly has authored numerous articles of interest to employers and is a much-sought- after speaker. She is also a member of the New York State Bar Association’s Labor and Employment Law Section. Holly earned a J.D. from the University of Virginia School of Law and a B.A. from Emory University.

Notes:

Triggers for Restructuring

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Building for transition to next generation • Capital transaction • Bringing in a new group of professionals/new line of business • Retention of key employees

Notes:

Firm Dynamics

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Firm dynamics and firm culture could be impaired, temporarily or permanently, by a restructuring event -- Present the restructuring to personnel in a strategic manner to attain support and reduce surprises and concerns • The topics of compensation, governance and titles generate emotional responses and tend to uncover existing, but hidden, frictions • The terms of the restructuring will impact firm culture going forward -- A compensation model based on participation in aggregate firm profits will generate a different culture than a compensation model that is an “eat what you kill” model • Promotions will impact both those being promoted and those who are not

Notes:

Compensation: Salary, Profits, Equity

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Employee compensation generally consists of salary and bonus -- Ordinary income, which is currently taxed at 35% (39.6% starting in 2013) -- Employer and employee also both pay Medicare tax, which is currently 1.45% paid by each, with the employer’s rate increasing to 2.35% in 2013 -- Timing of payment of employee compensation must comply with deferred compensation rules • Partner compensation may consist of guaranteed payments, annual profits share and interest in firm enterprise value -- Guaranteed payments are taxed as ordinary income and subject to Medicare tax (partner pays both portions) -- Possible capital gains treatment on profits share related to the incentive allocation and profits from a sale of the firm -- Medicare savings on “limited partner” participation in management company profits -- Consider state and local tax impact to management company when employees are promoted to partner status (e.g., NYC UBT) • Salaries/guaranteed payments are fixed amounts that generally do not vary from year to year for senior personnel in the firm • Bonus/profits interest are tied to the performance of the firm and may be based on profits generated from performance-based compensation (e.g., incentive allocations/fees), asset-based compensation (e.g., net management fees) or some combination thereof • Bonus/profits interest may be based on a fixed percentage of profits, determined on a discretionary basis by the decision maker(s) of the firm or some combination thereof -- Determination of compensation by an individual or committee -- Reset of profits interest on an annual or multi-year basis

• Bonus/profits interest may be based on a fixed percentage of profits, determined on a discretionary basis by the decision maker(s) of the firm or some combination thereof(continued) -- Dilution -- Vesting — consider tax distributions -- Fixed profits interests may apply to a portion of total profits with the balance to go into a bonus pool to be allocated at the discretion of the decision maker(s) • Taxability of equity grants -- “Profits interest” granted to a service provider is not taxable compensation (with certain exceptions) under IRS Revenue Procedures -- “Profits interest” means an interest that would yield the recipient $0 if, at the time of grant, all of the partnership’s assets were sold at fair market value and all proceeds were distributed -- Legislation has been proposed several times to codify this result -- Grant of anything other than a “profits interest” to a service provider is generally taxable as compensation and is ordinary income -- May produce substantial “phantom income” to the recipient -- May prevent the individual from recognizing capital gain on a sale of the firm • Mechanics of granting equity — alternatives -- Equity refers to the right to participate in terminal value transactions -- Individual buys equity interest at current firm valuation — this is an after-tax purchase (and, therefore, costly) and is relatively uncommon for hedge fund managers -- Individual shares only in the proceeds generated from the sale of the firm that are in excess of the value of the company at the time of the grant. An individual can “catch up” by granting an interest in a larger percentage of the proceeds attributable to the value in excess of the value of the company at the time of the grant (i.e., a threshold value). The “catch up” can seek to place the individual where he would have been had he received his grant at the launch of the firm. This result could only be achieved if the firm is sold at a value that is materially higher than the threshold value.

Notes:

Compensation: Proposed Legislation

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Proposed “carried interest” legislation -- 75% of “carried interest” recharacterized as ordinary income from the performance of services (reduced to 50% to the extent attributable to assets held for at least five years) -- Tax treatment of sale of “investment services partnership interest” is similarly altered • Proposed Medicare tax on “limited partner” service providers -- Proposal to remove current exclusion for “limited partners” of a service business • Current individual tax rates extended through 2012 • Medicare tax on investment income beginning in 2013 -- 3.8% tax on investments, including carried interest (if proposed “carried interest” legislation passes, recharacterized income is taxed under existing Medicare regime)

Notes:

Withdrawal: The Prenupi

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• It is important to document the parties’ agreements regarding rights and obligations upon withdrawal • In the absence of an agreement, disputes are more likely • Departure scenarios: -- Withdrawal for cause (or forfeiting event) -- Withdrawal without cause -- Resignation without good reason -- Resignation with good reason (including retirement) -- Disability -- Death • Elements of agreement: -- Definitions of cause, good reason and disability -- Withdrawal triggers (e.g., written notice of withdrawal from managing member or departing member) -- Notice periods (including obligations during notice periods) -- Compensation entitlements (and forfeitures) under the defined departure scenarios (e.g., liquidation of capital account, continued draw, buyout, profits or equity share, deferred compensation) -- Payment dates -- Conditions to receipt of compensation entitlements (e.g., executing a release, refraining from competition or other detrimental conduct prior to payment dates) -- Continuing obligations (e.g., non-competition, non-solicitation, confidentiality, non-disparagement) -- Dispute resolution (choice of law and forum (e.g., jurisdiction, arbitration vs. litigation)). Dispute resolution provisions play a critical role when a dispute arises and should not be regarded as “boilerplate.”

• A senior member of the firm may be entitled to payments under certain departure scenarios. These payments may take the form of a purchase of the departing partner’s interest in the firm (a “buyout”) or payments to the departing partner over a number of years equal to a declining percentage of revenues (a “sunset”). -- The circumstances where a partner is entitled to a buyout or sunset payments typically include death, disability, withdrawal without cause and retirement -- Periods of sunset vary widely and may range from ten years or more for a founding partner to one year for a new partner • Buyouts may be beneficial to a departing partner due to potential capital gains treatment on the sale of the interest but are less common in the hedge fund industry because of the tax considerations for the remaining partners in the firm, which makes a buyout very costly to them -- Generally buyouts are after-tax payments, with the remaining partners also being allocated the profits that were to be allocated to the departing partner -- Certain payments may be deductible over a 15-year period • Sunsets are more common in the hedge fund industry as sunset payments merely phase out the departing partner without changing payment mechanics (other than reducing the departing partner’s percentage interest over time) -- Departing partner retains a profits interest in the firm and is allocated a declining percentage of income and gain over a period of years -- Payments are “pre-tax” to the remaining partners -- Departing partner’s income is ordinary or capital, depending on the nature of the income earned by the partnership • Consider whether “drag-alongs” and “tag-alongs” are appropriate • Consider whether the sunset also covers terminal value transactions

Notes:

Estate Planning

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Restructuring creates an opportunity for new principals to transfer a portion of their interest in the business to trusts for their children and other beneficiaries for estate planning purposes • Valuation will most likely be done at that time • Transferring interests is best accomplished by a special type of trust known as a GRAT -- GRATs are essentially fully amortized loans -- Eliminate any gift tax risk -- Remove fund interest from principal’s taxable estate • Need for “vertical slice” — if a portion of GP of domestic fund is transferred, must also transfer the same percentage of the principal’s “investment capital”

Typical Hedge Fund Structure Notes:

M anaq o General Partner LLC

GRAT GRAT Management General Partner LLC Company LP (Recipient of (Recl ntof "" mcennve nllocatio n) na m=1111

hun Fond

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR I a «a

• GRAT will become a non-managing member of the General Partner LLC and will also become a limited partner of Management Company LP • In order to achieve vertical slice, the GRAT must also receive the same percentage of the principal’s investment capital in the fund (including deferrals) • GRAT will also participate in terminal value transactions

Notes:

Governance

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Decision Making -- Day-to-day decision making authority is vested in the officers of the company -- Concentrated governance (e.g., sole or limited decision makers) -- Management committees -- Calculation of voting power -- Majority, super-majority or unanimous consent -- Certain subject matters may require different levels of participation in decision making and require different majorities; for instance, launching or dissolving a product vs. opening or closing an office vs. entering into a terminal value transaction • Partners in a partnership (and members of a limited liability company) are entitled by statute to access to the books and records of the partnership (or limited liability company). This right, however, can be waived pursuant to a contract. • If your funds rely on Section 3(c)(7) of the Investment Company Act, an employee may become a member of the general partner, share in the incentive allocation and invest in the fund if the employee/member is a knowledgeable employee or a qualified purchaser

Notes:

Other Considerations

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• When bringing in new personnel: -- Document terms and conditions of the arrangement, including: -- Title, reporting, duties and responsibilities -- Compensation (employee vs. partner compensation) -- Other obligations (e.g., confidentiality, ownership of firm property, work product, non-competition, non-solicitation, non-disparagement, compliance with firm policies) -- Termination and/or withdrawal (how effectuated (e.g., notice period), entitlements and obligations in various scenarios) -- Dispute resolution -- Representation that employee is free to work for firm and has not and will not breach any existing obligations to former employer (e.g., non-competition, non-solicitation, confidentiality, work product, property) -- Background check, confirmation of identification and eligibility to work in the United States -- Get it signed! • When changing structure: -- Starting point: what are current contractual obligations? Is the firm sufficiently protected? Are the withdrawal scenarios clear? Are the consequences of withdrawal clear? -- Will any employees become members in addition to or instead of being employees (requiring new agreements)? -- Opportunity to clarify, confirm prior compliance with and/or strengthen restrictive covenants

Notes:

Getting it Done

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• The firm will have to be valued by a third party valuation firm to the extent equity is being granted and/or interests are being transferred to estate planning vehicles • Administrative issues (e.g., required investment in the firm, payroll, K-1s, periodic tax distributions) • Corporate/securities issues to consider for completing the restructuring -- Key man event -- Change of control under the Advisers Act -- Use of prior track record -- Form ADV disclosure -- Track record disclosure going forward -- Background checks -- Pay-to-play (Advisers Act Rule 206(4)-5) -- Conflicts of interest • Make sure everything gets signed properly -- Oral partnerships are enforceable under Delaware and New York law -- Unsigned restrictive covenants are not enforceable

Notes:

Foundations

-ANN]ALRRNATE INVESTMEM U-SEMINAR r.,i sr,iro ao

• Private foundation is a privately funded and controlled organization that makes grants for various charitable causes • Private foundations are tax-exempt entities and contributions to them are tax-deductible • Why create a foundation? Deduct now, distribute later. • Fund managers can invest foundation assets • Many tax rules apply to foundations

Speakers Kristin Boggiano Ron Feldman Dominique Padilla Gallego 2Craig Stein 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Kristin Boggiano New York Office +1 212.756.2204 [email protected]

Kristin Boggiano is a special counsel in the Structured Products & Derivatives, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel. Her area of concentration includes structuring and negotiating structured products transactions and derivatives agreements on behalf of private investment funds and other financial institutions. She also advises clients on regulatory issues related to derivatives and other hedge fund–related matters.

Kristin is a frequent writer on topics related to structured products and derivatives and, in addition to writing many SRZ Client Alerts, recently co-authored “Dodd-Frank Becomes Law: Key Issues for Private Fund Managers,” which appeared in The Hedge Fund Journal, as well as “New Bullet LCDS Contract Replaces Cancellable Contract,” which was published in Pratt’s Journal of Bankruptcy Law. She has also given numerous lectures regarding derivatives documentation, speaking at Columbia Law School, New York University’s Courant Institute of Mathematical Sciences and a variety of derivatives workshops.

A founder of Women in Derivatives, Kristin is also a member of the Loan Syndications and Trading Association, the International Swaps and Derivatives Association Inc., the New York State Bar Association and the New York City Bar Association.

Prior to joining SRZ, Kristin was an associate at Merrill Lynch, where she was a member of the investment bank’s global equity-linked products team. Kristin obtained her J.D., with a concentration in finance and specialty coursework in derivatives, from Northeastern University School of Law, was awarded an M.B.A. from Northeastern University Graduate School of Business and received her B.A. from Sarah Lawrence College.

Ron Feldman London Office +44 (0) 20 7081 8027 ' ,, [email protected]

Ron Feldman is a senior associate in the Structured Products & Derivatives and Financial Services Groups at Schulte Roth & Zabel. The main areas of his practice include the negotiation of prime brokerage and custody documentation and advising and negotiating derivatives and structured products transactions. With global prime brokers and investment banks, Ron has experience negotiating all forms of derivative, trading and prime brokerage agreements. He has structured and negotiated OTC (ISDA) derivatives transactions, exchange-traded derivatives, master repurchase agreements, global master repurchase agreements, overseas securities lending agreements, prime brokerage and terms-of-business and give-up agreements. Ron also has experience structuring and negotiating structured products transactions and derivatives agreements on behalf of private investment funds and other financial institutions.

Ron was actively involved in the firm’s response to the collapse of Lehman Brothers in 2008. During the crisis, he was a key contact for international clients in the London office and has authored a number of SRZClient Alerts in response to the administration of Lehman Brothers International (Europe) Ltd. More recently, he has written about the FSA’s policy statement concerning prime brokerage client assets, possible new European Commission regulations for OTC derivatives and the new Lehman Brothers International (Europe) U.K. High Court decision on suspension of payments under an ISDA Master Agreement.

Prior to joining SRZ, Ron was a vice president at Credit Suisse, where he was a member of the legal and compliance department in the derivatives practice group. He also worked at Landesbank Hessen-Thüringen Girozentrale and focused on derivatives. He was awarded his LL.B., with honors, from Kingston Law School at Kingston University in London.

Dominique Padilla Gallego New York Office +1 212.756.2332 [email protected]

Dominique Padilla Gallego is a partner in the Tax and Financial Services Groups at Schulte Roth & Zabel. She focuses her practice on U.S. federal income tax matters relating to investment funds, financial products and structured finance transactions.

Dominique is often invited to speak at industry conferences and events. She recently participated in an SRZ audio conference on “ISDA 2010 HIRE Act Protocol: What Fund Managers Need to Understand Before September 14, 2010” and, at the ABA’s 2009 Joint Fall CLE Meeting, she presented on “Tax Issues with Respect to Redemptions and Transfers of Partnership Interests.” Other topics she has spoken on include the tax aspects of distressed investing and developments in structured products and derivatives.

She is a member of the New York State Bar Association, the American Bar Association and the Integrated Bar of the Philippines. In 2000, she received the prestigious AT&T Asia Pacific Leadership Award. Dominique earned an LL.M. in international taxation from New York University School of Law, a J.D., cum laude, from Ateneo de Manila University in Manila, where she was valedictorian, and her B.S.A.E., summa cum laude, from De La Salle University in Manila, Philippines.

Craig Stein New York Office +1 212.756.2390 [email protected]

Craig Stein, a partner in the Structured Products & Derivatives, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, focuses his practice on the representation of investment advisers and private investment funds in swaps and other derivative products, prime brokerage and customer trading agreements, and structured finance and asset-backed transactions. He also represents issuers, underwriters and portfolio purchasers and sellers in public and private structured financings, including collateralized loan obligations (CLOs).

A much sought-after speaker for hedge fund industry conferences, Craig is also the author of numerous articles on advanced financial products for publications such as Credit magazine, Loan Market Week, Pratt’s Journal of Bankruptcy Law and the Journal of Derivatives. He recently co-authored “Dodd-Frank Becomes Law: Key Issues for Private Fund Managers” published in The Hedge Fund Journal.

Craig is a member of the American Bar Association, the New York State Bar Association and the ISDA Credit Derivatives Market Practice Committee. He has been recognized by the prestigious legal directory Chambers USA: America’s Leading Lawyers for Business, which stated: “Clients and peers have ‘nothing but great things to say about’ him. He is ‘a great thinker and excellent credit derivatives operator.’” He earned his J.D., cum laude, from the University of Pennsylvania Law School and his B.A., cum laude, from Colgate University.

Notes:

Primary Goals of Dodd-Frank

• The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Barrack Obama on July 21, 2010. The text of the Dodd-Frank Act can be accessed at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf • The Act provides that it was enacted “[t]o promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail,” to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes” • Title VII is entitled the “Wall Street Transparency and Accountability Act of 2010” • Under the Act, the SEC and the CFTC will have dual oversight of derivatives. The Act provides that the SEC will regulate “security-based swaps” and the CFTC will regulate “swaps.” “Mixed swaps” will be subject to joint regulation.

Notes:

European Union Overview: Regulation of Derivatives

• The EU is not a federation like the United States. Member States remain independent and sovereign. Member States delegate some decision-making powers to shared institutions. EU has 27 Member States with 495 million inhabitants — the world’s third largest population after China and India. • Three main EU institutions: -- European Parliament: represents the EU’s citizens and is directly elected by them -- Council of the European Union: represents Member States, consists of government ministers from all EU countries, meets regularly to make decisions and pass EU laws -- European Commission: the EU’s executive body, drafts proposals for EU laws. Manages the implementation of EU policies. Has the power to impose sanctions on individuals or companies who break EU law. • EU legislation: -- Directive -- Adopted by the Council and the European Parliament or by the Commission alone -- Binding on the Member States as to the end result to, but leaves them the choice of the form and method they adopt within their internal law. Each directive specifies the date by which the national laws must be adapted. -- Regulation -- Adopted by the Council and the European Parliament or by the Commission alone -- A general measure that is binding in all its parts and creates law which takes immediate effect in all the Member States in the same way as a national instrument, without any further action on the part of the national authorities -- Is legally binding throughout every EU Member State, on a par with national laws

• The Commission proposed, on Sept. 15, 2010, a new Regulation aimed at increasing safety and transparency in the OTC derivatives market1 • The proposed Regulation follows the Toronto G20 commitment in June 2010, to accelerate the implementation of strong measures to improve the transparency and regulatory oversight of OTC derivatives • The proposed Regulation is accompanied by an impact assessment, which analyzes the alternative measures being considered in order to reduce systematic risk by increasing the safety and efficiency of OTC derivatives market2 • The Commission has sought to address certain concerns arising from deficiencies exposed in the recent financial crisis in relation to: -- Reporting and transparency -- Counterparty risk -- Operational risk • The proposal is consistent with the Dodd-Frank Act and contains similar provisions requiring the reporting of OTC derivatives contracts and clearing of eligible contracts • The proposed Regulation might be amended during the legislative process, but is intended to be finalized by the end of 2011 • Specific regulatory technical standards not covered by the Regulation to be put in place by June 30, 2012

1 http://europa.eu/rapid/pressReleasesAction.do?reference=IP/10/1125&format=HTML&aged=0&language=EN&guiLanguage=en 2 http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/20100915_impact_assessment_en.pdf

Notes:

Dealers and Major Participants

• The Dodd-Frank Act defines a dealer as (i) an entity that holds itself out as a dealer in swaps or security-based swaps (“SBSs”), (ii) makes a market in swaps or SBSs, (iii) regularly enters into swaps or SBSs with counterparties as an ordinary course of business for one’s own account, or (iv) engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps. Clause (iii) in particular could be broadly construed. However, the definition is not likely to include most private fund managers. (See Joint Proposed Rule Entitled “Further Definition of ‘Swap Dealer,’ ‘Security-Based Swap Dealer,’ ‘Major Swap Participant,’ ‘Major Security-Based Swap Participant,’ and ‘Eligible Contract Participant,’” available at http://www.sec.gov/rules/proposed/2010/34-63452.pdf (the “Joint Proposed Rule”)) • There are three parts to the Dodd-Frank Act definition of major participant (“MP”). A person that satisfies any one of them is a major participant: -- A person that maintains a “substantial position” in any of the “major categories” of swaps or SBSs, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan -- A person whose outstanding swaps or SBSs create “substantial counterparty exposure that could have serious, adverse effects on the financial stability of the U.S. banking system or financial markets” -- Any financial entity that is “highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate federal banking agency” and that maintains a “substantial position” in any of the major categories of swaps or SBSs • The SEC and the CFTC in their Joint Proposed Rule set forth quantitative tests which outline whether a private investment fund would qualify as a MP. See the following for a discussion of the proposed tests: Joint Proposed Rule, p.172 and the CFTC Fact Sheet, available at http://cftc.gov/ucm/groups/public/@newsroom/documents/file/defs_factsheet.pdf

Notes:

Swaps: Not 1256 Contracts

• Credit default swaps, equity swaps (+ equity index swaps), interest rate swaps (+ basis swaps, caps/floors), commodity swaps, currency swaps are not 1256 contracts • Internal Revenue Code (I.R.C.) Section 1256 contracts are required to be marked-to-market annually for federal income tax purposes. Gains are treated as 60% long-term capital gain and 40% short-term capital gain. • The treatment of financial instruments like swaps is not always certain. Credit default swaps, for example, could be options, notional principal contracts, insurance contracts or guarantee contracts for tax purposes (even Treasury has not decided what credit default swaps are). Dodd- Frank attempted to preclude another layer of complexity to be included in the analysis of these instruments. • Prior to Dodd-Frank — a contract where any amount to be deposited or withdrawn per contract depends on a mark-to-market system and is either traded on or merely subject to the rules of an exchange or board of trade could be treated as a 1256 contract. Dodd-Frank, by mandating swap clearing, created the potential for swaps to be “subject to” the rules of an exchange or board of trade, thus sweeping swaps into I.R.C. Section 1256. Congress decided that it was best to expressly state that swaps would not be 1256 contracts.

Notes:

Clearing and Trading of Derivatives

• Section 723(a)(3) of the Act provides that “it shall be unlawful for any person to engage in a swap unless that person submits such swap for clearing to a derivatives clearing organization that is registered under [the] Act or a derivatives clearing organization that is exempt from registration under [the] Act if the swap is required to be cleared” • Section 745(b) of the Act directs the Commissions to prescribe criteria, conditions or rules under which the Commissions will determine the initial eligibility or the continuing qualification of a DCO to clear swaps • Under proposed rules, a DCO would be presumed eligible to accept for clearing any swap that is within a group, category, type or class of swaps that the DCO already clears. A DCO that plans to accept for clearing any swap that is not within a group, category, type or class of swaps that the DCO already clears also would be required to request a determination by the Commissions of its eligibility to clear the swap. • The Act requires the Commissions on an ongoing basis to review swaps that have not been accepted for clearing by the DCO to make a determination as to whether the swaps should be required to be cleared. If no DCO has accepted for clearing swaps that the Commissions find would otherwise be subject to a clearing requirement, the Commissions would investigate the relevant facts and circumstances and, within 30 days of the completion of its investigation, issue a public report containing the results of the investigation. The Commissions would take such actions as it determines to be necessary and in the public interest, which may include establishing margin or capital requirements for parties to the swaps. • After making a determination that a swap (or group, category, type or class of swaps) is required to be cleared, the Commissions, on application of a counterparty to a swap or on its own initiative, may stay the clearing requirement until it completes a review of the terms of the swap and the clearing arrangement

• Under proposed rules, a counterparty to a swap that wants to apply for a stay of the clearing requirement would be required to submit a written request that includes: the identity and contact information of the counterparty, the terms of the swap subject to the clearing requirement, the name of the DCO that clears the swap, a description of the clearing arrangement and a statement explaining why the swap should not be subject to the clearing requirement • The Commissions would complete its review of the clearing of the swap no later than 90 days after the issuance of the stay, unless the DCO that clears the swap agrees to an extension. Upon completion of its review, the Commissions could determine, subject to any terms and conditions as the Commissions determine to be appropriate, that the swap must be cleared, or that the clearing requirement will not apply but clearing may continue on a non-mandatory basis. • End-user clearing exception: a swap that otherwise is subject to mandatory clearing is subject to an elective exception from clearing if at least one party to the swap is not a “financial entity,” is using the swap to hedge or mitigate commercial risk and a notice is provided regarding how it generally meets its financial obligations associated with entering into non-cleared swaps • The definition of “financial entity” includes “a private fund as defined in section 202(a) of the Investment Advisers Act of 1940.” A “private fund” is “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act.”

Notes:

Margin Requirements: Cleared and Non-Cleared Swaps

• Application of margin requirements: clearinghouses will have initial and variation margin requirements that will apply to hedge funds through the member firms of the clearinghouses. The Act will also require initial and variation margin for over-the-counter derivative transactions, applied directly to the SD and MP, which will very likely be passed along to private investment funds. The Act does not expressly provide that capital or margin requirements will be applied to existing swaps; however, it does not “grandfather in” existing swaps or exempt them from any new rules and regulations. The retroactive application of margin may be of considerable concern to private fund managers if it requires the unanticipated rebalancing of assets, which could force fund managers to liquidate current positions to satisfy margin calls. • Segregation of margin: in order to mitigate counterparty risk, the Act provides that, with respect to over-the-counter transactions, fund managers may require counterparties to segregate their initial margin. The same right does not apply to variation margin. The rationale for the disparate treatment of initial and variation margin is that variation margin is posted based on the daily theoretical value of the swap as if settlement were to occur on the date of valuation. Initial margin, however, is collateral held in order to mitigate large swings in the value of the contract. • Portfolio margining: it is unclear what the obligation to trade with new counterparties will mean for hedge funds, particularly because many transactions today occur through a central prime broker. Some transactions will trade through clearinghouses. Other transactions will trade over- the-counter with traditional counterparties. And some transactions will trade with the new affiliate counterparties. The paradigm of traditional portfolio margining occurring at a prime broker will inevitably be affected as a result of these new statutory requirements, and the cost of financing may increase. The Act, however, ensures that there may be portfolio margining between swaps and security-based swaps if the platform permits such portfolio margining, despite the fact that these products are governed by different regulators.

Notes:

EU Proposals: Scope and Applicability

• Applicability: -- The proposals apply both to financial counterparties and to non-financial counterparties -- The definition of financial counterparty includes investment firms, insurance and re-insurance undertakings and alternative investment fund managers established and regulated in the EU (definition to follow AIFM Directive)3 -- An OTC derivative entered into by a fund, whether or not managed by a fund manager should be considered within the scope of the Regulation • Scope: -- Clearing obligations don’t apply except where positions (excluding certain hedges) exceed clearing threshold -- Reporting obligations don’t apply except for non-financial counterparties whose positions exceed information threshold -- Margin requirements on uncleared transactions apply if own positions (excluding certain hedges) exceed clearing threshold -- Capital requirements for uncleared transactions don’t apply except for non-financial counterparties whose positions (excluding certain hedges) exceed clearing threshold

3 Alternative investment managers captured would include investment managers established within the EU and investment managers who manage a fund established in the EU

Notes:

Key EU Proposals: Central Clearing

• This part of the proposed Regulation is key to the implementation to the G20 commitment to clear all “standardized OTC derivatives” • Transactions which meet certain prescribed criteria such as having a high level of liquidity will be cleared through Central Counterparties (“CCPs”) who will step in between two counterparties to a transaction i.e., CCP will be a counterparty to every position. The objective is to reduce counterparty risk of a loss due to the failure of the other party to make payment due to its insolvency. • Two approaches to determine which contracts are to be cleared: -- “Bottom up” approach: CCPs decide to clear certain contracts, its national authority informs the new European Securities and Markets Authority (“ESMA”) who either decide if clearing should apply to all such contracts -- “Top down” approach: ESMA determines and specifies the contract types to be subject to the clearing obligation • Clearing obligation does not apply to non-financial counterparties whose transaction positions are below a clearing threshold (yet to be decided) • Member States to impose “effective” penalties for non-compliance4 • CCPs will be authorized and supervised by Member State national authorities and subject to strict common standards and internal governance rules, audit checks and capital requirements • Other requirements for CCPs include: -- Organizational requirements: include an independent board and risk committee. Governance arrangements to be publicly available and rules on record keeping and conflicts of interest. -- Prudential requirements: include a minimum capital requirement and rule on segregation and portability of trade positions and collateral

4 The Commission’s comment to the proposals is that there should be “effective, proportionate and dissuasive penalties with regard to the clearing and reporting obligations”

Notes:

Reporting: Pre and Post Dodd-Frank Transactions

• Generally, hedge fund managers that trade with swap dealers (“SDs”) will not have an obligation to report. The only time that a hedge fund manager may have to report is when a fund transacts with another fund. The rule in general is that swaps executed off of a swap execution facility (“SEF”) or a designated contract market (“DCM”) will have the SEF or DCM report the transaction. If the swap includes a SD, then the SD will report. If the swap does not include a SD but includes a MP, then the MP will report the transaction. If the swap counterparties are two SDs or two MPs, then the parties to the swap must choose which party must report. If the swap does not include either an SD or an MP, then the parties to the swap much choose which party must report. • The release regarding the proposed rules contemplate that the specific information related to reporting of various derivatives may differ from asset class to asset class and product type to product type. Both releases set forth by the CFTC and the SEC provide minimum information that needs to be reported. However, it’s unclear whether similarly substantive products that fall under different jurisdictions will have identical reporting requirements. For example, the SEC contemplates a “trader ID” in order to follow the trades of individuals. This is not set forth in the proposed rule by the CFTC.

Notes:

Key EU Proposals: Reporting

• Reporting of OTC derivatives transactions is required in order to identify which should be subject to clearing, the applicable regulatory thresholds and in order to identify systematically relevant non-financial counterparties • The proposed Regulation imposes a reporting obligation. Information on each transaction entered into, modified or terminated with a counterparty with “large positions” within the EU will be reported to central data centers (“Trade Repositories”) • Both cleared and uncleared transactions to be reported to allow for a wide-ranging overview of the market • The new European Securities and Markets Authority (“ESMA”) will supervise and be responsible for the registration of Trade Repositories • Regulators in the EU will have access to the Trade Repositories with the aim of enabling them to detect concentration of risk at an early stage • Trade Depositories will publish data on aggregate positions by transaction type • Member States to impose “effective” penalties for non-compliance5 • Reporting obligation does not apply to non-financial counterparties whose transaction positions are below a reporting threshold (yet to be decided)

5 The Commission’s comment to the proposals is that there should be “effective, proportionate and dissuasive penalties with regard to the clearing and reporting obligations”

Notes:

U.S. Equity Swaps: Dividend Equivalent Withholding

• In March 2010, Congress passed the HIRE Act. HIRE included an anti-abuse dividend withholding provision related to U.S. equity swaps. Congress was concerned that swaps were being utilized to avoid U.S. dividend withholding at 30%. HIRE included the concept of a “dividend equivalent amount.” • Pre-HIRE, if a U.S. equity swap was respected as a notional principal contract or swap for tax purposes, and that swap was entered into by a non-U.S. person, income and gains on such swap would not be U.S. source income and therefore not subject to U.S. withholding tax. HIRE says that if there is a “dividend equivalent” on a “specified notional principal contract” (a “bad swap”), then that dividend equivalent (e.g., amount determined by reference to or contingent upon, directly or indirectly, a payment of a U.S. source dividend) would be U.S. source and subject to U.S. withholding tax like a dividend on a physically held position. • Beginning Sept. 14, 2010, until March 18, 2012, the statute enumerates what are the bad swaps, but provides Treasury with the ability to add to the list of bad swaps. After March 18, 2012, all U.S. equity swaps are “bad” unless Treasury excludes certain swaps. Currently, the bad swaps include those where: -- The long party crosses in -- The short party crosses out -- The underlying security is used as collateral by the short party or -- The underlying security is not readily tradable on an established securities market • It doesn’t matter that the swaps were entered into before Sept. 14, 2010, what matters is that payments are made on the swap on or after Sept. 14, 2010, to be covered by the law • Investment funds need to consider both their long and short positions. Long for purposes of any substantive withholding liability and short for purposes of withholding agent liability. Withholding tax is due even if there is no net amount due because of the netting mechanism generally provided under the swaps.

• The provisions contained in the Short Form Protocol published by ISDA in November 2010, appears to be the new norm for new ISDA agreements that are being negotiated by certain dealers (particularly for those dealers that have signed up to the Protocol) and is a better form than the original Protocol put out in August 2010. It attempts to allocate the withholding tax risk to the party who has best knowledge/control of a transaction. As always, whether an investment fund would like to novate its existing agreements is a separate question if it otherwise feels that it is not in any major risk of withholding for both long and short positions on its U.S. equity swaps.

Notes:

2013: I.R.C. Sections 1471- 1474 "FATCA" Withholding

• The HIRE Act also contained anti-abuse provisions intended to catch U.S. persons hiding money through offshore entities that invest in the United States. The FATCA provisions cover all foreign financial institutions (“FFIs,” specially defined for the purpose and generally covers private investment funds) and non-financial foreign entities (“NFFEs”). These provisions are effective beginning 2013. • FFIs (including funds) would have to enter into an agreement with the Treasury/IRS (the specifics of such agreement are still to be defined) to provide in depth information regarding any U.S. person directly or indirectly invested in such FFI. NFFEs would have to comply with similar (but less burdensome) information/certification requirements. Failure to comply with these requirements would result in a 30% withholding tax on U.S. source income and for certain instruments — gross proceeds. • In the context of swaps — equity swaps in particular — one needs to pay close attention to the rule effective after March 18, 2012, that all U.S. equity swaps entered into by foreign persons could be “bad swaps” as discussed previously and could generate U.S. source “dividend equivalent” income for such foreign person. If such foreign person failed to enter into an agreement with the IRS or otherwise comply with the information reporting/certification requirements of the FATCA rules, a significant withholding burden could apply to a foreign person’s capital investment (not just income) beginning 2013.

Notes:

Impact of the Volcker Rule

• The Volcker Rule, among other things, prohibits all U.S. depository institutions and their affiliates (as well as foreign banks operating in the United States and their affiliates) (each a “banking entity”) from acquiring or retaining any equity, partnership or other ownership interest in, or sponsoring, any hedge fund or private equity fund (each defined as any entity exempt from registration as an investment company pursuant to Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, or any similar fund as determined by the federal banking regulators, the SEC or the CFTC), subject to certain exceptions and a transition period • However, a banking entity will be permitted to “organize and offer” a private equity or hedge fund (including serving as its general partner, managing member or trustee, or selecting or controlling a majority of the fund’s directors, trustees or management), subject to certain requirements and limitations, including significant restrictions on transactions with the fund • Notwithstanding the general investment prohibition, a banking entity will be permitted to make certain de minimis and seeding investments (potentially subject to additional capital requirements). However, the Volcker Rule limits these exceptions to funds that the banking entity “organizes and offers.” Thus, all investments in third-party funds will be prohibited. • De minimis exception: a banking entity will be permitted to make or retain an investment in a private equity or hedge fund that it organizes and offers, provided: -- The aggregate interest of the banking entity and its affiliates does not exceed 3% of that particular fund’s total ownership interests and -- The aggregate interest of the banking entity and its affiliates in all private equity and hedge funds does not exceed 3% of the banking entity’s tier 1 capital • Seeding activities: a banking entity will be permitted to make any investment (i.e., up to 100%) in a private equity or hedge fund that it organizes and offers, for the purpose of establishing the fund and providing it with sufficient capital to attract unaffiliated investors. However, the banking entity must actively seek unaffiliated investors to reduce or dilute its interest and such interest must comply with the aforementioned de minimis exception within a year of the fund’s launch (with the possibility of obtaining an extension of up to two additional years).

Notes:

Swaps Push-Out Rule

• Meaning of “federal assistance”: the use of any advances from any Federal Reserve credit facility or discount window that is not part of a program or facility with broad-based eligibility under section 13(3)(A) of the Federal Reserve Act [or] Federal Deposit Insurance corporation insurance or guarantees for the purpose of: -- Making any loan to, or purchasing any stock, equity interest, or debt obligation of, any swaps entity -- Purchasing the assets of any swaps entity -- Guaranteeing any loan or debt issuance of any swaps entity, or -- An entering into any assistance arrangement (including tax breaks), loss sharing or profit sharing with any swaps entity • Definition of “swaps entity”: any swap dealer or major swap participant that is registered under the Commodity Exchange Act or Securities Act • Exclusions from the definition of “swaps entity”: insured depository institutions that are major swap participants but not swap dealers are excluded from the definition of the term “swaps entity.” As a result, an insured depository institution would be a swaps entity only if it is a swap dealer. • Exemptions from the prohibition on providing federal assistance: insured depository institutions are not subject to the prohibition on federal assistance if they limit their swaps activities to the following: a hedging or similar risk mitigation directly related to its activities, or swaps involving rates or reference assets that are permissible for investment by a national bank under the portion of the National Bank Act contained in 12 U.S.C. §24(Seventh), other than uncleared credit default swaps, including those referencing the credit risk of asset-backed securities • Effective date and transition rule: the Swaps Push-Out Rule will become effective two years after the derivatives title of the Bill becomes effective, which is 360 days after the date of enactment. In addition, the Swaps Push-Out Rule requires the appropriate federal banking agency, in consultation with the SEC and CFTC, to permit insured depository institutions up to 24 months after the effective date to divest the swaps entity or cease the activities that require registration as a swaps entity. The regulators must take various factors into account in determining the appropriate transition period, which could be less than 24 months. The transition period may also be extended by the appropriate federal banking agency, after consultation with the SEC and CFTC, for an additional one-year period.

Notes:

U.K. Prime Brokerage Risks

• Counterparty risk (insolvency) • Operational risk (notifications, transfers, poor book keeping) • Legal risk (enforceability, recovery in insolvency) • Asset Risk: -- Cash -- Investments -- Rehypothecation right (assets not yet returned) -- Sub-custodian risk

Notes:

U.K. Asset Protection Initiatives

• New “bankruptcy independent” SPVs to segregate assets away from PB • HM Treasury consultation — Administration of Investment Firms — Nov. 16, 2010 • FSA Policy Statement was published Oct. 20, 2010 • Defines for the first time the terms prime brokerage firm, prime brokerage services and prime brokerage agreement. Definitions in force from Jan. 1, 2011. -- Prohibition on the use of general liens in custody agreements -- New rehypothecation disclosure annex

Speakers Betty Santangelo Sung-Hee Suh 2Peter White 20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR

Betty Santangelo New York Office +1 212.756.2587 [email protected]

Betty Santangelo is a partner in the Litigation, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, where the focus of her practice is white- collar criminal defense and securities enforcement. A former assistant U.S. attorney for the Southern District of New York, where she specialized in securities and commodities fraud prosecutions, Betty’s practice includes representing financial institutions, corporate entities and individuals in matters brought by U.S. attorney’s offices, various regulatory agencies — including the SEC, the CFTC, FINRA and SIGTARP — and state and local prosecutors, as well as conducting internal investigations for these institutions and entities. She has also served as an independent consultant in SEC enforcement matters. Prior to joining the firm, Betty served as first vice president and assistant general counsel for Merrill Lynch in charge of regulatory litigation, representing the firm and its employees in enforcement proceedings before federal and state regulatory agencies, and in criminal matters before U.S. attorney’s offices and state prosecutors, as well as in foreign jurisdictions.

Nationally recognized for her expertise in corporate compliance issues, including anti- money laundering, OFAC and FCPA, Betty’s representation of financial institutions in white collar and regulatory matters frequently draws on these areas of expertise, including advising financial institutions on their anti-money laundering/OFAC/FCPA procedures. Betty is a much-sought-after writer and speaker. In 2008, she won a Burton Award, which recognizes exceptional legal writing, for an article she co-authored on FCPA enforcement. She also co-authored a chapter entitled “Representation Prior to Indictment” in the Law Journal Press book Defending Federal Criminal Cases: Attacking the Government’s Proof and the chapter “Civil and Criminal Enforcement” in the Insider Trading Law and Compliance Answer Book, to be published this year by the Practising Law Institute.

Among Betty’s many professional activities, she has served as the Securities and Futures Industry’s representative on the Bank Secrecy Act Advisory Group of the U.S. Department of the Treasury and is currently counsel to the Securities Industry and Financial Markets Association’s (SIFMA) Anti-Money Laundering and Financial Crimes Committee. Betty is listed in The Best Lawyers in America and New York Super Lawyers and, in 2009, the New York Chapter of the National Organization for Women presented her with its annual Women of Power and Influence Award. Betty was among three FCPA attorneys named to the Ethisphere Institute’s “Attorneys Who Matter” list in 2010. She earned her J.D. from Fordham University School of Law, her B.A. from Trinity College and was selected to participate in an honors program at the University of Oxford.

Sung-Hee Suh New York Office +1 212.756.2418 [email protected]

Sung-Hee Suh, a partner in the Litigation, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, practices in the areas of white-collar criminal defense and securities regulatory enforcement, internal investigations, anti- money laundering compliance and complex commercial litigation. Her recent white- collar criminal and regulatory matters include defending a fund manager in pension fund–related “pay-to-play” investigations by the New York Attorney General’s Office and the SEC; representing a major securities firm in a FINRA investigation involving the firm’s anti-money laundering program; conducting an internal investigation for a global telecommunications company into possible Foreign Corrupt Practices Act violations; representing an interdealer brokerage firm in a FINRA investigation into certain brokerage practices and also in parallel criminal and regulatory investigations into alleged market manipulation of the stock of various financial institutions; and defending a former in-house attorney at Hollinger International Inc. in a federal criminal prosecution for alleged mail and wire fraud involving non- competition payments. Her recent work in civil cases includes representing Merck’s former chief scientist in numerous Vioxx-related securities, products liability, ERISA and shareholder derivative actions, and obtaining the voluntary dismissal of a putative class action against a fund of funds manager in connection with the failure of the Bayou hedge funds.

Sung-Hee is a frequent author and speaker on white-collar criminal defense and securities regulatory issues, having recently authored the “Use of Paid Consultants” chapter in the Insider Trading Law and Compliance Answer Book, to be published this year by the Practising Law Institute. She also co-authored the “Anti-Money Laundering” chapter in the Practitioner’s Guide for Broker-Dealers. Sung-Hee is a member of the New York Council of Defense Lawyers, the Federal Bar Council’s Program Committee and the New York City Bar Association’s Judiciary Committee. Prior to joining SRZ, she served as an assistant U.S. attorney in the Eastern District of New York, including as deputy chief of the Organized Crime and Racketeering Section. For her work as an assistant U.S. attorney, she received the Stimson Medal from the New York City Bar Association and the Department of Justice Director’s Award for Superior Performance. Sung-Hee earned her J.D., cum laude, from Harvard Law School, her A.M. from Harvard University and her A.B., cum laude, from Harvard College.

Peter H. White Washington DC Office ..,i7 +1 202.729.7476 n [email protected]

Peter H. White, a partner in the Litigation, Financial Services and Regulatory & Compliance Groups at Schulte Roth & Zabel, concentrates his practice on representing corporations and executives in criminal and related civil and administrative matters, including grand jury investigations, internal investigations, SEC enforcement proceedings, False Claims Act and qui tam lawsuits, and shareholder class actions. Pete has litigated disputes involving accounting and securities fraud, Foreign Corrupt Practices Act violations, government program fraud, false claims and statements, antitrust violations, public corruption, tax evasion, insider trading, environmental violations and other claims. A former assistant U.S. attorney for the Eastern District of Virginia and the District of Columbia, Pete has served as lead counsel in more than 80 federal and local jury trials and many more bench trials. Recent engagements have involved allegations of accounting and securities fraud, Foreign Corrupt Practices Act violations, government program fraud, false claims and statements, antitrust violations, public corruption, tax evasion, insider trading and environmental violations.

A frequent speaker and author, Pete recently co-wrote the “Civil and Criminal Enforcement” chapter in the Insider Trading Law and Compliance Answer Book, which is to be published this year by the Practising Law Institute. A recipient of the Department of Justice Director’s Award for Superior Performance as an assistant U.S. attorney, Pete has performed with comparable skill as a private practitioner. Among the many publications that have recognized him as a leading litigator are: The Best Lawyers in America, Washington DC Super Lawyers, Washingtonian Magazine and The Washington Post. Pete obtained his J.D. from the University of Virginia School of Law, where he was the notes editor of the Virginia Law Review, and his B.A., with high honors, from the University of Notre Dame.

Notes:

Intersection of the AML, OFAC and FCPA Rules

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Intersection of AML (Anti-Money Laundering), OFAC (Office of Foreign Assets Control) and FCPA (Foreign Corrupt Practices Act) issues -- Need to consider all three risk areas in conjunction with various investments and transactions -- Purpose of this presentation is to explain the interrelationship between AML/OFAC/FCPA and the activities that may trigger AML/OFAC/FCPA issues

Notes:

Why You Should Care About AML, OFAC and the FCPA

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• AML penalties -- Fines and jail time — vary by statute -- Civil penalties range from $1,000 to the amount of currency involved in the transaction (31 C.F.R. § 103.57) -- Criminal penalties • Five to ten years imprisonment plus $500,000 fine (Bank Secrecy Act) • Up to 20 years imprisonment and $500,000 fine or twice the amount of laundered proceeds (money laundering statutes) • OFAC penalties -- Violations of programs under IEEPA and TWEA -- Civil penalties • Under IEEPA, up to $250,000 per violation • Under TWEA, up to $65,000 per violation -- Criminal penalties • Up to 20 years imprisonment and/or a fine of $1 million, twice the gross pecuniary gain from the offense, or twice the gross pecuniary loss caused by the offense -- CISADA • Civil penalties up to $250,000 or twice the transaction value • Same criminal penalties as TWEA and IEEPA

• FCPA penalties -- Bribery violations -- Corporations can be fined up to $2 million for each violation -- Officers, directors, employees or agents can be fined up to $250,000, or imprisoned for up to five years, or both, for each violation • Fines cannot be paid by the corporation (15 U.S.C. § 78dd-2(g)(3)) -- Alternative fine: up to twice the profit gained from the illegal activity or twice the loss resulting from the illegal activity -- Records and control violations -- Corporations may be fined up to $25 million and individuals up to $5 million and/or 20 years in prison -- Criminal penalties can be imposed when an individual knowingly fails to implement a system of internal accounting controls or knowingly falsifies any books, accounts or records (15 U.S.C. § 78m(b)(5)) -- Additional SEC penalties for issuers • Additional consequences for AML/OFAC/FCPA violations -- Forfeiture of assets -- Congressional hearings and regulatory investigations -- Mere existence of investigation involving your fund likely to result in reputational harm and investor redemptions

Notes:

AML: Existing Criminal Laws

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Federal criminal AML statutes apply to all persons and entities, including investment advisers and hedge funds -- Cover financial transactions involving funds derived from specified unlawful activities • Money Laundering Control Act of 1986 made money laundering a crime in and of itself -- 18 U.S.C. § 1956: government must establish that the defendant: -- Conducted or attempted to conduct a “financial transaction” or transported or attempted to transport monetary instruments into or outside of the United States -- Knows that the property represents the proceeds of some form of unlawful activity -- Intends to promote the carrying on of a specified unlawful activity, or -- Knows that the transaction is designed to conceal or disguise the nature of the proceeds of that specified unlawful activity or avoids a transaction reporting requirement -- Sting provision -- 18 U.S.C. § 1957 -- Prohibits an individual from “knowingly” engaging in, or attempting to engage in, a “financial transaction” in “criminally derived property” of over $10,000 -- Defendant need only know that the money involved is derived from some criminal activity, not that the funds were derived from any specified unlawful activity

Notes:

AML Program

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Three proposed rules applicable to Unregistered Investment Companies, certain IAs and CTAs (withdrawn 9/30/08 but may be reissued): -- Includes hedge funds, private equity funds, venture capital funds, companies that invest primarily in real estate and/or interests therein, commodity pools operated by CPOs • MFA Sound Practices • AML program elements under MFA: -- Developing a system of anti-money laundering policies, procedures and controls -- Designating a compliance officer -- Training employees in money laundering detection and prevention -- Establishing an independent audit function to test programs on a regular basis -- Must be approved in writing by senior management • Written procedures and controls should be part of an overall compliance program that will: -- Identify vulnerabilities of your business to money laundering and terrorist financing activity -- Include procedures for the applicable BSA requirements: IRS/FinCEN Form 8300, CMIR (FinCEN Form 105) and FBAR (Treasury Form TDF 90-22.1) -- Periodically assess the effectiveness of the procedures and controls • Address key AML concerns: shell banks, SFPFs/PEPs, suspicious activity, funds derived from illegal activity, OFAC sanctions programs

Notes:

OFAC Sanctions Programs

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• OFAC sanctions programs apply to financial transactions for: -- Certain foreign governments and their agents -- Agencies and organizations that sponsor terrorism -- International terrorists -- International narcotics traffickers -- Proliferators of weapons of mass destruction • SDN List • OFAC requirements -- Asset freezes -- Prohibition of business transactions -- Rejection of transactions • Who must comply -- U.S. citizens and resident aliens, wherever located -- All non-U.S. citizens actually in the United States -- Entities and organizations organized in the United States -- Overseas subsidiaries of U.S. organizations -- In some cases, affiliates are covered • Targeted countries/list-based programs Balkans Iran North Korea Belarus Iraq Somalia Burma (Myanmar) Ivory Coast Sudan Cuba Lebanon Syria Dem. Rep. of Congo Liberia Zimbabwe

• Regulations are constantly changing • Need to screen individuals, entities and securities

Notes:

Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010 ("CISADA")

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• CISADA enacted July 1, 2010 • Section 104(c) requires the secretary of the treasury to: -- Prescribe regulations to prohibit, or impose strict conditions on, the opening or maintaining in the United States of a correspondent account or a payable-through account for a foreign financial institution (“FFI”) that the secretary finds “knowingly” facilitates and/or engages in one of five sanctionable activities relating to Iran • Section 104(d) requires the secretary of the treasury to: -- Prescribe regulations to prohibit any person owned or controlled by a U.S. financial institution from “knowingly” engaging in transactions with or benefiting Iran’s Revolutionary Guard Corps (“IRGC”) or any of its agents or affiliates whose property or interests in property are blocked pursuant to IEEPA • Regulations implementing Sections 104(c) and (d) of CISADA were issued by OFAC and became effective on Aug. 16, 2010 (the Iranian Financial Sanctions Regulations (“IFSR”)) • Additional regulations expected • Requires high sensitivity to transactions with FFIs dealing with Iran

Notes:

Foreign Corrupt Practices Act ("FCPA")

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• “I fully expect that the number of FCPA prosecutions — of corporations and individuals alike — will continue to rise … ” (DOJ Assistant Attorney General Lanny Breuer, Oct. 1, 2009) • In the FCPA arena, “More needs to be done, including being more proactive in investigations, working more closely with our foreign counterparts, and taking a more global approach to these violations.” (SEC Director of Enforcement Robert Khuzami, Aug. 5, 2009) • Expansion of FCPA enforcement resources -- Additional FCPA prosecutors at DOJ -- New FCPA unit at SEC • Aggressive law enforcement techniques -- Sting operations -- Sector-wide probes/sweeps -- Whistleblower provision • Anti-bribery enforcement is going global -- Increased cooperation among United States and foreign anti-bribery regulators -- Increased enforcement activity by some foreign nations (e.g., United Kingdom, Germany) -- New U.K. Bribery Act (2010)

Prosecution of Individuals and Companies Notes:

ao Cn,Omll a" s 35 pd nles

31 30

25 23

20 19

2005 2006 2007 2008 2009 2010

20th ANNUAL PRIVATE INVESTMENT FUNDS SEMINAR I zo11 a zaoei a

• The DOJ and SEC have dramatically stepped up FCPA enforcement in recent years • More cases are being brought -- 32 DOJ enforcement actions in 2005-2007 -- 92 DOJ enforcement actions in 2008-2010 • Higher penalties are being imposed -- In the FCPA’s first 25 years, only 4 fines > $1 million -- Now eight-digit and nine-digit fines are common • The trend toward increased FCPA enforcement shows no sign of abating

Notes:

What is the FCPA?

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Anti-bribery provisions -- Prohibit payment or offer of money or anything of value, directly or indirectly, to a foreign government official, with corrupt intent to influence or induce the recipient to misuse his/her official power or to secure an improper advantage, for the purpose of obtaining, retaining or directing business • FCPA applies to “issuers” and “domestic concerns” -- Issuers with a class of securities registered under the Securities Exchange Act of 1934 (includes foreign companies with U.S. ADRs) -- U.S. citizens, nationals and residents -- Companies that have their principal place of business in the United States or are organized under U.S. law • Areas of potential interaction with foreign government officials: -- Regulatory inspections or audits; licenses and permits; hiring a foreign official as an advisor or seating a foreign official on board of directors; joint ventures with state-owned entities; training and internships for employees of government-owned entities; jobs or internships for relatives of government officials; sponsorship of events, retreats or conferences for clients • Payment or offer of anything of value, directly or indirectly: monetary payments, shares in a company or joint venture, gifts, contractual payments, “favors” (e.g., employing official’s relative), entertainment, travel and hospitality, donations to an official’s favored charity • Prohibited recipient: “foreign official” is very broadly defined, and not limited to high level or just federal officials. U.S., not foreign, law governs who is a “foreign official” under the statute -- “[A]ny officer or employee of a foreign government or any department, agency or instrumentality thereof ... or any person acting in an official capacity for or on behalf of any such government or department, agency or instrumentality[.]” (15 U.S.C. § 78dd-1(f)(1)(A))

• Prohibited recipient: “foreign official” is very broadly defined, and not limited to high level or just federal officials. U.S., not foreign, law governs who is a “foreign official” under the statute (continued) -- Employees of state-owned or controlled entities, foreign political parties and their officials, candidates for foreign political office, encompasses officials of a “public international organization” (e.g., employees of the World Bank, EU entities, U.N. entities, etc.), anyone acting as a conduit for payments to any of the above, including relatives of officials • Corrupt intent: payment must be for purposes of: -- Influencing any act or decision of such official in his/her official capacity, inducing such foreign official to do or omit to do any act in violation of the lawful duty of such official, securing any improper advantage, or inducing such foreign official to use his/her influence with a foreign government or instrumentality to affect or influence any act or decision of such government or instrumentality -- Business purpose requirement — for the purpose of obtaining, retaining or directing business. Areas of potential interactions are limitless: approvals by government entities for acquisitions and other transactions, marketing of products or services to government agencies or employees, participation in a bidding process for the award of government contracts, privatization deals, soliciting investments from sovereign wealth funds or state-owned pension plans. • Knowledge: awareness of a “high probability” of bribery is enough under the FCPA unless the person “actually believes” that no bribery was taking place (15 U.S.C. § 78dd-1(f)(2)(B)) -- Similar to the concept of “conscious avoidance” or “willful blindness” in any criminal prosecution • U.S. v. Frederic Bourke (scheme to bribe government officials in Azerbaijan), SDNY Jury Foreman: “We thought (Bourke) knew (about the bribery) and definitely could have known. He’s an investor. It’s his job to know.” • Accounting provisions: require public companies to maintain accurate books and records and establish a system of internal controls -- No “scienter” or “materiality” requirement -- Issuer can be liable for books and records violation for inaccurately recorded bribe that occurs entirely outside the United States

Notes:

UK Bribery Act (2010)

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Expansive anti-bribery provisions -- Potential penalties: unlimited fines and up to 10 years imprisonment for individuals -- Person associated with company bribes another for advantage of the company’s business -- Strict criminal liability for companies that fail to prevent their employees or agents from engaging in bribery -- Prohibits commercial bribery of private citizens, as well as government officials -- No exception for “facilitation payments” or promotional expenses (like travel) unless the written law governing the official’s conduct requires or permits the official to be influenced by the offer, promise or gift -- Failure to prevent bribery constitutes an offense -- The Act provides only one statutory defense — if the organization can prove that it has adequate anti- corruption procedures and controls in place. Effectively requires any company conducting business in the U.K. to implement robust anti-bribery controls by April 2011, when the Act goes into effect. -- U.S. companies that have U.K. subs or JVs are subject to this law -- Non-U.K.-incorporated company can be prosecuted for acts committed outside the U.K. if it carries out business in the U.K.

Notes:

Due Diligence: Investors and Investments

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• AML/OFAC/FCPA considerations relating to investors and investments -- Who are you dealing with? -- Are they reputable? -- Are there senior foreign political figures (“SFPFs”) or politically exposed persons (“PEPs”) involved? -- What is the background of the company or the investor? -- What is the role of the government in the company, or relationship to the investor, if any? -- How did the company or investment come to your attention? -- Are there any payments to agents or government officials? -- Are there any payments for entertainment of government officials? -- Are there shell companies or personal holding companies (“PHCs”) involved? -- What is the source of funds? Are they legitimate? -- Do any of the individuals appear on the OFAC SDN List? -- Are any countries prohibited by the OFAC sanctions program involved?

Notes:

PHC controlled by wealthy government official - No OFAC SDN hit - Prior U.S. currency conviction

Sovereign Wealth Fund - No OFAC SDN hit - Possible terrorist financing activity in UAE

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Your fund is considering accepting subscription agreements from two potential investors located in the UAE • The first potential investor is a personal holding company (PHC), seeking to make a $20 million investment in the fund • Due diligence reveals that the PHC is controlled by the UAE vice minister of transportation • Your compliance officer advises you that this vice minister is extremely wealthy but that he can’t determine the source of the vice minister’s wealth except that his family has been in the oil business for many years • You screen the vice minister’s name and the PHC against the OFAC SDN List and determine that neither of them matches any name on the List • Your administrator informs you that additional due diligence indicates that this same vice minister of transportation pled guilty in 1997 to entering the United States with $100K in unreported currency in violation of the Bank Secrecy Act. He received probation. • The second potential investor is a sovereign wealth fund located in the UAE, looking to make a $100 million investment • The sovereign wealth fund is not on the OFAC SDN List • Due diligence reveals news articles about possible terrorist financing activity in the UAE, but according to the State Department, the UAE is not considered a state sponsor of terrorism • According to WikiLeaks, the UAE’s lack of effective border controls on cash is being exploited by Taliban couriers and Afghan drug lords • A search of Transparency International’s Corruption Perception Index shows that the UAE’s 2010 score is worse than its 2009 score

Notes:

investment riypo Publicly-traded company - Owns hotels in Cuba - Under investigation for market manipulation

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Your fund is looking to make an equity investment in ABC N.V., a publicly-traded company located in the Netherlands • You find out that the company owns hotels in Cuba and is expanding in hopes that the U.S. trade embargo may one day be lifted. This Cuban investment comprises 10% of ABC’s overall business. • Your fund initially wants to purchase 3% of the shares in the company • You want to buy public shares on the exchange where they are traded, but you are also considering purchasing shares in a private placement • You plan to increase your holdings within the next year and to try to obtain some board seats to protect your investment • During the course of your due diligence, you find out that both the company and one of its principals are under investigation in the Netherlands for market manipulation

Notes:

IFIIVUbLIfi>tFIB nypv Privately-held company Well-connected consultant - Recommends company controlled by CFO - CFO is government official Entertainment, gifts for company reps Recommended charitable contribution DOJ investigation

0 S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ - r

• Your PE fund is considering investing in a privately-held Chinese company, XYZ Holdings Ltd., based on the recommendation of a consultant who is well-connected in China • The consultant tells you that it is important that you understand that the Chinese have their own way of doing business • The consultant tells you that you would get a better price on the deal if you work through a company controlled by the family member of the CFO of XYZ • You learn that the CFO is also a Chinese government official • Your CCO tells you that, based on her research, China is considered to have a high degree of corruption risk • You reject the lower price, but decide to go forward with the deal • Your consultant has secured an evening meeting with the CFO and a senior vice president from XYZ, who are scheduled to be in London next week • You find out that your consultant has already extended invitations to both representatives and their guests, and the evening’s agenda consists of attending a performance by the London Opera Company and dinner at Tres Tres Cher, an expensive restaurant • The tickets are located in the VIP section and are valued at approximately $350 per ticket, and the meal has been estimated to cost approximately $200 per person • In addition to the entertainment, your consultant has already ordered $900 Steuben Crystal rocks engraved with your company’s logo to present to each of the representatives. The total approximate cost of the event is $1450 per person. • The consultant tells you that the CFO of XYZ wants you to make a charitable contribution to his favorite locally run charity, Help the Hungry, which assists in feeding orphaned children located in the region

• Your consultant tells you he has already made a contribution of $50K on your behalf, but the CFO would like you to contribute additional funds from your fund’s management company • The deal has been agreed to in principle, but not yet finalized • Six months later, you receive a subpoena from the DOJ demanding that the fund produce information relating to “any gifts or payments made by the fund, its employees, or agents” to the CFO or any other Chinese government official or other employees of XYZ • While you are gathering documents, you learn that the charity is run by the CFO’s wife and that it is not clear whether it is really doing any charity work

Notes:

Red Flags

S(Dh ANNUAL PUN--S--FUNDS SEMINAR[ -

• Unusual payment arrangements -- Payment in cash -- Payment to third party -- Payment outside the agent’s or counterparty’s country • Lack of transparency in expenses and accounting records • Unusually high commissions • Relationship between agent and potential government customer -- Agent was recommended by government customer -- Agent has family connection with foreign government agency or officials • Refusal of agent or counterparty to provide FCPA certification • Refusal of agent or counterparty to disclose owners, partners or principals • Lack of qualifications or resources on part of agent • History of corruption in the country • Media reports/rumors regarding unethical or suspicious conduct by agent or foreign official involved in transaction

Private Investment Funds Seminar | 18 | © 2011 Schulte Roth & Zabel LLP Disclaimer This information and any presentation accompanying it (the “Content”) has been prepared by Schulte Roth & Zabel LLP (“SRZ”) for general informational purposes only. It is not intended as and should not be regarded or relied upon as legal advice or opinion, or as a substitute for the advice of counsel. You should not rely on, take any action or fail to take any action based upon the Content.

As between SRZ and you, SRZ at all times owns and retains all right, title and interest in and to the Content. You may only use and copy the Content, or portions of the Content, for your personal, non-commercial use, provided that you place all copyright and any other notices applicable to such Content in a form and place that you believe complies with the requirements of the United States’ Copyright and all other applicable law. Except as granted in the foregoing limited license with respect to the Content, you may not otherwise use, make available or disclose the Content, or portions of the Content, or mention SRZ in connection with the Content, or portions of the Content, in any review, report, public announcement, transmission, presentation, distribution, republication or other similar communication, whether in whole or in part, without the express prior written consent of SRZ in each instance.

This information or your use or reliance upon the Content does not establish a lawyer-client relationship between you and SRZ. If you would like more information or specific advice of matters of interest to you please contact us directly.

U.S. Treasury Circular 230 Notice: Any U.S. federal tax advice included in this communication was not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal tax penalties.