January 26, 2017 1

Successfully Navigating the New

Investment Environment: Side Letters,

Single Investor Funds and Managed

Accounts

Christopher M. Wells

Partner, Head of Hedge Fund

Practice, Proskauer

January 26, 2017

Why the Recent Growth in SMAs and SIFs?

• What is driving the dramatic recent growth in separate

managed accounts (SMAs) and single investor funds

(SIFs)? Increased investor demand for:

- Desire for customized portfolios (excluding certain assets; SRI

portfolios; focus on certain sectors; increased concentration or

leverage; etc).

- Ability to negotiate different terms.

- Greater control of assets/power to remove manager.

- Greater transparency regarding underlying investments.

- Insulation from possible negative effects on performance due

to subscriptions and redemptions by other fund investors.

January 26, 2017 2

Key Pros and Cons of SMAs and SIFs

• SIF (Pro): Manager can receive more favorable tax treatment

from special allocation of profits rather than performance-based

fee.

• SIF (Con): Additional administrative costs: audit, tax reporting,

administration.

• SIF: Manager typically deals with all trading, credit and

counterparty arrangements.

• SIF or SMA (Con): May not be able to participate in some fund

positions that cannot be replicated in the market.

• SIF or SMA (Con): No automatic rebalancing of positions as in

master-feeder structure.

January 26, 2017 3

Key issues when managing parallel funds

and accounts: Trade Allocations

• Adopt appropriate trade allocation policies:

-Must not favor some accounts over others.

- Allocations do not have to be formulaic, but generally

better if they can be.

-Regular review of trade allocations / performance of

parallel accounts.

- Keep good records, and be prepared to explain

variances.

• Adopt a policy on co-investment opportunities?

January 26, 2017 4

Key issues when managing parallel funds

and accounts: Expense Allocations

• Recent focus of SEC scrutiny

• Adopt a policy

• Disclose policy in fund offering materials, ADV Part 2, etc.

• If a particular client does not agree to bear its share of a

particular cost, then the manager will need to absorb that

client’s portion of the cost.

January 26, 2017 5

Do investors in funds and SMAs have the

same rights? Are SMAs different?

• Does a fund manager have an obligation to offer the same terms

to all investors in a fund?

- No, but need to disclose in PPM that manager may offer more

favorable terms to some investors.

• What distinguishes differences in, for example, fees charged to

investors from differences in redemption rights?

- Precise terms must be disclosed to investors if more favorable terms

(e.g., more favorable redemption terms) granted to some investors

may have an actual economic impact on other investors.

• Investors should ask for information about the size and terms of

parallel funds and managed accounts.

January 26, 2017 6

What are some of the key issues that

investors typically ask for in Side Letters?

• Transparency: Information about portfolio investments.

• Liquidity: Variations or waivers of certain redemption

provisions.

• Reporting: Prompt notice of certain key developments

affecting fund or manager.

• Most favored customer (MFN) clause.

January 26, 2017 7

January 26, 2017 8

Transparency / Selective Disclosure: What

are the Key Issues?

• Need confidentiality agreement with investor

- Should include agreement not to trade on data.

• Need to disclose in offering materials that manager may selectively disclose portfolio information to investors.

• Need to disclose specific selective disclosure obligations if they could materially harm the fund or other investors.

• Key business and legal issue: What can recipients do with the information received that could harm the fund or other investors?

- e.g., short squeeze, front run trade, etc.

What protective measures can be used to

protect the fund and other investors?

• Build in time lag before disclosure (e.g., 30 or 60 day delay)

• Disclose gross or sector or position level data without names (rather than disclosing actual positions)

• Do not disclose short positions

• Disclose to agreed third party risk monitor / aggregator

• Have appropriate confidentiality agreements in place

January 26, 2017 9

January 26, 2017 10

What are Key Issues regarding Liquidity and

Redemption Terms?

• Need to disclose in offering materials that fund may agree to different liquidity terms.

• Need to disclose specific more favorable liquidity terms given to certain investors if they could potentially materially harm the fund or other investors.

• Probably a stronger presumption that all investors should be treated the same.

• Common requests from investors: - Cap on time for payment of withdrawals

- Cap on holdbacks/reserves

- In kind payments: best efforts to avoid in kind payments; require prior notice and/or consent of investor; sell for account of redeeming investor

- Best efforts to terminate suspensions promptly

- Cap on side pockets

- Prohibition against SPVs

- No or limited management fees on side pockets and SPVs or during suspension

- All investors treated same with respect to withdrawals (especially on suspension, gate, in kind distributions)

- Manager and principals/employees subject to same rules with respect to withdrawals

- Key person clause: who covered; how long to redeem/liquidate assets; does suspension clause still apply.

January 26, 2017 11

What Special Events do investors want

notice of?

• Key person event (departure of key personnel)

• Change of key service providers (auditors, administrator,

prime broker)

• Litigations, investigations (that could have material adverse

effect on fund or manager)

• Large redemptions by manager and principals

January 26, 2017 12

Most Favored Customer (MFN) Agreements

• Investor wants:

- MFN to apply to all funds and all managed accounts using same strategy

- Notice of any more favorable terms granted to other investors (even if not required to be offered to investor)

• Manager wants:

- Investor must agree to all associated obligations

- Carve-outs for:

- Bigger investors (treating affiliates as one investor, and including committed capital and commitments to other strategies)

- Seed investors, early investors, classes no longer offered

- Employees, principals, friends and family

- Investors with special regulatory needs

January 26, 2017 13

Key Due Diligence Questions to Ask

Managers

• Size and terms of parallel funds and SMAs (especially if

underlying portfolio is illiquid).

• Review trade allocation policies and practices.

• Review expense allocation policies and practices.

• Review actual variation in performance among accounts.

Final Advice

• Keep good records / database

- to facilitate side letter reviews, compliance, consistency,

disclosure

• Avoid overly restrictive confidentiality clauses

- other investors want to see redacted side letters

• Avoid overly restrictive merger (entire agreement) clauses

January 26, 2017 14

Speaking Faculty

Christopher M. Wells is a partner and head of the Hedge Funds Group. Chris advises hedge funds, funds of funds and other pooled investment vehicles and their managers on all aspects of fund formation, operations and compliance.

Chris was nationally ranked by Chambers USA 2014 for Hedge Funds, and was noted for being "one of the deans of the hedge fund bar" and described as "an outstanding attorney who is highly skilled and experienced in the area." He has also been named a leading lawyer in his field by US Legal 500 and recognized in The International Who’s Who in Private Funds Lawyers, the Best Lawyers in America and other publications.

Chris has organized on-shore and off-shore funds using a wide range of investment and trading strategies. He has been especially active in the formation of funds offered to investors in multiple jurisdictions, and in the development of tax-efficient management structures for U.S. and non-U.S. investment managers. Chris is a frequent speaker at conferences on investment funds and money managers, and is the author of various articles. Before joining Proskauer Rose in 2005, Chris was a partner at Coudert Brothers LLP, where he was head of the Global Investment Funds Practice and a member of the Executive Board.

Christopher Wells, JD, Partner, Proskauer

Mr. Crelinsten joined Greylock Capital in August 2013, and serves as General Counsel and Chief Compliance Officer. Prior to joining Greylock Capital, Mr. Crelinsten practiced corporate law at Proskauer Rose LLP as a member of the private investment funds practice group. At Proskauer, Mr. Crelinsten advised private fund managers in all aspects of fund formation (both onshore and offshore), ongoing compliance with securities, commodities and tax laws, as well as investments in both private and public companies, across a broad range of investment and trading strategies. Mr. Crelinsten started his career practicing corporate law at Coudert Brothers LLP.

Mr. Crelinsten received his LLB and BCL from McGill University in 2005, and a BA in International Relations from Mount Allison University in 2001. He is fluent in French.

Jason Crelinsten, JD, GC & CCO, Greylock Capital

Mike Neus, until recently was Managing Partner and General Counsel of Perry Capital, where he was responsible for all legal, compliance, human resource and administrative matters at Perry Capital, L.L.C. Prior to joining Perry Capital in 2005, Mike was the Chief Operating Officer and General Counsel at RHG Capital, L.P., Chief General Counsel at Andor Capital Management, L.L.C., and General Counsel of Soros Private Funds Management LLC. Mike began his professional career as an associate at Coudert Brothers in Singapore and New York. Mike received his law degree from Columbia University School of Law and his B.A. from the University of Notre Dame.

Mike is a frequent lecturer on hedge fund topics and testified at the Securities and Exchange Commission's Inaugural Hedge Fund Roundtable. Mike was formerly chairman of the investment advisory subcommittee and member of the Executive Committee of the Managed Funds Association.

Michael Neus, JD, Managing Partner & GC, Perry Capital

Simon Raykher is the General Counsel and Chief Compliance Officer of Kepos Capital, a systematic macro institutional investment management firm. Prior to Kepos, Simon served as General Counsel and Chief Compliance Officer of Lombard Odier Asset Management (USA) Corp, the US asset management subsidiary of one of the oldest and largest private banks in Switzerland. For the previous seven years, he was General Counsel, Chief Compliance Officer and Principal of Satellite Asset Management, L.P., a multi-strategy investment manager, based in New York and London. Prior to Satellite, Simon was an attorney with the law firm of Schulte Roth & Zabel LLP. Earlier in his career, he was a prosecutor with the Investigation Division of the New York County District Attorney’s office, where he conducted tax fraud and money laundering investigations. Simon started his career as an auditor with Coopers & Lybrand. Simon earned a B.B.A. and an M.B.A. in Accounting from Pace University in 1990 and a J.D. from Fordham University School of Law in 1995.

Simon Raykher, JD, GC & CCO, Kepos Capital

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January 26, 2017 23

Successfully Navigating the New

Investment Environment: Side Letters,

Single Investor Funds and Managed

Accounts

Christopher M. Wells

Partner,

Head of Hedge Fund Practice,

Proskauer

January 26, 2017

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