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    Mar. 13, 2025

Advantages and Challenges of Cash Hurdles for Fund Manager Incentive Fees (Part One of Two)

With the publication of “An Open Letter to the Hedge Fund Industry” (Letter), the issue of cash hurdles in incentive fee arrangements for private funds has gotten wider attention. The signatories to the Letter, 29 of the world’s largest institutional investors and pension funds, along with three investment consulting firms, addressed what they see as a fundamental misalignment between the interests of investors and fund managers, which, in their view, permits the managers to take home outsized fees that bear little or no relationship to how the funds have actually performed and how much alpha managers have delivered to investors. As a remedy, the Letter calls for the incorporation of cash hurdles into performance fee arrangements across the industry. This article, the first in a two-part series, explains what cash hurdles are and summarizes the advantages and challenges posed by their implementation. The second article will delve into the operational logistics of what needs to happen when a fund manager decides to adopt cash hurdles and offer key takeaways. See “Established Hedge Fund Manager Study Examines Strategies, Fees, Liquidity and Structures” (Nov. 21, 2024).

Study Finds Increasing Hedge Fund Interest in Digital Assets

“Traditional hedge funds are returning to digital asset investing after last year’s drop-off, and they are doing so in increasingly sophisticated ways,” notes the sixth annual study of when and how hedge funds invest in digital assets (Report) conducted by the Alternative Investment Management Association (AIMA) and PwC. The study explored funds’ trading strategies and venues; use of derivatives, stablecoins and bitcoin exchange traded products; institutional investor interest; trends in tokenization; key risks to growth of the digital asset ecosystem; barriers to entry; and needed infrastructure improvements. “Given recent market activity, the industry finally appears ready to move past the events of 2022, which saw several high-profile fraud cases and a general lack of maturity across the wider digital assets landscape,” AIMA managing director Tom Kehoe told the Hedge Fund Law Report. This article discusses the key takeaways from the Report, with additional commentary from Kehoe. See “Crypto Hedge Funds – and Interest in Digital Assets Among Traditional Funds – Increase, According to Study” (Jun. 24, 2021).

Tax Court: All Income Allocable to a Fund Manager’s LPs Constituted Self‑Employment Income

Self-employed individuals must pay Social Security and Medicare tax on their net earnings from self-employment (NESE). The distributive share of partnership income of a limited partner (LP) is generally excluded from NESE, except to the extent it constitutes guaranteed payment for services rendered to the partnership. There is ongoing debate, however, over when that exception applies. In tax years 2016 and 2017, private fund manager Denham Capital Management, LP (Denham) reported less than one-tenth of its LPs’ distributive share of partnership income as NESE. The IRS subsequently issued final adjustments for both years characterizing all such income as NESE, which Denham challenged. On December 23, 2024, affirming a 2023 decision on the same issue, the U.S. Tax Court (Court) upheld the IRS’ determination, ruling that all of the LPs’ distributive share of Denham’s income constituted NESE. The fact that the individuals in question were LPs under state law was not dispositive. Instead, the Court applied a functional test to determine whether the LPs’ income was passive or employment-related. This article parses the Court’s decision. See “IRS Wins Round One Over Meaning of ‘Limited Partner’ for Self-Employment Income Purposes” (Feb. 15, 2024).

A Look at FINRA’s 2025 Oversight Report

FINRA has released its 2025 Annual Regulatory Oversight Report (Report), covering financial crimes prevention; firm operations; digital assets; communications and sales; market integrity; and financial management. As in prior years, each topic area addressed in the Report identifies relevant laws and regulations and “observed weaknesses in firm compliance programs that could benefit from review and additional enhancements” and/or findings from FINRA’s examination, enforcement and other regulatory activities, including “findings we highlighted in prior Reports and that we continue to note in recent oversight activities.” Each topic also highlights effective practices that FINRA has observed that may help firms enhance their compliance programs. This article parses the Report. See our prior coverage of FINRA’s 2023, 2022 and 2021 reports.

SEC Charges Private Fund Adviser With Redemption-Related Failures

One way that investment advisers routinely run afoul of the SEC is by failing to adhere to their funds’ governing documents. They often compound their problems by failing to be forthright with their investors. In December 2024, the SEC charged a private fund manager and its founder (together, Defendants) with doing just that. Defendants allegedly committed multiple breaches of their fiduciary duty and fraud when they improperly suspended redemptions from a private fund, misrepresented the reason for the suspension, failed to honor redemption requests, failed to disclose conflicts of interest, failed to deliver financial statements and improperly calculated management fees. This article discusses the SEC’s civil enforcement action. See “Enforcement Actions Highlight Advisers’ Duty to Accurately and Honestly Communicate With Investors” (Oct. 10, 2024).

Former DOJ and SEC Enforcement Attorney Joins Latham & Watkins

Marc P. Berger has joined the New York office of Latham & Watkins LLP as a global co-chair of the white collar defense and investigations practice. Relying on his prior experience in leadership roles at the SEC and DOJ, Berger regularly represents asset managers, financial institutions, companies, boards, senior executives and cryptocurrency market participants in government and internal investigations, focusing on regulatory enforcement and compliance matters and high-profile disputes. For insights from other Latham partners, see “Navigating Ransomware’s Challenges” (Sep. 26, 2024).

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Women to Watch: Contributions, Achievements and Observations of Outstanding Female Professionals

To mark International Women’s Day, women editors and reporters at ION Analytics interviewed outstanding women in the industries and jurisdictions we cover. In this part, Law Report Group editors Jill Abitbol, Robin L. Barton and Megan Zwiebel profile notable women in data privacy, cybersecurity, private funds and anti-corruption law, including Anne-Gabrielle Haie, Jessica Lee, Micaela McMurrough, Laura Perkins, Amanda Raad, Madelyn Calabrese, Ranah Esmaili and Genna Garver. Enjoy reading their inspiring remarks here.