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    Dec. 24, 2008

Taxation of Carried Interests for Senior-Level Fund Managers

Carried interest arrangements have been common for years in many types of private investment funds (Funds), including private equity, real estate and hedge funds. Carried interest arrangements can be controversial, in part, because of the ability of Fund Managers (defined below) to treat the pass-through of earnings in certain types of Funds as long-term capital gains for tax purposes, notwithstanding that the carried interest arrangement provides for compensation in connection with the performance of personal services by the Fund Manager. In a guest article, Arthur H. Kohn, partner at Cleary Gottlieb, Andrew L. Oringer, partner at Dechert LLP, and Steven W. Rabitz, partner at Dechert LLP, summarize the principal U.S. federal income tax and related design considerations associated with carried interest arrangements for individuals (Fund Managers) who are employed by or otherwise provide services to sponsors of Funds. This article is intended to provide background to those interested in the design of carried interest arrangements and to serve as a useful practical checklist of relevant tax considerations; it is not intended to be either a comprehensive analysis of the large number of tax issues that may arise in the context of carried interest arrangements or serve as a catalogue of all potential design considerations. For additional insights from Oringer and Rabitz, see our four-part series “A ‘Clear’ Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans”: Part One (Jul. 28, 2016); Part Two (Aug. 4, 2016); Part Three (Aug. 11, 2016); and Part Four (Aug. 25, 2016).

Involvement of Funds of Funds in Alleged Madoff Fraud Reemphasizes Importance of Due Diligence

As Warren Buffett famously said in his 2001 Chairman’s Letter, “you only find out who is swimming naked when the tide goes out.”  According to a criminal complaint and press reports, the tide has clearly gone out on Bernard L. Madoff Investment Securities LLC and its founder Bernard Madoff, and a number of prominent funds of hedge funds have been caught swimming sans bathing trunks.  Specifically, a significant part of the value proposition of funds of funds is the ostensibly rigorous due diligence they perform on underlying managers.  Yet some of the biggest names in the fund of funds world appear to have invested in Madoff investment vehicles without performing adequate due diligence.  The anticipated losses of such names from the Madoff scandal emphasize the central importance of due diligence, especially for funds of funds, and the inadequacy of exclusive or near-exclusive reliance on personal relationships in making investment decisions.  We explore the implications of the Madoff scandal on the rigor and content of due diligence that should be performed by funds of funds prior to and after investing in underlying funds.

Stigma Fades as Use of Gates Becomes More Common

Since the onset of the credit crisis, the imposition of gates limiting redemptions from hedge funds has become increasingly common.  However, there was a time, not too long ago, when the lowering of a gate was a hedge fund industry taboo – a sign of imminent and irrevocable decline.  We explain what gates are, explore the rationale for lowering them in times of stress and discuss the increasing frequency of use of gates (and the concomitant fading of the old stigma).

The Hedge Fund Law Report Launches Interactive Regulatory & Legislative Chart

The response to the international financial crisis has included an unprecedented volume and complexity of new law and regulation – a trend likely to continue and even increase in the U.S. when the next Congress convenes and the new administration takes office.  Much of that new authority will affect hedge funds and their managers, directly or indirectly.  To help our subscribers navigate the shifting regulatory landscape as efficiently as possible, we at the Hedge Fund Law Report are proud to announce the launch of our new Regulatory & Legislative Chart.

Madoff: the SEC’s Complaint and What it May Mean for Private Fund Placement Agents

On December 11, 2008, the Securities and Exchange Commission brought a civil action against Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC (BMIS), a broker dealer and investment adviser registered in both capacities with the SEC, in the United States District Court for the Southern District of New York, alleging that Madoff and BMIS committed fraud through the investment advisory activities of BMIS.  We detail the complaint and discuss a topic that has not yet received significant attention – the implications of the Madoff scandal for private fund placement agents.

NFA Letter to CFTC Broadens Marketing Restrictions Applicable to Forex Dealer Members

The use by or on behalf of a Forex Dealer Member (FDM) of the National Futures Association (NFA) of hypothetical performance results in the context of promotional materials has long been a controversial subject.  A new NFA letter to the CFTC tweaks the rule book in this area, applying to off-exchange hypotheticals the same restrictions that have applied for more than a decade to on-exchange hypotheticals.  We detail the substance of the amendments, and changes they may require in the presentation of performance information and other policies and procedures of FDMs.

Proposed Senate Bill on Credit Derivatives Would Put CDS under the Umbrella of the CFTC, Running Counter to SEC Plans

In a move that could radically alter the DNA of the over-the-counter credit derivatives business, Senator Tom Harkin (Democrat, Iowa), chairman of the Senate Agriculture, Nutrition and Forestry Committee, introduced a bill on November 20 that would force all over the counter (OTC) financial instruments, including credit default swaps, onto regulated futures exchanges.  Harkin’s bill, named the Derivatives Trading Integrity Act 2008, would require derivatives to be traded as futures contracts, thus falling under the sole supervision of the Commodity Futures Trading Commission (CFTC).  We detail the substance of the bill and its potential implications for CDS and other OTC derivatives.

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