One of the topics that is being proposed for this October’s 5^th Annual Meeting of the Hedge Fund Business Operations Association is "Cleaning Up Your Prime Broker Arrangements." It seems that in late 2008 as hedge funds scrambled to ensure their prime broker business was no longer concentrated at one firm, many fund managers agreed to boiler plate agreements without fully understanding all of the implications of the terms of those agreement. Since I work for a fund of funds with no direct trading operations, I would never profess to be an expert on the intricacies of prime broker agreements. I can say with certainty, however, that the fact that issues can arise from the use of boiler plate agreements is not unique to prime broker arrangements.

One of the results of the "institutionalization" over the last several years of the hedge fund industry is a proliferation of "best practices" not only for hedge funds themselves but also for the wide variety of vendors that service the industry. These best practices have brought about tremendous improvements and standardization in the industry. As part of the standardization, every vendor has worked with their legal counsel to develop service agreements that accurately outline the terms of their services such as scope, cost and limitations and that also solicit representations from their clients that limit the vendor’s liability under certain circumstances or even gives the vendor the right to refuse or terminate services if the representation proves to be inaccurate, or becomes inaccurate over time. It is in the best interest of the vendor to deviate from their standardized or boiler plate agreement a little as possible.

It is important to do your homework and know the range of services and options available across competing vendors. It is a manager’s responsibility to negotiate the best arrangements possible for the benefit and protection of their investors. This includes both selecting the vendor best able to meet their needs when all factors are considered and negotiating the best terms possible. It is also important to have a complete understanding of the terms of the agreements entered into and the representations they contain. Without periodic reviews of agreements that are in place, veteran managers can miss seemingly irrelevant terms that become relevant over time or can forget representations they have made or circumstances can change and cause the representations to no longer be true. New managers may have limited operational bandwidth or experience with certain vendor arrangements and many look for turnkey solutions.

We have learned in recent years that a change in the industry can move obscure, hard to interpret provisions of an agreement between a fund and a vendor to a focal point of a fund’s survival. Such an event, or the lack of compliance with even the most minor terms or representations in an agreement, can give the vendor unintended power in the relationship, particularly when they hold assets of the fund or have mission critical functions in their hands.

Have you lived through an unexpected twist in a vendor relationship as a result of a boiler plate agreement? Will you share it with us so we can benefit from your experience?

Michelle Kline, Member of the HFBOA Executive Board

We’ve heard talk amongst industry commentators that hedge funds are regaining negotiating power with investors, the result of improved performance more generally and an increase in investor interest as sophisticated investors begin to re-engage with the marketplace. The HFBOA was curious: How much has leverage in negotiations been affected by the fiscal crisis? And are investors really expecting better terms and lower fees, or just greater transparency and openness during more rigorous and ongoing due diligence? So we sat down with a panel whose members represent a wide range of investors and asked them what they think about fees, liquidity, leverage, and the outlook for negotiating power in the hedge fund space.

Check out the latest HFBOA newsletter  to read the interviews!

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The past decade has been truly interesting for the hedge fund industry, starting with the cash inflow tsunami that occurred at the beginning of the decade, to the mass withdrawals of 2008 and 2009. We have witnessed rock star deification of managers to managers being unfairly maligned and prosecuted, with the prediction of the demise of the industry. But through it all, the one constant is the US Government’s reactionary and politically popular response to crisis.

Registration of advisors, will this really stop a future fraud? Personally I believe not as we have already seen the effectiveness of SEC oversight with the Madoff and Stanford frauds. The SEC’s report on its internal investigation in response to concerns of the alleged Stanford Ponzi scheme makes for interesting reading. It may be found at: 

The volume of information received by the SEC will be hard to process even with additional hiring. Was anything useful gleaned from the SEC’s requirement to report short positions for that 10 month period? Registration will only provide a false sense of security to investors, and increase the administrative burden on advisors. I would equate this as the investment advisors edition of Sarbanes Oxley.

A manager’s personal accumulation of wealth is a direct result of the success he or she has had on the generation of wealth for their investors, as the incentive fee is not earned unless the fund value appreciates. Investor wealth up, manager wealth up. This is completely contrary to the CEO’s of numerous publicly traded companies who have received millions of dollars in compensation while the company’s stock price remained stagnant or fell, and then received additional compensation upon departure. Shareholder value down, CEO wealth up. To me this is horrendously egregious, yet for the most part, it is the hedge fund manager’s compensation that receives most of the negative press and populist vitriol from Washington.

The hedge fund industry will live long and prosper (thank you Spock) in spite of additional administrative burden and political grandstanding. Sophisticated investors understand the value of alternative investments and the basic fact the industry is overwhelmingly comprised of extremely smart and ethical people. In short, despite its flaws whether actual or perceived, there is no place I would rather be.

Kurt D. Koeplin, Chief Financial Officer, Rail-Splitter Capital Management, LLC