In my last blog post I talked about boiler plate agreements used by vendors that service the hedge fund industry. Today, let’s look at agreements used when the hedge fund or the hedge fund manager is the "vendor." The most common agreement in this category is probably the subscription agreement by which an investor purchases an interest in the hedge fund. The subscription agreement memorializes the terms of the investor’s purchase by incorporating information contained in the hedge fund’s private placement memorandum (or equivalent document) and soliciting certain information and representations from the investor regarding their eligibility, authority and understanding of the investment. Subscription agreements are standardized to insure that only "eligible" investors are allowed to purchase interests and so that all investors "invest" under the same terms. Generally, if modifications are made to the terms of investment, it is done through a "side letter" rather than an actual modification to the wording found in the subscription agreement. As is the case with any vendor, it is in the hedge fund’s best interest to treat all of its investors equally and, therefore, to enter into as few side letters as possible.

Another agreement commonly used by hedge funds is the investment management agreement between the hedge fund and its manager. This agreement generally also incorporates the terms of the hedge fund’s private placement memorandum as the standard by which the manager will manage the hedge fund’s affairs and invest its assets. It is through the ratification of the investment management agreement that the directors of a hedge fund (if organized as a corporation) delegate the investment management authority to the hedge fund manager. By signing the investment management agreement, the hedge fund manager accepts certain fiduciary responsibility for the hedge fund and, in turn, its investors.

If a hedge fund manager also provides services to managed accounts, a third agreement that could be viewed as a combination of the subscription agreement and the management agreement will be common. This agreement is the investment advisory agreement between the owner of the account to be managed and the hedge fund manager. Since investment advisory services to managed accounts are not offered by way of a private placement memorandum, the investment advisory agreement generally will contain in its body, or as an appendix, detailed information on the investment strategy intended for the managed account as well as the related risks. The investment advisory agreement delegates authority for the investment management of the account by the account owner to the hedge fund manager. The hedge fund manager obtains the necessary information, representations and approvals from the account owner through the investment advisory agreement.

The private placement memorandum and equivalent information for a managed account, the subscription agreement, the management agreement and the investment advisory agreement are all closely related. It is important that they are not inconsistent with each other and that both the information and representations they contain are correct. They also need to be consistent with the current practices and strategies of the hedge fund manager. What process do you use to insure this consistency? How often do you request updated information and representations from your investors and managed account owners?

Michelle Kline, Member of the HFBOA Executive Board