14. June 2010 19:00
One of the topics that is being proposed for this October’s 5th 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