As hedge fund managers come under five about fiduciary responsibility, they are turning their backs on side letters which give one party an advantage and put other investors at a disadvantage by dictating different terms than the fund's standard offering documents.
It's the side letters which dictate greater liquidity and/or more frequent data reporting which are--and need to be--on the outs, believes Neil Morris, a partner at consultancy Kinetic Partners.
Michael Meyers, founder of Arcoda Capital Management, sees side letters as nothing more than preferential treatment--treatment which has been criticized by other investors as well as the Securities and Exchange Commission in the past year as certain clients have been able to redeem money, or get information, more readily than others.
Meyers said he takes particular issue with the different reporting standards. This is where side letters can get in the way of fiduciary responsibility, he noted, as in some cases certain big-time investors were receiving, say, weekly positions for funds while all other investors were receiving monthly position data.
Morris said while he believes the SEC should not get involved in forbidding all side letters as they're privately-negotiated agreements, he does think it's a good idea for the SEC to understand different side letter terms, making sure they do not put any investors at a disadvantage.
Ulf Nofelt, managing director of Scarsdale, New York-based UNConsulting, said that while in his experience hedge fund managers aren't getting rid of side letters entirely--legally that may be tricky--they are a lot more cautious in re-writing and negotiating new ones. "They will be used less and less going forward," Nofelt said. Morris agreed. "Side letters will be more the exception rather than the rule," he explained.
One $500 million fund of funds manager told AIN that many funds are either canceling side letters outright or declining to provide them. He said his firm has received a fair number of side letters over the years, and when he is now establishing new relationships he will request special liquidity agreements, for instance. "In the past they would be willing," he said. "Now there's been a pushback."
Still, for the cash-strapped, side letters have their benefits if written up carefully. Paul Jablansky, co-founder and managing partner of 400 Capital Management, said his firm has no plans to offer a side letter to clients, but if a "very big investor" were to demand one from 400 Capital, he said he'd consider it, and most likely give in. "Smaller managers who right now are hungry for business will negotiate them if it will bring in money," Nofelt acknowledged. --Corrie Driebusch
This article was originally published in Alternative Investment News.