HEDGE FUNDS

1. HEDGE FUNDS By Robert J. Kiggins, Esq. of McCarthy Fingar, White Plains, NY Presented on June 10, 2005

2. INTRODUCTION & SURVEY- “Hedge Fund” History • Many think of this industry as a fairly new innovation, but its history began in the late 1940s and perhaps even the early 1930’s • Alfred Winslow Jones was the first fund manager to combine a leveraged long stock position with a portfolio of short stock positions in an investment fund. • Using a private limited partnership structure for his fund, Jones was paid on an incentive fee basis. • Investors in Jones' little known fund enjoyed very handsome returns as his fund outperformed all mutual funds of the time. • However, Karl Karsten came up with the technique (in concept) in 1931 in a book entitled “Scientific Forecasting” published that year. • For example, Karsten’s theory for small funds that could not diversify across entire markets was “Buy the stocks in the group predicted to rise most in comparison with the others, and sell short the leading stocks in the group predicted to fall most” • The hedge fund idea started as a risk reduction technique – to reduce risk with respect to the direction of the market or individual securities (either entirely long, or entirely short). Hedge funds used hedging tactics (e.g. a combination of short and long positions) to pool investors' money and invest those funds in financial instruments in an effort to make a positive return • However, the chance for higher investment returns increased the popularity of hedge funds in the 1960s; • The nature of hedge fund management was shifting and managers took more risk by leveraging instead of hedging their positions. • When markets took a turn for the worst, these riskier strategies did not pay off, and hedge funds hit a difficult period from the mid 1960s to the end of the 1970s.

3. Hedge Funds Aren’t Usually Hedged • This history shows that even fairly early on the fact that something was referred to as a “hedge fund” did not mean that it was hedged with regard to all, or any, of its positions. • That is the case to this day. • In short, a hedge fund is descriptive of a type of entity – an investment limited partnership (although offshore funds are typically corporations) that invests in securities. • A “hedge” fund typically is not actually hedged. • By 1980 and throughout the 1990s, with the arrival of derivatives, new styles of management were developed. • Consequently hedge funds became a more mixed group. • The hedge fund industry started to offer a greater array of products, using more complex strategies. • This was the start of a growth industry. Hedge funds became the investment world’s Holy Grail. • Big winner – George Soro’s Quantum Fund – allegedly made more than $1B contra ER II Regina (Great Britain) by betting against the £ (i.e. Pound) in Euro Exchange Rate Crisis of 1992 • From 1994 to 1999, hedge funds performed phenomenally well as the Clinton bull market - unparalleled since the 1920’s - was pushing returns to record highs. Many traditional money managers were becoming hedge fund managers. It seems that hedge funds could do no wrong. • Then reality struck when the Tech Bubble burst in 2000. Even the high and mighty were struck down. My personal pick, albeit a 1998 event which did not result in the Fund going bust, was the Long-Term Capital Management fiasco.

4. The Story of Long Term Capital Management • Long-Term Capital Management, LLP (LTCM) was founded in March 1994 by • John Meriwether, the former head of the Salomon Brothers bond –arbitrage trading group, an extremely profitable venture • along with a small group of associates most notably economists Robert Merton and Myron Scholes (of Black Scholes Options Pricing Formula Fame) who received the Nobel Prize in economics in 1997. • Organizationally, LTCM was a Delaware LLP which operated a Cayman Island Partnership called Long Term Capital Portfolio LP • Meriwether had left Salomon after its 1991 bond scandal. A Salomon bond trader illegally tried to corner the primary Treasury auction market by bidding in excess of the firm’s limits. • A ban threatened by the Fed prompted a run on Salomon which almost brought down the highly leveraged firm. • The situation was salvaged only by Warren Buffet taking over Salomon and the Fed reversing the ban. • Meriwether was fined a rather puny $50K for failure to supervise his traders

5. The Story of Long Term Capital Management (Cont’d) • The core strategy of LTC can be described as “relative value”, or “convergence – arbitrage” trades try to take advantage of small differences and prices among closely related securities. • Definitions: • On-the-Run Bond the most recently issued U.S. Treasury bond or note of a particular maturity. These are the opposite of off-the-run treasuries • The on-the-run bond or note is the most frequently traded Treasury security of its maturity. Because on-the-run issues are the most liquid, they typically are a little bit more expensive and, therefore, yield less than their off-the-run counterparts.

6. The Story of Long Term Capital Management (Cont’d) • Off-the-Run Bond . All Treasury bonds and notes issued before the most recently issued bond or note of a particular maturity. These are the opposite of on-the-run treasuries. • Once a new Treasury security of any maturity is issued, the previously issued security with the same maturity becomes the off-the-run bond or note. • Because off-the-run securities are less frequently traded, they typically are less expensive and therefore carry a slightly greater yield. • For instance, an off-the-run treasury bond might yield 6.1% versus 6.0% for a more recently issued on-the-run. • The yield spread represents some compensation for liquidity risk. • Over a year of trade a long off the run and short on the run will be expected to return 10 basis points per dollar invested. The key is that eventually the two bonds must converge to the same value.

7. The Story of Long Term Capital Management (Cont’d) • The strategy was used in a variety of markets • long swap government spreads, • long mortgage-backed securities versus short government, • long high-yielding versus short low-yielding European bonds, • Barring Market Disruptions these trades generally prove profitable • The problem of convergence strategies is it they generate tiny profits so that leverage has to be used to create attractive returns. • In the case of LTCM to control risk, the target ceiling risk level was set to the volatility of an unleveraged position in US equities. • Positions were obtained by portfolio optimization with a constraint on volatility, with some additional constraints such as liquidity and concentration of positions. Leverage had to be quite large.

8. The Story of Long Term Capital Management (Cont’d) • The fund was initially very successful • by the end of 1995-96 it achieved annual rates of return around 40% • this was achieved largely through successful bets on convergence of European interest rates • that and the glitter of the sponsors made the fund very popular on Wall Street. • the fund was charging for this – 2% of capital fixed fee plus 25% of profits • The Fund was very highly leveraged $125B assets over $5B equity • This gave the fund a 25:1 ratio of assets to equity • Fund leveraged through very favorable repo financing • Repo A contract in which the seller of securities, such as Treasury Bills, agrees to buy them back at a specified time and price. also called repurchase agreement or buyback. • However in 1997 the Fund’s return was down to only about 17% • The US Stock return that year was 33% • Credit spreads had narrowed accounting in large part for the lower return. • Leverage had decreased from 25:1 to 18:1 due to asset growth • Management concluded that the capital base was too high to earn the rate of return on capital of which they were aiming • $2.7 billion was returned to the investors • This cut in the fund’s capital to 4.8 billion and increasing its leverage ratio to around 28:1 • This amplified returns to investors who stayed in the fund. • This also made the Fund much riskier

9. The Story of Long Term Capital Management (Cont’d) • Troubles Begin • In May and June, 1998 there was a downturn in the mortgage backed securities market • There was a 16% loss of capital to the Fund • Capital dropped from $4.7B to $4B • Leverage increased from 28:1 to 38:1 • Disaster then struck in August 1998: • the Russian government devalued the ruble and declared a moratorium on future debt repayments • those events led to major deterioration in the credit worthiness of many emerging-market bonds and corresponding large increases in the spreads between prices of Western government and emerging-market bonds.

10. The Story of Long Term Capital Management (Cont’d) • Those elements were very bad for the Fund because the fund had bet in mega fashion on the spreads narrowing. This was exacerbated by the fund sustaining major losses of other speculative positions as well. So: • By the end of August, 1998 Fund capital was down to 52% of the equity capital the Fund had at the start of that year. • But that time the asset-base was about $126 billion (an over 55:1 asset to capital ratio) • The fund was running short of high-quality assets for collateral to maintain its repo positions • The fund’s management spent the next few weeks looking for assistance in an increasingly desperate effort to keep the fund afloat • no immediate help was forthcoming • by September 19 the fund’s capital was down to only $600 million • fund had an asset-base of $80 billion to appoint its leverage ratio was approaching astronomical levels • doom was imminent

11. The Story of Long Term Capital Management (Cont’d) • Bailout • In a highly controversial move the US Federal Reserve put together a “bailout” • Many Wall Street firms had large stakes in the Fund and it was deemed that failure of the fund could lead to disastrous effects on the financial markets (the classic “too big to fail” case) • A liquidation of the Fund would have required dealers to sell of 10’s of Billions of securities and to cover their numerous derivatives trades with the Fund • In addition since the Fund was organized in the Caymans it was not certain if US Bankruptcy Law would apply • 14 banks and brokerage houses including UBS Goldman Sachs and Merrill Lynch but not the Fed agreed to invest $3.6 5 billion of equity capital in the Fund in exchange for 90% of the firm’s equity • Existing investors would therefore retain 10% holding valued at about $400 million (a competing offer from a wholly private group led by Warren Buffet would have cashed out the investors at $250 million) • Control of the fund passed to a new steering committee and the announcement of the rescue eased concerns about the fund’s immediate future • By the end of the year the Fund was making profits. • Eventually the fund was unwound and by the end of 1999 all money was repaid to investors

12. Anatomy of a Hedge Fund • The Fund • typically organized as a limited partnership, • although off-shore funds are often corporate entities • The Sponsor • the individuals or entity (might be a financial institution) who have organized and promote the Fund • The General Partner • typically (to limit liability) an entity: • often an LLC or occasionally corporation • The Manager • investment adviser to the Fund. • The General Partner might be the Manager • or a separate entity might serve as the Manager. • Investors • they contribute virtually all of the capital to the Fund. • typically high net worth individuals or institutions

13. Anatomy of a Hedge Fund – Cont’d • Limited Partners. In a Fund which is in the form of a limited partnership this is the investors. • liability is limited to their capital commitments to the Fund. • LP’s do not manage or operate the Fund - that is the role of the General Partner • Capital Contributions. • The capital invested or to be invested in the Fund by the investors • to a limited extent, by the General Partner. • the general partner and the investors would each have commitments to make capital contributions in a specified maximum amount. • Uses of Capital. • Under the sole control of the General Partner • However, generally to pay fund expense and to make investments for the Fund • Investment Guidelines or Investment Policies. • These are the road rules to be followed by the General Partner in directing Fund investments.

14. Anatomy of a Hedge Fund - – Cont’d • Management Agreement – where the Manager is different from the General Partner there is a management agreement spelling out the duties of the Manager – generally involving finding investments , monitoring investments and advising on strategies • Management Fee – It is intended to pay for salaries of management personnel and costs of management. • Generally this will fall in the range of 1.5% to 2.5% of the amount of the value of the Fund. • Taxed as Ordinary Income • Carried Interest – This is the incentive compensation paid to the General Partner out of Profit generated by the Fund investments • Amount varies but generally is 20% of the Funds Profits • Taxed as Capital Gain

15. Anatomy of a Hedge Fund - – Cont’d • Preferred Return – In many cases the Investors are entitled to receive a specified return on their capital (e.g. 7% per year) before the General Partner receives Carried Interest. • Pure Preferred Return – Investors get their Preferred Return and thereafter Profits are split in the ratio determined (typically 80%-20% on the excess) • Hurdle Rate – • After the Investors get their Preferred Return then there is a a Make Up to the General Partner • in the form of an incremental share of the Profits in excess of the Preferred Return • until the General Partner has receive the Carried Interest on all Profits • The term “hurdle” comes from the perception that the hurdle rate is the rate of return that will get someone "over the hurdle" to invest their money in the deal. • Clawback • As result of early portfolio gains followed by later significant losses • managers may receive carried interest distributions • in excess of their share of the fund's cumulative profits, • At the end of the Fund • the Fund’s cumulative profits are calculated • and compared with the distributions of carried interest made to the general partner during the life of the fund • To the extent the general partner has • received more than its agreed-upon share of the Fund's cumulative profits, • the excess must be returned.

16. Types of Funds – Venture Capital Funds • Basic Features: • Invest in development stage businesses • Often are in the form of preferred stock • The hope is to cash out at profit on an IPO or sale of the business to a strategic buyer. • Often diversify by making numerous small investments. • The limited partners often • lack expertise in a certain industry or • do not have the information or capacity to make direct investments in privately held companies. • rely on the general partners to select and monitor appropriate investment opportunities through the venture capital fund • Economics • GP’s Carried interest. • Based on realized capital gains plus the unrealized gains on marketable securities distributed to investors. • Typically range from 15% to 35% of the gains attributable to the investors capital contributions

17. Types of Funds – Venture Capital Funds • Example: • If GP provides 1.5% of the total capital and the investors 98.5% • GP will receive 1.5% of the gains as a return on its capital investment plus 20% of the gains on the 98.5% of the capital contributions provided by the investors • Total profits interests of the general partner is 20.12% representing • 20% of the total profits as carried interest and • The GP’s pro rata share as an investor of the 80% profits share going to the investors (1.5% of 80% equals .12%). • Preferred return • Not usually provided to investors • If provided, may vary from 6% to 12% depending on risk and interest rates • If provided, a GP Makeup is almost inevitable • Management Fee. • 1.5% to 3.0% of Capital Commitments • Generally, no decline in rate when Fund is fully invested

18. Types of Funds – Venture Capital Funds (Cont’d) • Leverage • VC funds rarely have the ability to borrow money • Exceptions (on a short-term basis): • to cover expenses • make up for gaps in capital contributions. • Transferor and redemption • VC Fund interest are highly illiquid • transfers are generally prohibited without the consent of the general partner. • Redemptions and withdrawals are rarely allowed • Reinvestment • proceeds from sales of investments • rarely subject to reinvestment • Additional investors. • Generally closed to new investors within six to 12 months after initial closing • Where allowed, subsequent investors often contribute their share of the cost of prior investment by the Fund (often with interest). • Closed to new money • is designed to keep things simple • and avoid the need for valuations of investments early in their life • valuations are imprecise (which can lead to disputes), complex and costly

19. Types of Funds – LBO and Investment Banking Funds • General Features. • LBO/IB funds purchase all or significant portion of stock or assets of a target company. • investments takes the form of equity securities of a newly formed corporation which will acquires stock or assets of the target company. • borrow money to fund a large portion the purchase price • Cash flow from the acquired company is used to service and repay acquisition indebtedness. • Likely candidates for LBO's • stable cash flow • good market share.

20. Types of Funds – LBO and Investment Banking Funds • Economics • Carried interest - typically consists of 20% of the gains attributable to capital commitments • Preferred return – generally 8% to 12% with a GP Makeup • Management fees 1.5 to 2.5% • Based on Capital Commitment during Investment Period • Thereafter, based on capital not retuned to investor • Transaction fees • Management is quite likely to have opportunity to receive fee income directly from target companies.

21. Types of Funds – LBO and Investment Banking Funds (Cont’d) • Thus the question of whether fee income should be treated as Fund income is often intensely negotiated • Transfer and Redemption • Investors generally prohibited from transferring their interests without the consent of the GP • redemptions and withdrawals are rarely allowed • Reinvestment - reinvestment is rare • Additional investors – same polices as with VC Funds discussed above

22. Types of Funds – Hedge Funds • General Strategies • Invest in listed securities, options, futures, and currencies • Or other liquid financial assets • The ability to invest in illiquid securities is sometimes also given • However, often there are caps on investments in illiquid securities • Organization • Many different types of structures are used • Short-term trading is involved • So not as geared toward capital gains as other types of funds • This makes partnership qualification less critical provided entity level tax can be minimized • Generally the structure depends on the investor group to whom the fund will be sold • US taxable investors • generally domestic limited partnership structure is used to avoid entity level tax • Non-US investors and US Tax Exempt Investors • Entity level tax is undesirable • However, pass thru is often not wanted either (e.g. UBTI for tax exempts) • So many hedge funds organize in tax havens such as Cayman Islands and Bermuda

23. Types of Funds – Hedge Funds (Cont’d) • Economics • Carried interest • Determined by reference to net asset value which takes into account unrealized as well as realized gains and losses. • The amount is typically 20% of the increase in NAV from one period to the next. • Generally paid annually • Clawbacks are unusual. • Higher Carried Interest rates of 25% or very exceptionally 30% are sometimes seen • Preferred returns • most hedge funds do not provide preferential returns • however funds which do often adopt a floating rate of return such as LIBOR -- the London Interbank offered rate • Management fees • usually an amount equal to a fixed percentage of NAV. • Typically these are paid quarterly in advance. • The general rate is 1% per annum • Transaction fees • these are not often present

24. Types of Funds – Hedge Funds (Cont’d) • Leverage • leverage ratios of three to one are common • funds which pursue arbitrage opportunities in financial assets may have significantly higher leverage • Transfer and Redemption • general partner consent is required to transfer • redemptions are typically allowed after perhaps an initial lockout from one to two years • redemptions - made quarterly or semiannually • Reinvestment - universal • Additional investors - most hedge funds are open to new investors on redemption dates

25. Types of Funds – Fund of Funds • Definition • This is a fund which invests in other funds • Rationale • access to deals • expertise • economies of scale • diversification • Access to deals • Many Funds require minimum investments that are beyond the reach of many individuals. • Regulatory reasons can restrict individual investors to those with net worth of $5 million+ • Expertise • lack of transparency in some markets • the only way to obtain certain market information is often to be an active market participant • fund of funds can bridge the information gap for investors • Economies of scale • Sponsor can the review prospective investments that would be prohibitively expensive if undertaken by each investor in paragraph

26. Types of Funds – Fund of Funds (Cont’d) • Investment strategy. • Better investment returns relative to mid-to long-term public equity market returns. • Most funds of funds focus on a particular category of underlying private equity funds • Organizational structure • typically limited partnerships. • The partners have capital commitments in specified amounts • The general partner is often organized as a limited partnership or an LLC • General partner of the fund sponsors typically do not organize a separate entity to serve as manager • Carried interest • Many of the funds of funds forego • Carried interest is still typical for a majority. • Generally arrived at by formula consisting of realized gain plus unrealized gain associated with marketable securities which are distributed to investors. • Carried interest is generally around 5%

27. Types of Funds – Fund of Funds (Cont’d) • Preferred return • most funds of funds provide preferred returns. • generally a fixed percentage annual rate of return • general range - from 6% to 12% • preferential returns are almost overly combined with a general partner makeup • Management fees • Usually an amount equal to a fixed percentage of capital commitments • Management fees are typically paid by a fund of funds quarterly in advance • ranges - .75 to 1.5% of capital commitments • Often management fee rates decline when the fund is fully invested. • If no carried interest • a higher management fee • less likely to be reduced if the fund is fully invested

28. Types of Funds – Fund of Funds (Cont’d) • Transaction fees • Unlikely • Size • certain critical mass is needed • to have access to deal flow • and to achieve economies of scale. • typically capital is $50 million to 100 million • Investor • profile high net worth individuals and small institutional investors paragraph • Leverage • fund of funds really has the ability to borrow money • except in short-term to cover expenses or bridge contributions

29. Types of Funds – Fund of Funds (Cont’d) • Transfer redemption • Transfer only on the consent of the general partner • Redemptions and withdrawals are rarely allowed • Reinvestment • typical fund of funds calls for capital contributions as needed for investments or to pay expenses • once fully invested or after a specified investment. • A fund of funds ordinarily goes into monitoring and liquidation stage. Proceeds from underlying • Additional investors • most funds of funds are closed to new money within six to 12 months after the initial closing • investors after initial closing contribute pro rata share of costs of prior investment (often with interest)

30. Types of Funds –Real Estate Funds • What they Do • These generally invest in large real estate assets • generally sponsored by experienced real estate owners or investment advisers • Investment strategy • superior return and risk reduction relative to direct real estate investments • generally structured with a specific investment focus such as • acquisition of real estate directly. • Acquisition of interests in properties on a joint-venture basis • investment in public or private operating companie • real estate loan origination or acquisition of real estate debt instruments • may also focus on specific real estate asset types such as • commercial office buildings • retail shopping mall facilities. • Multi-family properties or hotels. • They may also have an investment strategy that focuses on specific geographic regions.

31. Types of Funds –Real Estate Funds (Cont’d) • Organizational structure • these are typically either limited partnerships or LLC's • principals organize a controlled entity to be GP or managing member • Principals may organize a separate entity to invest in the fund. • The general partner or managing member entity is typically either corporation or LLC • Principals may organize a separate entity to serve as investment manager or investment adviser. • Carried interest. • Calculate from realized gains which are distributed • May also be calculated at fixed intervals by an appraisal of assets. • Typically consists of 20% after Hurdle Rates are achieved. • Often subject to claw back – final returns are really known until asset disposition • Preferred returns • a substantial majority of real estate funds provide preferential returns or hurdle rates • The percentage varies depending on the specific investment strategies used

32. Types of Funds –Real Estate Funds (Cont’d) • Management fees • these are usually annual amount equal to a fixed percentage of capital until 75% of the capital commitment is funded and invested • thereafter a fixed percentage of the NAV • typically paid quarterly or monthly in advance. • Fees generally range from 1% to 2% • Transaction fees • affiliates of the principals may receive • property Management fees, • leasing • or other fees for properties owned by the fund. • These fees are typically not shared with the fund or the investors • Typical investors • high net worth individuals, pension funds and other institutional investors • generally do not include banks and insurance companies

33. Types of Funds –Real Estate Funds (Cont’d) • Leverage • real estate funds typically employ leverage • additional leverage might be obtained by a fund level credit facility in addition to loans against assets • Transfer and Redemption • transfer requires consent of the general partner. • due to illiquid nature redemptions are not allowed except rarely • Reinvestment • real estate funds generally provide • A 2-3 year investment phase • A 1-2 year holding and monitoring period • A 1-2 year liquidation period • Proceeds from sales are generally not subject to reinvestment. • Additional investors • most real estate funds are close to new investors within 6- 12 months after the initial closing • additional investors leads to expense to value fund assets such as real estate appraisals

34. Key Structural Features • Limited Liability • Enabling state law legislation will provide for limited liability for LLC • E.G. Delaware – debts, obligations and liabilities of an LLC whether arising in contract or otherwise are the sole responsibility of the LLC • Compare LLP – the limited partners have limited liability but not the GP • Solution have an entity GP, e.g. an S corporation • However, keep in mind limited liability only extends to status based liability • Liability based on the personal conduct of a member or manager is not protected by the entity’s limited liability • Under US Securities laws liability sometimes extends to persons who control another person such as a corporation that violates the laws • Veil piercing – A somewhat open issue • Inadequately capitalized entities ?? • Failure to follow formalities ?? – But no real formalities and direct management by members is envisioned by the laws

35. Key Structural Features (Cont’d) • Multi-Tier Structures • Issue in LP’s is how to organize the GP on account of the Unlimited Liability of GP • Classic solution was a corporate GP • To eliminate entity level tax and for pass through of capital gains – “S” status elected • In fact, with hedge funds the GP was often a 2nd LLP with a corporate GP (three tiers) • This also eliminated entity level tax and preserved capital gains allocated to principals • Also allow division of Carried Interest and other economic attributes of the GP to be determined by contract instead of by share ownership • Now LLC (with no member having personal liability) has become the favored structure for Private Equity Funds

36. Key Structural Features (Cont’d) • Incentive Arrangements (Larger Funds) • Ideally to attract best talent (one notch below top fund management) is to have flexibility in allocating the Carried Interest • However, Sr. Fund Management not want to give up control and management – so preference is for a form of ownership that separates control & management from economic interests • Generally too Sr Principals will want ability to frequently change allocations of Carried Interst. • One structure that is used is LLC, with classes of membership interests, requiring establishment of separate capital accounts for each investment, and then allowing establishment of different sharing %’s for each transaction

37. Fiduciary Relationships Survey • Why would the limited partnership continue to matter if parties can obtain similar features along with partnership-type taxation by forming as LLCs? • the main distinct limited partnership feature is limited partners’ default non-management involvement • a firm can obtain the same feature in every state by forming as an LLC and opting for centralized management. • One major reason: a significant amount of case law dealing with • the fiduciary duties of general partners in limited partnerships • specifically with waiver of such duties • this is especially well developed in Delaware

38. Fiduciary Relationships (Cont’d) • Partners have duties to refrain from: • self-dealing • appropriation of partnership assets and opportunities, • competition with the partnership • mismanagement • Courts have compared general partners to corporate directors • Use of the “business judgment” rule. • See Wyler v. Feuer, 85 Cal. App. 3d 392, 149 Cal. Rptr. 626 (1979); • Trustees of Gen. Elec. Pension Trust v. Levenson, 1992 WL 41820 (Del. Ch. 1992). The Texas Revised Partnership Act applies an ordinary care standard subject to a business judgment rule taken from corporation law. Tex. Rev. Civ. Stat. Ann. art. 6132b-4.04(c), (d)) • This makes the legion of corporate business judgment rule cases arguably applicable.

39. Fiduciary Relationships (Cont’d) • Waivers • Delaware statutory law Del. Code § 17-1101 explicitly provides that GP duties and liabilities may be expanded or restricted by provisions in a partnership agreement • So in Delaware the keys for a GP are • Disclosure of conflicts of interest in Fund sales materials • Enumeration of permitted conflicts of interest activities of the GP in the Partnership Agreement. • Cases have allowed waivers: • GP to purchase assets of liquidating partnership. See In Re Cencom, Civ A No. 14634, 1996 WL 74726 (Del Ch Feb. 15, 1996) • GP to take advantage of partnership opportunity. See Kahn v. Icahn, Civ A No. 15916, 1998 WL 832629 (Del Ch Nov. 12, 1998) • Eliminate the duty of substantive fairness in transactions between general partners and their partnerships, at least as long as the limited partners have had an opportunity after full disclosure to vote on the transaction. See Sonet v. Timber Co. L.P,722 A.2d 319 (Del. Ch. 1998).

40. Fiduciary Relationships (Cont’d) • Can’t Go Overboard with This • a very broad provision in a partnership agreement in effect negating any duty of loyalty • such as a provision giving a managing partner • complete discretion to manage the business with no liability • except for acts and omissions that constitute willful misconduct • will not likely be enforced • .See, e.g., Labovitz v. Dolan, 189 Ill. App. 3d 403, 136 Ill. Dec. 780, 545 N.E.2d 304 (1989) • Also need to watch provisions allowing management to compete • this sort of provision would be expected in the typical limited partnership, which manages a portfolio of assets rather than running an ongoing business. • However, its generally a “No-No” where a partner seizes on the provision • not merely to engage in a different business • but to undercut the other partners and take over the business of the partnership • Laibowitz – • that the general partner refused unreasonably to distribute cash • thereby forced plaintiffs to continually dip into their own resources in order to pay heavy taxes on large earnings • in a calculated effort to force them to sell their interests to • an entity which GP owned and controlled • at a price well below at least the book value of those interests.

41. Fiduciary Relationships (Cont’d) • Delaware Approach to Waivers • First, the strongly worded statutory protection of “freedom of contract” • focuses the courts’ attention on the language and structure of the contract in the first instance. • This strongly discourages courts from substituting judicial default rules for clearly articulated contractual duties. • Second, the courts have reserved a category of fundamental, non-waivable fiduciary duties. • This default category effectively encourages the parties to substitute their own customized duties • These should reasonably meet the needs of the particular situation rather than risking invalidation of the waiver. • Third, to the extent that default duties are subject to waiver without displacement, the waiver must be explicit in order to be enforced. • Combined with the disclosure requirements of the federal securities laws and the other circumstances • serve to call the partners’ attention to the partnership agreement, • this ensures that limited partners are likely to be aware of any fiduciary duty waivers.

42. The End • If You Have Further Questions Contact: Robert J. Kiggins, Esq. McCarthy Fingar Tel 914-946-3817 Ext. 251 Email rkiggins@mfdds.com