I want to highlight in this talk the importance of developing a legal framework to apply to the hedge fund investment process.
By framework, I’m referring to a set of legal factors that can be applied by investors and investment professionals to assess managers and hedge funds in a systematic way. A framework that can complement an investor’s financial analysis during the hedge fund investment process — both before and after an investment is made.
A hedge fund investment process that doesn’t take into account legal and regulatory factors, that relies strictly on financial factors to make investment decisions, is incomplete in my opinion. By not analyzing legal and regulatory factors associated with a hedge fund investment or its manager, the risk of investment loss may be greater and investor bargaining power is diminished.
Or consider an investment professional managing money for an individual, family or entity. If that investment professional is considering making a hedge fund investment on behalf of its client and he or she doesn’t consider legal and regulatory issues associated with an investment, has that person met his or her fiduciary and/or other duties to its client? These issues are a big deal.
Avoid the Reactive Approach
The legal profession, in my opinion, has not supplied investors and investment advisors with an analytical framework with which to analyze hedge fund investments during the investment process.
To the extent that the lawyers address the concerns of hedge fund investors in any consistent way, they tend to address investment process issues in a piecemeal way.
The existing legal approach is often reactive as opposed to proactive (issues are discussed based on some headline risk that’s in the news at a particular time) and it doesn’t provide investors with a framework that they can apply consistently to consider and screen different investments. I think that’s a failure.
Why?
Because this approach fails to take into account the way that most successful investors that I know go about investing. The process that they rely on often involves the application of a consistent set of financial or investment beliefs that is utilized to help evaluate and screen potential investments and monitor and dispose of them once an investment has gone through.
Investment vs. Legal Framework
You can be a value investor, a distressed investor, a growth investor, use technical or fundamental analysis, believe or not believe in efficient markets, whatever. I’m not making any judgments as to the merits of any particular investment style or whether it will or won’t make money.
It’s only to note that investors often apply an analytical investment framework to screen investments based on certain quantitative and qualitative principles.
And yet, when they look to lawyers to help analyze factors associated with the hedge fund investment process in some systematic way, they’d be hard-pressed to find such an approach.
That’s ironic because this is an area that has gotten a lot of good work done in it over the years by regulators like the SEC.
Legal and regulatory issues associated with investing in a hedge fund shouldn’t be opaque or require an investor to have to “reinvent the wheel” each time.
In these talks, I’ll build a legal framework associated with the process of hedge fund investing and try to fill that gap. A legal framework should strive to be efficient, comprehensive and consistent in its application across many different hedge funds and that’s what I’ll aim for.