Tag: Fund managers

Remuneration in the Financial Services Industry 2015

Will Pearce is partner and Michael Sholem is European Counsel at Davis Polk LLP. This post is based on a Davis Polk client memorandum by Mr. Pearce, Mr. Sholem, Simon Witty, and Anne Cathrine Ingerslev. The complete publication, including footnotes, is available here. Related research from the Program on Corporate Governance includes Regulating Bankers’ Pay by Lucian Bebchuk and Holger Spamann (discussed on the Forum here), The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008 by Lucian Bebchuk, Alma Cohen, and Holger Spamann, and How to Fix Bankers’ Pay by Lucian Bebchuk.

The past year has seen the issue of financial sector pay continue to generate headlines. With the EU having put in place a complex web of overlapping law, regulation and guidance during 2013 and 2014, national regulators are faced with the task of interpreting these requirements and imposing them on a sometimes skeptical (if not openly hostile) financial services industry. This post aims to assist in navigating the European labyrinth by providing a snapshot of the four main European Directives that regulate remuneration:

  • Capital Requirements Directive IV (CRD IV);
  • Alternative Investment Fund Managers Directive (AIFMD);
  • Fifth instalment of the Undertakings for Collective Investment in Transferable Securities Directive (UCITS V); and
  • Markets in Financial Instruments Directive (MiFID).


Why University Endowments are Large and Risky

Thomas Gilbert is an Assistant Professor of Finance & Business Economics at the University of Washington. This post is based on an article authored by Professor Gilbert and Christopher Hrdlicka, Assistant Professor of Finance & Business Economics at the University of Washington.

Universities as perpetual ivory towers, though often meant as a pejorative, describes well universities’ special place in society as centers of learning with a mission distinct from that of businesses. Universities create new knowledge via research while preserving and spreading that knowledge through teaching. The social good aspect of universities makes donations critical to funding their mission. But rather than investing these donations internally to build the metaphorical towers higher and shine the light of learning more widely, universities have built large endowments invested heavily in risky financial assets.

In our paper, Why Are University Endowments Large and Risky?, forthcoming at The Review of Financial Studies, we model how universities’ objectives, investment opportunities (internal and external) and public policy, specifically the Uniform Prudent Management of Institutional Funds Act (UPMIFA), interact to create this behavior. Our findings suggest a reevaluation of UPMIFA’s ability to achieve its goal of maintaining donor intent in light of the costs it imposes on universities.


Proposed Regulations May Affect Fee Waivers

David I. Shapiro is a is a tax partner resident at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank publication authored by Mr. Shapiro, Michelle GoldBrian Kniesly, and Christopher Roman.

The Department of the Treasury and the IRS have issued proposed regulations regarding “disguised payments for services” under Section 707(a)(2)(A) of the Internal Revenue Code. The proposed regulations appear to be primarily focused on management fee waivers (and similar arrangements), but could also affect certain aspects of the tax treatment of carried interest.

Management fee waivers are a planning technique seen mostly in the private equity fund industry, where a fund manager waives a share of its management fee in exchange for a share of future profits (that is separate from any carried interest otherwise payable), often in amounts that are intended to replicate the foregone management fees. Management fee waivers are generally intended to achieve certain benefits, including deferring the receipt of taxable income by the fund sponsor, allowing the fund sponsor to meet its capital commitment to a fund on a non-cash basis, and providing for potentially more favorable tax rates applicable to individuals (i.e., if the underlying share of profits is comprised of long-term capital gain). Management fee waivers have been utilized in different forms, over many years, including arrangements which effectively amount to a package of a higher carried interest and a lower management fee, as well as arrangements which are structured as annual elective waivers. Different arrangements vary in the manner and priority in which waived amounts are paid out of future partnership profit.


Mutual Fund Flows When Managers Have Foreign-Sounding Names

Oliver Spalt is Professor of Behavioral Finance at Tilburg University. This post is based on an article authored by Professor Spalt; Alok Kumar, Professor of Finance at the University of Miami; and Alexandra Niessen-Ruenzi.

In our paper What’s in a Name? Mutual Fund Flows When Managers Have Foreign-Sounding Names, forthcoming in the Review of Financial Studies, we show that name-induced stereotypes affect the investment choices of U.S. mutual fund investors. Managers with foreign-sounding names have about 10% lower annual fund flows, and this effect is stronger among funds with investor clienteles that are more likely to be suspicious of foreigners ex ante.

Our results are based on a novel, hand-collected dataset that contains measures of foreignness of a large sample of mutual fund managers. Specifically, we conduct an online survey in which we present US residents with almost 4,000 actual fund manager names for actively managed US equity funds that appear in the CRSP database from 1993 to 2011. We then ask survey participants to rate for each name, whether or not it sounds foreign to them. Using their responses, we obtain for each fund a measure of whether the name of its manager sounds foreign to an investor when heard, read in a fund prospectus, or when it is found on a mutual fund web site. We hypothesize that the perceived foreignness of a name might trigger social biases such as discrimination and stereotyping and, thus, influence the investment decisions of mutual fund investors. We match our new dataset with the universe of actively managed US equity funds in the CRSP database to test this hypothesis.


Private Equity Fund Managers: Annual Compliance Reminders and New Developments

The following post comes to us from David J. Greene, partner focusing on investment fund formation, structuring, and related transactions at Latham & Watkins LLP, and is based on a Latham client alert by Mr. Greene, Amy Rigdon, Barton Clark, and Nabil Sabki.

US federal laws and regulations, as well as the rules of self-regulatory organizations, impose numerous yearly reporting and compliance obligations on private equity firms. While these obligations include many routine and ongoing obligations, new and emerging regulatory developments also impact private equity firms’ compliance operations. This post provides a round-up of certain annual or periodic investment advisory compliance-related requirements that apply to many private equity firms. In addition, this post highlights material regulatory developments in 2014 as well as a number of expectations regarding areas of regulatory focus for 2015.


Window Dressing in Mutual Funds

The following post comes to us from Vikas Agarwal and Gerald Gay, both of the Department of Finance at Georgia State University, and Leng Ling of the College of Business at Georgia College & State University.

In our paper, Window Dressing in Mutual Funds, forthcoming in the Review of Financial Studies, we investigate an alleged agency problem in the mutual fund industry. This problem involves fund managers attempting to mislead investors about their true ability by trading in such a manner that they disclose at quarter ends disproportionately higher (lower) holdings in stocks that have recently done well (poorly). The portfolio churning associated with this practice of window dressing has potentially damaging effects on both fund value and performance.


Compensating for Long-Term Value Creation in U.S. Public Corporations

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal.

Three categories of performers are rewarded for value creation in U.S. public corporations. They are: (1) the executives who manage the corporations; (2) the directors who oversee the performance of these corporations; and (3) the individual asset managers and others who provide investment services to investors who own, directly or indirectly, these corporations.

The following post takes a look at the correlation between the long-term incentive compensation of these three categories of performers and long-term value creation in U.S. public corporations that is attributable to them. In fact, such correlation appears to be limited. In addition, the article will consider a definition of “long-term” value creation, the roles of these three categories of performers in creating “long-term” value and the methods of compensating these different categories of performers in their respective roles in “long-term” value creation.


Evaluating Pension Fund Investments Through The Lens Of Good Corporate Governance

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the recent Latinos on Fast Track (LOFT) Investors Forum; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I understand today’s participants include a number of trustees and asset managers for some of the country’s largest public and private pension funds. Without a doubt, pension funds play an important role in our capital markets and the global economy. This is due, in part, to the fast growth in pension fund assets, both in the public and private sectors.

For example, since 1993, total public pension fund assets have grown from about $1.3 trillion to over $4.3 trillion in 2011. Over that same period, total private pension fund assets more than doubled from roughly $2.3 trillion to over $6.3 trillion by 2011. As of December 2013, total pension assets have reached more than $18 trillion. This growth was fueled by many factors, including the rise in government support of retirement benefits, and the increased use by companies of pension plans as a way to supplement wages.


Private Equity Management of Fees and Expenses: A Cautionary Tale

The following post comes to us from Veronica E. Rendón, partner at Arnold & Porter LLP and co-chair of the firm’s Securities Enforcement and Litigation practice. This post is a based on an Arnold & Porter memorandum.

In recent weeks, the Securities and Exchange Commission (SEC) has revealed that it is closely reviewing how private equity fund advisers disclose the allocation of fees and expenses to their investors. The SEC is primarily implementing this review through the Presence Exam Initiative (the Initiative), which has been initiated through the SEC’s Office of Compliance Inspections and Examinations (OCIE). [1] Under the Initiative, the SEC has examined more than 150 newly-registered private equity advisers. According to the OCIE, the goal is to examine 25% of the new private fund registrants by the end of the year. The SEC has indicated that over 50% of the newly-registered private equity fund advisers that it has examined to date have either violated the law or have demonstrated material weaknesses in their controls related to the allocation of fees and expenses. The SEC has identified inadequate policies and procedures and inadequate disclosure as related issues, with deficiencies in these arenas running between 40% and 60% of all adviser examinations conducted, depending on the year. This sheer number of perceived deficiencies likely will result in increased regulatory investigations, enforcement activity and possible sanctions, as well as increased exposure to investor-initiated lawsuits. As a result, (i) sophisticated fund investors will likely start asking questions to determine whether their fund managers engage in these practices and (ii) private equity firms should consider compliance and disclosure practices that can help limit this exposure.


Risk Choice under High-Water Marks

The following post comes to us from Itamar Drechsler of the Department of Finance at New York University Stern School of Business.

High-water mark (HWM) contracts are the predominant compensation structure for managers in the hedge fund industry. In the paper, Risk Choice under High-Water Marks, forthcoming in the Review of Financial Studies, I seek to understand the optimal dynamic risk-taking strategy of a hedge fund manager who is compensated under such a contract. This is both an interesting portfolio-choice question, and one with potentially important ramifications for the willingness of hedge funds to bear risk in their role as arbitrageurs and liquidity providers, especially in times of crises. High-water mark mechanisms are also implicit in other types of compensation structures, so insights from this question extend beyond hedge funds. An example is a corporate manager who is paid performance bonuses based on record earnings or stock price and whose choice of projects influences the firm’s level of risk.


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