Comments on: Hedge Funds Can Just Freeze Redemptions… Must Be Nice

By: Anonymous

Anonymous — Wed, 15 Aug 2007 16:25:00 +0000

The answer to legal liability is redemption gates that are clearly illuminated in the Offering Memorandum that every fund must issue to any prospective qualified investor. It must be signed by the investor prior to investment so that acknowledges consent to the OM. As with everything, buyer beware.
A restriction placed on a hedge fund limiting the amount of withdrawals from the fund during a redemption period. The implementation of a gate on a hedge fund is up to the hedge fund manager. The purpose of the provision is to prevent a run on the fund, which could cripple its operations, as a large number of withdrawals from the fund would force the manager to sell off a large number of positions.

This is a very common provision on a hedge fund and the exact percent of restriction can be found in the hedge fund prospectus. This is a less severe withdrawal restriction than an all out redemption suspension, which doesn’t allow for withdrawals at all. But a gate provision is still seen generally as a negative event.

By: rs6

rs6 — Mon, 06 Aug 2007 20:09:00 +0000

I think you are both right. What will happen is that both the investors and BSC will argue about the technicalities of the contract, specifically if the investors had the right to withdraw their money or not, as you stated. I predict that the investors will get a little money back, BSC and others in the industry will have to rewrite the contracts more explicitly, and of course, all the lawyers involved will get rich payouts every step of the way.

By: Chad Brand

Chad Brand — Sat, 04 Aug 2007 17:19:00 +0000

Regardless of why the freezing of redemptions is insisted upon (I don't refute your explanation by any means) I still think it opens up hedge funds to massive legal liability, which could eventually result in more regulation than is needed.

Let's use the BSC example. Let's assume there was a redemption window in the fund's rules. If the fund was down say, 50%, and investors tried to redeem but were told no, and then the fund ended up being worthless within weeks, I think Bear is in trouble with the current investor lawsuits.

How could the investors lose in court if they want to get that other 50% back. You can't just breach a contract due to market conditions because you want to.

If there was no redemption window, or it wasn't open yet, then I agree with you, as you can't simply demand money back whenever you want. But if investors have a contractual right to do so, I think the hedge funds that try this tactic will have issues in court.

Should be interesting to see what happens with Bear.

By: TheCapitalGame

TheCapitalGame — Sat, 04 Aug 2007 16:06:00 +0000

Chad,

There is a crisis currently in the mortgage CDO market. This crisis is being made worse by the fact that investors are panicking and demanding their money back. Even if the lock in period is over, hedge funds need to brief there clients on the situation and inform them that they will receive their money once the crisis has passed. Right now, mortgage CDOs are way underpriced due to the absence of buyers. This situation I believe is temporary and will work itself out over the next year. Panic liquidation of CDO funds in the short term will only escalate the crisis. What we are seeing is a case of the liquidation of the Bear Stearn funds causing a crisis in all other mortgage CDO funds as investors panic and withdraw money causing a downward spiral effect.
During this time of crisis, hedge funds have a right to stop investor redemptions.

By: Chad Brand

Chad Brand — Sat, 04 Aug 2007 02:11:00 +0000

I absolutely have no problem with hedge funds having whatever rules in place they want, but do you think they should be allowed to have a specific redemption window (say, semi-annually or annually) from the outset and then refuse to allow clients to do it if times get rough?

I just think people should know the rules from the beginning. Changing them in the middle of the game doesn’t seem right to me, but that’s just my opinion. In your case, would you ever not allow redemptions after three years even though that was the policy put in-place when they invested?