Hedge Fund Redemptions and the Gate Provision

It is no secret that many funds are hurting this year and that many investors are getting ready to, or have, pulled money from many hedge funds.  According to a New York Times article this morning, these redemptions are likely to cause managers to sell securities which may in turn further depress prices.  While the time period for hedge fund-of-funds redemptions has likely passed (FOFs usually require 95 days prior notice for redemption), redemption notices for normal hedge funds are due by tomorrow (assuming a 90-day notice period and end of year or quarter redemptions).

If your fund is feeling the pressure of quite a few redemptions, there are a couple of standard safeguards which are usually built into the hedge fund offering documents.  These provisions include the hedge fund gate provision and a general catch-all provision.  In general, the gate allows redemption requests to be reduced to a certain percentage of the fund’s total assets during any redemption period.  For example, if the fund has a gate of 15% and investors request redemptions which equal 20% of a fund’s NAV, then all redemption requests will be reduced pro rata until only 15% of the redemption requests are met.  The catch all provision allows a hedge fund manager to halt redemptions if certain catastrophic market events take place.  Depending on how the hedge fund offering documents are drafted, the current market situation may or may not apply and you should discuss this with your lawyer.

How to handle invoking a gate provision

In the next few days, managers will be getting a good idea of how much of the fund will be redeemed.  If a decision is made to invoke the gate provision, the manager should discuss this option with his attorney.   The attorney will help the manager decide the best course of action with regard to reducing the redemption amount, which will probably include writing a letter of explanation to the investors.  While each fund’s situation is different, that letter should probably include the expected amount of the reduction as well as a description of the authority (in the offering documents) for the reduction.  Additionally, you should also invite questions directly – it is during times like these when investors get scared and then start talking to their own attorneys.  It is much better to be candid and upfront than to receive a nasty letter from an attorney in the future.

Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include: