The downside of side letters

Abstract

PurposeTo discuss possible disadvantages and other implications for private investment fund managers of issuing side letters to certain investors.Design/methodology/approachDiscusses the relatively common practice of issuing side letters; issues surrounding side letters that relate to private equity funds and hedge funds; recent SEC pronouncements regarding side letters; industry practices, including disclosure issues and corporate‐related issues; and ERISA consequences.FindingsSide letters (i.e. agreements that afford investors of a private investment fund with rights and/or benefits that are different, and often superior, to those granted to such investors under the governing documents of the fund) have been utilized for years by sponsors of private investment funds. In fact, in many cases, it has been impossible for sponsors of private investment funds to close on subscriptions from large and/or strategic investors unless they agree to provide such investors with side letters. In light of the recent focus of the US Securities and Exchange Commission (the “SEC”) on the use of side letters by hedge fund managers, fund managers should consider what affect certain side letter provisions may have on the fund and its investors, in particular, the consequences such side letters will have under the Employee Retirement Income Security Act of 1974 (“ERISA”).Originality/valueUseful reference for fund managers that describes the potential issues related to side letters.