Increasingly, hedge fund managers are interested in acquiring investments from UK pension funds. This interest is in some cases being reciprocated, as pension funds suffering from depressed investment returns from traditional correlative investment portfolios look to diversify into alternative asset classes.
Pension fund investments in hedge funds can be structured in a number of ways, but (during the investment assessment process and afterwards) inevitably investors will receive and may generate confidential and commercially sensitive information. This can range from a fund’s offering document to terms of any preferential fee arrangement agreed between the hedge fund manager and the investor.
There are already reports that the FOIA is beginning to have an impact on some public authority investors in private equity funds in consequence of them receiving requests to disclose performance information from various organisations, including members of the press. It is yet to be seen whether this will also become the case in respect of hedge funds. Nevertheless, the FOIA clearly potentially creates a number of issues for the hedge funds industry which need to be considered.
The new rules allow any organisation or member of the public to request information held by or on behalf of a UK “public authority”. No reason has to be given for the request, no (or minimal) payment made and a response must be given promptly (and in any event within 20 working days) by the public authority receiving the request. The rules are retrospective Information provided to a public authority prior to the implementation of the FOIA may be disclosable.
The definition of “public authority” is very wide. It includes central and local government and authorities, the NHS, the police and many other bodies discharging public functions and can include pension funds of such bodies. The “right to know” created by FOIA also has implications for anyone contracting with public authorities.
The public’s right to know under the FOIA is qualified and there are a number of exemptions from the disclosure requirements. For information relating to hedge funds, the most important exemptions are that information that is given to a public authority in confidence, and information which is commercially sensitive, may not need to be disclosed. These exemptions and their use will be discussed more fully below.
The exemption for information provided in confidence is absolute. If disclosure of the relevant information would give rise to an actionable breach of confidence against the disclosing party, then no disclosure need be made. The law of confidence is governed by common law. Whether or not an obligation of confidence arises will depend upon whether the information has the necessary quality of confidence. The Information Commissioner’s Office, which is charged with enforcing the FOIA, has provided guidance relating to this exemption. This guidance sets out the two key elements of such quality: the information must not be trivial and it must not be readily available by other means. This, however, does not mean the information need be completely secret. The common law also applies a form of “public interest” test in determining whether or not an obligation of confidence arises. This should not, however, be confused with the explicit statutory public interest test applicable to certain of the FOIA exemptions discussed below.
The second relevant exemption relates to the release of information that is likely to prejudice the commercial interests of any person. This exemption is qualified and is subject to a statutory public interest test incorporated into the FOIA. If a public authority wishes to rely on this exemption, it must not only consider that disclosure would prejudice another’s commercial interests but also that keeping the information private outweighs the public interest in disclosure.
There are at least two potential problems with the FOIA provisions that may affect a hedge fund’s ability to avoid disclosure of confidential or commercially sensitive information. First, under FOIA, public authorities that receive disclosure requests are not under any obligation to notify or consult with the original provider of the information before it is revealed. Secondly the exemptions, if applicable, only allow a public authority to resist disclosure of information under FOIA: they do not obligate it to do so. Therefore a hedge fund manager could be in the position of finding confidential or commercially sensitive information which it has previously provided to its public authority investors disclosed to a third party, and then more widely, without any prior notice.
In the current climate of developing acceptance of the need for openness where commercially practical, the exemptions to the FOIA disclosure obligation seem broad enough to catch the more sensitive information which hedge funds provide to their investors. However, hedge funds should seek to manage the impact of the new legislation by putting in place protective measures. Clearly coming to a mutually acceptable arrangement on disclosure with a public authority investor is commercially preferable to suing it for breach ofconfidence, particularly when the hedge fund manager is reliant on its investment going forward.
Public authorities, when faced with information requests, may be considering their options against the background of a push for open government and in the light of guidance from the Information Commissioner, which is strongly skewed in favour of disclosure. Therefore, in the absence of meaningful communication with the hedge fund manager, it is easy to see how complete disclosure, even of highly commercially sensitive information, may become the default position for public authorities.
Form a policyForming an appropriate disclosure policy is key. Certainly most private equity fund managers now take the view (particularly in light of the more rigorous freedom of information legislation in the US) that dissemination of some information relating to their funds is inevitable and, in the climate of developing openness, appropriate. Hedge fund managers may take a similar view. Whatever policy is adopted, it is important that the thinking takes place early and that the terms of such policies can be justified. It is to be noted that public authorities are already requesting specific analysis of why particular pieces of requested information fall within particular exemptions in relation to private equity fund managers.
Review documentation and disclosure formatsIt would be advisable to review confidentiality provisions included in agreements with public authority investors, to ensure that they cover all the information that the hedge fund manager would seek to keep confidential. In addition, depending upon the approach to disclosure of information adopted by a hedge fund manager, it may be appropriate to review the format in which investors receive information relating to their investments.
The Information Commissioner’s guidance on the confidentiality exemption makes it clear that simply marking documents “Confidential” has no magic and, whilst such indications may be relevant at the time the information in question is provided, lapse of time, in particular, may change the nature of such information.
Hedge fund managers may also wish to restrict distribution of very sensitive information, perhaps by preparing confidential and non-confidential versions of reporting documents.
CommunicationSome hedge fund managers who have, or are developing, standing arrangements regarding confidentiality with public authority investors should not necessarily disregard existing arrangements. A collaborative approach between hedge fund manager and investor is obviously sensible when considering what to disclose. It would also be beneficial to ask public authority investors to inform a hedge fund manager of any request received under the FOIA which may lead to disclosure of information relating to that manager’s fund. One could go further and include provisions in agreements with public authority investors obliging them to inform the hedge fund manager if they receive such a request. This will at least give the hedge fund manager an opportunity to discuss the FOIA request with the public authority investor and put forward, if necessary, arguments for claiming an exemption to the disclosure of the information.
Notwithstanding the points made above, it is also key that public authority investors be made to understand that the FOIA does nothing to change their obligations of confidentiality under the legal documentation relating to their fund investments. Disclosure in breach of such obligations is not required under the FOIA where the confidential information exemption applies. Some hedge fund managers may choose to send reminders setting out investor’s confidentiality obligations alongside performance reports, others may adopt a more piecemeal approach.
Legal documentation relating to public authorities investments in hedge funds will no doubt develop following the FOIA. Hedge fund managers will inevitably seek to impose further restrictions on investors in respect of their use of fund information and may also require public authorities to notify them of any relevant FOIA request. Hedge fund managers may also wish to have the right to stop supplying very sensitive information to investors whom they consider may not keep such information private.
Investors (whether those who have already made investments or those who may be contemplating investment) may already be considering the guidance issued by the Secretary of State relating to the FOIA and the provisions which require public authorities to consider their duties of disclosure when entering into new arrangements, and warns them against attempting to “contract-out” of their obligations under the FOIA by entering into onerous confidentiality agreements.
Nick Terras is a partner in the London office of the European hedge funds group at SJ Berwin. He advises on all aspects of hedge funds and on structured products. The European hedge funds group is regarded as a market leader in the field of hedge funds, with offices in all the key European jurisdictions.