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Justlaw, The Binding Word of the Southern Trial Lawyers Association, Top 10 Myths of Deferring Contingent Fees, Rick Ehrhart, JD and Leif Lundberg, LLM, Vol.5, Issue 3, Third Quarter 2013
To see full article click here.
Abstract: With marginal income tax rates approaching or exceeding 50%, interest in tax deferral has also spiked. Most trial lawyers are familiar with the opportunity to receive their fees over time. Interviews with dozens of trial lawyers reveal, however, that the conventional wisdom is fraught with misconceptions. In this article we identify the ten most egregious myths.

In Brief, A Publication of the New Jersey Association For Justice, Inc., Seven Myths of Deferring Contingent Fees, Rick Ehrhart, JD and Leif Lundberg, LLM, September 2013
To see full article click here.
Abstract: Instead of having only half their fees to invest, and losing investment earnings to yearly taxation, fee deferral puts 100 percent of the fees to work and compounds the fees at the pre-tax rate of return. As a result, lawyers accumulate greater capital, can borrow more at lower interest costs, and improve their retention of key associates. But the conventional wisdom about fee deferral is fraught with misconceptions. Here are some of the most egregious myths.

The Tax Man Will Wait, Rick Ehrhart, JD and Leif Lundberg, LLM, January 2013
To see full article click here.
Abstract: Contingency fee law firms and their partners can now take advantage of the same tax-deferred compensation as Fortune 1000 executives have enjoyed for decades. By investing fees pre-tax, tax-deferred, participants accumulate greater wealth, can borrow more easily at lower cost, and can improve their retention of key lawyers and valuable cases.

Section 409A – Treasury ‘Newspeak’ Lost in the 'Briar Patch', Rick Ehrhart, JD, John Marshall Law Review (Fall 2005)
To see full article click here.
Abstract: Treasury overreached by interpreting Section 409A, ostensibly a gloss on constructive receipt principles, as modifying economic benefit principles.

Our Articles and White Papers about Investment Funds

A Far Sighted View: Fund Alignment Rights Are the Wave of the Future, Rick Ehrhart, JD, June 2014
To see full article click here.
Abstract: A long-standing drawback of hedge fund incentive compensation has finally reached a breakthrough. The traditional incentive compensation model short-changes institutional investors. It allows portfolio managers in a hedge fund to receive incentive compensation on a quarterly or annual basis while investors had to wait until redemption day to realize either an aggregate gain or loss. This mismatching of incentive goals gave the manager a disproportionate share of the 80/20% incentive compensation split over the life of the investment relationship, ultimately “punishing” the investor for remaining committed to the investment on a longer-term basis. With the vast majority well north of 90% of institutional investors committed to their hedge fund investment for at least three years and often for longer than 5 years, this misalignment in incentives payment causes a real value disparity in the mutual experience of hedge fund manager versus hedge fund investor within the same pool of funding.

Paying Hedge Fund Managers with Fair Market Value (FMV) Options Increases Pension Returns and Enriches Managers, Rick Ehrhart, JD, and Can Civi, October 2012
To see full article click here.
Abstract: The current incentive compensation model of annual (or quarterly) crystallization ("annual banking") is short-sighted and hurts both pensions and hedge fund managers. Pensions would realize significant increases in returns from their hedge fund investments if the fund paid the manager with fair market value (FMV) options. FMV options divide cumulative, pre-tax profits at the end of the life of the investment (or earlier if the parties agree). Based on historical averages of a sampling of ten "top 30" hedge funds, a 10-year investment using such a deferred profit sharing model could increase annualized returns by more than 2.0% and pension assets by more than $1 billion for every $1 billion invested. Pensions in the aggregate invest about $300 billion in hedge funds, and could realize an incremental gain of more than $300 billion of assets in 10 years simply by switching to FMV options. This incremental return is called "alignment alpha."

Under a FMV option model, a typical manager could increase its after-tax, disposable wealth substantially assuming a 10 to 20 year accumulation horizon. Annual banking may maximize incentive compensation over the 5 to 8 year life of the average investment, but it fails to maximize managers' long-term capital accumulation and sustainability. By accumulating on a pre-tax, tax-deferred basis over a period that spans investment lives, FMV options offer managers the opportunity to double their capital accumulation within 20 years.

Given the $3 trillion funding deficit, pensions have an urgent need to capture alignment alpha. FMV options offer a risk free way to increase returns substantially. Managers should appreciate the advantages of accumulating capital on a pre-tax, tax-deferred basis over the long term that spans investments. They should also appreciate the advantages of attracting pension capital, which tends to be "sticky" and is likely to be "stickier" under a deferred profit sharing model. Nevertheless, managers are likely to be slow to initiate change to FMV options, given inertia and the infrastructure changes required. Pensions can accelerate conversion, however, by sponsoring fund infrastructures that provide incentive compensation in the form of FMV options.

Top 10 Myths of FMV Options as Hedge Fund Incentive Compensation, Rick Ehrhart, JD and Thom Young, MBA (April, 2013)
To see full article click here.
Abstract: Institutional Investors have a major problem with the misalignment of incentives created by the hedge fund industry's performance fee structure. Misalignment has caused some investors to avoid the industry altogether and others to question the value delivered for the fees they pay. Lisa Shalett, Chief Investment Officer, Merrill Lynch Global Wealth Management, and Head of Investment Management and Guidance, commented "Hedge funds as a class of products will continue to fail in their diversification benefits because the incentives are wrong." Craig Dandurand, Portfolio Manager, Absolute Return Strategies, CalPERS, added "When you have quarterly crystallization of performance fees . . . what do you expect to happen? You are literally handing over the keys to the bank . . . . You're done before you can start."

There is an easy solution to this misalignment crisis – the same FMV options that Fortune 500 companies use to reward executives for maximizing shareholders' long-term value. By using FMV options, investors and managers share cumulative profits at the end of the life of the investment (or any earlier time if the parties agree), and all the profits accumulate and compound free of erosion from interim crystallization of the manager's share. As a result, investors enjoy greater returns than they would realize from the manager’s pari passu annual crystallization fund. This increase in return is Alignment Alpha®. Managers benefit as well because their compensation compounds pre-tax, tax-deferred at the gross performance of the fund.

Despite the availability of an alignment solution for several years now, hedge fund managers have been slow to convert to FMV options. Interviews with dozens of managers reveal that managers are generally unfamiliar with the technique, and that their opposition to change is rooted in misconceptions. In this article we identify the ten most egregious myths.

Closing the Pension Gap – with Hedge Funds, Rick Ehrhart, JD, Pension and Investments Online (March, 2010)
To see full article click here.
Abstract: Pension underfunding is at crisis levels. This article shows how pensions can increase returns significantly by paying hedge fund managers based on cumulative, pre-tax profits over the life of the pension's investment.

Section 409A – Treasury 'Newspeak' Lost in the 'Briar Patch', Rick Ehrhart, JD, John Marshall Law Review (Fall 2005) To see full article click here.
Abstract: Treasury overreached by interpreting Section 409A, ostensibly a gloss on constructive receipt principles, as modifying economic benefit principles.

Articles, White Papers and Opinions of Interest

How to get paid more for managing money and still give investors what they want, COO Connect (September 1, 2014). To see full article click here.

Fund Alignment Rights levels playing field between hedge fund managers and investors, Komfie Manalo, Opalesque (June 17, 2014). To see full article click here.

Hedge Fund Stock Options Get Green Light as IRS Clarifies Exemption, Mary Hughes, BNA.com (June 2014). To see full article click here.

The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees, By Philip S. Gross and James D. McCann, Kleinberg, Kaplan, Wolff & Cohen, P.C., The Hedge Fund Law Report, v.7, no. 24 (June 19, 2014).

Enhancing the Alignment of Interests between Fund Managers and Investors, HFM Week, US West Coast (2014). To see full article click here.

An Appreciation for Hedging Your Bets on Deferred Compensation, A Legal Update from Dechert's Employee Benefits and Executive Compensation Group (June 2014).

Revenue Ruling 2014-18 New Possibilities to Defer Offshore Compensation of Hedge Fund Managers and Employees, Anchin, Block and Anchin LLP, Anchin Alert (June 30, 2014).

IRS Issues guidance on application of Section 457A to nonqualified stock options and stock appreciation rights, Grant Thornton (June 24, 2014).

Rev. Rul. 2014-18 - Stock option, stock appreciation right exempt from section 457A, KPMG (June 12, 2014).

United States: IRS Ruling Allows Tax-Deferred Stock Rights for Fund Managers, Andrew Llazos, Ruth Wimer, CPA, and Cary C. Payne, McDermott, Will & Emery (June 25, 2014).

New Possibilities to Defer Offshore Compensation, Paul/Weiss (June 11, 2014).

Possible Offshore Deferrals for Hedge Fund Managers – IRS Confirms that Certain Stock Options and Stock Appreciation Rights are Exempt under Section 457A, Ira G. Bogner, Amanda H. Nussbaum, Christopher M. Wells, Robert G. Leonard, Fraser A. Alpine, and Adam W. Scoll, Proskauer Rose LLP (June 20, 2014).

The Sky is [Really] Still Blue: A revenue ruling released by the IRS last week reinforced the ability of fund managers to use options and stock appreciation rights in a multi-year compensation arrangement, Asset Management Alert, PWC (June 2014).

Recent IRS Revenue Ruling Clarifies the Tax Treatment of Stock Options and Physically-Settled Stock Appreciation Rights under Section 457A, Seward and Kissell LLP, (June 16, 2014).

New IRS Ruling May Facilitate Structuring Multi-Year Performance Measurement Periods in Offshore Hedge Funds, Sidley Austin LLP (June 12, 2014).

IRS Revenue Ruling Warmly Received by Hedge Funds and Expatriates, Michael G. Falk, Partner, Winston & Strawn LLP (June 20, 2014).

New IRS Revenue Ruling 2014-18 and the Use of Hedge Fund Stock Options, James Earle, Joel D. Almquist & Nicholas. S. Hodge, K&L Gates (June 2014). To see full article click here.

IRS Backs Investors Seeking Change to Hedge Fund Fees, Miles Weiss, Bloomberg.com (June 2014). To see full article click here.

Managers Face Tough Choice Over IRS Edict, Hedge Fund Alert (June 2014). To see full article click here.

IRS Revenue Ruling Backs Institutions Seeking Changes to Hedge Fund Fees, Miles Weiss with Mary Hughes, BNA.com (June 2014). To see full article click here.

Compensating Hedge Fund Managers with Stock Options – A New Path to Alignment of Interests with Investors, James E. Earle, Benefits Law Journal (Vol. 23, No. 3, Autumn 2010). To see full article click here.

Hedge Fund Investing, Opportunities and Challenges, Towers Watson (2012). To see full article click here.

Global Alternatives Survey 2012, Financial Times Towers Watson (July 2012). To see full article click here.


"Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration."

President Lincoln's First Annual Message to Congress, December 3, 1861