Don’t Secretly Change Your Fund Structure

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New Stream Capital took the unusual step or restructuring its fund structure in secret. The restructuring put its biggest investor into a preferred position, to the disadvantage of its other investors. At least according to the complaint filed by the Securities and Exchange Commission.

The SEC alleges that New Stream’s co-owners David Bryson and Bart Gutekunst secretly revised the fund’s capital structure to placate its largest investor. Secretly changing the priority structure is bad for your existing investors. The firm took it a step further and continued marketing the fund as though all investors were on the same footing when that was not true. New Stream raised an additional $50 million after the restructuring and received additional management fees, but left the investors with nearly worthless holdings when the fund failed.

New Stream had a structure that bifurcated investors, with US investors investing directly in the master fund and offshore investors contributing capital through a Bermuda feeder fund. The Bermuda moved capital into the master fund in the form of secured notes. In 2007, New Stream proposed a restructuring with a new onshore feeder fund for US Investors and new Cayman feeder fund for offshore investors.

The trick was moving the offshore investors out of the old Bermuda note feeder into the new Cayman feeder. As an incentive, New Stream gave equal priority to new Cayman feeder and the old Bermuda note feeder.

Gottex Fund Management had $300 million in the old Bermuda note feeder, which represented almost 40% of the capital in the entire fund structure. Gottex did not like the new structure and I assume was upset that New Stream made the change without their consent.

According to the complaint, New Stream lied to Gottex and told them that the Bermuda Feeder was senior to the new feeders. Then New Stream defrauded the other investors by actually making the Bermuda feeder senior. The marketing of the fund failed to disclose the structure to new investors. Also, the debt appears to have been mischaracterized in the fund’s financial reports.

On top of the misleading statements to new investors, the new structure also dramatically increased the management fees charged to the funds. The structure allowed for a management fee to be charged against the gross amount invested, including the loans. In November 2007, the management fee was $34,643, which increased to $318,561 in April of 2008 after the initial restructuring.

Then the financial crisis devastated the fund and it was hit hard with redemption requests. Many of those apparently came from investors in the old Bermuda feeder. By September 30, 2008, investor redemption requests totaled approximately $545 million. The fund managed stop many redemptions, but it was too late. The fund was in a death spiral, as redemption requests increased and the fund’s assets continued to decrease as the financial crisis of 2008 continued to devastate the economy and the fund’s investments.

New Stream sent one letter to Bermuda investors assuring them that their priority position would be maintained, and a different letter to the remaining investors that failed to mentioned the priority.

An initial fund restructuring/bankruptcy was rejected in Bermuda. Then a 2011 Delaware bankruptcy filing was finalized in April 2012 with the US and Cayman investors recovering only $9.7 million for their $182 million in claims. The old Bermuda investors are expected to recover much more.

The SEC additionally charged New Stream’s former head of investor relations Tara Bryson, who is David Bryson’s sister. She agreed to settle the SEC’s charges. It’s not her first scrape with the law. According to another story, she was busted in 2010 for turning her goat farm into a marijuana farm.