Management shares

Offshore hedge funds—those incorporated outside the United States, typically in jurisdictions like the Cayman Islands—sometimes issue special "management shares" to the investment manager, related companies, or designated trustees. These shares function quite differently from regular investor shares. While they carry voting rights that allow holders to make decisions about the fund, they have no economic participation in the fund's profits and losses.

Each management share typically provides one vote. The holders of these shares often control all voting power within the offshore fund structure, even though they may own very few shares compared to the investors who put money into the fund.

Giving decision-making authority to a single entity offers practical benefits compared to requiring input from all shareholders. This structure proves particularly valuable when organizing votes across all shareholders would be difficult or time-consuming. For example, routine amendments to the fund's governing documents can be approved quickly without having to contact hundreds or thousands of individual investors.

The arrangement also provides flexibility during fund liquidation. Regular shareholders can receive their distributions and exit the fund, while the management shareholder remains to handle the final administrative tasks needed to close the fund completely.

Management shareholders typically receive broad governance powers. These include authority over board composition, amendments to constitutional documents, and decisions regarding voluntary liquidation. However, these voting powers have important limitations. Management shareholders cannot exercise their votes in ways that would alter or damage the fundamental rights of other shareholder classes.

For example, a management shareholder could not vote to eliminate regular shareholders' rights to receive distributions or to force them to accept different terms than they originally agreed to.

Fund sponsors of offshore funds structured as companies face a choice when issuing shares. They may issue voting shares to all shareholders, or they may issue voting shares (often called "management shares") only to the fund sponsor, its affiliates, or to a trustee acting for their benefit.

Sponsors of funds structured as companies should consider using management shares because they make decision-making easier. Management shareholders generally hold exclusive authority to provide consent or vote on most corporate matters. This eliminates the need to coordinate votes among potentially thousands of individual investors for routine business decisions.

Management shareholders can generally amend constitutional documents through special resolutionsCorporate resolutions requiring higher approval thresholds than ordinary resolutions, typically used for significant decisions like constitutional amendments and requiring at least a two-thirds majority of shareholders.. However, they cannot make amendments that would vary rights attached to different share classesDifferent categories of fund shares with varying fee structures, rights, or redemption terms offered to different investor types.. Under Cayman Islands law, even when non-voting shares Non-voting shares Non-voting shares are a class of equity in a hedge fund structure that provides economic rights but no voting authority, commonly used in offshore funds to accommodate investors concerned about potential regulatory consequences of holding voting securities. exist and voting shares are held by third parties, certain shareholder rights require approval from a majority of the affected class—typically requiring a two-thirds majority.

The "variation of rightsLegal principle requiring that changes to the fundamental rights attached to specific classes of shares must be approved by the affected shareholder class, regardless of general voting control structures." principle may require each shareholder's individual consent when fundamental contractual arrangements between shareholders and the fund face significant alteration. For instance, if the fund wanted to change its fee structure or investment strategy in a way that materially affects investors, it might need their direct approval regardless of the management shares' voting power.

While management shares help facilitate routine constitutional amendments through independent third parties, they do not provide unlimited amendment authority. Many changes that could adversely impact shareholders still require some form of shareholder consent, regardless of whether their shares are designated as non-voting.

Companies that have not issued management shares may require their board of directors to seek shareholder consent for constitutional amendments. Such amendments require execution by special resolution, typically requiring at least a two-thirds majority of shareholders voting in a meeting, or unanimous written consent from all shareholders entitled to vote.

This alternative approach can be cumbersome for funds with many investors, as it requires extensive coordination and communication to achieve the necessary voting thresholds for even minor administrative changes.

Management shares may be issued to a designated trustee of the hedge fund rather than directly to the investment manager or its affiliates. This arrangement can provide additional flexibility in governance while maintaining the operational benefits of concentrated voting control.

The trustee structure may also help address certain regulatory or tax considerations that might arise from direct management control. For instance, using a trustee can help create legal separation between the fund manager and the fund itself, which may be beneficial for regulatory compliance in certain jurisdictions.

When management shares are directly or indirectly owned or controlled by U.S. personsIndividuals or entities subject to U.S. jurisdiction for securities law purposes, including U.S. citizens, residents, and entities organized under U.S. law., or when voting occurs according to U.S. person instructions, such control can trigger additional U.S. tax reporting obligations. This may require Form 5471IRS reporting form required to be filed by U.S. persons who are officers, directors, or shareholders of foreign corporations, used to report information about controlled foreign corporations and other foreign corporate interests. filings, additional tax certifications from investors, and could subject U.S. shareholders holding at least 10% of the fund's equity to controlled foreign corporation rules.

These tax implications can create significant compliance burdens and costs for U.S.-based fund managers, making the management share structure less attractive in some circumstances.

The management share structure must accommodate various regulatory constraints affecting different investor types. For example, the holder of management shares may make certain amendments to the memorandum and articles of association Memorandum and articles of association (M&A) Memorandum and articles of association (M&A) are the foundational legal documents that create a company in certain jurisdictions, such as the Cayman Islands. These documents establish the company's legal existence, define what powers it has, and set up its governance structure. They serve the same basic function as Articles of Incorporation and Bylaws do for U.S. corporations. , and they are the only shareholders permitted to vote at shareholder meetings.

However, according to Cayman Islands law, a shareholder retains the right to vote on any amendment that would materially affect its rights as a shareholder. This protection ensures that management shareholders cannot completely override the interests of investing shareholders.