There have been many questions about the Hedge Fund Lock-ups which were announced by Cerberus Capital today. Many of the explanations & by the major media outlets have been unclear if not incorrect.

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One of the main misconceptions with most of the articles presented in the media is that the Lockups will affect existing hedge fund investors. This is not the case, as the Lock-Up period will only be effecting investors who choose to move their investments to the new funds created by Cerberus Capital in the future.

To balance out the 3-year lock-up, the new Cerberus funds will be offering lower management fees. The success of this new structure will no doubt be watched by hedge fund managers around the world.

1. What is a Lock-Up Period?

A lock-up period is the time during which investors are prohibited from redeeming their shares. Hedge funds often have lock-up periods for funds so that the firms are able to take a longer investment horizon. The Lock-Up period is defined in the Fund’s Private Placement Memorandum.

Tradionally a Lock-Up period will be 1 year. With the possibility to redeem every quarter after a 30-60 day notice.

2. Can a hedge fund change a Lock-Up Period?

Yes. A change to the Lock-Up period would require a rewrite of the Hedge Fund’s Private Placement Memorandum (PPM). In most cases this would be considered a Material Change, and would require you to notify your Limited Partners in writing of the update.

Since changing your Lock-Up will have a direct impact on your Limited Partners, many hedge funds choose to give their Limited Partners the option to redeem part or all of their shares before the new Lock-Up period goes into effect.

Instead of changing a lock up period, you could get creative. In the case of Cerberus Partners LP, they chose to halt withdraws from the fund and set up a separate “Special Vehicle” fund which would handle the redemption requests over time.

As you can see there are a lot of legal hurdles to overcome when handling a Hedge Fund meltdown, many of the answers to these questions will be different based on the structure of the fund, or the legal team handling the requests.

3. What Hedge Funds do these lock-up periods apply to?

As announced by Financial times these 3-year lock ups will apply to two new funds, Cerberus Partners II and Cerberus International II. These funds are slated to open in Q4 of 2009.