Stark Restructures on Eve of Deephaven Deal

Stark Investments, which is scrambling to complete its acquisition of Deephaven Capital's main hedge fund, has told its own investors that it wants to restructure two big funds in the wake of sharp losses and heavy redemptions.

The multi-strategy fund operator, which manages more than $8.5 billion, has notified investors in its flagship Stark Investment vehicle and an offshore fund, Shepherd Investment, that they will receive a portion of their March 31 redemptions in the form of shares in a newly created vehicle. In a March 23 letter, the Milwaukee firm said it was setting up two companion vehicles to hold the funds' least-liquid assets - Stark Select Asset Fund and Shepherd Select Asset Fund.

The firm said it could take up to three years to liquidate the hard-to-sell holdings. Redeeming investors won't be charged a management fee on assets in the new vehicles.

The firm, run by Brian Stark and Mike Roth, said that about 55% of the net asset value of Shepherd Investment will be transferred to Shepherd Select. The figure doesn't include investments the firm parked in "side pockets" a few years ago to separate liquid assets from private equity-type investments. It's unclear what portion of the assets in Stark Investment would be transferred to Stark Select.

The Stark funds have been flooded with redemption requests amid severe losses last year and in early-2009. The Shepherd fund lost 22.2% in 2008 and another 4.2% during the first two months of this year. In their letter to investors, Stark and Roth said their restructuring plan seeks to balance the interests of redeeming investors with those who remain in the funds.

"We believe that in-kind distribution will provide a fair distribution of the risks and rewards associated with certain less-liquid investments and enable each fund to avoid becoming a forced seller of such investments," they wrote.

The letter arrived a week before Stark's deadline for closing its purchase of the Deephaven fund. The deal originally was scheduled to close at the end of February, but Stark extended the deadline until the end of March so the firm could speak with Deephaven investors about their investment options at Stark. As of yesterday, it was unclear when the deal would close. Stark announced in January that it would pay Deephaven $7.3 million up front, plus up to an additional $37.2 million, depending in part on the amount of assets that remain in the fund. Deephaven, a Minnetonka, Minn., unit of broker-dealer Knight Capital, plans to liquidate its other funds.

Stark and Roth started out in 1992 focusing on convertible-bond investments. They originally worked from offices in New York and Greenwich, Conn., but the following year moved their firm to Wisconsin, where both had grown up. By the late 1990s, they had expanded beyond convertible bonds, investing across a broad range of instruments, strategies and geographic markets. Today, Stark invests in commodities, real estate, loans, private equity and intellectual property.

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