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    Jan. 12, 2017

Best Practices for Fund Managers When Entering Into ISDAs: Negotiation Process and Tactics (Part One of Three) 

In the world of hedge funds, trading of over-the-counter (OTC) derivatives in the form of swaps has become ubiquitous, as funds do so for many reasons, including to hedge certain risks, take speculative positions, access difficult-to-trade assets or employ synthetic leverage. See “What Is Synthetic Prime Brokerage and How Can Hedge Fund Managers Use It to Obtain Leverage?” (Apr. 2, 2010). Most dealers require a fund to execute a variety of complex documents prior to entering into swap transactions on a bilateral basis with the fund. The responsibility for reviewing and negotiating these documents can be a daunting task for a manager’s legal, compliance and operations professionals. In an effort to distill the complexities of these documents and the negotiation process, the Hedge Fund Law Report interviewed several experts that negotiate these agreements on a daily basis on behalf of their fund clients. In this three-part series, we review the various trading agreements required for a fund to engage in the OTC trading of swaps, explain certain key negotiated provisions in swap agreements, discuss common amendments requested by dealers and provide guidance on what are currently viewed as “market terms” for certain provisions. This first article provides background on the various agreements that govern swaps, explains how the Dodd-Frank Act has introduced additional complications to the documentation process and offers advice on best practices for negotiating with dealers. The second article will review the most commonly negotiated events of default and termination events in the trading agreements and offers suggestions for negotiating these provisions. The third article will analyze the key considerations for funds with respect to the collateral arrangements – the delivery of margin to mitigate counterparty risk – between the two parties. 

How New Swiss Regulations Affect the Ability of Private Fund Managers to Market to Swiss Investors

Switzerland is in the process of adopting a new regime to regulate the financial services industry and its various participants. Two key pieces of Swiss legislation that are undergoing the legislative process will affect Swiss-based financial service provider operations and how financial service providers located outside Switzerland provide services to Swiss clients. Non-Swiss private fund managers will be most interested in the revised approach proposed to Switzerland’s distribution rules, which impact how a fund may be marketed to Swiss investors. To help provide clarity surrounding the Swiss regulatory environment and the expected impact of this new legislation on the private funds industry, the Hedge Fund Law Report interviewed Dr. Vaïk Müller, an attorney-at-law based in Geneva. Müller’s views are particularly relevant to private fund managers that previously prepared their funds for distribution into Switzerland – with the appointment of a Swiss representative and a Swiss paying agent – as the legislation may reduce their regulatory burden in the future. The new legislation is also relevant for private fund managers that are not currently set up to distribute their funds to Swiss-based investors, as the regulations may, to a certain extent, facilitate their ability to market into Switzerland. For additional insight from Müller, see “New Swiss Regulations Require Appointment of Local Agents and Increased Disclosure in Hedge Fund Documents” (May 14, 2015). For coverage of additional Swiss regulations, see “What U.S. and Other Non-Swiss Portfolio Managers Need to Know About Managing Assets of Swiss Occupational Benefit Plans” (Sep. 22, 2016).

Loss of Substratum: Steps to Ensure a Fund’s Soft Wind-Down Does Not Result in a Winding-Up Order (Part Two of Two)

Conflicting cases in the Cayman Islands mean that funds intending to operate during a soft wind-down are susceptible to an investor petition for a court-appointed liquidator to commence a winding-up of the fund due to loss of substratum (i.e., its purpose for existence). For more on soft wind-downs of Cayman funds, see “Cayman Hedge Funds, Soft Wind-Downs and Disclosure” (Feb. 25, 2011). Fund managers and their advisers are forced to navigate conflicting statements in the case law on this issue, while recent cases have further highlighted the need for the Cayman Islands Court of Appeal to finally resolve this issue. In this guest article, the second in a two-part series, Tony Heaver-Wren and Sebastian Said, partner and counsel, respectively, at Appleby (Cayman), detail the competing Cayman standards for considering a fund’s business when identifying loss of substratum, as well as practical steps that fund managers can take to avoid having a court reach such a determination when conducting a soft wind-down. The first article set forth the history of the Cayman Islands law on loss of substratum, as well as the divergent standards – the “impossibility test” and the “non-viability test” – currently being used by the Cayman Islands courts. For Cayman court considerations concerning loss of substratum, see “Cayman Islands Grand Court Rules That Investor in Hedge Fund Wyser-Pratte EuroValue Fund Is Entitled to Court-Imposed Liquidation of Fund, Even Though Fund Is Solvent, but Gives Fund Time to Complete Liquidation on Its Own” (Nov. 19, 2010).

Failure to Store Electronic Records in Proper Format May Result in Regulatory Enforcement Action

Accurate recordkeeping is one of the core duties of broker-dealers and investment advisers. FINRA recently settled enforcement actions against 12 of its members, and imposed a total of $14.4 million in fines, for their failures to store electronic records in “write once, read many” (commonly referred to as “WORM”) format, as well as other violations of SEC recordkeeping rules. For another recent FINRA enforcement proceeding involving recordkeeping violations, see “Failure to Safeguard Customer Data, Preserve Records and Properly Supervise May Expose Broker-Dealers to FINRA Enforcement Action” (Dec. 1, 2016). Private fund managers with affiliated broker-dealers should pay particular attention to this ruling. In addition, all registered investment advisers should pay heed to FINRA’s enforcement action, given that the Investment Advisers Act of 1940 imposes recordkeeping requirements similar to those that were violated in these instances. This article explores the nature of the violations and the key terms of the eight separate FINRA Letters of Acceptance, Waiver and Consent. For more on FINRA enforcement efforts, see “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016). 

Outgoing SEC Chair Outlines New Model for Enforcement Priorities in 2017 and Beyond

Mary Jo White, the departing SEC Chair, will leave the organization in a stronger position than it was when she joined it. The commission now operates with significantly enhanced abilities to detect, examine, prosecute and reach settlements over illegal activity in the funds sector. For another view of the agency’s priorities, see “Former SEC Senior Counsel Offers Insight on SEC Enforcement Focus and Priorities” (Sep. 1, 2016). White has helped drive several transformative innovations and developments with respect to the SEC’s tools, tactics and methodology, including shifting from research to evidence-gathering; sharing part or all of a case with defense counsel to promote settlements; using sophisticated data analytics to identify trading irregularities; utilizing whistleblowers, along with stepped-up efforts to protect them from employer retaliation; and decisively transitioning from “neither admit nor deny” toward a protocol that requires defendants to admit guilt in an enforcement matter. The above were detailed in a recent speech given by White. This article summarizes her key points, as they inform fund managers of the direction the SEC is likely to take in the coming year and beyond with respect to investigations and enforcement actions. For additional analysis of public commentary by White, see “Expectations for Fund Directors” (Apr. 7, 2016); “Two Types of Risks Hedge Fund Managers Must Consider” (Oct. 29, 2015); and “The SEC’s Game Plan With Respect to the Asset Management Industry” (Dec. 18, 2014). 

Hedge Fund Platinum Partners and Principals Face Civil and Criminal Proceedings From SEC and DOJ Over Alleged Fraudulent Valuation Practices and Liquidity Misrepresentations

The SEC has initiated an enforcement proceeding against Platinum Management (NY) LLC, Platinum Credit Management, L.P. and seven individuals, alleging that they improperly inflated the value of illiquid fund assets, made material misrepresentations to investors to hide the liquidity crisis faced by the firm’s flagship fund and orchestrated a scheme to defraud third-party bondholders of one of the fund’s portfolio companies. In a parallel investigation, the DOJ has brought an eight-count indictment against seven individual defendants for securities fraud, investment adviser fraud and conspiracy. The SEC complaint asserts 11 counts of securities and investment adviser fraud against the defendants. This article discusses the alleged fraudulent conduct, along with the specific SEC and DOJ charges. For additional coverage of the SEC’s recent attention to valuation of illiquid assets, see “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016); and “SEC Division Heads Enumerate Enforcement Priorities, Including Conflicts of Interest, Valuation, Performance Advertising and CCO Liability (Part Two of Two)” (May 5, 2016). For more on regulatory concerns over liquidity, see “FSOC Report Focuses on Liquidity, Leverage and Other Risks Facing Hedge Fund and Asset Managers” (Apr. 28, 2016).

Fried Frank Expands Its Asset Management Group in New York

Fried Frank has hired Jeremy Berry as a partner in the firm’s asset management practice in New York. In his new role, Berry will advise institutional alternative asset managers on the structuring and launch of hedge funds, private equity funds, venture capital funds and real estate funds. See “Establishing a Hedge Fund Manager in Seventeen Steps” (Aug. 27, 2015). For coverage of other hires at the firm, see “Fried Frank Bolsters Tax Department in New York” (Aug. 4, 2016); and “Fried Frank Adds Asset Management Regulatory Attorney Gregg Beechey in London” (Jul. 9, 2015).

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