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    Aug. 3, 2023

Second Marketing Rule Risk Alert Provides Little Substantive Guidance

Since the new marketing rule (Marketing Rule or Rule) – Rule 206(4)‑1 under the Investment Advisers Act of 1940 – took effect, the SEC has been very stingy in providing guidance on complying with the Rule. In September 2022, the SEC’s Division of Examinations (Division) issued a risk alert on Rule-related areas the Division planned to focus on in upcoming exams. In January 2023, the SEC updated its Marketing Compliance Frequently Asked Questions (FAQ) to address a narrow issue on the presentation of gross and net performance in marketing. Lastly, on June 8, 2023, the Division issued a second risk alert (Risk Alert) that discusses three additional Rule-related areas of emphasis in advisers’ exams: testimonials and endorsements; third-party ratings; and Form ADV. This article summarizes the Risk Alert, with commentary from Benjamin Kozinn, partner at Schulte Roth. “We are seeing a focus in exams on Marketing Rule compliance. This SEC has been aggressive on just about everything with respect to private fund managers,” observed Kozinn. “The advertising rules were always low‑hanging fruit for exam staff, and now with the Marketing Rule, there are just more things they can criticize.” For more on the FAQ, see “Parsing the Significance of the SEC’s FAQ on the Presentation of Gross and Net Performance” (Mar. 2, 2023).

Compliance Measures to Mitigate Sanctions Risk for U.S. Hedge Funds Investing on the HKEX

Unbeknownst to many hedge fund managers, U.S. funds are operating in a complex economic sanctions environment, with serious potential consequences for inadvertent trades in banned securities. The Trump administration imposed sanctions on a list of Chinese companies identified as supporting the Chinese military industrial complex (CMIC). Those sanctions prohibit U.S. persons, including hedge funds, from trading in the securities of “CMIC companies” – even if the securities are offered only on foreign exchanges, such as the Hong Kong Stock Exchange (HKEX). Although the CMIC list continues to grow and additional HKEX-listed securities are becoming subject to sanctions, many U.S. hedge fund managers trading in HKEX securities are not aware of the sanctions or do not understand the scope of the restrictions. Sanctions ban not only direct investments but also trading in derivatives and exchange-traded funds (ETFs) that provide exposure to the sanctioned securities. In an environment of software-managed trading, instant transactions, relentlessly shifting portfolios and little to no see‑through to the composition of ETFs or index funds, how do U.S. hedge fund managers mitigate sanctions risk? This guest article by Lowenstein Sandler attorneys Abbey Baker and Laura Fraedrich reviews the U.S. sanctions regime and sanctions regarding China; examines the sanctions outlook in China and beyond; explains the intersection between hedge funds and sanctions compliance; and discusses the importance of restricted-person screenings. For more insights from Lowenstein Sandler, see “Use of Alternative Data Continues to Grow, Says New Survey” (Mar. 2, 2023).

CFTC Commissioner Shares Five Pillars of Cyber Resilience

Cyber resilience should be prioritized over incident response, CFTC Commissioner Christy Goldsmith Romero said in a June 20, 2023, speech. In her address at the Futures Industry Association’s International Derivatives Expo Conference, she discussed the current cyber threat landscape, noted that the CFTC is continuing its work on a cyber resilience rule proposal and outlined a five-element framework for achieving cyber resilience. This article discusses the key takeaways from her speech, with commentary from Gregory R. Gonzalez, partner at Wilkinson Barker Knauer LLP. As is customary, Romero noted that the views she expressed were her own, not those of the CFTC, its other Commissioners or its staff. See “‘Risk to Resilience’: CFTC Commissioner Romero Discusses Climate and Cybercrime Risk” (May 25, 2023).

Standards and Requirements Under the FCA’s New U.K. Consumer Duty Rules (Part Two of Two)

In furtherance of its objective to protect investors, the U.K.’s Financial Conduct Authority (FCA) has articulated a new “consumer duty” (Consumer Duty) that is meant to bolster fund managers’ existing fiduciary duties to ultimately improve how firms serve investors. When coupled with recently introduced rules for marketing high-risk investments (High-Risk Marketing Rules), the measures functionally raise the floor of the U.K. private funds industry. The result, however, is that fund managers will need to begin taking steps – or, in the case of the High-Risk Marketing Rules, were required to comply as of December 1, 2022 – to incorporate the standards into their compliance efforts. To assist fund managers with understanding and preparing for the obligations under the Consumer Duty and High-Risk Marketing Rules, MJ Hudson hosted a program on the new U.K. rules that featured partner Mike Booth. This second article in a two-part series parses relevant takeaways for fund managers about their potential obligations under the Consumer Duty. The first article offered useful background information on both rules before delving into pertinent features of the High-Risk Marketing Rules. See our two-part series: “Key Differences Between U.S. and U.K. Marketing Rules and Tips for Dual Compliance” (May 11, 2023); and “Reconciling Disparate U.S. and U.K. Requirements for Preparing and Delivering Non‑Standard Track Records” (May 25, 2023).

SEC Short Sale Settlements Reflect Strict Enforcement of Rule 105

Rule 105 of Regulation M (Rule 105 or Rule) under the Securities Exchange Act of 1934 prohibits a person that has sold an issuer’s securities short within a specified period (Restricted Period) prior to a follow‑on or secondary offering of those securities from purchasing securities in the offering. The SEC has been vigilant in taking action against alleged Rule violations. In that regard, it settled separate proceedings against two private fund advisers, both of which sold short in a pre‑offering restricted period and then purchased shares in the offering. The settlements are notable because, although the charges were limited to violation of Rule 105, the SEC complaints suggest the agency considered the defendants’ compliance efforts to be sub-par in regard to the Rule. This article details the SEC’s allegations and the terms of the settlements. See “SEC Alleges Short Selling Violations by Firm Whose Compliance Staff Misinterpreted Rule 105” (Jul. 28, 2022); and “SEC’s Proposed Short Sale Rules Increase Transparency Into Large Short Positions” (Mar. 31, 2022).

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