• |

    Mar. 28, 2013

How Can Hedge Fund Managers Understand and Navigate the Perils of Insider Trading Regulation and Enforcement in Hong Kong and the People’s Republic of China

An old Chinese curse states: “May you live in interesting times.”  This proverb is often coupled with a more severe curse: “May you come to the attention of those in authority.”  For institutional investors trading in markets in Hong Kong and Mainland China (People’s Republic of China or PRC), these are indeed “interesting” regulatory times.  More importantly, an evolving legal and regulatory landscape has significantly increased the likelihood that those traders who are not informed and careful in their research and trading on those markets shall eventually “come to the attention of those in authority.”  For a further discussion of regulatory requirements governing establishing a hedge fund manager presence in Asia, see “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Four of Four),” Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  In a guest article, Michael A. Asaro and Douglas A. Rappaport, both partners at Akin Gump Strauss Hauer & Feld LLP, and Patrick M. Mott, an associate at Akin Gump, examine the provisions of Hong Kong and PRC insider trading law most important to U.S.-based hedge fund managers.  For the sake of comparison, the authors also discuss the corresponding provisions of U.S. insider trading law.  For a related discussion of U.S. and U.K. insider trading law, see “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012).  Importantly, in some instances, the insider trading laws in the PRC and Hong Kong may require hedge fund managers to proceed more cautiously than they would with regard to similarly-situated U.S. issuers.  Given that corporate and IR executives in Hong Kong and the PRC may lack the training and vigilance of their U.S. counterparts, it is crucial that hedge fund managers understand the rules applicable to trading on selectively disclosed inside information in these jurisdictions.  The risk of civil and criminal liability for foreign investors has increased as regulators push to clean up the laissez-faire attitude towards inside information that has historically prevailed in the Hong Kong and PRC markets.

Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices

For at least the last five years, Reed Brodsky has been at the epicenter of the evolution of insider trading law as it applies to hedge fund managers.  As an Assistant U.S. Attorney in the Southern District of New York, he was one of the three prosecutors who tried the largest criminal hedge fund insider trading trial in history, U.S. v. Raj Rajaratnam, which resulted in Rajaratnam’s conviction and sentence of 11 years.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Also, he was one of two prosecutors who tried the insider trading case against Rajat Gupta, the former McKinsey Chairman, which resulted in Gupta’s conviction; and he worked on the prosecution of former FrontPoint Partners portfolio manager Joseph Skowron for insider trading in connection with a drug trial.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Based on this experience, Brodsky’s command of insider trading doctrine as it applies to hedge fund managers is recent, relevant and deep.  The Hedge Fund Law Report recently had the opportunity to interview Brodsky in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, at which Brodsky is scheduled to participate.  (The details of the Symposium are discussed below.)  Our interview did not focus on insider trading doctrine per se, although Brodsky is eminently equipped to discuss doctrine in depth.  Rather, our interview focused on the application of evolving insider trading doctrine to a range of research and trading practices commonly undertaken by hedge fund managers.  Specifically, we explored with Brodsky: how insider trading law should inform the efforts of hedge fund managers with respect to the use of expert network firms, channel checking firms and political intelligence firms; the application of insider trading law to commodities, derivatives and trades in private company stock; the practicability of “walling off” employees with material nonpublic information; trends in investigative methods and enforcement topics; how to generate goodwill from witness cooperation; and the value of self-reporting discovered insider trading violations.  In addition, we posed a number of challenging hypotheticals to Brodsky – which were hypothetical only in the sense that we did not name names, although the fact patterns are quite real.  Brodsky’s answers were insightful, business-minded and candid, and provide invaluable insight into how prosecutors think about the hedge fund industry.  The RCA Symposium will be held at the Pierre Hotel in New York City on April 18, 2013, and is scheduled to include a panel covering government investigations and prosecutions of hedge fund and private equity fund managers entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  Subscribers to the Hedge Fund Law Report are eligible for a registration discount.  Brodsky will soon join Gibson Dunn & Crutcher LLP as a partner.  See “Rajaratnam and Gupta Prosecutor Reed Brodsky to Join Gibson Dunn,” Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

Four Recommendations for Private Fund Managers Wishing to Mitigate the Risks of Using Unregistered Brokers to Introduce Prospective Investors to Their Funds

Two recently-issued SEC orders settling administrative and cease-and-desist proceedings (Orders) demonstrate the regulatory risks private fund managers face in using unregistered brokers to introduce prospective investors to their funds.  One of those Orders was against a private equity fund manager and its former senior managing partner, and the other was against a third party consultant retained by the private equity fund manager to introduce potential investors to its funds.  The private equity fund manager paid the consultant a percentage of the capital commitments of investors he introduced, resulting in millions of dollars in compensation for him.  See generally “What Is the ‘Market’ for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?,” Hedge Fund Law Report, Vol. 3, No. 35 (Sep. 10, 2010).  Importantly, this case demonstrates that the SEC is willing to pursue not just unregistered brokers who engage in impermissible marketing activities on behalf of investment funds, but also the fund managers themselves if they are found to assist an unregistered broker or ignore warning signs that the unregistered broker is engaging in misconduct.  This article summarizes the alleged misconduct, causes of action and the remedies agreed upon in the settlement.  In addition, this article provides four recommendations for fund managers wishing to mitigate the risks of using unregistered brokers in introducing prospective investors to their funds.

Why and How Do Sovereign Wealth Funds Invest in Hedge Funds?

Investments from sovereign wealth funds (SWFs) can be attractive to hedge fund managers because such investments typically represent significant and sticky assets.  Understanding the character, investment processes, objectives and allocation preferences of SWFs can increase a manager’s likelihood of receiving an allocation from this investor type, thereby growing assets, fees and clout.  For insight on refining a marketing approach vis-à-vis another important hedge fund investor type, see “Rothstein Kass Study Explains the ‘Consultative’ Approach to Marketing to Single-Family Offices and the Importance of That Approach for Smaller Hedge Fund Managers,” Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011).  With these dynamics in mind, a recent report discusses trends in SWF growth and asset allocation preferences.  In particular, the report provides insight into SWF allocations to hedge funds and other alternative investment vehicles and the investment preferences of SWFs by economic sector.  This article summarizes the key findings of the report.  For a direct discussion of how hedge fund managers can hone their marketing efforts to attract SWF investments, see “Specific Steps that Hedge Fund Managers Can Take to Increase the Likelihood of an Investment from a Sovereign Wealth Fund,” Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).

BVI Court Rules on the Validity of the Appointment of Hedge Fund Liquidators by a Hedge Fund Manager Subject to SEC and CFTC Enforcement Actions

The Eastern Caribbean Supreme Court (Court) in the High Court of Justice in the British Virgin Islands (BVI) recently opined on the validity of the appointment of BVI liquidators for several BVI-domiciled hedge funds made by a manager that has been separately charged by the SEC and the U.S. Commodity Futures Trading Commission with defrauding investors.  The challenge to the liquidators’ appointment came from a U.S.-court-appointed receiver of the hedge funds.  This article summarizes the factual background, legal analysis and holdings by the Court in this matter.  For a discussion of the waterfall provisions applicable to BVI hedge fund insolvency proceedings, see “BVI Court of Appeal Rules on Priority of Redeemed Investors Versus Remaining Investors in a Hedge Fund Liquidation,” Hedge Fund Law Report, Vol. 6, No. 12 (Mar. 21, 2013).

Todd Ransom’s Arrival Expands Haynes and Boone’s Prime Brokerage Practice

On March 21, 2013, Haynes and Boone, LLP New York welcomed back Todd Ransom as a partner in the firm’s Prime Brokerage and Equity Lending Practice Group, a specialized practice focused on leveraged and derivative products and brokerage transactions used by financial institutions and private and public funds.

First Loss Capital Article Correction

Our September 27, 2012 article entitled, “First Loss Capital Arrangements for Hedge Fund Managers: Structures, Risks and the Market for Key Terms,” contained a list of first loss capital providers, which included Protégé Partners, LLC.  We have since learned that while Protégé Partners does, among other things, seed select emerging hedge fund managers, it does not provide first loss capital to hedge fund managers.

Most-Read Articles