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    Jan. 24, 2013

K&L Gates Investment Management Seminar Provides Guidance for Hedge Fund Managers on Social Media, Pay to Play Rules, ERISA Rule Changes, AIFMD, SEC Examination and Enforcement Priorities, Form PF, the JOBS Act, CPO Regulation and FATCA

On December 5, 2012, international law firm K&L Gates held its 2012 Investment Management Conference in New York.  Speakers at the conference provided guidance on various regulatory developments impacting hedge funds, including: the use of social media; pay to play rules; rule changes under the Employee Retirement Income Security Act of 1974 (ERISA) impacting managers of plan assets; the E.U. Alternative Investment Fund Managers Directive (AIFMD); SEC examination and enforcement priorities; Form PF; the JOBS Act; regulation of commodity pool operators (CPOs); and the Foreign Account Tax Compliance Act (FATCA).  This article highlights the key points discussed at the conference on each of the foregoing topics.

Challenges Faced By, Risks Encountered By and Lessons Learned From First Filers of Form PF

With the initial Form PF filings behind us, now is an opportune time to take stock of what lessons hedge fund advisers have learned from their experience with Form PF to date.  In a guest article, Tim Wilson (co-head of the risk practice of Global Risk Management Advisors) and Jonathan Miller (a partner in the New York office of Sidley Austin LLP) address, based on their work and discussions with first filers and other advisers, the following questions that advisers have asked them about Form PF: (1) What were the major challenges that large hedge fund advisers faced in completing their August and November 2012 filings?  (2) What are the principal risks to which hedge fund advisers are exposed as a result of their filings?  (3) What lessons should hedge fund advisers draw from the experience of first filers?  Addressing these questions can assist all Form PF filers in avoiding critical mistakes in preparing for, completing and making future Form PF filings.  The responses to these questions can be instrumental not only to those hedge fund advisers that have yet to make their initial Form PF filings, but also to those hedge fund advisers that will be making subsequent filings.  See also “Lessons Learned by Hedge Fund Managers from the August 2012 Initial Form PF Filing,” Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012).

Katten Partner Raymond Mouhadeb Discusses the Purpose, Applicability and Implications of the August 2012 ISDA Dodd-Frank Protocol for Hedge Fund Managers, Focusing on Whether Hedge Funds Should Adhere to the Protocol

The Dodd-Frank Act’s overhaul of over-the-counter derivatives trading will fundamentally change the trading relationship between swap dealers and major swap participants (MSPs) and hedge funds and other counterparties.  Among other things, the Dodd-Frank Act and related CFTC rules will impose significant new obligations on swap dealers and MSPs that will necessitate the amendment of bilateral swap documentation entered into with hedge funds.  To standardize this process, the International Swaps and Derivatives Association, Inc. (ISDA) introduced the August 2012 ISDA Dodd-Frank Protocol (Protocol).  The Protocol is a non-negotiable supplement designed to amend existing swap documentation with the goal of facilitating the exchange of information between swap dealers/MSPs and their counterparties.  While adherence to the Protocol is not mandatory for counterparties, non-adherence is likely to have consequences for their swap trading activities.  To help hedge fund managers understand the Protocol and evaluate whether their funds should adhere to it, the Hedge Fund Law Report recently interviewed Raymond Mouhadeb, a Partner at Katten Muchin Rosenman LLP.  Mouhadeb advises investment managers and sponsors of hedge funds, funds of funds and other investment vehicles on structuring and legal issues, including the applicability of the Dodd-Frank Act and regulations related to derivative transactions.  Our interview with Mouhadeb covered various topics, including: the purpose of the Protocol; understanding the hedge funds to which the Protocol applies; the specific entity that should consider Protocol adherence; consequences of non-adherence; principal concerns related to Protocol adherence; whether onshore funds should consider moving their swap relationships offshore; important compliance dates; the process for signing on to the Protocol; how adherence will lead to disclosure of information about the hedge fund; the types of representations that must be made in adhering to the Protocol; concerns relating to the DF Terms Agreement and the ISDA August DF Supplement; whether parties have entered into arrangements to amend the Protocol; continuing compliance obligations arising out of Protocol adherence; and whether the Protocol will change the procedures for entering into new ISDA agreements.

OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers at the RCA’s Compliance, Risk & Enforcement 2012 Symposium

For legal and compliance professionals in the hedge fund industry, understanding the priorities of the SEC is critical in assessing risk, allocating resources and updating policies and procedures.  In particular, legal and compliance professionals need to be aware of examination priorities and enforcement trends because fumbling in the course of an examination or enforcement action could have real and adverse business consequences.  The SEC communicates its priorities indirectly and directly.  It communicates indirectly via enforcement actions and the resulting documents.  See, e.g., “Recent Enforcement Action Highlights SEC’s Concern with Preferential Redemption Rights Granted to Favored Hedge Fund Investors,” Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).  And it communicates directly – albeit through the noncommittal prism of form disclaimers – via speeches by commissioners and high-level staffers.  Two important instances of such direct communications occurred on December 18, 2012, at the Regulatory Compliance Association’s Compliance, Risk & Enforcement 2012 Symposium in New York City.  At that event, Carlo V. di Florio, Director of OCIE, and Bruce Karpati, Chief of the Asset Management Unit (AMU) of the SEC’s Enforcement Division, jointly delivered the keynote address.  On the examinations side, di Florio described: how the SEC gathers information and assesses risk; the new presence examination program; and OCIE’s current examination priorities for hedge fund managers.  On the enforcement side, Karpati discussed: the Enforcement Division’s new approach to initiating matters; the AMU’s approach to risk assessment; ten seminal enforcement actions recently taken against hedge fund managers; current enforcement priorities; and compliance best practices for hedge fund managers.  This article summarizes the insights from both speeches that have direct bearing on preparation by hedge fund managers for examinations and enforcement actions.

Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors

To promote confidence in Cayman-regulated financial institutions, the Cayman Islands Monetary Authority (CIMA) recently introduced proposals designed to institute enhanced corporate governance reforms for CIMA-regulated financial institutions, including hedge funds.  Of most importance for hedge funds, the rule proposals include rule amendments requiring professional directors to register with CIMA; all fund directors of CIMA-regulated entities to register with CIMA; the creation of a publicly-available database containing the names of CIMA-registered and CIMA-licensed entities and their directors; and the application of delineated governance standards that have historically been inapplicable to most CIMA-registered hedge funds.  Such standards outline expectations concerning, among other things, director qualifications and responsibilities.  This article summarizes the proposed rule amendments and links to the documents in which they are described.  See also “Eight Corporate Governance Steps That Hedge Fund Managers Should Consider in Response to Concerns Expressed by Institutional Investors,” Hedge Fund Law Report, Vol. 4, No. 35 (Oct. 6, 2011).

When Can Short-Swing Trading in Different Types of Equity Securities of the Same Issuer Trigger Section 16(b) Liability for Hedge Funds Considered to Be Section 16 Insiders?

A federal appeals court recently considered whether Section 16(b) of the Securities Exchange Act of 1934 applies to transactions in which a Section 16 insider buys or sells shares of one type of equity security of an issuer and engages in an opposite-way transaction in another type of equity security of the same issuer within six months of the initial purchase or sale.  If Section 16(b) applies, shareholders can initiate actions to demand disgorgement of illicit profits from a Section 16 insider without demonstrating scienter.  See “Establishing, Maintaining and Exiting a Minority Equity Position: U.S. Securities Law Considerations for Hedge Funds,” Hedge Fund Law Report, Vol. 2, No. 2 (Jan. 15, 2009).  While the case did not involve a hedge fund, it will nonetheless impact the securities trading of most Section 16 insiders, which include, among others, hedge funds that (1) beneficially own ten percent or more of a class of a public issuer’s equity securities or (2) beneficially own less than ten percent of a class of a public issuer’s equity securities if the hedge fund is a member of a “group,” defined as two or more persons that agree to act together for the purpose of acquiring, holding, voting or disposing of an issuer’s equity securities.  See “Second Circuit Decision Sends CSX and Hedge Fund Suitors TCI and 3G Back to District Court to Examine When Funds Formed a ‘Group’ to Acquire CSX Stock,” Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  The decision will impact the investment activities of, among others, many activist hedge funds and their managers.  For more on activist strategies, see “Lawsuits and Letters: TPG-Axon’s Playbook for Unseating a Recalcitrant and Underperforming Board of Directors,” Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013); and “Dealing with Mr. Big: Recent Developments in Transactions Involving Controlling Shareholders,” Hedge Fund Law Report, Vol. 3, No. 4 (Jan. 27, 2010).  This article describes the factual background and the court’s analysis and holding in the case.  The article also discusses the potential impact of the case on hedge funds and their managers deemed to be Section 16 insiders.

Mark Leeds Joins Mayer Brown’s Tax Transactions & Consulting Practice in New York

On January 22, 2013, Mayer Brown announced that noted capital markets tax attorney Mark H. Leeds has joined the firm in New York as a partner in the Tax Transactions & Consulting practice.  A frequent writer and speaker on tax topics affecting the capital markets, Leeds’ past contributions to the Hedge Fund Law Report include “New IRS Audit Guidelines Target Equity Swaps with Non-U.S. Counterparties,” Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010); and “The Future Will Be Better Tomorrow: The Obama Tax Agenda Is Released,” Hedge Fund Law Report, Vol. 2, No. 21 (May 27, 2009).

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