The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Insider Trading

  • From Vol. 11 No.35 (Sep. 6, 2018)

    Although Martoma May Have Been Put to Rest, the Debate Over the “Personal Benefit” Test Continues

    Several recent high-profile insider trading cases have ignited a debate over what is necessary to satisfy the “personal benefit” requirement for purposes of tipper-tippee liability. With the recent announcement that the Second Circuit will not grant an en banc rehearing of the appeal of former SAC Capital employee Mathew Martoma’s conviction, that story appears to be coming to a close; however, the debate over the personal benefit test and the scope of tipper-tippee liability is sure to persist. Instead of providing much-needed guidance in a murky area of the law, U.S. v. Martoma is merely one of a group of recent decisions that have generated confusion over the line that delineates illegal insider trading from legal trading on proprietary information. This uncertainty and the continued debate over the contours of insider trading liability underscore the need for funds to be vigilant in this area. In a guest article, MoloLamken partner Justin V. Shur and associate Emily Damrau analyze the personal benefit test and offer guidance on what fund managers can do to avoid liability. For recent insider trading enforcement actions against hedge funds, see “Hedge Fund Manager Deerfield Fined $4.7 Million for Failing to Adopt Insider Trading Compliance Policies Tailored to the Firm’s Specific Risks” (Sep. 21, 2017); and “SEC Insider Trading Action Highlights Red Flags Hedge Fund Managers Must Heed When Employing Political Intelligence Consultants” (Jun. 8, 2017). For further commentary from Shur, see “The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability” (Oct. 8, 2015).

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  • From Vol. 11 No.31 (Aug. 2, 2018)

    Factors Fund Managers Must Consider When Addressing Cryptocurrencies and ICOs in Personal Trading Policies (Part Two of Two)

    Rule 204A-1 under the Investment Advisers Act of 1940 requires registered investment advisers to establish, maintain and enforce codes of ethics that require “access persons” to periodically report their holdings of, and transactions in, “reportable securities.” Unregistered fund managers also frequently adopt similar requirements for their employees. Although Rule 204A-1 is largely devoted to reporting requirements, many advisers go beyond the technical requirements of the rule and adopt more restrictive measures in their personal trading policies. These policies should address any assets in which employees may want to trade, including cryptocurrencies – such as bitcoin, ether or ripple – and initial coin offerings (ICOs). When including cryptocurrencies and ICOs in their personal trading policies, fund managers should consider, among other things, whether to completely ban that trading, what types of restrictions it may impose on employees if that trading is permitted and how to monitor employee trading. This article, the second in our two-part series on the inclusion of cryptocurrencies and ICOs in personal trading policies, explores the factors fund managers must consider when determining how to address these assets in their personal trading policies and examines the challenges in allowing employees to trade in this asset class. The first article analyzed why fund managers need to amend their personal trading policies to address cryptocurrencies and ICOs. For more on issues posed by cryptocurrency investing, see “Unique Security Risks Posed by Cryptocurrency Investing: Steps Fund Managers Must Take to Protect Individuals With Access to Client Assets” (Jun. 28, 2018).

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  • From Vol. 11 No.30 (Jul. 26, 2018)

    Why Fund Managers Should Ensure Personal Trading Policies Address Cryptocurrencies and ICOs (Part One of Two)

    Fund managers that invest in cryptocurrencies or cryptocurrency-related strategies must ensure that their personal trading policies take these instruments into account in order to address the conflict of interest that arises when employees invest in the same assets held by the managers’ funds. Hedge fund managers that have not invested in cryptocurrencies, however, cannot simply ignore the existence of this emerging asset class, because their employees may want to either trade in virtual currencies or participate in initial coin offerings (ICOs). As a result, all fund managers – even those whose investment strategies do not include cryptocurrencies or ICOs – should ensure that their personal trading policies address these assets. This two-part series discusses the inclusion of cryptocurrencies and ICOs in fund manager personal trading policies. This first article analyzes why fund managers must amend their personal trading policies to address cryptocurrencies and ICOs. The second article will explore the factors fund managers must consider when determining how to do so and examine the challenges in allowing employees to trade in this asset class. For more on personal trading policies generally, see our three-part series “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures”: Part One (Jan. 19, 2012); Part Two (Jan. 26, 2012); and Part Three (Feb. 9, 2012).

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  • From Vol. 11 No.30 (Jul. 26, 2018)

    Ropes & Gray Survey and Forum Consider Credit Fund Structures, Leverage, Conflicts of Interest and Challenging Environment (Part Two of Two)

    Credit fund managers must be keenly aware of the conflicts of interest that often go hand-in-hand with their strategies. This was one of the principal findings of a recent report issued by Ropes & Gray, which surveyed 100 credit fund managers in cooperation with Debtwire. In a recent webinar, Ropes & Gray partners James R. Brown, Eva Ciko Carman, Alyson Brooke Gal and Jessica Taylor O’Mary explained the survey results and key takeaways from the Ropes & Gray Credit Funds Forum. Our two-part series summarizes the report’s findings and the webinar speakers’ insights. This second article examines a variety of conflicts of interest that frequently arise for credit managers, the forms of leverage these managers are using, the types of issues that investors subject to the Employee Retirement Income Security Act of 1974 raise for credit managers and specific issues that arise for these managers when being examined by the SEC. The first article discussed the types of credit strategies offered by the survey participants, challenges currently facing credit funds and the types of fund structures adopted by credit fund managers – including “season and sell” structures, treaty funds, business development companies and blockers – when engaging in a direct lending strategy. See our three-part series on conflicts arising out of simultaneous management of hedge funds and private equity funds: “Investment Conflicts” (May 7, 2015); “Operational Conflicts” (May 14, 2015); and “How to Mitigate Conflicts” (May 21, 2015).

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  • From Vol. 11 No.21 (May 24, 2018)

    Usable Lessons and Proven Survival Techniques From the Hedge Fund Examination Trenches

    A 2014 program presented by the Regulatory Compliance Association reviewed the experiences of several in-house legal and compliance practitioners with SEC and NFA examinations. The program also provided an overview of key substantive issues that are likely to be addressed in those exams, including insider trading and expert networks; trade and investment allocations; expense allocations; marketing documents; high-frequency trading; cybersecurity; social media; and broker-dealer registration. The program was moderated by Christopher M. Wells, partner at Proskauer, and featured Cynthia Marian, then-vice president, chief compliance officer (CCO) and deputy general counsel (GC) of Tinicum; Dianne Mattioli, then-CCO of Hedgemark Securities; Mark Polemeni, then-CCO of asset management at Citadel; and Catherine Smith, GC of Guidepoint Global. Although the program dates from 2014, the issues raised and guidance offered by the participants remain relevant to fund managers today. This article highlights the key points raised by the panel. See “Practical Guidance From Former SEC Examiners on Preparing for and Surviving SEC Examinations” (Sep. 1, 2016); and our three-part series “What Do Hedge Fund Managers Need to Know to Prepare for, Handle and Survive SEC Examinations?”: Part One (Feb.  3, 2011); Part Two (Feb. 10, 2011); and Part Three (Feb. 18, 2011).

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  • From Vol. 11 No.17 (Apr. 26, 2018)

    SEC Confirms Cyber Disclosure Expectations in New Guidance

    The SEC’s latest guidance emphasizes proper and full disclosures related to cybersecurity risks and incidents throughout relevant filings. In that guidance, the SEC stated that “informing investors about material cybersecurity risks and incidents in a timely fashion” is critical, even if an entity has “not yet . . . been the target of a cyber attack.” The guidance reiterates the SEC’s 2011 guidance and addresses two new topics: (1) “the importance of cybersecurity policies and procedures”; and (2) the “application of insider trading prohibitions in the cybersecurity context.” This article analyzes the guidance and offers practical advice on risk disclosures from a chief compliance officer with experience preparing these types of disclosures. See our three-part series on how fund managers should structure their cybersecurity programs: “Background and Best Practices” (Mar. 22, 2018); “CISO Hiring, Governance Structures and the Role of the CCO” (Apr. 5, 2018); and “Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties” (Apr. 12, 2018).

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  • From Vol. 11 No.9 (Mar. 1, 2018)

    Securities Docket Webinar Analyzes SEC Focus on Cybersecurity and Cryptocurrencies, Along With Implications of Court Decisions on the ALJ Regime and Attorney-Client Privilege (Part Two of Two)

    The SEC, which increasingly uses technology to leverage its oversight and enforcement powers, recently reaffirmed its commitment to combatting cybercrime and misconduct in cryptocurrencies through the creation of a Cyber Unit. See “Co-Director of SEC Enforcement Division Champions New Retail Strategy Task Force and Cyber Unit” (Nov. 16, 2017). In addition, the Commission is continuing its trend of holding individuals accountable to deter misconduct. Finally, recent judicial decisions continue to shape insider trading law; the extraterritorial application of securities laws; the legitimacy of the SEC’s administrative law judge (ALJ) regime; and the risks and benefits of providing privileged material to government agencies. These issues, among others, were discussed in a recent Securities Docket webinar featuring William R. McLucas, partner at WilmerHale; Doug Davison, partner at Linklaters; and Martin Wilczynski and Steven E. Richards, senior managing directors at Ankura Consulting Group. This article, the second in a two-part series, analyzes developments in the areas of cybersecurity and cryptocurrencies; individual accountability; insider trading; extraterritorial application of securities laws; the ALJ regime; and attorney-client privilege. The first article summarized 2017 enforcement actions and other developments in the areas of accounting and audit cases, disgorgement and whistleblowers. For further commentary from WilmerHale attorneys, see “Financial CHOICE Act of 2017 Proposes Sweeping Reforms, but May Allow Regulators to Maintain Status Quo in Some Areas” (Jun. 1, 2017).

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  • From Vol. 11 No.8 (Feb. 22, 2018)

    Ways the Valeant-Pershing Square Settlement Could Affect Future Insider Trading Lawsuits

    Valeant Pharmaceuticals and Pershing Square recently announced their decision to make a joint $290 million payment to settle litigation arising from alleged insider trading committed in 2014. See “Did Pershing Square and Valeant Violate Insider Trading, Antitrust or Tender Offer Rules in Their Pursuit of Allergan?” (May 2, 2014). Shareholders of Allergan claimed that Pershing Square illegally enriched itself by buying Allergan shares, and earning more than $2 billion in profits, with the knowledge that Valeant planned to initiate a bid for Allergan. Although Valeant ultimately failed in its takeover bid for Allergan, allegations of insider trading and other violations of securities laws have dogged both Valeant and Pershing Square for years. Some observers may be surprised that the insider trading claims against Pershing Square and Valeant were not dismissed. Arguably, the respondents did not technically commit insider trading because they acted without scienter – a key component of insider trading violations as traditionally understood. This article analyzes the Valeant-Pershing Square settlement, together with insights from practitioners with expertise in insider trading law, to help readers understand the settlement’s implications on insider trading law and takeaways for activist investors. For additional analysis of the evolution of insider trading law, see “HFLR Panel Identifies Best Practices for Avoiding Insider Trading Liability in the Aftermath of Martoma” (Jan. 18, 2018).

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  • From Vol. 11 No.4 (Jan. 25, 2018)

    A Fund Manager’s Roadmap to Big Data: Privacy Concerns, Third Parties and Drones (Part Three of Three)

    A fund manager’s use of new technologies and processes to streamline its business and generate improved performance comes with significant risk, which is pronounced when using big data, as few best practices currently exist within the industry. One of the most significant concerns about big data involves the acquisition or use of personally identifiable information (PII). Although PII enjoys broad protection under U.S. law, many state laws impose even more stringent restrictions on the use of personal data, and the E.U. General Data Protection Regulation provides a comprehensive and onerous framework for data tied to E.U. citizens. Managers must also understand how to deal with third-party data vendors, including how to conduct due diligence on and negotiate contractual provisions with those service providers. Finally, as growing numbers of drones are used to capture images, managers must recognize and comply with a web of federal regulations, as well as state laws, surrounding this use. This third article in our three-part series discusses the risks associated with data privacy, the acquisition of data from third parties and the use of drones, as well as recommended methods for mitigating those risks. The first article explored the big-data landscape, along with how fund managers can acquire and use big data in their businesses. The second article analyzed issues and best practices surrounding the acquisition of material nonpublic information; web scraping; and the quality and testability of data. For more on the adoption by fund managers of new technology, see our three-part series on blockchain: “Basics of the Technology and How the Financial Sector Is Currently Employing It” (Jun. 1, 2017); “Potential Uses by Private Funds and Service Providers” (Jun. 8, 2017); and “Potential Impediments to Its Eventual Adoption” (Jun. 15, 2017).

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  • From Vol. 11 No.4 (Jan. 25, 2018)

    BakerHostetler Briefing Provides Regulatory Update: Developments in SEC Enforcement and Hot Topics in Taxation Affecting Private Funds (Part Two of Two)

    Since the enactment of the Dodd-Frank Act in 2010, compliance officers in the financial services industry have been working franticly to analyze and implement the multitude of rules and regulations that flowed from its passage. Although some in the industry have been hopeful that the Trump administration would herald a regulatory-lite approach by the SEC, only time will tell whether the administration’s anti-regulatory posture will trickle down to the regulatory agencies, their leadership and, in the case of the SEC, the staff of the Office of Compliance Inspections and Examinations. A recent program sponsored by BakerHostetler considered the impact of the new administration, as well as the leadership of SEC Chair Jay Clayton, on the regulation of investment advisers. The program was moderated by Marc D. Powers, partner at BakerHostetler and national leader of the firm’s securities litigation, regulatory enforcement and hedge fund industry practices; and featured Walter Van Dorn, partner and head of BakerHostetler’s international capital markets practice; Jonathan A. Forman, counsel at BakerHostetler; Simcha B. David, partner at EisnerAmper; and Andrew N. Siegel, then-partner, chief compliance officer and chief regulatory counsel at Perella Weinberg Partners. This second article in our two-part series discusses hot topics in the area of SEC enforcement, as well as the tax aspects of loan origination and cryptocurrencies. The first article reviewed recent regulatory initiatives undertaken by the SEC that impact investment advisers, whether the change in leadership at the SEC will affect the examination environment and the implementation of MiFID II. For more from Powers and Forman, see “BakerHostetler Panel Analyzes the Trump Effect on the SEC’s Initiatives and Enforcement Efforts” (May 4, 2017); and “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016).

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  • From Vol. 11 No.3 (Jan. 18, 2018)

    A Fund Manager’s Roadmap to Big Data: MNPI, Web Scraping and Data Quality (Part Two of Three)

    As fund managers increasingly turn to sophisticated data streams to boost investment returns and produce greater operational efficiencies, it is critical that they understand the legal and practical risks posed by the use of big data. Issues surrounding material nonpublic information (MNPI) pose the greatest threat to firms. Managers must understand not only the misappropriation framework under the Securities Exchange Act of 1934, but also how the New York State Attorney General and regulators in the E.U. pursue insider trading claims. Additionally, whether engaging internally in web scraping or purchasing scraped data from third parties, managers must be conscious of contractual, intellectual property and tort claims that a site owner may allege against a fund manager. Finally, many of the largest challenges posed by the use of big data are practical or ethical in nature. This second article in our three-part series on big data analyzes issues and best practices surrounding the acquisition of MNPI; web scraping; and the quality and testability of data. The first article explored the big-data landscape and how fund managers can acquire and use big data in their businesses. The third article will discuss risks associated with data privacy, the acquisition of data from third parties and the use of drones, as well as recommended methods for mitigating those risks. For more on big data, see “Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping” (Jun. 15, 2017).

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  • From Vol. 11 No.3 (Jan. 18, 2018)

    HFLR Panel Identifies Best Practices for Avoiding Insider Trading Liability in the Aftermath of Martoma

    The U.S. Court of Appeals for the Second Circuit’s ruling in U.S. v. Martoma in August 2017 raises the prospect that defendants in insider trading cases can no longer rely on defenses established in U.S. v. Newman. See “In U.S. v. Martoma, Second Circuit Eliminates ‘Meaningfully Close Personal Relationship’ Element Articulated in Newman for Insider Trading Prosecutions” (Sep. 14, 2017). The elimination of the requirement that the government must prove a meaningfully close personal relationship between tipper and tippee in order to bring an insider trading conviction is especially significant for hedge funds that employ outside networks for information to inform trading strategies and decisions. In the complex post-Martoma compliance landscape, fund general counsels and chief compliance officers must implement measures that adapt to the monumental changes in insider trading law, minimize compliance risk and shield themselves from the kinds of ruinous enforcement actions that have plagued some of the largest investment advisers in recent months. All of these points came across in a panel discussion sponsored by The Hedge Fund Law Report and MoloLamken. Moderated by William V. de Cordova, Editor-in-Chief of The Hedge Fund Law Report, the panel featured Katherine Goldstein, partner at Milbank Tweed Hadley & McCloy; Brian Guzman, general counsel of Indus Capital Partners; Brendan Kalb, managing director and general counsel of AQR Capital Management; and Justin Shur, partner at MoloLamken. This article summarizes the key takeaways from the discussion. For more on insider trading, see “Hedge Fund Manager Deerfield Fined $4.7 Million for Failing to Adopt Insider Trading Compliance Policies Tailored to the Firm’s Specific Risks” (Sep. 21, 2017); and “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?” (Nov. 19, 2009).

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  • From Vol. 11 No.1 (Jan. 4, 2018)

    Steps Advisers Can Take to Minimize the Risk That a Routine SEC Examination Ends With a Referral to Enforcement: Five Key Priorities for OCIE (Part One of Two)

    Although there has been much talk of deregulation under the Trump administration, investment advisers remain subject to close SEC scrutiny. A recent program presented by Davis Polk discussed the current SEC examination and enforcement climate affecting advisers, including an overview of five key examination priorities, and offered guidance on preparing for and handling routine examinations conducted by the SEC’s Office of Compliance Inspections and Examinations (OCIE), all with a view toward minimizing the risk of a referral to the SEC’s Division of Enforcement (Enforcement Division). The program featured Davis Polk partners Leor Landa, Amelia T.R. Starr and James H.R. Windels, along with associate Marc J. Tobak. This two-part series summarizes the panel’s insights. This first article discusses five areas identified by the panelists on which OCIE frequently focuses during the examination of investment advisers. The second article will provide guidance on the steps that advisers can take to minimize the likelihood that OCIE will refer certain issues to the Enforcement Division. For more on the current regulatory environment, see our two-part series providing commentary from former senior SEC attorneys: “Chair Clayton’s Priorities and the Current Enforcement Climate” (Dec. 7, 2017); and “Current Regulatory Climate, Adviser Examinations and the Enforcement Referral Process” (Dec. 21, 2017). For coverage of prior Davis Polk programs, see our two-part series on activist hedge funds: “Filing Obligations and Other Operational Considerations” (May 5, 2016); and “Settlement, Prospects, Shareholder Engagement and Proxy Access Considerations” (May 12, 2016).

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  • From Vol. 10 No.48 (Dec. 7, 2017)

    Former Senior SEC Attorneys Offer Insight on Chair Clayton’s Priorities and the Current Enforcement Climate (Part One of Two)

    Under former Chair Mary Jo White’s “broken windows” approach to enforcement, the SEC pursued minor infractions in an effort to prevent more serious misconduct. Although some have expressed hope that the Commission will become more pragmatic under Chair Jay Clayton, particularly in light of President Trump’s pro-business rhetoric, it remains difficult for fund managers to obtain perspective into the inner workings of the SEC and its enforcement agenda. A recent program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), provided fund managers with that valuable insight into the SEC, explaining the shift in tone under Clayton and offering perspectives on the regulator’s potential agendas. Moderated by Simpson Thacher partner Olga Gutman, the program featured partners David W. Blass, former Chief Counsel and Associate Director in the SEC Division of Trading and Markets, and Michael J. Osnato, Jr., former Chief of the Complex Financial Instruments Unit of the SEC Division of Enforcement. This two-part series summarizes the panel’s insights. This first article discusses the “zero-tolerance” approach under White, the direction Clayton intends to take and the SEC’s enforcement agenda. The second article will explore the SEC’s regulatory agenda, as well as the examination and enforcement referral process. For more from Simpson Thacher, see “Structuring Private Funds to Avoid ERISA While Accommodating Benefit Plan Investors”: Part One (Feb. 5, 2015); and Part Two (Feb. 12, 2015). For coverage of prior programs hosted by MLA, see “Client Consent and Other Issues Requiring Careful Consideration by Fund Managers Involved in M&A Transactions” (May 18, 2017); and “Former Prosecutors Address Trends in Cybersecurity for Alternative Asset Managers, Diligence When Acquiring a Company and Breach Response Considerations” (Oct. 6, 2016).

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  • From Vol. 10 No.47 (Nov. 30, 2017)

    Will Inadequate Policies and Procedures Be the Next Major Focus for SEC Enforcement Actions?

    The SEC has taken recent enforcement action against Deerfield Capital Management (Deerfield), Artis Capital Management (Artis) and R.T. Jones Capital Equities Management (R.T. Jones) for failing to maintain policies and procedures tailored to the risks of their respective operations. Although the areas of deficiency in question vary widely, the respondents all found themselves in trouble for allegedly failing to maintain and enforce “reasonably designed” policies and procedures. Despite expectations that the SEC, under new leadership, would reduce the “broken windows” approach to enforcement, some believe these three cases foreshadow the deployment of the dramatically expanded resources available to the SEC’s Office of Compliance Inspections and Examinations for investment adviser examinations in a broad effort to ensure that firms maintain appropriately tailored policies and procedures, as well as oversee employees in sensitive areas of their operations. As SEC Chair Jay Clayton recently told The Hedge Fund Law Report, “looking at firms’ policies and procedures will continue to be a priority for the Commission.” To help readers understand this trend, adopt best practices and insulate themselves against similar enforcement actions, the HFLR has interviewed legal professionals with expertise in regulatory enforcement matters. This article presents the insights from those interviews, along with Clayton’s further thoughts on the matter. For analysis of the Deerfield, Artis and R.T. Jones cases, respectively, see “Hedge Fund Manager Deerfield Fined $4.7 Million for Failing to Adopt Insider Trading Compliance Policies Tailored to the Firm’s Specific Risks” (Sep. 21, 2017); “General Insider Trading Policies and Procedures May Be Insufficient for Hedge Fund Managers to Avert SEC Enforcement Action” (Nov. 3, 2016); and “Investment Adviser Penalized for Weak Cyber Policies; OCIE Issues Investor Alert” (Oct. 1, 2015).

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  • From Vol. 10 No.44 (Nov. 9, 2017)

    Ganek Dismissal Demonstrates Broad Latitude Granted to Government During Investigations of Fund Managers

    Execution of a search warrant at a hedge fund manager’s business premises can be catastrophic. That was the case for Level Global Investors (LG), which folded less than three months after the FBI executed a search warrant at its offices seeking evidence of insider trading. After LG co-founder David Ganek learned that the warrant application incorrectly alleged that he knowingly received inside information from an LG analyst, he sued several government officials for damages, asserting violations of, among other things, his Fourth and Fifth Amendment rights. The U.S. Court of Appeals for the Second Circuit (Court) recently dismissed his causes of action, holding that the defendants are entitled to qualified immunity from suit and that misstatements in the search warrant did not violate Ganek’s constitutional rights. The Court’s finding should serve as an important warning that, even if the government commits missteps in its pursuit of insider trading and other violations, targeted fund managers may not have recourse to reverse or mitigate the damage done by those actions. This article analyzes the Court’s order, along with the facts and circumstances leading up to it. For a summary of Ganek’s complaint, see “Former Level Global Head David Ganek Sues U.S. Attorney Bharara and Other Senior DOJ and FBI Personnel, Claiming Fabrication of Evidence Against Him” (Mar. 12, 2015).

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  • From Vol. 10 No.37 (Sep. 21, 2017)

    Hedge Fund Manager Deerfield Fined $4.7 Million for Failing to Adopt Insider Trading Compliance Policies Tailored to the Firm’s Specific Risks

    It is widely understood that trading on information about pending government actions obtained through political intelligence firms can give rise to insider trading charges. A recent SEC settlement order with Deerfield Management Company, L.P. (Deerfield) makes clear that a fund manager’s generic policies and procedures to prevent trading on material nonpublic information (MNPI) may not pass muster if the manager makes use of political intelligence firms. In 2012 and 2013, two Deerfield analysts generated profits of nearly $4 million for Deerfield funds by trading on MNPI provided by a political intelligence consultant. See “SEC Insider Trading Action Highlights Red Flags Hedge Fund Managers Must Heed When Employing Political Intelligence Consultants” (Jun. 8, 2017). The SEC asserted that Deerfield’s policies and procedures were not reasonably designed to prevent the misuse of MNPI obtained from political intelligence firms. This article examines the events that gave rise to the SEC action; the alleged deficiencies in Deerfield’s policies and procedures; and the terms of the settlement. For an action involving alleged deficient policies and procedures at a political intelligence firm, see “Self-Evaluation Policies Are Insufficient for Political Intelligence Firms to Avoid MNPI Violations” (Dec. 17, 2015). For more on political intelligence and the risks of insider trading, see “How Can Hedge Fund Managers Identify and Mitigate Insider Trading Risks Associated With Gathering and Using Political Intelligence?” (Jul. 11, 2013); and “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls” (Apr. 5, 2012).

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  • From Vol. 10 No.36 (Sep. 14, 2017)

    In U.S. v. Martoma, Second Circuit Eliminates “Meaningfully Close Personal Relationship” Element Articulated in Newman for Insider Trading Prosecutions

    On August 23, 2017, the U.S. Court of Appeals for the Second Circuit issued a ruling in the case of U.S. v. Martoma, upholding the 2014 conviction of former S.A.C. Capital Advisors trader Mathew Martoma for securities fraud and insider trading. The Second Circuit ruling refers to several earlier landmark cases in the evolving jurisprudence regarding insider trading, including U.S. v. Newman, upon which Martoma had drawn heavily in his defense. In the view of the Second Circuit, the Supreme Court’s ruling in Salman v. U.S. supersedes and repudiates certain of Newman’s highly specific requirements to establish insider trading violations, including Newman’s “meaningfully close personal relationship” criterion. The ruling in Martoma is of monumental significance for investment advisers and traders because it weighs the differing legal standards under Newman and Salman and affirms a significantly lower bar for pursuing insider trading charges. This marks a decisive shift in a body of jurisprudence around insider trading that has evolved in numerous directions since the landmark 1983 ruling in Dirks v. SEC. To help readers understand the evolution of this body of law, this article summarizes the Martoma case within the context of earlier rulings and includes the views of attorneys with expertise in insider trading matters. For background on the Martoma case, see “Five Takeaways for Other Hedge Fund Managers From the SEC’s Record $602 Million Insider Trading Settlement With CR Intrinsic” (Mar. 21, 2013); and “Fund Manager CR Intrinsic and Former S.A.C. Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme” (Nov. 21, 2012).

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  • From Vol. 10 No.29 (Jul. 20, 2017)

    What Fund Managers Can Learn From “Tipper X”: Best Practices for Navigating the Evolving Insider Trading Landscape (Part Two of Two)

    Fund managers must continually adapt to an evolving landscape as regulators become more aggressive in pursuing insider trading. See “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part Two of Two)” (Aug. 15, 2013); and “When Does Talking to Corporate Insiders or Advisors Cross the Line Into Tipper or Tippee Liability Under the Misappropriation Theory of Insider Trading?” (Jan. 10, 2013). The Hedge Fund Law Report recently spoke with Tom Hardin, the founder of Tipper X Advisors LLC, who provided his unique perspective on insider trading based on his experience as a former insider trader and one of the most prolific informants in securities fraud history. This second article in our two-part series presents Hardin’s insights on how fund managers should react to developments in insider trading enforcement, including changes in examination and enforcement methods; recent insider trading decisions such as U.S. v. Newman and Salman v. U.S.; the Trump administration’s pro-business, anti-regulation stance; and the recent performance of the hedge fund industry. The first article explored how private fund compliance staff can prevent and detect insider trading activity, train employees, ensure prudent email use, prevent employees from rationalizing their insider trading and restructure employee compensation to avoid incentivizing risky behavior. For more on insider trading, see “ACA 2017 Fund Manager Compliance Survey Shows Continued SEC Focus on Compliance, Conflicts of Interest and Fees, and Illustrates Common Measures to Protect MNPI (Part One of Two)” (Jun. 1, 2017); and “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016).

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  • From Vol. 10 No.29 (Jul. 20, 2017)

    Compliance Corner Q3-2017: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

    What issues should hedge fund manager chief compliance officers (CCOs) be focusing on in the third quarter? In addition to completing the various regulatory filings and requirements due at the end of the quarter, CCOs should focus on building out their compliance programs to include forensic testing and other assessments to address internal risks and SEC staff expectations. See “Top Five Compliance Deficiencies in OCIE Risk Alert Include Annual Compliance Reviews, Accurate Regulatory Filings and Custody Issues” (Feb. 23, 2017). To ensure that fund managers stay on top of the regulatory filings they need to perform each quarter, The Hedge Fund Law Report is introducing this quarterly feature. This first installment, authored by Danielle Joseph and Anne Wallace, director and analyst, respectively, at ACA Compliance Group, highlights some notable regulatory filings fund managers need to perform in the third quarter of 2017, including the deadlines and requirements associated with quarterly transaction reports, Form PF, Form ADV and Form 13F. For additional coverage of reporting requirements applicable to fund managers under certain circumstances, see “Marketing and Reporting Considerations for Emerging Hedge Fund Managers” (Jun. 16, 2016); and our two-part series on regulatory reporting by non-E.U. hedge fund managers under E.U. private placement regimes: “Guidance for Registering” (Dec. 3, 2015); and “Roadmap for Reporting” (Dec. 10, 2015).

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  • From Vol. 10 No.28 (Jul. 13, 2017)

    What Fund Managers Can Learn From “Tipper X”: Best Practices for Preventing and Detecting Insider Trading (Part One of Two)

    As regulators continue focusing on insider trading, hedge fund managers must strive to improve their compliance policies and procedures to prevent employee misconduct. See “SEC Complaint Suggests the Agency Will Continue Aggressive Enforcement Actions for Insider-Trading Violations” (May 11, 2017). To provide another perspective on insider trading, The Hedge Fund Law Report recently spoke with Tom Hardin, founder of Tipper X Advisors LLC. Known as “Tipper X,” Hardin was one of the most prolific informants in securities fraud history, assisting the U.S. government in numerous criminal insider trading cases as part of a DOJ cooperation agreement. As a convicted insider trader and informant, he has a unique perspective on insider trading, including how fund employees rationalize trading on material nonpublic information and how the private fund industry’s culture of compliance has evolved. This first article in our two-part series presents Hardin’s insights on how private fund compliance staff can prevent and detect insider trading activity, including best practices for training employees, ensuring prudent email use, preventing employees from rationalizing their insider trading, restructuring employee compensation to avoid incentivizing risky behavior and identifying insider trading activity. The second article will analyze ways regulators combat insider trading activity, the impact of recent insider trading cases on the regulatory environment and the potential effect of the current administration’s anti-regulatory stance on insider trading. See “General Insider Trading Policies and Procedures May Be Insufficient for Hedge Fund Managers to Avert SEC Enforcement Action” (Nov. 3, 2016); and our two-part coverage of the Seward & Kissel Private Funds Forum: “Mitigate Improper Dissemination of Sensitive Information” (Sep. 22, 2016); and “Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading” (Sep. 29, 2016).

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  • From Vol. 10 No.28 (Jul. 13, 2017)

    Tips and Warnings for Navigating the Big Data Minefield

    Data-gathering and analytics have become valuable tools for private fund managers when making their investment decisions. As technology outpaces the law in this area, however, managers must use caution when acquiring and using data. See “Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping” (Jun. 15, 2017). A recent presentation featuring Proskauer partners Robert G. Leonard, Jeffrey D. Neuburger, Joshua M. Newville and Jonathan E. Richman discussed the evolving methods of collecting data, the risks involved and the ways managers can use big data without running afoul of applicable law. This article summarizes the panelists’ insights. For more from Leonard, see “How Fund Managers Can Prevent or Remedy Improper Fee and Expense Allocations (Part Three of Three)” (Sep. 15, 2016); and “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates: An Interview With Proskauer Partner Robert Leonard” (Mar. 5, 2015).

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  • From Vol. 10 No.27 (Jul. 6, 2017)

    How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?

    Hedge fund managers are in the business of collecting, analyzing and acting on a significant volume of complex information, which requires navigating various federal securities laws to determine whether that information can be traded upon. The spectrum of information received by managers ranges from public information gleaned from sources such as filed annual or quarterly reports (permitted for trading), to material nonpublic information (MNPI) obtained from someone with a duty to the securities’ issuer (impermissible for trading). Somewhere in the middle is “market color” – information that is more specific to a company, industry or market than public information, but that does not rise to the level of MNPI. Distinguishing between market color and inside information is, however, infamously difficult and fraught with peril considering the SEC’s recent attempts to crack down on insider trading. See “SEC Insider Trading Action Highlights Red Flags Hedge Fund Managers Must Heed When Employing Political Intelligence Consultants” (Jun. 8, 2017). This article addresses this issue by identifying sources of market color and the channels via which it is provided; distinguishing between these information types in various contexts; detailing the relationship between soft dollars and market color; and identifying regulatory precedents that may provide insight into how the SEC may treat market color. For coverage of recent developments in insider trading laws, see “Supreme Court’s Ruling in Salman v. U.S. Affirms the Importance of a Tipper’s ‘Personal Benefit’ for Insider Trading, but Also Creates Uncertainty” (Feb. 9, 2017); and “General Insider Trading Policies and Procedures May Be Insufficient for Hedge Fund Managers to Avert SEC Enforcement Action” (Nov. 3, 2016).

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  • From Vol. 10 No.24 (Jun. 15, 2017)

    Best Practices for Private Fund Advisers to Manage the Risks of Big Data and Web Scraping

    On April 13, 2017, craigslist obtained a judgment against RadPad, a third party that collected data through automated means from its site. The $60.5 million judgment was based on various claims relating to RadPad’s use of sophisticated techniques to evade detection and harvest content from craigslist’s site, as well as distribution of unsolicited commercial emails to craigslist users to market RadPad’s own apartment rental listing service. While it is doubtful that craigslist will ever collect this sizeable judgment, the case highlights some of the issues faced by persons, such as hedge fund managers, who collect – or engage others to collect – data through automated means for commercial purposes. In a guest article, Proskauer partners Robert G. Leonard, Jeffrey D. Neuburger and Joshua M. Newville provide an overview of big data and web scraping, outline potential sources of liability to hedge fund managers that collect big data and describe best practices for navigating several areas of potential liability. For additional insight from Newville and other Proskauer partners, see “Ten Key Risks Facing Private Fund Managers in 2017” (Apr. 6, 2017). For further commentary from Leonard, see our two-part series on The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 3, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016).

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  • From Vol. 10 No.23 (Jun. 8, 2017)

    SEC Insider Trading Action Highlights Red Flags Hedge Fund Managers Must Heed When Employing Political Intelligence Consultants

    The SEC recently filed a civil enforcement action against a U.S. government employee, a consultant and two hedge fund analysts. It alleges that, on three separate occasions, the government employee provided the consultant with nonpublic information about proposed changes to Medicare reimbursement rates. The consultant conveyed that information to his hedge fund clients who, in turn, traded on the information in advance of the public announcements of the rate changes. In the SEC press release announcing the action, Stephanie Avakian, Acting Director of the SEC Division of Enforcement, stated, “There’s no place on Wall Street or in our government for such blatant misuse of highly confidential information.” This article summarizes the SEC’s complaint, highlighting the allegations most relevant to hedge fund managers that use political intelligence firms. For another SEC action involving improper use of nonpublic regulatory information, see “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016). For an SEC action against a political intelligence firm, see “Self-Evaluation Policies Are Insufficient for Political Intelligence Firms to Avoid MNPI Violations” (Dec. 17, 2015).

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  • From Vol. 10 No.22 (Jun. 1, 2017)

    ACA 2017 Fund Manager Compliance Survey Shows Continued SEC Focus on Compliance, Conflicts of Interest and Fees, and Illustrates Common Measures to Protect MNPI (Part One of Two)

    The findings of the 2017 Alternative Fund Manager Compliance Survey by ACA Compliance Group (ACA) were discussed in a recent webinar by Danielle Joseph and Tessa Carbone, director and principal consultant, respectively, at ACA. This article, the first in a two-part series, covers the portions of the Survey that consider the frequency of SEC examinations and the topics they cover, as well as the pervasiveness of adviser efforts to protect material nonpublic information, including through the use of restricted lists and expert networks. The second installment will discuss common fee and expense-allocation practices by managers, along with manager efforts to comply with the recent business-continuity and transition-planning requirements promulgated by the SEC. See our two-part coverage of ACA’s 2016 Compliance Survey: “SEC Exams; Compliance Staffing and Budgeting; Annual and Ongoing Compliance Reviews; and AML/Sanctions Compliance” (Jan. 19, 2017); and “Custody; Fee Policies and Arrangements; Safeguarding of Assets; and Personal Trading” (Feb. 2, 2017).

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  • From Vol. 10 No.19 (May 11, 2017)

    SEC Complaint Suggests the Agency Will Continue Aggressive Enforcement Actions for Insider-Trading Violations

    As the financial sector waits eagerly to see who will fill vacancies in the leadership of the SEC, the agency continues to take an aggressive stance against insider trading. The tough posture of the regulators is evident in a recent SEC complaint filed against a vice president and risk management officer at a leading investment bank who allegedly committed insider trading in complicity with his wife. The complaint details a number of flagrant violations of internal policy at the insider’s bank and of insider-trading law. To help fund managers understand the case and its significance, this article analyzes the complaint and furnishes insight from legal experts specializing in white-collar enforcement cases. For discussion of another recent insider trading case, see “Court to Rule on Novel Issue of Insider Trading Law in Case Against Leon Cooperman and Omega Advisors” (Mar. 30, 2017); and “Alleging Dozens of Violations, SEC Charges Leon Cooperman and Omega Advisors With Insider Trading and Failing to Make Regulatory Filings” (Sep. 29, 2016).

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  • From Vol. 10 No.13 (Mar. 30, 2017)

    Court to Rule on Novel Issue of Insider Trading Law in Case Against Leon Cooperman and Omega Advisors

    In September 2016, the SEC commenced a civil enforcement action against hedge fund manager Leon G. Cooperman and his investment advisory firm, Omega Advisors, Inc. (Omega), charging that Cooperman received and traded on material nonpublic information (MNPI) and committed more than 40 violations of the beneficial ownership reporting requirements under federal securities laws. See “Alleging Dozens of Violations, SEC Charges Leon Cooperman and Omega Advisors With Insider Trading and Failing to Make Regulatory Filings” (Sep. 29, 2016). In response to the defendants’ motion to dismiss the SEC’s complaint for failure to state a claim for insider trading and improper venue for the reporting violations, the U.S. District Court for the Eastern District of Pennsylvania (Court) recently dismissed the reporting violation claims but ruled that the SEC’s insider trading claims could proceed. In its Memorandum accompanying the Order, the Court addressed a novel issue as to whether a defendant could be held liable under the misappropriation theory of insider trading where he entered into an explicit agreement not to trade after he received MNPI but before he traded on it. This article summarizes the Court’s Memorandum. For more on the misappropriation theory of insider trading, see “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part Two of Two)” (Aug. 15, 2013); and “When Does Talking to Corporate Insiders or Advisors Cross the Line Into Tipper or Tippee Liability Under the Misappropriation Theory of Insider Trading?” (Jan. 10, 2013).

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    SEC Settlement Reminds Fund Managers With Affiliated Broker-Dealers of Importance of Robust Controls Over Use of MNPI

    In an effort to expand its business, a broker-dealer established a private fund that traded in many of the same securities that it covered in its research and investment banking activities. That broker-dealer allegedly failed to adopt policies and procedures to prohibit its employees from using material nonpublic information learned from its investment banking clients in connection with the fund’s trading, however. The SEC’s recent settlement order (Order) with that broker-dealer is a timely reminder that fund managers and broker-dealers must adopt and implement appropriate policies and procedures to ensure compliance with insider trading and other applicable rules under the securities laws. This article summarizes the Order and crucial lessons for fund managers that can be gleaned from it. For more on mitigating the risk of insider trading through compliance programs, see “General Insider Trading Policies and Procedures May Be Insufficient for Hedge Fund Managers to Avert SEC Enforcement Action” (Nov. 3, 2016); “Ropes & Gray Partners Share Experience and Best Practices Regarding the JOBS Act, the Volcker Rule, Broker Registration, Information Barriers, Examination Priorities, Multi-Year Incentive Fees and Swap Execution Facilities” (Jan. 30, 2014); and “How Hedge Fund Managers Can Use Technology to Enhance Their Compliance Programs” (Nov. 17, 2011).

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  • From Vol. 10 No.7 (Feb. 16, 2017)

    WilmerHale Attorneys Detail 2016 CFTC Enforcement Actions and Potential Priorities Under Trump Administration

    Fund managers that trade futures, swaps and other derivatives may be subject to both CFTC and SEC supervision. A recent web briefing by regulatory and enforcement attorneys from WilmerHale provided a comprehensive review of significant enforcement and regulatory actions by the CFTC in 2016, considered pending CFTC legislation and regulation and offered insight into what CFTC operations and priorities may look like under the Trump administration. The briefing featured WilmerHale partners Paul M. Architzel, Dan M. Berkovitz and Anjan Sahni, along with special counsel Gail C. Bernstein. This article highlights the panelists’ key insights. For additional insight from WilmerHale attorneys, see “FCPA Concerns for Private Fund Managers (Part One of Two)” (May 28, 2015); “FCPA Risks Applicable to Private Fund Managers (Part Two of Two)” (Jun. 11, 2015); and “Best Legal and Accounting Practices for Hedge Fund Valuation, Fees and Expenses” (Jul. 18, 2013).

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  • From Vol. 10 No.6 (Feb. 9, 2017)

    Supreme Court’s Ruling in Salman v. U.S. Affirms the Importance of a Tipper’s “Personal Benefit” for Insider Trading, but Also Creates Uncertainty

    In the aftermath of the U.S. Supreme Court’s December 2016 order upholding the conviction in Salman v. U.S., it is crucial for asset managers to have a thorough, nuanced and up-to-date understanding of what constitutes insider trading. The Salman case is likely to have a dramatic impact on the interpretation of insider trading law for years to come. Though it is possible to discern a fundamental test for when insider trading exists, some gray areas persist in insider trading law. This article summarizes a recent talk delivered by Ralph A. Siciliano, partner at Tannenbaum Helpern Syracuse & Hirschtritt, that discussed the points above. For additional insight from Siciliano, see our two-part series “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks?”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013). For further commentary from Tannenbaum attorneys, see “Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three)” (Oct. 3, 2013); and our two-part series on closing hedge funds: “How to Close a Hedge Fund in Eight Steps” (May 8, 2014); and “When and How Can Hedge Fund Managers Close Hedge Funds in a Way That Preserves Opportunity, Reputation and Investor Relationships?” (Jun. 2, 2014).

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  • From Vol. 10 No.1 (Jan. 5, 2017)

    BakerHostetler Panel Analyzes Shifts in Enforcement Policies and Tactics As Industry Anticipates New Administration and SEC Chair (Part One of Two)

    The hedge fund industry stands at an uncertain juncture, with a new president set to take office in Washington in January 2017, and the announcement that SEC Chair Mary Jo White will be stepping down in the same month. While some observers expect the incoming administration to be generally pro-business and averse to overregulation, it may not be easy to alter or transform an environment in which aggressive financial regulatory policies have become the norm – including a rigorous crackdown on “pay to play” practices, insider trading and conflicts of interest; a growing use of, and reliance on, innovative data analytics to prosecute traders and investment managers; aggressive whistleblower incentives; and a push to bring enforcement cases on the SEC’s “home turf” through administrative law proceedings. The above practices were the subject of a recent panel discussion hosted by BakerHostetler and featuring Marc Powers and Mark Kornfeld, partners in BakerHostetler’s securities litigation practice; Walter Van Dorn, partner and national leader of the firm’s international securities and capital markets practices; and Michelle Chopper, director of the advisory and consulting practices at Arthur Bell. The key takeaways from the panel are presented in this two-part series. This first article reviews the nuances and potential pitfalls of the pay to play rule, the current priorities of the SEC’s enforcement program and the role of technology in detecting violations. The second article will discuss the SEC’s use of administrative proceedings to try enforcement cases, the impact of the Dodd-Frank Act’s whistleblower program and guidance for managers on approaching a regulatory exam or investigation. For recent insight from Powers and Kornfeld, see “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016); and “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act” (Mar. 5, 2015). 

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  • From Vol. 9 No.44 (Nov. 10, 2016)

    In Deutsche Bank Case, SEC Emphasizes Protecting Information From More Than Just Cyber Threats

    While regulators and companies have focused on cybersecurity efforts to keep data secure, the SEC’s recent administrative proceeding against Deutsche Bank Securities Inc. (DBSI) emphasizes that policies and practices to secure data must also safeguard material nonpublic information (MNPI) – including information generated by research analysts – from being disseminated, including via emails, chats, telephone calls and in-person meetings. See “Selective Dissemination of Research Through Surveys, Trade Ideas Platforms, Huddles and Desk Research: What Are the Implications for Hedge Funds?” (Aug. 2, 2012). The SEC’s order explains that DBSI has agreed to pay a $9.5 million penalty for (1) failing to properly safeguard MNPI generated by its research analysts; (2) publishing an improper research report; and (3) failing to properly preserve and provide electronic chat records sought by the SEC. This article explores the lessons about securing MNPI that hedge fund managers and other financial services companies can glean from the DBSI action. For more on insider trading, see “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment” (Feb. 17, 2010); “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation” (Nov.  9, 2012); as well as our two-part series “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks?”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013). For additional coverage of the SEC’s action against DBSI, see “SEC Action Emphasizes Importance of Safeguarding Analyst Reports and Opinions From Improper Disclosure” (Oct. 20, 2016).

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  • From Vol. 9 No.43 (Nov. 3, 2016)

    General Insider Trading Policies and Procedures May Be Insufficient for Hedge Fund Managers to Avert SEC Enforcement Action

    In a recently settled enforcement action, the SEC has again driven home its admonition that, “if the nature of a particular broker dealer’s or investment adviser’s business exposes employees to persons in possession of material nonpublic information on a regular basis, a general policy that those employees self-evaluate information they receive is insufficient” to meet the firm’s duty under the federal securities laws to take reasonable steps to prevent the misuse of material nonpublic information (MNPI). See “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016). In this action, a hedge fund manager and its senior analyst allegedly failed to supervise an analyst who provided them with MNPI about a pending acquisition of a publicly traded company. This article summarizes the SEC settlement order and lessons for fund managers who wish to avoid being subject to similar SEC enforcement scrutiny. For more on insider trading issues, see our two-part coverage of the Seward & Kissel Private Funds Forum: “How Managers Can Mitigate Improper Dissemination of Sensitive Information” (Sep. 22, 2016); and “How Managers Can Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading” (Sep. 29, 2016).

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  • From Vol. 9 No.42 (Oct. 27, 2016)

    BDO Gains Regulatory Compliance Specialist

    BDO USA has lured Gary Kaminsky to its New York office. Kaminsky joins as managing director of the firm’s financial services advisory practice. For additional commentary from Kaminsky, see “RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising” (Feb. 28, 2013); “When and How Can Hedge Fund Managers Permissibly Disguise the Identities of Their Hedge Funds in Form ADV and Form PF?” (Dec. 13, 2012); and “How Should Hedge Fund Managers Allocate Form PF Expenses Between Their Hedge Funds and Their Management Entities?” (Jun. 21, 2012).

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  • From Vol. 9 No.41 (Oct. 20, 2016)

    SEC Action Emphasizes Importance of Safeguarding Analyst Reports and Opinions From Improper Disclosure

    On October 12, 2016, the SEC announced yet another insider trading settlement, charging Deutsche Bank with failing to maintain proper safeguards over material nonpublic information generated by the bank’s research analysts from 2012 through 2014; improperly publishing a research report that inaccurately reflected its legal analyst’s views; and failing to maintain appropriate electronic records to deliver to regulators during their investigation. This article outlines Deutsche Bank’s alleged misconduct, the SEC’s charges and the terms of the SEC settlement order, as well as insight into the broader circumstances surrounding this settlement. For analysis of the implications of sharing research by hedge fund managers, see “Selective Dissemination of Research Through Surveys, Trade Ideas Platforms, Huddles and Desk Research: What Are the Implications for Hedge Funds?” (Aug. 2, 2012). For practical steps that hedge fund managers can take to avoid enforcement actions related to insider trading, see our three-part series: “Four Insider Trading Enforcement Trends With Direct Impact on Hedge Fund Trading Strategies” (Nov. 13, 2014); “Eight Actions That Hedge Fund Managers Can Take to Avoid Insider Trading Violations” (Nov. 20, 2014); and “Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers” (Jan. 8, 2015). For coverage of another recent SEC action targeting insider trading, see “Alleging Dozens of Violations, SEC Charges Leon Cooperman and Omega Advisors With Insider Trading and Failing to Make Regulatory Filings” (Sep. 29, 2016).

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  • From Vol. 9 No.41 (Oct. 20, 2016)

    What the SEC’s Enforcement Statistics Reveal About the Regulator’s Focus on Hedge Funds and Investment Advisers

    The SEC recently announced that it brought a record 868 enforcement actions in fiscal year 2016, which closed on September 30. As in prior years, these cases were brought against a broad spectrum of players in the financial industry – including investment advisers, investment companies, industry gatekeepers and broker-dealers – covering a wide range of securities law violations, including insider trading, market manipulation, delinquent filings and Foreign Corrupt Practices Act violations. SEC Chair Mary Jo White stated in the press release that the agency’s enforcement program is a “resounding success.” She credited the increase in actions to the use of new data analytics to uncover fraud, which has enhanced the SEC’s ability to litigate such cases and its capability to bring novel and significant actions to protect investors and the markets. For more on the SEC’s use of technology in the examination process, see “SEC’s Rozenblit and Law Firm Partners Explain the SEC’s Enforcement Priorities and Offer Tips on How Hedge Fund and Private Equity Managers Can Avoid Enforcement Actions (Part Three of Four)” (Jan. 15, 2015); and “OCIE Director Andrew Bowden Identifies the Top Three Deficiencies Found in Hedge Fund Manager Presence Exams and Outlines OCIE’s Examination Priorities” (Oct. 10, 2014). This article summarizes key data from the report relevant to hedge fund and private equity managers and includes reactions from industry experts regarding the SEC’s enforcement priorities. 

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  • From Vol. 9 No.38 (Sep. 29, 2016)

    Seward & Kissel Private Funds Forum Explains How Managers Can Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading (Part Two of Two) 

    The SEC has recently pursued significant enforcement actions for conflict of interest and insider trading violations, in addition to matters brought via the whistleblower program introduced in 2010 under the Dodd-Frank Act. In response, it is important for fund managers to implement safeguards to avoid becoming subject to SEC scrutiny. These issues, and practical measures that fund managers can adopt accordingly, were among the items addressed by a panel at the second annual Private Funds Forum produced by Seward & Kissel and Bloomberg BNA, held on September 15, 2016. Moderated by Seward & Kissel partner Patricia Poglinco, the panel included Laura Roche, chief operating officer and chief financial officer at Roystone Capital Management; Scott Sherman, general counsel at Tiger Management; and Rita Glavin and Joseph Morrissey, partners at Seward & Kissel. This second article in a two-part series explores the SEC’s targeting of various conflict of interest scenarios, provides an overview of the status of the SEC’s whistleblower program and examines the difficulty of prosecuting insider trading. The first article addressed the inflow and outflow of material nonpublic information, risks related thereto and the ways that fund managers can ensure it is not improperly used. For additional insight from Seward & Kissel attorneys, see “What D&O and E&O Insurance Will and Will Not Cover, and Other Hot Topics in the Hedge Fund Insurance Market” (Jul. 14, 2016); and “The First Steps to Take When Joining the Rush to Offer Registered Liquid Alternative Funds” (Nov. 6, 2014). For commentary from Poglinco, see “How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations” (Sep. 8, 2016). For more from Sherman, see “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two)” (Jun. 13, 2013).

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  • From Vol. 9 No.38 (Sep. 29, 2016)

    Alleging Dozens of Violations, SEC Charges Leon Cooperman and Omega Advisors With Insider Trading and Failing to Make Regulatory Filings

    On September 21, 2016, the SEC commenced a civil enforcement action in the U.S. District Court for the Eastern District of Pennsylvania against hedge fund manager Leon G. Cooperman and his investment advisory firm, Omega Advisors, Inc. The SEC charges that Cooperman received and traded on material nonpublic information about a proposed asset sale by an underlying portfolio company, netting more than $4 million in illicit profits for the funds and accounts he managed. The SEC also claims that Cooperman committed over 40 violations of beneficial ownership reporting requirements under federal securities law. This article summarizes the SEC complaint, with an emphasis on the insider trading allegations. For more on insider trading, see “K&L Gates Partners Identify Eight Actions That Hedge Fund Managers Can Take to Avoid Insider Trading Violations (Part Two of Three)” (Nov. 20, 2014); and our two-part series entitled “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks?”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013). For coverage of a derivative suit brought by Cooperman and his funds against a portfolio company, see “Hedge Fund Initiates Derivative Suit Against Directors of a Portfolio Company Alleging Self-Dealing in Approving an Acquisition” (Jul. 11, 2013).

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  • From Vol. 9 No.37 (Sep. 22, 2016)

    Seward & Kissel Private Funds Forum Explores How Managers Can Mitigate Improper Dissemination of Sensitive Information (Part One of Two)

    In the current heightened regulatory environment, the SEC has focused on safeguards that managers employ to prevent the dissemination of sensitive information and to ensure it is not used for improper trading. This was among the critical issues addressed by one of the panels at the second annual Private Funds Forum produced by Seward & Kissel and Bloomberg BNA, held on September 15, 2016. Moderated by Seward & Kissel partner Patricia Poglinco, the panel included Rita Glavin and Joseph Morrissey, partners at Seward & Kissel; Laura Roche, chief operating officer and chief financial officer at Roystone Capital Management; and Scott Sherman, general counsel at Tiger Management. This article, the first in a two-part series, reviews the panel’s discussion about risks associated with the inflow and outflow of material nonpublic information, as well as steps that fund managers can take to prevent its improper use. The second article will discuss the types of conflicts of interest targeted by the SEC, the current progress of the SEC’s whistleblower program and the difficulty of prosecuting insider trading. For coverage of the 2015 Seward & Kissel Private Funds Forum, see “Trends in Hedge Fund Seeding Arrangements and Fee Structures” (Jul. 23, 2015); and “Key Trends in Fund Structures” (Jul. 30, 2015). For additional commentary from Glavin, see “FCPA Compliance Strategies for Hedge Fund and Private Equity Fund Managers” (Jun. 13, 2014). For more from Sherman, see “RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence” (Apr. 2, 2015).

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  • From Vol. 9 No.29 (Jul. 21, 2016)

    Lessons for Hedge Fund Managers From the Government’s Failed Prosecution of Alleged Insider Trading Under Wire and Securities Fraud Laws

    The Supreme Court stated clearly in Chiarella v. United States that the mere fact that a person receives material nonpublic information and executes a trade based on that information does not constitute a crime. But judicial intervention has not stopped the government from trying to come up with novel theories by which to prosecute so-called “remote tippees” – recipients of information several steps removed from the corporate insiders at the beginning of the chain – for insider trading. This is exactly what happened in the recent prosecution of Steven E. Slawson, co-founder of the hedge fund Titan Capital Management. In a guest article, Todd R. Harrison, lead trial counsel for Slawson and a partner at McDermott Will & Emery, discusses the government’s unsuccessful prosecution of Slawson and the wire and securities fraud statutes upon which it was based, analyzing the ramifications of the case for hedge fund managers. For additional insight from McDermott partners, see “SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market” (Apr. 29, 2011). For recent coverage of insider trading issues, see “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016); “Hedge Fund Managers Must Ensure That Insider Trading Compliance Policies and Procedures Cover Third-Party Consultants” (Jun. 9, 2016); and “SEC to Return Insider Trading Settlement Payment to Level Global” (Feb. 4, 2016).

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  • From Vol. 9 No.26 (Jun. 30, 2016)

    SEC Continues to Focus on Insider Trading and Fund Valuation

    The 2013 landmark decision in U.S. v. Newman cast doubt on the state’s ability to prosecute insider trading by remote tippees. See “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016). Nevertheless, regulators continue to move aggressively against perceived insider trading. The SEC recently brought a civil enforcement action against portfolio manager Sanjay Valvani, a partner and portfolio manager for hedge fund manager Visium Asset Management (Visium), and Gordon Johnston, a former official of the U.S. Food and Drug Administration (FDA), alleging that they had engaged in insider trading of shares of pharmaceutical companies whose stock prices would be affected by the FDA’s approval or disapproval of certain generic drugs. In parallel actions, the SEC has also accused former Visium portfolio manager Christopher Plaford of participating in that and another such scheme and has accused both Plaford and former Visium portfolio manager Stefan Lumiere of manipulating the valuation of securities held by a Visium fund. This article summarizes the facts underlying the complaints, particularly the insider trading charges. The cases are noteworthy because insider trading claims based on receipt of confidential government information are relatively rare. Even so, political intelligence firms remain in the SEC’s crosshairs. See “Self-Evaluation Policies Are Insufficient for Political Intelligence Firms to Avoid MNPI Violations” (Dec. 17, 2015); and “GAO Report Dissects the Mechanics of the Political Intelligence Market and Highlights Insider Trading Risks for Hedge Fund Managers” (Apr. 25, 2013). 

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  • From Vol. 9 No.23 (Jun. 9, 2016)

    Hedge Fund Managers Must Ensure That Insider Trading Compliance Policies and Procedures Cover Third-Party Consultants

    The Investment Advisers Act of 1940 requires advisers to have written policies and procedures to prevent the misuse of material nonpublic information (MNPI) by the adviser and its associated persons. A recent SEC settlement order clarifies that an investment adviser must ensure that its policies and procedures extend to reach third-party consultants. Unbeknownst to the investment adviser in this case and its compliance department, an outside consultant that provided investment research and recommendations on biotech companies to the adviser’s portfolio managers also served as a director of some of those very companies. This article summarizes the facts that led up to the SEC’s allegations, alleged violations by the investment adviser and the settlement. For discussion of an SEC enforcement action involving the misuse of MNPI by an investment consultant, see “SEC Action Demonstrates the Potential Risks of Insider Trading by Investment Consultants Hired by Private Fund Managers” (Mar. 29, 2012). For other SEC actions involving failure to adopt appropriate policies and procedures, see “Steps All Investment Advisers – and Their Compliance Officers – Should Take in Light of the SEC’s Risk Alert on Outsourced CCOs (Part Two of Two)” (Mar. 10, 2016). 

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  • From Vol. 9 No.5 (Feb. 4, 2016)

    SEC to Return Insider Trading Settlement Payment to Level Global

    The U.S. Court of Appeals for the Second Circuit’s landmark decision in U.S. v. Newman has had many implications for prosecuting inside traders; it has led the DOJ and SEC to revisit, and in many instances vacate, a number of other recent insider trading settlements, convictions and guilty pleas. See our two part series on the “Supreme Court’s Denial of Cert in Newman”: Part One (Oct. 29, 2015); and Part Two (Nov. 5, 2015). In an unusual twist, Level Global Investors, L.P. (Level Global) – one of the casualties of the SEC’s multi-year battle to root out insider trading in the hedge fund space – sought to vacate its settlement with the SEC, even demanding that the SEC refund its settlement payment. The SEC did not oppose Level Global’s motions, and on January 26, 2016, the court vacated the settlement against Level Global and ordered the SEC to refund its settlement payment of approximately $21.5 million. This article provides a brief overview of the litigation, Level Global’s motion and the ensuing order. For another insider trading action arising out of the SEC investigation of Level Global, see “SEC’s Insider Trading Suit Against Former Level Global Trader Illustrates the Risk of Retaining a Former Public Company Employee as a Consultant” (Dec. 12, 2013).

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  • From Vol. 9 No.4 (Jan. 28, 2016)

    Hedge Fund Managers Advised to Prepare for Imminent SEC Examination

    As it pursues its “broken windows” approach to enforcement, the SEC has filed a record number of actions against hedge fund managers and investment advisers. Faced with this increased regulatory scrutiny, managers – both emerging and established – need to be cognizant of and prepared for aggressive inspection by regulators, as well as possible enforcement action. Among other topics, speakers at the annual Sadis & Goldberg Alternative Investment Seminar addressed the issue of increased regulatory scrutiny and how hedge fund managers can prepare for SEC examinations and investigations. This article summarizes the salient points made during the discussion. For more from Sadis & Goldberg, see “Practitioners Discuss U.S. and Canadian Shareholder Activism and Activist Tools” (Dec. 4, 2014); and “Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions” (Oct. 18, 2012).

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  • From Vol. 9 No.3 (Jan. 21, 2016)

    Despite His “Bad Acts,” Issuers Beneficially Owned by Steven A. Cohen Are Not Precluded From Private Offerings Based on the Bad Actor Rule

    Steven A. Cohen, the billionaire founder of S.A.C. Capital Advisors, LLC, has settled SEC charges that he failed reasonably to supervise Matthew Martoma, a portfolio manager who engaged in insider trading in shares of two pharmaceutical companies. The SEC charged that “Cohen received information that should have caused him to take prompt action to determine whether an employee under his supervision was engaged in unlawful conduct and to prevent violations of the federal securities laws. Cohen failed to take reasonable steps to investigate and prevent such a violation.” See “SEC Charges Steven A. Cohen With Failing to Supervise Employees Who Allegedly Engaged in Insider Trading” (Jul. 25, 2013). This article summarizes the terms of the settlement and the related SEC no-action letter regarding the ability of entities beneficially owned by Cohen and his funds to continue to rely on Rule 506(b) or (c) of Regulation D for private placements despite the “bad actor” rule set forth in Rule 506(d). See also “Defense White Paper Refutes SEC’s Allegations That Steven A. Cohen Failed to Supervise Employees Accused of Insider Trading and Provides a Behind-the-Scenes Look at SAC Capital’s Compliance Program and Culture” (Jul. 25, 2013).

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  • From Vol. 9 No.2 (Jan. 14, 2016)

    Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities

    A panel of current and former regulators at PLI’s recent Hedge and Private Fund Enforcement & Regulatory Developments 2015 event offered perspectives on the SEC’s focus on issues relating to conflicts of interest, valuation and fees and expenses in the private funds space; implications of the seminal Second Circuit insider trading decision in U.S. v. Newman; the DOJ’s focus on prosecution of individuals; enforcement efforts of the New York State Attorney General; and the role of whistleblowers in enforcement. The program, entitled “Current Hedge and Private Fund Enforcement Priorities – The Enforcers’ Perspective,” was moderated by Gibson Dunn partner Barry R. Goldsmith and featured Julie M. Riewe, Co-Chief of the Asset Management Unit of the SEC Division of Enforcement; Maria E. Douvas, a former federal prosecutor and a partner at Paul Hastings; Katherine R. Goldstein, an Assistant United States Attorney for the Southern District of New York and Chief of its Securities and Commodities Fraud Task Force; and Chad Johnson, Chief of the Investor Protection Unit of the New York State Attorney General. This article summarizes the key takeaways from the presentation. For additional insight from Riewe, see “SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest” (Apr. 23, 2015); and “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015). For coverage of similar discussions from PLI’s 2014 event, see “Regulators from the SEC, CFTC and New York Attorney General’s Office Reveal Top Hedge Fund Enforcement Priorities”: Part One of Four (Dec. 4, 2014); and Part Two of Four (Dec. 18, 2014).

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  • From Vol. 9 No.2 (Jan. 14, 2016)

    RCA Compliance, Risk and Enforcement Symposium Highlights Methods for Hedge Fund Managers to Upgrade Compliance Programs

    The development of a robust compliance program by hedge fund managers that addresses key issues, such as valuation, conflicts of interest and the use of expert networks, continues to be a focus for the SEC. Among various topics discussed during the recent Regulatory Compliance Association (RCA) Compliance, Risk and Enforcement Symposium, panelists proffered ways for hedge fund managers to enhance their compliance programs, including interaction with other groups within the firm; controls around expert networks; and the use of technology to augment compliance testing and controls to identify and address issues. This article highlights the salient points made on the foregoing issues. For additional insight from the RCA, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and “Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)” (Jan. 9, 2014).

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  • From Vol. 9 No.1 (Jan. 7, 2016)

    CFTC Resolves Its First Insider Trading Case

    The CFTC recently settled its first enforcement proceeding involving alleged insider trading in commodities futures. Although there have been previous cases alleging insider trading of products traditionally thought of as futures or commodities, such as credit default swaps, these actions have been brought by the SEC. See, e.g., “After Bench Trial of First-Ever Credit Default Swap Insider Trading Action, U.S. District Court Rules That Swaps Referencing Bonds Are Securities-Based Swap Agreements Under Antifraud Provisions of Securities Exchange Act, but Holds That SEC Failed to Prove Insider Trading” (Jul. 8, 2010). A proprietary trader employed by a large public company surreptitiously, and in violation of company policy, matched company trades in oil and gas futures with trades in two accounts that he personally controlled. He also traded for his own account ahead of his trades for the company. The CFTC accused the trader of violating the antifraud and anti-manipulation provisions of the Commodity Exchange Act and its rules. Of particular note to any hedge fund manager engaging in transactions involving commodity interests (including futures, options on futures and related swaps), the CFTC has firmly asserted that its Regulation 180.1 – which closely tracks Rule 10b-5 under the Securities Exchange Act of 1934 – permits the CFTC to prosecute commodities industry participants for insider trading. This article summarizes the CFTC’s allegations; the relevant laws and regulations; and the outcome of the settlement. For more on CFTC enforcement priorities, see “Regulators From the SEC, CFTC and New York Attorney General’s Office Reveal Top Hedge Fund Enforcement Priorities (Part Two of Four)” (Dec. 18, 2014).

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  • From Vol. 8 No.49 (Dec. 17, 2015)

    E.U. Market Abuse Scenarios Hedge Fund Managers Must Consider

    With regulatory authorities in the E.U. and elsewhere increasingly focused on market conduct, managing market abuse risks within hedge fund managers has become central to a firm’s culture of compliance.  For hedge fund managers trading on a cross-border (particularly a U.S.-E.U.) basis, divergent regimes make managing such risks more difficult.  In a guest article, Leonard Ng, co-head of the E.U. financial services regulatory group at Sidley, sets out some common scenarios faced by hedge fund managers and addresses how managers might wish to deal with them under the E.U. market abuse regime.  For additional insight from Ng, see “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers from the January 2015 AIFMD Annex IV Filing,” The Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For insight from Ng’s partner, Will Smith, see “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014); and our two-part series, “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers”: Part One, Vol. 8, No. 15 (Apr. 16, 2015); and Part Two, Vol. 8, No. 16 (Apr. 23, 2015).

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  • From Vol. 8 No.49 (Dec. 17, 2015)

    Self-Evaluation Policies Are Insufficient for Political Intelligence Firms to Avoid MNPI Violations

    Information obtained by political intelligence firms from government sources may constitute material nonpublic information (MNPI) and may give rise to insider trading liability.  See “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).  The SEC recently charged a political intelligence firm with failing to have adequate policies governing the receipt and dissemination of MNPI by its employees, and with failing to enforce the policies that it did have.  This article summarizes the relevant policies and procedures, alleged deficiencies and events that sparked the enforcement action.  In the press release announcing the settlement, Andrew J. Ceresney, the Director of the SEC Division of Enforcement, cautioned, “Government employees routinely possess and generate confidential market-moving information.  When political intelligence firms . . . obtain information from government employees, they must take the necessary steps to prevent the dissemination of potentially material nonpublic information obtained in the course of their research.”  However, bringing insider trading cases based on the use of political intelligence may be challenging.  See “RCA ECO 2014 Symposium Offers Insight from Top SEC Officials on Cybersecurity, Reg M, Examinations, Insider Trading Investigations, the Newman Appeal, Expert Networks and Political Intelligence (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 25 (Jun. 27, 2014).  For more on political intelligence, see “GAO Report Dissects the Mechanics of the Political Intelligence Market and Highlights Insider Trading Risks for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 17 (Apr. 25, 2013).

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  • From Vol. 8 No.47 (Dec. 3, 2015)

    Court Ruling Facilitates Investor Class Actions Against Hedge Fund Managers

    In 2014, Valeant Pharmaceuticals, in cooperation with one of William Ackman’s Pershing Square funds, launched an ultimately unsuccessful tender offer to take over Allergan, Inc.  In December 2014, Valeant and its CEO, Michael Pearson, together with Ackman and several Pershing Square entities, were named as defendants in a private class action lawsuit that seeks to recover damages from them on behalf of Allergan shareholders who sold Allergan stock while the tender offer was pending.  The suit claims that, in violation of federal tender offer rules, the defendants failed to disclose material information about the Allergan tender offer while the Pershing Square fund was acquiring a substantial position in Allergan.  The court recently ruled on the defendants’ motion to dismiss the complaint.  This article summarizes the key factual allegations and legal claims in the plaintiffs’ complaint and the court’s reasoning.  Separately, Allergan had commenced an action against Valeant and the other defendants to challenge the takeover.  That action became moot when Valeant withdrew its bid.  For more on the Allergan-Valeant litigation, see “Top SEC Officials, Law Firm Partners and In-House Counsel Discuss Private Fund Enforcement Priorities, Tender Offer Rules Applicable to Activist Investing, Valuation Challenges, Personal Trade Monitoring and Compliance Testing (Part Four of Four),” The Hedge Fund Law Report, Vol. 8, No. 3 (Jan. 22, 2015); and “Did Pershing Square and Valeant Violate Insider Trading, Antitrust or Tender Offer Rules in Their Pursuit of Allergan?,” The Hedge Fund Law Report, Vol. 7, No. 17 (May 2, 2014).

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  • From Vol. 8 No.43 (Nov. 5, 2015)

    Supreme Court’s Denial of Cert in Newman Complicates Insider Trading Prosecution (Part Two of Two)

    The impact of U.S. v. Newman has already been felt in courtrooms across the country, as well as with respect to investigations that are no longer being pursued.  The Supreme Court’s recent denial of certiorari will provide no change to the gloomy landscape for prosecution of insider trading cases set in place by Newman.  In a guest article, the second in a two-part series, Dechert partners Robert J. Jossen and Michael J. Gilbert discuss a recent Ninth Circuit decision the government asserts conflicts with Newman and assess the problems that lie ahead for insider trading investigations and prosecutions in a post-Newman world.  The first article in the series analyzed the Newman decision and the government’s unsuccessful certiorari petition.  For more from Gilbert, see “The SEC’s Investigation of FCPA Violations and Sovereign Wealth Funds – Implications for Hedge Funds,” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).  For insight from Jossen, see “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” The Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).  The Hedge Fund Law Report and Dechert will be co-sponsoring a panel entitled “The Evolving Role of GCs and CCOs in Marketing and Investor Management in Europe” to be held in London on November 17, 2015.  For more information, click here.  To register, click here.

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  • From Vol. 8 No.42 (Oct. 29, 2015)

    Supreme Court’s Denial of Cert in Newman Favors Insider Trading Defense (Part One of Two)

    Based on the Supreme Court’s October 5, 2015, denial of certiorari, the Second Circuit’s ruling in U.S. v. Newman – a decision widely considered to make insider trading convictions more difficult for the government to prove – remains intact.  Against a host of successful insider trading prosecutions by the Department of Justice, the Second Circuit’s decision in Newman was a sudden, and perhaps unexpected, development that severely limited the government’s ability to pursue insider trading charges in many instances.  In a guest article, the first in a two-part series, Dechert partners Robert J. Jossen and Michael J. Gilbert analyze the Newman decision and the government’s unsuccessful certiorari petition.  In the second article in the series, the authors will discuss a recent Ninth Circuit decision the government asserts conflicts with Newman and assess the problems that lie ahead for insider trading investigations and prosecutions in a post-Newman world. For insight from Jossen, see “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” The Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).   For more from Gilbert, see “Dechert Partners and Venor Capital General Counsel Describe the Scope of Supervisory Liability for Hedge Fund Manager Personnel,” The Hedge Fund Law Report, Vol. 7, No. 26 (Jul. 11, 2014).  The Hedge Fund Law Report and Dechert will be co-sponsoring a panel on fundraising and marketing in Europe, focusing on the role of the general counsel and chief compliance officer, to be held in London on November 17, 2015.  For more information, click here or contact rsvp@hflawreport.com.  To register, click here.

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  • From Vol. 8 No.38 (Oct. 1, 2015)

    Challenges Hedge Fund Managers May Encounter When Implementing a Chaperoning Program (Part Three of Three)

    Hedge fund managers planning to chaperone primary research calls in order to monitor information inflows are faced with numerous challenges.  Beyond the logistical issues surrounding the creation and implementation of a chaperoning program, managers may encounter challenges when operating that program, including issues regarding complexity, recordkeeping and cost.  These practical issues must be weighed against the benefits of chaperoning.  In this article, the third in a three-part series, Eugene Ingoglia, Partner at Morvillo; Laurence Herman, General Counsel and Managing Director at Gerson Lehrman Group (GLG); and Patrick Gordon, Senior Counsel at GLG, examine specific challenges that hedge fund managers may encounter when implementing a chaperoning program, weighed against the benefits gained from chaperoning.  The first article provided background on chaperoning, including a discussion of the statutory landscape, primary research and SEC guidance.  The second article addressed the potential scope of a chaperoning policy and offered practical guidance in implementing that policy.  For more on chaperoning, see “Strategies for Avoiding Insider Trading Violations: A Perspective Informed by SEC Service, Private Law Firm Practice and Work as General Counsel of a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).

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  • From Vol. 8 No.37 (Sep. 24, 2015)

    What Hedge Fund Managers Need to Contemplate When Implementing a Chaperoning Program (Part Two of Three)

    As insider trading cases against hedge fund managers continue to mount, as suggested by then director of the SEC’s Office of Compliance Inspections and Examinations Carlo di Florio, hedge fund managers may wish to consider chaperoning primary research calls as a means of monitoring information inflows.  However, while di Florio’s guidance was helpful, any manager attempting to implement chaperoning policies and practices was left with more questions than answers.  Which research interactions should be chaperoned?  Should only expert network calls be chaperoned, or should calls involving direct consulting also be chaperoned?  What about informal interactions with industry contacts?  How frequently should chaperoning occur?  What methods are there for chaperoning?  And what exactly should chaperoning compliance officers be listening for?  In this article, the second in a three-part series, Eugene Ingoglia, Partner at Morvillo; Laurence Herman, General Counsel and Managing Director at Gerson Lehrman Group (GLG); and Patrick Gordon, Senior Counsel at GLG, address the potential scope of a chaperoning policy, as well as offer practical guidance on implementing that policy.  The first article provided background on chaperoning, including a discussion of the statutory landscape, primary research and SEC guidance.  The third article will cover specific challenges to chaperoning.  For more on chaperoning, see “How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading? (Part Four of Four),” The Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).

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  • From Vol. 8 No.36 (Sep. 17, 2015)

    Are You Listening?  Whether Hedge Fund Managers Should Chaperone Primary Research Calls (Part One of Three)

    Insider trading and the potential for misuse of confidential information should be top-of-mind for investment professionals.  With the prevalence of insider trading cases brought over the last five years, the government’s initiative to stamp the practice out has been persistent, aggressive and fruitful, even after the Second Circuit dealt the government a setback in U. S. v. Newman.  See “The Newman/Chiasson Decision Continues to Have Implications for Insider Trading Compliance,” The Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015).  Nonetheless, it appears the temptations and incentives to find an edge in a highly competitive trading environment remain as strong as ever.  Against this backdrop, it is all the more critical for compliance departments to monitor information inflows.  In this guest article, Eugene Ingoglia, Partner at Morvillo; Laurence Herman, General Counsel and Managing Director at Gerson Lehrman Group (GLG); and Patrick Gordon, Senior Counsel at GLG, focus on how chaperoning primary research calls can help compliance officers meet these obligations.  This first article in a three-part series provides background on chaperoning, including a discussion of the statutory landscape, primary research and SEC guidance.  The second article will address the potential scope of a chaperoning policy, as well as offer practical guidance in implementing that policy.  The third article will cover specific challenges to chaperoning.  For more on chaperoning, see “RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three),” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).

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  • From Vol. 8 No.36 (Sep. 17, 2015)

    ACA 2015 Compliance Survey Covers SEC Exams, MNPI and Restricted Lists (Part One of Two)

    ACA Compliance Group recently released the results of its 2015 Alternative Fund Manager Compliance Survey, which considered a variety of compliance issues faced by private fund managers, including hedge fund managers.  At a recent webinar, Colleen Marencik, a senior principal consultant at ACA Compliance Group, and Tessa Carbone, a consultant at that firm, discussed the survey results and offered comparisons of this year’s results with those of the firm’s prior surveys.  This article, the first in a two-part series, summarizes the key findings from the survey and the insights offered by Carbone and Marencik with respect to the survey demographics; SEC exam experiences; material nonpublic information; and restricted lists.  The second article will address expert networks and consultants, fund expenses and electronic communications.  For coverage of prior ACA surveys, see “ACA 2014 Compliance Survey Covers SEC Exams, CCOs, Compliance Reviews, Custody, Fees and Personal Trading,” The Hedge Fund Law Report, Vol. 7, No. 46 (Dec. 11, 2014); “ACA Compliance Survey Covers Current Hedge Fund Practices on Marketing, Trading, Counterparties and Valuation,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014); and “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).

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  • From Vol. 8 No.35 (Sep. 10, 2015)

    J.P. Morgan Analyst, Friends and Family Hit with Civil and Criminal Charges for Insider Trading

    Insider trading remains a key area of interest for the SEC and DOJ.  Even though recent court decisions have scaled back – at least for the time being – those agencies’ expansive views of liability for trading on inside tips, every emerging fact pattern helps hedge fund managers understand the continually evolving insider trading doctrine.  See “Government Petition to Supreme Court for Review of Newman/Chiasson Reversal Provides Insight into Prosecutorial View of Insider Trading,” The Hedge Fund Law Report, Vol. 8, No. 32 (Aug. 13, 2015).  The SEC recently filed charges against a J.P. Morgan analyst and two friends who allegedly traded on material nonpublic information regarding pending acquisitions.  The analyst, who worked in the J.P. Morgan division that advised on those acquisitions, allegedly provided information to a close friend; that friend and another friend then allegedly traded on that information, individually and through brokerage accounts of family members, reaping nearly $600,000 in illicit trading profits.  The DOJ is pursuing parallel criminal charges against all three defendants.  This article summarizes the alleged insider trading scheme, the SEC’s specific charges and the relief it is seeking.  For more on the current insider trading enforcement climate, see “Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement,” The Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015).

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  • From Vol. 8 No.32 (Aug. 13, 2015)

    Government Petition to Supreme Court for Review of Newman/Chiasson Reversal Provides Insight into Prosecutorial View of Insider Trading

    Under well-established precedent, a key element of tipper-tippee insider trading liability is that the insider (tipper) must receive some personal benefit from the tip; a benefit may be inferred from a gift of information to a relative or friend.  In December 2014, the U.S. Court of Appeals for the Second Circuit (Second Circuit) reversed the insider trading convictions of Todd Newman and Anthony Chiasson, hedge fund portfolio managers who had been convicted of trading on inside information on Dell and NVIDIA earnings, finding that the Government had failed to prove awareness of such benefit.  See “Second Circuit Overturns Newman and Chiasson Convictions, Raising Government’s Burden of Proof in Tippee Liability Insider Trading Cases,” The Hedge Fund Law Report, Vol. 7, No. 47 (Dec. 18, 2014).  The Government has petitioned the Supreme Court to review the Second Circuit’s decision.  This article summarizes the Government’s petition, with an emphasis on its arguments as to why the Supreme Court should take the appeal.  For a discussion of the practical effect of the decision, see “The Newman/Chiasson Decision Continues to Have Implications for Insider Trading Compliance,” The Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015).  For coverage of the civil enforcement actions relating to the alleged insider trading, see “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012); and “SEC’s Insider Trading Suit against Former Level Global Trader Illustrates the Risk of Retaining a Former Public Company Employee as a Consultant,” The Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).

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  • From Vol. 8 No.19 (May 14, 2015)

    Operational Conflicts Arising Out of Simultaneous Management of Hedge Funds and Private Equity Funds (Part Two of Three)

    The simultaneous management of hedge funds and private equity funds is rife with potential conflicts of interest, including issues relating to allocation of investment opportunities between the funds, possession of material nonpublic information, valuation and allocation of expenses.  Conflicts of interest – and whether advisers have appropriately discharged their fiduciary duties to identify and eliminate or mitigate and disclose them – remain top enforcement priorities for the SEC and its Asset Management Unit.  See “Regulators from the SEC, CFTC and New York Attorney General’s Office Reveal Top Hedge Fund Enforcement Priorities (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 45 (Dec. 4, 2014).  Accordingly, especially in today’s regulatory environment, managers must be aware of and mitigate such conflicts of interest.  This article, the second in a three-part series, discusses operational conflicts arising out of simultaneous management of hedge funds and private equity funds, including conflicts involving the possession of material nonpublic information, valuation, allocation of expenses, personal trading and investors.  The first article explored the structural considerations that give rise to potential conflicts; conflicts involving the investments held by each fund; and conflicts with the allocation of investment and disposition opportunities between affiliated hedge funds and private equity funds.  The third article will address offshore concerns and ways to mitigate conflicts of interest.  See also “Operational Conflicts Arising Out of Simultaneous Management of Hedge Funds and Alternative Mutual Funds Following the Same Strategy (Part Two of Three),” The Hedge Fund Law Report, Vol. 8, No. 14 (Apr. 9, 2015).

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  • From Vol. 8 No.18 (May 7, 2015)

    Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement

    The U.S. Court of Appeals for the Second Circuit, with its high-profile decision in U.S. v. Newman, has not enabled investment fund managers and their ilk to commit insider trading with impunity, free from consequence.  Although some commentators have taken a contrary view, that perspective is mistaken, as evidenced by a recent district court decision, and may lead some market participants to adopt risky behavior if not corrected.  For more on Newman, see “The Newman/Chiasson Decision Continues to Have Implications for Insider Trading Compliance,” The Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015).  In April 2015, the Securities and Exchange Commission scored a significant victory in SEC v. Payton, obtaining the approval of the Honorable Jed S. Rakoff to pursue a civil enforcement action in the U.S. District Court for the Southern District of New York against two defendants accused of insider trading, notwithstanding the recent Newman decision.  While some commentators have questioned whether the Payton decision marks the beginning of an “erosion” of the insider trading framework recently overhauled in Newman and hailed in many corners of Wall Street, this belief is based upon multiple incorrect assumptions about Newman and its import, and both decisions’ impact on the hedge fund industry.  In a guest article, Marc R. Rosen, chair of the Litigation and Risk Management Department at Kleinberg, Kaplan, Wolff & Cohen, examines the recent insider trading landscape, discusses the Payton decision and explores its impact on the hedge fund community.  For more insight from Kleinberg, Kaplan, Wolff & Cohen, see “Insurance Dedicated Funds Offer Hedge Fund Exposure Plus Tax, Underwriting and Asset Protection Advantages for Investors,” The Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013); and “How Do New Commodities Regulations Impact Hedge Fund Managers with Respect to Registration, Marketing, Trading, Audits and Drafting of Governing Documents?,” The Hedge Fund Law Report, Vol. 5, No. 18 (May 3, 2012).

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  • From Vol. 8 No.17 (Apr. 30, 2015)

    The Newman/Chiasson Decision Continues to Have Implications for Insider Trading Compliance

    Whether a fund can trade on material nonpublic information is one of the more challenging calls faced by hedge fund compliance personnel.  Last December, a panel of the U.S. Court of Appeals for the Second Circuit dismissed the insider trading case against Todd Newman and Anthony Chiasson, hedge fund portfolio managers and remote tippees who had traded on inside information about Dell and Nvidia.  That Court recently denied the government’s request to reconsider the decision.  Thus, absent a successful appeal to the Supreme Court, to win a conviction against a remote tippee in tipper-tippee insider trading cases in the Second Circuit, the government must prove that the tippee knew that the insider had received a benefit from the improper tip and that the benefit was “of some consequence.”  See “Second Circuit Overturns Newman and Chiasson Convictions, Raising Government’s Burden of Proof in Tippee Liability Insider Trading Cases,” The Hedge Fund Law Report, Vol. 7, No. 47 (Dec. 18, 2014).  A panel of experts from the law firm Richards Kibbe & Orbe (RK&O) recently discussed the implications of that decision for compliance with insider trading rules and explored how a subsequent district court decision in a civil insider trading action applied the principles enunciated in U.S. v. Newman and Chiasson.  The program was moderated by Lee S. Richards, III, RK&O partner and former Assistant U.S. Attorney in the Southern District of New York.  The other panelists were RK&O partners Scott C. Budlong; Michael D. Mann, a former Director of International Affairs and Associate Director in the SEC’s Division of Enforcement; and David B. Massey, a former Assistant U.S. Attorney in the Southern District of New York.  This article summarizes the key takeaways from the program.

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  • From Vol. 8 No.16 (Apr. 23, 2015)

    ACA Compliance Professionals and SEC Veteran John H. Walsh Share Insights on SEC Priorities for 2015

    The SEC continues to hone its focus on investment advisers and funds, scrutinizing matters including firms’ compliance programs, conflicts of interest, cybersecurity and potential insider trading.  To that end, the SEC is conducting certain initiatives and employing various tools, such as data analytics and dialogue outreach.  A recent program presented by ACA Compliance Group offered the perspectives of three compliance practitioners about where the SEC will focus its attention in 2015.  It covered new and continuing SEC initiatives and the SEC’s use of quantitative analytics, highlighting areas of concern with regard to alternative mutual funds, fixed income managers, cybersecurity, conflicts of interest and insider trading.  The program featured Dan Campbell, Managing Director, and Joseph DiGiglio, a Principal Consultant, at ACA Compliance Group; and John H. Walsh, a 23-year veteran of the SEC and partner at Sutherland Asbill & Brennan.  See also “SEC’s Rozenblit and Law Firm Partners Explain the SEC’s Enforcement Priorities and Offer Tips on How Hedge Fund and Private Equity Managers Can Avoid Enforcement Actions (Part Three of Four),” The Hedge Fund Law Report, Vol. 8, No. 2 (Jan. 15, 2015).  This article summarizes the key points raised during the program.

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  • From Vol. 8 No.11 (Mar. 19, 2015)

    Ten Practical Consequences for Hedge Fund Managers of the FCA’s Thematic Review of Asset Managers and the EU Market Abuse Regulation

    Over the next eighteen months, compliance officers at UK hedge fund managers will be facing significant additional regulatory burdens.  In the context of market abuse, there is going to be significant legislative change coming from Europe.  Whilst the core market abuse offences will largely be unchanged, the market abuse regime across the EU will be significantly strengthened and broadened by the EU Market Abuse Regulation (MAR) that will replace the Market Abuse Directive with effect from July 3, 2016.  At the same time, there have been a number of regulatory enforcement actions that have shown a more assertive approach by regulators to the regulation of markets across the EU.  In February, the UK Financial Conduct Authority issued a thematic review into asset management firms and the risk of market abuse in equity markets.  This review made clear that the UK regulator considers that firms need to do further work to clarify and extend their compliance procedures to comply with current rules.  These changes will be required in addition to the new detailed obligations and processes under MAR.  For these reasons, compliance teams will have considerable work to undertake in relation to market abuse compliance policies, procedures and monitoring.  For many asset management firms, this will create a significant additional administrative burden and may have an impact on how managers interact with issuers.  In a guest article, Douglas Armstrong, a partner and Head of Funds and Financial Services for Dickson Minto W.S., offers a detailed discussion of MAR and the FCA thematic review, then identifies ten practical consequences of both for UK and global hedge fund managers.  See also “U.K. Financial Conduct Authority Issues Feedback Statement Supporting Proposed E.U. Limits on Soft Dollars,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015).

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  • From Vol. 8 No.10 (Mar. 12, 2015)

    Former Level Global Head David Ganek Sues U.S. Attorney Bharara and Other Senior DOJ and FBI Personnel, Claiming Fabrication of Evidence Against Him

    Execution of a search warrant can be the kiss of death for a hedge fund manager, even if the search uncovers no wrongdoing.  Criminal and even regulatory investigations can result in a spate of redemption requests.  Within months after the FBI and U.S. Attorney executed a search warrant in November 2010 at the offices of hedge fund manager Level Global Investors, L.P. (Level), as part of their widely-publicized campaign against insider trading by hedge funds, Level shut its doors.  Anthony Chiasson, one of Level’s co-founders, was eventually convicted of insider trading; his conviction was recently reversed on appeal.  Although named personally in the warrant, Level co-founder David Ganek was never charged with a crime.  Ganek is now striking back.  In a civil complaint recently filed in the U.S. District Court for the Southern District of New York that names as defendants U.S. Attorney Preet Bharara and other high-level prosecutors and FBI officials, Ganek accuses certain U.S. prosecutors and FBI agents of fabricating the evidence that led to Ganek being named in the warrant.  This article summarizes Ganek’s complaint.  For a discussion of the alleged insider trading scheme that led to Level’s demise, see “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).  For additional coverage of actions involving Level and its employees, see “The Newman-Chiasson Decision: Cold Comfort for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 47 (Dec. 18, 2014); and “SEC’s Insider Trading Suit against Former Level Global Trader Illustrates the Risk of Retaining a Former Public Company Employee as a Consultant,” The Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).

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  • From Vol. 8 No.7 (Feb. 19, 2015)

    RCA Compliance, Risk and Enforcement 2014 Symposium Highlights SEC Exam Priorities and Focus Areas, Mitigating Regulatory Filing Risk and Key AIFMD Issues for Non-E.U. Managers (Part One of Two)

    Hedge funds are subject to regulatory scrutiny, and enforcement actions against managers have been increasing in frequency and sophistication.  Hedge fund managers therefore need to ensure compliance with the ever-growing panoply of regulations to which they are subject; and registered managers need to prepare for routine and other examinations by regulators.  In order to assist managers with these aims, the Regulatory Compliance Association held its Compliance, Risk and Enforcement 2014 Symposium in New York City.  This article, the first in a two-part series, summarizes the panelists’ discussion on the NFA’s and SEC’s risk-focused tools and technologies; the SEC’s 2015 examination and enforcement priorities; and preparing for SEC examinations.  The second article in the series will cover risks associated with regulatory reporting and emerging AIFMD issues.  See also “How Do Regulatory Investigations Affect the Hedge Fund Audit Process, Investor Redemptions, Reporting of Loss Contingencies and Management Representation Letters?,” The Hedge Fund Law Report, Vol. 8, No. 3 (Jan. 22, 2015).  In April of this year, the RCA will be hosting its Regulation, Operations and Compliance (ROC) Symposium in Bermuda.  For more on ROC Bermuda 2015, click here; to register for it, click here.

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  • From Vol. 8 No.5 (Feb. 5, 2015)

    Why Should Hedge Fund Investors Perform On-Site Due Diligence in Addition to Remote Gathering of Information on Managers and Funds? (Part Two of Three)

    An on-site visit has become an essential element of a hedge fund operational due diligence program.  As one allocator told the HFLR, “There are a few important questions that can only be asked while looking into the eyes of the COO or CFO.”  But what are those questions and, more generally, what practices, approaches and techniques can investors implement to extract maximum value from an on-site visit?  This article is the second in a three-part series detailing how and why investors should perform on-site due diligence visits.  Based on insight from operational due diligence veterans, this article describes how investors should conduct diligence visits, and how managers can prepare for them effectively.  The first article focused on the rationale for the on-site visit and the mechanics of preparation.  The third article will discuss further on-site procedures, including red flags to identify, and an investor’s options following the on-site visit.  See also “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014).

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  • From Vol. 8 No.5 (Feb. 5, 2015)

    Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss Insider Trading, Proposed Changes to Form 13F and Schedule 13D and Employment-Related Disputes (Part Three of Four)

    This is the third article in a four-part series covering the Eighth Annual Hedge Fund General Counsel and Compliance Officer Summit, hosted by Corporate Counsel and ALM.  This article summarizes the primary points made at the Summit relating to insider trading, proposed changes to Form 13F and Schedule 13D and employment-related disputes with highly-compensated employees.  The first article in the series covered regulatory priorities, handling regulatory examinations and cybersecurity preparedness.  The second article discussed CFTC compliance, conflicting regulatory regimes in compliance programs and the regulatory and operational considerations of hedge fund marketing.  The last installment in the series will cover negotiating terms with institutional investors, structuring seeding arrangements and the convergence of mutual funds and hedge funds.  The HFLR has covered this annual event in each of the five prior years.  For our previous coverage, see: 2013 Part 32013 Part 22013 Part 12012 Part 22012 Part 120112010; and 2009.

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  • From Vol. 8 No.3 (Jan. 22, 2015)

    Top SEC Officials, Law Firm Partners and In-House Counsel Discuss Private Fund Enforcement Priorities, Tender Offer Rules Applicable to Activist Investing, Valuation Challenges, Personal Trade Monitoring and Compliance Testing (Part Four of Four)

    This is the final article in a four-part series covering the Practising Law Institute’s Hedge and Private Fund Enforcement & Regulatory Developments 2014 event.  The first article in this series discussed points made by Julie M. Riewe, Co-Chief of the SEC’s Asset Management Unit, on enforcement trends, principal transactions, conflicts raised by side-by-side management, valuation, allocation of expenses and the potential deterrent value of smaller enforcement actions.  The second article addressed CFTC enforcement concerns and cases, New York Attorney General’s Office initiatives and defense strategies for avoiding and managing government investigations.  The third article focused on best practices for preparing for and responding to SEC inspections and examinations.  This final article in the series summarizes the following additional areas impacting hedge fund managers: (1) current focus areas of the SEC’s Complex Financial Instruments Unit, especially as those focus areas relate to instruments traded by hedge funds; (2) the evolving regulatory ecosystem in which activist managers obtain, manage and deploy investment-sensitive information; and (3) the view of top in-house counsel on hedge fund manager compliance policies that are demonstrably effective.  On activism and information management, see also “‘Best Ideas’ Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 31 (Aug. 21, 2014); “Did Pershing Square and Valeant Violate Insider Trading, Antitrust or Tender Offer Rules in Their Pursuit of Allergan?” The Hedge Fund Law Report, Vol. 7, No. 17 (May 2, 2014).

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  • From Vol. 8 No.3 (Jan. 22, 2015)

    Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss Handling Regulatory Examinations and Mitigating Cybersecurity Risks (Part One of Four)

    Participants at the Eighth Annual Hedge Fund General Counsel and Compliance Officer Summit, hosted by Corporate Counsel and ALM, zeroed in on the key compliance issues currently facing the hedge fund industry.  This article, the first in a four-part series covering the Summit, contains insight on regulatory priorities, handling regulatory examinations and cybersecurity preparedness from Andrew Bowden, a director at the SEC’s Office of Compliance Inspections and Examinations; Dianne Mattioli, CCO at Hedgemark; Larry Block, managing director, counsel and CCO at Island Capital Group LLC; Cynthia Marian, vice president, CCO and deputy general counsel at Tinicum Inc.; and David Lashway, a partner at Baker & McKenzie LLP.  Future installments in the series will cover: CFTC compliance; proposed changes to Form 13F and Schedule 13D; employment-related disputes with highly compensated employees; conflicting regulatory regimes; marketing considerations; insider trading; negotiating terms with institutional investors; negotiating seeding arrangements; and the convergence of mutual funds and hedge funds.  The HFLR has covered this annual event in each of the five prior years.  For our previous coverage, see: 2013 Part 3; 2013 Part 2; 2013 Part 1; 2012 Part 2; 2012 Part 1; 2011; 2010; and 2009.

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  • From Vol. 8 No.2 (Jan. 15, 2015)

    Public-Side Versus Private-Side Information – Which Side To Take?

    Fund managers investing in distressed debt, syndicated loans, notes and other types of debt often get invited to data rooms and deal websites where they are offered access to confidential information about a borrower.  In contrast to the traditional (perhaps, now antiquated) method of obtaining confidential borrower information directly from an existing lender or a dealer, subject to a written non-disclosure agreement, obtaining confidential information through such data rooms presents a number of special concerns.  First, the bank or dealer responsible for the data room commonly asks existing and potential lenders to choose between so-called “public-side” information and “private-side” information.  Second, in relation to distressed debt, the information so offered is often related to a restructuring, refinancing or other significant event with respect to the borrower and, especially with respect to what is labeled as “private-side” information, tends to be of a higher level or quality than the information generally available to all lenders or debt holders.  Third, the agreement embodying the terms of disclosure is typically contained in a non-negotiable splash page or a “click-through” agreement rather than a conventional, written, bilateral confidentiality agreement negotiated, executed and exchanged by trading parties.  See “Key Legal and Business Considerations for Hedge Fund Managers in Drafting and Negotiating Confidentiality Agreements (Part Three of Three),” The Hedge Fund Law Report, Vol. 5, No. 28 (Jul. 19, 2012).  In addition, there is often some confusion on the part of traders and analysts regarding the true nature of public-side versus private-side information and the consequences of choosing one or the other.  In a guest article, William G. Frenkel and Michael Y. Sukhman, partners at Frenkel Sukhman LLP, discussed the legal consequences and risks associated with making that decision.  For a discussion of another legal issue relevant to distressed debt trading, see “Can a Hedge Fund Holding Secured Debt Credit Bid Up to the Face Amount of the Debt Or Only Up to the Amount Paid for the Debt?,” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).

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  • From Vol. 7 No.47 (Dec. 18, 2014)

    Second Circuit Overturns Newman and Chiasson Convictions, Raising Government’s Burden of Proof in Tippee Liability Insider Trading Cases

    The general principles of insider trading and tipper-tippee liability are fairly well-established.  It is clear that for an insider to be held liable for tipping material non-public information, the insider must breach a fiduciary duty to hold that information in confidence and must receive some personal benefit from the tip.  It is also clear that the recipient of the inside information – the tippee – must know that the tipper violated a fiduciary duty in providing that information.  What has been unclear is what the tippee needed to know, if anything, about the benefit to the tipper.  The U.S. Court of Appeals for the Second Circuit recently issued an important decision throwing out the convictions of Anthony Chiasson and Todd Newman, who were portfolio managers at Level Global Investors and Diamondback Capital Management, respectively.  The decision has direct and potentially profound implications for the research and investment activities of hedge fund managers.  This article provides a thorough discussion of the factual background and legal analysis in the decision.  For coverage of the civil enforcement actions relating to the alleged insider trading, see “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012); and “SEC’s Insider Trading Suit against Former Level Global Trader Illustrates the Risk of Retaining a Former Public Company Employee as a Consultant,” The Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).

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  • From Vol. 7 No.47 (Dec. 18, 2014)

    The Newman-Chiasson Decision: Cold Comfort for Hedge Fund Managers

    Last week, the Second Circuit issued its highly anticipated decision reversing the insider trading convictions of former Level Global Investors LP manager Anthony Chiasson and former Diamondback Capital Management LLC manager Todd Newman.  The decision sent a clear message to prosecutors – namely, that the prosecution of Newman and Chiasson was flawed and that its broad theories of culpability in insider trading cases needed to be significantly cut back.  But for hedge fund managers deciding how to conduct themselves in the world, what are the takeaways from the Newman-Chiasson decision?  In a guest article, Justin S. Weddle and Elnaz Zarrini, partner and associate, respectively, at Brown Rudnick, describe the key takeaways.

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  • From Vol. 7 No.44 (Nov. 20, 2014)

    K&L Gates Partners Identify Eight Actions That Hedge Fund Managers Can Take to Avoid Insider Trading Violations (Part Two of Three)

    This article is the second in a three-part series discussing practical insights from a recent presentation on insider trading by K&L Gates partners Michael W. McGrath, Carolyn A. Jayne and Nicholas S. Hodge.  This article details eight prophylactic measures that hedge fund managers can implement to avoid insider trading violations.  This article also includes a detailed discussion of what McGrath called “the next great undiscovered country for enforcement actions.”  The first article in this series provided background on aspects of insider trading doctrine relevant to hedge fund managers (including entity liability and special considerations for CFA charter holders) and outlined four enforcement trends bearing directly on hedge fund trading strategies and operations.  The third article in this series will offer concrete recommendations to hedge fund managers for amending their compliance programs to incorporate lessons from recent insider trading enforcement actions.  For more on insider trading issues relevant to hedge fund managers, see “When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).

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  • From Vol. 7 No.43 (Nov. 13, 2014)

    K&L Gates Partners Identify Four Insider Trading Enforcement Trends with Direct Impact on Hedge Fund Trading Strategies (Part One of Three)

    This article is the first in a three-part series discussing practical insights from a recent presentation on insider trading by K&L Gates partners Michael W. McGrath, Carolyn A. Jayne and Nicholas S. Hodge.  In particular, this article provides background on the aspects of insider trading doctrine most relevant to hedge fund managers (including entity liability and special considerations for CFA charter holders), then outlines four enforcement trends that bear directly on hedge fund trading strategies and operations.  The second article in this series will detail eight prophylactic measures that hedge fund managers can implement to avoid insider trading violations.  The third article in this series will make recommendations to hedge fund managers for amending their compliance programs in light of lessons from recent insider trading enforcement actions.  For more on insider trading issues relevant to hedge fund managers, see “‘Best Ideas’ Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 30 (Aug. 7, 2014).

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  • From Vol. 7 No.38 (Oct. 10, 2014)

    Usable Lessons and Proven Survival Techniques from the Hedge Fund Examination Trenches

    A recent PracticeEdge session presented by the Regulatory Compliance Association explored the panelists’ experiences with SEC and NFA examinations and provided an overview of key substantive issues that are likely to be addressed in those exams.  The program was moderated by Christopher M. Wells, a partner at Proskauer Rose LLP.  The other speakers were Cynthia Marian, a Vice President, Chief Compliance Officer and Deputy General Counsel of Tinicum, Inc.; Dianne Mattioli, CCO of Hedgemark Securities; Mark Polemeni, CCO – Asset Management at Citadel, LLC; and Catherine Smith, General Counsel of Guidepoint Global, LLC.  See also “RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three),” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).

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  • From Vol. 7 No.35 (Sep. 18, 2014)

    Three Reasons Why Hedge Fund Managers That Trade Commodities or Derivatives Should Care about Insider Trading in Securities

    For insider trading liability to attach, there must be, among other things, a purchase or sale of a security.  See “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” The Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012) (subsection entitled “Summary of the Elements Under U.S. Law”).  Therefore, one might conclude that the manager of a hedge fund that invests exclusively in commodities and derivatives might fall outside the ambit of insider trading laws.  Similarly, one might conclude that the manager of one or more hedge funds that invest in commodities, derivatives and securities might only have to concern itself with insider trading laws to the extent of its securities trading.  This line of thinking is wrong – and hedge fund managers focused on commodities and derivatives do have to concern themselves with insider trading – for at least three reasons.

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  • From Vol. 7 No.32 (Aug. 28, 2014)

    Alternative Investment General Counsel Summit Addresses Examinations, Insider Trading, Political Intelligence and Expert Networks (Part Two of Two)

    This is the second article in a two-part series covering ALM’s inaugural Alternative Investment General Counsel Summit in New York – an event at which law firm partners, in-house counsel and regulators discussed best practices on legal issues faced by hedge fund managers.  The first article addressed conflicts of interest raised by dual registration and valuation; the constituent elements of a culture of compliance; the interaction between compensation structures and regulatory developments; AIFMD compliance and timing; presence exam survival strategies; and the role of risk alerts in refining a compliance program.  This article discusses effective responses to regulatory audits and examinations; insider trading; political intelligence; and expert networks.  See also “ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing, OTC Derivatives Reforms, Insider Trading Best Practices, the JOBS Act, AIFMD and Activist Investing (Part Three of Three),” The Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).

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  • From Vol. 7 No.29 (Aug. 1, 2014)

    Gibson Dunn Trial Attorneys Discuss the Trial Victory of Hedge Fund Manager Nelson Obus, the “Lamest Insider Trader in History”

    On May 30, 2014, after an investigation and litigation that spanned 13 years, a jury found Nelson J. Obus, Peter F. Black and Thomas Bradley Strickland not liable for insider trading in the shares of SunSource, Inc. at the time of its acquisition by Allied Capital Corporation in 2001.  Two of Obus’ defense attorneys recently shared the lessons they learned from contending with the SEC investigation, the insider trading litigation and the trial of the case.  The program featured Gibson, Dunn & Crutcher LLP partner Joel M. Cohen and associate Mary Kay Dunning.  See “When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).

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  • From Vol. 7 No.25 (Jun. 27, 2014)

    RCA ECO 2014 Symposium Offers Insight from Top SEC Officials on Cybersecurity, Reg M, Examinations, Insider Trading Investigations, the Newman Appeal, Expert Networks and Political Intelligence (Part Two of Two)

    This is the second article in a two-part series covering the Regulatory Compliance Association’s Enforcement, Compliance and Operations 2014 Symposium, held on May 1, 2014 in New York City.  This article summarizes the key insights offered at the Symposium by top SEC officials and industry participants with respect to cybersecurity, Rule 105 of Regulation M, hedge fund manager examinations, evolving investigative techniques used in criminal investigations of insider trading, insider trading doctrine and the appeal in United States v. Newman, expert networks and political intelligence.  The first article in this series dealt with regulatory transparency, custody, conflicts raised by serving simultaneously as a broker and investment adviser, what the SEC’s Division of Trading and Markets does, interaction between the SEC’s Office of Compliance Inspections and Examinations and its Enforcement Division, broker registration of in-house marketing departments, alternative mutual funds and the JOBS Act.  See “RCA Enforcement, Compliance and Operations 2014 Symposium Offers Insight from Top SEC Officials on Custody, Conflicts, Broker Registration, Alternative Mutual Funds and the JOBS Act (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 22 (Jun. 6, 2014).

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  • From Vol. 7 No.23 (Jun. 13, 2014)

    The Best-Laid Plans: Preventing Rule 10b5-1 Plans from Going Awry (Part Two of Two)

    This is the second article in a two-part series explaining the mechanics of 10b5-1 plans and their application to the private funds industry; examining the lessons that can be learned from an inquiry into possible insider trading by a major private equity fund manager that purchased debt of a portfolio company pursuant to a 10b5-1 plan (the inquiry ultimately determined that the trading had not violated insider trading restrictions); and recommending practices that may enhance the defensibility of a 10b5-1 plan.  The authors of the series are Daniel Laguardia, a partner in Shearman & Sterling’s Litigation Group, and K. Mallory Brennan and Ross Kamhi, both associates in that group.  See also “The Best-Laid Plans: Preventing Rule 10b5-1 Plans from Going Awry (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 22 (Jun. 6, 2014).

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  • From Vol. 7 No.22 (Jun. 6, 2014)

    The Best-Laid Plans: Preventing Rule 10b5-1 Plans from Going Awry (Part One of Two)

    The increased focus of regulators, media and private litigants on insider trading has recently expanded to a new target: Rule 10b5-1 trading plans (10b5-1 plans), which are intended to invoke the affirmative defense against insider trading claims provided by Exchange Act Rule 10b5-1 for trades executed pursuant to a written plan that meets specific requirements.  10b5-1 plans are best known as devices to allow company insiders to buy or sell securities pursuant to a pre-arranged instruction without facing automatic liability for insider trading.  When properly implemented, the rule enables both investors and issuers to execute trades, even when they know material nonpublic information, so long as the trades are made pursuant to a plan established when the investor or issuer did not have inside information.  These protections can extend beyond the diversification needs of individual company executives.  For example, trades made by hedge funds pursuant to stop-loss and trailing-stop orders may be protected from insider trading liability if the orders are designed and implemented in accordance with Rule 10b5-1’s parameters.  And the protections of Rule 10b5-1 are not limited to publicly-traded stocks.  Private equity funds and other distressed debt investors and investment managers can also benefit from Rule 10b5-1, such as by using a 10b5-1 plan to make future acquisitions of company debt without running afoul of insider trading restrictions.  The protection of the affirmative defense is not absolute, however, and those trading under the auspices of even a properly adopted 10b5-1 plan have to be careful not to undermine their protection.  In a two-part series of guest articles, Daniel Laguardia, K. Mallory Brennan and Ross Kamhi explain the mechanics of 10b5-1 plans and their application to the private funds industry; examine the lessons that can be learned from an inquiry into possible insider trading by a major private equity fund manager that purchased debt of a portfolio company pursuant to a 10b5-1 plan (the inquiry ultimately determined that the trading had not violated insider trading restrictions); and recommend practices that may enhance the defensibility of a 10b5-1 plan.  Laguardia is a partner in Shearman & Sterling’s Litigation Group, and Brennan and Kamhi are associates in that group.  This is the first article in the two-part series.

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  • From Vol. 7 No.17 (May 2, 2014)

    Did Pershing Square and Valeant Violate Insider Trading, Antitrust or Tender Offer Rules in Their Pursuit of Allergan?

    Amid the sound and fury surrounding the hostile bid for Allergan by an entity jointly formed by Pershing Square Capital Management and Valeant Pharmaceuticals, a recurring question is whether the bid or the transactions leading up to it violated securities or antitrust law.  The short answer is no.  This article explains why.  See also “Can Activist Hedge Fund Managers Provide Special Compensation to Nominees That Are Elected to the Board of a Target? An Interview with Marc Weingarten, Co-Head of the Global Shareholder Activism Practice at Schulte Roth & Zabel,” The Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014).

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  • From Vol. 7 No.8 (Feb. 28, 2014)

    Co-Investments in the Hedge Fund Context: Structuring Considerations and Material Terms (Part Two of Three)

    Co-investments have been a regular feature of private equity investing for decades but historically have played a smaller role in the world of hedge funds.  However, as the range of strategies pursued by hedge funds increases – in particular, as more hedge fund assets are committed to activism, distressed and other illiquid strategies – co-investments are assuming a more prominent place in the hedge fund industry.  In an effort to help hedge fund managers assess the role of co-investments in their investment strategies and operating frameworks, The Hedge Fund Law Report is publishing a three-part series on the structure, terms and risks of hedge fund co-investments.  This article, the second in the series, describes the three general approaches to structuring co-investments; discusses the five factors that most directly affect management fee levels on co-investments; outlines the applicable incentive fee structures; details common liquidity or lockup arrangements; and highlights relevant fiduciary duty and insider trading considerations.  The first article in this series discussed five reasons why hedge fund managers offer co-investments; two reasons why investors may be interested in co-investments; the “market” for how co-investments are handled during the negotiation of initial fund investments; investment strategies that lend themselves to co-investments; and types of investors that are appropriate for co-investments.  See “Co-Investments Enable Hedge Fund Managers to Pursue Illiquid Opportunities While Avoiding Style Drift (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).  The third article will discuss regulatory and other risks in connection with co-investments.

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  • From Vol. 7 No.8 (Feb. 28, 2014)

    Second Circuit Holds that Portfolio Manager Who Engaged in Insider Trading to Benefit His Fund Is Personally Liable to Disgorge the Fund’s Illicit Profits, Regardless of How Much He Gained Personally

    A recent Second Circuit decision clarified the circumstances in which a hedge fund manager who engages in insider trading to benefit the fund can be held liable to disgorge all of the fund’s illicit profits, even if the manager does not personally receive any of those profits.  This article summarizes the court’s decision.  In a substantively related matter, the SEC is presently seeking disgorgement by a Level Global trader of illicit profits made by that fund as a result of insider trading by that trader.  See “SEC’s Insider Trading Suit against Former Level Global Trader Illustrates the Risk of Retaining a Former Public Company Employee as a Consultant,” The Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading? (Part Four of Four)

    This is the fourth article in our four-part series on information barriers in the hedge fund context.  The series aims to help hedge fund managers determine whether they should use information barriers and, if so, how they can establish and enforce such barriers.  In particular, this fourth article discusses the role of employee training and compliance surveillance in the maintenance of robust information barriers, and describes four significant challenges faced by hedge fund managers in structuring, implementing and enforcing information barriers.  The first article provided an overview of various insider trading controls, including restricted lists, watch lists and information barriers, explaining how they can work together; described four principal benefits available from the use of information barriers; highlighted the types of firms that can benefit most from the implementation of information barriers; and described the types of firms that will find the implementation of information barriers most challenging.  The second article discussed the legal and regulatory basis for information barriers and described the building blocks of effective barriers (including the key players, physical components and technological processes).  The third article described how a firm can limit access to material nonpublic information within the information barrier control environment and outlined policies and procedures designed to bolster the effectiveness of information barriers.

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    New York Federal District Court, Applying “Faithless Servant” Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading

    On December 19, 2013, the United States District Court for the Southern District of New York allowed Morgan Stanley to recoup more than $31 million paid in compensation to a former portfolio manager who admitted to insider trading.  Morgan Stanley originally sued former FrontPoint Partners, LLC portfolio manager Joseph F. “Chip” Skowron III (Skowron) in October 2012 to recoup compensation paid to him.  Morgan Stanley based its allegation of the right to claw back such compensation upon Skowron’s 2011 guilty plea to insider trading and obstruction of justice charges.  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,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  After prevailing on some of its claims and losing on others, Morgan Stanley moved for partial summary judgment, based on New York’s “faithless servant” doctrine.  This article summarizes the faithless servant doctrine and the Court’s analysis.

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  • From Vol. 7 No.4 (Jan. 30, 2014)

    Ropes & Gray Partners Share Experience and Best Practices Regarding the JOBS Act, the Volcker Rule, Broker Registration, Information Barriers, Examination Priorities, Multi-Year Incentive Fees and Swap Execution Facilities

    On February 4, 2014 – this coming Tuesday – the New York office of Ropes & Gray will host GAIM Regulation 2014.  The event will feature an all-star speaking faculty including general counsels and chief compliance officers from leading hedge fund managers, top partners from Ropes and other law firms and officials from the SEC, CFTC, FINRA and other U.S. and global regulators.  The intent of the event is to share best practices in a private setting, and to hear directly from relevant regulators.  For a fuller description of the event, click here.  To register, click here.  The Hedge Fund Law Report recently interviewed three Ropes partners on some of the more noteworthy topics expected to be discussed at GAIM Regulation 2014.  Generally, we discussed SEC and regulatory issues with Laurel FitzPatrick, co-leader of Ropes’ hedge funds practice and co-managing partner of its New York office; CFTC and derivatives issues with Deborah A. Monson, a partner in Ropes’ Chicago office; and enforcement issues with Zachary S. Brez, co-chair of Ropes’ securities and futures enforcement practice.  Specifically, our long form interview with these partners included detailed discussions of the future of hedge fund advertising following the JOBS Act; the impact of the Volcker rule on hedge fund hiring and trading; fund manager responses to the SEC’s focus on broker registration of in-house marketing personnel; best practices for preparing for and navigating SEC examinations; structuring multi-year incentive fees; the impact of swap execution facilities on hedge fund manager obligations and cleared derivatives execution agreements; recent National Futures Association developments relevant to hedge fund managers; design and enforcement of robust information barriers; measures that managers can take to preserve the firm before and after initiation of an enforcement action; government enforcement priorities for hedge fund managers; and specific financial products likely to face government scrutiny in the next two years.

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  • From Vol. 7 No.4 (Jan. 30, 2014)

    How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading? (Part Three of Four)

    This is the third article in The Hedge Fund Law Report’s four-part series on information barriers in the hedge fund context.  Generally, the series explores why hedge fund managers might want to implement information barriers and identifies best practices for doing so.  Specifically, this third article describes how a firm can limit access to material nonpublic information within the information barrier control environment and outlines policies and procedures designed to bolster the effectiveness of information barriers.  The first article in this series provided an overview of various insider trading controls, including restricted lists, watch lists and information barriers, explaining how they can work together; described four principal benefits available from the use of robust information barriers; highlighted the types of firms that can benefit most from the implementation of information barriers; and described the types of firms that will find the implementation of robust information barriers most challenging.  The second article discussed the legal and regulatory basis for information barriers and described the building blocks of effective information barriers (including the key players, physical components and technological processes).  The fourth article will discuss the benefits of training and compliance surveillance related to information barriers and describe the four most significant challenges faced by hedge fund managers in structuring, implementing and enforcing robust information barriers.

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  • From Vol. 7 No.4 (Jan. 30, 2014)

    Current and Former Regulators and Prosecutors Particularize the Enforcement Challenges Facing Hedge Fund Managers in 2014

    Current and former regulators and prosecutors from the SEC, CFTC and New York State Attorney General’s (NYSAG) Office recently offered insight on the enforcement landscape confronting hedge fund managers during a session entitled “Current Hedge Fund and Private Equity Fund Enforcement Priorities – The Enforcers’ Perspective,” which was part of PLI’s “Hedge Fund and Private Equity Enforcement & Regulatory Developments 2013” program.  Barry R. Goldsmith, a partner at Gibson, Dunn & Crutcher LLP, moderated the session.  The speakers were Stephen L. Cohen, an Associate Director at the SEC’s Division of Enforcement; Chad Johnson, Chief of the Investor Protection Bureau of the NYSAG’s Office; Colleen P. Mahoney, a partner at Skadden, Arps, Slate, Meagher & Flom LLP, and former SEC acting general counsel and Deputy Director of its Division of Enforcement; and Manal Sultan, Deputy Director and a chief trial attorney for the Division of Enforcement of the CFTC.  As is customary, Cohen, Johnson and Sultan all noted that the views they expressed were not official statements of agency policy.  This article summarizes the salient points raised during the panel discussion.  For details of a 2013 speech by Bruce Karpati, the former Chief of the Asset Management Unit of the SEC’s Division of Enforcement, outlining the SEC’s enforcement priorities for 2013, see “OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).

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  • From Vol. 7 No.3 (Jan. 23, 2014)

    How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading? (Part Two of Four)

    This is the second article in The Hedge Fund Law Report’s four-part series on information barriers in the hedge fund context.  Generally, the series explores why hedge fund managers might wish to implement information barriers and identifies best practices for doing so.  Specifically, this second article discusses the legal and regulatory basis for information barriers and describes the building blocks of effective information barriers (including the key players, physical components and technological processes).  The first article provided an overview of various insider trading controls, including restricted lists, watch lists and information barriers, explaining how they can work together; described four principal benefits available from the use of robust information barriers; highlighted the types of firms that can benefit most from the implementation of information barriers; and described the types of firms that will find the implementation of robust information barriers most challenging.  See “How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading?  (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).  The third article will describe how a firm can limit access to material nonpublic information within the information barrier control environment and outline policies and procedures designed to bolster the effectiveness of information barriers.  And the fourth article will discuss the benefits of training and compliance surveillance related to information barriers and describe the four most significant challenges faced by hedge fund managers in structuring, implementing and enforcing robust information barriers.

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  • From Vol. 7 No.2 (Jan. 16, 2014)

    How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading?  (Part One of Four)

    Insider trading law is rife with counterintuitive presumptions.  Notable among them is the presumption that if one employee of a hedge fund management company receives material nonpublic information (MNPI), all employees of that management company are in possession of MNPI for insider trading purposes, and any trade in the subject security will be “on the basis of” that information.  See “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  However, that presumption can be rebutted by the presence of well-designed information barriers.  An information barrier, in this context, is a set of physical, operational, legal and technological structures and processes used to prevent the flow of information from one part of a firm to another, thereby preserving the ability of one part of the firm to trade securities that another part of the firm may not trade.  For example, assume that a single manager has a distressed debt fund that trades bank debt and a separate high-yield credit fund that trades bonds.  If the investment team for the distressed debt fund receives nonpublic earnings projections of an issuer based on service on that issuer’s creditor committee, the investment team for the high-yield credit fund would be prohibited – as a default – from trading in the public bonds of the same issuer because the whole firm would be presumed to be in possession of MNPI of that issuer.  However, if the firm had implemented a legally sufficient information barrier between the distressed debt and high-yield credit fund teams prior to receipt by the distressed fund team of MNPI, the high-yield credit fund team would still be able to trade public bonds of the issuer, even after receipt by the distressed fund team of MNPI.  This legal issue matters to investment performance because a good and legitimate investment opportunity may arise anytime.  In the foregoing example, the high-yield credit fund team may wish to purchase bonds of the issuer based on immaterial or public information received after the receipt of MNPI by the distressed fund team.  In the presence of a legally sufficient information barrier, the high-yield credit fund team would be able to execute on the opportunity.  Absent such an information barrier, the high-yield credit fund team would have to forego the opportunity or assume heightened insider trading risk.  Implicit in the foregoing hypothetical is the notion that an information barrier is useful to the extent that it is legally, operationally and otherwise sufficient.  Which of course begs the question: How can a hedge fund manager structure, implement and enforce sufficient information barriers?  This is the first article in a four-part series that aims to answer this question, or at least provide the rudiments of an answer and direction for further analysis.  In particular, this article provides an overview of various insider trading controls, including restricted lists, watch lists and information barriers, explaining how they can work together; describes four principal benefits available from the use of robust information barriers; highlights the types of firms that can benefit most from the implementation of information barriers; and describes the types of firms that will find the implementation of robust information barriers most challenging.  The second article in this series will describe the regulatory environment surrounding the use of information barriers and discuss the building blocks of an effective information barrier control environment.  The third installment will describe how a firm can limit access to MNPI within the information barrier control environment and outline policies and procedures designed to bolster the effectiveness of information barriers.  The fourth installment will discuss the benefits of training and compliance surveillance related to information barriers and describe the four most significant challenges faced by hedge fund managers in structuring, implementing and enforcing robust information barriers.

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  • From Vol. 7 No.1 (Jan. 9, 2014)

    RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)

    This is the third installment in our three-part series covering the RCA’s Compliance, Risk & Enforcement 2013 Symposium.  It summarizes key points from two sessions, one offering perspectives from regulators and industry participants on regulatory risks and compliance best practices relating to expert networks, valuation, custody and allocation of expenses; and another providing a detailed look into fund administrator shadowing.  The first installment covered highlights from two sessions, one addressing effective risk assessments for hedge fund managers and the other offering current and former government officials’ perspectives on expert networks, political intelligence, insider trading and valuation-related conflicts of interest.  The second installment summarized the most salient points from two sessions, including the keynote address by OCIE Director Andrew Bowden, and a session addressing fund distribution, the JOBS Act, broker registration, National Futures Association oversight of hedge fund marketing practices and the EU’s Alternative Investment Fund Managers Directive.

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part One of Three)

    The Regulatory Compliance Association recently held its Compliance, Risk & Enforcement 2013 Symposium (Symposium), at which regulators and hedge fund industry experts offered insights on relevant regulatory, compliance and operational topics.  This first installment of a three-part series covering the Symposium summarizes two sessions, one on conducting effective risk assessments for hedge fund managers (including discussions of forensic testing and testing for insider trading, order allocations and best execution), and the other incorporating current and former government officials’ perspectives on expert networks, political intelligence, insider trading investigations and prosecutions and valuation-related conflicts of interest.  The second installment will summarize salient points from the keynote address by Andrew Bowden, Director of the SEC’s Office of Compliance Inspections and Examinations, and a session addressing challenges for fund distribution raised by the JOBS Act, broker registration issues and the AIFMD.  The third installment will summarize key points from two sessions, one on compliance best practices for use of expert networks, valuation, custody and expense allocation, and another on fund administrator shadowing.

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    SEC’s Insider Trading Suit against Former Level Global Trader Illustrates the Risk of Retaining a Former Public Company Employee as a Consultant

    On November 14, 2013, the SEC commenced a civil enforcement action against Mark Megalli, a trader at now-defunct hedge fund manager Level Global Investors, L.P., in the U.S. District Court for the Northern District of Georgia.  This article summarizes the factual and legal allegations leveled by the SEC against Megalli and describes some key implications for hedge fund managers, including risks associated with gathering information from former employees of public companies and all third-party consultants (including but not limited to consultants retained via expert networks).  See “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013).  This article also provides several best practices for mitigating insider trading-related risks arising out of the retention and use of such research providers.  See “Best Practices for Due Diligence by Hedge Fund Managers on Research Providers,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).  In many respects, the challenges associated with using these stand-alone third-party consultants are greater than those associated with the use of compliance-minded expert networks that have developed robust insider trading compliance infrastructures.

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  • From Vol. 6 No.46 (Dec. 5, 2013)

    ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing, OTC Derivatives Reforms, Insider Trading Best Practices, the JOBS Act, AIFMD and Activist Investing (Part Two of Three)

    Hedge fund industry thought leaders recently shared their insights on legal, operational and other issues impacting hedge fund managers during the 7th Annual Hedge Fund General Counsel Summit hosted by ALM Events.  This second installment in our three-part series covering the summit discusses topics including the impact of over-the-counter derivatives reforms on fund managers (including a discussion of new mandatory trade reporting, clearing and execution requirements as well as CFTC cross border rules); opportunities and challenges associated with distressed debt investing (including a discussion of opportunities to participate in Chapter 11 proceedings, considerations in claims trading and risks of distressed debt investing); and best practices to address insider trading risks.  The first installment discussed strategies for handling government investigations and challenges facing chief compliance officers, including dual-hatting and potential supervisory liability.  The third installment will provide regulatory updates on the JOBS Act, the Alternative Investment Fund Managers Directive and new Canadian and U.S. initiatives that will impact activist investing strategies.

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Investment Opt-Out Rights for Hedge Fund Investors: Regulatory Risks, Operational Challenges and Seven Best Practices (Part Three of Three)

    This is the third and final article in our series on investment opt-out rights in the hedge fund context.  This article continues the discussion of risks associated with opt-out rights, focusing on regulatory and other risks, and concludes with a discussion of seven best practices for minimizing the risks associated with such rights.  The first article in the series explored eight reasons why investors may demand and managers may grant opt-out rights.  See “Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 43 (Nov. 8, 2013).  And the second installment addressed the structure and exercise of opt-out rights, as well as regulatory risks associated with offering such rights.  See “Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part Two of Three),” The Hedge Fund Law Report, Vol. 6, No. 44 (Nov. 14, 2013).

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Akin Gump Partners Discuss Non-U.S. Enforcement, Insider Trading in Futures, Failure to Supervise Charges and Other Evolving Insider Trading Challenges for Hedge Fund Managers

    Akin Gump Strauss Hauer & Feld LLP recently hosted its “Private Investment Funds Conference: 2013 Trends and Developments” in New York City.  During a panel discussion entitled “Beyond the Headlines: Current Issues in Insider Trading Enforcement,” Akin Gump partners discussed new enforcement and prosecution tactics; the risks of gathering research through sell-side analysts, buy-side firms, expert networks, political intelligence firms, channel checking firms and meetings with current and former employees of companies; insider trading beyond U.S. borders; CFTC regulation of insider trading; whistleblowers; and five strategies for effectively mitigating insider trading risks.  The discussion was moderated by former federal prosecutor James Joseph Benjamin Jr., an Akin Gump partner and head of the firm’s securities enforcement and litigation practice group.  The other panelists were Akin Gump partners Michael A. Asaro, a former SEC staff attorney and Assistant U.S. Attorney, who practices in the areas of government investigations and enforcement proceedings; Douglas A. Rappaport, who handles civil litigation and regulatory and compliance matters; and Steven F. Reich, a white collar defense litigator with experience that includes serving as an Associate Deputy U.S. Attorney General and in the White House counsel’s office.  This article summarizes the key takeaways from the panel discussion.  See also “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” The Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012); and “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,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013).

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  • From Vol. 6 No.43 (Nov. 8, 2013)

    Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part Two of Three)

    Sidley Austin LLP recently presented a conference entitled “Private Funds 2013: Developments and Opportunities.”  At the conference, Sidley partners offered updates, market color and practice recommendations on hedge and private equity fund structuring, regulation, operations and transactions.  The Hedge Fund Law Report is covering the conference in a three-part article series.  The first article covered the sections of the conference addressing fund structuring developments, single-investor funds, first loss capital arrangements, side letter terms, hard wiring of feeder funds for ERISA purposes, liquidity terms, fee terms, founder share classes and expense allocations and caps.  See “Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).  This second installment addresses recent developments in SEC examinations and enforcement (including a discussion of compliance policy violations, valuation practices and allocation of investment opportunities); insider trading issues (including the use of political intelligence firms, expert networks and deputized directors); the SEC’s new policy requiring admissions of wrongdoing and best practices for compliance; seeding arrangements; and fund manager mergers and acquisitions (including a discussion of key terms and negotiating points for such transactions).  The third article in this series will describe regulatory developments impacting fund managers, including commodity pool operator registration and regulation, implementation and compliance with the JOBS Act and derivatives reforms.

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  • From Vol. 6 No.40 (Oct. 17, 2013)

    Daniel New, Executive Director of E&Y’s Asset Management Advisory Practice, Discusses Best Practices on “Hot Button” Hedge Fund Compliance Issues: Disclosure, Expense Allocations, Insider Trading, Political Intelligence, CCO Liability, Valuation and More

    The task of serving as chief compliance officer (CCO) of a hedge fund manager is becoming progressively more challenging in light of ever-increasing regulatory obligations, heightened enforcement activity and resource constraints.  CCOs can benefit from understanding the best practices being employed by their peers, and customizing relevant practices to their businesses.  As Executive Director of Ernst & Young’s Asset Management Advisory Practice, Daniel New sees a cross-section of compliance practices at brand-name hedge fund managers.  He sees what works from a compliance perspective, and what needs work.  The Hedge Fund Law Report recently interviewed New on a range of issues regularly encountered by hedge fund manager CCOs.  The interview spanned topics including consistency of fund marketing and disclosure documents; a CCO’s role in preparing and completing Form PF and other regulatory filings; structuring and memorializing annual compliance reviews; allocating expenses between a manager and its funds; insider trading and political intelligence controls; social media use by manager personnel; a CCO’s risk management responsibilities; outsourcing of CCO functions in light of resource constraints; and mitigating rogue trading risks.  The breadth of topics covered reflects the expansiveness of a typical CCO’s portfolio.  The idea behind this interview is to enable CCOs to allocate their scarcest resource – time – more effectively.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Compliance, Risk & Enforcement 2013 Symposium, to be held at the Pierre Hotel in New York City on October 31, 2013.  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.39 (Oct. 11, 2013)

    ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part Two of Two)

    ACA Compliance Group recently released a report and sponsored a webcast describing the results of its most recent survey of hedge fund and private equity fund manager compliance practices.  This article, the second in a two-part series covering the survey results, discusses: insider trading issues (including information barriers, online data rooms, non-disclosure agreements, restricted and watch lists, political intelligence, expert networks and public company contacts); and expense practices (including the use of expense caps, the allocation of expenses among a manager and its funds, expense allocation reasonableness reviews and other expense-related controls).  The first article in this series summarized survey results relating to fund managers’ preparation and completion of regulatory filings (e.g., Form ADV, Form PF and non-U.S. regulatory filings), including a discussion of how many managers are making various regulatory filings; what resources are being used to prepare such filings; how Form PF expenses are being allocated among a manager and its funds; and whether Form PF is being shared with fund investors.  The first article also discussed survey results relating to presence examinations.  See “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three)

    Hedge fund management is a human capital business, and employees are (or should be) the key asset of a manager.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).  However, employees can also be a manager’s most dangerous liability.  One rogue employee can destroy or seriously damage even the best hedge fund franchise by, among other things, inviting a presumption that the employee is not rogue but representative of a culture of permissiveness.  See “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  Recognizing the risks of picking bad apples, hedge fund managers are increasingly using employee background checks as a downside mitigation strategy.  But the concept of a background check spans a wide range of activities – everything from a superficial online search to a deep, manual process.  Whether to conduct a background check in the first instance, and what kind of background check to conduct, depends on dynamics specific to the industry, firm and prospective employee.  To assist hedge fund managers in understanding the role of background checks in their hiring and “people” processes, The Hedge Fund Law Report is publishing a three-part series on the role of background checks in the hedge fund industry, with the three parts focusing on, respectively, three questions: Why, how and who.  More specifically, this article – the first in the series – outlines the case for conducting background checks, cataloging the wide range of regulatory and other risks presented by employees (including discussions of insider trading, Rule 506(d), pay to play, track record portability, restrictive covenants and other topics).  The second installment will describe the anatomy of an employee background check, highlighting mechanics, common mistakes and risks.  And the third part will weigh the benefits and burdens of outsourcing background checks versus conducting them in-house.

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    Guidepoint Global’s General Counsel, Catherine Smith, Discusses How Hedge Fund Managers Are Using Expert Networks to Conduct Investment Research and Mitigate Insider Trading Risks

    SEC, FBI and other government officials have acknowledged that expert networks are a legitimate method for conducting primary investment research.  See “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013) (“Commenting on the permissible use of expert networks, FBI Special Agent David Chaves observed, ‘I think a majority of expert networks serve a very legitimate function and have always acted responsibly.  We do not want to scare people into thinking this is not a valid resource because it is, and you can continue to use them.  You will know when conduct crosses the line.  I do not think people should overreact.’”).  Yet many of the recent civil and criminal insider trading actions against hedge fund professionals have involved expert networks, directly or indirectly.  See, e.g., “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Accordingly, hedge fund managers have struggled with capturing the research and investment advantages of expert networks while avoiding insider trading and other information risks.  To offer concrete guidance and specific best practices in this area, The Hedge Fund Law Report recently interviewed Catherine Smith, former Senior Counsel of the SEC’s Division of Enforcement and current General Counsel of expert network firm Guidepoint Global.  Smith brought her regulatory and private practice experience to bear on topics including how the use by hedge fund managers of expert networks has evolved; whether managers impose restrictions or prohibitions on the experts that may be consulted; how managers conduct due diligence on expert networks; how expert networks screen prospective experts; whether expert networks restrict topics eligible for discussion by their experts; compliance controls implemented by expert network firms and hedge fund managers; and different surveillance methods for monitoring expert network consultations.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Compliance, Risk & Enforcement 2013 Symposium, to be held at the Pierre Hotel in New York City on October 31, 2013.  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part Two of Two)

    This is the second article in a two-part series detailing the application of abstract insider trading principles to specific scenarios and challenges faced by hedge fund managers.  This article discusses the misappropriation theory of insider trading; recent caselaw on the element of scienter; channel checking and field research; insider trading issues raised when fund investors are affiliated with portfolio companies; special insider trading rules that apply to tender offers; and criminal and civil penalties for insider trading.  The first article in this series discussed the definition of nonpublic information; the scope of the concept of materiality; the limits of the concept of fiduciary duty as it relates to insider trading; and the mosaic theory of insider trading.  See “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).  The author of this article series is Ralph Siciliano, head of the Governmental and Regulatory Investigations Practice at Tannenbaum Helpern Syracuse & Hirschtritt LLP.

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    Second Circuit Evaluates Whether Hedge Fund Employee Who Pled Guilty to Insider Trading Is Responsible for Reimbursing Morgan Stanley for Compensation and Legal Expenses

    The Second Circuit Court of Appeals (Court) recently considered a decision by the U.S. District Court for the Southern District of New York holding that Joseph “Chip” Skowron is responsible for reimbursing his former employer $10 million in compensation and legal expenses incurred in defending Skowron as a result of the SEC’s investigation into his insider trading.  Among other things, the Court evaluated to what extent the Mandatory Victims Restitution Act is available to employers that wish to claw back compensation from their employees for illegal conduct.  See “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).  This article outlines the factual and procedural background in this case as well as the legal analysis underpinning the Court’s decision.

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  • From Vol. 6 No.31 (Aug. 7, 2013)

    How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks? (Part One of Two)

    While the core tenets of insider trading law are well-established, the outer bounds of the law are continuously evolving, and the application of established doctrine to hedge fund industry-specific issues remains a challenge for many managers.  This article is the first in a two-part series designed to serve as a guide for hedge fund managers to the laws, regulations and cases that define the scope and contours of relevant insider trading doctrine.  Specifically, this first article discusses important elements of insider trading liability, including what constitutes nonpublic information; what information is considered material; when a fiduciary duty has been breached; and the mosaic theory of insider trading.  The second installment will discuss the misappropriation theory of insider trading; the element of scienter; insider trading consequences of fund investments by affiliates of portfolio companies; special tender offer rules; and penalties.  The author of this article series is Ralph Siciliano, a partner at Tannenbaum Helpern Syracuse & Hirschtritt LLP, and head of the firm’s Governmental and Regulatory Investigations Practice.

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  • From Vol. 6 No.29 (Jul. 25, 2013)

    SEC Charges Steven A. Cohen with Failing to Supervise Employees Who Allegedly Engaged in Insider Trading

    On July 19, 2013, the SEC instituted administrative proceedings against Steven A. Cohen, the embattled founder of hedge fund adviser S.A.C. Capital Advisors, LLC (SAC).  Generally, the SEC charges Cohen with failing to supervise two of his portfolio managers, Mathew Martoma and Michael Steinberg, both of whom have been indicted on insider trading charges arising out of their trading for hedge funds advised by SAC.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme, The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  The SEC claims that Cohen ignored “red flags” that Steinberg and Martoma were trading on inside information.  While the SEC does not set forth the standard for “failure to supervise” liability in its order instituting administrative proceedings, the order nonetheless provides a glimpse into the activities that, in the agency’s view, represent a failure to supervise in the hedge fund context.  This article summarizes the factual allegations and administrative charges levied against Cohen by the SEC.  Notably, the SEC did not file civil charges against Cohen and did not charge him – administratively, civilly or otherwise – with insider trading.

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  • From Vol. 6 No.29 (Jul. 25, 2013)

    Defense White Paper Refutes SEC’s Allegations That Steven A. Cohen Failed to Supervise Employees Accused of Insider Trading and Provides a Behind-the-Scenes Look at SAC Capital’s Compliance Program and Culture

    On July 19, 2013, the SEC filed an order instituting administrative proceedings against Steven A. Cohen, the founder of S.A.C. Capital Advisors, LLC (SAC Capital), generally alleging that Cohen failed to supervise two portfolio managers, Mathew Martoma and Michael Steinberg, by ignoring “red flags” that should have alerted him to their allegedly improper conduct in relation to fund investments in Elan Corporation, Plc, Wyeth and Dell, Inc.  See “SEC Charges Steven A. Cohen with Failing to Supervise Employees Who Allegedly Engaged in Insider Trading,” above, in this issue of The Hedge Fund Law Report.  In short, in a 46-page white paper (White Paper) dated July 22, 2013, Cohen’s defense team argues that there is no evidence to suggest that Cohen was aware of Martoma’s and Steinberg’s allegedly suspicious conduct and denied the characterization of the delineated conduct as representing “red flags.”  Furthermore, the White Paper argues that Cohen’s commitment to robust compliance, as demonstrated by his and SAC Capital’s development of a rigorous compliance program, belies any suggestion that Cohen overlooked the identified “red flags.”  Importantly, the White Paper also gives a behind-the-scenes look at the compliance program (most notably the insider trading controls) at one of the most sophisticated hedge fund firms in the world.  This article summarizes salient content from the White Paper.  For an in-depth discussion of the SEC’s settlement with SAC Capital and its affiliates relating to the above-referenced matters, see “Five Takeaways for Other Hedge Fund Managers from the SEC’s Record $602 Million Insider Trading Settlement with CR Intrinsic,” The Hedge Fund Law Report, Vol. 6, No. 12 (Mar. 21, 2013).

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  • From Vol. 6 No.29 (Jul. 25, 2013)

    SAC Capital Entities Indicted for Securities Fraud and Wire Fraud in Connection With Employees’ Alleged Insider Trading 

    On July 25, 2013, the U.S. Department of Justice unsealed a 41-page indictment against CR Intrinsic Investors, LLC, Sigma Capital Management, LLC, S.A.C. Capital Advisors, LLC and S.A.C. Capital Advisors, L.P. (SAC Entities), charging them with four counts of securities fraud and one count of wire fraud in connection with alleged employee insider trading activity.  Among other things, the indictment alleges that employee insider trading activity was made possible by “institutional practices that encouraged the widespread solicitation and use of illegal inside information,” painting a dreary picture of the firm’s hiring practices and compliance culture in the process.  This article describes the factual allegations (including a description of alleged institutional practices), charges levied against the SAC Entities and relief sought.

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  • From Vol. 6 No.27 (Jul. 11, 2013)

    Second Circuit Rules on Suppression of Wiretap Evidence and Application of the “Knowing Possession” Element of Insider Trading in Upholding Raj Rajaratnam’s Conviction for Insider Trading

    In 2011, Raj Rajaratnam, the founder of the Galleon hedge fund group, was convicted on fourteen counts of securities fraud and conspiracy to commit securities fraud arising out of insider trading in the securities of numerous companies.  He was sentenced to 11 years in prison.  See “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013).  The case was unusual, not only because of the stiff sentence, but also because it turned largely on evidence derived from wiretaps of Rajaratnam’s telephone conversations.  For more on the use of wiretaps, see “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  The trial judge denied Rajaratnam’s motion to suppress that evidence.  On June 24 of this year, the U.S. Court of Appeals for the Second Circuit (Court) upheld Rajaratnam’s conviction and ruled that the U.S. District Court for the Southern District of New York (District Court) correctly refused to suppress the wiretap evidence against Rajaratnam.  The Court also ruled that the District Court properly instructed the jury that it could convict Rajaratnam if it concluded that “material non-public information given to the defendant was a factor, however small, in the defendant’s decision to purchase or sell stock.”  See “Is the ‘Mosaic Theory’ a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  This article summarizes the Court’s decision and, more importantly, its analysis in ruling on the appeal.

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  • From Vol. 6 No.27 (Jul. 11, 2013)

    How Can Hedge Fund Managers Identify and Mitigate Insider Trading Risks Associated with Gathering and Using Political Intelligence?

    Many hedge fund managers and other buy-side firms use political intelligence (PI) to inform their trading decisions, but use of PI is not without risk, particularly the risk that misuse of that information could lead to an insider trading charge.  See “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  In that regard, the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act), enacted last year, clarified a gray area that had existed in insider trading jurisprudence – making clear that the insider trading prohibitions contained in the federal securities laws apply with respect to PI.  Consequently, a hedge fund that trades on material nonpublic information provided by a member of Congress or a congressional staffer is explicitly exposed to insider trading liability.  See “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).  Yet, much uncertainty remains, including understanding the boundaries of what constitutes PI as well as determining the circumstances under which PI constitutes material nonpublic information.  To shed light on these issues for hedge fund managers, a recent panel, which included an official from the SEC’s Division of Enforcement, discussed the contours of and the impact of the STOCK Act.  This article summarizes the key lessons from the panel discussion.

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  • From Vol. 6 No.25 (Jun. 20, 2013)

    RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part Two of Two)

    On April 18, 2013, the Regulatory Compliance Association held its Regulation, Operations & Compliance 2013 Symposium (Symposium), at which industry leaders and regulators offered perspectives on hot-button issues facing hedge fund managers and investors.  This article, the second installment in our series covering the Symposium, addresses how managers should address high-priority conflicts of interest; techniques and strategies regulators and prosecutors are using to investigate insider trading; the SEC’s whistleblower program; and Foreign Account Tax Compliance Act compliance.  The first article addressed challenges raised by side letters; evaluating requests for most favored nation provisions; and how hedge fund managers are using funds of one and managed accounts.  See “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

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  • From Vol. 6 No.18 (May 2, 2013)

    SEC Commissioner Aguilar Discusses Insider Trading by Hedge Fund Managers, Valuation and Other Examination and Enforcement Pressure Points

    In a speech at the Regulatory Compliance Association’s Regulation, Operations and Compliance Symposium, held on April 18, 2013, SEC Commissioner Luis Aguilar described the challenges to be tackled by hedge fund managers and regulators in serving investor interests.  In particular, Aguilar discussed the elements of a culture of compliance; how the SEC thinks about insider trading at hedge fund management companies; best practices in valuing assets; and internal dynamics at the SEC that may impact whether a hedge fund manager becomes an examination or enforcement target.  This article highlights the salient points from Aguilar’s speech.

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  • From Vol. 6 No.17 (Apr. 25, 2013)

    U.S. District Court Conditionally Approves CR Intrinsic Settlement with SEC Despite “Neither Admit Nor Deny Liability” Provision

    A hedge fund manager that is negotiating a settlement to terminate an SEC enforcement action should not assume that a U.S. District Court will “rubber-stamp” the proposed settlement.  A recent decision by a U.S. District Court conditionally approving the settlement of the SEC’s civil insider trading action against hedge fund manager CR Intrinsic Investors, LLC shows that even a landmark settlement amount that gives the SEC virtually everything it could have won at trial will not insulate the settlement from close judicial scrutiny when the defendant does not admit any of the SEC’s allegations.  This article summarizes the Court’s decision, which provides an excellent discussion of the policy, legal and practical issues that courts have been considering when asked to approve SEC settlements.

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  • From Vol. 6 No.17 (Apr. 25, 2013)

    GAO Report Dissects the Mechanics of the Political Intelligence Market and Highlights Insider Trading Risks for Hedge Fund Managers

    Hedge fund managers and other sophisticated investors are increasingly seeking out political intelligence (as defined below) to inform their investment decision-making.  While political intelligence can give hedge fund managers a trading edge, it also presents insider trading and other legal risks.  See “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  To address such insider trading risks, Congress passed the Stop Trading on Congressional Knowledge Act (STOCK Act) in 2012 to clarify that insider trading laws, including Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, apply to information derived from members of Congress and their staffs.  See “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).  The STOCK Act defines political intelligence to include information that is “derived by a person from direct communications with an executive branch employee, a Member of Congress, or an employee of Congress; and provided in exchange for financial compensation to a client who intends, and who is known to intend, to use the information to inform investment decisions.”  As part of the STOCK Act, Congress commissioned the United States Government Accountability Office (GAO) to study the role of political intelligence in investment decision-making and any attendant risks that could require the passage of additional legislation.  The GAO recently published a report detailing its findings (Report).  The Report discusses: (1) what is known about the sale of public and nonpublic political intelligence, including the extent to which investors rely on such information and the effect the sale of political intelligence may have on financial markets; and (2) potential benefits, costs and challenges associated with suggested legislation that would impose disclosure requirements on those who provide, gather, sell or use political intelligence.  The Report offers hedge fund managers a richer understanding of the political intelligence market and the risks involved in using this type of information in their investment decision-making.  This article summarizes key findings of the Report.

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  • From Vol. 6 No.16 (Apr. 18, 2013)

    Recent Survey Reveals Hedge Fund Professionals’ Perspectives on the Prevalence of and Pressures to Engage in Unethical Conduct and Illegal Activity in the Hedge Fund Industry

    A recent survey of hedge fund professionals asked respondents various questions to understand their views on the need for and prevalence of unethical conduct or illegal activity (together, misconduct) at their own firms and among their competitors; any temptations or pressure to engage in misconduct; their firms’ likely responses to misconduct; and the SEC’s effectiveness in stamping out misconduct.  The survey results were broken down into various demographic categories, including the respondents’ gender, 2012 earnings and years of work experience, as well as their firms’ assets under management.  This article summarizes key findings from the survey.

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  • From Vol. 6 No.14 (Apr. 4, 2013)

    Former Deputy U.S. Attorney and WilmerHale Partner Boyd M. Johnson III Addresses Risk Management Imperatives for Hedge Fund Managers: Insider Trading, Defense Strategy, Crisis Management, Money Laundering, Cyber Security and Tax Shelters

    Risk plays a different role in investments and operations.  In investments, as a general matter, returns are broadly correlated with risk.  In operations, on the other hand, quality tends to be inversely related with risk; there is no greater upside potential from increased operational risk, just a greater likelihood of fundamental error.  At the same time, operational risk is generally more dangerous to hedge fund managers than investment risk.  Investors understand that generating returns inevitably involves mistakes, but operational failures call into question a manager’s basic competence as a steward of capital.  Managing and mitigating operational risk are thus increasingly critical aspects of the hedge fund business.  But doing so is easier said than done.  In the first instance, it is challenging to identify the full range of operational risks facing a manager.  There is a group of usual suspects, but the less obvious and more insidious risks are unique to a manager’s strategy and operations.  Once risks are identified, best practices for addressing risks are hard to come by.  In an effort to assist hedge fund managers on both counts – identifying relevant risks and deciding what to do about them – The Hedge Fund Law Report recently interviewed Boyd M. Johnson III, a partner in the Litigation/Controversy Department and member of the Investigations and Criminal Litigation Practice Group and the Business Trial Group at WilmerHale.  Prior to joining WilmerHale, Johnson served as Deputy U.S. Attorney in the Southern District of New York with supervisory authority over 230 Assistant U.S. Attorneys.  As Deputy U.S. Attorney, Johnson managed the largest crackdown on Wall Street insider trading in history, including the prosecution of Raj Rajaratnam of the Galleon Group; criminal prosecutions and civil forfeiture proceedings related to the Bernard Madoff fraud; the investigation and prosecution of individuals and entities responsible for structuring and promoting international tax shelters; and numerous cyber security and other investigations.  For our interviews with other leading prosecutors in the Rajaratnam insider trading case, see “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013); and “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  The bulk of our interview with Johnson covered various aspects of insider trading – not surprising, given that insider trading remains primus inter pares among the various risks faced by managers in many strategies.  Specifically, with respect to insider trading, we discussed with Johnson: challenges in defending simultaneous civil and criminal insider trading actions; challenges in coordinating defenses to insider trading charges levied by multiple jurisdictions; considerations in evaluating an insider trading plea deal; strategies for obtaining prosecutorial leniency in insider trading cases; addressing insider trading risks from communications among investment professionals at different managers; maximizing the effectiveness of insider trading training; insider trading crisis management; and strategies for documenting findings from insider trading internal investigations.  Beyond insider trading, we also covered: anti-money laundering and cyber security risks confronting managers; identifying risky tax shelter pitches; and navigating fraud risks in healthcare investing.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel covering government investigation and prosecution of hedge fund and private equity fund managers entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.13 (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),” The 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,” The 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.

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  • From Vol. 6 No.13 (Mar. 28, 2013)

    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,” The 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,” The 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.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  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,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    Five Takeaways for Other Hedge Fund Managers from the SEC’s Record $602 Million Insider Trading Settlement with CR Intrinsic

    On March 15, 2013, the SEC issued a press release announcing a landmark $602 million civil insider trading settlement with hedge fund adviser CR Intrinsic Investors, LLC (CR Intrinsic) and affiliated entities arising out of alleged insider trading engaged in by Mathew Martoma, a co-defendant in the SEC enforcement action and formerly a portfolio manager at CR Intrinsic.  Martoma allegedly caused hedge funds managed by CR Intrinsic and S.A.C. Capital Advisors, LLC (S.A.C. Capital) to trade based on inside information relating to a drug trial conducted by pharmaceutical companies Wyeth and Elan.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  S.A.C. Capital and various funds managed by CR Intrinsic and S.A.C. Capital are also named as relief defendants in the settlement, although they are not charged with any securities law violations.  On the same day, the SEC also announced a $14 million insider trading settlement with Sigma Capital Management, LLC (Sigma), an affiliate of S.A.C. Capital, relating to trading in the shares of Dell, Inc. and Nvidia Corporation.  This article summarizes the background and terms of the settlements in both actions and offers five important takeaways for other hedge fund managers from the CR Intrinsic matter.  In addition, this article highlights the compliance lessons of the Sigma matter, particularly as those lessons relate to conversations between investment analysts employed by different hedge fund managers.

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    Recent District Court Decision in Mark Cuban’s Ongoing Insider Trading Case Clarifies the Application of the Misappropriation Theory to Interactions between Investment Professionals and Corporate Insiders

    On March 5, 2013, the U.S. District Court for the Northern District of Texas (Court) allowed the SEC to proceed to trial in its civil enforcement action against Dallas Mavericks owner Mark Cuban for insider trading.  The SEC accused Cuban of selling his shares in Mamma.com after learning material nonpublic information about the company’s planned private investment in public equity (PIPE) offering, thereby avoiding a $750,000 loss.  The Court held that the SEC presented enough evidence to convince a reasonable jury that Cuban could be held liable on the misappropriation theory of insider trading because he agreed, “at least implicitly, to maintain the confidentiality of Mamma.com’s material nonpublic information and not to trade on it or otherwise use it.”  See “When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).  For reasons described in more detail in this article, this decision helps to further clarify what hedge fund investment professionals should and should not say and do when talking to corporate insiders.  This article summarizes the factual background in the matter and the Court’s legal analysis, and enumerates some of the salient implications of this decision for the investment research process.

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    Best Practices for Due Diligence by Hedge Fund Managers on Research Providers

    Recent high-profile enforcement actions, including that involving Mathew Martoma and CR Intrinsic, an affiliate of SAC Capital, highlight the SEC Division of Enforcement’s continuing commitment to aggressively prosecuting hedge fund insider trading cases.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  While registered hedge fund managers are required by Rule 206(4)-7 under the Investment Advisers Act of 1940 to adopt policies and procedures reasonably designed to prevent and detect insider trading and other federal securities law violations, it behooves all hedge fund managers (even those that are not registered) to adopt such policies and procedures.  See “Three Recent SEC Orders Demonstrate a Renewed Emphasis on Investment Adviser Compliance Policies and Procedures by the Enforcement Division,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  Many hedge fund managers have recognized the insider trading risks posed by the use of expert network firms and have adopted policies and procedures designed to address these risks.  But other types of research firms also present insider trading and other regulatory risks.  Before using any investment research firm, it is imperative for hedge fund managers to conduct thorough due diligence to appropriately assess and address those risks.  In a guest article, Susan Mathews and Sanford Bragg describe the different types of research providers in the marketplace; the general approach to research provider due diligence; and some best practices for conducting due diligence on research providers.  Bragg is CEO of Integrity Research Associates, LLC, a consulting firm specializing in evaluating investment research providers, including their compliance platforms.  Mathews is Counsel and head of Integrity Research Compliance.

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    Proskauer Partner and SEC Enforcement Division Veteran Ronald Wood Explains the Implications for Hedge Fund Managers of Structure and Staffing Changes at the SEC

    In the past few years, the SEC’s Division of Enforcement has refocused its efforts with respect to the investment management industry via structure and staffing.  On the structuring side, the Division of Enforcement has established specialized units, such as the Asset Management Unit, devoted to addressing investor and systemic risks raised by private funds and their managers.  On the staffing side, the Division of Enforcement has hired investment management industry professionals – including hedge fund managers, analysts, operating professionals and due diligence experts – to staff these units.  With this new-found expertise, SEC staff not only “know where the bodies are buried,” but also “understand how they got there,” according to Bruce Karpati, Chief of the Asset Management Unit.  See “OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  On the foundation of its new expertise, the Division of Enforcement initiated 147 enforcement actions against investment advisers and investment companies in fiscal year 2012.  To provide deeper insight and actionable analysis on what the structuring and staffing changes at the Division of Enforcement mean for hedge fund managers, The Hedge Fund Law Report recently interviewed Ronald Wood.  Wood is a partner in the Securities Litigation Group at Proskauer Rose LLP, and prior to Proskauer spent a decade in the Division of Enforcement.  Our interview covered topics including SEC enforcement priorities; the use of reports filed with the SEC to identify enforcement targets; the SEC’s aberrational performance initiative; insider trading best practices; paid access to corporate executives; track record portability; due diligence on Chinese companies; pay to play issues; “big boy” letters; and FCPA concerns for hedge fund managers.  This article contains the transcript of our interview with Wood.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.10 (Mar. 7, 2013)

    Ropes & Gray Partners Share Insights Gleaned from Successfully Navigating Presence Examinations with Hedge Fund Manager Clients

    On October 9, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the SEC announced that it was going to conduct “focused, risk-based examinations of investment advisers to private funds that recently registered with the [SEC]” (Presence Exams).  See “OCIE Warns Newly Registered Hedge Fund Advisers to Watch Out for ‘Presence Examinations,’” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  On February 12, 2013, three partners at Ropes & Gray LLP presented a webinar entitled “SEC Presence Exams – Issues for Hedge Fund Managers,” to share their experience on how OCIE has conducted Presence Exams; their perspectives on hot-button areas of SEC investigations; and their tips for navigating a Presence Exam successfully.  This article summarizes the key points from the webinar.  See also “SEC’s National Examination Program Publishes Official List of Priorities for 2013 Examinations of Hedge Fund Managers and Other Regulated Entities,” The Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013).

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  • From Vol. 6 No.8 (Feb. 21, 2013)

    RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising (Part One of Two)

    On December 18, 2012, the Regulatory Compliance Association held its Compliance, Risk & Enforcement Symposium at the Pierre Hotel in New York City.  Participants at the event included leading hedge fund industry professionals, and panels focused on topics including insider trading, compliance programs and reviews, SEC examination priorities, hedge fund governance, Form PF and marketing and advertising issues.  We are covering the Symposium in a two article series.  This first installment addresses, among other things: insider trading (including a discussion of manager cooperation, the elements of insider trading, the continuing viability of the mosaic theory, insider trading investigative techniques and the use of expert networks and paid consultants); and compliance programs and reviews (including a discussion of the approach to and framework for hedge fund compliance programs and reviews, and specific policies and procedures designed to address trading risks).  The second installment will discuss SEC examination priorities (and practical guidance for addressing areas of concern); recent trends in hedge fund governance; lessons learned from initial Form PF filings and strategies for completing Form PF; and marketing and advertising issues, including a discussion of the JOBS Act and related issues.

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  • From Vol. 6 No.7 (Feb. 14, 2013)

    How Should Hedge Fund Managers Approach Formulating Risk Assessment Plans and What Regulatory Risks Should Be On Their Radar?

    On January 30, 2013, consulting firm The Regulatory Fundamentals Group (RFG) and risk management software developer MyComplianceOffice hosted a webinar entitled “Enterprise-Wide Hedge Fund Risk Assessment,” designed to help hedge fund managers understand risk assessments.  More specifically, the webinar described the “framework for conducting an enterprise-wide risk assessment” and highlighted a broad range of legal and regulatory risks to be considered.  Importantly, the speakers pointed out that “regulators other than the SEC and CFTC drive much of the regulation impacting hedge fund managers.”  See, e.g., “Hedge Fund Managers May Be Required to File TIC Form SHC by March 2, 2012,” The Hedge Fund Law Report, Vol. 5, No. 6 (Feb. 9, 2012).  This article summarizes key points from the webinar.

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  • From Vol. 6 No.2 (Jan. 10, 2013)

    When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?

    As evidenced by the ongoing series of enforcement actions, pleas and settlements of insider trading charges in the hedge fund context, social networks (primarily the old-fashioned kind) play an important role in the movement of corporate information from companies and their advisors to hedge fund managers.  See “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  College buddies, club acquaintances and former colleagues often talk investments.  But when one friend works at a company or for one of its advisors, and the other works at a hedge fund manager, such conversations are rife with insider trading risk.  In particular, such conversations create the possibility that the corporate insider or advisor may be considered a “tipper” under the misappropriation theory of insider trading; that the hedge fund manager employee may be considered a “tippee” vis-à-vis the corporate insider or advisor, and a “tipper” vis-à-vis his colleagues; and that everyone in the “chain” of tipping may be liable for insider trading.  In light of the ubiquity of social interactions with an investment component, and the ease with which such interactions can drift from the innocuous to the illegal, a recent federal appeals court decision merits close attention by hedge fund managers.  The decision offers the clearest and most authoritative recent statement of the standard for tipper or tippee liability under the misappropriation theory of insider trading.  In particular, the decision discusses the elements of tipper and tippee liability under the misappropriation theory, with a particular focus on the nature of the personal benefit required to trigger tipper liability; and the application of those elements to a fact pattern common in investment decision-making.  This article provides a comprehensive discussion of the appeals court decision; the trial court decision below; and analysis of what the decision means for the investment analysis process at hedge fund managers.  For a discussion of similar themes and challenges, see “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).

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  • From Vol. 5 No.48 (Dec. 20, 2012)

    SEC Settles Insider Trading Action against Tiger Asia Management

    On December 12, 2012, the SEC charged Tiger Asia Management, LLC (Tiger Asia Management), Tiger Asia Partners, LLC (Tiger Partners) and their principal, Sung Kook (Bill) Hwang, with insider trading and market manipulation relating to their trading in the shares of Bank of China, China Construction Bank and other Chinese companies.  The same day, Tiger Asia Management, Tiger Partners and Hwang agreed to pay $44 million in the aggregate to settle the charges.  This article summarizes the underlying misconduct, the settlement terms and the SEC’s charges.  See generally “Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 32 (Aug. 16, 2012).  Tiger Asia Management faces parallel criminal charges brought by the U.S. Attorney’s Office for the District of New Jersey.  For the details of an action brought by Hong Kong securities regulators against Hwang and Tiger Asia Management arising out of the same alleged insider trading, see “Hong Kong Securities and Futures Commission Wins Appeal of Insider Trading Action Against New York-Based Hedge Fund Manager Tiger Asia Management,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

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  • From Vol. 5 No.45 (Nov. 29, 2012)

    Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager

    Allegations of insider trading in the hedge fund industry are once again front-page news, what with the criminal and civil charges filed against former CR Intrinsic portfolio manager Mathew Martoma on November 20, 2012 and the receipt by SAC Capital Advisors of a Wells notice on the same day.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  But insider trading considerations were never far from the minds of hedge fund managers, lawyers or compliance professionals.  This is because vigorously pursuing important corporate information is central to most hedge fund strategies, yet doing so inherently involves the risk of obtaining material nonpublic information and trading on it.  At the same time, allegations of insider trading usually damage a hedge fund business fundamentally, and often shut it down altogether.  See “Navigating the Patchwork of Global Insider Trading Regulations: An Interview with Adam Wasserman of Dechert,” The Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012).  Hedge fund managers need to understand how the government thinks about this critical area, and it would be hard to find someone with better visibility into relevant government decision-making than former Deputy Chief of the DOJ’s Criminal Division and current Dechert partner Jonathan Streeter.  Streeter served as lead trial counsel for the government in the criminal trial of Raj Rajaratnam, founder and principal of the Galleon Group.  See “Galleon Management, LLC Founder Raj Rajaratnam Sentenced to 11 Years in Prison for Insider Trading,” The Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  Prior to the recent activity involving SAC, the Rajaratnam trial and conviction occasioned the last great crescendo of interest in hedge fund insider trading.  Among other things, the trial highlighted the new centrality of wiretap evidence and caused lawyers to revisit the meaning of the “mosaic theory.”  See “Is the ‘Mosaic Theory’ a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  Our interview with Streeter covered, among other things: how the government identifies targets for wiretaps; the communication channels covered by wiretaps (e.g., phones, e-mails); coordination between the DOJ and the FBI in sharing wiretap evidence; the extent to which the SEC can use wiretap evidence in its investigations and enforcement actions; the effectiveness of techniques used to challenge wiretaps; advice to personnel confronted with their wrongdoing and how to respond to government requests for cooperation; the value of cooperating with the government; the utility of a fund manager’s self-reporting of insider trading by an employee; how to handle government requests for information about insider trading by other hedge fund managers; the government’s view of the mosaic theory; how the government determines whether to make an insider trading investigation public; steps fund managers can take to avoid insider trading liability when talking with corporate executives or using expert networks; and the sources used by the government to identify potential insider trading targets.  The following is a complete transcript of our interview with Streeter.  This interview was conducted in connection with the Regulatory Compliance Association’s Compliance, Risk & Enforcement 2012 Symposium, which will take place on December 18, 2012 at the Pierre Hotel in New York.  For more information on the Symposium, click here.  To register for the Symposium, click here.  Hedge Fund Law Report subscribers are eligible for a registration discount.

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  • From Vol. 5 No.44 (Nov. 21, 2012)

    Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged “Record” $276 Million Insider Trading Scheme

    On November 20, 2012, the SEC filed a civil complaint charging hedge fund manager CR Intrinsic Investors, LLC (CR Intrinsic); one of its former portfolio managers, Mathew Martoma; and a doctor and medical consultant, Dr. Sidney Gilman, with allegedly participating in an insider trading ring in which CR Intrinsic, Martoma and funds managed by an unnamed affiliated hedge fund manager (identified in the financial press as SAC Capital) profited or avoided losses totaling $276 million – a record alleged value derived from an insider trading scheme, according to the U.S. Attorney’s Office.  According to the SEC’s complaint, CR Intrinsic traded ahead of a negative announcement of the results of a Phase II trial of a drug designed to treat Alzheimer’s disease that was being jointly developed by Elan Corporation, Plc and Wyeth.  Martoma allegedly received material nonpublic information through consultations with Gilman that were coordinated by an expert network firm.  Federal prosecutors in the Southern District of New York simultaneously unsealed a criminal complaint charging Martoma with insider trading.  This article summarizes the SEC’s complaint, including the allegations, claims and relief sought by the SEC.  (The factual allegations in the criminal complaint are substantially similar to those in the civil complaint.)

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  • From Vol. 5 No.44 (Nov. 21, 2012)

    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

    In April 2011, Joseph F. “Chip” Skowron III, a former portfolio manager at hedge fund manager FrontPoint Partners, LLC (FrontPoint) pleaded guilty to criminal insider trading and obstruction of justice charges arising out of his trading in Human Genome Sciences, Inc. and his subsequent efforts to cover up that trading.  Morgan Stanley, which owned FrontPoint at the time of Skowron’s trading, paid $33 million to settle the SEC’s enforcement action against Skowron and FrontPoint’s funds.  Morgan Stanley has now commenced a civil suit against Skowron to recover that amount, along with the millions of dollars in compensation it paid Skowron and other substantial expenses and damages it claims it incurred as a result of Skowron’s admitted criminal conduct.  It asserts five separate causes of action against Skowron.  This article summarizes the allegations, claims and relief requested in Morgan Stanley’s complaint.  See also “Former Portfolio Manager of Hedge Fund Manager FrontPoint Partners, Joseph F. ‘Chip’ Skowron, Is Charged with Civil and Criminal Insider Trading Arising Out of Trading in Human Genome Sciences Stock,” The Hedge Fund Law Report, Vol. 4, No. 13 (Apr. 21, 2011); and “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).

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  • From Vol. 5 No.42 (Nov. 9, 2012)

    Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation

    The ongoing crackdown on insider trading has been front page news for some time now.  Pundits have compared the situation to the 1980s when a wave of similar charges were leveled against Wall Street icon Ivan Boesky and other professional investors, bankers and lawyers of that era.  Unlike the 1980s, however, this latest round of insider trading enforcement is not limited to activity in the United States.  This time, foreign regulators have followed suit, bringing their own string of insider trading cases that, on the surface, seem to mirror what has been going on in the United States.  The leader of this pack has been the U.K.’s Financial Services Authority (FSA), which has cast aside its historical reputation as a “light touch” regulator by bringing a series of aggressive and unprecedented “insider dealing” cases against their own high-profile targets.  The FSA has secured 14 criminal convictions related to insider dealing since 2009 and is currently prosecuting another eight individuals on criminal insider dealing charges.  This recent flurry of international insider trading enforcement, coupled with the globalization of the world’s financial markets, subjects investment professionals to a new and unprecedented set of risks.  The crux of the problem is that the rules governing insider trading can differ significantly from jurisdiction to jurisdiction.  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, analyze the differences between U.S. and U.K. insider trading laws, and in the process, identify some of the potential pitfalls faced by U.S. investors who are active in investing in the United Kingdom.

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  • From Vol. 5 No.42 (Nov. 9, 2012)

    Competing Briefs in Rajaratnam Appeal Outline the Application of Wiretap Law to Hedge Fund Managers

    The use of wiretap evidence is the most important innovation in insider trading enforcement in the last five years, and nothing illustrates the evidentiary power of wiretap evidence as starkly as the Rajaratnam trial and conviction.  As the hedge fund industry well knows, on May 11, 2011, after a two-month trial, including 12 days of jury deliberations, Raj Rajaratnam, founder of hedge fund manager Galleon Group, was found guilty of nine counts of securities fraud and five conspiracy counts.  In October 2011, he was sentenced to 132 months in prison and ordered to pay a $10 million fine and to forfeit $53.8 million.  Prior to the Rajaratnam trial, most insider trading cases were based on circumstantial evidence.  But the case against Rajaratnam was based in large part on direct evidence – recordings of over 2,200 of Rajaratnam’s telephone conversations with more than 130 individuals.  As Rajaratnam’s defense team found, it is often difficult or impossible to rebut the validity of wiretap evidence.  Given the comprehensiveness of many wiretaps, it is even difficult in most cases to offer competing interpretations of the same wiretap.  There is no substitute from the prosecutor’s perspective – and little as damning – as a defendant explaining his bad acts in his own words.  Accordingly, the legal fight in connection with wiretaps often relates not to the content of the wiretap but to the validity of the wiretap in the first instance – and this is precisely the fight that Rajaratnam is waging in appealing his conviction to the Second Circuit.  Specifically, on appeal, Rajaratnam alleges that the government engaged in a flawed process in obtaining the warrant to wiretap his phones, and those flaws violated his Fourth Amendment rights as well as the federal wiretap statute.  Rajaratnam also challenges a jury instruction relating to the insider trading charges.  This article provides a feature-length analysis of Rajaratnam’s appeal brief and the government’s reply brief.  In doing so, this article provides a comprehensive view of the law governing wiretaps.  For hedge fund managers, general counsels, outside counsel, compliance officers, portfolio managers and others, it is now important to understand this area of law – an area previously applicable primarily in organized crime and conspiracy cases.  Understanding the law of wiretaps is important for many reasons.  Most notably, if the government wiretaps you or one of your portfolio managers, and if the wiretap bears fruit, there is a good chance that the government will approach you about settling before initiating a formal criminal matter.  If you understand the law of wiretaps – particularly if you can identify any infirmities in the process by which the government obtained its warrant – you will have a significant bargaining advantage vis-à-vis an investment management lawyer that is not conversant with this niche of criminal procedure.  You can hire a good white collar lawyer, of course, but if you understand this area, you will know what to ask and better appreciate the answers.  Our review of the appellate papers in the Rajaratnam matter is intended to highlight the primary legal considerations for the growing number of hedge fund industry participants that are concerned with wiretaps but that are not experts in criminal law and procedure.

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers

    At an October 1, 2012 event co-sponsored by The National Law Journal; MoloLamken LLP; Wachtell, Lipton, Rosen & Katz; and Wilmer Cutler Pickering Hale & Dorr LLP, an illustrious panel of former federal prosecutors discussed the current state of insider trading enforcement and reviewed numerous hot-button issues of interest to hedge fund managers and other investors.  This article summarizes the key insights from the panel discussion.

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  • From Vol. 5 No.38 (Oct. 4, 2012)

    Navigating the Patchwork of Global Insider Trading Regulations: An Interview with Adam Wasserman of Dechert

    As the investments and operations of hedge fund managers become increasingly global, managers must contend with a growing number and complexity of regulatory regimes.  One of the most complicated and important areas in which regulation varies from jurisdiction to jurisdiction is insider trading.  Insider trading regulation is complex enough domestically.  When you factor in the asymmetry among global regimes; different treatment of the same conduct; the often counterintuitive aspects of insider trading doctrine; and the ease of tripping jurisdictional wires, global insider trading regulation becomes a minefield for the unwary hedge fund manager.  Moreover, non-U.S. regulators – in the United Kingdom, Hong Kong and Japan, among other places – are growing more vigorous in their insider trading enforcement.  To help hedge fund managers identify and address some of the most important issues in global insider trading regulation, The Hedge Fund Law Report recently interviewed Adam Wasserman, a Partner at Dechert LLP.  The interview covered, among other topics: the biggest differences between the insider trading laws of the U.S. and non-U.S. jurisdictions; the unexpected aspects of insider trading doctrine from various jurisdictions; a discussion of the Greenlight Capital U.K. insider trading settlement; the relevance of the scienter element in insider trading claims in non-U.S. jurisdictions; the applicability of U.S. insider trading laws to conduct outside of the United States; the applicability of various jurisdictions’ insider trading laws in complex situations; whether the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ) are focusing insider trading efforts domestically or globally; identification of jurisdictions becoming more forceful in insider trading enforcement; the views of hedge fund managers with respect to domestic versus global insider trading issues; and policies and procedures hedge fund managers should implement to understand insider trading regulations where they do business and to prevent violations.  This article provides the complete transcript of our interview with Wasserman.  This interview was conducted in conjunction with the Regulatory Compliance Association’s upcoming Symposium entitled Compliance, Risk & Enforcement 2012.  Wasserman will be one of various asset management industry thought leaders participating at that Symposium, which will take place on October 30, 2012 at the Pierre Hotel in Manhattan.  For more information about the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for discounted registration.

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  • From Vol. 5 No.31 (Aug. 9, 2012)

    SEC Flexes Enforcement Muscle with Respect to Stock Offering Abuses Involving Reverse Merger Company China Yingxia International and Settles Enforcement Actions with Hedge Fund Manager Peter Siris and Others

    The Securities and Exchange Commission (SEC) has commenced civil enforcement proceedings against various individuals and entities involved in U.S. stock transactions involving China Yingxia International, Inc. (China Yingxia or Company), which went public via a 2006 reverse merger.  In one action, hedge fund manager Peter Siris (along with two affiliates) is accused of insider trading, acting as an unregistered broker and selling unregistered securities.  He is also accused of insider trading in the shares of a number of other small capitalization companies.  The SEC reports that he has settled those charges.  In a separate action, an investment relations firm employed by China Yingxia is accused of acting as an unregistered broker, and the company’s chief financial officer (CFO) is accused of fraud and a number of reporting violations.  The SEC has also entered into consent orders with three other individuals to resolve enforcement proceedings against them relating to their roles in the Company’s stock sales.  This article identifies the various players and their roles in China Yingxia’s capital markets activities; summarizes the charges against Siris, the CFO and the investment relations firm; and summarizes the settlements with the individuals.  See also “Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies,” The Hedge Fund Law Report, Vol. 4, No. 21 (Jun. 23, 2011).

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  • From Vol. 5 No.30 (Aug. 2, 2012)

    Selective Dissemination of Research Through Surveys, Trade Ideas Platforms, Huddles and Desk Research: What Are the Implications for Hedge Funds?

    A July 15, 2012 article in The New York Times originally entitled “In Surveys, Hedge Funds See Early Views of Stock Analysts,” highlighted the topic of selective dissemination of research, alleging that hedge funds are getting early access to ratings changes through surveys and “trade ideas” platforms.  Not to be outdone, The Wall Street Journal published an article on July 25, 2012 titled “Stock Research, For a Select Few” which discussed trade ideas platforms and the rise of “desk analysts” who are not subject to the same dissemination requirements as publishing analysts.  While selective dissemination is a front burner issue for regulators, the compliance implications for hedge funds are less clear.  In a guest article, Sanford (Sandy) Bragg, CEO of Integrity Research Associates, LLC, describes various methods for disseminating research, including surveys, trade ideas platforms, huddles and desk research; reviews recent regulatory activity on and rules governing the selective dissemination of research, particularly as it relates to trade ideas platforms; and discusses how hedge funds might mitigate selective dissemination risks.

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  • From Vol. 5 No.24 (Jun. 14, 2012)

    Davis Polk “Hedge Funds in the Current Environment” Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities

    On May 11, 2012, the New York City Bar Association held its annual “Hedge Funds in the Current Environment” program co-hosted by law firm Davis Polk & Wardwell LLP.  Speakers at this event addressed various topics of current relevance to the hedge fund industry, including: SEC examination priorities, such as insider trading, trade reviews and asset verification; establishing registered alternative funds; trends in hedge fund manager mergers and acquisitions; and hedge fund advertising after passage of the Jumpstart Our Businesses Startups (JOBS) Act.  Notably, Norm Champ, Deputy Director of the Office of Compliance Inspections and Examinations with the SEC, provided an up-to-date view of the SEC’s examination priorities in relation to hedge funds and their managers.  This article summarizes the key points discussed at the conference relating to each of the foregoing topics.

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  • From Vol. 5 No.23 (Jun. 8, 2012)

    RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part Two of Two)

    On April 16, 2012, the Regulatory Compliance Association held its Regulation and Risk Thought Leadership Symposium (RCA Symposium) in New York City at the Pierre Hotel.  The RCA Symposium brought together leading practitioners and regulators in a series of panel discussions, each of which offered unique insight on various topics of relevance for hedge fund managers.  This is the second article in a two-part series summarizing the highlights from the RCA Symposium.  This second article discusses the sessions covering: the new paradigm of regulatory enforcement and white-collar prosecution; chief compliance officer and general counsel liability; and re-evaluation of the operating model for third party relationships.  The first article discussed the sessions covering: fund governance issues; interpreting, preparing for and completing Form PF; and enterprise risk management for hedge fund managers.  See “RCA Symposium Focuses on Hedge Fund Governance, Form PF, Enterprise Risk Management, Regulatory Enforcement, Criminal Prosecution, CCO and GC Liability and Third Party Relationships (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 22 (May 31, 2012).

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  • From Vol. 5 No.20 (May 17, 2012)

    Navigating the Insider Trading Risks in Distressed Debt Trading

    The past two years have seen a dramatic increase in the number and visibility of insider trading cases brought by regulatory and enforcement authorities and private plaintiffs.  If the first few months of 2012 are any indication, this trend will continue.  Indeed, not only are enforcement authorities becoming more active in bringing such actions, they are also becoming more aggressive in their interpretation of the scope of actions which may constitute insider trading.  Thus, insider trading cases have been brought against a “tippee” who found a copy of a presentation about a buyout that a banker mistakenly left behind and against a director who is not even alleged to have traded or otherwise profited from the alleged misconduct.  To date, however, there have been relatively few attempts to pursue insider trading charges or civil claims in the context of bankruptcy claims trading, and those cases that have been brought have been largely limited to situations involving creditors’ committee members.  There are good reasons that such actions should be limited to the context of a creditors’ committee.  However, in light of the increasing activity in this area, it is worth reviewing the complexities involved in the application of insider trading laws to distressed debt trading.  In a guest article, Daniel H.R. Laguardia and K. Mallory Tosch, Partner and Associate, respectively, at Shearman & Sterling LLP, provide a comprehensive analysis of insider trading law as it applies to hedge funds that invest in distressed debt, bankruptcy claims and similar assets.

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  • From Vol. 5 No.16 (Apr. 19, 2012)

    Recent SEC Complaint Brings Together Two Headline Enforcement Trends: Insider Trading and China

    The SEC’s Division of Enforcement (Division of Enforcement) has redoubled its efforts to prosecute those engaged in various securities law violations by initiating a record 735 enforcement actions in 2011.  One of the SEC’s key initiatives has focused on ferreting out insider trading, and a number of the targets have been hedge fund managers and their personnel.  See “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).  It appears that the Division of Enforcement’s attempts to enhance its subject matter expertise and to upgrade the analytical and technological tools used to sniff out fraud have contributed to these efforts, as recently demonstrated by an action brought by the SEC against six Chinese traders and a British Virgin Islands corporation trader alleged to have engaged in insider trading.  This article describes the factual allegations, causes of action and relief sought by the SEC in the Complaint, as well as the cautionary lessons to be learned by hedge fund managers from the Complaint.  See “Insider Trading – The Long View,” The Hedge Fund Law Report, Vol. 4, No. 38 (Oct. 27, 2011).

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  • From Vol. 5 No.14 (Apr. 5, 2012)

    Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls

    Every day officials in Washington make decisions that affect the prospects and profitability of individual companies and entire industries.  Thus, it is not surprising that the use of political intelligence firms has become increasingly common among sophisticated investors such as hedge funds.  Depending on the focus of the engagement, these firms can help hedge funds in a variety of areas, including conducting research and due diligence, developing an investment idea or strategy and informing trades in financial markets.  For funds that need to follow legislative or regulatory developments closely, political intelligence consultants can serve as their eyes and ears in Washington.  By leveraging their relationships with lawmakers and agency officials, these consultants can deliver real-time “inside the Beltway” information thereby providing a competitive advantage over those simply monitoring news and data services.  On April 4, 2012, President Obama signed into law a bill that raises important issues for hedge funds that retain political intelligence firms.  The bill is called the Stop Trading on Congressional Knowledge Act, commonly referred to as the STOCK Act.  Although the primary purpose of the bill is to affirm that the insider trading laws apply to Members of Congress and other public officials, the legislation makes clear that hedge funds and their employees who trade on information obtained from a political intelligence firm can be exposed to potential liability.  The STOCK Act has also drawn significant attention to political intelligence firms and those who retain their services.  Given these developments, a heightened level of government scrutiny in this area is expected.  Federal prosecutors and regulators will likely be focused on the type of information these firms obtain, how they obtain it, who they provide it to and how it is used.  Thus, while political intelligence firms can deliver a valuable service that is entirely lawful, fund managers who employ these firms or who wish to do so should be aware of the possible associated risks.  In a guest article, Justin V. Shur, a Partner at Molo Lamken LLP, considers those risks and offers four specific suggestions as to how to manage them.

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  • From Vol. 5 No.14 (Apr. 5, 2012)

    Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act

    Hedge fund managers compensate their employees for services rendered with the expectation that such services will be rendered with competence, integrity and honesty.  However, when employees fail to live up to these expectations, do hedge fund managers have any recourse?  For example, may managers claw back compensation paid to such employees and recoup costs incurred in investigating and defending against securities fraud claims?  A recent decision by the U.S. District Court for the Southern District of New York suggests that, yes, hedge fund managers may in fact have some recourse against rogue employees.

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  • From Vol. 5 No.13 (Mar. 29, 2012)

    Recently-Filed SEC Action Demonstrates the Potential Risks of Insider Trading by Investment Consultants Hired by Private Fund Managers

    Private fund managers, including hedge fund managers, often hire investment consultants to help evaluate investments; analyze an investment target company’s operations, management and financial condition; offer strategic and structuring advice; and provide related services.  To provide value, such consultants typically request and receive deep access to confidential target company data.  The company typically grants such access under the terms of a confidentiality agreement between the company and the consultant, or among the company, the consultant and the private fund manager.  Typically, the primary purpose of such confidentiality agreements is to prevent confidential company information from reaching a competitor or from being used by the consultant on behalf of a competitor.  A secondary purpose of such agreements is to prevent insider trading by “temporary insiders” or their tippees, or Regulation FD violations by the company.  However, an enforcement action recently filed by the SEC suggests that confidentiality agreements, standing alone, may not be sufficient to prohibit insider trading by investment consultants.  While the private fund manager involved was not charged, the charges against the manager’s consultant reflect adversely on the manager.  The charges suggest, for example, that the manager did not take adequate precautions to control the conduct of the consultant.  Given the radioactivity of insider trading charges in the current enforcement environment, risk aversion with respect to insider trading is prudent business.  This article discusses the SEC’s factual and legal allegations in the matter, as well as the consultant’s proposed settlement agreement.  This article also details four steps that private fund managers may take to prevent insider trading by their investment consultants.

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  • From Vol. 5 No.10 (Mar. 8, 2012)

    Hong Kong Securities and Futures Commission Wins Appeal of Insider Trading Action Against New York-Based Hedge Fund Manager Tiger Asia Management

    On February 23, 2012, the Hong Kong Court of Appeal ruled on a dispute between hedge fund manager Tiger Asia Management LLC and the Hong Kong Securities and Futures Commission.  This ruling adds to the total mix of considerations for any U.S.-based hedge fund manager considering entering the Hong Kong market.  See also “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Four of Four),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  For a discussion of another matter highlighting the asymmetry between U.S. and non-U.S. insider trading doctrine, see “FSA Imposes £7.2 Million Penalty on Hedge Fund Manager David Einhorn and Greenlight Capital for Unintentional Insider Dealing in Shares of British Pub Owner Punch Taverns Plc,” The Hedge Fund Law Report, Vol. 5, No. 5 (Feb. 2, 2012).

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  • From Vol. 5 No.6 (Feb. 9, 2012)

    Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Three of Three)

    One of the principal challenges many hedge fund managers face is effectively and efficiently enforcing a firm’s compliance policies and procedures given limited compliance resources.  This problem has been historically acute with respect to personal trading compliance because of the significant manual effort required to ensure compliance with applicable rules and in-house personal trading requirements.  Nonetheless, in the past decade, technology vendors have made significant progress in developing personal trading compliance solutions that can significantly enhance the effectiveness and efficiency of personal trading compliance programs, at relatively modest prices.  Technological solutions can facilitate personal trading reporting as well as enforcement of a firm’s personal trading restrictions and prohibitions.  Furthermore, vendors can now tailor such solutions to meet the needs of hedge fund managers with varying operational requirements.  As such, hedge fund managers should explore and understand the various personal trading compliance solutions available to them to determine whether any such solutions will further advance the goals of their personal trading compliance programs.  This is the third article in a three-part series on personal trading policies and procedures for hedge fund managers.  The first article in this series discussed general considerations for hedge fund managers in developing effective personal trading policies; the scope of persons that may be covered by such personal trading policies; and the reporting obligations imposed on registered hedge fund managers by Rule 204A-1 under the Investment Advisers Act of 1940 (Advisers Act).  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part One of Three),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  The second article discussed various personal trading restrictions and prohibitions, including limitations on the number of brokerage firms covered persons can use to effect personal trades; pre-clearance requirements for personal trades; blackout periods during which personal trades cannot be effected; holding periods applicable to securities owned by covered persons; and other types of personal trading restrictions and prohibitions.  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Two of Three),” The Hedge Fund Law Report, Vol. 5, No. 4 (Jan. 26, 2012).  This third article in the series describes various solutions designed to facilitate monitoring of personal trading compliance by hedge fund managers.  Specifically, this article discusses various technological solutions designed to facilitate personal trading reporting, including the various methods for obtaining electronic personal trading data (instead of paper data) from broker-dealers; various solutions for automating personal trade monitoring; automated trade pre-clearance solutions; and a summary of key considerations for hedge fund managers when evaluating personal trading compliance solutions.  See generally “How Hedge Fund Managers Can Use Technology to Enhance Their Compliance Programs,” The Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011).

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  • From Vol. 5 No.6 (Feb. 9, 2012)

    Does Social Media Have a Place in the Hedge Fund Industry?

    While social media has captivated society and propelled it deeper into the communication age, the hedge fund industry has not yet embraced it on a meaningful scale.  See “Legal Considerations for Hedge Fund Managers that Use Social Media,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  In fact, a recent survey of hedge fund managers found that the vast majority of hedge fund managers are simply not using social media.  On the one hand, it is surprising that hedge fund managers have been slow to explore social media given the otherwise cutting edge nature of the hedge fund industry.  On the other hand, many compliance professionals are simply stretched too thin by the introduction of new regulatory challenges arising from the Dodd-Frank Act, and thus are unable to devote resources to exploring this new frontier.  In reality, there appears to be very little dialogue regarding whether social media could be used effectively in the hedge fund industry, and if so, how to do so in compliance with applicable laws and regulations.  Therefore, in a guest article, John Herbert Roth, Counsel and Chief Compliance Officer of Venor Capital Management LP, initiates that dialogue by asking whether social media can have a place in the hedge fund industry, and then proposing a comprehensive framework within which hedge fund managers may think about social media and its compliance implications.  See also “SEC Enforcement Action and Bulletins Shine Spotlight on Use of Social Media by Investment Advisers,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).

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  • From Vol. 5 No.5 (Feb. 2, 2012)

    FSA Imposes £7.2 Million Penalty on Hedge Fund Manager David Einhorn and Greenlight Capital for Unintentional Insider Dealing in Shares of British Pub Owner Punch Taverns Plc

    The UK Financial Services Authority (FSA) has concluded that hedge fund founder David Einhorn and his Greenlight Capital Inc. (Greenlight) engaged in impermissible “insider dealing” when they sold shares of British pub owner Punch Taverns Plc (Punch) immediately following a conference call with Punch management.  The FSA concluded that, even though Einhorn had refused to sign a nondisclosure agreement before the call and believed that he had not received inside information, Einhorn should have refrained from trading in Punch shares because he should have understood that he had received inside information about the terms and timing of a proposed equity issuance by Punch.  We summarize the FSA’s conclusions and the rationale for its actions.  See generally “Use by Hedge Fund Managers of Restricted Lists, Watch Lists and Ethical Walls to Prevent Insider Trading Violations,” The Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011).

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  • From Vol. 5 No.4 (Jan. 26, 2012)

    Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Two of Three)

    Carefully conceived personal trading restrictions and prohibitions (such as pre-clearance of personal trades and blackout periods) are some of the most valuable tools available to a hedge fund manager to detect and prevent personal trading fraud, including insider trading and front-running.  Such policies prove the adage that an ounce of prevention is worth a pound of cure.  Contrast such personal trading restrictions and prohibitions with the reporting obligations mandated by Rule 204A-1 under the Investment Advisers Act of 1940 (Advisers Act) which only require a firm to review its covered persons’ trades retroactively.  Once a trade has been effected, a firm has few remedial options other than breaking the trade (if it is discovered in time) or disciplining the covered person (potentially including requiring him or her to disgorge any profits).  More often than not, once a personal trading violation has occurred, the damage has been done.  As such, unless a hedge fund manager flatly prohibits all personal trading by its covered persons, it will need to adopt some personal trading restrictions and prohibitions to prevent personal trading fraud.  Unfortunately, the securities laws and rules (including Rule 204A-1) provide only limited guidance in this regard.  This is the second article in a three-part series on personal trading policies and procedures for hedge fund managers.  The first article in this series discussed general considerations for hedge fund managers in developing effective personal trading policies; the scope of persons that may be covered by such personal trading policies; and the reporting obligations imposed on registered hedge fund managers by Rule 204A-1.  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part One of Three),” The Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  This article discusses various personal trading restrictions and prohibitions, including limitations on the number of brokerage firms covered persons can use to effect personal trades; pre-clearance requirements for personal trades; blackout periods during which personal trades cannot be effected; holding periods applicable to securities owned by covered persons; and other types of personal trading restrictions and prohibitions.  The third article in this series will describe various solutions designed to facilitate monitoring of personal trading compliance by hedge fund managers.

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  • From Vol. 5 No.4 (Jan. 26, 2012)

    SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million

    The Securities and Exchange Commission (SEC) has continued its push to root out insider trading in the hedge fund industry by leveling charges against two prominent hedge fund managers, certain of their respective principals and a network of analysts who allegedly shared inside information about Dell and Nvidia.  This article details the SEC’s allegations and summarizes the status of the related criminal charges and recent developments.

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  • From Vol. 5 No.4 (Jan. 26, 2012)

    SEC Settlement with Diamondback Capital Evidences SEC’s New Practice of Prohibiting Defendants from Settling Cases Without Admitting or Denying Facts Admitted in Parallel Criminal Matters

    On January 23, 2012, Diamondback Capital Management, LLC (Diamondback) entered into agreements with the U.S. Attorney’s Office for the Southern District of New York (U.S. Attorney’s Office) and the SEC to, respectively, avoid criminal prosecution and settle parallel civil charges.  For a thorough discussion of the civil and criminal charges and resolutions to date, see “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” above, in this issue of The Hedge Fund Law Report.  The settlement with the SEC is important because it represents the first settlement under the SEC’s new policy adopted on January 6, 2012 whereby it no longer permits defendants to settle civil charges in connection with a civil injunctive complaint or an administrative order without admitting or denying allegations of wrongdoing where: (1) a defendant has been the subject of a parallel criminal conviction or; (2) a defendant has signed a non-prosecution agreement or deferred prosecution agreement in a parallel criminal prosecution in which it admits or acknowledges wrongdoing.  This article describes the new SEC policy change as well as the implications for hedge fund managers facing parallel criminal and civil actions.

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  • From Vol. 5 No.3 (Jan. 19, 2012)

    Delaware Chancery Court Sanctions Legendary Investor Michael Steinhardt for Trading in Occam/Calix Shares Based on Confidential Information He Received While Serving as a Representative Plaintiff in a Class Action Against Occam

    In October 2010, plaintiffs Michael Steinhardt (Steinhardt), two hedge funds managed by Steinhardt, Derek Sheeler and Herbert Chen (Chen) commenced a class action lawsuit seeking to enjoin the proposed acquisition of defendant Occam Networks, Inc. (Occam) by Calix, Inc. (Calix) and challenging the fairness of the transaction.  The injunction was denied and the transaction closed in February 2011, but the litigation continued.  During discovery, the defendants learned that Steinhardt and Chen had traded in Occam and Calix shares while subject to a confidentiality order that prohibited trading in shares of Occam and Calix and the use of non-public information discovered in the course of the suit.  The defendants moved for sanctions against them.  The Delaware Chancery Court ruled that Steinhardt had violated his fiduciary duty as a class representative, dismissed him and his funds from the suit with prejudice, and imposed various sanctions on them.  The Court denied the motion as against Chen.  We detail the facts of the case and the Court’s reasoning.

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  • From Vol. 5 No.2 (Jan. 12, 2012)

    STOCK Act Could Expand Insider Trading Laws to Prohibit Trading by Hedge Funds Based Upon Nonpublic “Political Intelligence”

    Last month the Senate Homeland Security & Governmental Affairs Committee passed the “Stop Trading on Congressional Knowledge Act,” or “STOCK Act,” and the House Financial Services Committee held hearings on similar legislation.  The primary purpose of this Act is to close a loophole in the law that may allow Members of Congress to legally trade securities based upon nonpublic “political intelligence.”  However, hedge fund managers should watch this legislation closely as it could have significant, perhaps unintended, implications.  Depending on what provisions (if any) are ultimately enacted, the legislation could alter the way fund managers conduct basic regulatory due diligence in connection with investments.  The legislation could weaken a key provision of Regulation FD, which confirms the “mosaic theory” defense to federal insider trading charges, and impact the way fund managers use employees, expert networks, lobbyists and political intelligence firms to research federal legislative and political activities in connection with their investments.  In fact, the legislation could fundamentally alter the way that fund managers interact with federal employees, including Members of Congress.  In a guest article, Scott E. Gluck, Of Counsel at Venable LLP, discusses: the background of the STOCK Act; relevant insider trading law; specific provisions of the STOCK Act relevant to hedge fund managers; and seven distinct issues for hedge fund managers to monitor, including the potential impact of the STOCK Act on the “mosaic theory” defense to insider trading charges.

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  • From Vol. 4 No.45 (Dec. 15, 2011)

    Is the “Mosaic Theory” a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?

    When a hedge fund manager pieces together what he or she reads in a recent article, blog or report with other inconsequential nonpublic information previously acquired in such a way that it reveals a material insight into an issuer or its prospects – and the manager trades based on the insight – should that manager be charged with insider trading?  Generally, such “Eureka” moments have been protected under the “mosaic theory,” which has been recognized explicitly both in caselaw and in pronouncements by the SEC.  For example, in October 2011, when SEC Chairman Mary Schapiro was asked for her views on the use of “expert network” firms by hedge fund managers, she noted that “[t]here is nothing wrong with doing tremendous due diligence” when it comes to stock research, and that there “is a . . . pretty bright line” between stock research and illegal insider trading.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part Two of Two),” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).  Recently, however, the SEC has brought a number of insider trading cases suggesting that the “line” separating research and conduct the SEC may seek to punish is far greyer and fainter than Chairman Schapiro indicated.  In a guest article, Perrie Weiner, Patrick Hunnius and Stephanie Smith, partner, senior counsel and associate, respectively, at DLA Piper, examine recent insider trading cases brought by the SEC based on investors having pieced together a mosaic of facts.  These cases provide valuable insight into important questions that should shape a hedge fund manager’s approach to the investment research process and what precautions the fund manager should take.  For example, what mosaic of activities has amounted to an inference of insider trading?  What actions should hedge fund managers take to ensure their conduct does not even give rise to the appearance of insider trading?

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  • From Vol. 4 No.41 (Nov. 17, 2011)

    How Do Courts Assess Civil Monetary Fines in Insider Trading Cases Against Hedge Fund Managers?

    On November 8, 2011, Judge Jed S. Rakoff of United States District Court for the Southern District of New York imposed a record civil penalty of $92,805,705 on Galleon Group founder Raj Rajaratnam.  Judge Rakoff’s opinion analyzes the civil penalty provisions of the Securities and Exchange Act of 1934 in a civil insider trading action against a hedge fund manager that has been convicted of insider trading in a parallel criminal case.  The opinion illustrates the factual and legal considerations that influence the calculation of civil penalties; the public policy purpose of civil penalties; whether civil penalties should be based on gross trading profits of a hedge fund or net fees and profits personally gained by the individual defendant; and the time during which relevant profit gained or loss avoided should be measured.  For hedge fund managers, Rakoff’s ruling serves as a reminder that profits from insider trading, if discovered, are in effect a loan from the government with usurious terms.  You have to pay it back, and the interest includes whatever you gained, the full value of your management company and the entirety of your reputation.

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  • From Vol. 4 No.40 (Nov. 10, 2011)

    Business Issues with Legal Consequences: A Wide-Ranging Interview with Dechert Partner George Mazin about the Most Important Challenges Facing Hedge Fund Managers

    The Hedge Fund Law Report recently had the privilege of interviewing George J. Mazin, a Partner at Dechert LLP, and a deservedly well-regarded member of the hedge fund bar.  As evidenced by the text of our interview, which is included in this issue of The Hedge Fund Law Report, George has an aptitude for identifying the legal consequences of business issues, and explaining them clearly.  He also has the kind of market color that only comes with years – decades – in the trenches, and experience across business cycles.  Our interview was wide-ranging, reflecting the diversity of George’s experience, which in turn reflects the range of legal issues relevant to hedge fund managers.  In particular, our interview covered: valuation considerations in connection with affiliate transactions; valuations based on fraudulent sales and rigged dealer bids; manager overrides of third-party valuations; whether side pockets remain viable in new hedge fund launches; how even non-ERISA hedge funds can analogize the ERISA model of independent pricing; effective valuation testing programs; the interaction between GAAP and the custody rule; GAAP exceptions to audit opinions; use of counterparty confirmations by the SEC; delayed audits; custody of derivatives and limited partnership interests; insider trading policies with respect to market chatter and channel checking; how to grant side letters in light of selective disclosure considerations; how algorithmic or high-speed trading firms can prepare for regulatory examinations; legal considerations in connection with loans from a hedge fund to a manager; best practices in connection with principal trades; and whether side-by-side investing by manager personnel can pass muster under fiduciary duty and related principles.  This interview was conducted in connection with the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, which is taking place today at the Pierre Hotel in New York.

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  • From Vol. 4 No.40 (Nov. 10, 2011)

    SEC Charges Hedge Fund Founder and His Friends and Family with Insider Trading

    On August 31, 2011, the United States Securities and Exchange Commission (SEC) continued its war on “family and friends” insider trading when it filed a civil complaint in the United States District Court for the District of New Jersey against Clay Capital Management, LLC; one of its founders, James F. Turner, II; his neighbor, Mark Durbin; and Mr. Turner’s alleged accomplices, Scott Vollmar and Scott Robarge (together, defendants).  The complaint accuses Turner of insider trading in early 2008 on information obtained from his brother-in-law Vollmar, a director of business development for Autodesk, Inc., and his college friend Robarge, a recruiting technology manager for Salesforce.com, Inc.  It also accused Turner of passing that information to the Clay Capital Fund, LP (the Fund) and other family members and friends, and accuses Vollmar of doing the same for his neighbor Durbin.  The complaint does not accuse his unnamed associates, including his partners in the Clay Fund, of participating in or having any knowledge of the scheme.  The accusations again Robarge and Durbin have already resulted in settlements with the SEC.  We detail the allegations in the complaint, which provide further insight into what information flows among friends and family constitute insider trading in the view of the current SEC Enforcement Division.

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  • From Vol. 4 No.38 (Oct. 27, 2011)

    SEC Exams of Hedge Fund Advisers: Focus Areas and Common Deficiencies in Compliance Policies and Procedures

    It is a well-known fact that the SEC has significantly fewer examiners than it has registrants to examine.  Nowhere is the SEC more outnumbered than in the investment adviser arena, with approximately 435 examiners compared to more than 11,000 registered investment advisers.  In the first quarter of 2012, advisers with less than $100 million in assets under management will generally transition from SEC registration to state registration.  However, the mandatory registration of private fund advisers with more than $150 million in assets will continue to pose significant resource challenges to SEC examiners.  What’s more, the newly registered private fund advisers will likely be higher risk and more complex firms, which will require more examination resources than those firms moving off the SEC’s rosters.  To help manage this resource imbalance, SEC examinations are becoming much more focused and targeted on high-risk firms and the highest risk activities and practices within those firms; and as a result of various factors discussed in this article, SEC examiners are much better prepared than in the past to scrutinize hedge fund business practices and they have an eager group of well-equipped enforcement staff ready to bring cases – often a series of cases – on the issues where examiners are focusing.  In a guest article, Kimberly Garber – a Founding Principal of boutique compliance firm CORE-CCO, LLC, and former Associate Regional Director in charge of the Examination Program in the Fort Worth Regional Office of the SEC – discusses five risk areas where SEC examiners commonly focus in hedge fund examinations and where compliance policies and procedures are often lacking.  In each area, how comprehensive a firm’s procedures need to be will depend on the risks presented by the firm’s business practices, affiliates and client relationships, and how actively the firm and its personnel engage in each type of activity.  If a firm does not purport to engage in or chooses to prohibit certain activities, its policies and procedures should specify such prohibited practices but also contemplate controls to ensure that employees do not inadvertently or purposefully engage in prohibited activities.

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  • From Vol. 4 No.38 (Oct. 27, 2011)

    Insider Trading – The Long View

    Meyer “Mike” Eisenberg has experienced the evolution of insider trading doctrine and enforcement over decades, and from diverse vantage points.  He worked at the SEC during an era when some of the seminal cases were litigated.  Then he experienced the impact of those cases on industry participants in private practice.  And he has taught about the intersection of the cases and their practical import in various academic appointments.  Eisenberg is expected to participate at the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, to be held on November 10, 2011 at the Pierre Hotel in New York.  (For a fuller description of the Symposium, click here; to register for the Symposium, click here; subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  In particular, while each of the expected participants at the upcoming RCA Symposium – including private side and public side thought leaders – will have a firm grasp of current regulatory developments and their impact on hedge fund managers, Eisenberg is unique in his ability to provide what might be called the “long view.”  He has lived insider trading law for decades, from different angles.  He knows how the current crop of cases is similar to and different from what has come before – and how hedge fund managers can put that context into practice; he can credibly discern regulatory trends; and he knows what motivates and matters to regulators.  In anticipation of the RCA Symposium, The Hedge Fund Law Report had the opportunity to interview Eisenberg on insider trading and related topics.  Our interview specifically covered, among other things: Eisenberg’s background; some hoary but still relevant case law; why the SEC may bring an enforcement action where only a small dollar amount is at issue; interaction between OCIE and Enforcement; whether the SEC or private parties may bring aiding and abetting insider trading claims; whether the SEC must prove scienter when it brings a fraud claim against a hedge fund manager under Advisers Act Section 206; what hedge fund managers should do in response to the new use of wiretaps in insider trading investigations; whether the DOJ is likely to use wire fraud charges to “criminalize” activity that does not satisfy the elements of criminal securities fraud; how hedge fund portfolio managers can safely talk to corporate insiders; and compliance policies and procedures hedge fund managers should implement regarding use of consultants, channel checking firms and similar persons.  The full text of our interview with Eisenberg is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 4 No.37 (Oct. 21, 2011)

    Use by Hedge Fund Managers of Restricted Lists, Watch Lists and Ethical Walls to Prevent Insider Trading Violations

    Information management is at the core of the hedge fund business.  If managed properly, information can generate outsized returns.  If managed improperly, information can lead to insider trading and other securities law charges, and criminal liability.  Hedge fund managers, accordingly, work hard to compile mosaics of information that can serve as the basis of legal trading, and that do not include material nonpublic information (MNPI).  See “Investment Research and Insider Trading on ‘Outside Information’,” The Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011).  In doing so, one of the more popular and potent tools is the restricted list.  A close cousin of the restricted list is the watch list, and a related technique is the ethical wall.  This article provides a guide for hedge fund managers in creating, disseminating, updating and enforcing a restricted list.  In particular, the article discusses: the definition of a restricted list; the legal, regulatory and practical sources of the obligation to maintain a restricted list; relevant issues raised by the simultaneous management of hedge funds that invest in public and private securities; when a name should be added to and removed from a restricted list; whether subsidiaries, affiliates and various parts of the capital structure should be included in a restricted list; access to and dissemination and updating of a restricted list; two SEC enforcement actions highlighting compliance concerns that may motivate the SEC to bring an action against a hedge fund manager in this context; and eight techniques for enforcement of a restricted list.  The article also provides a chart of six fact patterns in which names may be added to a restricted list, listing, for each, the event that may require addition to the restricted list and the event that may justify removal.  In addition, the article contains a detailed discussion of “wall crossing” scenarios in the hedge fund context and concludes with a discussion of what watch lists are and how they are used by hedge fund managers.

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  • From Vol. 4 No.36 (Oct. 13, 2011)

    Galleon Management, LLC Founder Raj Rajaratnam Sentenced to 11 Years in Prison for Insider Trading

    On October 13, 2011, U.S. District Judge Richard J. Holwell sentenced Galleon Management, LLC founder Raj Rajaratnam, 54 years old, to 11 years in prison.  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,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  About five months ago, on May 11, 2011, Rajaratnam was convicted of all 14 counts of conspiracy and securities fraud with which he was charged, following an eight-week jury trial.  See “On Motion to Set Aside Verdict, Trial Court Upholds All Fourteen Counts of Rajaratnam Insider Trading and Conspiracy Conviction,” The Hedge Fund Law Report, Vol. 4, No. 30 (Sep. 1, 2011).  According to the U.S. Attorney’s Office for the Southern District of New York, Rajaratnam’s sentence is the longest sentence to be imposed for insider trading in history.  See “Strategies for Avoiding Insider Trading Violations: A Perspective Informed by SEC Service, Private Law Firm Practice and Work as General Counsel of a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  In addition to his prison term, Rajaratnam was sentenced to two years of supervised release, ordered to pay forfeiture in the amount of $53,816,434 and ordered to pay a $10 million fine.  Rajaratnam is scheduled to surrender to authorities on November 28, 2011.  See “How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?,” The Hedge Fund Law Report, Vol. 4, No. 28 (Aug. 19, 2011).

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  • From Vol. 4 No.35 (Oct. 6, 2011)

    WaMu Bankruptcy Judge Allows Equity Committee’s Action for Equitable Disallowance of Hedge Fund Noteholders’ Claims to Proceed on the Ground that Equity Committee Stated a “Colorable Claim” that those Noteholders Engaged in Insider Trading

    In a shot across the bow of investors who trade in the debt of bankrupt companies, a U.S. bankruptcy court has held that the Equity Committee of Washington Mutual, Inc. (WaMu) has stated a “colorable claim” that four hedge funds that held WaMu debt and participated in bankruptcy settlement negotiations engaged in insider trading when they traded WaMu’s debt.  Hedge funds Appaloosa Management, L.P., Aurelius Capital Management LP, Centerbridge Partners, LP, and Owl Creek Asset Management, L.P. (together, Noteholders), acquired enough WaMu debt that they were in a position to block approval of portions of WaMu’s plan of reorganization.  As a result, they were allowed to participate in negotiations among the various stakeholders in the bankruptcy.  WaMu’s Equity Committee alleged that the Noteholders had engaged in insider trading using information they received during settlement negotiations and that, as a result, their claims should be equitably disallowed.  In a wide-ranging decision denying confirmation of WaMu’s sixth amended reorganization plan, the Court ruled that the Equity Committee had alleged a colorable claim of insider trading by the Noteholders that could support equitable disallowance of their claims.  This article provides a feature length synopsis of the facts that gave rise to the insider trading charges, and the Court’s reasoning.

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  • From Vol. 4 No.34 (Sep. 29, 2011)

    Strategies for Avoiding Insider Trading Violations: A Perspective Informed by SEC Service, Private Law Firm Practice and Work as General Counsel of a Hedge Fund Manager

    The Hedge Fund Law Report publishes frequently on the topic of insider trading.  It is, perhaps, the most important topic we cover, for at least six reasons.  First, it is complex and at times counterintuitive.  Second, it is particularly difficult to apply the doctrine to the day-to-day facts of investment analysis, research and trading.  Third, while the bedrock doctrine remains relatively constant, the outside contours of the law and the fact patterns in which the law applies are changing continuously.  Fourth, insider trading considerations are pervasive: they apply across strategies and geographies, in funds and in personal accounts.  Fifth, investigative techniques and technology are evolving rapidly.  And sixth, insider trading violations – or even suspicions thereof – can promptly bring down the curtain on a hedge fund management business.  The list goes on, but the point is that for hedge fund managers, insider trading is a virtually inexhaustible topic, an ongoing concern.  Like The Hedge Fund Law Report, the Regulatory Compliance Association (RCA) regularly includes in-depth analysis of insider trading at its Symposia.  Consistent with that focus, the RCA’s Fall 2011 Asset Management Thought Leadership Symposium (to be held on November 10, 2011 at the Pierre Hotel in New York) will feature a session on insider trading.  (For a fuller description of the Symposium, click here; to register for the Symposium, click here; subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  We have interviewed various of the speakers expected to participate in the insider trading session, and we have published the full transcripts of some of those interviews.  For the transcript of our interview with Scott Pomfret, Regulatory Counsel for a Boston-based institutional money manager and a former branch chief in the SEC’s Division of Enforcement, click here.  And for the transcript of our interview with Kevin O’Connor, Partner at Bracewell & Giuliani and Chair of the firm’s White Collar Practice Group, and previously Associate Attorney General of the United States and United States Attorney for Connecticut, click here.  This week’s issue of The Hedge Fund Law Report includes a transcript of our interview with Scott Black.  Black is General Counsel and Chief Compliance Officer at Hudson Bay Capital Management LP.  He previously served as Assistant Regional Director in the Division of Enforcement of the SEC’s New York Regional Office and practiced law at Wachtell, Lipton, Rosen & Katz.  Our interview with Black covered, among other things: characteristics of a hedge fund manager that make it more likely to become the target of an insider trading investigation; steps that hedge fund managers can take to diminish the likelihood that they will become such a target; selective disclosure considerations; how hedge fund managers should respond to the increasing use of wiretaps in insider trading investigations; whether the government will use wire fraud charges to criminalize activity that would not constitute criminal securities fraud; steps hedge fund managers can take to avoid insider trading violations when talking to company insiders; best practices for engaging expert network firms; best practices for using experts, consultants, channel checking firms and others outside of the context of an expert network; steps to prevent insider trading violations when hedge fund manager personnel serve on a creditors’ committees; and the practical implications of the SEC’s recent cooperation initiative.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Fifth Annual Hedge Fund General Counsel Summit Covers Insider Trading, Expert Networks, Whistleblowers, Exit Interviews, Due Diligence, Examinations, Pay to Play and More

    On September 13, 2011, ALM Events hosted its fifth annual Hedge Fund General Counsel Summit at the Harvard Club in New York City.  Participants at the event discussed how the changing regulatory landscape is impacting the day-to-day policies, procedures and practices of hedge fund managers.  Of particular note, discussions focused on insider trading in the post-Galleon world; best compliance practices for engaging and using expert network firms; how to motivate employees to report wrongdoing internally rather than filing whistleblower complaints; the interaction between non-disparagement clauses in hedge fund manager exit agreements and the whistleblower rule; best practices for exit interviews; best practices for responding to initial and ongoing due diligence inquiries; consistency across DDQs and other documents; standardization of DDQs versus customized answers; whether to disclose the existence or outcome of regulatory actions; how to deal with government investigations and examinations; and strategies for complying with the pay to play rule.  This article summarizes the most noteworthy points made at the event.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Wiretaps, Whistleblowers, Expert Networks and Insider Trading: A Conversation with Kevin O’Connor, Former Associate Attorney General of the U.S. and Former U.S. Attorney for Connecticut

    Hedge fund managers remain a prime target for civil and criminal insider trading charges.  This is so for at least five reasons.  First, regulators and prosecutors have been emboldened by the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam on 14 counts of conspiracy and securities fraud.  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,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Second, wiretapping has become a viable tool for investigating insider trading by hedge fund manager personnel, and a source of persuasive evidence.  See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Third, in the course of examinations of hedge fund managers, SEC examination personnel are looking for (among other things) evidence of insider trading that can serve as the basis of referrals to the SEC’s Enforcement Division.  See “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?,” The Hedge Fund Law Report, Vol. 4, No. 32 (Sep. 16, 2011).  Fourth, the staff of the SEC’s Enforcement Division can now use tools developed in the criminal context in bringing, negotiating and settling insider trading charges against hedge fund managers.  See “Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  And fifth, budgetary constraints have led the SEC to place a higher priority on deterrence, and insider trading actions against hedge fund managers are thought to have a powerful deterrent effect.  See “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  In light of the vigor with which civil and criminal authorities are pursuing insider trading actions – and the ongoing susceptibility of hedge fund managers to insider trading charges – the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – The New Enforcement Paradigm.”  That RCA Symposium will take place on November 10, 2011 at the Pierre Hotel in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  One of the speaking faculty members expected to participate in the insider trading session is Kevin J. O’Connor.  O’Connor is a Partner at Bracewell & Giuliani and Chair of the firm’s White Collar Practice Group.  Previously, O’Connor was Associate Attorney General of the United States, the third-ranking official at the U.S. Department of Justice, and United States Attorney for Connecticut.  In anticipation of the upcoming RCA Symposium, The Hedge Fund Law Report interviewed O’Connor regarding insider trading considerations for hedge fund managers and related topics.  Specifically, our interview covered: implications for hedge fund managers of the increased use of wiretap evidence in insider trading investigations; the use of criminal wiretaps in civil proceedings; wiretaps of mobile phones and Voice over Internet Protocol lines; “tapping” of Blackberries and social media; how to incentivize internal reporting under the new SEC whistleblower rule; whether hedge fund service providers can be whistleblowers; activities other than insider trading that may serve as the basis of a whistleblower complaint; best compliance practices for engaging expert network firms; compliance training with respect to the use of expert networks; due diligence on expert network firms; and how to avoid FCPA violations when engaging third-party placement agents to solicit investments from sovereign wealth funds.  The full text of our interview with O’Connor is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks in Connection with Leveraged Loan Market Transactions?

    On July 27, 2011, compliance software provider Compliance11 hosted a webinar entitled, “Best Practices for use of Expert Networks and the Leveraged Loan Market.”  The purpose of the event was to provide “solutions, tactical input and strategies” designed to avoid insider trading pitfalls when hedge fund managers use expert networks in connection with leveraged loan trades.  For more on this general topic, see “Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun 17, 2011).  The webinar was moderated by Tracey Straub, Vice President of Strategy at Compliance11.  Laurence Herman, General Counsel and Managing Director of Gerson Lehrman Group (GLG), spoke about the use of expert networks, and Tim Houghton, Founding Principal of Cortland Capital Market Services (CCMS), spoke about trading in the leveraged loan market.  See “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  This article summarizes the most important points made during the webinar.  In particular, this article discusses: the ways in which expert networks can diminish the opportunities for inappropriate conveyance of material nonpublic information (MNPI); four recommended steps for hedge fund managers to take prior to engaging an expert network firm or expert; seven best practices for using expert network firms; nine compliance policies and procedures for using experts; whether leveraged loans are “securities” for insider trading purposes; and how to manage MNPI at hedge fund managers that participate in the leveraged loan market.  See “Big Boys Don’t Cry: How ‘Big Boy’ Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).

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  • From Vol. 4 No.30 (Sep. 1, 2011)

    On Motion to Set Aside Verdict, Trial Court Upholds All Fourteen Counts of Rajaratnam Insider Trading and Conspiracy Conviction

    Raj Rajaratnam, founder of hedge fund manager Galleon Group, was convicted on May 11, 2011 of fourteen counts of securities fraud and conspiracy to commit securities fraud arising out of years of alleged insider trading.  He moved for a judgment of acquittal on all counts on the basis that the government failed to present sufficient evidence to convict him.  The Trial Court has upheld the conviction in its entirety.  This article offers a comprehensive overview of the Court’s decision and legal analysis.  See also “Investment Research and Insider Trading on ‘Outside Information’,” The Hedge Fund Law Report, Vol. 4, No. 29 (Aug. 25, 2011).

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  • From Vol. 4 No.29 (Aug. 25, 2011)

    Investment Research and Insider Trading on “Outside Information”

    Recent high-profile prosecutions, including the Galleon and “expert network” criminal cases, have once again reminded the investment community of the perils of trading on material nonpublic information, or “MNPI.”  These cases have been sensational, but they have not made new law.  At the heart of each case was MNPI that unscrupulous traders allegedly knew had come from within the public companies whose shares they traded.  The focus on expert networks, however, has placed a spotlight on how hedge funds and other investment professionals conduct their investment research.  Many firms have reacted to this new reality by reconsidering how they use industry experts and by fashioning policies to address these latest concerns.  This is an important step, but investors must also anticipate new issues that will arise in the future from today’s heightened focus on investment research.  In a guest article, Michael A. Schwartz, a Partner at Willkie Farr & Gallagher LLP, starts by discussing “inside” versus “outside” information.  Schwartz then analyzes – via a hypothetical that can easily describe a real-world situation – the circumstances in which information obtained by a hedge fund manager from an expert about one company may prohibit trading by the manager’s funds in securities of another company in the same industry.  This article is important in understanding the implications of recent insider trading enforcement activity for day-to-day investment research by hedge fund managers.

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  • From Vol. 4 No.28 (Aug. 19, 2011)

    How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?

    Insider trading enforcement remains a top priority for regulators and prosecutors.  For example, just this month to date: (1) Joseph F. “Chip” Skowron III, a former healthcare portfolio manager at FrontPoint Partners LLC, pleaded guilty to conspiracy to engage in insider trading and obstruction of justice; (2) the DOJ brought conspiracy to commit securities fraud and wire fraud charges against Stanley Ng, the former SEC Reporting Manager at Marvell Technology Group, Ltd., for allegedly providing material nonpublic information to Winifred Jiau; (3) the SEC charged a former professional baseball player and three others with insider trading ahead of the early 2009 buyout by Abbott Laboratories Inc. of Advanced Medical Optics Inc.; and (4) the SEC charged a California man with purchasing Marvel Entertainment call options while in possession of material nonpublic information obtained from his girlfriend (who worked at the Walt Disney Company) regarding Disney’s acquisition of Marvel.  In this still-heightened insider trading enforcement climate, hedge fund managers remain a prime target for civil and criminal insider trading charges.  This is so for at least five reasons.  First, regulators and prosecutors have been emboldened by the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam on 14 counts of conspiracy and securities fraud.  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,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Second, wiretapping has become a viable tool for investigating insider trading by hedge fund manager personnel, and a source of persuasive evidence.  See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Third, in the course of examinations of hedge fund managers, SEC examination personnel are looking for (among other things) evidence of insider trading that can serve as the basis of referrals to the SEC’s Enforcement Division.  See “Is a Hedge Fund Manager Required to Disclose the Existence or Substance of SEC Examination Deficiency Letters to Investors or Potential Investors?,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Fourth, the staff of the SEC’s Enforcement Division can now use tools developed in the criminal context in bringing, negotiating and settling insider trading charges against hedge fund managers.  See “Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  And fifth, budgetary constraints have led the SEC to place a higher priority on deterrence, and insider trading actions against hedge fund managers are thought to have a powerful deterrent effect.  See “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  In light of the vigor with which civil and criminal authorities are pursuing insider trading actions – and the ongoing susceptibility of hedge fund managers to insider trading charges – the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – The New Enforcement Paradigm.”  That RCA Symposium will take place on November 10, 2011 at the Pierre Hotel in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.)  Scott Pomfret – Regulatory Counsel for a Boston-based institutional money manager and a former branch chief in the SEC’s Division of Enforcement – participated in the insider trading session during the RCA’s Spring 2011 Symposium and is expected to participate in the RCA’s Fall 2011 Symposium.  As a former regulator and current in-house counsel, Pomfret has a unique, and uniquely relevant, perspective on insider trading enforcement trends as they relate to hedge fund managers.  By way of revisiting some of the topics that Pomfret discussed during the last RCA Symposium, and by way of preview of some of the topics that he may discuss at the next RCA Symposium, The Hedge Fund Law Report recently conducted an interview with Pomfret.  Our interview covered: Pomfret’s background; a shift in the focus of the SEC’s insider trading enforcement efforts; the rationale for and implications of the SEC’s focus on “gatekeepers”; how the SEC collects and uses hedge fund trading data; the role of trade profitability in allocating SEC enforcement resources; how hedge fund managers can answer investor questions about SEC inquiries; specific steps hedge fund managers can take to mitigate insider trading risk when using expert networks; three specific ways in which hedge fund managers are revising their insider trading compliance policies and procedures; and insider trading concerns for hedge fund managers that typically invest in “private” securities and assets.  The full text of our interview with Pomfret is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 4 No.20 (Jun. 17, 2011)

    Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement

    Recent events have brought increased regulatory and judicial focus on the world of debt instruments.  The stock market crash of the fall of 2008 was largely precipitated by the implosion of debt instruments linked to sub-prime mortgages loans.  These market crises put into relief the relative size and power of the bond markets.  The equity markets were, at least as of mid-2009, less than half the size of the debt markets, $14 trillion versus $32 trillion in the U.S. and $44 trillion versus $82 trillion globally.  Perhaps understanding this, since 2008, the SEC has begun new, unprecedented investigations of insider trading in the realm of debt instruments.  In a guest article, Mark S. Cohen, Co-Founder and Partner at Cohen & Gresser LLP, and Lawrence J. Lee, an Associate at Cohen & Gresser, discuss: hedge funds and the debt markets; the law of insider trading; potential sources of inside information; relationships that are likely to give rise to duties of confidentiality in connection with a debt trading strategy; types of insider trading cases concerning debt securities and credit, including discussions of specific cases involving derivatives, bankruptcy, distressed debt, government bonds and bank loans; and practical steps that hedge fund managers can take to avoid insider trading violations when trading various types of debt and debt-related instruments.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    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

    For a decade, Raj Rajaratnam, the founder and principal partner of the much heralded Galleon Group hedge fund, forged a reputation as one of Wall Street’s most accomplished traders.  Galleon managed over $7 billion in assets at its peak and Rajaratnam’s personal wealth, estimated at $22 billion dollars at one point, made the first generation Sri Lankan immigrant one of the wealthiest individuals in the United States.  Not surprisingly then, Rajaratnam’s May 11, 2011 conviction on 14 counts of conspiracy and securities fraud has roiled the hedge fund industry.  The government’s unprecedented use of wiretapping in a securities fraud case serves notice that a powerful and invasive investigative tool will be unleashed against suspected inside traders; there are also strong indications that the unraveling of the Galleon empire and the 25 other indictments flowing from it foreshadow other charges and investigations in the New York investment sector.  As legal precedent, however, the far flung Galleon case has not generally been considered significant.  The prosecution’s theory – that Rajaratnam and his network of associates obtained confidential corporate information from company insiders and then parlayed their knowledge into millions of dollars of gains from stock transactions – is a classic insider trading scenario that has not moved the boundaries of established law.  But beyond the verdict in United States v. Rajaratnam are legitimate questions about the state of insider trading law, most of which is made by judges and bureaucrats rather than lawmakers.  For example, what is the nexus that the government must prove between illegal inside information and specific stock transactions, and what should it be?  For the white collar defense bar and the hedge fund industry, the Rajaratnam verdict also portends trouble for the viability of the “mosaic theory” that the defendant pinned his hopes on at trial.  The jury’s rejection of that defense, and Rajaratnam’s contention that Galleon’s trades were based on a “mosaic” of legitimate, non-confidential pieces of information, raises new uncertainties for a range of investment analysts whose business model depends on the accumulation of information.  Finally, as the government more vigorously pursues insider trading cases, new cutting edge claims of liability are emerging: defendants are being ensnared even when stocks were not actually bought or sold, as occurs in at least some of the December 2010 charges in United States v. Shimoon, et al.  In a guest article, former Congressman and current SNR Denton Partner Artur Davis provides a detailed analysis of: the implications of the Rajaratnam verdict for the mosaic theory; the nexus between inside information and a specific trade required for insider trading liability to attach; the judicial – as opposed to regulatory – basis for the “knowing possession” standard; practical consequences of the verdict for hedge fund investment analysis and trading; how the verdict will impact the ongoing expert networks investigation; potential strategies for a legal challenge to the theory of causation espoused by the SEC in insider trading enforcement actions; the relevance of the “honest services” doctrine for insider trading jurisprudence; and the potential for “wire fraud” charges to criminalize breaches of corporate confidentiality agreements.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    Are Side Letters Granting Preferential Transparency and Liquidity Terms to One Investor Ipso Facto Illegal?

    We recently analyzed a decision of an SEC administrative law judge (ALJ) holding that fund-level information, as opposed to portfolio-level information, can constitute material nonpublic information (MNPI) for insider trading purposes.  See “SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  Specifically, the ALJ held that information regarding a major fund redemption, fund management’s decision to increase cash levels and efforts to sell a large portion of the bonds in the fund’s portfolio each constituted MNPI.  Accordingly, the ALJ found that the fund manager’s recommendation to his daughter to sell fund shares while the manager was aware of the foregoing three categories of MNPI constituted insider trading under a tipper-tippee theory.  On the scope of the tipper-tippee theory, see the heading “Insider Trading Law” in “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  As explained in our analysis, while that decision arose in the mutual fund context, it has direct relevance for hedge fund managers and investors.  One of the more provocative questions raised by the decision is: are side letters granting preferential transparency and liquidity terms to one investor ipso facto illegal?  For more on side letters, see “What Is the Legal Effect of a Side Letter That Contains Specific Terms More Favorable Than a Hedge Fund’s General Offering Documentation?,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).

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  • From Vol. 4 No.14 (Apr. 29, 2011)

    SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information

    In the vast majority of insider trading cases involving fund management, the material nonpublic information at issue relates to a company whose securities the fund may buy or sell.  However, in a provocative recent initial decision (Decision), an SEC Administrative Law Judge (ALJ) held that information about a fund itself may constitute material nonpublic information for insider trading and breach of fiduciary duty purposes.  This article explains in detail: the factual background of the Decision; the ALJ’s legal analysis; what specific categories of fund-level information may constitute material nonpublic information in the hedge fund management context; the disclosure implications of the potentially expanded scope of material nonpublic information; the interplay between the potentially expanded scope of material nonpublic information and the idea (most notably enunciated in Goldstein v. SEC) that a hedge fund is a manager’s “client”; the implications of the Decision for drafting, negotiating and performing under side letters and managed account agreements; the importance for hedge fund managers of internal investigations; how chief compliance officers (CCOs) can point to the “human toll” in this matter to capture the attention of investment personnel during compliance training; and a new category of monitoring of family relationships to be performed by hedge fund manager CCOs.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    Former Portfolio Manager of Hedge Fund Manager FrontPoint Partners, Joseph F. “Chip” Skowron, Is Charged with Civil and Criminal Insider Trading Arising Out of Trading in Human Genome Sciences Stock

    The Securities and Exchange Commission (SEC) has amended its complaint in its insider trading action against Dr. Yves M. Benhamou to name Joseph F. “Chip” Skowron III as an additional defendant.  Skowron allegedly traded on inside information provided by Benhamou about the results of a clinical trial of a hepatitis drug manufactured by Human Genome Sciences, Inc. (HGSI).  Skowron had served as portfolio manager for six funds sponsored by hedge fund manager FrontPoint Partners LLC.  Benhamou is a doctor who was on a steering committee overseeing a clinical trial of HGSI’s drug Albumin Interferon Alfa 2-a.  The U.S. Attorney for the Southern District of New York has brought parallel criminal insider trading charges against Skowron based in large part on the testimony of Benhamou, who has already pleaded guilty to similar charges and is now a cooperating witness.  We provide a detailed summary of the amended complaint.  For a summary of the SEC’s original complaint, which referred to Skowron only as “Co-Portfolio Manager 1,” see “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).

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  • From Vol. 4 No.12 (Apr. 11, 2011)

    U.S. District Court Rules on Statute of Limitations Issues in Civil Insider Trading Action against Prominent Hedge Fund Managers Sam and Charles Wyly, and Their Advisers

    In July 2010, the Securities and Exchange Commission (SEC) commenced a civil enforcement action against investor-entrepreneurs Samuel Wyly and Charles J. Wyly, Jr., their attorney Michael C. French, and one of their brokers, Louis J. Schaufele III.  The SEC alleges that the defendants committed various securities laws violations, including insider trading, through “a labyrinth of offshore trusts and subsidiary entities” that enabled them to conceal their true holdings and trading in various public companies.  The defendants moved to dismiss certain of the SEC’s causes of action for insider trading and securities fraud on the grounds that those claims were barred by the applicable statutes of limitations and that they failed to state claims upon which relief could be granted.  The U.S. District Court for the Southern District of New York has denied the defendants’ motion in its entirety and ruled that equitable tolling principles apply to the statute of limitations governing the civil penalty provisions of the Securities Exchange Act.  As a result, the applicable limitations period did not begin to run until the SEC had reason to know of the alleged fraud.  We provide a detailed summary of the Court’s decision, with an emphasis on the statute of limitations ruling.

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part Two of Two)

    This is the second article in our two-part series intended to assist hedge fund managers in avoiding insider trading violations when using expert networks.  The first article in the series provided a detailed discussion of the law of insider trading.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  This article – the second in our series – includes a detailed summary of the factual and legal allegations in the relevant civil and criminal complaints.  In light of the importance of the ongoing expert networks insider trading investigation to the hedge fund industry, and in light of the importance of the alleged facts in understanding the investigation, this article provides a comprehensive discussion of the alleged facts.  This article is long – over 25 pages – but is important reading for anyone who wants to understand the investigation, and its implications for hedge fund managers, at a granular level.  Specifically, this article provides: links to the primary civil complaint and the eight primary criminal complaints; a chart listing, with respect to the defendants and relevant uncharged parties: name, job category, background information, civil and criminal charges and plea status (where applicable); public companies about which experts in the network of Primary Global Research, LLC (PGR) allegedly passed inside information to PGR clients; language of selected public company compliance policies; PGR revenues during the relevant period and the sources of those revenues; compensation of PGR experts and employees; and the sources of information included in the criminal complaints.  The core of this article is a series of detailed summaries of the material civil and criminal allegations against the various defendants.  The allegations are organized by defendant, and for each defendant, are listed chronologically.  Also, for each allegation, we have included a citation to the specific paragraph of the specific complaint containing the allegation.  (For HFLR subscribers that wish to undertake a review of the original documents, these citations, along with our links to the relevant complaints, will save hours of research time.)  Our summaries of the factual allegations focus on the specific information allegedly conveyed by PGR experts to hedge fund managers, the timing of communications relative to public earnings announcements, the methods and channels through which information was communicated and the interconnections between the nine documents under analysis.  This article is a significantly expanded version of a prior article published in our March 11, 2011 issue.  See “The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).  For HFLR subscribers who have read that prior article, we have included in this article a redline highlighting the new information in this article.  Also, it should be noted that this article focuses on the civil and criminal allegations relating to trading in shares of public technology companies based on material nonpublic information allegedly obtained via one expert network firm or its employees or experts.  This article does not cover another category of complaints involving drug trials and alleged insider trading allegedly facilitated, directly or indirectly, by expert networks.  However, the HFLR has covered those other matters.  See “Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011); “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 10, 2010).

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  • From Vol. 4 No.10 (Mar. 18, 2011)

    Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network

    On March 9, 2011, the Enforcement Section of the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth filed an administrative complaint against investment adviser Risk Reward Capital Management Corp., the hedge fund it advised, the fund’s general partner and their principal.  This article summarizes the Division’s allegations, which constitute the first state-level enforcement efforts in the unfolding investigation of alleged insider trading in connection with the use of expert networks by hedge fund managers.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks

    Hedge fund managers have responded to the ongoing expert networks investigation by revisiting their insider trading compliance policies and procedures generally, and their expert networks policies specifically.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  Institutional investors have responded by updating their due diligence questionnaires and approaches.  At a minimum, investors are asking their current or prospective managers: whether they use expert networks and if so which; what compliance policies and procedures they have in place with respect to the use of expert networks; and whether they are under investigation for insider trading in connection with expert networks.  But investor due diligence on this topic can get significantly more granular.  According to one well-regarded industry source with whom we spoke, some institutional investors, or their third-party due diligence service providers, are asking their current or prospective managers for records of trades (in hedge funds and personal accounts) in securities of companies mentioned in the primary civil and criminal expert network complaints, around the dates mentioned in those complaints.  The goals of this exercise are to uncover trading patterns that resemble the patterns described in the complaints, to discover spikes in advance of earnings releases mentioned in the complaints and to find other fund or personal trading that is suspicious in light of the allegations in the complaints.  Regulators have undertaken similar analyses of trading patterns for some time, usually with the goal of identifying evidence of insider trading or market manipulation; and those efforts have improved in speed and effectiveness as the relevant technology has improved.  But institutional investors generally have not undertaken due diligence of this sort because it has been considered too attenuated – too much of a search for a needle in a haystack.  The key difference here is that the expert networks insider trading complaints provide a roadmap to potentially problematic issuers, dates and events.  The practical problem is that those issuers, dates and events are buried in hundreds of pages of legal papers.  We at The Hedge Fund Law Report have solved this problem by: analyzing the primary civil and criminal complaints alleging the use of expert networks to facilitate insider trading in technology company shares (as distinct from the biotechnology-related matters); extracting the salient facts; and organizing them in a manner that can serve as a due diligence roadmap for institutional investors.  This article contains the results of that analysis.  This article is long – close to 20 pages – but shorter than the source documents, and a ready-made framework for hedge fund due diligence.  Specifically, this article contains: a chart listing the names of the key civil and criminal defendants, their employers and job descriptions during the relevant periods and the charges brought against them; a list of the public companies about which Primary Global Research, LLC (PGR) experts allegedly passed material nonpublic information (MNPI) to PGR clients; the language of PGR and relevant public company compliance policies; PGR revenues and revenue sources; compensation numbers of PGR experts and employees; and sources of the data and information underlying the allegations in the criminal complaints.  In addition, this article contains a detailed summary of the allegations in the primary civil and criminal complaints against various categories of defendants, including: employees or former employees of PGR; experts in PGR’s network who also worked at technology companies; and employees or principals of hedge fund management companies that were also clients of PGR.  To enhance the utility of this article, we have listed the allegations chronologically in each category and emphasized the specific types of information alleged to have been improperly communicated.  Also, for each material allegation mentioned in this article, we have included references to the specific paragraphs of the relevant complaint containing the allegation, and we have included links to the relevant complaints.  Finally, it should be emphasized that this article is intended for use not only by institutional investors, but also by hedge fund managers.  That is, just as institutional investors can use this article as a framework for performing due diligence, managers can use this article to prepare for due diligence requests that may be in the offing.  While such preparation likely would not rise to the level of an “internal investigation,” managers may consider an internal review of fund and employee trading based on the issuers, dates and events mentioned in the complaints in this article.  Just as it is preferable for a manager to uncover bad facts before the SEC does so in an examination, it is better for a manager to uncover bad facts before an investor does so in due diligence.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part Three of Three)

    Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of expert network firms.  See “The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks,” above, in this issue of The Hedge Fund Law Report.  While the merits of these actions largely remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research may be redefining the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management LLC; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover was included in the February 25, 2011 issue of The Hedge Fund Law Report, and our interview with John Robbins was included in last week’s issue.  Our interview with Adam Wasserman, included in full below, covered a wide range of relevant topics, including but not limited to: a taxonomy of the categories of potentially problematic information as revealed in the current criminal and civil complaints alleging insider trading in connection with expert networks; the government’s evolving view of what constitutes improper information; the definition of channel checking and how it is performed; the level of risk associated with various types of channel checks; whether hedge fund managers have been prohibiting their personnel outright from using expert networks; which categories of experts, consultants or entities should be covered by a hedge fund manager’s expert networks compliance policy; whether compliance policies should prohibit the use of an expert employed by a company in which the hedge fund has an investment, or within a certain period of the expert’s employment by the company; whether hedge fund investment personnel should be limited in the number of experts with whom they can consult in a certain period; the use of scripts or certifications; when to obtain certifications; how to prevent improper communications in informal settings; next steps in the ongoing insider trading investigation; potential RICO charges; how to talk to corporate insiders; and what to do when the FBI comes knocking.

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  • From Vol. 4 No.8 (Mar. 4, 2011)

    Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part Two of Three)

    Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of at least one expert network firm.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the merits of these actions remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research may be redefining the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management LLC; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover was included in last week’s issue of The Hedge Fund Law Report.  See “Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 7 (Feb. 25, 2011).  The full text of our interview with John Robbins is included in this issue, and our interview with Adam Wasserman will be published in next week’s issue.  Our interview with John Robbins, included in full below, covered a wide range of relevant topics, including but not limited to: typical ways in which a hedge fund manager might acquire material nonpublic information (MNPI) about an issuer that would inhibit trading; designing “wall crossing” policies and procedures; the possibility of automating analysis of wall-crossing inquiries; points that CCOs should keep in mind when designing and implementing effective information walls; what exactly inclusion of a name on the restricted list means; how managers can enforce the prohibition on trading names on the restricted list in funds and personal accounts; the utility of Big Boy letters in SEC and private actions (including a reference to an important SEC enforcement action involving Big Boy letters); the possibility of complying with SEC Rule 10b5-1 through the use of “information walls”; the difference between a restricted list and a watch list; who at a hedge fund management company should have access to a watch list; and how to determine when a name should be added to or removed from a restricted list.

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  • From Vol. 4 No.7 (Feb. 25, 2011)

    Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part One of Three)

    Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of at least one expert network firm.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the merits of these actions remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research has redefined the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover is included in this issue of The Hedge Fund Law Report; our interview with John Robbins will be published in next week’s issue; and our interview with Adam Wasserman will be published in the following week’s issue.  Our interview with Robert Van Grover, included in full below, covered a wide range of relevant topics, including but not limited to: steps that hedge fund analysts, traders or portfolio managers should take when talking to corporate insiders in order to avoid insider trading violations; whether hedge fund analysts, traders or portfolio managers may be charged with aiding and abetting a breach of Regulation FD by a corporate insider; the definition of “market color,” and how it differs from material nonpublic information; how to handle rumors; what a CCO should do upon discovery of insider trading by junior or senior personnel; what a hedge fund manager should do if the FBI comes knocking; what managers should do about the increasing use of wiretaps in insider trading investigations; trends with respect to banning the use of expert networks outright; terms that managers are negotiating in their engagement letters with expert networks; how to mitigate improper informal communications; best practices with respect to electronic communications; implications of increased flexibility in the SEC’s Enforcement Division with respect to issuing subpoenas; interaction between the SEC examination and enforcement processes; and considerations for hedge fund manager personnel considering entering into immunity agreements with the SEC under the new cooperation initiative.  Notably, Van Grover recently sought and obtained no-action relief under the amended custody rule.  See “SEC Temporarily Permits Hedge Fund Managers to Avoid Surprise Examination Requirement with Audits by Auditors That Are Registered with, but Not Subject to Inspection by, the PCAOB,” The Hedge Fund Law Report, Vol. 3, No. 42 (Oct. 29, 2010).

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  • From Vol. 4 No.5 (Feb. 10, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two)

    The investment returns of hedge funds often depend directly on the depth of their managers’ understanding of companies, industries and trends.  Expert network firms exist to enhance that understanding by providing investment managers with efficient access to persons with deep and difficult-to-replicate domain expertise – persons including corporate managers across a range of industries, doctors, engineers, lawyers, accountants, academics and others.  Specifically, expert network firms provide at least three services on behalf of their investment manager clients: they compile networks; they make relevant connections; and they structure interactions to comply with relevant law, most notably, insider trading law.  These services have generated a range of benefits for a range of parties: hedge fund managers have obtained more relevant and granular research, which has enabled them to allocate capital more effectively, which has improved the efficiency of capital markets generally; experts in expert networks – and there are hundreds of thousands of them – have commercialized expertise and experience that was heretofore confined to their direct job functions; and, recent sound and fury to the side, there is a persuasive argument that expert networks have reduced insider trading on a systemic basis.  Nonetheless, the regulatory investigation of insider trading and expert networks is far from complete.  More broadly, since the line between insider trading and diligent research can be blurry, many hedge fund managers have used the current investigation as an occasion to revisit their insider trading compliance policies and procedures generally, and their compliance policies and procedures with respect to expert networks specifically.  This article is the first in a two-part series undertaken to assist hedge fund managers and others as they revisit and revise their compliance policies and procedures relating to the use of expert networks.  This article provides a detailed overview of the law of insider trading, including detailed discussions of the following subtopics: the definition of “materiality” for insider trading purposes; three SEC pronouncements that provide guidance in making materiality determinations; the definition of “nonpublic” for insider trading purposes; breach of duty as a prerequisite for insider trading liability; the three theories of insider trading: classical, misappropriation and tipper-tippee; the “mosaic” theory (and two very important caveats to the mosaic theory); criminal enforcement of insider trading laws, including a brief discussion of substantially all of the civil and criminal insider trading actions brought in the course of the recent investigation, along with links to the underlying documents; and an underappreciated section of the Sarbanes-Oxley Act of 2002 that may offer regulators a potent enforcement tool.  The second article in this series will provide a detailed analysis of substantially all of the civil and criminal filings alleging insider trading in connection with expert networks.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three)

    This is the third installment in our three-part series on the movement of talent from bank proprietary (prop) trading desks to hedge fund managers.  The series focuses on the legal and business considerations raised by such moves, and highlights the different considerations faced by the different constituencies.  The first article in the series focused on the talent perspective, that is, the considerations that investment and non-investment personnel should address when moving from a bank to a hedge fund manager.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Talent Perspective (Part One of Three),” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  The second article in the series focused on the bank perspective, and demonstrated that while banks face many of the same issues as talent in this context, banks often face those issues from a different perspective, and weight those issues differently.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Bank Perspective (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 2 (Jan. 14, 2011).  This article focuses on the perspective of the hedge fund manager to which talent moves.  While the legal and business issues faced by such recipient managers are complex, at a broad level, they can be broken down into a simple binary question: Are your hiring decisions motivated by the goal of buying talent or access?  Generally, if you are looking to buy talent, you are okay, but if you are looking to buy access, you are in trouble.  Put slightly differently, while a variety of legal disciplines govern the relationships between hedge fund managers and their employees, the unifying theme among those disciplines is ensuring that business success or failure is based on merit commercialized on a level playing field.  If this sounds too pious to be plausible, read on – and also read some of our cautionary tales of recent access-buying in the hedge fund arena.  To illustrate this general idea, this article discusses the following categories of considerations for hedge fund managers receiving talent: avoiding insider trading violations based on material, non-public information possessed by incoming talent; the three-step process for avoiding liability for aiding and abetting a breach by a new employee of that employee’s employment or post-employment covenants with his or her former bank employer, including non-competition agreements (non-competes), non-solicitation agreements (non-solicits), termination, severance and option agreements; special considerations in connection with the movement of teams (as opposed to individuals); avoiding liability for unauthorized use by an incoming employee of trade secrets or other intellectual property owned by a former bank employer; use of data regarding employee performance at a prior bank employer; avoiding pay-to-play violations; and what to look for when performing background checks.

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  • From Vol. 3 No.50 (Dec. 29, 2010)

    Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations

    By and large, and subject to the inequities of resources and circumstances, individuals in the U.S. are still innocent until proven guilty.  Not so entity defendants, for whom that time-honored axiom is reversed.  In practice, entity defendants are guilty until proven innocent; the law moves deliberately, but markets and investors move quickly.  And in the rare circumstances where the law vindicates an entity defendant (Andersen comes prominently to mind), it is often too late.  Hedge funds and their managers are uniquely susceptible to this guilty until proven innocent phenomenon.  Raj Rajaratnam and Galleon, and Art Samburg and Pequot, are exhibits A and B.  Granted, Rajaratnam, Samberg and their respective management companies have not been "proven innocent" of the insider trading with which they were charged.  But nor have they been proven guilty or liable.  Yet the reputations of the individual defendants have been irrevocably tarnished, and both of those seafaring management companies have sailed into the hedge fund graveyard.  Indeed, it has effectively become a truism in the hedge fund industry that an accusation of insider trading by the SEC or DOJ against a hedge fund management company or any of its personnel constitutes a "death knell" for that management company and its funds.  However, a recent development suggests that an insider trading charge need not be fatal to hedge fund managers that appropriately prepare for and respond to discovered or suspected insider trading.  On December 20, 2010, the SEC entered into a non-prosecution agreement with Carter's Inc., a publicly traded clothing marketer, based on the company's response to discovery of accounting fraud and insider trading by one of its sales executives.  In doing so, the SEC exercised for the first time one of the tools added to its enforcement arsenal as part of its cooperation initiative announced in January 2010.  See "Katten Muchin Rosenman Hosts Program on 'Infected Hedge Funds' Highlighting Rights and Remedies of Investors in Hedge Funds Whose Managers are Accused of Insider Trading or of Operating Ponzi Schemes," The Hedge Fund Law Report, Vol. 3, No. 12 (Mar. 25, 2010); "Paul Hastings Hosts Program on Securities Litigation and Enforcement in Light of New SEC Initiatives to Enhance Enforcement Efforts and Encourage Witness Cooperation," The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  Although the Carter's matter arose in the public company context, the SEC's stated rationale for entering into a non-prosecution agreement with Carter's − as opposed to initiating an enforcement action against Carter's (as it did against the sales executive) − would apply with equal strength to a scenario where a hedge fund manager discovers, responds vigorously to and had prepared for an isolated instance of insider trading by one of its employees.  Accordingly, this article examines the Carter's matter as a precedent for how hedge fund managers can discover an insider trading violation by one of their employees, yet live to fight another day.  Specifically, this article: briefly reviews the relevant facts and legal allegations of the Carter's matter; discusses the SEC's stated rationale for entering into the non-prosecution agreement with Carter's; details four important lessons for hedge fund managers to be drawn from that rationale; then details the relevant provisions of the non-prosecution agreement (which are quite rigorous; the SEC does not give up good enforcement facts for a peppercorn).

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  • From Vol. 3 No.48 (Dec. 10, 2010)

    Federal District Court Upholds the Government’s Right to Use Wiretaps to Investigate Suspected Insider Trading by Hedge Fund Manager Personnel

    On November 24, 2010, the United States District Court for the Southern District of New York handed the United States Attorney’s Office (USAO) and the FBI (together, the government) a major victory in their ongoing criminal prosecution of Raj Rajaratnam, founder of Galleon Management, LP, and Danielle Chiesi, a former manager of New Castle Funds, LLC (defendants), for their alleged participation in a massive insider trading conspiracy.  In a precedential decision, the court upheld the government’s authority to secretly record phone calls under Title III of the Omnibus Crime Control and Safe Streets Act of 1968 (Title III or the Act) to investigate insider trading schemes using interstate wires, even though the Act does not specifically authorize wiretaps to investigate insider trading alone.  It also rejected defendants’ specific challenges to the government’s underlying search warrant applications, notwithstanding what it considered a “troubling” lack of government candor, because disclosure of the details “the government recklessly omitted would ultimately have shown that a wiretap was necessary and appropriate.”  As a result of its decision, the government may now present these recordings – likely the most persuasive evidence it will offer – at the trials of Rajaratnam and Chiesi, now tentatively scheduled to start on January 17, 2011.  We detail the background of the action and the Southern District’s legal analysis, primarily as it pertains to Rajaratnam’s claims, because the opinion heavily redacted the facts relating to Chiesi’s prosecution.  See also “Decision in the Galleon Matter Illustrates Application of Wiretap Law in the Hedge Fund Context,” The Hedge Fund Law Report, Vol. 3, No. 41 (Oct. 22, 2010).

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  • From Vol. 3 No.48 (Dec. 10, 2010)

    SEC Commences Civil Insider Trading Action Against Deloitte Mergers and Acquisitions Partner and Spouse Who Allegedly Tipped Off Relatives to Impending Acquisitions of Seven Public Companies

    On November 30, 2010, the Securities and Exchange Commission (SEC) commenced a civil insider trading action against Deloitte Tax LLP (Deloitte) partner Arnold A. McClellan and his wife, Annabel McClellan, after they allegedly passed to their London-based relatives material, non-public information about pending acquisitions by Deloitte clients.  Those relatives, and the brokerage through which they traded, made millions of dollars trading ahead of the announcements of those acquisitions.  Arnold McClellan allegedly told his wife about seven acquisition deals on which Deloitte had been retained as an adviser.  Annabel McClellan, in turn, passed those tips to her sister and brother-in-law, Miranda and James Sanders.  The Sanders then took equity positions in the target companies and made substantial profits when the deals were announced.  The SEC charges that the McClellans violated the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.  This article summarizes the SEC’s Complaint.

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  • From Vol. 3 No.47 (Dec. 3, 2010)

    Lessons for Hedge Fund Managers and Expert Network Firms from the Government’s Criminal Complaint against Don Chu, Formerly of Primary Global Research LLC

    On Wednesday, November 24, 2010, agents of the Federal Bureau of Investigation arrested Don Chu, at the time, an employee of expert network firm Primary Global Research LLC (Primary Global).  (Primary Global fired Chu after his arrest.)  The arrest was based on probable cause established in a Complaint filed in the United States District Court for the Southern District of New York the day prior to the arrest.  This article offers a critical reading of the Complaint and its implications for hedge fund managers and expert network firms.  By “critical,” we do not mean to take issue with the allegations in the complaint or the sufficiency of the evidence; the evidence appears to have been carefully collected and is persuasively marshaled.  Rather, by “critical,” we mean to describe our purpose in writing about the Complaint.  Here, as in substantially every article in The Hedge Fund Law Report, our purpose in writing about a particular legal document is to extract the insights and lessons that may be more broadly applicable to hedge fund managers and other hedge fund industry participants.  Such articles are intended to assist our subscribers in updating their assumptions, revising their policies and procedures and tracking the concerns of regulators and prosecutors.  With those and related goals in mind, this article discusses the following issues, insights and ideas arising out of the Chu Complaint: the three ways in which expert networks can facilitate the movement of material, non-public information; the ways in which expert networks, properly structured and used, can inhibit the movement of material, non-public information; the categories and timing of information allegedly communicated in the Chu matter; an important compliance suggestion for hedge fund managers that use expert networks, based on the specifics of the allegations in the Chu Complaint; the role of soft dollars in the ongoing insider trading investigation; the jurisdictional issue raised by the Complaint; and the interaction between competition in the expert network business, insider trading and insider trading law.

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  • From Vol. 3 No.46 (Nov. 24, 2010)

    Participants at Hedge Fund Compliance Summit Detail Best Practices with Respect to Insider Trading, SEC Examinations, Risk Mitigation, Marketing Materials, Valuation and Avoiding Investor Lawsuits: Part One of Two

    On November 15 and 16, 2010, Financial Research Associates, LLC and the Hedge Fund Business Operations Association presented a Hedge Fund Compliance Summit at the Princeton Club in New York City.  The substance of the Summit was relevant – even prescient – and the timing was fortuitous.  Insider trading was a prominent topic of discussion at the Summit, and on November 20, 2010, about two weeks after the Summit, insider trading received a stunning boost on the list of concerns of hedge fund managers.  That day, The Wall Street Journal and other sources disclosed the existence of a wide-ranging civil and criminal insider trading probe being jointly conducted by the SEC and the U.S. Attorney’s Office in Manhattan.  Then, on Monday, November 22, 2010, the Federal Bureau of Investigation raided the offices of three hedge fund managers.  According to press reports, at least one purpose of those raids was to gather documents in connection with the insider trading investigation reported by the Journal.  Following the raids, a number of well-known hedge fund and mutual fund managers received subpoenas from the U.S. Attorney’s Office in Manhattan.  According to press reports, those subpoenas are very broad and include requests for documents and information relating to use of expert networks and soft dollar practices.  See “For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).  Insider trading is a topic that The Hedge Fund Law Report has covered in depth, and that we intend to cover in even more depth in the coming months.  Notably, Harry S. Davis (who participated at the Summit), Richard Morvillo and Justin Mendelsohn, all of Schulte Roth & Zabel LLP, published an article on insider trading in the HFLR earlier this year that we think should be required reading for hedge fund manager personnel.  See “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  Also, Michael D. Trager, Richard L. Jacobson and Christopher Rhee, of Arnold & Porter LLP, published an article in the HFLR that can – and should – be read as a companion piece to the Schulte article.  See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010).  Our coverage of the Summit complements these and other HFLR articles on insider trading by highlighting the more important and nonintuitive insights offered by Summit participants on insider trading.  In particular, we discuss points raised by panelists on consultants and expert networks, sharing of information among personnel at different hedge fund managers, rumors and insider trading considerations in connection with bank debt trading.  Beyond insider trading, this article summarizes key insights from Summit participants regarding SEC examinations and identification and mitigation of key risks.  A follow-up article will discuss points made by Summit participants on compliance considerations in connection with preparing and using marketing and advertising materials, valuation and avoiding investor lawsuits.

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  • From Vol. 3 No.46 (Nov. 24, 2010)

    SEC Sanctions Buckingham Capital Management, Its Chief Compliance Officer and Its Research Affiliate for Inadequate Handling of Material, Non-Public Information

    As further evidence of the renewed focus of the Securities and Exchange Commission (SEC) on insider trading, especially within the hedge fund and investment management industries, the SEC has issued an Order imposing fines and a cease and desist order on research boutique The Buckingham Research Group, Inc. (BRG), investment manager Buckingham Capital Management, Inc. (BCM) and Lloyd R. Karp (Karp).  BCM is a wholly-owned subsidiary of BRG and shares an office suite with it.  Karp served as chief compliance officer for both BCM and BRG.  The SEC claimed that, commencing at least as early as 2005, BRG and BCM failed to have in place adequate procedures “to prevent the misuse of material, non-public information,” as required by both the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934.  In addition, BRG, BCM and Karp failed to follow the limited procedures that they did have in place and fabricated data in response to an SEC examination of those procedures.  We summarize the SEC’s Order and the remedial measures it requires.

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  • From Vol. 3 No.44 (Nov. 12, 2010)

    Key Elements of Electronic Communications Policies and Procedures for Hedge Fund Managers

    Electronic communications technologies – phone, e-mail, instant messaging, social media and others described in this article – are essential to the efficient operations of hedge fund managers, but at the same time pose considerable regulatory and litigation, reputational and trading risks.  Hedge fund managers cannot live without electronic communications, but may not survive if such communications are not properly handled.  Moreover, electronic communications are among the most difficult categories of information to contain – they are indelible, pervasive and often determine the outcome of private and government litigation.  Yet more often than not, such communications are drafted under the mistaken impression that they are as easy to erase as they are to create.  Despite a lengthy list of cases illustrating the error in this view, hedge fund manager personnel continue to create and send electronic communications that would fail the commonly used litmus test: “If you wouldn’t want it on the cover of the Wall Street Journal, don’t send it.”  The intent of this article is to assist hedge fund managers in creating, refining and enforcing electronic communications policies and procedures.  To do so, this article first catalogues the various types of electronic communications technologies used by hedge fund manager personnel, as well as the categories of communications that may be made with such technologies.  Next, the article identifies specific risks arising out of the various communications and technologies.  Notably, the range of risks posed by electronic communications in the hedge fund context is significantly broader than the risk of embarrassment or bad evidence at trial – other risks relate to loss of trading advantages, insider trading charges, spoliation sanctions and more.  Incorporating the discussion of communications, technologies and risks, the article then discusses the key elements of electronic communications policies and procedures for hedge fund managers.

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  • From Vol. 3 No.44 (Nov. 12, 2010)

    SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial

    The Securities and Exchange Commission (SEC) has commenced a civil insider trading action against Dr. Yves M. Benhamou (Benhamou) after a hedge fund allegedly traded on inside information provided by Benhamou about the prospects of Human Genome Sciences, Inc. (HGSI).  Benhamou is a doctor who was on a steering committee overseeing a clinical trial of HGSI’s drug Albumin Interferon Alfa 2-a (Albuferon).  An unnamed hedge fund manager, through six separate funds (Funds), owned over six million shares of HGSI.  One of its investment managers was a friend and business acquaintance of Benhamou.  According to the Complaint, Benhamou revealed material nonpublic information about the Albuferon trial to the investment manager from December 2007 through January 2008.  During that same period, the Funds sold all of their HGSI shares, including a block trade of the Funds’ remaining two million shares at the close of trading on January 22, 2008, the day before HGSI announced negative information about the Albuferon trial.  By selling prior to that announcement, the Funds avoided a $30 million loss on the HGSI shares.  The SEC charges that Benhamou violated the antifraud provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934.  The U.S. Attorney for the Southern District of New York has also brought criminal insider trading charges against him.  Benhamou was arrested in Boston on November 2, 2010.  We summarize the SEC’s civil complaint.

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  • From Vol. 3 No.43 (Nov. 5, 2010)

    Office Depot Settles SEC Charges that It Violated Regulation FD by Indirectly Signaling Its Quarterly Estimates Privately to Analysts and Institutional Investors

    On October 21, 2010, the U.S. Securities and Exchange Commission (SEC) filed a Complaint in the Southern District of New York and simultaneously settled enforcement actions against Office Depot, Inc., its CEO, Stephen A. Odland, and its former CFO, Patricia A. McKay (collectively, the Defendants).  The SEC charged the Defendants with violating Section 13(a) of the Securities Exchange Act of 1934 (Exchange Act), and SEC Regulation FD, in 2007, for selectively communicating to analysts and institutional investors that Office Depot would not meet the analysts’ quarterly earnings estimates.  The settlement is noteworthy because Office Depot did not directly inform analysts that it would not meet expectations, a classic Regulation FD violation, but signaled that fact through references to recent public statements of comparable companies and its prior cautionary public statements.  This matter is of particular importance to the hedge fund community because it highlights the risks involved when hedge fund managers, analysts and traders gather information from corporate insiders in small group meetings or other private settings.  For more on situations in which hedge fund managers speak to corporate management, see “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This article discusses the legal principles underlying Regulation FD, the background of the action and the settlement.

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  • From Vol. 3 No.41 (Oct. 22, 2010)

    Decision in the Galleon Matter Illustrates Application of Wiretap Law in the Hedge Fund Context

    On September 29, 2010, the U.S. Court of Appeals for the Second Circuit issued a writ of mandamus on behalf of Raj Rajaratnam, founder and general partner of Galleon Management, LP and Danielle Chiesi, former manager and consultant of New Castle Funds LLC (Defendants).  The writ vacated a discovery order of the U.S. District Court for the Southern District of New York that had required Defendants to disclose thousands of wiretaps to the Securities and Exchange Commission (SEC) as part of its civil enforcement action.  Defendants had obtained those wiretaps from the U.S. Attorney’s Office (USAO) in a parallel criminal action against them pursuant to Title III of the Omnibus Crime Control and Safe Streets Act of 1968 (18 U.S.C. §§2510-2522) (Title III or the Act).  Recognizing that the USAO had taken the position that the Act prohibits it from disclosing these wiretaps to the SEC, the Second Circuit held that the Act does not prohibit a federal court from ordering the Defendants to disclose that information during discovery in a civil action.  It reasoned that, in this instance, the district court clearly abused its discretion by issuing the order prior to a criminal court “ruling on the legality of the wiretaps and without limiting the disclosure to relevant considerations.”  We detail the background of the action and the Second Circuit’s legal analysis.

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  • From Vol. 3 No.41 (Oct. 22, 2010)

    Participants at Fourth Annual Hedge Fund General Counsel Summit Outline Key Risks Facing Hedge Fund Managers and How to Address Them

    On October 4, 2010, ALM Events hosted its fourth annual Hedge Fund General Counsel Summit in New York City.  The event brought together a number of industry thought leaders who identified key areas of risk facing hedge fund managers, and offered ideas on how to address those risks.  Specifically, participants at the Summit discussed: Dodd-Frank; insider trading; implementing and maintaining ethical walls; investors’ due diligence expectations; risk management trends; preparing for an SEC examination; and developing pay to play policies and procedures.  This article summarizes some of the key ideas discussed at the Summit.

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  • From Vol. 3 No.38 (Oct. 1, 2010)

    SEC’s Insider Trading Case Against Nelson Obus of Hedge Fund Wynnefield Capital Thrown Out on Summary Judgment Motion Because SEC Failed to Prove that GE Capital Tipper Acted Deceitfully or in Violation of a Confidentiality Duty

    The U.S. District Court for the Southern District of New York has thrown out the SEC’s insider trading case against three individuals, the “tipper,” the “tippee” and the tippee’s superior, who allegedly traded in the securities of SunSource, Inc. (SunSource) after receiving inside information about the potential sale of SunSource.  In early 2001, Allied Capital Corporation (Allied) began exploring the possibility of acquiring SunSource and spinning off one of SunSource’s subsidiaries.  GE Capital was one of several lenders that were approached about the possibility of financing the transaction.  Defendant Thomas Strickland worked for the commercial finance group of GE Capital and was assigned to the SunSource deal team.  Strickland noticed that hedge fund Wynnefield Capital, Inc. (Wynnefield) owned SunSource stock.  In May 2001, Strickland had a conversation about SunSource with defendant Peter Black, an analyst at Wynnefield who happened to have been a college classmate of his.  Black advised his boss, defendant Nelson Obus, of Strickland’s interest in SunSource.  Obus then purchased additional shares of SunSource stock.  After Allied merged with SunSource, the Securities and Exchange Commission (SEC) brought civil insider trading charges against Strickland, Black and Obus.  On the defendants’ motion for summary judgment, the District Court dismissed the case against them.  It reasoned that, in mentioning the SunSource financing to Black, Strickland had not violated any fiduciary duty to GE Capital or SunSource, had not breached any duty of confidentiality to either company and had not acted deceptively.  Therefore, Strickland’s tip did not give rise to liability.  We outline the facts of the case and the Court’s reasoning.

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  • From Vol. 3 No.38 (Oct. 1, 2010)

    Fifth Circuit Holds that SEC’s Allegations Against Mark Cuban Provide a Plausible Basis for Finding that Cuban Traded in Violation of an Agreement Not to Trade

    On September 21, 2010, the SEC won a significant victory in the United States Court of Appeals for the Fifth Circuit.  The Circuit Court reversed the SEC’s loss in its insider trading civil action against entrepreneur and Dallas Mavericks owner Mark Cuban.  The real question, however, and one highlighted by the Circuit Court, remains whether the SEC has sufficient facts to survive summary judgment or win at trial.  We summarize the background of the action, the Court’s legal analysis and Cuban’s related Freedom of Information Act request.

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  • From Vol. 3 No.37 (Sep. 24, 2010)

    SEC Obtains Partial Victory in Securities Fraud Civil Action against Hedge Fund Manager Robert Berlacher and the Lancaster Hedge Funds for Insider Trading on Nonpublic “PIPE” Offering Information

    As part of a broader federal investigation into hedge funds that use non-private information obtained during Private Investment in Public Equity (PIPE) offerings in order to short-sell the stock of those companies – a technique that virtually guarantees profits since a PIPE typically drives down the price of public shares – the SEC recently accused hedge fund manager Robert A. Berlacher, and eight hedge funds he managed or advised (the Defendants), of insider trading and securities fraud in connection with four such transactions.  Specifically, it alleged that the Defendants unlawfully traded on non-public information obtained by Berlacher in a PIPE issued by Radyne ComStream, and made material misrepresentations in the PIPE stock purchase agreements (SPAs) Berlacher had signed with Radyne, Hollywood Media, International Display Works (IDWK), and SmithMicro.  On September 13, 2010, the U.S. District Court for the Eastern District of Pennsylvania concluded, following a bench trial, “The SEC has not sustained its burden of proof on the insider-trading count and two of the fraud claims” but “has met its burden on two separate fraud claims” in connection with the Radyne and IDWK transactions because the SPAs for those transactions had prohibited the types of trading in which Berlacher had engaged.  The court ordered Berlacher to disgorge net profits of $352,363.68, but refused to impose civil penalties, pre-judgment interest, or injunctive relief, as sought by the SEC.  We detail the background of the action and the court’s legal analysis.

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  • From Vol. 3 No.27 (Jul. 8, 2010)

    After Bench Trial of First-Ever Credit Default Swap Insider Trading Action, U.S. District Court Rules that Swaps Referencing Bonds Are “Securities-Based Swap Agreements” Under Antifraud Provisions of Securities Exchange Act, but Holds that SEC Failed to Prove Insider Trading

    The Securities and Exchange Commission (SEC) has succeeded in bringing credit default swaps under its jurisdiction over insider trading, but has lost its securities fraud suit against Jon-Paul Rorech (Rorech), a Deutsche Bank bond and credit default swap salesman, and Renato Negrin (Negrin), a portfolio manager employed during the relevant period by hedge fund manager Millennium Partners, L.P.  The SEC had alleged that Rorech and Negrin engaged in insider trading of the credit default swaps of VNU N.V. (VNU), a Dutch media conglomerate.  Rorech allegedly revealed to Negrin non-public information about a proposed bond offering by VNU that would result in an immediate increase in the value of certain credit default swaps that referenced VNU bonds.  As a result of that disclosure, Negrin allegedly purchased VNU credit default swaps shortly before the bond offering was announced and made a substantial profit when the value of those swaps increased following the announcement of the proposed offering.  The District Court determined that, while the SEC did have the power to prosecute its insider trading claims arising out of trading in the VNU credit default swaps, the SEC failed to prove that Rorech revealed material non-public information to Negrin.  We offer a comprehensive summary of the factual findings and legal reasoning in the court’s 122-page opinion.

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  • From Vol. 3 No.26 (Jul. 1, 2010)

    AKO Capital LLP Options Trader and Risk Manager Pleads Guilty to One Count of Insider Dealing for Directing Preferential Trades to a Broker in Exchange for Cash and Gifts

    On May 18, 2010, former AKO Capital LLP options trader and risk manager Anjam Saeed Ahmad pled guilty to one count of insider dealing after entering into an agreement with the U.K.’s Financial Services Authority (FSA) under the Attorney General’s Guidelines on Plea Discussions in Cases of Serious or Complex Fraud.  On June 22, 2010, the Southwark Crown Court sentenced him to a suspended prison term, community service and a £50,000 fine.  That same day, the FSA issued a Final Notice requiring that Ahmad disgorge an additional £131,000 as restitution for profits he made from regulatory misconduct unrelated to his insider dealing.  We describe the conduct that led to the guilty plea, the relevant statutes and regulations and the FSA’s analysis of the proposed sanction (including its consideration of Ahmad’s cooperation as a mitigating factor in determining the appropriate sanction).

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  • From Vol. 3 No.25 (Jun. 25, 2010)

    Registered Direct Offerings Enable Hedge Funds to Make Advantageously-Structured Investments in Public Equity While Avoiding the Illiquidity and Other Downsides of PIPEs

    Investment structuring can profoundly affect investment outcomes – an insight that accounts, in large part, for the growing participation by hedge funds as investors in registered direct offerings (RDOs).  As explained in more detail below, an RDO involves the sale by a public company of registered securities via a placement agent to institutional investors, such as hedge funds.  Since the securities purchased in an RDO are registered, the purchaser can sell them immediately.  By contrast, the securities purchased in a private investment in public equity (PIPE) are restricted and generally cannot be sold for 60 to 90 days following the purchase.  The illiquidity of PIPEs can adversely affect investment returns.  For example, assume hedge fund A purchased 10,000 shares of common stock of Company X in an RDO on January 1, 2010 for $50 per share and sold those shares a week later for $51.  Hedge fund A would have a pre-tax profit of $10,000.  Now assume that hedge fund A purchased those same 10,000 shares of common stock of Company X in a PIPE on January 1, 2010 for the same $50 per share.  And assume that during the two months following the purchase, the fortunes of Company X declined, such that as of March 1, 2010, the price of Company X common stock had fallen to $35 per share.  Under the terms of most PIPEs, hedge fund A would be legally prohibited from selling the shares it purchased in the PIPE during those two months, and would watch without recourse as its investment in Company X lost $150,000.  Efforts by hedge funds to offset such losses via short sales have often backfired, resulting in allegations of insider trading and violations of Regulation M.  See “Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009); “SEC Obtains Permanent Injunction Against Hedge Fund Colonial Fund LLC for Illegal Short Sales; Opinion Addresses Fund Manager’s Faulty Internal Compliance and Accounting Systems,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009); “District Court Preserves PIPE Insider Trading Claims Against Gryphon Hedge Fund,” The Hedge Fund Law Report, Vol. 2, No. 15 (Apr. 16, 2009).  Beyond liquidity, RDOs offer additional benefits to hedge funds, some relative to PIPEs and others independently.  With the goal of helping hedge funds evaluate whether RDOs offer an attractive investment structure and opportunity, this article details the mechanics of RDOs; includes statistics on RDO and PIPE activity; catalogs 13 distinct benefits to hedge funds of participating in RDOs; and identifies and discusses insider trading concerns in connection with RDOs.

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  • From Vol. 3 No.22 (Jun. 3, 2010)

    The SEC’s New Focus on Insider Trading by Hedge Funds

    The Securities and Exchange Commission (SEC) has attempted to stop insider trading since its creation.  Eliminating this misconduct has proven to be an elusive goal, as the Boesky scandal of the 1980s demonstrated.  The growth of the hedge fund industry has heightened the SEC’s challenge.  There is a longstanding and widespread belief among law enforcement personnel that insider trading involving hedge funds is a systemic problem.  Until recently, however, very few of the SEC’s insider trading cases involved hedge funds.  Today, the SEC is committed “to root[ing] out insider trading on Wall Street and in the hedge fund industry.”  It is bringing to bear more resources and new investigative tools to do the job.  A restructured Enforcement Division has new units ramping up that will concentrate on, among other things, insider trading by market professionals, including hedge funds.  In addition, joint investigations with the Department of Justice (DOJ) are now more common, allowing the SEC to take advantage of investigative strategies and tools long used in criminal cases.  Several insider trading cases involving hedge funds were brought in the past year, and more can be expected.  It has been reported that the SEC sent “at least” three dozen subpoenas to hedge funds and brokerages in “an expanding sweep of potential insider trading violations” relating to health care mergers in the past three years.  Also, the SEC filed charges in May 2010 against a Walt Disney Company executive and her companion, who allegedly shopped confidential earnings information about the company to over 30 hedge funds (some – but not all – of which reported the overture to the government).  Given this unprecedented level of enforcement attention, hedge funds and their investment advisers need to make sure that adequate procedures, customized for their particular business models and strictly enforced, are in place to minimize the risk of insider trading violations.  Fund managers that fail to consult counsel now may discover, only when it is too late, that they are the target of an extensive undercover government investigation.  In a guest article, Michael D. Trager, Richard L. Jacobson and Christopher Rhee, respectively, Senior Partner, Counsel and Partner at Arnold & Porter LLP, offer a comprehensive analysis of the current developments in insider trading law most relevant to hedge funds and hedge fund managers.

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  • From Vol. 3 No.20 (May 21, 2010)

    Richards Kibbe & Orbe LLP and ACA Compliance Group Webcast Highlights Developments in SEC Examinations of Registered Investment Advisers, and How to Prepare for a Surprise Visit from the SEC

    Hedge fund advisers represent a significant priority for the Securities and Exchange Commission (SEC) in its rulemaking, enforcement and examination efforts.  For hedge fund managers registered with the SEC as investment advisers, the SEC’s examination program has become increasingly important; and significantly more hedge fund managers are likely to be required to register with the SEC in light of the Senate's passage of the Financial Stability Bill.  Pursuant to Section 204 of the Investment Advisers Act of 1940 (the Advisers Act), the books and records of any registered investment adviser (RIA) may undergo compliance examinations by SEC staff.  These examinations aim to protect investors by determining whether RIAs are complying with the law, adhering to the disclosures that they have provided to their clients and maintaining appropriate compliance programs to ensure compliance with the law.  If the SEC examines an RIA, the RIA must provide examiners with access to all requested advisory records that it maintains.  The RIA must also provide the SEC with access to the written policies and procedures required by law to prevent violations of federal securities laws.  The policies and procedures, once implemented, should prevent violations from occurring, detect violations that have occurred and promptly correct any past violations.  The RIA should also prepare for the examination staff to review communications with investors for consistency and accuracy.  The failure of this examination program to detect several high-profile investment adviser frauds, including the Ponzi scheme perpetrated by Bernard Madoff, has led to criticism of the SEC and increased the significance of the examination itself.  On April 22, 2010, Richards Kibbe & Orbe LLP partner Eva Marie Carney co-presented a webcast entitled “SEC Examinations of Investment Advisers” with Joel Sauer of the ACA Compliance Group.  The webcast focused on some of the most important developments in RIA examinations.  It addressed topics such as how to prepare for the visit, asset verification tests, e-mail requests, common exam deficiencies, and the SEC’s enhanced subpoena powers.  It also addressed various “polling questions” or hypotheticals as tutorials for the audience.  This article summarizes the salient details of the presentation, including a step-by-step analysis of how an RIA can best prepare for and effectively manage an SEC examination, and the most common areas of focus during the examination.

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  • From Vol. 3 No.12 (Mar. 25, 2010)

    Katten Muchin Rosenman Hosts Program on “Infected Hedge Funds” Highlighting Rights and Remedies of Investors in Hedge Funds Whose Managers are Accused of Insider Trading or of Operating Ponzi Schemes

    The discovery, duration and depth of Ponzi schemes and insider trading rings uncovered during the last two years have altered, to a degree, the assumptions of institutional investors.  While investors do not presume that every hedge fund manager is engaged in illicit activity, they have expanded their due diligence checklists to include questions intended to identify and avoid bad actors.  Investors also realized that due diligence can never be perfect, and accordingly, have refocused on the legal rights and remedies available to parties invested with managers that are or are alleged to be operating Ponzi schemes or engaged in insider trading.  See “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  In recognition of these abiding concerns among institutional investors, and the concomitant interest among hedge fund managers in demonstrating their commitment to compliance, law firm Katten Muchin Rosenman LLP hosted a seminar on March 16, 2010 titled “Infected Hedge Funds: Rights and Remedies.”  The Katten Partners that served as panelists discussed various relevant topics, including the categories of claims and defenses available to investors in hedge funds whose managers are accused of Ponzi scheme operation or insider trading; differences in remedies available to direct and indirect investors; the SEC’s new enforcement initiatives and cooperation measures (including cooperation agreements, deferred prosecution agreements and non-prosecution agreements); and prophylactic measures hedge fund managers can take to prevent accusations of insider trading or running a Ponzi scheme.  This article describes in detail the most relevant topics discussed and points made at the Katten seminar.

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  • From Vol. 3 No.8 (Feb. 25, 2010)

    U.K Financial Services and Markets Tribunal Upholds Findings of Market Abuse Against Individuals for Using Inside Information to Make Spread Bets

    In a rare, circumstantial case for the U.K., a London tribunal has found that two close friends colluded in using confidential information to make quick profits from so-called spread betting.  On December 29, 2009, the U.K.’s Financial Services and Markets Tribunal (Tribunal), an executive agency of the U.K. Ministry of Justice which rules on disputes between the Financial Services Authority (FSA) and individuals and firms facing regulatory action, upheld the FSA’s case against Robin Chhabra and Sameer Patel.  In confirming the FSA’s findings, the Tribunal agreed that both Chhabra and Patel had engaged in market abuse under the Financial Services and Markets Act 2000 because Patel placed bets “on the basis of restricted information not generally available which was disclosed to him by Chhabra.”  This article analyzes the Tribunal’s decision including the facts of the civil case, the relevant laws and arguments made by the parties.

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  • From Vol. 3 No.7 (Feb. 17, 2010)

    Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment

    As the Securities Exchange Commission and federal prosecutors continue their crackdown on what they perceive to be “systemic” insider trading within the hedge fund industry, now more than ever it is critical for all industry participants to be aware of the line between good research, including entirely lawful information-gathering, and impermissible insider trading.  In a guest article that should be required reading for investment, legal, compliance, marketing, operational and other professionals at hedge fund managers and their service providers – in short, for everyone in the hedge fund industry – Harry S. Davis and Richard Morvillo, both partners at Schulte Roth & Zabel LLP, and Justin Mendelsohn, an associate at Schulte, examine some of the commonly misunderstood areas of the law of insider trading in the context of the current, unprecedented regulatory environment.  Understanding the subtleties in the statutory framework is fundamental to protecting hedge fund management firms because, as we have all observed, mere allegations of insider trading can wipe out a multi-billion dollar hedge fund operation through massive investor redemptions.  In particular, this article discusses: the current regulatory environment; the definition of an “insider”; the broad scope of what constitutes a “trade in securities”; the meaning of a trade which is “on the basis of” material, non-public information; determining whether information is “material”; and the “mosaic theory” and its relationship to “materiality”.  Three among many critical points highlighted by this article are: (1) the definitions of “insider” and “security” for insider trading purposes are broader than you may think; (2) you do not have to actually use the information you receive in trading for a trade to be “on the basis of” that information; and (3) the “mosaic theory” does not permit a firm to trade in the securities of an issuer while a person at that firm is in possession of material, non-public information about that issuer.

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  • From Vol. 3 No.6 (Feb. 11, 2010)

    Paul Hastings Hosts Program on Securities Litigation and Enforcement in Light of New SEC Initiatives to Enhance Enforcement Efforts and Encourage Witness Cooperation

    On February 2, 2010, law firm Paul, Hastings, Janofsky & Walker LLP hosted a Securities Litigation & Enforcement Roundtable focusing on key current enforcement and witness cooperation initiatives at the Securities and Exchange Commission (SEC).  The SEC Enforcement Division, led by Director Robert Khuzami, recently introduced new investigative units designed to enhance and revamp its investigation efforts, as well as to encourage witness cooperation in investigations.  See “SEC Names New Co-Chiefs of Enforcement Division Asset Management Unit and Other Specialized Unit Chiefs,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010).  The speakers also discussed the implications of these initiatives and current enforcement trends for financial institutions and alternative investment vehicles, such as hedge funds.  One of the key points of the discussion was the SEC’s increased emphasis on insider trading enforcement, in particular in the hedge fund context.  The SEC has increased the number of insider trading enforcement actions recently initiated, and the techniques used by the regulator to investigate suspected insider trading have become increasingly aggressive and sophisticated.  For a comprehensive discussion of practice points that can help hedge fund managers avoid insider trading allegations, including links to relevant articles from The Hedge Fund Law Report, see “Regulatory Compliance Association Hosts Program on Increased Risk for Hedge Fund Directors and Officers in the New Era of Heightened Regulation and Enforcement,” The Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).  This article summarizes the most relevant topics discussed at the Paul Hastings Roundtable, focusing on the SEC’s new enforcement initiatives and cooperation measures (including cooperation agreements, deferred prosecution agreements and non-prosecution agreements), and emphasizing the potential impact of those measures on hedge funds and their managers.

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  • From Vol. 2 No.52 (Dec. 30, 2009)

    SEC Accuses Former Associates at Global Financial Institutions of Tipping Friends in “Serial” Insider Trading Scheme

    On December 16, 2009, the Securities and Exchange Commission (SEC) filed suit in the U.S. District Court for the Northern District of California against Vinayak Gowrish, a former associate at private equity firm TPG Capital L.P., formerly Texas Pacific Group.  The complaint accuses Gowrish of providing his friends with tips including confidential business information in a “serial insider trading scheme.”  The SEC alleges that the friends used the illegally communicated and obtained information to trade profitably in the stocks of companies engaged in mergers and acquisitions.  Gowrish’s friends – Adnan Zaman, a former vice president and investment banker at Lazard Freres & Co. LLC; Pascal S. Vaghar, who is currently unemployed; and Sameer N. Khoury, a mortgage broker – have settled with the SEC by collectively paying approximately $310,000 in disgorgement for their part in the purported scheme.  This article summarizes the SEC’s allegations in its civil suit against Gowrish, and details the terms of the SEC’s settlement with Zaman, Vaghar and Khoury.

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  • From Vol. 2 No.51 (Dec. 23, 2009)

    SEC’s First-Ever Credit Default Swap Insider Trading Case Survives Motion to Dismiss

    On May 5, 2009, the Securities and Exchange Commission (SEC) commenced an insider trading enforcement action against Jon-Paul Rorech, a Deutsche Bank bond and credit default swap salesman during the relevant period, and Renato Negrin, a portfolio manager employed during the relevant period by hedge fund adviser Millennium Partners, L.P.  This case is the first insider trading case the SEC has brought with respect to credit default swaps, which are not registered securities.  The SEC alleged that Rorech and Negrin engaged in insider trading of the credit default swaps of VNU N.V., a Dutch media conglomerate.  The defendants moved to dismiss the complaint primarily on the basis that credit default swaps were not “securities based swap agreements” for purposes of insider trading law.  Rorech also argued that the relevant information was not confidential and that the SEC lacked jurisdiction over foreign bonds.  The court rejected their contentions and allowed the SEC’s case to proceed.  We review the arguments made and the court’s rationale for its decision.  See also “SEC Brings First-Ever Credit Default Swaps Insider Trading Case,” The Hedge Fund Law Report, Vol. 2, No. 19 (May 13, 2009).

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    Regulatory Compliance Association Hosts Program on Increased Risk for Hedge Fund Directors and Officers in the New Era of Heightened Regulation and Enforcement

    On December 9, 2009, The Regulatory Compliance Association (RCA) hosted a teleconference titled “Director and Officer Liability Escalate in the New Era of Heightened Regulation,” as part of its CCO University Outreach Series.  Walter Zebrowski, CIO and COO for Hedgemony Partners and Chairman of the RCA, explained in his introductory remarks that the “aftermath of the financial collapse coupled with the new era of heightened regulation shall significantly intensify the scrutiny and liability for directors and officers.”  The event was moderated by Richard Maloy, CIC, CRM, Chairman and CEO of Maloy Risk Services.  The panelists included Peter Welsh, a Partner at Ropes & Gray LLP; Ingrid Pierce, a Partner at Walkers Global; and Michael Pereira, Publisher of The Hedge Fund Law Report.  The panelists discussed issues including: the increased effectiveness on the part of regulators, especially the SEC; pending legislation relating to registration of hedge fund managers, and the practical burdens that registration would (and would not) entail; liquidity and regulation of the insurance industry; demands from institutional investors and insurance underwriters for transparency from hedge funds and managers; the role of independent directors; claims trends, including insider trading (and 12 specific strategies that may be used to avoid insider trading allegations); the institutionalization of the hedge fund industry; and the changing directors and officers (D&O) insurance landscape.  This article summarizes the speakers’ insights on the foregoing issues, and highlights the salient points raised by the speakers on related topics.

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations

    Portfolio managers, investment analysts and others with investment decision-making responsibility at hedge fund managers – especially those managing funds invested in public equity – face an ongoing predicament: the most valuable information from an investment perspective would be material, nonpublic information, but trading while in possession of material, nonpublic information is illegal.  Accordingly, hedge fund investment decision-makers routinely seek to compile a mosaic consisting of material, public information; immaterial, nonpublic information; and other information that broadly falls under the rubric of “market color.”  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  Generally, trading on the basis of such a mosaic is legal.  But knowing whether you have a legal mosaic or illegal inside information is complex.  In particular, determining materiality involves an assessment of the relevant facts in light of a daunting volume of statutes, rules, cases, SEC pronouncements and other formal and informal guidance.  In a word, the “better” a piece of information from the perspective of a hedge fund manager, the more scrutiny it merits (from at least the manager’s general counsel, chief compliance officer and outside counsel) to determine whether the manager’s funds may trade based on the information (or whether manager personnel may trade in their personal accounts while in possession of the information).  Nowhere is this predicament more pronounced than in situations in which hedge fund manager personnel talk to corporate insiders, in particular, executives of companies whose securities are owned or may be purchased or sold by the manager’s funds.  Talking to corporate insiders is essential in light of the competition in the investment world.  However, such communications are also fraught with the opportunity to acquire and inappropriately use material, nonpublic information.  In an article in our October 29, 2009 issue, we discussed a number of specific strategies that hedge fund managers can implement to minimize the likelihood that communications with corporate insiders may result in insider trading violations.  See “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  One of the techniques discussed briefly in that article is the use by hedge fund managers of expert networks.  Expert networks generally are companies that broker and structure communications between buy-side investors, such as hedge fund managers, and experts in designated areas, including corporate insiders and others with domain expertise.  This article expands substantially on the discussion in our previous article, describing in detail: what an expert network is; how such networks operate; the categories of experts available via networks; fees charged for membership in a network and periodic access to experts; the mechanics of communications with experts in a network; the benefits and limits of expert networks in preventing insider trading charges; eight specific steps taken by expert network companies to prevent insider trading violations; and Regulation Fair Disclosure (Reg FD) concerns.  One of the basic insights of this article is that expert networks have both offensive and defensive uses: they can be used to locate and glean information from experts who otherwise may be hard to find or hesitant to talk (the offensive use), and they provide a structure for communication that would be difficult to replicate in ad hoc or informal settings (the defensive use).

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    Big Boys Don’t Cry: How “Big Boy” Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations

    Various factors recently have increased the sensitivity of hedge fund managers, lawyers, compliance professionals, investors and others to insider trading concerns.  Those factors include, but are not limited to: insider trading allegations against Galleon Group founder Raj Rajaratnam and others; remarks delivered by SEC Enforcement Division Director Robert Khuzami on November 23 indicating that the Division will increase its enforcement activity with respect to insider trading by hedge funds, and in particular will focus on insider trading in the derivatives context; and press reports that the SEC has sent at least three dozen subpoenas to hedge fund managers and broker-dealers during November 2009 relating to communications in connection with healthcare industry transactions closed during the past three years and certain retail industry transactions.  See “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” The Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).  In light of the increased regulatory scrutiny of activity that may constitute insider trading, hedge fund lawyers, compliance professionals and others are re-examining how and where to draw the line between permissible and impermissible information, and how to police that line effectively.  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  In addition, hedge fund industry participants are refocusing on the promise and limits of tools they may employ to prevent or mitigate allegations of trading on material, nonpublic information.  One such tool is the so-called “Big Boy” provision, or disclaimer of reliance.  In our November 19, 2009 issue, we published the first part of a two-part analysis of Big Boy provisions in the hedge fund context by Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP.  That first part discussed the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no federal counterpart.  See “When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This second part expands on that analysis, focusing in depth on the enforceability of Big Boy provisions in securities and non-securities transactions, with a special emphasis on the enforceability of such provisions under New York law in the context of trading in bank loans.  In addition, this part includes a detailed discussion of, and a comprehensive review of the caselaw relating to, specific steps that hedge fund managers can take to increase the likelihood that a court will enforce a Big Boy provision.

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    Best Practices for a Hedge Fund Manager General Counsel or Chief Compliance Officer that Suspects or Discovers Insider Trading by Manager Employees or Principals

    A confluence of factors – including Galleon; Madoff, and in particular the SEC’s failure to catch the Ponzi scheme earlier; other discovered frauds; the credit crisis; etc. – have enhanced scrutiny by regulators of actions at hedge fund managers that may constitute insider trading.  See “Another Hedge Fund Manager, Former Jefferies Group Manager Joseph Contorinis, Indicted for Insider Trading,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “For Hedge Funds and Their Managers, the SEC’s New Enforcement Initiatives May Increase the Likelihood, Speed and Vigor of Inspections and Examinations,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009); “What Can Hedge Fund Managers Learn From the SEC’s Failure to Catch Madoff? An Interview with Charles Lundelius, Senior Managing Director at FTI Consulting, Inc.,” The Hedge Fund Law Report, Vol. 2, No. 40 (Oct. 7, 2009).  In light of this increased regulatory scrutiny, many hedge fund managers are reviewing their policies, practices and procedures with respect to insider trading.  For any hedge fund manager, whether registered or unregistered, it is critical to have an insider trading policy that is comprehensive, legally accurate, practicable and effective.  See “Key Elements of a Hedge Fund Manager’s Insider Trading Policies and Procedures,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  Beyond having a best-of-breed insider trading policy, though, hedge fund management firms also have to think about how they would respond to suspicion or discovery of insider trading by an employee or principal of the manager.  Within hedge fund management firms, the general counsel (GC) and chief compliance officer (CCO) are on the front lines of investigation, discovery and response.  Accordingly, this article offers guidance and a review of best practices with respect to what a hedge fund manager GC or CCO should do in the event of suspicion or discovery of insider trading.  Specifically, the article discusses: the corporate charging guidelines of the Department of Justice (DOJ); internal investigations; the advisability of suspending suspected violators; how and when to preserve the record; what to do in the event of an actual discovery of insider trading; and how to prepare for surprise government interviews.

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  • From Vol. 2 No.46 (Nov. 19, 2009)

    How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?

    All hedge fund managers, in a manner of speaking, are in the information business – the business of collecting, analyzing and acting on a significant volume of complex information.  At a similar level of generality, many of the federal securities laws and rules govern the use that may and may not be made of certain categories of information.  At one end of the spectrum of permissibility is material, nonpublic information.  Generally, hedge fund managers may not trade securities based on such information where it is obtained from someone with a fiduciary duty to the issuer of those securities.  At the other end of the spectrum is public information, such as that gleaned from public filings such as annual or quarterly reports.  Somewhere in the middle is so-called “market color,” generally understood to refer to information that is more specific to a company, industry or market than public information, but that does not rise to the level of material, nonpublic information.  In other words, if information is market color, a hedge fund manager can trade on it, whereas if information crosses the line from market color to inside information, a manager cannot trade on it.  However, the distinction is easier to draw in hindsight, and the line is often blurry.  Moreover, as recent insider trading charges have demonstrated, the practical standard of proof in the court of institutional investor opinion is significantly lower than in a civil or administrative proceeding: insider trading charges alone, even if unproven, are sufficient to unravel a hedge fund business that may have taken years to build.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009); “SEC Sues Hedge Fund CFO and Venture Capital Fund CFO Alleging Insider Trading in Tempur-Pedic and Acxion Stock,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009); “A Pequot Postmortem: What is Headline Risk and How Can it be Avoided or Mitigated?,” The Hedge Fund Law Report, Vol. 2, No. 24 (Jun. 17, 2009).  At the same time, many traders, analysts and others at hedge fund managers have to determine on a day-to-day basis whether certain categories of information they receive, alone or in combination with other information possessed by them or their firms, constitutes market color that may be acted upon, or material, nonpublic information that may not be acted upon.  Given that distinguishing between market color and inside information can have profound consequences, is infamously difficult and is a labor routinely practiced by many in the hedge fund industry, this article seeks to provide guidance in making that distinction in various contexts.  In particular, this article discusses: the definition of market color; who provides market color and the channels via which it is provided; the interaction of soft dollars and market color; factors to consider in determining whether and when a particular piece of information crosses the line from market color to inside information; and regulatory precedents that may provide insight into how the SEC may treat market color.

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  • From Vol. 2 No.46 (Nov. 19, 2009)

    When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?

    For hedge fund lawyers and compliance professionals who are charged with protecting their institutions from allegations of trading on material, nonpublic information, “Big Boy” provisions, or disclaimers of reliance, are potentially helpful tools.  In the first of a two-part series of guest articles, Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP, discuss the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the Federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no Federal counterpart.  The second article in this series will focus on the usefulness of Big Boy provisions in securities and non-securities transactions and steps that will increase the likelihood a court will enforce a Big Boy provision; the discussion of New York law in that second article will focus on its application in secondary market bank loan transactions.

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  • From Vol. 2 No.46 (Nov. 19, 2009)

    Another Hedge Fund Manager, Former Jefferies Group Manager Joseph Contorinis, Indicted for Insider Trading

    On November 6, 2009, the United States Attorney’s Office for the Southern District of New York announced the indictment of Joseph Contorinis, a former Jefferies Group, Inc. hedge fund portfolio manager, on charges of conspiracy and securities fraud relating to his alleged participation in an insider trading conspiracy ring.  See United States v. Contorinis, Case No. 09 Maj 289 (S.D.N.Y., filed Nov. 5, 2009).  According to the indictment, Contorinis, who acted as managing director and portfolio manager for the Jefferies Paragon Fund, allegedly received material, nonpublic information from UBS Investment Bank investment banker Nicos Stephanou (Stephanou), regarding merger and acquisition activity that led to Contorinis making profits of about $7 million for his hedge fund.  The indictment capped a series of insider trading cases announced since the beginning of November by the U.S. Attorney’s Office.  On November 5, 2009, the U.S. Attorney’s Office announced the indictment of fourteen other individuals for insider trading as part of a widening investigation of the alleged insider trading scheme by Galleon Group founder Raj Rajaratnam, a scheme federal law enforcement officials describe as the largest ever hedge fund-related insider trading conspiracy.  For more background on the Galleon Group insider trading case, see “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  We detail the allegations in the Contorinis indictment and a related action.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs

    In November 2007, Scott Friestad, Associate Director of the SEC’s Enforcement Division, announced that trading abuses would be a priority for the then-newly-launched Hedge Fund Working Group.  He defined “trading abuse” to include abuses of private investments in public equity (PIPE) transactions, as well as insider trading and improper short sales under Regulation M.  But the advertised crackdown was already underway.  For example, that September, the SEC had initiated an enforcement action against Robert A. Berlacher and others alleging that the defendants had engaged in unlawful insider trading in connection with the Radyne ComStream Inc. PIPE offering of 2004, by selling short Radyne securities prior to the public announcement of the PIPE.  As an alternative theory of liability, the SEC also alleged that the trading violated Section 5 of the Securities Act of 1933 (Securities Act).  Section 5 generally requires that every offer or sale of securities must be either registered or exempt from registration.  The SEC claimed in Berlacher and analogous cases that the use of PIPE shares after the effective date of the relevant registration statement to cover short sales made prior to the effective date of the relevant registration statement effectively constituted an unregistered sale of securities that required registration.  The SEC has since suffered a series of setbacks in connection with PIPEs, especially with respect to its Section 5 theory of liability.  The various dismissals of claims under Section 5 are, in turn, part of a broader pattern of setbacks for the SEC in its enforcement efforts in connection with PIPEs, and the decisions that have resulted from this effort have affected the practices of issuers, placement agents and investors.  This article reviews the mechanics of PIPE transactions and the informal confidentiality arrangements traditionally entered into by PIPE issuers and investors.  The article then surveys the insider trading caselaw applicable to investors in PIPEs (many of whom are hedge funds); the insider trading claims against Mark Cuban, which were dismissed in July of this year, including insights from the lawyer who successfully represented Cuban in that matter; the changing dynamics of the PIPE marketplace, including the entry of more sophisticated issuers, and the concomitant new emphasis on the terms of confidentiality and standstill agreements; and the materiality of PIPEs in any insider trading analysis.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    SEC Sues Hedge Fund CFO and Venture Capital Fund CFO Alleging Insider Trading In Tempur-Pedic and Acxiom Stock

    On October 30, 2009, the Securities and Exchange Commission (SEC) commenced a civil enforcement action against a group of seven individuals who allegedly engaged in insider trading in the securities of Tempur-Pedic International, Inc. (Tempur) and Acxiom Corporation (Acxiom).  Defendant King Chuen Tang (Chen Tang) was Chief Financial Officer of an unnamed hedge fund.  He allegedly conveyed confidential information about Tempur to five co-defendants, and traded on that information for his own account, through funds that he controlled, and through accounts held in the names of friends and family members.  His brother-in-law, defendant Ronald Yee, was Chief Financial Officer of a venture capital fund.  He is said to have been the tipper who provided Chen Tang with non-public information about Acxiom.  The SEC is seeking a permanent injunction, disgorgement of profits and civil penalties against the seven defendants involved in the scheme.  It is also seeking disgorgement of profits and an accounting from the investment funds controlled by the defendants and from the friends and family members of the defendants in whose names the illicit trades were conducted.  We summarize the details of the scheme, as pleaded in the SEC’s complaint, and the SEC’s legal allegations.

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  • From Vol. 2 No.44 (Nov. 5, 2009)

    As Criminal Trial Looms, Small Victory for Bear Stearns Hedge Fund Manager Matthew Tannin

    The notable indictment, arrest and prosecution of Matthew Tannin and Ralph Cioffi, two hedge fund managers for the now-defunct Bear Stearns Asset Management (BSAM) has, at least for Tannin, taken a momentarily beneficial turn.  Accused of conspiracy, securities fraud and wire fraud, and with trial looming, Tannin moved to suppress a purportedly damaging e-mail the Federal Bureau of Investigation (FBI) had recovered from his personal e-mail account with a search warrant.  The Honorable Frederic Block, who presides over the case in the United States District Court for the Eastern District of New York, agreed with Tannin that the search warrant was deficient, the resulting search unconstitutional and that the United States Attorney’s Office could not cure the error.  As a result, on October 26, 2009, the court ordered the e-mail suppressed on the eve of trial.  We describe the background of the action and the court’s legal analysis with respect to Tannin’s motion to suppress.

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  • From Vol. 2 No.43 (Oct. 29, 2009)

    How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?

    The recent insider trading allegations against Raj Rajaratnam, founder of Galleon Group, and others highlight a predicament faced by many in the hedge fund industry: absent a seer-like insight (a la Buffett) or superior computers (a la Renaissance Technologies and others), the only way to consistently generate alpha is to consistently obtain information that is not available to others, or to apply information that is available to others in unique ways.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  Especially after promulgation of Regulation Fair Disclosure (Reg FD), everyone can read and internalize the same disclosure documents at roughly the same time.  Therefore, hedge fund managers – especially those that invest in public equity or debt – have to talk to corporate insiders to stay competitive; to stay ahead, they have to talk to a lot of corporate insiders.  And hence the predicament: how to talk to corporate insiders without violating the insider trading laws?  Those laws generally prohibit trading while in possession of material, nonpublic information.  But what constitutes “materiality” for insider trading purposes, and what information is considered “nonpublic”?  For a hedge fund manager, analyst or trader who spends a good portion of each work day talking to corporate insiders, the line can often be blurry, and the consequences can be dire.  Galleon, for example, liquidated in record time in response to as yet unproven allegations of insider trading by its principal.  In recognition of the importance to hedge fund managers of avoiding insider trading allegations, this article examines the facts and allegations of the Galleon case; the statutory and regulatory bases for the prohibition of insider trading; 10b5-1 plans; the categories of financial instruments to which the prohibition applies; insider trading policies and procedures at hedge fund managers; specific best practices that hedge fund managers can employ to prevent insider trading or mitigate its impact; the “mosaic theory” of information gathering and use; and the utility and limitations of expert networks.

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  • From Vol. 2 No.43 (Oct. 29, 2009)

    Key Elements of a Hedge Fund Manager’s Insider Trading Policies and Procedures

    While the insider trading allegations against Raj Rajaratnam of Galleon Group and others remain to be proved or disproved, the case has already confirmed the fundamental importance to hedge fund managers of having, enforcing and training personnel with respect to comprehensive and strategy-specific insider trading policies and procedures.  See “Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  The SEC requires registered investment advisers to have written compliance policies and procedures and written codes of ethics – either may contain the adviser’s written policies and procedures regarding insider trading (or the code of ethics may be part of the compliance manual).  However, the prohibition against insider trading – a broad legal framework based in caselaw, regulatory pronouncements and statutory provisions – applies to all investment advisers and all hedge fund managers, not just registered managers.  Therefore, most hedge fund managers have written insider trading policies and procedures, those that do not should and even those that do should revisit them.  The importance and urgency of focusing or refocusing on written insider trading policies and procedures is based on at least two trends.  First, the allegations against Galleon are part of a renewed enforcement effort on the part of the SEC and DOJ against hedge funds specifically and insider trading generally.  See “For Hedge Funds and Their Managers, the SEC’s New Enforcement Initiatives May Increase the Likelihood, Speed and Vigor of Inspections and Examinations,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009).  Second, most hedge fund managers likely will be required to register with the SEC within a relatively short time.  On Tuesday, October 27, 2009, the Private Fund Investment Advisers Registration Act, which generally would require registration by most hedge fund managers, passed the House Financial Services Committee.  See “U.S. House of Representatives Holds Hearing on Hedge Fund Adviser Registration,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009); “Hedge Fund Association Hosts Capitol Hill Symposium Focused on Hedge Fund Adviser Registration and Hedge Fund Industry Regulation,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  In light of the fundamental importance to hedge fund managers of having apt and thorough written insider trading policies and procedures, and making such policies part of the firm’s “culture of compliance,” this article examines the nuts and bolts of what should be in such policies and procedures and why.  In particular, we examine the statutory, regulatory and practical requirements for having an insider trading policy; certain key definitions typically included in an insider trading policy, including the definitions of “insider,” “nonpublic information,” “materiality” and “security”; remedies and penalties for violations of insider trading laws and insider trading policies; guidelines for avoiding violations, including watch lists and ethical walls; related categories of market manipulation; personal trading policies and procedures; the critical importance of training; and the utility of filtering information through the Chief Compliance Officer.

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  • From Vol. 2 No.42 (Oct. 21, 2009)

    Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy

    On October 16, 2009, the United States Attorney for the Southern District of New York and the Federal Bureau of Investigation announced the filing of criminal charges against several people involved with the Galleon Group family of hedge funds and New Castle Funds, LLC, for allegedly engaging in a massive insider trading scheme.  Specifically, the government accuses Raj Rajaratnam, founder and manager of Galleon, Mark Kurland, a top executive at New Castle, and Danielle Chiesi, a New Castle employee, of contacting a network of close business associates, including Rajiv Goel, a managing director at Intel Capital, Anil Kumar, a director at McKinsey & Company, Robert Moffat, an IBM senior executive, and one another to obtain confidential information about corporate earnings and takeover activity at several public companies.  The complaints also accuse Rajaratnam of using that non-public information to illegally trade on behalf of funds under his management to obtain more than $20 million in profits.  According to federal prosecutors, this criminal action, brought in two separate, but interconnected criminal complaints, is the largest ever against a hedge fund for insider trading, and it represents the first time that the government has used wiretaps to target “significant insider trading on Wall Street.”  In a related action, the Securities and Exchange Commission (SEC) also filed a civil injunctive action in the United States District Court for the Southern District of New York against Rajaratnam, Galleon Management L.P., and the aforementioned executives based on the same allegations.  Nonetheless, this case implicates far more than just the run-of-the-mill SEC civil complaint.  Instead, as the United States Attorney remarked, it “should be a wake up call” for the entire hedge fund community.  We detail the factual allegations and legal claims in the criminal and civil complaints.

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  • From Vol. 2 No.36 (Sep. 9, 2009)

    How Can Hedge Fund Managers Structure Their Compliance, Reporting and Disclosure Systems to Avoid Allegations of Principal Trading Rule Violations Such As Those Recently Alleged by the DOJ Against Former Bear Stearns Hedge Fund Manager Ralph Cioffi?

    In a motion in limine filed in the insider trading case against Ralph Cioffi, the former head of failed Bear Stearns hedge funds, the U.S. Attorney’s Office for the Eastern District of New York alleged that Cioffi repeatedly violated the policies and procedures of Bear Stearns Asset Management, Inc. (BSAM) regarding principal trades.  Specifically, the motion alleges that despite repeated warnings from the BSAM compliance department, Cioffi repeatedly executed principal trades without making the disclosures or obtaining the consent required by Section 206 of the Investment Advisers Act of 1940 (Advisers Act).  Unlike the better-publicized allegations that Cioffi touted the glowing prospects of his funds while expressing serious misgivings about their prospects behind closed doors, or that he redeemed from his funds while in possession of material non-public information that, if public, would have severely diminished the value of the funds, the alleged principal trading rule violations are noteworthy for hedge fund managers for the same reasons that they are not front page news.  Saying X and doing Y is wrong for obvious reasons, as is redeeming when counseling investors not to redeem.  But precisely what constitutes a principal trade, when and how to obtain consent, what to disclose – these are subtler questions that may apply to any hedge fund manager with an interest in one of its own funds, whether or not the funds are on the brink of collapse.  Accordingly, the principal trading rule violations alleged against Cioffi offer a cautionary tale for hedge fund managers, and serve as an occasion to revisit the most pressing questions arising in the hedge fund context relating to principal trades, including: what precisely are the relevant principal trading rules and the statutory bases therefor?  At what threshold of ownership is a client or account of a hedge fund manager considered “owned” by that manager or its principals for purposes of the principal trading rules?  How is that ownership stake calculated?  In light of the allegations against Cioffi, what specific measures can hedge fund managers take to craft effective compliance, reporting and disclosure systems to avoid similar allegations?  What happens if a principal trade occurs without proper disclosure and consent?  This article explores these and related questions.

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  • From Vol. 2 No.19 (May 13, 2009)

    SEC Brings First-Ever Credit Default Swaps Insider Trading Case

    On May 5, 2009, the Securities and Exchange Commission (SEC) charged Jon-Paul Rorech, a salesman at Deutsche Bank Securities, and Renato Negrin, a former Millennium Partners, L.P. hedge fund portfolio manager with insider trading in credit default swaps of VNU N.V., a Dutch media conglomerate (VNU).  According to the SEC, this case is the first insider trading enforcement action it has brought with respect to credit default swaps (CDSs).  Rorech allegedly learned information from Deutsche Bank investment bankers about a change to a proposed VNU bond offering that was expected to increase the price of CDSs on VNU bonds.  Rorech then purportedly illegally tipped Negrin about the contemplated change.  Negrin then purchased CDSs (which are not registered securities, and are used to insure against the default of debt and certain related credit events) on VNU for a Millennium hedge fund.  According to the SEC, when news of the restructured bond offering became public in late July 2006, the price of VNY credit default swaps increased, and Negrin closed Millennium’s VNU credit default position at a profit of about $1.2 million.  The SEC seeks an injunction barring further securities laws violations, disgorgement of profits and civil penalties.  We detail the SEC’s factual allegations and legal claims.

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  • From Vol. 2 No.17 (Apr. 30, 2009)

    The Hedge Fund Industry in Transition

    With the completion of the G20 summit and the continued coverage of economic woes by the media, it leaves the reader to ponder how we arrived at this point in our history.  In a comprehensive guest article, Ernest Edward Badway and Lauren Lezak, Partner and Associate, respectively, at Fox Rothschild LLP, explore the foundation for and the potential changes in store for the hedge fund industry.

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  • From Vol. 2 No.15 (Apr. 16, 2009)

    District Court Preserves PIPE Insider Trading Claims Against Gryphon Hedge Fund

    On March 23, 2009, the United States District Court for the Southern District of New York  decided that a lawsuit brought by the Securities and Exchange Commission against hedge fund manager Edwin “Bucky” Buchanan Lyon, IV, and the Gryphon family of hedge funds (Gryphon Funds) he managed (collectively, the defendants), may advance to trial.  The SEC accused the defendants of securities fraud and insider trading for allegedly short selling shares in four companies after obtaining confidential non-public solicitations to participate in those companies’ upcoming private investments in public equities (PIPE) transactions.  The trial court declined to enter summary judgment on behalf of either party, holding “issues of material fact remain in dispute – namely, whether defendants accepted a duty of confidentiality with regard to each of the four PIPE offerings” which they subsequently breached.  We explain how a PIPE transaction works, and detail the facts of the case and the court’s holding and analysis.

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  • From Vol. 2 No.2 (Jan. 15, 2009)

    Establishing, Maintaining and Exiting a Minority Equity Position: U.S. Securities Law Considerations for Hedge Funds

    A hedge fund that takes a minority equity position in a U.S. public company may encounter a variety of complex issues under the federal securities laws and other investment-related statutes.  In a guest article, Scott Budlong, a partner in the New York office of Richards Kibbe & Orbe LLP, and other RKO attorneys and an advisor to the firm, offer a comprehensive discussion of the most important of these U.S. legal issues from the perspective of an equity investment’s lifecycle: establishing, maintaining and exiting the position.

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  • From Vol. 1 No.10 (May 6, 2008)

    Second Circuit Holds that Directors by Deputization are Covered by Exemption to Liability for Short-Swing Profits

    • Second Circuit held that “directors by deputization” - that is, shareholders who exercise the power to appoint directors to an issuer’s board of directors - are exempted under Rule 16b-3(d) from the general rule of strict liability of insiders for short swing profits under Exchange Act Section 16(b).
    • Court deferred to SEC’s policy rationale for including directors by deputization in the scope of the rule. That is, court agreed with SEC that transactions between issuers and directors by deputization do not pose the danger of abuse of informational asymmetries that Section 16(b) was enacted to address, and thus the SEC appropriately exempted such transactions from liability under Section 16(b).
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  • From Vol. 1 No.2 (Mar. 11, 2008)

    SEC Warns Public Pension Funds About Inadequate Compliance Policies and Procedures Following Report of Investigation Into Insider Trading By Employees of the Retirement System of Alabama

    • The Retirement System of Alabama purchased stock in The Liberty Corporation based on information obtained in the course of providing debt financing to Liberty in connection with the acquisition of Liberty by a company controlled by the RIA.
    • The RIA had no compliance policies or procedures in place at the time of the insider trading, but agreed to institute such policies following the investigation.
    • The SEC wrote a Report of Investigation describing the matter, and used the occasion of the Report to remind pension funds that although they are generally exempt from the Investment Company Act and the Investment Advisers Act, they remain subject to the anti-fraud provisions of the federal securities laws and rules.
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