The Hedge Fund Law Report

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

Articles By Topic

By Topic: Books and Records

  • From Vol. 11 No.25 (Jun. 21, 2018)

    What Robo-Advisers Can Expect From SEC Examinations

    There are no compliance shortcuts available to robo-advisers; investment advisers that offer automated advice must fully comply with all the duties imposed by the Investment Advisers Act of 1940 and its rules, as well as the obligations pertaining to technology platforms. A recent ACA Compliance Group (ACA) program offered a view from the trenches as to what the SEC looks for when it examines robo-advisers. The program featured Burton J. Esrig, managing director at ACA Technology; Luis Garcia, principal consultant with ACA; and Susan I. Gault-Brown, partner at Morrison & Foerster. This article summarizes their insights. For coverage of ACA’s 2018 compliance survey, see our two-part series: “Compliance Programs and SEC Examination Priorities” (May 31, 2018); and “Electronic Communications, Personal Trading and Corruption Risk” (Jun. 14, 2018).

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  • From Vol. 11 No.18 (May 3, 2018)

    Ten Risk Areas for Private Funds in 2018

    A recent program presented by Proskauer Rose examined the key regulatory and litigation risks currently facing private fund managers. Unsurprisingly, near the top of the list were prominent issues on the regulatory radar, including cryptocurrency and blockchain; data privacy; and performance claims. A common theme among many of the risks covered in the presentation is that the law has not yet sufficiently developed to address current business practices. The program featured Proskauer partners Timothy W. Mungovan and Joshua M. Newville; counsel Anthony M. Drenzek; and associate Michael R. Hackett. This article explores the speakers’ insights. For coverage of the 2017 Proskauer presentation, see “Ten Key Risks Facing Private Fund Managers in 2017” (Apr. 6, 2017).

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  • From Vol. 11 No.18 (May 3, 2018)

    SEC Charges Broker-Dealer With Numerous Violations of Customer Protection, Hypothecation and Reporting Rules

    Rule 15c3-3 under the Securities Exchange Act of 1934 (Exchange Act), known as the Customer Protection Rule, requires broker-dealers to take specific steps to safeguard customer cash and securities. Rule 15c2-1(a)(1) under the Exchange Act prohibits, without customer consent, hypothecation of customer securities that would result in the customer’s securities being commingled with another customer’s securities. A broker-dealer recently settled SEC charges that it had violated both rules, as well as the reporting requirements under the Exchange Act, by permitting cash customers’ fully paid securities to be improperly commingled in omnibus margin accounts at a clearing broker and to be hypothecated without their consent. The broker allegedly used those securities to finance its own operations and margin obligations. The settlement serves as a reminder that private fund advisers should pay close attention to how their brokers are protecting fund assets and whether those brokers are using fund assets to finance their operations. This article details the SEC’s allegations and the terms of the settlement. See “Morgan Stanley Settles SEC Charges Stemming From the Use of Customer Cash to Finance a Broker’s Hedge Positions” (Jan. 19, 2017); and “Merrill Lynch Settlement Reminds Hedge Fund Managers to Be Aware of How Brokers Are Handling Their Assets” (Jul. 7, 2016).

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  • From Vol. 11 No.11 (Mar. 15, 2018)

    FCA Solicits Industry Input on Machine-Executable Regulatory Reporting

    The U.K. Financial Conduct Authority (FCA) has been exploring ways to streamline and automate regulatory reporting – one of the critical compliance challenges facing private fund managers. Last November, in a so-called “TechSprint,” the FCA and the Bank of England worked with various financial services and technology firms to develop and successfully implement a machine-executable reporting rule. This project is detailed in a recent report, which also seeks input from market participants and other interested parties on how to proceed with this potentially revolutionary approach to reporting. The report should be of interest to FCA-regulated firms; financial services regulators; regulatory and financial technology companies; and professional services, technology and software providers. This article summarizes the key takeaways from the report. For more on FCA reporting requirements, see FCA Amends Its Position on Annex IV Reporting: U.K. and Non-EEA Managers, Including U.S. Managers, Must Now Report Holdings at Master Fund Level” (Apr. 13, 2017); and “U.S. Managers Marketing to U.K. Investors Could Face Ballooning Reporting Burdens Under Proposed Rule” (Jul. 28, 2016).

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  • From Vol. 11 No.10 (Mar. 8, 2018)

    With the Filing Deadline Looming for Many Advisers, Seward & Kissel Attorneys Provide a Roadmap to Amended Form ADV

    In August 2016, the SEC adopted a number of amendments to Part 1A of Form ADV, which took effect on October 1, 2017. Many advisers are now contending with the revised form in connection with their annual updates that are due March 31. A recent Seward & Kissel presentation offered an overview of the most material and vexing changes, offering practical advice on how to complete the revised form. The program featured Seward & Kissel partners Paul M. Miller, Patricia A. Poglinco and Robert B. Van Grover, along with counsel David Tang. This article summarizes the key points raised by the panelists. For more on the amendments, see our two-part series on what investment advisers need to know about the SEC’s 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). For additional insights from Van Grover and Poglinco, see “Pro-Business Environment of New Administration Continues to Have Challenges and Pitfalls for Private Funds” (Sep. 14, 2017); and “How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations” (Sep. 8, 2016).

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  • From Vol. 10 No.44 (Nov. 9, 2017)

    ACA Offers Roadmap to Maintaining Books and Records: Document Retention and SEC Expectations (Part Two of Two)

    Investment advisers are faced with the ongoing challenge of ensuring compliance with the numerous rules and regulations governing their books and records. A recent ACA Compliance Group (ACA) program offered a comprehensive overview of the documents and records that investment advisers are required to maintain, focusing on ways advisers can ensure that those records be complete, accessible and in the proper form in the event of an SEC examination. The program featured Beth Manzi, chief operating officer of private fund administrator PEF Services LLC, and Theodore E. Eichenlaub, partner at ACA. This second article in our two-part series considers the electronic storage of records, document destruction, testing of compliance programs and SEC examinations. The first article discussed the regulatory background surrounding the maintenance of adviser-specific records, including corporate and accounting documents; marketing documents; and emails. For additional insights from ACA, see our two-part series “A Roadmap for Advisers to Comply With Marketing and Advertising Regulations”: Part One (Aug. 3, 2017); and Part Two (Aug. 10, 2017).

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  • From Vol. 10 No.43 (Nov. 2, 2017)

    A Roadmap to Maintaining Books and Records: Compliance With Applicable Regulations (Part One of Two)

    Investment advisers are subject to numerous rules and regulations regarding their books and records. A recent ACA Compliance Group (ACA) program, featuring Beth Manzi, chief operating officer of private fund administrator PEF Services LLC, and Theodore E. Eichenlaub, partner at ACA, offered a comprehensive overview of the documents and records that investment advisers are required to maintain. The program also focused on methods for ensuring that those documents and records be complete, accessible and in a proper form in the event of an SEC examination. This article, the first in a two-part series, discusses the regulatory background surrounding the maintenance of adviser-specific records, including corporate and accounting documents; marketing documents; and emails. The second article will consider the electronic storage of records, document destruction, testing of compliance programs and SEC examinations. For additional commentary from ACA, see “How Private Fund Managers Can Avoid Common Pitfalls When Calculating and Advertising Internal Rates of Return” (Sep. 7, 2017); and “Compliance Corner Q4-2017: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter” (Oct. 12, 2017).

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  • From Vol. 10 No.40 (Oct. 12, 2017)

    Steps an Exempt Reporting Adviser Must Take to Transition to SEC Registered Investment Adviser Status: Adopting Compliance Policies and Procedures (Part Two of Three)

    Designing compliance policies and procedures that are appropriately tailored to a private fund adviser’s risks is a critical component of a compliance program for an SEC registered investment adviser (RIA). Exempt reporting advisers (ERAs) transitioning to RIA status that have not already devoted the time and resources to developing these policies and procedures will likely find this to be the most time-consuming aspect of the registration process. To assist ERAs with the creation and implementation of appropriate compliance policies and procedures, this second article in our three-part series outlines key policies and procedures that ERAs should consider when drafting their compliance manuals. The first article discussed the circumstances under which an ERA would be required to switch to SEC registration, along with considerations for ERAs building out their compliance programs. The third article will review the regulatory filings required to be filed by RIAs, amendments that ERAs may need to make to their fund offering documents in anticipation of their change in registration status, as well as guidance as to what newly registered advisers should expect from the SEC examination process. 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).

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  • From Vol. 10 No.40 (Oct. 12, 2017)

    Compliance Corner Q4-2017: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

    While the fourth quarter is often the busiest one for regulatory filings and fulfilling other compliance obligations, hedge fund managers should ensure that their compliance programs finish the year on a strong note and that key compliance processes are not neglected. This second installment of The Hedge Fund Law Report’s quarterly compliance update, authored by Danielle Joseph and Anne Wallace, director and analyst, respectively, at ACA Compliance Group, highlights certain notable regulatory filings fund managers need to address in the fourth quarter of 2017. In addition to the filing obligations discussed herein, this article examines recent actions by the SEC relating to virtual currency and electronic communications, along with their potential impact on advisers’ compliance programs. For other recent commentary from the SEC, see “SEC Chair Clayton Details Eight Guiding Principles for Enforcement and Agency Strategies for Their Implementation” (Aug. 10, 2017); and “SEC Chair’s Budget Testimony Emphasizes Strong Agency Focus on Oversight and Enforcement in Trump Era” (Jul. 13, 2017). For additional insights from Joseph, see our two-part series “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices”: Part One (Oct. 3, 2013); and Part Two (Oct. 11, 2013).

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  • From Vol. 10 No.31 (Aug. 3, 2017)

    A Roadmap for Advisers to Comply With Marketing and Advertising Regulations (Part One of Two)

    Advertising by investment advisers is subject to numerous rules and regulations, and rife with potential traps for the unwary. A recent ACA Compliance Group (ACA) program provided a comprehensive overview of the relevant rules and SEC guidance that govern these advertising practices and discussed multiple potential pitfalls. The program featured Mark Lawler, ACA senior principal consultant, Matthew Shepherd, ACA principal consultant, and Erika Roess, senior principal consultant at ACA Performance Services. This article, the first in a two-part series, discusses regulations governing performance advertising, compliance with GIPS, recordkeeping requirements relating to marketing materials and use of past specific recommendations. The second article will consider the permissibility of advertising backtested performance and partial client lists; portability of track records; use of solicitors to raise capital; marketing to investors in private funds; and compliance with private placement requirements. For additional insight from Roess, see “Expert Panel Provides Roadmap for Hedge Fund Managers Looking to Present Performance in Compliance With GIPS” (Aug. 1, 2013).

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

    Blockchain and the Private Funds Industry: Potential Impediments to Its Eventual Adoption (Part Three of Three)

    Although excitement about the potential use of blockchain technology – an immutable, time-stamped and decentralized digital ledger of transactions – in the private funds industry has been growing, numerous impediments to its large-scale adoption remain. Issues ranging from a lack of regulatory support of blockchain to basic concerns about the resources required to implement the technology could slow its growth in the private funds industry. Consequently, it will likely be several years before the industry fully uses this technology, with the adoption driven by large organizations and service providers rather than fund managers. To assist our readers with comprehending the nature, uses and future of blockchain, this three-part series provides an overview of the technology through the lens of the private funds industry. This third article details issues that could stymie the spread of blockchain, while also setting forth a realistic timeline and manner for its likely adoption by the private funds industry. The first article provided a primer on the technology and detailed several financial industry uses that are already being explored. The second article explored potential private fund back-office functions (e.g., regulatory reporting and maintaining shareholder ledgers) that could be optimized using blockchain technology. For more on how fund managers can utilize technology, see Can Private Fund Marketing Be Automated?” (Aug. 7, 2014); and our two-part series on “Key Considerations for Hedge Fund Managers in Evaluating the Use of Cloud Computing”: Part One (Oct. 18, 2012); and Part Two (Oct. 25, 2012).

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  • From Vol. 10 No.23 (Jun. 8, 2017)

    Blockchain and the Private Funds Industry: Potential Uses by Private Funds and Service Providers (Part Two of Three)

    Blockchain technology – a distributed database used to immutably timestamp and record transactions – is most commonly thought of in a single context, yet its applications are varied and limited only by the objectives of the adopting users. While popular society is fixated on its use for digital currencies (e.g., Bitcoin) or as a medium for illicit transactions, many more practical blockchain applications could greatly enhance the efficacy of the financial sector while also dramatically reducing its overhead expenses, such as by streamlining fund operations while simultaneously improving compliance protocols. This three-part series provides an overview of necessary information and considerations for the eventual integration of blockchain technology into the financial sector. This second article describes various potential uses of blockchain technology, such as reconciling trades and onboarding investors, to improve private fund operational efficiencies and compliance efforts. The first article detailed how blockchain works and provided examples of how major elements of the financial industry (e.g., derivatives trading and repurchase agreements) are already incorporating the technology. The third article will explore how and when the private funds industry will adopt the technology, while presenting issues related to that implementation. For more on how fund managers can utilize technology, see “The SEC’s Broken Windows Approach: Compliance Resources, CCO Liability and Technology Concerns for Hedge Fund Managers (Part Two of Two)” (Oct. 1, 2015); “Can Emerging Hedge Fund Managers Use Technology to Satisfy Business Continuity Requirements and Mitigate Third-Party Risk?” (Sep. 3, 2015); and “Can Private Fund Marketing Be Automated?” (Aug. 7, 2014).

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  • From Vol. 10 No.16 (Apr. 20, 2017)

    SEC Urges Advisers Relying Upon Unibanco No-Action Letters to Submit Certain Documentation 

    As investment advisers eagerly await clarity about the direction the SEC will take in the Trump era and whether it will deviate from past enforcement practices, SEC guidance and information updates on major policy issues face intense scrutiny. One of the most significant publications to come out of the agency since the new administration took office provides specific guidance to multi-national financial institutions relying on the “Unibanco letters,” which concern the extra-territorial application of the Investment Advisers Act of 1940. This update contains valuable information from compliance and procedural standpoints, as the SEC appears to be reminding advisers that rely upon the Unibanco letters about the complex requirements set forth therein. To help readers understand the significance of the information update and its effect on their businesses, this article analyzes the update and provides commentary from legal practitioners with experience representing multi-national advisory firms. For more on the Unibanco letters, see “SEC Delays Registration Deadline for Hedge Fund Advisers, and Clarifies the Scope and Limits of Registration Exemptions for Private Fund Advisers, Foreign Private Advisers and Family Offices” (Jun. 23, 2011).

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  • From Vol. 10 No.14 (Apr. 6, 2017)

    Ten Key Risks Facing Private Fund Managers in 2017

    A recent seminar presented by Proskauer Rose provided valuable insight on emerging risks for hedge fund managers, including the uncertain regulatory landscape, and perennial SEC targets such as conflicts of interest, valuation and performance marketing. The program was moderated by Proskauer partner Timothy W. Mungovan and featured partner Joshua M. Newville; associates Michael R. Hackett and William Dalsen; and special regulatory counsel Anthony Drenzek. This article summarizes their key insights. For additional commentary from Drenzek, 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.8 (Feb. 23, 2017)

    Top Five Compliance Deficiencies in OCIE Risk Alert Include Annual Compliance Reviews, Accurate Regulatory Filings and Custody Issues

    Each year, fund managers attempt to anticipate what new areas the SEC will focus on in its upcoming examinations. In their push to get ahead, however, those managers often fail to adequately perform many of the compliance requirements to which they have been subject for years. The SEC’s Office of Compliance Inspections and Examinations (OCIE) recently issued a risk alert (Risk Alert) which, in some respects, urges fund managers to return to the basics as it pertains to their compliance efforts. This is because the five most common compliance issues identified in deficiency letters to investment advisers by OCIE which were described in the Risk Alert include traditional duties such as maintaining proper books and records, conducting annual compliance reviews and making accurate regulatory filings. All investment advisers should review their compliance policies and procedures considering the Risk Alert to ensure they avoid the five deficiencies highlighted by OCIE. This article summarizes the compliance failures and other items covered by the Risk Alert. For a similar 2014 OCIE alert, see “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).

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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.2 (Jan. 12, 2017)

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

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

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  • From Vol. 9 No.47 (Dec. 1, 2016)

    How Investment Managers Can Advertise Sub-Adviser Performance Without Violating SEC Rules 

    In a series of recent enforcement actions, the SEC has held investment advisers responsible for performance claims included in their marketing materials that they received from sub-advisers and that turned out to be false and misleading. Although the SEC acknowledged that the investment advisers may have been unaware that the performance information was false and misleading, the regulator concluded that they were nevertheless responsible for ensuring that the overall reported performance record from their sub-advisers was compliant with the Investment Advisers Act of 1940. To avoid running afoul of applicable law, investment advisers conveying third-party performance returns should obtain adequate documentation to verify their accuracy and establish policies and procedures that govern what due diligence they will conduct on the sub-advisers’ performance. In a guest article, Daniel G. Viola, partner at Sadis & Goldberg, and Antonella Puca, head of the investment performance attestation practice at RSM US, review the key aspects of the recent enforcement activity of the SEC on performance advertising and provide guidance on how to address some of the SEC’s concerns. For additional insight from Viola, see “Hedge Fund Managers Advised to Prepare for Imminent SEC Examination” (Jan. 28, 2016). For more on performance advertising, see “The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Retaining Performance Records (Part Two of Two)” (Nov. 17, 2016); and “Liquidity and Performance Representations Present Potential Pitfalls for Hedge Fund Managers” (Mar. 31, 2016).

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  • From Vol. 9 No.47 (Dec. 1, 2016)

    Failure to Safeguard Customer Data, Preserve Records and Properly Supervise May Expose Broker-Dealers to FINRA Enforcement Action

    FINRA recently entered into a Letter of Acceptance, Waiver and Consent with a general securities business that has in excess of 1,100 registered representatives in more than 500 branch locations. The action alleged that the firm failed to safeguard customer data, preserve customer records and implement an appropriate supervisory system to prevent these violations. The affected firm has agreed to a censure and to pay a substantial fine. Private fund managers with affiliated broker-dealers should pay particular attention to this ruling, although FINRA’s cybersecurity preparedness expectations outlined in the action should be of interest to all private fund managers. This article outlines the alleged misconduct, the terms of the settlement and the remedial measures the broker is implementing. For coverage of other FINRA enforcement proceedings, see “FINRA Fines Terra Nova $400,000 for Making Over $1 Million in Improper Soft Dollar Payments to Hedge Fund Managers” (Dec. 10, 2009); and “In FINRA’s First Action Involving Credit Default Swaps, FINRA Fines ICAP $2.8 Million to Settle Price Fixing Claims” (Jul. 16, 2009).

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  • From Vol. 9 No.45 (Nov. 17, 2016)

    The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management (Part Two of Two)

    On August 25, 2016, the SEC adopted much-anticipated amendments to Form ADV, Part 1A and to Rule 204-2 (recordkeeping rule) under the Investment Advisers Act of 1940. These amendments further the SEC’s agenda to gather more information about its registrant base to inform the agency’s risk-based approach to adviser examinations. See “OCIE Director Marc Wyatt Details Use of Technology and Coordination With Other Agencies to Execute OCIE’s Four-Pillar Mission” (Nov. 3, 2016). In a two-part guest series, Michael F. Mavrides and Anthony M. Drenzek, partner and special regulatory counsel, respectively, at Proskauer Rose, review the amendments to Form ADV and the recordkeeping rule and provide practical guidance to SEC-registered investment advisers on the steps to take prior to the compliance date to ensure their firms are prepared to comply with the amended rules. This second article in the series discusses the new disclosure requirements relating to an adviser’s use of social media; office locations; the amount of an adviser’s proprietary assets and assets under management; the sale of 3(c)(1) fund interests to qualified clients; and the recordkeeping requirements regarding performance claims in communications that are distributed to any person. The first article reviewed the detailed disclosures that advisers will be required to provide with respect to managed account clients and the firm’s chief compliance officer, as well as factors to consider when pursuing an umbrella registration. For additional commentary from Proskauer partners, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates: An Interview With Proskauer Partner Robert Leonard” (Mar. 5, 2015); and “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters” (Feb. 1, 2013). For more on Form ADV, see “How Can Hedge Fund Managers Rebut the Presumption of Materiality of Certain Disciplinary Events in Form ADV, Part 2?” (Jan. 5, 2012); and “Recent SEC Enforcement Action Demonstrates the SEC’s Focus on the Accuracy and Consistency of Disclosures by Hedge Fund Managers in Form ADV” (Jan. 5, 2012).

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  • From Vol. 9 No.43 (Nov. 3, 2016)

    The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Managed Account Disclosure, Umbrella Registration and Outsourced CCOs (Part One of Two)

    On August 25, 2016, the SEC adopted amendments to Form ADV, Part 1A, and to Rule 204-2 under the Investment Advisers Act of 1940 (Advisers Act), the so-called “recordkeeping rule.” The amendments were previously proposed on May 20, 2015. See “A Roadmap to the SEC’s Proposed Changes to Form ADV” (Jun. 4, 2015). The amendments to Form ADV provide several points of clarification and elicit new or additional information from investment advisers, while the amendments to Rule 204-2 impose additional recordkeeping requirements on investment advisers with respect to communications that contain performance claims. These changes are designed to better protect clients and investors from fraudulent or otherwise misleading performance information. In a two-part guest series, Michael F. Mavrides and Anthony M. Drenzek, partner and special regulatory counsel, respectively, from Proskauer Rose discuss the practical implications of the amendments and highlight important steps legal and compliance personnel can take to ensure they are prepared in advance of the compliance date. This first article discusses the detailed disclosures that advisers will be required to provide with respect to managed account clients and the firm’s chief compliance officer, as well as factors a registrant should consider with respect to pursuing an umbrella registration. The second article will address the new disclosure requirements relating to an adviser’s use of social media; office locations; the amount of an adviser’s proprietary assets and assets under management; the sale of interests in 3(c)(1) funds to qualified clients; and the recordkeeping requirements regarding performance claims in communications that are distributed to any person. For additional insight from Mavrides, see “Key Legal and Operational Considerations in Connection With Preparing, Filing and Updating Form PF (Part Two of Three)” (Nov. 10, 2011); as well as our two part-series on remote examinations: Part One (May 12, 2016); and Part Two (May 19, 2016). For more on Form ADV, see “When and How Can Hedge Fund Managers Permissibly Disguise the Identities of Their Hedge Funds in Form ADV and Form PF?” (Dec. 1, 2012); and “ALJ Decision Against Investment Adviser Who Received Undisclosed Compensation From a Hedge Fund Manager It Recommended to Clients Highlights SEC Scrutiny of Forms ADV” (May 3, 2012).

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  • From Vol. 9 No.8 (Feb. 25, 2016)

    Hedge Fund Managers Face Imminent NFA Cybersecurity Deadline

    The NFA’s recent Interpretive Notice on cybersecurity is poised to become effective in a matter of days. NFA members, including hedge fund managers registered with the NFA as commodity pool operators or commodity trading advisers, are now required to adopt an Information Systems Security Program. See “NFA Notice Provides Cybersecurity Guidance to Hedge Fund Managers Registered As CPOs and CTAs” (Nov. 19, 2015). To help NFA members prepare for the impending deadline, the NFA recently held a “Cybersecurity Workshop” featuring a number of senior NFA personnel and industry experts. Among other topics discussed during the presentation, panelists offered an overview of the requirements set out in the Notice and insight into what NFA examiners will look for after the notice takes effect. This article summarizes the panelists’ discussion of these issues. For more on CFTC and NFA requirements applicable to hedge fund managers, see our three-part CPO Compliance Series: “Conducting Business With Non-NFA Members (NFA Bylaw 1101)” (Sep. 6, 2012); “Marketing and Promotional Materials” (Oct. 4, 2012); and “Registration Obligations of Principals and Associated Persons” (Feb. 7, 2013).

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  • From Vol. 8 No.44 (Nov. 12, 2015)

    How Hedge Fund Managers Can Operate an AML Program Under FinCEN’s Proposed Rules (Part Two of Two)

    Under the recent proposal by the Financial Crimes Enforcement Network (FinCEN), investment advisers that are registered or required to be registered with the SEC would have to meet the suspicious activity reporting and anti-money laundering (AML) requirements of the Bank Secrecy Act.  To do so, hedge fund managers and other investment advisers would be required to report suspicious activity and retain records relating to certain fund transfers.  During Pepper Hamilton’s seminar, “Investment Management and Hedge Funds: What’s Happening Now?,” partners Gregory Nowak and Timothy McTaggart, as well as Walter Donaldson, managing director of Freeh Group International Solutions, LLC, discussed the proposed rule, including its mandates and anticipated impact on the hedge fund industry.  This article, the second in a two-part series, examines those specific reporting, information sharing and recordkeeping requirements, as well as the adoption and implementation of the rule.  The first article summarized the panelists’ discussion of the proposed rule and the elements of an AML program that it would require.  For more from Nowak, see “Conflicts and Opportunities Offered by Concurrent Management of Employee-Owned Hedge Funds and Outside-Investor Hedge Funds,” The Hedge Fund Law Report, Vol. 2, No. 32 (Aug. 12, 2009).

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  • From Vol. 8 No.22 (Jun. 4, 2015)

    A Roadmap to the SEC’s Proposed Changes to Form ADV

    On May 20, the SEC proposed a number of significant changes to Form ADV and the rules under the Investment Advisers Act of 1940 (Advisers Act).  The changes to Form ADV have three primary goals: to fill in perceived data gaps; to facilitate “umbrella registration” for multiple private fund advisers that operate as part of a single advisory business; and to make certain technical and clarifying amendments.  The changes to the Advisers Act rules primarily expand certain of the “books and records” provisions and make certain technical amendments.  This article summarizes the proposed changes.  For more on Form ADV, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates:  An Interview with Proskauer Partner Robert Leonard,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015).

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  • From Vol. 8 No.21 (May 28, 2015)

    WilmerHale Attorneys Discuss FCPA Concerns for Private Fund Managers (Part One of Two)

    The U.S. has taken the lead in anti-corruption efforts through its vigorous enforcement of the Foreign Corrupt Practices Act (FCPA), and in recent years, regulators around the globe have started to follow suit.  See “Anti-Bribery Compliance for Private Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 39 (Nov. 3, 2011).  This article, the first in a two-part series, identifies the two primary types of corruption risks faced by hedge fund managers, summarizes fundamental provisions of the FCPA and highlights key points from a recent program on the current U.S. and global anti-corruption enforcement climate.  The program featured Kimberly A. Parker and Erin G.H. Sloane, both partners at WilmerHale.  The second article will discuss FCPA risks of particular concern to hedge fund managers, as identified by Parker and Sloane, and summarize recent FCPA enforcement actions involving financial institutions. 

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  • From Vol. 7 No.39 (Oct. 17, 2014)

    Derivative Actions and Books and Records Demands Involving Hedge Funds

    This article explores the use of derivative actions by investors in hedge funds, which investors may bring against hedge fund managers, and explains that where a fund is organized determines whether an investor can maintain a derivative action.  This article also discusses investor requests for books and records relating to a hedge fund, which typically precede an investor’s derivative action.  The authors of this article are Thomas K. Cauley, Jr. and Courtney A. Rosen, both litigation partners in the Chicago office of Sidley Austin LLP.  See also “Contractual Provisions That Matter in Litigation between a Fund Manager and an Investor,” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014).

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  • From Vol. 7 No.35 (Sep. 18, 2014)

    Further CFTC Harmonization of Rules for Hedge Funds: A Welcome and Continuing Trend

    It is widely recognized that the Commodity Futures Trading Commission (CFTC) has made great strides previously in terms of harmonizing its rules with those of other regulators, including the Securities Exchange Commission (SEC).  See “What Do the CFTC Harmonization Rules Mean for Non-Mutual Fund Commodity Pools, Including Hedge Funds?,” The Hedge Fund Law Report, Vol. 6, No. 40 (Oct. 17, 2013).  In perhaps a sign that new leadership at the CFTC has settled in and intends to continue the trend toward harmonization, the CFTC has recently acted on a variety of items with respect to which the industry was waiting, in some cases for a year or more, for sorely needed guidance.  While not all pressing issues have been resolved by the CFTC, a number of them have been.  In a guest article, Steven M. Felsenthal, General Counsel and Chief Compliance Officer of Millburn Ridgefield Corporation, The Millburn Corporation and Millburn International, LLC, summarizes some of the recent CFTC actions and guidance, notes certain implications thereof that may or may not require further guidance and identifies certain items with respect to which further CFTC action would be welcome.  The focus of this article is on certain issues affecting hedge fund advisers that are also commodity pool operators, who are thus subject to both SEC and CFTC regulatory regimes.

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  • From Vol. 6 No.43 (Nov. 8, 2013)

    SEC Sanctions Two Private Fund Managers for Custody Rule Violations, Including Imposing Statutory Bars on Their Chief Compliance Officers

    On October 28, 2013, the SEC entered into settlement orders with three registered investment advisers who were charged with violations of Rule 206(4)-2 (Custody Rule) under the Investment Advisers Act of 1940 (Advisers Act), and other Advisers Act provisions and rules.  These enforcement actions, spurred by high-profile scandals as well as deficiencies uncovered during presence examinations of newly registered advisers, is emblematic of the SEC’s increasingly aggressive approach to enforcement.  See “Recently Published SEC Risk Alert Reveals Significant Deficiencies In Custody Practices of Hedge Fund Managers and Other Investment Advisers,” The Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013).  This article summarizes the settlements entered into with two private fund managers that provide the most pertinent lessons for hedge fund managers.  See also “How Does the SEC Approach Custody Issues in the Course of Examinations of Hedge Fund Managers?,” The Hedge Fund Law Report, Vol. 5, No. 18 (May 3, 2012).  In addition to the Custody Rule violations, the SEC also cited the fund managers for other significant Advisers Act violations (including a violation of Section 206(3) (with respect to an undisclosed principal transaction), style drift, making material misrepresentations in Form ADV, compliance program violations, and making improper distributions to investors).  Importantly, in both settlement orders, the chief compliance officers (CCOs) of both firms agreed to statutory bars, demonstrating the SEC’s commitment to holding CCOs responsible for the compliance failures of their firms.  See “Simon Lorne, Chief Legal Officer of Millennium Management LLC, Discusses the Evolving Roles, Challenges and Risks Faced by Hedge Fund Manager General Counsels and Chief Compliance Officers,” The Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013).

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  • From Vol. 6 No.42 (Nov. 1, 2013)

    K&L Gates Seminar Discusses Impact of CFTC Harmonization Rules on Alternative Mutual Funds and Other Registered Investment Companies

    In the absence of an exemption, a manager of a fund that trades in “commodity interests” (including swaps) may be required to register with the U.S. Commodity Futures Trading Commission (CFTC) as a commodity pool operator (CPO) and become subject to the Commodity Exchange Act and the CFTC’s “Part 4” regulations (which specify a CPO’s disclosure, financial reporting and recordkeeping obligations).  See “Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do? (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  For managers of alternative mutual funds or other registered investment companies (RICs), the CFTC regime is yet another set of rules to navigate; such managers are already subject to the Securities Act of 1933 (Securities Act), the Securities Exchange Act of 1934, the Investment Company Act of 1940 (Company Act), the Investment Advisers Act of 1940, and rules under those statutes.  See “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  To mitigate administrative and coordination challenges associated with duplicative or conflicting CFTC and SEC obligations impacting registered CPOs, on August 13, 2013, the CFTC issued an Adopting Release (Adopting Release) in which it amended existing CFTC rules to create a “substituted compliance” regime (harmonization rules).  Through these harmonization rules, compliance with designated SEC rules will be deemed to satisfy obligations imposed under corresponding CFTC rules.  A recent K&L Gates LLP seminar reviewed the Adopting Release, the harmonization rules and their impact on RICs.  As an increasing number of hedge fund managers have launched or are contemplating launching registered funds, this relief is welcome news in the hedge fund industry.  This article summarizes the key insights from that seminar.  For a discussion of the substituted compliance regime and its impact on managers of hedge funds and other entities not registered pursuant to the Company Act, see “What Do the CFTC Harmonization Rules Mean for Non-Mutual Fund Commodity Pools, Including Hedge Funds?,” The Hedge Fund Law Report, Vol. 6, No. 40 (Oct. 17, 2013).

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  • From Vol. 6 No.40 (Oct. 17, 2013)

    What Do the CFTC Harmonization Rules Mean for Non-Mutual Fund Commodity Pools, Including Hedge Funds?

    As a result of 2012 changes in the exemptions from registration as a commodity pool operator (CPO) available to operators of pooled investment vehicles, a large number of operators of unregistered investment companies – which may include hedge fund investment advisers, investment managers and/or boards of directors – were required to register with the Commodity Futures Trading Commission (CFTC) as CPOs, thus becoming subject to the Commodity Exchange Act (CEA) and the rules promulgated by the CFTC thereunder (CFTC Rules, and, together with the CEA, the Commodity Rules).  As a result, many investment advisers that were already subject to various federal securities laws and regulations, including the Investment Company Act of 1940 (Company Act), the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 and the rules under each of those Acts (collectively, Securities Rules), became subject to an additional regulatory regime.  Duplicative rules and regulations are nothing new to investment advisers or CPOs, and the public, press, politicians and regulators whose collective conscience had been scarred and greatly influenced by Madoff and other scandals and a debilitating financial crisis for which many scapegoated hedge funds were not particularly concerned with creating a larger regulatory and compliance burden for investment advisers.  Nevertheless, it was soon recognized that conflicting Commodity Rules and Securities Rules created an environment under which dual registrants (that is, those subject to both the Commodity Rules and Securities Rules) could not reasonably comply with certain of the conflicting requirements of both sets of rules.  Rather than permit this situation to drive certain types of pooled investment vehicles either to cease or materially alter their operations due to these conflicts, the CFTC adopted rules and rule interpretations designed to resolve them (Harmonization Rules).  Most of the Harmonization Rules pertain to “investment companies” registered under the Company Act (RICs), many of which are commonly referred to as mutual funds.  In a guest article, Steven M. Felsenthal and Stephanie T. Green focus on those Harmonization Rules that apply to CPOs whose pooled investment vehicles are not RICs, including hedge funds and other commodity pools, describing the implications of the Harmonization Rules for such commodity pools in the process.  Felsenthal is General Counsel and Chief Compliance Officer of Millburn Ridgefield Corporation, The Millburn Corporation and Millburn International, LLC; Green is a legal and compliance associate at The Millburn Corporation.

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  • From Vol. 6 No.17 (Apr. 25, 2013)

    How Can Hedge Fund Managers Use Advisory Committees to Manage Conflicts of Interest and Mitigate Operational Risks? (Part Two of Two)

    Domestic hedge funds typically have no governance analogue to the offshore fund board of directors.  This governance asymmetry has been receiving increased scrutiny from regulators and investors, and that scrutiny has grown stricter in light of a series of notable governance failures.  In response to that scrutiny, hedge fund managers have been exploring, and in some cases implementing, advisory committees for their domestic funds.  At a broad level, advisory committees serve as a proxy board of directors for domestic hedge funds, typically Delaware limited partnerships.  But advisory committees often do more than replicate onshore the functions of an offshore board of directors.  To help hedge fund managers assess the applicability of advisory committees to their circumstances, this article – the second in a two-part series – addresses what types of funds should organize advisory committees; issues involved in organizing an advisory committee (including determining the committee’s composition and compensation); operation of advisory committees; benefits and drawbacks of serving as an advisory committee member; and liability and indemnity protections afforded to advisory committee members.  The first installment discussed what advisory committees are; their principal functions; how they are different from offshore fund boards of directors; how much authority advisory committees typically have; and the principal benefits and drawbacks of organizing and operating advisory committees.  See “How Can Hedge Fund Managers Use Advisory Committees to Manage Conflicts of Interest and Mitigate Operational Risks? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 15 (Apr. 11, 2013).

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  • From Vol. 5 No.47 (Dec. 13, 2012)

    Understanding the Regulatory Regime Governing the Use of Social Media by Hedge Fund Managers and Broker-Dealers

    Social media has been increasingly adopted, if not embraced, by businesses, including investment advisers (such as hedge fund managers) and broker-dealers (which may be affiliates of certain hedge fund managers).  The question that arises is how does social media fit into the regulatory regime governing investment advisers and broker-dealers?  The question is increasingly important in light of both the forthcoming rule-making by the Securities and Exchange Commission (SEC) pursuant to the Jumpstart Our Business Startup Act (JOBS Act) as well as the SEC’s recent release of a National Examination Risk Alert entitled “Investment Adviser Use of Social Media” (Alert).  The Financial Industry Regulatory Authority, Inc. (FINRA) has also issued regulatory notices within the last two years providing guidance on the use of social media by broker-dealers.  In a guest article, Ricardo W. Davidovich, a partner at Tannenbaum Helpern Syracuse & Hirschtritt LLP, and Karina Bjelland, a managing consultant in the Financial Institutions Practice at Berkeley Research Group, LLC, summarize the relevant regulatory guidance from the federal securities laws, the JOBS Act, the Alert and the FINRA rules and notices to members.  Bjelland also recently participated in a webinar covered in the HFLR.  See “How Can Fund Managers Address the Regulatory, Compliance, Privacy and Ethics Issues Raised by Social Media?,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Sixth Annual Hedge Fund General Counsel Summit Highlights SEC Enforcement Priorities, Side Letters, Investment Allocations, Expense Allocations, Trade Errors, Record Retention, Fund Marketing, Secondaries, JOBS Act and STOCK Act (Part One of Two)

    On September 18 and 19, 2012, ALM Events hosted its Sixth Annual Hedge Fund General Counsel Summit (GC Hedge Summit) at the University Club in New York City.  Panelists, including regulators, in-house practitioners and law firm professionals, discussed topics of significant relevance for hedge fund general counsels, including: SEC enforcement priorities relating to hedge funds; the nuts and bolts of a successful hedge fund compliance program (including a discussion of side letters, investment allocations, expense allocations, trade errors and record retention); marketing of hedge funds (including a discussion of compensation of marketing professionals and the Jumpstart Our Business Startups (JOBS) Act); secondary market transactions in fund shares; and the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act) and its implications for the gathering of political intelligence.  Our coverage of the GC Hedge Summit is provided in two installments.  This first installment covers the session addressing the nuts and bolts of a successful compliance program and the session addressing marketing of hedge funds and secondary market transactions in hedge fund shares.  The second article will cover the session discussing the SEC’s enforcement priorities and the session discussing the implications of the STOCK Act for the gathering of political intelligence by hedge fund managers.  See also “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).

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  • From Vol. 5 No.36 (Sep. 20, 2012)

    How Should Hedge Fund Managers Handle and Document Investor Complaints?

    Not all hedge fund investors are satisfied customers, but not all dissatisfied hedge fund customers sue or seek to arbitrate.  A halfway house between legal action and no action is the investor complaint – an expression of dissatisfaction with some aspect of the investment relationship, which need not relate to performance.  Good performing hedge fund managers can (and do) receive investor complaints, and the most formidable types of complaints frequently relate to matters other than performance, for example, the legality or propriety of conduct of manager personnel.  Adaptive hedge fund managers have developed an infrastructure and style for responding to complaints, and view them as an opportunity to engage investors and other constituencies.  Lesser managers bristle at any whiff of criticism, though that is a bad strategy for all involved; from the investor perspective, part of the job of a hedge fund manager is engaging with reasonable investor inquiries, including justified complaints.  Moreover, given the relatively small size of the hedge fund investor universe (at least compared to the retail investing population), the SEC’s whistleblower bounty program and competition for scarce assets, appropriately calibrated responses to investor complaints can have implications for marketing, reputation and regulatory relations.  In short, navigating the investor complaint process is a relatively novel challenge in the hedge fund industry, but an increasingly important one.  To help hedge fund managers think through the various components of this challenge, this article discusses: what constitutes an investor complaint; who within the management company should receive such complaints; how investor complaints should be investigated and addressed; when to notify the general counsel of an investor complaint; how to determine the appropriate course of action, including whether, when and how to respond to complaints; and how to document a complaint.

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  • From Vol. 5 No.35 (Sep. 13, 2012)

    SEC Commences Administrative and Cease and Desist Proceedings against Hedge Fund Adviser for Failing to File Form ADV Updates and Maintain Required Books and Records

    The Securities and Exchange Commission (SEC) has issued an order commencing administrative and cease and desist proceedings against a registered investment adviser and its principal.  The SEC alleges various violations of the Investment Company Act of 1940 and the Investment Advisers Act of 1940 arising out of, among other things, the adviser’s failure to maintain required books and records relating to its service as a registered investment adviser to a registered investment company (Fund); failure to file Form ADV updates; failure to file Form ADV-W when its client ceased to be a registered investment company; and failure to supply information to the Fund’s board of directors.  This article summarizes the relevant terms of the SEC’s order, with emphasis on the violations of the Form ADV filing requirements and the books and records requirement.

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  • From Vol. 5 No.19 (May 10, 2012)

    Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do?  (Part Two of Two)

    On February 9, 2012, the Commodity Futures Trading Commission (CFTC) amended the CFTC Rules to rescind an exemption from commodity pool operator (CPO) registration heavily relied upon by hedge fund managers.  This development, in combination with statutory changes to the Commodity Exchange Act enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act, will require many hedge fund managers to register as CPOs.  This article is the second part of a two-part series by Stephen A. McShea, General Counsel and Chief Compliance Officer of Larch Lane Advisors LLC, providing an overview of the current regulatory landscape of CFTC regulations impacting CPOs.  Part one of this series focused on the managers of private funds and their CPO registration and compliance obligations.  In particular, part one discussed: the regulatory framework governing commodity pools and CPOs and the remaining exemption from CPO registration for managers who operate or control a private fund; the compliance obligations of a registered CPO; and the enforcement mechanisms and penalties for non-compliance.  See “Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do?  (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  This part two focuses on the funds (i.e., commodity pools) operated or controlled by registered CPOs.  Specifically, this article discusses: general fund disclosure and reporting obligations applicable to CPOs; the exemptions from certain of those disclosure and reporting obligations available under CFTC Rules 4.7 and 4.12; and the reporting obligations applicable to funds operating under those exemptions.

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  • From Vol. 5 No.17 (Apr. 26, 2012)

    What Concerns Do Mobile Devices Present for Hedge Fund Managers, and How Should Those Concerns Be Addressed? (Part Three of Three)

    For hedge fund managers, mobile devices are pervasive, unavoidable, valuable and dangerous.  Substantially everyone that works at a hedge fund management company has some sort of mobile device – personal or company-issued or both – and those devices are becoming more sophisticated every day.  On the positive side, mobile devices can raze the obstacles created by time and place; they enable employees to be productive on the go or at off hours.  But on the negative side, mobile devices introduce a number of competitive and regulatory challenges for hedge fund managers: they increase the odds that confidential data will leak; they facilitate the knowing or negligent misuse of material nonpublic information; they raise questions with regard to recordkeeping obligations; and so on.  This article is the last in a three-part series intended to help hedge fund managers identify and address – via policies, procedures and technology – the thorniest business and legal questions raised by mobile devices.  The first article in this series highlighted the risks to hedge fund managers posed by mobile devices, including susceptibility of critical information to leakage or theft, unauthorized trading, penetration of systems by malware and viruses and other potential harms.  See “What Concerns Do Mobile Devices Present for Hedge Fund Managers, and How Should Those Concerns Be Addressed? (Part One of Three),” The Hedge Fund Law Report, Vol. 5, No. 15 (Apr. 12, 2012).  The second article offered concrete suggestions on how hedge fund managers can anticipate and address those risks using policies, procedures and technology solutions.  Specifically, that second article identified three suggested steps that managers should take before crafting their mobile device policies and procedures, and made specific recommendations regarding the content of such policies and procedures.  See “What Concerns Do Mobile Devices Present for Hedge Fund Managers, and How Should Those Concerns Be Addressed? (Part Two of Three),” The Hedge Fund Law Report. Vol. 5, No. 16 (Apr. 19, 2012).  This article discusses additional specific suggestions on crafting policies and procedures and deploying technology to address the risks posed by mobile devices.  In particular, this article details: how hedge fund managers can prevent access to data on mobile devices by unauthorized persons; how managers may prevent firm personnel from exceeding authorized levels of data access; technology solutions for monitoring mobile devices; archiving data on mobile devices to comply with books and records policies and laws; and policies governing social media access via mobile devices.  See “SEC Risk Alert Discusses When Social Media Interactions May Constitute Prohibited Hedge Fund Client Testimonials,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).

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  • From Vol. 5 No.15 (Apr. 12, 2012)

    What Concerns Do Mobile Devices Present for Hedge Fund Managers, and How Should Those Concerns Be Addressed?  (Part One of Three)

    Mobile devices, such as smartphones and tablet computers, have significantly enhanced the ability of hedge fund managers and their personnel to conduct business more effectively and efficiently by, among other things, facilitating performance of job functions outside of the office.  However, such productivity gains come at a cost.  The ability to remotely access firm networks and information via mobile devices magnifies the risk of losing some control over access to firm information and firm systems.  Such loss of control can, in turn, create additional perils, most notably, security concerns for hedge fund managers who closely guard any informational advantage they have over competitors.  Additionally, such loss of control over access may heighten risks that a firm’s network is compromised, which can cause significant damage to a firm’s operations.  As such, it is imperative for hedge fund managers to keep up with the ever-growing risks that arise from the rapidly evolving mobile device technology landscape and to adopt policies and solutions designed to minimize the loss of control over access to firm information and systems.  This is the first article in a three-part series designed to address the concerns raised by mobile devices and to outline policies and procedures as well as technology solutions that can help hedge fund managers mitigate the risks posed by the use of mobile devices.  This first article provides an overview of the use of mobile devices and how hedge fund managers have historically addressed the use of mobile devices.  In particular, this article surveys the various risks for hedge fund managers raised by mobile devices, including security risks, risks related to unauthorized trading and risks related to the downloading of malware and viruses.  This article also addresses concerns relating to retention and archiving of books and records, and advertising and communications.  The second and third installments in this three-part series will discuss principles and detail best practices for establishing mobile device policies and procedures as well as specific mobile device solutions and technologies designed to address the risks catalogued in this article.

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  • From Vol. 5 No.2 (Jan. 12, 2012)

    SEC Enforcement Action and Bulletins Shine Spotlight on Use of Social Media by Investment Advisers

    Respondent Anthony Fields (Fields) is an Illinois accountant who operated as a registered investment adviser under the d/b/a Anthony Fields & Associates (AFA).  Fields was also the sole proprietor of Platinum Securities Brokers (Platinum), which was briefly registered as a broker-dealer.  The Securities and Exchange Commission (SEC) has issued an order commencing cease and desist proceedings against Fields, AFA and Platinum for various alleged violations of the securities laws.  Many of those violations arose from postings and offerings of fictitious securities made on the respondents’ websites and social media sites, including LinkedIn.  The SEC seeks injunctive relief, disgorgement of profits and civil penalties.  Simultaneously with the commencement of this enforcement proceeding, the SEC issued a “Risk Alert” covering compliance issues that arise when investment advisers use social media and two alerts that warn individual investors of the potential risks posed by social media sites.  This article summarizes the key points from the SEC’s order and the related alerts.  See also “Legal Considerations for Hedge Fund Managers that Use Social Media,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).

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  • From Vol. 4 No.41 (Nov. 17, 2011)

    How Hedge Fund Managers Can Use Technology to Enhance Their Compliance Programs

    Heightened regulatory scrutiny and investor expectations in today’s hedge fund environment have prompted many fund managers to look to technology solutions to increase the effectiveness and efficiency of their compliance programs.  Lori Richards, principal of PricewaterhouseCoopers LLP (PWC) and former Director of the U.S. Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations, recently published a report (Report) entitled “Integrating technology into your compliance program to improve effectiveness and efficiency.”  The Report states that maintaining manual compliance processes can be time-consuming, costly and prone to error while technology enhancements can provide numerous benefits for a fund manager, including: enhancement of the efficiency, accuracy and consistency of data gathering; scalability of technology infrastructure for firm growth that is resistant to staff turnover; demonstration of a compliance culture to regulators and investors; reduction in the burden of inspections with easily generated reports; and overall cost efficiencies.  For a similar argument in favor of automation, see “Spreadsheets Can Stunt a Hedge Fund Manager’s Growth,” The Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).  The Report also cautions that piecemeal automation of compliance processes can lead to nonintegrated systems that are costly to maintain and unable to provide a consolidated risk assessment across the firm.  Additionally, firms that do not appropriately utilize technological solutions to modernize their compliance programs may not be able to meet industry standard practices.  The crux of the Report surveys the types of technology solutions that can enhance a hedge fund manager’s compliance program and details the process fund managers should use in selecting vendors.  See “Hedge Fund-Specific Issues in Portfolio Management Software Agreements and Other Vendor Agreements,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011).  This article details the contents of the Report and highlights the lessons most critical to hedge fund managers looking to apply best technology practices to their compliance policies and procedures.

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  • From Vol. 4 No.39 (Nov. 3, 2011)

    Anti-Bribery Compliance for Private Fund Managers

    Managing the risks inherent in dealing with foreign officials should be a top priority for managers of hedge funds and private equity funds.  This is especially true in the current climate of expansive government interpretations of anti-bribery laws, new incentives for whistleblowers and the recent government scrutiny of the inner workings of fund managers.  It has become standard fare for fund managers to have regular interactions with foreign officials or their representatives in the ordinary course of raising capital and making investments.  There is nothing inherently wrong with such interactions.  Still, those dealings need to be informed by a heightened sensitivity to the possible appearance that something of value was given to a foreign official in connection with a particular investment or transaction.  The risk is that, regardless of the intent of the fund manager, certain conduct may be viewed in hindsight as an effort to improperly influence the actions of a foreign official.  As a result, a fund manager needs to focus on more than just the substance of the transaction and needs to consider both how the transaction might be perceived and the record that is being created.  As cross-border investments continue apace, fund managers can protect themselves by having adequate policies and procedures in place to identify potential bribery risks and to prevent violations from occurring.  Aggressive enforcement of the Foreign Corrupt Practices Act (FCPA) by U.S. authorities and the comprehensive overhaul of anti-corruption laws in the U.K., culminating in the new Bribery Act 2010 (Bribery Act), highlight the importance of implementing effective anti-corruption compliance policies and procedures.  In these circumstances, fund managers must do more than assure themselves that they are not acting with a corrupt intent; they also need to be alert to the risk of misunderstandings and to be diligent in creating a record of compliance.  In a guest article, Paul A. Leder and Sarah P. Swanz, partner and counsel, respectively, in the Washington D.C. office of Richards Kibbe & Orbe LLP, outline steps to take to identify and manage the compliance risks faced by fund managers both directly (through their own dealings with foreign officials) and indirectly (through investments in operating companies that operate overseas).  Specifically, Leder and Swanz identify conduct at the fund manager level that can put the manager at risk; discuss the importance of strong internal controls and compliance programs to mitigate corruption risks; and highlight categories of conduct at the portfolio company level that can put the manager at risk.  The authors then make specific suggestions for identifying potential bribery risks and managing such risks.  They conclude with a case study of a criminal prosecution that demonstrates the potential exposure for managers when making foreign investments.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    SEC No-Action Letter Outlines Alternative Recordkeeping Regime for Compliance with the Pay to Play Rule

    On July 1, 2010, the SEC adopted Rule 206(4)-5 (Pay to Play Rule) under one of the antifraud provisions of Investment Advisers Act of 1940 (Advisers Act).  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).  The Pay to Play Rule generally prohibits registered or unregistered investment advisers, including hedge fund managers, from providing advisory services for compensation to a government client (such as a public pension fund) for two years after the adviser or certain of its employees or third-party solicitors make a contribution to certain candidates or elected officials.  See “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010).  Simultaneous with the adoption of the Pay to Play Rule, the SEC amended the recordkeeping rules under the Advisers Act to, as explained in the adopting release, “allow [the SEC] to examine for compliance with new rule 206(4)-5.”  On examinations, see “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011).  While the general prohibition on pay to play practices of the Pay to Play Rule applies to registered and unregistered investment advisers, the related recordkeeping requirements only apply to registered investment advisers, as the SEC noted in footnote 405 of the adopting release.  Specifically, the SEC amended the recordkeeping rules to require registered investment advisers to maintain books and records containing lists or other records of four categories of information, each of which is described in detail in this article.  On September 12, 2011, the Investment Company Institute (ICI) – the mutual fund industry trade group – submitted a letter (Incoming Letter) to the SEC’s Division of Investment Management (Division) requesting no-action relief from specified provisions of the recordkeeping requirements related to the Pay to Play Rule.  In particular, the Incoming Letter noted that investment advisers are having difficulty complying with relevant recordkeeping requirements where the presence or identity of government plan investors in omnibus accounts cannot be reliably determined.  The ICI proposed an alternative recordkeeping regime that would address the identified transparency issues.  This article details: the four relevant recordkeeping requirements; the four prongs of the ICI’s proposed alternative recordkeeping regime, and the rationale for each; the SEC’s no-action letter; and the application of the no-action letter itself and the analysis in the letter to hedge funds and hedge fund managers.

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  • From Vol. 4 No.30 (Sep. 1, 2011)

    Nine Steps That Hedge Fund Managers Should Take to Develop a Defensible Electronic Discovery Strategy

    Few hedge fund managers spend adequate time proactively considering the risks associated with electronic discovery (e-discovery) before they face a lawsuit or an investigation.  Then, when it is too late to be proactive, managers typically scramble and over-collect data, substantially increasing their e-discovery costs, or they miss data, leading to claims of spoliation and sanctions.  See “Pension Committee Case Highlights Obligations of Hedge Fund Managers to Preserve Documents and Information in Anticipation of Litigation,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  While hedge fund managers have limited control over whether their funds or management companies are sued or audited, managers can adopt best practices that will help manage the risks and costs associated with e-discovery.  In a guest article, Jon Resnick, worldwide vice president of field operations at Applied Discovery, and Monte Mann, a partner at Novack and Macey LLP, describe nine categories of actions that hedge fund managers should take, and two categories of actions that hedge fund managers should avoid, to develop a sound, defensible e-discovery strategy.

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  • From Vol. 4 No.19 (Jun. 8, 2011)

    How Can Hedge Fund Managers Avoid Criminal Securities Fraud Charges When Allocating Trades Among Multiple Funds and Accounts?

    All hedge fund managers that manage multiple funds and accounts – which is to say, the vast majority of hedge fund managers – have to draft, implement and enforce policies and procedures governing the allocation of trades among those funds and accounts.  Where those funds and accounts follow explicitly different strategies, the appropriate approach to allocations is relatively straightforward.  For example, if a manager manages an equity long/short fund and a credit fund, equities go to the equity fund and bonds go to the credit fund.  But where multiple funds and accounts may be eligible to invest in the same security, the appropriate approach to allocations is more challenging.  For example, if a manager manages an equity long/short fund and an activist fund and purchases a block of public equity, how and when should the manager determine how to allocate the block between the two funds?  While the specifics of an allocations policy will depend on the manager’s fund structures and strategies, some general principles and proscriptions apply.  As for principles, an allocations policy should be equitable, should take into account the size and strategies of various funds, should provide a mechanism for correcting allocation errors and should give the manager an appropriate degree of discretion in making allocation determinations.  As for proscriptions, the boundaries of “appropriate discretion” in this context generally are set by the anti-fraud provisions of the federal securities laws and principles of fiduciary duty.  In other words, you cannot allocate trades in a manner that constitutes securities fraud.  How might trade allocations constitute securities fraud?  A recent SEC order (Order) answers that question; and a prior criminal indictment (Indictment, and together with the Order, the Charging Documents) and plea arising out of the same facts raises the frightening prospect that in more egregious circumstances, fraudulent trade allocation practices may constitute criminal securities fraud.  This article explains the facts and legal violations that led to the Order, Indictment and plea, then discusses the implications of this matter for hedge fund managers in the areas of trade allocations, marketing, disclosure on Form ADV and creation and maintenance of books and records.  In particular, this article discusses: why the cherry-picking scheme at issue in this matter was not just a bad legal decision, but also a bad business decision; two types of cherry-picking; whether and in what circumstances cherry-picking may lead to criminal liability; how the sometimes purposeful vagary of criminal indictments can subtly expand the reach of white collar criminal liability; whether disclosure can cure trade allocation practices that are otherwise fraudulent; the compliance utility of technology; conflicts of interest inherent in one person serving as chief compliance officer and in other roles; whether post-trade allocations are ever permissible; how hedge fund managers can test the sufficiency of their trade allocation policies; how trade allocation policies interact with the transparency rights sometimes granted to larger hedge fund investors; and the idea of “cross-fund transparency.”

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Accounting for Uncertain Income Tax Positions for Investment Funds

    FIN 48, now included in ASC Topic 740 (Income Taxes) under the Financial Accounting Standards Board’s Codification, was issued in 2006 and after two one-year deferrals became effective for all entities issuing financial statements under Generally Accepted Accounting Principles (GAAP) for years beginning after December 15, 2008.  FIN 48 was issued as an interpretation of FASB Statement 109, Accounting for Income Taxes, with the intent of reducing the diversity of practice in financial accounting for income taxes, including U.S. federal, state and local taxes as well as foreign taxes.  A major component of FIN 48 is that its reach includes all statutory open tax years, not just the accounting reporting year.  This requires that each year is looked at on a cumulative basis.  Entities that report on a non-GAAP basis, such as International Financial Reporting Standards (IFRS), are not subject to FIN 48.  FIN 48 has become a hot topic for fund managers and their auditors.  Given the complicated nature of fund structures, global investment strategies and the variety of financial products that managers invest in, it is an important area, and one to which managers should allocate sufficient resources.  In a guest article, Michael Laveman, a Partner at EisnerAmper LLP, discusses in detail the four-step process for adoption of and compliance with FIN 48.

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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.30 (Jul. 30, 2010)

    How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New “Pay to Play” Rule?

    On July 1, 2010, the SEC adopted Rule 206(4)-5 (Rule) under the Investment Advisers Act of 1940 (Advisers Act).  See “SEC Adopts Pay to Play Rules for Investment Advisers; Total Placement Agency Ban Avoided,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  The Rule generally seeks to curtail pay to play practices in the selection by state investment funds, most notably public pension funds, of hedge fund managers and other investment advisers.  Broadly, the Rule does this in three ways: (1) by limiting donations by principals of investment advisers and others with an economic stake in winning public fund business to election campaigns of public officials who may directly or indirectly influence the selection of the adviser to manage a public fund; (2) by prohibiting payments by investment advisers to any person for soliciting government entities for advisory services unless that person is (a) a registered investment adviser subject to the Rule or a registered broker dealer subject to a similar rule to be promulgated by FINRA, or (b) a principal or employee of the adviser; and (3) by revising Advisers Act Rule 204-2 (the recordkeeping rule) to require investment advisers with government clients, or advisers to hedge funds with government entity investors, to maintain records regarding political contributions by the adviser and its covered associates.  According to private fund data provider Preqin, public pension funds represent approximately 17 percent of all institutional hedge fund investors, with an average allocation of six percent of total assets to hedge funds.  The Rule governs the process by which hedge fund managers seek advisory business from this important constituency.  Accordingly, the Rule is of fundamental importance to a wide range of hedge fund managers, for whom the Rule creates a range of new compliance and marketing challenges.  The purpose of this article is to identify and provide guidance with respect to many of those new challenges.  In particular, the descriptive section of this article provides an overview of the mechanics of the Rule.  The analytic section of this article addresses areas in which hedge fund managers should revisit their policies and procedures in light of the Rule, including policies and procedures relating to: political contributions; monitoring contributions; preclearance of contributions; due diligence on placement agents; compliance training with respect to contributions; prescreening of new employees; acquisitions of hedge fund management firms; state, local and fund-specific rules relating to pay to play arrangements; sub-advisers and funds of funds; and mandatory redemptions.  The analytic section also includes a discussion of the implications of the Rule for lobbying by hedge fund managers.  See “Hedge Funds Increasing Lobbying Efforts, Focusing On Shaping Regulations Rather Than Preventing Them,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  The article concludes with a note on potential constitutional challenges to the Rule.  One of the more important points made by this article is that while the Rule has garnered significant attention, it is just part of a patchwork of federal, state, local and fund-specific rules governing the process by which hedge fund managers solicit investment advisory business from government entities.

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  • From Vol. 3 No.11 (Mar. 18, 2010)

    Employee Misappropriation of Trade Secrets Litigation Stresses Dangers of Willful Spoliation of Evidence; Texas Federal Court Orders Trial, Adverse Inference Instruction and Monetary Sanctions for Willful Destruction of Electronically Stored Information

    The subject of spoliation of electronically stored information raises grave concerns for litigation generally, and in the hedge fund community in particular.  As we discussed in our February 11, 2010 issue, in Pension Committee of the University of Montreal Pension Plan v. Banc of Am. Sec., LLC, No. 05 Civ. 9016, 2010 WL 184312 (S.D.N.Y. Jan.15, 2010), Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York addressed the duties of hedge fund managers and investors to preserve electronically stored information in anticipation of litigation involving failed hedge funds, and the sanctions for negligent spoliation of such evidence.  See “Pension Committee Case Highlights Obligations of Hedge Fund Managers to Preserve Documents and Information in Anticipation of Litigation,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  The instant case, an employment dispute in the U.S. District Court for the Southern District of Texas, presents the next step in understanding this issue: what happens when the conduct complained of involves intentional spoliation?  On February 19, 2010, Judge Lee H. Rosenthal of the U.S. District Court answered that question.  He severely sanctioned defendants Nickie G. Cammarata and Gary Bell for their intentional spoliation of e-mails relevant to litigation with their former employer, plaintiff Rimkus Consulting Group, Inc.  The lawsuit arose over defendants purported use of trade secrets and proprietary information in forming a competing firm, U.S. Forensic, L.L.C., after resigning from Rimkus, and their alleged violation of non-compete and non-solicitation clauses in their employment contracts.  Rimkus moved for sanctions after discovering that defendants had destroyed e-mails relevant to the dispute.  Relying heavily on Pension Committee, Judge Rosenthal conducted an extensive analysis of spoliation law.  He found that defendants had a legal duty to preserve the e-mails in question; that they had committed a culpable breach of that duty; that the e-mails appeared to be relevant to the dispute; and that Rimkus suffered prejudice as a result of their destruction.  As a result, he imposed harsh sanctions: permitting the jury to hear detailed evidence of the defendants’ misconduct; providing the jury with an adverse inference instruction against them; and awarding Rimkus attorneys fees and costs resulting from the spoliation.  Notably, the court also cited the defendants’ spoliation and withholding of evidence as the basis to partially dismiss their motion for summary judgment.  We provide extensive detail the background of the action and the court’s legal analysis.

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  • From Vol. 3 No.7 (Feb. 17, 2010)

    Key Elements of a Hedge Fund Adviser Business Continuity Plan

    The credit crisis changed the nature of institutional investor due diligence of hedge fund managers.  While performance remains a critical diligence point, aspects of the hedge fund advisory business other than performance now play a more prominent role in the investment decision-making process of institutional investors.  See “How Can Start-Up Hedge Fund Managers Use Past Performance Information to Market New Funds?,” The Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).  The idea is that even hedge fund managers with years of competitive fund performance and deep benches of investment talent can be laid low by inadequate risk management, compliance and controls.  Galleon is the paradigmatic example.  See “Best Practices for a Hedge Fund Manager General Counsel or Chief Compliance Officer that Suspects or Discovers Insider Trading by Manager Employees or Principals,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).  One element of hedge fund adviser infrastructure that has received significant attention of late from institutional investors (as well as regulators) is the business continuity plan (BCP).  Broadly, as the name implies, a BCP is a written plan (often included in the compliance manual) in which a hedge fund manager identifies the range of events and risks that can interrupt business operations and investment activities, and details the steps that the manager will take if those events or risks come to fruition.  Events that may trigger the procedures in a BCP can be natural (e.g., hurricanes, earthquakes, pandemics), man-made (e.g., terrorism, theft, other crimes) or technological (e.g., power outages, disruption of exchanges, computer viruses).  And the procedures used to address those risks must be tailored to the manager’s strategy, technology, network of service providers and geographic location.  Moreover, the BCP has to be a living document – something that is tested, communicated to employees and other constituents, and updated as relevant.  It cannot be boilerplate: at this point, institutional investors have seen a healthy number of BCPs, and they will know when they see a BCP that reflects inadequate customization – and that can make the difference between investment and non-investment.  This article offers a comprehensive analysis of BCPs in the hedge fund context, as well as reporting from a recent webinar on the topic hosted by hedge fund technology firm Eze Castle Integration and prime broker Pershing Prime Services.  In particular, this article: defines a BCP more particularly; enumerates key elements of a hedge fund manager BCP (including, among others, development of an impact analysis, communications plans, backup facilities, coordination with third-party service providers and succession planning); and discusses: the impact of a hedge fund’s strategy on its manager’s BCP; regulatory requirements, including what the SEC looks for with respect to BPCs in the course of inspections and examinations; institutional investor expectations; disclosure considerations; communicating a BCP to hedge fund manager employees; and the frequency with which a BCP should be reviewed and updated.  This article is the first in a two-part series.  The second article in the series will deal with disaster recovery plans, which are close cousins of BCPs and are outlined in this article.

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  • From Vol. 3 No.6 (Feb. 11, 2010)

    Pension Committee Case Highlights Obligations of Hedge Fund Managers to Preserve Documents and Information in Anticipation of Litigation

    In the most recent decision in the ongoing litigation involving failed hedge funds managed by Lancer Management Group, Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York detailed the obligations of hedge fund managers and investors with respect to preservation of evidence in anticipation of litigation.  See Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, LLC (No. 05-CV-9016 (S.D.N.Y. Jan. 15, 2010)).  More generally, since litigation is a reasonably foreseeable fact of life for hedge fund managers, the Pension Committee decision offers authoritative guidance to hedge fund managers on structuring policies and procedures with respect to data collection, preservation and destruction.  In other words, the key take-away from the Pension Committee decision is that by the time a hedge fund files or receives a complaint, it is too late to start thinking about data management issues.  Rather, data management has to be integrated into the compliance culture and processes at a hedge fund manager, and anything less than best of breed data management may result in draconian spoliation sanctions and reputational harm.  In an effort to assist hedge fund managers in translating the principles of the Pension Committee decision into actual policies, procedures and practices, this article discusses: the facts and legal analysis of the Pension Committee case; the practical considerations from the case most relevant to hedge fund managers (including tips relating to the irrelevance of organizational size to discovery obligations, interdepartmental cooperation, data mapping and document destruction); considerations with respect to departed or terminated employees (including provisions to include in severance agreements); back-up tapes; and cross-border data preservation and access issues (with a focus on the interaction of European privacy regulations and U.S. discovery rules).  The Hedge Fund Law Report has covered the Lancer litigation extensively.  See, e.g., “Second Circuit Revives Hedge Fund Fraud Claims Against Banc of America Securities,” The Hedge Fund Law Report, Vol. 2, No. 26, (Jul. 2, 2009); “Federal Court Permits Suit Concerning Collapsed Lancer Funds to Proceed in Part,” The Hedge Fund Law Report, Vol. 2, No. 5 (Feb. 4, 2009); “Federal Court Bars Investors’ Claims Against Hedge Fund Administrator,” The Hedge Fund Law Report, Vol. 1, No. 28 (Dec. 16, 2008).)

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    How Can Start-Up Hedge Fund Managers Use Past Performance Information to Market New Funds?

    Recent market dislocations have given rise in the hedge fund industry, as in other industries, to an increasing crescendo of entrepreneurship.  According to data from Hedge Fund Research Inc., 224 hedge funds launched worldwide during the third quarter of this year, while 190 closed in the same period – the first time since early 2008 that the number of new launches exceeded the number of closures.  While compensation has come down on average, especially at firms under their high water marks, so has the opportunity cost of casting out on one’s own.  See “How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009).  In short, for star traders on broker-dealer prop desks, second chairs, co-managers and trusted lieutenants, the climate for hedge fund entrepreneurship is unusually fertile.  See “As Banks Close Prop Desks and Traders Move to Hedge Funds, Hedge Fund Managers Focus on Permissible Scope of Use of Confidential Information,” The Hedge Fund Law Report, Vol. 2, No. 18 (May 7, 2009).  While hedge fund entrepreneurs face all of the usual issues involved in entrepreneurship – employment matters, office leases, professional services fees, etc. – they also face certain issues unique to the hedge fund industry.  See “Stars in Transition: A New Generation of Private Fund Managers,” The Hedge Fund Law Report, Vol. 2, No. 49 (Dec. 10, 2009).  Chief among those unique issues are the legal and regulatory limitations on what a hedge fund entrepreneur can communicate to potential investors in the new funds or management entity with respect to prior performance.  Specifically, despite the ubiquity of the disclaimer stating that past performance does not guarantee future results, there remains no more reliable predictor of future results than past performance.  Accordingly, new investors are keenly interested in past performance, and for any hedge fund entrepreneur that seeks to create a viable business, the question is not whether to communicate past performance, but how.  The short answer is: carefully.  Few topics are as central to marketing discussions when launching a new hedge fund management company and new hedge funds, and few topics are as fraught with legal risk.  In an effort to help hedge fund entrepreneurs navigate the thicket of relevant regulation, this article analyzes in depth the laws, rules, regulatory pronouncements (in particular, no-action letters) and market practices governing the permissible and impermissible uses of past performance data when launching new funds or managers.  While the authority is complex and fact-specific, this article extracts and drills down on five broad principles that new managers would be well-advised to keep in mind during (and even after) new fund or manager launches.  Within those five broad principles, this article describes concrete strategies that managers can follow to stay within the rules governing the use of past performance information in marketing efforts.  This article also details the key points from the seminal Clover Capital no-action letter.

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    As the Pace of Enforcement Activity Quickens, Hedge Fund Managers Refocus on the Law and Technology of Data Storage

    With the dramatic expansion of the range and ease of communication technologies has come an expansion of the channels through which inside information and other illegal or inappropriate information may pass.  For hedge fund manager chief compliance officers and others at hedge fund managers tasked with enforcing insider trading and other laws, the proliferation of communication technologies has made life both harder and easier: harder because there is a greater volume of information to monitor, and easier because the technology for monitoring has never been more accessible.  In addition, the cost of storage of data and documents has fallen precipitously, causing expectations to rise on the part of regulators and prosecutors with respect to the volume and duration of storage.  This article examines data retention issues in the hedge fund context.  In particular, the article discusses: the relevant statutes and guidelines with respect to data storage; the law on spoliation of evidence; adverse inference instructions; how spoliation and adverse inference considerations may apply in the context of employees that leave a firm to set up a competitor; treatment of data storage in hedge fund manager compliance manuals; and employee training with respect to data storage.

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  • From Vol. 2 No.47 (Nov. 25, 2009)

    For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges

    In the public company context, internal investigations have become an accepted and expected adjunct of good corporate governance.  In response to even the remotest whiff of a violation of law, regulation or internal policy, prudent public company managers generally initiate a thorough investigation with the twin goals of fact-finding and precluding or mitigating civil or criminal charges.  As responses by some notable hedge fund managers to the Galleon allegations have demonstrated, the purposes, goals and many of the techniques of internal investigations developed in the public company context apply, albeit with some variation, in the hedge fund world.  That is, for hedge fund managers whose current or former principals or employees have been or may be charged with civil or criminal violations, or may simply be in the zone of suspicion, an internal investigation can uncover relevant evidence, identify the absence of evidence and can credibly demonstrate to regulators and prosecutors that the hedge fund manager has an independent commitment to compliance and thus does not require any external prodding in that regard.  In light of the explicitly stated plan on the part of the SEC’s Enforcement Division to step up enforcement of insider trading laws and regulations applicable to hedge fund managers, internal investigations are expected to become a more standard aspect of hedge fund legal and operational practice.  However, hedge fund managers as a group have a relatively short track record with internal investigations, at least compared to public company managers, and internal investigations in the hedge fund context raise specific concerns.  Accordingly, this article seeks to acquaint hedge fund industry participants with the primary issues to be considered when initiating and conducting an internal investigation, and in doing so discusses: recent examples of internal investigations initiated by operating companies and hedge fund managers in response to the Galleon allegations; the eight most common contexts in which a hedge fund manager may consider initiating an internal investigation; the purpose of an internal investigation; when and how to define the scope of an internal investigation; whether the fact and any findings of an investigation must be disclosed; retention of documents and records; whether an investigation should be conducted by internal personnel or outside law and accounting firms; who outside counsel represents; whether or not an investigation report should be written; and what to do if the investigation uncovers a violation.

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  • From Vol. 2 No.32 (Aug. 12, 2009)

    SEC Proposes “Pay to Play” Rules for Investment Advisers

    On August 3, 2009, the Securities and Exchange Commission (SEC) published the full text of its proposed rule regarding “Political Contributions by Investment Advisers,” Investment Advisers Act Rule 206(4)-5.  Its intended purpose is to curtail so-called “pay to play” practices involving investment advisers.  The phrase “pay to play” refers to arrangements whereby investment advisers make political contributions or related payments to governmental officials in order to be rewarded with, or afforded the opportunity to compete for, contracts to manage the assets of public pension plans and other government accounts.  On July 22, 2009, the SEC unanimously voted to approve the proposed rule, which remains subject to a 60-day public comment period after its publication in the Federal Register.  We provide a detailed description of the proposed rule.

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