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    Mar. 23, 2017

Avoiding Common Pitfalls Under the Custody Rule: Inadvertent Custody, Delivery Failures and GAAP Compliance (Part One of Two)

Since its initial adoption in 1962, Rule 206(4)-2 of the Investment Advisers Act of 1940, commonly referred to as the “custody rule,” has undergone a number of revisions and has increasingly been the subject of SEC comments. The SEC’s Office of Compliance Inspections and Examinations has issued several risk alerts – in 2013 and, most recently, in February 2017 – identifying custody deficiencies as an area of concern. See “Top Five Compliance Deficiencies in OCIE Risk Alert Include Annual Compliance Reviews, Accurate Regulatory Filings and Custody Issues” (Feb. 23, 2017); and “SEC Risk Alert Reveals Significant Deficiencies in Custody Practices of Hedge Fund Managers and Other Investment Advisers” (Mar. 7, 2013). This latest risk alert prompted the Hedge Fund Law Report to investigate whether the staff commonly identifies deficiencies in custody rule compliance by investment advisers. Our research suggests that, while alternative asset managers of “plain vanilla” private funds tend to comply with the rule with minimal difficulty, weaknesses can and do occur when advisers are presented with nuanced circumstances. In this two-part series, we identify six common traps that can lead to a private fund adviser’s non-compliance with elements of the custody rule. This first article identifies options for private fund managers to comply with the rule; discusses the frequency with which custody is reviewed during SEC examinations; and identifies common weaknesses in the areas of inadvertent custody, preparing audited financial statements (AFS) and meeting the deadline for delivering AFS. The second article will discuss circumstances under which private fund advisers may fail to realize that they have custody, the auditor independence requirement and liquidation audits.

Best Practices for Investment Advisers Using Social Media to Mitigate Advertising Rule Violations and Other Risks

The advent of Twitter, Facebook, LinkedIn and other widely popular social media forums has had a dramatic impact on society at large, including the investment funds industry. Yet investment advisers and firms may not fully grasp the compliance and operational risks that new technologies and sites can pose. Questions abound as to whether social media can be used to provide material information to certain investors at the expense of others; when the line is crossed from informational content to marketing a fund; and whether the social media accounts of individual employees and representatives need to be monitored for compliance purposes. These issues were the subject of a recent Regulatory Compliance Association (RCA) PracticEdge session that offered insights from Heather Traeger, chief compliance officer for the Teacher Retirement System of Texas; Parisa Haghshenas, a Branch Chief in the Chief Counsel’s Office of the SEC’s Division of Investment Management; Catherine Courtney Gordon, counsel at Morgan Lewis; and Isabelle Sajous, associate general counsel and deputy chief compliance officer at Cramer Rosenthal McGlynn. This article highlights the key takeaways from the session. For coverage of other RCA panels, see “Risks With Investment Allocation, Trade Execution, Soft Dollars, Client Solicitation and Valuation” (Apr. 14, 2016); and “Issues Pertaining to the Custody Rule, ERISA, Client Agreements, Fees, Codes of Ethics and Confidentiality” (Apr. 7, 2016). On May 18, 2017, RCA will host its annual Enforcement, Compliance & Operations Symposium in New York City. For additional information or to register for the symposium, click here.

Protecting Attorney-Client Privilege and Attorney Work Product While Cooperating With the Government: Establishing Privilege and Work Product in an Investigation (Part One of Three)

Guarding attorney-client privileged communications and attorney work product are often important objectives, particularly for fund managers conducting internal investigations while simultaneously cooperating with the government. The privilege and, to a lesser extent, the work product doctrine generally require confidentiality, which can be contrary to the disclosure required when cooperating with the DOJ or the SEC’s Enforcement Division. In a three-part guest series, Eric J. Gorman and Brooke A. Winterhalter, partner and associate, respectively, at Skadden, examine the interplay between the attorney-client privilege and attorney work product protection, on the one hand, and cooperation with the government, on the other. This first article in the series addresses how and when the attorney-client privilege and attorney work product protection are created during internal investigations, and steps that can be taken to establish and maintain those protections. The second article will analyze what investigation materials can be shared with the government without implicating the privilege or attorney work product protection, and what steps can be taken to help preserve these protections if applicable documents are shared, intentionally or otherwise, with the government. The third article will provide an overview of when and how privileged or protected investigation materials that have been shared with the government can be protected from discovery in collateral litigation. For more on internal investigations, see “D.C. Circuit Confirms Applicability of Attorney-Client Privilege to Internal Investigations” (Aug. 7, 2014); and “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges” (Nov. 25, 2009).

K&L Gates Program Addresses State and Local Lobbying; Pay to Play; and Gifts and Entertainment Limitations (Part One of Two)

Private fund advisers that seek investments from public pension plans enter a minefield of federal, state and local rules, and those that think that compliance with the “pay to play” rules under the Investment Advisers Act of 1940 affords sufficient protection may be sadly mistaken. States, municipalities and even individual government pension plans have a wide array of rules regarding lobbying, political contributions and gifts and entertainment. Further, sensitive information provided to public pension plans in the course of the investment management relationship may be subject to disclosure under public records and freedom of information (FOI) laws. A recent program presented by K&L Gates offered valuable insights into those state and local rules. The program featured Cary J. Meer and Ruth E. Delaney, partner and associate, respectively, at K&L Gates; and Eric J. Smith, managing director and deputy general counsel at PineBridge Investments. This article, the first in a two-part series, covers the portions of the program devoted to lobbyist regulation; political contributions; and gifts and entertainment. The second article will discuss state “sunshine” and FOI laws. For additional insight from Meer, see “How Hedge Fund Managers Can Prepare for SEC Remote Examinations (Part Two of Two)” (May 19, 2016); “Practical Guidance for Hedge Fund Managers on Raising Capital in Australia, the Middle East and Asia” (Oct. 30, 2014); and “Impact of CFTC Harmonization Rules on Alternative Mutual Funds and Other Registered Investment Companies” (Nov. 1, 2013).

Lock-Ups and Investor-Level Gates Prevalent in New Hedge Funds

New hedge funds continue to find the capital-raising environment to be challenging, and once they have raised capital, most funds look for ways to retain it. This was one of the findings of a recent study conducted by Seward & Kissel that found that all of the funds it examined had lock-ups or investor-level gates (with some funds employing both). In its annual study, Seward & Kissel analyzed several key findings relating to hedge funds launched in 2016 by new U.S.-based manager clients. This article summarizes the key takeaways from the study, including investment strategy trends; management fees and incentive allocations; liquidity terms; fund structures; and seed capital. For coverage of previous editions of Seward & Kissel’s annual study, see: 2015 Study (Mar. 31, 2016); 2014 Study (Mar. 5, 2015); 2012 Study (Apr. 11, 2013); and 2011 Study (Feb. 23, 2012).

U.K. Investment Advisers Fail to Meet FCA Expectations on Best Execution and Dealing Commissions

The U.K. Financial Conduct Authority (FCA) recently issued a pair of press releases expressing concern over continued compliance shortcomings at investment management firms. One release concerned firms’ dealing commission arrangements, while the other addressed inadequate industry oversight of best execution. The FCA reiterated its commitment to scrutinizing these areas and, in each case, will “consider appropriate action, including more detailed investigations into specific firms, individuals or practices” when warranted. This article highlights the FCA’s principal observations. For additional recent guidance and commentary from the FCA, see “FCA Outlines Priorities of Liquidity and Fair Practices for Open-End Funds Investing in Illiquid Assets” (Mar. 16, 2017); “FCA Director of Enforcement Details the Goals and Tenets of the Agency’s Senior Managers Regime and Proposed Modifications to Its ‘Early Settlement’ Program” (Feb. 16, 2017); and “FCA Director Lays Out Expectations for Cybersecurity of Financial Services Firms: Identification of Cyber Risks, Detection, Firm Preparedness and Information Sharing” (Sep. 29, 2016).

Adam Tope Joins Hogan Lovells in New York

Hogan Lovells has hired Adam Tope as a partner in its corporate practice in New York. Tope advises sponsors of hedge funds, private equity funds, venture capital funds and real estate funds on fund formation, and has particular expertise in the areas of direct investments, co-investments, managed accounts and secondary transactions. For more on co-investments, see “Ample Fundraising and Co-Investment Opportunities in the Private Equity Industry, Along With Attendant Deal Flow and Fee Structure Issues” (Dec. 8, 2016); and “Private Equity Firms From Across the Industry Spectrum Advise on Trends and Terms in the Current Co-Investment Market” (Aug. 11, 2016).

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