Apr. 20, 2017

Reed Smith Adds Funds and Corporate Partners in New York and San Francisco

Reed Smith has expanded its bench with the addition of Parik Dasgupta as a funds partner in New York and Scott Smith as a corporate partner in San Francisco. Dasgupta advises fund managers and investors on the complexities of private equity and venture capital fund formation from both a transactional and regulatory standpoint. See “Seminar Highlights the Ample Fundraising and Co-Investment Opportunities in the Private Equity Industry, Along With Attendant Deal Flow and Fee Structure Issues” (Dec. 8, 2016). Smith advises hedge funds, real estate funds, venture capital funds, corporations, institutional investors, partnerships and non-profits on mergers and acquisitions, financings, fund formation, investments, corporate governance and regulatory compliance matters.

Failure to Consider Relevant Market Inputs When Valuing Assets May Draw SEC Enforcement Action Against Fund Managers

Valuation by private fund managers remains a focus of SEC attention for its effect on performance, the fees payable to managers and the price at which investors enter and exit a fund. As it relates to illiquid or thinly traded assets, this exercise is particularly nettlesome. In a recently settled enforcement proceeding, the SEC asserted that, in contravention of its funds’ governing documents and valuation policies, a registered investment adviser and one of its principals ignored for valuation purposes its own trades in certain assets. Instead, the adviser favored the higher valuations provided by a third-party pricing service that did not use actual market inputs, resulting in a significant overvaluation of those securities. For another recent action in which a manager improperly used pricing service marks instead of actual trades, see “SEC Settlement With PIMCO Highlights the Importance of Proper Valuation and Performance Disclosures” (Dec. 8, 2016). This article summarizes the valuation practices that the SEC challenged, the sanctions imposed and the other relevant terms of the settlement order. For additional coverage of the SEC’s recent attention to valuation of illiquid assets, see “Hedge Fund Platinum Partners and Principals Face Civil and Criminal Proceedings From SEC and DOJ Over Alleged Fraudulent Valuation Practices and Liquidity Misrepresentations” (Jan. 12, 2017); and “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016).

Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar

Pay to play and wrap-fee violations, as well as improper revenue-sharing arrangements, are perennial SEC hot-button issues. Enforcement often turns on whether there has been adequate disclosure, but even extensive disclosure may be insufficient to avoid sanctions in certain cases. An added concern in the industry is that the SEC and FINRA often identify conflicts of interest in circumstances that do not seem obvious. Further, even if the SEC de-emphasizes enforcement under the Trump administration, FINRA and state regulators may try to fill the gap. These issues and others were addressed in a recent presentation by MyComplianceOffice (MCO) featuring Cipperman Compliance Services founder Todd Cipperman. This article summarizes Cipperman’s insights. For additional commentary from Cipperman, see our three-part series on the side-by-side management of hedge funds and alternative mutual funds: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015). For other recent insights from MCO, see “Study Reveals Weaknesses in Asset Managers’ Third-Party and Vendor Risk Management Programs” (Mar. 9, 2017); and “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016).

Mourant Ozannes Partner Touts the Cayman Islands Hedge Fund Industry Amid Local and Foreign Developments

As the arguable jurisdiction of choice for U.S. fund managers seeking to establish offshore funds, the Cayman Islands is frequently at the forefront of hedge fund industry innovations and developments. See “U.S., U.K. and Cayman Regulators Address Upcoming Areas of Focus, Passporting Concerns and Intra-Agency Collaboration” (Nov. 17, 2016). In terms of local developments, the Cayman Islands are fast approaching the first anniversary of the introduction of the limited liability company vehicle, as well as confronting dramatic changes to its fund governance practices. At the international level, the potential extension of the Alternative Investment Fund Managers Directive marketing passport to non-E.U. countries and the potential regulatory changes under the Trump administration each has a substantial bearing on the islands’ hedge fund industry. To help our readers better understand these developments and anticipate the future of the Cayman Islands’ hedge fund industry, the Hedge Fund Law Report recently interviewed Hayden Isbister, a partner at Mourant Ozannes and a panel moderator at the 2017 Cayman Alternative Investment Summit. For additional commentary from Isbister, see “Despite Fiduciary Duty Questions, Cayman LLCs Can Offer Savings and Other Advantages to Hedge Fund Managers” (Jul. 21, 2016). 

Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers

U.S. fund managers that set up operations in the U.K. have historically tended to favor a U.K. limited liability partnership (LLP) as opposed to a U.K. limited company (LTD). In broad terms, the preference for using an LLP was due to the greater commercial and legal flexibility – and reduced U.K. tax burden – offered by the LLP structure. See “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships” (Mar. 13, 2014). A number of recent U.K. developments, however, are likely to be material to any U.S. fund manager when deciding how to structure a new U.K. presence or when reconsidering any existing U.K. arrangements. In a guest article, Sidley Austin partner Will Smith examines the history of these structures, recent developments impacting their utility and considerations for managers converting from an LLP to an LTD. For additional insight from Smith, see our two-part series on the effect of recent U.K. legislation criminalizing the facilitation of tax evasion: “U.K. Proposes Legislation to Impose Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion” (Feb. 23, 2017); and “How U.S. Private Fund Managers May Avoid Running Afoul of Proposed U.K. Legislation Criminalizing the Facilitation of Tax Evasion” (Mar. 2, 2017); as well as our two-part series entitled “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated With Hedge Fund Managers”: Part One (Apr. 16, 2015); and Part Two (Apr. 23, 2015).

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).

ESMA Chair Calls for Stronger Supervisory Tools to Achieve Capital Markets Union

E.U. member states carry out trade and investment activity on a daily basis with a potentially dramatic impact on the entire union or its individual members. For the purpose of ensuring market stability and protecting investors in these situations, it is necessary to implement policies that address issues holistically with respect to all member states. The ultimate goal of these policies and protocols is the realization of the Capital Markets Union (CMU). See “European Commissioner Emphasizes Need for Proportionate Regulation to Promote the CMU” (Mar. 17, 2016); and “E.U. Action Plan to Unify Capital Markets May Affect Hedge Fund Managers” (Oct. 8, 2015). All these points came across in a recent speech by Steven Maijoor, chair of the European Securities and Markets Authority (ESMA). This article highlights the key takeaways from Maijoor’s speech, which provide fund managers with insight as to the possible future of E.U. regulatory developments. For analyses of other recent speeches by Maijoor, see “ESMA Chair Outlines Rulemaking Authority and Implementation of MiFID II” (Jul. 14, 2016); and “ESMA Chair Calls for Increased Transparency and Regulatory Convergence As Interest Rates Rise” (Jan. 28, 2016).