Jun. 1, 2017

Blockchain and the Private Funds Industry: Basics of the Technology and How the Financial Sector Is Currently Employing It (Part One of Three)

“Blockchain” is frequently mentioned at industry conferences as a transformative technology with the potential to “disrupt” the private funds industry. Given the frequency and reverence with which it is mentioned, at first glance it appears that blockchain technology is already widely used in the industry. Upon closer inspection, however, it becomes clear that widespread uncertainty persists about what blockchain even entails, not to mention where the technology currently stands and how it could plausibly be used to improve private fund operations. To help our subscribers understand the status of blockchain technology and its potential to aid the private funds industry, this three-part series serves as a primer about the technology and its interplay with the private funds industry going forward. This first article provides an overview of how blockchain functions and examines how the finance industry is already utilizing it. The second article will describe potential ways private funds and service providers can adopt blockchain technology to enhance fund operations and compliance practices. The third article will explore some of the risks impeding the growth of blockchain and address the most plausible timing and manner for it to be eventually adopted in the industry. For more on how fund managers can utilize technology, see “Hedge Fund Managers Are Advised to Build Robust Infrastructure” (Mar. 3, 2012); and our two-part series on automated trading strategies: “Examining and Documenting” (Jan. 7, 2016); and “Monitoring and Reviewing” (Jan. 14, 2016).

Financial CHOICE Act of 2017 Proposes Sweeping Reforms, but May Allow Regulators to Maintain Status Quo in Some Areas

The Financial CHOICE Act of 2017 (CHOICE Act) has emerged as one of the most sweeping and controversial pieces of economic legislation during the first months of the Trump administration. The bill could dramatically affect the private funds sector by eliminating registration requirements for private equity advisers; changing the private placement regime; promoting dialogue between the industry and regulators; and requiring the SEC to be more transparent and streamline its enforcement process. It is important to remember, however, that continuing negotiations leave the bill’s fate uncertain in the House and Senate, and the magnitude of any reform can be shaped by the SEC’s discretion over how final rules will work. To assist readers in understanding the legislation’s potential impact on the funds sector, this article analyzes the CHOICE Act and provides insights from practitioners at the forefront of interactions between the industry and the regulators. For analysis of other recent initiatives and rulemaking under the Trump administration, see “Fund Managers Must Address Investors’ Fee and Liquidity Concerns to Maintain Strong Performance in 2017, While Also Preparing for Trump Administration Regulations” (Mar. 30, 2017); and “Ways the Trump Administration’s Policies May Affect Private Fund Advisers” (Mar. 2, 2017).

Broadening the Scope of MiFIR Intervention Powers: ESMA Demands Direct Supervisory Authority to Limit “Top-Up” Management Activities and Reduce Regulatory Arbitrage

Upon its creation, the European Securities and Markets Authority (ESMA) was imbued with the authority to restrict certain financial activities that destabilize or otherwise threaten to inhibit the E.U.’s financial markets from functioning properly. In navigating the E.U.’s various directives while attempting to perform this duty, ESMA has occasionally unearthed regulatory loopholes that restrict its ability to carry out its mission and which can be exploited by market actors. This recently occurred when ESMA identified gaps in the Markets in Financial Instruments Directive that could result in regulatory arbitrage and impede its ability to limit certain “top-up” management company activities. As a solution to this issue, ESMA issued a January 2017 opinion in which it proposed an expansion of its powers, as well as those of National Competent Authorities. In a guest article, Attilio Veneziano, the founder of consulting firm Veneziano & Partners Ltd., analyzes the scope of ESMA’s responsibilities, the deficiencies highlighted in its opinion and the solution proposed therein. For discussion of other instances where ESMA has exercised its supervisory convergence authority, see “ESMA Provides Hedge Fund Managers With Plan for Supervisory Convergence” (Mar. 10, 2016); and “ESMA Chair Calls for Increased Transparency and Regulatory Convergence As Interest Rates Rise” (Jan. 28, 2016).

SEC Complaints Against Former CMBS Traders Highlight Need for Fund Managers to Verify Broker Pricing for Thinly Traded Securities

In a pair of complaints filed on May 15, 2017, the SEC charged two former high-level commercial mortgage-backed securities traders at an investment bank with deliberately committing fraud against customers of the firm over a period of years. The deceptive behavior attributed to the two former traders illustrates the dangers and risks of working with brokers in trading relationships that are skewed or lopsided from an informational standpoint. These complaints follow another SEC action against a different group of traders from the same investment bank citing similar misconduct. See “Pricing Information Provided by Brokers to Hedge Fund Managers for Thinly Traded Securities May Not Be Reliable” (Sep. 17, 2015). The SEC’s complaints point to the need for sophisticated internal compliance to detect and avert fraud, as well as the need to be wary of how, when and where a broker might take advantage of a customer’s informational disadvantages in the frenzy of day-to-day trading. This article summarizes the issues raised in the SEC’s complaints, while also providing steps that firms can take to avert similar fraudulent conduct. For additional coverage of valuing illiquid assets, see “DLA Piper Hedge Fund Valuation Webinar Covers Fair Value Methodologies, Valuation Services, Valuing Illiquid Positions and Handling Valuation Inquiries During SEC Examinations” (Aug. 7, 2013).

Proskauer Attorneys Evaluate the Dodd-Frank Whistleblower Program and Its Future Under the Trump Administration

Although President Trump recently issued executive orders aimed at reducing regulatory oversight, the situation at many U.S. regulatory agencies largely remains business as usual. See “BakerHostetler Panel Analyzes the Trump Effect on the SEC’s Initiatives and Enforcement Efforts” (May 4, 2017); and “How the Trump Administration’s Core Principles for Financial Regulation May Benefit the U.S. Funds Industry” (Feb. 16, 2017). A recent Proskauer Rose program examined the efforts of the SEC’s Office of the Whistleblower to date under the Trump administration; the SEC’s continuing scrutiny of confidentiality provisions that deter whistleblowing; and the potential impact on whistleblowing of a recent regulatory action and the appointment of Neil Gorsuch to the Supreme Court. The program featured Proskauer partner Lloyd B. Chinn and senior counsel Harris M. Mufson. This article summarizes the panelists’ thoughts most relevant to fund managers. For additional insights from Proskauer attorneys, see “Ten Key Risks Facing Private Fund Managers in 2017” (Apr. 6, 2017). For further insight from Chinn, see “Three Best Practices for Reconciling the Often Conflicting Sources of Privacy Rights of Hedge Fund Manager Employees (Part Two of Three)” (Apr. 11, 2014).

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

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

Rob Mailer Joins Morrison & Foerster in London

Morrison & Foerster has added Rob Mailer, an attorney specializing in investment fund formation and management, as a partner in its London office. Mailer’s clients include fund sponsors and investors active in the venture capital, infrastructure, buyout, growth and debt fund sectors, and he has particular expertise in financial technology investing. For coverage of other recent hires at the firm, see “Morrison & Foerster Adds Corporate and Funds Partner in New York” (Oct. 20, 2016); and “Investment Funds Partner Joins Morrison & Foerster’s London Office” (Sep. 8, 2016).