Jan. 19, 2017

BakerHostetler Panel Analyzes SEC Use of Administrative Proceedings and Whistleblower Incentives, and Provides Guidance for Fund Managers Facing an Examination (Part Two of Two)

As part of the transition to the incoming administration of President-Elect Donald J. Trump, many in the hedge fund industry anticipate the potential for a lighter-touch regulatory approach at the SEC. This was the focus of a recent panel discussion hosted by BakerHostetler and featuring Marc Powers and Mark Kornfeld, partners in BakerHostetler’s securities litigation practice; Walter Van Dorn, partner and national leader of the firm’s international securities and capital markets practices; and Michelle Chopper, director of the advisory and consulting practices at Arthur Bell. The key takeaways from the panel are presented in this two-part series. This second article discusses the SEC’s practice of trying contested cases in front of administrative law judges hired by the SEC, evaluates the impact of the Dodd-Frank Act’s whistleblower program on SEC enforcement efforts and provides guidance for managers on navigating a regulatory exam or investigation. The first article addressed the SEC’s renewed interest in compliance with the pay to play rule, the relentless crack down on insider trading and ways technology is giving the SEC an edge in detecting violations. For additional insight from Powers, see “Investment Strategies, Considerations and Uncertainties of Distressed Debt Investments by Hedge Funds” (Apr. 9, 2015); “Chapter 15 of the Bankruptcy Code Presents Litigation Risks and Liability for Creditors, Counterparties, Service Providers and Others Doing Business With Bankrupt Offshore Hedge Funds” (Oct. 3, 2013); and “Five Takeaways for Other Hedge Fund Managers From the SEC’s Record $602 Million Insider Trading Settlement With CR Intrinsic” (Mar. 21, 2013).

Ireland Further Opens the Door for Loan Origination in Europe by Relaxing Restrictions on Eligible Investments by Certain Irish Funds

Ireland introduced a specific regulatory framework for loan originating investment funds in October 2014. In January 2017, the Central Bank of Ireland introduced flexibility to the permitted scope of activities of loan originating investment funds. Separately, the European Securities and Markets Authority has given its view on the necessary elements for a common European framework for loan origination by investment funds, and the European Commission has indicated that it intends to develop its thinking in this area as part of its ongoing work on building a capital markets union. See “E.U. Action Plan to Unify Capital Markets May Affect Hedge Fund Managers” (Oct. 8, 2015). In a guest article, partner Vincent Coyne of William Fry, along with associate David Naughton, outline the recent regulatory change in Ireland, analyze some of its practical implications, summarize the applicable regulatory framework and review how a manager may establish and obtain authorization for a loan originating investment fund in Ireland. For additional insight from Coyne, see “Trends in Irish Fund Launches and the Challenges – and Solutions – for Non-E.U. Fund Managers Using These Vehicles” (Oct. 6, 2016); and “New Irish Fund Structure Offers Re-Domiciliation Possibilities and Tax Advantages for Hedge Funds” (Mar. 12, 2015). For more on loan origination by private funds, see “The Current State of Direct Lending by Hedge Funds: Fund Structures, Tax and Financing Options” (Oct. 27, 2016); “Hedge Funds As Direct Lenders: Structures to Manage the U.S. Trade or Business Risk to Foreign Investors (Part Two of Three)” (Sep. 29, 2016); and “Hedge Funds As Shadow Banks: Tax Considerations for Hedge Funds Pursuing Direct Lending Strategies (Part One of Three)” (Sep. 22, 2016).

ACA 2016 Compliance Survey Covers SEC Exams; Compliance Staffing and Budgeting; Annual and Ongoing Compliance Reviews; and AML/Sanctions Compliance (Part One of Two)

ACA Compliance Group (ACA) recently completed its 2016 Alternative Fund Manager Compliance Survey, covering a number of top-of-mind issues facing the managers of hedge funds and more illiquid private funds. The survey’s findings were described in a recent webinar by ACA’s Danielle Joseph, a senior principal consultant, and Brian Lattanzio, a senior compliance analyst and private equity associate. This article, the first in a two-part series, examines the survey’s findings with respect to recent SEC examination experiences; compliance staffing and budgeting; compliance reviews, testing and training; and anti-money laundering and sanctions compliance. The second article will summarize the survey’s findings and speakers’ insights concerning custody; fees; safeguarding assets; and personal trading. For our two-part coverage of ACA’s 2015 compliance survey, see: “SEC Exams, MNPI and Restricted Lists” (Oct. 1, 2015); and “Expert Networks, Fund Expenses and Electronic Communications” (Oct. 8, 2015). For coverage of prior ACA surveys, see “SEC Exams, CCOs, Compliance Reviews, Custody, Fees and Personal Trading” (Dec. 11, 2014); “Current Hedge Fund Practices on Marketing, Trading, Counterparties and Valuation” (Jun. 13, 2014); and “Benchmarking of Private Fund Manager Compliance Practices (Part One of Two)” (Oct. 3, 2013).

Best Practices for Fund Managers When Entering Into ISDAs: Negotiating Event of Default and Termination Event Provisions (Part Two of Three) 

One of the lessons learned by investment managers that previously traded swaps with Lehman Brothers was the importance of having robust legal documentation in place to govern these trades. For example, the bankruptcy filing by Lehman Brothers Holdings Inc. (LBH) generally triggered an event of default by LBH in its swap contracts that were traded under the International Swaps and Derivatives Association Master Agreement (Master Agreement), entitling LBH’s counterparties to certain remedies. See “Lehman Sues J.P. Morgan Over Allegedly ‘Inflated’ Claims Under Derivative Contracts and Improper Setoffs” (Oct. 25, 2012); and “The Lehman Bankruptcy and Swap Lessons Learned Negotiating an ISDA Master Agreement in Today’s Market” (Mar. 4, 2009). In this second article of a three-part series, we review commonly negotiated events of default in the Master Agreement and additional termination events in the schedule to the Master Agreement, in addition to suggesting tactics fund managers can employ when negotiating certain key provisions. The first article provided background on the various documents required to trade swaps and explained the impact the Dodd-Frank Act has had on trading these instruments. The third article will analyze the key considerations for funds when negotiating the collateral arrangements – the delivery of margin to mitigate counterparty risk – between two parties. 

Cyber Insurance Coverage, Pre-Breach Mitigation Efforts and Post-Breach Response Plans Can Reduce Harm to Fund Managers From Cyber Attacks 

Cyber insurance policies are indispensable for investment firms operating in an age of widespread cyber attacks and data breaches costing millions of dollars in damages and liability. Investment fund manager principals need to have a nuanced grasp of what those policies cover and ensure they maximize their value. Doing so can put their firms in a good position to reduce reputational and financial harm in the event of a cyber breach or investigation of their cyber preparedness by a regulatory agency. See “Essential Tools for Hedge Fund Managers to Combat Escalating Cyber Threats” (Feb. 4, 2016). These points were explored in a panel discussion presented by Haynes and Boone. Moderated by Haynes and Boone partner Werner Powers, the panel included Ron Borys, managing director of Crystal & Company; Sandy Crystal, executive vice president of Crystal & Company; Christopher Liu, head cyber specialist for financial institutions at AIG; and Haynes and Boone partners Ricardo Davidovich and David Siegal. This article presents the key insights communicated by the panel. For additional insight from Davidovich, see “Understanding the Regulatory Regime Governing the Use of Social Media by Hedge Fund Managers and Broker-Dealers” (Dec. 13, 2012); as well as our two-part series on closing hedge funds: “How to Close a Hedge Fund in Eight Steps” (May 8, 2014); and “When and How Can Hedge Fund Managers Close Hedge Funds in a Way That Preserves Opportunity, Reputation and Investor Relationships?” (Jun. 2, 2014).

Morgan Stanley Settles SEC Charges Stemming From the Use of Customer Cash to Finance a Broker’s Hedge Positions

As the collapse of Lehman Brothers painfully showed, the trading and financing activities of prime brokers can pose significant risks to hedge fund managers. Rule 15c3-3 under the Securities Exchange Act of 1934, commonly known as the Customer Protection Rule, requires broker-dealers to safeguard customer cash and securities, including maintaining a sufficient amount on deposit in a segregated bank account to pay the net amount that the broker-dealer owes to its customers. Morgan Stanley & Co. LLC recently settled SEC charges that it engineered internal financing transactions with an affiliate that improperly reduced the amount of cash it was required to segregate. This article highlights the key points in the settlement order. The settlement is another reminder that hedge fund managers must always be aware of how their assets are being used by their prime brokers and other counterparties. For another recent case involving a broker’s violation of the Customer Protection Rule, see “Merrill Lynch Settlement Reminds Hedge Fund Managers to Be Aware of How Brokers Are Handling Their Assets” (Jul. 7, 2016). For additional guidance on mitigating prime brokerage risk, see “How Fund Managers Can Mitigate Prime Broker Risk: Structural Considerations of Multi-Prime or Split Custodian-Broker Arrangements (Part Two of Three)” (Dec. 8, 2016). 

Robert Woll Joins Mayer Brown in Hong Kong

Mayer Brown has announced the addition of partner Robert Woll in Hong Kong. Woll advises emerging managers and institutions on the formation and management of numerous types of funds, including private equity funds, buyout funds, venture capital funds, growth equity funds, infrastructure funds, real estate funds, funds-of-funds and co-investment vehicles. For coverage of another recent hire at the firm, see “Mayer Brown Enhances Its Banking and Fund Finance Practices in New York” (Dec. 15, 2016). For insight from Mayer Brown partners, see our three-part series on subscription and other financing facilities: “Provide Funds With Needed Liquidity but Require Advance Planning by Managers” (Jun. 2, 2016); “Offer Hedge Funds and Managers Greater Flexibility” (Jun. 9, 2016); and “Operational Challenges for Private Fund Managers” (Jun. 16, 2016).