Aug. 3, 2017

Are Fund Platforms Truly a Turnkey Solution? Pros and Cons of Using the Structure to Market to E.U. Investors (Part Two of Three)

At first glance, creating a sub-fund on an umbrella fund platform (Fund Platform) operated by a third-party management company (ManCo) seems like an ideal way for a U.S. fund manager to access E.U. investors. In addition to the risk-management and regulatory expertise conferred by the ManCo as the Fund Platform’s alternative investment fund manager, the economies of scale of this approach can reduce costs and rapidly accelerate the manager’s time to market. It is essential, however, for fund managers to balance these benefits against some of the potential disadvantages of this approach, including a lack of control, various conflicts with the ManCo and negative investor perceptions. To aid U.S. fund managers in determining whether Fund Platforms provide the optimal method for marketing to E.U. investors, this three-part series critically considers the structure from an array of vantage points. This second article in the series provides contrasting advantages and disadvantages for fund managers to weigh when deciding whether to use a Fund Platform. The first article offered an overview of the mechanics of Fund Platforms and explored how to mitigate obstacles caused by Brexit while using the structure. The third article will detail various factors for fund managers to consider when selecting platform providers and negotiating onboarding agreements. See also “Strategies for U.S. Hedge Fund Managers Looking to Outsource the Risk and Reporting Requirements of the AIFMD While Focusing on Capital Raising in Europe” (Aug. 1, 2014); and “Risks Faced by Hedge Fund Managers That Access the Alternative Mutual Fund Market Via Turnkey Platforms” (Mar. 13, 2014).

U.S. Tax Court Ruling May Lead to Increased After-Tax Returns for Foreign Investors That Invest in U.S. Partnerships

On July 13, 2017, the U.S. Tax Court issued a ruling that when a non-U.S. investor realizes a gain through the disposition of an interest in a partnership engaged in a U.S. trade or business, that gain is not “effectively connected income” (ECI) and therefore is not subject to U.S. federal income tax. The ruling has potentially monumental significance for investors around the world with interests in U.S. partnerships and for U.S. managers seeking to raise capital abroad, as certain investment opportunities may become more attractive from a tax perspective to foreign investors. Conversely, the decision’s future and long-term impact are uncertain, given that the Internal Revenue Service (IRS) will likely contest the ruling and the U.S. Treasury Department may implement regulations that effectively render it meaningless. To help our readers understand the potential impact of the Tax Court’s decision, this article summarizes the ruling and presents insight from attorneys and tax practitioners at the forefront of interactions between the financial services sector and the IRS. For background on ECI, see “Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and ‘Season and Sell’ Techniques” (Jan. 22, 2015); and “Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four)” (Jan. 23, 2014).

How Recent Data Breaches Have Affected the Cyber Insurance Market for Fund Managers

As cyber thieves, malware agents and other bad actors become increasingly savvy and data breaches – as exemplified by recent high-profile cases involving Target and WannaCry – continue to multiply, the need for sophisticated technology capable of safeguarding firm and client information grows ever more acute. If a cyber breach occurs, the potential ramifications for a firm are almost incalculable, including possible litigation from clients who feel that their sensitive information has not been properly protected, as well as possible enforcement action by regulators that are paying increasing attention to cybersecurity issues. The insurance industry has responded to the current climate, providing myriad options to corporate clients and offering plans that focus on minimizing operational and reputational damage. In the last few years, investment managers have devoted resources to identifying vulnerabilities from a cyber perspective and adopting safeguards to address these risks, with more advisers purchasing cyber insurance than ever before. To help readers understand these issues and determine which cyber insurance options might be best for them, the Hedge Fund Law Report interviewed Graig Vicidomino, associate director of Crystal & Company. This article sets forth Vicidomino’s thoughts on trends in the market for cyber insurance for fund managers, including with respect to costs, scope of coverage and benefits of these policies. For more on cybersecurity, see “Surveys Show Cyber Risk Remains High for Investment Advisers and Other Financial Services Firms Despite Preventative Measures” (Jul. 20, 2017); and “Navigating the Intersection of ERISA Fiduciary Duties and Cybersecurity Data Breach Protections” (Jun. 29, 2017).

Gauging the Commercial Impact of MiFID II Product-Governance Rule Compliance on Fund Management Companies

The recent iteration of the Markets in Financial Instruments Directive (MiFID II) is set to take investor protection to a completely new level. The introduction of product governance rules – a main innovation under the next generation of MiFID – will impose radical changes to the way conflicts of interests with investors are managed. The new rules ensure that funds complying with MiFID II prioritize investors’ interests throughout the entire lifecycle of their products and services, both at inception and on an ongoing basis thereafter. See “MiFID II Expands MiFID I and Imposes Reporting Requirements on Asset Managers, Including Non-E.U. Asset Managers” (May 28, 2015). The European Securities and Markets Authority recently issued a consultation paper providing draft guidelines for the product governance requirements that clearly articulate how they strengthen investor protections. In a guest article, Attilio Veneziano, founder of consulting firm Veneziano & Partners, details the new MiFID II product governance rules and their interplay with existing directive rules; how firms can use the consultation paper guidelines to comply with the rules; and how the rules address the threat of regulatory arbitrage going forward. For additional insight from Veneziano, see “Broadening the Scope of MiFIR Intervention Powers: ESMA Demands Direct Supervisory Authority to Limit ‘Top-Up’ Management Activities and Reduce Regulatory Arbitrage” (Jun. 1, 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).

Survey Reveals Substantial Disconnect Between Actual and Desired Hedge Fund Fee Structures

Credit Suisse Capital Services (CS) recently issued its Mid-Year Survey of Hedge Fund Investor Sentiment (Mid-Year Survey), an extension of its annual hedge fund industry sentiment survey. See “Credit Suisse Investor Survey Finds Steady Demand for Hedge Funds and Growing Demand for Less-Liquid Products” (Apr. 13, 2017). The Mid-Year Survey explores current investor interest in various fee structures, appetite for hedge fund investments, strategy preferences and interest in non-traditional hedge fund products. This article summarizes CS’ key findings. For coverage of previous CS investor surveys, see “Despite Significant Redemptions, Investors Remain Committed to Hedge Funds” (Aug. 4, 2016); “Growing Demand by Hedge Fund Investors for Managed Accounts, Long-Only Funds and Alternative Mutual Funds” (Apr. 7, 2016); and “Investor Appetite for Alternative Investment Vehicles and Strategy Preferences” (Aug. 27, 2015).

Gibson Dunn Expands Munich Finance Practice

Sebastian Schoon is the newest addition to Gibson Dunn’s finance practice in Munich. Schoon, who had practiced law at Ashurst since 2004, advises private equity clients on financings, mergers and acquisitions, real estate transactions and restructurings. For commentary from Gibson Dunn partners, see “Implications for Fund Managers of the Supreme Court’s Ruling in Kokesh v. SEC” (Jun. 15, 2017); and our two-part series: “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016); and “Current and Former Regulators Advise Hedge Fund Managers on How to Prepare for SEC Exams” (Feb. 18, 2016).