Sep. 28, 2017

Advertising Compliance Series: Six Methods for a Fund Manager to Test Its Advertising Review Procedures (Part Three of Three)

Rule 206(4)-7 of the Investment Advisers Act of 1940 (Advisers Act) requires investment advisers to adopt policies and procedures reasonably designed to prevent violations of the Advisers Act and to review the adequacy and effectiveness of those policies and procedures. In addition to complying with the Advisers Act, advisers are also expected to design policies and procedures that can detect violations. Although testing is one of the primary means of detecting violations, building an effective testing program is not an easy task, and in the absence of SEC guidance, chief compliance officers are often left to question whether they have designed and implemented effective testing protocols. To assist advisers with developing their testing programs, this third article in our three-part series explores six different testing mechanisms firms can employ to verify compliance with their advertising procedures. The first article outlined what documents fall within the advertisement definition and outlined ten best practices that managers should consider when designing or evaluating their advertising review procedures. The second article discussed five high-risk areas within marketing materials, provided guidance to compliance officers on what to look for when encountering high-risk content and suggested ways to present that information that meet the needs of both the business development and compliance teams. See “SEC Continues Its Crackdown on Misleading Representations of ‘Skin in the Game’ by Hedge Fund Managers” (Jan. 10, 2013); and “Brockton Retirement Board Files Class Action Lawsuit Against Oppenheimer Fund of Private Equity Funds and Executive Officers for Allegedly False Claims Relating to Fund Performance and Investment Valuations Contained in Fund Marketing Materials” (Apr. 12, 2012).

ECHR Decision Imposes New Criteria for Email Monitoring Practices on Fund Managers With European Operations

The Grand Chamber of the European Court of Human Rights has sided with an employee who claimed his privacy rights were violated, setting out criteria for national courts to consider when evaluating whether companies, including fund managers, have safeguarded employees’ rights to privacy. In light of this decision, fund managers operating in the 47 jurisdictions that are parties to the European Convention on Human Rights should revisit their policies for monitoring employees’ communications. This article analyzes the implications of the decision, including how it aligns with other national laws, and presents insights from practitioners with expertise in data privacy. See our three-part series on employee privacy issues relevant to hedge fund managers: “Reconciling Effective Monitoring of Electronic Communications With Employees’ Privacy Rights” (Apr. 4, 2014); “Reconciling Conflicting Sources of Privacy Rights of Employees” (Apr. 11, 2014); and “Six Privacy-Related Topics to Be Covered By Compliance Policies and Procedures” (May 23, 2014).

Mock Audits Are Essential Preparatory Tools for Fund Principals in the Current Regulatory Environment

It can be difficult for an investment adviser, fund manager, compliance officer or other private fund executive who has never undergone an SEC examination to know what to expect or how best to prepare. Technical requirements and best-practice standards and expectations are often in flux, even under the current, supposedly pro-business administration and regulatory regime. See “Pro-Business Environment of New Administration Continues to Have Challenges and Pitfalls for Private Funds” (Sep. 14, 2017). Examiners remain exacting in their demands, not only with respect to the variety and format of documents they wish to review. When furnishing materials and answers to examiners, it is critically important for advisers to provide correct information while remaining concise and avoiding contradicting other responses or unnecessarily opening up further avenues of inquiry. To fully prepare for an examination, the importance and utility of conducting a mock audit are difficult to overstate. In a recent interview with the Hedge Fund Law Report, David Tang, counsel at Seward & Kissel with a concentration on regulatory-compliance consulting, provided his thoughts on mock audits, their prevalence in the industry and best practices for advisers to use mock audits to prepare for an SEC examination, and discussed other developments in the examination and enforcement arena. This article highlights Tang’s key insights. For additional commentary from Seward & Kissel partners, 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 “Lock-Ups and Investor-Level Gates Prevalent in New Hedge Funds” (Mar. 23, 2017).

SEC Continues Its Pursuit of Firms That Licensed F‑Squared Indices

In yet another reminder that fund managers must be scrupulously accurate when making performance claims – and must perform appropriate due diligence when using the track records of third-party advisers – the SEC recently commenced an enforcement action against an investment adviser and its principal (collectively, the Defendants). The SEC’s complaint alleges that the Defendants breached their fiduciary duties and committed fraud by using materially misleading marketing materials created by F‑Squared Investments, Inc. (F‑Squared) for F‑Squared’s “AlphaSector” strategies. Worse, the SEC claims that the Defendants continued to use those materials after the investment adviser’s principal learned that the materials contained fraudulent performance claims, and later sold the business to avoid potential liability for advertising a fraudulent track record. This article summarizes the complaint. For other enforcement actions stemming from third-party advisers licensing F‑Squared’s products, see “SEC Settlements Highlight Need for Managers to Verify Performance Claims of Others Prior to Use” (Sep. 22, 2016); and “Hedge Fund Managers May Be Liable for Performance Claims of Others” (Mar. 3, 2016).

Survey Finds Compliance Programs and Cybersecurity Preparedness of Alternative Asset Managers to be Inadequate Relative to Traditional Asset Managers and Broker-Dealers

Cipperman Compliance Services (CCS) recently issued the results of its 2017 C‑Suite Survey. CCS asked financial services executives seven questions about the role of their firms’ chief compliance officers; attitudes toward compliance; and the sophistication of their firms’ compliance programs and cybersecurity preparedness. Based upon the responses of executives from alternative asset managers, the survey suggests that their compliance programs are less likely to withstand SEC scrutiny and their firms are less prepared on cybersecurity matters, relative to traditional asset manager and broker-dealer participants. This article analyzes CCS’ findings and provides commentary on those findings from CCS’ president, Rob Prucnal. For coverage of CCS’ 2016 survey, see “Survey Reveals Compliance Weaknesses of Hedge Fund Managers Relative to Other Financial Services Firms, Including CCO Qualifications and Frequency of Annual Compliance Reviews” (Sep. 15, 2016). For additional compliance insights from CCS founder Todd Cipperman, see “Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar” (Apr. 20, 2017); and our three-part series on the simultaneous management of hedge funds and alternative mutual funds following the same strategy: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015).

Dechert Expands Corporate Practice in Singapore

Siew Kam Boon has joined Dechert as a corporate partner based in Singapore. Boon advises clients on domestic and cross-border investments, mergers, acquisitions and regulatory compliance issues. Her broad base of clients include private equity funds, venture capital funds, sovereign wealth funds and corporations. For additional insights from Dechert attorneys, see “Dechert Partners Discuss How Cross-Border European Fund Managers Can Prepare for Brexit’s Momentous Regulatory Effect” (Apr. 6, 2017); “The Current State of Direct Lending by Hedge Funds: Fund Structures, Tax and Financing Options” (Oct. 27, 2016); and “Dechert Panel Discusses Recent Hedge Fund Fee and Liquidity Terms, the Growth of Direct Lending and Demands of Institutional Investors” (Jul. 14, 2016).