Nov. 2, 2017

The Challenges and Benefits of Multi-Factor Authentication in the Financial Sector (Part One of Two)

The use of more than one factor to establish identity online – multi-factor authentication (MFA) – is a crucial way to protect against breaches that involve stolen credentials or account compromise. MFA is particularly significant in the financial sector, where failure to secure the accounts of clients, investors or employees can lead to massive losses. Online authentication factors must not only be secure, but also convenient for the user and, of course, make economic sense. This first article of our two-part series explores the MFA landscape for the financial sector; strategies for fund managers to ensure both security and user-friendliness; challenges certain factors present; and ways to overcome those challenges. The second article will discuss MFA innovations, including those from the Fast Identity Online Alliance; the expectations of global regulators; and how fund managers can economically implement an MFA system. For more on cybersecurity issues facing investment managers, see “Survey Finds Compliance Programs and Cybersecurity Preparedness of Alternative Asset Managers to Be Inadequate Relative to Traditional Asset Managers and Broker-Dealers” (Sep. 28, 2017); and “Cyber Insurance Coverage, Pre-Breach Mitigation Efforts and Post-Breach Response Plans Can Reduce Harm to Fund Managers From Cyber Attacks” (Jan. 19, 2017).

How the E.U. Tax-Haven Blacklist May Affect Private Funds Formed in Blacklisted Jurisdictions

Due to be finalized in late 2017, the European Commission (EC) has proposed a “tax‑haven blacklist” that could have significant implications for current fund structures that contain entities with a connection to “blacklisted” jurisdictions. The initiative is expected to be used as a tool by the E.U. to combat perceived tax evasion and tax avoidance globally. For information on the U.K.’s approach to combatting tax evasion, see “U.K. Proposes Legislation to Impose Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion (Part One of Two)” (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 (Part Two of Two)” (Mar. 2, 2017). A jurisdiction’s inclusion on the blacklist may also result in E.U. Member States collectively imposing counter-measures against the jurisdiction, potentially including denial of tax deductions or tax exemptions; and imposition of additional withholding taxes. In a guest article, Will Smith and Caleb McConnell, partner and associate, respectively, at Sidley Austin, review the status of the compilation of the blacklist, the criteria being used by the EC to determine which countries to include on the blacklist and the consequences to countries that are eventually included on the blacklist, as well as to funds formed in blacklisted jurisdictions. For additional insights from Smith on tax matters, see “Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers” (Apr. 20, 2017); and our two-part series “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).

What the Outcome of BlackRock’s Petition Could Portend for the SEC’s Stance on Pay to Play

BlackRock has petitioned the SEC for an exemption from the prohibition against its collection of fees from Ohio-based “government entity” clients, following a violation of the so-called “pay to play” rule stemming from a $2,700 contribution to the presidential campaign of Ohio Governor John Kasich by one of its top executives. Absent exemptive relief, BlackRock will be denied the ability to collect fees, totaling an estimated $37 million, from any Ohio government entity. The petition comes at a critical juncture, as top SEC roles have finally been filled, and many observers are closely following actions taken by the SEC to assess whether the new administration’s pro-business stance is rhetoric or a reality. BlackRock’s prospects for winning an exemption may be brighter than they would have been before President Trump took office, but many forces are likely to shape the outcome, including SEC actions as recent as January 2017 that sent a loud and clear message about the seriousness of pay to play violations. See “Campaign Contributions As Small As $500 Could Draw SEC Enforcement Action for Pay to Play Violations” (Jan. 26, 2017). To help readers understand these issues, this article analyzes BlackRock’s petition, along with insight from legal practitioners with experience with the pay to play rule and SEC enforcement matters. For more on BlackRock, see “Lessons on Separation Agreements That Fund Managers Can Glean From Recent SEC Action” (Feb. 2, 2017).

Simmons & Simmons Briefing Covers Revisions to U.K. Fund Documents in Anticipation of MiFID II Deadline and the Potential Impact of Pending U.K. Partnership Taxation Rules

The January 3, 2018, deadline for compliance with the latest revisions to the Markets in Financial Instruments Directive (MiFID II) is quickly approaching. Additionally, a bill pending in the U.K. Parliament could dramatically affect the taxation of pass-through entities in the U.K. A recent Simmons & Simmons briefing offered guidance to fund managers on preparing for MiFID II and how the pending tax changes could affect their operations. The program was moderated by Simmons partner Devarshi Saksena and featured partners Lucian Firth and Martin Shah and senior lawyer Russell Afifi. This article highlights their key insights. For additional commentary from Simmons on MiFID II, see “Simmons & Simmons and Advise Technologies Provide Comprehensive Overview of MiFID II”: Part One (Jun. 18, 2015); and Part Two (Jun. 25, 2015). See also “MiFID II Expands MiFID I and Imposes Reporting Requirements on Asset Managers, Including Non-E.U. Asset Managers” (May 28, 2015). For more from Saksena and Firth, see “FCA Amends Its Position on Annex IV Reporting: U.K. and Non-EEA Managers, Including U.S. Managers, Must Now Report Holdings at Master Fund Level” (Apr. 13, 2017).

A Roadmap to Maintaining Books and Records: Compliance With Applicable Regulations (Part One of Two)

Investment advisers are subject to numerous rules and regulations regarding their books and records. A recent ACA Compliance Group (ACA) program, featuring Beth Manzi, chief operating officer of private fund administrator PEF Services LLC, and Theodore E. Eichenlaub, partner at ACA, offered a comprehensive overview of the documents and records that investment advisers are required to maintain. The program also focused on methods for ensuring that those documents and records be complete, accessible and in a proper form in the event of an SEC examination. This article, the first in a two-part series, discusses the regulatory background surrounding the maintenance of adviser-specific records, including corporate and accounting documents; marketing documents; and emails. The second article will consider the electronic storage of records, document destruction, testing of compliance programs and SEC examinations. For additional commentary from ACA, see “How Private Fund Managers Can Avoid Common Pitfalls When Calculating and Advertising Internal Rates of Return” (Sep. 7, 2017); and “Compliance Corner Q4-2017: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter” (Oct. 12, 2017).

How the New Partnership Audit Regulations Affect Private Funds: Imputed Underpayments, Push-Out Elections and Fund Document Provisions to Amend (Part Two of Two)

The new regulations (BBA Regulations) introduced under The Bipartisan Budget Act of 2015 are expected to make it easier for the Internal Revenue Service (IRS) to audit private funds structured as partnerships. Consequently, advisers to these funds should proactively take steps to understand how the BBA Regulations differ from the current partnership audit rules and amend their fund operating documents accordingly. Baker Tilly Virchow Krause recently offered a comprehensive overview of the BBA Regulations and practical ways for managers to address those changes, in a panel moderated by Mark Heroux, principal at Baker Tilly and former trial attorney in the IRS Office of Chief Counsel, and featuring Colin Walsh and Brad Polizzano, Baker Tilly senior manager and manager, respectively. This second article in our two-part series discusses the treatment of underpayments under the BBA Regulations and the option for partnerships to push out the adjustment to those who were partners during the year that was under review; the application of Accounting Standards Codification 740 to partnerships; the ways in which most managers will need to update their partnership agreements; and the effect of the BBA Regulations on the filing of state tax returns. The first article provided an overview of the BBA Regulations, identified key ways in which the BBA Regulations differ from existing partnership audit regulations and explained the new concept of a “partnership representative.” For a comprehensive look at hedge fund taxation, see our four-part series: “Allocations of Gains and Losses, Contributions to and Distributions of Property From a Fund, Expense Pass-Throughs and K-1 Preparation” (Jan. 16, 2014); “Provisions Impacting Foreign Investors in Foreign Hedge Funds” (Jan. 23, 2014); “Taxation of Foreign Investments and Distressed Debt Investments” (Jan. 30, 2014); and “Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles” (Feb. 6, 2014).

Upcoming HFLR Webinar to Explore How Advisers Can Avoid Common Deficiencies Under the Advertising Rule

Please join the Hedge Fund Law Report on Monday, November 13, 2017, at 11:00 a.m. EST, for a complimentary webinar discussing how advisers can avoid common deficiencies in their marketing materials and advertising practices under Rule 206(4)-1 of the Investment Advisers Act of 1940, commonly referred to as the “Advertising Rule.” This presentation will offer a detailed review of the advertising deficiencies identified in the September 2017 Risk Alert issued by the SEC’s Office of Compliance Inspections and Examinations, discuss how advisers can avoid these sorts of deficiencies in their own marketing materials and build on the topics discussed in our recent three-part advertising compliance series: “Ten Best Practices for a Fund Manager to Streamline Its Compliance Review” (Sep. 14, 2017); “Five High-Risk Areas for a Fund Manager to Focus on When Reviewing Marketing Materials” (Sep. 21, 2017); and “Six Methods for a Fund Manager to Test Its Advertising Review Procedures” (Sep. 28, 2017). The webinar, entitled “How Advisers Can Avoid Common Deficiencies Under the Advertising Rule,” will be moderated by Kara Bingham, Associate Editor of the Hedge Fund Law Report, and will feature Christine M. Lombardo, partner at Morgan Lewis; Richard F. Kerr, partner at K&L Gates; and Todd Kaplan, founder and principal of Cloudbreak Compliance Group. To register for the webinar, click here.

James Bermingham Joins Ogier in Luxembourg

Ogier has hired investment funds lawyer James Bermingham as a counsel in its Luxembourg office. Joining the firm after previously serving as in-house general counsel at several companies, he specializes in all aspects of the structuring, formation, management and operation of alternative investment vehicles. For insight from another Ogier partner, see “Jersey Offers Range of Marketing and Distribution Options, Operational Support for Investment Funds” (Mar. 9, 2017).