Nov. 16, 2017

How ESMA’s Opinions on the Relocation of U.K. Financial Market Participants to the E.U. May Affect Fund Managers Post-Brexit

Each of the key E.U. financial services directives – the Markets in Financial Instruments Directive, the Alternative Investment Fund Managers Directive and the Directive on Undertakings for Collective Investment in Transferable Securities (collectively, the Directives) – contains requirements on the “substance” required to establish an asset management firm in an E.U. member state, including restrictions on a manager’s ability to outsource key functions to other entities. The U.K.’s decision to withdraw from the E.U., and the anticipated relocation of U.K.-based firms to the E.U., has led to further efforts within the E.U. to clarify positions on outsourcing. The European Securities and Markets Authority (ESMA) has published several opinions in 2017 outlining principles for competent authorities to follow when authorizing U.K. investment firms and managers (among others) to relocate within the E.U. In a guest article, John Young, PSL counsel at Ropes & Gray, considers the basic substance requirements in the Directives, along with the highlights of ESMA’s opinions and how those opinions might affect U.K. firms that have plans to relocate following Brexit. For more on ESMA, see “ESMA Strives to Prepare Markets As MiFID II, MiFIR and Brexit Approach” (Oct. 12, 2017); and “ESMA Requires Enhanced Supervisory Role and Tools for Harmonizing E.U. and Third-Country Regulations” (Jun. 22, 2017). For additional insight from Young, see “Ropes & Gray Attorneys Discuss Implications for U.S. Hedge Fund Managers of the European Market Infrastructure Regulation” (Jul. 18, 2014).

Fund Managers Must Supervise Third-Party Service Providers or Risk Regulatory Action

It is not enough for a fund manager to have its own cybersecurity defenses; a manager must also exercise appropriate oversight of the defenses of third parties acting on its behalf. A recent CFTC settlement affirms the notion that registrants are not only responsible for their own compliance programs, but are also charged with the duty of supervising third-party vendors and are expected to maintain appropriate procedures to monitor those third parties. Further, a fund manager may be held responsible for the actions of third parties, even when the fund manager itself lacks the power to directly take those actions or when the fund manager itself is the victim of a third party’s missteps. This article analyzes the underlying facts and terms of the CFTC settlement order. For coverage of other recent CFTC enforcement efforts, see “New CFTC Chair Outlines Enforcement Priorities and Approaches to FinTech, Cybersecurity and Swaps Reform” (Nov. 9, 2017); “Newly Revealed CFTC Self-Reporting and Cooperation Regime Could Offer Benefits to Fund Managers, or Lead to Increased Enforcement” (Oct. 19, 2017); and “Two Recent Settlements Demonstrate CFTC’s Continued Focus on Spoofing” (Oct. 12, 2017).

Recent SEC Settlement Reminds Fund Managers to Strictly Adhere to Disclosed Fee and Expense Calculation Methodologies and Fully Disclose Conflicts of Interest

The SEC recently entered a settlement order against an investment adviser and its principal for their failures to properly calculate fees and expense reimbursements as disclosed in their fund documents and SEC filings, and to make adequate disclosure regarding related-party-transaction conflicts of interest, resulting in over $2 million in fines, disgorgement and interest. The action is a critical reminder to fund managers of the importance of ensuring that fees and expenses are calculated precisely in accordance with disclosed methodologies; the significance of fully disclosing all conflicts of interest; and the SEC’s continued attention to these areas. This article summarizes the SEC’s findings and the terms of the settlement order. For more on SEC scrutiny of these issues, see “Eight Bad Excuses Fund Managers Have Raised Trying to Avoid SEC Sanctions for Fee and Expense Allocation Violations and Undisclosed Conflicts of Interest” (Oct. 13, 2016).

HFLR and Seward & Kissel Webinar Explores Key Side Letter Terms (Part One of Two)

Seward & Kissel (S&K) recently completed its second annual hedge fund side letter study. See “Seward & Kissel Study Finds Reduced Fees and MFN Clauses Remain Most Prevalent Side Letter Terms” (Oct. 5, 2017). To provide fund managers with additional perspectives on the evolution of the side letter landscape over the past year, the Hedge Fund Law Report and S&K hosted a webinar moderated by William V. de Cordova, Editor-in-Chief of the Hedge Fund Law Report, and featuring insights on the side letter environment from Steve Nadel, lead author of the S&K side letter study. This article, the first in a two-part series, discusses the demographics of investment managers and investors that are more inclined to enter into side letters, along with key side letter terms. The second article will explore side letter trends, key takeaways from the study and the effect President Trump’s administration may have on the terms offered by managers in side letters. For coverage of S&K’s 2015/2016 side letter study, see “Seward & Kissel Study Finds MFN Clauses and Reduced Fees Most Prevalent Terms in Side Letters” (Oct. 6, 2016).

Thomson Reuters Survey Reveals Concerns About and Shortcomings With AML Compliance

U.S. financial firms are subject to a constantly evolving regime of domestic and foreign anti-money laundering (AML) regulations. Thomson Reuters (TR) recently asked more than 400 AML professionals for their insights on how to manage organizational AML compliance. The survey covered AML challenges, screening, monitoring, suspicious activity reports, beneficial ownership, enhanced due diligence, screening technology and budgets. Respondents noted challenges with increased regulation, lack of resources, concerns about liability and shortcomings with respect to the suspicious activity report process. This article highlights TR’s key findings. For another recent AML survey, see “ACA 2016 Compliance Survey Covers SEC Exams; Compliance Staffing and Budgeting; Annual and Ongoing Compliance Reviews; and AML/Sanctions Compliance (Part One of Two)” (Jan. 19, 2017).

Co-Director of SEC Enforcement Division Champions New Retail Strategy Task Force and Cyber Unit

In a recent speech, Stephanie Avakian, Co-Director of the Enforcement Division (Division) of the SEC, outlined new initiatives aimed at shielding retail investors and protecting against cybersecurity risks. She also emphasized that the Division will pursue the same mission and high-level priorities despite new leadership within the SEC. Avakian’s speech offers an important look into the areas fund managers should prioritize with respect to their disclosure and compliance. This article summarizes the portions of the speech most relevant to fund managers. For additional insights from Avakian, see our two-part series on SEC cybersecurity enforcement and examination priorities: Part One (May 11, 2017); and Part Two (May 18, 2017).

Leith Moghli Joins Reed Smith in London

Reed Smith has expanded its global private equity and investment funds practice with the addition of partner Leith Moghli, who advises fund sponsors and financial institutions in many jurisdictions on the structuring and formation of investment vehicles designed to invest in sectors such as debt, energy, natural resources and infrastructure. Moghli has expertise in many transactional areas including joint ventures, portfolio acquisitions, cornerstone fund investments, spinouts and restructurings. For coverage of other hires at Reed Smith, see “Reed Smith Adds Funds and Corporate Partners in New York and San Francisco” (Apr. 20, 2017).

Harneys Expands Global Investment Funds Practice

Rob McIntyre and Daniella Skotnicki have joined the investment funds practice of Harneys as counsel and senior associate, respectively. McIntyre joins the London office of Harneys, while Skotnicki joins the Harneys office in the Cayman Islands. McIntyre advises clients on the structuring and management of offshore funds and on myriad regulatory and compliance matters. Skotnicki provides counsel on fund formation, restructuring and regulatory issues, and her expertise encompasses closed- and open-end funds. For coverage of other recent hires at the firm, see “Harneys Expands BVI Funds and Regulatory Practice” (Aug. 10, 2017).