Feb. 9, 2017

Why Funds Should Confirm Clear Contractual Obligations and Liabilities With Their Administrators

In recent years – following the Madoff scandal and the corresponding increase in regulatory scrutiny of hedge funds – investors have increasingly pressured managers to hire third-party fund administrators. See “Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators” (Jan. 21, 2009). Administrators add an extra layer of review and verification to mitigate the insularity and lack of oversight that allowed Madoff’s fraud to flourish undetected for decades. Notwithstanding the critical role that administrators play in the financial services industry, they are not subject to the same level of regulatory oversight as other service providers, such as a fund’s prime broker or auditor. Accordingly, when an administrator’s processes break down, causing losses directly to the fund and indirectly to its investors, the fund’s only option may be to pursue a civil action against the administrator. The success of such a claim will then depend on not only the facts of the case, but also the provisions setting forth the administrator’s obligations and liabilities contained in the agreement between the fund and the administrator. In a guest article, Lisa Solbakken, a partner at Arkin Solbakken, provides insight on the proper role of the administrator, details ongoing litigation in which funds allege that their administrators breached their contractual duties to the funds and offers advice on how funds should approach the negotiation of their administration agreements. For more on administrator liability, see “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016). 

Best Practices for Fund Managers to Mitigate Litigation and Regulatory Risk Before Terminating Employees

The hedge fund industry has recently been battered by performance struggles and rising operating costs from increased regulatory pressures. Amid these circumstances, many fund managers find themselves facing difficult employee-related decisions – from which employees deserve bonuses to which warrant the proverbial pink slip. While issuing performance bonuses is a purely financial decision, serious legal risks are associated with a manager’s decision to terminate employees. In addition to the recent spate of SEC actions against employers alleging that provisions within their employment documents violated the SEC’s whistleblower rules, there is also the risk of lawsuits from former employees who believe they were improperly terminated. For coverage of a wrongful termination suit against a fund manager, see “Four Recommendations for Hedge Fund Managers Designed to Minimize Risk and Damage From Employment Discrimination Lawsuits” (Oct. 11, 2012). This article outlines certain steps fund managers should take prior to terminating employees – including reviewing their documentation and delivering feedback to poor performers – to mitigate regulatory and litigation risks. For more on important employment considerations for investment managers, see “Trending Issues in Employment Law for Private Fund Managers: Non-Compete Agreements, Intellectual Property, Whistleblowers and Cybersecurity” (Nov. 17, 2016); and “Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements” (Nov. 23, 2011).

Steps Hedge Fund Managers Should Take Now to Ensure Their Swap Trading Continues Uninterrupted When New Regulation Takes Effect March 1, 2017

In the aftermath of the 2008 global financial crisis, the Basel Committee on Banking Supervision and the Board of the International Organization of Securities Commissions sought to reduce systemic risk and promote central clearing by recommending mandatory margin requirements on non-centrally cleared derivatives (i.e., derivatives that trade bilaterally). See “OTC Derivatives Clearing: How Does It Work and What Will Change?” (Jul. 14, 2011). In late 2015, five federal regulators adopted a joint rule that applies these requirements to swap dealers under their supervision; the CFTC adopted its own rule. The compliance date for the variation margin requirements under these rules is March 1, 2017. See “Hedge Funds Face Increased Margin Requirements Under Final Swap Rules (Part One of Two)” (Feb. 18, 2016); and “Hedge Funds Face Increased Trading Costs Under Final Swap Rules (Part Two of Two)” (Feb. 25, 2016). To better understand how the rules affect the private funds industry, the Hedge Fund Law Report recently interviewed Leigh Fraser, a partner at Ropes & Gray and co-leader of the firm’s hedge fund group, regarding the steps that funds should take to ensure that their swaps trading continues on an uninterrupted basis. For additional insights from Fraser, see our three-part series on best practices in negotiating prime brokerage arrangements: “Preliminary Considerations When Selecting Firms and Brokerage Arrangements” (Dec. 1, 2016); “Structural Considerations of Multi-Prime and Split Custodian-Broker Arrangements” (Dec. 8. 2016); and “Legal Considerations When Negotiating Prime Brokerage Agreements” (Dec. 15, 2016).

How Tax Reforms Proposed by the Trump Administration and House Republicans May Affect Private Fund Managers

Tax reform has been a perennial centerpiece of the Republican Party’s agenda, and with the election of Donald Trump and a Republican majority in both houses of Congress, that reform may be more likely than ever. A recent program presented by the New York Hedge Fund Roundtable provided an overview of both the Trump and the House Republican tax proposals as they relate to individual and entity taxes, comparing and contrasting them with each other and the current tax regime and offering key takeaways for fund managers about each proposal. The program was led by Robert E. Akeson, chief operating officer at Mirae Asset Securities, and featured Vadim Blikshteyn, a senior tax manager at Baker Tilly Virchow Krause. This article summarizes the key insights from the program. For more on tax reform, see our two-part series on the global trend toward tax transparency: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016); as well as “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015). 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).

FCA Fines Deutsche Bank £163 Million for Lax AML Controls, Warns Other Firms to Review AML Procedures

In early 2016, the U.K. Financial Conduct Authority (FCA) cited anti-money laundering (AML) as one of its priorities. See “FCA 2016-2017 Regulatory and Supervisory Priorities Include Focus on AML, Cybersecurity and Governance” (Apr. 14, 2016). True to its word, the FCA recently reached a £163 million settlement with Deutsche Bank AG (DB) over its suspect AML policies, procedures and controls. The action is notable both for the size of the fine and for the stern admonition in the press release announcing the settlement by Mark Steward, FCA Director of Enforcement and Market Oversight, who ominously warned that “other firms should take notice of today’s fine and look again at their own AML procedures to ensure they do not face similar action.” This article analyzes the suspect trades that gave rise to the enforcement action and the AML shortcomings cited by the FCA. For a recent look at AML enforcement efforts in the U.S., see “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016). For a discussion of the Financial Crimes Enforcement Network’s (FinCEN) new AML rules, see “Best Practices for Hedge Fund Managers to Adopt in Anticipation of Enactment of FinCEN AML Rule Proposal” (Aug. 4, 2016); and our series on the potential impact of the proposed FinCEN AML rule: Part One (Jun. 30, 2016); and Part Two (Jul. 7, 2016). 

Supreme Court’s Ruling in Salman v. U.S. Affirms the Importance of a Tipper’s “Personal Benefit” for Insider Trading, but Also Creates Uncertainty

In the aftermath of the U.S. Supreme Court’s December 2016 order upholding the conviction in Salman v. U.S., it is crucial for asset managers to have a thorough, nuanced and up-to-date understanding of what constitutes insider trading. The Salman case is likely to have a dramatic impact on the interpretation of insider trading law for years to come. Though it is possible to discern a fundamental test for when insider trading exists, some gray areas persist in insider trading law. This article summarizes a recent talk delivered by Ralph A. Siciliano, partner at Tannenbaum Helpern Syracuse & Hirschtritt, that discussed the points above. For additional insight from Siciliano, see our two-part series “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks?”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013). For further commentary from Tannenbaum attorneys, see “Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three)” (Oct. 3, 2013); and 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).

CLO Specialist Joins Greenberg Traurig in New York

Greenberg Traurig has bolstered its corporate practice in New York with the hiring of shareholder Joseph Suh, who advises investment managers and investors on the formation of collateralized loan obligations, hedge funds and private equity funds. Many of the transactions Suh works on involve funds and assets in Brazil. For coverage of another recent hire at the firm, see “Private Equity Fund Formation Partner Joins Greenberg Traurig in New York” (Aug. 11, 2016).