Mar. 8, 2018

Beware of False Friends: A Hedge Fund Manager’s Guide to Social Engineering Fraud

Cybercriminals are increasingly relying on social engineering to attack corporate systems. Hedge funds are particularly vulnerable, given that they typically lack extensive in-house cybersecurity expertise; deal with large sums of capital; and have relationships with powerful clients and individuals. Social engineering fraud poses a number of risks to fund managers, including money transfer fraud; theft of passwords or trade secrets; customer-data compromise; revelation of trading positions and plans; and attacks on principals. Fortunately, managers can mitigate these risks by educating and training employees; instituting multi-factor authentication; adopting verification procedures; limiting user access; and monitoring cybersecurity regulations. In addition, managers are increasingly able to rely on insurance to cover social engineering fraud losses. In a guest article, Ron Borys, senior managing director in Crystal & Company’s financial institutions group, and Jordan Arnold, executive managing director in K2 Intelligence’s New York and Los Angeles offices and head of the firm’s private client services and strategic risk and security practices, examine the risks of social engineering fraud, how fund managers can prevent it and how insurance policies can be used to protect against related losses. See “New CFTC Chair Outlines Enforcement Priorities and Approaches to FinTech, Cybersecurity and Swaps Reform” (Nov. 9, 2017); and “SEC Tackles Internal Cybersecurity Issues While Sharpening Cybersecurity Enforcement Focus” (Oct. 5, 2017). For additional commentary from Borys, see “How E&O and D&O Liability Insurance Can Help Hedge Fund Managers Mitigate the Consequences of Regulatory Enforcement Actions” (Jun. 2, 2016).

Understanding Subscription Credit Facilities: Principal Advantages and Key Points to Negotiate in the Credit Agreement (Part Two of Three)

Negotiating a subscription credit facility on behalf of a private fund can be a daunting task for attorneys practicing outside the world of fund finance. While members of a sponsor’s business team may negotiate the economic terms of the facility, the two main agreements that govern a subscription credit facility – the credit agreement and security agreement – are replete with representations, warranties, covenants and event of default provisions. These provisions must be carefully scrutinized to confirm their accuracy; ensure that the fund’s existing business model is adequately designed to fulfill future obligations under the agreements; and evaluate the likelihood that the fund will avoid any potential event of default scenario. This second article of our three-part series discusses the primary advantages to funds, sponsors and investors of using these facilities and explores the legal documents that govern them. The first article provided background on the types of funds that frequently use these facilities, recent trends that have emerged regarding this form of financing, basic mechanics of these facilities’ structures and the types of lenders that routinely offer these products. The third article will evaluate concerns raised by members of the private equity industry regarding these facilities, including whether they should be used for longer-term financing and how they impact a fund’s internal rate of return. See “Types, Terms and Negotiation Points of Short- and Long-Term Financing Available to Hedge Fund Managers” (Mar. 16, 2017).

Interest in Bespoke Fund Structures Surges As Markets Adjust to New Administration and Regulatory Regime

A little more than a year into the Trump administration, the private funds market displays growing levels of innovation and experimentation. Fund managers are increasingly opting to employ bespoke fund structures, such as first loss capital arrangements, each of which has its own unique set of advantages as well as potentially catastrophic liabilities. Recent changes at the regulatory level – including the newly effective revisions to Form ADV; a heightened regulatory focus on blockchain and the fiduciary responsibilities of legal professionals providing related advice; and a growing emphasis on individual liability, particularly with respect to chief compliance officers – add to the environment’s complexity and may sometimes appear contrary to the administration’s pro-business rhetoric. These factors and trends make the 2018 private funds environment drastically different from that under the previous administration, raising exhilarating and daunting possibilities for fund managers. To help readers understand the unique benefits and potential drawbacks of some of the more popular bespoke fund structures, the Hedge Fund Law Report recently interviewed Peter Bilfield, partner at Day Pitney with experience in this area. This article presents his thoughts. For further commentary from Bilfield, see “What Do the Investor Advisory Committee’s Recommendations Mean for the Future of Marketing of Hedge Funds to Natural Persons?” (Oct. 24, 2014); and “Investments by Family Offices in Hedge Funds Through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part One of Two)” (Apr. 1, 2011).

With the Filing Deadline Looming for Many Advisers, Seward & Kissel Attorneys Provide a Roadmap to Amended Form ADV

In August 2016, the SEC adopted a number of amendments to Part 1A of Form ADV, which took effect on October 1, 2017. Many advisers are now contending with the revised form in connection with their annual updates that are due March 31. A recent Seward & Kissel presentation offered an overview of the most material and vexing changes, offering practical advice on how to complete the revised form. The program featured Seward & Kissel partners Paul M. Miller, Patricia A. Poglinco and Robert B. Van Grover, along with counsel David Tang. This article summarizes the key points raised by the panelists. For more on the amendments, see our two-part series on what investment advisers need to know about the SEC’s revisions to Form ADV and the recordkeeping rule: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 3, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016). For additional insights from Van Grover and Poglinco, see “Pro-Business Environment of New Administration Continues to Have Challenges and Pitfalls for Private Funds” (Sep. 14, 2017); and “How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations” (Sep. 8, 2016).

Retail Investors Top List of OCIE 2018 Exam Priorities

The SEC Office of Compliance Inspections and Examinations (OCIE) recently issued its 2018 National Exam Program Examination Priorities. The priorities, which emphasize the protection of retail investors, are in line with what OCIE announced last year and include cybersecurity; anti-money laundering; market infrastructure; and the operations of FINRA and the Municipal Securities Rulemaking Board. In the press release announcing the 2018 priorities, SEC Chair Jay Clayton commended “OCIE’s dedication to maximizing the effectiveness of their resources with a keen eye toward asset verification, market infrastructure, and duties owed to retail investors.” This article analyzes the list of OCIE priorities, presenting the key points most relevant to private fund advisers. See also our coverage of OCIE’s 2017 Examination Priorities; and 2016 Examination Priorities.

How Alternative Investment Managers Can Avoid Becoming Digital Dinosaurs: KPMG and CREATE-Research Survey Examines How Private Fund Managers Are Entering the Digital Age (Part Two of Two)

The alternative investment industry has been slow to embrace digitization. A recent study conducted by KPMG International and CREATE-Research found that private equity managers, in particular, have lagged behind their hedge fund manager peers in implementing emerging digital technologies. This two-part series summarizes the key findings from the report and includes insights from Professor Amin Rajan, chief executive of CREATE-Research and one of the study’s authors. This second article discusses how both hedge fund and private equity managers are currently implementing digital innovations into their businesses, including the types of digital technologies they have adopted, and how alternative investment managers can move toward a more digital environment. The first article examined digitization as a disrupter in the alternative investment industry and its anticipated effects; seven drivers of digitization; and key factors that are likely to affect its pace. For more on how technology is affecting the alternative investment industry, see “How Blockchain Will Continue to Revolutionize the Private Funds Sector in 2018” (Jan. 4, 2018).

Heather Wyckoff Joins Schulte Roth & Zabel

Heather Wyckoff has joined Schulte Roth & Zabel’s investment management practice as a special counsel based in New York. Wyckoff advises hedge funds and private equity funds on fund formation, fund structuring and regulatory compliance matters. For insight from other Schulte attorneys, see “Implications of Lehman Brothers Decision on Hedge Fund Managers Trading CDOs” (Jul. 28, 2016); and “Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements” (Nov. 23, 2011).