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    Mar. 15, 2018

Understanding Subscription Credit Facilities: Key Concerns Raised by Investors and the SEC (Part Three of Three)

One of 2017’s most hotly debated topics in the world of private equity involved the use of subscription credit facilities by private funds that employ a capital call structure. This grew into a debate in which seemingly everyone – including bloggers, reporters, investment consultants and even one of the co-founders of Oaktree Capital Management, Howard Marks – wanted to participate. In June 2017, the Institutional Limited Partners Association (ILPA) issued guidance articulating its own views on several issues that comprise this debate, which shined an even brighter spotlight on a topic that was already receiving significant attention. This final article of our three-part series on subscription credit facilities reviews the ILPA guidance and its corresponding effect on these credit facilities, as well as two of the most controversial aspects of these facilities: the impact a subscription credit facility has on a fund’s internal rate of return and the use of these facilities by investment managers for longer-term financing. 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 second article discussed the primary advantages to funds, sponsors and investors of using these facilities and explored the legal documents that govern them. For coverage of ILPA guidance on other issues affecting the private funds industry, see “How Managers May Address Increasing Demands of Limited Partners for Standardized Reporting of Fund Fees and Expenses” (Sep. 1, 2016).

Does the Digital Realty Decision Represent a Sea Change for Whistleblowers or Merely More of the Same?

The U.S. Supreme Court opinion in Digital Realty Trust, Inc. v. Somers addresses the scope of the whistleblower anti-retaliation provision of the Dodd-Frank Act. In a unanimous decision, the Court held that an individual can bring a claim under Dodd-Frank’s anti-retaliation provision only if he or she has made a formal report to the SEC; internal reporting does not confer protection under the statute. Many commentators have predicted alarming consequences from the decision, but there are reasons to believe that many of those are unlikely to materialize. In a guest article, Anne E. Beaumont and Alexander D. Levi, partner and associate, respectively, at Friedman Kaplan Seiler & Adelman, review the statutory framework of whistleblower protections, lower court decisions in Digital Realty, the Supreme Court’s decision in Digital Realty and the ruling’s implications for private fund managers. For a discussion of whistleblower protections in another jurisdiction, see “CIMA Regulator Discusses Key Issues for Advisers That Manage Cayman Funds: AIFMD Marketing Passport, Whistleblowers and Administrative Fines Regime (Part Two of Two)” (Sep. 21, 2017). For additional commentary from Beaumont, see “Recent New York Court of Appeals Decision Eases Path for Investor Lawsuits Against Cayman Funds, but Certain Hurdles Remain” (Dec. 7, 2017); and “How Hedge Fund Managers Can Balance Protecting Confidential Information Against Complying With Whistleblower Laws” (Aug. 25, 2016).

SEC’s Reg Flex Agenda Promotes Transparency While Adding Potential Compliance Burdens

The SEC recently published its latest semi-annual Regulatory Flexibility Agenda (Agenda) setting forth rulemaking actions that Chair Jay Clayton and his staff intend to pursue over the next several months. Investment advisers and hedge funds will be directly affected by several of the Agenda items, such as the reporting of proxy votes on executive compensation. Likewise, the Agenda’s provisions relating to business continuity and transition plans will affect investment advisers, although those proposed rules may be difficult to apply, given the variance in hedge fund manager sizes, profiles and leadership structures. Despite implementation and other challenges, the Commission’s push to publicize its rulemaking priorities helps fund managers prepare for possible major regulatory developments and marks a step toward greater transparency and accountability. To that extent, the publication of the Agenda aligns with the Trump administration’s stated pro-business stance. To cast light on the above issues, this article analyzes the Agenda’s provisions that are most relevant to private fund managers and provides insights from legal professionals with experience in SEC enforcement matters. For coverage of recent SEC enforcement trends, see “SEC Enforcement Action Highlights Highly Specific Regulatory Focus on Conflicts of Interest” (Jan. 25, 2018); and “SEC Signals Aggressive Stance on Individual Responsibility, Including Potential CCO Liability, in FY 2017 Annual Report” (Dec. 14, 2017).

Panel Offers Perspectives on Internal Compensation Arrangements for Investment Professionals: Carried Interest and Deferred Compensation (Part One of Two)

Private equity (PE) firms award carry at the fund level or on a deal-by-deal basis; while the deal-by-deal structure is more flexible, it is also more difficult to properly implement. Recent changes to the taxation of carried interest may further affect how PE firms award carry. In addition, private funds are increasingly deferring compensation to incentivize employees to stay, although significant issues persist over how employment contracts define “cause” and “good reason.” See “Ways Fund Managers Can Compensate and Incentivize Partners and Top Performers” (Dec. 14, 2017). A recent program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), and featuring McDermott Will & Emery partners Ian M. Schwartz, Evan A. Belosa and Alejandro Ruiz, discussed these and similar issues. This article, the first in a two-part series, discusses carried interest, taxation thereof and deferred compensation arrangements. The second article will explore hedge fund compensation, including profit shares, and restrictive employment covenants. For insight from another McDermott Will & Emery partner, see “Lessons for Hedge Fund Managers From the Government’s Failed Prosecution of Alleged Insider Trading Under Wire and Securities Fraud Laws” (Jul. 21, 2016). For coverage of prior programs hosted by MLA, see “Client Consent and Other Issues Requiring Careful Consideration by Fund Managers Involved in M&A Transactions” (May 18, 2017); and “Former Prosecutors Address Trends in Cybersecurity for Alternative Asset Managers, Diligence When Acquiring a Company and Breach Response Considerations” (Oct. 6, 2016).

CFTC Enforcement Action Spotlights Fund Managers’ Duty to Supervise IT Providers

The CFTC recently announced a settlement with a registered futures commission merchant (FCM) that had tens of thousands of client records compromised after its information technology vendor installed a backup drive on the FCM’s network that included an unsecured port of which the vendor was unaware. Although this case concerned an FCM, it puts all CFTC registrants on notice that they are responsible for protecting sensitive information. “Entities entrusted with sensitive information must work diligently to protect that information,” CFTC Director of Enforcement James McDonald noted, adding that, “[a]s this case shows, the CFTC will work hard to ensure regulated entities live up to that responsibility, which has taken on increasing importance as cyber threats extend across our financial system.” Further, the settlement reminds fund managers and other CFTC-registered entities that, under CFTC Regulation 166.3, they must monitor third-party service providers to avoid similar regulatory action. This article analyzes the terms of the settlement order, including the facts that led up to the settlement, the penalties imposed and the remedial steps the FCM agreed to take. For more from the CFTC, see “Virtual Currencies Present Significant Risk and Opportunity, Demanding Focus From Regulators, According to CFTC Chair” (Feb. 8, 2018).

FCA Solicits Industry Input on Machine-Executable Regulatory Reporting

The U.K. Financial Conduct Authority (FCA) has been exploring ways to streamline and automate regulatory reporting – one of the critical compliance challenges facing private fund managers. Last November, in a so-called “TechSprint,” the FCA and the Bank of England worked with various financial services and technology firms to develop and successfully implement a machine-executable reporting rule. This project is detailed in a recent report, which also seeks input from market participants and other interested parties on how to proceed with this potentially revolutionary approach to reporting. The report should be of interest to FCA-regulated firms; financial services regulators; regulatory and financial technology companies; and professional services, technology and software providers. This article summarizes the key takeaways from the report. For more on FCA reporting requirements, 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); and “U.S. Managers Marketing to U.K. Investors Could Face Ballooning Reporting Burdens Under Proposed Rule” (Jul. 28, 2016).

Former SEC Examiner Launches Compliance Consulting Firm

Brad Burgtorf, a former senior consultant at ACA Compliance Group (ACA) and former SEC examiner, has reentered the compliance advisory space with the launch of a new firm – HighCamp Compliance. Joining Burgtorf is another former ACA consultant, Azra Hafizovic. Burgtorf and Hafizovic will advise clients on regulatory issues as the contours of the Trump administration enforcement regime take shape. For insight from other ACA practitioners, see our two-part series on maintaining books and records: “Compliance With Applicable Regulations” (Nov. 2, 2017); and “Document Retention and SEC Expectations” (Nov. 9, 2017).

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