Apr. 12, 2018

How Fund Managers Should Structure Their Cybersecurity Programs: Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties (Part Three of Three)

Cybersecurity stakeholders, particularly those in information security and legal/compliance, must communicate effectively to ensure that a fund manager’s cybersecurity program is fully implemented and able to respond to cyber attacks. Although managers of all sizes should aim to build in-house cybersecurity expertise to increase responsiveness, some may benefit from outsourcing or co-sourcing certain cybersecurity functions given the involved costs and shortage of qualified workers. Managers must, however, ensure that they properly vet and oversee third-party cybersecurity vendors, and this requires coordination between the chief compliance officer (CCO) and on-site technology leaders. This article, the third in our three-part series, evaluates methods for facilitating communication between cybersecurity stakeholders; outsourcing and co-sourcing of cybersecurity functions; and best practices for employing and overseeing third-party cybersecurity vendors. The first article discussed the risks and costs associated with cyber attacks; the global focus on cybersecurity; relevant findings observed by the Office of Compliance Inspections and Examinations during the examination of SEC registrants; and cybersecurity best practices. The second article analyzed the reasons why fund managers should hire a dedicated chief information security officer, reviewed information security governance structures and explored the role of the CCO as a strategic partner. See “Fund Managers Must Supervise Third-Party Service Providers or Risk Regulatory Action” (Nov. 16, 2017); and “How Managers Can Identify and Manage Cybersecurity Risks Posed by Third-Party Service Providers” (Jul. 27, 2017).

How Quant Funds Can Maximize Appeal to Investors While Minimizing Cyber and Regulatory Risk

In the hyper-connected trading and investment world of 2018, quant funds, which utilize highly sophisticated computer-based models to automatically carry out trades, are gaining increasing appeal. As the lure of these funds grows, however, it is critically important for investors to understand the differences between quant funds and seemingly similar vehicles; the various investment strategies that they offer; and the numerous risks that come with this type of trading. Managers must also recognize that running a quant fund raises unique operational and marketing challenges, not least because of the extremely high standard of due diligence that many institutional investors are likely to apply before making allocations. Quant funds also face unique external problems; for example, luring and retaining talent in a tech world dominated by Silicon Valley presents certain difficulties. To help readers understand these issues, the Hedge Fund Law Report interviewed Ildiko Duckor, head of the emerging hedge fund manager program and co-head of the investment funds practice at Pillsbury in San Francisco. This article presents her insights. For more from Duckor, see “What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?” (Feb. 18, 2011). For commentary from another Pillsbury attorney, see “ALM General Counsel Summit Reveals How Hedge Fund Managers Can Prepare for SEC Examinations” (Nov. 19, 2015).

Three Asset-Based Financing Options for Private Funds: Total Return Swaps, Structured Repos and SPV Financing (Part Two of Two)

In the ongoing pursuit to generate alpha, some hedge fund managers have increased allocations to more illiquid assets. Many of these assets, however, are not suitable for traditional forms of financing, including short-term margin and repurchase agreement (repo) financing, and can only be financed through bespoke financing arrangements, including total return swap (TRS) financing, structured repo financing and special purpose vehicle/entity (SPV) financing. In this guest article, the second in a two-part series, Fabien Carruzzo and Daniel King, partner and associate, respectively, at Kramer Levin, review the main features of structured repo financing and SPV financing, and highlight the comparative advantages and disadvantages to private funds of using these structures, taking into consideration the flexibility of the structures, the complexity of the legal documentation of each structure and the level of asset protection afforded by each structure. The first article provided an in-depth discussion of TRS financing. For analysis of another type of lending facility, see our three-part series on understanding subscription credit facilities: “Their Popularity and Usage Soar Despite Concerns Raised by Certain Members of the Private Funds Industry” (Mar. 1, 2018); “Principal Advantages and Key Points to Negotiate in the Credit Agreement” (Mar. 8, 2018); and “Key Concerns Raised by Investors and the SEC” (Mar. 15, 2018). For additional insight from Carruzzo, see “New York Appellate Court Affirms Broad Rights of Parties in CDS Transactions to Pursue Their Economic Self-Interests, Despite Adverse Effect on Counterparties” (Mar. 30, 2017).

The Death of Alpha: A True Challenge or a Poor Manager’s Excuse? DMS Summit Discusses Alpha Generation, “2 and 20” Fees, AI and Impact Investing

DMS Governance (DMS) recently held its second annual Investment Funds Summit, featuring distinguished representatives of both fund managers and fund investors. John D’Agostino, DMS managing director, moderated the program, which included lively debates on whether it is still possible to generate alpha and the viability of the traditional “2 and 20” fee structure, as well as presentations on marketing into the E.U., artificial intelligence and impact investing. This article outlines the key points raised during the program, which included various divergent perspectives on the topics discussed. For further commentary from DMS, see Former General Counsel and Current Independent Director Discusses the Importance of Robust Fund Governance” (Dec. 8, 2016); and “DMS Review Highlights Issues With Regulation, Institutionalization and Customization of Hedge Funds” (May 21, 2015).

U.S. District Court Rules That Virtual Currencies Are Commodities Under the Commodity Exchange Act

Blockchain, virtual currencies and the businesses associated with them are developing in largely uncharted regulatory territory. This does not mean, however, that regulators are ignoring the technology and asset class. The U.S. District Court for the Eastern District of New York (EDNY) recently handed the CFTC a significant victory, ruling that virtual currencies are commodities under the Commodity Exchange Act, thereby giving the CFTC jurisdiction over fraudulent conduct involving them. See “What Fund Managers Investing in Virtual Currency Need to Know About NFA Reporting Requirements and the CFTC’s Proposed Interpretation of ‘Actual Delivery’” (Mar. 1, 2018); and “Virtual Currencies Present Significant Risk and Opportunity, Demanding Focus From Regulators, According to CFTC Chair” (Feb. 8, 2018). This article details the facts and circumstances leading up to the enforcement action and the EDNY’s reasoning. For more on blockchain, see “How Blockchain Will Continue to Revolutionize the Private Funds Sector in 2018” (Jan. 4, 2018); as well as our three-part series on blockchain and the financial services industry: “Basics of the Technology and How the Financial Sector Is Currently Employing It” (Jun. 1, 2017); “Potential Uses by Private Funds and Service Providers” (Jun. 8, 2017); and “Potential Impediments to Its Eventual Adoption” (Jun. 15, 2017).

FCA Chief Executive Touts Senior Managers Regime and Remuneration Restrictions As Important Incentives to Promote Good Culture at Fund Managers

In a recent speech, Andrew Bailey, Chief Executive of the U.K. Financial Conduct Authority (FCA) extolled the U.K. Senior Managers and Certification Regime (SM&CR) and measures to govern the remuneration of senior managers as important ways to incentivize the creation of “good culture” – defined as encouraging good things, rather than simply stopping bad things from occurring – at fund managers and other financial services firms. Bailey outlined his thoughts on ways the FCA can promote good culture; discussed factors driving bad conduct at fund managers; lauded the SM&CR and remuneration guidelines as two recent developments that incentivize good culture; and promoted increased workplace diversity. Bailey’s remarks provide fund managers with important insight into the FCA, which views culture – and the protection of the public interest – as the responsibility of firms, their managers and owners. This article summarizes the key points from his speech. For more on the SM&CR, see “FCA Issues Guidance on Expansion of Senior Managers Regime to Fund Managers and Others” (Feb. 1, 2018). For additional commentary from Bailey and the FCA, see “FCA Details Three of Its 2017 Priorities: Competition in the Asset Management Market, Liquidity Management and Custodians” (May 4, 2017).

Neal Gerber Eisenberg Adds Partner in Chicago

Wesley Nissen has joined Neal Gerber Eisenberg as a partner in the firm’s corporate and securities practice in Chicago. Nissen advises asset managers; trading firms; and single- and multi-family offices on mergers and acquisitions, fund formation and regulatory compliance matters. For insights from Nissen, see 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).