May 31, 2018

Ten Common Mistakes Fund Managers Must Avoid When Adopting or Updating Their Employee Handbooks (Part Three of Three)

With employee handbooks – as is the case with all legal documents – content matters. Each adviser must ensure that its handbook not only includes the correct policies but also avoids language that can expose the manager to potential liability or limit the manager’s flexibility when making employment-related decisions. This article, the third in our three-part series, discusses how advisers can avoid ten common mistakes when adopting or updating their employee handbooks. The first article outlined the key benefits to fund managers of adopting employee handbooks, the laws that frequently inform the policies included in handbooks and the administration of employee handbooks. The second article reviewed ten policies that advisers should consider including in their handbooks, including a statement on at-will employment, as well as policies prohibiting discrimination and harassment in the workplace. For more on employment-related issues, see “Best Practices for Fund Managers to Mitigate Litigation and Regulatory Risk Before Terminating Employees” (Feb. 9, 2017).

The SEC’s Proposed Form CRS: An Overview of the Key Requirements (Part One of Two)

The SEC recently proposed new rules under the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934 that would require registered investment advisers and registered broker-dealers to provide a brief customer- or client-relationship summary in a new short-form disclosure document: Form CRS. According to the SEC, Form CRS is intended to provide retail investors with simple, easy-to-understand information about the nature of their relationships with each investment professional and would supplement other, more detailed disclosures. Comments on the proposed new form must be submitted to the SEC over the next several months. This two-part series analyzes the proposed Form CRS requirements; discusses various issues the form raises; and provides insight from lawyers and compliance professionals on the proposal. This first article in the series provides an overview of the proposed Form CRS and its key requirements. The second article will discuss whether the form is likely to achieve the SEC’s stated goal and explore potential issues it raises for SEC-registered investment advisers. For more on the SEC’s focus on retail investors, see “Retail Investors Top List of OCIE 2018 Exam Priorities” (Mar. 8, 2018); and “Co-Director of SEC Enforcement Division Champions New Retail Strategy Task Force and Cyber Unit” (Nov. 16, 2017).

SEC Settlement Reminds Investment Advisers to Properly Disclose Securities Lending Practices

Conflicts of interest remain one of the key regulatory risks faced by investment advisers. See Ten Key Risks Facing Private Fund Managers in 2017” (Apr. 6, 2017). For more than a decade, two affiliated investment advisers recalled securities that had been loaned out by insurance-dedicated funds they advised so that the corporate shareholders in those funds – which included the advisers’ affiliated insurers – could take advantage of the deduction available for certain dividend income. The advisers allegedly failed to disclose this practice, however, to either the funds’ investors or their board of directors, thus creating an unaddressed conflict of interest that favored their affiliates at the expense of the funds they advised, which lost out on the securities lending income during the period when the securities were recalled. The advisers recently entered into a settlement with the SEC with respect to this behavior, agreeing to pay a significant amount in disgorgement, interest and penalties. This article details the securities lending practices that led to the enforcement action and the terms of the settlement order. For other enforcement actions involving conflicts of interest, see “SEC Settles Three Additional Enforcement Actions for Inadequate Share-Class Disclosure” (May 17, 2018); and “Ameriprise Settlement Reflects Continued SEC Focus on Conflicts of Interest and Retail Investors” (Apr. 19, 2018).

Preparing for Brexit a Key FCA Priority for 2018/2019

The U.K. Financial Conduct Authority (FCA) recently published its 2018/19 Business Plan (Plan), its 2018 Sector Views and a consultation paper on 2018/19 fees and levies. A recurring theme of the Plan is the potential impact of the U.K.’s impending withdrawal from the E.U. In a press release, Andrew Bailey, the FCA’s Chief Executive, emphasized that the priorities discussed in the Plan “reflect the high level of resource we need to dedicate to EU Withdrawal, given its impact both on our regulation and on the firms we regulate.” The Plan focuses on the seven “cross-sector priorities” affecting some or all of the business sectors within its purview. It also delineates the FCA’s priorities in each of seven distinct sectors, including investment management. This article summarizes the FCA’s cross-sector priorities, as well as the other portions of the FCA materials most relevant to private fund managers. For coverage of prior FCA business plans, sector views and mission statements, see “FCA Details Three of Its 2017 Priorities: Competition in the Asset Management Market, Liquidity Management and Custodians” (May 4, 2017); and “FCA 2016-2017 Regulatory and Supervisory Priorities Include Focus on AML, Cybersecurity and Governance” (Apr. 14, 2016).

As Cryptocurrencies Advance, CFTC Commissioner Encourages Formation of an SRO to Oversee Customer Protection

In the past year, cryptocurrencies have received increasing attention from fund managers, investors and the media. Regulators have also been focusing on cryptocurrencies, although a cohesive approach to regulating this developing asset class has yet to emerge. See “Funds and Managers Must Be Wary of State, in Addition to Federal, Regulatory Scrutiny of ICOs” (May 17, 2018); and “SEC Halts Registration of Cryptocurrency Mutual Funds, Calling for Dialogue Regarding Valuation, Liquidity, Custody, Arbitrage and Manipulation Risk” (Feb. 15, 2018). In a recent speech, CFTC Commissioner Brian Quintenz examined the role of regulators such as the CFTC during periods of technological change; discussed the use of blockchain technology by funds and managers; explored current approaches to cryptocurrencies by U.S. and global regulators; and called for the formation of a self-regulatory organization by cryptocurrency spot platforms to enforce customer protection rules in spot commodity markets. This article highlights the key points from Quintenz’s remarks. For more on the CFTC’s approach to cryptocurrencies, see “U.S. District Court Rules That Virtual Currencies Are Commodities Under the Commodity Exchange Act” (Apr. 12, 2018); and “Virtual Currencies Present Significant Risk and Opportunity, Demanding Focus From Regulators, According to CFTC Chair” (Feb. 8, 2018).

ACA 2018 Compliance Survey Examines Compliance Programs and SEC Examination Priorities (Part One of Two)

ACA Compliance Group (ACA) recently completed its 2018 Alternative Fund Manager Compliance Survey, which included responses from 280 illiquid and hedge fund managers on a variety of compliance topics, and the results were discussed in a presentation by ACA director Danielle Joseph and principal consultant Ken Harman. This article, the first in a two-part series, details the portions of the survey that covered compliance programs and SEC examination priorities, and offers insights from the speakers. The second article will examine electronic communications, personal trading and corruption risk. For coverage of ACA’s 2017 compliance survey, see “Continued SEC Focus on Compliance, Conflicts of Interest and Fees, and Common Measures to Protect MNPI” (Jun. 1, 2017); and “Variety in Expense Allocation Practices and Business Continuity Measures” (Jun. 8, 2017).

Davis Polk Hires Michael Hong in New York

Michael Hong has joined Davis Polk as a partner in the firm’s investment management division in New York. Hong advises fund managers on fund formation, investments and joint ventures, and he has particular expertise in the private equity realm. For commentary from other Davis Polk attorneys, see our two-part series on steps advisers can take to minimize the risk that a routine SEC examination ends with a referral to enforcement: “Five Key Priorities for OCIE” (Jan. 4, 2018); and “Examination Process, Interview Preparation and Remediation Considerations” (Jan. 18, 2018); as well as “U.S. Tax Court Ruling May Lead to Increased After-Tax Returns for Foreign Investors That Invest in U.S. Partnerships” (Aug. 3, 2017).