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    Aug. 2, 2018

Factors Fund Managers Must Consider When Addressing Cryptocurrencies and ICOs in Personal Trading Policies (Part Two of Two)

Rule 204A-1 under the Investment Advisers Act of 1940 requires registered investment advisers to establish, maintain and enforce codes of ethics that require “access persons” to periodically report their holdings of, and transactions in, “reportable securities.” Unregistered fund managers also frequently adopt similar requirements for their employees. Although Rule 204A-1 is largely devoted to reporting requirements, many advisers go beyond the technical requirements of the rule and adopt more restrictive measures in their personal trading policies. These policies should address any assets in which employees may want to trade, including cryptocurrencies – such as bitcoin, ether or ripple – and initial coin offerings (ICOs). When including cryptocurrencies and ICOs in their personal trading policies, fund managers should consider, among other things, whether to completely ban that trading, what types of restrictions it may impose on employees if that trading is permitted and how to monitor employee trading. This article, the second in our two-part series on the inclusion of cryptocurrencies and ICOs in personal trading policies, explores the factors fund managers must consider when determining how to address these assets in their personal trading policies and examines the challenges in allowing employees to trade in this asset class. The first article analyzed why fund managers need to amend their personal trading policies to address cryptocurrencies and ICOs. For more on issues posed by cryptocurrency investing, see “Unique Security Risks Posed by Cryptocurrency Investing: Steps Fund Managers Must Take to Protect Individuals With Access to Client Assets” (Jun. 28, 2018).

How to Navigate the Testimonial Rule in the Age of Social Media: Handling Clients’ Online Reviews

The SEC recently settled five separate proceedings against registered investment advisers, investment adviser representatives and a marketing consultant for violating Rule 206(4)-1(a)(1) (the Testimonial Rule) under the Investment Advisers Act of 1940 through their use of social media and the internet. The Commission has focused on the misuse of testimonials for some time, including through the “touting initiative” in which the SEC’s Office of Compliance Inspections and Examinations (OCIE) conducted focused reviews of advisers’ promotion of industry awards, testimonials, professional certifications and ranking lists. Among the deficiencies that OCIE staff found during that initiative was the use of client statements on social media and websites. See “HFLR Program Parses OCIE’s Recent Advertising Risk Alert: Misleading Claims of GIPS Compliance, Past Specific Investment Recommendations and Results of SEC’s Touting Initiative (Part Two of Two)” (Jan. 11, 2018). These enforcement actions serve as a warning to investment advisers that the SEC continues to scrutinize their advertising practices, including the use of testimonials. This article examines the mistakes made by the respondents in these cases, discusses the key takeaways elucidated by an industry expert and considers the future of the Testimonial Rule. See our three-part advertising compliance series: “Ten Best Practices for a Fund Manager to Streamline Its Compliance Review” (Sep. 14, 2017); “Five High-Risk Areas for a Fund Manager to Focus on When Reviewing Marketing Materials” (Sep. 21, 2017); and “Six Methods for a Fund Manager to Test Its Advertising Review Procedures” (Sep. 28, 2017).

IMDDA Offers Fund Managers a Blueprint for Conducting Sexual Harassment Due Diligence

The Investment Management Due Diligence Association (IMDDA) has issued the results of its recent study that examined current investor due diligence practices on sexual harassment issues that may adversely affect fund managers. In a related IMDDA webcast, Simone Foxman, a Bloomberg L.P. reporter, interviewed Kroll managing director Dan Schorr and associate director Monica Monticello about conducting due diligence on sexual harassment issues. This article summarizes the key takeaways from the survey report and webcast. For more from the IMDDA on operational due diligence, see “Insights on Operational Due Diligence From the IMDDA and the U.K. Pension Protection Fund” (Sep. 14, 2017); and “How Due Diligence Professionals Approach the Private Fund Review Process” (Jun. 15, 2017).

$42-Million Enforcement Action Against Merrill Lynch Reminds Fund Managers to Probe Where Broker-Dealers Are Routing Their Trades

Hedge fund managers may choose to route trades to dark pools and other trading venues in order to conceal the source of an order or to avoid revealing sensitive strategy information. A recent SEC settlement order reveals that, for five years, Merrill Lynch, Pierce, Fenner & Smith Incorporated (Merrill Lynch) intentionally hid from certain customers the fact that it was routing portions of their trades – approximately 15.8 million customer orders – to other broker-dealers known as external liquidity providers or electronic liquidity partners. The action is yet another reminder of the need for fund managers to conduct initial and ongoing due diligence on their counterparties to identify problematic behavior. This article reviews the facts and circumstances leading up to the $42‑million settlement. For coverage of another recent enforcement action against Merrill Lynch, see “$16‑Million Enforcement Action Against Merrill Lynch Demonstrates SEC’s Continued Pursuit of Misleading Broker Sales Talk and Excessive Markups in Mortgage-Backed Securities Trading” (Jul. 19, 2018).

ACA-IAA Investment Management Compliance Testing Survey Covers Fees and Expenses, Investment Mandates, Big Data and Custody (Part One of Two)

The role of the chief compliance officer is becoming more challenging and complex, according to panelists Enrique Carlos Alvarez, senior principal consultant at ACA Compliance Group (ACA); Sarah A. Buescher, associate general counsel at the Investment Adviser Association (IAA); and Sanjay Lamba, assistant general counsel at the IAA in a recent webinar presenting the results of the joint ACA-IAA 2018 Investment Management Compliance Testing Survey. Among the survey’s other notable findings are that more than three-quarters of respondents have not decreased their compliance testing and that nearly three-quarters of respondents employ some form of technology in compliance. This article, the first in a two-part series, examines the portions of the survey that covered compliance program testing; fees and expenses; socially responsible investing; sub-advisers; alternative data; trade surveillance; and custody. The second article will analyze the survey’s findings on best execution; soft dollars; advertising and social media; individual clients; cryptocurrency; cybersecurity; and other compliance trends. For coverage of ACA’s 2018 compliance survey, see “Compliance Programs and SEC Examination Priorities” (May 31, 2018); and “Electronic Communications, Personal Trading and Corruption Risk” (Jun. 14, 2018).

FCA Executive Director Outlines Regulator’s Brexit Preparations and Expectations for Fund Managers

As the two-year period for negotiations regarding the U.K.’s withdrawal from the E.U. (commonly known as “Brexit”) winds down, the U.K. Financial Conduct Authority (FCA) expects fund managers to anticipate various scenarios and prepare accordingly. In a recent speech, Nausicaa Delfas, Executive Director of International at the FCA, offered her reflections on the regulator’s preparations for Brexit. During her remarks, Delfas outlined the FCA’s behind-the-scenes work to facilitate a smooth transition; the regulator’s expectations of fund managers and other firms it regulates; and its vision for the future. The speech provides valuable insight to fund managers about what the FCA expects regarding Brexit, as well as what they should be doing currently to prepare. This article highlights Delfas’ key points. For more on Brexit, see “Preparing for Brexit a Key FCA Priority for 2018/2019” (May 31, 2018); “Dechert Partners Discuss How Cross-Border European Fund Managers Can Prepare for Brexit’s Momentous Regulatory Effect” (Apr. 6, 2017); and “How ESMA’s Opinions on the Relocation of U.K. Financial Market Participants to the E.U. May Affect Fund Managers Post-Brexit” (Nov. 16, 2017).

AQR’s Former GC Joins Investment Management Team at Morgan Lewis

Morgan Lewis is welcoming Brendan R. Kalb, former managing director and general counsel of AQR Capital Management, LLC, to its investment management team as a partner in New York. Drawing on his experience with AQR’s commingled private funds, separately managed accounts, liquid alternatives and registered funds businesses, his practice at Morgan Lewis will focus on counseling advisers to private funds as well as registered funds. For additional commentary from Kalb, see “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” (Apr. 12, 2018); and “HFLR Panel Identifies Best Practices for Avoiding Insider Trading Liability in the Aftermath of Martoma” (Jan. 12, 2018).

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