Sep. 6, 2018

An Introduction to Quantitative Investing: Special Risks and Considerations (Part Three of Three)

Although both quantitative and fundamental strategies expose fund managers to similar risks, a quantitative manager’s heavy dependence on technology and mathematical models means that it must consider and address those risks differently. It must, for example, place greater emphasis on cybersecurity and intellectual property, given that a cyber attack or reproduction of the underlying model are more likely to cripple its trading. In addition, quantitative managers must contend with unique capacity constraints – which inform investor negotiations – and compete with the technology sector for talent. This article, the third in a three-part series, explores the heightened importance of cybersecurity and IP protection for quantitative managers; negotiations with investors over capacity constraints; and methods for quantitative managers to attract and retain talent in the face of stiff competition. The first article provided an overview of quantitative investing and the ways it differs from fundamental investing; discussed the growth of quantitative investing; and evaluated the practical risks and misconceptions of quantitative investing. The second article analyzed regulatory actions and guidance applicable to quantitative managers, as well as the special regulatory risks those managers may face. See our three-part series on how fund managers should structure their cybersecurity programs: “Background and Best Practices” (Mar. 22, 2018); “CISO Hiring, Governance Structures and the Role of the CCO” (Apr. 5, 2018); and “Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties” (Apr. 12, 2018).

Walkers Partner Outlines the Steps Cayman Funds Should Take Now to Comply With New Requirement to Appoint AML Officers

The September 30, 2018, deadline for funds formed in the Cayman Islands to comply with the new requirement to designate natural persons as anti-money laundering (AML) officers is rapidly approaching. What steps do Cayman funds need to take to comply with this new requirement? In a recent interview with the Hedge Fund Law Report, Walkers partner Lucy Frew discussed the new requirement arising from the Cayman Islands Anti-Money Laundering Regulations (2018 Revision) to designate AML officers, practical considerations for deciding whom to appoint to serve in these roles and steps that funds should take to ensure they comply with this requirement. See our two-part series “CIMA Regulator Discusses Key Issues for Advisers That Manage Cayman Funds”: AML, Fund Governance and the Cayman LLC (Sep. 7, 2017); and AIFMD Marketing Passport, Whistleblowers and Administrative Fines Regime (Sep. 21, 2017). For additional insight from Walkers attorneys, see “Annual Walkers Fundamentals Seminar Highlights Trends in Investor Sentiment, Governance, Side Letters, Fund Structures, Investment Vehicles and Restructurings” (Jan. 11, 2018).

Although Martoma May Have Been Put to Rest, the Debate Over the “Personal Benefit” Test Continues

Several recent high-profile insider trading cases have ignited a debate over what is necessary to satisfy the “personal benefit” requirement for purposes of tipper-tippee liability. With the recent announcement that the Second Circuit will not grant an en banc rehearing of the appeal of former SAC Capital employee Mathew Martoma’s conviction, that story appears to be coming to a close; however, the debate over the personal benefit test and the scope of tipper-tippee liability is sure to persist. Instead of providing much-needed guidance in a murky area of the law, U.S. v. Martoma is merely one of a group of recent decisions that have generated confusion over the line that delineates illegal insider trading from legal trading on proprietary information. This uncertainty and the continued debate over the contours of insider trading liability underscore the need for funds to be vigilant in this area. In a guest article, MoloLamken partner Justin V. Shur and associate Emily Damrau analyze the personal benefit test and offer guidance on what fund managers can do to avoid liability. For recent insider trading enforcement actions against hedge funds, see “Hedge Fund Manager Deerfield Fined $4.7 Million for Failing to Adopt Insider Trading Compliance Policies Tailored to the Firm’s Specific Risks” (Sep. 21, 2017); and “SEC Insider Trading Action Highlights Red Flags Hedge Fund Managers Must Heed When Employing Political Intelligence Consultants” (Jun. 8, 2017). For further commentary from Shur, see “The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability” (Oct. 8, 2015).

The Duty to Supervise: Recent SEC Enforcement Actions Claim Violations by Broker-Dealers and Investment Advisers (Part One of Three)

The SEC has repeatedly emphasized that the duty to supervise is a critical component of the federal regulatory scheme. Registered broker-dealers and investment advisers must not only adopt effective supervisory policies and procedures, but also provide adequate staffing and resources; training; and a system of testing and review to ensure that duty is being fulfilled. Since the beginning of 2018, the SEC has released settlement orders for several enforcement actions that all include violations of the duty to supervise by broker-dealers and investment advisers. This three-part series examines the duty to supervise and common themes in these violations of this duty. The first article reviews the duty to supervise for both broker-dealers and investment advisers and summarizes the facts that led to the violations in four of these enforcement actions. The second and third articles will explain how to avoid five traps related to the duty to supervise, with input from a compliance consultant and a lawyer with in-house experience. For enforcement actions involving duty to supervise charges against individuals, see “Charges of Fraudulent Valuation, Insider Trading and Failure to Supervise Employees Cost Manager and CFO More Than $10 Million in SEC Settlement” (Jun. 14, 2018); and “Despite His ‘Bad Acts,’ Issuers Beneficially Owned by Steven A. Cohen Are Not Precluded From Private Offerings Based on the Bad Actor Rule” (Jan. 21, 2016).

SEC Prevails Against Hedge Fund Manager and Its Principal for Ponzi‑Like Scheme

In a scenario reminiscent of the Madoff scandal from ten years ago, the SEC received a final judgment against a hedge fund manager and two management companies he formed, permanently enjoining them from violating the antifraud provisions of the federal securities laws and ordering them to pay significant amounts in disgorgement and interest. This article details the allegations in the SEC’s civil enforcement complaint, the terms of the judgment and the resolution of the parallel criminal action against the manager. Unlike many SEC enforcement proceedings that turn on conflicts of interest, related-party transactions, inadequate disclosures, performance claims and fee and expense practices, this case appears to be one of unvarnished fraud. Nevertheless, the action reminds investors that they must verify both a manager’s custody of fund assets and certain of its claims. For lessons learned from other fraud cases, see “Fourteen Due Diligence Lessons to Be Derived From the SEC’s Action Against a Serial Practitioner of Hedge Fund Fraud” (Jul. 27, 2011); and “Twelve Operational Due Diligence Lessons From the SEC’s Action Against the Manager of a Commodities-Focused Hedge Fund” (Apr. 1, 2011).

ACA Panel Reviews Affiliated Transaction Rules (Part One of Two)

Investment advisers that advise alternative mutual funds or other registered funds are subject to the overlapping – but distinct – regulatory regimes established by the Investment Company Act of 1940 (Investment Company Act) and the Investment Advisers Act of 1940. A recent ACA Compliance Group (ACA) program – featuring Erik Olsen and Vicki Hulick, ACA director and senior principal consultant, respectively – offered a detailed overview of the provisions of the Investment Company Act and related rules that govern trading by registered investment companies. This article, the first in a two-part series, covers the portions of the program that addressed transactions with affiliates. The second article will address the aggregation of publicly traded securities; best execution; soft dollars; portfolio-holding liquidity; and gifts and entertainment. See our three-part series on the simultaneous management of hedge funds and alternative mutual funds following the same strategy: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015).

King & Spalding Boosts Private Equity Practice With Addition of Nine Lawyers

King & Spalding has added three partners, four counsel and two associates to its private equity practice. Partners Enrico Granata, Edouard Markson and Jonathan Melmed; counsel Ashley Arons, Adam Hankiss and Natascha Kiernan; and associates Egbert de Groot and Keiko Hayakawa are joining the firm’s New York office. Counsel Zori Ferkin is joining the firm’s Washington, D.C. office. For commentary from other King & Spalding attorneys, see our three‑part series on employee discipline: “Developing an Employee Discipline Framework That Fosters Predictability in the Face of Inconsistent Laws” (Feb. 8, 2018); “Investigating and Documenting Employee Discipline” (Feb. 15, 2018); and “Ensuring a Fair Process When Disciplining Employees” (Feb. 22, 2018).