Oct. 4, 2018

Why Equal Representation Within Fund Managers Is Essential (Part One of Four)

Women, African-Americans and Latinos are proportionately underrepresented in the financial services sector in ownership and management positions, as well as in rank-and-file employment. Few hedge fund managers currently have formal structures in place to correct underrepresentation, and research shows that organizations often perceive themselves as more diverse than they actually are. In conjunction with an open-minded work climate, however, diversity can lead to a number of benefits, including stronger performance; fewer errors; increased creativity and cooperation; and greater empathy. This article, the first in a four-part series, discusses the lack of diversity within the financial services and alternative investment management industries and explains why fund managers should focus on increasing diversity. The second article will analyze diversity training; performance ratings and hiring tests; grievance procedures; and specific actions managers can take to promote diversity and inclusion. The third article will explore implicit biases, their harms and whether they can be reduced in both the short and long term. The fourth article will evaluate methods for constraining decision making and examine the role that legal and compliance leaders can take to promote diversity and reduce implicit biases. See “HFLR Program Looks at Recent Developments and Trends in Employment Law Relevant to Fund Managers” (Jul. 26, 2018).

A Fund Manager’s Guide to the Initial Margin Rules for Uncleared Swaps (Part Two of Two)

U.S. and E.U. regulators continue to phase in the application of initial margin (IM) requirements applicable to uncleared over-the-counter (OTC) derivatives transactions. September 1, 2020, is the date when most funds that are in scope of the IM rules in the U.S. and the E.U. (together, the IM Rules) will be required to post and collect IM to/from their dealer counterparties. Many swap dealers are currently contacting their clients to determine which of them will be in scope and when. All fund managers that trade uncleared OTC derivatives, therefore, will need to understand the IM Rules and how they affect the funds that they manage in order to engage in productive conversations with their dealer counterparties and amend their swaps trading documentation. In this guest article, the second in a two-part series, Sidley Austin partners Elizabeth Schubert and Leonard Ng, along with associate Kate Lashley, explore which funds will be in scope of the IM Rules and review the timing for the implementation of the IM Rules. The first article provided an overview of the IM Rules and discussed the IM threshold that affected parties may adopt; the requirement to segregate IM; the changes an affected fund will be required to implement to accommodate compliance; and the models and methodologies available to calculate IM. See our two-part series on how the final margin rules will affect hedge funds: “Increased Margin Requirements” (Feb. 18, 2016); and “Increased Trading Costs” (Feb. 26, 2016). For additional insight from Ng, see “Hedge Fund Legal Personnel May Fall Under U.K. Senior Managers Regime” (Feb. 4, 2016).

Federal District Court in New York Rules That ICOs May Be Securities

In the first federal court decision on the status of initial coin offerings (ICOs) in a criminal context, the U.S. District Court for the Eastern District of New York denied a motion to dismiss an indictment, ruling that a reasonable jury could conclude that the relevant ICOs were “investment contracts” and thus “securities.” This article reviews the facts alleged in the indictment; examines what the decision does and does not say; and considers its implications in general, as well as for fund managers that have invested in ICOs or are considering doing so. For more on ICOs, see “Funds and Managers Must Be Wary of State, in Addition to Federal, Regulatory Scrutiny of ICOs” (May 17, 2018); “HFLR Cryptocurrency Webinar Examines Regulatory Developments, ICOs, Cryptocurrency Sweep, Custody and Other Compliance Issues” (May 3, 2018); and “SEC Cyber Unit Files Charges Against Allegedly Fraudulent ICO” (Jan. 11, 2018).

Transamerica Entities Fined $97.6 Million for Use of Faulty Quantitative Investment Models and Misleading Disclosures Regarding Quant Mutual Funds

A recent SEC settlement order against AEGON USA Investment Management, LLC (AUIM) and three Transamerica entities highlights the potential perils of using quantitative models to manage client assets. The respondents allegedly deployed models without properly validating them and made numerous misrepresentations about those models in fund offering documents and marketing materials. In parallel proceedings, the SEC also took aim at two senior AUIM managers who allegedly negligently caused certain of the other respondents’ violations. Although the models in question were used to manage mutual funds, the principles enunciated in the settlement orders are equally applicable to private fund managers that develop and deploy quantitative trading strategies. This article details the alleged misconduct and the terms of the respective settlements. See our three‑part series on quantitative investing: “Dispelling Myths and Misconceptions” (Aug. 9, 2018); “Regulatory Action, Guidance and Risk” (Aug. 23, 2018); and “Special Risks and Considerations” (Sep. 6, 2018).

Performance, In-Person Communication and Fees Are Key Elements of Hedge Fund Manager Success, According to AIMA/PwC Survey

PwC and the Alternative Investment Management Association (AIMA) recently released the results of their Global Alternatives Distribution Survey 2018, which addresses several topics relating to marketing and distribution by fund managers, including drivers of alternative investment allocations; managers’ investor bases; fees; demand for funds formed as Undertakings for Collective Investment in Transferable Securities structures; managed accounts; Brexit; and the marketing passport under the Alternative Investment Fund Managers Directive. The survey shows increasing demands made by investors on alternative fund managers, as the industry shifts to place greater emphasis on being solutions-based. Managers must thus be flexible to meet the needs of clients and articulate their value propositions to investors clearly and vigorously. This article summarizes the principal findings of the survey. For additional commentary from AIMA, see “Study Examines How Hedge Funds Are Adapting to a Less Liquid Market, the Need for Better Liquidity Reporting and the Future Role of Hedge Funds As Price-Makers” (Dec. 15, 2016). For more from PwC, see “PwC Benchmarks Alternative Asset Manager Governance Practices” (Oct. 15, 2015).

SEC Continues to Pursue Advisers That Fail to Make Adequate Disclosures About Selection of Mutual Fund Share Classes

Mutual fund share class selection, which presents conflicts of interest for advisers, has been the subject of significant SEC scrutiny over the past year. In a recent settlement order with a dually registered investment adviser and broker-dealer, the SEC claimed that the adviser failed to disclose that it received a share of 12b‑1 fees on sales of mutual funds and failed to recommend to eligible clients share classes that did not charge 12b‑1 fees. This article details the SEC’s allegations, the adviser’s alleged compliance failures and the terms of the settlement. See “SEC Settles Three Additional Enforcement Actions for Inadequate Share-Class Disclosures” (May 17, 2018).

Former Asset Management CCO Joins Cloudbreak Compliance Group As Director

Cloudbreak Compliance Group has expanded its senior consulting team with the addition of Michael Cairo as director. Cairo was previously with a hedge fund manager for more than a decade, most recently serving as its chief compliance officer (CCO) since 2012. In addition, he previously served as compliance manager for Amaranth Advisors, a multi-strategy hedge fund, and in various regulatory roles at several broker-dealers. For insight from Cloudbreak founder Todd Kaplan, see our two-part series “The SEC Is Calling”: What CCOs Should Expect During Initial Communications With OCIE Examiners (Sep. 13, 2018); and How CCOs Can Stay Prepared for Initial Communications With OCIE Examiners (Sep. 20, 2018); as well as “How to Avoid the Eight Best Execution Compliance Issues in OCIE’s Latest Risk Alert” (Aug. 30, 2018).