Oct. 11, 2018

Ways Fund Managers Can Promote Diversity and Inclusion (Part Two of Four)

Fund managers frequently employ several strategies to increase diversity in the workplace, including training, performance ratings and formal grievance procedures. Simply adopting ostensibly fair procedures can lead to unintended consequences, however, such as backlash, greater hostility toward underrepresented groups and less diversity. Thus, managers must ensure that they properly implement these programs, starting with transparency, accountability and a firm-wide assessment. It is important for decision makers to be aware that diversity structures may create an illusion of fairness, resulting in the underestimation of discrimination; to understand whether, and how best, to implement specific diversity programs; and to use the relevant and necessary data to assess the real-world efficacy of those programs. This article, the second in a four-part series, analyzes diversity training; performance ratings and hiring tests; grievance procedures; and specific actions managers can take to promote diversity and inclusion. The first article discussed the lack of diversity within the financial services and alternative investment management industries and why fund managers should focus on equitable representation. 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 the role that legal and compliance leaders can take to promote diversity and reduce implicit biases. See “What Fund Managers Need to Know About the Legislative Response to #MeToo” (May 3, 2018); and “How Investment Managers Can Prevent and Manage Claims of Harassment in the Age of #MeToo” (Dec. 14, 2017).

Reflections on the Tenth Anniversary of the Financial Crisis: The Collapse and Aftermath (Part One of Two)

On September 15, 2008, Lehman Brothers filed for bankruptcy, essentially marking the beginning of the 2008 global financial crisis. In response, Congress passed the Dodd-Frank Act, which, among other things, directed the establishment of risk-based capital requirements and liquidity requirements for large banks; barred banks from maintaining ownership interests and other relationships with hedge and private equity funds; and amended the Investment Advisers Act of 1940 to change registration, reporting, recordkeeping and disclosure requirements for private funds. Ten years later, however, is the financial system stronger and more resilient? Have hedge funds changed their structures, practices and compliance programs to better protect themselves and their investors? How have new regulations affected the hedge fund space? In connection with the tenth anniversary of the financial crisis, the Hedge Fund Law Report asked Lowenstein Sandler partner Benjamin Kozinn, who was vice president and associate general counsel at Goldman Sachs during the crisis, to answer these and other questions on the 2008 crisis and its impact on hedge funds. In the first article in this two-part series, Kozinn explains the causes of the crisis; the role – if any – hedge funds played in it; the regulatory changes in its aftermath; and the new focus on counterparty risk. In the second article, he will discuss the focus on compliance programs and chief compliance officers; the present strength of the financial system; changes in hedge fund strategies; the current state of hedge fund regulation; and the future of the hedge fund space. For additional insight from Kozinn, see our two-part series “Why Fund Managers Should Ensure Personal Trading Policies Address Cryptocurrencies and ICOs” (Jul. 26, 2018); and “Factors Fund Managers Must Consider When Addressing Cryptocurrencies and ICOs in Personal Trading Policies” (Aug. 2, 2018).

How Funds Formed in the Cayman Islands Can Mitigate Legal Risk by Aligning Their Constitutional Documents and Operations

In a recent case, a Cayman Islands court followed a strict literal interpretation of a fund’s constitutional documents – even where that interpretation ran contrary to market practice. Although the case is under appeal, the strict approach to the construction of constitutional documents by the Cayman courts is well established. This approach creates legal risk wherever there is a mismatch between a fund’s constitutional documents and its operations. In a guest article, Appleby attorneys David Lee, Paul Kennedy and Christian Victory review the relevant cases and highlight six steps that market participants can take to manage that legal risk. For more on issues pertaining to the Cayman Islands, see “How Fund Managers Can Navigate the E.U. General Data Protection Regulation and the Cayman Islands Data Protection Law” (Aug. 9, 2018); and “In Madoff-Related Litigation, Cayman Court of Appeal Holds That a Liquidator May Not Adjust a Shareholder’s NAV, Even When Based on Fictitious Profits” (May 17, 2018). For additional commentary from Appleby attorneys, see our two-part series on closing a hedge fund: “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).

Use of Undisclosed Backtested Performance Data May Lead to Significant Fines

The SEC continues to scrutinize advisers’ compliance with rules regarding advertising. See “Risk Alert Highlights Six Most Frequent Advertising Rule Compliance Issues” (Oct. 19, 2017). The Commission recently settled with an investment adviser that allegedly failed to adequately disclose its use of backtested data in certain marketing materials. This article details the alleged misconduct and the terms of the settlement order. 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).

Mitigating Insider Trading Risks: Expert Networks, Political Intelligence, Meetings With Management, Data Rooms, Information Barriers and Office Sharing (Part Two of Two)

A recent ACA Compliance Group (ACA) program, featuring Joel Stocksdale and Erika Chua, ACA senior principal consultant and principal consultant, respectively, addressed common insider trading risks and the controls that fund managers can implement to mitigate those risks. This article, the second in a two-part series, highlights specific controls related to common sources of insider trading risk, including expert networks, political intelligence, meetings with management, data rooms, information barriers and office sharing. The first article covered the portions of the program that addressed the relevant laws and regulations; internal controls applicable to all advisers; restricted lists; confidentiality agreements; personal trading; testing; and training. For additional commentary from ACA, see our two-part series on maintaining books and records: “Compliance With Applicable Regulations” (Nov. 2, 2017); and “Document Retention and SEC Expectations” (Nov. 9, 2017).

SEC Sanctions Adviser That Failed to Disclose Sufficient Information About Its Conflicts of Interest in Recommending Wrap Fee Programs to Clients

Wrap fee programs remain an SEC examination priority. See “Retail Investors Top List of OCIE 2018 Exam Priorities” (Mar. 8, 2018). A recent SEC enforcement proceeding involving a dual-registered investment adviser and broker-dealer illustrates that not only are wrap fee program sponsors subject to scrutiny, but so too are advisers who recommend third-party wrap fee programs to their clients. The relevant investment adviser allegedly favored a wrap fee program offered by an affiliated adviser over comparable programs offered by two independent advisers, and it failed to disclose sufficient information regarding the conflicts of interest created by the programs’ fee structures. This article details the alleged misconduct and the terms of the settlement order. For more on SEC concerns about wrap fee programs, see “Former SEC Examiners Provide Perspective on 2018 OCIE Examination Priorities” (Apr. 5, 2018); and “Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar” (Apr. 20, 2017).

Sadis & Goldberg Adds Former Hedge Fund GC/CCO to Regulatory and Compliance Group

Sadis & Goldberg has expanded its regulatory and compliance group with the addition of Eliott Frank as partner. Formerly the general counsel and chief compliance officer of a long/short equity hedge fund manager and an investment adviser that managed several billion dollars in assets, Frank’s practice focuses on day-to-day and strategic legal and compliance matters relevant to hedge funds and asset managers. For additional insight from Sadis & Goldberg partners, see “The SEC’s Proposed Form CRS: Does It Accomplish Its Goals? (Part Two of Two)” (Jun. 7, 2018); and “How Hedge Fund Managers Can Raise Capital and Expand Despite Increasing Regulation and Investor Demands” (Feb. 4, 2016).