Nov. 29, 2018

What Fund Managers Need to Know About Corporate Access: Six Front-End Controls to Manage the Risk of Inadvertently Receiving MNPI (Part Two of Three)

Fund managers have adopted stringent controls around their investment team members speaking with industry experts and political consultants, but when it comes to speaking directly with officers and executives of publicly traded companies – frequently referred to as “corporate access” – the consensus around best practices has been slower to develop. This second article in our three-part series discusses how advisers can design policies to minimize the risks associated with these meetings, as well as six front-end controls that advisers should consider adopting. The first article provided an overview of the context in which meetings between fund managers and issuers arise; the goals of corporate access; the ways brokers are compensated for facilitating these meetings; and two key legal risks presented by this practice. The third article will analyze several testing mechanisms that managers can use to ensure compliance with their policies governing corporate access, as well as the SEC’s expectations regarding an adviser’s oversight, controls and procedures related to communications with executives at publicly traded companies. See our two-part series on mitigating insider trading risks: “Relevant Laws and Regulations; Internal Controls; Restricted Lists; Confidentiality Agreements; Personal Trading; Testing; and Training” (Sep. 27, 2018); and “Expert Networks, Political Intelligence, Meetings With Management, Data Rooms, Information Barriers and Office Sharing” (Oct. 11, 2018).

Five Ways to Avoid Common Violations of the Cash Solicitation Rule Identified in OCIE’s Recent Risk Alert

Rule 206(4)‑3 (the Cash Solicitation Rule) of the Investment Advisers Act of 1940 (Advisers Act) bars investment advisers that are required to be registered under the Advisers Act from paying a cash fee – directly or indirectly – to any person who solicits clients for the adviser unless the arrangement complies with certain conditions. The SEC Office of Compliance Inspections and Examinations (OCIE) recently issued a National Exam Program Risk Alert that discusses the most frequent compliance issues related to the Cash Solicitation Rule identified in deficiency letters from adviser examinations completed in the past three years. Although prior SEC guidance has stated that the Cash Solicitation Rule does not apply to the solicitation of investors for a private fund, the rule does apply to the solicitation of separately managed account clients. Thus, fund managers that use solicitors for referrals of clients for separate accounts should understand the Risk Alert and review their policies and procedures accordingly. This article analyzes OCIE’s findings and provides guidance from a former SEC lawyer on how investment advisers can avoid the identified violations. For coverage of other OCIE Risk Alerts, see “How to Avoid the Eight Best Execution Compliance Issues in OCIE’s Latest Risk Alert” (Aug. 30, 2018); “OCIE Risk Alert Warns of Six Most Frequent Fee and Expense Compliance Issues” (May 3, 2018); and “Risk Alert Highlights Six Most Frequent Advertising Rule Compliance Issues” (Oct. 19, 2017).

Auction Funds Offer a New Source of Liquidity for Private Fund Interests

A recent program hosted by international recruiting firm Major, Lindsey & Africa (MLA) offered an in‑depth look at auction funds, which offer a novel approach to providing liquidity to private fund investors. Hosted by MLA partners Brian T. Davis and Dimitri G. Mastrocola, the program featured Adena T. Friedman, president and CEO of Nasdaq; Adam Fleisher, partner at Cleary Gottlieb; and Robert E. Rice, founder and managing partner of Tangent Capital Partners, LLC. This article summarizes the key takeaways from the program. For more on novel fund structures, see “Trends in Investor Sentiment, Governance, Side Letters, Fund Structures, Investment Vehicles and Restructurings” (Jan. 11, 2018). For coverage of a prior program hosted by MLA, see our two-part series offering perspectives on internal compensation arrangements for investment professionals: “Carried Interest and Deferred Compensation” (Mar. 15, 2018); and “Hedge Fund Compensation and Non-Competes” (Mar. 22, 2018).

CFTC Chair Calls for Reset on Cross-Border Swaps Regulation

Asserting that the CFTC’s “flawed approach” to the regulation of cross‑border swaps has fostered market fragmentation, alienated foreign regulators and potentially increased systemic risk, CFTC Chairman J. Christopher Giancarlo has issued a white paper calling for the CFTC to rethink its approach. The white paper details perceived problems with the current regime; enunciates six principles that should guide its rulemaking; and makes specific recommendations for regulation in five areas. This article explores the key concepts and recommendations of the white paper. For additional commentary from Giancarlo, see “Women in Derivatives Event Features Address by CFTC Chair Giancarlo and Panel Discussion on the Intersection of Technology and Regulation” (Jul. 12, 2018); and “Enforcement Priorities and Approaches to FinTech, Cybersecurity and Swaps Reform” (Nov. 9, 2017).

SEC Halts Allegedly Fraudulent ICO That Employed a Bogus Regulatory Agency and False Claims of SEC Approval

At the request of the SEC, the U.S. District Court for the Southern District of California recently issued a temporary restraining order (TRO) stopping an allegedly fraudulent initial coin offering (ICO) by a company and its founder. The SEC complaint alleges that, to give apparent legitimacy to the ICO, the defendants created a bogus regulatory agency modeled on the SEC; falsely claimed that the offering was approved by the SEC and exempt from registration; and engaged in other misleading conduct. In announcing this action, the SEC has reiterated that it does not endorse investment products such as ICOs and emphasized that investors should regard any claims to the contrary with skepticism. This article details the SEC’s allegations in the complaint and the terms of the TRO. See “Unregistered Crypto Fund Hit With Multiple Securities Laws Violations by SEC” (Oct. 18, 2018); and SEC Cyber Unit Files Charges Against Allegedly Fraudulent ICO” (Jan. 11, 2018).

Ernst & Young 2018 Survey Finds Investors Cooling to Hedge Funds; “Seismic Shifts” in Tech Capabilities; and Convergence Across Hedge Fund and Private Equity Products (Part One of Two)

The 12th annual Global Alternative Fund Survey published by Ernst & Young (EY) explores how certain disruptions – including the need to attract individuals with diverse skill sets; developments in technologies; and the blurring line between hedge fund and private equity strategies – are affecting the alternative investment industry. Disruption is reshaping and redefining the alternative asset management industry; technology is changing manager operations and staffing requirements; and changing investor preferences and demands for customized products are leading to product diversification and convergence between industry players, EY staff informed Hedge Fund Law Report. This first article in a two-part series summarizes the survey’s key findings on manager priorities, investor allocation plans, private fund offerings, separately managed accounts, growing use of technology by managers and interest in cryptocurrencies. The second article will discuss changes in the employee talent pool; fees and expenses, including expense management, alternative fee arrangements, use of technology and outsourcing; and respondents’ perspectives on industry risks. See also our coverage of EY’s 2017 Survey; 2016 Survey; 2015 Survey; 2014 Survey; 2013 Survey; 2012 Survey; and 2011 Survey.

Upcoming Webinar to Explore NYDFS Cybersecurity Regulation’s Ongoing Compliance Challenges

Many of the provisions of the New York Department of Financial Services’ Cybersecurity Regulation are now in effect, and firms are looking ahead to the March 2019 third-party requirements. Some industry professionals believe that compliance with this regulation will become the “gold standard” for hedge fund managers and that the SEC or other states may adopt similar measures. Please join the Hedge Fund Law Report’s sister product – Cybersecurity Law Report – on December 6, 2018, at 12:00 p.m. EST, for a complimentary webinar on best practices for complying with the law. James Shreve, partner at Thompson Coburn, and Shawn Malone, CEO of Security Diligence, will join the Cybersecurity Law Report’s Rebecca Hughes Parker to discuss how the regulation’s provisions lay the groundwork for various aspects of a cybersecurity program, as well as how fund managers and other firms can create a program that is efficient and satisfies regulators. To register for the webinar, click here.

Seward & Kissel’s Corporate Finance Group Expands With the Addition of Miki Navazio

Michele (Miki) Navazio has joined Seward & Kissel LLP as a partner in New York. Navazio advises hedge funds and other asset managers on derivative transactions and regulatory compliance, bringing more than a decade of experience negotiating complex derivatives to the firm’s corporate finance group. For additional commentary from Navazio, see “ISDA 2018 U.S. Resolution Stay Protocol: Should Fund Managers Adhere or Not?” (Nov. 8, 2018); and “Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part Three of Three)” (Nov. 14, 2013).