Jan. 17, 2019

Why, When and How Fund Managers Should Self-Report Violations to the SEC (Part Two of Two)

Voluntarily reporting misconduct to the SEC is not a decision to be made lightly. While there may be benefits to self-reporting violations, such as reduced penalties, there are also downsides – most notably, alerting the government to misconduct it might not have otherwise discovered. Once a fund manager has decided that the benefits of self-reporting outweigh the drawbacks, it must still consider the logistics, including when to notify the SEC and whom to notify within the regulator, as well as what measures it can take to put itself in the best position possible when self-reporting. This two-part series explores why, when and how fund managers should self-report violations to the SEC. This second article addresses the timing and logistics of self-reporting; ways managers can put themselves in the best position possible when self-reporting; and things managers should do if they ultimately decide not to self-report violations. The first article discussed the SEC’s Cooperation Program; the pros and cons of self-reporting violations to the SEC; and the factors fund managers should consider when deciding whether to self-report. For more on self-reporting, see “Entry by SEC Into a Non-Prosecution Agreement With Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations” (Dec. 29, 2010).

How Fund Managers May Address End-of-Life Issues in Closed-End Funds

In the search for novel investment opportunities, hedge fund managers have started to pursue less-liquid investment opportunities, which were previously only sought after by closed-end, private equity (PE)-style funds. In addition, managers of those PE-style funds are increasingly finding themselves holding portfolio investments with investment horizons that extend beyond the intended term of the fund that holds them. As a result, hedge funds that seek creative methods for holding illiquid investments and PE-style funds must either plan in advance for options to address the longer lives of those investments or seek investor approval to lengthen the funds’ harvest periods. In a guest article, Ira P. Kustin, partner at Paul Hastings, outlines some of the tools available to private fund managers seeking to free themselves of the time constraints typically placed on them in the context of a fund’s harvest period, including secondary sales of fund assets to third parties – including existing investors in the fund – or affiliates of the fund manager; secondary sales of fund interests themselves; “tender offer”-style sales of fund interests by limited partners to third parties, as well as the potential conflicts and regulatory concerns raised by these transactions; and a rollover of fund assets into a successor fund. For more on PE funds, see our three-part series on deal-by-deal funds: “An Overview of the Structure and Investor Perceptions Toward It” (Oct. 18, 2018); “Key Fundraising and Structural Considerations When Establishing a Fund” (Nov. 1, 2018); and “Balancing Deal Uncertainty Issues Against Attractive Carried Interest Opportunities” (Nov. 8, 2018). For additional insight from Kustin, see “Beyond the Master-Feeder: Managing Liquidity Demands in More Flexible Fund Structures” (May 25, 2017).

SEC and CFTC Whistleblower Awards Continue to Grow

The Dodd-Frank Act amended both the Securities Exchange Act of 1934 and the Commodity Exchange Act to create whistleblower bounty programs, both of which took effect in late 2011 and have since borne fruit for regulators. The SEC and CFTC recently released their respective whistleblower program annual reports. The SEC’s 2018 Annual Report to Congress indicates that fiscal year 2018 was a banner year, with the highest number of tips and the highest individual and aggregate award payments in the history of that program. The CFTC’s 2018 Annual Report to Congress also reflects a record number of tips, as well as aggregate and individual awards. This article summarizes the key takeaways from each report. See “RCA Session Offers Insights on Dodd-Frank Whistleblower Regime, Incentives, Anti-Retaliation Protections and Risks” (Apr. 9, 2015).

Annual Walkers Fundamentals Seminar Explores Suspensions, Liquidations and Restructurings (Part Two of Two)

Walkers partners Nicholas Blake‑Knox, Rolf Lindsay, Ingrid Pierce, Colette Wilkins and Caroline Williams recently spoke at the 2018 Walkers Fundamentals Hedge Fund Seminar, discussing issues of current relevance to fund managers. This two-part series summarizes the key takeaways from the seminar. This second article outlines best practices for managers to navigate suspensions of redemptions, liquidations and restructurings. The first article explored recent trends in fund launches, asset flows and preferred strategies; fund durations, fees and governance; expectations for cryptocurrency and environmental, social and governance investing; and the impact of Brexit. For coverage of the Walkers Fundamentals Hedge Fund Seminar from prior years, see: 2013 Seminar; 2012 Seminar; 2011 Seminar; and 2009 Seminar.

Allegations That Private Equity Manager Misallocated Expenses and Failed to Disclose Conflicts of Interest Result in Nearly $3 Million in Disgorgement and Fines

Improper expense allocations and conflicts of interest, which often go hand in hand, are easy and frequent SEC targets. An investment adviser landed in trouble on both counts by allocating personnel expenses to its funds when not explicitly permitted by the funds’ governing documents; failing to appropriately allocate certain expenses among the adviser’s clients; and misallocating expenses to its clients that should have been borne by the adviser or one of its principals. This action is a reminder that advisers must be scrupulous in allocating expenses among themselves and their funds, and that advisers must insist that third-party service providers keep accurate logs of the services they provide to the adviser, its clients and affiliates. This article analyzes the SEC settlement order. See “OCIE Risk Alert Warns of Six Most Frequent Fee and Expense Compliance Issues” (May 3, 2018); and “Eight Bad Excuses Fund Managers Have Raised Trying to Avoid SEC Sanctions for Fee and Expense Allocation Violations and Undisclosed Conflicts of Interest” (Oct. 13, 2016).

Ira P. Kustin Joins Paul Hastings’ Investment Management Practice in New York

Paul Hastings recently announced that Ira P. Kustin has joined the firm as partner in its investment management practice in New York. Kustin focuses his practice on advising sponsors of, and investors in, complex hedge, private equity and credit funds, as well as counseling private fund advisers on international investment platforms, especially in Europe, Asia and Latin America. For additional commentary from Kustin, see “How Fund Managers May Address End-of-Life Issues in Closed-End Funds” (Jan. 17, 2019); “Stars in Transition: A New Generation of Private Fund Managers” (Dec. 10, 2009); and “Addressing (and Resisting) Demands for Changes in Hedge Fund Manager Compensation” (Apr. 23, 2009).