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    Sep. 5, 2019

AI for Fund Managers: How to Use It to Streamline Operations (Part One of Three)

The use of artificial intelligence (AI) in the investment management industry has traditionally focused on quantitative investing. Nevertheless, fund managers can use AI for several back-office functions, including monitoring trader behavior, assisting with the anti-money laundering/know your customer process and improving cybersecurity defenses. Employing AI for these purposes, however, does not come without challenges, particularly for smaller managers. This article, the first in a three-part series, explores what AI is; how prevalent it is in the funds industry; how it can be used; how fund managers can determine what functions to automate and what obstacles may interfere with implementing AI solutions; and whether humans are still needed in the process. The second article will analyze what the U.S. government and others are doing to both promote AI and foster its responsible use; how fund managers should diligence and contract with third-party AI service providers; and what risks of bias exist. The third article will evaluate how fund managers can automate their legal departments and what they should do to ensure that they maintain their data subjects’ privacy. For a discussion of machine learning in the quantitative-investing context, see our three-part series: “Dispelling Myths and Misconceptions” (Aug. 9, 2018); “Regulatory Action, Guidance and Risk” (Aug. 23, 2018); and “Special Risks and Considerations” (Sep. 6, 2018).

How NY‑Based Investment Managers Can Craft Enforceable Non‑Competes That Do Not Provide for Post‑Employment Compensation

Courts in New York have long required that non-competes and other post-employment restrictive covenants be supported by adequate consideration in order to be enforceable. While this general rule leads many New York investment managers and their legal counsel to assume that employers must continue to pay former employees during a non-compete period, this assumption may be incorrect, as long as the restrictive covenant in question is otherwise reasonable and the employee in question was well compensated during his or her tenure. In a guest article, Pryor Cashman partner Jonathan Shepard and counsel Eric Dowell explain the circumstances under which New York courts will find consideration to be adequate despite the absence of post-employment pay and provide practical advice on how to draft non-compete language that is likely to be held enforceable even where there is no provision for that pay during the subject non-compete period. See our two-part series 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). For additional insight from Shepard and Dowell, see “How Fund Managers Can Use Non‑Reliance Clauses to Protect Themselves From Investor Claims of Misrepresentation” (May 23, 2019).

The Exempt Offering Framework: Review of the Concept Release (Part One of Two)

Exceptions to a rule can sometimes become so extensive that they overpower the rule itself, as some could argue is the case with the rules regarding the registration of securities. Although the Securities Act of 1933 requires that every offer and sale of securities be registered with the SEC absent an exemption, reliance on numerous exemptions created over the years has become so common that, according to SEC estimates, new capital raised in 2018 through exempt offerings was more than double that raised through registered offerings. Further, the exempt offering framework has evolved into a complex patchwork that can be difficult for would-be participants to navigate. As a result, the SEC recently published its Concept Release on Harmonization of Securities Offering Exemptions (Concept Release) seeking public comment – due September 24, 2019 – on ways “to simplify, harmonize, and improve” the rules for exempt offerings. This two‑part series examines the exempt offerings framework and the Concept Release’s questions about that framework. This article summarizes the elements of the Concept Release of particular interest to private fund managers. The second article will discuss the key takeaways from the Concept Release for private fund managers. For analysis of other SEC initiatives, see “Key Takeaways for Private Fund Managers From SEC’s Latest Reg Flex Agenda” (Aug. 15, 2019).

Manipulating Fund Valuations Can Bring Penalties From Multiple Regulators

The valuation practices of fund managers remain in regulators’ crosshairs. In a recently settled enforcement action, the SEC and CFTC took aim at a portfolio manager for an unnamed hedge fund adviser, alleging that he used different valuation model inputs for similar assets in order to generate paper profits for one of the adviser’s private funds – and unwarranted bonuses for himself. This article analyzes the portfolio manager’s alleged misconduct and the terms of both the SEC and CFTC settlement orders. See “Recent SEC Action Shows That Even Undervaluing Fund Assets Can Draw Significant Penalties” (Jul. 11, 2019); and “Improper Expense Allocations and Careless Valuation Practices Result in Nearly $4 Million in Fines and Disgorgement for BDC Adviser” (Jan. 10, 2019).

Is the Advertising Rule Obsolete? (Part Two of Two)

At a recent forum hosted by Paul Hastings, in-house and outside counsel examined the fundamentals and underpinnings of Rule 206(4)‑1 (Rule) under the Investment Advisers Act of 1940, which governs advertising by advisers. Hosted by Kevin Broughel, vice chair of Paul Hastings’ global securities litigation practice, the discussion was moderated by Paul Hastings partner John P. Nowak and featured Ken C. Joseph, managing director and head of disputes consulting at Duff & Phelps; Michael A. Kitson, senior compliance officer and counsel at Bridgewater Associates; Ira P. Kustin, partner at Paul Hastings; Meredith Smith, general counsel of Stash; and Alastair Wood, general counsel of Kindur. This article, the second in a two-part series, discusses ways the SEC’s approach to regulating the advertising of investment advisers differs from other regulators; best practices for complying with the cherry picking provision of the Rule; ways violations of the Rule are often a result of an adviser’s inadequate policies and procedures; and potential amendments to the Rule. The first article explored the fundamentals of the Rule, how the Rule applies to newer forms of media and additional guidance that the SEC has provided on compliance with the Rule. See our two-part series “HFLR Program Parses OCIE’s Recent Advertising Risk Alert”: Identifying Advertisements and Common Deficiencies in Performance Advertising (Jan. 4, 2018); and Misleading Claims of GIPS Compliance, Past Specific Investment Recommendations and Results of SEC’s Touting Initiative (Jan. 11, 2018).

Former CCO Adam J. Reback Joins Consulting Firm in New York

Optima Partners announced that Adam J. Reback has joined as a director at the firm. Based in New York, Reback will focus on the regulatory and compliance needs of hedge funds, private equity funds, registered investment advisers, broker-dealers and global financial services firms. For commentary from Reback, see our two‑part series “The SEC Is Calling: What CCOs Should Expect During Initial Communications With OCIE Examiners”: Part One (Sep. 13, 2018); and Part Two (Sep. 20, 2018).

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