Oct. 3, 2019

Six Criteria for Hedge Fund Managers to Evaluate Before Granting an Investor’s Request to Rescind Its Redemption (Part One of Two)

The beginning of the fourth quarter often leaves hedge fund managers bracing for year-end redemptions, as December 31 is relevant to funds that permit monthly, quarterly or annual redemptions. Fund managers – and their legal and compliance staff – may also face redemption-related decisions, including whether to allow an investor to rescind an otherwise properly submitted redemption request. While an investment manager may be happy to permit an investor to rescind its request – if for no other reason than it would continue to earn fixed fees on that capital – decisions around rescission requests must weigh several factors, including potential conflicts of interest. Additionally, investors and regulators may take the view that investors that are permitted to rescind their redemption requests have essentially been granted different liquidity terms than the other investors, which can raise disclosure and fairness issues. In anticipation of year-end redemptions, this two-part series explores how fund managers should evaluate rescission requests. This first article analyzes the provisions in a fund’s governing documents that are relevant to those requests, investors’ motivations underlying rescission requests and three considerations that fund managers should factor into their decision-making processes. The second article will outline three additional factors that fund managers should consider and explore ways fund managers should document their decision-making processes. For more on the importance of adhering to a fund’s redemption terms, see “SEC Order Reminds Advisers to Adhere to Stated Redemption Procedures” (Nov. 1, 2018).

Fund Managers Can Make Their Funds More Attractive Through Mock Operational Due Diligence

The modern-day institutional investor demands far more from fund managers than attractive strategies, as the superficial, check-the-box reviews of decades past have been replaced by multifaceted operational due diligence (ODD), often undertaken by a dedicated internal team of specialists or a third-party advisory firm. Today’s ODD is far from a nominal “kick-the-tires” exercise, as seasoned professionals methodically dissect and scrutinize all aspects of an adviser’s business and investment operations. The most discerning investors also endow their independent ODD teams with veto power – the unilateral right to vote down, delay or place contingencies on allocations if they identify procedural weaknesses or deficient controls. In order to adequately prepare for this greater scrutiny, investment managers are increasingly turning to professional consultants to perform mock ODD reviews that closely mirror the type of diligence large allocators or their hired guns are likely to conduct. Through this process, fund managers can explore the questions that will inevitably be asked; formulate responses; identify potential issues; and proactively craft the narrative that highlights strengths and mitigates perceived weaknesses. In a guest article, Sean Wilke, partner at Greyline, discusses the concept of a mock ODD exercise in terms of: (1) structure and scope; (2) individuals who commonly participate; and (3) how and which managers benefit from this type of review. See “Emerging Managers Need Appropriate Infrastructure – Not Only Solid Performance – To Attract Investors” (Jun. 20, 2019); and “Perspectives on Operational Due Diligence From an Investor, Consultant and Manager” (Nov. 9, 2017).

Engaging With the California Consumer Privacy Act: How Hedge Fund Managers Can Prepare for Compliance With the Act (Part Two of Two)

In 2018, California passed The California Consumer Privacy Act of 2018 (CCPA or Act) – a law that is likely the most expansive piece of privacy legislation in the U.S. to date and that becomes largely effective on January 1, 2020. SEC-registered investment advisers have not received a blanket exemption under the Act by virtue of the fact that they are already subject to the Gramm-Leach-Bliley Act (GLBA) and its implementing regulation – Regulation S‑P. In a recent interview with the Hedge Fund Law Report, Ropes & Gray partner Melissa Bender and counsel Catherine Skulan discussed how the CCPA will affect the businesses of private fund managers. This second article in our two-part series reviews two recent amendments to the CCPA that would help address areas where the GLBA exemption falls short and next steps for managers that believe they are subject to the CCPA, including an explanation of how fund managers can complete a data-mapping exercise and other insights. The first article explored how fund managers can determine whether they are subject to the CCPA, including a detailed discussion of how the carve-out for entities subject to the GLBA will provide some, but likely not complete, relief from compliance with the CCPA. For more on privacy considerations, see our three-part series: “How Can Hedge Fund Managers Reconcile Effective Monitoring of Electronic Communications With Employees’ Privacy Rights?” (Apr. 4, 2014); “Three Best Practices for Reconciling the Often Conflicting Sources of Privacy Rights of Hedge Fund Manager Employees” (Apr. 11, 2014); and “Six Privacy-Related Topics to Be Covered by a Hedge Fund Manager’s Compliance Policies and Procedures” (May 23, 2014).

SEC Takes Action Against Broker-Dealer Implicated in Premium Point Valuation Scheme

In May 2018, the SEC filed a civil enforcement action against Premium Point Investments L.P. (PPI) and three of its principals, accusing them of fraudulently mismarking certain mortgage-backed securities to boost the performance of their flagging hedge funds. The repercussions of PPI’s alleged fraud continue to be felt. The SEC recently settled enforcement proceedings against a broker-dealer and its CEO for allegedly failing to supervise an associate who provided inflated marks to PPI, and this article examines the terms of the settlement orders. See our three-part series on the duty to supervise: “Recent SEC Enforcement Actions Claim Violations by Broker-Dealers and Investment Advisers” (Sep. 6, 2018); “Conducting Proper Trade and Electronic Communications Surveillance” (Sep. 13, 2018); and “Responding to Red Flags; Implementing Reasonable Policies and Procedures; and Conducting Adequate Training” (Sep. 20, 2018). The SEC Office of Compliance Inspections and Examinations has also been focusing on oversight by investment advisers, which must likewise supervise employees with a view to preventing violations of the federal securities laws. See “OCIE Issues Risk Alert on Advisers’ Oversight of Employees With a History of Disciplinary Events” (Aug. 29, 2019).

How Managers Can Navigate the Final Changes to GIPS 2020 and Prepare for Its Implementation (Part Two of Two)

K&L Gates and The Spaulding Group recently hosted a program that explored the new Global Investment Performance Standards (GIPS 2020), ways it differs from the August 31, 2018, exposure draft and the steps advisers should take to comply with it. The presentation featured Jennifer Barnette, vice president at The Spaulding Group; Michael S. Caccese, K&L Gates management committee chair; and Michael W. McGrath, partner at K&L Gates, and focused on the GIPS 2020 provisions applicable to firms and verifiers, rather than those applicable to asset owners. This article, the second in a two-part series, addresses GIPS reports, portability of track records, carve-outs, verification standards, advertising guidelines and other issues of particular relevance to fund managers. The first article synthesized the speakers’ insights on, among other topics, the new GIPS framework; composites versus pooled funds; and the use of money-weighted returns in calculating and presenting performance. For additional commentary from K&L Gates attorneys, see “Forbes Insights and K&L Gates Examine How Financial Executives and GCs Are Responding to Technological Disruption” (May 9, 2019); and our two-part series on the ins and outs of global fundraising for fund managers: “The E.U. and the Middle East” (Jun. 7, 2018); and “The Asia-Pacific Region” (Jun. 28, 2018).

Scott Kitchens Opens New Denver Office for Cole‑Frieman & Mallon

Cole‑Frieman & Mallon recently announced that Scott Kitchens has joined the firm as a partner. Kitchens, who opened the firm’s new Denver office, focuses his practice on advising private funds and investment advisers on their structure, formation and ongoing operational needs. For insights from other Cole‑Frieman & Mallon attorneys, see “Trending Issues in Employment Law for Private Fund Managers: Non-Compete Agreements, Intellectual Property, Whistleblowers and Cybersecurity” (Nov. 17, 2016); and “Who Should Newly Registered Fund Managers Designate As the Chief Compliance Officer and How Much Are Chief Compliance Officers Paid?” (Feb. 25, 2011).