Oct. 24, 2019

Navigating the SEC’s Interpretation Regarding an Investment Adviser’s Standard of Conduct: Six Tools to Systematically Identify Conflicts of Interest (Part Two of Three)

The SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers (Interpretation) recently became effective. In the Interpretation, the SEC affirmed that an adviser’s fiduciary duty comprises a duty of care and a duty of loyalty. Going forward, the Interpretation is expected to serve as a guide to private fund managers and their legal advisers on the SEC’s expectations regarding those duties. The Interpretation confirms that an adviser could meet its duty of loyalty by making full and fair disclosure to its clients of all material facts relating to the advisory relationship, including all conflicts of interest that might incline the adviser to render advice that was not disinterested. This three-part series examines the practical implications of the Interpretation for private fund managers. This second article outlines key tools that fund managers may employ to identify their conflicts of interest. The third article will address best practices for investment advisers to manage their conflicts of interest. The first article provided an overview of the Interpretation and explored six key takeaways for fund managers from the Interpretation. For more on conflicts of interest, see “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015); and “Identifying and Addressing the Primary Conflicts of Interest in the Hedge Fund Management Business” (Jan. 17, 2013).

Dissecting the SEC’s Recent Guidance on Investment Adviser Proxy Voting Responsibilities

The SEC recently provided guidance to investment advisers on how they can fulfill their proxy voting responsibilities. The guidance discusses, among other topics, how an investment adviser can agree upon the scope of its authority and responsibilities to vote proxies on behalf of clients; what steps an adviser must take to demonstrate that it is making voting determinations in clients’ best interests and in accordance with its policies and procedures; how an adviser should evaluate a proxy advisory firm, both prior to engagement and during engagement; and what steps an adviser should take in the event that it becomes aware of a proxy advisory firm’s errors. To help readers understand issues related to the SEC’s proxy voting guidance, the Hedge Fund Law Report interviewed Paulita A. Pike, partner in Ropes & Gray’s asset management group. This article presents her insights. For a summary of the guidance, see “SEC Issues Guidance on Proxy Voting Responsibilities of Investment Advisers” (Oct. 10, 2019). For additional commentary from Ropes attorneys, see our three-part series on subscription credit facilities: “Their Popularity and Usage Soar Despite Concerns Raised by Certain Members of the Private Funds Industry” (Mar. 1, 2018); “Principal Advantages and Key Points to Negotiate in the Credit Agreement” (Mar. 8, 2018); and “Key Concerns Raised by Investors and the SEC” (Mar. 15, 2018).

OCIE Risk Alert Details Concerns About Principal Transactions and Agency Cross Trades

Transactions with clients, almost by definition, pose conflicts of interest for investment advisers. In some situations, not only must an adviser satisfy its general fiduciary duties, but also Section 206(3) of the Investment Advisers Act of 1940, which requires an adviser – prior to completing a transaction with a client or prior to effecting a trade for a client while acting as broker for both the client and another person – to disclose the transaction to the client and obtain the client’s consent. A recent risk alert issued by the SEC Office of Compliance Inspections and Examinations (OCIE) highlights common deficiencies in compliance with Section 206(3) and Rule 206(3)‑2 thereunder. This article discusses OCIE’s findings, with added insight from a legal practitioner with significant experience in the area. See also our coverage of OCIE risk alerts on oversight of employees with disciplinary histories; electronic messaging; the cash solicitation rule; best execution; fees and expenses; the advertising rule; compliance topics; custody; cybersecurity; business continuity and disaster recovery plans; and social media.

Compliance Corner Q4‑2019: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

Fund managers must take steps to ensure that they are prepared to meet quarter- and year-end compliance deadlines, as well as take note of recent industry developments that will impact their businesses. This tenth installment of the Hedge Fund Law Report’s quarterly compliance update, authored by consultants Anne Wallace, John Mrakovcic and Chris Ray at ACA Compliance Group (ACA), highlights upcoming filing deadlines for the fourth quarter and discusses certain filing obligations of fund managers and their private funds. In addition to the upcoming filing requirements, this article examines two documents recently published by the SEC on an adviser’s standard of care and proxy voting responsibilities; the risk alert on principal and agency cross trading; and ACA’s observations on the SEC examination and enforcement fronts. For more on regulatory filings, see “A Guide for Private Fund Managers to Evaluate Whether They Are Required to File TIC Form SHL” (Aug. 8, 2019).

Tenth Circuit Applies Lorenzo to Failure to Correct Misstatements

A principal of an investment adviser sold a branch office of a securities brokerage firm to a friend but allegedly failed to disclose to the investment adviser that the friend was paying the purchase price out of commissions generated by the adviser’s bond trades. This led the investment adviser to file materially inaccurate Forms ADV and to make inaccurate statements on its website. Both an SEC administrative law judge and, on appeal, the SEC concluded that the principal had violated the anti-fraud provisions of the federal securities laws and had aided and abetted violations by the investment adviser. The principal appealed the SEC decision to the U.S. Court of Appeals for the Tenth Circuit (Court), which upheld it in full. Notably, the Court ruled that the principal could be held liable for engaging in a fraudulent or deceptive scheme simply by failing to correct the adviser’s alleged misstatements. This article analyzes the facts leading up to the enforcement action and the Court’s decision – the first case by a U.S. Court of Appeals to apply the Supreme Court’s decision in Lorenzo v. SEC. See “What the Supreme Court’s Decision in Lorenzo v. SEC Means for Fund Managers” (Apr. 25, 2019).

Oren Gertner Joins Sidley Austin’s Investment Funds Group

Sidley Austin has added Oren Gertner to the firm’s New York office as a partner in its investment funds group and member of its private equity (PE) fund formation practice. Gertner focuses his practice on the formation, structuring and offering of domestic and international large and mid-market PE funds, hedge funds, secondary funds and funds-of-funds. He also provides regulatory and compliance advice to private fund managers. For another recent Sidley hire, see “Sidley Expands Chicago Office With Addition of Funds Lawyer Joshua Cohen” (May 16, 2019).