Mar. 5, 2020

Encryption for Fund Managers: Legal and Regulatory Framework (Part Two of Three)

Although most laws and regulations do not specifically require it, there are several legal incentives for a fund manager to employ encryption. For instance, regulators now largely expect covered entities to use encryption, and many state laws exempt firms from notification requirements if data were encrypted at the time of a breach. This second article in a three-part series explores the legal and regulatory framework surrounding encryption, including various federal and state laws. The first article reviewed the basics of encryption, when it should be used and challenges with implementing it. The third article will evaluate the policies and procedures a manager should enact; the role of legal and compliance personnel; and the management of third parties with respect to data security. See our three-part series “How Fund Managers Should Structure Their Cybersecurity Programs”: Background and Best Practices (Mar. 22, 2018); CISO Hiring, Governance Structures and the Role of the CCO (Apr. 5, 2018); and Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties (Apr. 12, 2018).

Considerations for Advisers to Properly Classify Single Investor Funds Under the Custody Rule and Form ADV

Rule 206(4)‑2 under the Investment Advisers Act of 1940, known as the “custody rule,” requires an adviser to implement controls to safeguard client assets over which it has custody, and Rule 204‑1 requires an adviser to periodically file amendments to Form ADV. The custody rule and Form ADV both involve classifying different types of advisory clients. SEC staff guidance on the custody rule and Form ADV potentially diverge, however, in the case of a single-investor fund (SIF) client organized as a limited partnership (LP) or limited liability company (LLC) that operates as a means for the adviser to provide individualized investment advice directly to the investor. In a guest article, Simpson Thacher attorney Samuel Francis discusses practical considerations for fund managers when determining whether to treat a SIF client as a pooled investment vehicle (PIV) or a separately managed account (SMA) under the custody rule and Form ADV. Further, this article asserts that an adviser can treat a SIF client that is organized as an LP or LLC as a PIV under the custody rule even if that same client is treated as an SMA on Form ADV. For more on Form ADV, see “Unexpected Traps for Filing Other-Than-Annual Amendments Using the Revised Form ADV and How to Avoid Them” (Jul. 13, 2017); and “A Roadmap of Potential Landmines for Fund Managers to Avoid When Completing the Revised Form ADV” (May 25, 2017).

NYC Bar Report on CCO Liability Calls for More Regulatory Guidance, Transparency and Cooperation

In recent years, chief compliance officers (CCOs) of financial industry firms have not only contended with ever-increasing regulation, but also been at risk of being held individually accountable for their firms’ compliance failures. As a result, there are concerns that fear of regulatory investigations and personal liability may have a chilling effect on CCOs and may discourage qualified individuals from taking on those roles. The New York City Bar Association, in conjunction with the American Investment Council; the Association for Corporate Growth; and the Securities Industry and Financial Markets Association, recently issued a report on CCO liability in the financial sector that explores how regulators and compliance professionals can achieve the shared goals of preventing, detecting and remediating compliance failures. This article analyzes the key takeaways from the report, including the call for the issuance of more precise regulatory guidance and the development of additional means to increase cooperation and transparency between CCOs and regulators. For discussion of an SEC enforcement action that resulted in a compliance bar against a CCO, see “Absence of Harm No Defense Against Conflicts of Interest: SEC Issues Lifetime Bar From Compliance Work to CCO” (Sep. 13, 2018).

CFTC Adopts Final Rule Revisions on CPO and CTA Exemptions and Exclusions From Compliance Obligations

In 2018, the CFTC proposed several amendments to the so-called Part 4 rules, which set forth the regulations applicable to commodity pool operators and commodity trading advisors, including registration exemptions and exclusions, as well as ongoing compliance obligations. The CFTC recently approved a number of those proposed amendments. This article summarizes the key provisions of the final amendments. For additional discussion of those amendments, see “K&L Gates Program Examines Recent CFTC Developments Affecting CPOs and CTAs” (Feb. 27, 2020). For more on recent CFTC developments, see “CFTC’s DSIO Issues Guidance for CCOs on Futures and Swap Dealer Annual Compliance Reports” (Feb. 20, 2020).

JPM Report Identifies Opportunities for Hedge Funds, PE and Other Alternative Investments

J.P. Morgan Asset Management (JPM), which manages a $146‑billion alternatives platform, has released its second annual Global Alternatives Outlook. The report considers the overall state of the economy; the process of allocating to alternative investments; and the outlook for a range of available alternative investments, including hedge funds, private equity, private credit, infrastructure, real estate and transport. This article presents the key takeaways from the report. See our coverage of JPM’s 2019 institutional investor survey: “Drivers of Hedge Fund Allocations and Fee Pressures” (May 16, 2019), and “Non‑Traditional Alternative Investment Vehicles and Due Diligence” (May 23, 2019).

Former FINRA Head of Enforcement Joins WilmerHale

WilmerHale announced that Susan Schroeder, the former head of enforcement at FINRA, rejoined the firm as a partner and vice chair of its securities department. Schroeder advises broker-dealers and other clients investigating potential issues and responding to inquiries from the SEC, self-regulatory organizations and state securities regulators. She also provides counseling on current issues shaping the financial industry, including Regulation BI (Reg BI), as well as shifting financial and operational requirements. For more on Reg BI, see “Present and Former SEC Attorneys Discuss Retail Investors, CAT Implementation, Enforcement Issues, Reg BI and SRO Oversight” (Dec. 12, 2019); and “SEC Chair Defends Regulation Best Interest and Investment Adviser Fiduciary Duty” (Sep. 19, 2019).