Apr. 16, 2020

How Fund Managers Can Withstand the Coronavirus Pandemic: Business Continuity and Other Operational Risks (Part Three of Three)

Fund managers are preparing for long-term disruption to their business operations, as the global coronavirus pandemic continues to wreak havoc on financial markets and businesses. Measures fund managers should take to ensure they can thrive during a long-lasting pandemic include reevaluating employee efforts; vendor safeguards; basic compliance measures, such as their abilities to satisfy the custody rule; and insurance coverage. To support those efforts, the Hedge Fund Law Report interviewed various legal professionals on how fund managers can smoothly navigate the coronavirus pandemic. This final article in a three-part series examines operational risks, including important business continuity measures, vendor management techniques and insurance coverage issues. The second article recommended disclosures to provide while marketing during this period, features to review in key person provisions and cyber risks to mitigate. The first article detailed the SEC’s relief for Form ADV and Form PF filings, as well as guidance for communicating with investors and managing liquidity risks introduced by the coronavirus. For more on mitigating operational risks, see “Fund Managers Must Supervise Third-Party Service Providers or Risk Regulatory Action” (Nov. 16, 2017); and “Challenges and Solutions in Managing Global Compliance Programs” (Oct. 5, 2017).

Proposed Expansion of New York Department of Financial Services Could Impact Hedge Funds

In the legislative language accompanying his 2021 budget proposals, New York Governor Andrew M. Cuomo proposed to significantly expand the powers of the state’s banking and insurance regulator – the New York Department of Financial Services (DFS) – to reach certain securities transactions and investment advice. Under Cuomo’s plan, DFS would have gained broad jurisdiction and substantial enforcement powers over certain consumer products and services, as well as the power to levy increased penalties and seek restitution. Although the budget that was approved amid the coronavirus pandemic did not include that proposed expansion, if the Governor’s proposal is revisited and adopted in the future, DFS – an aggressive state watchdog with broad rulemaking authority under existing law – would likely vigorously assert its new powers, including in areas in which its powers would overlap with and occasionally surpass those of the New York Attorney General. In a guest article, WilmerHale attorneys Brian Mahanna, Susan Schroeder, Tim Silva and Jarret Zafran address how DFS might assert any expanded powers and how that could affect hedge funds. For additional coverage of Cuomo and DFS, see “New York State Governor Cuomo Nominates Benjamin Lawsky to Head New York State Department of Financial Services” (May 20, 2011).

Disgorgement Action Reveals Dangers of Having an Unqualified CCO

The CCO of the adviser to a number of private funds, who allegedly had “a complete lack of qualifications” for the job and aided and abetted the adviser’s violations, has been ordered to disgorge half of the salary he earned as CCO. Although the dollar amounts at stake were miniscule by hedge fund standards, the enforcement action is a reminder that the SEC expects each CCO to be qualified for the role and to exercise independent judgment. This article analyzes the underlying misconduct; the enforcement action; and the terms and reasoning of the Order. The article also provides insights on hiring a qualified CCO from two former SEC officials. See “NYC Bar Report on CCO Liability Calls for More Regulatory Guidance, Transparency and Cooperation” (Mar. 5, 2020); and “HFLR Fireside Chat With SEC Commissioner Hester M. Peirce Explores Fiduciary Duty, Accredited Investor Standard and CCO Liability (Part One of Two)” (Nov. 21, 2019).

ACA Briefing: Regulatory Responses to Coronavirus Pandemic and Best Practices for Business Continuity and Compliance

As the coronavirus pandemic continues to spread social and financial turmoil, private fund advisers must adapt to rapidly changing – and potentially unforeseen – circumstances, including the possibility that they will have to operate with distributed workforces for a considerable time and that large portions of their staffs may be affected simultaneously. Although regulators are offering relief from certain filing and other obligations, advisers must nevertheless attempt to continue their operations in compliance with the existing regime. A recent ACA Compliance Group (ACA) seminar discussed the steps that regulators are taking to address the crisis and how advisers can enhance their operational resiliency while fulfilling their compliance duties. The program featured Carlo di Florio, partner and global chief services officer at ACA; Laurin Blumenthal Kleiman, partner at Sidley Austin; and Michael Pappacena, partner at ACA. This article discusses the key takeaways from the presentation. For additional insights from di Florio and Pappacena, see our two-part series on safeguards for proper disposal of hardware: “Risks and Examiner Expectations” (Mar. 19, 2020); and “Effective Inventories, Policies and Due Diligence” (Mar. 26, 2020).

SEC Continues to Focus on Cross Trades and Principal Transactions

Because of the potential conflicts of interest inherent in transactions between an adviser and its funds, and trades between funds managed by the same adviser, the SEC scrutinizes those transactions closely. An investment adviser and its principal recently ran afoul of the SEC by effecting transactions between one of the adviser’s funds in which the principal held a substantial position and other adviser funds or separately managed accounts. The SEC claimed that the respondents failed to comply with the notice and consent requirements for principal transactions set forth in Section 206(3) of the Investment Advisers Act of 1940 and failed to implement the adviser’s compliance policies and procedures. This article explores the SEC settlement order. See “OCIE Risk Alert Details Concerns About Principal Transactions and Agency Cross Trades” (Oct. 24, 2019).

Proskauer Adds E.U. Regulatory Expert to Its Growing London-Based Funds Group

Proskauer has hired Kirsten Lapham, who specializes in regulatory issues in the asset management industry, to bolster its private funds group in London. Lapham advises hedge funds, private equity funds, Undertakings for Collective Investment in Transferable Securities management companies and other private fund managers, with a particular focus on regulatory issues arising under the Alternative Investment Fund Managers Directive and Markets in Financial Instruments Directive. Her work includes helping private fund managers navigate the rules across jurisdictions, establish E.U. presences, manage regulatory concerns that affect transactions, plan Brexit contingencies and negotiate counterparty documentation requirements. See “KPMG Reports on AIFMD’s Efficacy Five Years After Implementation” (May 30, 2019); and “Challenges and Solutions in Managing Global Compliance Programs” (Oct. 5, 2017).