May 14, 2020

How Fund Managers Can Mitigate NAV Triggers’ Impact on Trading Agreements

With the outbreak of the coronavirus and the subsequent social upheaval, markets have become increasingly volatile. That volatility has resulted in the first bear market since the 2008 financial crisis and has negatively affected both equity and debt markets. Some funds have put up negative performance figures, while others have become – or may soon become – subject to redemptions from investors in need of liquidity. Both consequences have materially increased the occurrence of and likelihood that net asset value decline triggers (NAV Triggers) will be tripped by funds. Once those triggers are breached, hedge funds and their managers will find themselves in the precarious position of being subject to termination by their swap dealers, prime brokers and other counterparties. In a guest article, Poseidon Retsinas, founder of HedgeLegal, unpacks the components of NAV Triggers and highlights important negotiation points and current market practices. The article also recommends actions that managers should take in consideration of recent events to protect their trading lines, investors and businesses. For more on valuation by private fund managers, see “Failure to Consider Relevant Market Inputs When Valuing Assets May Draw SEC Enforcement Action Against Fund Managers” (Apr. 20, 2017).

Former OCIE Private Funds Examiner Explores Compliance Issues Introduced by the Coronavirus Pandemic and Mitigation Tips (Part Two of Two)

As a Senior Specialized Examiner in the SEC’s Office of Compliance Inspections and Examinations (OCIE) Private Funds Unit, Drew Weilbacher identified compliance shortcomings of fund managers and helped craft OCIE’s examination priorities. Now at Promontory Financial Group (Promontory), he uses that expertise to focus on consulting investment advisers on their SEC registration obligations. To obtain an OCIE examiner’s perspective on the coronavirus pandemic, the Hedge Fund Law Report recently interviewed Weilbacher in connection with his move to Promontory. This second article in a two-part series explains how fund managers must diligently review their own business continuity plans and those of their vendors; be transparent with investors; and carefully document risky valuations. The first article detailed his experience at the SEC and role at Promontory, while also forecasting OCIE’s potential treatment of fund manager compliance practices during the coronavirus pandemic. For additional commentary from Promontory staff, see “Focus Areas for Private Fund Managers From OCIE’s 2020 Exam Priorities” (Feb. 27, 2020); and “Key Takeaways for Private Fund Managers From SEC’s Latest Reg Flex Agenda” (Aug. 15, 2019).

The Current State and Future of AI Regulation

Private fund managers are increasingly incorporating artificial intelligence (AI) into their investment processes. AI models, which incorporate vast amounts of data and may be hard to understand, present unique regulatory risks. Legal and reputational consequences of improper handling of AI should be avoided by fund managers. A recent Debevoise & Plimpton program addressed the current state of AI regulation, AI governance, mitigation of risks associated with the use of AI and where AI regulation may be headed. The program also examined the potential use of AI in combating the coronavirus pandemic and the associated risks. The webinar featured Debevoise partner Avi Gesser and associate Anna R. Gressel, as well as Matthew Homer, Executive Deputy Superintendent of the Research and Innovation Division of the New York State Department of Financial Services. This article synthesizes the panelists’ commentary most relevant to hedge fund managers. See “EY 2019 Survey Explores Growing Importance of Talent Management, Diversity and Inclusion; Use of Technology, Big Data and AI; and Cybersecurity (Part Two of Two)” (Dec. 19, 2019); and “AI for Fund Managers: How to Use It to Streamline Operations (Part One of Three)” (Sep. 5, 2019).

The SEC’s Response to the Coronavirus Pandemic and Its 2020 Exam Priorities

In the face of the evolving coronavirus pandemic, the SEC remains committed to protecting investors, preserving market integrity and ensuring that investment advisers operate in compliance with all applicable regulations. A recent program explored the SEC’s response to the pandemic and key pandemic-related risks; the Form CRS compliance deadline; examination priorities for 2020; common exam deficiencies; and ways advisers can prepare for SEC exams in the coming months. Matt Ahlstrand, vice president at SS&C Advent, moderated the program, which featured Krista Zipfel, director at Focus 1 Associates. This article summarizes her insights. For additional commentary from Zipfel, see “A Checklist for Advisers to Ensure Compliance With the Advertising Rule” (Dec. 12, 2019). See also “Key Considerations for Fund Managers Responding to the Coronavirus Outbreak” (Mar. 26, 2020).

SEC Imposes Minimal Fine on Adviser That Self‑Reported After the SCSD Initiative Deadline

For several years, the SEC’s Division of Enforcement has been taking action against investment advisers that make inadequate disclosures about the conflicts of interest associated with their mutual fund share class selection practices. Commencing in 2018, the SEC’s Share Class Selection Disclosure Initiative (SCSD Initiative) offered advisers the opportunity to resolve SEC charges by paying disgorgement and interest to affected clients – but without paying a financial penalty. Recent SEC settlement orders issued against two registered investment advisers may be the last enforcement proceedings under the SCSD Initiative. Simultaneously, the SEC issued a settlement order against an adviser that self-reported after the SCSD Initiative deadline and thus received a minimal fine. This article analyzes the terms of those settlement orders. See “SEC Continues to Pursue Advisers That Provide Inadequate Disclosures About Mutual Fund Share Class Selection Practices and Other Conflicts of Interest” (Nov. 15, 2018).

Investment Management and Private Fund Formation Attorneys Jodi L. Lashin and Stacy H. Louizos Join Blank Rome

Blank Rome recently announced that Jodi L. Lashin and Stacy H. Louizos have joined the firm as partners in its investment management practice group. Lashin advises private fund clients on fund formation and other investment management matters; Louizos counsels registered investment companies and their independent directors and investment advisers. For commentary from another Blank Rome partner, see “How Can Hedge Fund Managers Rebut the Presumption of Materiality of Certain Disciplinary Events in Form ADV, Part 2?” (Jan 5, 2012).