Nov. 5, 2020

Valuations: Crises May Require Deviation From Usual Procedures (Part One of Two)

The market volatility caused by the coronavirus pandemic and steps taken in response to the pandemic have, among other things, made it challenging for hedge fund managers to value certain assets. For example, closure of the Chinese financial markets in early 2020 made it impossible for managers to obtain prices for stocks traded in those markets. Other kinds of crises, such as terrorist attacks or the hacking of a third-party pricing agent, could also make it difficult for fund managers to accurately value their assets. Ideally, a manager should have robust valuation policies and procedures that not only specify the methodology to be used to value the fund’s assets but also include a contingency plan for when that methodology cannot be used – but not all policies and procedures have backup plans. In that event, what should a manager do? This first article in a two-part series analyzes why proper valuation of a hedge fund’s assets is so important, especially in the eyes of the SEC; discusses circumstances that may make valuing a fund’s assets challenging; and emphasizes the need for establishing fair market value. The second article will spell out the steps that a manager without a specified contingency plan in its valuation policy should take if it must deviate from its usual valuation procedures due to a crisis. See “Paul Hastings Attorneys Discuss Fund Governance and Management, Valuation and Line of Credit Issues Arising Out of the Coronavirus Pandemic (Part One of Two)” (Jun. 4, 2020); and “How Fund Managers Can Withstand the Coronavirus Pandemic: Form ADV Filing Relief, Investor Communications and Fund Valuation Issues (Part One of Three)” (Apr. 2, 2020).

Could the SEC Use Dealer Registration Requirements to Target Investors in PIPE Transactions?

Amplifying a recent trend in aggressive enforcement actions against convertible debt investors, the SEC continues to bring charges against lenders in microcap companies for alleged violations of Section 15(a) of the Securities Exchange Act of 1934 (Exchange Act). In four recently filed actions, the SEC has adopted a novel – and aggressive – view of what it means to be an “unregistered dealer” under Section 15(a). One of the SEC’s actions directly targets a defendant that at least marketed itself as engaged in legitimate private investment in public equity (PIPE) raises. PIPE transactions certainly bear some similarities to the convertible debt transactions recently targeted by the SEC. That resemblance, combined with the SEC’s enforcement action, have rightly alarmed investors with the prospect of the SEC’s attempting to sweep all manner of PIPE transactions under the dealer registration requirements of Section 15(a). In a guest article, Baker McKenzie attorneys Perrie M. Weiner, Ben Turner and Kirby Hsu explain the dealer requirements under the Exchange Act; analyze the recent SEC enforcement actions involving unregistered dealer claims; discuss the difference between most PIPE transactions and the investment activity at issue in those cases; and conclude that those differences will make it difficult for the SEC to seriously target investors in PIPE transactions as “unregistered dealers.” For more on PIPEs, see “Registered Direct Offerings Enable Hedge Funds to Make Advantageously Structured Investments in Public Equity While Avoiding the Illiquidity and Other Downsides of PIPEs” (Jun. 25, 2010); and “Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs” (Nov. 11, 2009).

Vulnerable Fund Managers Are Targets of Cultural Engineering Cyber Attacks: How Can Your Firm Avoid Being Next?

Three British asset management firms were recent victims of an elaborate cyber attack that fraudulently induced them to wire $1.3 million, of which nearly $700,000 was never recouped. The hackers used cultural engineering through multiple phishing campaigns spanning several months to exfiltrate credentials, mimic a fake investment in a startup and redirect communications in real time to trigger the wire transfer. The recent rise of highly sophisticated cultural engineering attacks against fund managers has raised concerns in the industry, including prompting the SEC to issue a recent risk alert on the topic. To attain a clearer understanding of cultural engineering attacks and how to prevent them, the Hedge Fund Law Report interviewed Mark Sangster, vice president and industry security strategist at eSentire Inc. This article explores how cultural engineering is a sophisticated outgrowth of social engineering attacks, provides examples of attacks against fund managers, describes why the private funds industry is uniquely vulnerable to those attacks, details measures managers can take to prevent attacks from occurring and proposes ways to mitigate the harm from an attack. See “Six Ways For Fund Managers to Prepare for the SEC’s Focus on Cybersecurity and Resiliency” (Apr. 30, 2020).

FCA Resolves First Enforcement Action Under E.U. Short Sale Disclosure Rules

Eight years after the E.U. adopted a regulation requiring companies to disclose their short positions when those positions exceed specified thresholds, the U.K. Financial Conduct Authority (FCA) has resolved its first enforcement action arising out an alleged violation of that regulation. The FCA Final Notice, which imposes a significant penalty on the subject asset manager, alleges that the manager failed to make requisite notifications and disclosures of its short positions in a single U.K.‑listed issuer on more than 150 occasions over several years. This article discusses the short selling regulation, the manager’s alleged violations and the terms of the Final Notice. See “A Fund Manager’s Guide to Calculating and Reporting Short Sales Under European Regulations” (Jan. 5, 2017); and “How Fund Managers Can Navigate and Avoid the Pitfalls of European Short Sale Reporting Obligations” (Dec. 1, 2016).

SEC Commissioner Peirce Shares Views on Personal Liability for CCOs

Regardless of whether one agrees with SEC Commissioner Hester M. Peirce’s views, there is no doubt that she has a way with words. Her speeches are always colorful and interesting, relying on relatable – and often amusing – anecdotes or analogies to explain or illustrate important points on the regulation of the financial industry. Case in point: in a recent speech, Peirce used a proverb about a nail and a horseshoe leading to the downfall of a kingdom as a jumping-off point for analyzing when CCOs should be held personally liable. This article presents the key takeaways from Peirce’s speech. For further commentary from Peirce, see our two-part coverage of the HFLR’s fireside chat featuring the Commissioner: “Fiduciary Duty, Accredited Investor Standard and CCO Liability” (Nov. 21, 2019); and “Rule Updates, Technological Change, Role of Enforcement and Hot‑Button Issues” (Dec. 5, 2019).