Jan. 28, 2021

Is Your Legal and Compliance Team Ready? How Recent Developments Will Drive Demand for In-House Staff and Increase Regulatory Scrutiny (Part One of Two)

Numerous changes have affected the regulatory arena – including the transfer of power to the new Presidential administration and changeover of many high-level staff at the SEC – and fund managers must anticipate the potential effects of those developments on their businesses. Specifically, fund managers must ensure that their legal and compliance staffs are adequately prepared for increased regulatory scrutiny, particularly given recent risk alerts issued by the SEC Division of Examinations – formerly the Office of Compliance Inspections and Examinations, or OCIE. To examine those issues and their impact on the market for legal and compliance staff, the Hedge Fund Law Report recently spoke with David Claypoole, founder of Claypoole Executive Search. This article, the first in a two-part series, sets forth his insights on the factors driving increased demand for in-house staff; the anticipated effects of the Biden administration on the private funds industry; the likelihood of increased regulatory scrutiny of fund managers; and the need to ensure that legal and compliance staff has adequate resources. The second article will explore recent changes to the SEC and their potential impact on the industry; the regulator’s and industry’s performance during the coronavirus pandemic; and trends in compensation of and demand for legal and compliance personnel. For further commentary from Claypoole, see our two-part series: “How Have Industry Developments Affected the Value of Legal and Compliance Staff?” (Feb. 2, 2017); and “Will Industry Deregulation Affect the Value of Legal and Compliance Staff?” (Feb. 16, 2017).

Compliance Corner Q1‑2021: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

With many hedge fund compliance teams still operating remotely, the typical first quarter annual compliance planning, review and update processes may have increased significance in light of business changes many hedge fund managers experienced during the coronavirus pandemic. More specifically, for many fund managers, the first quarter of the new year is often a time to update Form ADV; finalize and deliver an updated compliance manual to employees; and collect employees’ annual disclosures and personal holdings reports. This fifteenth installment of the Hedge Fund Law Report’s quarterly compliance update, authored by consultants Joey Martinez and Chris Ray of ACA Compliance Group (ACA), highlights various important points for fund managers to consider to help ensure a smooth process for completing the annual updating amendments to Form ADV. In addition, this article summarizes certain filings required of fund managers that are due in the first quarter, as well as code of ethics reporting deadlines; various risk alerts issued by the recently renamed Division of Examinations – formerly the Office of Compliance Inspections and Examinations, or OCIE; a regulatory reminder on CCO authority and empowerment; updates on European and U.K. short selling reporting requirements; and some annual compliance-related items that many fund managers consider during the first quarter of the year. For more from ACA, see “Advisers Must Prepare for the Upcoming Expansion of the E.U. and U.K. Prudential Regimes” (Nov. 12, 2020); and “Advisers Should Be Planning Now for the End of LIBOR” (Oct. 29, 2020).

HFLR Program Explores Valuation of Illiquid Assets and Valuation Governance

Valuation of illiquid or hard-to-value assets is a perennial business and compliance challenge for hedge fund managers. Because valuations have a direct impact on manager compensation; the price at which investors enter and exit a fund; and the manager’s track record, valuation is also always on the SEC’s radar. A recent webinar presented by the Hedge Fund Law Report explored how assets are classified in the fair value hierarchy; common valuation challenges; valuation frequency, processes and governance; the use of valuation committees and third-party valuation agents; the impacts of the coronavirus pandemic on valuation; and the effect the impending transition away from the London Interbank Offered Rate may have on valuation models. Robin L. Barton, Associate Editor of the Hedge Fund Law Report, moderated the discussion, which featured Benjamin Kozinn, partner at Lowenstein Sandler, and Hugh Nelson, director in Houlihan Lokey’s portfolio valuation and fund advisory business. This article presents the key takeaways from the program. For a discussion of the SEC’s concerns regarding valuation, see “Steps Advisers Can Take to Minimize the Risk That a Routine SEC Examination Ends With a Referral to Enforcement: Five Key Priorities for OCIE (Part One of Two)” (Jan. 4, 2018).

Manager Learns $170M Lesson: Replacing Successful Traders With Algorithms May Result in Significant Penalties Unless Properly Disclosed

Management of parallel funds that follow similar strategies can be a minefield for an adviser. One fund manager learned that lesson the hard way and has settled with the SEC for $170 million in disgorgements, interest and penalties on charges that it transferred top-performing traders from its flagship fund to a proprietary fund and replaced them with what the SEC claimed was a “replication algorithm” that underperformed the live traders. The SEC’s charges rested on the manager’s alleged failure to make adequate disclosures about material matters, including the existence of the proprietary fund, the manager’s transfer of traders and its use of the algorithm. The action is notable because the manager was accused not of cherry picking profitable trades but, rather, the traders themselves. This article details the facts giving rise to the enforcement action; the manager’s alleged disclosure and compliance failures; and the terms of the settlement. See our two-part series on avoiding parallel fund conflicts: “New SBAI Standards and Case Study Provide Guidance for Mitigating Conflicts” (Jun. 11, 2020); and “Common Challenges for Hedge Fund and Credit Strategies” (Jun. 18, 2020).

Preparing for the Post‑Pandemic Operating Environment

Although the coronavirus rages on, with vaccines slowly being administered, it is becoming easier to envision an end to many of the disruptions and dislocations the pandemic has caused. Regardless, some changes necessitated by the pandemic are likely to be permanent. A recent GAIM Ops Connect program examined how the pandemic has accelerated existing trends toward product customization, use of technology and outsourcing; its impact on talent pools, fee structures, fundraising and emerging managers; and ways managers may structure their offices and operations in the post-pandemic world. The program was moderated by Alan Flanagan, managing director and head of fund services at BNY Mellon, and featured Michael Fastert, COO and chief legal officer at TIG Advisors, LLC; Carlos Ferreira, managing director and head of investment operations at PAAMCO; and Nicole J. Macarchuk, COO and GC at Angel Island Capital. This article outlines the speakers’ core insights. For coverage of another recent GAIM Ops Connect program, see our two-part series “Practical Lessons From OCIE’s Risk Alert on Compliance Issues for Private Fund Managers”: Part One (Nov. 19, 2020); and Part Two (Dec. 3, 2020).