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    Jul. 7, 2022

Sanctions 101: How to Comply With Them (Part Three of Three)

The need to have policies and procedures to ensure compliance with government-imposed sanctions is nothing new for private fund managers. In fact, according to a 2016 ACA Group (ACA) compliance survey of alternative fund managers, 89 percent of respondents conduct checks of investors or separate account clients against lists of sanctioned individuals and entities maintained by the Office of Foreign Assets Control (OFAC) of the U.S. Treasury Department. In light of the latest sanctions against Russia, however, OFAC and FinCEN have both issued alerts, advising financial institutions to be vigilant about potential Russian sanctions evasion. Therefore, it would be prudent for private fund managers to review their sanctions compliance policies and procedures now to ensure they are up to snuff – and for managers without a sanctions compliance regime to implement one. This final article in a three-part series explores what managers should do to ensure they comply with sanctions and have sufficient protections in their fund documents. The first article explained how sanctions regimes work, and the second article discussed how sanctions can impact a private fund manager’s investors and investments. For more results from the ACA survey, see our two-part series: “SEC Exams; Compliance Staffing and Budgeting; Annual and Ongoing Compliance Reviews; and AML/Sanctions Compliance” (Jan. 19, 2017); and “Custody; Fee Policies and Arrangements; Safeguarding of Assets; and Personal Trading” (Feb. 2, 2017).

Allianz to Pay Billions to Resolve Alleged Concealment of Private Funds’ Downside Risks

Allianz Global Investors U.S. LLC (AGI) offered institutional investors “Structured Alpha” products that provided exposure to a variety of debt or equity securities coupled with a complex options trading strategy that was designed to generate additional profits. Contrary to AGI’s representations to investors, however, the funds that employed that strategy took on more risk than disclosed, the SEC alleged in a settled enforcement proceeding against AGI. Worse, the funds’ portfolio managers repeatedly lied to investors about various critical risk metrics and later tried to conceal their fraud from the SEC, according to the SEC’s enforcement action against them. The funds lost billions during the March 2020 market turmoil and subsequently folded. To resolve parallel civil and criminal proceedings, AGI has agreed to make restitution to investors; pay forfeiture and disgorgement of more than $463 million; and pay nearly $3 billion in fines. This article details the SEC’s allegations against AGI; the enforcement action against the three portfolio managers; the AGI settlement of the SEC civil action; and the parallel criminal proceedings against AGI and the portfolio managers. See “High‑Profile Risk Management Misrepresentation Could Personally Cost Portfolio Manager $13.6 Million” (May 26, 2022); and “SEC and CFTC Impose Stiff Penalties on Adviser for Failing to Follow Disclosed Risk Management Policies” (Feb. 20, 2020).

CFTC Consults on Climate Risk

Climate risk has become a pressing regulatory concern. In March 2022, the SEC proposed long-awaited rules for climate risk disclosures by public companies; in May, it proposed enhanced disclosure rules for certain investment advisers and investment companies on their environmental, social and governance practices. The CFTC recently moved in that direction, issuing a request for information (RFI) pertaining to climate-related financial risk relevant to the derivatives markets and the underlying commodities markets. The RFI solicits information in ten broad areas, including data; analysis and testing; risk management; disclosure; product innovation; voluntary carbon markets; digital assets; financially vulnerable communities; public-private partnerships; and CFTC capacity and coordination. This article examines the information solicited by the RFI, the context for the request and the views of the individual Commissioners, two of whom expressed concern that the agency could be stepping outside its regulatory boundaries. See our two-part coverage of the SEC’s proposed climate risk disclosure rules: “Five Key Elements” (May 19, 2022); and “Implications, Challenges, Timing and Pushback” (May 26, 2022).

SEC Sanctions Investment Adviser Over Shortcomings With Custody Rule Financial Statement Requirements

A recent SEC settlement order (Order) highlights the importance of fund managers’ obligations under Rule 206(4)‑2 – the so-called “custody rule” – of the Investment Advisers Act of 1940 to distribute audited annual financial statements on a timely basis to investors in private funds. The custody rule generally requires registered investment advisers that have custody of client funds or securities to implement certain safeguards to prevent the loss, misuse or misappropriation of the assets. The SEC recently sanctioned a manager for failing to comply with the custody rule in connection with its role as an adviser to certain private equity funds and funds of funds. In addition to failing to distribute audited annual financial statements in a timely manner, the adviser had several deficient practices that impeded its auditor’s efforts, such as a lack of pertinent information; inadequate policies and procedures; and improper reallocations of expenses. This article highlights the alleged misconduct and the terms of the Order. See “Adviser and CCO Sanctioned for Undisclosed Conflicts; Custody Rule Violations; and Deficient Policies and Procedures” (Oct. 14, 2021); and “SEC Continues to Bring Enforcement Actions for Compliance Infractions: Undisclosed Conflicts of Interest and Custody Rule Violations” (Sep. 14, 2017).

Behavioral Science in Compliance Programs: Learning From the Data and Changing the Perspective (Part Two of Two)

Often, our picture of behavior is based on a picture skewed toward misconduct, which creates gaps that make analyzing data difficult, Christian Hunt, founder of Human Risk, a behavioral science consultancy and training firm, argued. The Hedge Fund Law Report recently spoke with Hunt about his passion for reshaping the way compliance practitioners think about the human factor in their program design and execution. This second article in our two-part series addresses the gaps in data, learning from patterns and making compliance iterative. The first article explored the importance of considering behavioral science in compliance and how using concepts such as social proof and salience can enhance a compliance program. See our two-part series on compliance training: “SEC Expectations and Substantive Traps to Avoid” (Sep. 23, 2021); and “Who Conducts the Training and Five Traps to Avoid When Providing Training” (Sep. 30, 2021).

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