Jul. 20, 2023

Designing a State‑of‑the‑Art Hedge Fund Compliance Department: Leveraging Cutting‑Edge Technology

In today’s rapidly evolving and highly regulated financial environment, hedge funds are under increased scrutiny from regulators and investors alike. The need for a robust compliance department is now more important than ever, as non‑compliance can result in severe financial penalties and reputational damage. To keep pace with the increasing regulatory requirements and technological advancements, hedge fund managers must embrace the latest compliance technology and tools – including generative artificial intelligence – to build a robust compliance department. This guest article by Brian Meyer, COO, CCO and GC of Fir Tree Partners (Fir Tree), is a case study that explores how Fir Tree embarked on a multi-year process to create a compliance department that leverages advanced regulatory technology (RegTech) solutions to ensure the highest level of compliance and risk management. Fir Tree determined that the use of RegTech could bring about an array of substantial benefits, effectively transforming the landscape of its compliance operations. For a look at Fir Tree’s application of many of the same processes and technology solutions used by large corporate law departments, see “How Fund Managers Can Use Technology to Transform and Streamline Complex Legal Operations: One Manager’s Example” (Jul. 18, 2019).

Managing Risks Associated With Outsourcing

There are many good reasons to outsource, but outsourcing is not without risk, observed Krista Zipfel, director at ACA Global, at a recent National Society of Compliance Professionals seminar. The benefits include better use of internal resources and cost savings; scalability; access to expertise; and risk mitigation, especially through information security services, she said. Nevertheless, the responsibility and risk associated with outsourced functions remains with the firm that outsources them. Zipfel, along with Robin Freeman, CCO at LaSalle Investment Management Distributors, LLC, and J. Christopher Jackson, senior vice president and GC at Calamos Investments LLC, discussed the evolving regulatory requirements for outsourcing; key concerns associated with outsourcing; and the vendor selection and due diligence processes. This article synthesizes their insights. See “Asset Managers Seeking Efficiency Through Outsourcing and Technology, According to Recent Survey” (Sep. 15, 2022); and “IOSCO Issues Seven Key Outsourcing Principles” (Dec. 16, 2021).

Enhanced Warnings and Other Obligations From the FCA’s New U.K. Rules on Marketing High Risk Investments (Part One of Two)

As part of its consumer investment strategy, the U.K.’s Financial Conduct Authority (FCA) introduced a new “consumer duty” (Consumer Duty) that aims to improve how firms serve consumers. In addition, the FCA has finalized new rules for marketing high-risk investments (High-Risk Marketing Rules) to ensure that only investors with appropriate risk appetites invest in high-risk products. Firms had to be in compliance with the High-Risk Marketing Rules as of December 1, 2022. For new and existing products or services that are open to sale or renewal, the Consumer Duty will take effect July 31, 2023; for closed products or services, it will take effect July 31, 2024. In light of the broad application of the rules to fund managers, placement agents and other service providers, MJ Hudson partner Mike Booth presented a program examining key features and terms of both rules. This first article in a two-part series provides useful background information for both rules before delving into the nuances and requirements of the High-Risk Marketing Rules. The second article will provide relevant takeaways for fund managers about their obligations under the Consumer Duty. For more on other recent FCA activity, see “FCA Seeks Input on Updating Asset Management Regulation” (Apr. 27, 2023); and “New FCA Consultation: the U.K. Version of the E.U.’s SFDR?” (Jan. 5, 2023).

SEC Commissioner Uyeda Questions Utility of ESG Regulations

In a January 27, 2023, speech before the California ’40 Acts Group, a nonprofit organization that discusses matters affecting the investment management industry, SEC Commissioner Mark T. Uyeda questioned the utility of regulations that specifically address investing driven by environmental, social and governance (ESG) factors, arguing that the existing SEC regime is already well-suited to regulating the area. He focused on the uncertain definition of ESG, the potential for regulatory overreach and the practices of large asset managers, repeatedly citing concerns about asset managers’ pursuit of political or social causes. As is customary, Uyeda clarified that the views he expressed were his own, not those of the SEC or any of his fellow commissioners. This article distills his insights. See our two-part series on the evolving SEC approach to ESG: “SEC Commissioners Peirce and Roisman Argue Against Prescriptive ESG Disclosures” (Oct. 21, 2021); and “SEC Commissioners Gensler and Lee Advocate Further SEC Oversight of ESG Efforts” (Oct. 28, 2021).

SEC Fines Bloomberg for Misleading Disclosures About Valuation Service Methodologies

Fund managers often rely on pricing services for valuing thinly traded securities. The SEC recently sent a shot across the bow of pricing service providers in a settled enforcement proceeding against Bloomberg Finance L.P. (Bloomberg), a subsidiary of privately held Bloomberg L.P., which offers a pricing service known as BVAL. The SEC alleged that Bloomberg violated the antifraud provisions of the Securities Act of 1933 because it made material misstatements about BVAL’s methodologies. The SEC acknowledged, however, that BVAL’s deviations from its disclosed methodologies were rare. Moreover, it did not allege that the prices themselves were misleading. Commissioners Hester M. Peirce and Mark T. Uyeda opposed the proceeding on the grounds that the alleged misrepresentations were not made in connection with the offer or sale of securities. This article details the SEC’s allegations, the settlement’s terms and the Peirce/Uyeda dissenting statement. See “HFLR Program Explores Valuation of Illiquid Assets and Valuation Governance” (Jan. 28, 2021); “Is the Use of an Independent Valuation Firm Superior to a Manager’s Internal Valuation Process?” (Apr. 23, 2015); and “DLA Piper Hedge Fund Valuation Webinar Covers Fair Value Methodologies, Valuation Services, Valuing Illiquid Positions and Handling Valuation Inquiries During SEC Examinations” (Aug. 7, 2013).