Sep. 14, 2023

Technology & Conflicts of Interest: Proposal Background and Overview (Part One of Two)

On July 26, 2023, the SEC proposed new requirements (Proposal) to address risks to investors from conflicts of interest associated with the use of predictive data analytics (PDA) by investment advisers and broker-dealers (collectively, firms). The Proposal, which was published in the Federal Register on August 9, 2023, would require firms to take certain steps to eliminate or neutralize the effect of conflicts of interest associated with their use of PDA, artificial intelligence and similar technologies to interact with investors – notably, disclosure of such conflicts would not be an option. The deadline for comments to the Proposal is October 10, 2023. If adopted as is, the Proposal could have serious implications for advisers to hedge funds that use even the most basic technology. This article, the first in a two-part series, explains the events that lead to the Proposal and provides an overview of its key elements. The second article will discuss questions raised by the Proposal and its implications for hedge fund managers. See “Understanding and Mitigating Risks of Using ChatGPT and Other AI Systems” (Jul. 6, 2023).

NY Court Expands Employer Liability for Economic Harm Due to Negligent Supervision

Historically, negligent supervision claims under New York law have primarily involved personal injury or property damage rather than economic loss. For that reason, they are only rarely asserted in commercial cases. In Moore Charitable Foundation v. PJT Partners, Inc. (Moore), however, the New York Court of Appeals (Court) revived a negligent supervision claim in a decision with potentially far-reaching implications for New York employers, including hedge fund managers. This guest article by Anne E. Beaumont, partner at Friedman Kaplan Seiler Adelman & Robbins LLP, explains negligent supervision claims under New York law, summarizes the fraud that led to the litigation in question, reviews the history of the Moore case and assesses the significance of the Court’s opinion. For more insights from Beaumont, see “What Hedge Fund Managers Need to Know About Arbitration of Disputes” (Feb. 10, 2022).

Former SEC Officials Discuss Aggressive Enforcement Climate

The SEC Division of Enforcement (Division) brought 760 enforcement proceedings in its last fiscal year, a number consistent with pre-pandemic enforcement activity. The SEC also ordered respondents and defendants to pay a record $6.44 billion in penalties and disgorgement. The Division is sure to continue its aggressive approach to enforcement, according to the former SEC officials who analyzed the SEC’s 2022 enforcement results at a Securities Docket program. Critically, the SEC appears to be stretching the boundaries of what constitutes securities fraud. The program featured Doug Davison, partner at Linklaters; William R. McLucas, partner at WilmerHale; and Jason Flemmons and Martin Wilczynski, senior managing directors at Ankura Consulting Group. This article distills the key takeaways from the presentation. See “Discussing 2022 Enforcement Results, SEC Enforcement Director Stresses Trust-Building Measures” (Jan. 5, 2023); and “Former SEC Enforcement Official Looks Back at 2022 and Forward to 2023” (Jan. 5, 2023).

SEC Enters Final Judgments Against Premium Point and Individual Defendants in Valuation Fraud Matter

In May 2018, the SEC commenced a civil enforcement action against Premium Point Investments L.P. (Premium Point) and certain principals and traders. The SEC claimed that the defendants, with the assistance of a friendly broker-dealer representative, fraudulently inflated the values of thinly traded mortgage securities held by two hedge funds advised by Premium Point. The DOJ pursued parallel criminal charges against the individual defendants, all of whom eventually pled guilty. The SEC recently obtained injunctions and industry bars against three of the civil defendants. This article discusses the latest developments in the matter. See “SEC, CFTC and DOJ Take Action Against Alleged $1‑Billion Valuation Fraud” (Mar. 17, 2022).

Insiders Tsao, Soltes and Kahn Share Insights on Investigations

Although there is no shortage of legal textbooks on most legal topics, practical knowledge on how things actually work can be hard to come by, especially when it comes to modern corporate criminal investigations and prosecutions, which is an area unlike others. “You can’t go to the common law and read judicial opinions to figure out this area of practice. For example, to understand how to do a presentation to the DOJ on the appropriate resolution, you need to have inside knowledge on what questions the DOJ wants answered,” said Leo Tsao, partner at Paul Hastings. He and two of his colleagues, Dan Kahn, partner at Davis Polk and former Chief of the Fraud Section at the DOJ, and Eugene Soltes, professor at Harvard Business School, have a written a book designed to fill that gap in knowledge and practice, “Corporate Criminal Investigations and Prosecutions” (Aspen Publishing 2022). This article provides the book’s highlights from Kahn, Soltes and Tsao, who was Principal Deputy Chief of the DOJ’s Money Laundering and Asset Recovery Section, as well as their take on current enforcement trends and the all-important topic of data analytics. For additional insights from Kahn, see “Can Compliance Certifications Empower CCOs?” (Jul. 14, 2022).