Mar. 30, 2023

Compliance Corner Q2‑2023: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

This twenty-fourth installment of the Hedge Fund Law Report’s quarterly compliance update highlights upcoming filing deadlines and reporting requirements that fund managers should be aware of during the second quarter of 2023. This guest article by ACA Group consultants Valerie Speare, Grazia Gatti and Dan Campbell also discusses the potential impact of proposed amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 – also known as the Custody Rule – and two recent SEC settlements concerning Rule 105 of Regulation M under the Securities Exchange Act of 1934. For another case involving Rule 105, see “SEC Alleges Short Selling Violations by Firm Whose Compliance Staff Misinterpreted Rule 105” (Jul. 28, 2022).

Three SEC Enforcement Actions Illustrate the Increasingly Quantitative Analysis Used to Enforce Rules & Verify Disclosures

The SEC’s Division of Examinations (Examinations) has evolved over time to be a large, expert-driven team with revamped technology to efficiently oversee a broad swath of managers. Simultaneously, the types of deficiencies targeted by Examinations have also evolved. Previously, there was a larger focus on whether adequate policies and disclosures existed – i.e., fund managers’ having the bones of an effective compliance program. Now, the SEC is focused on whether fund managers are successfully applying those tools to different data-related areas (e.g., fee and expense allocations; performance advertising; etc.). That shift was apparent in three SEC enforcement actions against fund managers for improper fee and expense allocations that resulted in violations of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940. When coupled with the proposed private fund reforms and other recent SEC guidance, the enforcement actions show the Commission is prepared to put muscle behind its rules – and fund managers are expected to as well. This article analyzes the facts and deficiencies that prompted the three SEC enforcement actions and includes commentary from several industry experts about the SEC’s approach and key takeaways for improving managers’ compliance efforts. See “How Fund Managers Can Use Technology to Transform and Streamline Complex Legal Operations: One Manager’s Example” (Jul. 18, 2019); and “OCIE Director Marc Wyatt Details Use of Technology and Coordination With Other Agencies to Execute OCIE’s Four-Pillar Mission” (Nov. 3, 2016).

Recent SEC ESG Rulemaking, Examination and Enforcement Activity

The SEC has been laser-focused on the use of environmental, social and governance (ESG) criteria by investment advisers and the impact of climate and other ESG concerns on issuers. Pending rule proposals address both those issues. In the interim, the SEC continues to use its existing examination and enforcement tools to identify and address alleged misconduct on ESG matters. An ACA Group program examined all three areas of SEC activity, with a focus on how advisers can prepare for the new ESG rules and avoid running afoul of existing requirements. The program featured Adam S. Aderton, partner at Willkie Farr & Gallagher and former Co-Chief of the SEC’s Asset Management Unit and member of the SEC’s Climate and ESG Task Force; Alyssa Briggs, Managing Director of Client Development at ACA Group; and Dan Mistler, partner at ACA Group and head of ESG Advisory and Analytics. This article distills their insights. See “How the SEC’s Recent ESG Proposals May Impact Private Funds” (Sep. 22, 2022).

The Great Resignation: Cyber Risks in the Crypto Sector

Employees are resigning at a record pace across the United States, impacting both U.S.-based companies and global firms. Although debate still surrounds the motivation behind this trend, the impact on an organization’s risk landscape as it relates to cyber breaches has only heightened since the “Great Resignation” began in 2021. The outbreak of the coronavirus pandemic created countless challenges for organizations globally, including around the traditional management of critical data and trade secret information. The move to a remote environment or a hybrid model in the ensuing weeks and months ultimately led to many of the barriers that protected critical IT infrastructure coming down or being modified to ease the transition to remote work. This, combined with the overall increase in employee resignations, has only heightened the risk of trade-secret theft or cyber-related incidents. One sector particularly vulnerable to these risks is decentralized finance, including blockchain, non-fungible tokens and distributed ledger technology. This guest article by Libero Marconi and Graeme Buller from Alvarez & Marsal includes key considerations that crypto organizations should consider to mitigate the increased risk of information loss or data breaches, along with reactive solutions that can help organizations limit the impact of such events. See “Navigating the Intersection of Blockchain and Data Privacy Laws” (Jun. 2, 2022).

Advisers and Brokers Must Be Wary of Municipal Advisor Registration Requirements

Last fall, the SEC resolved its first-ever enforcement proceeding against a broker-dealer for failure to comply with the registration requirements for municipal advisors. The SEC claimed that a representative of a broker-dealer had provided advice concerning purchases of municipal securities to a Midwestern city without the firm’s being registered as a municipal advisor. This article details the alleged violations and the terms of the resolution, with commentary and recommendations for avoiding violations of the municipal advisor registration rules from Peter W. LaVigne, partner at Goodwin Procter LLP. See “Marketing to Public Pension Plans: Municipal Advisors; Pay to Play Laws; and Gift and Entertainment Rules (Part One of Two)” (Apr. 18, 2019).