Apr. 25, 2024

SEC Finalizes Rules Updating the Definition of “Dealer” (Part One of Two)

Two years ago, the SEC proposed a significant expansion of the definition of “dealer” intended to capture certain unregistered firms that provide liquidity to the securities markets and act as de facto market makers (Proposed Rules). On February 6, 2024, the SEC adopted final rules (Rules) updating the definitions of “dealer” and “government securities dealer” under the Securities Exchange Act of 1934. Notwithstanding commenters’ requests, the SEC did not include a blanket exclusion for registered investment advisers or private funds but did make some modifications narrowing the scope of the definition. This article, the first in a two-part series, discusses the Rules, how they differ from the Proposed Rules and the commissioners’ individual views on the rulemaking. The second article will explore what hedge fund managers should do in the wake of the new dealer definition, including which hedge funds may fall under that definition and the options available to the managers of such funds. See “SEC’s Proposed Dealer Rules Would Capture Certain Private Funds” (Jun. 2, 2022).

Preparing for Private Fund Quarterly Reporting

In August 2023, the SEC adopted five new rules (Rules) for advisers to private funds, which, among other things, mandate quarterly fee, expense and performance reporting to investors (quarterly statements). The Rules “materially increase the compliance burden for private fund advisers and represent a dramatic shift in the relationship between investors and advisers,” said K&L Gates partner TJ Bright at a recent CFA Institute program devoted to the quarterly statement requirement. The program examined which funds are covered by the Quarterly Statement Rule, its detailed reporting requirements and the practical issues advisers will face when preparing quarterly statements. Krista Harvey, director at the CFA Institute, moderated the program, which also featured K&L Gates partner Pamela A. Grossetti and Karyn D. Vincent, senior head at the CFA Institute. See our two-part coverage of the Rules: “Overview and Key Changes From the Proposal” (Sep. 28, 2023); and “Key Compliance Challenges and Next Steps” (Oct. 12, 2023).

AI Widely Used by Hedge Funds, AIMA Study Finds

Many hedge fund managers and other financial services firms have been using artificial intelligence (AI) to some extent for a long time. The arrival of ChatGPT’s generative AI (Gen AI) technology on the scene, however, has brought new focus on the disruptive power of AI. The Alternative Investment Management Association (AIMA) recently asked more than 150 hedge fund managers about their uptake of Gen AI, its potential benefits and how it may affect fund management. Notably, a majority of the managers in the study permit their staff to use outside Gen AI tools. AIMA’s report “is a useful strategic roadmap to help asset management firms engage with and harness the power of this evolving technology,” AIMA managing director Tom Kehoe told the Hedge Fund Law Report. This article synthesizes AIMA’s key findings, with additional insights from Kehoe. See “Understanding and Mitigating Risks of Using ChatGPT and Other AI Systems” (Jul. 6, 2023).

Off-Channel Communications Are Not the Only Source of Electronic Recordkeeping Violations

In the past several years, regulators have been laser-focused on the recordkeeping duties of regulated firms with respect to business communications made on unapproved channels. The SEC and CFTC have together imposed nearly $3 billion in penalties for violations of those duties. A recent FINRA proceeding is an important reminder that regulated firms should also remain vigilant with respect to authorized firm systems – especially legacy systems. FINRA’s letter of acceptance waiver and consent (AWC) with a broker-dealer alleges that, due to deficient supervisory procedures, the firm failed to preserve more than a million business-related electronic communications on four of its own platforms. This article details FINRA’s allegations and the terms of the AWC. See “Four Electronic Communication and Recordkeeping Traps for Hedge Fund Managers to Avoid” (Oct. 26, 2023).

Benefits and Challenges Associated With Tokenization of Assets

One of the practical applications of distributed ledger technology, or blockchain, is evidencing ownership of assets. So-called “tokenization” or “digitalization” of assets could improve accuracy and accountability; streamline transfers and payment flows; and provide greater liquidity. At the same time, digitalization faces multiple challenges, especially significant regulatory uncertainty. A recent program presented by IFI Global and Jersey Finance examined the current tokenization landscape, its potential benefits, the challenges hindering broader adoption and where tokenization is heading. This article summarizes the key takeaways from the program. See “Landscape of On‑Chain Asset Tokenization & Blockchain Technology’s Path Toward Maturity” (Apr. 13, 2023).