Dec. 3, 2009

For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations

Portfolio managers, investment analysts and others with investment decision-making responsibility at hedge fund managers – especially those managing funds invested in public equity – face an ongoing predicament: the most valuable information from an investment perspective would be material, nonpublic information, but trading while in possession of material, nonpublic information is illegal.  Accordingly, hedge fund investment decision-makers routinely seek to compile a mosaic consisting of material, public information; immaterial, nonpublic information; and other information that broadly falls under the rubric of “market color.”  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  Generally, trading on the basis of such a mosaic is legal.  But knowing whether you have a legal mosaic or illegal inside information is complex.  In particular, determining materiality involves an assessment of the relevant facts in light of a daunting volume of statutes, rules, cases, SEC pronouncements and other formal and informal guidance.  In a word, the “better” a piece of information from the perspective of a hedge fund manager, the more scrutiny it merits (from at least the manager’s general counsel, chief compliance officer and outside counsel) to determine whether the manager’s funds may trade based on the information (or whether manager personnel may trade in their personal accounts while in possession of the information).  Nowhere is this predicament more pronounced than in situations in which hedge fund manager personnel talk to corporate insiders, in particular, executives of companies whose securities are owned or may be purchased or sold by the manager’s funds.  Talking to corporate insiders is essential in light of the competition in the investment world.  However, such communications are also fraught with the opportunity to acquire and inappropriately use material, nonpublic information.  In an article in our October 29, 2009 issue, we discussed a number of specific strategies that hedge fund managers can implement to minimize the likelihood that communications with corporate insiders may result in insider trading violations.  See “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  One of the techniques discussed briefly in that article is the use by hedge fund managers of expert networks.  Expert networks generally are companies that broker and structure communications between buy-side investors, such as hedge fund managers, and experts in designated areas, including corporate insiders and others with domain expertise.  This article expands substantially on the discussion in our previous article, describing in detail: what an expert network is; how such networks operate; the categories of experts available via networks; fees charged for membership in a network and periodic access to experts; the mechanics of communications with experts in a network; the benefits and limits of expert networks in preventing insider trading charges; eight specific steps taken by expert network companies to prevent insider trading violations; and Regulation Fair Disclosure (Reg FD) concerns.  One of the basic insights of this article is that expert networks have both offensive and defensive uses: they can be used to locate and glean information from experts who otherwise may be hard to find or hesitant to talk (the offensive use), and they provide a structure for communication that would be difficult to replicate in ad hoc or informal settings (the defensive use).

Big Boys Don’t Cry: How “Big Boy” Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations

Various factors recently have increased the sensitivity of hedge fund managers, lawyers, compliance professionals, investors and others to insider trading concerns.  Those factors include, but are not limited to: insider trading allegations against Galleon Group founder Raj Rajaratnam and others; remarks delivered by SEC Enforcement Division Director Robert Khuzami on November 23 indicating that the Division will increase its enforcement activity with respect to insider trading by hedge funds, and in particular will focus on insider trading in the derivatives context; and press reports that the SEC has sent at least three dozen subpoenas to hedge fund managers and broker-dealers during November 2009 relating to communications in connection with healthcare industry transactions closed during the past three years and certain retail industry transactions.  See “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).  In light of the increased regulatory scrutiny of activity that may constitute insider trading, hedge fund lawyers, compliance professionals and others are re-examining how and where to draw the line between permissible and impermissible information, and how to police that line effectively.  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  In addition, hedge fund industry participants are refocusing on the promise and limits of tools they may employ to prevent or mitigate allegations of trading on material, nonpublic information.  One such tool is the so-called “Big Boy” provision, or disclaimer of reliance.  In our November 19, 2009 issue, we published the first part of a two-part analysis of Big Boy provisions in the hedge fund context by Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP.  That first part discussed the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no federal counterpart.  See “When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?,” Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This second part expands on that analysis, focusing in depth on the enforceability of Big Boy provisions in securities and non-securities transactions, with a special emphasis on the enforceability of such provisions under New York law in the context of trading in bank loans.  In addition, this part includes a detailed discussion of, and a comprehensive review of the caselaw relating to, specific steps that hedge fund managers can take to increase the likelihood that a court will enforce a Big Boy provision.

Best Practices for a Hedge Fund Manager General Counsel or Chief Compliance Officer that Suspects or Discovers Insider Trading by Manager Employees or Principals

A confluence of factors – including Galleon; Madoff, and in particular the SEC’s failure to catch the Ponzi scheme earlier; other discovered frauds; the credit crisis; etc. – have enhanced scrutiny by regulators of actions at hedge fund managers that may constitute insider trading.  See “Another Hedge Fund Manager, Former Jefferies Group Manager Joseph Contorinis, Indicted for Insider Trading,” Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “For Hedge Funds and Their Managers, the SEC’s New Enforcement Initiatives May Increase the Likelihood, Speed and Vigor of Inspections and Examinations,” Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009); “What Can Hedge Fund Managers Learn From the SEC’s Failure to Catch Madoff? An Interview with Charles Lundelius, Senior Managing Director at FTI Consulting, Inc.,” Hedge Fund Law Report, Vol. 2, No. 40 (Oct. 7, 2009).  In light of this increased regulatory scrutiny, many hedge fund managers are reviewing their policies, practices and procedures with respect to insider trading.  For any hedge fund manager, whether registered or unregistered, it is critical to have an insider trading policy that is comprehensive, legally accurate, practicable and effective.  See “Key Elements of a Hedge Fund Manager’s Insider Trading Policies and Procedures,” Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  Beyond having a best-of-breed insider trading policy, though, hedge fund management firms also have to think about how they would respond to suspicion or discovery of insider trading by an employee or principal of the manager.  Within hedge fund management firms, the general counsel (GC) and chief compliance officer (CCO) are on the front lines of investigation, discovery and response.  Accordingly, this article offers guidance and a review of best practices with respect to what a hedge fund manager GC or CCO should do in the event of suspicion or discovery of insider trading.  Specifically, the article discusses: the corporate charging guidelines of the Department of Justice (DOJ); internal investigations; the advisability of suspending suspected violators; how and when to preserve the record; what to do in the event of an actual discovery of insider trading; and how to prepare for surprise government interviews.

As the Pace of Enforcement Activity Quickens, Hedge Fund Managers Refocus on the Law and Technology of Data Storage

With the dramatic expansion of the range and ease of communication technologies has come an expansion of the channels through which inside information and other illegal or inappropriate information may pass.  For hedge fund manager chief compliance officers and others at hedge fund managers tasked with enforcing insider trading and other laws, the proliferation of communication technologies has made life both harder and easier: harder because there is a greater volume of information to monitor, and easier because the technology for monitoring has never been more accessible.  In addition, the cost of storage of data and documents has fallen precipitously, causing expectations to rise on the part of regulators and prosecutors with respect to the volume and duration of storage.  This article examines data retention issues in the hedge fund context.  In particular, the article discusses: the relevant statutes and guidelines with respect to data storage; the law on spoliation of evidence; adverse inference instructions; how spoliation and adverse inference considerations may apply in the context of employees that leave a firm to set up a competitor; treatment of data storage in hedge fund manager compliance manuals; and employee training with respect to data storage.

Conyers Dill to Offer Cyprus Advice out of Moscow Office

On December 1, 2009, multi-jurisdictional law firm Conyers Dill & Pearman announced that it will be adding Cyprus legal advice to its roster of jurisdictions.  The Cyprus practice will be launched out of Conyers’ Moscow office, and the firm will provide advice on all aspects of Cyprus corporate law.

ISDA Announces Appointment of Conrad P. Voldstad as Chief Executive Officer

On November 19, 2009, The International Swaps and Derivatives Association, Inc. announced that its Board of Directors had appointed Conrad P. Voldstad as Chief Executive Officer.