Apr. 5, 2012

Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls

Every day officials in Washington make decisions that affect the prospects and profitability of individual companies and entire industries.  Thus, it is not surprising that the use of political intelligence firms has become increasingly common among sophisticated investors such as hedge funds.  Depending on the focus of the engagement, these firms can help hedge funds in a variety of areas, including conducting research and due diligence, developing an investment idea or strategy and informing trades in financial markets.  For funds that need to follow legislative or regulatory developments closely, political intelligence consultants can serve as their eyes and ears in Washington.  By leveraging their relationships with lawmakers and agency officials, these consultants can deliver real-time “inside the Beltway” information thereby providing a competitive advantage over those simply monitoring news and data services.  On April 4, 2012, President Obama signed into law a bill that raises important issues for hedge funds that retain political intelligence firms.  The bill is called the Stop Trading on Congressional Knowledge Act, commonly referred to as the STOCK Act.  Although the primary purpose of the bill is to affirm that the insider trading laws apply to Members of Congress and other public officials, the legislation makes clear that hedge funds and their employees who trade on information obtained from a political intelligence firm can be exposed to potential liability.  The STOCK Act has also drawn significant attention to political intelligence firms and those who retain their services.  Given these developments, a heightened level of government scrutiny in this area is expected.  Federal prosecutors and regulators will likely be focused on the type of information these firms obtain, how they obtain it, who they provide it to and how it is used.  Thus, while political intelligence firms can deliver a valuable service that is entirely lawful, fund managers who employ these firms or who wish to do so should be aware of the possible associated risks.  In a guest article, Justin V. Shur, a Partner at Molo Lamken LLP, considers those risks and offers four specific suggestions as to how to manage them.

Former Employee Seeks Over $150 Million in Damages from Daniel Och, Och-Ziff and Affiliated Management Entities for Alleged Improper Termination

Many hedge fund managers incentivize key investment professionals and other employees to remain loyal to the firm by giving them either a profits or equity interest in the firm’s management entities.  See “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two),” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  However, such marriages do not always end well, as demonstrated by a recent action brought by a former Och-Ziff employee against Daniel Och, Och-Ziff and affiliated management entities.  The facts alleged in the Complaint offer a rare glimpse into ownership and compensation structures at one of the world’s largest hedge fund management companies.  This article summarizes the factual and legal allegations in the Complaint.  This article also contains a link to the Complaint, which is publicly available but difficult to obtain.  For further insight into a high-level compensation arrangement (and dispute) at a successful hedge fund management company, see “Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager,” Hedge Fund Law Report, Vol. 4, No. 8 (Mar. 4, 2011).

Implications of the JOBS Act for Hedge Fund Managers

The President is expected to sign into law today the Jumpstart Our Business Startups (JOBS) Act, which could represent a positive development for many small businesses, including hedge funds, that generally seek to raise their profile within the capital markets and specifically seek to raise capital.  While it may still be premature to prognosticate the impact that the JOBS Act will have on hedge fund marketing and advertising because the SEC has not provided details regarding its anticipated rulemaking, hedge fund managers and their compliance staff should nonetheless be cognizant of the potential implications of this legislation on their businesses.  This article surveys some of these potential implications.

Don Seymour Discusses Hedge Fund Governance and the Impact of the Recent SEC-CIMA Cooperation Arrangement on Hedge Fund Manager Examinations

On March 23, 2012, the U.S. Securities and Exchange Commission (SEC) announced that it had entered into a supervisory cooperation arrangement with the Cayman Islands Monetary Authority (CIMA).  In its press release announcing the memorandum of understanding (MOU) embodying the supervisory cooperation arrangement, the SEC identified five categories of information that may be shared pursuant to the arrangement.  Those five categories include information required to: (1) conduct routine supervision; (2) monitor risk concentrations; (3) identify emerging systemic risks; (4) better understand a globally active regulated entity’s compliance culture; and (5) conduct on-site examinations of registered entities located abroad.  See “Is This an Inspection or an Investigation? The Blurring Line Between Examinations of and Enforcement Actions Against Private Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012).  Hedge fund managers, lawyers, compliance professionals and others have asked the Hedge Fund Law Report what this MOU means for their businesses.  To help answer that question, we recently interviewed Don Seymour.  Seymour is the founder and Managing Director of dms Management Ltd. (dms Management) and the former head of the Investment Services Division of the CIMA.  At the CIMA, Seymour directed the authorization, supervision and enforcement of regulated mutual funds, including hedge funds, under the Mutual Funds Law of the Cayman Islands, and the supervision of company managers under the Cayman Companies Management Law.  Seymour brought his CIMA experience to bear in explaining how the MOU will impact Cayman-domiciled hedge funds and their managers with respect to data collection and sharing, supervision, monitoring, examinations and regulatory coordination.  Moreover, based on his service on the boards of several notable investment companies, Seymour offered insight on hedge fund governance issues, including: director independence; evolution in best corporate governance practices following the decision in Weavering Macro Fixed Income Fund Limited v. Stefan Peterson and Hans Ekstrom; valuation expertise required of fund directors; specific steps that directors can take to manage fund conflicts of interest; maximum number of directorships; and whether investors should have rights to appoint fund directors.  This article includes the full transcript of our interview with Seymour.

SEC Risk Alert Discusses When Social Media Interactions May Constitute Prohibited Hedge Fund Client Testimonials

On January 4, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the Securities and Exchange Commission (SEC) released a National Examination Risk Alert on Investment Adviser Use of Social Media (Risk Alert).  The Risk Alert addresses the use by registered investment advisory firms of social media that integrate technology, social interaction and content creation – from blogs, wikis and photo sharing sites, to LinkedIn, YouTube, Facebook and other similar websites.  The Risk Alert serves as a reminder that use by hedge fund managers and other investment advisers of social media must comply with, among other things, the antifraud, compliance and recordkeeping provisions of the federal securities laws, including, the Investment Advisers Act of 1940 (Advisers Act).  The Risk Alert sets forth factors that the SEC staff believes, based on observations from recent OCIE exams, an investment adviser may wish to consider in complying with such obligations.  In a guest article, Kenneth J. Berman and Marcia L. MacHarg, both Partners at Debevoise & Plimpton LLP, and Gregory T. Larkin and Jaime D. Schechter, both Associates at Debevoise, analyze the Risk Alert and its implications for private fund managers.  See also “Does Social Media Have a Place in the Hedge Fund Industry?,” Hedge Fund Law Report, Vol. 5, No. 6 (Feb. 9, 2012).

Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act

Hedge fund managers compensate their employees for services rendered with the expectation that such services will be rendered with competence, integrity and honesty.  However, when employees fail to live up to these expectations, do hedge fund managers have any recourse?  For example, may managers claw back compensation paid to such employees and recoup costs incurred in investigating and defending against securities fraud claims?  A recent decision by the U.S. District Court for the Southern District of New York suggests that, yes, hedge fund managers may in fact have some recourse against rogue employees.

SEC Provides Recommendations for Establishing an Effective Risk Management Program for Hedge Fund Managers at Its Compliance Outreach Program National Seminar

While many hedge fund managers recognize the necessity of identifying, monitoring for and addressing risks confronting their businesses, few firms have developed institutional-quality programs that can systematically address operational, investment, strategic and compliance risks.  Some of the challenges in adopting a risk management program include assigning responsibility for identifying and addressing risks; identifying key risks confronting the firm; and understanding what risk metrics to use in evaluating risks and how the firm has addressed such risks.  From the investor perspective, it can be difficult to assess the quality of a manager’s risk management systems, and even more difficult to compare risk management systems across managers.  (However, SSAE 16s can help facilitate single-manager risk assessments and comparisons across managers.  See “Use of SSAE 16 (SAS 70) Internal Control Reports by Hedge Fund Managers to Credibly Convey the Quality of Internal Controls, Raise Capital and Prepare for Audits,” Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).)  On January 31, 2012, the SEC addressed enterprise risk management for hedge fund managers and other investment advisers during the risk management session (Risk Management Session) of its annual “Compliance Outreach Program National Seminar” (Seminar).  The Seminar also included sessions on enforcement issues relevant to hedge fund managers and hedge fund manager trading practices; prior articles in the Hedge Fund Law Report detailed the key lessons from both the enforcement and trading sessions.  During the Risk Management Session, the panelists shared with industry participants recommendations on how to allocate resources to create a risk management program that will identify key risk areas and appropriately address compliance issues.  This article discusses the key takeaways from the Risk Management Session.

Vinson & Elkins Expands Private Investment Funds Practice in New York with the Addition of Mark Proctor as a Partner

On March 5, 2012, Vinson & Elkins announced that Mark Proctor has joined its Private Investment Funds practice as a partner in New York.  Proctor’s practice will focus on structuring, forming and operating private investment funds, as well as advising private funds in connection with their investment activities.

Berkeley Research Group Adds Four Experts to Financial Institutions Practice

Charles Lundelius, Jr., Jim Conversano, Jennifer Hull and David Martin have joined Berkeley Research Group’s Financial Institutions practice, specializing in the regulation of and securities trading by hedge funds, alternative investment funds, broker-dealers, investment advisers, insurance companies and banks.