May 10, 2012

Benefits, Challenges and Recommendations for Persons Simultaneously Serving as General Counsel and Chief Compliance Officer of a Hedge Fund Manager

As a result of law, regulation, investor pressure or the gravitational pull of best practices – or a combination of these forces – more and more hedge fund managers feel the need to have a general counsel (GC) and a chief compliance officer (CCO).  For managers with both titles on the organization chart, the question inevitably arises: Should different people serve in the different roles, or should one person serve in both roles?  There are advantages and disadvantages to both approaches.  A so-called “dual-hatted” employee serving as both GC and CCO is typically less expensive from a compensation perspective, but the volume of work at a larger or more complex manager may be more than one person can handle.  But the analysis extends well beyond compensation and quantity of work.  The decision to dual-hat implicates attorney-client privilege issues, examination preparedness, the reliability of internal controls, the effectiveness of marketing and investor relations and other issues.  At a fundamental level, the decision will inform the scope and depth of the manager’s “culture of compliance” – and it is not necessarily the case that a hedge fund manager with a dual-hatted GC/CCO has an inferior culture of compliance.  The analysis is more refined, and often turns on the structure and strategy of the manager, and effectiveness and ethics at the individual level.  The goal of this article is to help hedge fund managers think through the issues raised by dual-hatting.  For managers considering dual-hatting, this article provides a roadmap to the relevant questions.  For managers that have already made a decision with respect to dual-hatting – whether for or against – this article highlights relevant issues and strategies for addressing them.  In particular, this article discusses: the roles and responsibilities of the GC and CCO; the benefits and costs of having one employee wear both hats; recommendations for hedge fund managers that wish to employ such arrangements; and alternative solutions for hedge fund managers that choose not to use such arrangements.  This article also includes specific compensation ranges for hedge fund manager GCs, CCOs and dual-hatted employees.

Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do?  (Part Two of Two)

On February 9, 2012, the Commodity Futures Trading Commission (CFTC) amended the CFTC Rules to rescind an exemption from commodity pool operator (CPO) registration heavily relied upon by hedge fund managers.  This development, in combination with statutory changes to the Commodity Exchange Act enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act, will require many hedge fund managers to register as CPOs.  This article is the second part of a two-part series by Stephen A. McShea, General Counsel and Chief Compliance Officer of Larch Lane Advisors LLC, providing an overview of the current regulatory landscape of CFTC regulations impacting CPOs.  Part one of this series focused on the managers of private funds and their CPO registration and compliance obligations.  In particular, part one discussed: the regulatory framework governing commodity pools and CPOs and the remaining exemption from CPO registration for managers who operate or control a private fund; the compliance obligations of a registered CPO; and the enforcement mechanisms and penalties for non-compliance.  See “Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do?  (Part One of Two),” Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  This part two focuses on the funds (i.e., commodity pools) operated or controlled by registered CPOs.  Specifically, this article discusses: general fund disclosure and reporting obligations applicable to CPOs; the exemptions from certain of those disclosure and reporting obligations available under CFTC Rules 4.7 and 4.12; and the reporting obligations applicable to funds operating under those exemptions.

Cayman Grand Court Ruling Supports Proposition That Hedge Fund Managers Do Not Have Unfettered Discretion in Making Distributions In Kind to Investors

The 2008 financial crisis raised investor concerns related to the discretion that hedge funds and their managers often maintained with respect to decisions impacting investor redemptions.  In some circumstances, hedge funds invoked gates or suspended redemptions that delayed distribution of redemption proceeds that were to be delivered pursuant to fund governing documents.  In other circumstances, hedge funds paid redemption proceeds “in kind” as opposed to making cash payments.  While hedge fund governing documents often give hedge funds and their managers broad discretion in making distributions in kind, a recent decision handed down by the Grand Court of the Cayman Islands supports the proposition that hedge funds do not have unfettered discretion to make in kind distributions to investors and that a favorable valuation assigned by a fund to an in kind distribution of redemption proceeds may not insulate it from a claim that the fund is insolvent and should be liquidated.

Civil and Criminal Enforcement Actions Against Former Morgan Stanley Employee Highlight the Relevance of the FCPA for Private Fund Managers

Hedge fund managers are often concerned about the potential for firm liability where rogue employees violate securities and other laws.  Recent parallel civil and criminal actions initiated by the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) charging a rogue employee of a private fund adviser with violating the anti-bribery and internal controls provisions of the Foreign Corrupt Practices Act of 1977 (FCPA) and the Investment Advisers Act of 1940 demonstrate that a firm that has taken measures to adopt robust internal controls and other measures designed to prevent FCPA violations can avoid liability for the actions of rogue employees.  This article summarizes the parallel SEC and DOJ actions; the terms of the rogue employee’s settlement with the SEC; and the types of measures a company can implement to avoid liability for FCPA violations by a rogue employee.  See also “Practical Considerations for Compliance by Hedge Fund Managers with the FCPA When Evaluating and Engaging Foreign Advisors in Connection with Foreign Bankruptcy Investments,” Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).

SEC’s OCIE Director, Carlo di Florio, Discusses Examination Strategies and Expectations for Impending Examinations of Private Equity Advisers

Now that the registration deadline for many private fund advisers to register with the SEC has come and gone, the SEC’s Office of Compliance Inspections and Examinations (OCIE) is ramping up its efforts to prepare for the impending examinations of many newly registered private fund advisers.  In that vein, on May 2, 2012, OCIE Director Carlo V. di Florio addressed the Private Equity International Private Fund Compliance Forum on various topics, including: demographic information regarding the population of advisers that are now registered with the SEC; the SEC’s anticipated multi-phase examination strategy and risk-based examination approach; and the SEC’s expectations for impending examinations of newly registered advisers.  Although di Florio’s remarks were specifically targeted towards private equity fund advisers, they are nonetheless very relevant for all SEC-registered private fund advisers, including hedge fund managers.  This article summarizes the key takeaways from di Florio’s address.

Is the New Form ADV Investor Friendly?

When the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) repealed the “private adviser exemption” from registration contained in Section 203(b)(3) of the Investment Advisers Act (Advisers Act), many hedge fund managers who enjoyed the exemption found themselves facing the sure fate of having to register with the U.S. Securities and Exchange Commission as investment advisers.  Many of these managers had to file their first Form ADV by March 30, 2012.  March 30 was also the deadline for all previously registered investment advisers to file amendments to their current Form ADV.  Over a month has passed since the March 30 deadline and it is clear, from the viewpoint of an investor, that the new Form ADV has proved to be a mixed bag of good and bad.  In this guest op-ed, Siddhya Mukerjee and Michael Schmieder – both senior operational analysts at Aksia LLC, responsible for performing all aspects of hedge fund operational due diligence – analyze how new Form ADV has helped and hindered the operational and investment due diligence efforts of hedge fund investors.

District Court Decision Addresses Privity of Contract and Statute of Limitations Issues under the Investment Advisers Act

A recent District Court decision clarified the circumstances under which private investor lawsuits against investment advisers will be barred by statutes of limitations, statutes of repose and privity of contract considerations.  Such defenses may be relevant to hedge fund managers faced with legal claims by investors.

Timothy J. Clark Joins Sidley’s Investment Funds, Advisers and Derivatives Practice in New York

On May 7, 2012, Sidley Austin LLP announced that Timothy J. Clark is joining the firm’s Investment Funds, Advisers and Derivatives practice as a partner in the New York office.

Matt Richards Joins Ropes & Gray’s Private Equity Practice in Chicago

Ropes & Gray recently announced that Matt Richards will join the firm as a partner in its private equity practice.