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    Jan. 26, 2012

Form PF: Operational Challenges and Strategic, Regulatory and Investor-Related Implications for Hedge Fund Managers

In October 2011, the Securities and Exchange Commission and the Commodity Futures Trading Commission adopted the much-anticipated final rule for Form PF, which requires reporting of risk measurement information by registered investment advisers regarding the private funds they manage.  As hoped, the agencies made a number of modifications to the proposed form to ease some of the burdens associated with these new risk-reporting requirements.  Specifically, the agencies established a minimum assets under management threshold for filing Form PF, raised the threshold for detailed hedge fund reporting, extended the length of time hedge fund advisers would have to file and the start date for compliance.  However, the core elements of the new reporting requirements remain largely unchanged, especially since there has been no substantial reduction in the volume of information required.  Therefore, although some improvements to the form have been made, Form PF is still likely to pose significant challenges for many hedge fund managers, especially with regard to implementation.  This guest article discusses some of the major operational challenges that many hedge funds will face in the preparation and implementation required to complete Form PF and provides guidance on some of the larger strategic and investor-related implications stemming from Form PF.  The authors of this article are Samuel K. Won, the Founder and Managing Director of Global Risk Management Advisors, and David Vaughan, a Partner at Dechert LLP.  See “David Vaughan Returns to Dechert from SEC Division of Investment Management,” Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).  This article begins with a discussion of the Form PF reporting requirements.  The article then explains the operational challenges that many hedge fund managers face in accurately and timely gathering and reporting information required by Form PF.  The article then moves to a discussion of the strategic, regulatory and investor-related implications raised by Form PF.  Finally, the article concludes with a discussion of recommendations designed to address the operational and other challenges hedge fund managers face with respect to Form PF.

Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part Two of Three)

Carefully conceived personal trading restrictions and prohibitions (such as pre-clearance of personal trades and blackout periods) are some of the most valuable tools available to a hedge fund manager to detect and prevent personal trading fraud, including insider trading and front-running.  Such policies prove the adage that an ounce of prevention is worth a pound of cure.  Contrast such personal trading restrictions and prohibitions with the reporting obligations mandated by Rule 204A-1 under the Investment Advisers Act of 1940 (Advisers Act) which only require a firm to review its covered persons’ trades retroactively.  Once a trade has been effected, a firm has few remedial options other than breaking the trade (if it is discovered in time) or disciplining the covered person (potentially including requiring him or her to disgorge any profits).  More often than not, once a personal trading violation has occurred, the damage has been done.  As such, unless a hedge fund manager flatly prohibits all personal trading by its covered persons, it will need to adopt some personal trading restrictions and prohibitions to prevent personal trading fraud.  Unfortunately, the securities laws and rules (including Rule 204A-1) provide only limited guidance in this regard.  This is the second article in a three-part series on personal trading policies and procedures for hedge fund managers.  The first article in this series discussed general considerations for hedge fund managers in developing effective personal trading policies; the scope of persons that may be covered by such personal trading policies; and the reporting obligations imposed on registered hedge fund managers by Rule 204A-1.  See “Key Legal and Operational Considerations for Hedge Fund Managers in Establishing, Maintaining and Enforcing Effective Personal Trading Policies and Procedures (Part One of Three),” Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  This article discusses various personal trading restrictions and prohibitions, including limitations on the number of brokerage firms covered persons can use to effect personal trades; pre-clearance requirements for personal trades; blackout periods during which personal trades cannot be effected; holding periods applicable to securities owned by covered persons; and other types of personal trading restrictions and prohibitions.  The third article in this series will describe various solutions designed to facilitate monitoring of personal trading compliance by hedge fund managers.

SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million

The Securities and Exchange Commission (SEC) has continued its push to root out insider trading in the hedge fund industry by leveling charges against two prominent hedge fund managers, certain of their respective principals and a network of analysts who allegedly shared inside information about Dell and Nvidia.  This article details the SEC’s allegations and summarizes the status of the related criminal charges and recent developments.

Investing in Cayman Islands Hedge Funds Through a Nominee or Custodian: An Unforeseen Peril

The advantages of investing in corporate or limited partnership hedge funds through a nominee or a custodian registered as a shareholder or a named limited partner are well known.  Principally, the investor retains anonymity or some other perceived business advantage.  On the other hand, investing in corporate or limited partnership hedge funds through a nominee involves the risk of misappropriation by the nominee, ignoring of instructions or the loss of or delay in recovering dividends or redemption proceeds in the event of the insolvency of the nominee.  These disadvantages may of course be avoided or minimised by careful selection of the nominee, and by close regard to the terms of the nominee agreement (although, typically, the nominee will have standard terms, departure from which will be difficult, if not impossible).  There is another area of potential disadvantage – and that other area is the focus of this guest article by Christopher Russell, Partner and head of the litigation and insolvency department of Ogier, Cayman Islands, and Shaun Folpp, a Managing Associate in the litigation and insolvency department of Ogier, Cayman Islands.

SEC Settlement with Diamondback Capital Evidences SEC’s New Practice of Prohibiting Defendants from Settling Cases Without Admitting or Denying Facts Admitted in Parallel Criminal Matters

On January 23, 2012, Diamondback Capital Management, LLC (Diamondback) entered into agreements with the U.S. Attorney’s Office for the Southern District of New York (U.S. Attorney’s Office) and the SEC to, respectively, avoid criminal prosecution and settle parallel civil charges.  For a thorough discussion of the civil and criminal charges and resolutions to date, see “SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million,” above, in this issue of the Hedge Fund Law Report.  The settlement with the SEC is important because it represents the first settlement under the SEC’s new policy adopted on January 6, 2012 whereby it no longer permits defendants to settle civil charges in connection with a civil injunctive complaint or an administrative order without admitting or denying allegations of wrongdoing where: (1) a defendant has been the subject of a parallel criminal conviction or; (2) a defendant has signed a non-prosecution agreement or deferred prosecution agreement in a parallel criminal prosecution in which it admits or acknowledges wrongdoing.  This article describes the new SEC policy change as well as the implications for hedge fund managers facing parallel criminal and civil actions.

Recent SEC Enforcement Action Against Private Fund Manager Underscores Importance of Identifying and Understanding Money Transfers Between a Hedge Fund and the Hedge Fund Manager During the Investor Due Diligence Process

On January 17, 2012, Judge Carol E. Jackson of the U.S. District Court, Eastern District of Missouri granted the SEC’s request for emergency injunctive relief (including an asset freeze and appointment of a receiver) against Burton Douglas Morriss as well as several investment management companies and private equity funds operated by Morriss in response to the SEC’s complaint alleging that Morriss misappropriated more than $9 million in investor assets from 2005 through 2011.  See generally “Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers,” Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  This article describes the SEC action brought against Morriss and the investment management companies and private equity funds he operated.  The article also provides several recommendations to assist hedge fund investors in identifying and understanding asset transfers between a hedge fund manager and its hedge funds.  See also “Ten Steps That Hedge Fund Managers Can Take to Avoid Improper Transfers among Funds and Accounts,” Hedge Fund Law Report, Vol. 4, No. 13 (Apr. 21, 2011).

Survey by SEI and Greenwich Associates Highlights the Importance to Hedge Fund Investors of a Clearly Articulated, Comprehensible and Credible Value Proposition

In October 2011, SEI Knowledge Partnership (SEI) and Greenwich Associates conducted their fifth annual survey of institutional hedge fund investors.  On January 25, 2012, they released a report summarizing part one of the results of that survey (Report), including current trends affecting the hedge fund industry, including institutional hedge fund allocations, objectives, performance and preferences in investment strategies and vehicles.  The Report, entitled “The Shifting Hedge Fund Landscape, Part I of II: Institutions Put Fund Managers to the Test,” identifies a deepening commitment to hedge funds on the part of institutional investors, and foreshadows increased institutional allocations.  At the same time, however, the Report finds that institutions keep creating new challenges and requirements for hedge fund managers.  Notably, the Report also details what hedge fund managers must do in order to maintain investor confidence.  Part two of the survey will explore investors’ chief concerns regarding hedge fund investing, as well as the continuing evolution of institutional standards for hedge fund evaluation, selection and monitoring.  This article summarizes the findings of the Report and the key takeaways for hedge fund managers.  See also “SEI Report Describes the Growth Opportunity for Hedge Fund Managers in Regulated Alternative Funds,” Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).

FinCEN Working on a Proposed Rule That Would Require Investment Advisers to Establish Anti-Money Laundering Programs and Report Suspicious Activity

On November 15, 2011, James H. Freis, Jr., Director of the Financial Crimes Enforcement Network (FinCEN), delivered remarks to the American Bankers Association/American Bar Association’s annual money laundering enforcement conference.  2011 was the fifth year in a row in which Freis delivered remarks to the annual gathering.  See also “FinCEN Withdraws AML Rule Proposals for Alternative Investment Entities,” Hedge Fund Law Report, Vol. 1, No. 25 (Nov. 26, 2008).

Brad Caswell Joins Schulte Roth & Zabel’s Regulatory & Compliance Practice

On January 17, 2012, Schulte Roth & Zabel LLP announced that Brad Caswell joined the firm as a Special Counsel in the Investment Management Group.

Stephen Pollard Joins WilmerHale’s Investigations and Criminal Litigation Practice in the London Office

Stephen Pollard, a leading practitioner in the areas of white-collar crime and regulatory financial services, has joined WilmerHale’s London office as a partner in the Investigations and Criminal Litigation Practice.

Timothy Wilson Joins Global Risk Management Advisors as Managing Director

Timothy Wilson, a veteran hedge fund and investment bank risk manager, recently joined Global Risk Management Advisors (GRMA) as a Managing Director and Senior Principal.  For more insight from GRMA, see “Form PF: Operational Challenges and Strategic, Regulatory and Investor-Related Implications for Hedge Fund Managers,” above, in this issue of the Hedge Fund Law Report.

Lorin Reisner Appointed Chief of the Criminal Division of the United States Attorney’s Office for the Southern District of New York

On January 25, 2012, Preet Bharara, the United States Attorney for the Southern District of New York, announced the appointment of Lorin L. Reisner as Chief of the Office’s Criminal Division.  Criminal law is becoming increasingly important in the hedge fund arena.  See, e.g., “SEC Settlement with Diamondback Capital Evidences SEC’s New Practice Prohibiting Defendants from Settling Cases Without Admitting or Denying Facts Admitted in Parallel Criminal Matters,” above, in this issue of the Hedge Fund Law Report.

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