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    Apr. 18, 2013

Do In-House Marketing Activities and Investment Banking Services Performed by Private Fund Managers Require Broker Registration?

In an April 5, 2013 speech delivered before the American Bar Association, Trading and Markets Subcommittee, David W. Blass, Chief Counsel of the SEC’s Division of Trading and Markets, cautioned private fund managers that certain in-house marketing and investment banking activities may require the manager or its personnel to register as a broker with the SEC.  The speech was in response to certain practices identified by the SEC staff during presence examinations of newly registered advisers.  See “SEC’s OCIE Director, Carlo di Florio, Discusses Examination Strategies and Expectations for Impending Examinations of Private Equity Advisers,” Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  Blass highlighted two groups of practices that raise regulatory concerns: (1) the marketing of fund securities by a manager’s in-house personnel; and (2) “purported investment banking or other broker activities” related to a fund’s portfolio companies.  For more on the broker registration consequences of the former practice, see “Is the In-House Marketing Department of a Hedge Fund Manager Required to Register as a Broker?,” Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).  This article provides an overview of broker registration issues pertinent to hedge fund managers; summarizes key takeaways from Blass’ speech; and helps hedge fund managers understand and analyze their activities within the broker registration framework.

Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations between Hedge Fund Managers and Futures Commission Merchants Regarding Cleared Derivative Agreements

The Dodd-Frank Act eliminated bilateral trading for most over-the-counter derivatives and will require most derivatives to be cleared through a clearinghouse, or central counterparty (CCP), which will hold collateral (i.e., margin) from both counterparties.  The principal goal of central clearing is to reduce counterparty risk associated with swaps and other derivatives transactions.  Hedge funds that trade swaps, futures and options on futures will likely need to clear those derivative transactions through a registered “futures commission merchant” (FCM) which will, in turn, face the CCP as counterparty with respect to such transactions.  As a result of these regulatory changes, hedge fund managers must understand cleared derivatives agreements entered into with FCMs and the key points to negotiate with respect to such agreements.  A recent webinar hosted by Dechert LLP provided an overview of the new rules governing margin held by FCMs on behalf of their customers and a roadmap for negotiating cleared derivative agreements with FCMs.  This article summarizes the key takeaways from the webinar.  For a general discussion of central clearing, see “Don Muller and Joshua Satten of Northern Trust Hedge Fund Services Discuss the Impact of OTC Derivatives Reforms on Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).

Kramer Levin Partner George Silfen Discusses Challenges Faced by Hedge Fund Managers in Operating and Distributing Alternative Mutual Funds

Hedge fund and retail investors are increasingly receptive to the liquidity, transparency and fee benefits associated with alternative mutual funds.  Recognizing that receptivity, hedge fund managers are increasingly interested in launching such products.  While there are notable similarities between managing mutual funds and hedge funds, there are also fundamental differences – many of them regulatory and operational.  For example, the manner in which hedge funds and mutual funds are distributed to investors is considerably different.  Therefore, hedge fund managers interested in entering the alternative mutual funds market must contend with a range of issues that they typically are not equipped to handle by experience, staffing or structure.  See “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  To help hedge fund managers identify the issues that they will have to tackle before entering the alternative mutual funds market – and to provide strategies for handling those issues – the Hedge Fund Law Report recently spoke with George Silfen, a partner at Kramer Levin Naftalis & Frankel LLP.  Silfen has significant experience advising sponsors on the organization, operation and distribution of alternative mutual funds.  Our interview with Silfen covered various topics relevant to alternative mutual funds and their managers, including popular investment strategies; distribution arrangements and fees; fulcrum fees and other compensation for the fund sponsor; the risk of cannibalization of a manager’s hedge funds; affiliated transaction concerns; appeal for institutional investors; side letters; side by side management with traditional hedge funds; and managing conflicts of interest.  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, 2012).

Recent Survey Reveals Hedge Fund Professionals’ Perspectives on the Prevalence of and Pressures to Engage in Unethical Conduct and Illegal Activity in the Hedge Fund Industry

A recent survey of hedge fund professionals asked respondents various questions to understand their views on the need for and prevalence of unethical conduct or illegal activity (together, misconduct) at their own firms and among their competitors; any temptations or pressure to engage in misconduct; their firms’ likely responses to misconduct; and the SEC’s effectiveness in stamping out misconduct.  The survey results were broken down into various demographic categories, including the respondents’ gender, 2012 earnings and years of work experience, as well as their firms’ assets under management.  This article summarizes key findings from the survey.

SEC Charges Hedge Fund Manager with Manipulating the Value of Fund Holdings, Paying Excessive Fees to an Interested Brokerage Firm and Making Misrepresentations to Investors

The SEC recently filed a settled enforcement action against a hedge fund manager and its founder as well as the CEO of an interested brokerage firm that provided placement agent and trade execution services to the manager’s funds, alleging that the defendants defrauded investors in several ways.  Among other things, the hedge fund manager and its founder inflated the valuation of assets held by its funds; paid excessive fees and commissions to the brokerage firm; and hired stock promoters to manipulate the price of microcap stocks held by the fund.  For discussions of other recent SEC enforcement actions involving valuation of assets, see “SEC Charges Fund Sponsor Yorkville Advisors and Its Principals with Fraud in Connection with Valuation of Fund Assets,” Hedge Fund Law Report, Vol. 5, No. 41 (Oct. 25, 2012); and “SEC Charges Hedge Fund Manager with Impermissible Cross Trades, Inflating Valuation and Misleading Investors in a Scheme to Hide Fund Losses,” Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  The CEO of the brokerage firm was charged with aiding and abetting the hedge fund manager’s fraud related to payments made to the brokerage firm.  This article summarizes the allegations, claims and relief sought by the SEC.

SEC Commissioner Walter Explains How an Overworked and Under-Resourced SEC Staff Can Nonetheless Examine Private Fund Advisers Effectively

On April 16, 2013, SEC Commissioner Elisse Walter addressed the 2013 NASAA Public Policy Conference in Washington, D.C.  The general theme of Walter’s address was that with respect to examinations of investment advisers, federal and state securities regulators have more obligations than they have resources.  Specifically, the Dodd-Frank Act reallocated responsibility for examinations of small and mid-sized investment advisers from the SEC to state securities regulators.  See “NASAA Report Identifies Most Commonly Cited Investment Adviser Deficiencies Found in Coordinated State Adviser Examinations and Recommends Compliance Best Practices for Mid-Sized Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 12 (Mar. 22, 2012).  While part of the intent of this reallocation of responsibility was to “free up” the SEC’s examination resources, Dodd-Frank may have increased the SEC’s total workload by bringing private fund advisers under its regulatory, examination and enforcement auspices.  See “Challenges Faced By, Risks Encountered By and Lessons Learned From First Filers of Form PF,” Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  In short, state securities regulators have more advisers to examine and federal securities regulators have larger and more complex advisers to examine.  Yet neither has materially more budget.  So how are the various regulators supposed to conduct adequate examinations and protect investors?  Walter’s speech was intended, in part, to address that question by sharing the SEC’s learning with her state counterparts.  To do so, Walter discussed the challenges presented by small firms; three specific ways in which SEC examination staff members have remained effective in light of limited resources; and relevant examination statistics.  Walter’s speech was, in effect, a follow-up to her statement on the SEC’s 2011 Study on Enhancing Investment Adviser Examinations.  For a discussion of that study, and of Walter’s contemporaneous statement, see “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).

Clive Snowdon Joins Moore Group

On April 15, 2013, hedge fund administrator Moore Group announced that Clive Snowdon has been appointed Group Managing Director.  See “Who Are the Top Ten Hedge Fund Administrators by Assets Under Administration?,” Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012).

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