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    Jul. 11, 2013

Seven Recommendations to Assist Private Fund Managers in Navigating Heightened SEC Examination and Enforcement Activity

Hedge fund managers must contend with a gathering storm of SEC examinations and heightened attention from the SEC’s Division of Enforcement.  This guest article describes the context and goals of the increased examination and enforcement activity, and provides seven practical recommendations to assist private fund managers in preparing for and navigating heightened examination and enforcement scrutiny.  The authors of this article are Marc Fagel, previously Director the SEC’s San Francisco Regional Office and now a partner at Gibson, Dunn & Crutcher LLP, and Kenneth Burke, a litigation associate at Gibson Dunn.

Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part One of Two)

If you as a hedge fund manager want to raise and retain institutional investor capital, you have to make (or remain) friends with investment consultants.  Such consultants are playing an increasingly central role in the allocation decisions of institutional investors with respect to hedge funds, for at least five reasons.  First, funding gaps, demographic shifts and other factors have increased the need among many institutions to generate consistent alpha; the same dynamics have accentuated the stakes of making an allocation mistake.  Second, consultants are usurping much of the advisory terrain previously occupied by funds of funds because of concerns regarding the latters’ fees and performance shortcomings.  See “SEI Report Highlights Challenges Faced by Fund of Hedge Funds Industry and Recommends Improvements,” Hedge Fund Law Report, Vol. 5, No. 47 (Dec. 13, 2012).  Third, the due diligence process and allocation decisions have become more multifaceted, focusing as much (or more) on operational issues than on performance alone.  See “What Should Hedge Fund Managers Expect When ERISA Plans Conduct Due Diligence on and Negotiate for Investments in Their Funds?,” Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).  Fourth, the pace of regulatory change and new fund launches make it difficult for institutions to keep up with due diligence best practices or investment options.  See “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Fifth, the growing use of investment consultants by institutions has made any particular institution less inclined to go it alone.  In short, investment consultants are fast becoming the standard of care for institutional investors allocating capital to private funds.  As such, they effectively serve as “gatekeepers” – in the commonly heard phrase – to the deepest pool of capital available to hedge fund managers.  In light of the centrality of investment consultants to the world of private fund allocations, this article offers a tutorial to hedge fund managers on what matters to consultants.  To do so, this article – the first in a two-part series – memorializes our interviews with a range of leading consultants on the topics they consider most important.  In particular, this article provides an overview of services and service models employed by investment consultants; discusses how consultants staff engagements and how they are compensated; explores how consultants think about manager selection; and details how managers can disclose information required by consultants while protecting such information.  The second article in this series will focus on the legal and regulatory risks faced by hedge fund managers in working with consultants, and will offer suggestions on mitigating those risks.

Second Circuit Rules on Suppression of Wiretap Evidence and Application of the “Knowing Possession” Element of Insider Trading in Upholding Raj Rajaratnam’s Conviction for Insider Trading

In 2011, Raj Rajaratnam, the founder of the Galleon hedge fund group, was convicted on fourteen counts of securities fraud and conspiracy to commit securities fraud arising out of insider trading in the securities of numerous companies.  He was sentenced to 11 years in prison.  See “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013).  The case was unusual, not only because of the stiff sentence, but also because it turned largely on evidence derived from wiretaps of Rajaratnam’s telephone conversations.  For more on the use of wiretaps, see “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  The trial judge denied Rajaratnam’s motion to suppress that evidence.  On June 24 of this year, the U.S. Court of Appeals for the Second Circuit (Court) upheld Rajaratnam’s conviction and ruled that the U.S. District Court for the Southern District of New York (District Court) correctly refused to suppress the wiretap evidence against Rajaratnam.  The Court also ruled that the District Court properly instructed the jury that it could convict Rajaratnam if it concluded that “material non-public information given to the defendant was a factor, however small, in the defendant’s decision to purchase or sell stock.”  See “Is the ‘Mosaic Theory’ a Viable Defense to Insider Trading Charges Against Hedge Fund Managers Post-Galleon?,” Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  This article summarizes the Court’s decision and, more importantly, its analysis in ruling on the appeal.

How Can Hedge Fund Managers Identify and Mitigate Insider Trading Risks Associated with Gathering and Using Political Intelligence?

Many hedge fund managers and other buy-side firms use political intelligence (PI) to inform their trading decisions, but use of PI is not without risk, particularly the risk that misuse of that information could lead to an insider trading charge.  See “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  In that regard, the Stop Trading on Congressional Knowledge Act of 2012 (STOCK Act), enacted last year, clarified a gray area that had existed in insider trading jurisprudence – making clear that the insider trading prohibitions contained in the federal securities laws apply with respect to PI.  Consequently, a hedge fund that trades on material nonpublic information provided by a member of Congress or a congressional staffer is explicitly exposed to insider trading liability.  See “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).  Yet, much uncertainty remains, including understanding the boundaries of what constitutes PI as well as determining the circumstances under which PI constitutes material nonpublic information.  To shed light on these issues for hedge fund managers, a recent panel, which included an official from the SEC’s Division of Enforcement, discussed the contours of and the impact of the STOCK Act.  This article summarizes the key lessons from the panel discussion.

CIMA-Sponsored Survey Highlights Hedge Fund Industry Views on Cayman Islands Corporate Governance Practices and Suggested Reforms

As part of its corporate governance reform process, the Cayman Islands Monetary Authority (CIMA) recently surveyed hedge fund managers, investors, directors and service providers regarding their views on corporate governance at Cayman Islands hedge funds.  See “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors,” Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  Specifically, the survey solicited the views of respondents on what elements comprise robust corporate governance at a Cayman fund; the strengths and weaknesses of Cayman boards; the adequacy of the current Cayman governance regime; the types of information that would assist in evaluating the robustness of a fund’s governance standards; and the areas in which Cayman corporate governance standards can be improved.  Among other things, the survey also drilled down on issues such as whether there should be a limit placed on the number of directorships that may be held by a single director and whether it would be beneficial to require disclosure of the total number of directorships held by each director.  This article summarizes the noteworthy findings from the survey.  For more on Cayman corporate governance issues, see “Speakers at Walkers Fundamentals Hedge Fund Seminar Discuss Recent Trends in Hedge Fund Terms, Corporate Governance, Side Letters, FATCA and Cayman Fund Regulation,” Hedge Fund Law Report, Vol. 5, No. 48 (Dec. 20, 2012).

Hedge Fund Initiates Derivative Suit Against Directors of a Portfolio Company Alleging Self-Dealing in Approving an Acquisition

Hedge fund managers keen on protecting their funds and their investors from self-dealing or fraud engaged in by directors and officers of portfolio companies or underlying funds must sometimes resort to initiating derivative suits on behalf of such entities against such directors and officers.  For a discussion of derivative suits initiated by investors on behalf of hedge funds, see “In What Circumstances May Hedge Fund Investors Bring Proceedings in the Name of the Fund for a Wrong Committed Against the Fund, When Those in Control of It Refuse to Do So?,” Hedge Fund Law Report, Vol. 6, No. 3 (Jan. 17, 2013).  A recent example of such a derivative suit was initiated on June 18, 2013, when Omega Overseas Partners, Ltd. (Omega), a hedge fund and a shareholder in investment company Tetragon Financial Group, Ltd. (TFG or the Company), filed an action in the U.S. District Court for the Southern District of New York on behalf of TFG against its officers and directors; its investment manager, Tetragon Financial Management LP; and certain of their affiliates in connection with the board’s decision to approve TFG’s purchase of an investment firm owned and controlled by TFG’s principals and the subsequent share repurchase scheme.  These acts allegedly enriched the principals and TFG management unjustly.  An allegedly “deeply conflicted” TFG board committee approved this two-part scheme, benefitting themselves and TFG principals at the Company’s and its shareholders’ expense.  This article summarizes the primary allegations in Omega’s complaint.

Former CFTC Counsel Joins Norton Rose Fulbright in Washington, D.C.

On June 26, 2013, Norton Rose Fulbright announced that experienced government lawyer Terry Arbit is joining its global legal practice in its member firm in Washington, D.C., focusing on commodities, futures and derivatives issues, including regulatory, compliance and litigation matters.  See “Practising Law Institute Panel Discusses Sweeping Regulatory Changes for Hedge Fund Managers That Trade Swaps,” Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012); and “RCA Symposium Panels Discuss New CFTC and NFA Regulations Governing Obligations of Hedge Fund Managers Required to Register as CPOs or CTAs,” Hedge Fund Law Report, Vol. 6, No. 21 (May 23, 2013).

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