Jul. 25, 2013

SEC Charges Steven A. Cohen with Failing to Supervise Employees Who Allegedly Engaged in Insider Trading

On July 19, 2013, the SEC instituted administrative proceedings against Steven A. Cohen, the embattled founder of hedge fund adviser S.A.C. Capital Advisors, LLC (SAC).  Generally, the SEC charges Cohen with failing to supervise two of his portfolio managers, Mathew Martoma and Michael Steinberg, both of whom have been indicted on insider trading charges arising out of their trading for hedge funds advised by SAC.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme, Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  The SEC claims that Cohen ignored “red flags” that Steinberg and Martoma were trading on inside information.  While the SEC does not set forth the standard for “failure to supervise” liability in its order instituting administrative proceedings, the order nonetheless provides a glimpse into the activities that, in the agency’s view, represent a failure to supervise in the hedge fund context.  This article summarizes the factual allegations and administrative charges levied against Cohen by the SEC.  Notably, the SEC did not file civil charges against Cohen and did not charge him – administratively, civilly or otherwise – with insider trading.

Defense White Paper Refutes SEC’s Allegations That Steven A. Cohen Failed to Supervise Employees Accused of Insider Trading and Provides a Behind-the-Scenes Look at SAC Capital’s Compliance Program and Culture

On July 19, 2013, the SEC filed an order instituting administrative proceedings against Steven A. Cohen, the founder of S.A.C. Capital Advisors, LLC (SAC Capital), generally alleging that Cohen failed to supervise two portfolio managers, Mathew Martoma and Michael Steinberg, by ignoring “red flags” that should have alerted him to their allegedly improper conduct in relation to fund investments in Elan Corporation, Plc, Wyeth and Dell, Inc.  See “SEC Charges Steven A. Cohen with Failing to Supervise Employees Who Allegedly Engaged in Insider Trading,” above, in this issue of Hedge Fund Law Report.  In short, in a 46-page white paper (White Paper) dated July 22, 2013, Cohen’s defense team argues that there is no evidence to suggest that Cohen was aware of Martoma’s and Steinberg’s allegedly suspicious conduct and denied the characterization of the delineated conduct as representing “red flags.”  Furthermore, the White Paper argues that Cohen’s commitment to robust compliance, as demonstrated by his and SAC Capital’s development of a rigorous compliance program, belies any suggestion that Cohen overlooked the identified “red flags.”  Importantly, the White Paper also gives a behind-the-scenes look at the compliance program (most notably the insider trading controls) at one of the most sophisticated hedge fund firms in the world.  This article summarizes salient content from the White Paper.  For an in-depth discussion of the SEC’s settlement with SAC Capital and its affiliates relating to the above-referenced matters, see “Five Takeaways for Other Hedge Fund Managers from the SEC’s Record $602 Million Insider Trading Settlement with CR Intrinsic,” Hedge Fund Law Report, Vol. 6, No. 12 (Mar. 21, 2013).

SAC Capital Entities Indicted for Securities Fraud and Wire Fraud in Connection With Employees’ Alleged Insider Trading 

On July 25, 2013, the U.S. Department of Justice unsealed a 41-page indictment against CR Intrinsic Investors, LLC, Sigma Capital Management, LLC, S.A.C. Capital Advisors, LLC and S.A.C. Capital Advisors, L.P. (SAC Entities), charging them with four counts of securities fraud and one count of wire fraud in connection with alleged employee insider trading activity.  Among other things, the indictment alleges that employee insider trading activity was made possible by “institutional practices that encouraged the widespread solicitation and use of illegal inside information,” painting a dreary picture of the firm’s hiring practices and compliance culture in the process.  This article describes the factual allegations (including a description of alleged institutional practices), charges levied against the SAC Entities and relief sought.

Schulte, Cleary and MoFo Partners Discuss How the Final and Proposed JOBS Act Rules Will Impact Hedge Fund Managers and Their Funds

On July 10, 2013, the SEC adopted and proposed various rules to implement the JOBS Act enacted last year.  The adopted rules will (1) permit general solicitation and advertising for offerings made in reliance on Rule 506 under Regulation D and Rule 144A under the Securities Act of 1933, and (2) disqualify certain “bad actors” from being able to offer securities in reliance on Rule 506.  The SEC also proposed certain rule changes impacting Rule 506 offerings that would enhance Form D reporting; require legends on general solicitation and advertising materials; apply new anti-fraud rules to Rule 506 advertising materials; and require pre-filing of general solicitation and advertising materials with the SEC for a two-year period.  See “SEC JOBS Act Rulemaking Creates Opportunities and Potential Burdens for Hedge Funds Contemplating General Solicitation and Advertising,” Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  During a recent Practising Law Institute briefing, expert panelists Paul N. Roth, a founding partner of Schulte Roth & Zabel LLP; Alan L. Beller and Nicolas Grabar, both partners at Cleary Gottlieb Steen & Hamilton LLP; and David M. Lynn, a partner at Morrison & Foerster LLP, explained the SEC rulemaking; dissected the differences between the adopted rules and the 2012 rule proposals; and considered the implications of the rule changes for hedge funds offering securities in reliance on Rule 506.  This article summarizes the salient points raised by the expert panel during the briefing.

A Practical Guide to the Implications of Derivatives Reforms for Hedge Fund Managers 

Under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, a new world of cleared derivatives products is being developed, and hedge funds that employ derivatives will be required to use such cleared products.  To paraphrase the law, what is available for clearing must be cleared (subject to few exemptions that generally do not apply to funds).  This new world has created significant consternation for the hedge fund industry, which must engage new service providers, enter into new trading agreements and enter into new collateral arrangements.  These and other changes will create additional risks for hedge fund managers; likely increase the cost of doing business; and increase the complexity of trading relationships.  However, hedge fund managers that proactively address these concerns and challenges can mitigate some of the impact from these new regulations.  In a guest article, Matthew A. Magidson, Chair of Lowenstein Sandler’s Derivatives Practice Group and a Partner in the firm’s Investment Management Group, provides a roadmap for hedge fund managers on how to identify and address relevant challenges.

Mechanics of a Counterintuitive Conversion of a Hedge Fund to a Mutual Fund

The competition for investor capital among traditional managers and private fund managers is increasingly fierce, which has fueled many private fund managers to enter the mutual fund market.  See “Citi Prime Finance Report Describes the Competition among Traditional, Hedge and Private Equity Fund Managers for $1.3 Trillion in Liquid Alternative Assets (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 22 (May 30, 2013).  Hedge fund managers that have elected to pursue this strategy have typically done so by creating new, stand-alone alternative mutual funds.  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).  However, BTS Asset Management (BTSAM) recently pursued another approach, electing to “convert” the BTS Tactical Fixed Income Fund LLC (Fund) from a hedge fund to a mutual fund.  To understand the rationale for the conversion and the mechanics of effecting it, the Hedge Fund Law Report recently conducted an interview with Isaac Braley and Gary Shilman, CEO and Chief Compliance Officer, respectively, of BTSAM.  Specifically, our interview with Braley and Shilman covered: factors motivating the decision to convert the Fund to a mutual fund; legal and operational mechanics of the conversion; expenses incurred in effecting the conversion; changes in compliance policies, investment strategy and fund governance practices resulting from the conversion; and new challenges relating to the restrictions on transactions with affiliates contained in the Investment Company Act of 1940.  See also “Dechert Partners Aisha Hunt and Richard Horowitz Discuss Strategies and Challenges for Hedge Fund Managers Wishing to Enter the Alternative Mutual Fund Space,” Hedge Fund Law Report, Vol. 6, No. 20 (May 16, 2013).

Duane Morris’ London Office Adds Corporate Tax Partner Jennifer C. Wheater

On July 16, 2013, Duane Morris announced that Jennifer C. Wheater has joined the firm’s Corporate Practice Group in the London office as a tax partner.  See “FATCA Implementation Summit Identifies Best Practices Relating to FATCA Reporting, Due Diligence, Withholding, Operations, Compliance and Technology,” Hedge Fund Law Report, Vol. 6, No. 7 (Feb. 14, 2013).