Oct. 25, 2013

Can Hedge Fund Managers Use Gross (Rather Than Net) Results in Performance Advertising? (Part One of Two)

The hedge fund industry’s enthusiasm for the JOBS Act has been tempered by the recognition that while the law and related rules expand the opportunities for advertising by managers, they do not alter much of the long-standing authority governing such advertising.  See “Schulte, Cleary and MoFo Partners Discuss How the Final and Proposed JOBS Act Rules Will Impact Hedge Fund Managers and Their Funds,” Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).  In particular, the JOBS Act rules did not abridge or relax the regulatory regime governing performance advertising by hedge fund managers.  See “A Compilation of Important Insights from Leading Law Firm Memoranda on the Implications of the JOBS Act Rulemaking for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013).  Norm Champ, the Director of the SEC’s Division of Investment Management, emphasized this point in a September 12, 2013 speech at the Practising Law Institute, cautioning, “I’ve instructed Division of Investment Management rulemaking and risk and examination staff to pay particular attention to the use of performance claims in the marketing of private fund interests.  In particular, this review will endeavor to identify potentially fraudulent behavior and to assess compliance with the federal securities laws, including appropriate Investment Advisers Act provisions.”  What hedge fund managers can and cannot do in the course of performance advertising is the product of law, SEC rules, no-action precedent and decades of practice; it is largely a function of principles and experience rather than explicit or rules-based guidance.  At the same time, performance remains a dominant factor in the capital allocation decisions of institutional investors.  See “Goldman Prime Brokerage Survey Relays the Views of Institutional Investors on Hedge Fund Fees, Manager Selection, Due Diligence, Return Expectations, Liquidity, Managed Accounts, UCITS and Alternative Mutual Funds,” Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).  Accordingly, hedge fund managers want (and need) to know how to put their best foot forward in performance advertising without causing that foot to trip a regulatory wire.  And in analyzing this area, managers are particularly concerned with whether they can advertise using gross performance results; if so, how; and, if not, how to calculate and present net performance results in a way that passes legal muster while still reflecting positively on the manager.  This article is the first in a two-part series that aims to help managers think through these and similar questions relating to the calculation and presentation of performance results in marketing, advertising, governing documents and other contexts.  Specifically, this article provides an overview of relevant law and SEC guidance (including relevant no-action letters), and offers practical guidance on calculating and presenting net performance results.  The second installment will identify situations in which managers may, consistent with relevant regulation, present gross performance results; outline the mechanics of calculating and presenting performance results in a number of challenging scenarios that hedge fund managers regularly face; and describe best practices for hedge fund managers in presenting their performance results.

Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part One of Three)

Sidley Austin LLP recently hosted a conference in its New York office entitled “Private Funds 2013: Developments and Opportunities.”  At the conference, Sidley partners discussed various structuring, regulatory, operational and transactional developments impacting private funds and their managers.  The Hedge Fund Law Report is publishing a three-part series of articles covering the most important insights arising out of the conference.  In this first installment, we summarize the parts of the conference dealing with recent developments in fund structuring, single-investor funds, first loss capital arrangements, side letter terms, hard wiring of feeder funds for ERISA purposes, liquidity terms, fee terms, founder share classes and expense allocations and expense caps.  The second article in the series will discuss recent developments in SEC examinations and enforcement (including a discussion of compliance policy violations, valuation practices, allocation of investment opportunities, insider trading issues, use of political intelligence firms and expert networks, the SEC’s new policy requiring admissions of wrongdoing and best practices for compliance); seeding arrangements; and fund mergers and acquisitions (including a discussion of key terms and negotiating points for such transactions).  The third article will provide an update on regulatory developments impacting fund managers, including recent issues involving commodity pool operator registration and regulation, implementation and compliance with the JOBS Act and derivatives reforms.

National Futures Association Director of Compliance, Patricia L. Cushing, Discusses the Chief Regulatory Obstacles Faced by Hedge Fund Managers When Marketing Commodity Funds

Following repeal of the CFTC Rule 4.13(a)(4) commodity pool operator (CPO) registration exemption, numerous hedge fund managers with strategies involving commodities or derivatives registered as CPOs with the CFTC and became members of the National Futures Association (NFA).  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).  Such managers face at least two broad challenges in marketing fund interests.  First, CFTC rules governing commodity pool marketing differ in important ways from SEC rules governing hedge fund marketing.  On CFTC marketing rules, see “CPO Compliance Series: Marketing and Promotional Materials (Part Two of Three),” Hedge Fund Law Report, Vol. 5, No. 38 (Oct. 4, 2012); on hedge fund marketing, see “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement? (Part Three of Three),” Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013).  Second, effectively negotiating CFTC marketing and other rules requires a thorough and continuously updated understanding of the views of relevant compliance and enforcement officials.  As an adjunct to the efforts of hedge fund managers on the latter point, the Hedge Fund Law Report recently interviewed Patricia L. Cushing, Director of Compliance at the NFA, which is charged with regulating and examining CPOs.  Our interview with Cushing addressed, among other topics, whether the NFA will increase its scrutiny of marketing by CPOs now that the JOBS Act rules have become effective; the NFA’s emerging enforcement focus areas; most common deficiencies uncovered during reviews of CPO marketing materials; the NFA’s views on the use of past specific recommendations in performance presentations; the NFA’s approach to marketing issues raised by use of social media; best practices for review and approval of marketing materials; best practices for retention of promotional materials disseminated through website, radio and television; the role of the CCO or other supervisors in the marketing review process; and supervisory liability of CCOs.  See “Recent SEC Settlement Clarifies the Scope of Supervisory Liability for Chief Compliance Officers of Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Compliance, Regulation and Enforcement 2013 Symposium, to be held at the Pierre Hotel in New York City on October 31, 2013.  Subscribers to the Hedge Fund Law Report are eligible for a registration discount.

PLI Panel Addresses Recent Developments with Respect to Prime Brokerage Arrangements, Alternative Registered Funds and Hedge Fund Manager Mergers and Acquisitions

A recent Practising Law Institute (PLI) program provided a timely overview of current issues with respect to the establishment of prime brokerage arrangements, including the negotiation of prime brokerage agreements; mergers and acquisitions of hedge fund managers; and the formation and operation of registered funds.  This article summarizes the key points from that presentation.  The speakers were Nora M. Jordan, a partner at Davis Polk & Wardwell LLP; Harry Jho, Principal of Harry Jho LLC; and Andrew Siegel, a partner and General Counsel of Perella Weinberg Partners.

Recent Developments Affecting the Protection of Trade Secrets by Hedge Fund Managers

The past few years have seen a significant and highly public move by the Department of Justice and other government entities to pursue prosecutions of the criminal laws governing the theft of trade secrets, including the theft of trade secrets from hedge fund managers.  In articles published in the Hedge Fund Law Report in December 2010 and April of 2012, Sean R. O’Brien and Sara A. Welch, Managing Partner and Counsel, respectively, at O’Brien LLP, examined the significant government resources being committed to these efforts, as well as the fast-changing legal framework that applied to them.  See “Protecting Hedge Funds’ Trade Secrets: The Federal Government’s Enforcement of Criminal Laws Protecting Proprietary Trading,” Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010); and “Protecting Hedge Funds’ Trade Secrets: What a Difference a Year Makes,” Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).  Another year has wrought equally significant developments in this critical area.  In this guest article, O’Brien and Welch return to the pages of the HFLR to examine these developments and explain their implications for hedge fund managers.

What Do the SEC’s Recently Released FAQs on Supervisory Liability Mean for Legal and Compliance Personnel at Broker-Dealers and Hedge Fund Managers?

The prospect of supervisory liability for legal and compliance personnel at hedge fund managers has occasioned concern among such employees, particularly since there has been a dearth of definitive guidance from the SEC as to when such liability attaches.  On September 30, 2013, the SEC’s Division of Trading and Markets issued a set of frequently asked questions (FAQs) addressing the supervisory liability of compliance and legal personnel at broker-dealers pursuant to Sections 15(b)(4) and 15(b)(6) of the Securities Exchange Act of 1934.  However, as the Investment Advisers Act of 1940 also contains a provision that imposes supervisory liability on compliance and legal personnel at investment advisers, legal experts have already begun to weigh in on the potential impact of the FAQs for investment advisers, including hedge fund managers.  This article summarizes the SEC guidance contained in the FAQs and offers valuable insights from Russell Sacks and Charles Gittleman, partner and of counsel, respectively, at Shearman & Sterling LLP, and Jay Gould, partner at Pillsbury Winthrop Shaw Pittman LLP, on the implications of the FAQs for legal and compliance personnel at broker-dealers and investment advisers.  For a discussion of a recent SEC settlement involving supervisory liability of a chief compliance officer at an investment advisory firm, see “Recent SEC Settlement Clarifies the Scope of Supervisory Liability for Chief Compliance Officers of Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

Former Credit Suisse Director of Alternative Investments Joins Lowenstein Sandler

On October 21, 2013, Lowenstein Sandler LLP announced that Edward S. Nadel is joining its Investment Management Group as senior counsel.  Nadel was previously General Counsel and Chief Compliance Officer at Star Mountain Capital, LLC, and, prior to that, was Director of Alternative Investments at Credit Suisse.  For insight from Lowenstein, see “A Practical Guide to the Implications of Derivatives Reforms for Hedge Fund Managers,” Hedge Fund Law Report, Vol. 6, No. 29 (Jul. 25, 2013).

Lynn Chan Joins Proskauer’s Hong Kong Office

On October 22, 2013, Proskauer Rose LLP announced that Lynn Chan has been appointed as a consultant in its private investment funds group, resident in Hong Kong.  Chan joins from O’Melveny & Myers LLP, where she served as counsel in their investment funds practice and worked in the Hong Kong and Singapore offices.  For more on Hong Kong, see “How Can Hedge Fund Managers Understand and Navigate the Perils of Insider Trading Regulation and Enforcement in Hong Kong and the People’s Republic of China,” Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013); and “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Four of Four),” Hedge Fund Law Report, Vol. 5, No. 3 (Jan. 19, 2012).  For more on Singapore, see “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Three of Four),” Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).