Jun. 27, 2014

The Hedge Fund Law Report Will Not Publish an Issue This Week and Will Resume Its Regular Publication Schedule Next Week

Please note that, consistent with prior practice, the Hedge Fund Law Report will not publish an issue for the week starting June 30, 2014 (and including the July 4 holiday), and will resume its regular publication schedule next week, the week starting July 7, 2014.

RCA ECO 2014 Symposium Offers Insight from Top SEC Officials on Cybersecurity, Reg M, Examinations, Insider Trading Investigations, the Newman Appeal, Expert Networks and Political Intelligence (Part Two of Two)

This is the second article in a two-part series covering the Regulatory Compliance Association’s Enforcement, Compliance and Operations 2014 Symposium, held on May 1, 2014 in New York City.  This article summarizes the key insights offered at the Symposium by top SEC officials and industry participants with respect to cybersecurity, Rule 105 of Regulation M, hedge fund manager examinations, evolving investigative techniques used in criminal investigations of insider trading, insider trading doctrine and the appeal in United States v. Newman, expert networks and political intelligence.  The first article in this series dealt with regulatory transparency, custody, conflicts raised by serving simultaneously as a broker and investment adviser, what the SEC’s Division of Trading and Markets does, interaction between the SEC’s Office of Compliance Inspections and Examinations and its Enforcement Division, broker registration of in-house marketing departments, alternative mutual funds and the JOBS Act.  See “RCA Enforcement, Compliance and Operations 2014 Symposium Offers Insight from Top SEC Officials on Custody, Conflicts, Broker Registration, Alternative Mutual Funds and the JOBS Act (Part One of Two),” Hedge Fund Law Report, Vol. 7, No. 22 (Jun. 6, 2014).

Cybersecurity for Hedge Fund Managers: Compliance Best Practices, SEC Examinations and Cyber-Liability Insurance

On March 26, 2014, the SEC hosted a cybersecurity roundtable featuring representatives from regulators and the private sector.  See “Seven Cybersecurity Risks That SEC Examiners Will Look for in Examinations of Hedge Fund Managers,” Hedge Fund Law Report, Vol. 7, No. 17 (May 2, 2014).  Three weeks later, OCIE issued a Risk Alert on cybersecurity preparedness in the securities industry, and announced a plan to examine more than 50 registered investment advisers and broker-dealers on cybersecurity matters.  Just last week, CNBC and others reported that in late 2013, cyber criminals installed a malicious computer program on the servers of a large hedge fund manager, interrupting its high-speed trading strategy and routing trade information to offsite servers.  Clearly, cyber threats are a practical problem for hedge fund managers and – in light of regulators’ recognition of the practical problem – a regulatory issue.  A recent program offered concrete advice for hedge fund managers on addressing both the practical risk from cyber threats and the derivative regulatory risk.  In particular, the program focused on three themes: how to craft and implement effective cybersecurity policies and procedures; what the SEC wants to see at hedge fund managers in terms of cybersecurity; and the availability of insurance against cyber risks and losses.  This article summarizes the points from the discussion that hedge fund managers can use to update their approaches to cybersecurity.  In addition, this article relays the four main findings from a recent report by McKinsey & Company on effective cybersecurity strategies.  See also “Evolving Operational Due Diligence Trends and Best Practices for Due Diligence on Emerging Hedge Fund Managers,” Hedge Fund Law Report, Vol. 7, No. 15 (Apr. 18, 2014) (section entitled “Cybersecurity”).

The Role of Outsourced Compliance Consultants in the Hedge Fund Compliance Ecosystem

Under Advisers Act Rule 206(4)-7, registered hedge fund managers are required to designate a chief compliance officer (CCO), but they are not required to hire an additional executive to serve in that capacity.  Instead, they can assign the CCO role to an existing executive in another role – for example, the general counsel – so long as that person has, in the language of the rule release, “sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.”  See “Simon Lorne, Chief Legal Officer of Millennium Management LLC, Discusses the Evolving Roles, Challenges and Risks Faced by Hedge Fund Manager General Counsels and Chief Compliance Officers,” Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013).  However, even a person with sufficient seniority and authority may not have sufficient time to discharge the duties of a CCO effectively, especially in larger or more complex management companies.  Similarly, “single hatted” CCOs – those with the CCO title and no other – may find their resources taxed and their experience bounded in light of the growth or complexity of the management company.  In short, even a well-staffed compliance function at a hedge fund manager may need to be supplemented with external resources.  Not surprisingly, an industry of compliance consultants and outsourced compliance service providers has arisen to serve this demand.  A relatively new entrant into this industry – albeit one affiliated with an old accounting name – is EisnerAmper Compliance and Regulatory Services, LLC, or CARS.  The Hedge Fund Law Report recently conducted an interview with the principals of CARS – Gary Swiman and Carmine Angone – in an effort to understand where CARS and similar services fit within the hedge fund compliance ecosystem.  In particular, we asked Swiman and Angone for their views on: how an outsourced compliance service provider can be effective if it is not on the ground on a day-to-day basis; conflicts inherent in a compliance service provider’s affiliation with an accounting firm, and how to handle those conflicts; pricing of outsourced compliance services, and measuring the effectiveness of such services; assessing hedge fund enterprise risk; mitigating conflicts raised by dual registration as an investment adviser and broker-dealer; allocating expenses at private equity firms; compliance challenges for family offices; anti-money laundering considerations for hedge fund managers; and the skill sets and backgrounds that should be present among the staff at an outsourced compliance firm.

Can a Hedge Fund That Holds Senior Subordinated Notes Issued by a Credit Default Swap Seller Sue the Issuer Despite a “No-Action” Clause in the Indenture Governing the Notes?

The New York Court of Appeals, the state’s highest court, recently ruled on the scope of a “no-action” clause in a bond indenture.  This article analyzes the ruling.  For a discussion of a dispute involving bond redemption rights, see “Recent Decision Highlights the Perils for Hedge Fund Managers of Failing to Understand Early Redemption Provisions in Bond Indentures,” Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013).  For a discussion of a dispute involving an indenture’s impact on bankruptcy claims, see “Tribune Bankruptcy Highlights the Importance of Close Reading of Indenture Agreements by Hedge Funds That Trade Bankruptcy Claims or Distressed Debt,” Hedge Fund Law Report, Vol. 5, No. 43 (Nov. 15, 2012).

Key Investment and Operational Restrictions Imposed on Alternative Mutual Funds by the Investment Company Act of 1940 (Part Two of Two)

This is the second article in a two-part series covering a recent program on alternative mutual funds.  Speakers at the program – including K&L Gates partners and Cordium executives – discussed the benefits and limitations of alternative mutual funds, outlined ways to enter the alternative mutual fund market and provided a thorough overview of some of the investment and operational restrictions imposed on alternative mutual funds by the Investment Company Act of 1940.  This article summarizes the investment and operational restrictions identified by the speakers, including issues relating to leverage, custody, prime brokerage, valuation, liquidity, portfolio management, CFTC jurisdiction and compliance policies and procedures.  The first article in this series addressed the potential advantages of alternative mutual funds over hedge funds, mutual fund laws and rules that are typically foreign to hedge fund managers, hedge fund strategies that “fit” within the mutual fund model and the pros and cons of three structures for entry by hedge fund managers into the alternative mutual fund business.  See “K&L Gates and Cordium Detail the Structuring, Investment and Operational Mechanics of Entry by Hedge Fund Managers Into the Alternative Mutual Fund Business (Part One of Two),” Hedge Fund Law Report, Vol. 7, No. 24 (Jun. 19, 2014).

Investment Funds Attorney Scott MacLeod Joins Greenberg Traurig

Scott R. MacLeod recently moved his practice to Greenberg Traurig’s Orlando, Florida office, from Holland & Knight.  For insight from MacLeod, see “Legal Mechanics of Converting a Hedge Fund Manager to a Family Office,” Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011); “How Will the SEC’s New Pay to Play Rule Impact Mergers and Acquisitions of Hedge Fund Management Companies?,” Hedge Fund Law Report, Vol. 3, No. 31 (Aug. 6, 2010).

Financial Institutions Litigation and Regulation Partner Jason Jurgens Joins Jones Day in New York

Jason Jurgens recently joined Jones Day as a partner in the firm’s Financial Institutions Litigation and Regulation practice in New York.  His practice focuses on the representation of major financial institutions and market participants in connection with civil litigation and regulatory investigations arising out of structured finance arrangements, derivatives and contractual disputes.  On derivatives, see “Five Steps for Proactively Managing OTC Derivatives Documentation,” Hedge Fund Law Report, Vol. 7, No. 16 (Apr. 25, 2014); on structured finance, see “Private Investment Funds Investing in CLO Equity and CLO Warehouse Facilities,” Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).