Sep. 18, 2014

Further CFTC Harmonization of Rules for Hedge Funds: A Welcome and Continuing Trend

It is widely recognized that the Commodity Futures Trading Commission (CFTC) has made great strides previously in terms of harmonizing its rules with those of other regulators, including the Securities Exchange Commission (SEC).  See “What Do the CFTC Harmonization Rules Mean for Non-Mutual Fund Commodity Pools, Including Hedge Funds?,” Hedge Fund Law Report, Vol. 6, No. 40 (Oct. 17, 2013).  In perhaps a sign that new leadership at the CFTC has settled in and intends to continue the trend toward harmonization, the CFTC has recently acted on a variety of items with respect to which the industry was waiting, in some cases for a year or more, for sorely needed guidance.  While not all pressing issues have been resolved by the CFTC, a number of them have been.  In a guest article, Steven M. Felsenthal, General Counsel and Chief Compliance Officer of Millburn Ridgefield Corporation, The Millburn Corporation and Millburn International, LLC, summarizes some of the recent CFTC actions and guidance, notes certain implications thereof that may or may not require further guidance and identifies certain items with respect to which further CFTC action would be welcome.  The focus of this article is on certain issues affecting hedge fund advisers that are also commodity pool operators, who are thus subject to both SEC and CFTC regulatory regimes.

Internal Memo Describes IRS Position on Whether Limited Partner Exemption from Self-Employment Tax Is Available to Owners of an Investment Management Company

The Office of Chief Counsel of the Internal Revenue Service (IRS) recently released a Memorandum that considers whether members of a limited liability company that serves as an investment manager to several investment funds are entitled to rely on the exemption from self-employment taxes afforded to “limited partners” under §1402(a)(13) of the Internal Revenue Code.  The IRS’ position is important because the federal Medicare tax applies to all self-employment earnings; there is no income limit, as there is for social security tax.  See also “Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions,” Hedge Fund Law Report, Vol. 5, No. 40 (Oct. 18, 2012).

CFTC Allows Hedge Fund Managers to Advertise

Private funds that are subject to regulation by the SEC may also constitute commodity pools within the meaning of the Commodity Exchange Act, which may subject them and their advisers to regulation by the CFTC.  See “Do You Need to Be a Registered Commodity Pool Operator Now and What Does It Mean If You Do? (Part Two of Two),” Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  In accordance with the JOBS Act, the SEC issued new rules that lift the ban on general solicitation and general advertising by private fund sponsors under certain conditions.  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).  The CFTC did not follow suit, leaving managers of funds that trade in commodities in a bind, because general solicitation and general advertising render commodity pool operators ineligible for certain important exemptions from CFTC rules.  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).  Specifically, CFTC Regulation 4.7(b) provides registered commodity pool operators with relief from certain disclosure, reporting and recordkeeping requirements; and Regulation 4.13(a)(3) contains an exemption from registration as a commodity pool operator.  However, both regulations contain requirements that are inconsistent with the lifting of the ban on general solicitation and general advertising reflected in new SEC Rules 506(c) and 144A.  On September 9, 2014, the CFTC’s Division of Swap Dealer and Intermediary Oversight issued exemptive relief to bring Regulations 4.7(b) and 4.13(a)(3) into line with those new SEC Rules.  This article summarizes the existing regulatory lay of the land and the key provisions of the relief.

Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse (Part Three of Five)

This is the third article in our five-part serialization of a treatise chapter by Dechert LLP partner Andrew Oringer.  The chapter describes the ERISA provisions of chief relevance to private fund managers, and includes references to a wide range of relevant and, in some cases, obscure authority.  This third article in the series focuses on prohibited transactions, qualified professional asset managers, the “service provider” exemption and the exemption for compensation for services.  The second article in the series covered fiduciary duty considerations, including delegation, allocation of investment opportunities, varied interests of fund investors, indemnification and insurance, investments in portfolio funds, enforcement-related matters and diversification requirements.  The first article in the series discussed the “plan assets” rules and rules for the delegation and allocation of fiduciary responsibility.

Three Reasons Why Hedge Fund Managers That Trade Commodities or Derivatives Should Care about Insider Trading in Securities

For insider trading liability to attach, there must be, among other things, a purchase or sale of a security.  See “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012) (subsection entitled “Summary of the Elements Under U.S. Law”).  Therefore, one might conclude that the manager of a hedge fund that invests exclusively in commodities and derivatives might fall outside the ambit of insider trading laws.  Similarly, one might conclude that the manager of one or more hedge funds that invest in commodities, derivatives and securities might only have to concern itself with insider trading laws to the extent of its securities trading.  This line of thinking is wrong – and hedge fund managers focused on commodities and derivatives do have to concern themselves with insider trading – for at least three reasons.

SEC Investment Management Division Director Norm Champ Pinpoints the Key Compliance Challenges in Hedge Fund and Alternative Mutual Fund Management

On September 11, 2014, SEC Division of Investment Management Director Norm Champ delivered remarks at the Practising Law Institute’s 2014 hedge fund management seminar.  Champ covered a wide range of territory, including industry statistics, use of Forms ADV and PF for systemic risk monitoring and enforcement purposes, recent guidance updates and no-action letters relevant to hedge fund managers, evolving examination dynamics, signs of a weak compliance program and industry-specific conflicts of interest.  Champ also highlighted notable conflicts of interest inherent in simultaneously managing alternative mutual funds and hedge funds, expanding on the ideas he introduced in a speech at a PLI private equity event on June 30, 2014.  For more on Champ’s June 30 speech, see “Five Key Compliance Challenges for Alternative Mutual Funds: Valuation, Liquidity, Leverage, Disclosure and Director Oversight,” Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

Matthew Griffin to Lead White & Case’s Investment Funds Practice in London

On September 15, 2014, White & Case announced that Matthew Griffin will join the firm to lead its Investment Funds Practice in London.  Griffin has experience advising on investments in and formation of funds, as well as fund-related transactions such as restructurings and secondaries.  See “Key Structuring and Negotiating Points in Secondary Sales of Private Fund Interests,” Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).  His particular focus on is on private equity funds.  See “How Does the Custody Rule Apply to Special Purpose Vehicles Used by Private Equity Funds to Purchase, and Escrow Accounts Used to Sell, Portfolio Companies?,” Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014); “Anatomy of a Publicly-Offered Private Equity Investment Vehicle,” Hedge Fund Law Report, Vol. 7, No. 19 (May 16, 2014).  For insight from Griffin’s prior firm, see “Options Under the Volcker Rule for Bank Investment in Unaffiliated Private Equity and Hedge Funds,” Hedge Fund Law Report, Vol. 7, No. 9 (Mar. 7, 2014).