Feb. 13, 2014

Three Steps in Responding to an SEC Examination Deficiency Letter and Other Practical Guidance for Hedge Fund Managers from SEC Veteran and Sutherland Partner John Walsh

The vast majority of hedge fund managers with any nexus to the U.S. interact with the SEC – directly via examinations, enforcement actions or filings, or indirectly by operating under the specter of anti-fraud enforcement.  Counsel (in-house or outside) and compliance officers can, accordingly, best effectuate their prophylactic purpose by understanding the expectations, operations and motivations of SEC officials and staff.  Few understand these dynamics – and how they relate to hedge fund managers – better than Sutherland Asbill & Brennan LLP partner and former SEC official John H. Walsh.  During his 23-year tenure at the SEC, Walsh, among other things, played a key role in creating the Office of Compliance Inspections and Examinations (OCIE), designed and implemented the SEC’s securities compliance examination practices and served as OCIE’s acting director in 2009.  The Hedge Fund Law Report recently interviewed Walsh in connection with the publication of Investment Adviser’s Legal and Compliance Guide, Second Edition, a treatise that Walsh co-authored with Terrance J. O’Malley.  Our interview aimed to connect Walsh’s experience with the concerns of hedge fund managers, and covered topics including: retraining of OCIE staff in 2009; building blocks of a credible “tone at the top”; managing voluminous SEC information requests during examinations; the role of technology in a well-designed examination strategy; factors SEC officials consider in making referrals to Enforcement; the advisability of voluntary presentations to SEC examiners; core elements of effective information barriers; responding to SEC deficiency letters; access to previously-issued SEC deficiency letters; information sharing between the SEC and other regulators; admissions of wrongdoing; and attorney-client privilege.

OCIE Risk Alert Identifies the Chief Concerns of Pension Fund Gatekeepers When Performing Hedge Fund Due Diligence

The SEC’s Office of Compliance Inspections and Examinations (OCIE), in coordination with the Division of Investment Management and the Asset Management Unit of the Enforcement Division, recently issued a Risk Alert summarizing the due diligence procedures that certain investment advisers employ when considering hedge funds and other alternative investments for their clients.  This article summarizes the key findings of the Risk Alert.  See also “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).

Four Strategies for Hedge Fund Managers for Accessing EU Capital Under the AIFMD

The European Union’s (EU) Alternative Investment Fund Managers Directive (AIFMD) took effect on July 22, 2013.  It established a comprehensive regime that regulates EU-based funds and fund managers and governs when and how alternative investments may be offered to prospective investors in the EU.  The AIFMD affects hedge funds, private equity funds, investment trusts and most other funds other than mutual funds, which in the EU are governed by the Undertakings for Collective Investment in Transferable Securities Directive.  See “A Practical Guide to AIFMD Reporting for Non-U.S. Fund Managers: Reporting Under AIFMD versus Form PF,” Hedge Fund Law Report, Vol. 6, No. 20 (May 16, 2013).  A recent panel of industry experts discussed how hedge fund managers can market their funds in the EU under the AIFMD.  This article summarizes the key insights from the program.  For an overview of the AIFMD and its impact on U.S. managers, see “Application of the AIFMD to Non-EU Alternative Investment Fund Managers (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

What Are the Duties of Directors of Cayman Islands Hedge Funds, and Should Those Duties Be Codified?

Corporate governance reform has been on the radar of the Cayman Islands for several years.  The landmark 2011 decision by the Financial Services Division of the Cayman Islands Grand Court, Weavering Macro Fixed Income Fund Limited v. Stefan Peterson and Hans Ekstrom, held that a fund’s directors had willfully neglected their duties to supervise a fund’s operations when they acted as little more than figureheads or rubber stamps of manager actions.  See “The Cayman Islands Weavering Decision One Year Later: Reflections by Weavering’s Counsel and One of the Joint Liquidators,” Hedge Fund Law Report, Vol. 5, No. 36 (Sep. 20, 2012).  In January 2013, the Cayman Islands Monetary Authority (CIMA) issued proposed rule amendments and proposed revised governance standards – spelled out in the revised Statement of Guidance on fund Governance (Governance SOG) – for hedge funds and their directors.  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).  In December 2013, CIMA adopted the final Governance SOG.  Cayman directors’ duties have traditionally been derived primarily from common law principles of care, skill and diligence, and good faith, loyalty and other fiduciary duties.  The CIMA governance standards mentioned above were one effort to codify some of those principles with respect to directors of CIMA-regulated entities.  In another step towards governance reform, the Cayman Islands Law Reform Commission recently released an “Issues Paper” exploring the duties of Cayman directors and asking whether there would be any improvement in corporate governance if those duties were enumerated and codified in Cayman statutes.  This article summarizes the key points from the Issues Paper.

Chinese Companies “Going Dark”: Finally Accountable to U.S. Hedge Funds and Other Shareholders

In the last two years, there has been a growing and insidious trend among valuable, operational and publicly listed Chinese companies in the U.S. to suddenly stop reporting and making requisite financial disclosures with the SEC.  After raising millions of dollars on the U.S. capital markets, these companies have either informally, or formally through the filing of a Form 15 with the SEC, “gone dark” – in some cases, with the manifest intention to depress the value of their stock to facilitate an insider-led privatization.  Once a company has gone dark, U.S. shareholders are left with little or no current financial information and are deprived of the most basic of shareholder rights: the ability to make reasoned investment decisions, and, if desired, exit their investment.  The problem is magnified in the case of thinly traded securities, for which the company’s decision to go dark creates an illiquid market.  Hedge funds that have invested in companies that have gone dark and subsequently seen their stock price collapse need not always accept such losses at face value.  In some circumstances, legal efforts to recoup investment value may pay rich dividends.  Moreover, funds that invested in companies that abruptly stopped reporting may be exposed not only to investment loss but also to investor litigation alleging failure of due diligence.  Taking legal action has the added benefit of demonstrating to investors that the fund is vigilant and aggressive in pursuit of its rights as an investor.  In a guest article, David Graff and Shveta Kakar, shareholder and attorney, respectively, at Anderson Kill P.C., describe how hedge funds can pursue recovery when companies in which they are invested go dark.

Bob Evans Farms Amends Bylaws in Response to Pressure from Sandell Asset Management

On January 14, 2014, hedge fund manager Sandell Asset Management Corp. (Sandell), which owns approximately 6.5% of Bob Evans Farms, Inc. (Bob Evans) common stock, filed a complaint in the Delaware Court of Chancery asking the court to invalidate the allegedly unilateral attempt by the Bob Evans Board of Directors (Board) to change the company’s Bylaws (Bylaws) to require a supermajority rather than a simple majority vote to amend them.  In August 2011, Bob Evans shareholders voted to reduce the requirement of an 80% supermajority shareholder vote to amend most Bylaw provisions to a simple majority.  Three months later, the Board reinstated the supermajority requirement, allegedly in contravention of Delaware corporate law.  On January 28, 2014 – seemingly in response to Sandell’s multipronged campaign to effect governance reforms at the company – Bob Evans noted in an 8-K that its Board had amended its Bylaws to, among other things, allow amendments to the Bylaws by simple majority vote of common stockholders.  This article summarizes Sandell’s factual and legal allegations and its other efforts in connection with its Bob Evans investment.  For more on activist campaigns, see “Drawbacks of Being a Lone Dissident on a Board of Directors, Starting an Activist Campaign and Targeting Retail Investors Are Themes at Activist Investor Conference,” Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011).  For coverage of recent litigation involving the consent solicitation process at Delaware public companies, see “Lawsuits and Letters: TPG-Axon’s Playbook for Unseating a Recalcitrant and Underperforming Board of Directors,” Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).

Former SEC Co-Director of Enforcement George Canellos to Return to Milbank as Global Head of Litigation

On February 12, 2014, Milbank, Tweed, Hadley & McCloy announced that George S. Canellos, who stepped down in January as co-director of the Enforcement Division of the SEC, will join the firm in mid-March as Global Head of the firm’s Litigation Department.  For insight from Canellos, 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).