Oct. 8, 2015

The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability

A federal appeals court recently rejected a challenge to the SEC’s pay to play rule.  Adopted by the SEC to prevent “pay to play” arrangements between public officials and investment advisory firms, the rule restricts certain registered investment advisers from making political contributions to officials with some level of control over the investment decision-making of public pension plans and other government entities.  Last week, the U.S. Court of Appeals for the D.C. Circuit threw out a lawsuit seeking to set aside the rule.  This latest development has put a spotlight on the pay to play rule, which is extremely broad and can be confusing in its application.  With the 2016 elections quickly approaching, it is important that affected firms re-examine their efforts to comply with the rule – especially given the heightened level of SEC scrutiny in this area, as indicated by recent enforcement activity.  In a guest article, Justin V. Shur and Gerald P. Meyer, a partner and an associate, respectively, at Molo Lamken, discuss the facts and findings of the case; analyze liability under the pay to play rule; clarify penalties for non-compliance; and offer tips to prevent and mitigate violations.  For additional insight from Shur, see “FCPA Considerations for the Private Fund Industry: An Interview with Former Federal Prosecutor Justin Shur,” Hedge Fund Law Report, Vol. 7, No. 20 (May 23, 2014); “How Private Fund Managers Can Manage FCPA Risks When Investing in Emerging Markets,” Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013); and “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).

Indicia of Ownership and Bond Documentation Considerations Under ERISA for European Hedge Fund Managers (Part Three of Three)

As their appetite for investment from U.S. investors subject to the Employee Retirement Security Act of 1974 (ERISA) grows, European hedge fund managers must remain aware of the increased and complex tangle of regulations and compliance obligations that are imposed on hedge funds and managers that fall under ERISA’s ambit.  This final article in our three-part series analyzes various approaches to ERISA’s indicia of ownership requirements for U.K. and other European hedge fund managers; discusses concerns relating to bond documentation; and examines overarching issues affecting European managers choosing to manage ERISA assets.  The first article explored issues relating to liability standards and incentive fees for European managers operating under the ERISA regime, while the second article analyzed specific concerns regarding the prohibited transactions rules, reporting requirements and side letters.  See also “Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers (Part Three of Three),” Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014); and “Applicability of New Disclosure Obligations Under ERISA to Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).

Investor Suit Against Hedge Fund Manager Illustrates the Perils of Valuing Illiquid Securities

The SEC remains keenly interested in the valuation practices of private funds, especially with regard to illiquid assets.  See “SEC’s Rozenblit Discusses Operations and Priorities of the Private Funds Unit,” Hedge Fund Law Report, Vol. 8, No. 37 (Sep. 24, 2015).  Valuing illiquid securities is a fraught activity in the best of times because of the inherent conflict of interest such valuations present.  A manager must have in place an appropriate process for valuing illiquid holdings, must disclose that process to investors and, most importantly, must apply that process fairly and consistently.  Managers vary from these processes at their peril.  See, e.g., SEC Settlement Suggests that Prime Brokers Have Due Diligence and Disclosure Obligations with Respect to Manager-Provided Hedge Fund Valuations,” Hedge Fund Law Report, Vol. 8, No. 28 (Jul. 16, 2015); and SEC’s Recent Settlement with a Hedge Fund Manager Highlights the Importance of Documented Internal Controls when Managing Conflicts of Interest Associated with Asset Valuation and Cross Trades,” Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).  However, a liquidity crisis  which may be caused by a spate of investor redemptions  can exacerbate the manager’s challenges and threaten the very survival of the fund.  The recent investor suit against Boaz Weinstein’s Saba Capital Management, L.P., is evidence of the potential pitfalls surrounding valuation during periods of stress.  The Public Sector Pension Investment Board (Pension Board) charges that it was shortchanged when the defendants altered the method of valuing certain of the fund’s illiquid holdings midstream, resulting in a significant reduction to the fund’s net asset value – and a correspondingly lower redemption payment to the Pension Board.  This article summarizes the Pension Board’s allegations.  For discussion of another investor suit premised in part on improper valuation practices, see “Brockton Retirement Board Files Class Action Lawsuit Against Oppenheimer Fund of Private Equity Funds and Executive Officers for Allegedly False Claims Relating to Fund Performance and Investment Valuations Contained in Fund Marketing Materials,” Hedge Fund Law Report, Vol. 5, No. 15 (Apr. 12, 2012).

E.U. Action Plan to Unify Capital Markets May Affect Hedge Fund Managers

On September 30, 2015, the European Commission (Commission) launched an Action Plan on Building a Capital Markets Union (Action Plan).  At their core, these measures are designed to stimulate long-term investment and growth in the European economy by improving debt and equity market functioning throughout Europe.  The Action Plan is divided into six sections, embodying the priority action areas identified by the Commission to achieve Capital Markets Union (CMU) in Europe.  This article focuses on the areas relevant to hedge fund managers and others undertaking investment activity in Europe, specifically addressing the Action Plan’s approach to long-term investment, infrastructure and sustainable development; fostering retail and institutional investment; and facilitating cross-border investing.  These sections bring hedge fund managers valuable insight regarding the Commission’s priorities in order to assess their impact and evaluate potential opportunities.  The remaining sections of the Action Plan deal with initiatives in financing for innovation, start-ups and non-listed companies; facilitating capital raising on public markets; and leveraging banking capacity to support the wider economy.  For more on the CMU, see “European Commissioner Calls for Economic and Regulatory Coordination,” in this issue.  For more from the Commission, see “E.U. Commission Publishes Regulations Setting Forth Clearing Obligations for Hedge Funds and Other Counterparties,” Hedge Fund Law Report, Vol. 8, No. 32 (Aug. 13, 2015).

ACA 2015 Compliance Survey Covers Expert Networks, Fund Expenses and Electronic Communications (Part Two of Two)

ACA Compliance Group recently released the results of its 2015 Alternative Fund Manager Compliance Survey, which considered a variety of compliance issues faced by hedge fund managers and other private fund managers.  The survey results and comparisons to those of the firm’s prior surveys were presented at a recent webinar by Colleen Marencik, a senior principal consultant at ACA Compliance Group, and Tessa Carbone, a consultant at that firm.  This article, the second in a two-part series, summarizes the key findings from the survey and the insights offered by Carbone and Marencik with respect to expert networks and consultants, fund expenses and electronic communications.  The first article addressed the survey demographics, SEC exam experiences, material nonpublic information and restricted lists.  For coverage of prior ACA surveys, see “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part Two of Two),” Hedge Fund Law Report, Vol. 6, No. 39 (Oct. 11, 2013); and “ACA Compliance Group Survey Provides Benchmarks for a Range of Hedge Fund Manager Compliance Functions, Including Dual-Hatting, Annual Compliance Reviews, Forensic Testing, Custody, Fees and Signature Authority,” Hedge Fund Law Report, Vol. 6, No. 19 (May 9, 2013).

European Commissioner Calls for Economic and Regulatory Coordination

In his keynote speech at the Eurofi Financial Forum 2015, European Commissioner Jonathan Hill described the Commission’s promotion of the Capital Markets Union and the CMU’s essential role in developing the European economy.  The speech provided valuable insight for hedge fund managers and other players in the European markets into the goals and work-streams identified by the Commission for the upcoming year, in particular with regard to the development of the CMU.  Specifically, the Commissioner highlighted areas for in-depth review and regulatory development and summarized the proposals to be promoted by the Commission regarding securitizations.  In subsequent remarks at the launch of the CMU Action Plan, he expanded on the mix of legislative and non-legislative measures to be adopted in the initial phase.  This article summarizes the Commissioner’s remarks at both venues. For an in-depth review of key areas of the CMU Action Plan, see “E.U. Action Plan to Unify Capital Markets May Affect Hedge Fund Managers,” in this issue.  For more on upcoming European initiatives, see “ESMA Chair Highlights Upcoming Focus on Supervisory Convergence,” Hedge Fund Law Report, Vol. 8, No. 38 (Oct. 1, 2015).