Nov. 12, 2015

Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action

“Private equity advisers must be particularly vigilant about conflicts of interest and disclosure when entering into arrangements with affiliates that benefit them at the expense of their fund clients or when receiving payments from portfolio companies,” warned SEC enforcement director Andrew J. Ceresney in a press release announcing the SEC’s recent settlement with an investment adviser.  The SEC charged that the investment adviser and its principals failed to disclose conflicts of interest to clients and made statements to investors that omitted material information regarding consulting payments to an affiliate and incentive payments to certain adviser employees from a private equity portfolio company.  This article summarizes the facts underlying the enforcement proceeding, the SEC’s specific charges and the sanctions imposed.  For more on conflicts of interest involving fee and expense allocations, see “Blackstone Settles SEC Charges Over Undisclosed Fee Practices,” Hedge Fund Law Report, Vol. 8, No. 41 (Oct. 22, 2015); “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers,” Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); and “SEC Enforcement Action Involving ‘Broken Deal’ Expenses Emphasizes the Importance of Proper Allocation and Disclosure,” Hedge Fund Law Report, Vol. 8, No. 27 (Jul. 9, 2015).  For ways to address and mitigate potential conflicts, see “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends,” Hedge Fund Law Report, Vol. 8, No. 41 (Oct. 22, 2015).

Ninth Circuit’s Misapplication of Derivative Injury Analysis May Encourage Direct Claims Against Hedge Funds

As courts have lamented, “[d]etermining whether an action is derivative or direct is sometimes difficult.”  Difficult though it may be, this determination is generally an important issue in litigation initiated by investors in hedge funds and other investment companies.  Indeed, the proper characterization of a claim brought by a fund investor against the fund’s adviser and others involved in the management and administration of the fund has many legal consequences, some of which may be outcome determinative.  See “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PwC,” Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  While courts have sought to simplify the direct vs. derivative analysis in recognition of its significance, they continue to be challenged when attempting to apply the proper test.  A noteworthy example is a recent decision by the Ninth Circuit in which the court applied the wrong direct/derivative test and then compounded the error by suggesting that courts should abandon the test whenever faced with claims involving investments in mutual funds.  Although the case involved a mutual fund, it will likely sow confusion in future hedge fund litigation where courts must decide whether a claim is direct or derivative in nature.  In a guest article, Seth Schwartz and Jason Vigna, a partner and a counsel, respectively, at Skadden, analyze the Ninth Circuit’s decision and identify potential ramifications for the hedge fund and alternative mutual fund industry.  For additional insight from Skadden, see “What Do the Investor Advisory Committee’s Recommendations Mean for the Future of Marketing of Hedge Funds to Natural Persons?,” Hedge Fund Law Report, Vol. 7, No. 40 (Oct. 24, 2014); and our two-part series on Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors: Part One, Vol. 8, No. 5 (Feb. 5, 2015); and Part Two, Vol. 8, No. 6 (Feb. 12, 2015).

What the Evolving European Marketing Environment Means for Hedge Fund GCs and CCOs

Hedge funds looking to market in Europe face an increasingly complex regulatory environment, and hedge fund GCs and CCOs must adapt to these changes to ensure their firms appropriately solicit and engage with investors.  In a recent interview with the Hedge Fund Law Report, Jeffrey Bronheim, GC of Cheyne Capital Management (UK) LLP; Philip Niel, GC and CCO of Egerton Capital (UK) LLP; and Karen Anderberg, a partner at Dechert, discussed implications of the changes in the European regulatory environment on hedge fund GCs and CCOs; challenges for hedge fund managers pursuing private and retail investors in Europe; and the evolving role of hedge fund GCs and CCOs with respect to marketing.  These experts, along with Dechert partner Gus Black, will expand on the topics in this article – as well as other issues affecting hedge fund GCs and CCOs – in a panel co-sponsored by the Hedge Fund Law Report and Dechert.  Entitled “The Evolving Role of GCs and CCOs in Marketing and Investor Management in Europe,” the panel will be held in London on November 17, 2015, at 5:30 p.m. GMT.  For more information, click here.  To register, click here.  For more from Dechert, see “Dechert Global Alternative Funds Symposium Highlights Trends in Hedge Fund Expense Allocations, Fees, Redemptions and Gates,” Hedge Fund Law Report, Vol. 8, No. 20 (May 21, 2015); and our recent two-part series on the Supreme Court’s Denial of Cert in Newman: Part One, Vol. 8, No. 42 (Oct. 29, 2015); and Part Two, Vol. 8, No. 43 (Nov. 5, 2015). 

How Hedge Fund Managers Can Operate an AML Program Under FinCEN’s Proposed Rules (Part Two of Two)

Under the recent proposal by the Financial Crimes Enforcement Network (FinCEN), investment advisers that are registered or required to be registered with the SEC would have to meet the suspicious activity reporting and anti-money laundering (AML) requirements of the Bank Secrecy Act.  To do so, hedge fund managers and other investment advisers would be required to report suspicious activity and retain records relating to certain fund transfers.  During Pepper Hamilton’s seminar, “Investment Management and Hedge Funds: What’s Happening Now?,” partners Gregory Nowak and Timothy McTaggart, as well as Walter Donaldson, managing director of Freeh Group International Solutions, LLC, discussed the proposed rule, including its mandates and anticipated impact on the hedge fund industry.  This article, the second in a two-part series, examines those specific reporting, information sharing and recordkeeping requirements, as well as the adoption and implementation of the rule.  The first article summarized the panelists’ discussion of the proposed rule and the elements of an AML program that it would require.  For more from Nowak, see “Conflicts and Opportunities Offered by Concurrent Management of Employee-Owned Hedge Funds and Outside-Investor Hedge Funds,” Hedge Fund Law Report, Vol. 2, No. 32 (Aug. 12, 2009).

Class Action Lawsuit May Affect Retirement Plan Allocations to Hedge Funds

Following the 2008 financial crisis, pension managers looked to hedge funds as one way of making up performance losses.  That approach may have backfired for one large corporation whose alternative pension investments stand accused of poor performance.  A former employee is the named plaintiff and class representative in a putative class action against the corporate committees and their members that were responsible for the corporation’s pension investments.  The suit charges that, by investing heavily in “risky and high-cost hedge funds and private equity investments,” and by eschewing more widely accepted pension allocation models, the defendants breached their fiduciary duties to the pension plans, which sustained “massive losses and enormous excess fees.”  This article summarizes the key allegations against the ERISA fiduciaries who elected to invest in hedge funds and other alternative investments.  For more on ERISA fiduciary duties, see the first two parts of our series entitled “Happily Ever After? – Investment Funds that Live with ERISA, For Better and For Worse”: Part One, Vol. 7, No. 33 (Sep. 4, 2014); and Part Two, Vol. 7, No. 34 (Sep. 11, 2014).

SEC Chair Emphasizes Enforcement Focus on Strong Remedies and Individual Liability

In the past fiscal year, the SEC brought an unprecedented 807 enforcement actions and obtained orders for a record $4.2 billion in monetary remedies.  These numbers were highlighted by Mary Jo White in her opening address to the SEC’s 21st Annual International Institute for Securities Enforcement and Market Oversight, as she emphasized the SEC’s role in pursuing wrongdoing in the financial markets.  In her remarks, White discussed the SEC’s collaboration with foreign regulators in policing global markets; enumerated key enforcement tools in the SEC’s “arsenal”; and addressed the SEC’s ability to leverage data and technology in investigations.  White’s speech provides hedge fund managers with valuable insight as to the SEC’s enforcement focus, including its emphasis on stiff penalties and pursuit of individual liability.  This article summarizes her remarks.  For additional insight from White, see “SEC Chair Highlights Two Types of Risks Hedge Fund Managers Must Consider,” Hedge Fund Law Report, Vol. 8, No. 42 (Oct. 29, 2015); “SEC Chair White Describes the SEC’s Game Plan with Respect to the Asset Management Industry,” Hedge Fund Law Report, Vol. 7, No. 47 (Dec. 18, 2014); and “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).

K&L Gates Welcomes Bruce MacLennan to New York Office

K&L Gates recently added Bruce MacLennan as a partner in the investment management, hedge funds and alternative investments practice in New York.  For insight from the firm, see “K&L Gates-IAA Panel Addresses Cyber Insurance Plans for Investment Advisers (Part Two of Two),” Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); and “K&L Gates Partners Outline Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers (Part Three of Three),” Hedge Fund Law Report, Vol. 8, No. 1 (Jan. 8, 2015).  MacLennan counsels clients on complex international business transactions with a focus on the structuring and formation of private investment funds, including private equity, real estate, venture capital and hedge funds, as well as unique investment vehicles.  

SEC Asset Management Unit Veteran Joins Squire Patton Boggs

Former SEC senior counsel Coates Lear recently joined Squire Patton Boggs as a principal, based in the firm’s Denver and Washington, D.C. offices.  For insight from the firm, see “How Hedge Fund Managers Should Respond to Tax Regulator Attacks on ‘Disguised Management Fees’ (Part Two of Two),” Hedge Fund Law Report, Vol. 8, No. 34 (Sep. 3, 2015).  Coates comes to the firm after eight years in the SEC’s Division of Enforcement, most recently in the Asset Management Unit, a specialized unit devoted exclusively to investigating potential violations by companies and individuals involved in managing hedge funds, private equity funds, mutual funds and separate accounts.  See “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit,” Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).