Mar. 17, 2016

How Are Your Peers Responding to the Most Intrusive Requests From Hedge Fund Investors? (Part One of Two)

Hedge fund investors have become increasingly savvy in recent years, and one sign of that growing sophistication is the level of scrutiny focused on managers of hedge funds in which they are considering investing. Far beyond the simple review process that it once was, due diligence of hedge fund managers and their funds has become an intrusive process, as prospective investors seek deeper looks into managers’ operations and access to sensitive documents. Consequently, a manager must be prepared to tactfully respond to these invasive requests for information, providing sufficient information to satisfy the investors’ requests while protecting the manager’s business and confidentiality. In an effort to determine industry best practices for responding to such requests from prospective investors, the Hedge Fund Law Report surveyed 20 general counsels and other “C-level” decision-makers at leading hedge fund managers. We are presenting the results of that survey in a two-part article series. This first part describes the types of information requests that hedge fund managers are encountering from investors, focusing on the most intrusive requests. The second article will explore how managers have responded to those requests while mitigating the potential negative consequences of releasing sensitive information. For more on due diligence, see “Why Should Hedge Fund Investors Perform Onsite Due Diligence in Addition to Remote Gathering of Information on Managers and Funds? (Part Three of Three)” (Feb. 12, 2015). For analysis of the investor view of due diligence, see “Operational Due Diligence From the Hedge Fund Investor Perspective: Deal Breakers, Liquidity, Valuation, Consultants and Onsite Visits” (Apr. 25, 2014). For another industry survey conducted by the HFLR, see our two-part series on how hedge fund managers: “Define and Handle Trade Errors” (Oct. 15, 2015); and “Detect and Bear Responsibility for Trade Errors” (Oct. 22, 2015).

How Hedge Funds Can Mitigate FIN 48 Exposure in Europe (Part One of Three)

Funds that invest in foreign securities face a host of tax issues ranging from withholding on interest, dividends and capital gains to evaluating the fund’s exposure under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). In the last several years, there have been significant developments in the treatment of interest, dividends and capital gains derived by funds in non-U.S. securities. In this guest three-part series, Harold Adrion of EisnerAmper discusses issues relating to foreign withholding taxes and FIN 48 exposure applicable to hedge funds. This first article explains FIN 48 and explores E.U. developments regarding free movement of capital and its impact on funds. The second article will address the limited exemption from capital gains taxation of non-residents announced by China, and other issues faced by non-resident investors. The third article will discuss developments in Australia and Mexico, and how hedge funds can minimize exposure to withholding taxes. For additional coverage of withholding tax issues pertaining to hedge funds, see our two-part series on the new Section 871(m) regulations: Part One (Jan. 21, 2016); and Part Two (Jan. 28, 2016). For further insight from EisnerAmper professionals, see “Accounting for Uncertain Income Tax Positions for Investment Funds” (Jan. 14, 2011).

Failure to Ensure Portfolio Value Calculations Comport With Disclosed Methods May Bring SEC Enforcement Action, Even If the Valuation Method Would Otherwise Be Permissible

Hedge fund managers and other investment advisers that charge management fees based on a percentage of client portfolio values must be circumspect when calculating those values. If a manager’s calculations are inconsistent with the method specified in its documentation, such as its client advisory agreements, that manager risks disciplinary action, particularly as the SEC is currently focusing on adviser fee and valuation practices. See “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016). In a recent enforcement action, the SEC alleged that an investment adviser inflated its management fees by deviating from disclosed calculation methods for valuing client portfolios. This article summarizes the SEC’s allegations against the investment adviser, as well as the terms of the settlement order. This SEC enforcement action underscores the need for hedge fund managers and investment advisers to ensure that client agreements and other documents are always up-to-date and accurately reflect actual business practices. See also “Adhering to Disclosed Fee and Valuation Methodologies Is Crucial for Hedge Fund Managers to Avert Enforcement Action” (Jan. 28, 2016). For discussion of additional enforcement actions involving fee disclosures and practices, see “Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action” (Nov. 12, 2015); “Blackstone Settles SEC Charges Over Undisclosed Fee Practices” (Oct. 22, 2015); and “SEC Enforcement Action Involving ‘Broken Deal’ Expenses Emphasizes the Importance of Proper Allocation and Disclosure” (Jul. 9, 2015).

CIMA Enumerates Best Practices for Hedge Fund Manager AML Programs

The Cayman Islands Monetary Authority (CIMA) recently published the first edition of its bi-annual Supervisory Issues & Information Circular (Circular). Aiming to “raise awareness, in the industry, of common regulatory and thematic issues identified through our off-site and on-site supervisory practices and highlight regulatory developments for the financial sector,” the Circular identifies several regulatory initiatives important for hedge fund managers and other licensees. In addition, CIMA outlined the minimum elements it expects to be included in hedge fund managers’ anti-money laundering programs. This article explores the guidance contained in the Circular. For guidance from CIMA on fund governance, see “CIMA-Sponsored Survey Highlights Hedge Fund Industry Views on Cayman Islands Corporate Governance Practices and Suggested Reforms” (Jul. 11, 2013); and “Cayman Islands Monetary Authority Introduces Proposals to Apply Revised Governance Standards to CIMA-Regulated Hedge Funds and Require Registration and Licensing of Fund Directors” (Jan. 24, 2013).

Deutsche Bank Alternative Investment Survey Explores Potential Asset Flows, Investor Allocation Plans and Portfolio Construction Considerations (Part One of Two)

Deutsche Bank Global Prime Finance (DB) has released the results of its 14th annual Alternative Investment Survey. This article, the first in a two-part series, covers the portions of the survey addressing asset flows, allocation plans and portfolio construction. The second article will cover the survey’s findings on hedge fund fees, early stage investing and the Alternative Investment Fund Managers Directive. For coverage of similar sections of DB’s 2015 survey, see “Investor Appetite for Hedge Funds and Other Alternative Investments and Strategies, and Criteria for Investing in Hedge Funds” (May 21, 2015). For coverage of its 2013 survey, see “Deutsche Bank Survey Describes the Contours of the Nontraditional Hedge Fund Product Market: Investor Appetite, Performance, Marketing, Fees and More” (Jan. 23, 2014). For discussion of another recent survey of the alternative investment space, see “Ernst & Young’s 2015 Global Hedge Fund and Investor Survey Probes Hedge Fund Growth Priorities, Fee and Expense Climate, Prime Brokerage and Operational Matters” (Dec. 3, 2015).

European Commissioner Emphasizes Need for Proportionate Regulation to Promote the CMU

On March 10, 2016, European Commissioner Jonathan Hill gave a keynote speech at The Economist’s Future of Banking Summit in Paris. The speech included an update on the European Commission’s implementation of its Capital Markets Union action plan. He also provided valuable insight into the Commission’s priorities for the months ahead as it works to strengthen capital markets in Europe. Hill’s speech illustrates to hedge fund managers the Commissioner’s aspiration for targeted and proportionate legislation in an effort to unify the E.U.’s market for capital, as well as his desire to promote growth of investment funds by improving the AIFMD marketing passport. See “Hedge Fund GCs and CCOs Face an Expanding Role in Changing E.U. Marketing Environment (Part Two of Two)” (Dec. 17, 2015). For more on the CMU, see “ESMA Chair Calls for Increased Transparency and Regulatory Convergence As Interest Rates Rise” (Jan. 28, 2016); and “E.U. Action Plan to Unify Capital Markets May Affect Hedge Fund Managers” (Oct. 8, 2015). For additional commentary from Hill, see “European Commissioner Calls for Economic and Regulatory Coordination” (Oct. 8, 2015).

Peter Driscoll Named Head of New SEC Office of Risk and Strategy

On March 8, 2016, the SEC announced the creation of the Office of Risk and Strategy within its Office of Compliance Inspections and Examinations (OCIE). The new office will consolidate and streamline OCIE’s risk assessment, market surveillance and quantitative analysis teams and provide operational risk management and organizational strategy for OCIE. Peter B. Driscoll will lead the office and has been named as its first Chief Risk and Strategy Officer, responsible for managing the new office and the investment adviser / investment company examination staff based in Washington, D.C. For more on SEC examinations, see “Current and Former Regulators Advise Hedge Fund Managers on How to Prepare for SEC Exams” (Feb. 18, 2016); and “Hedge Fund Managers Advised to Prepare for Imminent SEC Examination” (Jan. 28, 2016).

David Tang Joins Seward & Kissel

David W. Tang recently joined Seward & Kissel as counsel in its investment management group. Tang concentrates his practice on providing regulatory compliance consulting, compliance support services and legal counsel to fund advisers and asset managers. For more from Seward & Kissel attorneys, see our two-part series on the firm’s private funds forum: “Trends in Hedge Fund Seeding Arrangements and Fee Structures” (Jul. 23, 2015); and “Key Trends in Fund Structures” (Jul. 30, 2015); as well as “Seward & Kissel New Hedge Fund Study Identifies Trends in Investment Strategies, Fees, Liquidity Terms, Fund Structures and Strategic Capital Arrangements” (Mar. 5, 2015).