Apr. 7, 2016

How Can Hedge Fund Managers Legally Penalize Employee Wrongdoing? (Part One of Two)

As they continue to be scrutinized by the SEC and other regulators, hedge fund managers must ensure that their employees are properly trained and incentivized to avoid regulatory violations. See “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends” (Oct. 22, 2015). However, despite a manager’s best precautions, an employee’s actions may result in an adverse regulatory action or fine. In such situations, hedge fund managers may seek recourse against the employee responsible for the violation – to recoup losses to the hedge fund manager and to deter similar behavior by other employees. To determine industry best practices with respect to imposing fines on employees, the Hedge Fund Law Report spoke with employment counsel and also surveyed 15 general counsels and other “C-level” decision-makers at leading hedge fund managers. We present our findings in a two-part article series. This first part explores the options available to hedge fund managers for imposing penalties on their employees for regulatory violations and examines the limits of those options under employment law. The second part will examine how these options are put into practice, addressing the prevalence of these remedies in the industry and best practices for deployment. For more on hedge fund manager employment issues, see “New York Federal District Court, Applying ‘Faithless Servant’ Doctrine, Allows Morgan Stanley to Recoup Entire Compensation Paid to a Former Hedge Fund Portfolio Manager Who Admitted to Insider Trading” (Feb. 6, 2014); and our two-part series on “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013).

Steps That Alternative Investment Fund Managers Need to Take Today to Comply With the Global Trend Toward Tax Transparency (Part One of Two)

If one word can describe the focus of international tax policy today, that word is transparency. Taxing authorities around the world continue to demand increased levels of transparency and reporting from alternative investment funds (AIFs) and other financial institutions with respect to their investors, business operations and transactions. This increased focus on transparency will affect planning and compliance for AIFs, their management companies and investors. Despite the obvious challenges, taking a proactive approach to reporting and planning issues could enhance an AIF’s position in a competitive market. In a two-part guest series, Dmitri Semenov, Jun Li, Lucas Rachuba and Carter Vinson of Ernst & Young (EY) highlight challenges and recommend steps for AIFs to meet these global planning and reporting challenges. This first article addresses global reporting and areas on which AIFs should immediately focus. The second article will discuss planning and other long-term considerations for hedge funds and other AIFs to consider. For more on tax transparency, see “Understanding the Intricacies for Private Funds of Becoming and Remaining FATCA-Compliant” (Sep. 12, 2013). For commentary from other EY professionals, see “Critical Components of a Hedge Fund Manager Cybersecurity Program: Resources, Preparation, Coordination, Response and Mitigation” (Jan. 15, 2015); and “Considerations for Hedge Fund Managers Evaluating Forming Reinsurance Vehicles in the Cayman Islands” (Sep. 4, 2014).

Barbash, Breslow and Rozenblit Discuss Hedge Fund Allocations, Restructurings and Advisory Boards

Liquidity and performance presentation are only two of the myriad issues facing hedge fund managers. See “Liquidity and Performance Representations Present Potential Pitfalls for Hedge Fund Managers” (Mar. 31, 2016). Hedge fund and private equity managers must also be wary of numerous issues that can trigger conflicts of interest or anti-fraud violations, including expense allocations, restructuring and the use of advisory boards. See “Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action” (Nov. 12, 2015). During a recent Practising Law Institute program, panelists discussed these and other topics. Barry P. Barbash, a former Director of the SEC Division of Investment Management and now a partner at Willkie Farr & Gallagher, moderated the program, which featured Stephanie R. Breslow, a partner at Schulte Roth & Zabel; and Igor Rozenblit, co-leader of the Private Funds Unit of the SEC Office of Compliance Inspections and Examinations. This article summarizes the panelists’ discussion of these issues. For additional commentary from Breslow, see “Schulte Partner Stephanie Breslow Discusses Tools for Managing Hedge Fund Crises Caused by Liquidity Problems, Poor Performance or Regulatory Issues” (Jan. 9, 2014). For further insight from Rozenblit, see “SEC’s Rozenblit and Law Firm Partners Explain the SEC’s Enforcement Priorities and Offer Tips on How Hedge Fund and Private Equity Managers Can Avoid Enforcement Action (Part Three of Four)” (Jan. 15, 2015).

RCA Session Highlights Issues Pertaining to the Custody Rule, ERISA, Client Agreements, Fees, Codes of Ethics and Confidentiality

The first session of the Regulatory Compliance Association’s (RCA) Compliance Program Transparency Series examined key provisions from the CFA Institute’s Asset Manager Code of Professional Conduct (AMCC) and the RCA’s Model Compliance Manual (Manual), which is intended to facilitate implementation of the AMCC. Among the topics covered by the panel were client and fiduciary relationships, including compliance with the custody rule and ERISA as well as best practices for entering into agreements with and charging fees to clients; codes of ethics; and confidentiality. Moderated by Jane Stafford, the RCA’s general counsel, the session featured James G. Jones, a founder and portfolio manager of Sterling Investment Advisors; Michelle Clayman, managing partner and chief investment officer of New Amsterdam Partners; Gerald Lins, general counsel of Voya Investment Management; and Tanya Kerrigan, general counsel and chief compliance officer of Boston Advisors. This article highlights the salient points made on the foregoing issues. For additional insight from RCA programs, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and our coverage of the most recent RCA Compliance, Risk and Enforcement Symposium: “Methods for Hedge Fund Managers to Upgrade Compliance Programs” (Jan. 14, 2016); and “Ways for Hedge Fund Managers to Mitigate Conflicts of Interest” (Jan. 21, 2016).

Credit Suisse Survey Reveals Growing Demand by Hedge Fund Investors for Managed Accounts, Long-Only Funds and Alternative Mutual Funds

Credit Suisse Capital Services (CS) recently released the results of its 2016 hedge fund investor survey. CS asked hedge fund investors about industry risks, trends and the drivers of investments and redemptions; appetite for non-traditional hedge fund investment vehicles; anticipated allocations; and performance expectations. Among the survey findings, CS found growing demand for alternatives to direct hedge fund investments, such as managed accounts, long-only funds and alternative mutual funds offered by hedge fund managers. This article examines key takeaways from the survey. For more on alternative mutual funds, see our three-part series on conflicts arising out of simultaneous management of hedge funds and alternative mutual funds: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015). For coverage of past CS investor surveys, see “Investor Appetite for Alternative Investment Vehicles and Strategy Preferences” (Aug. 27, 2015); “Factors in Institutional Investors’ Investment and Redemption Decisions, Appetite for Alternative UCITS and Anticipated 2015 Hedge Fund Investments by Strategy and Region” (Mar. 27, 2015); and “Allocation Preferences of Hedge Fund Investors, With Particular Attention on Preferences of Pension Funds and Insurance Companies” (Mar. 14, 2013).

SEC Chair Outlines Expectations for Fund Directors

The board of directors plays a central role in mitigating conflicts inherent in the relationship between a hedge fund and its manager. See “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015). In her keynote address at the Mutual Fund Directors Forum 2016 Policy Conference, SEC Chair Mary Jo White shared her view on the role of directors in assessing risks to mutual funds and conveyed her perspective on what fund directors should be considering and doing in 2016. Delivered to mutual fund directors, White’s remarks also provide valuable guidance to hedge funds and other private investment funds as to SEC expectations for director oversight. Specifically, White suggested appropriate questions for fund directors to ask, explored the limits of director oversight and provided the enforcement perspective on fund directors. This article summarizes the portions of White’s speech most relevant to hedge fund managers. For more on hedge fund governance, see “Walkers Fundamentals Hedge Fund Seminar Addresses Fund Structuring Trends, Governance Best Practices, Fee and Liquidity Terms, Irish Vehicles, Marketing in Asia and FATCA” (Feb. 12, 2015); and “Former SEC Commissioner Roel Campos Discusses Hedge Fund Governance With Hedge Fund Law Report” (Mar. 8, 2012). For additional insight from White, see “SEC Chair Emphasizes Enforcement Focus on Strong Remedies and Individual Liability” (Nov. 12, 2015); “SEC Chair Highlights Two Types of Risks Hedge Fund Managers Must Consider” (Oct. 29, 2015); and “SEC Chair White Describes the SEC’s Game Plan With Respect to the Asset Management Industry” (Dec. 18, 2014).

Sidley Austin Adds Investment Funds Partner in Boston

David P. Kreisler has joined Sidley Austin as a partner in its Boston office. As a member of the firm’s investment funds, advisers and derivatives practice, Kreisler will advise clients on a range of private equity matters, with a focus on fund formation. For insight from Sidley partners, see “E.U. Market Abuse Scenarios Hedge Fund Managers Must Consider” (Dec. 17, 2015); “How Hedge Fund Managers Can Protect Privileged Internal Investigations Without Violating SEC Whistleblower Rule 21F-17” (May 21, 2015); and our two-part series “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers”: Part One (Apr. 16, 2015); and Part Two (Apr. 23, 2015).