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    May 19, 2016

How Hedge Fund Managers Can Prepare for SEC Remote Examinations (Part Two of Two)

As the SEC, including its Office of Compliance Inspections and Enforcement, expands the number of examinations it conducts of hedge fund managers and registered investment advisers, it is increasingly turning to remote examinations, both to reach more never-before examined advisers and to sweep for particular issues. However, remote exams carry with them certain risks that hedge fund managers must anticipate and mitigate, and managers must properly prepare for these exams. This second article in a two-part series explores the risks of a remote exam and the best practices for a hedge fund manager in preparing for and weathering one. The first article outlined reasons why the SEC examines hedge fund managers remotely and delineated the differences between remote and in-person exams. For more on preparing for SEC examinations, see “Usable Lessons and Proven Survival Techniques From the Hedge Fund Examination Trenches” (Oct. 10, 2014); and “SEC Staff Provides Roadmap to Middle-Market Private Fund Adviser Examinations” (May 16, 2014).

MiFID II Will Affect Market Structure, Registration and Soft Dollars for Hedge Funds Trading in Europe

Broker-dealers, asset managers and investment advisers all are affected by the E.U. Markets in Financial Instruments Directive (MiFID), which includes rules regarding authorization, business conduct, governance, market activities and reporting. Clifford Chance recently presented a program on how pending revisions to MiFID (commonly referred to as “MiFID II”) may affect U.S. hedge fund and other asset managers. The program – featuring partner Nick O’Neill and associate Sarah James – focused on implementation logistics and timing; market structure; product development and soft dollar rules; the third-country equivalency regime; and other relevant E.U. developments. This article summarizes their key insights. For more on MiFID II, see “ESMA Releases Final Report on MiFID II Technical Standards for Hedge Fund Management Firms” (Jul. 16, 2015); and “MiFID II Expands MiFID I and Imposes Reporting Requirements on Asset Managers, Including Non-E.U. Asset Managers” (May 28, 2015). For additional insight from Clifford Chance partners, see “Hedge Fund Managers Trading Distressed Debt Must Understand LMA Standard Form Documentation” (Feb. 25, 2016); and our series, “How Can Hedge Fund Managers Use Reinsurance Businesses to Raise and Retain Assets and Achieve Uncorrelated Returns?”: Part One (Jan. 10, 2013); and Part Two (Jan. 17, 2013).

Preparing for Contingent Liabilities: How an Alternative to Hedge Fund Contingency Reserves May Offer More Equitable Investor Treatment (Part Two of Two)

The power to establish reserves for contingent liabilities and other potential fund obligations may be deployed whenever a fund manager foresees a possible future event that could adversely affect the fund. Depending on the outcome of that possible future event (as well as fund policies on adjusting net asset value), contributing, redeeming or “status quo” investors may bear a higher proportion of such contingency reserve. In this two-part guest series, S. Brian Farmer and Alina A. Grinblat, partner and associate, respectively, at Hirschler Fleischer, explore the drawbacks of hedge fund contingency reserves and suggest an alternative structure. In the first article, they explained how hedge fund contingency reserves operate in practice, illustrating how reserves can affect fund shareholders and the unequal treatment that can result. This second article analyzes hedge fund manager motivations in establishing reserves and proposes an alternative structure that may avoid consequent investor inequality. For additional insight from Farmer, see our series on “The Use of Benchmarks to Measure Hedge Fund Performance by Pension Funds and Institutional Investors”: Part One (Jul. 30, 2015); and Part Two (Aug. 6, 2015).

U.S., U.K. and Offshore Regulators Share Views on Cybersecurity, AML, AIFMD, Advertising and Liquidity Issues Affecting Hedge Fund Managers (Part Two of Two)

As hedge fund managers find themselves scrutinized by numerous regulators, it is important for them to understand those regulators’ views and priorities with respect to issues including cybersecurity, anti-money laundering, the Alternative Investment Fund Managers Directive, advertising and liquidity. These topics were addressed during a Global Regulatory Briefing presented by the Hedge Fund Association, featuring Emma Bailey, Director of the Investment Supervision and Policy Division of the Guernsey Financial Services Commission; Jennifer A. Duggins, Co-Head of the Private Funds Unit in the SEC Office of Compliance Inspections and Examinations; Garth Ebanks, Deputy Head of the Investments and Securities Division of the Cayman Islands Monetary Authority; Ifor Hughes, Assistant Director of Policy in the Policy, Legal and Enforcement department of the Bermuda Monetary Authority; and Robert Taylor, Head of the Investment Management Department at the U.K. Financial Conduct Authority. This second article in a two-part series highlights the panelists’ key insights on these topics. The first article recapped the speakers’ commentary on fund regulation in their respective jurisdictions, cooperation among regulators and whether hedge fund regulation is sufficient to address fraud. For more on the regulatory approach to these issues, see “FCA 2016-2017 Regulatory and Supervisory Priorities Include Focus on AML, Cybersecurity and Governance” (Apr. 14, 2016); and “Luxembourg Financial Regulator Issues Guidance on AIFMD Marketing and Reverse Solicitation” (Sep. 3, 2015).

SEC Enforcement Director Highlights Increased Focus on Undisclosed Private Equity Fees and Expenses

The private equity industry is squarely within the crosshairs of the SEC of late. The Commission – specifically its Division of Enforcement (Enforcement) and Office of Compliance Inspections and Enforcement (OCIE) – considers the private equity industry a focal point. See “Acting OCIE Director Discusses the Office’s Focus on Private Equity Managers and Emphasizes the Importance of Disclosure by Advisers” (May 28, 2015). In a recent speech, SEC Director of Enforcement Andrew Ceresney discussed Enforcement’s work in the private equity industry, along with its collaboration with OCIE and the Division of Investment Management. He also gave valuable guidance to private equity managers by sharing numerous arguments that have ultimately proven to be unsuccessful in swaying Enforcement staff. Finally, he explained the impact that Enforcement’s actions have had on the private equity industry as a whole. This article highlights the most significant takeaways from Ceresney’s speech. For additional insight from Ceresney, see “SEC Enforcement Director Assures CCOs They Need Not Fear SEC Action Absent Wrongdoing” (Nov. 19, 2015); and our two-part series on Enforcement and OCIE priorities: “Cybersecurity, Fees, Bad Actors and Never-Before Examined Hedge Fund Managers” (Apr. 28, 2016); and “Conflicts of Interest, Valuation, Performance Advertising and CCO Liability” (May 5, 2016).

SEC No-Action Letter Eliminates Surprise Examination Requirement Under Custody Rule for Certain Sub-Advisers

In 2009, in the wake of the Madoff Ponzi scheme and other adviser frauds, the SEC revised Rule 206(4)-2 under the Investment Advisers Act of 1940, the so-called “custody rule.” See “SEC Adopts Investment Adviser Custody Rule Amendments” (Jan. 6, 2010). A critical element of the revised rule is that, absent an applicable exception, an adviser with custody of client funds or securities must undergo a surprise annual examination by an independent public accountant to verify custody. The revised custody rule requires both a sub-adviser and a related primary adviser to have a surprise annual exam when the primary adviser (or an affiliate) also serves as the qualified custodian. The SEC recently issued a no-action letter indicating that it would not take enforcement action against a sub-adviser in such circumstances if certain conditions are met. This article summarizes the terms of the relief provided by the SEC. For examples of the SEC’s severe treatment of custody rule violations, see “Repeat Custody Rule Offenders Face Severe SEC Sanctions” (Dec. 10, 2015); and “SEC Sanctions Two Private Fund Managers for Custody Rule Violations, Including Imposing Statutory Bars on Their Chief Compliance Officers” (Nov. 8, 2013).

Private Equity Lawyers Join Kirkland & Ellis in New York

Michael Weisser and Sarah Stasny recently joined the New York office of Kirkland & Ellis as partners in the firm’s corporate practice group. Both attorneys represent leading private equity funds and their portfolio companies in connection with investments, acquisitions, divestitures and other corporate matters. They also represent pension plans and hedge funds regarding their private equity investments. See “An Examination of Exit Rights for Hedge Funds Making Non-Controlling Private Equity Investments” (Jul. 18, 2013). For insight from Kirkland & Ellis attorneys, see “Portability and Protection of Hedge Fund Investment Track Records” (Nov. 10, 2011); and “New Tax Law Restricts Hedge Fund Fee Deferral Arrangements” (Oct. 10, 2008).

Ulmer & Berne Adds Senior FINRA Counsel

Michael A. Gross, previously Senior Litigation Counsel at the Financial Industry Regulatory Authority (FINRA), has joined Ulmer & Berne as a partner. Gross’ practice focuses on representing broker-dealers, investment advisers and registered persons operating in the broader financial services industry. He has represented clients in disciplinary proceedings and arbitrations, primarily in actions involving complex charges, including fraud, anti-money laundering, sales of unregistered securities, excessive mark-ups, unsuitability, churning, disclosures, licensing, registration, record retention and supervision.

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