Jun. 2, 2016

Independent Contractors vs. Employees: What Hedge Fund Managers Must Know About Classifying Staff and Protecting Proprietary Secrets

As high-profile corporations such as FedEx and Uber find themselves embroiled in, or in the aftermath of, costly lawsuits over the misclassification of people they have hired, it is critically important for hedge fund managers to understand how classification issues may affect their businesses. Under federal and state law, the status of independent contractors is fundamentally different from that of employees, affecting everything from compensation and taxes to the safety procedures and protocols needed to protect employers’ sensitive information from theft. Even without the crackdown at the regulatory level and the massive liability facing employers who misclassify workers, the risk of data theft requires asset managers to be specially knowledgeable and vigilant about the issue’s implications. These topics were the focus of a recent panel discussion held at the New York offices of law firm Pepper Hamilton. Moderated by Pepper Hamilton partner Gregory Nowak, the panel featured Richard Reibstein, a partner at Pepper Hamilton, and Laura Kibbe, managing director of professional services at RVM Enterprises. For more on hedge fund manager employment issues, see “District Court Decision Suggests That Overly Broad Restrictive Covenants Will Not Be Enforced in Employment Agreements in the Wealth Management Industry” (Apr. 26, 2012); and our two-part series on “How Can/Do Hedge Fund Managers Legally Penalize Employee Wrongdoing?”: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016). For coverage of other Pepper Hamilton seminars, see our two-part series on “How Hedge Fund Managers Can Establish/Operate an AML Program Under FinCEN’s Proposed Rules”: Part One (Nov. 5, 2015); and Part Two (Nov. 12, 2015); as well as “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015). 

Subscription Facilities Provide Funds With Needed Liquidity But Require Advance Planning by Managers (Part One of Three)

In order to quickly act on investments, instead of waiting for investors to fund capital calls, private equity and other private funds are turning to subscription credit facilities for necessary liquidity. Along with other types of fund financing facilities, subscription credit facilities are becoming more prevalent in the asset management industry. However, to facilitate the execution of a subscription facility, a manager must make certain preparations, particularly at the outset of the fund. In a recent interview with the Hedge Fund Law Report, Zac Barnett and Liz Soutter, partners at Mayer Brown, discussed subscription and other financing facilities used by funds. In this first article of a three-part series, Barnett and Soutter examine the prevalence of subscription facilities in the asset management industry, investor response to these structures and primary considerations for managers anticipating entering into such a facility. The second article will review the evolution of other types of financing facilities in the current market, including fund-of-fund facilities, portfolio acquisition facilities and general partner support facilities. The third article will focus on market, structuring and operational considerations for managers when establishing financing facilities. For more on subscription financing, see “How Can Private Fund Managers Use Subscription Credit Facilities to Enhance Fund Liquidity?” (Apr. 4, 2013). 

OTC Options on Major Currencies May Be Marked-to-Market for Tax Purposes

In Wright v. Commissioner, a recent court decision that came as a surprise to many, the Sixth Circuit held that over-the-counter (OTC) options on so-called “major” currencies should be marked-to-market for U.S. federal income tax purposes. This could have significant consequences for investment funds that take positions in options of this type. In a guest article, John Kaufmann of Greenberg Traurig discusses the Wright case; the applicable regulations and legislative history; and the decision’s potential implications for hedge fund managers who take positions in OTC options on major currencies. For additional insight from Kaufmann, see our two-part series on “The New Section 871(m) Regulations: Withholding Law Applicable to Non-U.S. Hedge Funds”: Part One (Jan. 21, 2016); and Part Two (Jan. 28, 2016). For more on mark-to-market accounting, see “Tax Practitioners Discuss Taxation of Options and Swaps and Impact of Proposed IRS Regulations” (Feb. 19, 2015).

How E&O and D&O Liability Insurance Can Help Hedge Fund Managers Mitigate the Consequences of Regulatory Enforcement Actions

Responding to a regulatory inquiry can entail substantial legal and other expenses for a hedge fund manager – even if the manager is not the target of the investigation. Furthermore, private litigation often follows regulatory action. One way to mitigate such risks is through appropriately tailored errors and omissions (E&O) and directors and officers (D&O) liability insurance. A recent alternative asset manager forum sponsored by insurance advisory and brokerage firm Crystal & Company examined how and when such insurance may cover the cost of responding to regulatory inquiries; the claims process; the policy provisions a manager should focus on to ensure appropriate coverage; and the current market for such insurance. Moderated by Ron Borys, a managing director at Crystal & Company, the discussion featured Theodore A. Keyes, special counsel at Schulte Roth & Zabel; Michael Machin, a national underwriting officer at Travelers; Thomas Ruck, a managing director at CNA; and Ray Santiago, a senior vice president at XL Catlin Professional. This article highlights the key takeaways from the discussion. For coverage of a separate panel from the forum covering cyber insurance, see “Cyber Insurance Providers May Play a Key Role in Assisting Hedge Fund Managers Mitigate Cyber Incidents” (May 26, 2016). For a comprehensive overview of D&O and E&O insurance, see “Hedge Fund D&O Insurance: Purpose, Structure, Pricing, Covered Claims and Allocation of Premiums Among Funds and Management Entities” (Nov. 17, 2011).

SEC Commissioners and Staff Discuss Possible Amendments to Definition of Accredited Investor

Many hedge fund and other private fund managers rely on the private offering safe harbor set forth in Rule 506 of Regulation D, a fundamental benefit of which is that the issuer may offer securities to an unlimited number of “accredited investors.” Last year, after a staff review and consultation with its Advisory Committee on Small and Emerging Companies (Committee), the SEC issued a “Report on the Review of the Definition of ‘Accredited Investor’” (Report). On May 18, 2016, the SEC broadcast a public meeting of the Committee, at which SEC Chair Mary Jo White and Commissioners Michael Piwowar and Kara M. Stein, along with members of the SEC Office of Small Business Policy (part of the Division of Corporation Finance), discussed the Report with Committee members. This article summarizes the principal points raised during the meeting. For other recommendations regarding the definition of accredited investor, see “What Do the Investor Advisory Committee’s Recommendations Mean for the Future of Marketing of Hedge Funds to Natural Persons?” (Oct. 24, 2014); and “Best Practices for Ensuring That Only Accredited Investors Participate in Publicly Advertised Private Offerings by Hedge Funds (Part Two of Three)” (Oct. 17, 2014).

FCA Enforcement Director Emphasizes Responsibilities Under Senior Managers Regime

Mark Steward, Director of Enforcement and Market Oversight at the U.K. Financial Conduct Authority (FCA), delivered a speech at the recent Thomson Reuters Annual Compliance & Risk Summit in London. In his remarks, Steward outlined the strategic direction of the FCA and discussed several key initiatives undertaken by the regulator, including the Senior Managers and Certification Regime; the requirement of skill, care and diligence found in the Conduct Rules; enforcement decision-making; and the broad span of work undertaken by the FCA. Steward’s speech provides valuable guidance to hedge fund managers as to the priorities and focus of the FCA, particularly as the regulator imposes increased responsibility for improving firm culture and governance on managers and other financial institutions. For more from Steward’s colleagues at the FCA, see “Focus on Hedge Fund Managers and Market Liquidity May Be Overemphasized, Argues FCA Director” (Mar. 31, 2016); “FCA Acting Chief Calls for Hedge Fund Managers to Take Greater Responsibility for Implementing MiFID II” (Feb. 18, 2016); and “Hedge Fund Managers Must Prepare for Benchmark Regulation” (Feb. 11, 2016).

Sullivan & Worcester Welcomes Partner to Investment Management Practice in Boston

Sullivan & Worcester recently announced that John Hunt has joined the investment management group in its Boston office. Hunt represents U.S. and non-U.S. investment advisers as well as mutual funds, hedge funds, bank-managed collective investment funds, private equity funds and venture capital funds. He also represents the independent directors of mutual funds. See “SEC Chair Outlines Expectations for Fund Directors” (Apr. 7, 2016). For insight from Sullivan & Worcester attorneys, see “Is the In-House Marketing Department of a Hedge Fund Manager Required to Register As a Broker?” (Mar. 18, 2011); and “Certain Hedge Funds Are Using Enhanced Investor Liquidity As a Marketing Tool” (Jun. 3, 2009).

K&L Gates Adds Investment Management and Corporate Partner in Miami, New York Offices

K&L Gates has added Arturo (Art) Requenez II as a partner in the firm’s investment management/private funds and corporate/private equity practices. Requenez advises public and private companies, including investment funds, investment banks, corporate boards, entrepreneurs and business owners, on a wide range of private equity, corporate and international matters. He has experience in fund formation, U.S. and offshore securities offerings, cross-border mergers and acquisitions, joint ventures and international real estate deals. For insight from K&L Gates partners, see “K&L Gates Partners Outline Six Compliance Requirements and Four Enforcement Themes for Private Fund Advisers (Part Three of Three)” (Jan. 8, 2015); and “Key Investment and Operational Restrictions Imposed on Alternative Mutual Funds by the Investment Company Act of 1940 (Part Two of Two)” (Jun. 27, 2014).

Paul Patrow Joins FaegreBD’s Tax and Corporate Teams in Chicago

Paul Patrow has joined Faegre Baker Daniels’ tax and corporate practices as a partner in Chicago. Patrow advises business entities on tax strategies during business formation and transactions. He also represents private equity and hedge fund sponsors in connection with the formation and operation of investment funds and the acquisition and disposition of investments. For insight from FaegreBD, see “What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?” (Feb. 18, 2011); “Investors Demand More Specificity in Hedge Fund Governing Documents Regarding Circumstances in Which Liquidity Management Tools May Be Used” (Jul. 29, 2009); and “How Can Hedge Fund Managers Prevent or Mitigate Revocations of Redemption Requests?” (May 27, 2009).