Jun. 30, 2016

How FinCEN’s Proposed AML Rule Will Affect Hedge Fund Managers and Other Investment Advisers (Part One of Two)

After years of debate, regulators are poised to require registered investment advisers to implement anti-money laundering (AML) programs mirroring those of banks, broker-dealers and other financial institutions. Not since Dodd-Frank have investment advisers faced such meaningful change to the regulatory framework underlying their operations; they will have to create an infrastructure to facilitate formal compliance with AML rules, as well as suspicious activity reporting and information-sharing requirements that may be new to most advisers. In a two-part guest series, William P. Barry, Kimberly Versace and Jamie Schafer, partner, counsel and associate, respectively, at Richards Kibbe & Orbe, analyze the anticipated role of investment advisers in the U.S. AML regulatory framework. This article discusses the genesis and impact of proposed regulations that would apply to investment advisers. The second article will recommend steps investment advisers should take now to protect themselves in anticipation of the new regulations and ensure they can meet their AML compliance obligations. For more on the proposed AML regulations, see “How Hedge Fund Managers Can Establish an AML Program Under FinCEN’s Proposed Rule (Part One of Two)” (Nov. 5, 2015). For additional insight from practitioners at RK&O, see our two-part “Succession Planning Series”: “A Blueprint for Hedge Fund Founders Seeking to Pass Along the Firm to the Next Generation of Leaders” (Nov. 21, 2013); and “Selling a Hedge Fund Founder’s Interest to an Outside Investor” (Jan. 16, 2014).

How Can Private Fund Managers Grant Preferential Rights? Delaware Chancery Court Decision Stresses Need for Fund Document Integration

A decision by the Delaware Court of Chancery points to certain issues that private fund general partners and managers must take into account when committing to agreements with investors. The decision exposes false assumptions as to the meaning and enforceability of side letters. Issues brought to light during the proceedings have ramifications for the hedge fund sector more generally, asserted a panel at the Ninth Annual Advanced Topics in Hedge Fund Practices: Manager and Investor Perspectives conference recently hosted by Morgan, Lewis & Bockius. The panel featured Morgan Lewis partners and co-heads of the firm’s global hedge funds practice Richard Goldman and Jedd Wider, as well as partner-elect Christopher Dlutowski. This article highlights the panelists’ key insights relevant to hedge fund and other private fund managers with respect to granting investors preferential rights in light of the Delaware decision, responding to requests for most favored nation status and providing investors with notice of material events. For another ruling affecting side letters, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters” (May 28, 2015). For additional insight from Morgan Lewis partners, see “Becoming a Plan Assets Fund May Limit Hedge and Other Private Funds’ Abilities to Charge Fees” (Apr. 21, 2016); and “Under What Conditions Can a Hedge Fund Manager Present Hypothetical Backtested Performance Results?” (Feb. 1, 2013).

Fees, Conflicts, Investment Allocations and Other Hot Topics Hedge Fund Managers Should Expect During an SEC Examination (Part Two of Two)

As the SEC increases investigations and enforcement of hedge fund managers and other registered investment advisers to private funds, it is honing its focus on certain topics. Subject to requests for increasing amounts of information and scrutiny in particular areas, managers must know what to expect from and how to respond to SEC examinations. To help prepare hedge fund managers for an SEC examination, Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa, hosted a panel discussion featuring Ropes & Gray partners Eva Carman, Sarah Davidoff and Joel Wattenbarger. The first article in this two-part series summarized the panel’s insights on effectively navigating the SEC examination process. This second article addresses key areas of SEC focus, including requests for email; conflicts of interest; allocation of fees, expenses and investment opportunities; valuation; cybersecurity; broker-dealer registration; and attorney-client privilege. For additional insight from Carman, see “Ropes & Gray Hosts Teleconference on SEC Enforcement Actions Against Investment Managers, Potential Regulatory Changes in Response to Madoff and Private Plaintiff Claims Against Investment Managers” (Feb. 12, 2009). For further commentary from Wattenbarger, see “Proposed Volcker Rule and the Effect on Private Fund Sponsors and Investors” (Oct. 27, 2011); and “How Will the SEC’s Pay to Play Rule Impact Mergers and Acquisitions of Hedge Fund Management Companies?” (Aug. 6, 2010).

Expanded “Gatekeeper” Responsibilities May Impact Relationship Between Hedge Funds and Service Providers

The Dodd-Frank Act expanded the SEC’s authority and oversight of the fund industry, in part by subjecting previously unregistered advisers to registration requirements. Two recent SEC enforcement actions have further increased this authority, finding that a service provider to hedge funds – not itself subject to fiduciary or other obligations under the Investment Advisers Act of 1940 (Advisers Act) – was responsible for Advisers Act violations by two of its clients. On June 16, 2016, the SEC announced the resolution of two enforcement actions against a private fund administrator that, by missing various red flags raised by activities of its private fund clients, allegedly caused those clients to violate antifraud provisions of the Advisers Act. This article analyzes the facts that led up the SEC’s allegations, resolution of the enforcement actions and potential industry implications. For more on the SEC’s focus on gatekeepers, see “How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?” (Aug. 19, 2011).

SEC Continues to Focus on Insider Trading and Fund Valuation

The 2013 landmark decision in U.S. v. Newman cast doubt on the state’s ability to prosecute insider trading by remote tippees. See “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016). Nevertheless, regulators continue to move aggressively against perceived insider trading. The SEC recently brought a civil enforcement action against portfolio manager Sanjay Valvani, a partner and portfolio manager for hedge fund manager Visium Asset Management (Visium), and Gordon Johnston, a former official of the U.S. Food and Drug Administration (FDA), alleging that they had engaged in insider trading of shares of pharmaceutical companies whose stock prices would be affected by the FDA’s approval or disapproval of certain generic drugs. In parallel actions, the SEC has also accused former Visium portfolio manager Christopher Plaford of participating in that and another such scheme and has accused both Plaford and former Visium portfolio manager Stefan Lumiere of manipulating the valuation of securities held by a Visium fund. This article summarizes the facts underlying the complaints, particularly the insider trading charges. The cases are noteworthy because insider trading claims based on receipt of confidential government information are relatively rare. Even so, political intelligence firms remain in the SEC’s crosshairs. See “Self-Evaluation Policies Are Insufficient for Political Intelligence Firms to Avoid MNPI Violations” (Dec. 17, 2015); and “GAO Report Dissects the Mechanics of the Political Intelligence Market and Highlights Insider Trading Risks for Hedge Fund Managers” (Apr. 25, 2013). 

C. Dabney O’Riordan Named Co-Chief of SEC Asset Management Unit

The SEC recently announced that C. Dabney O’Riordan has been named Co-Chief of the Division of Enforcement’s Asset Management Unit (AMU), a national specialized unit that focuses on misconduct by investment advisers, investment companies and private funds. She joins Anthony Kelly as Co-Chief of the AMU and succeeds Marshall Sprung, who left the agency in April. For more on the AMU, see “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015).