Sep. 8, 2016

D.C. Circuit Delivers Significant Victory for the SEC in Upholding the Use of Administrative Law Judges in Enforcement Proceedings

On August 9, 2016, the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit) ruled in favor of the SEC, rejecting a challenge to the constitutionality of the agency’s practice of bringing enforcement actions in front of administrative law judges (ALJs). In finding for the SEC against a registered investment adviser, the D.C. Circuit validated a long-standing practice utilized by the SEC to try certain enforcement cases in administrative proceedings. In addition to reviewing the D.C. Circuit’s decision, this article provides background on the SEC’s history of bringing contested cases before ALJs, discusses some of the recent criticism surrounding these tribunals and explores ways the decision may influence the SEC’s enforcement of hedge fund managers. For additional discussion of the SEC’s use of administrative proceedings, see “Four Insider Trading Enforcement Trends with Direct Impact on Hedge Fund Trading Strategies (Part One of Three)” (Nov. 13, 2014); and “Compliance Obligations for Registered CPOs and CTAs, OTC Derivatives Trading, SEC Examinations of Private Fund Managers and the JOBS Act (Part Two of Two)” (Feb. 6, 2014).

SEC Settlement With Ex-Goldman Head RMBS Trader Highlights Risk That Puffery May Become Misrepresentation When Trading Illiquid Securities

Hedge fund traders must exercise caution when purchasing hard-to-value securities. Often, the primary source of pricing information comes from the brokers and dealers with which they do business. A recent SEC settlement illustrates a downside of this system: specifically, a broker’s customers can fall prey to an unscrupulous trader who moves beyond sales puffery to outright misrepresentation. The SEC charged that, on at least five occasions in 2011 and 2012, the head of the residential mortgage-backed securities (RMBS) trading desk at Goldman Sachs & Co. (Goldman) misled customers interested in certain RMBS trades, netting Goldman much higher compensation on those trades than the customers thought they were paying. This article summarizes the alleged fraudulent conduct, the SEC’s charges and the terms of the SEC settlement order. For coverage of other enforcement actions involving misrepresentations in sales of RMBS, see “Pricing Information Provided by Brokers to Hedge Fund Managers for Thinly Traded Securities May Not Be Reliable” (Sep. 17, 2015); and “Puffery or Securities Fraud? Litvak Conviction Sheds Light on Permissible Bounds of Bond Sales Talk and the Evidentiary Power of Bloomberg Chats” (Mar. 21, 2014).

What the NLRB Complaint Against Bridgewater Means for Hedge Fund Manager Employment Agreements

A complaint filed by the National Labor Relations Board (NLRB) against Bridgewater Associates (Bridgewater) cites several provisions from a Bridgewater employment agreement that allegedly violated the rights of employees under the National Labor Relations Act (NLRA). The provisions in question – addressing issues such as confidentiality, non-disparagement and waiver of rights to bring certain actions – have been commonplace in employment agreements generally, particularly at hedge funds, for many years. The NLRB’s complaint illustrates a striking disparity between regulators’ standards and expectations, as codified in the NLRA, and employers’ grasp of what constitutes a legal policy or practice. This article provides a summary of the NLRB complaint, along with analysis from law firm partners and other experts in employment-related matters affecting hedge funds regarding the steps managers can take to anticipate and avoid similar administrative actions. For analysis of other restrictive covenants in employment agreements, 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 “Schulte Roth & Zabel Partners Discuss Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements” (Nov. 23, 2011). For analysis of a civil complaint filed by Bridgewater against two former employees, see “Bridgewater Associates Sues Ex-Employees Who Allegedly Seek to Trade Off Its Name and Goodwill” (Oct. 30, 2014). 

Flawed Disclosures to Avoid – and Policies and Procedures to Adopt – for Managers to Reduce Risk of SEC Scrutiny of Fee and Expense Practices (Part Two of Three)

Since early 2015, when it announced that private fund fee and expense allocation practices would be an enforcement priority, the SEC has pursued actions against managers for an array of improper fee and expense allocations. These enforcement actions frequently alleged inadequate disclosure or deficient policies and procedures. This article, the second in a three-part series, examines inadequacies in disclosures that often lead to SEC enforcement actions and provides guidance for how managers should disclose fee and expense allocations going forward. For more on disclosure to investors, see “Growing SEC Enforcement of Hedge Fund Managers Requires Greater Focus on Cybersecurity and Financial Disclosure” (Jul. 7, 2016); and “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?” (Sep. 16, 2011). This article also summarizes the types of allocation scenarios and other recommended features managers should include in their written expense allocation policies and procedures. For additional coverage of manager compliance programs, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014). The first article in this series detailed trends in the types of expense allocations most aggressively scrutinized by the SEC. The third article will describe practices managers should adopt to prevent violations, as well as remedial actions to take upon discovering the improper allocation of a fee or expense. For additional coverage of expense allocations, see “Dechert Global Alternative Funds Symposium Highlights Trends in Hedge Fund Expense Allocations, Fees, Redemptions and Gates” (May 21, 2016); and “Barbash, Breslow and Rozenblit Discuss Hedge Fund Allocations, Restructurings and Advisory Boards” (Apr. 7, 2016).

“Gatekeeper” Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry

Fund administrators have been the target of several recent SEC enforcement actions and civil lawsuits by investors that seek to make administrators liable for the misconduct of fund managers and their principals. These aggressive enforcement actions and civil lawsuits are the first of their kind to argue that administrators serve in a gatekeeper role. For more on the SEC’s focus on another category of 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). In a guest article, Marc Powers and Jonathan Forman, partner and senior associate, respectively, at BakerHostetler, review recent SEC enforcement actions and civil lawsuits against administrators as gatekeepers and outline implications of these actions for hedge fund administrators, managers and investors. For additional insight from Powers, see “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act” (Mar. 5, 2015); and “Chapter 15 of the Bankruptcy Code Presents Litigation Risks and Liability for Creditors, Counterparties, Service Providers and Others Doing Business With Bankrupt Offshore Hedge Funds” (Oct. 3, 2013). For coverage of fund managers shadowing administrators, see “Certain Hedge Fund Managers Are Moving from Full to Partial Shadowing of Administrator Functions” (Sep. 12, 2013); and “When and How Should Hedge Fund Managers Shadow Functions Performed by Their Fund Administrators?” (Mar. 8, 2012).

How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations

In a recent interview with the Hedge Fund Law Report, Patricia A. Poglinco and Robert G. Van Grover, partners at Seward & Kissel, discussed the types of activities the SEC is targeting when bringing enforcement actions against hedge and other fund managers. They also explored the evolving nature of SEC investigations and what hedge fund managers can do to prepare for these examinations. These are among the issues that Poglinco and Van Grover will explore in greater depth as they each moderate panels at the upcoming “Private Funds Forum” co-hosted by Seward & Kissel and Bloomberg BNA to be held on September 15, 2016. For additional insight from Poglinco, see “How Do Regulatory Investigations Affect the Hedge Fund Audit Process, Investor Redemptions, Reporting of Loss Contingencies and Management Representation Letters?” (Jan. 22, 2015). For commentary from Van Grover, see “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?” (Sep. 16, 2011); “Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part One of Three)” (Feb. 25, 2011); and our three-part series entitled “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?”: Part One (Sep. 12, 2013); Part Two (Sep. 19, 2013); and Part Three (Sep. 26, 2013).

K&L Gates Adds Investment Management Partners in Chicago and San Francisco

K&L Gates has expanded its investment management practice with the addition of Joshua J. Yang and Sasha Burstein. Yang advises investment managers on the structuring of hedge funds, commingled funds and investment trusts, and assists banks and funds with derivatives documentation and regulatory compliance matters. Burstein counsels investment advisers and institutional investors regarding hedge funds, private equity funds and hybrid funds. For insight from other K&L Gates attorneys, see our two-part series on SEC examinations: “What Hedge Fund Managers Can Expect” (May 12, 2016); and “How Hedge Fund Managers Can Prepare” (May 19, 2016); as well as our two-part series entitled “K&L Gates-IAA Panel Addresses Regulatory Compliance and Practical Elements of Cybersecurity Testing”: Part One (May 21, 2015); and Part Two (May 28, 2015).

Investment Funds Partner Joins Morrison & Foerster’s London Office

Morrison & Foerster has expanded its fund formation practice in London with the hiring of partner Oliver Rochman. Rochman advises clients on buyout funds, infrastructure funds and funds of funds. For commentary from other Morrison & Foerster attorneys, see “How the Final and Proposed JOBS Act Rules Will Impact Hedge Fund Managers and Their Funds” (Jul. 25, 2016); and our two-part series on how hedge fund managers can use reinsurance businesses to raise and retain assets and achieve uncorrelated returns: Part One (Jan. 10, 2013); and Part Two (Jan. 17, 2013).