Synthetic leverage – the use of derivative instruments, rather than direct borrowing, to gain exposure in financial markets – has grown in popularity with investment funds. The rising prominence of this practice has attracted a correspondingly greater level of attention from regulators, making it critically important for hedge fund managers to be aware of the risks it poses to financial stability and how regulators may respond to its use. See “European Central Bank Official Regards Hedge Fund Leverage As Risk to Financial System” (Mar. 24, 2016). A recent report published by the European Securities and Markets Authority contains a section devoted to analyzing these risks in a regulatory enforcement context. This article highlights the key takeaways most relevant to hedge fund managers deploying, or considering using, synthetic leverage. For more on alternative methods by which hedge funds obtain leverage, see our three-part series on subscription credit and other financing facilities: “Needed Liquidity and Advance Planning” (Jun. 2, 2016); “Greater Flexibility” (Jun. 9, 2016); and “Operational Challenges” (Jun. 16, 2016). 

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It is common for private equity managers to use certain fees they receive from portfolio companies to offset a portion of the management fees owed to the manager by investors in the fund. While this custom is undeniably investor-friendly, the SEC has repeatedly taken issue with how managers calculate these management fee offsets and the level of disclosure provided to investors about those calculations. See “Proper Disclosure of Fee and Expense Allocations Is Crucial for Managers to Avoid SEC Enforcement Action” (Sep. 1, 2016); “Expense Allocation and Fee Practices Fund Managers Should Avoid to Reduce Risk of SEC Scrutiny (Part One of Three)” (Aug. 25, 2016); and “Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action” (Nov. 12, 2015). The SEC recently settled an enforcement action against a private equity manager for failing to disclose that, in certain circumstances, the methodology it used when calculating its management fee offset caused investors to pay a higher management fee than if other methods had been employed. Despite taking steps to remedy the alleged violations, including reimbursing excess fees and providing additional disclosure to investors, the SEC has imposed a multi-million dollar civil penalty on the manager. This article summarizes the allocation practices challenged by the SEC, the specific violations alleged and the other key provisions of the settlement order. This enforcement action by the SEC is the latest in a string of actions concerning fee and expense practices, including with respect to legal fees; broken deal expenses; failure to follow allocation policies; and allocation methodology. Read full article …

In recent years, the SEC has targeted perceived fee and expense improprieties by private fund managers, with each enforcement action causing managers to fortify their internal practices in an attempt to avoid similar regulatory scrutiny. This increased SEC focus has also caused managers to proactively remedy improper fee or expense allocations revealed by their newly enhanced policies and procedures. This final article in our three-part series provides practical guidance about preventative measures fund managers can take to ensure fees and expenses are properly allocated, as well as post-violation efforts they can perform to remedy any improper allocations. Taken together, these can help managers ensure their procedures meet industry standards and may mitigate the severity of any future SEC sanctions. The first article in this series detailed trends in the types of expense allocations most aggressively scrutinized by the SEC. The second article in the series examined the role of inadequate disclosure and failed policies and procedures in causing expense allocation violations and provided steps managers can take to buttress each of those areas. For more on expense allocations, see “Fees, Conflicts, Investment Allocations and Other Hot Topics Hedge Fund Managers Should Expect During an SEC Examination (Part Two of Two)” (Jun. 30, 2016); and our two-part series entitled “How Should Hedge Fund Managers Approach the Allocation of Expenses Among Their Firms and Their Funds?”: Part One (May 2, 2013); and Part Two (May 9, 2013). Read full article …

Julie M. Riewe, a partner at Debevoise & Plimpton and the former Co-Chief of the Asset Management Unit of the SEC’s Division of Enforcement, spoke with the Hedge Fund Law Report about the SEC’s recent enforcement efforts. The discussion centered on the SEC’s focus on conflicts of interest, including its targeting of horizontal allocations between funds and use of analytics to identify the improper cherry-picking of trade allocations. Riewe also explained the SEC’s decision to increase its personnel dedicated to uncovering violations of private fund managers. Riewe will be speaking at the Tenth Annual Hedge Fund General Counsel and Compliance Officer Summit, hosted by Corporate Counsel and ALM, in New York City on September 28-29. Click here for more information and to register for the Summit, using the HFLR’s promotional code available in this article for a discount of $200 off the registration price. For additional insight from Riewe, see “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016); and “SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest” (Apr. 23, 2015). For more on conflicts of interest, see “Proper Use of Advisory Committees by Private Fund Managers May Mitigate Conflicts of Interest” (Dec. 17, 2015); and “Appropriately Crafted Disclosure of Conflicts of Interest Can Mitigate the Likelihood of an Enforcement Action Against an Investment Adviser” (Oct. 15, 2015). Read full article …

On July 19, 2016, the Cayman Islands Court of Appeal (CICA) delivered an important decision in the litigation between liquidators of the Herald Fund SPC and the Primeo Fund, each of which were directly or indirectly feeder funds in the Ponzi scheme run by Bernard Madoff. The CICA’s ruling changes the law on priorities in insolvencies, clarifying where redeemed investors rank relative to outside creditors. However, the decision also calls into question the scope and application of the Cayman Islands statute governing redemptions by fund investors. It is vital for managers of – and investors in – Cayman Islands hedge funds facing liquidity problems to consider the CICA’s findings going forward. In a guest article, Jeremy Walton and Paul Kennedy, partner and senior associate, respectively, at Appleby (Cayman), provide an overview of the history and holding of the case, analysis of potential issues created by the ruling and practical advice for hedge fund managers and investors in light of the decision. For additional commentary from Appleby attorneys, see “Cayman Islands Decision Highlights Three Questions That May Affect the Enforceability of Fund Side Letters” (May 28, 2015); and “How May Investors in Cayman Islands Hedge Funds in Liquidation Protect Their Interests If Dissatisfied With the Liquidators’ Conduct of the Liquidation?” (Sep. 11, 2014). For coverage of another hedge fund forced to liquidate due to its investment in Madoff feeder funds, see “BVI Court Rules on the Validity of the Appointment of Hedge Fund Liquidators by a Hedge Fund Manager Subject to SEC and CFTC Enforcement Actions” (Mar. 28, 2013). Read full article …

Many private fund managers, including hedge and private equity fund managers, have fortified their compliance programs in response to increased regulatory scrutiny in recent years. Cipperman Compliance Services (CCS) recently issued the results of its 3rd Annual C-Suite Survey, which provides a snapshot of the current status of the compliance programs of hedge funds and other financial firms in light of this scrutiny. Among the results captured in the survey concerning hedge fund managers are the pervasiveness of dual-hatting of chief compliance officers; the surprisingly small percentage of hedge funds that have been examined by the SEC in recent years; the significant percentage of hedge fund managers that have failed to perform their required annual compliance reviews; and the sizable amount of revenue that managers have allocated to compliance. This article analyzes these and other key findings from the survey. For additional commentary from CCS founder Todd Cipperman, see our three-part series on the simultaneous management of hedge funds and alternative mutual funds following the same strategy: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015). For more on hedge fund compliance programs, see “SEC Chief of Staff Shares Fifteen-Step Plan for Adjusting to Compliance Responsibilities” (May 26, 2016); and “RCA Compliance, Risk and Enforcement Symposium Highlights Methods for Hedge Fund Managers to Upgrade Compliance Programs” (Jan. 14, 2016). Read full article …

EisnerAmper has increased its financial services practice with the hiring of business development specialist Eugene Tetlow in San Francisco. Tetlow advises clients in the asset management space on fund formation and regulatory issues. For insight from other EisnerAmper partners, see our three-part series on how hedge funds can mitigate FIN 48 exposure in certain jurisdictions: Europe (Mar. 17, 2016); China (Mar. 24, 2016); and Australia and Mexico (Mar. 31, 2016); as well as our two-part series on hedge fund audit holdbacks: “Operational Considerations” (Sep. 10, 2015); and “Implementation” (Sep. 17, 2015). 

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JP Integra Group, the financial services organization formerly known as JP Funds Group, has hired Peter Cockhill, an investment funds and corporate attorney, as group legal director. For commentary from Cockhill, see “Consequences for Global Hedge Fund Managers of the ‘Foreign Private Adviser’ Exemption Included in the Dodd-Frank Act” (Aug. 20, 2010); “Consistent With International Trends, Cayman Islands Monetary Authority May Require More Transparency From Cayman-Registered Hedge Funds” (Jul. 2, 2009); and “Directors of Cayman Islands Hedge Funds Assume a More Substantive Governance Role in Response to Institutional Investor Demands” (Apr. 16, 2009).

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