Sep. 29, 2016

FCA Director Lays Out Expectations for Cybersecurity of Financial Services Firms: Identification of Cyber Risks, Detection, Firm Preparedness and Information Sharing

Cyber attacks and data breaches pose a threat of such magnitude to the financial services sector that past attitudes and approaches to cybersecurity are no longer sufficient. To safeguard sensitive personal and financial data and assets, and to protect the stability of the financial markets, an industry-wide “security culture” is necessary. Firms of all sizes and profiles must actively and continually refine their governance, detection and prevention methods in response to the ever-evolving threat. This was the theme of a speech delivered by Nausicaa Delfas, Director of Specialist Supervision for the U.K. Financial Conduct Authority (FCA), at the FT Cyber Security Summit on September 21, 2016. This article highlights the points of the speech most relevant to hedge fund managers. For coverage of additional insight from the FCA, see “FCA Director Emphasizes Regulator’s Focus on Firm’s Culture of Compliance” (Jul. 21, 2016); and “FCA 2016-2017 Regulatory and Supervisory Priorities Include Focus on AML, Cybersecurity and Governance” (Apr. 14, 2016). For a comparison of the FCA and SEC stances on cybersecurity, see our two-part series “Navigating FCA and SEC Cybersecurity Expectations”: Part One (Jan. 7, 2016); and Part Two (Jan. 14, 2016). For further analysis of the SEC’s stance on cybersecurity issues, see “SEC Chief of Staff Outlines Asset Management Initiatives on Cybersecurity and Transition Planning and Emphasizes Robust Enforcement Environment” (Jul. 7, 2016); and “Growing SEC Enforcement of Hedge Fund Managers Requires Greater Focus on Cybersecurity and Financial Disclosure” (Jul. 7, 2016).

Seward & Kissel Private Funds Forum Explains How Managers Can Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading (Part Two of Two) 

The SEC has recently pursued significant enforcement actions for conflict of interest and insider trading violations, in addition to matters brought via the whistleblower program introduced in 2010 under the Dodd-Frank Act. In response, it is important for fund managers to implement safeguards to avoid becoming subject to SEC scrutiny. These issues, and practical measures that fund managers can adopt accordingly, were among the items addressed by a panel at the second annual Private Funds Forum produced by Seward & Kissel and Bloomberg BNA, held on September 15, 2016. Moderated by Seward & Kissel partner Patricia Poglinco, the panel included Laura Roche, chief operating officer and chief financial officer at Roystone Capital Management; Scott Sherman, general counsel at Tiger Management; and Rita Glavin and Joseph Morrissey, partners at Seward & Kissel. This second article in a two-part series explores the SEC’s targeting of various conflict of interest scenarios, provides an overview of the status of the SEC’s whistleblower program and examines the difficulty of prosecuting insider trading. The first article addressed the inflow and outflow of material nonpublic information, risks related thereto and the ways that fund managers can ensure it is not improperly used. For additional insight from Seward & Kissel attorneys, see “What D&O and E&O Insurance Will and Will Not Cover, and Other Hot Topics in the Hedge Fund Insurance Market” (Jul. 14, 2016); and “The First Steps to Take When Joining the Rush to Offer Registered Liquid Alternative Funds” (Nov. 6, 2014). For commentary from Poglinco, see “How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations” (Sep. 8, 2016). For more from Sherman, see “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two)” (Jun. 13, 2013).

How Hedge Fund Managers May Address the Practical Implications of the NY Court of Appeals Attempt to Clarify the Common Interest Doctrine

Hedge fund managers regularly seek and rely on the advice of counsel, and the confidentiality of those communications is of paramount importance and is frequently taken for granted. The so-called “common interest doctrine,” when applicable, extends the protection of that privilege to third parties and their counsel when the parties share a common legal interest and objective. Relying upon this extended scope of the attorney-client privilege, it has become accepted practice for investment managers and other parties in a wide range of transactions to align themselves in pursuit of mutual objectives, pooling their ideas and invoking a collaborative approach. In a much-anticipated decision rendered in June 2016, New York’s highest court added clarity to the parameters of the common interest doctrine. In doing so, however, the court created myriad everyday ambiguities and potential pitfalls for the uninformed hedge fund manager, including uncertainty about whether a hedge fund manager would be protected by the doctrine at the time that privileged communications are shared with others. In a guest article, David M. Levy, partner at Kleinberg, Kaplan, Wolff & Cohen, discusses the significance of the decision, analyzes its potential ramifications on the hedge fund industry and proposes a potential solution to issues arising from the decision. For additional commentary from Kleinberg Kaplan attorneys, see “How to Draft Key Hedge Fund Documents to Take New Partnership Rules Into Account” (Feb. 11, 2016); “Modified High Water Mark Provisions May Be Difficult for Managers to Market and Implement (Part Two of Two)” (Jun. 11, 2015); and “Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement” (May 7, 2015). For more on the attorney-client privilege, see “Six Recommendations for Hedge Fund Managers Seeking to Protect Themselves From Waiver of Attorney-Client Privilege When Faced With SEC Document Requests” (Jan. 17, 2013).

Hedge Funds As Direct Lenders: Structures to Manage the U.S. Trade or Business Risk to Foreign Investors (Part Two of Three)

Investor demand for exposure to lending strategies continues unabated, as allocators seek investment strategies with attractive yields and lower correlation to the broader markets. Much of the demand comes from pension plans and foreign institutions, which often seek to invest through offshore funds. However, an offshore fund originating loans to U.S. companies runs the risk of being deemed to be engaged in a trade or business in the U.S., thus potentially subjecting its investors to an effective tax rate of more than 50 percent. See “IRS Memo Analyzes Whether Offshore Fund That Engaged in Underwriting and Lending Activities in the U.S. Through an Investment Manager Was Engaged in a ‘Trade or Business’ in the U.S. and Subject to U.S. Income Tax” (Jan. 29, 2015). To mitigate this risk, hedge fund managers have taken advantage of various strategies and structures. This article, the second in a three-part series, examines how direct lending can constitute engaging in a “U.S. trade or business” and explores options available to minimize this risk to investors in an offshore fund. The first article discussed the prevalence of hedge fund lending to U.S. companies and the primary tax considerations for hedge fund investors associated with direct lending. The third article will provide an overview of the regulatory environment surrounding direct lending and a discussion of the common terms applicable to direct lending funds. See also “Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and ‘Season and Sell’ Techniques” (Jan. 22, 2015).

Alleging Dozens of Violations, SEC Charges Leon Cooperman and Omega Advisors With Insider Trading and Failing to Make Regulatory Filings

On September 21, 2016, the SEC commenced a civil enforcement action in the U.S. District Court for the Eastern District of Pennsylvania against hedge fund manager Leon G. Cooperman and his investment advisory firm, Omega Advisors, Inc. The SEC charges that Cooperman received and traded on material nonpublic information about a proposed asset sale by an underlying portfolio company, netting more than $4 million in illicit profits for the funds and accounts he managed. The SEC also claims that Cooperman committed over 40 violations of beneficial ownership reporting requirements under federal securities law. This article summarizes the SEC complaint, with an emphasis on the insider trading allegations. For more on insider trading, see “K&L Gates Partners Identify Eight Actions That Hedge Fund Managers Can Take to Avoid Insider Trading Violations (Part Two of Three)” (Nov. 20, 2014); and our two-part series entitled “How Can Hedge Fund Managers Apply the Law of Insider Trading to Address Hedge Fund Industry-Specific Insider Trading Risks?”: Part One (Aug. 7, 2013); and Part Two (Aug. 15, 2013). For coverage of a derivative suit brought by Cooperman and his funds against a portfolio company, see “Hedge Fund Initiates Derivative Suit Against Directors of a Portfolio Company Alleging Self-Dealing in Approving an Acquisition” (Jul. 11, 2013).

Absent Proper Disclosure, Allocation of Manager Expenses to Funds May Bring Significant SEC Penalties

The SEC recently settled an enforcement action against a private equity manager, serving as the latest reminder to investment advisers that they must scrupulously adhere to the terms of their disclosures when it comes to allocating fees and expenses to funds, particularly expenses incurred (or discounts obtained) by the adviser itself. In the action, the SEC claimed that the private equity manager, without providing adequate disclosure to fund investors, inappropriately allocated overhead expenses of manager affiliates to two private funds, charged certain funds liability insurance premiums in contravention of the funds’ governing documents and negotiated a legal fee discount for itself while its funds paid the same law firm full price for the same services. Within the settlement order, the SEC also reiterated its view that conflicts of interest that have not been adequately disclosed to or approved by investors (or, where appropriate, their representatives) should be resolved in favor of the investors. See “SEC Enforcement Director Highlights Increased Focus on Undisclosed Private Equity Fees and Expenses” (May 19, 2016). This article summarizes the underlying facts, the SEC’s allegations, the remedial actions undertaken by the manager and the terms of the settlement. For a comprehensive look at private fund fee and expense allocation practices, see our three-part series: “Practices Fund Managers Should Avoid” (Aug. 25, 2016); “Flawed Disclosures to Avoid” (Sep. 8, 2016); and “Preventing and Remedying Improper Allocations” (Sep. 15, 2016).

Former SEC Official Joins Ropes & Gray in Washington, D.C.

Ropes & Gray has lured Dalia Blass, a former Assistant Chief Counsel in the Division of Investment Management’s Office of the Chief Counsel at the SEC, to join the firm as counsel. During her tenure at the SEC, Blass provided guidance with regard to securities laws; oversaw the agency’s exemptive relief program for registered funds and the development of legal positions for novel exemptive relief for products and transactions; and drafted SEC rules concerning matters such as liquidity risk management and data gathering. For more on the liquidity risk management rule, see “Current and Former Directors of SEC Division of Investment Management Discuss Hot Topics Under the Investment Company Act” (Mar. 10, 2016). For coverage of other recent hires at Ropes & Gray, see “Amanda Persaud Joins Ropes & Gray’s Private Investment Funds Practice” (Aug. 25, 2016); “Senior AMU Counsel Joins Ropes & Gray in D.C.” (May 12, 2016); and “Ropes & Gray Strengthens Private Investment Funds Practice” (Feb. 18, 2016).

Perkins Coie Adds Four Investment Management Partners in New York

Perkins Coie has expanded its investment management practice in New York with the recruitment of four attorneys, all of whom have joined the firm as partners: Carl Frischling, Alexandra Kambouris Alberstadt, Aviva Grossman and Mark Parise. Frischling guides clients with respect to structuring mutual fund agreements and fiduciary obligations under federal law. Alberstadt advises domestic and international fund clients on a broad range of regulatory and compliance matters. Grossman specializes in the Investment Company Act of 1940 and the Investment Advisers Act of 1940, counseling investment advisers, funds and independent directors. See “SEC Chair Outlines Expectations for Fund Directors” (Apr. 7, 2016). Parise assists hedge funds, mutual funds, closed-end funds and investment advisers with corporate governance, transactional and regulatory matters.