• August 19, 2016

    The Hedge Fund LCD 2016 Mid-Year Review

    It’s hard to believe that 2016 is more than halfway over. It seems like just yesterday we reported the Securities and Exchange Commission’s “risk-based” examination priorities for 2016, and in the intervening eight months, we’ve dissected more than 11 of the regulator’s most instructive enforcement actions against investment advisers for violations ranging from operational deficiencies to failure to disclose conflicted transactions to cherry-picking. The CFTC has also been busy, and notably, anticipates finalizing its rules providing for enhanced cybersecurity testing for trading platforms and other entities it oversees, and registration and standards for proprietary traders and algorithmic trading systems, by the end of the year. Other developments in the hedge fund industry have continued apace. Investment advisers prepared for the SEC’s expanded examination team to knock on their doors; authorities further assessed how to regulate dark pools; firms started reviewing how to implement FinCEN’s new AML regime; Brexit happened; and everyone talked about—but never quite figured out—what ‘creating a culture of compliance’ means. Here at The Hedge Fund LCD, we culled through all of the proposed and finalized rules, speeches from regulators, enforcement actions, conferences, surveys and presentations; analyzed; prioritized; and conferred with experts, in order to report information that gives you, our readers, an edge on what’s happening in the industry. In these final few weeks of summer, when things slow down just enough for everyone to catch their breath, it’s a terrific time to take a step back and take stock of what has transpired in the year to-date, and utilize those lessons learned for the coming onslaught of fall and end-of-year. So we have assembled a comprehensive summary of four topics that resonated highest with general counsels and chief compliance officers this year, based on feedback from you, our readers: cybersecurity; developments in the European Union, including AIFMD passporting and Brexit; fees and expenses policies and procedures; and shareholder activism. We also address updates on insider trading, data analytics, succession planning and political contributions, among a few other timely issues which have also received significant attention this year. Each topic includes a breakdown of where things stand to date, any pertinent regulatory enforcement activity, forecasts of what’s ahead and advice on best practices from industry experts, along with links to resources for optional further reading on each topic. Our goal is to provide you with a single resource that gets you up to speed with what’s going on with regulators and your peers. We hope you will find it valuable. Read More »

  • August 11, 2016

    Best Practices for Promoting Internal Reporting of Compliance Issues Without Violating SEC and CFTC Whistleblower Rules (Part Two of Two)

    Regardless of how whistleblowers are perceived in the corporate world—whether revered, hated or disregarded—today’s regulatory environment could very well have precipitated what some have called “the age of the whistleblower”: There are more than 40 whistleblower-friendly federal statutes on the books involving areas as wide-ranging as taxation, environmental protection and corporate bribery abroad. The Securities and Exchange Commission alone fields nearly 4,000 whistleblower tips a year, and the complaints it and the Commodities and Futures Trading Commission investigate could result in significant reputational and legal fallout. Hedge fund managers must address whistleblower complaints immediately and comprehensively to avoid enforcement actions and their consequent stiff financial penalties. The first article in this two-part series outlined hedge fund managers’ obligations under the SEC’s and CFTC’s whistleblower programs and how managers can incentivize employers to first report compliance issues internally. This article outlines best practices for responding to internal whistleblower complaints, reviews the importance of anti-retaliation practices and the current regulatory environment penalizing employer reprisals against whistleblowers, and explains how to craft confidentiality agreements that protect managers’ interests without running afoul of applicable laws and regulations. Read More »

  • August 4, 2016

    Best Practices for Promoting Internal Reporting of Compliance Issues Without Violating SEC and CFTC Whistleblower Rules (Part One of Two)

    Probably since the issuance of the very first share in the Dutch East India Company, the specter of the corporate whistleblower—part hero, part traitor—exposing the intentional or unintentional wrongdoing of his employer, has inspired a certain ambivalence in the public imagination. Corporate history celebrates Frank Camps (the Pinto, Ford Motor Company), Cynthia Cooper (WorldCom) and Frank Casey (Madoff) as heroes; regards Mark Whiteacre (ADM, price-fixing) and Julian Assange (Wikileaks) with some degree of skepticism; and queries why Takata failed to heed employees’ internal reports nearly ten years ago that its airbags were defective. However, one thing is clear: In today’s post-Dodd-Frank regulatory environment, called “the age of the whistleblower” by some, in part because of the outsized bounties regulators are awarding whistleblowers, hedge fund managers cannot afford to be ambivalent about potential whistleblowers; they must embrace them. Hedge fund managers may—not unreasonably—assume that a fairly robust compliance program, designed to prevent and detect fraudulent, criminal, unethical or any behavior that goes against a firm’s policies and procedures, should be sufficient to uncover malfeasance before regulators become aware of the activity. But the simple fact is that regulators increasingly are tipped off by whistleblowers to actual or potential wrongdoing and begin an investigation before the manager even knows there is, or could be, a problem. To complicate matters, hedge fund managers must toe a fine line between encouraging and adequately addressing internal reporting of potential violations of law, and (or while) avoiding even the hint of appearing to hinder employees’ ability to report those violations to regulators. This article, the first in a two-part series, highlights the main provisions of the Securities and Exchange Commission and Commodity Futures Trading Commission’s whistleblower programs and how hedge fund managers can incentivize employees to first report compliance issues internally. The second article in this series will outline best practices for responding to internal whistleblower complaints, crafting confidentiality agreements that protect managers’ interests without running afoul of applicable laws and regulations, as well as explore the current regulatory environment. Read More »

Legal Proceedings & Laws

  • August 11, 2016

    New Luxembourg Funds Regime RAIF With Possibilities

    Luxembourg has staked its claim to become the European Union hedge fund domicile of choice through a major change to its alternative investment fund regime. On July 14, the Grand Duchy’s parliament approved Bill 6929, the Reserved Alternative Investment Fund Law, first proposed late last year. The new legislation, which came into effect at the end of last month, offers hedge funds and other alternative investment managers across the EU—and potentially beyond—a flexible new structure combining the benefits of the country’s longstanding funds regime with its three-year-old unregulated funds regime. With RAIF, Luxembourg has a funds regime that will make it an attractive onshore domicile for the EU, one that has been compared to those available in the British Virgin Islands, the Cayman Islands and Delaware. And with the U.K.’s impending exit from the EU, RAIF could make Luxembourg the predominant EU domicile for managers from Europe’s largest hedge fund center seeking continuing access to the European Common Market. This article, with insight from Patrick Goebel, a partner in Dechert's Luxembourg office, summarizes the new law, its requirements and key features that may make Luxembourg the favored locale for establishing private funds in the EU. Read More »

  • August 4, 2016

    SEC Gauging Disclosed Risks, Style Drift as Litigation Funding Strategies Proliferate

    Litigation finance continues to evolve as a lucrative—and increasingly credible—investment strategy. A 2016 survey of law firms and in-house counsel conducted by the publicly-traded litigation finance firm, Burford Capital, found that 28% of lawyers surveyed say their firms have used litigation finance, and a whopping 75% predict that the strategy will grow over the next five years. Indeed, this past spring, the strategy gained some traction beyond investment management, in the American pop cultural zeitgeist, after it was revealed that the billionaire co-founder of PayPal, Peter Thiel, financed Hulk Hogan’s lawsuit against Gawker Media for invasion of privacy. The reasons for litigation financing’s growing popularity are straightforward: The strategy is generally uncorrelated with the stock market and can yield very high returns—one quantitative researcher cites annual returns between 29% and 42%, with the average around 36%. Yet the very same opacity and lack of liquidity that can potentially lead to higher investor returns may have contributed to the fraud the Securities and Exchange Commission alleges was perpetrated upon investors in funds managed by registered investment manager, RD Legal Capital, and RDLC’s president and chief executive officer, Roni Dersovitz. On July 14, the SEC issued an order instituting administrative and cease and desist proceedings against RDLC and Dersovitz, alleging that they defrauded investors by “marketing and selling investments in two funds based on misrepresentations concerning the type and diversification of assets under management.” The SEC also alleged the investment manager, aided and abetted by Dersovitz, withdrew money from the funds using valuations based on unreasonable assumptions about the underlying litigation risk. The case, the SEC’s second just this year in the litigation finance arena, shows that the regulator is now weighing in on the representations concerning litigation risk and disclosures regarding deviations in investment strategy that managers must make to investors. Read More »

Summary & Synthesis

August 11, 2016

Best Execution, Due Diligence Primary Concerns Regarding Hedge Funds’ Use of Dark Pools

Dark pools—private exchanges that operate with no pre-execution transparency—have found a loyal group of end-users because of their ability to protect sensitive trading information. This added layer of anonymity provides users, including hedge funds, with numerous advantages—among them, protecting the identity of participants and limiting the market impact of large trades. However, bearing out the old adage that there’s no such thing as a free lunch, dark pools also present latent potential pitfalls for those participants that utilize them: most notably, issues surrounding best execution obligations and assurances that the dark pool is operating in a manner the user expects it to. Indeed, pegging the dollar volume of transactions on alternative trading systems—which include dark pools—at around 15% of U.S. exchange-listed equities, the SEC has continued to probe dark pools’ purported ability to offer participants the benefits operators allege through investigations—that have lead to a number of enforcement actions—public comments and proposed rules. To more completely understand the current landscape, as well as to ensure the equitability, effectiveness and competitiveness of the wholesale financial markets, the U.K. Financial Conduct Authority recently conducted a thematic review of the country’s dark pools by analyzing various data and informational sources, as well as speaking with both operators and users (including hedge funds) to gauge dark pool trading in the U.K. And while the survey focused on the U.K. market, there are lessons for all participants in dark pools. This article summarizes the key findings of that review and, along with insight from Lee Unterman, a partner at Montgomery McCracken Walker & Rhoads, provides timely guidance for hedge funds who utilize dark pools when performing due diligence on dark pool operators and addressing best execution issues that might arise in the course of that utilization. Read More »

August 4, 2016

Planning and Preparation Key for Hedge Fund Managers to Implement Long-Delayed AML Rules

Fourteen years after first seeking to impose anti-money laundering compliance rules on hedge funds, the U.S. Treasury’s Financial Crimes Enforcement Network is trying again. Citing risks specific to the large size of hedge fund investments and fears that the U.S. is falling behind in AML enforcement, the regulator last year unveiled new regulations that would require investment advisers to put AML compliance procedures in place. “There seem to be a tremendous number of new regulations,” Adam Gehrie, general counsel and chief compliance officer of Gresham Investment Management, said during a recent webinar hosted by Cadwalader, Wickersham & Taft LLP. But given that many hedge funds already have at least some of the required practices in place, and in light of the rules’ focus on risk-based approaches, FinCEN’s AML compliance regulations may not be as onerous as they initially seem. During the webinar, Gehrie and fellow panelists Maureen Dollinger, vice president of financial crime legal at Barclays, Dorothy Mehta, a partner in the financial services group at Cadwalader and Joseph Moreno, a partner in the white collar defense and investigations group at Cadwalader, and the moderator of the panel, discussed the state of AML compliance for hedge fund managers and the potential burdens of the FinCEN proposal. This article shares their insights and addresses how to set up an AML compliance program that will pass regulatory muster. Read More »


  • August 11, 2016

    Hedge Funds Turn to One Another as Prime Brokers Pull Back

    For hedge funds, prime brokers used to be a one-stop shop. These concierge businesses would provide execution, clearing and custody services. They offered securities lending and reporting. Their capital introduction teams would connect hedge funds with potential investors. Last but not least, they provided margin financing and other lending services. The raft of banking regulations adopted around the world in the wake of the global financial crisis has upended the last of those key prime brokerage services. While some banks—notably Credit Suisse and Deutsche Bank—have recently announced plans to bolster their prime brokerage businesses, it is within a notably constrained framework. Having spent the previous few years shedding smaller clients and restricting financing to come into compliance with strict new capital requirements, banks are showing no signs of abandoning a focus on larger clients—and even they aren’t getting the easy financing they were once used to. This has left hedge funds scrambling for new lenders, and, increasingly, those moving to fill that gap are fellow hedge funds. This article, with insights from Dechert partner Matthew Kerfoot and Tim Clark, partner at O’Melveny & Myers, examines the regulatory environment that has created, and potential risks attendant to, the private-fund-to-private-fund financing trend. A follow-up article will outline key market terms for hedge fund-originated loans and due diligence best practices for both borrowers and lenders. Read More »

  • July 21, 2016

    European Regulator Recommends ‘Passport’ for Funds From U.S., Eight Other Countries

    Most U.S. hedge funds should receive a “passport” to market and manage funds across the European Union, the European Securities and Markets Authority recommended. The regulator on July 19 said there were “no significant obstacles regarding investor protection and the monitoring of systemic risk” blocking an EU passport from U.S. hedge funds offered through private placements. ESMA did say that there could be issues with extending the passport to U.S. funds that involve a public offering, including those structured as mutual funds. Read More »

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