Insights

  • February 23, 2017

    Hedge Fund Fees: Terms and Alternative Structures Negotiated in the Current Market

    Disappointed with the returns hedge fund managers have been producing, investors have started to question whether traditional fee arrangements appropriately align their interests with managers’. Investors’ dissatisfaction with fees has grown so great that at least one large pension plan recently adopted a fee structure that aims to turn the traditional model and its incentive structure on their heads by negotiating a fee arrangement that guarantees that the pension will always pay hedge funds it’s invested in a 1% management fee, regardless of performance, but will never pay more than 30% of the gross alpha produced annually. It’s a radical new way to pay alpha, but the consensus among experts is that while such alternative structures may have their attractive qualities, they’re isolated incidences, unlikely to become features of mainstream arrangements. Still, to further address investors’ concerns, managers are getting more creative, offering—or acquiescing to investor demands for—terms such as hurdle rates, multi-year performance assessments and performance fees based on realized gains. This article discusses the traditional hedge fund fee structure and more fully details the fee-related terms managers and investors currently are negotiating, as well as certain additional demands investors are making before allocating capital to hedge fund managers. Read More »

  • February 23, 2017

    Considerations for Hedge Fund Managers and Investors Contemplating a Fund-of-One Vehicle (Part One of Two)

    As hedge funds have faced performance and capital raising hurdles over the last two years, more institutional investors—including pension plans, endowments and sovereign wealth funds—have sought customized solutions for their investment objectives and operational priorities. In response, and as the overall hedge fund market trends toward customization, managers have embraced the need to address institutional investors’ priorities by offering separately managed accounts and funds-of-one. For institutional investors that would otherwise invest capital in commingled funds, the fund-of-one (or captive fund) structure can be the optimal vehicle to provide the customization, preferential terms, limited liability shield and other benefits they seek. In a two-part guest article, Morgan Lewis partner Jedd Wider and associate Joseph Zargari, examine the advantages and disadvantages of funds-of-one for both managers and investors. The first article reviews fund-of-one legal structures, and explores the fine points of advantages to investors such as oversight of portfolio composition and leverage guidelines, tailored investment restrictions, accelerated liquidity and reduced fees. The second article examines additional preferential terms like increased control and transparency, and heightened standards of care, and also considers certain expense and ownership-related disadvantages of funds-of-one. Read More »

  • February 9, 2017

    What Hedge Fund Managers Can Do to Prevent, Detect and Correct Trade Errors (Part Two of Two)

    Trade errors happen, and because a variety of different mistakes can amount to a trade error—including fat finger errors in the input of trade-execution parameters, excessive time lags in between sending and receiving an order and algorithm coding errors, among others—they are easy to make at any stage in a hedge fund manager’s career. Because of their inevitability, hedge fund managers’ most important consideration is not the fact that a trade error has occurred, but whether appropriate policies and procedures tailored to the trading strategy were in place to prevent and monitor for trade errors, and whether, once discovered, it’s properly corrected and documented. This article, the second in a two-part series, outlines the specific governance and compliance best practices—controls, technology, infrastructure and personnel—hedge fund managers can put in place to prevent, detect and mitigate the risk of traditional and algorithmic trading errors. The first part laid out a framework for hedge fund managers to evaluate whether a trade error has occurred and the legal obligations related to handling, correcting and disclosing trade errors when they have occurred. Read More »

Legal Proceedings & Laws

  • February 23, 2017

    SEC Joins FTC in Scrutinizing Activist Investors’ Securities Acquisitions Reporting

    The Department of Justice isn’t the only regulator compelling activist investors to disclose their intent to change or influence control of issuers: The Securities and Exchange Commission recently entered into a collective settlement agreement with a group of individual and hedge fund investors who failed to timely, and in some cases altogether, report their acquisitions of securities above the Exchange Act’s passive-activist investing threshold. Over the last few years, the SEC’s beneficial ownership reporting rules have been less publicized than the Federal Trade Commission’s Hart-Scott-Rodino Act’s notification thresholds and waiting periods, but the SEC is no less concerned with alerting the market to potential activist campaigns that could affect securities prices: In aggregate, the activist group was fined approximately $420,000 for their reporting violations. This article reviews the beneficial ownership rules and the enforcement action’s allegations against the activist investors. Read More »

  • February 9, 2017

    Truth or Consequences: CCO Accountability for Accurate Regulatory Filings Highlighted in SEC Enforcement Action

    Chief compliance officers currently preparing Forms ADV in anticipation of this year’s March 31st deadline take note: answering a question incorrectly can end careers, or at least that’s one way to interpret a recently settled order filed by the Securities and Exchange Commission. The agency alleged that the chief compliance officer of an exempt reporting adviser filed multiple Forms ADV with false statements. Not incidentally, early last year the Commission sued the exempt reporting adviser and its principal in federal district court alleging, among other things, that they perpetrated a $5 million Ponzi-like fraud on investors. But the order does not allege that the CCO was involved in that fraud. Nor does the SEC allege for most of the false Form ADV statements that the CCO actually knew they were false. Nonetheless, the CCO was fined, suspended and ultimately prohibited from ever acting in a managerial or compliance capacity in the securities industry. At a minimum, the enforcement action counsels that CCOs can face liability for violations solely related to performing the compliance function, perhaps even when made unknowingly, and thus should take steps to confirm that responses to Form ADV are accurate. This article reviews the SEC’s allegations. Read More »

  • February 3, 2017

    FTC Updates Reporting Thresholds, Sanctions Two Investors for Failing to File Necessary Notifications

    As it’s required to do each year to account for changes in gross national product, on January 26, 2017, the Federal Trade Commission published updated, and higher, pre-merger reporting thresholds for the Hart-Scott-Rodino Act. The HSR Act’s requirements are no small detail for hedge fund managers pursuing activist strategies since the thresholds, if met, trigger statutory waiting periods prior to closing stock or asset purchase transactions. In the past few years, several notable hedge funds have found themselves on the wrong side of the FTC’s interpretation of the Act’s requirements, either because they consummated a reportable transaction without observing the notification and waiting periods, or because they incorrectly concluded that their position qualified for the Act’s passive investment exemption. Getting it wrong is costly too, as one hedge fund found out within days of the FTC’s release of the 2017 reporting thresholds—effective January 24, 2017, the maximum civil penalty for violations of the HSR Act is $40,654 per day. This article, with insight from Peter Halasz, partner and general counsel at Schulte Roth & Zabel, and Joel Mitnick, partner at Sidley Austin, summarizes the new reporting thresholds, assesses their sometimes nuanced application, and reviews two of the FTC’s recent actions against investors for violations of the HSR Act. Read More »

Conferences & Seminars

  • February 23, 2017

    How U.S. Hedge Fund Managers Can Effectively and Efficiently Reach the Growing European Marketplace

    Hedge fund managers looking to raise assets in Europe often find themselves stymied by inadequate direct knowledge regarding the demand for alternative products in the EU, the regulatory requirements involved with actively pursuing that market and, once committed, which structures and domiciles make the most sense. The Hedge Fund Association recently hosted a seminar entitled “Global Distribution Strategies for U.S. Hedge Fund Managers.” Moderated by Michael Delano, an audit partner at PwC Luxembourg, panelists Carl Verbrugge, capital partner at Lombard Odier Group, Guillaume Touze, founder and managing director at Quadra Capital and Jérôme Wigny, a partner at Elvinger Hoss Prussen, set out to answer some of the prevailing questions and concerns managers express when eyeing the European market as a source of potential asset growth. This article summarizes the panelists’ key insights, including on the demand for alternatives in Europe, which structures correspond best with the market and potential implications for marketing plans in light of Brexit. Read More »

  • February 9, 2017

    Protecting What’s Yours: Options for Hedge Fund IP Defense

    There could be many different components of a hedge fund manager’s “secret sauce”—a proprietary trading strategy, a piece of technology for running the business, the firm’s name or its client list, among others. Whatever it is that makes a manager unique, it’s likely that it’s legally protectable intellectual property, and managers have several options available for safeguarding and defending it. During its monthly roundtable, “Investment Management and Hedge Funds—What’s Happening Now?” Pepper Hamilton attorneys and industry experts discussed why it is necessary for hedge funds to protect their intellectual property, either through trademarks, copyrights, patents or contractual provisions. This article summarizes their insights on what protections are available for various types of intellectual property, how to apply for trademarks and other protections, what constitutes a trade secret and what recourse firms have if protected intellectual property is stolen. Read More »

  • February 9, 2017

    Planning, Preparation Key to Satisfying Investors’ Cybersecurity Due Diligence Concerns

    The SEC and FINRA recently reiterated their focus on cybersecurity via their respective annual examination priority releases. And it’s not just regulators with a keen interest in cyber-related controls; cybersecurity remains a key aspect of due diligence—both on hedge fund managers by investors, and by hedge fund managers on service providers—and with good cause. A breach can prove costly, causing major business disruptions, reputational damage, lost revenue and regulatory sanctions. A recent panel, hosted by the Investment Management Due Diligence Association, featured insight from Michael Stiglianese, managing director at BDO, Herrick Feinstein partners Rick Morris and Alan Lyons, and associate Erica Markowitz on the current cybersecurity landscape for investment managers. The panelists discussed, among other topics, key aspects of investors’ cybersecurity due diligence on managers, best practices investors should expect managers to implement to mitigate the risk of cyber attack and key terms of a cyber insurance policy. This article highlights the webinar’s key takeaways. Read More »

News

  • February 23, 2017

    OCIE Risk Alert Highlights Most Common Compliance Deficiencies for Investment Advisers

    The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations investment adviser exams have kept apace with the rapidly increasing numbers of private fund manager registrants: In fiscal year 2016, the regulator hit a new record, completing over 2,400 examinations across all program areas, a more than 20% increase over 2015’s record exam statistics. Although private fund managers now have become accustomed to complying with the SEC’s regulations and submitting to both routine and surprise exams, OCIE has noted that they’re still deficient in certain common areas. In a recent risk alert, OCIE identified five compliance topics most frequently identified in deficiency letters and related to the compliance rule, regulatory filings, custody, codes of ethics, and books and records. This article highlights the Risk Alert’s findings and includes advice from Barbara Niederkofler, a partner at Akin Gump Strauss Hauer & Feld; Steven Nadel, a partner at Seward & Kissel; and Scott Moss, a partner at Lowenstein Sandler, on the exam areas where managers are weakest and best practices for strengthening compliance with the applicable rules. Read More »

  • February 9, 2017

    CFTC Update Provides Managers with Blueprint for Cooperating in an Investigation

    Self-reporting a violation to a regulatory overseer can be a tricky proposition: From the regulator’s perspective, it would seem that self-reporting is a net good because it has the potential to increase both the efficacy of investigations and the efficient distribution of the agency’s limited resources. From a hedge fund manager’s perspective, a presumption that the firm will be accorded some degree of leniency—a reasonable expectation for managers to have in light of the economic gains to regulators—can be the deciding factor that tips the scales toward alerting regulators to malfeasance. In practice, however, rarely are the benefits, and potential drawbacks, of cooperation so clear-cut. Many self-reporting firms have found themselves subject to the vagaries of bureaucracy or the regime in place at an enforcement agency at the time, leading some legal practitioners to advise against self-reporting. The CFTC recently released updated guidance that helps clarify for firms what constitutes cooperation sufficient to garner leniency in fines or other sanctions. The guidance outlines a comprehensive list of actions companies should, and should not, take once they discover that they’re on the wrong side of the law or regulations the CFTC is tasked with enforcing. Although the guidance is specific to the CFTC, the principles outlined can serve as a framework for firms considering cooperation with other financial regulators. This article summarizes key aspects of the CFTC’s guidance on self-reporting. Read More »

  • January 26, 2017

    SEC Chair White Discusses Importance Of Agency’s Independence In Last Speech Before Leaving Post

    Just days before she stepped down from her post as chairwoman of the Securities and Exchange Commission, Mary Jo White addressed the Economic Club of New York in a speech arguably memorializing her legacy entitled, “The SEC after the Financial Crisis: Protecting Investors, Preserving Markets.” In her remarks, Chair White discussed the Commission’s role in the post-financial crisis environment, regulations enacted in its wake and the continuing importance of the SEC’s political independence to fulfilling its mandate to protect both investors and the integrity of capital markets. This article summarizes the key points from the speech. Read More »

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