Source: https://www.hflawreport.com/content/vol-4/no-5-feb-10-2011/
Timestamp: 2019-08-25 22:22:39
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Feb. 10, 2011 | Hedge Fund Law Report Home | Law Report Group
How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part One of Two)
The investment returns of hedge funds often depend directly on the depth of their managers’ understanding of companies, industries and trends. Expert network firms exist to enhance that understanding by providing investment managers with efficient access to persons with deep and difficult-to-replicate domain expertise – persons including corporate managers across a range of industries, doctors, engineers, lawyers, accountants, academics and others. Specifically, expert network firms provide at least three services on behalf of their investment manager clients: they compile networks; they make relevant connections; and they structure interactions to comply with relevant law, most notably, insider trading law. These services have generated a range of benefits for a range of parties: hedge fund managers have obtained more relevant and granular research, which has enabled them to allocate capital more effectively, which has improved the efficiency of capital markets generally; experts in expert networks – and there are hundreds of thousands of them – have commercialized expertise and experience that was heretofore confined to their direct job functions; and, recent sound and fury to the side, there is a persuasive argument that expert networks have reduced insider trading on a systemic basis. Nonetheless, the regulatory investigation of insider trading and expert networks is far from complete. More broadly, since the line between insider trading and diligent research can be blurry, many hedge fund managers have used the current investigation as an occasion to revisit their insider trading compliance policies and procedures generally, and their compliance policies and procedures with respect to expert networks specifically. This article is the first in a two-part series undertaken to assist hedge fund managers and others as they revisit and revise their compliance policies and procedures relating to the use of expert networks. This article provides a detailed overview of the law of insider trading, including detailed discussions of the following subtopics: the definition of “materiality” for insider trading purposes; three SEC pronouncements that provide guidance in making materiality determinations; the definition of “nonpublic” for insider trading purposes; breach of duty as a prerequisite for insider trading liability; the three theories of insider trading: classical, misappropriation and tipper-tippee; the “mosaic” theory (and two very important caveats to the mosaic theory); criminal enforcement of insider trading laws, including a brief discussion of substantially all of the civil and criminal insider trading actions brought in the course of the recent investigation, along with links to the underlying documents; and an underappreciated section of the Sarbanes-Oxley Act of 2002 that may offer regulators a potent enforcement tool. The second article in this series will provide a detailed analysis of substantially all of the civil and criminal filings alleging insider trading in connection with expert networks. Read full article …
By July 21, 2011, many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register. Specifically, two categories of hedge fund managers will be required to register with the SEC as investment advisers: (1) hedge fund managers with assets under management in the U.S. of at least $150 million that manage solely private funds; and (2) hedge fund managers with assets under management in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle (for example, a managed account). Registration will subject previously unregistered hedge fund managers to a range of new regulatory obligations and burdens. One of the most notable new burdens is that registered hedge fund managers will be subject to SEC examinations. (Generally, unregistered hedge fund managers are not subject to examinations, though they may be subject to subpoenas or information requests from the SEC where the agency suspects fraud or violation of the federal securities laws.) To assist newly registered (or soon to be registered) hedge fund managers and other registered investment advisers in preparing for, handling and surviving SEC examinations, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature an extended 1.5 hour session entitled “Regulatory Examinations – Briefing on Latest Inquiries from SEC and NFA Staff.” That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York. The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Regulatory Examinations session at the RCA’s April Symposium: Steven A. Yadegari, Senior Vice President & General Counsel at Cramer Rosenthal McGlynn, LLC; Stephen A. McShea, General Counsel & Chief Compliance Officer at Larch Lane Advisors LLC; and Matthew Eisenberg, Partner at Finn Dixon & Herling LLP. Those interviews provide a preview of the topics to be discussed at the RCA Symposium, and offer detailed insights, practical strategies and actionable recommendations for newly registered hedge fund managers facing the prospect of regulatory examinations – in many cases, for the first time. We are publishing these interviews as a three-part series. The full text of our interview with Steven Yadegari was included in last week’s issue of the Hedge Fund Law Report. See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part One of Three),” Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011); our interview with Stephen McShea is included in this issue; and our interview with Matthew Eisenberg will be published in next week’s issue. Our interview with Stephen McShea, included in full below, covered a wide range of relevant topics, including but not limited to: how the length, depth and coverage period of examinations of hedge fund managers have evolved; the average length of time between notification and initiation of an exam; grounds (if any) upon which the SEC may grant a delayed exam start date; trends with respect to the number of additional requests that hedge fund managers can expect during an exam; the role of presentations in the exam process (as distinct from interviews with key people); the advisability of creating a regulatory exam preparation team; the utility of mock examinations; the importance of getting all management company personnel on the same page with respect to the business of the management company and its products; the difference between compliance policies and procedures in theory and in practice; regulatory attention on the allocation of responsibility (internally and externally) for specific functions; creating a written matrix of responsibilities; steps hedge fund managers can take to strike the right “tone at the top”; how to use prior deficiency letters; what to say and not to say at exit interviews; and the relevance for examinations of resource constraints at the SEC. Read full article …
On September 29, 2010, the SEC approved new FINRA Rule 5131, New Issue Allocations and Distributions. Paragraph (b) of Rule 5131 generally prohibits “spinning” – that is, the practice in which FINRA members (substantially all SEC-registered broker-dealers) allocate new issues to officers and directors of current, and certain past or prospective, investment banking clients. As FINRA noted in Regulatory Notice 10-60, “[b]ecause such persons are often in a position to hire members on behalf of the companies they serve, allocating new issues to such persons creates the appearance of impropriety and has the potential to divide the loyalty of the agents of the company (i.e., the executive officers and directors) from the principal (i.e., the company) on whose behalf they must act.” The rule will become effective on May 27, 2011. For hedge funds that invest in new issues, Rule 5131(b) presents a range of compliance and structuring challenges. Although the rule directly governs the relationships between broker-dealers and corporate officers and directors, hedge funds often serve as the vehicle through which such corporate officers and directors invest in new issues. Therefore, the brunt of the compliance burden of Rule 5131(b) will, in many cases, devolve to hedge fund managers. The purpose of this article is to help hedge fund managers design or recalibrate their compliance programs to accommodate new Rule 5131(b), and to highlight some fund structuring options that may be relevant. Specifically, this article discusses: the general rule imposed by Rule 5131(b); the specific prohibitions included in Rule 5131(b); the de minimis exception to the prohibitions (which is relevant for hedge funds); and – most importantly – compliance and structuring strategies for hedge fund managers. Read full article …
On January 26, 2011, the U.S. Commodity Futures Trading Commission (CFTC) proposed amendments to Part 4 of its regulations promulgated under the Commodity Exchange Act (CEA) governing Commodity Pool Operators (CPOs) and Commodity Trading Advisers (CTAs). The CFTC announced a joint effort with the U.S. Securities and Exchange Commission (SEC) proposing the adoption of a new rule on reporting for investment advisers required to register with the SEC that advise one or more private funds and that are also CPOs or CTAs required to register with the CFTC (dual registrants). This joint endeavor, mandated by Section 406 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), would obligate dual registrants to file newly-created Form PF with the SEC in order to satisfy both Commissions’ filing requirements. In an effort to harmonize its rules with this regulatory scheme, the CFTC separately announced a proposed amendment requiring all registered CPOs and CTAs to electronically file newly-created Forms CPO-PQR and CTA-PR with the National Futures Association (NFA) pursuant to § 4.27 of the CFTC regulations, forms substantively identical to Form PF. The CFTC has also proposed further changes to its regulations that it deemed necessary in the wake of recent economic turmoil and the new regulatory environment engendered by the Dodd-Frank Act. These proposed amendments would: (1) rescind the exemption from registration for CPOs provided in §§ 4.13(a)(3) and (a)(4) of its regulations; (2) revise § 4.7 so that CPOs may no longer claim an exemption from certifying certain annual reports; (3) incorporate the definition of “accredited investor” promulgated by the SEC in Regulation D into § 4.7; (4) reinstate the criteria for claiming an exclusion from the definition of CPO provided in § 4.5; (5) require any CPO or CTA seeking exemptive relief pursuant to §§ 4.5, 4.13 and 4.14 to annually renew their request with the NFA; and (6) require an additional risk disclosure statement under §§ 4.24 and 4.34 for any CPO or CTA engaged in swap transaction. The CFTC intends to promulgate these new rules in an effort to provide effective oversight of the commodity futures and derivatives markets and to manage the risks, especially systemic risks, posed by any pooled investment vehicles under its jurisdiction. This article provides a detailed summary of the CFTC’s proposed amendments. Read full article …
Facing a growing divide between the number of SEC-registered investment advisers (RIAs) and its ability to examine them, on January 19, 2011, the SEC released its “Study on Enhancing Investment Adviser Examinations,” for congressional review. The Study, mandated by Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), disclosed that RIA examinations had significantly declined in the last six years due to the increase in RIAs as well as RIA assets under management, and a concomitant decrease in Office of Compliance Inspections and Examination (OCIE) staff. The Study’s authors predicted that this imbalance would continue to get worse as OCIE staffing cannot keep pace with future industry growth. That, it said, was certain even though Congress, in the Dodd-Frank Act, had substantially lessened the SEC's workload in the immediate future by raising the asset threshold for SEC registration from $25 million to, in general, $100 million. Based on its conclusion that the SEC still faces “significant capacity challenges,” the Study's authors recommended that Congress strengthen the SEC investment adviser examination program by either: (1) authorizing the SEC's imposition of "user fees" on RIAs to fund the program; (2) authorizing one or more SROs, subject to SEC supervision, to examine all RIAs; or (3) authorizing FINRA to examine dually registered broker-dealer/RIAs for compliance with the Investment Advisers Act of 1940, as amended. This article summarizes the background of the Study and these recommendations. Significantly, this article also details the process of an OCIE-led examination and thus provides a helpful guide for any hedge fund manager preparing for an SEC examination. See also “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Two of Three),” above, in this issue of the Hedge Fund Law Report; “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part One of Three),” Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011). Read full article …
K&L Gates Adds Leading Hedge Fund Attorney Martin Cornish to its Financial Services Practice in London
On February 7, 2011, law firm K&L Gates LLP announced the addition of Martin Cornish as a Partner in the Financial Services Practice in the firm’s London office. Cornish joins K&L Gates from Katten Muchin Rosenman Cornish LLP, where he served as Managing Partner. Read full article …
On February 4, 2011, the Securities and Exchange Commission announced the promotion of Mark D. Cahn to General Counsel in its Office of the General Counsel. He will assume his new role when David M. Becker steps down from the position later this month. Read full article …