Articles Tagged with Hedge Funds

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The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued a notice of proposed rulemaking on August 25, 2015 which, among other things, would add SEC-registered investment advisers to the “financial institutions” regulated under the Bank Secrecy Act (BSA). This represents another step by the U.S. government to expand the professions and industries deemed anti-money laundering (AML) gatekeepers. Covered investment advisers will face new AML program, reporting and record-keeping requirements, with implications for hedge, private equity and other funds; money managers; and public or private real estate funds.

FinCEN has long expressed an interest in regulating investment advisers, which it believes may be vulnerable to or may obscure money laundering and terrorist financing. Should the rule become final, SEC-registered investment advisers would be included in the regulatory definition of “financial institution” and, as a consequence, required to establish and implement appropriately comprehensive written AML programs and comply with a variety of reporting and recordkeeping requirements under the BSA. Investment advisers that already implemented AML programs would need to evaluate them to ensure they comply with BSA requirements.

Who are Covered “Investment Advisers”?

Investment advisers provide advisory services, such as portfolio management, financial planning, and pension consulting, to many different types of clients, including institutions, private funds and other pooled investment vehicles, pension plans, trusts, foundations and mutual funds. According to the proposed rule, an “investment adviser” would be defined as “[a]ny person who is registered or required to register with the SEC under section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(a)).”

The definition would cover all investment advisers, including subadvisers, subject to Federal regulation which, generally speaking, would include advisers that have $100 million or more in assets under management. This includes investment advisers engaging in activities with publicly or privately offered real estate funds. Small- and medium-sized investment advisers that are state-registered and other investment advisers that are exempt from SEC registration requirements would not be captured by the proposed rule. FinCEN indicated, however, that future rulemaking may include those types of advisers.

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Read this article and additional publications at pillsburylaw.com/publications-and-presentations.  You can also download a copy of the Client Alert.

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During the second quarter of 2015, fund administrator Citco overtook State Street Global Fund Services to become the top fund administrator with regulatory assets under management (RAuM) of $1.06trn as reported to the Securities and Exchange Commission, according to HFM Week.

HFM Week tracks fund administrators, on a quarterly basis, by both the number of funds managed and RAuM. Citco’s ascension to the number one spot for RAuM continues the momentum that Citco previously established through its position as the number one fund administrator based on the number of funds administered in prior HFM Week studies.

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Pillsbury hosted a panel event for 100 Women in Hedge Funds on July 28 discussing conflicts of interests hedge fund managers face in managing multiple account types, such as funds, institutional separate accounts and sub-advised mutual funds.  Kristin Snyder, Associate Regional Director for Examinations, San Francisco Regional Office of the Securities and Exchange Commission, emphasized that while the SEC does not expect advisers to have conflict-free business models, clear disclosure and effective mitigation of material conflicts are essential fiduciary duties of an adviser.  Other panelists and representatives of hedge fund managers (Frank Martin, President, Standard Pacific Capital, LLC) and institutional investors (Michelle Young, Managing Director, Ohana Advisors), provided insights into identifying, assessing, mitigating, and managing those conflicts. Ildiko Duckor, Partner and co-head of Pillsbury’s Investment Funds and Investment Management group, moderated the panel and offered tips and comments on practical solutions to account conflicts.

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Pillsbury partner Ildiko Duckor will participate in the 100 Women in Hedge Funds sponsored event titled “HOT topics in Compliance: Conflicts of Interests in Account Management and more” on July 28, 2015.

In quest for assets and investors, hedge fund managers continue to diversify their client base. When they are successful, they may end up with a broad spectrum of accounts: managed accounts, 40 Act registered funds and proprietary accounts in addition to hedge funds. With variety comes complication – from a compliance perspective.

Are your side-by-side account management procedures up to par?

Join us in a panel discussion with experts from the SEC, Legal/Compliance, and Managers/Investors highlighting just what you need to know about the following compliance hot button topics:

  • Conflicts of interests in the center of the SEC’s focus – arising from trade allocations, expense allocations, related party transactions, side letters and proprietary account biases
  • Best practices you should have in place now
  • Investors’ main concerns during negotiations with the managers and what you need to know about their due diligence expectations

For more information, visit 100 Women in Hedge Funds.

Date & Time
7/28/2015
6:00 pm PT

Location
Pillsbury’s San Francisco office
Four Embarcadero Center
22nd Floor
San Francisco, CA 94111

Event Contact
Jessica Slater

Speakers

Ildiko Duckor
Kristin Synder, Securities and Exchange Commission
Frank Martin, Standard Pacific Capital, LLC
Michelle Young, Ohana Advisors

Sponsors
Pillsbury
100 Women in Hedge Funds

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Threats go way beyond simple theft of client information — Can you fend off a big heist?

Recently, the government identified hedge funds as a “weak link in the U.S. financial system’s defense against hackers and terrorists.” The messenger was no less than John Carlin, head of the Justice Department’s National Security Division, speaking at this year’s annual SALT hedge fund conference in Las Vegas. Since then, there have been reports that some of the biggest names in asset management and banking were affected by cyber-attacks. It is, in fact, a Who’s Who of asset managers, banks, and brokers.

This February, the SEC’s summary of its cybersecurity sweep has revealed that over three-quarters of the 100 brokers and advisers examined were subject to cyber-attacks, directly or through third-party service providers, even though upward of 80% of broker and adviser firms have implemented cybersecurity policies. The SEC followed up with guidance in April, making it clear that it intends to conduct more exams of advisers. These exams will be “more substantial,” with longer onsite visits and sit-down meetings with senior management.

Yet for all the heartburn caused by these SEC examinations, they seem to be only scratching the surface when it comes to the types of cyber-threats confronting hedge funds.

The SEC notes that it is focusing on protecting “client assets” by reviewing security measures such as password storage and the vetting of third parties. Those kinds of questions and exam goals indicate that the SEC is mostly interested in protecting against the theft of client data and information. But those are by no means the only potentially damaging threats faced by investment advisers nor are they the only ones that can impact investor assets.

As Carlin pointed out in his comments, hedge funds are a particularly desirable target for criminal cartels, foreign governments, and militaries around the world, basically anyone seeking profit, disruption in financial systems, or both. Hedge funds have valuable and vast assets, including their trading strategies and trades, as well as algorithms, in addition to those the SEC is worried about. Hedge funds are also easier to hack than banks, which have recently reinforced their cybersecurity defenses and, unlike most hedge funds, have teams available to handle the threats.

All hedge fund managers and investment advisers should therefore question how effective their cybersecurity controls are in light of the following real threats posed by cyber-criminals:

  • Hacking and stealing your strategy and algorithms. They will use your own and your employees’ handheld and portable devices, social media posts, and blogs, for phishing and otherwise hacking your internal systems. They will use high-frequency trading algorithms to steal your proprietary trade information in order to front-run you or otherwise engage in manipulative trading. They will steal and use your algorithms to replicate your strategy.
  • Blackmailing and extortion. They will hack and encrypt your data, and blackmail you for payment in return for your data. The Department of Justice is reportedly working with several hedge funds on just such cyber-extortion cases, as Carlin remarked.
  • Corrupting your data and crippling your trading process: They will use a form of malware that will intentionally distort or change data, making information unreliable at best or useless at worst. Perhaps even worse, the corruption of proprietary algorithms used to make investment decisions could go unnoticed for some time. In that event, advisers and their clients face losses, regulatory action, and reputational damage following the disclosure – likely mandatory — of such an incident.
  • Wiping your data: Perhaps the most dreaded of all attacks: hackers have repeatedly demonstrated their ability to literally wipe servers clean of data. Victims are left scrambling to reconstruct files either from scattered data backups or even paper records. This process is extremely laborious and time- consuming, and is not guaranteed in any way to completely restore records. In fact, this type of event is virtually guaranteed to put a broker/dealer or investment adviser out of business, as the reputational damage alone will likely be catastrophic.
  • Disrupting your operations: Too many companies take for granted the availability of their information technology systems. And, when those systems fail, managers tend to assume a technical fault that can be resolved quickly. As the cyber-attack on Sony Pictures proved, however, any company can be paralyzed by the deliberate introduction of malware, which also happened in 2013 to a large hedge fund. A well-crafted attack can render a company unable to do business for months at a time. Unfortunately, the tools and skills needed to conduct such an attack against you are readily available across the globe.

The key takeaway is this: just focusing on making sure hackers don’t break into accounts to steal investor information is not enough. There are many other ways hackers can wreak havoc, and the financial industry has to be prepared to respond to that wide variety of scenarios.

Stay tuned for our article on tips to prevent, detect and respond to cyber-attacks.

Ildiko Duckor is a partner and co-head of Pillsbury Winthrop Shaw Pittman LLP’s Investment Funds and Investment Management Practice. She specializes in hedge funds. She can be reached at ildiko.duckor@pillsburylaw.com or 415-983-1035.

Brian Finch (@BrianEFinch) is a partner in Pillsbury Winthrop Shaw Pittman LLP’s Government Law & Strategies Practice. He specializes in cybersecurity. He can be reached at brian.finch@pillsburylaw.com or 202-663-8062.

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The Bureau of Economic Analysis (BEA) has extended the deadline to file Form BE-10, Benchmark Survey of U.S. Direct Investment Abroad, to June 30, 2015, for all new filers.

For information on Form BE-10 filing, please read our recent article HERE.

Further information on BE-10 is available at the BEA website.

 

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  • Mandatory reporting required by the Bureau of Economic Analysis on Form BE-10 – 2014 Benchmark Survey of U.S. Direct Investment Abroad
  • Investment managers, general partners, hedge funds and private equity funds are among those that may have to file

What is BE-10?

BE-10 is a benchmark survey of U.S. direct investment abroad, conducted once every five years by the Bureau of Economic Analysis (“BEA”) of the U.S. Department of Commerce. The purpose of the survey is to obtain economic data on the operations of U.S. parent companies and their foreign affiliates. The BE-10 survey is conducted pursuant to the International Investment and Trade in Services Survey Act, and the filing of reports is mandatory pursuant to Section 5(b)(2) of that Act. BE-10 reports are kept confidential and used for statistical analysis.

What is the filing deadline?

May 29, 2015 – if you are a U.S. Reporter (defined below) filing to report fewer than 50 Foreign Affiliates (defined below).

June 30, 2015 – if you are a U.S. Reporter filing to report 50 or more Foreign Affiliates.

Extensions. The BEA will consider reasonable requests for extensions if received before the applicable due date of the report. Extension requests should “enumerate the substantive reasons necessitating the extension” on the form provided by the BEA.

Who must file?

All U.S. persons that had direct or indirect ownership or control (each, a “U.S. Reporter”) of at least 10%[i] of the voting stock of a foreign business enterprise (a “Foreign Affiliate”) at any time during the entity’s 2014 fiscal year must file.

Any U.S. general partner or investment manager of a private fund could be a U.S. Reporter, and any hedge fund, private equity fund, or other private fund could be either a U.S. Reporter or a Foreign Affiliate, if they meet the above criteria.

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[i] A U.S. Reporter’s ownership interest in a Foreign Affiliate may be held indirectly through a directly held Foreign Affiliate that owned the given foreign enterprise. You must “look through” all intervening foreign enterprises in the chain to determine whether you hold a foreign business enterprise to the extent of 10% or more. To calculate your ultimate ownership percentage, multiply the direct ownership percentage in the first Foreign Affiliate by that first Foreign Affiliate’s direct ownership percentage in the second enterprise in the chain, multiplied by the direct ownership percentage for all other intervening enterprises in the ownership chain, until you reach the ownership percentage in the final foreign business enterprise. To illustrate, if a U.S. Reporter owned 50% of Foreign Affiliate A directly, and A owned 75% of foreign business enterprise B which, in turn, owned 80% of foreign business enterprise C, the U.S. Reporter’s percentage of indirect ownership of B would be 37.5% (the product of the first two percentages), its indirect ownership of C would be 30% (the product of all three percentages), and B and C (as well as A) would be considered Foreign Affiliates of the U.S. Reporter.

Read this article and additional publications at pillsburylaw.com/publications-and-presentations.

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The expense provisions of many private fund governing documents are becoming longer and more detailed for good reason – increased Securities and Exchange Commission (SEC) scrutiny and prosecution relating to expense allocation and disclosure.

On April 29th, the SEC announced charges against Alpha Titans LLC, a hedge fund advisory firm, its principal, Timothy P. McCormack and its general counsel, Kelly D. Kaeser, for improper use of fund assets to pay expenses that were not previously disclosed to fund investors. According to the SEC, office rent, employee salaries and benefits and other expenses totaling more than $450,000 were paid by two affiliated private funds without adequate disclosure or authorization. The SEC further alleged that Alpha Titans, McCormack and Kaeser sent investors audited financials that did not disclose that approximately $3 million of expenses pertained to transactions involving affiliates of McCormack.

According to the SEC, the funds’ outside auditor, Simon Lesser, was aware of the manner in which expenses and assets were allocated, yet approved audit reports containing unqualified opinions that the financial statements were presented fairly. He was charged with engaging in improper professional conduct in connection with an audit of the funds’ financial statements. The advisory firm also was charged with custody rule violations relating to its distribution on non-GAAP-compliant financial statements.

All of the charges were settled without admission or denial of responsibility; however, not without significant cost. McCormack and Kaeser will be barred from the securities industry for one year and Kaeser will be unable to represent an SEC-regulated entity for one year. Lesser will be suspended from providing accounting services on behalf of an entity regulated by the SEC for at least three years. Substantial monetary penalties also were assessed and the advisory firm and its principal agreed to pay disgorgement and prejudgment interest.

The lesson for private funds, their advisers and outside auditors is simple. First, fund documents should clearly, accurately and thoroughly disclose the types and amounts of expenses to be charged to the fund or its investors. Second, fund managers must allocate expenses and use fund assets strictly in accordance with the relevant provisions in the fund documents. Finally, outside auditors must be diligent in reviewing expense allocations and the use of fund assets to determine compliance with fund documents.

There should be no doubt that the risk of non-compliance is real.

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With interest rates and credit spreads near historic lows and equity valuation above historical averages, many people are concerned that the Federal Reserve, by artificially keeping rates low, has created a 2007 type asset bubble in the capital markets where many securities are priced to perfection. What happens to the financial markets when the Fed begins to raise interest rates or there is some other economic shock to the financial system, and what impact will this have on the hedge fund industry? We recently saw a glimpse of this from mid-September to mid-October when we experienced a slight tremor in the capital markets which saw asset prices decline and volatility spike. This was followed by an onslaught of negative articles from the mainstream media relative to the hedge fund industry.

Agecroft Partners believes there is a low probability of another 2008 type market selloff in the near future. However, if it were to occur, the outcome in the hedge fund industry would be very different than what was experienced in 2008. The hedge fund industry is structurally much more stable today than in 2008. As describe below, such stability would result in significantly less redemptions and an avoidance of a complete seizing of inflows.

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Read this article and additional publications at pillsburylaw.com/publications-and-presentations.

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China imposes controls on the inflow and outflow of foreign exchange. Given the involvement of State Administration of Foreign Exchange and various other governmental agencies in the process, repatriating funds from China can be a trap for the unwary. Foreign investors should familiarize themselves with the approval requirements and procedures.