Jan. 2, 2020
Jan. 2, 2020
Five Articles Hedge Fund Managers Must Review in Anticipation of 2020
With a new year upon us, the Hedge Fund Law Report is evaluating the trends and challenges fund managers may face in 2020. Based on SEC enforcement actions, regulatory proposals and guidance; statements by SEC officials; and industry trends that we have observed, the Hedge Fund Law Report is highlighting five articles from its archives covering issues of which fund managers should be aware as they prepare for 2020, including the SEC’s focus on responsible investing and insider trading; the need to manage conflicts of interest as part of an adviser’s fiduciary duty; the continued use of big data by both fund managers and regulators; and the latest cybersecurity sweep by the SEC. Next week (the week starting January 6, 2020), the Hedge Fund Law Report will resume its normal weekly publication.
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The Past, Present and Future of ESG Investing in the Hedge Fund Industry
The integration of environmental, social and governance (ESG) factors into the investment process has become a primary objective of certain investors. According to EY’s recent 13th annual Global Alternative Fund Survey, nearly three in ten investors said that they presently invest, or plan to invest, in products that incorporate ESG criteria, and the overwhelming majority of investors said that an alternative manager’s internal ESG policy was either critically or somewhat important when deciding whether to invest with that manager. See “EY 2019 Survey Finds Hedge Funds Losing Ground to PE; Need for Cost Controls; and Growth of Non‑Traditional Investment Products, ESG and Separate Accounts (Part One of Two)” (Dec. 12, 2019). The SEC has also started to focus on ESG, reportedly examining advisers’ criteria for determining whether an investment is socially responsible, along with their methodologies for applying those criteria and making investments. Nevertheless, the adoption of formal ESG policies by hedge fund managers remains fairly uncommon. The first article in this two-part series explores the development of ESG investing and its prevalence in the hedge fund space. The second article reviews advice from industry experts on considerations for managers wishing to develop an ESG investment policy, as well as the due diligence demands from investors seeking investment managers that incorporate ESG factors into the investment process. For more on ESG, see “Luxembourg Plays Prominent Role in ESG Investing and Sustainable Finance” (Nov. 21, 2019); and “Preparing for the Impact Revolution: How Fund Managers Can Implement the Philosophy of ‘Doing Well by Doing Good’” (Mar. 21, 2019).
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What Fund Managers Need to Know About Corporate Access
The House of Representatives recently passed the Insider Trading Prohibition Act, which would bar “insider trading” – that is, securities trading, as well as related communications to others, by a person aware of material, nonpublic information (MNPI). The Act further provides, for purposes of establishing a violation of this prohibition, that it is not necessary for such a person to know specifically how the MNPI was obtained or whether a personal benefit was paid or promised. If passed by the Senate, the prosecution of insider trading would no longer be based solely on case law but would have statutory authority for the first time. One practice that could lead to the risk of insider trading is fund managers’ meeting with officers and executives of publicly traded companies – frequently referred to as “corporate access” – an integral aspect of the research processes of many equity-focused fund managers. This three-part series provides an in-depth look at corporate access and the insider trading risks it can pose. The first article provides an overview of the context in which meetings between fund managers and issuers arise; the goals of corporate access; ways brokers are compensated for facilitating those meetings; and two key legal risks presented by this practice. The second article discusses how advisers can design policies to minimize the risks associated with these meetings, as well as six front-end controls that advisers should consider adopting. The third article analyzes several testing mechanisms that managers can use to ensure compliance with their policies governing corporate access, along with the SEC’s expectations regarding an adviser’s oversight, controls and procedures related to communications with issuer management. See our two-part series on mitigating insider trading risks: “Relevant Laws and Regulations; Internal Controls; Restricted Lists; Confidentiality Agreements; Personal Trading; Testing; and Training” (Sep. 27, 2018); and “Expert Networks, Political Intelligence, Meetings With Management, Data Rooms, Information Barriers and Office Sharing” (Oct. 11, 2018).
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A Fund Manager’s Roadmap to Big Data
The term “big data” refers to data coming from a wide range of sources, including digitized public records, consumer activities, cellphones, industry trends and the “Internet of Things.” Although big data can be beneficial to fund managers, its use poses various compliance challenges in areas such as data privacy and security. Thus, it is not surprising that the SEC is not only increasingly relying on big data itself, but also reviewing managers’ use of big data in recent examinations – a trend that is expected to continue in 2020. The first article in this three-part series explores the big-data landscape and how fund managers can acquire and use big data. The second article analyzes issues and best practices surrounding the acquisition of material nonpublic information; web scraping; and the quality and testability of data. The third article discusses risks associated with data privacy, the acquisition of data from third parties and the use of drones, as well as ways fund managers can mitigate those risks. For more on big data, see “Survey Finds Widespread and Increasing Use of Alternative Data by Hedge Funds” (Oct. 17, 2019); and “FINRA RegTech Conference Examines AI and Big Data; Blockchain; and Regulators’ Views (Part One of Two)” (Mar. 21, 2019). On Wednesday, January 15, 2020, at 11:00 a.m. EST, the Hedge Fund Law Report will host a complimentary webinar, entitled “Best Practices for Private Fund Managers’ Use of Alternative Data.” Moderated by William V. de Cordova, Editor-in-Chief of the Hedge Fund Law Report, the panel will feature Adam Reback, director at Optima Partners; Stacey M. Brandenburg, shareholder at ZwillGen; and Jeffrey Neuburger, partner at Proskauer. The discussion will address issues including the pros and cons of generating or purchasing datasets; managing third-party data providers; complying with data privacy laws and cybersecurity guidance; and avoiding insider trading and other risks. To register for the webinar, click here.
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Navigating the Interpretation Regarding an Investment Adviser’s Standard of Conduct
The SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers (Interpretation) recently became effective. Part of a collection of rulemakings and interpretations that also included the adoption of Regulation Best Interest and Form CRS, the Interpretation is, by far, the most relevant to SEC-registered investment advisers that advise private funds and other institutional clients. Although the Interpretation does not say anything particularly new about an adviser’s fiduciary duty, its detailed discussion regarding an adviser’s obligation to “make full and fair disclosure of all conflicts of interest” reinforces the SEC’s continuing focus on conflicts of interest in recent enforcement actions and risk alerts. This three-part series examines the practical implications of the Interpretation for private fund managers. The first article provides an overview of the Interpretation and explores six key takeaways for fund managers from the Interpretation. The second article outlines key tools that fund managers may employ to identify their conflicts of interest. The third article addresses best practices for investment advisers to manage their conflicts of interest.
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How Fund Managers Can Prepare for the Latest SEC Cyber Sweeps
Over the past five years, OCIE has conducted a series of sweeps examining registrants’ practices related to cybersecurity. Through this process, the SEC has gained information, which, in turn, has helped to both shape its expectations and identify areas of concern and focus. In 2019, the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced two new sets of cyber sweeps, following one in 2014 and another in 2015: the third sweep, announced in March 2019, was primarily focused on cybersecurity practices at investment advisers; and the fourth sweep is focused on cloud service providers, vendor diligence and oversight. OCIE will look at how fund managers are ensuring systems and data are secure at third parties and the cloud service providers they use. For the latest sweeps, the SEC’s standards have risen, the inquiries will be more rigorous and the examiners are bringing more technical expertise. By now, the SEC expects that fund managers have invested resources, technology or human capital to align their programs with SEC expectations. To assist fund managers with responding effectively, this article reviews the current and past cyber sweeps and provides advice on how to prepare for a cyber-focused examination. See our three-part series on how fund managers should structure their cybersecurity programs: “Background and Best Practices” (Mar. 22, 2018); “CISO Hiring, Governance Structures and the Role of the CCO” (Apr. 5, 2018); and “Stakeholder Communication, Outsourcing, Co-Sourcing and Managing Third Parties” (Apr. 12, 2018).
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