On Tuesday, February 13th, the Securities and Exchange Commission (SEC) announced the opening of registration for its 2018 national compliance outreach seminar for investment companies and investment advisers. The event is intended to help Chief Compliance Officers (CCOs) and other senior personnel at investment companies and investment advisory firms to enhance their compliance programs. Continue Reading
With the public equity markets at an all-time high and private equity fund raising setting new records, it might seem counterintuitive to forecast litigation and regulatory risks. The opposite is true. Disputes typically follow capital, and the steeper the growth curve, the greater the risk of litigation and regulatory scrutiny. With that backdrop, we are pleased to present our Top Ten Regulatory and Litigation Risks for Private Funds in 2018.
1. Regulatory Scrutiny Involving Cryptocurrencies and ICOs
Cryptocurrencies and other instruments based on blockchain technology – such as Initial Coin Offerings (ICOs) – are in the regulators’ sights. The SEC has asserted jurisdiction over products structured as ICOs and is pursuing violations of the anti-fraud provisions and registration violations involving ICOs and cryptocurrencies. A number of enforcement attorneys in the SEC’s new Cyber Unit are focused on ICO and cryptocurrency investigations, with more cases in the pipeline. In addition, the CFTC has declared virtual currencies to be “commodities” subject to its oversight under the Commodity Exchange Act and has brought a number of actions under the anti-fraud provisions of the CEA against industry participants. Fund managers with investments in or exposure to these areas should prepare for questions about disclosures and increasing regulatory scrutiny and spillover relating to those investments. Continue Reading
In his recent remarks at the Securities Regulation Institute, SEC Chairman Jay Clayton had some stern words for market professionals, especially lawyers, involved in initial coin offerings (ICOs). He expressed concern that lawyers in the space “can do better” in their role as gatekeepers to the securities markets, particularly in advising clients whether the “coin” being offered is a security requiring registration.
If a team from the SEC arrives at your office and says, “We are conducting an on-site examination and would like to talk to the CCO right now,” are you prepared? A handful of registered investment advisers have faced surprise SEC exams in recent months. These exams come in two flavors: either a “for cause” exam arising from SEC staff concerns relating to a specific ongoing issue, or a standard exam that for some reason has a surprise component.
There are several logistical items that a fund manager might consider before the SEC shows up unannounced in the lobby, regardless of the substance of the SEC’s inquiry. Thinking and planning ahead can minimize unnecessary stress and confusion in the moment. Fund managers should consider the following questions: Continue Reading
Proskauer’s Private Investment Funds Group recently released its 2017 Annual Review and Outlook for Hedge Funds, Private Equity Funds and Other Private Funds. This yearly publication provides a summary of some of the significant changes and developments that occurred in the past year in the private equity and hedge funds space, as well as certain recommended practices that investment advisers to hedge funds, private equity funds and other private funds should consider when preparing for 2018.
Highlights from the annual review include:
- SEC examination priorities and initiatives and enforcement developments related to the private fund industry, as articulated by SEC officials and corroborated by industry participants, including a review of actions in the areas of performance marketing, valuation, conflicts of interest and investment allocation;
- A review of regulators’ continued focus on whistleblower programs, including an overview of the SEC’s continued scrutiny of separation agreements and the CFTC’s amendments to its own whistleblower program;
- An analysis of the current state of insider trading law, including an analysis of the U.S. Supreme Court’s decision in Salman v. United States, the Court’s first ruling in the area of insider trading in nearly 20 years, and the Second Circuit’s approach to the personal-benefit requirement in United States v. Martoma;
- Ongoing proposed tax changes, including an overview of the evolving tax landscape and a discussion of the recently released GOP tax plan;
- A review of Big Data, including an examination of securities, technology and privacy laws that may impact the use of Big Data;
- Regulatory developments in the area of cybersecurity, including new areas of focus for SEC enforcement initiatives and sources of industry guidance issued by the SEC staff;
- Industry developments in the areas of blockchain and bitcoin technology, including a discussion of state law developments concerning blockchain implementation and an overview of the SEC’s report on the application of the federal securities laws to initial coin offerings;
- Regulatory developments in the European Union, including an update on the Brexit process and a review of both the Alternative Investment Fund Managers Directive and the impending implementation of the General Data Protection Regulation in each of the EU Member States; and
- A comprehensive overview of required regulatory filings across the many agencies overseeing the private funds industry, including a quick reference table for monthly filings in 2018.
Last night, the SEC announced its enforcement results for the Fiscal Year 2017, accompanied by a report from the Co-Directors of its Division of Enforcement. While the total number of actions was down slightly from 2016, the percentage of those cases involving investment advisers or investment companies – 18% – remained consistent, and amounted to over 80 cases. Similarly, insider trading cases remained about 9% of the actions filed. The Annual Report specifically highlighted cases where large investment advisers allegedly charged undisclosed or inappropriate fees to clients, focusing on the fiduciary duties advisers owe to clients. The SEC also noted a case it settled with a large fund adviser, alleging misleading performance marketing and valuation concerns. As we have previously noted, we expect continued SEC attention in the unicorn and startup field relating to valuation and performance during FY 2018.
The results indicate that individual accountability is front and center for the agency’s enforcement staff. With 73% of the Commission’s standalone actions including charges against individuals, Co-Directors of the Enforcement Division asserted that “pursuing individuals has continued to be the rule, not the exception.” Further, the SEC has highlighted its work protecting retail or “Main Street” investors. Based on our interactions with senior SEC staff, this focus on protecting Main Street extends to funds that manage pension and retirement fund investments.
A new development at the end of FY 2017 was the creation of the specialized Cyber Unit, focusing on computer hacking, distributed ledger technology and other cyber-related threats. Fund managers with exposure to ICOs or distributed ledger technology should prepare themselves—those issuers may face increasing regulatory scrutiny which might impact the value of those investments. For example, the SEC just recently obtained an asset freeze in a case involving allegedly fraudulent ICOs. In addition, the use of alternative data sources is likely to be a focus, particularly in situations where the Enforcement Division suspects that potential material nonpublic information is being used or shared.
Yearly data from 2014 through 2017 is summarized in the table below:
|Follow-on Administrative Proceedings (i.e., SEC Proceedings initiated following conviction or injunction in District Court)||232||168||195||196|
|Disgorgement and Penalties Ordered||$4.16 billion||$4.19 billion||$4.08 billion||$3.79 billion|
For more insights into the SEC’s focus over the past year, please see our prior posts:
- SEC Chairman Identifies Guiding Principles
- SEC Flags the Top Six Advertising Rule Deficiencies for Investment Advisers
- Pay-to-Play – SEC Expands Scope of Rule to CABs
- SEC Speaks on Initial Coin Offerings: Tokens May Be Securities
- SEC Announces 2017 Compliance Outreach Program Seminars for Investment Companies and Investment Advisers
- SEC Speaks: 2017 Enforcement and Exam Trends for Private Funds
If enacted, the Bill would amend the Securities Act, the Securities Exchange Act, the Investment Company Act and the Investment Advisers Act to prohibit the SEC staff from obtaining algorithmic trading source code without a subpoena. This would prevent the SEC staff from obtaining source code through OCIE exam requests or during the early stages of an investigation before the staff has obtained authority to issue subpoenas. Continue Reading