The Capital Commitment

Proskauer on Private Equity Litigation

Five Things to Think About Before a Surprise SEC Exam

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 Private Investment Funds Group Releases Annual Review and Outlook

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.

SEC Releases FY 2017 Enforcement Results: Maintaining Focus on Individual Accountability and Investment Advisers

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:

Fiscal Year 2014 2015 2016 2017
Independent/Standalone Actions 413 507 548 446
Follow-on Administrative Proceedings (i.e., SEC Proceedings initiated following conviction or injunction in District Court) 232 168 195 196
Delinquent Filings 110 132 125 112
Total Actions 755 807 868 754
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:

U.S. House Bill Aims to Curtail SEC Staff’s Ability to Obtain Algorithmic Trading Source Code

On October 4, 2017, U.S. Representative Sean P. Duffy [R-WI-7] introduced U.S. House of Representatives Bill H.R.3948 entitled the “Protection of Source Code Act.”

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

Pay-to-Play – SEC Expands Scope of Rule to CABs

The SEC’s pay-to-play rule has given advisers reason to worry about potential foot faults since its adoption. As we have noted in prior posts, the rule is filled with landmines and is therefore difficult to navigate.  As was evident from the SEC’s announcement of a series of settlements of alleged pay-to-play violations in early 2017, even a small contribution without any intent to influence an election or an official can run afoul of the rule and put two years of fees and carry at risk.

Last week, the SEC issued an order that will expand the scope of the pay-to-play rule.  The SEC approved a FINRA proposal to extend the self-regulatory organization’s Rules 2030 and 4580 (its pay-to-play and associated recordkeeping rules) to a recently established category of FINRA-registered firms known as capital acquisition brokers, or CABs.

Continue Reading

Veil-Piercing Under California Law – Heightened Risks for Fund Managers

We recently posted about the risks associated with veil-piercing claims and the ways in which fund managers can protect themselves from exposure to these claims. Our first post on veil-piercing focused on Delaware standards, while this post discusses California law.

California law differs in several important respects from Delaware law on this topic. If a company is subject to suit in California, there are increased risks even if the company is incorporated elsewhere.  Courts may assert that California law should apply when the plaintiff is a California resident or when the company operates in California.

And where California law applies, courts may aggressively set aside corporate distinctions, leading to unanticipated results. Continue Reading

SEC Flags the Top Six Advertising Rule Deficiencies for Investment Advisers

The SEC staff recently published an alert highlighting the most common deficiencies seen in investment advisers’ marketing materials.  Based on its recent examinations and initiatives, the Office of Compliance Inspections and Examinations (OCIE) issued its risk alert to highlight compliance issues relating to Rule 206(4)-1 (the “Advertising Rule”).  Here are the top six:

  1. Misleading Performance Results.
  2. Misleading One-on-One Presentations.
  3. Misleading Claim of Compliance with Voluntary Performance Standards.
  4. Cherry-Picked Profitable Stock Selections.
  5. Misleading Selection of Investment Recommendations.
  6. Lack of Adequate Compliance Policies and Procedures.

Earlier this year, we wrote that performance marketing was one of the top 10 regulatory risks for private funds.  And after an OCIE risk alert, we often expect to see an uptick in related enforcement activity.  At minimum, OCIE is putting the industry on notice that it will scrutinize managers’ advertising and marketing materials.

For additional guidance, please read our full client alert on this topic.

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