Regulation

Subscribe to Regulation via RSS

Since the Second Circuit’s 2014 decision in United States v. Newman triggered a debate about the personal benefit requirement, several bills have been introduced in Congress to define insider trading. The most recent effort is H.R. 2534, the Insider Trading Prohibition Act, which the House of Representatives passed overwhelmingly last week. The bill would codify certain aspects of the judicially created body of insider trading law. Although we understand that the Senate is unlikely to consider this legislation at least in the near term, the bill’s provisions – if ever enacted – could make it easier for the government to prove insider trading cases, at least against individuals.

Under rule 206(4)-2 of the Advisers Act, otherwise known as the Custody Rule, it is a fraudulent practice for a registered investment adviser to have custody of client funds or securities, unless the adviser takes certain required steps to protect the assets.  Over the past year the SEC’s Enforcement division has been relatively active investigating and enforcing the rule – which, at most, requires a showing of negligence – with a number of complicated provisions that can trip up the uninformed.

Recently, the SEC brought enforcement actions that highlight two key areas under the Custody Rule that can result in liability. First, in addition to maintaining client funds and securities with a “qualified custodian,” advisers with custody of the funds and securities must obtain either (i) a “surprise examination” of those assets annually from an independent public accountant or (ii)  an annual audit of its financial statements by an independent public accounting firm that is registered with (and is subject to regular inspection by) the PCAOB and distribute the financial statements prepared in accordance with GAAP to each investor in the fund within 120 days of the fund’s fiscal year end (180 days for fund of funds).  Most registered private fund advisers rely on the annual audit approach.

Proskauer’s Private Investment Funds Group recently released its 2019 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 advisers should consider when preparing for 2020.

Yesterday the SEC announced its enforcement results for FY 2019, accompanied by a report from the Co-Directors of its Division of Enforcement.  While the total number of actions increased slightly from 2018, the percentage of cases involving investment advisers or investment companies increased more dramatically, growing from 22% in 2018 to 36% in 2019, with a significant portion of the increase attributable to the SEC’s Share Class Selection Disclosure Initiative. Investment advisory issues accounted for 191 standalone actions in the past year.

As a further indication of the SEC’s focus on the asset management industry, on November 1, 2019 the Commission formally established an Asset Management Advisory Committee. This follows the SEC’s recent announcement of its intent to establish the committee.

A settlement last week involving a private equity fund sponsor is a reminder that compliance with fee calculation provisions and valuation policies and procedures are crucially important for fund managers.  Even when an error is the result of simple negligence, the SEC will take enforcement action when fee calculations do not strictly comply with the governing documents, especially where investments are overvalued. 

Recently, a group of Congress members introduced into Congress Senate Bill 2155 named the Stop Wall Street Looting Act of 2019. Although unlikely to be enacted into law as drafted, this proposed legislation would directly and substantially affect a number of fundamental operational aspects of private equity funds and their affiliates.

Today, we are launching a proprietary database tracking all SEC enforcement actions involving private equity advisers. The tracker contains key information from the actions, including summaries of key issues, settlement terms, and relevant statutory provisions. The tracker will be an important resource for us and our clients, providing us with…

A recent action where the SEC focused on the presumably conservative undervaluation of assets suggests that it is more than willing to use valuation as a hook to deter “smoothing” of returns. As we previously noted, while the SEC consistently announces that valuation is a “key area of focus,” it is uncommon for regulators to second guess valuation determinations in the absence of other potential violations. However, failure to adhere to stated valuation policies/procedures is one situation that may lead to heightened regulatory exposure and disputes.

The SEC, in conjunction with the Colorado Bar Association and Colorado Society of Certified Public Accountants, recently sponsored the 51st Annual Rocky Mountain Securities Conference featuring SEC officials and corporate experts from across the nation.  Sam Waldon, partner at Proskauer and former Assistant Chief Counsel in the SEC’s Division of Enforcement, moderated a panel of expert practitioners on developments in securities enforcement and white collar defense.  The following topics were discussed:

1. Current Commission and Division of Enforcement

The Panel generally agreed that commentators have largely overstated the extent to which the current Enforcement program has changed under the current administration.  However, they agreed that the types of cases being brought today, and the current case mix, is somewhat different than the immediately preceding Enforcement program, with a greater emphasis on cases involving retail investor harm.  And the Panel agreed that the single biggest factor impacting the Enforcement program today has been the prolonged hiring freeze.

2. Sharing results of internal investigations

The Panel discussed recent experiences with having to decide whether and how to share the results of an internal investigation with staff, highlighting the challenge of balancing the desire to gain meaningful cooperation credit, against the value of preserving privilege.  The speakers also discussed how it can often be prudent to share with staff the findings of an investigation generally, but not share memoranda memorializing witness interviews.  Such an approach reduces the risk of waiver of the attorney-client privilege and/or attorney work product immunity covering the internal investigation as a result of disclosure to the SEC.