The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Pay to Play

  • From Vol. 10 No.16 (Apr. 20, 2017)

    Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar

    Pay to play and wrap-fee violations, as well as improper revenue-sharing arrangements, are perennial SEC hot-button issues. Enforcement often turns on whether there has been adequate disclosure, but even extensive disclosure may be insufficient to avoid sanctions in certain cases. An added concern in the industry is that the SEC and FINRA often identify conflicts of interest in circumstances that do not seem obvious. Further, even if the SEC de-emphasizes enforcement under the Trump administration, FINRA and state regulators may try to fill the gap. These issues and others were addressed in a recent presentation by MyComplianceOffice (MCO) featuring Cipperman Compliance Services founder Todd Cipperman. This article summarizes Cipperman’s insights. For additional commentary from Cipperman, see our three-part series on the side-by-side management of hedge funds and alternative mutual funds: “Investment Allocation Conflicts” (Apr. 2, 2015); “Operational Conflicts” (Apr. 9, 2015); and “How to Mitigate Conflicts” (Apr. 16, 2015). For other recent insights from MCO, see “Study Reveals Weaknesses in Asset Managers’ Third-Party and Vendor Risk Management Programs” (Mar. 9, 2017); and “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016).

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  • From Vol. 10 No.14 (Apr. 6, 2017)

    Ten Key Risks Facing Private Fund Managers in 2017

    A recent seminar presented by Proskauer Rose provided valuable insight on emerging risks for hedge fund managers, including the uncertain regulatory landscape, and perennial SEC targets such as conflicts of interest, valuation and performance marketing. The program was moderated by Proskauer partner Timothy W. Mungovan and featured partner Joshua M. Newville; associates Michael R. Hackett and William Dalsen; and special regulatory counsel Anthony Drenzek. This article summarizes their key insights. For additional commentary from Drenzek, see our two-part series on The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 3, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016).

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  • From Vol. 10 No.12 (Mar. 23, 2017)

    K&L Gates Program Addresses State and Local Lobbying; Pay to Play; and Gifts and Entertainment Limitations (Part One of Two)

    Private fund advisers that seek investments from public pension plans enter a minefield of federal, state and local rules, and those that think that compliance with the “pay to play” rules under the Investment Advisers Act of 1940 affords sufficient protection may be sadly mistaken. States, municipalities and even individual government pension plans have a wide array of rules regarding lobbying, political contributions and gifts and entertainment. Further, sensitive information provided to public pension plans in the course of the investment management relationship may be subject to disclosure under public records and freedom of information (FOI) laws. A recent program presented by K&L Gates offered valuable insights into those state and local rules. The program featured Cary J. Meer and Ruth E. Delaney, partner and associate, respectively, at K&L Gates; and Eric J. Smith, managing director and deputy general counsel at PineBridge Investments. This article, the first in a two-part series, covers the portions of the program devoted to lobbyist regulation; political contributions; and gifts and entertainment. The second article will discuss state “sunshine” and FOI laws. For additional insight from Meer, see “How Hedge Fund Managers Can Prepare for SEC Remote Examinations (Part Two of Two)” (May 19, 2016); “Practical Guidance for Hedge Fund Managers on Raising Capital in Australia, the Middle East and Asia” (Oct. 30, 2014); and “Impact of CFTC Harmonization Rules on Alternative Mutual Funds and Other Registered Investment Companies” (Nov. 1, 2013).

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    Ways the Trump Administration’s Policies May Affect Private Fund Advisers

    With a Republican president and Republican-controlled Congress, there is the possibility for comprehensive changes in several areas of concern to private fund managers, including taxation, regulation and enforcement. In his first weeks in office, President Trump issued a series of sweeping, yet sometimes confusing, orders directed at fulfilling some of his campaign promises. A recent seminar presented by the Association for Corporate Growth (ACG) provided insight on the impact of the Trump executive orders regarding the pending fiduciary rule and other regulatory matters; developments at the SEC; the future of the Dodd-Frank Act and other laws that may affect the private fund industry; proposed tax reform; cybersecurity; and political contributions. Scott Gluck, special counsel at Duane Morris, moderated the discussion, which featured Langston Emerson, a managing director at advisory firm The Cypress Group; Basil Godellas, a partner at Winston & Strawn; Ronald M. Jacobs, a partner at Venable; and Michael Pappacena, a managing director at ACA Aponix. This article summarizes their insights. For coverage of other ACG webinars, see “SEC Staff Provides Roadmap to Middle-Market Private Fund Adviser Examinations” (May 16, 2014); and “SEC’s David Blass Expands on the Analysis in Recent No-Action Letter Bearing on the Activities of Hedge Fund Marketers” (Mar. 13, 2014). 

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  • From Vol. 10 No.4 (Jan. 26, 2017)

    Campaign Contributions As Small As $500 Could Draw SEC Enforcement Action for Pay to Play Violations

    The SEC continues to focus on political contributions by investment advisers seeking to secure government pension investments. It recently charged 10 advisers with violating Rule 206(4)-5 under the Investment Advisers Act of 1940 (Advisers Act) – the so-called “pay to play rule” (Rule). This Rule makes it unlawful for an investment adviser to provide for compensation investment advice to public pension funds for two years after covered employees of that investment adviser contribute to the campaign of officials that can influence the selection of investment advisers by those funds. See “The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability” (Oct. 8, 2015). This article summarizes the key terms of the settlements and their lessons for private fund advisers. All fund managers should pay heed to these settlements, as they illustrate the SEC’s aggressive pursuit of pay to play violations, including the regulator’s enforcement of minor violations of – and broad interpretation of definitions under – the Rule. See “BakerHostetler Panel Analyzes Shifts in Enforcement Policies and Tactics As Industry Anticipates New Administration and SEC Chair (Part One of Two)” (Jan. 5, 2017); “SEC Starts Year With Pay to Play Penalties” (Jan. 28, 2016); and “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them” (Feb. 5, 2015).

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  • From Vol. 10 No.1 (Jan. 5, 2017)

    BakerHostetler Panel Analyzes Shifts in Enforcement Policies and Tactics As Industry Anticipates New Administration and SEC Chair (Part One of Two)

    The hedge fund industry stands at an uncertain juncture, with a new president set to take office in Washington in January 2017, and the announcement that SEC Chair Mary Jo White will be stepping down in the same month. While some observers expect the incoming administration to be generally pro-business and averse to overregulation, it may not be easy to alter or transform an environment in which aggressive financial regulatory policies have become the norm – including a rigorous crackdown on “pay to play” practices, insider trading and conflicts of interest; a growing use of, and reliance on, innovative data analytics to prosecute traders and investment managers; aggressive whistleblower incentives; and a push to bring enforcement cases on the SEC’s “home turf” through administrative law proceedings. The above practices were the subject of a recent panel discussion hosted by BakerHostetler and featuring Marc Powers and Mark Kornfeld, partners in BakerHostetler’s securities litigation practice; Walter Van Dorn, partner and national leader of the firm’s international securities and capital markets practices; and Michelle Chopper, director of the advisory and consulting practices at Arthur Bell. The key takeaways from the panel are presented in this two-part series. This first article reviews the nuances and potential pitfalls of the pay to play rule, the current priorities of the SEC’s enforcement program and the role of technology in detecting violations. The second article will discuss the SEC’s use of administrative proceedings to try enforcement cases, the impact of the Dodd-Frank Act’s whistleblower program and guidance for managers on approaching a regulatory exam or investigation. For recent insight from Powers and Kornfeld, see “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016); and “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act” (Mar. 5, 2015). 

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  • From Vol. 9 No.40 (Oct. 13, 2016)

    How Hedge Fund Managers Can Accommodate Heightened Investor Demands for Bespoke Negative Consent, Liquidity, MFN and Other Provisions in Side Letters

    As investors increasingly demand tailored investment terms, fund managers find themselves forced to accommodate these requests in light of today’s difficult capital raising environment. See “How Emerging Hedge Fund Managers Can Raise Capital in a Challenging Market Without Overstepping Legal Bounds” (Aug. 4, 2016). Some fund managers are incorporating common investor demands into their standard side letters and fund documentation in order to limit negotiations. Many are also adopting side letter policies to accommodate investor demands while avoiding any appearance of preferential treatment and preventing friction among investors. These themes came across in the opening session of the Tenth Annual Hedge Fund General Counsel and Compliance Summit, hosted by Corporate Counsel and ALM on September 28, 2016. Moderated by Mark Proctor, a partner in the private funds group at Vinson & Elkins, the panel featured S. Dov Lando, managing director, general counsel and chief compliance officer at MKP Capital Management; Nicole M. Tortarolo, head of investment structuring at UBS Hedge Fund Solutions; Solomon Kuckelman, head of U.S. legal for Man Investments; and Marc Baum, general counsel and chief administrative officer at Serengeti Asset Management. This article presents the key takeaways from the panel discussion. For additional commentary from Baum, see “Participants at Eighth Annual Hedge Fund General Counsel Summit Discuss CFTC Compliance, Conflicting Regulatory Regimes and Best Marketing Practices (Part Two of Four)” (Jan. 29, 2015). For insight from Tortarolo, see “RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence” (Apr. 2, 2015). For additional views from Lando, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and “Three Pillars of an Effective Hedge Fund Valuation Process” (Jun. 19, 2014).

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  • From Vol. 9 No.4 (Jan. 28, 2016)

    SEC Starts Year With Pay to Play Penalties

    A wide variety of both specific and general rules prohibit the making of political contributions in exchange for government business. See “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them” (Feb. 5, 2015). In the hedge fund space, pay to play schemes often involve making political contributions to secure investment allocations from public pensions or other public funds. Rule 206(4)-5 under the Investment Advisers Act of 1940 was adopted to prevent precisely such misconduct by investment advisers. See “The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability” (Oct. 8, 2015). Pay to play charges can also be brought under the general antifraud provisions of the federal securities laws. The SEC recently charged State Street Bank and Trust (SSBT), along with a senior executive and others, with violating the antifraud provisions of the securities laws in connection with a scheme to win lucrative pension business from the State of Ohio by allegedly funneling cash to the Ohio Deputy Treasurer and campaign contributions to the Ohio State Treasurer. This article summarizes the alleged pay to play scheme and the outcomes of the SEC enforcement actions, as well as the SEC’s determination on SSBT’s parent’s no-action request for confirmation that it would not be deemed an “ineligible issuer” under Rule 405 of the Securities Act of 1933 by reason of the enforcement action.

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  • From Vol. 8 No.39 (Oct. 8, 2015)

    The SEC’s Pay to Play Rule Is Here to Stay: Tips for Hedge Fund Managers to Avoid Liability

    A federal appeals court recently rejected a challenge to the SEC’s pay to play rule.  Adopted by the SEC to prevent “pay to play” arrangements between public officials and investment advisory firms, the rule restricts certain registered investment advisers from making political contributions to officials with some level of control over the investment decision-making of public pension plans and other government entities.  Last week, the U.S. Court of Appeals for the D.C. Circuit threw out a lawsuit seeking to set aside the rule.  This latest development has put a spotlight on the pay to play rule, which is extremely broad and can be confusing in its application.  With the 2016 elections quickly approaching, it is important that affected firms re-examine their efforts to comply with the rule – especially given the heightened level of SEC scrutiny in this area, as indicated by recent enforcement activity.  In a guest article, Justin V. Shur and Gerald P. Meyer, a partner and an associate, respectively, at Molo Lamken, discuss the facts and findings of the case; analyze liability under the pay to play rule; clarify penalties for non-compliance; and offer tips to prevent and mitigate violations.  For additional insight from Shur, see “FCPA Considerations for the Private Fund Industry: An Interview with Former Federal Prosecutor Justin Shur,” The Hedge Fund Law Report, Vol. 7, No. 20 (May 23, 2014); “How Private Fund Managers Can Manage FCPA Risks When Investing in Emerging Markets,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013); and “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).

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  • From Vol. 8 No.27 (Jul. 9, 2015)

    RCA Panel Discusses Pay to Play Rules, GIPS Compliance, Disclosures, Risk Assessments and ERISA Proposals

    Panelists at the recent RCA Enforcement, Compliance & Operations Symposium emphasized the importance of understanding and complying with the various requirements applicable to fund managers.  In particular, speakers discussed compliance with pay to play rules; GIPS compliance and performance reporting; disclosure requirements; and risk assessment requirements.  Additionally, panelists discussed a proposed expansion of the fiduciary definition under ERISA.  This article highlights the key points arising from discussion of the foregoing issues.  For additional coverage of the Symposium, see “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015); and “RCA Panel Outlines Keys for Hedge Fund Managers to Implement a Comprehensive Cybersecurity Program,” The Hedge Fund Law Report, Vol. 8, No. 24 (Jun. 18, 2015).

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  • From Vol. 8 No.5 (Feb. 5, 2015)

    Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them

    A number of state and federal laws and rules are implicated when an investment adviser or one of its employees makes a political contribution to a candidate or government official who may have influence over the decision to award government investment advisory business to the adviser.  The most widely-known of those rules is SEC Rule 206(4)-5, commonly known as the “pay to play” rule.  A recent PracticeEdge session presented by the Regulatory Compliance Association (RCA) provided an overview of four areas where pay to play concerns arise.  This article describes those four areas of concern.  See also “How Can Hedge Fund Managers Participate in the Political Process without Violating Pay to Play Regulations at the Federal, State, Municipal or Fund Level?,” The Hedge Fund Law Report, Vol. 4, No. 35 (Oct. 6, 2011).  Cf. “How Much Are In-House Hedge Fund Marketers Paid, and How Will Recent Developments in New York City and California Lobbying Laws Impact the Compensation Levels and Structures of In-House Hedge Fund Marketers (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun. 17, 2011).  In April of this year, the RCA will be hosting its Regulation, Operations and Compliance (ROC) Symposium in Bermuda.  For more on ROC Bermuda 2015, click here; to register for it, click here.

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  • From Vol. 8 No.4 (Jan. 29, 2015)

    2014 Was a Series of “Firsts” in the SEC’s Focus on Investment Advisers and Investment Companies

    Ever since the SEC created the Asset Management Unit back in 2010, the amount of scrutiny investment advisers face has continued to intensify.  And with this intense scrutiny, the SEC is forging new ground in its regulation of investment managers.  In a guest article, Andrew Dunbar, a partner at Sidley Austin LLP, discusses the series of “firsts” in SEC enforcement actions we saw in 2014 relating to investment advisers.  These firsts included the SEC’s increasing requirement in seeking admissions, as well as actions relating to “pay to play” and fees and expenses.  Understanding these new areas of enforcement, which may develop into trends, can help investment managers navigate the 2015 enforcement climate and update their compliance programs and risk inventories appropriately.  For additional insight from Dunbar, see “How Can Hedge Fund Managers Understand Recent SEC Developments to Mitigate Enforcement Risk?,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).

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  • From Vol. 7 No.37 (Oct. 2, 2014)

    All-Star Panel at RCA PracticeEdge Session Analyzes Five Key Regulatory Challenges Facing Hedge Fund Managers

    A recent PracticeEdge session presented by the Regulatory Compliance Association (RCA) addressed five key regulatory issues facing hedge fund managers: Broker-dealer registration, the JOBS Act, alternative mutual funds, fiduciary duties and cybersecurity.  Matthew S. Eisenberg, a partner at Finn Dixon & Herling, moderated the discussion.  The speakers included Walter Zebrowski, principal of Hedgemony Partners and RCA Chairman; David W. Blass, at the time of the session, Chief Counsel and Associate Director of the SEC Division of Trading and Markets; Brendan Kalb, General Counsel of AQR Capital Management LLC; Scott D. Pomfret, Regulatory Counsel and Chief Compliance Officer of Highfields Capital Management LP; and D. Forest Wolfe, Chief Compliance Officer and General Counsel of Angelo, Gordon & Co.  As is customary, Blass offered his own opinions, not the official views of the SEC.  (Subsequent to the event, Blass was appointed general counsel of the Investment Company Institute.)  See also “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement? (Part Three of Three),” The Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013); Part Two and Part One.

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  • From Vol. 7 No.26 (Jul. 11, 2014)

    SEC Sanctions Fund Adviser for Violation of “Pay to Play” Rule and for Failing to Register

    Rule 206(4)-5 (Rule) under the Investment Advisers Act of 1940, commonly known as the “pay to play” rule, prohibits an investment adviser from providing paid investment advisory services to a government entity for two years after the adviser or certain of its employees or executives make a contribution to an official of the government entity.  See “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010).  In a recent administrative order, the SEC sanctioned a private fund adviser for violating the Rule.  For an example of SEC leniency for an inadvertent violation of the Rule, see “SEC Excuses a Hedge Fund Manager’s Inadvertent Violation of the Pay to Play Rule,” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).

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  • From Vol. 7 No.3 (Jan. 23, 2014)

    SEC Excuses a Hedge Fund Manager’s Inadvertent Violation of the Pay to Play Rule

    The SEC recently issued an exemptive order pursuant to Section 206A of the Investment Advisers Act of 1940 (Advisers Act) and Rule 206(4)-5(e) thereunder in response to an application by a hedge fund manager to excuse its inadvertent violation of the so-called “pay to play” rule, codified as Rule 206(4)-5 under the Advisers Act.  See “How Can Hedge Fund Managers Participate in the Political Process without Violating Pay to Play Regulations at the Federal, State, Municipal or Fund Level?,” The Hedge Fund Law Report, Vol. 4, No. 35 (Oct. 6, 2011).  This article covers the legal and factual background of the firm’s application, as well as the SEC’s rationale for granting an exemptive order.  The exemptive order and application provide guidance for similarly-situated hedge fund managers on addressing inadvertent violations of the pay to play rule via SEC relief.  The order also clarifies the application of the pay to play rule to donations to state officials running for federal office.  See “Five Best Practices for Avoidance of Pay to Play Violations by Hedge Fund Managers or Their Covered Associates,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).

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  • From Vol. 6 No.26 (Jun. 27, 2013)

    PLI Panel Addresses Marketing and Brokerage Issues Impacting Hedge Fund Managers, Including Marketing to State Pension Plans, Capital Introduction and Broker Implications of In-House Marketing Activities

    At the Practising Law Institute’s Hedge Fund Compliance and Regulation 2013 program, an expert panel comprised of SEC attorneys and industry practitioners shared insights on topics involving marketing and brokerage issues that impact hedge fund managers.  Among other things, the wide-ranging discussion covered the regulatory perils that accompany marketing to government pension funds, including local, state and federal pay-to-play and lobbying laws; capital introduction programs; the European Union’s Alternative Investment Fund Managers Directive; broker regulations implicated by in-house fund marketing activities; and investment-related regulations impacting broker-dealers and their hedge fund clients, including the Market Access Rule, circuit breakers, the use of dark pools, short selling, securities lending and large trader reporting.  This article summarizes the highlights from the panel discussion that are most pertinent to hedge fund managers.  See also “PLI Panel Provides Regulator and Industry Perspectives on Ethical and Compliance Challenges Associated with Hedge Fund Investor Relations,” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013); “PLI Panel Provides Regulator and Industry Perspectives on SEC and NFA Examinations, Allocation of Form PF Expenses, Annual Compliance Review Reporting and NFA Bylaw 1101 Compliance,” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    PLI Panel Provides Regulator and Industry Perspectives on SEC and NFA Examinations, Allocation of Form PF Expenses, Annual Compliance Review Reporting and NFA Bylaw 1101 Compliance

    The Practising Law Institute recently sponsored a program entitled “Hedge Fund Compliance and Regulation 2013,” which included a segment entitled “Building an effective compliance program and strategies for dealing with regulators.”  During that segment, the expert panel – consisting of regulators and industry professionals – offered unique and detailed insight on how regulators and managers approach the SEC and NFA examination process.  Among other things, the panel offered a behind-the-scenes look at how the SEC and NFA approach regulatory examinations; practical guidance on how managers should approach the examination process; candid thoughts on hot-button issues, including the allocation of Form PF expenses, whether managers should document their annual compliance reviews and how regulators use such reports; challenges that hedge fund managers face in complying with NFA Bylaw 1101; and making disciplinary disclosures.

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    Proskauer Partner and SEC Enforcement Division Veteran Ronald Wood Explains the Implications for Hedge Fund Managers of Structure and Staffing Changes at the SEC

    In the past few years, the SEC’s Division of Enforcement has refocused its efforts with respect to the investment management industry via structure and staffing.  On the structuring side, the Division of Enforcement has established specialized units, such as the Asset Management Unit, devoted to addressing investor and systemic risks raised by private funds and their managers.  On the staffing side, the Division of Enforcement has hired investment management industry professionals – including hedge fund managers, analysts, operating professionals and due diligence experts – to staff these units.  With this new-found expertise, SEC staff not only “know where the bodies are buried,” but also “understand how they got there,” according to Bruce Karpati, Chief of the Asset Management Unit.  See “OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013).  On the foundation of its new expertise, the Division of Enforcement initiated 147 enforcement actions against investment advisers and investment companies in fiscal year 2012.  To provide deeper insight and actionable analysis on what the structuring and staffing changes at the Division of Enforcement mean for hedge fund managers, The Hedge Fund Law Report recently interviewed Ronald Wood.  Wood is a partner in the Securities Litigation Group at Proskauer Rose LLP, and prior to Proskauer spent a decade in the Division of Enforcement.  Our interview covered topics including SEC enforcement priorities; the use of reports filed with the SEC to identify enforcement targets; the SEC’s aberrational performance initiative; insider trading best practices; paid access to corporate executives; track record portability; due diligence on Chinese companies; pay to play issues; “big boy” letters; and FCPA concerns for hedge fund managers.  This article contains the transcript of our interview with Wood.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.4 (Jan. 24, 2013)

    K&L Gates Investment Management Seminar Provides Guidance for Hedge Fund Managers on Social Media, Pay to Play Rules, ERISA Rule Changes, AIFMD, SEC Examination and Enforcement Priorities, Form PF, the JOBS Act, CPO Regulation and FATCA

    On December 5, 2012, international law firm K&L Gates held its 2012 Investment Management Conference in New York.  Speakers at the conference provided guidance on various regulatory developments impacting hedge funds, including: the use of social media; pay to play rules; rule changes under the Employee Retirement Income Security Act of 1974 (ERISA) impacting managers of plan assets; the E.U. Alternative Investment Fund Managers Directive (AIFMD); SEC examination and enforcement priorities; Form PF; the JOBS Act; regulation of commodity pool operators (CPOs); and the Foreign Account Tax Compliance Act (FATCA).  This article highlights the key points discussed at the conference on each of the foregoing topics.

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  • From Vol. 4 No.44 (Dec. 8, 2011)

    Five Best Practices for Avoidance of Pay to Play Violations by Hedge Fund Managers or Their Covered Associates

    On November 29, 2011, law firm Venable LLP hosted a webinar entitled “Best Practices for Investment Advisers to Avoid Violating Pay-to-Play Regulations (Webinar).”  The purpose of the event, which was hosted by Venable attorneys Ron Jacobs and Scott Gluck, was to help hedge fund managers navigate the various federal, state and municipal restrictions on political contributions by hedge fund managers that solicit government investors.  The Webinar included ideas previously discussed by Gluck in The Hedge Fund Law Report.  See “How Can Hedge Fund Managers Participate in the Political Process without Violating Pay to Play Regulations at the Federal, State, Municipal or Fund Level?,” The Hedge Fund Law Report, Vol. 4, No. 35 (Oct. 6, 2011).  This article summarizes the points made during the Webinar with most direct relevance to hedge fund managers, including what the relevant regulations are, how they are applied and how they intersect.  This article also relates five best practices for avoiding violations of relevant regulations, as described by Gluck and Jacobs during the Webinar.

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  • From Vol. 4 No.43 (Dec. 1, 2011)

    Third Party Marketers Association 2011 Annual Conference Focuses on Hedge Fund Capital Raising Strategies, Manager Due Diligence, Structuring Hedge Fund Marketer Compensation and Marketing Regulation

    Changing investor expectations and heightened regulation of hedge fund marketing has ushered in a new era for hedge fund managers seeking to raise capital.  Hedge fund managers must continuously keep abreast of the issues that will impact their ability to effectively raise capital, particularly from institutional investors.  Additionally, recent regulatory developments have created new challenges for fund managers that use third party marketers to assist in raising capital.  This “New Normal” was the backdrop of the 2011 annual conference of the Third Party Marketers Association (3PM) in Boston on October 26 and 27, 2011.  This article focuses on the most important points for hedge fund managers that were discussed during the conference.  The article begins with a discussion of how fund managers can enhance their marketing efforts to raise more capital by understanding various aspects of the capital raising cycle, including the changing request for proposal (RFP) process, product positioning, the investor due diligence process and the manager selection process.  The article then moves to a discussion of the regulatory challenges facing hedge fund managers using third party marketers, including a discussion of third party marketer due diligence of fund managers and appropriate compensation arrangements for third party marketers in light of lobbying law changes and pay to play regulations.  The final section discusses impending and existing rules that will have a significant impact on hedge fund marketing.

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  • From Vol. 4 No.35 (Oct. 6, 2011)

    How Can Hedge Fund Managers Participate in the Political Process without Violating Pay to Play Regulations at the Federal, State, Municipal or Fund Level?

    As the campaign season heats up, hedge fund managers who wish to engage in the political process are confronted with a conundrum.  On one hand, the Securities and Exchange Commission (SEC) and individual states, municipalities and public pension funds have enacted a variety of pay-to-play regulations designed to limit political involvement by investment advisers who manage money on behalf of public pension funds.  The penalties for even a minor violation of these rules can be severe.  On the other hand, last year’s Supreme Court decision in Citizens United v. Federal Election Commission reaffirmed the right of corporations, unions and individuals to make independent expenditures in connection with federal elections as protected free speech under the First Amendment.  The result is a confusing duality where political “contributions” may be regulated on pay-to-play grounds yet independent “expenditures” are permitted as free speech.  Adding to the complexity is the variety of entities and organizations that now engage in the political process.  These entities may allow donors to participate in the political process more efficiently and effectively.  However, the variety of organizations creates challenges when combined with complex, broadly drafted statutes in overlapping jurisdictions.  Moreover, several entities may contribute money to candidates and parties at multiple levels of government, increasing the risk of an inadvertent violation of pay-to-play statutes.  In a guest article, Scott E. Gluck, Of Counsel at Venable LLP, brings much-needed clarity to the complex issue of pay-to-play compliance by hedge fund managers.  Gluck starts with a review of the SEC’s pay-to-play rule, then continues with a detailed discussion of specific policies, procedures, practices and precautions that hedge fund managers should undertake to avoid pay-to-play or similar violations.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    SEC No-Action Letter Outlines Alternative Recordkeeping Regime for Compliance with the Pay to Play Rule

    On July 1, 2010, the SEC adopted Rule 206(4)-5 (Pay to Play Rule) under one of the antifraud provisions of Investment Advisers Act of 1940 (Advisers Act).  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).  The Pay to Play Rule generally prohibits registered or unregistered investment advisers, including hedge fund managers, from providing advisory services for compensation to a government client (such as a public pension fund) for two years after the adviser or certain of its employees or third-party solicitors make a contribution to certain candidates or elected officials.  See “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010).  Simultaneous with the adoption of the Pay to Play Rule, the SEC amended the recordkeeping rules under the Advisers Act to, as explained in the adopting release, “allow [the SEC] to examine for compliance with new rule 206(4)-5.”  On examinations, see “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011).  While the general prohibition on pay to play practices of the Pay to Play Rule applies to registered and unregistered investment advisers, the related recordkeeping requirements only apply to registered investment advisers, as the SEC noted in footnote 405 of the adopting release.  Specifically, the SEC amended the recordkeeping rules to require registered investment advisers to maintain books and records containing lists or other records of four categories of information, each of which is described in detail in this article.  On September 12, 2011, the Investment Company Institute (ICI) – the mutual fund industry trade group – submitted a letter (Incoming Letter) to the SEC’s Division of Investment Management (Division) requesting no-action relief from specified provisions of the recordkeeping requirements related to the Pay to Play Rule.  In particular, the Incoming Letter noted that investment advisers are having difficulty complying with relevant recordkeeping requirements where the presence or identity of government plan investors in omnibus accounts cannot be reliably determined.  The ICI proposed an alternative recordkeeping regime that would address the identified transparency issues.  This article details: the four relevant recordkeeping requirements; the four prongs of the ICI’s proposed alternative recordkeeping regime, and the rationale for each; the SEC’s no-action letter; and the application of the no-action letter itself and the analysis in the letter to hedge funds and hedge fund managers.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Fifth Annual Hedge Fund General Counsel Summit Covers Insider Trading, Expert Networks, Whistleblowers, Exit Interviews, Due Diligence, Examinations, Pay to Play and More

    On September 13, 2011, ALM Events hosted its fifth annual Hedge Fund General Counsel Summit at the Harvard Club in New York City.  Participants at the event discussed how the changing regulatory landscape is impacting the day-to-day policies, procedures and practices of hedge fund managers.  Of particular note, discussions focused on insider trading in the post-Galleon world; best compliance practices for engaging and using expert network firms; how to motivate employees to report wrongdoing internally rather than filing whistleblower complaints; the interaction between non-disparagement clauses in hedge fund manager exit agreements and the whistleblower rule; best practices for exit interviews; best practices for responding to initial and ongoing due diligence inquiries; consistency across DDQs and other documents; standardization of DDQs versus customized answers; whether to disclose the existence or outcome of regulatory actions; how to deal with government investigations and examinations; and strategies for complying with the pay to play rule.  This article summarizes the most noteworthy points made at the event.

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  • From Vol. 3 No.46 (Nov. 24, 2010)

    New York Attorney General Andrew Cuomo Files Civil and Forfeiture Actions Against Steven Rattner, Former Principal of Private Equity Fund Manager Quadrangle Group, in State Pension Fund Pay To Play Scheme, While SEC Files and Settles Similar Charges Against Rattner

    On November 18, 2010, the New York State Attorney General (AG) and the U.S. Securities and Exchange Commission (SEC) filed related civil charges against Steven L. Rattner, founder and former principal of the Quadrangle Group, LLC (Quadrangle), for his participation in a pay to play kickback scheme devised by former members of the New York State Comptroller’s Office, administrators of the New York State Common Retirement Fund (CRF).  The complaints accuse Rattner of arranging a distribution deal for a film produced by the brother of David Loglisci, the Deputy Comptroller; retaining and paying Henry “Hank” Morris, the top political adviser and chief fundraiser for former State Comptroller Alan Hevesi, over $1 million in sham placement fees; and of obtaining, at Morris’ request, $50,000 in third-party contributions for Hevesi’s reelection campaign, in order to secure a $150 million investment in a Quadrangle fund from the CRF.  Rattner agreed to settle with the SEC, while neither admitting nor denying any wrongdoing.  The AG’s civil action remains pending.  The SEC and the AG have already brought cases against other parties to the pay to play scheme.  On April 19, 2010, the SEC settled a related action against Quadrangle and its affiliates.  SEC v. Quadrangle Group LLC, et al., 10-CV-3192.  It has also accused Morris, Loglisci and several others with orchestrating the fraudulent scheme to extract kickbacks from investment management firms.  SEC v. Morris, et al., 09-CV-2518.  Similarly, the AG has filed and obtained civil settlements from nineteen individuals, as well as guilty pleas from eight individuals, including: Hevesi, who, on October 7, 2010, pled guilty to receiving a reward for official misconduct; Loglisci, who, on March 10, 2010, pled guilty to violating the Martin Act; and Morris, who, on November 22, 2010, pled guilty to violating the Martin Act.  Morris admitted in court that he “intentionally engaged in fraud, deception . . . and made material false representations and statements with intent to deceive and defraud.”  This article details the allegations in the respective complaints and the causes of action against Rattner.

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  • From Vol. 3 No.37 (Sep. 24, 2010)

    Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers

    New limits on political contributions and other political activity by advisers to hedge funds with public pension plan investors will become effective on March 14, 2011.   Many of the concepts in Rule 206(4)-5 (Rule) under the Investment Advisers Act of 1940 are grounded in campaign finance law, rather than the securities laws.  For this reason, compliance with the Rule may present challenges to many advisers.  At the same time, however, the penalties for failing to adhere to the strict requirements of the Rule will be severe – including a two-year ban on business, loss of revenues, and possible sanctions by regulators.  In a guest article, Edward L. Pittman, Counsel at Dechert LLP, provides a practical overview of a compliance program for hedge fund advisers.

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  • From Vol. 3 No.37 (Sep. 24, 2010)

    Second Circuit Upholds Connecticut’s Ban on Campaign Contributions by State Contractors and Contractors’ Principals and Family Members, But Invalidates “Pay to Play” Law on First Amendment Grounds to the Extent that it Bans Contributions by Lobbyists or the Solicitation of Contributions by Lobbyists or Contractors

    The United States Court of Appeals for the Second Circuit has handed Connecticut a partial victory in its efforts to address the potentially corrupting influence of campaign contributions by contractors and lobbyists in the state.  The Second Circuit has upheld Connecticut’s “pay to play” law insofar as it imposes a complete ban on campaign contributions both by contractors that have business pending with the State and by their principals and close family members.  On the other hand, the Second Circuit ruled that the portions of the law banning campaign contributions by lobbyists and prohibiting lobbyists and contractors from soliciting campaign contributions were so broad as to violate the First Amendment’s free speech protections.  We summarize the decision, which could provide valuable insight into how courts might address similar challenges to other “pay to play” laws, such as the SEC’s new Rule 206(4)-5, which affects investment advisers.  See “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” above, in this issue of The Hedge Fund Law Report.

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  • From Vol. 3 No.36 (Sep. 17, 2010)

    Three Significant Legal Pitfalls for Hedge Fund Marketers, and How to Avoid Them

    Until recently, the generally held perception was that the worst a hedge fund marketer could do is fail to raise money.  But then came the credit crisis, a raft of new regulations, a newly enlarged and invigorated SEC and a tectonic shift in the hedge fund investor base in favor of more public and private pension funds and other retirement plans.  In this fraught new operating environment, hedge fund marketers can do more than fail to benefit the fund: they can affirmatively harm the fund and manager.  In particular, marketers can, in different contexts: jeopardize fees; render ideal investors off-limits; subject a manager to complex regulatory schemes from which the manager would otherwise be exempt; and give investors the right to rescind their investments.  This article details three significant legal pitfalls that can give rise to these and other harms, and suggests ways to avoid them.

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  • From Vol. 3 No.35 (Sep. 10, 2010)

    What Is the “Market” for Fees and Other Key Terms in Agreements between Hedge Fund Managers and Placement Agents?

    Historically, hedge fund managers have retained placement agents and other third-party intermediaries to identify investors, obtain investments and for related purposes.  Hedge fund managers’ use of placement agents is likely to continue and even increase for two simple reasons: because such use is permitted, and because it can add value.  On the first point, the fact that hedge fund managers can use placement agents is only news because between August 2009 and June 2010, the continued viability of that use was in doubt.  In short, in August 2009, the SEC proposed a pay to play rule that would have prohibited hedge fund managers from using placement agents (or “third-party solicitors,” “solicitors,” “finders” or “pension consultants”) to obtain investments from public pension funds.  Given the importance of public pension funds in the hedge fund investor base – according to Preqin, public pension funds comprise approximately 17 percent of all institutional hedge fund investors – many in the hedge fund industry thought that the proposed ban marked the beginning of the end of the use by hedge fund managers of placement agents.  See, e.g., “The Four P’s of Marketing by Hedge Fund Managers to Pension Fund Managers in the Post-Placement Agent Era: Philosophy, Process, People and Performance,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).  However, the final pay to play rule, adopted by the SEC on June 30, 2010, did not prohibit hedge fund managers from using placement agents to solicit investments from public pension funds, but rather permitted such use so long as the relevant placement agent is a registered investment adviser or registered broker-dealer.  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).  Along similar lines, on September 2, 2010, the SEC adopted a temporary rule (Rule 15Ba2-6T under the Securities Exchange Act of 1934) requiring municipal advisors to register with the SEC by October 1, 2010 (i.e., within three weeks).  This rule does not prohibit the use by hedge fund managers of “finders,” “solicitors” or other previously unregistered entities to obtain investments from public pension funds, but it may require such entities to register with the SEC.  See “Third-Party Marketers that Solicit Public Pension Fund Investments on Behalf of Hedge Funds May Have to Register with the SEC within Three Weeks,” below, in this issue of The Hedge Fund Law Report.  In short, while the legal and regulatory environment for placement agents has become more complex, their activities are, in general, still legally permitted.  And on the second point – the idea that placement agents can add value – there are two categories of rationales for this idea: micro rationales and macro rationales.  The micro rationales – the specific categories of services that placement agents are well-positioned to provide to hedge fund managers – are detailed below.  As for the macro rationales, four trends suggest that placement agents will play an increasingly important role in the allocation of capital to hedge funds.  First, a disproportionate volume of recent inflows have gone to larger managers.  Second, according to Preqin, 29 percent of institutional investors plan to invest more capital in hedge funds over the next 12 months than they did during the previous 12 months, and 46 percent of investors plan to increase their hedge fund allocations in the next three to five years.  Third, according to Preqin, 37 percent of institutional investors plan to direct any hedge fund allocations in the short to medium term to a mixture of new and existing managers, and 23 percent of institutional investors plan to invest in new managers only (that is, new to the investor, though not necessarily new to the market, i.e., not necessarily startup managers).  Fourth, according to Preqin, “firm reputation” is tied with “track record” as the second most important factor for institutional investors when making hedge fund allocations.  The point: capital is likely to flow into hedge funds over the next five years, but if you are anything other than a large, established manager, the competition for capital is likely to remain fierce.  And importantly in an industry where performance is easily measured, readily comparable and frequently updated, even “large, established managers” can stumble in terms of size and stature, and find themselves pounding the proverbial fundraising pavement once again.  In light of the anticipated importance of placement agents in steering capital into hedge funds over the next (at least) five years, this article seeks to shed light on a relatively obscure topic: the “market” for fees and other terms in agreements between hedge fund managers and placement agents.  Specifically, this article first identifies seven distinct reasons why a manager may hire a placement agent, then details the most important terms of, and issues in connection with, placement agent agreements, including the following: fee structures and levels; declining fees; duration of engagements and sunset provisions; carve-outs for the manager’s pre-existing relationships; exclusivity; licensing, registration and representations with respect to both; indemnification; insurance; and the pay to play overlay.

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  • From Vol. 3 No.31 (Aug. 6, 2010)

    How Will the SEC’s New Pay to Play Rule Impact Mergers and Acquisitions of Hedge Fund Management Companies?

    Three trends are likely to increase the volume of mergers and acquisitions of hedge fund management companies – especially sales of smaller firms to larger firms and sales by banking entities of advisers to “sponsored” hedge funds.  First, various provisions of the Dodd-Frank Act (most notably, the registration provisions) are likely to increase ongoing compliance costs for hedge fund managers.  Many such costs will be fixed, and thus will adversely impact smaller hedge fund managers to a greater degree than larger ones.  Some of those smaller managers will determine that selling the advisory business is preferable to continuing to operate independently.  See “For Managers Facing Strong Headwinds, Sales of the Advisory Business Offer a Means of Preserving the Franchise While Avoiding Fund Liquidations,” The Hedge Fund Law Report, Vol. 2, No. 11 (Mar. 18, 2009).  Increased compliance costs also are likely to deter, at the margin, entry into the hedge fund management business by potential startups.  Second, the version of the Volcker Rule included in the Dodd-Frank Act is likely to cause some investment and commercial banks to divest certain internal hedge fund management businesses.  See “Implications of the Volcker Rule – Managing Hedge Fund Affiliations with Banks,” The Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010).  In cases where banks purchased going hedge fund management concerns rather than developing them internally, management buyouts may be a common deal structure.  Also, various hedge fund industry participants expect the Volcker Rule to displace traders and portfolio managers currently working at investment banks on proprietary trading desks or at in-house hedge funds.  Certain of those traders and managers will start new hedge fund management firms: some of those new firms will fail, some will continue independently and some will be sold to established players.  See “Stars in Transition: A New Generation of Private Fund Managers,” The Hedge Fund Law Report, Vol. 2, No. 49 (Dec. 10, 2009).  Third, the fundraising environment may remain difficult, causing smaller managers to sell to larger managers with more developed marketing and distribution infrastructures.  Indeed, distribution is a key consideration even in deals involving larger hedge fund managers: the proxy statement relating to Man Group’s acquisition of GLG Partners cited Man’s distribution capabilities as one of the strategic benefits of the transaction.  See "Transaction Analysis: Hedge Fund Managers Man Group and GLG Partners Announce Plans to Merge,” The Hedge Fund Law Report, Vol. 3, No. 21 (May 28, 2010).  (That acquisition is expected to close in the third quarter of 2010.)  The SEC’s recently approved pay to play rule (Rule) introduces a new category of legal risk into mergers and acquisitions of hedge fund management companies.  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New ‘Pay to Play’ Rule?,” The Hedge Fund Law Report, Vol. 3, No. 30 (Jul. 30, 2010).  At best, the Rule will add new categories of due diligence, new integration tasks and new post-closing training requirements to such transactions.  At worst, the Rule will delay or even derail such transactions.  This article identifies concerns raised by the Rule in the hedge fund manager M&A context, and offers strategies to address them.  Specifically, this article outlines fact patterns in which the Rule can adversely affect the outcome in the purchase or sale of a hedge fund management business; identifies notable recent investment management merger and acquisition transactions and transaction trend statistics; lists the four primary options available to hedge fund managers or others to prevent or remedy violations of the Rule in connection with acquisitions of hedge fund management businesses; discusses the pros and cons of each of the primary options; and outlines five alternative options, and the benefits and burdens of each.

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  • From Vol. 3 No.30 (Jul. 30, 2010)

    How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures and Marketing Practices in Light of the SEC’s New “Pay to Play” Rule?

    On July 1, 2010, the SEC adopted Rule 206(4)-5 (Rule) under the Investment Advisers Act of 1940 (Advisers Act).  See “SEC Adopts Pay to Play Rules for Investment Advisers; Total Placement Agency Ban Avoided,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  The Rule generally seeks to curtail pay to play practices in the selection by state investment funds, most notably public pension funds, of hedge fund managers and other investment advisers.  Broadly, the Rule does this in three ways: (1) by limiting donations by principals of investment advisers and others with an economic stake in winning public fund business to election campaigns of public officials who may directly or indirectly influence the selection of the adviser to manage a public fund; (2) by prohibiting payments by investment advisers to any person for soliciting government entities for advisory services unless that person is (a) a registered investment adviser subject to the Rule or a registered broker dealer subject to a similar rule to be promulgated by FINRA, or (b) a principal or employee of the adviser; and (3) by revising Advisers Act Rule 204-2 (the recordkeeping rule) to require investment advisers with government clients, or advisers to hedge funds with government entity investors, to maintain records regarding political contributions by the adviser and its covered associates.  According to private fund data provider Preqin, public pension funds represent approximately 17 percent of all institutional hedge fund investors, with an average allocation of six percent of total assets to hedge funds.  The Rule governs the process by which hedge fund managers seek advisory business from this important constituency.  Accordingly, the Rule is of fundamental importance to a wide range of hedge fund managers, for whom the Rule creates a range of new compliance and marketing challenges.  The purpose of this article is to identify and provide guidance with respect to many of those new challenges.  In particular, the descriptive section of this article provides an overview of the mechanics of the Rule.  The analytic section of this article addresses areas in which hedge fund managers should revisit their policies and procedures in light of the Rule, including policies and procedures relating to: political contributions; monitoring contributions; preclearance of contributions; due diligence on placement agents; compliance training with respect to contributions; prescreening of new employees; acquisitions of hedge fund management firms; state, local and fund-specific rules relating to pay to play arrangements; sub-advisers and funds of funds; and mandatory redemptions.  The analytic section also includes a discussion of the implications of the Rule for lobbying by hedge fund managers.  See “Hedge Funds Increasing Lobbying Efforts, Focusing On Shaping Regulations Rather Than Preventing Them,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).  The article concludes with a note on potential constitutional challenges to the Rule.  One of the more important points made by this article is that while the Rule has garnered significant attention, it is just part of a patchwork of federal, state, local and fund-specific rules governing the process by which hedge fund managers solicit investment advisory business from government entities.

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  • From Vol. 3 No.28 (Jul. 15, 2010)

    SEC Adopts Pay to Play Rules for Investment Advisers; Total Placement Agency Ban Avoided

    As previously reported in The Hedge Fund Law Report, on August 3, 2009, the Securities and Exchange Commission (SEC) proposed its “pay to play” rules for investment advisers in Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended (the Act).  See “SEC Proposes ‘Pay to Play’ Rules for Investment Advisers,” Vol. 2, No. 32 (Aug. 12, 2009).  On June 30, 2010, the SEC adopted Rule 206(4)-5 to protect public pension plans by deterring investment advisers from participating in “pay to play” practices, that is, practices wherein politicians encourage financial contributions from any person, political action committee or company, including hedge funds, in exchange for the chance to be selected as investment adviser for those plans.  The new rule has three essential elements, each of which is detailed in this article.  In a departure from the prior version of the rule circulated for public comment, the rule does not include an outright ban on investment advisers compensating a third-party solicitor to obtain governmental entities as advisory clients, provided, however, that the solicitor must register with the SEC and/or the Financial Industry Regulatory Authority (FINRA) (as an investment adviser or broker-dealer), and remain subject to pay to play restrictions.  In other words, the new rule allows hedge fund managers to continue using registered placement agents in the United States.  We summarize the key provisions of the new pay to play rule, focusing on those applicable to hedge fund managers and placement agents.

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  • From Vol. 2 No.37 (Sep. 17, 2009)

    Preqin Report Reveals Institutional Investors’ Opposition to Proposed Placement Agent Ban in SEC’s Proposed “Pay to Play” Rules

    Preqin, an alternative investment research firm, released a report assessing the potential impact of SEC proposed rule release IA-2910, for Advisers Act Rule 206(4)-5 (Proposed Rule), on the private funds industry.  The firm surveyed 50 leading United States institutional investors, and found that the majority support the aim of the Proposed Rule but oppose its ban on placement agents soliciting investments from public pension funds.  This article summarizes the key findings of this report and outlines Preqin’s proposed alternatives to the Proposed Rule.

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  • From Vol. 2 No.32 (Aug. 12, 2009)

    SEC Proposes “Pay to Play” Rules for Investment Advisers

    On August 3, 2009, the Securities and Exchange Commission (SEC) published the full text of its proposed rule regarding “Political Contributions by Investment Advisers,” Investment Advisers Act Rule 206(4)-5.  Its intended purpose is to curtail so-called “pay to play” practices involving investment advisers.  The phrase “pay to play” refers to arrangements whereby investment advisers make political contributions or related payments to governmental officials in order to be rewarded with, or afforded the opportunity to compete for, contracts to manage the assets of public pension plans and other government accounts.  On July 22, 2009, the SEC unanimously voted to approve the proposed rule, which remains subject to a 60-day public comment period after its publication in the Federal Register.  We provide a detailed description of the proposed rule.

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  • From Vol. 2 No.30 (Jul. 29, 2009)

    What Do the Regulatory and Industry Responses to the New York Pension Fund “Pay to Play” Scandal Mean for the Future of Hedge Fund Marketing?

    New York’s so-called “pay to play” scandal – in which state officials conditioned investments of state pension money in hedge and private equity funds on payments by the funds’ managers to the officials or their affiliates – has yielded a range of regulatory and industry responses, of varying degrees of severity.  At the most draconian is New York Attorney General Andrew Cuomo’s Code of Conduct (Code), to which three alternative investment managers have thus far agreed in settlement of pay to play charges.  The Code bans the use of placement agents altogether, but is not yet law and has not yet been adopted by any industry group as a best practice.  (However, it has been adopted by the New York State Teachers’ Retirement System.)  Somewhat less severe is a recently proposed SEC rule intended to curtail pay to play practices.  That rule generally provides that an investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser to manage money for state or local governments would be barred for two years from providing advisory services for compensation, either directly or through a fund.  A yet more measured response to the pay to play scandal ­– and in the view of many on the hedge fund side, a more practicable one – has come from CalPERS and other pension funds.  These pension funds have required increased disclosure and transparency with respect to compensation arrangements between investment managers seeking to manage pension assets and any placement agents or third party marketers acting on behalf of such managers.  Finally, lurking in the background has been Investment Advisers Act Rule 206(4)-3, which generally requires disclosure of the compensation arrangement between a registered investment adviser and a placement agent, to any “client” of the adviser that was solicited by the placement agent.  The application of this rule in the pay to play scandal is subtle, as explained more comprehensively in this article.  The regulatory responses have changed the game of hedge fund marketing.  The difficult (though apparently improving) investment climate for hedge funds has made marketing more difficult as a practical matter, and the regulatory responses to the pay to play scandal have made marketing more treacherous as a legal matter.  Therefore, this article provides background on the scandal and the various settlements; offers details of Cuomo’s Code; addresses the likelihood that other states will follow New York’s lead; discusses actions by pension funds in response to the scandal, the SEC’s recently proposed anti-pay to play rule and Rule 206(4)-3; and, importantly, explores the future of hedge fund marketing without placement agents, or with harsh restrictions on their activities.

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