The Hedge Fund Law Report

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By Topic: Expert Networks

  • From Vol. 9 No.2 (Jan. 14, 2016)

    RCA Compliance, Risk and Enforcement Symposium Highlights Methods for Hedge Fund Managers to Upgrade Compliance Programs

    The development of a robust compliance program by hedge fund managers that addresses key issues, such as valuation, conflicts of interest and the use of expert networks, continues to be a focus for the SEC. Among various topics discussed during the recent Regulatory Compliance Association (RCA) Compliance, Risk and Enforcement Symposium, panelists proffered ways for hedge fund managers to enhance their compliance programs, including interaction with other groups within the firm; controls around expert networks; and the use of technology to augment compliance testing and controls to identify and address issues. This article highlights the salient points made on the foregoing issues. For additional insight from the RCA, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014); and “Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)” (Jan. 9, 2014).

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  • From Vol. 8 No.39 (Oct. 8, 2015)

    ACA 2015 Compliance Survey Covers Expert Networks, Fund Expenses and Electronic Communications (Part Two of Two)

    ACA Compliance Group recently released the results of its 2015 Alternative Fund Manager Compliance Survey, which considered a variety of compliance issues faced by hedge fund managers and other private fund managers.  The survey results and comparisons to those of the firm’s prior surveys were presented at a recent webinar by Colleen Marencik, a senior principal consultant at ACA Compliance Group, and Tessa Carbone, a consultant at that firm.  This article, the second in a two-part series, summarizes the key findings from the survey and the insights offered by Carbone and Marencik with respect to expert networks and consultants, fund expenses and electronic communications.  The first article addressed the survey demographics, SEC exam experiences, material nonpublic information and restricted lists.  For coverage of prior ACA surveys, see “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 39 (Oct. 11, 2013); and “ACA Compliance Group Survey Provides Benchmarks for a Range of Hedge Fund Manager Compliance Functions, Including Dual-Hatting, Annual Compliance Reviews, Forensic Testing, Custody, Fees and Signature Authority,” The Hedge Fund Law Report, Vol. 6, No. 19 (May 9, 2013).

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  • From Vol. 8 No.38 (Oct. 1, 2015)

    Challenges Hedge Fund Managers May Encounter When Implementing a Chaperoning Program (Part Three of Three)

    Hedge fund managers planning to chaperone primary research calls in order to monitor information inflows are faced with numerous challenges.  Beyond the logistical issues surrounding the creation and implementation of a chaperoning program, managers may encounter challenges when operating that program, including issues regarding complexity, recordkeeping and cost.  These practical issues must be weighed against the benefits of chaperoning.  In this article, the third in a three-part series, Eugene Ingoglia, Partner at Morvillo; Laurence Herman, General Counsel and Managing Director at Gerson Lehrman Group (GLG); and Patrick Gordon, Senior Counsel at GLG, examine specific challenges that hedge fund managers may encounter when implementing a chaperoning program, weighed against the benefits gained from chaperoning.  The first article provided background on chaperoning, including a discussion of the statutory landscape, primary research and SEC guidance.  The second article addressed the potential scope of a chaperoning policy and offered practical guidance in implementing that policy.  For more on chaperoning, see “Strategies for Avoiding Insider Trading Violations: A Perspective Informed by SEC Service, Private Law Firm Practice and Work as General Counsel of a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).

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  • From Vol. 8 No.37 (Sep. 24, 2015)

    What Hedge Fund Managers Need to Contemplate When Implementing a Chaperoning Program (Part Two of Three)

    As insider trading cases against hedge fund managers continue to mount, as suggested by then director of the SEC’s Office of Compliance Inspections and Examinations Carlo di Florio, hedge fund managers may wish to consider chaperoning primary research calls as a means of monitoring information inflows.  However, while di Florio’s guidance was helpful, any manager attempting to implement chaperoning policies and practices was left with more questions than answers.  Which research interactions should be chaperoned?  Should only expert network calls be chaperoned, or should calls involving direct consulting also be chaperoned?  What about informal interactions with industry contacts?  How frequently should chaperoning occur?  What methods are there for chaperoning?  And what exactly should chaperoning compliance officers be listening for?  In this article, the second in a three-part series, Eugene Ingoglia, Partner at Morvillo; Laurence Herman, General Counsel and Managing Director at Gerson Lehrman Group (GLG); and Patrick Gordon, Senior Counsel at GLG, address the potential scope of a chaperoning policy, as well as offer practical guidance on implementing that policy.  The first article provided background on chaperoning, including a discussion of the statutory landscape, primary research and SEC guidance.  The third article will cover specific challenges to chaperoning.  For more on chaperoning, see “How Can Hedge Fund Managers Structure, Implement and Enforce Information Barriers to Mitigate Insider Trading Risk Without Impairing Securities Trading? (Part Four of Four),” The Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).

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  • From Vol. 8 No.36 (Sep. 17, 2015)

    Are You Listening?  Whether Hedge Fund Managers Should Chaperone Primary Research Calls (Part One of Three)

    Insider trading and the potential for misuse of confidential information should be top-of-mind for investment professionals.  With the prevalence of insider trading cases brought over the last five years, the government’s initiative to stamp the practice out has been persistent, aggressive and fruitful, even after the Second Circuit dealt the government a setback in U. S. v. Newman.  See “The Newman/Chiasson Decision Continues to Have Implications for Insider Trading Compliance,” The Hedge Fund Law Report, Vol. 8, No. 17 (Apr. 30, 2015).  Nonetheless, it appears the temptations and incentives to find an edge in a highly competitive trading environment remain as strong as ever.  Against this backdrop, it is all the more critical for compliance departments to monitor information inflows.  In this guest article, Eugene Ingoglia, Partner at Morvillo; Laurence Herman, General Counsel and Managing Director at Gerson Lehrman Group (GLG); and Patrick Gordon, Senior Counsel at GLG, focus on how chaperoning primary research calls can help compliance officers meet these obligations.  This first article in a three-part series provides background on chaperoning, including a discussion of the statutory landscape, primary research and SEC guidance.  The second article will address the potential scope of a chaperoning policy, as well as offer practical guidance in implementing that policy.  The third article will cover specific challenges to chaperoning.  For more on chaperoning, see “RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three),” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).

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  • From Vol. 7 No.44 (Nov. 20, 2014)

    K&L Gates Partners Identify Eight Actions That Hedge Fund Managers Can Take to Avoid Insider Trading Violations (Part Two of Three)

    This article is the second in a three-part series discussing practical insights from a recent presentation on insider trading by K&L Gates partners Michael W. McGrath, Carolyn A. Jayne and Nicholas S. Hodge.  This article details eight prophylactic measures that hedge fund managers can implement to avoid insider trading violations.  This article also includes a detailed discussion of what McGrath called “the next great undiscovered country for enforcement actions.”  The first article in this series provided background on aspects of insider trading doctrine relevant to hedge fund managers (including entity liability and special considerations for CFA charter holders) and outlined four enforcement trends bearing directly on hedge fund trading strategies and operations.  The third article in this series will offer concrete recommendations to hedge fund managers for amending their compliance programs to incorporate lessons from recent insider trading enforcement actions.  For more on insider trading issues relevant to hedge fund managers, see “When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).

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  • From Vol. 7 No.43 (Nov. 13, 2014)

    K&L Gates Partners Identify Four Insider Trading Enforcement Trends with Direct Impact on Hedge Fund Trading Strategies (Part One of Three)

    This article is the first in a three-part series discussing practical insights from a recent presentation on insider trading by K&L Gates partners Michael W. McGrath, Carolyn A. Jayne and Nicholas S. Hodge.  In particular, this article provides background on the aspects of insider trading doctrine most relevant to hedge fund managers (including entity liability and special considerations for CFA charter holders), then outlines four enforcement trends that bear directly on hedge fund trading strategies and operations.  The second article in this series will detail eight prophylactic measures that hedge fund managers can implement to avoid insider trading violations.  The third article in this series will make recommendations to hedge fund managers for amending their compliance programs in light of lessons from recent insider trading enforcement actions.  For more on insider trading issues relevant to hedge fund managers, see “‘Best Ideas’ Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 30 (Aug. 7, 2014).

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  • From Vol. 7 No.38 (Oct. 10, 2014)

    Usable Lessons and Proven Survival Techniques from the Hedge Fund Examination Trenches

    A recent PracticeEdge session presented by the Regulatory Compliance Association explored the panelists’ experiences with SEC and NFA examinations and provided an overview of key substantive issues that are likely to be addressed in those exams.  The program was moderated by Christopher M. Wells, a partner at Proskauer Rose LLP.  The other speakers were Cynthia Marian, a Vice President, Chief Compliance Officer and Deputy General Counsel of Tinicum, Inc.; Dianne Mattioli, CCO of Hedgemark Securities; Mark Polemeni, CCO – Asset Management at Citadel, LLC; and Catherine Smith, General Counsel of Guidepoint Global, LLC.  See also “RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three),” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014).

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  • From Vol. 7 No.32 (Aug. 28, 2014)

    Alternative Investment General Counsel Summit Addresses Examinations, Insider Trading, Political Intelligence and Expert Networks (Part Two of Two)

    This is the second article in a two-part series covering ALM’s inaugural Alternative Investment General Counsel Summit in New York – an event at which law firm partners, in-house counsel and regulators discussed best practices on legal issues faced by hedge fund managers.  The first article addressed conflicts of interest raised by dual registration and valuation; the constituent elements of a culture of compliance; the interaction between compensation structures and regulatory developments; AIFMD compliance and timing; presence exam survival strategies; and the role of risk alerts in refining a compliance program.  This article discusses effective responses to regulatory audits and examinations; insider trading; political intelligence; and expert networks.  See also “ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing, OTC Derivatives Reforms, Insider Trading Best Practices, the JOBS Act, AIFMD and Activist Investing (Part Three of Three),” The Hedge Fund Law Report, Vol. 6, No. 47 (Dec. 12, 2013).

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  • From Vol. 7 No.28 (Jul. 24, 2014)

    U.K. Financial Conduct Authority Clarifies Whether Hedge Fund Managers May Use Dealing Commissions to Pay for Substantive Research or Corporate Access

    U.S. investment advisers are required to seek best execution for their clients’ securities trades, a duty that generally includes seeking to pay the lowest available commissions.  However, under Section 28(e) of the Securities and Exchange Act of 1934, advisers are permitted under certain circumstances to pay higher commissions if, in exchange, they receive credits – “soft dollars” – that can be used to pay for certain eligible brokerage or research services.  See “Katten Forum Identifies Best Practices for Hedge Fund Managers Regarding Best Execution, Soft Dollars, Principal Trades, Agency Cross Trades, Cross Trades and Trade Errors,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  The U.K. has a similar regime, and the U.K. Financial Conduct Authority recently clarified the application of that regime to the use of dealing commissions by hedge fund managers to purchase substantive research or corporate access.  See also “Best Practices for Due Diligence by Hedge Fund Managers on Research Providers,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).

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  • From Vol. 7 No.25 (Jun. 27, 2014)

    RCA ECO 2014 Symposium Offers Insight from Top SEC Officials on Cybersecurity, Reg M, Examinations, Insider Trading Investigations, the Newman Appeal, Expert Networks and Political Intelligence (Part Two of Two)

    This is the second article in a two-part series covering the Regulatory Compliance Association’s Enforcement, Compliance and Operations 2014 Symposium, held on May 1, 2014 in New York City.  This article summarizes the key insights offered at the Symposium by top SEC officials and industry participants with respect to cybersecurity, Rule 105 of Regulation M, hedge fund manager examinations, evolving investigative techniques used in criminal investigations of insider trading, insider trading doctrine and the appeal in United States v. Newman, expert networks and political intelligence.  The first article in this series dealt with regulatory transparency, custody, conflicts raised by serving simultaneously as a broker and investment adviser, what the SEC’s Division of Trading and Markets does, interaction between the SEC’s Office of Compliance Inspections and Examinations and its Enforcement Division, broker registration of in-house marketing departments, alternative mutual funds and the JOBS Act.  See “RCA Enforcement, Compliance and Operations 2014 Symposium Offers Insight from Top SEC Officials on Custody, Conflicts, Broker Registration, Alternative Mutual Funds and the JOBS Act (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 22 (Jun. 6, 2014).

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  • From Vol. 7 No.1 (Jan. 9, 2014)

    RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part Three of Three)

    This is the third installment in our three-part series covering the RCA’s Compliance, Risk & Enforcement 2013 Symposium.  It summarizes key points from two sessions, one offering perspectives from regulators and industry participants on regulatory risks and compliance best practices relating to expert networks, valuation, custody and allocation of expenses; and another providing a detailed look into fund administrator shadowing.  The first installment covered highlights from two sessions, one addressing effective risk assessments for hedge fund managers and the other offering current and former government officials’ perspectives on expert networks, political intelligence, insider trading and valuation-related conflicts of interest.  The second installment summarized the most salient points from two sessions, including the keynote address by OCIE Director Andrew Bowden, and a session addressing fund distribution, the JOBS Act, broker registration, National Futures Association oversight of hedge fund marketing practices and the EU’s Alternative Investment Fund Managers Directive.

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    RCA Symposium Offers Perspectives from Regulators and Industry Experts on 2014 Examination and Enforcement Priorities, Fund Distribution Challenges, Conducting Risk Assessments, Compliance Best Practices and Administrator Shadowing (Part One of Three)

    The Regulatory Compliance Association recently held its Compliance, Risk & Enforcement 2013 Symposium (Symposium), at which regulators and hedge fund industry experts offered insights on relevant regulatory, compliance and operational topics.  This first installment of a three-part series covering the Symposium summarizes two sessions, one on conducting effective risk assessments for hedge fund managers (including discussions of forensic testing and testing for insider trading, order allocations and best execution), and the other incorporating current and former government officials’ perspectives on expert networks, political intelligence, insider trading investigations and prosecutions and valuation-related conflicts of interest.  The second installment will summarize salient points from the keynote address by Andrew Bowden, Director of the SEC’s Office of Compliance Inspections and Examinations, and a session addressing challenges for fund distribution raised by the JOBS Act, broker registration issues and the AIFMD.  The third installment will summarize key points from two sessions, one on compliance best practices for use of expert networks, valuation, custody and expense allocation, and another on fund administrator shadowing.

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Akin Gump Partners Discuss Non-U.S. Enforcement, Insider Trading in Futures, Failure to Supervise Charges and Other Evolving Insider Trading Challenges for Hedge Fund Managers

    Akin Gump Strauss Hauer & Feld LLP recently hosted its “Private Investment Funds Conference: 2013 Trends and Developments” in New York City.  During a panel discussion entitled “Beyond the Headlines: Current Issues in Insider Trading Enforcement,” Akin Gump partners discussed new enforcement and prosecution tactics; the risks of gathering research through sell-side analysts, buy-side firms, expert networks, political intelligence firms, channel checking firms and meetings with current and former employees of companies; insider trading beyond U.S. borders; CFTC regulation of insider trading; whistleblowers; and five strategies for effectively mitigating insider trading risks.  The discussion was moderated by former federal prosecutor James Joseph Benjamin Jr., an Akin Gump partner and head of the firm’s securities enforcement and litigation practice group.  The other panelists were Akin Gump partners Michael A. Asaro, a former SEC staff attorney and Assistant U.S. Attorney, who practices in the areas of government investigations and enforcement proceedings; Douglas A. Rappaport, who handles civil litigation and regulatory and compliance matters; and Steven F. Reich, a white collar defense litigator with experience that includes serving as an Associate Deputy U.S. Attorney General and in the White House counsel’s office.  This article summarizes the key takeaways from the panel discussion.  See also “Perils Across the Pond: Understanding the Differences Between U.S. and U.K. Insider Trading Regulation,” The Hedge Fund Law Report, Vol. 5, No. 42 (Nov. 9, 2012); and “How Can Hedge Fund Managers Understand and Navigate the Perils of Insider Trading Regulation and Enforcement in Hong Kong and the People’s Republic of China,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013).

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  • From Vol. 6 No.43 (Nov. 8, 2013)

    Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part Two of Three)

    Sidley Austin LLP recently presented a conference entitled “Private Funds 2013: Developments and Opportunities.”  At the conference, Sidley partners offered updates, market color and practice recommendations on hedge and private equity fund structuring, regulation, operations and transactions.  The Hedge Fund Law Report is covering the conference in a three-part article series.  The first article covered the sections of the conference addressing fund structuring developments, single-investor funds, first loss capital arrangements, side letter terms, hard wiring of feeder funds for ERISA purposes, liquidity terms, fee terms, founder share classes and expense allocations and caps.  See “Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).  This second installment addresses recent developments in SEC examinations and enforcement (including a discussion of compliance policy violations, valuation practices and allocation of investment opportunities); insider trading issues (including the use of political intelligence firms, expert networks and deputized directors); the SEC’s new policy requiring admissions of wrongdoing and best practices for compliance; seeding arrangements; and fund manager mergers and acquisitions (including a discussion of key terms and negotiating points for such transactions).  The third article in this series will describe regulatory developments impacting fund managers, including commodity pool operator registration and regulation, implementation and compliance with the JOBS Act and derivatives reforms.

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  • From Vol. 6 No.41 (Oct. 25, 2013)

    Sidley Austin Private Funds Conference Addresses Recent Developments Relating to Fund Structuring and Terms; SEC Examinations and Enforcement Initiatives; Seeding Arrangements; Fund Mergers and Acquisitions; CPO Regulation; JOBS Act Implementation and Compliance; and Derivatives Reforms (Part One of Three)

    Sidley Austin LLP recently hosted a conference in its New York office entitled “Private Funds 2013: Developments and Opportunities.”  At the conference, Sidley partners discussed various structuring, regulatory, operational and transactional developments impacting private funds and their managers.  The Hedge Fund Law Report is publishing a three-part series of articles covering the most important insights arising out of the conference.  In this first installment, we summarize the parts of the conference dealing with recent developments in fund structuring, single-investor funds, first loss capital arrangements, side letter terms, hard wiring of feeder funds for ERISA purposes, liquidity terms, fee terms, founder share classes and expense allocations and expense caps.  The second article in the series will discuss recent developments in SEC examinations and enforcement (including a discussion of compliance policy violations, valuation practices, allocation of investment opportunities, insider trading issues, use of political intelligence firms and expert networks, the SEC’s new policy requiring admissions of wrongdoing and best practices for compliance); seeding arrangements; and fund mergers and acquisitions (including a discussion of key terms and negotiating points for such transactions).  The third article will provide an update on regulatory developments impacting fund managers, including recent issues involving commodity pool operator registration and regulation, implementation and compliance with the JOBS Act and derivatives reforms.

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  • From Vol. 6 No.39 (Oct. 11, 2013)

    ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part Two of Two)

    ACA Compliance Group recently released a report and sponsored a webcast describing the results of its most recent survey of hedge fund and private equity fund manager compliance practices.  This article, the second in a two-part series covering the survey results, discusses: insider trading issues (including information barriers, online data rooms, non-disclosure agreements, restricted and watch lists, political intelligence, expert networks and public company contacts); and expense practices (including the use of expense caps, the allocation of expenses among a manager and its funds, expense allocation reasonableness reviews and other expense-related controls).  The first article in this series summarized survey results relating to fund managers’ preparation and completion of regulatory filings (e.g., Form ADV, Form PF and non-U.S. regulatory filings), including a discussion of how many managers are making various regulatory filings; what resources are being used to prepare such filings; how Form PF expenses are being allocated among a manager and its funds; and whether Form PF is being shared with fund investors.  The first article also discussed survey results relating to presence examinations.  See “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 38 (Oct. 3, 2013).

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    Guidepoint Global’s General Counsel, Catherine Smith, Discusses How Hedge Fund Managers Are Using Expert Networks to Conduct Investment Research and Mitigate Insider Trading Risks

    SEC, FBI and other government officials have acknowledged that expert networks are a legitimate method for conducting primary investment research.  See “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013) (“Commenting on the permissible use of expert networks, FBI Special Agent David Chaves observed, ‘I think a majority of expert networks serve a very legitimate function and have always acted responsibly.  We do not want to scare people into thinking this is not a valid resource because it is, and you can continue to use them.  You will know when conduct crosses the line.  I do not think people should overreact.’”).  Yet many of the recent civil and criminal insider trading actions against hedge fund professionals have involved expert networks, directly or indirectly.  See, e.g., “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Accordingly, hedge fund managers have struggled with capturing the research and investment advantages of expert networks while avoiding insider trading and other information risks.  To offer concrete guidance and specific best practices in this area, The Hedge Fund Law Report recently interviewed Catherine Smith, former Senior Counsel of the SEC’s Division of Enforcement and current General Counsel of expert network firm Guidepoint Global.  Smith brought her regulatory and private practice experience to bear on topics including how the use by hedge fund managers of expert networks has evolved; whether managers impose restrictions or prohibitions on the experts that may be consulted; how managers conduct due diligence on expert networks; how expert networks screen prospective experts; whether expert networks restrict topics eligible for discussion by their experts; compliance controls implemented by expert network firms and hedge fund managers; and different surveillance methods for monitoring expert network consultations.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Compliance, Risk & Enforcement 2013 Symposium, to be held at the Pierre Hotel in New York City on October 31, 2013.  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.38 (Oct. 3, 2013)

    ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part One of Two)

    ACA Compliance Group (ACA) recently released the second part of its three-part report describing the results of its surveys of hedge fund and private equity fund manager compliance practices, focusing on the completion and preparation of regulatory filings, various insider trading issues and expense practices.  ACA also presented a webcast explaining and expanding on the survey findings.  The report and webcast provided important market color and guidance enabling hedge fund and private equity fund managers to benchmark their compliance practices against those of their peers.  This article, the first of two installments covering the report and webcast, summarizes survey results relating to (1) the present status and focus areas of hedge fund and private equity fund manager presence examinations, and (2) fund managers’ preparation and completion of regulatory filings (e.g., Form ADV, Form PF and non-U.S. regulatory filings), including a discussion of how many managers are making various regulatory filings; what resources are being used to prepare such filings; how Form PF expenses are being allocated among a manager and its funds; and whether Form PF is being shared with fund investors.  The second installment will address insider trading issues (including discussions of information barriers, online data rooms, non-disclosure agreements, restricted and watch lists, political intelligence, expert networks and public company contacts); and expense practices (including the use of expense caps and the allocation of expenses among a manager and its funds).  For coverage of the first part of the ACA compliance report, conducted during the first quarter of this year, see “ACA Compliance Group Survey Provides Benchmarks for a Range of Hedge Fund Manager Compliance Functions, Including Dual-Hatting, Annual Compliance Reviews, Forensic Testing, Custody, Fees and Signature Authority,” The Hedge Fund Law Report, Vol. 6, No. 19 (May 9, 2013).

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  • From Vol. 6 No.25 (Jun. 20, 2013)

    RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part Two of Two)

    On April 18, 2013, the Regulatory Compliance Association held its Regulation, Operations & Compliance 2013 Symposium (Symposium), at which industry leaders and regulators offered perspectives on hot-button issues facing hedge fund managers and investors.  This article, the second installment in our series covering the Symposium, addresses how managers should address high-priority conflicts of interest; techniques and strategies regulators and prosecutors are using to investigate insider trading; the SEC’s whistleblower program; and Foreign Account Tax Compliance Act compliance.  The first article addressed challenges raised by side letters; evaluating requests for most favored nation provisions; and how hedge fund managers are using funds of one and managed accounts.  See “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

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  • From Vol. 6 No.13 (Mar. 28, 2013)

    Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices

    For at least the last five years, Reed Brodsky has been at the epicenter of the evolution of insider trading law as it applies to hedge fund managers.  As an Assistant U.S. Attorney in the Southern District of New York, he was one of the three prosecutors who tried the largest criminal hedge fund insider trading trial in history, U.S. v. Raj Rajaratnam, which resulted in Rajaratnam’s conviction and sentence of 11 years.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Also, he was one of two prosecutors who tried the insider trading case against Rajat Gupta, the former McKinsey Chairman, which resulted in Gupta’s conviction; and he worked on the prosecution of former FrontPoint Partners portfolio manager Joseph Skowron for insider trading in connection with a drug trial.  See “Morgan Stanley Sues Former FrontPoint Partners Portfolio Manager Joseph F. ‘Chip’ Skowron III for Losses Allegedly Caused by Skowron’s Insider Trading and Subsequent Cover-Up,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Based on this experience, Brodsky’s command of insider trading doctrine as it applies to hedge fund managers is recent, relevant and deep.  The Hedge Fund Law Report recently had the opportunity to interview Brodsky in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, at which Brodsky is scheduled to participate.  (The details of the Symposium are discussed below.)  Our interview did not focus on insider trading doctrine per se, although Brodsky is eminently equipped to discuss doctrine in depth.  Rather, our interview focused on the application of evolving insider trading doctrine to a range of research and trading practices commonly undertaken by hedge fund managers.  Specifically, we explored with Brodsky: how insider trading law should inform the efforts of hedge fund managers with respect to the use of expert network firms, channel checking firms and political intelligence firms; the application of insider trading law to commodities, derivatives and trades in private company stock; the practicability of “walling off” employees with material nonpublic information; trends in investigative methods and enforcement topics; how to generate goodwill from witness cooperation; and the value of self-reporting discovered insider trading violations.  In addition, we posed a number of challenging hypotheticals to Brodsky – which were hypothetical only in the sense that we did not name names, although the fact patterns are quite real.  Brodsky’s answers were insightful, business-minded and candid, and provide invaluable insight into how prosecutors think about the hedge fund industry.  The RCA Symposium will be held at the Pierre Hotel in New York City on April 18, 2013, and is scheduled to include a panel covering government investigations and prosecutions of hedge fund and private equity fund managers 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.  Brodsky will soon join Gibson Dunn & Crutcher LLP as a partner.  See “Rajaratnam and Gupta Prosecutor Reed Brodsky to Join Gibson Dunn,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    Best Practices for Due Diligence by Hedge Fund Managers on Research Providers

    Recent high-profile enforcement actions, including that involving Mathew Martoma and CR Intrinsic, an affiliate of SAC Capital, highlight the SEC Division of Enforcement’s continuing commitment to aggressively prosecuting hedge fund insider trading cases.  See “Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged ‘Record’ $276 Million Insider Trading Scheme,” The Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  While registered hedge fund managers are required by Rule 206(4)-7 under the Investment Advisers Act of 1940 to adopt policies and procedures reasonably designed to prevent and detect insider trading and other federal securities law violations, it behooves all hedge fund managers (even those that are not registered) to adopt such policies and procedures.  See “Three Recent SEC Orders Demonstrate a Renewed Emphasis on Investment Adviser Compliance Policies and Procedures by the Enforcement Division,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  Many hedge fund managers have recognized the insider trading risks posed by the use of expert network firms and have adopted policies and procedures designed to address these risks.  But other types of research firms also present insider trading and other regulatory risks.  Before using any investment research firm, it is imperative for hedge fund managers to conduct thorough due diligence to appropriately assess and address those risks.  In a guest article, Susan Mathews and Sanford Bragg describe the different types of research providers in the marketplace; the general approach to research provider due diligence; and some best practices for conducting due diligence on research providers.  Bragg is CEO of Integrity Research Associates, LLC, a consulting firm specializing in evaluating investment research providers, including their compliance platforms.  Mathews is Counsel and head of Integrity Research Compliance.

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  • From Vol. 6 No.10 (Mar. 7, 2013)

    Ropes & Gray Partners Share Insights Gleaned from Successfully Navigating Presence Examinations with Hedge Fund Manager Clients

    On October 9, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the SEC announced that it was going to conduct “focused, risk-based examinations of investment advisers to private funds that recently registered with the [SEC]” (Presence Exams).  See “OCIE Warns Newly Registered Hedge Fund Advisers to Watch Out for ‘Presence Examinations,’” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  On February 12, 2013, three partners at Ropes & Gray LLP presented a webinar entitled “SEC Presence Exams – Issues for Hedge Fund Managers,” to share their experience on how OCIE has conducted Presence Exams; their perspectives on hot-button areas of SEC investigations; and their tips for navigating a Presence Exam successfully.  This article summarizes the key points from the webinar.  See also “SEC’s National Examination Program Publishes Official List of Priorities for 2013 Examinations of Hedge Fund Managers and Other Regulated Entities,” The Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013).

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  • From Vol. 5 No.44 (Nov. 21, 2012)

    Fund Manager CR Intrinsic and Former SAC Portfolio Manager Are Civilly and Criminally Charged in Alleged “Record” $276 Million Insider Trading Scheme

    On November 20, 2012, the SEC filed a civil complaint charging hedge fund manager CR Intrinsic Investors, LLC (CR Intrinsic); one of its former portfolio managers, Mathew Martoma; and a doctor and medical consultant, Dr. Sidney Gilman, with allegedly participating in an insider trading ring in which CR Intrinsic, Martoma and funds managed by an unnamed affiliated hedge fund manager (identified in the financial press as SAC Capital) profited or avoided losses totaling $276 million – a record alleged value derived from an insider trading scheme, according to the U.S. Attorney’s Office.  According to the SEC’s complaint, CR Intrinsic traded ahead of a negative announcement of the results of a Phase II trial of a drug designed to treat Alzheimer’s disease that was being jointly developed by Elan Corporation, Plc and Wyeth.  Martoma allegedly received material nonpublic information through consultations with Gilman that were coordinated by an expert network firm.  Federal prosecutors in the Southern District of New York simultaneously unsealed a criminal complaint charging Martoma with insider trading.  This article summarizes the SEC’s complaint, including the allegations, claims and relief sought by the SEC.  (The factual allegations in the criminal complaint are substantially similar to those in the civil complaint.)

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers

    At an October 1, 2012 event co-sponsored by The National Law Journal; MoloLamken LLP; Wachtell, Lipton, Rosen & Katz; and Wilmer Cutler Pickering Hale & Dorr LLP, an illustrious panel of former federal prosecutors discussed the current state of insider trading enforcement and reviewed numerous hot-button issues of interest to hedge fund managers and other investors.  This article summarizes the key insights from the panel discussion.

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  • From Vol. 5 No.8 (Feb. 23, 2012)

    Trading Practices Session at SEC’s Compliance Outreach Program National Seminar Addresses Need for Holistic Compliance Procedures Dealing with Allocations, Best Execution and Cross Trades

    On January 31, 2012, the SEC hosted its annual, “Compliance Outreach Program National Seminar” (Seminar).  (The program was previously called “CCOutreach,” but it has been “rebranded,” as the SEC explained in a press release, to be more inclusive of all senior personnel at firms.)  The Seminar included five sessions.  The Hedge Fund Law Report recently reported on the session entitled “Enforcement-Related Matters” (Enforcement Session).  See “Enforcement Session at SEC’s Compliance Outreach Program National Seminar Highlights Regulatory Focus on Valuation, Conflicts of Interest and Compliance Shortcomings at Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012).  This article focuses on the “Trading Practices” session and highlights best practices for addressing the identified compliance concerns.

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  • From Vol. 5 No.4 (Jan. 26, 2012)

    SEC Files Civil Insider Trading Complaint Against Diamondback Capital Management, Level Global Investors and Seven Individuals Based on Trading in Dell and Nvidia; Diamondback Strikes Non-Prosecution Deal with U.S. Department of Justice and Settles with the SEC for $9 Million

    The Securities and Exchange Commission (SEC) has continued its push to root out insider trading in the hedge fund industry by leveling charges against two prominent hedge fund managers, certain of their respective principals and a network of analysts who allegedly shared inside information about Dell and Nvidia.  This article details the SEC’s allegations and summarizes the status of the related criminal charges and recent developments.

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  • From Vol. 5 No.2 (Jan. 12, 2012)

    STOCK Act Could Expand Insider Trading Laws to Prohibit Trading by Hedge Funds Based Upon Nonpublic “Political Intelligence”

    Last month the Senate Homeland Security & Governmental Affairs Committee passed the “Stop Trading on Congressional Knowledge Act,” or “STOCK Act,” and the House Financial Services Committee held hearings on similar legislation.  The primary purpose of this Act is to close a loophole in the law that may allow Members of Congress to legally trade securities based upon nonpublic “political intelligence.”  However, hedge fund managers should watch this legislation closely as it could have significant, perhaps unintended, implications.  Depending on what provisions (if any) are ultimately enacted, the legislation could alter the way fund managers conduct basic regulatory due diligence in connection with investments.  The legislation could weaken a key provision of Regulation FD, which confirms the “mosaic theory” defense to federal insider trading charges, and impact the way fund managers use employees, expert networks, lobbyists and political intelligence firms to research federal legislative and political activities in connection with their investments.  In fact, the legislation could fundamentally alter the way that fund managers interact with federal employees, including Members of Congress.  In a guest article, Scott E. Gluck, Of Counsel at Venable LLP, discusses: the background of the STOCK Act; relevant insider trading law; specific provisions of the STOCK Act relevant to hedge fund managers; and seven distinct issues for hedge fund managers to monitor, including the potential impact of the STOCK Act on the “mosaic theory” defense to insider trading charges.

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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. 4 No.33 (Sep. 22, 2011)

    Wiretaps, Whistleblowers, Expert Networks and Insider Trading: A Conversation with Kevin O’Connor, Former Associate Attorney General of the U.S. and Former U.S. Attorney for Connecticut

    Hedge fund managers remain a prime target for civil and criminal insider trading charges.  This is so for at least five reasons.  First, regulators and prosecutors have been emboldened by the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam on 14 counts of conspiracy and securities fraud.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” The Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Second, wiretapping has become a viable tool for investigating insider trading by hedge fund manager personnel, and a source of persuasive evidence.  See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Third, in the course of examinations of hedge fund managers, SEC examination personnel are looking for (among other things) evidence of insider trading that can serve as the basis of referrals to the SEC’s Enforcement Division.  See “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?,” The Hedge Fund Law Report, Vol. 4, No. 32 (Sep. 16, 2011).  Fourth, the staff of the SEC’s Enforcement Division can now use tools developed in the criminal context in bringing, negotiating and settling insider trading charges against hedge fund managers.  See “Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  And fifth, budgetary constraints have led the SEC to place a higher priority on deterrence, and insider trading actions against hedge fund managers are thought to have a powerful deterrent effect.  See “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  In light of the vigor with which civil and criminal authorities are pursuing insider trading actions – and the ongoing susceptibility of hedge fund managers to insider trading charges – the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – The New Enforcement Paradigm.”  That RCA Symposium will take place on November 10, 2011 at the Pierre Hotel in New York.  (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.)  One of the speaking faculty members expected to participate in the insider trading session is Kevin J. O’Connor.  O’Connor is a Partner at Bracewell & Giuliani and Chair of the firm’s White Collar Practice Group.  Previously, O’Connor was Associate Attorney General of the United States, the third-ranking official at the U.S. Department of Justice, and United States Attorney for Connecticut.  In anticipation of the upcoming RCA Symposium, The Hedge Fund Law Report interviewed O’Connor regarding insider trading considerations for hedge fund managers and related topics.  Specifically, our interview covered: implications for hedge fund managers of the increased use of wiretap evidence in insider trading investigations; the use of criminal wiretaps in civil proceedings; wiretaps of mobile phones and Voice over Internet Protocol lines; “tapping” of Blackberries and social media; how to incentivize internal reporting under the new SEC whistleblower rule; whether hedge fund service providers can be whistleblowers; activities other than insider trading that may serve as the basis of a whistleblower complaint; best compliance practices for engaging expert network firms; compliance training with respect to the use of expert networks; due diligence on expert network firms; and how to avoid FCPA violations when engaging third-party placement agents to solicit investments from sovereign wealth funds.  The full text of our interview with O’Connor is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks in Connection with Leveraged Loan Market Transactions?

    On July 27, 2011, compliance software provider Compliance11 hosted a webinar entitled, “Best Practices for use of Expert Networks and the Leveraged Loan Market.”  The purpose of the event was to provide “solutions, tactical input and strategies” designed to avoid insider trading pitfalls when hedge fund managers use expert networks in connection with leveraged loan trades.  For more on this general topic, see “Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun 17, 2011).  The webinar was moderated by Tracey Straub, Vice President of Strategy at Compliance11.  Laurence Herman, General Counsel and Managing Director of Gerson Lehrman Group (GLG), spoke about the use of expert networks, and Tim Houghton, Founding Principal of Cortland Capital Market Services (CCMS), spoke about trading in the leveraged loan market.  See “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  This article summarizes the most important points made during the webinar.  In particular, this article discusses: the ways in which expert networks can diminish the opportunities for inappropriate conveyance of material nonpublic information (MNPI); four recommended steps for hedge fund managers to take prior to engaging an expert network firm or expert; seven best practices for using expert network firms; nine compliance policies and procedures for using experts; whether leveraged loans are “securities” for insider trading purposes; and how to manage MNPI at hedge fund managers that participate in the leveraged loan market.  See “Big Boys Don’t Cry: How ‘Big Boy’ Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).

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  • From Vol. 4 No.30 (Sep. 1, 2011)

    Massachusetts Securities Division Adopts Final Regulation on the Use of Expert Network Services by Hedge Fund Managers

    On August 8, 2011, the Massachusetts Securities Division (Division) adopted a final regulation on the use by hedge fund managers of expert network services.  The Division had proposed the recently finalized regulation four months earlier.  See “Massachusetts Securities Division Proposes Regulation on the Use by Hedge Fund Managers of Expert Networks,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  One of the stated goals of the final regulation is to “provide investment advisers with greater clarity as to what is impermissible conduct when paying consultants for information.”  However, the final regulation appears to be redundant of existing commercial standards and unlikely on its face to prevent the sort of conduct that motivated the Division’s rulemaking.  See “Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).  Quite apart from providing the intended clarity, the final regulation may constitute a missed opportunity to provide much-needed guidance to the expert network industry and a template for similar state and federal efforts.  This article explains: the mechanics of the final regulation; the three primary changes from the proposed regulation; the Division’s view of the burden to be imposed by the final regulation on expert network firms; whether the final regulation is preempted by federal law; timing of effectiveness of the final regulation; who the final regulation does and does not cover; and four substantive criticisms of the final regulation.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    Implications of the Rajaratnam Verdict for the “Mosaic Theory,” the “Knowing Possession” Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade

    For a decade, Raj Rajaratnam, the founder and principal partner of the much heralded Galleon Group hedge fund, forged a reputation as one of Wall Street’s most accomplished traders.  Galleon managed over $7 billion in assets at its peak and Rajaratnam’s personal wealth, estimated at $22 billion dollars at one point, made the first generation Sri Lankan immigrant one of the wealthiest individuals in the United States.  Not surprisingly then, Rajaratnam’s May 11, 2011 conviction on 14 counts of conspiracy and securities fraud has roiled the hedge fund industry.  The government’s unprecedented use of wiretapping in a securities fraud case serves notice that a powerful and invasive investigative tool will be unleashed against suspected inside traders; there are also strong indications that the unraveling of the Galleon empire and the 25 other indictments flowing from it foreshadow other charges and investigations in the New York investment sector.  As legal precedent, however, the far flung Galleon case has not generally been considered significant.  The prosecution’s theory – that Rajaratnam and his network of associates obtained confidential corporate information from company insiders and then parlayed their knowledge into millions of dollars of gains from stock transactions – is a classic insider trading scenario that has not moved the boundaries of established law.  But beyond the verdict in United States v. Rajaratnam are legitimate questions about the state of insider trading law, most of which is made by judges and bureaucrats rather than lawmakers.  For example, what is the nexus that the government must prove between illegal inside information and specific stock transactions, and what should it be?  For the white collar defense bar and the hedge fund industry, the Rajaratnam verdict also portends trouble for the viability of the “mosaic theory” that the defendant pinned his hopes on at trial.  The jury’s rejection of that defense, and Rajaratnam’s contention that Galleon’s trades were based on a “mosaic” of legitimate, non-confidential pieces of information, raises new uncertainties for a range of investment analysts whose business model depends on the accumulation of information.  Finally, as the government more vigorously pursues insider trading cases, new cutting edge claims of liability are emerging: defendants are being ensnared even when stocks were not actually bought or sold, as occurs in at least some of the December 2010 charges in United States v. Shimoon, et al.  In a guest article, former Congressman and current SNR Denton Partner Artur Davis provides a detailed analysis of: the implications of the Rajaratnam verdict for the mosaic theory; the nexus between inside information and a specific trade required for insider trading liability to attach; the judicial – as opposed to regulatory – basis for the “knowing possession” standard; practical consequences of the verdict for hedge fund investment analysis and trading; how the verdict will impact the ongoing expert networks investigation; potential strategies for a legal challenge to the theory of causation espoused by the SEC in insider trading enforcement actions; the relevance of the “honest services” doctrine for insider trading jurisprudence; and the potential for “wire fraud” charges to criminalize breaches of corporate confidentiality agreements.

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  • From Vol. 4 No.14 (Apr. 29, 2011)

    Massachusetts Securities Division Proposes Regulation on the Use by Hedge Fund Managers of Expert Networks

    On April 20, 2011, the Massachusetts Securities Division (Division) proposed regulations that would impose new conditions on the use of “matching or expert network services” by Massachusetts-registered hedge fund managers or unregistered hedge fund managers operating in Massachusetts.  In the proposing release, the Division stated: “The rise of expert network firms, and the number of abuses which have been addressed by regulators, make it clear that additional measures are required to ensure that confidential information is not being accessed and traded upon.”  By way of evidence of “the number of abuses which have been addressed by regulators,” the Division’s proposing release cites the Division’s own recently filed complaint against Risk Reward Capital Management Corp., the allegations of which remain to be proven.  See “Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011).  This article describes relevant Massachusetts regulation and how the proposed regulation would change the current regulatory regime.  This article concludes with a critique of the proposed resolution, generally suggesting that it is overbroad, redundant of current law, redundant of current practice and incomplete.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    Former Portfolio Manager of Hedge Fund Manager FrontPoint Partners, Joseph F. “Chip” Skowron, Is Charged with Civil and Criminal Insider Trading Arising Out of Trading in Human Genome Sciences Stock

    The Securities and Exchange Commission (SEC) has amended its complaint in its insider trading action against Dr. Yves M. Benhamou to name Joseph F. “Chip” Skowron III as an additional defendant.  Skowron allegedly traded on inside information provided by Benhamou about the results of a clinical trial of a hepatitis drug manufactured by Human Genome Sciences, Inc. (HGSI).  Skowron had served as portfolio manager for six funds sponsored by hedge fund manager FrontPoint Partners LLC.  Benhamou is a doctor who was on a steering committee overseeing a clinical trial of HGSI’s drug Albumin Interferon Alfa 2-a.  The U.S. Attorney for the Southern District of New York has brought parallel criminal insider trading charges against Skowron based in large part on the testimony of Benhamou, who has already pleaded guilty to similar charges and is now a cooperating witness.  We provide a detailed summary of the amended complaint.  For a summary of the SEC’s original complaint, which referred to Skowron only as “Co-Portfolio Manager 1,” see “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part Two of Two)

    This is the second article in our two-part series intended to assist hedge fund managers in avoiding insider trading violations when using expert networks.  The first article in the series provided a detailed discussion of the law of insider trading.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks? (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  This article – the second in our series – includes a detailed summary of the factual and legal allegations in the relevant civil and criminal complaints.  In light of the importance of the ongoing expert networks insider trading investigation to the hedge fund industry, and in light of the importance of the alleged facts in understanding the investigation, this article provides a comprehensive discussion of the alleged facts.  This article is long – over 25 pages – but is important reading for anyone who wants to understand the investigation, and its implications for hedge fund managers, at a granular level.  Specifically, this article provides: links to the primary civil complaint and the eight primary criminal complaints; a chart listing, with respect to the defendants and relevant uncharged parties: name, job category, background information, civil and criminal charges and plea status (where applicable); public companies about which experts in the network of Primary Global Research, LLC (PGR) allegedly passed inside information to PGR clients; language of selected public company compliance policies; PGR revenues during the relevant period and the sources of those revenues; compensation of PGR experts and employees; and the sources of information included in the criminal complaints.  The core of this article is a series of detailed summaries of the material civil and criminal allegations against the various defendants.  The allegations are organized by defendant, and for each defendant, are listed chronologically.  Also, for each allegation, we have included a citation to the specific paragraph of the specific complaint containing the allegation.  (For HFLR subscribers that wish to undertake a review of the original documents, these citations, along with our links to the relevant complaints, will save hours of research time.)  Our summaries of the factual allegations focus on the specific information allegedly conveyed by PGR experts to hedge fund managers, the timing of communications relative to public earnings announcements, the methods and channels through which information was communicated and the interconnections between the nine documents under analysis.  This article is a significantly expanded version of a prior article published in our March 11, 2011 issue.  See “The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks,” The Hedge Fund Law Report, Vol. 4, No. 9 (Mar. 11, 2011).  For HFLR subscribers who have read that prior article, we have included in this article a redline highlighting the new information in this article.  Also, it should be noted that this article focuses on the civil and criminal allegations relating to trading in shares of public technology companies based on material nonpublic information allegedly obtained via one expert network firm or its employees or experts.  This article does not cover another category of complaints involving drug trials and alleged insider trading allegedly facilitated, directly or indirectly, by expert networks.  However, the HFLR has covered those other matters.  See “Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network,” The Hedge Fund Law Report, Vol. 4, No. 10 (Mar. 18, 2011); “SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 10, 2010).

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  • From Vol. 4 No.10 (Mar. 18, 2011)

    Massachusetts Commences Civil Securities Fraud Enforcement Action against Hedge Fund Investment Adviser Risk Reward Capital Alleging that the Hedge Fund Traded on Inside Information Provided through an Expert Network

    On March 9, 2011, the Enforcement Section of the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth filed an administrative complaint against investment adviser Risk Reward Capital Management Corp., the hedge fund it advised, the fund’s general partner and their principal.  This article summarizes the Division’s allegations, which constitute the first state-level enforcement efforts in the unfolding investigation of alleged insider trading in connection with the use of expert networks by hedge fund managers.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks

    Hedge fund managers have responded to the ongoing expert networks investigation by revisiting their insider trading compliance policies and procedures generally, and their expert networks policies specifically.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  Institutional investors have responded by updating their due diligence questionnaires and approaches.  At a minimum, investors are asking their current or prospective managers: whether they use expert networks and if so which; what compliance policies and procedures they have in place with respect to the use of expert networks; and whether they are under investigation for insider trading in connection with expert networks.  But investor due diligence on this topic can get significantly more granular.  According to one well-regarded industry source with whom we spoke, some institutional investors, or their third-party due diligence service providers, are asking their current or prospective managers for records of trades (in hedge funds and personal accounts) in securities of companies mentioned in the primary civil and criminal expert network complaints, around the dates mentioned in those complaints.  The goals of this exercise are to uncover trading patterns that resemble the patterns described in the complaints, to discover spikes in advance of earnings releases mentioned in the complaints and to find other fund or personal trading that is suspicious in light of the allegations in the complaints.  Regulators have undertaken similar analyses of trading patterns for some time, usually with the goal of identifying evidence of insider trading or market manipulation; and those efforts have improved in speed and effectiveness as the relevant technology has improved.  But institutional investors generally have not undertaken due diligence of this sort because it has been considered too attenuated – too much of a search for a needle in a haystack.  The key difference here is that the expert networks insider trading complaints provide a roadmap to potentially problematic issuers, dates and events.  The practical problem is that those issuers, dates and events are buried in hundreds of pages of legal papers.  We at The Hedge Fund Law Report have solved this problem by: analyzing the primary civil and criminal complaints alleging the use of expert networks to facilitate insider trading in technology company shares (as distinct from the biotechnology-related matters); extracting the salient facts; and organizing them in a manner that can serve as a due diligence roadmap for institutional investors.  This article contains the results of that analysis.  This article is long – close to 20 pages – but shorter than the source documents, and a ready-made framework for hedge fund due diligence.  Specifically, this article contains: a chart listing the names of the key civil and criminal defendants, their employers and job descriptions during the relevant periods and the charges brought against them; a list of the public companies about which Primary Global Research, LLC (PGR) experts allegedly passed material nonpublic information (MNPI) to PGR clients; the language of PGR and relevant public company compliance policies; PGR revenues and revenue sources; compensation numbers of PGR experts and employees; and sources of the data and information underlying the allegations in the criminal complaints.  In addition, this article contains a detailed summary of the allegations in the primary civil and criminal complaints against various categories of defendants, including: employees or former employees of PGR; experts in PGR’s network who also worked at technology companies; and employees or principals of hedge fund management companies that were also clients of PGR.  To enhance the utility of this article, we have listed the allegations chronologically in each category and emphasized the specific types of information alleged to have been improperly communicated.  Also, for each material allegation mentioned in this article, we have included references to the specific paragraphs of the relevant complaint containing the allegation, and we have included links to the relevant complaints.  Finally, it should be emphasized that this article is intended for use not only by institutional investors, but also by hedge fund managers.  That is, just as institutional investors can use this article as a framework for performing due diligence, managers can use this article to prepare for due diligence requests that may be in the offing.  While such preparation likely would not rise to the level of an “internal investigation,” managers may consider an internal review of fund and employee trading based on the issuers, dates and events mentioned in the complaints in this article.  Just as it is preferable for a manager to uncover bad facts before the SEC does so in an examination, it is better for a manager to uncover bad facts before an investor does so in due diligence.

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  • From Vol. 4 No.9 (Mar. 11, 2011)

    Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part Three of Three)

    Recent criminal and civil enforcement actions allege that hedge fund manager personnel obtained material nonpublic information from employees and experts of expert network firms.  See “The Hedge Fund Law Report Provides Due Diligence Roadmap for Institutional Investors Examining Use by Hedge Fund Managers of Expert Networks,” above, in this issue of The Hedge Fund Law Report.  While the merits of these actions largely remain to be determined, the impact of these actions on the hedge fund industry has already been considerable.  At least one hedge fund management firm that was raided by the FBI has announced that it will wind down, and other firms that were raided by the FBI have sustained sizable redemptions.  Even for managers that have not been directly involved, the renewed focus of the SEC, DOJ and FBI on insider trading has caused hedge fund managers to revisit their insider trading compliance policies and procedures.  See “How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  While the legal principles and theories of insider trading have not changed, the application of those principles and theories to new methods of investment research may be redefining the scope of permitted activity.  To assist hedge fund managers in understanding what is permitted and what is prohibited in the current environment, how to conduct investment research without violating insider trading law and how to design compliance policies and procedures that reflect the new enforcement reality, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – Analyzing and Addressing the Latest Enforcement Initiatives.”  That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York.  (For a fuller description of the Symposium, click here.  To register for the Symposium, click here.)  The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Insider Trading Enforcement session at the RCA’s April Symposium: Robert B. Van Grover, Partner at Seward & Kissel LLP; John Robbins, Managing Director and Global Head of Compliance at Babson Capital Management LLC; and Adam J. Wasserman, Partner at Dechert LLP.  The goal of these interviews is to enable hedge fund managers to continue performing rigorous and productive research while avoiding insider trading violations.  We are publishing these interviews as a three-part series.  The full text of our interview with Robert Van Grover was included in the February 25, 2011 issue of The Hedge Fund Law Report, and our interview with John Robbins was included in last week’s issue.  Our interview with Adam Wasserman, included in full below, covered a wide range of relevant topics, including but not limited to: a taxonomy of the categories of potentially problematic information as revealed in the current criminal and civil complaints alleging insider trading in connection with expert networks; the government’s evolving view of what constitutes improper information; the definition of channel checking and how it is performed; the level of risk associated with various types of channel checks; whether hedge fund managers have been prohibiting their personnel outright from using expert networks; which categories of experts, consultants or entities should be covered by a hedge fund manager’s expert networks compliance policy; whether compliance policies should prohibit the use of an expert employed by a company in which the hedge fund has an investment, or within a certain period of the expert’s employment by the company; whether hedge fund investment personnel should be limited in the number of experts with whom they can consult in a certain period; the use of scripts or certifications; when to obtain certifications; how to prevent improper communications in informal settings; next steps in the ongoing insider trading investigation; potential RICO charges; how to talk to corporate insiders; and what to do when the FBI comes knocking.

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  • From Vol. 4 No.5 (Feb. 10, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks?  (Part One of Two)

    The investment returns of hedge funds often depend directly on the depth of their managers’ understanding of companies, industries and trends.  Expert network firms exist to enhance that understanding by providing investment managers with efficient access to persons with deep and difficult-to-replicate domain expertise – persons including corporate managers across a range of industries, doctors, engineers, lawyers, accountants, academics and others.  Specifically, expert network firms provide at least three services on behalf of their investment manager clients: they compile networks; they make relevant connections; and they structure interactions to comply with relevant law, most notably, insider trading law.  These services have generated a range of benefits for a range of parties: hedge fund managers have obtained more relevant and granular research, which has enabled them to allocate capital more effectively, which has improved the efficiency of capital markets generally; experts in expert networks – and there are hundreds of thousands of them – have commercialized expertise and experience that was heretofore confined to their direct job functions; and, recent sound and fury to the side, there is a persuasive argument that expert networks have reduced insider trading on a systemic basis.  Nonetheless, the regulatory investigation of insider trading and expert networks is far from complete.  More broadly, since the line between insider trading and diligent research can be blurry, many hedge fund managers have used the current investigation as an occasion to revisit their insider trading compliance policies and procedures generally, and their compliance policies and procedures with respect to expert networks specifically.  This article is the first in a two-part series undertaken to assist hedge fund managers and others as they revisit and revise their compliance policies and procedures relating to the use of expert networks.  This article provides a detailed overview of the law of insider trading, including detailed discussions of the following subtopics: the definition of “materiality” for insider trading purposes; three SEC pronouncements that provide guidance in making materiality determinations; the definition of “nonpublic” for insider trading purposes; breach of duty as a prerequisite for insider trading liability; the three theories of insider trading: classical, misappropriation and tipper-tippee; the “mosaic” theory (and two very important caveats to the mosaic theory); criminal enforcement of insider trading laws, including a brief discussion of substantially all of the civil and criminal insider trading actions brought in the course of the recent investigation, along with links to the underlying documents; and an underappreciated section of the Sarbanes-Oxley Act of 2002 that may offer regulators a potent enforcement tool.  The second article in this series will provide a detailed analysis of substantially all of the civil and criminal filings alleging insider trading in connection with expert networks.

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  • From Vol. 3 No.49 (Dec. 17, 2010)

    Does a Prime Broker Have a Due Diligence or Monitoring Obligation When Paying With Soft Dollars for a Hedge Fund Customer's Access to Expert Networks or Other Alternative Research?

    A recent court opinion, a recent criminal complaint and certain bedrock principles of investment advisory law may be understood in concert to suggest a new category of potential liability for prime brokers, and thus a new or heightened due diligence obligation on the part of prime brokers.

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  • From Vol. 3 No.47 (Dec. 3, 2010)

    Lessons for Hedge Fund Managers and Expert Network Firms from the Government’s Criminal Complaint against Don Chu, Formerly of Primary Global Research LLC

    On Wednesday, November 24, 2010, agents of the Federal Bureau of Investigation arrested Don Chu, at the time, an employee of expert network firm Primary Global Research LLC (Primary Global).  (Primary Global fired Chu after his arrest.)  The arrest was based on probable cause established in a Complaint filed in the United States District Court for the Southern District of New York the day prior to the arrest.  This article offers a critical reading of the Complaint and its implications for hedge fund managers and expert network firms.  By “critical,” we do not mean to take issue with the allegations in the complaint or the sufficiency of the evidence; the evidence appears to have been carefully collected and is persuasively marshaled.  Rather, by “critical,” we mean to describe our purpose in writing about the Complaint.  Here, as in substantially every article in The Hedge Fund Law Report, our purpose in writing about a particular legal document is to extract the insights and lessons that may be more broadly applicable to hedge fund managers and other hedge fund industry participants.  Such articles are intended to assist our subscribers in updating their assumptions, revising their policies and procedures and tracking the concerns of regulators and prosecutors.  With those and related goals in mind, this article discusses the following issues, insights and ideas arising out of the Chu Complaint: the three ways in which expert networks can facilitate the movement of material, non-public information; the ways in which expert networks, properly structured and used, can inhibit the movement of material, non-public information; the categories and timing of information allegedly communicated in the Chu matter; an important compliance suggestion for hedge fund managers that use expert networks, based on the specifics of the allegations in the Chu Complaint; the role of soft dollars in the ongoing insider trading investigation; the jurisdictional issue raised by the Complaint; and the interaction between competition in the expert network business, insider trading and insider trading law.

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  • From Vol. 3 No.44 (Nov. 12, 2010)

    SEC and DOJ Commence, Respectively, Civil and Criminal Insider Trading Actions Against a Doctor Who Allegedly Tipped Off a Hedge Fund Manager to Impending Negative Information About a Drug Trial

    The Securities and Exchange Commission (SEC) has commenced a civil insider trading action against Dr. Yves M. Benhamou (Benhamou) after a hedge fund allegedly traded on inside information provided by Benhamou about the prospects of Human Genome Sciences, Inc. (HGSI).  Benhamou is a doctor who was on a steering committee overseeing a clinical trial of HGSI’s drug Albumin Interferon Alfa 2-a (Albuferon).  An unnamed hedge fund manager, through six separate funds (Funds), owned over six million shares of HGSI.  One of its investment managers was a friend and business acquaintance of Benhamou.  According to the Complaint, Benhamou revealed material nonpublic information about the Albuferon trial to the investment manager from December 2007 through January 2008.  During that same period, the Funds sold all of their HGSI shares, including a block trade of the Funds’ remaining two million shares at the close of trading on January 22, 2008, the day before HGSI announced negative information about the Albuferon trial.  By selling prior to that announcement, the Funds avoided a $30 million loss on the HGSI shares.  The SEC charges that Benhamou violated the antifraud provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934.  The U.S. Attorney for the Southern District of New York has also brought criminal insider trading charges against him.  Benhamou was arrested in Boston on November 2, 2010.  We summarize the SEC’s civil complaint.

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations

    Portfolio managers, investment analysts and others with investment decision-making responsibility at hedge fund managers – especially those managing funds invested in public equity – face an ongoing predicament: the most valuable information from an investment perspective would be material, nonpublic information, but trading while in possession of material, nonpublic information is illegal.  Accordingly, hedge fund investment decision-makers routinely seek to compile a mosaic consisting of material, public information; immaterial, nonpublic information; and other information that broadly falls under the rubric of “market color.”  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  Generally, trading on the basis of such a mosaic is legal.  But knowing whether you have a legal mosaic or illegal inside information is complex.  In particular, determining materiality involves an assessment of the relevant facts in light of a daunting volume of statutes, rules, cases, SEC pronouncements and other formal and informal guidance.  In a word, the “better” a piece of information from the perspective of a hedge fund manager, the more scrutiny it merits (from at least the manager’s general counsel, chief compliance officer and outside counsel) to determine whether the manager’s funds may trade based on the information (or whether manager personnel may trade in their personal accounts while in possession of the information).  Nowhere is this predicament more pronounced than in situations in which hedge fund manager personnel talk to corporate insiders, in particular, executives of companies whose securities are owned or may be purchased or sold by the manager’s funds.  Talking to corporate insiders is essential in light of the competition in the investment world.  However, such communications are also fraught with the opportunity to acquire and inappropriately use material, nonpublic information.  In an article in our October 29, 2009 issue, we discussed a number of specific strategies that hedge fund managers can implement to minimize the likelihood that communications with corporate insiders may result in insider trading violations.  See “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  One of the techniques discussed briefly in that article is the use by hedge fund managers of expert networks.  Expert networks generally are companies that broker and structure communications between buy-side investors, such as hedge fund managers, and experts in designated areas, including corporate insiders and others with domain expertise.  This article expands substantially on the discussion in our previous article, describing in detail: what an expert network is; how such networks operate; the categories of experts available via networks; fees charged for membership in a network and periodic access to experts; the mechanics of communications with experts in a network; the benefits and limits of expert networks in preventing insider trading charges; eight specific steps taken by expert network companies to prevent insider trading violations; and Regulation Fair Disclosure (Reg FD) concerns.  One of the basic insights of this article is that expert networks have both offensive and defensive uses: they can be used to locate and glean information from experts who otherwise may be hard to find or hesitant to talk (the offensive use), and they provide a structure for communication that would be difficult to replicate in ad hoc or informal settings (the defensive use).

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