1 Compliance Corner
5 How Commodity Regulations Impact
Private Equity Fund Managers
9 SEC Continues Its Focus on Private Fund Managers
13 AIFMD in the United Kingdom
15 Right of Buy-Side Counterparties to Segregate Initial Margin for Uncleared Swaps
PRIVATE
FUNDS
PRACTICE
NEWSWIRE
SPRING 2014
IN THIS ISSUE
Talbert I. Navia +1 (212) 408-5316 [email protected] Morton E. Grosz +1 (212) 408-5592 [email protected] ADVISORS
Private Funds Practice NewsWire is published by Chadbourne & Parke LLP for general information purposes only. It does not constitute the legal advice of Chadbourne & Parke LLP, is not a substitute for fact-specific legal counsel and does not necessarily represent the views of the firm or its clients.
PRIVATE
FUNDS
PRACTICE
NEWSWIRE
SPRING 2014 Alan Raylesberg +1 (212) 408-5198 [email protected]Marian Baldwin Fuerst
+1 (212) 408-5231 [email protected] Alex M. Herman +1 (212) 728-4478 [email protected] Beth R. Kramer +1 (212) 408-1080 [email protected] Garrett Lynam +1 (212) 408-5350 [email protected] Scott W. Naidech +1 (212) 408-5440 [email protected] Partha S. Pal +44 (0) 20-7337-8032 [email protected] Sean Dailey +1 (212) 408-1154 [email protected]
CONTRIBUTORS Monika Szymanski
+1 (212) 408-5430
Jan Peter Weiland
+44 (0) 20-7337-8175 [email protected] Scott W. Naidech +1 (212) 408-5440 [email protected] Beth R. Kramer +1 (212) 408-1080 [email protected]
EDITORS Sean Dailey
+1 (212) 408-1154 [email protected]
Recently, the Securities and Exchange Commission (SEC) has been active both in pursuing numerous enforcement
actions and launching additional compliance examination initiatives.
1The SEC’s Office of Compliance Inspections
and Examinations (OCIE), for instance, is performing presence examinations on newly registered investment
advisers,
2has recently announced examination initiatives targeting never-before examined registrants
3and cybersecurity preparedness,
4and is forming a specialized unit of dedicated private funds examiners.
5The following is a summary of recent compliance updates released by the SEC regarding social media and
cybersecurity, as well as best practices and practical advice to assist firms in maintaining a compliant business
and avoiding deficiencies in the event of an examination.
Social Media and the Testimonial Rule:
The SEC’s Division of Investment Management issued a guid-ance update in March 2014 lessening the impact of the testi-monial rule of the Advisers Act of 1940, as amended (Advisers
Act) on the use of social media.6 Pursuant to this newly
re-leased guidance, an investment adviser (Adviser) can publish public commentary from an independent social media site (Site) on its own internet or social media site without impli-cating the testimonial rule7 if:
• the Adviser cannot affect which public commentary is
in-cluded, how it is presented, commentators’ ability to post, and the Site allows viewing of all public commentary and updates it on a real-time basis;
• the Site provides content that is independent of
the Adviser;
• there is no material connection between the Adviser and
the Site that would call into question the independence
of the site or the commentary on it, such as a payment arrangement or commentary prioritization arrangement (Material Connection); and
• the Adviser publishes all of the unedited comments on the
Site regarding itself.
Advisers may do the following without implicating the testimonial rule, subject to some limitations:
• provide a mechanism for sorting the commentary for use
by social media users, so long as the Adviser itself does not sort the commentary;
• publish testimonials with a mathematical average of the
commentary, so long as the ratings system was not de-signed to elicit pre-determined results, and neither the Site nor the Adviser provide subjective analysis of the commentary;
COMPLIANCE CORNER
By Beth R. Kramer and Alex M. Herman
1 For additional detail regarding the SEC’s recent examination initiatives and areas of focus for 2014, please see our Winter 2014 issue of the Private Funds Practice Newswire, availableat: http:// www.chadbourne.com/files/Publication/ae4f94c5-34ec-4edf-99fd-d8680edadbcc/Presentation/PublicationAttachment/809dfe29-1944-4b89-ab24-d9efb93d2071/PrivateFundsNewsWire_ Feb14_web.pdf.
2 The SEC officially announced the Presence Examination Initiative in a Letter to the Industry on October 9, 2012 available at: https://www.sec.gov/about/offices/ocie/letter-presence-exams.pdf. Mary Jo White, Chair, SEC, Remarks at the Securities Enforcement Forum (Oct. 9, 2013), http://www.sec.gov/News/Speech/Detail/Speech/1370539872100.
3 The SEC officially announced the Never-Before Examined Initiative in a Letter to the Industry on February 20, 2014 available at: http://www.sec.gov/about/offices/ocie/nbe-final-letter-022014.pdf
4 Office of Compliance Inspections and Examinations, “OCIE Cybersecurity Initiative,” National Exam Program Risk Alert, Volume IV, Issue 2 (April 15, 2014), availableat: http://www.sec.gov/ocie/ announcement/Cybersecurity+Risk+Alert++%2526+Appendix+-+4.15.14.pdf.
5 Office of Compliance Inspections and Examinations Director Andrew J. Bowden, “Spreading Sunshine in Private Equity” (May 6, 2014), availableat: http://www.sec.gov/News/Speech/Detail/ Speech/1370541735361#.U3DvOPldXQg.
6 Investment Management Guidance Update, No. 2014-4, “Guidance on the Testimonial Rule and Social Media” (March 28, 2014), availableat: www.sec.gov/investment/im-guidance-2014-04.pdf.
7 Rule 206(4)-1(a)(1) under the Advisers Act is referred to as the “testimonial rule,” and prohibits Advisers from publishing, circulating, or distributing any advertisement that refers to any testimonial concerning the investment adviser or any advice, analysis, report, or other service rendered by such investment adviser. The SEC staff has previously interpreted the term “testimonial” to include a “statement of a client’s experience with, or endorsement of, an investment adviser.” See Cambiar Investors, Inc., SEC Staff No-Action Letter (pub. avail. August 28, 1997). Such testimonials are prohibited in Adviser advertising because their use can create a fraudulent or deceptive implication, and fraudulent and deceptive actions are prohibited under Section 206(4) of the Advisers Act.
• refer readers of a newspaper or other print advertisement to a Site that has public commentary, so long as they do not publish the testimonials in the advertisement;
• advertise themselves on a Site with public commentary, so
long as a) the relationship is not a Material Connection and b) it is clear that the advertisement is a sponsored state-ment; and
• show lists of contacts or “friends,” so long as there is no
im-plication that those contacts have experienced favorable results from the Adviser in the past.
Advisers should avoid the following conduct that may implicate the testimonial rule:
• submitting commentary itself that is included on
the Site;
• editing, designating the presentation order, or restricting
the publication of all or part of the commentary;
• compensating a person (employee, other supervised
person, client or prospective client) in any way to submit testimonials about the Adviser on a Site, and then using those testimonials in an advertisement; and
• referring users to content of a third party community or fan
page, or republishing such content in any way.
If Advisers do take advantage of these newly established per-missible social media activities, it is likely that the SEC will carefully review their social media practices during an exami-nation. Also, any Advisers that choose to utilize social media according to these newly published guidelines should modify their procedures to follow the guidance and monitor on an ongoing basis both their performance of those procedures and the Sites they use commentary from.
Cybersecurity Examinations
As indicated by the SEC’s Cybersecurity Roundtable hosted in March, the SEC has begun to view cybersecurity as an integral
part of investor protection.8 As part of an ongoing
cyberse-curity initiative, the SEC has since announced in a Risk Alert that OCIE will be performing cybersecurity preparedness
examinations.9
Who will be examined: over 50 registered broker-dealers and registered investment advisers.
Examination focus areas: OCIE’s examiners will focus on cybersecurity governance, identification and assessment of cybersecurity risks, protection of networks and information, risks associated with remote customer access, funds transfer requests, vendors and other third parties, detection of unauthorized activity, and past experiences with
cybersecurity threats. Likely document requests:10
• Policies and procedures related to the following:
• written information security policy and business
conti-nuity of operations plan;
• identify any published cybersecurity risk
manage-ment process standards the firm has modeled its processes on;
• identify specific practices and controls regarding
pro-tection of networks and information that the firm uti-lizes, and provide any relevant policies and procedures regarding those items;
• procedures to verify authenticity of email requests to
transfer customer funds;
• policies to address responsibility for losses associated
with attacks or intrusions that impact customers;
8 See Chair Mary Jo White, “Opening Statement at SEC Roundtable on Cybersecurity” (March 26, 2014), availableat: http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541286468.
9 Office of Compliance Inspections and Examinations, “OCIE Cybersecurity Initiative,” National Exam Program Risk Alert, Volume IV, Issue 2 (April 15, 2014), availableat: http://www.sec.gov/ocie/ announcement/Cybersecurity+Risk+Alert++%2526+Appendix+-+4.15.14.pdf.
10The full, 28-item sample document request list is attached as an appendix to the Risk Alert.
“If Advisers do take advantage of these
newly established permissible social media
activities, it is likely that the SEC will
carefully review their social media
practices during the examination.”
• policies and procedures and training materials regard-ing information securities procedures for vendors and business partners authorized to access the firm’s network; and
• an affirmation that the firm updated its written
su-pervisory procedures to reflect the Identity Theft Red Flags Rules, or an explanation of why they did not.
• Detailed information regarding:
• vendors, business partners and third parties who
conduct remote maintenance;
• cybersecurity risk assessments of vendors and
part-ners that have access to firm networks, data and sensi-tive information;
• certain practices the firm uses to assist in detecting
unauthorized activity on networks and devices, includ-ing how and by whom the practice is carried out;
• information security compliance audits;
• if the firm provides online account access,
informa-tion regarding the service provider, funcinforma-tionality of the platform, customer authentication, deletion software, customer PIN security measures and information given to customers regarding reducing cybersecurity threats; and
• whether the firm has experienced certain types of
cybersecurity events since January 1, 2013, including information regarding the duration, frequency, and se-verity of such events, as well as the remediation efforts. How to prepare:
• evaluate and assess your supervisory, compliance and/or
other risk management systems, policies, and procedures related to the risk focus areas above and any other cyber-security risks;
• make any appropriate changes to address or strengthen
such systems, policies, and procedures; and
• gather documentation of such changes as well as those
documents listed above, particularly any relevant policies and procedures.
Additional Areas of SEC Focus; OCIE Examination Practical Tips:
The SEC is not just looking for fraud anymore. This past October, Chair Mary Jo White announced that the SEC has
begun to focus on comparatively minor violations,11
emulat-ing New York Mayor Rudy Giuliani’s “broken windows” law enforcement regime. The core theory behind the “broken windows” program is that when minor violations are over-looked or ignored, they can lead to bigger violations.12 Further, in a speech given on May 6, 2014, OCIE Director Drew Bowden confirmed industry rumors that OCIE is forming a special unit of examiners that will focus on examinations of advisers to
private funds.13 Following these practical tips may help to
avoid some stumbling blocks that the SEC is now much more prone to highlight as deficiencies:
• Carefully follow established valuation methods: Examiners will be looking specifically for indications of cherry-picking and additions of inappropriate items into EBITDA without a rational reason for the change or sufficient disclosure to investors, and changes in the valuation methodology from period to period without additional disclosure where there is no logical reason for the change in methodology. Advisers should use the same valuation methodology that was origi-nally disclosed to investors. If a new methodology is used, advisers should maintain documentation of the reasons behind the decision to use the new methodology and dis-close the new valuation methodology to investors.
11 Securities and Exchange Commission Chair Mary Jo White, “Remarks at the Securities Enforcement Forum” (October 9, 2013), availableat: -http://www.sec.gov/News/Speech/Detail/ Speech/1370539872100#.U1VMs_ldXQg.
12 Examples of the rules that are receiving special attention are: Advisers Act Rule 204(4)-2, the books and records rule, Rule 206(4)-2, the custody rule, and Rule 206(4)-7, the compliance policy rule.
13 Office of Compliance Inspections and Examinations Director Andrew J. Bowden, “Spreading Sunshine in Private Equity” (May 6, 2014), availableat: http://www.sec.gov/News/Speech/Detail/ Speech/1370541735361#.U3DvOPldXQg.
“The SEC’s Office of Compliance
Inspections and Examinations is forming a
special unit of examiners that will focus on
examinations of advisers to private funds.”
• Explicitly detail the division of expenses in your fund docu-ments: Examiners will pay close attention to whether ex-penses are clearly allocated to the fund or to the invest-ment manager/general partner. Examiners focusing on the private fund space will also specifically look for hidden fees coupled with expense-shifting. The SEC has noted a lack of clarity in operative fund documents as to what consti-tutes a fund expense and what consticonsti-tutes an investment manager/general partner expense, which can lead to defi-ciencies during an SEC examination.
• Evidence a genuine commitment to compliance policies:
Examiners will start their analysis by evaluating whether an adviser has appropriate policies and procedures given the size and scope of its operations. Advisers should confirm that their compliance departments have adequate
resources and that their compliance policies are reviewed and revised as needed to properly reflect their specific needs.
• Demonstrate a “tone at the top” evidencing a commitment to compliance: Examiners will take a cue from the
behav-ior of the people in charge.14 Advisers should ensure that
their leadership maintains a pro-compliance “tone at the top” to help avoid enforcement referrals in the event of an
OCIE examination.
14 See Division of Enforcement Director Andrew Ceresney, “Keynote Address at Compliance Week 2014” (May 20, 2014), available at: http://www.sec.gov/News/Speech/Detail/ Speech/1370541872207#.U4yfZPldXQg.
If you are a private equity fund manager advising a fund that uses derivatives to hedge foreign exchange or
interest rate risks, regulations of the U.S. Commodity Futures Trading Commission (CFTC) may require that you
register as a “Commodity Pool Operator” (CPO) with the CFTC and subject yourself to various operational and
regulatory requirements.
2Even a private equity fund manager that is registered as an investment adviser with
the U.S. Securities and Exchange Commission (SEC) or qualifies as an “exempt reporting adviser” under the
Investment Advisers Act of 1940, as amended, must analyze whether it is a CPO under the CFTC’s rules, as the
CFTC and SEC are separate regulators with different mandates.
3Although CFTC rules were not historically of concern for private equity fund managers (private equity funds tradi-tionally invest in securities, which are regulated by the SEC, as opposed to commodity interests, which are regulated by the CFTC), Dodd-Frank greatly expanded the CFTC’s ability to regulate private equity fund managers by including interest rate and currency derivatives within the definition of “swaps,” which are now characterized as “commodity interests” that fall under the CFTC’s jurisdiction.4 Due to this jurisdictional ex-pansion, the CFTC has broad regulatory power over a variety of hedging instruments that private equity funds often use to hedge interest rate and currency risks, among other things. To comply with CFTC rules, private equity fund managers need to analyze whether they must register as a CPO and, if so, whether they fit within one of the CFTC’s exemptions from registration. This article addresses these issues through a series of short questions and answers.
1. We Manage a Private Equity Fund That Invests Only in Securities. How Could We Be Subject to CFTC Regulations?
Unlike hedge funds, private equity funds generally do not invest in the various assets that the CFTC historically con-sidered to be “commodity interests.” However, Dodd-Frank amended the statutory definition of the terms “commodity pool operator” and “commodity pool” to include entities that
trade in “swaps,”5 which is why private equity fund managers
need to review whether they must comply with CFTC regula-tions (see Question 4 below). For example, when establishing a private equity fund that will acquire portfolio companies, it may still be desirable to manage risk through swaps positions, such as currency and interest rate swaps. A private equity fund that enters into swaps to hedge its currency or interest rate exposure therefore may fall within the CFTC’s jurisdiction and its manager should determine whether an exemption from CPO registration is available (see Question 6 below).
HOW COMMODITY REGULATIONS IMPACT
PRIVATE EQUITY FUND MANAGERS
By Beth R. Kramer and Garrett Lynam1
1The authors would like to thank two Chadbourne summer associates, Eric Zember and Matthew Cognetti, for their contributions to this article.
2A CPO is generally any person engaged in a business that is of the nature of a commodity pool and who, in connection with that role, solicits, accepts, or receives capital for the purpose of trading in commodity interests. Since this definition could encompass both the management of a fund and acceptance of its capital, a fund’s general partner (if the fund is a limited partnership) or director(s) (if the fund is a corporation) will usually be its CPO. However, the CFTC permits a CPO to delegate its CPO duties to another entity (e.g., the fund’s investment manager) under certain circumstances so that only one registration is required (see Question 7 concerning new CFTC guidance in this regard).
3Although not the focus of this article, hedge funds are more likely to fall within the CFTC’s jurisdiction due to the nature of their investment strategies. Therefore, the issues discussed in this article are equally applicable to hedge funds as they are to private equity funds. If it has not already done so, a hedge fund that trades derivatives should carefully evaluate its CFTC registration status, including but not limited to CPO registration.
4See Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48208 (Aug. 13, 2012) (available at http://www.gpo.gov/fdsys/pkg/FR-2012-08-13/pdf/2012-18003.pdf).
2. We Manage a Private Equity Fund That Has Very Limited Hedging Arrangements. Are We Still Subject to CFTC Regulations?
Possibly. Private equity fund managers are subject to CFTC reg-ulations if their fund is operated “for the purpose” of trading in CFTC regulated “commodity interests,” which in turn will render their fund a “commodity pool” under the CFTC’s
juris-diction.6 Unfortunately, the phrase “for the purpose” is not
defined; rather, the CFTC states that the determination is a fact-intensive inquiry that depends on the circumstances. The CFTC has suggested in commentary to one of its rules that a fund entering into even one swap contract could be enough to characterize the fund as a commodity pool, therefore pos-sibly requiring the fund’s manager to register as a CPO unless
a registration exemption is available (see Question 6 below).7
3. We Are a Non-U.S. Manager of a Non-U.S. Private Equity Fund. How Could We Be Subject
to CFTC Regulations?
The CFTC has suggested that private equity fund manag-ers who advise a non-U.S. fund with only one U.S. inves-tor (defined broadly by the CFTC to include a U.S. resident or citizen, an entity formed or incorporated in the U.S., and a foreign entity with its principal place of business in the U.S., among other things) are subject to CFTC regulations if their fund is operated “for the purpose” of trading in CFTC
regulated commodity interests (as discussed in Question 2
above).8 In addition, a non-U.S. fund that trades outside the
U.S. could be at risk of CFTC enforcement action if its trades impact prices in the U.S.
4. What Currency and Interest Rate Hedging Activities Are Regulated by the CFTC?
Dodd-Frank granted the CFTC broad jurisdiction over “swaps.” Swaps are broadly defined in the U.S. Commodity Exchange Act (CEA) and accompanying CFTC regulations to include: (i) interest rate swaps; (ii) currency swaps; (iii) foreign exchange
swaps; (iv) total return swaps; and (v) credit default swaps.9
Subject to certain exclusions, a derivative will be a “swap” if it provides “one or more payments based on the value or level of one or more interest or other . . . financial or economic in-terests . . . based on the value thereof, and that transfers, as between the parties to the transaction, . . . the financial risk associated with a future change in any such value or level without also conveying a current or future direct or indirect ownership interest in an asset . . . or liability that incorporates the financial risk so transferred. . . .” 10 Given the breadth of this definition, it is generally a best practice to assume that a financial instrument that bears resemblance to a swap would be considered a “swap” under CFTC regulations.
5. What Are the Penalties for Violating CFTC Rules?
The CEA provides a private right of action with respect to persons or entities that violate the CEA or willfully aid, abet, counsel, induce or procure the commission of a violation of the CEA. Among other things, the CFTC can also seek injunc-tions and administrative sancinjunc-tions (including civil monetary penalties and revoking or restricting registration and ex-change trading privileges).
6. What CPO Registration Exemptions Are Available?
U.S. and non-U.S. private equity fund managers may be able to claim an exemption from CPO registration if they only
engage in a de minimis (i.e., minimal) amount of
commod-ity interest trading activcommod-ity pursuant to CFTC Rule 4.13(a)(3)
67 U.S.C. § 1a(10).
7See Commodity Pool Operators and Commodity Trading Advisors: Compliance Obligations, 77 Fed. Reg. 11252, at 11263 (Feb. 24, 2012) (available at http://www.gpo.gov/fdsys/pkg/FR-2012-02-24/ pdf/2012-3390.pdf).
8 See id. at 11264 (explaining that the CFTC “is not providing an exemption for foreign advisors at this time.”)
9 7 U.S.C. § 1a(47)(A)(iii).
10Id.
“...it is generally a best practice to
assume that a financial instrument
that bears resemblance to a swap
would be considered a “swap”
under CFTC regulations.”
and make the corresponding notice filing with the National
Futures Association.11 This rule provides an exemption from
CPO registration for the operators of commodity pools that are offered via private placement (i.e., without marketing to the public in the U.S.) generally only to “accredited investors” (or certain other categories of sophisticated investors) and satisfy the detailed numerical thresholds in the rule, which are summarized as follows:
At all times, the fund meets either of the following tests with respect to its commodity interest positions:
• The aggregate initial margin, premiums, and required
minimum security deposit for retail forex transactions re-quired to establish such positions, determined at the time the most recent position was established, will not exceed 5% of the liquidation value of the fund, after taking into account unrealized profits and unrealized losses on any such positions it has entered into; or
• The aggregate net notional value of such positions,
de-termined at the time the most recent position was es-tablished, does not exceed the liquidation value of the fund’s entire portfolio, after taking into account unrealized profits and unrealized losses on any such positions it has entered into.
Also, interests in the fund cannot be not marketed as or in a vehicle for trading in the commodity futures or commodity options markets.
To claim the CFTC Rule 4.13(a)(3) exemption, the CPO will need to file a notice of exemption with the NFA for each pool for which it claims an exemption (i.e., the exemption is not self-executing, and the notice of exemption must be reaf-firmed each year).
Additional exemptions from CPO registration exist, although in most circumstances they would not apply in the context of a private equity fund.
7. Any Additional Considerations?
The CEA’s definition of “CPO” is broad and typically captures the general partner of a fund formed as a limited partnership, the managing member of a fund formed as a limited liabil-ity company and the directors of a fund formed as a
corpo-ration.12 Although the CEA requires each person who comes
within the CPO definition to register absent an available ex-emption, the CFTC has historically relieved non-exempt CPOs from registration if their pool’s investment manager served as its registered CPO in lieu of each general partner, managing member or director, subject to certain conditions. In May 2014 the CFTC announced that it has implemented a “streamlined approach” for a CPO to delegate its investment management authority over a commodity pool to a registered CPO (typi-cally the fund’s investment manager) if certain facts are met and a letter containing specific representations is sent to the
CFTC requesting registration relief.13 CPOs that cannot make
the required representations are able to seek separate no-action relief from CPO registration. Additionally, the CFTC’s streamlined approach for CPO delegation does not apply to CPOs that are exempt from CPO registration (whether under the 4.13(a)(3) de minimis exemption or otherwise).
In addition to CPO registration, general partners and invest-ment managers to commodity pools also need to assess their registration status as a commodity trading adviser (a CTA). A CTA is generally any person who, for compensation or profit, engages in the business of advising others as to the value (or the advisability) of trading in any contract of sale of a com-modity interest.
11The National Futures Association is a self-regulatory organization that has been delegated authority by the CFTC to administer the oversight of CPOs and CTAs, among other categories of regu-lated persons. A CPO (and CTA) is therefore subject to dual oversight by both the CFTC and the NFA.
12 See footnote 2.
13 CFTC Staff Letter No. 14-69 (May 12, 2104). A PDF of the CFTC’s letter can be viewed on the following web page:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-69.pdf. The CFTC’s letter follows a set of frequently asked questions released by the CFTC in 2012 concerning CPO delegation (available here: http://www.cftc.gov/ucm/groups/public/@newsroom/ documents/file/faq_cpocta.pdf).
In order to rely on this “streamlined approach” to CPO delegation, the following criteria must be satisfied: (1) pursuant to a legally binding document, the delegating CPO must delegate to the designated CPO all of its investment management authority with respect to the commodity pool; (2) the delegating CPO must not participate in the solicitation of participants for the commodity pool; (3) the delegating CPO must not manage any property of the commodity pool; (4) the designated CPO must be registered as a CPO; (5) the delegating CPO must not be subject to a statutory disqualification; (6) there must be a business purpose for the designated CPO being a separate entity from the delegating CPO that is not solely to avoid registration by the delegating CPO under the CEA and the CFTC’s regulations; (7) the books and records of the delegating CPO with respect to the commodity pool must be maintained by the designated CPO in accordance with CFTC Rule 1.31; (8) if the delegating CPO and the designated CPO are each a non-natural person, then one such CPO must control, be controlled by, or be under common control with the other CPO; (9) if a delegat-ing CPO is a non-natural person, then such delegatdelegat-ing CPO and the designated CPO must have executed a legally binddelegat-ing document whereby each undertakes to be jointly and severally liable for any violation of the CEA or the CFTC’s regulations by the other in connection with the operation of the commodity pool; (10) if a delegating CPO is a natural person and is not an unaffiliated board member, then such delegating CPO and the designated CPO must have executed a legally binding document whereby each undertakes to be jointly and severally liable for any violation of the CEA or the CFTC’s regulations by the other in connection with the operation of the commodity pool; and (11) if a delegating CPO is an unaffiliated board member, then such delegating CPO must be subject to liability as a board member in accordance with the laws under which the commodity pool is established.
As a general matter, CTA registration is not a pressing concern for managers and general partners of traditional private equity funds, as CFTC Rule 4.14(a)(10) will exempt a general partner or manager from CTA registration so long as it has not furnished commodity trading advice to more than 15 persons during the course of the preceding 12 months and does not hold itself out generally to the public as a commod-ity trading adviser.14 Additionally, CFTC Rule 4.14(a)(5) exempts a firm from CTA registration if it is also exempt from CPO reg-istration and its commodity trading advice is directed solely to, and for the sole use of, the pool or pools for which it is so
exempt.15
Even if a CPO is registered, it may be exempted from compli-ance with several CFTC rules if the applicable requirements of CFTC Rule 4.7 are met. CFTC Rule 4.7 provides in relevant part that the registered CPOs of pools owned exclusively by “quali-fied eligible persons” (which includes “quali“quali-fied purchasers” (as defined in section 2(a)(51)(A) of the Investment Company Act of 1940, as amended) and non-United States persons (as defined in CFTC Rule 4.7)), among others, are relieved from certain disclosure, recordkeeping and reporting requirements
if a notice filing is made with the NFA for each eligible pool.
14 CFTC Rule 4.14(a)(10) generally provides that a single “person” includes an entity that receives commodity interest trading advice based on its investment objectives rather than the individual
investment objectives of its owners. Therefore, an entity’s owner would be counted in its own capacity if the CTA provides advisory services to the owner separate and apart from the advisory services provided to the entity.
1Investment Advisers Act Release No. 688 (July 12, 1979).
2See generally Section 203(e) (granting authority to discipline an investment adviser if it finds that the investment adviser (or a person associated with the investment adviser) has, among other things, made certain false statements, been convicted of certain offenses or committed certain willful violations of U.S. federal securities laws), Section 203(i) (authorizing the SEC to assess a range of monetary penalties against investment advisers and others) and Section 217 (providing for criminal penalties for willful violations of the Advisers Act).
3Mary Jo White, Chair, Sec. Exch. Comm’n., Chairman’s Address at SEC Speaks 2014 (Feb. 21, 2014). The full text of Chair White’s speech can be viewed at http://www.sec.gov/News/Speech/Detail/ Speech/1370540822127.
SEC CONTINUES ITS FOCUS ON
PRIVATE FUND MANAGERS
By Sean Dailey
• the SEC’s continued focus on insider trading;
• the possibility that more enforcement actions will
be brought in SEC administrative proceedings (rather than in federal courts); and
• the SEC’s new technological capabilities.
Background: SEC’s Enforcement Jurisdiction
A firm, such as a private fund manager, that falls within the definition of “investment adviser” (and is not eligible for an exclusion or otherwise prohibited from registering) gener-ally must register with the SEC pursuant to the Investment Advisers Act of 1940, as amended (Advisers Act). Registered investment advisers are subject to the requirements of the Advisers Act, which include:
• fiduciary duties to clients;
• substantive prohibitions and requirements;
• contractual requirements with clients;
• recordkeeping requirements; and
• administrative oversight by the SEC.
Although many individuals who are employed by firms that are registered investment advisers, including private fund managers, may also fall within the definition of “investment adviser,” the SEC generally does not require those individu-als to register. Instead, the firm must register; its registration covers its employees and other persons under its control (so long as the individuals’ advisory activities are undertaken on behalf of the firm).1
The Advisers Act contains several provisions granting the SEC the power to impose disciplinary sanctions and other penal-ties on registered investment advisers and their affiliated
persons.2 These include the power to restrict the investment
adviser’s activities and impose monetary sanctions.
In addition to the Advisers Act, the SEC may also bring en-forcement actions against private fund managers and their employees for violations of other U.S. federal securities laws including, among others, the Securities Act of 1933, as amended (Securities Act) and the Securities Exchange Act of 1934, as amended (Exchange Act).
“SEC Speaks in 2014” Focus on Enforcement
The SEC held its annual “SEC Speaks” conference in Washington, DC, from February 21-22, 2014, at which senior staff reviewed significant developments from the prior year and discussed current and upcoming enforcement priorities. SEC Chair Mary Jo White made clear that the agency is eager to complete and move beyond its extensive rule-making re-sponsibilities mandated by the Dodd-Frank Act and JOBS Act to focus on and understand the ever-changing financial markets. Chair White noted that she set three priorities when she arrived at the SEC in April, 2013:
• rule making;
• ensuring that the equity markets are structured and
operate efficiently; and
• increasing the robustness of the enforcement program.3
The Securities and Exchange Commission (SEC) continues to devote resources to examining private fund
managers. SEC officials have described the agency’s plans for private fund managers at several industry events
held in 2014. In particular, private fund managers should be aware of:
“Private fund managers should expect the
SEC to bring more actions through
administrative proceedings than
in the past.”
4 See generally, SEC v. Sigma Capital Management, LLC, et al., Litig. Rel. No. 22662 (Apr. 1, 2013), SEC v. CR Intrinsic Investors, LLC, et al., Litig. Rel. No. 22539 (Nov. 20, 2012) and 22647 (Mar. 18, 2013),
SEC v. Dosti, et al., Litig. Rel. No. 22725 (June 12, 2013), SEC v. Adondakis, et al., Litig. Rel. No. 22691 (Apr. 30, 2013), SEC v. Rajaratnam, et al., Litig. Rel. No. 22658 (Mar. 22, 2013), SEC v. Whitman, et al., Litig. Rel. No. 22653 (Mar. 20, 2013) and SEC v. Tiger Asia Management, LLC, et al., Litig. Rel. No. 22569 (Dec. 13, 2012).
5 Slip Op., No. 12-1723-cv (Feb. 18, 2014).
6 Practicing Law Institute, White Collar Crime in 2013: Prosecutors and Regulators Speak (Oct. 1, 2013).
7 The Dodd-Frank Wall Street Reform and Consumer Protection Act permitted amendments to the Advisers Act, the Exchange Act and the Securities Act, among others. Dodd-Frank Wall Street
Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).
With respect to the enforcement program, Chair White noted that enforcement will continue to be one of the SEC’s top pri-orities and cited 169 charges, brought under her watch, tied to the financial crisis (including 70 brought against high-rank-ing executives) that resulted in $3.4 billion in disgorgement and other civil penalties. She remarked that, during that time, the SEC “brought landmark insider trading cases and created specialized units that pursued complex cases against invest-ment advisers, broker dealers and exchanges…. But there is always more to do.”
The SEC pursued a number of insider trading actions against private fund managers and their employees in 2013 and
has continued that trend in 2014.4 In particular, Matthew
Solomon, the SEC’s Chief Litigation Counsel for Enforcement, discussed changes to the SEC’s approach to insider trading
cases. He noted that the recent SEC v. Contorinis decision
provides the SEC with a powerful tool for settlement nego-tiations. In SEC v. Contorinis5 the U.S. Court of Appeals for the Second Circuit affirmed an order requiring Contorinis, for-merly a managing director at Jeffries & Company, Inc. who co-managed the Jeffries Paragon Fund, to personally disgorge more than $7 million in insider trading profits realized by the fund even though he did not personally realize those gains.
SEC Administrative Actions Versus Suits Brought in Federal Court
Private fund managers should expect the SEC to bring more actions through administrative proceedings than in the past. Given the differences between a court action and an admin-istrative proceeding before the SEC, private fund managers should take note of the manner in which the SEC is currently utilizing the administrative process.
Andrew Ceresney, then the Co-Director of Enforcement, told
a Practicing Law Institute6 audience that he expected the SEC
to bring more administrative proceedings (relative to court actions) given the recent statutory changes conferring addi-tional powers on the SEC. Those changes granted the agency broad authority to impose civil monetary penalties in ad-ministrative proceedings in addition to the cease-and-desist orders previously available.7
In an administrative proceeding the SEC can seek many of the remedies also available to it in a federal court action, includ-ing civil monetary penalties and disgorgement, censures, bars from association with the securities industry, cease and desist orders and suspension or revocation of investment adviser (or broker-dealer) registrations. Administrative proceedings differ from civil court actions in that they are conducted by an SEC administrative law judge (ALJ), an independent judi-cial officer conducting public hearings in a manner similar to non-jury trails in federal district court. Following the hearing the ALJ issues an initial decision that includes findings of fact, legal conclusions and the suggested remedy, if any. Both the SEC staff and the respondent may appeal all or any portion of the initial decision to the SEC’s commissioners (the Commission). The Commission may affirm the decision of the ALJ, reverse the decision, or remand it for additional hearings. The Commission’s decision can be appealed in federal court. There are a number of important procedural differences between an SEC administrative hearing and a proceeding in federal court. SEC administrative proceedings, among other differences, (1) offer only limited discovery to a respondent (the inability to depose witnesses can put a respondent at
“NEAT...will permit the SEC’s examiners to
access and systematically analyze massive
amounts of a private fund’s trading data.”
a disadvantage because the SEC has the ability to take the testimony of a witness outside the presence of any defense counsel other than counsel to that particular witness during the investigation leading up to an administrative proceed-ing), (2) are expedited (this expedited process can put a spondent at a disadvantage because the SEC, unlike the re-spondent’s lawyers, has full access to the investigative record before the administrative proceeding begins) and (3) offer no right to a jury trial.8
Example of the SEC’s Use of its Administrative Forum: Failure to Supervise Action
During his keynote address at a recent seminar,9 Andrew
Calamari, Director, New York Regional Office of the SEC, suggested that the private funds industry can expect the SEC to bring administrative actions against individuals and entities for failure to supervise employees using the blue-print developed in its well-publicized 2013 action against
Steven A. Cohen.10
The SEC’s decision to bring an administrative action against
Cohen, alleging failure to supervise,11 instead of a charge of
insider trading in federal court, may signal an important shift in its enforcement strategy. In the past the SEC has generally brought failure to supervise actions against broker-dealers or chief compliance officers for systematic failures to main-tain, for instance, adequate regulatory procedures and com-pliance tools and typically involve the failure of a supervisor to perform specified tasks. Charging Cohen with failure to supervise marked a departure from the SEC’s traditional use of that action.
When the SEC brings an insider trading case against a private fund manager and/or its employees under the Exchange Act, it must prove that the respondent knowingly engaged in insider trading (or recklessly disregarded the fact that it was taking place). In an administrative action brought under the Advisers Act alleging failure to supervise a person acting on his or her behalf, the SEC need only prove that the respondent was negligent with respect to that failure. Notwithstanding the SEC’s decreased burden of persuasion in a failure to
8The right to a jury trial is generally available in cases brought by the SEC in federal court that seek monetary penalties. See SEC v. Adler, 137 F. 3d 1325, 1343 (11th Cir. 1998). 9 New York City Bar, Hot Topics in SEC Enforcement: The SEC Gets Tougher (March 21, 2014).
10 In re Steven A. Cohen (Jul. 19, 2013).
11 A failure to supervise action is based upon Section 203(e)(6) of the Advisers Act which, in pertinent part, provides for the imposition of sanctions on an investment adviser employee if he or she
has, among others, failed to reasonably supervise others with a view to preventing violations of the provisions of certain U.S. federal securities laws.
12 Mary Jo White, Chair, Sec. Exch. Comm’n., 41st Annual Securities Regulation Institute, Coronado, Calif. (Jan 27, 2014). The full text of Chair White’s speech can be viewed at http://www.sec.gov/
News/Speech/Detail/Speech/1370540677500.
supervise action, a private fund manager and/or its employ-ees may face severe penalties, including fines, censures and bars from association with the securities industry.
If the SEC continues to make greater use of its administrative forum, private fund managers and their employees may find themselves charged with an action for failure to supervise that, in the past, might not have been pursued by the SEC in federal court.
New Technologies and Industry Knowledge
Private fund managers should be aware of certain new tech-nological tools that the SEC has developed that will, among others, be employed during examinations and on which the SEC will likely rely for routine market regulation and monitor-ing and general enforcement activities.
In her speech to the 41st Annual Securities Regulation Institute, Chair White noted that the securities markets have been revolutionized by advances in computing power and other technology and that it is the SEC’s job to not only “keep pace with this rapidly changing environment, but, where pos-sible, also to harness and leverage advances in technology to better carry out our mission.”12 She briefly described a new SEC computer program, developed by the Quantitative Analytics Unit of the National Exam Program, called the National Exam Analytics Tool (NEAT) and a trade data analysis program called the Market Information Data Analytics System (MIDAS), each of which is discussed below.
NEAT
NEAT is an analytical tool that can be applied to sift through trading data to detect trading patterns. It is expected to be used during examinations and will permit the SEC’s examin-ers to access and systematically analyze massive amounts of a private fund’s trading data. Chair White noted that NEAT will allow SEC examiners to compare a “database of signifi-cant corporate activity like mergers against the companies in which a registrant is trading and analyze how the registrant traded at the time of those significant events.” 13 For instance, NEAT may be used during an SEC examination of a hedge fund manager to search for evidence of insider trading by reviewing every trade that a private fund manager executed around the time of a merger or earnings announcement to detect suspi-cious trading patterns.
Andrew Calamari, speaking both at a recent seminar14 and at
an industry event held on April 8, 2014, noted that he expects NEAT to revolutionize the SEC’s ability to detect patterns of insider trading, front running and violations of Regulation M, among others. He described an example of an examina-tion of a registered investment adviser in which NEAT was able to download three years’ worth of the manager’s trade blotter and, within 36 hours, analyze nearly seventeen million transactions.
MIDAS
Unlike NEAT, which is designed to be used in examinations of investment advisers, MIDAS collects vast amounts of in-formation about the broad activities of the markets. It col-lects more than one billion records per day from each of the 13 national equity exchanges, each time-stamped to the mi-crosecond. MIDAS allows the SEC to access data about every displayed order posted in the national exchanges in near real-time. MIDAS is designed to give the SEC the horsepower to monitor market activities as they happen, and can be used in forensic analysis to spot abnormal trading patterns.
The SEC expects that this type and amount of trading data may help reduce speculation about the behavior of the current market structure by, for instance, monitoring and helping to understand mini-flash crashes, reconstructing market events and developing a better understanding of long-term market trends. Certain parts of the MIDAS system are accessible on the SEC’s website and the SEC has and plans to continue making available market studies based on trading pattern
analyses performed by MIDAS.
13 Ibid. 14 See footnote 9.
AIFMD IN THE UNITED KINGDOM
1In the Winter 2014 issue of the
Private Funds Practice Newswire
,
2we reminded readers that, starting on July
22, 2014, fund managers that are not domiciled in the European Economic Area
3and that market or intend to
market to European Union (EU) investors (Private Fund Managers) will have to comply with certain requirements
of the Alternative Investment Fund Managers Directive (AIFMD) promulgated by the European Commission,
because certain transitional arrangements established by the AIFMD relieving Private Fund Managers from
compliance expire on July 21, 2014.
This note provides practical considerations for Private Fund Managers planning to rely on the United Kingdom (UK)
na-tional private placement regime4 in order to market securities
in an alternative investment fund (AIF) to investors domiciled in or with a registered office in the UK.
Required Filings
In order to rely on the UK national private placement regime, Private Fund Managers will have to complete either:
• an Article 42 form,5 if either (a) all of their AIFs are unlev-eraged, their aggregate assets under management exceed €500 million, and their investors have no redemption rights exercisable within five years of their initial investment, or (b) any of their AIFs are leveraged and their aggregate assets under management exceed €100 million (i.e., in each case, an “above-threshold non-EEA AIFM”); or
• a Small Third Country form,6 if they do not meet either
of the threshold tests described above (i.e., a “small non-EEA AIFM”).
Both forms require that the Private Fund Manager provide certain identifying information about itself and about its AIFs to be marketed in the UK, as well as information about whether the AIFs are structured as a master-feeder arrange-ment, as well as the AIFs’ custodial, prime broker and auditing arrangements and investment strategies. These forms must be emailed to the UK Financial Conduct Authority (FCA) prior to the commencement of marketing activities. The FCA has
published a guidance note7 to assist Private Fund Managers
with the completion of these forms.
Also, in order to rely on the UK national private placement regime, a supervisory cooperation arrangement must be in place between the FCA and the securities regulator of the
Private Fund Manager’s home jurisdiction.8 The US Securities
and Exchange Commission, among others, is party to such an arrangement.
1 The editors would like to thank Partha Pal, Peter Weiland and Coleman Miller for contributing to this article.
2 Available here: http://www.chadbourne.com/files/Publication/ae4f94c5-34ec-4edf-99fd-d8680edadbcc/Presentation/PublicationAttachment/809dfe29-1944-4b89-ab24-d9efb93d2071/
PrivateFundsNewsWire_Feb14_web.pdf
3 The European Economic Area includes the member states of the European Union plus Norway, Lichtenstein and Iceland.
4 The AIFMD marketing restrictions do not apply to an offering or placement of units or shares to an investor made “at the initiative of that investor.” This is referred to as “passive marketing” in the
Perimeter Guidance Manual of the FCA Handbook (PERG) and is otherwise commonly referred to as “reverse solicitation” by the private funds industry. The primary difficulty in relying on reverse so-licitation arises in trying to sufficiently evidence it. In this regard the PERG provides that “[a] confirmation from the investor that the offering or placement of units of shares of the AIF was made at its initiative, should normally be sufficient to demonstrate that this is the case, provided this is obtained before the offer or placement takes place.” The FCA notes, however, that Private Fund Managers, among others, should not be able to rely on such confirmations if they have been obtained to circumvent the requirements of the AIFMD. The FCA has declined to give examples of circumstances in which Private Fund Managers would not be able to rely on these confirmations.
5 Available here: http://www.fca.org.uk/static/documents/forms/aifmd-nppr-a42.xlsx 6 Available here: http://www.fca.org.uk/static/documents/forms/aifmd-nppr-stc.xlsx 7 Available here: http://www.fca.org.uk/static/documents/forms/aifmd-nppr-stc.xlsx
8 The list of signed supervisory cooperation arrangements is available here: http://www.fca.org.uk/firms/markets/international-markets/aifmd/nppr. This website also contains a set of useful FAQs
9 The details of the resulting reporting regime can be found in sections FUND 3.2, FUND 3.3 and FUND 3.4. of the FCA Handbook, available here: http://fshandbook.info/FS/html/FCA/FUND/3. 10 Section FUND 3.2.2 of the FCA Handbook.
11 See generally January 2014 FCA guidance, FG14/2 - General guidance on the AIFM Remuneration Code (SYSC 19B). 12 Specifically, this encompasses the following:
(a) the main instruments in which it is trading; (b) the principal markets of which it is a member or where it actively trades; (c) the principal exposures and most important concentrations of each AIF it manages; (d) details of the AIF’s liquidity position and liquidity management arrangements and the results of certain liquidity stress tests; (e) details of the AIF’s risk profile and risk management arrangements and the results of certain risk stress tests; (f) the main categories of assets the AIF is invested in; and (g) where the AIF employs leverage on a substantial scale additional reporting on its leverage position is required.
13 Available here: http://www.fca.org.uk/static/documents/forms/notification-of-major-holdings.doc
Reporting Obligations
As a consequence of marketing an AIF under the UK national private placement regime, the Private Fund Manager will be subject to certain ongoing reporting obligations:
• A “small non-EEA AIFM” will have to comply with a reduced
reporting regime that requires it to file an annual form with the FCA disclosing the main instruments in which it trades, its principal exposures (designed to measure risk) and in-vestment concentrations of the AIFs it manages; and
• An “above-threshold non-EEA AIFM” will have more
exten-sive ongoing reporting obligations. Generally, it will have the same reporting obligations as an AIFM that has been authorized by the FCA and is subject to the full require-ments of AIFMD (full-scope UK AIFM) in respect of informa-tion to be provided to investors and to the FCA, as well as
annual reporting by the AIFs under its management. 9
In particular, an above-threshold non-EEA AIFM is subject to the following reporting requirements.
• It must report to investors as follows:
• before an investor subscribes to the AIF, the Private
Fund Manager must provide comprehensive up-front information on the AIF that is similar in scope and manner to the disclosure one would generally expect
in a prospectus or offering memorandum for a fund;10
and
• on an ongoing basis it must report (i) changes in the
liquidity position of the AIF, (ii) its risk management, (iii) changes in its leverage and (iv) the total leverage of the AIF.
• It must prepare an annual report for the AIF it markets and
provide it to the FCA and any investor who requests the report. The report, which is similar in scope to the Form PF, must be prepared no later than six months after the AIF’s fiscal year end and must contain: (i) financial statements (balance sheet, income and expenditure statement), (ii) an
activities report, (iii) information on any changes to the in-formation previously made available and (iv) certain infor-mation on the aggregate remuneration paid by the Private Fund Manager to its staff.
Note that the AIFM Remuneration Code will only apply to
full-scope UK AIFMs. 11
• It must make regular disclosure to the FCA of certain key
information regarding its activities in the financial markets, its liquidity and risk positions, and (if applicable) leverage.12 In addition, for so long as the securities of an AIF marketed by or on behalf of a Private Fund Manager in the UK pursuant to the UK private placement regime are held by UK investors, and where an AIF managed by the Private Fund Manager (or a combination of AIFs acting jointly) acquires, disposes of or holds interests in a company with its registered office in the EU whose securities are not listed on a regulated market (a Non-Listed Company), the Private Fund Manager must notify the FCA of the proportion of voting rights of the Non-Listed Company held by the AIF whenever the proportion reaches, exceeds or falls below the thresholds of 10%, 20%, 30%, 50% or 75%. In addition, if the AIF acquires control of a Non-Listed Company or a company whose securities are listed on a regu-lated market, the Private Fund Manager must send a notice to the target company, the company’s other shareholders (to the extent identifiable by the Private Fund Manager) and the FCA that describes the AIF’s voting rights in the target company and the conditions subject to which, and the date on which, control was acquired. The FCA has published a form of such notice.13
Private Fund Managers seeking to raise capital in the UK should keep these notification requirements and the result-ing ongoresult-ing obligations in mind not only durresult-ing marketresult-ing but during the term of the marketed AIF, so as not to run afoul of the FCA’s regulations. Because of the existence of the su-pervisory cooperation arrangements, failure to comply with FCA regulations could result in sanctions and other penalties
Buy-side swap counterparties are beginning to receive notices from their swap dealers of the right to have their
initial margin for uncleared swaps (swaps that are not cleared through a clearinghouse) segregated and held in
a separate account with an independent third party custodian. Failure to respond to these segregation rights
notices may result in swap dealers ceasing or delaying trading uncleared swaps with the buy-side entity.
Section 724(c) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act,1 codified as Section 4s(l) of the
Commodity Exchange Act, contains provisions regarding treatment of margin for uncleared swaps and in response the Commodity Futures Trading Commission (the “CFTC”)
adopted Regulations 23.700 through 23.7042 with respect to
the protection of collateral of counterparties to uncleared swaps. Swap dealers are required to provide segregation rights notices to end-users of their right to segregate initial margin for uncleared swaps as of the following dates:
• May 5, 2014 for “new counterparties” (those with whom
there was no agreement concerning uncleared swaps as of January 6, 2014); and
• November 3, 2014 for “existing counterparties” (those
with whom there was such an existing agreement as of January 6, 2014).
The rules were implemented in response to the Lehman Brothers bankruptcy and the Lehman’s customers’ losses, and are designed to protect and segregate collateral from the assets of the swap dealers.
The right to segregation applies only to initial margin (collat-eral posted to cover future exposures arising from changes in the market value of the position, and which is referred to in the International Swaps and Derivatives Association (“ISDA”) Credit Support Annex as the “Independent Amount”), not variation margin (additional collateral posted
to cover current exposures arising from changes in the market value of the position).
If buy-side counterparties elect to segregate initial margin, the swap dealer must identify one or more custodians, of which one must be a creditworthy non-affiliate, and provide the price of segregation, if known. There likely may be higher fees associated with trading as the swap dealer will lose the benefit of being able to use the segregated collateral. Buy-side counterparties will need to enter into a written custodial agreement with the custodian and the swap dealer that meets the requirements of CFTC Regulation 23.702. Specifically, if the buy-side counterparty elects to segregate initial margin,
• such segregated collateral must be held in a segregated
account designated as being for and on behalf of the buy-side counterparty,
• withdrawals from the account can be made only by
agree-ment of both the buy-side counterparty and the swap dealer, unless exclusive control is exercised, and
• any notice to the custodian for the purpose of obtaining
ex-clusive control of the collateral must be in writing and given under oath and under penalty of perjury, stating that such party is entitled to exclusive control pursuant to an agree-ment between the parties, and the other party must be no-tified immediately.
RIGHT OF BUY-SIDE COUNTERPARTIES
TO SEGREGATE INITIAL MARGIN FOR
UNCLEARED SWAPS
By Marian Baldwin Fuerst and Monika Szymanski
1 Section 4s(l) of the Commodity Exchange Act, 7 U.S.C. § 6s(l).
2 Protection of Collateral of Counterparties to Uncleared Swaps; Treatment of Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy, 17 CFR Parts 23 and 190 (November 6,
The segregated collateral must be invested in “highly liquid” investments consistent with CFTC Regulation 1.25, which limits how futures commission merchants and deriva-tives clearing organizations may invest customer funds and imposes requirements to better mitigate credit, liquidity and market risk. For example, the collateral may not be invested in corporate debt securities that are not guaranteed by the United States or in foreign sovereign debt securities.
The segregation rights notice from the swap dealer must be provided:
• to the officer responsible for collateral management (or
if no such officer is identified, to the chief risk officer, or if there is none, then to the chief executive officer, or if there is none, then to the next highest level decision-maker); and
• at least annually (unless there are no uncleared swaps
between the parties during such year).
The segregation rights notice may be given on a swap-by-swap basis. Investment advisers or asset managers who provide the segregation election on behalf of the buy-side counterparty may be required to represent as to their author-ity to do so. The election would apply solely with respect to the counterparty’s swaps executed by the electing invest-ment advisor or manager and identified in the election letter. The buy-side counterparty may change its election at any time, but such election will apply only to future swaps and
not existing ones. Markit’s ISDA Amend platform will allow counterparties to identify the appropriate recipient for the segregation rights notices, to confirm receipt of such notices and to make the election. Alternatively, buy-side counterpar-ties may make such designations in a separate communica-tion to the swap dealer.
If a buy-side counterparty already has an existing collateral segregation agreement in place with its swap dealer, it has the option to continue that existing arrangement (and not elect segregation under the new CFTC regulations) or elect to apply the new CFTC regulations to the existing collateral segregation agreement (and such agreement will need to be revised accordingly).
If a buy-side counterparty elects not to segregate the initial margin, the swap dealer’s chief compliance officer must provide a quarterly notice of whether its back office proce-dures were in compliance with the agreement between the counterparty and the swap dealer.
On March 27, 2014, ISDA published a form of segregation rights notice, along with a form of segregation election letter and frequently asked questions, which are available on its website. It is important that buy-side counterparties respond promptly to the segregation rights notices from their swap dealers, acknowledging receipt of the notice and providing
100 WOMEN IN HEDGE FUNDS: THIRD ANNUAL
SALUTE TO THE GLOBAL ANGELS
On May 5, 2014, Chadbourne’s New York office hosted the 100 Women in Hedge Funds’ “Third Annual Salute to the Global Angels” cocktail party and dinner. The event wel-comed more than 120 guests, including several members of the 100 Women in Hedge Funds Board of Directors. Gov. George E. Pataki delivered the evening’s keynote address before being named an “Honorary Angel” by 100 Women in Hedge Funds.
Hosts:
Beth R. Kramer, Partner, Chadbourne & Parke LLP Scott W. Naidech, Partner, Chadbourne & Parke LLP Keynote Speaker:
Gov. George E. Pataki Monday, May 5, 2014 5:00 - 9:00 p.m.
Chadbourne & Parke LLP 30 Rockefeller Plaza New York, NY 10112
100 WOMEN IN HEDGE FUNDS: BROKEN WINDOWS:
SEC ENFORCEMENT AND EXAMINATION INITIATIVES,
2014 AND BEYOND
On April 8, 2014, Chadbourne’s New York office hosted a panel discussion with 100 Women in Hedge Funds, a global association of more than 12,000 professional women. The distinguished panel provided attendees with a 360-degree look at best practices for dealing with and surviving an SEC examination, and gave insight into the SEC’s increased focus on private equity fund managers and its new “broken windows” enforce-ment policy.
Panelists:
Andrew Calamari, Director, New York Regional Office of the SEC
Ken Joseph, Associate Director, SEC
Beth Kramer, Partner, Chadbourne & Parke LLP
James Capezzuto, CCO, New York Life Investors
Tuesday, April 8, 2014 5:00 p.m.
Chadbourne & Parke LLP 30 Rockefeller Plaza New York, NY 10112
www.chadbourne.com
New York 30 Rockefeller Plaza New York, NY 10112 Telephone: +1 (212) 408-5100 Facsimile: +1 (212) 541-5369 Washington, DC1200 New Hampshire Avenue, NW Washington, DC 20036
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