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    Nov. 21, 2024

Understanding the Implications for Hedge Fund Managers of FinCEN’s Final AML Rules (Part Two of Two)

For more than 20 years, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) has attempted to impose anti-money laundering (AML) rules on private fund managers by expanding the definition of “financial institution” under the Bank Secrecy Act of 1970 to include certain investment advisers. As far back as 2002, FinCEN has proposed – and then withdrawn – rules that would have required designated investment advisers to, among other things, implement AML programs and file suspicious activity reports. FinCEN was finally successful in August 2024, when it adopted final AML rules (Rules) that, with limited exceptions, apply to all advisers registered or required to register with the SEC under Section 203 of the Investment Advisers Act of 1940, as well as all exempt reporting advisers. “A lot of rulemaking is naturally reactive. When investigations began uncovering money from Russian oligarchs flowing through private funds, officials may have thought, ‘Can that finally get us over the hump to getting AML rules in place?’ I think that’s, in part, what’s happened here,” explained Arnold & Porter partner Kevin M. Toomey. “We’ve worked on some complicated criminal investigations involving the perceived laundering of money from Russia into the U.S., and but for moving the money through private funds, those bad actors may not have been able to achieve their goals. The DOJ is clearly focused on this method of moving money.” This second article in a two-part series examines the key challenges hedge fund managers will face in complying with the Rules and provides the steps they should take. The first article discussed the applicability of the Rules, their key provisions and how they differ from the original proposal. See our two-part series on the 2015 FinCEN AML rule proposal: “How Hedge Fund Managers Can Establish an AML Program” (Nov. 5, 2015); and “How Hedge Fund Managers Can Operate an AML Program” (Nov. 12, 2015).

Navigating Substantiation of Facts, Testimonials and Performance Claims Under the Marketing Rule

In the two years since the SEC adopted Rule 206(4)‑1 under the Investment Advisers Act of 1940 (Marketing Rule or Rule), its risk alerts, FAQs and enforcement activities have provided some clarity, but many questions remain, noted Julia Reyes, partner at ACA Group, during a program focused on best practices for complying with the Rule. Reyes, along with ACA Group director Matthew Shepherd and K&L Gates partners Lance C. Dial and Pamela A. Grossetti, provided practical guidance on meeting the Rule’s requirements for substantiation of material facts; testimonials and endorsements; performance claims; and hypothetical performance. This article distills their insights. See “Performance Advertising Is a Significant Pain Point Under the Marketing Rule” (Oct. 24, 2024); and “ACA Compliance Testing Survey: Marketing Rule Remains Top Compliance Focus” (Feb. 1, 2024).

Inadequate MNPI Policies Cost CLO and Hedge Fund Adviser $1.8 Million

Section 204A of the Investment Advisers Act of 1940 requires advisers to adopt and implement written policies and procedures reasonably designed to prevent misuse of material nonpublic information (MNPI). The SEC’s recent settlement with a hedge fund adviser “demonstrates the SEC’s focus on the risk of MNPI misuse in the fast-growing private credit market,” Elizabeth L. Mitchell, partner at WilmerHale, told the Hedge Fund Law Report. The adviser, which also manages and trades collateralized loan obligations (CLOs) and pursues other credit strategies, sold certain CLO tranches while in possession of MNPI concerning one of the companies whose debt was held by the CLO. A day after the sale, that information became public, leading to a drop in value of the CLO – and a threat of legal action from one of the adviser’s counterparties. Although the adviser had general insider trading policies, those policies did not require it to consider whether MNPI about a borrower whose debt was held by a CLO was material to a sale of a tranche of such CLO, the SEC claimed. This article discusses the adviser’s alleged compliance failures and the terms of the settlement, with additional commentary from Mitchell. See “Risk Alert Cites Compliance Issues Regarding Advisers’ Handling of MNPI” (May 19, 2022).

Established Hedge Fund Manager Study Examines Strategies, Fees, Liquidity and Structures

Seward & Kissel LLP recently released its second annual study of established hedge fund managers, i.e, those that have been in business for more than five years and have at least $1 billion in regulatory assets under management. The study, which focused on managers that launched new funds or new fund classes in 2023, focused on the strategies offered, management fees, incentive compensation, redemption rights and fund structures. Notably, most managers in the study pursue traditional, rather than bespoke, investment strategies, with traditional strategies commanding significantly higher management fees than bespoke strategies. This article discusses the key findings from the study, with commentary from Seward & Kissel partner Daniel Bresler. See “Investment Fund Survey Finds Growing Investor Bargaining Power” (Aug. 17, 2023).

Answers to Six Key Questions About How Enforcers View Gatekeepers

The SEC and DOJ often speak about their commitment to holding individuals accountable for corporate wrongdoing. One way in which they uphold this principle is by focusing on company gatekeepers – those with unique access to knowledge who are in the best position to prevent, detect and mitigate issues. A recent program hosted by the Practising Law Institute, entitled “Storming the Gatekeepers: When Compliance Officers and In-House Lawyers Are at Risk 2024,” dove deep into corporate gatekeepers and their possible liability for corporate crime. This article draws insights from two separate panels at the program to answer six fundamental questions about gatekeepers. See “Former SEC Officials Discuss Aggressive Enforcement Climate” (Sep. 14, 2023); and “SEC Order Warns Fund ‘Gatekeepers’ That They Remain a Focus of SEC Scrutiny” (Feb. 8, 2018).

K&L Gates Adds New Partner to Chicago Office

Sarah Riddell has joined K&L Gates as a partner in its asset management and investment funds practice. Working out of the firm’s Chicago office, Riddell regularly advises private fund managers, exchange-traded fund issuers, futures commission merchants, swap dealers, exchanges and clearinghouses. For insights from other K&L Gates partners, see “Key Takeaways From the Latest Round of Form PF Amendments (Part Two of Two)” (Jun. 20, 2024); “Preparing for Private Fund Quarterly Reporting” (Apr. 25, 2024); and “Tennessee Sues BlackRock Over Allegedly ‘False and Deceptive’ ESG Claims” (Feb. 1, 2024).

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