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    May 9, 2024

Implications of New Dealer Definition for Hedge Funds (Part Two of Two)

On February 6, 2024, the SEC adopted final rules (Rules) updating the definitions of “dealer” and “government securities dealer” under the Securities Exchange Act of 1934 (Exchange Act). Section 15(a)(1) of the Exchange Act makes it unlawful for a “dealer” to effect securities transactions without first registering as such with the SEC; Section 15C similarly prohibits “government securities dealers” from effecting transactions in government securities without first registering. Because the SEC declined to exclude registered investment advisers or private funds from the scope of the new definitions, hedge fund managers must assess whether any of their funds now qualify as dealers and thus may be required to register as such. The Rules took effect April 29, 2024, with a compliance deadline of April 29, 2025. This second article in our two-part series explores what hedge fund managers should do in the wake of the new dealer definition, including which hedge funds may fall under that definition and the options available to the managers of such funds. The first article discussed the Rules, how they differ from the rules originally proposed in April 2022 and the SEC Commissioners’ individual views on the rulemaking. See “SEC’s Proposed Dealer Rules Would Capture Certain Private Funds” (Jun. 2, 2022).

Testing Is an Integral Component of Compliance Programs

Rule 206(4)‑7 under the Investment Advisers Act of 1940, commonly known as the “Compliance Rule,” requires advisers to review the adequacy and effectiveness of their compliance policies and procedures. One of the essential tools advisers use to fulfill their obligations under the Compliance Rule is testing. An ACA Group presentation, part of its “Building a Gold Standard Compliance Program” series, examined the role of testing in a compliance program; hallmarks of effective testing; and testing design and implementation. The program featured L. Allison Charley, director, and Jaqueline Hummel, director of thought leadership, at ACA Group. This article synthesizes their insights. For coverage of prior installments in that series, see “Managing Conflicts and Developing Effective Compliance Policies and Procedures” (Jan. 4, 2024); and “Improving Compliance Programs With Gap Analysis and Risk Assessments” (Oct. 26, 2023).

Identifying and Managing Common Conflicts of Interest

Conflicts of interest are a perennial SEC priority. To assist advisers in identifying and mitigating conflicts, a panel of senior private fund in-house counsel at the PLI Advanced Issues in Private Funds 2023 program took an in-depth look at the most common conflicts of interest faced by private fund managers and the ways managers mitigate those conflicts. The panelists drew from their firms’ experiences in addressing expense and investment allocations; valuation; exposure to different levels of a company’s capital structure; transactions with affiliates; and side letters. The program featured Marisa J. Beeney, senior managing director at The Blackstone Group and GC of Blackstone Credit; Scott Black, chief legal officer and CCO at Hudson Bay Capital Management LP; and Kelly M. Pettit, managing director, CCO and assistant GC at General Atlantic Service Company. This article summarizes their insights. See “SEC Reiterates Standards of Conduct for Advisers and Broker‑Dealers As to Conflicts” (Sep. 29, 2022).

SEC Charges Broker-Dealer Over Information Barrier Failures

Insider trading is another perennial focus area for the SEC. Its regulations require both investment advisers and broker-dealers to adopt and implement reasonably designed policies and procedures for preventing misuse of material nonpublic information (MNPI), such as the use of information barriers. The SEC commenced a civil enforcement action against a broker-dealer for failing to implement appropriate information barriers between the proprietary and customer-facing trading operations, arguing that traders’ unfettered access to customer MNPI rendered public statements about controls materially misleading. This article parses the SEC’s complaint, with commentary from Philip Moustakis, partner at Seward & Kissel. See “Emerging Trends and Themes in the SEC’s Oversight of Private Funds” (Jun. 8, 2023); and “Risk Alert Cites Compliance Issues Regarding Advisers’ Handling of MNPI” (May 19, 2022).

Key Issues When Establishing and Marketing Funds in Dubai and Abu Dhabi

The United Arab Emirates (UAE) is a high-quality financial center and tax-favorable jurisdiction with political stability and a good legal system that is based on the U.K. model. Several large fund managers have set up in the Middle East, which has strengthened the jurisdiction’s credibility and encouraged smaller managers to make the move. The UAE’s positive attributes are even more attractive as other jurisdictions around the globe are faced with political uncertainty and less favorable tax laws. To address some of the key issues for the growing number of fund managers interested in establishing a presence in Dubai or Abu Dhabi for investment management and capital raising purposes, Dechert hosted a webinar that was moderated by partner Craig Borthwick and featured Christopher Gardner (partner), Phillip Sacks (partner) and Dounia Mansour (counsel). The program discussed important considerations when setting up a presence in the main jurisdictions, rules for marketing to UAE investors and features of local fund products. For further insights from Dechert attorneys, see “Central Bank of Ireland Report Discusses Key Risks and Regulatory Focus Areas” (Aug. 17, 2023); and “Legal and Compliance Challenges for Global Asset Managers From Disparate ESG Regulations in the U.S. and Europe” (Nov. 10, 2022).

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