Heard from GAIM Ops West - Day 2

Castle Hall is pleased to attend this year's GAIM Ops West conference in Palm Springs, California. The flagship panel brought together representatives from the SEC, CFTC and FBI to discuss current regulatory and enforcement trends.

Some themes from the regulatory discussion:

• Regulatory focus remains on the retail investor, with a particular attention on fraudsters who target the elderly (the FBI are very aware of the number of "scammers" trying to fleece the retired community). However, institutional asset managers continue to fall within the scope of ongoing regulatory oversight.
• Enforcement actions continue to be significant: the CFTC, in particular, has brought (and won) significantly more cases in the past 12 months as compared to prior years. In 2018, the CFTC brought 10 "major" cases with settlements in excess of $10 million - normal levels are 2-3 per year.
• CFTC Priority #1: Co-operative enforcement with other regulators. The regulator also noted that "strong regulation makes for strong markets".
• CFTC Priority #2: Individual Accountability. The CFTC will bring charges against individuals, not just management companies - including in cases where there was a failure to supervise junior staff. Charges against gatekeepers (lawyers, accountants) who facilitate a manager's fraud will also be pursued.
• CFTC Priority #3: Compliance and reporting. Education, training, surveillance and reporting procedures should all be effective, designed to prevent market manipulation and disruptive trading practices.
• SEC Priority #1: Valuation. The SEC will not opine on a whether a valuation is subjectively "correct" (when dealing with illiquid assets where pricing is not transparent). However, the regulator will bring cases where the investment manager does not follow their written procedures, or values an asset inconsistent with the manner which was disclosed to investors.
• SEC Priority #2: Expenses. The SEC remains focused on expenses, particularly in terms of allocation of expenses between the manager and the fund (i.e. the investors), and allocation of expenses between funds. Undisclosed compensation is also a key concern.
• SEC Priority #3: Cyber. The SEC have recently created a dedicated cyber unit, with the result that there will likely be more cases in the same vein as Voya.
• Cyber creates a new type of insider trading - there is no longer the tipper and the tippee...there is the hacker and the tippee. The SEC, CFTC and FBI all emphasized the technological ability of regulators and law enforcement to follow the flow of information and determine who receives data stolen by hackers.
• Collusion in markets was noted as an area where further enforcement actions could be brought. This follows lawsuits around manipulation of Libor, fx rates etc. Fixed income could be next!

Other topics:

• Private equity data needs standardization. Following on from yesterday's discussion, a panel of allocators discussed their challenges dealing with hundreds (if not thousands) of capital calls, distributions and manager notifications each quarter. Some form of standardized reporting, ideally with digital transmission and security, is the aspirational goal - yet seemingly a way off given the number of parties involved and the difficulty of co-ordination.
• Sexual harassment was discussed during a specific session. Ultimately, investment managers are employers and businesses, like any other company or business. Even "sophisticated" investment managers need basic HR policies. We expect to see more managers, at smaller headcounts, start to see the value in a dedicated HR professional. An HR professional is likely much better placed to professionally respond to a workplace complaint as compared to relying on the COO or other accounting / ops staff.
• LPACs (limited partner advisory committees) and governance. A Cayman directorship company raised the need for better governance in partnership structures, including situations where a hedge fund master entity is structured as a partnership; for onshore US funds (typically structured as LPs); and especially for private equity. In PE, of course, funds continue to be formed as partnerships, not corporations, where governance power is given to the manager (as GP), not to an independent board. Castle Hall continues to see several foundational weaknesses in the LPAC model (see our earlier blog). It remains puzzling as to the degree to which the PE community seem unaware that there are other options which could dramatically increase governance quality and investor protection.
• ESG was discussed at more length, with reference to recent European Union proposals to create a standard ESG "taxonomy" - and work to avoid "green washing" (a manager claiming they are ESG focused when, in fact....)
• Managed accounts and hybrid structures. For a sub set of investors in a sub set of strategies, managed accounts can be an ideal solution. Audience comments, however, raised ongoing concerns about the inherent liquidity mismatch of a managed account having de facto instantaneous liquidity (seize account) as compared to investors in a fund, which can be gated. As is always the case, there is rarely a simply answer to a complex question.

Thanks once more to the organizers for a very successful event!