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    Feb. 13, 2025

The Algorithmic CCO: AI’s Role in Shaping the Future of Hedge Fund Governance (Part One of Two)

In the modern era, artificial intelligence (AI) has transcended the realm of hypothetical futurism and become a critical tool for businesses worldwide. Nowhere is this more evident than in the financial services sector, in which hedge fund managers increasingly leverage AI-driven technologies to gain competitive advantages and meet the demands of rapidly evolving markets. Traditionally, these tools have been synonymous with alpha generation and quantitative trading strategies. However, AI is now making significant inroads into areas such as legal, compliance and operational risk management. Why does this matter? Hedge funds operate in an environment of stringent regulatory oversight and global scrutiny. The SEC, CFTC, U.K.’s Financial Conduct Authority and other authorities worldwide expect hedge fund managers to adhere to increasingly complex and sometimes overlapping regulations. In this context, even a small oversight can lead to significant enforcement actions, reputational damage and hefty fines. By leveraging AI tools for surveillance, analytics and reporting, hedge fund managers can gain a proactive edge in managing compliance risks, ultimately strengthening investor confidence and protecting the integrity of the markets. This first article in a two-part guest series by Brian Meyer, partner at AirGC, examines the evolution of hedge fund governance; current and emerging AI use cases in compliance; and potential regulatory challenges. The second article will discuss the changing skill set required of the modern CCO, practical steps for implementing AI in compliance functions and the future of AI in hedge fund governance. For more from the author, see “Designing a State‑of‑the‑Art Hedge Fund Compliance Department: Leveraging Cutting‑Edge Technology” (Jul. 20, 2023); and “How Fund Managers Can Use Technology to Transform and Streamline Complex Legal Operations: One Manager’s Example” (Jul. 18, 2019).

Practical Challenges and Potential Conflicts of Interest When Operating Hybrid Funds (Part Two of Two)

Fund managers that launch hybrid funds containing features of both open- and closed-end funds are often acutely aware of some of the complications and practical issues that need to be negotiated in fund documents with investors to ensure the structure is workable and sound. Often overlooked, however, are the operational struggles that can accompany hybrid funds, including the employment of qualified employees and third-party vendors and the development of tailored policies and procedures to mitigate conflicts of interest. Those and other issues caused by hybrid funds were addressed at a panel hosted by the Practising Law Institute as part of its Advanced Issues in Private Funds 2024 program. Moderated by Cleary Gottlieb partner Maurice R. Gindi, the panel featured Matthew Jill, partner and GC, private funds and secondaries at Ares Management; Barbara Niederkofler, partner at Akin; and Amelia Stoj, CCO and assistant GC at Foresite Capital. This second article in a two-part series analyzes key features and considerations when operating a hybrid fund, including as to investor discussions, operational challenges, management fees, carried interest, clawbacks and conflicts of interest. The first article discussed the fundraising benefits and challenges presented by hybrid funds, as well as several types of liquidity mechanisms that managers can wield to meet their investors withdrawal needs. See “Structural and Operational Considerations for Hybrid Funds” (Jan. 14, 2021).

CFTC Finalizes Scaled-Back Amendments to Regulation 4.7

CFTC Regulation 4.7 exempts commodity pool operators (CPOs) with pool participants that are “qualified eligible persons” (QEPs) and commodity trading advisors (CTAs) that advise QEPs from certain compliance obligations imposed by Part 4 of the regulations under the Commodity Exchange Act. In October 2023, the CFTC issued a notice of proposed rulemaking that would have imposed significant new disclosure requirements on CPOs and CTAs relying on Regulation 4.7, raised financial qualifications for certain QEPs and codified certain exemptive relief the CFTC routinely provides to Regulation 4.7 fund of funds pools. On September 12, 2024, the CFTC adopted the proposed higher QEP thresholds and codified the fund of funds exemptive relief (Rules). However, after considerable industry pushback, the CFTC decided not to impose the proposed disclosure requirements. “Relative to the proposed rule, the final rule is a win for private fund managers and their investors,” Gretchen Passe Roin, partner at WilmerHale, told the Hedge Fund Law Report. This article discusses the Rules, with additional commentary from Roin and WilmerHale partner Matthew Kulkin. See “What’s Next for the SEC and CFTC? A Look at the Latest Reg Flex Agendas” (Aug. 15, 2024); and “Evaluating the CFTC’s Actions in 2023 and the Outlook for 2024” (Jun. 20, 2024).

Emerging Manager Survey Finds Steady Fees Among Smaller Managers

The Alternative Investment Management Association and Marex Prime Services (together, AIMA/Marex) released the results of their fourth emerging manager survey, which encompassed significant cross-sections of emerging hedge fund managers and the investors that allocate to them. Among other notable findings, AIMA/Marex found little change in average management and performance fees, as well as improved operating expense ratios but longer investor closing times since 2022. “This year’s research highlights the remarkable resilience and adaptability of small and emerging managers. Despite higher costs and intense fee pressures, these businesses continue to stand strong, attract investors and expertly manage expenses to stay ahead,” said AIMA managing director Tom Kehoe in the press release announcing the report. This article distills the key takeaways from the report. See “New Hedge Funds: Short‑Term Challenges Create Long‑Term Views” (Jun. 6, 2024).

SEC Sanctions Adviser and Recidivist Principal for Fund Audit Misrepresentations

Because financial statement audits provide important assurance to investors, it is no surprise that the SEC considers representations as to whether and when a fund is audited to be material. The SEC settled an enforcement proceeding against an investment adviser and its principal in which the regulator alleged that, from about July 2020 through late 2023, the defendants breached their fiduciary duty and falsely told investors and prospective investors in private funds they advised that the funds were subject to an annual audit by an independent auditing firm. Consequently, “investors in the [funds] were led to believe that there was a safeguard in place surrounding their investments – a third party audit – that did not exist,” claimed the SEC. This article discusses the SEC charges and the final judgments entered against the defendants. For discussion of a previous enforcement action involving the principal, see “SEC Sanctions Adviser for Undisclosed Conflicts and Misleading Form ADV” (Jun. 3, 2021).

Former Chief of the Securities and Commodities Fraud Task Force Joins Quinn Emanuel

Scott Hartman has joined Quinn Emanuel as a partner in its New York office. Hartman, who has expertise in securities and commodities fraud litigation, was recently at the U.S. Attorney’s Office for the Southern District of New York, where he served as Chief of the Securities and Commodities Fraud Task Force for more than three years. For insights from other Quinn Emanuel partners, see “Current and Former Enforcement Staffs’ Tips for Litigating Against the SEC” (Aug. 17, 2023).

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