The coronavirus has no doubt changed all of our lives. For fund managers, the rapid and dramatic decline in March of prices on a variety of assets, including equities, bonds, and commodities, has posed a variety of challenges, including for some a significant decline in revenues. Though capital markets have rallied since the break, specific securities, particularly in the fixed income and alternatives space, continue to be adversely affected. The economic and financial effects of COVID-19, and the dramatic reaction to it by governments, will have long-term consequences on capital markets. Notably, the deep and wide disruption of the economy is likely to threaten the value of a variety of securities for many quarters to come. The work you do now, and the decisions you make regarding your fund, will help you weather the effects the recent market break and better position your firm to weather future market breaks.
This article briefly sets forth some specific and practical steps fund managers should consider taking now in the wake of the first quarter market break to protect themselves and their investors, both now and in the future.
- Governance documents. Review your governance documents and confirm that you are in compliance with them. Were there aspects of your governance structure that did not serve you well during the market break? Are there amendments you should consider adopting now to better position you in the future?
- Board relations. Take a look at your communications with the fund board: were they timely and effective? Was your reaction to events in alignment with board expectations and concerns? Were you able to allay board concerns quickly?
- Disclosure documents. Review your fund disclosure documents and confirm that investment guidelines and restrictions have been adhered to. Are any amendments to your investment restrictions and guidelines in order? For example, were you able to navigate the dramatically shifting market conditions without causing any investment breaches? Review the risk factors in particular; are there any additions or modifications that should be considered in light of recent events? It is precisely in the wake of a market break that you can expect lots of new eyes, not all of them friendly, on your disclosure documents.
- Valuation challenges. Assess your pricing policies and procedures. How well did you handle valuation issues during the market break? Were your valuation policy and related procedures adequate? How many securities did you have fair value and for how many days?
- Liquidity management. Evaluate your liquidity management tools. Did you see a high volume of redemptions? Did you have sufficient liquidity to meet redemption requests in a timely fashion? Would you be better positioned in the future to manage liquidity risk if you adopted new liquidity management mechanisms (gating restrictions; redemption suspensions; in-kind redemptions)?
- Compliance program. Assess the effectiveness of your compliance program. In stressful times, and periods of diminished revenue, compliance programs can sometimes be adversely affected. How well has yours held up? Did the market break expose any weaknesses in your program that should be evaluated and, perhaps, remediated?
- 2020 audit. Anticipate this year’s audit. Expect fund auditors to be especially vigilant in applying auditing standards during this year’s audit, especially with respect to NAV’s, fair valuation and internal controls.
- Fiduciary duties. Keep in mind that, as an investment adviser (registered or unregistered), you are a fiduciary under Section 206 of the Investment Advisers Act of 1940, as amended. So all the decisions you make in response to the market break should be flowed through the lens of your duty of undivided loyalty to your clients and your obligation of utmost good faith. Regarding disclosure obligations, you should consider whether you have made full and fair disclosure of all material facts to your clients; have you fulfilled your duty to avoid misleading them?
Of course, your ability to respond to the market break will be dependent, in part, on the structure of the specific fund or funds you are managing: an investment company registered under the Investment Company Act of 1940, as amended; a private fund under 3(c) (1) or 3(c )(7) of the 1940 Act; another type of fund excluded from the definition of “investment company” under the 1940 Act; or a fund otherwise exempt from registration under the 1940 Act. Regardless of the structure of your fund, using recent events to your advantage can be a way to “make lemonade out of lemons.”
Please contact us if you have any questions about fund investment management. We look forward to your questions and calls.
About Croke Fairchild Morgan & Beres
Croke Fairchild Morgan & Beres is a corporate law firm providing services to businesses, private equity and venture firms and their portfolio companies, public companies, founders and family offices. Formed by partners who worked at preeminent international law firms, the firm boasts a deep bench of sophisticated and experienced corporate lawyers. With offices in Chicago, Lake Forest, and Milwaukee, our team provides exceptional legal service while affording our clients the benefits of working with a small, agile, and driven law firm. For more information, please visit us online at crokefairchild.com