Nov. 30, 2023

Embracing AI in Private Funds: Challenges, Best Practices for Implementation and the Road Ahead (Part Two of Two)

The paradigm shift driven by artificial intelligence (AI) has gained remarkable momentum across many industries, and PE is no exception. Adopting AI is not just a trend; it is a profound turning point for PE. As we delve deeper into the heart of the transformation, however, the private funds industry finds itself at a crossroads where traditional approaches meet cutting‑edge solutions. Underscoring all of those developments is the reality that the widespread adoption of AI by fund managers brings a host of complex new challenges for legal and compliance teams to consider and mitigate. This second article in a two‑part series addresses the paramount issues AI raises in PE, such as ensuring privacy, preventing discrimination and maintaining quality control. The article also examines the ethical and regulatory concerns raised by AI and outlines best practices for implementation. The first article detailed the two primary types of AI and the various ways that fund managers can beneficially use the technology, including for portfolio analysis, due diligence, discovery, legal research and contract analysis. See “Safeguarding Proprietary Fund Data and Intellectual Property When Using Generative AI (Part One of Two)” (Oct. 19, 2023).

Competitive Update of the Luxembourg Investment Funds Toolbox Facilitates Alternative Investments and Future Retailization

Luxembourg is a leader in the structuring and distribution of investment funds; the world’s second most attractive financial center for the creation, management and marketing of investment funds; and a prime location for investments in alternative assets. Luxembourg achieved its leading position with €5.16 trillion assets under management in investment funds created and managed by 330 asset managers registered therein by constantly adapting its legal framework based on European and global legislative developments and market trends. In this context, the Luxembourg Parliament adopted the highly anticipated bill no. 8183 on July 11, 2023, which was published on July 24, 2023, and entered into force on July 28, 2023 (Law). The purpose of the Law is to improve and modernize the Luxembourg investment funds toolbox to maintain the jurisdiction’s attractiveness and competitiveness as a financial center, as well as to promote access of retail investors to alternative investment opportunities. In a guest article, DLA Piper attorneys Caroline Pimpaud and Céline Curatola detail the parameters of the Law and how its reforms are directed at promoting the ongoing prominence of Luxembourg as an attractive jurisdiction for fund managers. Specifically, the article details two types of changes to the existing Luxembourg sectoral laws: modifications designed to directly or indirectly encourage investments, and to either endorse existing practices or to make corrections to facilitate the structuring of investment funds. See “Unlocking Global Investment Opportunities: The Power of Luxembourg Private Funds” (Aug. 10, 2023).

Tips for Enduring an SEC Examination With the Lightest Possible Ramifications

With the SEC bolstering the staff and capabilities of its Division of Examinations, it is almost impossible for fund managers to avoid eventually facing unwanted scrutiny. A routine examination can quickly escalate to a referral to the SEC’s Division of Enforcement if fund managers are unprepared to move with the haste and thoughtfulness necessary to mitigate harm as much as possible. Accordingly, fund managers should heed the advice of the cadre of attorneys in the industry with extensive experience dealing with the SEC. To help fund managers prepare for potential SEC examinations, the Practising Law Institute gathered several expert attorneys to offer tips on communicating with staff, when to involve counsel, whether to self-report violations and other critical considerations. The panel that was moderated by Ken C. Joseph, managing director, financial services compliance and regulation for the Americas at Kroll; and featured Schulte Roth partner Marc E. Elovitz; Sidley Austin partner Ranah L. Esmaili; and Maurya C. Keating, Associate Regional Director of the SEC’s New York Regional Office. This article summarizes relevant takeaways for PE sponsors from the discussion. For coverage of other insights shared by Keating, see our two-part series: “Key Compliance Issues for Advisers and Funds Arising From the SEC’s 2022 Exam Priorities” (Sep. 27, 2022); and “Overview of the SEC’s Standards for Resilient and Effective Compliance Programs and Fiduciary Practices” (Oct. 4, 2022).

Previewing AIFMD 2.0: Updated Rules on Delegation, Annex I Services and Liquidity Management Tools (Part One of Two)

Article 69 of the Alternative Investment Fund Managers Directive (AIFMD) required the European Commission to start reviewing the directive in 2017, but the process was delayed largely as a result of Brexit. Before the summer break on July 19, 2023, inter-institutional negotiations with representatives of the European Parliament, the Council of the E.U. and the European Commission reached a compromise on the final text of AIFMD 2.0. To assist alternative investment fund managers in understanding and preparing for AIFMD 2.0, a panel at Dechert’s recent Luxembourg Annual Funds Conference discussed the current state and future direction of the amended directive. The program featured Dechert partners Angelo Lercara (Munich), Colin Sharpsmith (London), Christine A. Renner (Luxembourg), Cyril Fiat (Paris) and Patrick Goebel (Luxembourg). This first article in a two-part series details material changes to the delegation requirements under the new rules, updates to the Annex I services and certain issues introduced by mandated liquidity management tools. The second article will analyze relevant changes affecting loan origination funds, fallout from the lack of revisions to marketing practices under AIFMD and the ramifications of a handful of omitted items under the new rules. See “The European Commission and ESMA Lay Groundwork for AIFMD II” (Nov. 3, 2020); and “KPMG Reports on AIFMD’s Efficacy Five Years After Implementation” (Apr. 16, 2019).

U.K. Penalizes Morgan Stanley for Lax Electronic Communications Practices

Investment advisers and other financial services companies are by now well-aware of the SEC’s and CFTC’s focus on appropriate recording and retention of electronic communications relevant to their business operations. A recent proceeding brought by the U.K.’s Office of Gas and Electricity Markets (Ofgem) is an important reminder that firms must also be cognizant of the requirements of other jurisdictions and regulators. Ofgem determined that Morgan Stanley & Co. International plc (MSIP) had violated recordkeeping regulations applicable to trading in the energy markets by failing to record and retain employees’ WhatsApp messages. To resolve the matter, MSIP agreed to pay a penalty of £5.41 million. This settlement is the first time a fine has been issued in the U.K. for failure to record and retain electronic communications relating to trading in wholesale energy products. This article details the relevant regulatory regime and MSIP’s violations. For related SEC enforcement efforts, see “Enforcement Actions Resulting From SEC Sweep Keep Off‑Channel Communications in the Spotlight” (Oct. 5, 2023); and “Ongoing SEC Sweep Targets Advisers’ Off‑Channel Electronic Communication Recordkeeping Practices” (Mar. 9, 2023).

Lowenstein Sandler Adds New Co‑Chair of Its Fund Formation Group

Michael D. Saarinen has joined Lowenstein Sandler as a partner in the firm’s investment management group and as co‑chair of its fund formation & structuring group in New York. His practice focuses on the establishment and operation of funds across all major asset classes and strategies, including buyout, growth equity, venture capital, real estate, hedge, credit, distressed debt, special situations and fund-of-funds. For commentary from Saarinen, see “Inflection Points in Negotiating PE Fund Core Economic Terms and Structuring GP‑Entity Carry Allocations to Incentivize Employees” (Aug. 4, 2020); and “SEC’s Reg Flex Agenda Promotes Transparency While Adding Potential Compliance Burdens” (Mar. 15, 2018).