US Election 2020: How Six Lambda helps asset managers address political contribution risk

US Presidential election

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With the US presidential election campaign rapidly gathering pace, the issue of political contributions – and the potential for conflicts of interest – has become a major issue on fund managers’ compliance radars.

Launched in 2018 by a team of former investment management professionals, Six Lambda offers a political contribution monitoring tool for compliance teams, examining federal, state and local contribution data to help firms avoid pay-to-play rule violations and offering daily updates of employees’ contribution activity. Its current client base includes hedge funds, mutual fund companies, banks and private equity firms, totalling more than USD600 billion in assets under management.

Financial services firms and contractors’ political donations are now subject to a dizzying array of regulations – including SEC Rule 206(4)-5, FINRA Rule 2030, the MSRB’s Municipal Securities Rulemaking Board Rule G-37, and the CFTC Regulation 23.45. With the 2020 election campaign heating up, falling foul of the extensive rules is a key risk for hedge funds of all sizes and strategy types.

Six Lambda’s founder and CEO Jon Liggett – who began his investment career at Bear Stearns before becoming a rates and currencies portfolio manager at emerging market macro hedge fund Pharo Management, later joining Philadelphia-based multi-family office JL Squared Group – explains how the firm’s product offering helps asset managers tackle this increasingly critical issue.

What is the background behind Six Lambda?

“In 2011, I left Pharo and joined JL Squared Group, a multi-family office, whose primary role was to help a few families in the Philadelphia area invest in other hedge funds. We had a pooled product that was a fund of funds, we did some advisory as well.

“My job was doing diligence on a very large number of hedge funds and some private equity opportunities too – we looked at probably 100-150 hedge funds every year. Through that process of due diligence, we found one hedge fund which had violated the pay-to-play policy in the US.

“They were investigated and fined by the SEC. They were required to do all this remediation, to go back and look at all their employees’ giving, state-by-state. After hearing the firm describe how onerous this would be for their compliance officers to do, I knew that a computer could do that – scrape all this data out of all of these databases daily, and aggregate all the information in one place.”

How does your product work?

“We have built this tool where we can go out and obtain political contribution data daily, and aggregate it in a database. We let our clients give us basic information like employee names and addresses, and we are then able to return to them the contribution history and current activity of their employees. This allows firms to do testing on political contribution activity, and examine it relatively quickly, rather than them having to dig through all of these databases and do random sampling that would never give them the answers they needed.

“If you’re trading stocks in your personal portfolio, for instance, and you also work at an asset manager, generally all those firms are in some way monitoring your personal trading accounts – they’re getting copies of the statements at a minimum; sometimes they're plugged in directly to an electronic feed of your personal trading accounts. They know that you've done a trade, even if you didn't ask permission.

“But something like this wasn’t available in the realm of political contributions. Regulated firms were having employees ask permission to make political contributions, but they had no verification layer, no way of knowing what the people were actually doing versus what they had asked to do.

“I realised we could really provide something that’s quick, efficient, and saves compliance officers time. It was essentially building a verification layer into their compliance programs.”

What has brought political contributions onto the financial services regulatory agenda?

“There are a few things that have happened since the financial crisis that drove increased compliance. One was making hedge funds register as registered investment advisors (RIAs) following the crash. This put them underneath all the laws of what of any registered investment advisor in the US – whether it be a financial advisor, a mutual fund, anyone who managed US funds onshore.

“That brought in a huge regulatory burden onto the hedge funds that were managing the US assets. There was also Rule 206 4-5, which took effect in 2011, generally referred to the ‘pay-to-play’ rule. This provides for a two-year time-out for firms to take money from places they’ve contributed money to. 

“Therefore, if you’ve made a contribution this year in a state where you seek state pension fund clients, that contribution could bar you from accepting management fees and performance fee for two years. That’s a big deal - it’s a missed revenue opportunity if, for whatever reason, you violate this policy.”

How have clients’ needs shaped the development of your product?

“We spent a year developing the product, and when we took on some pilot customers, they were very helpful in designing a system they needed. We rewrote the initial software to get it to how they wanted it to work.  They needed to show a complete audit trail of political contributions, so that if the SEC were to come in and do an exam, they could hand over something that showed and proved they actually did their work and investigated all these issues.

“We’ve added the ability to tag employees whether they’re a covered associate, or a former employee, so that we can help segment out the riskier parts of their pay-to-play programme.  “We’ve also added the ability through user feedback to take notes on each transaction, to tag each transaction, and to make them all searchable, so that every transaction now has a whole comments section associated with it, which shows managers have reviewed them, taken notes, and taken action one way or another.

“Finally, a lot of people want some sort of custom reporting which we can provide, so when they need to do due diligence questionnaires or some kind of disclosure report to win a new contract they can come to us and what would have taken a marketing person days or week to put together, we can do relatively rapidly for them so that they can get those proposals out much quicker.

“So, there’s not only a compliance angle, but there’s also a marketing angle to using this data.”

Are you seeing more demand during the election season? 

“We definitely saw a huge interest during the mid-terms. It was quieter during 2019, but in 2020 we’ve seen more firms refocus on contributions. Managers are getting a lot of preclearance request from their employees.

“Increasingly, the regulators know these products exist, so they’re expecting firms to be doing more testing, more monitoring of what's actually going on in the campaign and the political contribution universe, rather than just preclearance.

“Our expectation is that this year is going to be very active in terms of political contributions. By all measures, they’re expecting more money to be raised for political campaigns than ever before here in the United States. It makes monitoring and verification more important than it's ever been in the past.”

“You also have a very divided electorate in the US – people have strong opinions, and they’re going to be very tempted to try to help their cause this year.”

Is this issue here to stay?

“The SEC is trying to eliminate any conflicts associated with money in politics and ultimately management and performance fees from the asset management industry. There’s a lot of risk for potential violation of rule with such a charged climate in the US around the election this year.

“Generally, if firms do violate the rule and they discover a violation within four months of it being reported, they should be okay.

“Our tool acts as an insurance-like product for a firm, so that they’re not going to give away two years’ worth of management fees and performance fees on a one-off issue where someone has made a mistake. The cost of our product is relatively inexpensive compared to the cost of losing two years of management fees.”

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