Articles By Topic
By Topic: Examinations
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From Vol. 6 No.24 (Jun. 13, 2013)
PLI Panel Provides Regulator and Industry Perspectives on SEC and NFA Examinations, Allocation of Form PF Expenses, Annual Compliance Review Reporting and NFA Bylaw 1101 Compliance
The Practising Law Institute recently sponsored a program entitled “Hedge Fund Compliance and Regulation 2013,” which included a segment entitled “Building an effective compliance program and strategies for dealing with regulators.” During that segment, the expert panel – consisting of regulators and industry professionals – offered unique and detailed insight on how regulators and managers approach the SEC and NFA examination process. Among other things, the panel offered a behind-the-scenes look at how the SEC and NFA approach regulatory examinations; practical guidance on how managers should approach the examination process; candid thoughts on hot-button issues, including the allocation of Form PF expenses, whether managers should document their annual compliance reviews and how regulators use such reports; challenges that hedge fund managers face in complying with NFA Bylaw 1101; and making disciplinary disclosures.
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From Vol. 6 No.21 (May 23, 2013)
OCIE Director Bowden Identifies Five Key Lessons for Hedge Fund Managers from Recent Presence Examinations
On April 18, 2013, just before being named the new Director of the SEC’s Office of Compliance Inspections and Examinations (OCIE), Andrew J. Bowden spoke at the Regulatory Compliance Association’s “Regulation, Operations & Compliance 2013” Symposium. Bowden provided context for and color on OCIE’s recently-issued policy statement entitled “Examination Priorities for 2013,” and highlighted important findings from recently-conducted presence examinations. This article summarizes the key points from Bowden’s speech. For more on concerns identified by SEC staff during recent presence examinations, see “Do In-House Marketing Activities and Investment Banking Services Performed by Private Fund Managers Require Broker Registration?,” The Hedge Fund Law Report, Vol. 6, No. 16 (Apr. 18, 2013).
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From Vol. 6 No.20 (May 16, 2013)
How Can Hedge Fund Managers Prepare for an SEC Investigation and Maximize the Odds of Obtaining Insurance Coverage? (Part One of Two)
On May 2, 2013, a panel of experts from K&L Gates, Jamison & Co. L.L.C. and ACA Compliance Group hosted a webinar entitled, “Issues Arising from SEC Investigations of Private Fund Managers: How to Prepare for an Investigation and How to Maximize the Odds of Obtaining Insurance Coverage.” This article, the first in a two-part series covering the webinar, addresses the SEC’s enforcement push against hedge fund managers; steps managers can take to formulate a plan for handling an SEC investigation; common mistakes managers make during investigations; and measures that managers can take to minimize enforcement risk. For our coverage of current SEC enforcement priorities, see “SEC Commissioner Aguilar Discusses Insider Trading by Hedge Fund Managers, Valuation and Other Examination and Enforcement Pressure Points,” The Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013).
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From Vol. 6 No.19 (May 9, 2013)
ACA Compliance Group Survey Provides Benchmarks for a Range of Hedge Fund Manager Compliance Functions, Including Dual-Hatting, Annual Compliance Reviews, Forensic Testing, Custody, Fees and Signature Authority
On April 16, 2013, ACA Compliance Group hosted a webinar in which it discussed findings from its recent survey of hedge and private equity fund managers regarding annual compliance reviews, forensic testing, risk management, custody, safeguarding of client assets, fee calculations and resources dedicated to compliance. This article summarizes the survey findings and the practical takeaways from those findings as communicated by ACA in the course of the webinar.
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From Vol. 6 No.16 (Apr. 18, 2013)
SEC Commissioner Walter Explains How an Overworked and Under-Resourced SEC Staff Can Nonetheless Examine Private Fund Advisers Effectively
On April 16, 2013, SEC Commissioner Elisse Walter addressed the 2013 NASAA Public Policy Conference in Washington, D.C. The general theme of Walter’s address was that with respect to examinations of investment advisers, federal and state securities regulators have more obligations than they have resources. Specifically, the Dodd-Frank Act reallocated responsibility for examinations of small and mid-sized investment advisers from the SEC to state securities regulators. See “NASAA Report Identifies Most Commonly Cited Investment Adviser Deficiencies Found in Coordinated State Adviser Examinations and Recommends Compliance Best Practices for Mid-Sized Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 12 (Mar. 22, 2012). While part of the intent of this reallocation of responsibility was to “free up” the SEC’s examination resources, Dodd-Frank may have increased the SEC’s total workload by bringing private fund advisers under its regulatory, examination and enforcement auspices. See “Challenges Faced By, Risks Encountered By and Lessons Learned From First Filers of Form PF,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013). In short, state securities regulators have more advisers to examine and federal securities regulators have larger and more complex advisers to examine. Yet neither has materially more budget. So how are the various regulators supposed to conduct adequate examinations and protect investors? Walter’s speech was intended, in part, to address that question by sharing the SEC’s learning with her state counterparts. To do so, Walter discussed the challenges presented by small firms; three specific ways in which SEC examination staff members have remained effective in light of limited resources; and relevant examination statistics. Walter’s speech was, in effect, a follow-up to her statement on the SEC’s 2011 Study on Enhancing Investment Adviser Examinations. For a discussion of that study, and of Walter’s contemporaneous statement, see “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).
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From Vol. 6 No.10 (Mar. 7, 2013)
Ropes & Gray Partners Share Insights Gleaned from Successfully Navigating Presence Examinations with Hedge Fund Manager Clients
On October 9, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the SEC announced that it was going to conduct “focused, risk-based examinations of investment advisers to private funds that recently registered with the [SEC]” (Presence Exams). See “OCIE Warns Newly-Registered Hedge Fund Advisers to Watch Out for ‘Presence Examinations,’” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012). On February 12, 2013, three partners at Ropes & Gray LLP presented a webinar entitled “SEC Presence Exams – Issues for Hedge Fund Managers,” to share their experience on how OCIE has conducted Presence Exams; their perspectives on hot-button areas of SEC investigations; and their tips for navigating a Presence Exam successfully. This article summarizes the key points from the webinar. See also “SEC’s National Examination Program Publishes Official List of Priorities for 2013 Examinations of Hedge Fund Managers and Other Regulated Entities,” The Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013).
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From Vol. 6 No.9 (Feb. 28, 2013)
RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising (Part Two of Two)
On December 18, 2012, the Regulatory Compliance Association held its Compliance, Risk & Enforcement Symposium at the Pierre Hotel in New York City. Participants at the event included leading hedge fund industry professionals, and panels focused on topics including insider trading, compliance programs and reviews, SEC examination priorities, hedge fund governance, Form PF and marketing and advertising issues. This article – the second installment in a two-part series covering the Symposium – discusses SEC examination priorities (and practical guidance for addressing areas of concern); recent trends in hedge fund governance; lessons learned from initial Form PF filings and strategies for completing Form PF; and marketing and advertising issues, including a discussion of the JOBS Act and related topics. The first installment covered, among other things: insider trading (including a discussion of manager cooperation, the elements of insider trading, the continuing viability of the mosaic theory, insider trading investigative techniques and the use of expert networks and paid consultants); and compliance programs and reviews (including a discussion of the approach to and framework for hedge fund compliance programs and reviews, and specific policies and procedures designed to address trading risks). See “RCA Symposium Identifies Best Practices for Hedge Fund Managers on Topics Including Insider Trading, Compliance Reviews, SEC Examinations, Fund Governance, Form PF and Marketing and Advertising (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).
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From Vol. 6 No.9 (Feb. 28, 2013)
SEC’s National Examination Program Publishes Official List of Priorities for 2013 Examinations of Hedge Fund Managers and Other Regulated Entities
On February 21, 2013, the SEC’s National Examination Program (NEP) published its list of priorities for examinations of investment advisers (including hedge fund managers) and other regulated entities for 2013. The NEP list not only addresses presence examinations of newly-registered investment advisers, but also discusses focus areas for examinations of previously-registered advisers. Also, unlike prior speeches addressing adviser examination priorities for 2013, this announcement reflects an official SEC statement on the matter. This article offers a deep dive into the SEC’s thinking on each of the specified examination priorities.
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From Vol. 6 No.4 (Jan. 24, 2013)
K&L Gates Investment Management Seminar Provides Guidance for Hedge Fund Managers on Social Media, Pay to Play Rules, ERISA Rule Changes, AIFMD, SEC Examination and Enforcement Priorities, Form PF, the JOBS Act, CPO Regulation and FATCA
On December 5, 2012, international law firm K&L Gates held its 2012 Investment Management Conference in New York. Speakers at the conference provided guidance on various regulatory developments impacting hedge funds, including: the use of social media; pay to play rules; rule changes under the Employee Retirement Income Security Act of 1974 (ERISA) impacting managers of plan assets; the E.U. Alternative Investment Fund Managers Directive (AIFMD); SEC examination and enforcement priorities; Form PF; the JOBS Act; regulation of commodity pool operators (CPOs); and the Foreign Account Tax Compliance Act (FATCA). This article highlights the key points discussed at the conference on each of the foregoing topics.
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From Vol. 6 No.4 (Jan. 24, 2013)
OCIE Director Carlo di Florio and Asset Management Unit Chief Bruce Karpati Address Examination and Enforcement Priorities for Hedge Fund Managers at the RCA’s Compliance, Risk & Enforcement 2012 Symposium
For legal and compliance professionals in the hedge fund industry, understanding the priorities of the SEC is critical in assessing risk, allocating resources and updating policies and procedures. In particular, legal and compliance professionals need to be aware of examination priorities and enforcement trends because fumbling in the course of an examination or enforcement action could have real and adverse business consequences. The SEC communicates its priorities indirectly and directly. It communicates indirectly via enforcement actions and the resulting documents. See, e.g., “Recent Enforcement Action Highlights SEC’s Concern with Preferential Redemption Rights Granted to Favored Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011). And it communicates directly – albeit through the noncommittal prism of form disclaimers – via speeches by commissioners and high-level staffers. Two important instances of such direct communications occurred on December 18, 2012, at the Regulatory Compliance Association’s Compliance, Risk & Enforcement 2012 Symposium in New York City. At that event, Carlo V. di Florio, Director of OCIE, and Bruce Karpati, Chief of the Asset Management Unit (AMU) of the SEC’s Enforcement Division, jointly delivered the keynote address. On the examinations side, di Florio described: how the SEC gathers information and assesses risk; the new presence examination program; and OCIE’s current examination priorities for hedge fund managers. On the enforcement side, Karpati discussed: the Enforcement Division’s new approach to initiating matters; the AMU’s approach to risk assessment; ten seminal enforcement actions recently taken against hedge fund managers; current enforcement priorities; and compliance best practices for hedge fund managers. This article summarizes the insights from both speeches that have direct bearing on preparation by hedge fund managers for examinations and enforcement actions.
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From Vol. 5 No.48 (Dec. 20, 2012)
Former SEC Asset Management Unit Co-Chief Robert Kaplan and Former NYS Insurance Superintendent Eric Dinallo, Both Current Debevoise Partners, Discuss the Purpose, Process and Consequences of Presence Examinations of Hedge Fund Managers
On October 9, 2012, the SEC’s Office of Compliance Inspections and Examinations (OCIE) sent a letter to senior management of newly-registered private fund advisers noting that such managers imminently may be subjected to so-called “presence examinations.” See “OCIE Warns Newly-Registered Hedge Fund Advisers to Watch Out for ‘Presence Examinations,’” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012). The letter provided some information on how presence examinations would work and what examiners would be looking for, but the letter also left many important questions unanswered. To fill in the gaps left by the letter and round out the industry’s understanding of what presence examinations will mean for registered hedge fund managers, The Hedge Fund Law Report recently conducted an interview with Robert Kaplan and Eric Dinallo. Kaplan is the former Co-Chief of the SEC’s Asset Management Unit within the Division of Enforcement and Dinallo is the former New York State Superintendent of Insurance; both are currently partners at Debevoise & Plimpton LLP. Our interview covered, among other things: what presence examinations are; how OCIE evaluates the risk of hedge fund managers when allocating examination resources; the impact of a whistleblower on a manager’s risk profile; whether and how managers should approach mock examinations; whether self-reporting of violations found during mock examinations is advisable; how managers should approach senior management interviews with OCIE staff; how managers can ensure consistency across various fund documents and examination interview responses; key conflicts of interest OCIE will focus on during presence examinations; other key focal areas for presence examinations; whether managers must disclose the initiation of routine OCIE examinations to investors; whether managers must disclose unremediated material deficiencies to prospective fund investors; how OCIE approaches referrals of matters to the Division of Enforcement; and steps a manager can take to speed up an OCIE examination.
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From Vol. 5 No.39 (Oct. 11, 2012)
OCIE Warns Newly-Registered Hedge Fund Advisers to Watch Out for “Presence Examinations”
On October 9, 2012, the Securities and Exchange Commission’s (SEC’s) Office of Compliance Inspections and Examinations (OCIE) sent a letter (Letter) to senior management of newly-registered investment advisers (i.e., advisers that registered with the SEC after July 21, 2011), describing the SEC’s National Examination Program, alerting them to upcoming OCIE examinations of newly-registered advisers to private funds to be conducted in the next two years (presence examinations) and highlighting the focal areas of such presence examinations. This article summarizes some key takeaways from the Letter.
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From Vol. 5 No.24 (Jun. 14, 2012)
Davis Polk “Hedge Funds in the Current Environment” Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities
On May 11, 2012, the New York City Bar Association held its annual “Hedge Funds in the Current Environment” program co-hosted by law firm Davis Polk & Wardwell LLP. Speakers at this event addressed various topics of current relevance to the hedge fund industry, including: SEC examination priorities, such as insider trading, trade reviews and asset verification; establishing registered alternative funds; trends in hedge fund manager mergers and acquisitions; and hedge fund advertising after passage of the Jumpstart Our Businesses Startups (JOBS) Act. Notably, Norm Champ, Deputy Director of the Office of Compliance Inspections and Examinations with the SEC, provided an up-to-date view of the SEC’s examination priorities in relation to hedge funds and their managers. This article summarizes the key points discussed at the conference relating to each of the foregoing topics.
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From Vol. 5 No.19 (May 10, 2012)
Benefits, Challenges and Recommendations for Persons Simultaneously Serving as General Counsel and Chief Compliance Officer of a Hedge Fund Manager
As a result of law, regulation, investor pressure or the gravitational pull of best practices – or a combination of these forces – more and more hedge fund managers feel the need to have a general counsel (GC) and a chief compliance officer (CCO). For managers with both titles on the organization chart, the question inevitably arises: Should different people serve in the different roles, or should one person serve in both roles? There are advantages and disadvantages to both approaches. A so-called “dual-hatted” employee serving as both GC and CCO is typically less expensive from a compensation perspective, but the volume of work at a larger or more complex manager may be more than one person can handle. But the analysis extends well beyond compensation and quantity of work. The decision to dual-hat implicates attorney-client privilege issues, examination preparedness, the reliability of internal controls, the effectiveness of marketing and investor relations and other issues. At a fundamental level, the decision will inform the scope and depth of the manager’s “culture of compliance” – and it is not necessarily the case that a hedge fund manager with a dual-hatted GC/CCO has an inferior culture of compliance. The analysis is more refined, and often turns on the structure and strategy of the manager, and effectiveness and ethics at the individual level. The goal of this article is to help hedge fund managers think through the issues raised by dual-hatting. For managers considering dual-hatting, this article provides a roadmap to the relevant questions. For managers that have already made a decision with respect to dual-hatting – whether for or against – this article highlights relevant issues and strategies for addressing them. In particular, this article discusses: the roles and responsibilities of the GC and CCO; the benefits and costs of having one employee wear both hats; recommendations for hedge fund managers that wish to employ such arrangements; and alternative solutions for hedge fund managers that choose not to use such arrangements. This article also includes specific compensation ranges for hedge fund manager GCs, CCOs and dual-hatted employees.
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From Vol. 5 No.19 (May 10, 2012)
SEC’s OCIE Director, Carlo di Florio, Discusses Examination Strategies and Expectations for Impending Examinations of Private Equity Advisers
Now that the registration deadline for many private fund advisers to register with the SEC has come and gone, the SEC’s Office of Compliance Inspections and Examinations (OCIE) is ramping up its efforts to prepare for the impending examinations of many newly-registered private fund advisers. In that vein, on May 2, 2012, OCIE Director Carlo V. di Florio addressed the Private Equity International Private Fund Compliance Forum on various topics, including: demographic information regarding the population of advisers that are now registered with the SEC; the SEC’s anticipated multi-phase examination strategy and risk-based examination approach; and the SEC’s expectations for impending examinations of newly registered advisers. Although di Florio’s remarks were specifically targeted towards private equity fund advisers, they are nonetheless very relevant for all SEC-registered private fund advisers, including hedge fund managers. This article summarizes the key takeaways from di Florio’s address.
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From Vol. 5 No.14 (Apr. 5, 2012)
Don Seymour Discusses Hedge Fund Governance and the Impact of the Recent SEC-CIMA Cooperation Arrangement on Hedge Fund Manager Examinations
On March 23, 2012, the U.S. Securities and Exchange Commission (SEC) announced that it had entered into a supervisory cooperation arrangement with the Cayman Islands Monetary Authority (CIMA). In its press release announcing the memorandum of understanding (MOU) embodying the supervisory cooperation arrangement, the SEC identified five categories of information that may be shared pursuant to the arrangement. Those five categories include information required to: (1) conduct routine supervision; (2) monitor risk concentrations; (3) identify emerging systemic risks; (4) better understand a globally active regulated entity’s compliance culture; and (5) conduct on-site examinations of registered entities located abroad. See “Is This an Inspection or an Investigation? The Blurring Line Between Examinations of and Enforcement Actions Against Private Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012). Hedge fund managers, lawyers, compliance professionals and others have asked The Hedge Fund Law Report what this MOU means for their businesses. To help answer that question, we recently interviewed Don Seymour. Seymour is the founder and Managing Director of dms Management Ltd. (dms Management) and the former head of the Investment Services Division of the CIMA. At the CIMA, Seymour directed the authorization, supervision and enforcement of regulated mutual funds, including hedge funds, under the Mutual Funds Law of the Cayman Islands, and the supervision of company managers under the Cayman Companies Management Law. Seymour brought his CIMA experience to bear in explaining how the MOU will impact Cayman-domiciled hedge funds and their managers with respect to data collection and sharing, supervision, monitoring, examinations and regulatory coordination. Moreover, based on his service on the boards of several notable investment companies, Seymour offered insight on hedge fund governance issues, including: director independence; evolution in best corporate governance practices following the decision in Weavering Macro Fixed Income Fund Limited v. Stefan Peterson and Hans Ekstrom; valuation expertise required of fund directors; specific steps that directors can take to manage fund conflicts of interest; maximum number of directorships; and whether investors should have rights to appoint fund directors. This article includes the full transcript of our interview with Seymour.
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From Vol. 5 No.13 (Mar. 29, 2012)
Is This an Inspection or an Investigation? The Blurring Line Between Examinations of and Enforcement Actions Against Private Fund Managers
The most significant impact of SEC registration on a private fund adviser is that the adviser becomes subject to inspection by the SEC’s Office of Compliance Inspections and Examinations (OCIE). The greatest risk arising from an examination is that the inspection staff decides to refer a finding from an inspection to the Division of Enforcement (Enforcement) for an investigation. Despite the severe collateral consequences that can befall a fund manager simply from the initiation of an investigation, divining whether the staff is contemplating an Enforcement referral is a surprisingly elusive proposition. With numerous newly registered hedge fund managers about to undergo their first inspection, the risk of investigations has never been higher. In a guest article, Mark K. Schonfeld and Kenneth J. Burke, Partner and Associate, respectively, at Gibson Dunn & Crutcher LLP, discuss the increasing risks of compliance examinations becoming enforcement investigations and practical strategies for hedge fund managers for anticipating and mitigating those risks.
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From Vol. 5 No.12 (Mar. 22, 2012)
NASAA Report Identifies Most Commonly Cited Investment Adviser Deficiencies Found in Coordinated State Adviser Examinations and Recommends Compliance Best Practices for Mid-Sized Hedge Fund Managers
The Dodd-Frank Wall Street Reform and Consumer Protection Act shifted a great deal of responsibility for regulating many mid-sized investment advisers with between $25 million and $100 million in assets under management (AUM) to state regulatory authorities. See “Registration, Reporting, Disclosure and Operational Consequences for Hedge Fund Managers of the SEC’s New ‘Regulatory Assets Under Management’ Calculation,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012). Hedge fund managers within that AUM range must therefore become familiar with the state laws, rules and regulations that govern their activities because they will likely be subject to periodic examinations from state regulatory authorities. While the SEC staff attempts to convey its adviser examination priorities to the advisory industry through various speeches and pronouncements, state regulatory authorities are generally silent with respect to their adviser examination priorities. As such, state-regulated investment advisers have little guidance to inform their preparations for regulatory examinations. Given this backdrop, at the end of 2011, the North American Securities Administrators Association (NASAA), the lobbying arm of the various state securities authorities, issued a report (Report) detailing the most common deficiencies found during state regulatory examinations of investment advisers conducted between January 1, 2011 and June 30, 2011. The Report also contained a series of recommended best practices to assist mid-sized hedge fund managers and other investment advisers in mitigating risks of regulatory violations. While state examinations priorities can vary from state to state, the Report nonetheless provides valuable insight into what state regulators, as a whole, are focusing on in their examinations of investment advisers. This article details the 13 categories of cited deficiencies and the 15 best practice recommendations contained in the Report.
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From Vol. 5 No.10 (Mar. 8, 2012)
ACA Webcasts Detail Exempt Reporting Adviser Qualifications and Compliance Obligations
While the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) repealed the exemption from registration found in Section 203(b)(3) of the Investment Advisers Act of 1940 (Advisers Act) historically relied upon by most hedge fund managers with fewer than 15 clients, it created several more narrowly tailored adviser registration exemptions, including separate exemptions for advisers solely to venture capital funds and advisers solely to private funds with aggregate regulatory assets under management (Regulatory AUM) of less than $150 million (private fund adviser exemption). See “Registration, Reporting, Disclosure and Operational Consequences for Hedge Fund Managers of the SEC’s New ‘Regulatory Assets Under Management’ Calculation,” The Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012). These advisers now fall into a newly created class of advisers called exempt reporting advisers. Although exempt reporting advisers are exempt from SEC registration, they are nonetheless required to fulfill certain regulatory obligations not applicable to unregistered advisers, including completing certain items in Part 1A of Form ADV, maintaining certain books and records and submitting to SEC examinations. Exempt reporting advisers are also subject to other compliance obligations imposed by the Advisers Act, including the pay-to-play restrictions contained in Rule 206(4)-5. See “Key Elements of a Pay-to-Play Compliance Program for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 37 (Sep. 24, 2010). With this in mind, the ACA Compliance Group (ACA) held two separate webcasts to highlight issues important to advisers that may qualify as exempt reporting advisers. This article summarizes some of the highlights from both webcasts with relevance to hedge fund managers.
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From Vol. 4 No.46 (Dec. 21, 2011)
RCA Asset Management Thought Leadership Symposium Highlights Regulators’ Examination and Enforcement Priorities, the New SEC Examination Paradigm and Liability Concerns for CCOs and General Counsels
On November 10, 2011, the Regulatory Compliance Association held its Annual Fall Asset Management Thought Leadership Symposium (RCA Symposium) in New York City. Panelists repeatedly emphasized the trend towards increased regulatory scrutiny of hedge fund managers. The SEC’s Division of Enforcement (Enforcement Division) anecdotally confirmed this sentiment the day before the RCA Symposium when it announced that it had filed a record 735 enforcement actions against a variety of market professionals during fiscal year 2011. Through these actions, the SEC has demonstrated its willingness to hold not only firms liable for their compliance failures, but also those individuals that provided inadequate oversight of their firms’ compliance programs. See “Three Recent SEC Orders Demonstrate a Renewed Emphasis on Investment Adviser Compliance Policies and Procedures by the Enforcement Division,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011). Speakers at the RCA Symposium addressed numerous topics, including: examination and enforcement priorities for the SEC and the NFA; the different types of SEC and NFA examinations; recent examination experiences and advice on preparing for examinations; the reality of CCO and GC liability for compliance failures; and the need for operational changes in light of new regulations impacting hedge fund managers. This article summarizes key points discussed during the RCA Symposium on each of the foregoing topics.
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From Vol. 4 No.46 (Dec. 21, 2011)
Michael Garrity Named Head of Examination Program in SEC’s Boston Regional Office
On December 19, 2011, the Securities and Exchange Commission announced the appointment of Michael E. Garrity to lead the examination program in its Boston Regional Office. See “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011).
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From Vol. 4 No.42 (Nov. 23, 2011)
Private Lawsuits Against Hedge Fund Managers Can Be Important Sources of Examination and Enforcement “Leads” for the SEC
On November 10, 2011, the Securities and Exchange Commission (SEC) announced the simultaneous filing and settling of charges against investment adviser Lilaboc, LLC d/b/a ThinkStrategy Capital Management, LLC (ThinkStrategy) and its founder and managing director, Chetan Kapur (Kapur, and together with ThinkStrategy, Defendants). The SEC’s Complaint in the action (Complaint) alleges that over nearly seven years the Defendants made false statements to investors in ThinkStrategy Capital Fund (Capital), a hedge fund managed by the Defendants, and TS Multi-Strategy Fund (Multi-Strategy, and together with Capital, Funds), a fund of funds managed by the Defendants. Those allegedly false statements related to the Funds’ performance, longevity and assets under management (AUM), as well as the credentials of Kapur and his management team. Moreover, with respect to Multi-Strategy, the Complaint alleges that the Defendants failed to perform due diligence commensurate with their representations to investors before investing with underlying managers. As a result of such inadequate due diligence, Multi-Strategy invested in notorious Ponzi schemes such as Bayou, Valhalla/Victory Funds and Finvest Primer Fund. See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011). Allegations in the SEC action incorporate and expand upon allegations in a private civil action recently filed against the Defendants, and – as discussed more fully in this article – highlight the interaction between private claims and SEC enforcement actions. See “Federal Court Decision Holds that a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).
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From Vol. 4 No.40 (Nov. 10, 2011)
Business Issues with Legal Consequences: A Wide-Ranging Interview with Dechert Partner George Mazin about the Most Important Challenges Facing Hedge Fund Managers
The Hedge Fund Law Report recently had the privilege of interviewing George J. Mazin, a Partner at Dechert LLP, and a deservedly well-regarded member of the hedge fund bar. As evidenced by the text of our interview, which is included in this issue of The Hedge Fund Law Report, George has an aptitude for identifying the legal consequences of business issues, and explaining them clearly. He also has the kind of market color that only comes with years – decades – in the trenches, and experience across business cycles. Our interview was wide-ranging, reflecting the diversity of George’s experience, which in turn reflects the range of legal issues relevant to hedge fund managers. In particular, our interview covered: valuation considerations in connection with affiliate transactions; valuations based on fraudulent sales and rigged dealer bids; manager overrides of third-party valuations; whether side pockets remain viable in new hedge fund launches; how even non-ERISA hedge funds can analogize the ERISA model of independent pricing; effective valuation testing programs; the interaction between GAAP and the custody rule; GAAP exceptions to audit opinions; use of counterparty confirmations by the SEC; delayed audits; custody of derivatives and limited partnership interests; insider trading policies with respect to market chatter and channel checking; how to grant side letters in light of selective disclosure considerations; how algorithmic or high-speed trading firms can prepare for regulatory examinations; legal considerations in connection with loans from a hedge fund to a manager; best practices in connection with principal trades; and whether side-by-side investing by manager personnel can pass muster under fiduciary duty and related principles. This interview was conducted in connection with the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium, which is taking place today at the Pierre Hotel in New York.
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From Vol. 4 No.39 (Nov. 3, 2011)
Andrew Bowden to Lead National Investment Adviser/Investment Company Exam Program at OCIE
On October 21, 2011, the Securities and Exchange Commission announced that Andrew J. Bowden was appointed as Associate Director to lead the National Investment Adviser/Investment Company Examination Program in the SEC’s Office of Compliance Inspections and Examinations (OCIE). OCIE conducts the SEC’s national examination program for hedge fund advisers and other investment advisers, investment companies, broker-dealers, self-regulatory organizations, clearing agencies, transfer agents and credit rating agencies to fulfill its mission of promoting compliance, preventing fraud, monitoring risk and informing SEC policy. See “SEC Exams of Hedge Fund Advisers: Focus Areas and Common Deficiencies in Compliance Policies and Procedures,” Vol. 4, No. 38 (Oct. 27, 2011).
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From Vol. 4 No.38 (Oct. 27, 2011)
SEC Exams of Hedge Fund Advisers: Focus Areas and Common Deficiencies in Compliance Policies and Procedures
It is a well-known fact that the SEC has significantly fewer examiners than it has registrants to examine. Nowhere is the SEC more outnumbered than in the investment adviser arena, with approximately 435 examiners compared to more than 11,000 registered investment advisers. In the first quarter of 2012, advisers with less than $100 million in assets under management will generally transition from SEC registration to state registration. However, the mandatory registration of private fund advisers with more than $150 million in assets will continue to pose significant resource challenges to SEC examiners. What’s more, the newly registered private fund advisers will likely be higher risk and more complex firms, which will require more examination resources than those firms moving off the SEC’s rosters. To help manage this resource imbalance, SEC examinations are becoming much more focused and targeted on high-risk firms and the highest risk activities and practices within those firms; and as a result of various factors discussed in this article, SEC examiners are much better prepared than in the past to scrutinize hedge fund business practices and they have an eager group of well-equipped enforcement staff ready to bring cases – often a series of cases – on the issues where examiners are focusing. In a guest article, Kimberly Garber – a Founding Principal of boutique compliance firm CORE-CCO, LLC, and former Associate Regional Director in charge of the Examination Program in the Fort Worth Regional Office of the SEC – discusses five risk areas where SEC examiners commonly focus in hedge fund examinations and where compliance policies and procedures are often lacking. In each area, how comprehensive a firm’s procedures need to be will depend on the risks presented by the firm’s business practices, affiliates and client relationships, and how actively the firm and its personnel engage in each type of activity. If a firm does not purport to engage in or chooses to prohibit certain activities, its policies and procedures should specify such prohibited practices but also contemplate controls to ensure that employees do not inadvertently or purposefully engage in prohibited activities.
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From Vol. 4 No.33 (Sep. 22, 2011)
Fifth Annual Hedge Fund General Counsel Summit Covers Insider Trading, Expert Networks, Whistleblowers, Exit Interviews, Due Diligence, Examinations, Pay to Play and More
On September 13, 2011, ALM Events hosted its fifth annual Hedge Fund General Counsel Summit at the Harvard Club in New York City. Participants at the event discussed how the changing regulatory landscape is impacting the day-to-day policies, procedures and practices of hedge fund managers. Of particular note, discussions focused on insider trading in the post-Galleon world; best compliance practices for engaging and using expert network firms; how to motivate employees to report wrongdoing internally rather than filing whistleblower complaints; the interaction between non-disparagement clauses in hedge fund manager exit agreements and the whistleblower rule; best practices for exit interviews; best practices for responding to initial and ongoing due diligence inquiries; consistency across DDQs and other documents; standardization of DDQs versus customized answers; whether to disclose the existence or outcome of regulatory actions; how to deal with government investigations and examinations; and strategies for complying with the pay to play rule. This article summarizes the most noteworthy points made at the event.
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From Vol. 4 No.32 (Sep. 16, 2011)
Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?
Generally, two categories of hedge fund managers will be required to register with the SEC as investment advisers by March 30, 2012: (1) managers with assets under management (AUM) in the U.S. of at least $150 million that manage solely private funds; and (2) managers with AUM in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle, such as a managed account. See “Will Hedge Fund Managers That Do Not Have To Register with the SEC until March 30, 2012 Nonetheless Have To Register in New York, Connecticut, California or Other States by July 21, 2011?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011). Registration will trigger a range of new obligations. For example, registered hedge fund managers that do not already have a chief compliance officer (CCO) will have to hire one. See “To Whom Should the Chief Compliance Officer of a Hedge Fund Manager Report?,” The Hedge Fund Law Report, Vol. 4, No. 22 (Jul. 1, 2011). Also, registered hedge fund managers will have to complete, file and deliver, as appropriate, Form ADV. See “Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011). But perhaps the most onerous new obligation for newly registered hedge fund managers will be the duty to prepare for, manage and survive SEC examinations. Most hedge fund managers facing a registration requirement for the first time have hired high-caliber people and completed complex forms. Therefore, hiring a CCO and completing Form ADV will exercise existing skill sets. But few such managers have experienced anything like an SEC examination. On the contrary, many such managers have spent years behind a veil of permissible secrecy, disclosing little, rarely disseminating information beyond top employees and large investors and interacting with the government only indirectly. Examinations will change all that. The government will show up at your office, often with little or no notice; they will ask to review substantially everything; and a culture of transparency will have to replace a culture of secrecy, where the latter sorts of cultures still exist. (The SEC does not appreciate secrecy and has any number of ways of demonstrating its lack of appreciation.) Hedge fund managers facing the new examination reality will have to think about two sets of issues. The first set of issues relates to examination preparedness, and The Hedge Fund Law Report has written in depth on this topic. See, e.g., “Legal and Practical Considerations in Connection with Mock Examinations of Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 26 (Aug. 4, 2011). The second set of issues relates to examination management and survival, and that is the broad topic of this article. Specifically, this article addresses a question that hedge fund managers inevitably face in connection with examinations: What should we tell investors and when and how? To help hedge fund managers identify the relevant subquestions, think through the relevant issues and hopefully plan a disclosure strategy in advance of the commencement of an examination, this article discusses: the three types of SEC examinations and similar events that may trigger a disclosure examination; the five primary sources of a hedge fund manager’s potential disclosure obligation; whether and in what circumstances hedge fund managers must disclose the existence or outcome of the three types of SEC examinations; rules and expectations regarding responses to due diligence inquiries; selective and asymmetric disclosure issues; how hedge fund managers may reconcile the privileged information rights often granted to large investors in side letters with the fiduciary duty to make uniform disclosure to all investors; whether hedge fund managers must disclose deficiency letters in response to inquiries from current or potential investors, and whether such disclosure must be made even absent investor inquiries; whether managers that elect to disclose deficiency letters should disclose the letters themselves or only their contents; best practices with respect to the mechanics of disclosure (including how and when to use telephone and e-mail communications in this context); and whether deficiency letters may be obtained via a Freedom of Information Act request.
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From Vol. 4 No.19 (Jun. 8, 2011)
How Can Hedge Fund Managers Avoid Criminal Securities Fraud Charges When Allocating Trades Among Multiple Funds and Accounts?
All hedge fund managers that manage multiple funds and accounts – which is to say, the vast majority of hedge fund managers – have to draft, implement and enforce policies and procedures governing the allocation of trades among those funds and accounts. Where those funds and accounts follow explicitly different strategies, the appropriate approach to allocations is relatively straightforward. For example, if a manager manages an equity long/short fund and a credit fund, equities go to the equity fund and bonds go to the credit fund. But where multiple funds and accounts may be eligible to invest in the same security, the appropriate approach to allocations is more challenging. For example, if a manager manages an equity long/short fund and an activist fund and purchases a block of public equity, how and when should the manager determine how to allocate the block between the two funds? While the specifics of an allocations policy will depend on the manager’s fund structures and strategies, some general principles and proscriptions apply. As for principles, an allocations policy should be equitable, should take into account the size and strategies of various funds, should provide a mechanism for correcting allocation errors and should give the manager an appropriate degree of discretion in making allocation determinations. As for proscriptions, the boundaries of “appropriate discretion” in this context generally are set by the anti-fraud provisions of the federal securities laws and principles of fiduciary duty. In other words, you cannot allocate trades in a manner that constitutes securities fraud. How might trade allocations constitute securities fraud? A recent SEC order (Order) answers that question; and a prior criminal indictment (Indictment, and together with the Order, the Charging Documents) and plea arising out of the same facts raises the frightening prospect that in more egregious circumstances, fraudulent trade allocation practices may constitute criminal securities fraud. This article explains the facts and legal violations that led to the Order, Indictment and plea, then discusses the implications of this matter for hedge fund managers in the areas of trade allocations, marketing, disclosure on Form ADV and creation and maintenance of books and records. In particular, this article discusses: why the cherry-picking scheme at issue in this matter was not just a bad legal decision, but also a bad business decision; two types of cherry-picking; whether and in what circumstances cherry-picking may lead to criminal liability; how the sometimes purposeful vagary of criminal indictments can subtly expand the reach of white collar criminal liability; whether disclosure can cure trade allocation practices that are otherwise fraudulent; the compliance utility of technology; conflicts of interest inherent in one person serving as chief compliance officer and in other roles; whether post-trade allocations are ever permissible; how hedge fund managers can test the sufficiency of their trade allocation policies; how trade allocation policies interact with the transparency rights sometimes granted to larger hedge fund investors; and the idea of “cross-fund transparency.”
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From Vol. 4 No.18 (Jun. 1, 2011)
Is a Hedge Fund Manager Required to Disclose the Existence or Substance of SEC Examination Deficiency Letters to Investors or Potential Investors?
Following an examination of a registered hedge fund manager by the SEC staff, the staff typically issues a deficiency letter to the manager listing compliance shortcomings identified by the staff during the examination. See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011). Quickly, comprehensively and conclusively remedying compliance shortcomings identified in a deficiency letter should be a first order of business for any hedge fund manager – that is the easy part, a point that few would dispute. However, considerably more ambiguity surrounds the question of whether and to what extent hedge fund managers must disclose to investors and potential investors various aspects of SEC examinations – including their existence, scope, focus and outcome. More particularly, hedge fund managers that receive deficiency letters routinely ask: must we disclose the fact of receipt of this deficiency letter or its contents to investors or potential investors? And does the answer depend on whether potential investors have requested information about or contained in a deficiency letter in due diligence or in a request for proposal (RFP)? The answers to these questions generally have been governed by a “materiality” standard – the same standard that, at a certain level of generality, governs all disclosure questions. The consensus guidance has been: disclose whatever is material. But this is more of a reframing of the question than an answer. The practical question in this context is how to assess materiality in the interest of disclosing adequately, avoiding anti-fraud or breach of fiduciary duty claims and ensuring best investor relations practices. A recently issued SEC order (Order) settling administrative proceedings against a registered investment adviser provides limited guidance on the foregoing questions. This article describes the facts recited in the Order, the SEC’s legal analysis and how that analysis can inform decision-making of hedge fund managers considering whether and to what extent to disclose the existence or substance of deficiency letters to investors or potential investors. This analysis has particular relevance for hedge fund managers seeking to grow institutional assets under management by responding to RFPs.
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From Vol. 4 No.14 (Apr. 29, 2011)
SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market
Recently, during Congressional testimony, Robert Khuzami, the Director of the SEC’s Division of Enforcement (Enforcement Division), faced tough questions regarding the SEC’s response to the Madoff scandal. In response, Khuzami revealed an investigative initiative concerning hedge funds. The Enforcement Division is now focusing on hedge funds that outperform “market indexes by 3% and [are] doing it on a steady basis.” Khuzami referred to such performance as “aberrational,” and stated that Enforcement is “canvassing all hedge funds” for such “aberrational performance.” This initiative raises a number of questions. Should skilled portfolio managers (and their investors) bear the burden and costs of an SEC investigation just because they have returned more than the market? How and why did the Enforcement Division determine to set the threshold at three percent? Does the three percent threshold reflect “aberrational” performance, as Khuzami suggests? What is considered outperformance on a “steady basis”? Will the Enforcement Division focus on performance on a quarterly basis, or over one year, three years, or longer periods? In a guest article, Fredric Firestone, Eugene Goldman and Michael Ungar – all Partners in the White Collar & Securities Defense Practice Group at McDermott Will & Emery LLP, based in Washington, D.C., and all Enforcement Division alumni – address these and related questions, and explain the implications of the new enforcement initiative for hedge fund managers.
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From Vol. 4 No.6 (Feb. 18, 2011)
What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Three of Three)
By July 21, 2011, many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register. Specifically, two categories of hedge fund managers will be required to register with the SEC as investment advisers: (1) hedge fund managers with assets under management in the U.S. of at least $150 million that manage solely private funds; and (2) hedge fund managers with assets under management in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle (for example, a managed account). Registration will subject previously unregistered hedge fund managers to a range of new regulatory obligations and burdens. One of the most notable new burdens is that registered hedge fund managers will be subject to SEC examinations. (Generally, unregistered hedge fund managers are not subject to examinations, though they may be subject to subpoenas or information requests from the SEC where the agency suspects fraud or violation of the federal securities laws.) To assist newly registered (or soon to be registered) hedge fund managers and other registered investment advisers in preparing for, handling and surviving SEC examinations, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature an extended 1.5 hour session entitled “Regulatory Examinations – Briefing on Latest Inquiries from SEC and NFA Staff.” That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York. (For a fuller description of the Symposium, click here. To register for the Symposium, click here.) The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Regulatory Examinations session at the RCA’s April Symposium: Steven A. Yadegari, Senior Vice President & General Counsel at Cramer Rosenthal McGlynn, LLC; Stephen A. McShea, General Counsel & Chief Compliance Officer at Larch Lane Advisors LLC; and Matthew Eisenberg, Partner at Finn Dixon & Herling LLP. Those interviews provide a preview of the topics to be discussed at the RCA Symposium, and offer detailed insights, practical strategies and actionable recommendations for newly registered hedge fund managers facing the prospect of regulatory examinations – in many cases, for the first time. We are publishing these interviews as a three-part series. The full text of our interview with Steven Yadegari was included in our issue of February 3, 2011. See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011). And full text of our interview with Stephen McShea was included in our issue of February 10, 2011. See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Two of Three),” The Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011). The full text of our interview with Matthew Eisenberg is included in this issue of The Hedge Fund Law Report, below. The Eisenberg interview covered a wide range of relevant topics, including but not limited to: four principal areas in which the SEC has been focusing its enforcement activity of late; the relationship among SEC sweeps, examinations and enforcement actions; primary lessons for hedge fund managers from the SEC’s recent sweeps and enforcement actions; the impact of new leadership in key examination roles at the SEC (for example, Carlo di Florio as Director of OCIE) on examinations of hedge fund managers; the SEC’s goals in conducting examinations; suggested goals of hedge fund managers when undergoing examinations; lessons for both the SEC and hedge fund managers of the report by the SEC Inspector General on Westridge Capital Management and related matters; the likelihood that a self-regulatory organization (SRO) for investment advisers will be given authority to examine registered hedge fund managers; whether SRO examination authority over hedge fund managers would be better or worse than the current state of affairs; principal areas of focus of the CFTC and National Futures Association (NFA) in their enforcement efforts; authority of the CFTC and NFA to examine hedge fund managers; and specific steps that managers can take to create and demonstrate a commitment to compliance and to strike the right “tone at the top.”
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From Vol. 4 No.5 (Feb. 10, 2011)
What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Two of Three)
By July 21, 2011, many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register. Specifically, two categories of hedge fund managers will be required to register with the SEC as investment advisers: (1) hedge fund managers with assets under management in the U.S. of at least $150 million that manage solely private funds; and (2) hedge fund managers with assets under management in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle (for example, a managed account). Registration will subject previously unregistered hedge fund managers to a range of new regulatory obligations and burdens. One of the most notable new burdens is that registered hedge fund managers will be subject to SEC examinations. (Generally, unregistered hedge fund managers are not subject to examinations, though they may be subject to subpoenas or information requests from the SEC where the agency suspects fraud or violation of the federal securities laws.) To assist newly registered (or soon to be registered) hedge fund managers and other registered investment advisers in preparing for, handling and surviving SEC examinations, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will feature an extended 1.5 hour session entitled “Regulatory Examinations – Briefing on Latest Inquiries from SEC and NFA Staff.” That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York. (For a fuller description of the Symposium, click here. To register for the Symposium, click here.) The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Regulatory Examinations session at the RCA’s April Symposium: Steven A. Yadegari, Senior Vice President & General Counsel at Cramer Rosenthal McGlynn, LLC; Stephen A. McShea, General Counsel & Chief Compliance Officer at Larch Lane Advisors LLC; and Matthew Eisenberg, Partner at Finn Dixon & Herling LLP. Those interviews provide a preview of the topics to be discussed at the RCA Symposium, and offer detailed insights, practical strategies and actionable recommendations for newly registered hedge fund managers facing the prospect of regulatory examinations – in many cases, for the first time. We are publishing these interviews as a three-part series. The full text of our interview with Steven Yadegari was included in last week’s issue of The Hedge Fund Law Report. See “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011); our interview with Stephen McShea is included in this issue; and our interview with Matthew Eisenberg will be published in next week’s issue. Our interview with Stephen McShea, included in full below, covered a wide range of relevant topics, including but not limited to: how the length, depth and coverage period of examinations of hedge fund managers have evolved; the average length of time between notification and initiation of an exam; grounds (if any) upon which the SEC may grant a delayed exam start date; trends with respect to the number of additional requests that hedge fund managers can expect during an exam; the role of presentations in the exam process (as distinct from interviews with key people); the advisability of creating a regulatory exam preparation team; the utility of mock examinations; the importance of getting all management company personnel on the same page with respect to the business of the management company and its products; the difference between compliance policies and procedures in theory and in practice; regulatory attention on the allocation of responsibility (internally and externally) for specific functions; creating a written matrix of responsibilities; steps hedge fund managers can take to strike the right “tone at the top”; how to use prior deficiency letters; what to say and not to say at exit interviews; and the relevance for examinations of resource constraints at the SEC.
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From Vol. 4 No.5 (Feb. 10, 2011)
Key Insights for Registered Hedge Fund Managers from the SEC's Recently Released Study on Investment Adviser Examinations
Facing a growing divide between the number of SEC-registered investment advisers (RIAs) and its ability to examine them, on January 19, 2011, the SEC released its “Study on Enhancing Investment Adviser Examinations,” for congressional review. The Study, mandated by Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), disclosed that RIA examinations had significantly declined in the last six years due to the increase in RIAs as well as RIA assets under management, and a concomitant decrease in Office of Compliance Inspections and Examination (OCIE) staff. The Study’s authors predicted that this imbalance would continue to get worse as OCIE staffing cannot keep pace with future industry growth. That, it said, was certain even though Congress, in the Dodd-Frank Act, had substantially lessened the SEC's workload in the immediate future by raising the asset threshold for SEC registration from $25 million to, in general, $100 million. Based on its conclusion that the SEC still faces “significant capacity challenges,” the Study's authors recommended that Congress strengthen the SEC investment adviser examination program by either: (1) authorizing the SEC's imposition of "user fees" on RIAs to fund the program; (2) authorizing one or more SROs, subject to SEC supervision, to examine all RIAs; or (3) authorizing FINRA to examine dually registered broker-dealer/RIAs for compliance with the Investment Advisers Act of 1940, as amended. This article summarizes the background of the Study and these recommendations. Significantly, this article also details the process of an OCIE-led examination and thus provides a helpful guide for any hedge fund manager preparing for an SEC examination. See also “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part Two of Three),” above, in this issue of The Hedge Fund Law Report; “What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part One of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).
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From Vol. 4 No.4 (Feb. 3, 2011)
What Do Hedge Fund Managers Need to Know to Prepare For, Handle and Survive SEC Examinations? (Part One of Three)
By July 21, 2011, many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register. Specifically, two categories of hedge fund managers will be required to register with the SEC as investment advisers: (1) hedge fund managers with assets under management in the U.S. of at least $150 million that manage solely private funds; and (2) hedge fund managers with assets under management in the U.S. between $100 million and $150 million that manage at least one private fund and at least one other type of investment vehicle (for example, a managed account). Registration will subject previously unregistered hedge fund managers to a range of new regulatory obligations and burdens. One of the most notable new burdens is that registered hedge fund managers will be subject to SEC examinations. (Generally, unregistered hedge fund managers are not subject to examinations, though they may be subject to subpoenas or information requests from the SEC where the agency suspects fraud or violation of the federal securities laws.) To assist newly registered (or soon to be registered) hedge fund managers and other registered investment advisers in preparing for, handling and surviving SEC examinations, the Regulatory Compliance Association’s 2011 Spring Asset Management Thought Leadership Symposium will include a session entitled “Regulatory Examinations – Briefing on Latest Inquiries from SEC and NFA Staff.” That RCA Symposium will take place on April 7, 2011 at the Marriott Marquis in Times Square in New York. (For a fuller description of the Symposium, click here. To register for the Symposium, click here.) The Hedge Fund Law Report recently conducted detailed interviews with three of the thought leaders scheduled to participate in the Regulatory Examinations session at the RCA’s April Symposium: Steven A. Yadegari, Senior Vice President & General Counsel at Cramer Rosenthal McGlynn, LLC; Stephen A. McShea, General Counsel & Chief Compliance Officer at Larch Lane Advisors LLC; and Matthew Eisenberg, Partner at Finn Dixon & Herling LLP. Those interviews provide a preview of the topics to be discussed at the RCA Symposium, and offer detailed insights, practical strategies and actionable recommendations for newly registered hedge fund managers facing the prospect of regulatory examinations – in many cases, for the first time. We are publishing these interviews as a three-part series. The full text of our interview with Steven Yadegari is included in this issue of The Hedge Fund Law Report; our interview with Stephen McShea will be published in next week’s issue; and our interview with Matthew Eisenberg will be published in the following week’s issue. Our interview with Steven Yadegari, included in full below, covered a wide range of relevant topics, including but not limited to: the statutory authority upon which the SEC relies in conducting examinations; the SEC’s authority to examine unregistered hedge fund managers; the three primary types of inspections and examinations; when to disclose examinations to hedge fund investors, and what to avoid in the course of disclosure; how the presence of multiple SEC divisions with authority over hedge fund managers impacts the examination process; the goals and objectives that hedge fund managers should aspire to when under examination; the average length of time between notification and initiation of an exam; grounds (if any) upon which the SEC may grant a delayed exam start date; the advisability of creating a regulatory exam preparation group; the SEC’s move to so-called “risk-based” exams, and the import of that move for hedge fund managers; how exams have evolved in terms of length or duration; the interaction between interviews of key personnel and presentations to SEC staff; whether presentations should be written or only oral; the utility of mock examinations; books and records rules as applied to mock examinations; and steps hedge fund managers can take to strike the right “tone at the top.”
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From Vol. 4 No.3 (Jan. 21, 2011)
Federal Court Decision Provides Guidance to Newly Registered Hedge Fund Managers on Litigation Strategy in Enforcement Actions Brought by the SEC
On December 2, 2010, Magistrate Judge Sheila Finnegan of the U.S. District Court for the Northern District of Illinois issued an order partially granting a discovery motion filed by Eric A. Bloom, the former President and CEO of Sentinel Management Group, Inc., a registered investment adviser, in a civil enforcement action brought by the U.S. Securities and Exchange Commission (SEC) against Sentinel, Bloom and Sentinel Senior Vice President Charles K. Mosley. The SEC had accused Bloom and Mosley of engaging in a massive fraud from around October 2002 through August 2007 relating to their use of client assets. In response, Bloom sought the SEC’s file for Sentinel from an examination it conducted in January and February 2002, in the hope that it may contain relevant information, and sought answers to his interrogatories relating to any witness interviews the SEC conducted with Sentinel staff in preparation for litigation. Although Sentinel was a registered investment adviser that managed cash for hedge funds, rather than being a hedge fund manager itself, this decision is nonetheless relevant to hedge fund managers, especially as more hedge fund managers become subject to a registration requirement, SEC examinations and resulting enforcement actions. Specifically, the decision sheds light on the merits of a litigation strategy adopted by a hedge fund industry participant and its principals in litigation against the SEC. Thus, the decision offers lessons regarding when to litigate or settle, how to craft a litigation strategy, and which documents may be obtained via discovery requests. We detail the background of the action and the court’s pertinent legal analysis.
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From Vol. 3 No.46 (Nov. 24, 2010)
Participants at Hedge Fund Compliance Summit Detail Best Practices with Respect to Insider Trading, SEC Examinations, Risk Mitigation, Marketing Materials, Valuation and Avoiding Investor Lawsuits: Part One of Two
On November 15 and 16, 2010, Financial Research Associates, LLC and the Hedge Fund Business Operations Association presented a Hedge Fund Compliance Summit at the Princeton Club in New York City. The substance of the Summit was relevant – even prescient – and the timing was fortuitous. Insider trading was a prominent topic of discussion at the Summit, and on November 20, 2010, about two weeks after the Summit, insider trading received a stunning boost on the list of concerns of hedge fund managers. That day, The Wall Street Journal and other sources disclosed the existence of a wide-ranging civil and criminal insider trading probe being jointly conducted by the SEC and the U.S. Attorney’s Office in Manhattan. Then, on Monday, November 22, 2010, the Federal Bureau of Investigation raided the offices of three hedge fund managers. According to press reports, at least one purpose of those raids was to gather documents in connection with the insider trading investigation reported by the Journal. Following the raids, a number of well-known hedge fund and mutual fund managers received subpoenas from the U.S. Attorney’s Office in Manhattan. According to press reports, those subpoenas are very broad and include requests for documents and information relating to use of expert networks and soft dollar practices. See “For Hedge Fund Managers, Expert Networks Offer Access to Corporate Insiders While Mitigating (Though Not Eliminating) the Likelihood of Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009). Insider trading is a topic that The Hedge Fund Law Report has covered in depth, and that we intend to cover in even more depth in the coming months. Notably, Harry S. Davis (who participated at the Summit), Richard Morvillo and Justin Mendelsohn, all of Schulte Roth & Zabel LLP, published an article on insider trading in the HFLR earlier this year that we think should be required reading for hedge fund manager personnel. See “Hedge Funds in the Crosshairs: The Law of Insider Trading in an Active Enforcement Environment,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010). Also, Michael D. Trager, Richard L. Jacobson and Christopher Rhee, of Arnold & Porter LLP, published an article in the HFLR that can – and should – be read as a companion piece to the Schulte article. See “The SEC’s New Focus on Insider Trading by Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010). Our coverage of the Summit complements these and other HFLR articles on insider trading by highlighting the more important and nonintuitive insights offered by Summit participants on insider trading. In particular, we discuss points raised by panelists on consultants and expert networks, sharing of information among personnel at different hedge fund managers, rumors and insider trading considerations in connection with bank debt trading. Beyond insider trading, this article summarizes key insights from Summit participants regarding SEC examinations and identification and mitigation of key risks. A follow-up article will discuss points made by Summit participants on compliance considerations in connection with preparing and using marketing and advertising materials, valuation and avoiding investor lawsuits.
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From Vol. 3 No.20 (May 21, 2010)
Richards Kibbe & Orbe LLP and ACA Compliance Group Webcast Highlights Developments in SEC Examinations of Registered Investment Advisers, and How to Prepare for a Surprise Visit from the SEC
Hedge fund advisers represent a significant priority for the Securities and Exchange Commission (SEC) in its rulemaking, enforcement and examination efforts. For hedge fund managers registered with the SEC as investment advisers, the SEC’s examination program has become increasingly important; and significantly more hedge fund managers are likely to be required to register with the SEC in light of the Senate's passage of the Financial Stability Bill. Pursuant to Section 204 of the Investment Advisers Act of 1940 (the Advisers Act), the books and records of any registered investment adviser (RIA) may undergo compliance examinations by SEC staff. These examinations aim to protect investors by determining whether RIAs are complying with the law, adhering to the disclosures that they have provided to their clients and maintaining appropriate compliance programs to ensure compliance with the law. If the SEC examines an RIA, the RIA must provide examiners with access to all requested advisory records that it maintains. The RIA must also provide the SEC with access to the written policies and procedures required by law to prevent violations of federal securities laws. The policies and procedures, once implemented, should prevent violations from occurring, detect violations that have occurred and promptly correct any past violations. The RIA should also prepare for the examination staff to review communications with investors for consistency and accuracy. The failure of this examination program to detect several high-profile investment adviser frauds, including the Ponzi scheme perpetrated by Bernard Madoff, has led to criticism of the SEC and increased the significance of the examination itself. On April 22, 2010, Richards Kibbe & Orbe LLP partner Eva Marie Carney co-presented a webcast entitled “SEC Examinations of Investment Advisers” with Joel Sauer of the ACA Compliance Group. The webcast focused on some of the most important developments in RIA examinations. It addressed topics such as how to prepare for the visit, asset verification tests, e-mail requests, common exam deficiencies, and the SEC’s enhanced subpoena powers. It also addressed various “polling questions” or hypotheticals as tutorials for the audience. This article summarizes the salient details of the presentation, including a step-by-step analysis of how an RIA can best prepare for and effectively manage an SEC examination, and the most common areas of focus during the examination.
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