The Hedge Fund Law Report

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By Topic: Form ADV

  • From Vol. 9 No.45 (Nov. 17, 2016)

    The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management (Part Two of Two)

    On August 25, 2016, the SEC adopted much-anticipated amendments to Form ADV, Part 1A and to Rule 204-2 (recordkeeping rule) under the Investment Advisers Act of 1940. These amendments further the SEC’s agenda to gather more information about its registrant base to inform the agency’s risk-based approach to adviser examinations. See “OCIE Director Marc Wyatt Details Use of Technology and Coordination With Other Agencies to Execute OCIE’s Four-Pillar Mission” (Nov. 3, 2016). In a two-part guest series, Michael F. Mavrides and Anthony M. Drenzek, partner and special regulatory counsel, respectively, at Proskauer Rose, review the amendments to Form ADV and the recordkeeping rule and provide practical guidance to SEC-registered investment advisers on the steps to take prior to the compliance date to ensure their firms are prepared to comply with the amended rules. This second article in the series discusses the new disclosure requirements relating to an adviser’s use of social media; office locations; the amount of an adviser’s proprietary assets and assets under management; the sale of 3(c)(1) fund interests to qualified clients; and the recordkeeping requirements regarding performance claims in communications that are distributed to any person. The first article reviewed the detailed disclosures that advisers will be required to provide with respect to managed account clients and the firm’s chief compliance officer, as well as factors to consider when pursuing an umbrella registration. For additional commentary from Proskauer partners, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates: An Interview With Proskauer Partner Robert Leonard” (Mar. 5, 2015); and “Proskauer Partner Christopher Wells Discusses Challenges and Concerns in Negotiating and Administering Side Letters” (Feb. 1, 2013). For more on Form ADV, see “How Can Hedge Fund Managers Rebut the Presumption of Materiality of Certain Disciplinary Events in Form ADV, Part 2?” (Jan. 5, 2012); and “Recent SEC Enforcement Action Demonstrates the SEC’s Focus on the Accuracy and Consistency of Disclosures by Hedge Fund Managers in Form ADV” (Jan. 5, 2012).

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  • From Vol. 9 No.43 (Nov. 3, 2016)

    The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Managed Account Disclosure, Umbrella Registration and Outsourced CCOs (Part One of Two)

    On August 25, 2016, the SEC adopted amendments to Form ADV, Part 1A, and to Rule 204-2 under the Investment Advisers Act of 1940 (Advisers Act), the so-called “recordkeeping rule.” The amendments were previously proposed on May 20, 2015. See “A Roadmap to the SEC’s Proposed Changes to Form ADV” (Jun. 4, 2015). The amendments to Form ADV provide several points of clarification and elicit new or additional information from investment advisers, while the amendments to Rule 204-2 impose additional recordkeeping requirements on investment advisers with respect to communications that contain performance claims. These changes are designed to better protect clients and investors from fraudulent or otherwise misleading performance information. In a two-part guest series, Michael F. Mavrides and Anthony M. Drenzek, partner and special regulatory counsel, respectively, from Proskauer Rose discuss the practical implications of the amendments and highlight important steps legal and compliance personnel can take to ensure they are prepared in advance of the compliance date. This first article discusses the detailed disclosures that advisers will be required to provide with respect to managed account clients and the firm’s chief compliance officer, as well as factors a registrant should consider with respect to pursuing an umbrella registration. The second article will address the new disclosure requirements relating to an adviser’s use of social media; office locations; the amount of an adviser’s proprietary assets and assets under management; the sale of interests in 3(c)(1) funds to qualified clients; and the recordkeeping requirements regarding performance claims in communications that are distributed to any person. For additional insight from Mavrides, see “Key Legal and Operational Considerations in Connection With Preparing, Filing and Updating Form PF (Part Two of Three)” (Nov. 10, 2011); as well as our two part-series on remote examinations: Part One (May 12, 2016); and Part Two (May 19, 2016). For more on Form ADV, see “When and How Can Hedge Fund Managers Permissibly Disguise the Identities of Their Hedge Funds in Form ADV and Form PF?” (Dec. 1, 2012); and “ALJ Decision Against Investment Adviser Who Received Undisclosed Compensation From a Hedge Fund Manager It Recommended to Clients Highlights SEC Scrutiny of Forms ADV” (May 3, 2012).

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  • From Vol. 9 No.40 (Oct. 13, 2016)

    Advisers Investing Client Assets in Affiliated Funds Could Face SEC Scrutiny for Conflicts of Interest

    Hedge fund managers and investment advisers periodically allocate client or fund assets to affiliated vehicles. The SEC remains highly attuned to the conflicts of interest inherent in those situations, including when an adviser improperly collects both a management fee from the client and an additional fee on the same client assets invested in the affiliated fund. That was precisely the case in the SEC’s recently settled enforcement proceeding against the principals of an investment adviser that used client funds to purchase shares in an affiliated mutual fund without providing adequate disclosure. See our three-part series on fee and expense allocations: “Practices Fund Managers Should Avoid” (Aug. 25, 2016); “Flawed Disclosures to Avoid” (Sep. 8, 2016); and “Preventing and Remedying Improper Allocations” (Sep. 15, 2016). This article summarizes the alleged improper conduct and the terms of the settlement. For coverage of a recent SEC enforcement action alleging similar issues, see “Undisclosed Increase in Investment Adviser’s Fees Could Result in Significant Penalties” (Jun. 23, 2016). Even an undisclosed “preference” for investing in proprietary funds can be problematic. See “Preference for Investing in Proprietary Hedge Funds Must Be Fully Disclosed by Investment Banks to Avoid Conflicts” (Jan. 7, 2016).

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  • From Vol. 9 No.35 (Sep. 8, 2016)

    Flawed Disclosures to Avoid – and Policies and Procedures to Adopt – for Managers to Reduce Risk of SEC Scrutiny of Fee and Expense Practices (Part Two of Three)

    Since early 2015, when it announced that private fund fee and expense allocation practices would be an enforcement priority, the SEC has pursued actions against managers for an array of improper fee and expense allocations. These enforcement actions frequently alleged inadequate disclosure or deficient policies and procedures. This article, the second in a three-part series, examines inadequacies in disclosures that often lead to SEC enforcement actions and provides guidance for how managers should disclose fee and expense allocations going forward. For more on disclosure to investors, see “Growing SEC Enforcement of Hedge Fund Managers Requires Greater Focus on Cybersecurity and Financial Disclosure” (Jul. 7, 2016); and “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?” (Sep. 16, 2011). This article also summarizes the types of allocation scenarios and other recommended features managers should include in their written expense allocation policies and procedures. For additional coverage of manager compliance programs, see “Four Essential Elements of a Workable and Effective Hedge Fund Compliance Program” (Aug. 28, 2014). The first article in this series detailed trends in the types of expense allocations most aggressively scrutinized by the SEC. The third article will describe practices managers should adopt to prevent violations, as well as remedial actions to take upon discovering the improper allocation of a fee or expense. For additional coverage of expense allocations, see “Dechert Global Alternative Funds Symposium Highlights Trends in Hedge Fund Expense Allocations, Fees, Redemptions and Gates” (May 21, 2016); and “Barbash, Breslow and Rozenblit Discuss Hedge Fund Allocations, Restructurings and Advisory Boards” (Apr. 7, 2016).

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  • From Vol. 9 No.18 (May 5, 2016)

    SEC Division Heads Enumerate Enforcement Priorities, Including Conflicts of Interest, Valuation, Performance Advertising and CCO Liability (Part Two of Two)

    If historical trends continue, at least one out of ten examinations of investment advisers and investment companies conducted by the SEC Office of Compliance Inspections and Enforcement (OCIE) will be referred to the Division of Enforcement (Enforcement). To avoid becoming subject to sanctions or used to send a message to the industry, hedge fund managers must keep a close watch on areas that Enforcement considers priorities. In addition, as the SEC Division of Investment Management (IM) churns out new rules, guidance and restrictions, hedge fund managers face a corresponding expansion of their compliance obligations. The current initiatives and priorities of Enforcement and IM were some of the topics discussed during a recent day-long seminar hosted by the SEC as part of its Compliance Outreach Program. SEC Chair Mary Jo White delivered opening remarks, and participants included Enforcement Director Andrew Ceresney, IM Director David Grim and OCIE Director Marc Wyatt. The first two segments of the seminar featured Diane C. Blizzard, Associate Director of IM; Jane Jarcho, Deputy Director of OCIE’s National Exam Program; and Anthony S. Kelly, Co-Chief of the Asset Management Unit (AMU) of Enforcement. Our two-part series highlights the key insights from those presentations. This second part examines the priorities and operations of each of Enforcement and IM. The first part discussed SEC initiatives, including the Compliance Outreach Program itself, and also explored OCIE’s characteristics, current campaigns and examination priorities. For more on Enforcement, see “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016); and our series on “The SEC’s Broken Windows Approach”: “Conflicts of Interest and Expense Allocation Concerns” (Sep. 24, 2015); and “Compliance Resources, CCO Liability and Technology Concerns” (Oct. 1, 2015).

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    Barbash, Breslow and Rozenblit Discuss Hedge Fund Allocations, Restructurings and Advisory Boards

    Liquidity and performance presentation are only two of the myriad issues facing hedge fund managers. See “Liquidity and Performance Representations Present Potential Pitfalls for Hedge Fund Managers” (Mar. 31, 2016). Hedge fund and private equity managers must also be wary of numerous issues that can trigger conflicts of interest or anti-fraud violations, including expense allocations, restructuring and the use of advisory boards. See “Full Disclosure of Portfolio Company Fee and Payment Arrangements May Reduce Risk of Conflicts and Enforcement Action” (Nov. 12, 2015). During a recent Practising Law Institute program, panelists discussed these and other topics. Barry P. Barbash, a former Director of the SEC Division of Investment Management and now a partner at Willkie Farr & Gallagher, moderated the program, which featured Stephanie R. Breslow, a partner at Schulte Roth & Zabel; and Igor Rozenblit, co-leader of the Private Funds Unit of the SEC Office of Compliance Inspections and Examinations. This article summarizes the panelists’ discussion of these issues. For additional commentary from Breslow, see “Schulte Partner Stephanie Breslow Discusses Tools for Managing Hedge Fund Crises Caused by Liquidity Problems, Poor Performance or Regulatory Issues” (Jan. 9, 2014). For further insight from Rozenblit, see “SEC’s Rozenblit and Law Firm Partners Explain the SEC’s Enforcement Priorities and Offer Tips on How Hedge Fund and Private Equity Managers Can Avoid Enforcement Action (Part Three of Four)” (Jan. 15, 2015).

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  • From Vol. 9 No.13 (Mar. 31, 2016)

    Liquidity and Performance Representations Present Potential Pitfalls for Hedge Fund Managers

    Hedge fund managers must guard against insidious issues that can give rise to conflicts of interest or trigger anti-fraud violations, such as liquidity issues caused by a manager’s operation of multiple funds. See “Operational Conflicts Arising Out of Simultaneous Management of Hedge Funds and Private Equity Funds (Part Two of Three)” (May 14, 2015). Similarly, performance representations present potential issues for hedge fund managers, including possible misrepresentations caused by improper valuation practices and fee deferrals. Both the enforcer and industry perspectives of these and other topics were explored at a recent Practising Law Institute program. Barry P. Barbash, a former Director of the SEC Division of Investment Management and now a partner at Willkie Farr & Gallagher, moderated the program, which featured Stephanie R. Breslow, a partner at Schulte Roth & Zabel; and Igor Rozenblit, co-leader of the Private Funds Unit of the SEC Office of Compliance Inspections and Examinations. This article highlights the panelists’ commentary on these matters. For more from Breslow, see our two-part series on “Gates, Side Pockets, Secondaries, Co-Investments, Redemption Suspensions, Funds of One and Fiduciary Duty”: Part One (Dec. 4, 2014); and Part Two (Dec. 11, 2014). For insight from Rozenblit, see “SEC’s Rozenblit Offers Perspectives From the Private Funds Unit” (Feb. 11, 2016); and “Operations and Priorities of the Private Funds Unit” (Sep. 24, 2015).

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  • From Vol. 9 No.10 (Mar. 10, 2016)

    Steps All Investment Advisers – and Their Compliance Officers – Should Take in Light of the SEC’s Risk Alert on Outsourced CCOs (Part Two of Two)

    The SEC remains keenly concerned with ensuring that hedge fund managers and other regulated firms devote sufficient resources to compliance. See “SEC Chief of Staff Offers Nine Key Considerations for Investment Adviser and Broker-Dealer Compliance Officers” (Oct. 22, 2015). In November 2015, the SEC Office of Compliance Inspections and Examinations issued a Risk Alert describing its recent “Outsourced CCO Initiative” and highlighting compliance issues observed at firms that outsourced their CCO function. However, all investment advisers, investment companies and their compliance officers – in-house as well as at third parties – can learn from the Risk Alert, using the issues it addresses to enhance their internal compliance programs. In this two-part guest series, Andrew W. Reich, counsel at BakerHostetler, offers guidance on the issues in the Risk Alert applicable to all investment advisers and investment companies as well as their CCOs, along with the application of those issues to their compliance programs. This second article addresses written policies and procedures and suggests steps for firms to enhance their culture of compliance. The first article explored the background that gave rise to the Risk Alert; allocation of resources to compliance; and CCO independence and empowerment. For more on outsourcing CCO responsibilities, see “The Role of Outsourced Compliance Consultants in the Hedge Fund Compliance Ecosystem” (Jun. 27, 2014); and our two-part series on in-house staff at hedge fund managers: “The Value of Legal and Compliance Staff” (Mar. 12, 2015); and “Trends in Legal and Compliance Hiring and Staffing” (Mar. 19, 2015).

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  • From Vol. 9 No.9 (Mar. 3, 2016)

    Why All Investment Advisers – and Their Compliance Officers – Should Heed the SEC’s Risk Alert About Outsourced CCOs (Part One of Two)

    As recent reports of the firing by JPMorgan Chase of the head of its government debt trading desk and another trader for compliance violations make clear, it is vital for hedge fund managers and other financial services firms to take compliance seriously. As part of its effort to ensure that regulated firms devote sufficient attention and resources to compliance, the SEC Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert in November describing its recent “Outsourced CCO Initiative.” In a two-part guest series, Andrew W. Reich, counsel at BakerHostetler, analyzes the Risk Alert and offers guidance on the issues addressed therein applicable to all investment advisers and investment companies as well as their CCOs (not just those employed at third parties), along with the application of those issues to their compliance programs. This first article explores the background that gave rise to the Risk Alert; allocation of resources to compliance; and CCO independence and empowerment. The second article will clarify written policies and procedures as well as outline steps to enhance firms’ culture of compliance. See “The Role of Outsourced Compliance Consultants in the Hedge Fund Compliance Ecosystem” (Jun. 27, 2014). For more on CCO responsibilities, see “SEC Chief of Staff Offers Nine Key Considerations for Investment Adviser and Broker-Dealer Compliance Officers” (Oct. 22, 2015); and “SEC Enforcement Action Shows Hedge Fund Managers May Be Liable for Failing to Adequately Support Their CCOs” (Jul. 23, 2015).

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  • From Vol. 8 No.43 (Nov. 5, 2015)

    SEC Release of Private Fund Statistics Illuminates Key Trends in Hedge Fund Industry

    The Risk and Examinations Office of the SEC Division of Investment Management recently released a compilation of Private Fund Statistics (Report) that provides data from filers of Form PF and Form ADV in 2013 and 2014.  In a recent speech, SEC Chair Mary Jo White said of the Report, “The public availability of aggregated information should help to address persistent questions, and to some degree misconceptions, about the practices and size of the private fund industry.”  Accordingly, the data in the Report helps identify trends within the hedge fund industry, allowing hedge fund advisers to benchmark themselves against their peers and competitors, as well as providing investors with information to refine their due diligence processes.  This article examines the Report, focusing particularly on data relevant to hedge funds and hedge fund advisers, including leverage and liquidity practices.  The SEC also issues an annual report on how it uses such data.  See “Report Describes the SEC’s Use of Form PF for Hedge Fund Manager Examination Targeting and Risk Management,” The Hedge Fund Law Report, Vol. 7, No. 38 (Oct. 10, 2014); and “SEC’s First Report on Initial Form PF Filings Offers Insight into How the Agency Is Using the Collected Data for Examinations, Enforcement and Systemic Risk Monitoring,” The Hedge Fund Law Report, Vol. 6, No. 34 (Aug. 29, 2013).

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  • From Vol. 8 No.22 (Jun. 4, 2015)

    A Roadmap to the SEC’s Proposed Changes to Form ADV

    On May 20, the SEC proposed a number of significant changes to Form ADV and the rules under the Investment Advisers Act of 1940 (Advisers Act).  The changes to Form ADV have three primary goals: to fill in perceived data gaps; to facilitate “umbrella registration” for multiple private fund advisers that operate as part of a single advisory business; and to make certain technical and clarifying amendments.  The changes to the Advisers Act rules primarily expand certain of the “books and records” provisions and make certain technical amendments.  This article summarizes the proposed changes.  For more on Form ADV, see “Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates:  An Interview with Proskauer Partner Robert Leonard,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015).

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  • From Vol. 8 No.9 (Mar. 5, 2015)

    Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates:  An Interview with Proskauer Partner Robert Leonard

    The Hedge Fund Law Report recently interviewed Robert Leonard, a partner in Proskauer’s Hedge Funds Group, on implications of the recently effective Swiss Collective Investment Scheme for marketing hedge funds in Switzerland; two new forms required by the Bureau of Economic Analysis to be filed by certain hedge funds; and considerations arising out of Form ADV annual amendments.  This interview was conducted in connection with the Hedge Funds Care 17th Annual NY Open Your Heart to the Children Benefit, to be held in New York City tonight, March 5, 2015.  For more on Hedge Funds Care, click here; for registration information on tonight’s Open Your Heart to the Children Benefit, click here.  See also “The Changing Face of Alternative Asset Management in Switzerland,” The Hedge Fund Law Report, Vol. 5, No. 5 (Feb. 2, 2012).

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  • From Vol. 7 No.35 (Sep. 18, 2014)

    SEC Investment Management Division Director Norm Champ Pinpoints the Key Compliance Challenges in Hedge Fund and Alternative Mutual Fund Management

    On September 11, 2014, SEC Division of Investment Management Director Norm Champ delivered remarks at the Practising Law Institute’s 2014 hedge fund management seminar.  Champ covered a wide range of territory, including industry statistics, use of Forms ADV and PF for systemic risk monitoring and enforcement purposes, recent guidance updates and no-action letters relevant to hedge fund managers, evolving examination dynamics, signs of a weak compliance program and industry-specific conflicts of interest.  Champ also highlighted notable conflicts of interest inherent in simultaneously managing alternative mutual funds and hedge funds, expanding on the ideas he introduced in a speech at a PLI private equity event on June 30, 2014.  For more on Champ’s June 30 speech, see “Five Key Compliance Challenges for Alternative Mutual Funds: Valuation, Liquidity, Leverage, Disclosure and Director Oversight,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    SEC Provides Guidance in Frequently Asked Questions on Form PF Concerning Reporting of Related Persons; Disregarded Entities; Derivatives Positions and Volumes; Master-Feeder Structures; and Calculation of Gross Asset Value and Regulatory Assets Under Management

    As filers continue to confront challenges in providing accurate and complete reporting on Form PF, the SEC has at various times during the past year provided answers to its Form PF Frequently Asked Questions (FAQs).  The most recent of these updates were provided on March 8, 2013 and November 20, 2012, and addressed issues such as how to report various related persons; report certain disregarded investments; calculate derivatives position exposures and trading volumes; report private funds that are part of a master-feeder structure; and calculate the gross asset value and regulatory assets under management of a reporting fund.  This article summarizes highlights from these most recent updates to the SEC’s Form PF FAQs.  For coverage of previous updates to the FAQs, see “SEC Staff Publishes Answers to Frequently Asked Questions Concerning Form PF,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).

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  • From Vol. 5 No.47 (Dec. 13, 2012)

    When and How Can Hedge Fund Managers Permissibly Disguise the Identities of Their Hedge Funds in Form ADV and Form PF?

    Historically, hedge fund managers generally have not been required to disclose information about their funds to regulators or the public.  Hedge funds were excluded from the definition of “investment company” in the Investment Company Act of 1940 and therefore did not have to file registration statements, as mutual funds do.  Many hedge fund managers were not required to register as investment advisers and therefore did not have to file Form ADV, which contains fund information.  And the U.S. had no analogue to the U.K. FSA’s periodic reports on systemic risk posed by hedge funds.  Hedge funds are still excluded from the investment company definition, but many managers now must register and file Form ADV.  See “How Can Hedge Fund Managers Rebut the Presumption of Materiality of Certain Disciplinary Events in Form ADV, Part 2?,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  And, as the industry well knows, the U.S. has implemented its own version of systemic risk reporting by private fund managers via Form PF.  See “Assumptions to Consider in Completing Form PF Effectively: Experiences from First Filers,” The Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  Form ADV requires hedge fund managers to disclose significant fund information to regulators and the public, and Form PF requires managers to disclose voluminous and detailed fund information to regulators.  However, the instructions to both forms now allow a manager to preserve the anonymity of its private funds by using a code or designation to identify the funds referenced in those forms.  Some well-known hedge fund managers reportedly have taken advantage of this new opportunity, and there is speculation that more managers will do so.  Nonetheless, the relief provided in the instructions is conditioned on satisfaction of delineated obligations.  This article provides an overview of key considerations for fund managers that wish to mask the identities of their private funds in Form PF and Form ADV filings.  Specifically, this article outlines some of the reasons why hedge fund managers may wish to shield the identities of their private funds in Form ADV and Form PF; the circumstances under which hedge fund managers can mask the identity of their private funds; how fund managers can go about disguising the identities of their private funds; whether such masking will raise suspicion from regulators and investors; and best practices for managers that wish to implement a masking strategy.

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  • From Vol. 5 No.35 (Sep. 13, 2012)

    SEC Commences Administrative and Cease and Desist Proceedings against Hedge Fund Adviser for Failing to File Form ADV Updates and Maintain Required Books and Records

    The Securities and Exchange Commission (SEC) has issued an order commencing administrative and cease and desist proceedings against a registered investment adviser and its principal.  The SEC alleges various violations of the Investment Company Act of 1940 and the Investment Advisers Act of 1940 arising out of, among other things, the adviser’s failure to maintain required books and records relating to its service as a registered investment adviser to a registered investment company (Fund); failure to file Form ADV updates; failure to file Form ADV-W when its client ceased to be a registered investment company; and failure to supply information to the Fund’s board of directors.  This article summarizes the relevant terms of the SEC’s order, with emphasis on the violations of the Form ADV filing requirements and the books and records requirement.

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  • From Vol. 5 No.19 (May 10, 2012)

    Is the New Form ADV Investor Friendly?

    When the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) repealed the “private adviser exemption” from registration contained in Section 203(b)(3) of the Investment Advisers Act (Advisers Act), many hedge fund managers who enjoyed the exemption found themselves facing the sure fate of having to register with the U.S. Securities and Exchange Commission as investment advisers.  Many of these managers had to file their first Form ADV by March 30, 2012.  March 30 was also the deadline for all previously registered investment advisers to file amendments to their current Form ADV.  Over a month has passed since the March 30 deadline and it is clear, from the viewpoint of an investor, that the new Form ADV has proved to be a mixed bag of good and bad.  In this guest op-ed, Siddhya Mukerjee and Michael Schmieder – both senior operational analysts at Aksia LLC, responsible for performing all aspects of hedge fund operational due diligence – analyze how new Form ADV has helped and hindered the operational and investment due diligence efforts of hedge fund investors.

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  • From Vol. 5 No.18 (May 3, 2012)

    Recent ALJ Decision Against Investment Adviser Who Received Undisclosed Compensation from a Hedge Fund Manager It Recommended to Clients Highlights SEC Scrutiny of Forms ADV

    An initial decision handed down by Chief Administrative Law Judge Brenda P. Murray (ALJ) on April 20, 2012 highlights the severe penalties that can be imposed on investment advisers and their principals for making materially false Form ADV filings.  The enforcement action in question involved a registered investment adviser and its owner (respondents) that were charged with failing to disclose compensation received from a hedge fund manager that was recommended to the investment adviser’s clients.  For a previous discussion of the initiation of this administrative proceeding, see “An Investment Adviser May Not Call Itself Independent If It Receives Fees from Underlying Managers,” The Hedge Fund Law Report, Vol. 4, No. 33 (Sep. 22, 2011).  This article outlines: the factual background in this case; the holdings and legal analysis applied by the ALJ; the sanctions imposed on the respondents; and some lessons learned for investment advisers that file Forms ADV with the SEC.

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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. 5 No.9 (Mar. 1, 2012)

    Registration, Reporting, Disclosure and Operational Consequences for Hedge Fund Managers of the SEC’s New “Regulatory Assets Under Management” Calculation

    The SEC’s newly-adopted assets under management (AUM) calculation, known as an investment adviser’s “regulatory assets under management” (Regulatory AUM), will have numerous important regulatory implications for hedge fund managers.  Among other things, the calculation will govern whether the manager must or may register with the SEC as an investment adviser; whether the manager must file Form ADV; and which parts, if any, of Form PF the manager must complete and file.  See “Former SEC Commissioner Paul Atkins Discusses the Big Issues Raised by Form PF: Law, Operations, Confidentiality, Risk Management, Disclosure, Enforcement and Policy,” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).  Unfortunately for many hedge fund managers, the calculation of a firm’s Regulatory AUM is quite different from the calculation of the firm’s traditional AUM.  Also, in certain circumstances, large hedge fund managers may need to calculate their Regulatory AUM for each month.  Therefore, hedge fund managers must understand their Regulatory AUM and arrange to have it calculated in a timely fashion to ensure that they will comply with applicable registration and reporting requirements.  This article begins by defining Regulatory AUM and discussing how to calculate it.  The article then discusses the applicability of a firm’s Regulatory AUM with respect to the hedge fund adviser registration regime; the various exemptions from adviser registration; and the various new reporting obligations imposed on hedge fund advisers, including those relating to Form PF.  The article concludes with an analysis of some of the challenges associated with Regulatory AUM and specific guidance on navigating such challenges.

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  • From Vol. 5 No.7 (Feb. 16, 2012)

    How Should Hedge Fund Managers Determine Which of Their Advisory Affiliates Should Register with the SEC?

    On January 18, 2012, the SEC’s Division of Investment Management (Staff) issued a no-action letter in response to a request for guidance from the ABA Subcommittee on Hedge Funds seeking confirmation as to whether certain affiliates of an investment adviser must separately register with the SEC.  This article discusses the Staff guidance in detail and outlines the implications of the guidance for hedge fund managers.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    How Can Hedge Fund Managers Rebut the Presumption of Materiality of Certain Disciplinary Events in Form ADV, Part 2?

    Part 2 of Form ADV (specifically Item 9 of Part 2A) requires a registered hedge fund manager to disclose all “material facts about any legal or disciplinary event that is material to a client’s (or prospective client’s) evaluation of the integrity of the adviser or its management personnel.”  In contrast to the check-the-box disclosures regarding disciplinary history required by Part 1 of Form ADV, the disciplinary disclosures required by Item 9 of Part 2A must be made in narrative form and in plain English.  Item 9 requires a registered hedge fund manager to disclose all material facts about a disciplinary event involving the firm or any of its “management persons” if that event is material to a client’s evaluation of the firm or its management persons.  Items 9A, B and C provide a list of disciplinary events that are presumed to be material and must be disclosed unless, among other things, the hedge fund manager can rebut the presumption of materiality.  Rebutting the presumption is important for hedge fund managers because disclosing disciplinary events can undermine capital raising, obscure other achievements (even a good track record), monopolize due diligence conversations and give risk-averse institutions a reason not to invest or to redeem.  Therefore, this article discusses how registered hedge fund managers can rebut the presumption of materiality in determining what disciplinary events must be disclosed in Item 9.  This article begins with a discussion of Item 9, including a listing of disciplinary events presumed to be material as well as an explanation of key definitions that inform the required disclosures.  The article then explains the four factors that registered hedge fund managers should use in evaluating whether they can rebut the presumption of materiality and applies the factors to specific scenarios.  Next, the article discusses best practices for documenting determinations rebutting the presumption of materiality.  In addition, the article examines: other disciplinary events to be disclosed in Item 9 (even though not specifically listed); the materiality standard; other areas where a hedge fund manager must make disciplinary disclosures; consequences for omitting disciplinary information required by Part 2; and best practices for gathering disciplinary information about a firm’s advisory personnel.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Recent SEC Enforcement Action Demonstrates the SEC’s Focus on the Accuracy and Consistency of Disclosures by Hedge Fund Managers in Form ADV

    The SEC initiated a record number of enforcement actions in fiscal year 2011.  Among other things, the SEC has focused more attention on ferreting out false and misleading statements made by investment advisers in communications with investors and regulators.  As recently as November 2011, Robert Khuzami, Director of the SEC’s Division of Enforcement, explained that the SEC is specifically targeting investment advisers that it suspects may have filed Forms ADV containing false or misleading statements.  This article describes a recent SEC action indicating that the agency will bring enforcement actions based on allegations of inaccuracies in Form ADV.  This article also makes recommendations that hedge fund managers can implement to avoid Form ADV-related violations.  For a discussion of another current SEC enforcement initiative, see “Hedge Fund Managers with Unexplained Aberrational Performance Are More Likely to Become Targets of SEC Enforcement Actions,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011).

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    An Investment Adviser May Not Call Itself Independent If It Receives Fees from Underlying Managers

    The SEC recently commenced administrative proceedings against an investment adviser that allegedly received undisclosed fees for channeling over $80 million into SJK Investment Management, LLC (SJK).  As previously reported in The Hedge Fund Law Report, on January 6, 2011, the SEC filed an emergency civil injunctive action charging SJK and its principal, Stanley Kowalewski, with securities fraud, and obtained a temporary restraining order and asset freeze against SJK and Kowalewski.  See “Thirteen Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Fund of Funds Manager Alleging Misuse of Fund Assets,” The Hedge Fund Law Report, Vol. 4, No. 3 (Jan. 21, 2011).  The order in this administrative proceeding (Order) is interesting to hedge fund and hedge fund of funds managers primarily in helping clarify the circumstances in which managers may and may not claim to be “independent.”  The facts alleged by the SEC are rather egregious, and thus the Order itself does not make noteworthy new law.  However, the Order does raise close and interesting questions regarding the language of representations that hedge fund of fund managers and other investment advisers may make to investors with respect to independence; the channels through which such representations are made (including websites); how to approach disclosure with respect to conflicts and independence in Form ADV; and how to move client assets from one investment manager to another without breaching fiduciary duties or running afoul of the antifraud provisions of the federal securities laws.

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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.11 (Apr. 1, 2011)

    Application of Brochure Delivery and Public Filing Requirements of New Form ADV to Offshore and Domestic Hedge Fund Managers

    Many hedge fund managers that previously were not required to register with the SEC as investment advisers will be required to register by July 21, 2011 – that is, in just under four months – unless the SEC extends the registration deadline.  Rule 203-1 under the Investment Advisers Act of 1940 (Advisers Act) currently provides that to apply for registration with the SEC as an investment adviser, a hedge fund manager must complete Form ADV, file Part 1A of Form ADV and file the brochure(s) required by Part 2A of Form ADV electronically with the Investment Adviser Registration Depository (IARD).  Last July, the SEC finalized amendments to Part 2 of Form ADV and related rules under the Advisers Act.  Those amendments were long in the making – a decade, by some counts – and they have changed Part 2 significantly.  Most notably, Part 2 is now entirely narrative, publicly filed and deeper and broader in terms of the categories of required disclosure (including disciplinary history).  So, hedge fund managers will have to register as investment advisers and registered investment advisers must file Form ADV, Part 2.  Therefore, registered hedge fund managers will have to file Form ADV, Part 2.  For managers, this has been an expensive syllogism.  Many have hired compliance consultants with the goal of saying no more and no less than is required in their Part 2s.  Recently, the staff of the SEC’s Division of Investment Management (Division) offered assistance in this collective benchmarking effort by publishing “Staff Responses to Questions About Part 2 of Form ADV” (Staff Responses).  The Staff Responses include a series of commonly asked questions and answers to those questions.  But the questions are broad and the answers are terse, in some cases, limited to a single, oracular word.  While better than no statement from the Division, the Staff Responses raise as many questions as they answer.  In particular, the Staff Responses say nothing about the background and context of the answers; provide no guidance on the interaction among and application of the answers; and fail to highlight the extent to which certain answers render others largely moot.  This article seeks to fill in the blanks left by the Staff Responses.  It does so by discussing: the legal and regulatory authority supporting some of the more relevant answers; where those answers fit into the more general patchwork of hedge fund regulation; the interaction among the answers; and the application of the answers to offshore advisers to offshore hedge funds.  The article also offers guidance on implementing certain answers and highlights what certain of the answers do not cover.

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    Twelve Operational Due Diligence Lessons from the SEC’s Recent Action against the Manager of a Commodities-Focused Hedge Fund

    On March 15, 2011, the SEC filed a complaint the U.S. District Court for the Southern District of New York against Juno Mother Earth Asset Management, LLC (Juno) and its principals, Arturo Rodriguez and Eugenio Verzili.  The complaint alleges that Juno and its principals started selling interests in the Juno Mother Earth Resources Fund, Ltd. (Resources Fund) in late 2006, and by the middle of 2008, substantially all of the Resources Fund's investors had requested redemptions.  The SEC alleges that during the short life of the Resources Fund, Rodriguez and Verzili engaged in a range of bad acts, including misappropriation of fund assets, inappropriate loans from the fund to the management company, misrepresentations of strategy and assets under management and disclosure violations.  Assuming for purposes of analysis that the allegations in the complaint are true, the complaint illuminates a variety of pitfalls for institutional investors to avoid.  This article describes the factual and legal allegations in the complaint, then details twelve important lessons to be derived from the complaint.  Similar to other articles we have published extracting due diligence lessons from SEC complaints, the intent of this article is to serve as a tool for institutional investors or their agents that can be used directly in performing due diligence, or can be used to update a due diligence questionnaire.  Our hope in publishing this article (and others of its type) is that at least one of the twelve lessons that we extract from the complaint enables an investor to identify a due diligence issue that it otherwise would have missed.  We think that there is no better way to identify future hedge fund frauds than to understand the mechanics and lessons of past frauds.

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  • From Vol. 3 No.46 (Nov. 24, 2010)

    SEC Sanctions Registered Investment Adviser Thrasher Capital Management and its CEO for Misleading Statements in Thrasher’s Form ADV

    The Securities and Exchange Commission (SEC) has accepted an offer of settlement from James Perkins, the CEO and managing member of Thrasher Capital Management, LLC (Thrasher), an investment adviser registered with the SEC, for failing to make documents available to the SEC and for making false statements of material fact on Thrasher’s Form ADV.  Pursuant to the settlement, on November 16, 2010, the SEC issued an Order setting forth civil penalties against Perkins and Thrasher, including a cease-and-desist order, suspending Perkins from association with any investment adviser for nine months and revoking Thrasher’s registration.  Perkins escaped any monetary penalties because he submitted financial statements and other evidence of his inability to pay.  Perkins and Thrasher did not admit or deny the SEC’s findings set forth in its Order, except for admission of the SEC’s jurisdiction and the subject matter of the Order.  The matter helps define the appropriate scope of disclosure in a Form ADV.  Such disclosure, in turn, is newly relevant to the hedge fund industry because the Dodd-Frank Act will require many hedge fund managers to file Form ADV, in many cases for the first time, by July 21, 2011.

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