The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Deficiency Letters

  • From Vol. 9 No.35 (Sep. 8, 2016)

    How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations

    In a recent interview with The Hedge Fund Law Report, Patricia A. Poglinco and Robert G. Van Grover, partners at Seward & Kissel, discussed the types of activities the SEC is targeting when bringing enforcement actions against hedge and other fund managers. They also explored the evolving nature of SEC investigations and what hedge fund managers can do to prepare for these examinations. These are among the issues that Poglinco and Van Grover will explore in greater depth as they each moderate panels at the upcoming “Private Funds Forum” co-hosted by Seward & Kissel and Bloomberg BNA to be held on September 15, 2016. For additional insight from Poglinco, see “How Do Regulatory Investigations Affect the Hedge Fund Audit Process, Investor Redemptions, Reporting of Loss Contingencies and Management Representation Letters?” (Jan. 22, 2015). For commentary from Van Grover, see “Are Hedge Fund Managers Required to Disclose the Existence or Outcome of Regulatory Examinations to Current or Potential Investors?” (Sep. 16, 2011); “Implications for Hedge Fund Managers of Recent Insider Trading Enforcement Initiatives (Part One of Three)” (Feb. 25, 2011); and our three-part series entitled “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?”: Part One (Sep. 12, 2013); Part Two (Sep. 19, 2013); and Part Three (Sep. 26, 2013).

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  • From Vol. 9 No.34 (Sep. 1, 2016)

    Practical Guidance From Former SEC Examiners on Preparing for and Surviving SEC Examinations

    With the SEC continuing to focus on investment adviser compliance, a recent presentation hosted by compliance solutions provider MyComplianceOffice (MCO) and compliance consultant NorthPoint Compliance offered timely and practical guidance on preparing for SEC examinations, the examination process and examination trends. The program was moderated by Stephen Taylor, chief commercial officer at MCO, and featured Victoria Hogan, NorthPoint’s president, and Colleen Montemarano, a NorthPoint consultant, each of whom has more than six years’ experience as an SEC compliance examiner. This article highlights the key insights from the presentation. For another discussion of the exam process, see our two-part series: “What Hedge Fund Managers Need to Know About Getting Through an SEC Examination” (Jun. 16, 2016); and “Fees, Conflicts, Investment Allocations and Other Hot Topics” (Jun. 30, 2016).

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  • From Vol. 8 No.2 (Jan. 15, 2015)

    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 Actions (Part Three of Four)

    This is the third article in a four-part series covering the Practising Law Institute’s (PLI) Hedge and Private Fund Enforcement & Regulatory Developments 2014 event, chaired by Barry Goldsmith, a partner at Gibson Dunn & Crutcher and co-head of its Securities Enforcement Practice.  The first article in this series discussed key points made by Julie M. Riewe, Co-Chief of the SEC’s Asset Management Unit, on enforcement trends, principal transactions, conflicts raised by side-by-side management, valuation, allocation of expenses and the potential deterrent value of smaller enforcement actions.  The second article addressed CFTC enforcement concerns and cases, New York Attorney General’s Office initiatives and defense strategies for avoiding and managing government investigations.  This third article in the series focuses on: (1) SEC priorities for inspections and examinations of private fund advisers; (2) new technology and quantitative examination tools; (3) best practices for preparing for inspections and examinations; (4) how to interact with regulators to maximize positive outcomes and minimize the chance of an enforcement referral; and (5) how to preserve attorney-client privilege while complying with requests for information.  The participants in the relevant PLI panel included Hannah Berkowitz, a shareholder at Murphy & McGonigle, P.C.; Marc Elovitz, a partner and chair of Schulte Roth & Zabel’s Investment Management Regulatory & Compliance Group; Igor Rozenblit, co-head of the Private Funds Unit at the SEC’s Office of Compliance Inspections and Examinations; and John H. Walsh, a 23-year veteran of the SEC and partner at Sutherland Asbill & Brennan LLP.  See “Three Steps in Responding to an SEC Examination Deficiency Letter and Other Practical Guidance for Hedge Fund Managers from SEC Veteran and Sutherland Partner John Walsh,” The Hedge Fund Law Report, Vol. 7, No. 6 (Feb. 13, 2014).

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  • From Vol. 7 No.6 (Feb. 13, 2014)

    Three Steps in Responding to an SEC Examination Deficiency Letter and Other Practical Guidance for Hedge Fund Managers from SEC Veteran and Sutherland Partner John Walsh

    The vast majority of hedge fund managers with any nexus to the U.S. interact with the SEC – directly via examinations, enforcement actions or filings, or indirectly by operating under the specter of anti-fraud enforcement.  Counsel (in-house or outside) and compliance officers can, accordingly, best effectuate their prophylactic purpose by understanding the expectations, operations and motivations of SEC officials and staff.  Few understand these dynamics – and how they relate to hedge fund managers – better than Sutherland Asbill & Brennan LLP partner and former SEC official John H. Walsh.  During his 23-year tenure at the SEC, Walsh, among other things, played a key role in creating the Office of Compliance Inspections and Examinations (OCIE), designed and implemented the SEC’s securities compliance examination practices and served as OCIE’s acting director in 2009.  The Hedge Fund Law Report recently interviewed Walsh in connection with the publication of Investment Adviser’s Legal and Compliance Guide, Second Edition, a treatise that Walsh co-authored with Terrance J. O’Malley.  Our interview aimed to connect Walsh’s experience with the concerns of hedge fund managers, and covered topics including: retraining of OCIE staff in 2009; building blocks of a credible “tone at the top”; managing voluminous SEC information requests during examinations; the role of technology in a well-designed examination strategy; factors SEC officials consider in making referrals to Enforcement; the advisability of voluntary presentations to SEC examiners; core elements of effective information barriers; responding to SEC deficiency letters; access to previously-issued SEC deficiency letters; information sharing between the SEC and other regulators; admissions of wrongdoing; and attorney-client privilege.

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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.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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