The Hedge Fund Law Report

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

Articles By Topic

By Topic: Form ADV

  • From Vol. 11 No.37 (Sep. 20, 2018)

    Advisers With Wrap Fee Programs Must Provide Clear Information About Trading Away to Participating Advisers and Clients

    Wrap fee programs remain an enforcement priority for the SEC, which is concerned with whether the programs are suitable for clients, whether sponsors adequately disclose conflicts of interest and whether advisers are achieving best execution for participants. An investment adviser that sponsors wrap fee programs disclosed that managers in its programs may trade away or execute trades at additional cost to clients, and it also conducted periodic reviews of trading away. In a recently settled enforcement proceeding, however, the SEC claimed that the adviser failed to consider a manager’s trading away practices prior to including it in a program and failed to provide the information it obtained about trading away to advisers that recommended its programs to their own clients, which made it impossible for those advisers to determine whether they were achieving best execution for those clients. This article details the alleged shortcomings in the adviser’s compliance policies and procedures, along with the terms of the settlement order. For recent SEC interest in wrap fee programs, see “OCIE Risk Alert Warns of Six Most Frequent Fee and Expense Compliance Issues” (May 3, 2018); “Former SEC Examiners Provide Perspective on 2018 OCIE Examination Priorities” (Apr. 5, 2018); and “Retail Investors Top List of OCIE 2018 Exam Priorities” (Mar. 8, 2018).

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  • From Vol. 11 No.34 (Aug. 30, 2018)

    How to Avoid the Eight Best Execution Compliance Issues in OCIE’s Latest Risk Alert

    Section 206 of the Investment Advisers Act of 1940 establishes a federal fiduciary standard under which an investment adviser has a duty to seek to obtain “best execution” of client transactions, taking into consideration the circumstances of the particular transaction. In other words, an adviser must execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances. Ensuring best execution, however, is challenging given the highly subjective nature of the assessment. The SEC Office of Compliance Inspections and Examinations (OCIE) recently issued a National Exam Program Risk Alert that discusses the eight most frequent best execution-related compliance issues identified in deficiency letters from more than 1,500 adviser examinations. In addition to summarizing OCIE’s findings, this article provides guidance on how advisers can avoid similar errors from an industry practitioner with expertise in this area. For more on other recent OCIE Risk Alerts, see “Six Most Frequent Fee and Expense Compliance Issues” (May 3, 2018); and “Six Most Frequent Advertising Rule Compliance Issues” (Oct. 19, 2017).

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  • From Vol. 11 No.32 (Aug. 9, 2018)

    ACA-IAA Investment Management Compliance Testing Survey Covers Best Execution, Soft Dollars, Advertising, Individual Clients and Cryptocurrency Trading (Part Two of Two)

    For the fifth consecutive year, cybersecurity remains the most prominent compliance topic, as noted in the 2018 Investment Management Compliance Testing Survey recently completed by ACA Compliance Group (ACA) and the Investment Adviser Association (IAA). The results of the survey were discussed in a recent webinar presented by Enrique Carlos Alvarez, senior principal consultant at ACA; Sarah A. Buescher, associate general counsel at the IAA; and Sanjay Lamba, assistant general counsel at the IAA. This article, the second in a two-part series, analyzes the survey’s findings on best execution; soft dollars; advertising and social media; individual clients; cryptocurrency; cybersecurity; and other compliance trends. The first article examined the portions of the survey that covered compliance program testing; fees and expenses; socially responsible investing; sub-advisers; alternative data; trade surveillance; and custody. For coverage of ACA’s 2017 compliance survey, see “Continued SEC Focus on Compliance, Conflicts of Interest and Fees, and Common Measures to Protect MNPI” (Jun. 1, 2017); and “Variety in Expense Allocation Practices and Business Continuity Measures” (Jun. 8, 2017).

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  • From Vol. 11 No.23 (Jun. 7, 2018)

    Why Fund Managers Must Review Their Positions on Succession Planning and CCO Outsourcing (Part One of Three)

    The SEC proposed – and recently withdrew – a rule that would have required registered investment advisers to adopt and implement detailed business continuity and transition plans. Despite the rule’s withdrawal, however, the SEC has signaled that it will continue to scrutinize the robustness of advisers’ plans. To the extent that advisers’ business continuity and transition plans cover the departure of key personnel, they generally do so only with respect to founders; yet, from a business and regulatory perspective, they should also cover others, including chief compliance officers (CCOs). The proposed rule would have also required advisers to evaluate third-party service providers’ business continuity and transition plans, including those of outsourced CCOs. This article, the first in a three-part series, discusses the SEC’s proposed rule on business continuity and transition plans; the impact, if any, of the rule’s withdrawal; the importance of CCO succession planning; and the risks of using an outsourced CCO. The second article will examine CCO hiring and onboarding; whether managers should separate their compliance departments from their legal departments; and the risks of high CCO turnover. The third article will evaluate the risks of poor succession planning and provide a roadmap for developing a robust succession plan. See “Pro-Business Environment of New Administration Continues to Have Challenges and Pitfalls for Private Funds” (Sep. 14, 2017).

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  • From Vol. 11 No.23 (Jun. 7, 2018)

    The SEC’s Proposed Form CRS: Does It Accomplish Its Goals? (Part Two of Two)

    When the SEC recently released proposed Form CRS, it explained that the new short-form disclosure document is intended to give retail investors simple, easy-to-understand information about the nature of their relationships with their investment professionals; prompt them to ask informed questions; and enable them to compare firms that offer the same or substantially similar services. Does Form CRS actually accomplish these goals, however? This two-part series analyzes the proposed Form CRS requirements, reviews various issues the form raises and provides insight from lawyers and compliance professionals on the proposal. This second article in the series discusses whether the form is likely to achieve the SEC’s stated goals and explores potential issues it raises for registered investment advisers. The first article provided an overview of proposed Form CRS and its key requirements. For additional proposals by the SEC that would further regulate fund managers, see “SEC Emphasizes Investment Adviser Fiduciary Duty and Proposes Enhanced Adviser Regulation” (May 10, 2018).

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  • From Vol. 11 No.22 (May 31, 2018)

    The SEC’s Proposed Form CRS: An Overview of the Key Requirements (Part One of Two)

    The SEC recently proposed new rules under the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934 that would require registered investment advisers and registered broker-dealers to provide a brief customer- or client-relationship summary in a new short-form disclosure document: Form CRS. According to the SEC, Form CRS is intended to provide retail investors with simple, easy-to-understand information about the nature of their relationships with each investment professional and would supplement other, more detailed disclosures. Comments on the proposed new form must be submitted to the SEC over the next several months. This two-part series analyzes the proposed Form CRS requirements; discusses various issues the form raises; and provides insight from lawyers and compliance professionals on the proposal. This first article in the series provides an overview of the proposed Form CRS and its key requirements. The second article will discuss whether the form is likely to achieve the SEC’s stated goal and explore potential issues it raises for SEC-registered investment advisers. For more on the SEC’s focus on retail investors, see “Retail Investors Top List of OCIE 2018 Exam Priorities” (Mar. 8, 2018); and “Co-Director of SEC Enforcement Division Champions New Retail Strategy Task Force and Cyber Unit” (Nov. 16, 2017).

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  • From Vol. 11 No.16 (Apr. 19, 2018)

    Compliance Corner Q2-2018: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

    The SEC continues to increase its touchpoints with registered investment advisers. In its most recently published Agency Financial Report, the Commission reported that it examined 15 percent of SEC-registered investment advisers during its 2017 fiscal year, up from 11 percent in 2016 and 8 percent five years ago. Given the SEC’s heightened examination coverage, private fund investment advisers should continue to ensure that they are making timely and accurate filings and meeting required compliance deadlines and obligations in order to reduce potential regulatory scrutiny from SEC staff during examinations. This fourth installment of The Hedge Fund Law Report’s quarterly compliance update, authored by Danielle Joseph and Anthony Frattone, director and consultant, respectively, at ACA Compliance Group, highlights regulatory filings and code of ethics reports that must be completed during the second quarter of 2018. In addition, this article discusses compliance deadlines relating to Rule 22e‑4 under the Investment Company Act of 1940 (the Liquidity Risk Management Program Rule) and the E.U. General Data Protection Regulation (GDPR). For more on GDPR, see “A Fund Manager’s Roadmap to Big Data: Privacy Concerns, Third Parties and Drones (Part Three of Three)” (Jan. 25, 2018).

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  • From Vol. 11 No.14 (Apr. 5, 2018)

    Former SEC Examiners Provide Perspective on 2018 OCIE Examination Priorities

    The SEC Office of Compliance Inspections and Examinations (OCIE) recently issued its 2018 National Exam Program Examination Priorities. A recent program presented by MyComplianceOffice (MCO) focused on the examination priorities concerning retail investors, cybersecurity and anti-money laundering. The program, moderated by MCO marketing executive Joe Boyhan, featured Victoria Hogan, president of NorthPoint, and Colleen Montemarano, a consultant at that firm, each of whom has more than six years of experience as an SEC examiner. This article summarizes their insights. For further coverage of OCIE exam priorities, see 2018 Examination Priorities; 2017 Examination Priorities; and 2016 Examination Priorities. For additional commentary from Hogan and Montemarano, see “Practical Guidance From Former SEC Examiners on Preparing for and Surviving SEC Examinations” (Sep. 1, 2016).

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  • From Vol. 11 No.10 (Mar. 8, 2018)

    Interest in Bespoke Fund Structures Surges As Markets Adjust to New Administration and Regulatory Regime

    A little more than a year into the Trump administration, the private funds market displays growing levels of innovation and experimentation. Fund managers are increasingly opting to employ bespoke fund structures, such as first loss capital arrangements, each of which has its own unique set of advantages as well as potentially catastrophic liabilities. Recent changes at the regulatory level – including the newly effective revisions to Form ADV; a heightened regulatory focus on blockchain and the fiduciary responsibilities of legal professionals providing related advice; and a growing emphasis on individual liability, particularly with respect to chief compliance officers – add to the environment’s complexity and may sometimes appear contrary to the administration’s pro-business rhetoric. These factors and trends make the 2018 private funds environment drastically different from that under the previous administration, raising exhilarating and daunting possibilities for fund managers. To help readers understand the unique benefits and potential drawbacks of some of the more popular bespoke fund structures, The Hedge Fund Law Report recently interviewed Peter Bilfield, partner at Day Pitney with experience in this area. This article presents his thoughts. For further commentary from Bilfield, see “What Do the Investor Advisory Committee’s Recommendations Mean for the Future of Marketing of Hedge Funds to Natural Persons?” (Oct. 24, 2014); and “Investments by Family Offices in Hedge Funds Through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part One of Two)” (Apr. 1, 2011).

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  • From Vol. 11 No.10 (Mar. 8, 2018)

    With the Filing Deadline Looming for Many Advisers, Seward & Kissel Attorneys Provide a Roadmap to Amended Form ADV

    In August 2016, the SEC adopted a number of amendments to Part 1A of Form ADV, which took effect on October 1, 2017. Many advisers are now contending with the revised form in connection with their annual updates that are due March 31. A recent Seward & Kissel presentation offered an overview of the most material and vexing changes, offering practical advice on how to complete the revised form. The program featured Seward & Kissel partners Paul M. Miller, Patricia A. Poglinco and Robert B. Van Grover, along with counsel David Tang. This article summarizes the key points raised by the panelists. For more on the amendments, see our two-part series on what investment advisers need to know about the SEC’s revisions to Form ADV and the recordkeeping rule: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 3, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016). For additional insights from Van Grover and Poglinco, see “Pro-Business Environment of New Administration Continues to Have Challenges and Pitfalls for Private Funds” (Sep. 14, 2017); and “How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations” (Sep. 8, 2016).

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  • From Vol. 11 No.4 (Jan. 25, 2018)

    Compliance Corner Q1-2018: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

    In light of SEC Chair Jay Clayton’s recent statement that the Commission will continue to focus on the compliance programs of private fund advisers, it is important for those advisers to start 2018 on the right note. See “Will Inadequate Policies and Procedures Be the Next Major Focus for SEC Enforcement Actions?” (Nov. 30, 2017). One effective measure that chief compliance officers can take at the start of this calendar year is to create or update a compliance calendar that tracks regulatory filing deadlines, code of ethics reporting requirements and other relevant compliance tasks and responsibilities. This third installment of The Hedge Fund Law Report’s quarterly compliance update, authored by Danielle Joseph and Manny Halberstam, director and senior compliance analyst, respectively, at ACA Compliance Group, aims to assist advisers with ensuring that their 2018 compliance calendars are current by highlighting regulatory filings and code of ethics reports that must be completed during the first quarter of 2018. In addition to addressing these first-quarter deadlines, this article discusses the treatment of virtual currency tokens held by employees for purposes of code of ethics reporting, along with the SEC’s growing use of data surveillance and analytics as part of its examination process. For additional guidance on the reporting obligations of advisers, see “Steps an Exempt Reporting Adviser Must Take to Transition to SEC Registered Investment Adviser Status: Regulatory Filings, Updates to Fund Documents and Preparation for SEC Examination (Part Three of Three)” (Oct. 19, 2017); and “Marketing and Reporting Considerations for Emerging Hedge Fund Managers” (Jun. 16, 2016).

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  • From Vol. 11 No.2 (Jan. 11, 2018)

    HFLR Program Parses OCIE’s Recent Advertising Risk Alert: Misleading Claims of GIPS Compliance, Past Specific Investment Recommendations and Results of SEC’s Touting Initiative (Part Two of Two)

    SEC commentary provides valuable insight to compliance personnel on the hot-button issues being prioritized by the Commission, as well as the sort of conduct that does, and does not, lead to a referral to the SEC’s Division of Enforcement. By staying informed of the SEC’s approach to certain issues, advisers can learn from the mistakes of similarly situated advisers. A recent webinar presented by The Hedge Fund Law Report discussed six deficiencies identified in a National Exam Program Risk Alert that violate Rule 206(4)-1 of the Investment Advisers Act of 1940 – the so-called “Advertising Rule” – as well as other compliance issues that frequently arise with respect to an adviser’s advertising practices. Kara Bingham, Associate Editor of The Hedge Fund Law Report, moderated the discussion, which featured Todd Kaplan, founder and principal of Cloudbreak Compliance Group; Christine M. Lombardo, partner at Morgan Lewis; and Richard F. Kerr, partner at K&L Gates. This article, the second in a two-part series, explores the disclosures required when presenting gross performance in a one-on-one presentation to prospective investors, the circumstances under which claims of compliance with voluntary performance disclosure standards may be deemed misleading, ways to avoid deficiencies when discussing past specific recommendations in advertisements and the results of the touting initiative conducted by the SEC’s Office of Compliance Inspections and Examinations. The first article discussed the broad view that the SEC takes when deciding which communications fall within the definition of an advertisement, as well as four examples of deficiencies frequently found in performance advertising. See “Risk Alert Highlights Six Most Frequent Advertising Rule Compliance Issues” (Oct. 19, 2017).

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  • From Vol. 10 No.45 (Nov. 16, 2017)

    Recent SEC Settlement Reminds Fund Managers to Strictly Adhere to Disclosed Fee and Expense Calculation Methodologies and Fully Disclose Conflicts of Interest

    The SEC recently entered a settlement order against an investment adviser and its principal for their failures to properly calculate fees and expense reimbursements as disclosed in their fund documents and SEC filings, and to make adequate disclosure regarding related-party-transaction conflicts of interest, resulting in over $2 million in fines, disgorgement and interest. The action is a critical reminder to fund managers of the importance of ensuring that fees and expenses are calculated precisely in accordance with disclosed methodologies; the significance of fully disclosing all conflicts of interest; and the SEC’s continued attention to these areas. This article summarizes the SEC’s findings and the terms of the settlement order. For more on SEC scrutiny of these issues, see “Eight Bad Excuses Fund Managers Have Raised Trying to Avoid SEC Sanctions for Fee and Expense Allocation Violations and Undisclosed Conflicts of Interest” (Oct. 13, 2016).

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  • From Vol. 10 No.43 (Nov. 2, 2017)

    A Roadmap to Maintaining Books and Records: Compliance With Applicable Regulations (Part One of Two)

    Investment advisers are subject to numerous rules and regulations regarding their books and records. A recent ACA Compliance Group (ACA) program, featuring Beth Manzi, chief operating officer of private fund administrator PEF Services LLC, and Theodore E. Eichenlaub, partner at ACA, offered a comprehensive overview of the documents and records that investment advisers are required to maintain. The program also focused on methods for ensuring that those documents and records be complete, accessible and in a proper form in the event of an SEC examination. This article, the first in a two-part series, discusses the regulatory background surrounding the maintenance of adviser-specific records, including corporate and accounting documents; marketing documents; and emails. The second article will consider the electronic storage of records, document destruction, testing of compliance programs and SEC examinations. For additional commentary from ACA, see “How Private Fund Managers Can Avoid Common Pitfalls When Calculating and Advertising Internal Rates of Return” (Sep. 7, 2017); and “Compliance Corner Q4-2017: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter” (Oct. 12, 2017).

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  • From Vol. 10 No.41 (Oct. 19, 2017)

    Steps an Exempt Reporting Adviser Must Take to Transition to SEC Registered Investment Adviser Status: Regulatory Filings, Updates to Fund Documents and Preparation for SEC Examination (Part Three of Three)

    Section 208(a) of the Investment Advisers Act of 1940, as well as prior statements made by the SEC, make it clear that an investment adviser is prohibited from using its registration status to suggest that the Commission has approved, recommended or sponsored the adviser. The fact remains, however, that being an SEC registered investment adviser (RIA) carries weight in the industry if for no other reason than registration with the Commission is a threshold issue for some investors. This final article in our three-part series outlining the steps that exempt reporting advisers (ERAs) must take to transition to RIA status reviews the key regulatory filings that RIAs must file examines amendments that ERAs may need to make to their fund documents in anticipation of their change in registration status and provides insight into what newly registered advisers should expect from the SEC examination process. The first article discussed the circumstances under which an ERA would be required to register as an RIA, along with considerations for ERAs augmenting their compliance programs. The second article outlined key policies and procedures that ERAs should consider when drafting their compliance manuals. For more on the examination of RIAs, see “OCIE 2017 Examination Priorities Illustrate Continued Focus on Conflicts of Interest; Branch Offices; Advisers Employing Bad Actors; Oversight of FINRA; Use of Data Analytics; and Cybersecurity” (Jan. 26, 2017).

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  • From Vol. 10 No.41 (Oct. 19, 2017)

    Risk Alert Highlights Six Most Frequent Advertising Rule Compliance Issues

    Rule 206(4)-1 under the Investment Advisers Act of 1940 prohibits investment advisers from including testimonials, certain past specific recommendations and misleading information in marketing materials. The SEC Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert that discusses the six most frequent advertising issues identified in deficiency letters from more than 1,000 adviser examinations, as well as the results of its 2016 “Touting Initiative,” which focused on nearly 70 advisers’ use of awards, rankings, professional designations and testimonials in their marketing materials. This article summarizes OCIE’s findings. See also our three-part advertising compliance series: “Ten Best Practices for a Fund Manager to Streamline Its Compliance Review” (Sep. 14, 2017); “Five High-Risk Areas to Focus on When Reviewing Marketing Materials” (Sep. 21, 2017); and “Six Methods to Test Advertising Review Procedures” (Sep. 28, 2017).

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  • From Vol. 10 No.40 (Oct. 12, 2017)

    Compliance Corner Q4-2017: Regulatory Filings and Other Considerations That Hedge Fund Managers Should Note in the Coming Quarter

    While the fourth quarter is often the busiest one for regulatory filings and fulfilling other compliance obligations, hedge fund managers should ensure that their compliance programs finish the year on a strong note and that key compliance processes are not neglected. This second installment of The Hedge Fund Law Report’s quarterly compliance update, authored by Danielle Joseph and Anne Wallace, director and analyst, respectively, at ACA Compliance Group, highlights certain notable regulatory filings fund managers need to address in the fourth quarter of 2017. In addition to the filing obligations discussed herein, this article examines recent actions by the SEC relating to virtual currency and electronic communications, along with their potential impact on advisers’ compliance programs. For other recent commentary from the SEC, see “SEC Chair Clayton Details Eight Guiding Principles for Enforcement and Agency Strategies for Their Implementation” (Aug. 10, 2017); and “SEC Chair’s Budget Testimony Emphasizes Strong Agency Focus on Oversight and Enforcement in Trump Era” (Jul. 13, 2017). For additional insights from Joseph, see our two-part series “ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices”: Part One (Oct. 3, 2013); and Part Two (Oct. 11, 2013).

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  • From Vol. 10 No.28 (Jul. 13, 2017)

    Unexpected Traps for Filing Other-Than-Annual Amendments Using the Revised Form ADV and How to Avoid Them

    New SEC rules to amend Part 1A of Form ADV will become effective on October 1, 2017. See “The ‘Why’ Behind the Recent Form ADV Amendments: What Information the SEC Will Require and How the Agency Intends to Use It” (May 4, 2017). Much has been written about how a fund manager should complete the amended Form ADV anew as part of its annual updating amendment, which most advisers will file in March 2018. See “A Roadmap of Potential Landmines for Fund Managers to Avoid When Completing the Revised Form ADV” (May 25, 2017). If an adviser is required to amend its Form ADV after October 1, 2017, but prior to its March 2018 annual update (Other-Than-Annual Amendment), however, it may have to disclose additional information, creating a new and larger project out of what otherwise might have been a simple change to its Form ADV. In a guest article, Steven M. Felsenthal, general counsel and chief compliance officer of Millburn Ridgefield Corporation, discusses two potential traps that may cause an adviser to file an Other-Than-Annual Amendment using the amended form, explores the ramifications of doing so and suggests an approach to avoid providing some of this information earlier than anticipated. This article incorporates insights gleaned from personal conversations the author had with industry participants on how to effectively navigate the nuances of the amended Form ADV for an Other-Than-Annual Amendment. For additional insight from Felsenthal, see “Further CFTC Harmonization of Rules for Hedge Funds: A Welcome and Continuing Trend” (Sep. 18, 2014); and “CFTC and SEC Propose Rules to Further Define the Term ‘Eligible Contract Participant’: Why Should Commodity Pool and Hedge Fund Managers Care?” (Jun. 23, 2011).

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  • From Vol. 10 No.21 (May 25, 2017)

    A Roadmap of Potential Landmines for Fund Managers to Avoid When Completing the Revised Form ADV

    Effective October 1, 2017, advisers must contend with an updated Form ADV that makes a number of helpful technical changes and streamlines the process for filing umbrella registrations. Despite these beneficial changes, the amended Form ADV imposes significant new reporting duties for separately managed accounts and advisers operating multiple branches. A recent program presented by Proskauer Rose, Advise Technologies and The Hedge Fund Law Report offered a page-by-page guide to understanding the revised form. Moderated by Rorie A. Norton, Associate Editor of The Hedge Fund Law Report, the discussion featured Michael F. Mavrides, partner at Proskauer, and Jeanette Turner, chief regulatory attorney and a managing director at Advise Technologies. This article summarizes their insights. For more from Turner on Form ADV changes, see “The ‘Why’ Behind the Recent Form ADV Amendments: What Information the SEC Will Require and How the Agency Intends to Use It” (May 4, 2017). For additional commentary from Mavrides, see our two-part series on the latest revisions to Form ADV and the so-called “recordkeeping rule”: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 10, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016).

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  • From Vol. 10 No.18 (May 4, 2017)

    The “Why” Behind the Recent Form ADV Amendments: What Information the SEC Will Require and How the Agency Intends to Use It

    On August 25, 2016, the SEC adopted amendments to Form ADV that will become effective October 1, 2017. The amendments are designed to improve the depth and quality of information collected, to facilitate risk-monitoring initiatives, to assist the SEC staff in its risk-based examination program and to provide additional disclosure to investors and the public. In a guest article, Jeanette Turner, chief regulatory attorney and a managing director at Advise Technologies, provides an introduction to these recent amendments to Form ADV to help firms determine how to alter their internal procedures and processes. For additional insight from Turner, see “MiFID II Expands MiFID I and Imposes Reporting Requirements on Asset Managers, Including Non-E.U. Asset Managers” (May 28, 2015). On Thursday, May 11, 2017, from 12:00 p.m. to 1:00 p.m. EDT, Turner will expand on the thoughts in this article – as well as other ramifications of the recent amendments to Form ADV – in a webinar entitled “2017 Form ADV Changes,” which will be moderated by Rorie A. Norton, an associate editor of The Hedge Fund Law Report. Turner will be joined by fellow panelist Michael F. Mavrides, a partner at Proskauer Rose. To register for the webinar, click here. For further commentary from Mavrides on what investment advisers need to know about these SEC revisions to Form ADV and the recordkeeping rule, see our two-part series: “Managed Account Disclosure, Umbrella Registration and Outsourced CCOs” (Nov. 3, 2016); and “Retaining Performance Records and Disclosing Social Media Use, Office Locations and Assets Under Management” (Nov. 17, 2016).

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  • 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.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. 9 No.25 (Jun. 23, 2016)

    Undisclosed Increase in Investment Adviser’s Fees Could Result in Significant Penalties 

    Fee and expense practices of private fund advisers remain in the SEC’s crosshairs. See “SEC Division Heads Enumerate OCIE Priorities, Including Cybersecurity, Fees, Bad Actors and Never-Before Examined Hedge Fund Managers (Part One of Two)” (Apr. 28, 2016). The SEC recently brought suit in Connecticut against a registered investment adviser, alleging improper transfer of client assets into new mutual funds, thereby increasing client advisory fees without changing the clients’ investment strategy. The adviser failed to disclose the alleged conflict of interest to its clients. The SEC seeks an injunction, disgorgement and civil penalties. This article summarizes the facts giving rise to the action and the SEC’s civil complaint. For more on enforcement actions involving fee disclosures and practices, see “Blackstone Settles SEC Charges Over Undisclosed Fee Practices” (Oct. 22, 2015); and “SEC Enforcement Action Involving ‘Broken Deal’ Expenses Emphasizes the Importance of Proper Allocation and Disclosure” (Jul. 9, 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.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.19 (May 14, 2015)

    K&L Gates Panel Offers Advice on Taxation, Regulatory and Business Integration Issues with M&A Transactions in the Asset Management Industry (Part Two of Two)

    As firms in the asset management industry structure merger and acquisition transactions – including joint ventures, acquisitions of minority interests and lift-outs of teams – they need to be aware of the potential issues that arise with such transactions.  Integrating two businesses may result in tax consequences, regulatory issues or other compliance concerns.  A panel of domain experts from K&L Gates recently discussed current trends in the asset management industry and a number of considerations in planning an acquisition or other deal with an asset manager, broker-dealer or adviser, including choice of partner, due diligence, structuring, taxation and various regulatory and compliance considerations.  Moderated by Michael S. Caccese, a practice area leader, the program featured partners Kenneth G. Juster and Michael W. McGrath; and practice area leaders D. Mark McMillan and Robert P. Zinn.  This article, the second in a two-part series, summarizes the key takeaways from that program with respect to taxation, regulatory and business integration concerns.  The first article addressed asset management industry trends, choosing a partner, due diligence and structuring considerations.  See also “PLI Panel Addresses Recent Developments with Respect to Prime Brokerage Arrangements, Alternative Registered Funds and Hedge Fund Manager Mergers and Acquisitions,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).

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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. 6 No.43 (Nov. 8, 2013)

    SEC Sanctions Two Private Fund Managers for Custody Rule Violations, Including Imposing Statutory Bars on Their Chief Compliance Officers

    On October 28, 2013, the SEC entered into settlement orders with three registered investment advisers who were charged with violations of Rule 206(4)-2 (Custody Rule) under the Investment Advisers Act of 1940 (Advisers Act), and other Advisers Act provisions and rules.  These enforcement actions, spurred by high-profile scandals as well as deficiencies uncovered during presence examinations of newly registered advisers, is emblematic of the SEC’s increasingly aggressive approach to enforcement.  See “Recently Published SEC Risk Alert Reveals Significant Deficiencies In Custody Practices of Hedge Fund Managers and Other Investment Advisers,” The Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013).  This article summarizes the settlements entered into with two private fund managers that provide the most pertinent lessons for hedge fund managers.  See also “How Does the SEC Approach Custody Issues in the Course of Examinations of Hedge Fund Managers?,” The Hedge Fund Law Report, Vol. 5, No. 18 (May 3, 2012).  In addition to the Custody Rule violations, the SEC also cited the fund managers for other significant Advisers Act violations (including a violation of Section 206(3) (with respect to an undisclosed principal transaction), style drift, making material misrepresentations in Form ADV, compliance program violations, and making improper distributions to investors).  Importantly, in both settlement orders, the chief compliance officers (CCOs) of both firms agreed to statutory bars, demonstrating the SEC’s commitment to holding CCOs responsible for the compliance failures of their firms.  See “Simon Lorne, Chief Legal Officer of Millennium Management LLC, Discusses the Evolving Roles, Challenges and Risks Faced by Hedge Fund Manager General Counsels and Chief Compliance Officers,” The Hedge Fund Law Report, Vol. 6, No. 37 (Sep. 26, 2013).

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  • From Vol. 6 No.40 (Oct. 17, 2013)

    Daniel New, Executive Director of E&Y’s Asset Management Advisory Practice, Discusses Best Practices on “Hot Button” Hedge Fund Compliance Issues: Disclosure, Expense Allocations, Insider Trading, Political Intelligence, CCO Liability, Valuation and More

    The task of serving as chief compliance officer (CCO) of a hedge fund manager is becoming progressively more challenging in light of ever-increasing regulatory obligations, heightened enforcement activity and resource constraints.  CCOs can benefit from understanding the best practices being employed by their peers, and customizing relevant practices to their businesses.  As Executive Director of Ernst & Young’s Asset Management Advisory Practice, Daniel New sees a cross-section of compliance practices at brand-name hedge fund managers.  He sees what works from a compliance perspective, and what needs work.  The Hedge Fund Law Report recently interviewed New on a range of issues regularly encountered by hedge fund manager CCOs.  The interview spanned topics including consistency of fund marketing and disclosure documents; a CCO’s role in preparing and completing Form PF and other regulatory filings; structuring and memorializing annual compliance reviews; allocating expenses between a manager and its funds; insider trading and political intelligence controls; social media use by manager personnel; a CCO’s risk management responsibilities; outsourcing of CCO functions in light of resource constraints; and mitigating rogue trading risks.  The breadth of topics covered reflects the expansiveness of a typical CCO’s portfolio.  The idea behind this interview is to enable CCOs to allocate their scarcest resource – time – more effectively.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Compliance, Risk & Enforcement 2013 Symposium, to be held at the Pierre Hotel in New York City on October 31, 2013.  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    Why and How Should Hedge Fund Managers Conduct Background Checks on Prospective Employees? (Part One of Three)

    Hedge fund management is a human capital business, and employees are (or should be) the key asset of a manager.  See “Key Legal Considerations in Connection with the Movement of Talent from Proprietary Trading Desks to Start-Up or Existing Hedge Fund Managers: The Hedge Fund Manager Perspective (Part Three of Three),” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).  However, employees can also be a manager’s most dangerous liability.  One rogue employee can destroy or seriously damage even the best hedge fund franchise by, among other things, inviting a presumption that the employee is not rogue but representative of a culture of permissiveness.  See “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  Recognizing the risks of picking bad apples, hedge fund managers are increasingly using employee background checks as a downside mitigation strategy.  But the concept of a background check spans a wide range of activities – everything from a superficial online search to a deep, manual process.  Whether to conduct a background check in the first instance, and what kind of background check to conduct, depends on dynamics specific to the industry, firm and prospective employee.  To assist hedge fund managers in understanding the role of background checks in their hiring and “people” processes, The Hedge Fund Law Report is publishing a three-part series on the role of background checks in the hedge fund industry, with the three parts focusing on, respectively, three questions: Why, how and who.  More specifically, this article – the first in the series – outlines the case for conducting background checks, cataloging the wide range of regulatory and other risks presented by employees (including discussions of insider trading, Rule 506(d), pay to play, track record portability, restrictive covenants and other topics).  The second installment will describe the anatomy of an employee background check, highlighting mechanics, common mistakes and risks.  And the third part will weigh the benefits and burdens of outsourcing background checks versus conducting them in-house.

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    ACA Compliance Report Facilitates Benchmarking of Private Fund Manager Compliance Practices (Part One of Two)

    ACA Compliance Group (ACA) recently released the second part of its three-part report describing the results of its surveys of hedge fund and private equity fund manager compliance practices, focusing on the completion and preparation of regulatory filings, various insider trading issues and expense practices.  ACA also presented a webcast explaining and expanding on the survey findings.  The report and webcast provided important market color and guidance enabling hedge fund and private equity fund managers to benchmark their compliance practices against those of their peers.  This article, the first of two installments covering the report and webcast, summarizes survey results relating to (1) the present status and focus areas of hedge fund and private equity fund manager presence examinations, and (2) fund managers’ preparation and completion of regulatory filings (e.g., Form ADV, Form PF and non-U.S. regulatory filings), including a discussion of how many managers are making various regulatory filings; what resources are being used to prepare such filings; how Form PF expenses are being allocated among a manager and its funds; and whether Form PF is being shared with fund investors.  The second installment will address insider trading issues (including discussions of information barriers, online data rooms, non-disclosure agreements, restricted and watch lists, political intelligence, expert networks and public company contacts); and expense practices (including the use of expense caps and the allocation of expenses among a manager and its funds).  For coverage of the first part of the ACA compliance report, conducted during the first quarter of this year, see “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,” The Hedge Fund Law Report, Vol. 6, No. 19 (May 9, 2013).

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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.21 (Jun. 23, 2011)

    SEC Delays Registration Deadline for Hedge Fund Advisers, and Clarifies the Scope and Limits of Registration Exemptions for Private Fund Advisers, Foreign Private Advisers and Family Offices

    At an open meeting held on June 22, 2011, the Securities and Exchange Commission adopted and amended rules that will directly affect the registration, reporting and disclosure obligations of U.S. and non-U.S. hedge fund managers.  While the texts of most of those rules or rule amendments remain to be published as of this writing, comments by SEC commissioners at the open meeting outlined the general scope of the final rules and amendments.  Of particular relevance to hedge fund managers, the SEC addressed the following topics at the open meeting: delay of registration and reporting deadlines; who may and must register with the SEC and the states based on assets under management; the private fund adviser exemption; the foreign private adviser exemption; continuing relevance of the Unibanco no-action letter for global hedge fund sub-­advisory relationships; filing, recordkeeping and examination obligations of exempt reporting advisers; and the exemption from registration for family offices.  This article offers more detail on the SEC’s statements on each of the foregoing topics at the open meeting.

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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.16 (May 13, 2011)

    Impact of the Foreign Private Adviser Exemption and the Private Fund Adviser Exemption on the U.S. Activities of Non-U.S. Hedge Fund Managers

    Passage of the Dodd-Frank Act and relevant SEC rulemaking has changed the regulatory landscape for non-U.S. hedge fund managers that have or plan to establish an advisory presence in the U.S. or that have or plan to target U.S. investors.  Generally – and despite references to “international comity” in one of the relevant proposed rule releases – the Dodd-Frank Act has increased the regulatory burden on non-U.S. hedge fund managers wishing to access the U.S. market.  Or, put another way, Dodd-Frank has narrowed considerably the range of conduct in which non-U.S. managers may engage without getting caught in the purview of U.S. investment adviser registration, or many of its substantive burdens.  This article provides detailed synopses of the relevant provisions of the foreign private adviser exemption and the private fund adviser exemption, focusing in particular on: rules relating to counting clients and investors; measuring “regulatory assets under management”; definitions of “place of business,” “in the United States” and other relevant terms; and recordkeeping and reporting obligations and examination exposure of “exempt reporting advisers.”  This article concludes by discussing how the exemptions may impact U.S. activities typically engaged in by non-U.S. hedge fund managers, such as marketing to U.S. tax-exempt entities and sourcing U.S. investment opportunities.

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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.48 (Dec. 10, 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 Two 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.  In our issue of November 24, 2010, we detailed the key insights of Summit participants on topics including insider trading; the use by hedge fund managers of consultants and expert networks; sharing of information among personnel at different hedge fund managers; market rumors; insider trading considerations in connection with bank debt trading; and how to prepare for, handle and follow up on SEC examinations.  See “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,” The Hedge Fund Law Report, Vol. 3, No. 46 (Nov. 24, 2010).  As we observed in that article, the timing of the Summit was fortuitous because two weeks after it, The Wall Street Journal and other sources disclosed a wide-ranging, inter-agency insider trading investigation focusing on hedge fund managers, expert networks and other alternative research providers, investment banks and others.  See “Lessons for Hedge Fund Managers and Expert Network Firms from the Government’s Criminal Complaint against Don Chu, Formerly of Primary Global Research LLC,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  This article finalizes our coverage of the Summit.  Specifically, this article summarizes the most relevant points made by Summit participants with respect to: the revised “accredited investor” definition in Dodd-Frank; the consequences of violating Regulation D, and how to mitigate those consequences; how to negotiate the apparent conflict between the prohibition on general solicitation of Regulation D and the expanded disclosures required by revised Form ADV, Part 2; the importance of consistency between marketing materials and fund documents; recordkeeping with respect to hedge fund manager websites; the distinction between specific representations in and collective impressions created by marketing materials; rules with respect to presentation of performance information; four specific items that the SEC looks for in valuation policies and procedures of hedge fund managers; six specific red flags that the SEC looks for with respect to valuation in the course of inspections and examinations of hedge fund managers; big boy letters; what provisions in side letters may, in the view of the SEC, need to be disclosed to hedge fund investors; and why the fraud exclusion in D&O and E&O insurance policies may often be moot.

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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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  • From Vol. 3 No.4 (Jan. 27, 2010)

    How Does the Amended Custody Rule Change the Balance of Power Between Hedge Fund Managers and Accountants?

    The bad news about the amended custody rule is the surprise examination requirement.  The good news, at least for many hedge fund managers, is the annual audit exception.  (That is, the amended custody rule contains an exception from the surprise examination requirement for advisers to pooled investment vehicles that are annually audited by a PCAOB-registered accountant and that distribute audited financial statements prepared in accordance with GAAP to fund investors within 120 days (180 days for funds of funds) of the fund’s fiscal year end.)  See “SEC Adopts Investment Adviser Custody Rule Amendments,” The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).  The qualified news is that while many hedge fund managers may avail themselves of the annual audit exception, an appreciable number may not.  For example, managers whose funds are audited by non-PCAOB-registered accountants, or that do not (or cannot) distribute audited financial statements to fund investors within 120 days of the fund’s fiscal year end, would not be eligible for the annual audit exception.  See “How Should Hedge Fund Managers Revise Their Compliance Policies and Procedures in Light of Amendments to the Custody Rule?,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010).  For such “ineligible” hedge fund managers, the surprise examination requirement may complicate operations for at least two reasons.  First, it creates a de facto annual audit requirement.  The substance of a surprise examination – explained in the SEC’s adopting release and a related interpretive release providing specific guidance for accountants – closely resembles the substance of an annual audit.  (The substance of a surprise examination is discussed in more detail in this article.)  Moreover, as the SEC pointed out in the adopting release accompanying the custody rule amendments, a hedge fund manager’s inability to predict which transactions an auditor will test in the course of an annual audit is analogous to the “surprise” element of the examination requirement.  Second – and perhaps more controversially – the surprise examination requirement may complicate operations for hedge fund managers that are not eligible for the annual audit exception because of various SEC reporting requirements imposed on accountants that conduct surprise examinations.  Those reporting requirements are described in more detail in this article, but in pertinent part would require an accountant to file with the SEC, within four business days of resignation, dismissal or other termination from an engagement to provide surprise examinations, Form ADV-E, along with an explanation of any problems that contributed to such resignation, dismissal or other termination.  Importantly, Form ADV-E, along with the accompanying explanation, would be publicly available.  According to the adopting release, the policy rationale for such public availability is to enable current and potential clients of an adviser to assess for themselves the importance of the explanation provided by the accountant for its resignation, dismissal or other termination.  The concern haunting the subset of hedge fund managers that are (or are concerned about becoming) subject to the annual surprise examination requirement is that the Form ADV-E filing requirement may – in cases where reasonable minds can differ on close accounting and valuation calls – further enhance the leverage of accountants over managers.  In other words, the concern is that revised Form ADV-E may increase the volume and specificity of an accountant’s “noisy withdrawal,” and in recognition of that, may increase risk aversion on the part of hedge fund managers in dealings with accountants.  The rejoinder to this argument is that accountants already have considerable leverage over hedge fund managers, as evidenced most starkly by the consequences flowing from withholding of an unqualified audit opinion letter.  See, e.g., “Former CFO of Highbridge/Zwirn Special Opportunity Fund Sues Ex-Partner Daniel B. Zwirn for Defamation and Breach of Contract,” The Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  In an effort to assess the extent to which the custody rule amendments may alter the balance of power between accountants and hedge fund managers, this article examines: how custody is defined in the amended custody rules (because custody is a condition precedent for application of the surprise examination requirement); the substance of the surprise examination requirement; the three exceptions from the surprise examination requirement; relevant SEC reporting requirements (on Form ADV-E); expert insight on whether and how the SEC reporting requirements may increase the leverage of accountants vis-à-vis hedge fund managers; existing accountant leverage (including a discussion of audit representation letters); who bears the cost of a surprise examination; and PCAOB resource limits.

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  • From Vol. 2 No.25 (Jun. 24, 2009)

    The SEC’s Proposed Custody Rule Changes: An Analysis of the Impact on Hedge Fund Managers

    The SEC recently voted to propose changes to the Advisers Act custody rule.  The SEC initiated this action with the intention of providing additional safeguards when an adviser has custody of client assets.  The proposed changes follow a series of recent enforcement actions involving alleged misappropriation or other misuse of client assets.  The proposed changes would primarily impose two new requirements on registered advisers with custody of client assets.  First, those advisers would need to undergo an annual surprise examination by an independent public accountant to verify client assets.  Second, those advisers who are qualified custodians and self custody client assets or use a related person who is a qualified custodian (rather than an “independent” qualified custodian) would need to obtain a written report from an independent public accountant.  The report would include an opinion as to the qualified custodian’s controls regarding the custody of client assets.  While the proposed changes would impact all registered advisers with custody of client assets, the changes would also have unique application to hedge fund managers.  In a guest article, Terrance J. O’Malley and Jessica Forbes, both Partners at Fried, Frank, Harris, Shriver & Jacobson LLP, examine the proposed changes to the custody rule from the perspective of a hedge fund manager.  Their article begins with a brief review of the rule’s history, then examines the current requirements under the rule and finally describes the proposed changes, including those most relevant to hedge fund managers.

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  • From Vol. 2 No.22 (Jun. 3, 2009)

    Bill Requiring Hedge Fund Managers to Disclose “Material Conflicts of Interest” Passes Connecticut State Senate

    On May 26, 2009, Connecticut’s Senate passed a bill that, if passed by the House and signed into law by the Governor, would require investment advisers to hedge funds and other private investment funds, whether or not registered with the Securities and Exchange Commission (SEC), to disclose “material conflicts of interest.”  The heart of Connecticut Senate Bill No. 953, “An Act Concerning Hedge Funds,” is Subsection 1(b), which provides: “Any investment adviser to a private investment fund, regardless of whether such investment adviser is registered with the United States Securities and Exchange Commission, shall comply with the disclosure requirements of Rule 204-3 under the Investment Advisers Act of 1940 . . . provided nothing in this subsection shall require the disclosure of any information other than material conflicts of interest of the investment adviser.”  We explore the bill’s legislative history, likelihood of passage, interaction with federal bills covering substantially similar substantive areas, the role of the Connecticut Banking Commissioner and the operation of Advisers Act Rule 204-3.

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