Sep. 20, 2018

The SEC Is Calling: How CCOs Can Stay Prepared for Initial Communications With OCIE Examiners (Part Two of Two)

Interacting with SEC examiners can be a nerve-racking experience for even the most seasoned chief compliance officer (CCO). Serving as the key point persons during examinations, CCOs must think quickly on their feet to respond accurately to questions from examiners, while ensuring that they present themselves and their employers in the best light possible. This two-part series explores the initial interactions during examinations between examiners from the SEC’s Office of Compliance Inspections and Examinations (OCIE) and an adviser’s CCO, including a detailed discussion about OCIE’s fairly new practice of requesting the CCO to participate in a call to discuss the adviser’s business and compliance program (Interim Call) prior to coming onsite to the adviser’s office. This second article in the series examines how the SEC is using Interim Calls to meet multiple objectives; outlines the topics that are generally discussed during these calls; and provides guidance for how CCOs can prepare for them, including what documents and information they should review in advance and what materials should be on hand during these calls. The first article discussed the ways in which the SEC initiates the examination process and provided insight into the form and substance of initial calls between the examiners and the CCO, including analysis of who participates in them on behalf of each of the SEC and the adviser. See “How Studying SEC Enforcement Trends Can Help Hedge Fund Managers Prepare for SEC Examinations and Investigations” (Sep. 8, 2016); and “ALM General Counsel Summit Reveals How Hedge Fund Managers Can Prepare for SEC Examinations” (Nov. 19, 2015).

With Midterm Elections Looming, Fund Managers Must Review the Pay to Play Rule

With the approach of the midterm elections, the current political climate has spurred increasing levels of political involvement, including large numbers of political contributions. Although citizen participation in the electoral process is a laudable democratic ideal, donations by designated individuals to certain government officials can create issues for investment advisers that provide investment services to government entities such as public pension funds under Rule 206(4)-5 of the Investment Advisers Act of 1940 – the so-called “pay to play rule” (Rule). The Rule bars an investment adviser from collecting compensation for providing investment advice to government entities for two years after a covered employee makes more than a de minimis contribution to the campaign of an official who can influence the selection of investment advisers by those entities. The SEC recently released settlement orders for three separate proceedings against investment advisers for violating the Rule by continuing to provide investment advice for compensation to public pension funds or plans during the “timeout” period. These enforcement actions are a sign that the agency continues to target pay to play violations – even those involving relatively small contributions. See “Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar” (Apr. 20, 2017); and “SEC Starts Year With Pay to Play Penalties” (Jan. 28, 2016). This article analyzes the Rule, discusses the relevant facts of these enforcement actions and presents insight from a compliance expert on their key takeaways. See “Four Pay to Play Traps for Hedge Fund Managers, and How to Avoid Them” (Feb. 5, 2015).

NFA Mandates New Disclosures on Certain Virtual Currency Activities

Citing a “variety of unique and potentially significant risks,” the NFA has issued an Interpretive Notice (Notice) to NFA-regulated firms that engage in certain derivatives and underlying or spot transactions involving virtual currencies. The Notice requires that regulated entities provide robust disclosures about the risks peculiar to virtual currency activities in their offering and disclosure documents and promotional materials, and provide customers with a specific notice expressing that the NFA does not have regulatory authority over spot or underlying virtual currency transactions. This article analyzes the key provisions of the Notice, along with several potential traps for unwary fund managers, with insight from a practitioner with expertise in this area. See our three-part series on blockchain and the financial services industry: “Basics of the Technology and How the Financial Sector Is Currently Employing It” (Jun. 1, 2017); “Potential Uses by Private Funds and Service Providers” (Jun. 8, 2017); and “Potential Impediments to Its Eventual Adoption” (Jun. 15, 2017).

How to Avoid Five Common Duty to Supervise Traps: Respond to Red Flags; Implement Reasonable Policies and Procedures; and Conduct Adequate Training (Part Three of Three)

A review of recent SEC enforcement actions against broker-dealers and investment advisers alleging violations of their respective duties to supervise their employees provides practical guidance to fund managers on how they can avoid similar SEC allegations. With the circumstances of these enforcement actions as the backdrop, the second and third articles in this three-part series discuss five common duty to supervise traps. This third article explores failure to respond properly to red flags; failure to implement reasonable policies and procedures; and failure to properly train supervisors, traders and salespeople. The second article analyzed failures to conduct adequate trade surveillance and to conduct adequate communications surveillance. The first article reviewed the duty to supervise for both broker-dealers and investment advisers and summarized the violations in those enforcement actions. See “Will Inadequate Policies and Procedures Be the Next Major Focus for SEC Enforcement Actions?” (Nov. 30, 2017).

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).

Former OCC Examiner Joins ACA Compliance Group As Director of Banking Asset Management

The new director of banking asset management for ACA Compliance Group (ACA) is Roy Kim. Based in New York City, Kim joins ACA from the Office of the Comptroller of the Currency, where he was an examiner supervising the asset management activities of national banks. For commentary from other ACA consultants, see “Effects of Impending MiFID II on U.S. Advisers” (Dec. 7, 2017); “Challenges and Solutions in Managing Global Compliance Programs” (Oct. 5, 2017); and “How Private Fund Managers Can Avoid Common Pitfalls When Calculating and Advertising Internal Rates of Return” (Sep. 7, 2017).