by HFBOA
17. May 2010 18:26
HFBOA Luncheon Recap
May 13, 2010
The May luncheon was held May 13, 2010 in Chicago. Thanks to Drinker Biddle for hosting the event and Jeff Blumberg for leading the discussion. The main theme was the general state of the industry and regulatory environment, but other topics also were covered.
The industry is presently under more scrutiny than ever. The recent SEC charges against Goldman Sachs have caused the fiduciary duty of investment advisors to be closely reviewed for improprieties. The duration of institutional due diligence has increased significantly. Instead of asking for certain documents and then checking the box when the document is received, institutions are taking the time to read and examine what is given, searching for inconsistencies and actual adherence to written policies. Appropriate checks and balances in allocating trades and best execution requirements are important. Segregation of assets and appropriate custody mandatory. If managers self-administer, a SAS 70 report on the manager will most likely be required.
Hedge-Fund Regulation
Regulation has been on the table for over a year but was pushed aside during the health care debate. It is now gaining momentum in the Senate, with passing generally assured. Funds will probably have twelve months to register after the date of enactment, with January 1, 2012 being the likely date.
There has been a tepid grass roots campaign by hedge fund managers to oppose registration. The advocacy organization for hedge funds is the Managed Funds Association ("MFA"), which is controlled by personnel from the largest hedge funds. The large funds are registered already, so opposition is not a MFA priority.
As part of the Senate bill there is a directive to the SEC to increase the net worth criteria for Accredited Investor status, by utilizing the increase in the Consumer Price Index ("CPI"). Presently, it is unclear if the starting point would be 1982, which is the year the current $1,000,000 threshold was instituted, or if the CPI adjustment would be prospective from the enactment date. If the CPI adjustment is applied retroactively from 1982, the net worth threshold would increase immediately to over $2,000,000. In any event, should a current investor no longer qualify as accredited because of an increase in the net worth threshold, he or she would not have to exit the fund, but would be precluded from investing additional capital.
Alternative measures being discussed for Accredited Investor status would remove the net worth requirement and replace it with a minimum education standard. Another, perhaps better alternative, would require the investor to have a minimum of $1,000,000 in investments. The current net worth requirement of $1,000,000 may include the investor’s personal residence. No matter the outcome, the advisor will need a reasonable basis to believe an investor is as financially sound as purported, with supporting documentation supplied with the subscription documents.
SEC Audit Issues
Although politically popular, SEC registration will provide a false sense of security as the SEC has insufficient manpower. One attendee whose firm underwent an audit has not received the closing letter from the SEC even though fieldwork was completed fourteen months ago. Further, another attendee stated the last SEC audit her firm was subject to, the SEC auditor could not speak English, and likely was sent to the wrong RIA. There is a push by the SEC to hire knowledgeable and experienced personnel, many being ex-Wall Street employees laid off during the crisis. Even with a SEC personnel upgrade, an advisor will eventually be sued for fraud, even if the advisor is registered (another black eye for the SEC).
The SEC is conducting more surprise audits based upon tips, with the SEC arriving at the subject advisor within twenty-four hours from receiving the information. During an audit, it is not uncommon for the SEC to expect document requests to be fulfilled within twenty-four hours.
Other
The House of Representatives has twice passed legislation that would tax incentive fees as ordinary income instead of capital gain income, only to have the measures die in the Senate. There is now strong support in the Senate and will probably be included in the next tax bill. Effective date would be January 1, 2011.
Mandatory listing on an exchange of derivative products is still being debated. The benefit would be the reduction of counter-party default risk because the exchange would guarantee the trade, not a JP Morgan or Morgan Stanley. The detriment would be the standardization of the products. Since the purpose of products such as credit default swaps is the capacity to hedge risk, standardized products will be unable to address all risk scenarios.
Kurt Koeplin, Member of the HFBOA Executive Board
by HFBOA
11. May 2010 19:01
I recently attended a symposium hosted by the Chicago office of a law firm with a substantial investment management practice. Topics discussed were broad but focused primarily on operations, with several interesting points. In general, the duration of time to complete operational due diligence on a manager has increased substantially.
Back office responsibilities have expanded to include portfolio stress testing and risk management. Value at Risk under different scenarios such as oil price shocks, the sub-prime defaults, inflationary periods and the Greek credit crisis are typical. Further, the time period to completely liquidate the portfolio under the aforementioned scenarios should be addressed.
Managers that run a co-mingled fund along with managed accounts are facing additional scrutiny. Should the owner of the managed account force a complete liquidation, the manager needs to demonstrate how asset prices in the co-mingled fund are potentially affected.
A comprehensive disaster recovery and business continuity plan must be in place with evidence of robust testing, even for advisors that are not registered with the Securities and Exchange Commission. Also, compliance manuals and a code of ethics are frequently being requested from non-registered advisors.
A usual query by a potential investor is how the portfolio or business would be affected should the CIO or a key analyst be "hit by a bus." This question is now being posed in the instance of the CFO’s or COO’s unexpected demise. Be prepared to define the responsibilities of all back office\operational personnel, and the adverse affect on the organization should any operations personnel become suddenly inactive.
Sincerely,
Kurt Koeplin, Chief Financial Officer, Rail-Splitter Capital Management, LLC
Member of the HFBOA Board of Directors
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