by HFBOA
11. April 2011 18:41
View the latest edition of the HFBOA Newsletter: Regulatory Update! Where's the SEC Focus? What's Coming Down the Pike?
HFBOA interviewed Barry Schwartz, Partner at ACA Compliance Group, and Robert Van Gvoer and Steven Nadel, both Partners at Seward & Kissel LLP, to determine the most important regulatory issues funds are now facing, and to determine the implications of proposed regulations that may affect funds in the near future. There are a number of "hot button" ares of SEC focus that fund managers must be aware of, and several key issues involved in the implementation of the Dodd-Frank Act that will greatly affect fund managers.
HFBOA_April_2011_Newsletter_v2[1].pdf (97.72 kb)
by HFBOA
1. February 2011 01:06
Expert networking firms are now a target of the SEC, along with traders who act upon any inside information. So far expert networking firms that provide information via channel checks have not been subject to SEC inquiry. However, a concern in the future is at what point does information gathered become inside information. Asking a pharmacist at the local Walgreen’s how much of a drug is prescribed is ok. Asking the same question to the regional Walgreen’s VP could be an issue. Speaking with operations and sales people of companies is becoming a questionable area. There is huge uncertainty in this area. Be careful if the expert used to work at the company you are discussing, or if he or she were once a consultant for the company.
The Galleon case is the first insider trading case that has relied upon wiretaps for information gathering. Wiretaps remove the circumstantial nature of evidence gathered in insider trading cases and have the potential of turning civil cases into criminal cases, as the Department of Justice has authority to request wiretaps, not the SEC.
Officers of foreign companies may not be subject to equivalent insider trading or full disclosure requirements as their US counterparts. However, any information obtained from the foreign company must be treated in the same manner as information obtained from a US company.
A CCO can protect their firm by emphasizing training of its professionals at least annually. Also, know the firms experts, what steps does the expert networking firm take if the firm thinks it has received insider information? Create and document policies and procedures and make sure they are followed. From an SEC standpoint, not following written policies is nearly as egregious as having no policy at all. Look at the source of information in determining a trade. If it is at the least suspect, put the company on the do not trade list.
Kurt Koeplin, Chief Financial Officer, RAIL-SPLITTER CAPITAL MANAGEMENT, LLC
by HFBOA
25. January 2011 18:24
All HFBOA members are invited to download a copy of the presentation from the January luncheon - featuring topic experts from Rothstein Kass!
Click here to download:
www.hfboa.org\pdf\sas70hf.pdf
by HFBOA
14. January 2011 16:56
The first HFBOA luncheon of 2011 was held in New York City on January 13, 2011. The event was hosted by Evan Margolin of Studley, a tenant only advisory service firm. Evan concentrates in locating office space for hedge fund managers and began the lunch with a few observations.
After two years of contraction, there have been over 700 launches of new hedge funds during the first three quarters of 2010, with several existing firms expanding. Manhattan vacancy rates are decreasing with a commensurate increase in rental rates. Lease rates for mid-town office space are creeping toward $100 per square foot. Of the hedge funds located in New York, approximately 90% are situated in the mid-town area, with the balance located downtown.
Rothstein Kass Update
The main portion of the lunch was a discussion by Joshua Blumenthal and Joseph Markowski of Rothstein Kass ("RK"), focusing on regulatory issues and year-end processes, concentrating on preparations for the annual audit. RK suggested the first step is the development of a timeline with input from all three groups involved in the audit, the client, the administrator and the audit firm. With the timeline, there will be accountability for everyone on their respective deliverables. Also, preferably prior to year-end, the auditor should be alerted of the following:
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Fund structure changes
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Offering document changes
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New side letters
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Any new fund offerings
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Investment or valuation changes
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Any communications from regulatory agencies
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Any service provider changes
The above list is not all-inclusive. Further, the financial statement templates should be confirmed as quickly as possible.
The major 2010 change in the financial statement presentation is the FAS 57 (Topic 820) footnote disclosure detailing the asset levels. The footnote will need more detail and explain more clearly what assets comprise each level. The observable inputs used in valuing the assets will need expanded explanation, and transfers between levels will require explanation. Mandatory beginning in 2011, but optional for 2010 audits, a roll-forward schedule of the assets in each level will need inclusion in the financial statements.
As for Fin 48, the major change was positive. Australia recently issued its position, and stated it will not collect tax on investment income sourced in that country, for the years ended 2010 and prior. The ruling removed uncertainty and will allow any fund that previously booked a liability for potential Australian tax to reverse the accrual.
Dodd\Frank Bill
As everyone is aware by now, an investment advisor with $150 million or more under management must register with the SEC by July 21, 2011. Investment advisors with $100 - $150 million under management are not required to register unless the advisor has a managed account. There are further exemptions from registering for advisors managing less than $100 million. RK suggests the investment advisor file its Form ADV with the SEC at least six weeks prior to the July 21 deadline.
Should a SEC registered investment advisor liquidate a fund, the fund is required to have an audit that reflects the fund having zero assets and zero liabilities. This will be convoluted as most funds hold back assets for expenses incurred for winding down the fund. A liquidating trust may be set up to transfer assets used to wind down the fund, but the liquidating trust must then be audited and reflect zero assets and liabilities. A conundrum, with at this point no logical solution.
SAS 70
SAS 70 is being replaced by a new standard, SSAE 16. The new standard requires an assertion by company management that opines on the effectiveness of the company’s internal controls.
Becoming more common when conducting due diligence, foreign investors and large pension plans are requesting SAS 70 reports on a fund manager’s front and middle office operations. Assumptively the back office SAS 70 will be covered by the fund’s administrator. The fund manager may not have the ability or financial wherewithal to provide a front\middle office SAS 70 report, but should be ready to document and explain its control processes in these two areas.
Finally, inflows are beginning to inch into smaller funds after two years of being the exclusive domain of the larger, more recognized funds.
Kurt D. Koeplin, Chief Financial Officer, RAIL-SPLITTER CAPITAL MANAGEMENT, LLC, Member, HFBOA EXECUTIVE BOARD
To register to receive a copy of Rothstein Kass’ Alternative Investment Fund Pro Forma Financial Statements Reference Manuel: http://www.rkco.com/Site/CorpAlternativeInvestmentFundProforma.aspx
2010 Hedge Fund Outlook: Back to the Future:
http://rkco.com/Site/ProprietaryResearch/CorpContent.aspx
SAS70 Presentation, see SAS 70 For Hedge Fund- November 2010, webinar slides:
http://www.rkco.com/Site/Webinars/CorpContent.aspx
http://www.hfboa.org/pdf/sas70hf.pdf
by HFBOA
30. November 2010 23:48
The HFBOA interviewed several experts in the UCITS arena, following its well-attended conference on the topic held November 8. The HFBOA and Financial Research Associates are planning another UCITS event March 30-31 in New York. To read what our experts had to say about questions related to UCITS such as, "Is the demand for UCITS going to last?", download our latest newsletter today!
by HFBOA
14. September 2010 18:48
What have reactions been to the latest regulatory initiatives, and what are the expectations moving forward? The HFBOA sat down with three panelists: A legal expert, a CCO from a non-registered investment adviser & hedge fund, and a CCO from a registered investment adviser & hedge fund. Each brings to the table a unique perspective on the hottest issues, including: Registration with the SEC and with individual states; financial reporting requirements; the expected impacts on smaller funds and private equity firms; and things we should all be working on to ensure we're prepared.
Download the latest HFBOA Newsletter now!
by HFBOA
13. August 2010 03:12
This article is written by Janaya P. Moscony, President of SEC Compliance Consultants and the chairperson of the October 27th Hedge Fund Registration Master Class. We've reposted it from the FINalternatives website, where it was featured on August 11, 2010
(Psssst.... Reference this blog posting code: FMP197 to save 15% off the registration fee for that one-day program)
The article:
Are Hedge Funds Ready for SEC Registration? In most cases, they are more ready than they believe.
October 16, 2009 - We at the SEC are committed to pulling back the curtain on hedge fund operations and taking a close look at their activity. We are developing a variety of initiatives to do that involving greater specialization and expertise, improved technological tools to track and analyze trading, better coordination among regulators and law enforcement, new legislative initiatives, and other means to address these areas.
It would be wise for investment advisers and corporate executives to closely look at [the Raj Rajaratnam] case, their own internal operations, and the increasing focus and scrutiny on hedge fund trading activity by the SEC and others, and consider what lessons can be learned and applied to their own operations.
Robert Khuzami,
Director, SEC Division of Enforcement
U.S. Securities and Exchange Commission
Based on the above quote, who can blame a hedge fund manager for being a little skittish about pending SEC registration?
Despite the hype, the SEC is not out to get hedge funds. They are focused on improving their batting average with finding fraud and hedge funds provide good headlines. Even though the number of hedge funds willfully engaging in misconduct is minute, hedge fund managers should expect to be examined by the SEC. Although the implications and cost of on-going registration may appear burdensome, many firms may be better prepared than they think. By formalizing existing procedures as part of a complete compliance program with policies and procedures mapped to a thorough firm-wide risk-assessment, any SEC visit should be routine.
Nonetheless, many managers to hedge funds continue to be concerned. This is to be expected with the recent passage of the Private Fund Investment Advisers Registration Act of 2010. The registration act is part of the larger Dodd-Frank Wall Street Reform and Consumer Protection Act. The 27 pages of the registration act could easily be missed in the 2,307 pages of the larger reform bill. However, the impact of those few pages will be dramatic on hedge funds with assets greater than $150 million.
Hedge fund managers will need to quickly become familiar with Rule 206(4)-7 of the Investment Advisers Act of 1940 known as the Compliance Rule. Enacted in 2004, following scandals almost a decade ago, Rule 206(4)-7 requires registered advisers to adopt and implement written policies and procedures reasonably designed to prevent violation of the Advisers Act by the adviser or any of its supervised persons. The rule requires advisers to consider their fiduciary and regulatory obligations under the Advisers Act and to formalize policies and procedures to address them.
Rule 206(4)-7 does not specifically list the elements that advisers must include in their policies and procedures. The SEC acknowledges that advisers are too varied in their operations for the rules to impose a single set of universally applicable required elements. Each adviser is required to adopt policies and procedures that take into consideration the nature of their specific operations. Advisers must therefore have customized policies and procedures designed to prevent violations from occurring, detect violations that have occurred, and correct promptly any violations that have occurred.
It is our experience that many unregistered hedge fund advisers already have procedures and controls in place in certain areas of their business that are pretty close to satisfying the SEC's expectations. In some cases, prime brokers and third party administrators and trading platforms provide certain checks and verification procedures which can be incorporated into a compliance program.
Below are some of the compliance areas hedge fund advisers may have procedures close to satisfying SEC requirements.
Portfolio Management Processes.
This includes allocation of investment opportunities among clients, managing portfolios consistently with stated mandates, and abiding by applicable regulatory restrictions. Given that certain private fund advisers may manage more than one fund, matters regarding allocation and adherence to the different mandates and objectives of each fund, are already in place.
Trading Practices.
This includes procedures by which the adviser satisfies its obligation to seek best execution and using client brokerage to obtain research and other services. Managers realize one of their strongest currencies on the street is their commission dollars and are aggressive in seeking the best combination of commission rates and services from their brokers. Hence, most advisers have practices in places to assess best execution.
Accuracy of Disclosures.
All advisers, whether registered or not are subject to the anti-fraud provisions of the Advisers Act and ensuring adequate disclosure is always the first level of defense. As such, hedge fund lawyers are very good at ensuring all necessary disclosures are including in offering documents and a large part of the required disclosure is already exists. Once registered, advisers will be required to complete Form ADV, the main disclosure document for SEC-registered advisers. Also known as the firm’s brochure, Form ADV Part II is where advisers discuss their business, conflicts of interest and other material facts. All new investors must be presented with a copy and all existing investors must be offered at least annually an updated brochure. Even if something is not specifically addressed in the ADV, the SEC expects disclosure if an item would be deemed material to an investor making a decision to invest or remain invested with a manager. When we draft a hedge fund client’s ADV, we are able to obtain a great deal of the information from existing offering documents. The new ADV requirements will require all disclosure to be publically available on the SEC’s website.
Safeguarding of Client Assets.
This includes safeguarding fund assets from conversion or inappropriate use by advisory personnel. Private fund managers may already have more sophisticated expertise in this area than other investment managers given the greater variety, and relatively atypical nature, of instruments held in some private fund portfolios compared to those of other advisers who typically hold only publicly-traded securities. Experience in securing possession of, and holding, non-traditional investments makes safeguarding an area where private fund advisers may already have established systems and controls, especially with the help of their prime brokers and other service providers.
Books and Records.
This involves maintenance of records in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction. The SEC has precise requirements regarding types of records to be maintained and how long they must be maintained. Again, prime brokers and other service providers often perform services and maintain certain records with the necessary redundancy.
Asset Valuation.
Valuation has been an issue of major importance to all hedge fund constituents including regulators as it is a critical factor in determining compensation to the fund adviser. Potential institutional investors often inquire about valuation methodologies used especially with respect to alternative, illiquid or otherwise closely-held investments. Private fund advisers should have fairly strong procedures in place for valuing investments. Like institutional investors, the SEC staff will also have similar interest.
Business Continuity Plans.
Many private fund advisers may consist of just a few employees, having outsourced many functions to other service providers. Therefore, while they may not have formal business continuity plans, certain service providers may be providing the necessary level of redundancy in certain areas. As stated above, policies and procedures are to "take into consideration the nature of their specific operations." An adviser's business continuity plans should take into account the number of staff members and support provided by service providers in order to continue business operations during the period of disruption.
In many cases, hedge funds have established practices. It may be an issue of formalizing them into written policies and procedures.
SEC Compliance Consultants’ Guide to SEC Registration for Private Fund Investment Advisers provides a complete guide to the SEC registration process and the on-going compliance requirements.
Janaya Moscony, CFA, is the President and Founder of SEC Compliance Consultants, Inc. As a former Securities and Exchange Commission regulator, Moscony has extensive experience in the examination, implementation and enforcement of securities regulations of investment advisers. As a consultant, she advises financial institutions how best to effectively manage the regulatory environment with a focus on balancing business needs with regulatory requirements. Prior to incorporating SEC3, Moscony served as Vice President of Bank of Hawaii’s Asset Management Group where she advised and implemented the bank’s regulatory compliance program. Prior to Bank of Hawaii, Moscony was employed as a regulatory consultant by a nationally recognized consulting firm where she managed numerous engagements with banks, mutual funds, investment advisers and broker-dealers. Moscony began her career as an examiner with the Philadelphia District Office of the SEC where she worked on routine and for- cause examinations as well as enforcement cases on behalf of a broad-range of financial entities.
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
28. April 2010 00:27
The April luncheon was held April 22nd in New York. Thank you to Linedata Services for hosting this event.
The topics discussed were: Institutional Hedge Fund Due Diligence, Properly Managing Operational Risk –Technology’s Increased Role in Fund Management and What to Expect from Regulators in 2010.
Institutional Due Diligence-The New Checklist.
The panel started out by agreeing that investors are spending significantly more time on due diligence and that the investment process has lengthened averaging about six months in duration. Small hedge funds are being held to standards that previously only applied to larger hedge funds and investors are demanding proof that managers actually are doing what they promised to do.
The panel suggested that managers put a risk assessment process in place to review (no less than annually) their firms in an effort to spot conflicts and issues with respect to their operations. Managers need to be able to recognize issues, address them and document how they resolve the particular matter. If necessary, it was suggested that Committees be formed and/or outside persons be brought in to assist with the review.
Additional best practices suggestions were strengthening internal management, having real time risk management, automation of processes front to back and multiple prime brokers and custodians to reduce the risk to assets.
Investors performing due diligence are looking for any inconsistency between what is in the fund’s marketing and organizational documents and what they hear or see is actually occurring. As part of the due diligence process, it is not uncommon for investors to ask to meet with traders, back office and compliance personnel as well as tracing transactions from front to back.
New Operational Requirements
Investors want to know who has access to information at a firm? They want to know what are the security protocols for data transmissions? What are the disaster recovery procedures? How quickly can you recover? What are the controls on cash and cash movements? How are trades aggregated and allocated when there are multiple funds or a managed account running alongside a commingled fund? What is the manager’s valuation policy? They want to test it.
While an outside administrator is a necessity-How does the manager check the work of the administrator? Does the manager reconcile to the administrator? How often does the manager meet with their service providers? How often does the manager review the service provider’s level of service?
The greater the degree of automation the better. Stand-alone excel schedules are frowned upon. Investors want to see systems in place and controls against human error.
Remember, there are always other places to invest-investors want to be with managers that are continually upgrading their systems and controls and providing transparency on their operations.
What Can We Expect From Regulators?
Most commentators are expecting that Advisors will have to register at some level of AUM whether that is 30 million, 100 million or 150 million. While it is expected that there would be some period to ramp up, the panel recommended not waiting until the last minute to register, as there may be delays in the registration process.
For advisors that have been in business for some time, that will most likely require a scrubbing and updating of their organizational documents. While most advisors whether registered or not, have best practices in place, the biggest change is probably undergoing the required audit by the SEC.
SEC audits have become more intense and time consuming. Current areas of interest to the SEC are controls on cash, operational controls, insider trading, best execution, how analysts get their investment ideas, fund expenses, soft dollar arrangements and disclosure thereon.
SEC examination teams may have enforcement division staff mixed in in an effort to obtain greater insight on the hedge fund business. This carries a greater risk to managers that may not be aware of the mixed make up of some teams.
Advisors need to have procedures in place to maintain all of the information required by the SEC and be able to produce it in a short period of time if requested by an examiner.
- George Roeck, Executive Board Member, HFBOA
by HFBOA
15. March 2010 18:55
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