Hey Private Fund Advisor…The SEC is watching you!

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Hey Private Fund Advisor…The SEC is watching you!

Speaking at the Managed Fund Association (MFA) Outlook 2015 Conference earlier this month, Securities & Exchange Commission (SEC) Chair Mary Jo White noted that July marked the fifth anniversary of the Dodd-Frank Act which required the SEC to implement many, mostly completed, regulatory mandates. Most significant for private fund advisors were the rulemakings creating new registration and reporting requirements that entered approximately 1,500 new registrants into the SEC database.

Bigger numbers generate bigger data

A bigger database opens the door to more data collection on the advisors and their funds, White told attendees, adding that “required registration and reporting have been critical to increasing transparency and protecting investors in private funds.  But…having moved past the financial crisis and the implementation of the post-crisis rules, [the SEC is] in a new phase of oversight.

“Registration and reporting have given us significant insight into the nearly 30,000 private funds managed by 4,500 registered advisers, which helps us to understand potential risks for both individual firms and the broader financial system…We have also begun to analyze data reflecting private fund strategies, including the use of leverage and counterparty exposures.  Excessive leverage, lack of liquidity, and asset concentrations have in the past been at the root of financial crises, and we now have the regulatory tools to help better identify and appropriately mitigate potential problems. ”

More firms and advisors for the SEC to watch

According to White, “registration and reporting have also enabled [the SEC’s] staff in the Office of Compliance Inspections and Examinations (OCIE) to conduct targeted presence exams, and when appropriate, the Division of Enforcement to bring actions for the most serious violations.  Conflicts of interest and inadequately disclosed fees and expenses are examples of the serious firm-specific risks that have been identified through this process.”

So…when the SEC comes calling, will you be ready?

The financial crisis refocused financial regulators, causing them to look beyond risks that could have systemic impacts towards individual firm exposures as well. “Addressing these risks,” she said, “is fundamental to our longstanding mission to protect investors, maintain market integrity, and promote capital formation…investors are not protected if broad and interconnected segments of the financial system are at risk.”

Newly public Form PF statistics count nearly 2,600 private fund advisors managing more than $150 million each in private fund assets.  Among the largest of these private fund investors are individuals, pension plans, non-profits, and large hedge funds. “It is therefore natural,” White explained, “for the characteristics of [private funds] – their leverage, their concentration, their size – to be of interest to the SEC and [its] fellow regulators.”

The SEC is looking at individual firms

The SEC believes that some of the risks that can harm investors most directly are from recurring, specific compliance risks its examiners recommend every private fund adviser address every day.  Fiduciary duty is the cornerstone of the SEC’s regulatory framework for asset managers.  As part of that duty, the SEC recommends that investment advisers must serve the best interests of their clients and seek to avoid, or at least make full disclosure of, conflicts of interest, including those related to their organization, operation, and management of client assets.  At the completion of its presence exam initiative last year, SEC examiners identified several areas where cracks in this bulwark were found, including:


  • Marketing. Some hedgefund advisers may have used marketing materials that included back-tested performance numbers, portable performance numbers, and benchmark comparisons without key disclosures;
  • Disclosure of conflicts. Examiners observed that some hedge fund advisers may not adequately disclose conflicts related to advisers’ proprietary funds and the personal accounts of their portfolio managers.  Examiners saw, for example, advisers allocating profitable trades and investment opportunities to proprietary funds rather than client accounts in contravention of existing policies and procedures. On the private equity adviser side, examiners observed instances of conflicts involving fees and expenses, where some advisers may have improperly shifted expenses away from the adviser and to the funds or portfolio companies by, for example, charging a fund for the salaries of the adviser’s employees or hiring the adviser’s former employees as “consultants” paid by the funds.  Examiners also continue to observe advisers collecting millions of dollars in accelerated monitoring fees without disclosing the practice; and
  • Hiring. The SEC’s Private Funds Unit in OCIE is completing a review of private fund real estate advisers, many of which may be hiring related parties. Examiners are concerned that disclosure about these arrangements may be non-existent or potentially misleading, particularly with regard to whether or not the related parties charge market rates.


In her summation, White urged her audience “to focus on a number of recent, important enforcement actions by the Commission against private fund advisers.  Many of these actions also center on disclosure and conflicts of interest, including advisers misallocating expenses to funds; failing to disclose loans from clients; using funds to pay their operating expenses without authorization and disclosure; and failing to disclose fees and discounts from service providers.

“Investors,” she concluded, “regardless of their sophistication level, must have, and deserve to have, the information necessary about their adviser and funds to make an informed investment decision – including their adviser’s actual or potential conflicts of interests.”


So…compliance matters

Now that you are registered, the SEC can find you, audit your compliance processes and procedures, and ask you to produce data and records as they see fit.

Will you be ready? A recent survey reported that Chief Compliance Officers and their teams still spend a disproportionate amount of time collecting data, versus time spent adding strategic value to the business through analyzing and trending the data collected.”

Is that you? Do you have the right processes, programs, or systems in place?  And, if so, how do you access that data? How will you give the SEC what it wants when it wants it? CCOs are spending this “disproportionate amount of time” because they don’t have the right processes, programs, or systems in place, and they haven’t automated those processes, programs, or systems.

Are you juggling files and mountains of paper? How about outsourcing the burden of tracking and organizing your data and documents to an independent regulatory archival and compliance solutions specialist, like us to help keep your compliance processes and procedures running smoothly and compliantly? Ask about Patrina’s cost-effective and comprehensive regulatory archival and compliance solutions specifically designed for Broker/Dealers, RIAs, and FCMs.

Let’s talk. Call  (212-233-1155).