Wednesday, 23 July 2014
Last updated 4 hours ago
Jul 9 2012 | 7:43am ET
Perrie Weiner and Nick Morgan are both partners at DLA Piper—Weiner is the international co-chair of firm’s securities litigation practice and a managing partner of the Century City office while Morgan is the West Coast chair of the firm’s securities enforcement practice. FINalternatives recently asked them to respond to some frequently asked questions about increasing regulation and scrutiny in the hedge fund industry. Here’s what they had to say.
1. What new techniques is the SEC employing that will impact hedge funds?
The SEC recently announced implementation of a "risk analytics" program. The SEC’s “Aberrational Performance Inquiry,” conducted by the SEC enforcement division’s asset management unit, uses proprietary techniques to evaluate hedge fund returns. Performance that appears inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further scrutiny. In other words, the SEC is looking for returns that appear too good to be true, and is launching investigations and bringing cases, including four in December 2011. In recent testimony, SEC Chairman Mary Schapiro said the commission’s enforcement and examination programs will “continue to develop and implement robust analytical models to identify regulated entities with high-risk profiles.”
2. What sorts of issues is the SEC looking for with these new techniques?
One big issue we see time after time under the SEC's microscope involves portfolio valuation. These issues could involve allegations of something as nefarious as market manipulation of thinly traded stocks to pump up a portfolio or making arbitrary "price adjustments" designed to spread markdowns over a period of time instead of all at once to something as difficult to assess as when to mark down a convertible security in an insolvent portfolio company with significant assets. We are seeing multiple current instances of the SEC's closely examining, with the benefit of hindsight, the appropriateness of various funds and others' valuation estimates for hard-to-value and/or illiquid investments. The SEC's director, office of compliance inspections and examinations, reiterated in late March 2012 that "valuation practices are a top priority, particularly when the adviser manages difficult to value instruments." And the SEC has not been shy about using its relatively new rule 206(4)-8 in this area (and brought at least three cases under the rule in the past 12 months). The rule does not require showing any fraudulent intent, so the SEC could charge even negligent valuation decisions.
3. How has the social media explosion impacted hedge funds and advisers?
The use of social media like LinkedIn and Facebook actually raises a number of compliance, ethical, and record-keeping issues. Earlier this year, the SEC put out a publication entitled Investment Adviser Use of Social Media, which provides advice on things like the use of the "like" feature as a testimonial, record-keeping requirements of postings, and other related issues. One day prior to the social media alert, the SEC had instituted administrative and cease-and-desist proceedings against an investment adviser (Anthony Fields), alleging that Fields used various social media sites, including LinkedIn, to offer to buy and sell more than US$500 billion of fictitious bank guarantees and medium-term notes. The order also accuses Fields of (1) failing to adopt or implement written policies and procedures designed to prevent violations of the Investment Advisers Act of 1940, (2) failing to maintain books and records required of registered investment advisers, (3) failing to establish, maintain and enforce a required written code of ethics and (4) publishing false and materially misleading information on various websites.
4. What are the most significant impacts of Dodd-Frank legislation on hedge funds?
Many of the most significant impacts are only occurring as the regulators implement various Dodd-Frank provisions through rule making. For example, late last year, the SEC and CFTC jointly adopted a rule requiring many hedge fund advisers to complete a Form PF, disclosing detailed information about their funds' holdings and investments to federal regulators. Under the rule, commission-registered investment advisers managing at least $150 million in private fund assets will be required to periodically file Form PF. For large advisers (i.e., those with over $5 billion in assets under management), these filings will be due as early as the third quarter of 2012.
5. Is the news all negative on the regulatory front for hedge funds?
No, in fact, the JOBS Act, which President Obama signed into legislation on April 5, contains, among other things, a provision that would lift a Depression-era ban on advertising unregistered private placements to the general public. That would allow hedge funds and private equity funds to advertise under certain circumstances, but of course any such advertisements will be heavily scrutinized by regulators. Under the terms of the Act, the SEC is required to modify the prohibition against general solicitation and general advertising in Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933 (Securities Act) within 90 days of the Act’s enactment (i.e., by early July 2012).
Jul 8 2014 | 10:48am ET
The surge in derivatives regulation is among the most complex challenges facing the financial services industry today. Northern Trust’s Joshua Satten recently spoke with FINalternatives to share insights into the challenges presented by new regulation and explore how the industry is responding. Read more…