A Resolution for Advisers and CCOs: The (New Year’s) Annual Review

It’s a New Year!  And for advisers it’s again time for a new year’s resolution, only this kind of resolution is not voluntary.  Like holidays, it comes once a year, and while the responsibility for it falls on the adviser, the obligation to “administer” (or the commitment to follow our new year’s theme) falls on the Chief Compliance Officer – it’s called the Annual Compliance Review.  Further, consider it the type of resolution made mandatory by Rule 206-4(7) of the Investment Advisers Act of 1940 known as the “Compliance Rule.”

This new year’s “resolution” requires advisers and their CCOs not simply to resolve that they will do better with compliance than last year, but requires them actually to adopt and implement written policies and procedures reasonably designed to prevent a violation of the federal securities laws, and to evaluate their adequacy and effectiveness.

With this in mind, as CCO what have you resolved to do this year?  As the SEC’s Final Rule  clearly mandated, will your annual review of 2011, at a minimum,  address the adequacy of your policies and procedures in the following areas:

  • Portfolio management processes, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, disclosures by the adviser, and applicable regulatory restrictions;
  • Trading practices, including procedures by which the adviser satisfies its best execution obligation, uses client brokerage to obtain research and other services (“soft dollar arrangements”), and allocates aggregated trades among clients;
  • Proprietary trading of the adviser and personal trading activities of supervised persons;
  • The accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements;
  • Safeguarding of client assets from conversion or inappropriate use by advisory personnel;
  • The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
  • Marketing advisory services, including the use of solicitors;
  • Processes to value client holdings and assess fees based on those valuations;
  • Safeguards for the privacy protection of client records and information; and
  • Business continuity plans.

After considering those questions, among others, will advisers resolve in the new year to test 2011 to determine whether they have (i) met regulatory deadlines? (ii) conducted a risk assessment to determine any unique compliance risk exposure to its business?(iii) determined whether compliance procedures needed to be changed to better reflect the adviser’s business practices? (Obsolete procedures or programs that the firm cannot follow should be repealed) (iv) conducted adequate transactional, forensic or periodic tests of its procedures and programs in the areas mentioned in the Final Rule? (In both speeches and its own seminars, the SEC has made clear the importance of proper testing); and (v) adequately documented the annual review?  The SEC examination staff will ask advisers for documentation of their annual compliance review.  Further, Investment Advisers Act Rule 204-2(17)(ii) and Investment Company Act Rule 38a-1(d)(3) to preserve records documenting the annual review.

When looking back on your annual compliance review for 2011, what resolutions/changes or enhancements will you be making?

 

 

 

With New SEC Unit and Data Mining, Advisers Face Closer Scrutiny in 2012

With a renewed focus on analytics and more readily available data, expect the SEC’s scrutiny of investment advisers, including advisers to mutual funds, hedge funds, and private equity funds, to get  tougher.

In December, in a speech before the Consumer Federation of America’s Financial Services Conference, the SEC’s Director of Enforcement, Robert Khuzami, once again emphasized many of the organizational and structural changes that have already occurred and that will continue to impact the way investment advisers and mutual funds will be watched and regulated going forward.  Moreover, advisers may begin to feel the heat from these changes in a deeper, and for their investment adviser reps, and more personal way.  With changes to its organizational structure, the SEC created the Asset Management Specialized Unit to evaluate data and risk-based analytics.  One of the investigative practices the unit is implementing involves adopting a kind of early-warning framework to detect what Khuzami says is the kind of “retail fraud” that may foreshadow more serious problems within assets management and mutual funds.    

Utilizing a retail approach, what might the SEC’s enforcement division be looking at for potential signs of fraud?  Khuzami gives a few examples.  One involves the SEC scouring an adviser’s Form ADV to determine if they’ve lied about their educational achievements, their business affiliations, and their assets under management.  “For us, it’s advisers who lie about graduating Phi Beta Kappa, conceal their association in a past failed business venture, or inflate their assets under management who might well be the same persons who outright steal your money when the markets turn against them,” says Khuzami.

A second approach, for mutual funds, might involve the SEC reviewing databases in an effort to identify poor performance, when at the same time, the fund has relatively high fee arrangements, for them and their sub-advisers.  This, Khuzami says, may suggest excessive fee arrangements that can eat away at the mutual fund investment returns.  See More……

 

Effective July 21, 2011, Advisers to Hedge Funds and Private Equity Funds Face Registration

Under Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act, effective July 21, 2011, changes to the registration and reporting and recordkeeping requirements of the Investment Advisers Act of 1940 require advisers to private funds (hedge funds and private equity funds) to register with the SEC. In the past, many of these advisers relied on the so-called “private adviser” exemption to avoid registration. Under Section 403 of the Dodd-Frank Act, now some of these same advisers that exclusively advise venture capital funds and private fund advisers with less than $150 million in assets under management in the United States, face narrower exemptions for adviser registration. However, foreign private advisers and advisers to licensed small business investment companies are exempted.

Under the Dodd-Frank Act, the SEC will also have the authority to collect data from investment advisers about their private funds for the purposes of the assessment of systemic risk by the Financial Stability Oversight Council. Finally, the Dodd-Frank Act modifies the allocation of regulatory responsibility for mid-sized advisers between state regulators and the SEC. View More…