Is Your Pooled Investment Vehicle In Compliance with the SEC's New Custody Rule for Investment Advisers
The recent changes by the U.S. Securities and Exchange Commission ("SEC") to Rule 206(4)-2 under the Investment Advisers Act of 1940 include an important development for investment advisers that operate so called pooled investment vehicles. Pooled investment vehicle is an SEC term and includes private investments such as limited liability companies and limited partnerships not registered as investment companies. For example, unregistered hedge funds fall under this category.
Investment advisers that operate pooled investment vehicles are required to: use a qualified custodian (e.g. a registered broker/dealer or registered bank) to hold assets of the pooled investment vehicle; form a reasonable belief that the qualified custodian delivers account statements to all investors; and comply with the annual surprise verification examination. Many pooled investment vehicles own or hold assets, such as real estate, not held at a qualified custodian. Therefore, complying with the qualified custodian, account statements and surprise verification examination requirements will prove impossible. For this reason, the SEC has provided relief to these requirements so long as the pooled investment vehicle is subject to an annual financial statement audit performed by an independent accounting firm; the audit is performed within 120 days after the pooled investment vehicle’s fiscal year-end; and the results of the audit are delivered to all investors of the pooled investment vehicle.
Many pooled investment vehicles are already subject to annual financial statement audits and deliver the results to investors so the new rule will have little impact in this regard. However, the new rule requires pooled investment vehicles to hire and retain independent accounting firms that are registered with and inspected by the Public Company Accounting Oversight Board (PCAOB). Pooled investment vehicles that are not subject to an annual financial statement audit performed by a PCAOB registered and inspected accounting firm and/or do not deliver the results of such an audit to investors, must ensure assets are held with a qualified custodian, all investors receive statements directly from the qualified custodian(s), and ensure compliance with the annual surprise examination requirements.
This Thursday, March 25, we will be hosting our second webinar on the new SEC custody rule. The webinar will begin at 12:00 p.m. Central and will focus specifically on how the rule applies to pooled invest vehicles and investment advisers operating a qualified custodian and/or introducing broker-dealer. We discuss the annual audit requirements and many other pressing issues for pooled investment vehicles. Click here to enroll.
Investment advisers that operate pooled investment vehicles are required to: use a qualified custodian (e.g. a registered broker/dealer or registered bank) to hold assets of the pooled investment vehicle; form a reasonable belief that the qualified custodian delivers account statements to all investors; and comply with the annual surprise verification examination. Many pooled investment vehicles own or hold assets, such as real estate, not held at a qualified custodian. Therefore, complying with the qualified custodian, account statements and surprise verification examination requirements will prove impossible. For this reason, the SEC has provided relief to these requirements so long as the pooled investment vehicle is subject to an annual financial statement audit performed by an independent accounting firm; the audit is performed within 120 days after the pooled investment vehicle’s fiscal year-end; and the results of the audit are delivered to all investors of the pooled investment vehicle.
Many pooled investment vehicles are already subject to annual financial statement audits and deliver the results to investors so the new rule will have little impact in this regard. However, the new rule requires pooled investment vehicles to hire and retain independent accounting firms that are registered with and inspected by the Public Company Accounting Oversight Board (PCAOB). Pooled investment vehicles that are not subject to an annual financial statement audit performed by a PCAOB registered and inspected accounting firm and/or do not deliver the results of such an audit to investors, must ensure assets are held with a qualified custodian, all investors receive statements directly from the qualified custodian(s), and ensure compliance with the annual surprise examination requirements.
This Thursday, March 25, we will be hosting our second webinar on the new SEC custody rule. The webinar will begin at 12:00 p.m. Central and will focus specifically on how the rule applies to pooled invest vehicles and investment advisers operating a qualified custodian and/or introducing broker-dealer. We discuss the annual audit requirements and many other pressing issues for pooled investment vehicles. Click here to enroll.
Labels: Custody, Hedge Funds, Pooled Investment Vehicle, Webinar
posted by bhill at 11:31 AM
Private Investment Advisers Registration Act is Passed by House Committee on Financial Services
The Financial Services Committee of the U.S. House of Representatives passed H.R. 3818, the Private Fund Investment Advisers Registration Act, which requires advisers to private funds to register with the U.S. Securities and Exchange Commission ("SEC").
The Wall Street Journal reported that the Committee agreed that private funds managing less than $150 million would be exempt from the SEC registration requirement. The WSJ noted that small business investment companies ("SBICs") subject to the oversight of the U.S. Small Business Administration along with venture capital fund managers will be exempted from SEC registration. However, it appears that private equity funds and single family offices will be required to register with the SEC in the bill passed by the Financial Services Committee. MarketWatch reported that Rep. Susan Kosmas explained that this bill includes a one-year transition period before registration with the SEC is mandatory for private funds.
The next stop for H.R. 3818 is the floor of the U.S. House of Representatives. RIA Compliance Consultants will continue to keep readers abreast of the status of the bill in the House and its counterpart in the Senate.
The Wall Street Journal reported that the Committee agreed that private funds managing less than $150 million would be exempt from the SEC registration requirement. The WSJ noted that small business investment companies ("SBICs") subject to the oversight of the U.S. Small Business Administration along with venture capital fund managers will be exempted from SEC registration. However, it appears that private equity funds and single family offices will be required to register with the SEC in the bill passed by the Financial Services Committee. MarketWatch reported that Rep. Susan Kosmas explained that this bill includes a one-year transition period before registration with the SEC is mandatory for private funds.
The next stop for H.R. 3818 is the floor of the U.S. House of Representatives. RIA Compliance Consultants will continue to keep readers abreast of the status of the bill in the House and its counterpart in the Senate.
Labels: Hedge Funds, Registration
posted by bhill at 10:46 PM
SEC Chair Predicts Detailed Disclosures by Hedge Funds to Regulators
The Wall Street Journal ("WSJ") recently reported that "Securities and Exchange Commission Chairman Mary Schapiro predicted that any new regulation of hedge funds will likely require detailed disclosure to regulators, but not necessarily as much disclosure to the public."
According to the WSJ, "[i]f proposed legislation under consideration by Congress to require hedge-fund advisers to register with the SEC is enacted, Ms. Schapiro predicted that the final regulation will result in "fairly detailed reporting to regulators and some level of public reporting to investors."
However, the WSJ noted that Schapiro "...acknowledged that in some instances, such as dealing with hedge funds, it can be hard to strike a balance between informing investors without disclosing too much about firms' trading strategies. She said there are still "issues to be resolved" in this area."
According to the WSJ, "[i]f proposed legislation under consideration by Congress to require hedge-fund advisers to register with the SEC is enacted, Ms. Schapiro predicted that the final regulation will result in "fairly detailed reporting to regulators and some level of public reporting to investors."
However, the WSJ noted that Schapiro "...acknowledged that in some instances, such as dealing with hedge funds, it can be hard to strike a balance between informing investors without disclosing too much about firms' trading strategies. She said there are still "issues to be resolved" in this area."
Labels: Hedge Funds
posted by bhill at 9:16 PM
SEC Files Enforcement Action Against an RIA for Allegedly Failing to Disclose Compensation Received from Private Investment Funds
On May 20, 2009, the U.S. Securities and Exchange Commission ("SEC") announced that it had filed an emergency civil action charging Wealth Management LLC (registered investment adviser), James Putman (founder, majority owner and Chief Executive Officer of Wealth Management), and Simone Fevola (former President and Chief Investment Officer of Wealth Management) with engaging in a kickback scheme and other fraudulent conduct involving unregistered investment pools for which Wealth Management served as a General Partner or Managing Member and as the registered investment adviser responsible for managing the pooled assets.
In the complaint, the SEC alleges breach of fiduciary duty and fraud for misrepresenting the safety and stability of the two largest private funds managed by Wealth Management while placing their clients into these investments even though they were unsuitable for some of their clients. The SEC's complaint also alleged, among other things, that Mr. Putman and Mr. Fevola each accepted at least $1.24 million in undisclosed payments derived from certain investments made within the private funds that were managed by Wealth Management, while continuing to cause clients to invest in these private funds.
The offering documents for the private investment funds disclose that Wealth Management would be compensated for managing the funds through a management fee based on a percentage of assets under management. Additionally, on four of the six funds that were managed by Wealth Management an annual "Incentive Allocation" of up to 10% (depending on the fund) of the annual profits could be paid to Wealth Management. No other forms of compensation were disclosed, and Wealth Management's Form ADV indicated that the adviser and its associated persons did not receive any economic benefits from non-clients in connection with giving investment advice to clients. No references were made regarding the payments received from the investments made within the funds.
This case should serve as a reminder to a registered investment adviser that it has a fiduciary duty to its clients. As a fiduciary, a registered investment adviser has an affirmative duty of utmost good faith to act solely in the best interests of the client and to make full and fair disclosure of all material facts, especially when the registered investment adviser's interest may conflict with the client's interest. Not providing proper disclosure to advisory clients can result in violations to the anti-fraud provisions of the Investment Advisers Act of 1940. The receipt of any form of additional compensation received from any source other than the client when the adviser is recommending a security to a client is just one example of a conflict of interest that must be fully disclosed to the client.
In the complaint, the SEC alleges breach of fiduciary duty and fraud for misrepresenting the safety and stability of the two largest private funds managed by Wealth Management while placing their clients into these investments even though they were unsuitable for some of their clients. The SEC's complaint also alleged, among other things, that Mr. Putman and Mr. Fevola each accepted at least $1.24 million in undisclosed payments derived from certain investments made within the private funds that were managed by Wealth Management, while continuing to cause clients to invest in these private funds.
The offering documents for the private investment funds disclose that Wealth Management would be compensated for managing the funds through a management fee based on a percentage of assets under management. Additionally, on four of the six funds that were managed by Wealth Management an annual "Incentive Allocation" of up to 10% (depending on the fund) of the annual profits could be paid to Wealth Management. No other forms of compensation were disclosed, and Wealth Management's Form ADV indicated that the adviser and its associated persons did not receive any economic benefits from non-clients in connection with giving investment advice to clients. No references were made regarding the payments received from the investments made within the funds.
This case should serve as a reminder to a registered investment adviser that it has a fiduciary duty to its clients. As a fiduciary, a registered investment adviser has an affirmative duty of utmost good faith to act solely in the best interests of the client and to make full and fair disclosure of all material facts, especially when the registered investment adviser's interest may conflict with the client's interest. Not providing proper disclosure to advisory clients can result in violations to the anti-fraud provisions of the Investment Advisers Act of 1940. The receipt of any form of additional compensation received from any source other than the client when the adviser is recommending a security to a client is just one example of a conflict of interest that must be fully disclosed to the client.
Labels: Enforcement, Fiduciary, Hedge Funds
posted by bhill at 10:20 PM
Obama Administration Calls for Managers of Hedge Funds and Other Private Investment Funds to Register as Investment Advisers
Earlier this week, the Obama Administration called for all managers of hedge funds and other private investment pools (including private equity funds and venture capital funds) that exceeded a modest asset threshold to register with the U.S. Securities and Exchange Commission ("SEC") under the Investment Advisers Act of 1940.
Moreover, the Obama Administration proposes that all investment funds managed by SEC registered investment advisers be subject to record keeping, investor disclosure and regulatory reporting requirements requirements and periodic examinations by the SEC.
As explained in the U.S. Treasury Department's proposal entitled "Financial Regulatory Reform: A New Foundation," by requiring SEC registration of investment advisers to hedge funds and other private investment funds, the SEC could monitor and assess whether these private funds have become so large, leveraged and interconnected so as to require further regulation.
It's appears that the Obama Administration proposal goes well beyond the SEC's previous efforts to regulate hedge fund managers. As these proposals to regulate private investment funds and their managers are considered in the U.S. Senate and House of Representatives, RIA Compliance Consultants will note key developments in our blog, Navigating the Regulatory Maze for Investment Advisers.
Moreover, the Obama Administration proposes that all investment funds managed by SEC registered investment advisers be subject to record keeping, investor disclosure and regulatory reporting requirements requirements and periodic examinations by the SEC.
As explained in the U.S. Treasury Department's proposal entitled "Financial Regulatory Reform: A New Foundation," by requiring SEC registration of investment advisers to hedge funds and other private investment funds, the SEC could monitor and assess whether these private funds have become so large, leveraged and interconnected so as to require further regulation.
It's appears that the Obama Administration proposal goes well beyond the SEC's previous efforts to regulate hedge fund managers. As these proposals to regulate private investment funds and their managers are considered in the U.S. Senate and House of Representatives, RIA Compliance Consultants will note key developments in our blog, Navigating the Regulatory Maze for Investment Advisers.
Labels: Hedge Funds
posted by bhill at 9:27 AM
Adoption of Rule 206(4)-8
In July, we told you about an SEC open meeting which would include the discussion of a new anti-fraud rule under Section 206 of the Investment Advisers Act of 1940. The new rule was aimed at advisers to pooled investment vehicles such as hedge funds. Earlier this month, the SEC adopted Rule 206(4)-8 which prohibits fraudulent and deceptive practices by investment advisers (whether registered or not) to many types of pooled investment vehicles. In response to the Goldstein v. SEC decision which vacated Rule 203(3)(3)-1 requiring advisers to hedge funds register as investment advisers, the SEC has passed Rule 206(4)-8 to clarify that action can be brought against advisers to pooled investment vehicles regardless of their registration status. This new rule is not intended to add or modify existing requirements or duties of investment advisers currently registered under the Advisers Act.
Specifically, the rule states, “It shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business […] for any investment adviser to a pooled investment vehicle to: (1) Make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle; or (2) Otherwise engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle.”
Specifically, the rule states, “It shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business […] for any investment adviser to a pooled investment vehicle to: (1) Make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle; or (2) Otherwise engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle.”
Labels: Hedge Funds
posted by bhill at 11:27 AM
SEC Will Consider New Anti-Fraud Rule Under Section 206 of the Investment Advisers Act of 1940
During its open meeting on Wednesday, July 11, 2007, the United State Securities Commission (SEC) will consider adopting the a new anti-fraud rule under Section 206 of the Investment Advisers Act of 1940 for pooled investment vehicles such as hedge funds.
As you may recall, in 2006 the U.S. Court of Appeals for the District of Columbia Circuit vacated the SEC's rule which had essentially required managers of certain hedge funds to register as investment advisors with the SEC. In response, the SEC proposed a new rule under the Investment Advisers Act of the 1940 that prohibits investment advisers to pooled investment vehicles from making misleading statements or otherwise defrauding investors or prospective investors in such pooled investment vehicles. In other words, although hedge fund managers will not be required to register as an investment advise, such managers can still be pursued by the SEC under the anti-fraud provisions of the Investment Advisers Act.
The SEC explained this rule will prohibit "... materially false or misleading statements regarding investment strategies the pooled investment will pursue (including strategies the adviser may pursue for the pool in the future), the experience and credentials of the adviser (or its associated persons), the risks associated with an investment in the pool, the performance of the pool or other funds advised by the adviser, the valuation of the pool or investor accounts in it, and practices the adviser follows in the operation of its advisory business such as how the adviser allocates investment opportunities."
If interested, you can tune into the SEC's open meeting on Wednesday, June 11 via a webcast to learn more about the SEC's response to the comments letters it received on this subject and whether the Commission will approve this proposed rule.
As you may recall, in 2006 the U.S. Court of Appeals for the District of Columbia Circuit vacated the SEC's rule which had essentially required managers of certain hedge funds to register as investment advisors with the SEC. In response, the SEC proposed a new rule under the Investment Advisers Act of the 1940 that prohibits investment advisers to pooled investment vehicles from making misleading statements or otherwise defrauding investors or prospective investors in such pooled investment vehicles. In other words, although hedge fund managers will not be required to register as an investment advise, such managers can still be pursued by the SEC under the anti-fraud provisions of the Investment Advisers Act.
The SEC explained this rule will prohibit "... materially false or misleading statements regarding investment strategies the pooled investment will pursue (including strategies the adviser may pursue for the pool in the future), the experience and credentials of the adviser (or its associated persons), the risks associated with an investment in the pool, the performance of the pool or other funds advised by the adviser, the valuation of the pool or investor accounts in it, and practices the adviser follows in the operation of its advisory business such as how the adviser allocates investment opportunities."
If interested, you can tune into the SEC's open meeting on Wednesday, June 11 via a webcast to learn more about the SEC's response to the comments letters it received on this subject and whether the Commission will approve this proposed rule.
Labels: Hedge Funds
posted by bhill at 10:12 PM
Legislation Proposes Required Hedge Funds to Register as an Investment Advisor
Investment News is reporting that U.S. Senator Charles Grassley, the ranking Republican on the Senate Finance Committee, has introduced legislation that would require hedge fund managers to register as an investment advisor with the U.S. Securities and Exchange Commission.
Labels: Hedge Funds
posted by bhill at 8:45 AM
Custody Requirements for Advisors to Hedge Funds
If you are an advisor to a private fund (i.e. hedge fund or pooled investment vehicle) do you know if you are deemed to have custody? If so, is your Form ADV Part I completed correctly?
According to SEC Rule 206(4)-2(c)(1)(iii), the definition of custody includes an investment advisor with “any capacity (such as a general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities.” In other words, if your investment advisor firm is the general partner (or similar status) of a hedge fund that it also manages, the advisor firm is deemed to have custody.
Investment advisor firms that fall under the definition of custody must meet a number of additional requirements. Under SEC Rule 206(4)-2, “it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless" the following are satisfied:
1. A qualified custodian maintains those funds and securities in a separate account for each client or in accounts that contain your clients’ funds and securities, under your name as agent or trustee for the clients;
2. You notify your clients in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, when the account is opened and when any changes to this information occur;
3. You verify the delivery and accuracy of account statements prepared by the qualified custodian, or, if you send account statements to clients, an independent public accountant must conduct a surprise audit of those funds and securities at least once each calendar year (please keep in mind that account statements must be sent to each limited partner, member or other beneficial owner); and
4. A client may designate an independent representative to receive, on her behalf, notices and account statements.
The Rule 206(4)-2 does allow for some exceptions of “certain privately offered securities”. According to the Rule, advisors “are not required to comply with this section with respect to securities that are:
A. acquired from the issuer in a transaction or chain of transaction not involving any public offering;
B. uncertificated, and ownership thereof is recorded only on books of the issuer or its transfer agent in the name of the client; and
C. transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.
While these exceptions do provide some relief for advisors to hedge funds, they are only available if the advisor is audited at least annually and then distributes the audit findings to all limited partners, members, or beneficial owners. The audit findings must be distributed within 120 days (or 180 days in the case of an advisor to a fund of funds) of the advisor’s fiscal year end. In addition, an advisor may satisfy its obligation to deliver account information (as described under number three above) to investors by distributing the audited financial statements to investors.
Finally, advisors need to ensure their ADV Part I is completed correctly. Item 9.A. and 9.B. require advisors to disclose if they maintain custody of cash or bank accounts and securities.
For many newly registered advisor firms, the custody rules seem intimidating and overwhelming. However, the SEC views these rules as extremely important and are sure to be reviewed during a regulatory examination. If you have questions on how to meet these requirements or would like us to conduct a mock exam, please give us a call today.
According to SEC Rule 206(4)-2(c)(1)(iii), the definition of custody includes an investment advisor with “any capacity (such as a general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities.” In other words, if your investment advisor firm is the general partner (or similar status) of a hedge fund that it also manages, the advisor firm is deemed to have custody.
Investment advisor firms that fall under the definition of custody must meet a number of additional requirements. Under SEC Rule 206(4)-2, “it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless" the following are satisfied:
1. A qualified custodian maintains those funds and securities in a separate account for each client or in accounts that contain your clients’ funds and securities, under your name as agent or trustee for the clients;
2. You notify your clients in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, when the account is opened and when any changes to this information occur;
3. You verify the delivery and accuracy of account statements prepared by the qualified custodian, or, if you send account statements to clients, an independent public accountant must conduct a surprise audit of those funds and securities at least once each calendar year (please keep in mind that account statements must be sent to each limited partner, member or other beneficial owner); and
4. A client may designate an independent representative to receive, on her behalf, notices and account statements.
The Rule 206(4)-2 does allow for some exceptions of “certain privately offered securities”. According to the Rule, advisors “are not required to comply with this section with respect to securities that are:
A. acquired from the issuer in a transaction or chain of transaction not involving any public offering;
B. uncertificated, and ownership thereof is recorded only on books of the issuer or its transfer agent in the name of the client; and
C. transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.
While these exceptions do provide some relief for advisors to hedge funds, they are only available if the advisor is audited at least annually and then distributes the audit findings to all limited partners, members, or beneficial owners. The audit findings must be distributed within 120 days (or 180 days in the case of an advisor to a fund of funds) of the advisor’s fiscal year end. In addition, an advisor may satisfy its obligation to deliver account information (as described under number three above) to investors by distributing the audited financial statements to investors.
Finally, advisors need to ensure their ADV Part I is completed correctly. Item 9.A. and 9.B. require advisors to disclose if they maintain custody of cash or bank accounts and securities.
For many newly registered advisor firms, the custody rules seem intimidating and overwhelming. However, the SEC views these rules as extremely important and are sure to be reviewed during a regulatory examination. If you have questions on how to meet these requirements or would like us to conduct a mock exam, please give us a call today.
Labels: Custody, Hedge Funds
posted by bhill at 7:15 PM
Registration for Advisors to Private Funds
By now, you are probably aware that advisors to private funds (a/k/a hedge funds or pooled investments) need to register as investment advisors if they provide advice on securities to private funds. (To learn more, please read the SEC's rule release.) The SEC is requiring these advisors to become registered by February 1, 2006. While we recommend submitting your filing with the SEC as soon as possible (preferably before December 1, 2005), an applicant needs to have all its ducks in a row before filing.
The rumor on the street is that the SEC is seeking opportunities to audit newly registered advisors to private funds. In fact, we have heard of at least one firm being audited within weeks of SEC approval. The key to surviving an SEC audit is to understand the Investment Advisers Act of 1940 and then prepare in detail your documents and procedures in accordance with these requirements.
In order to register, the SEC merely requires the submission of the Form ADV Part I, which is probably the simplest form to complete and file. Nonetheless, when the SEC conducts an examination, it will be focused upon ensuring that the advisor firm has properly completed the Form ADV Part II with sufficient details regarding advisory services, fees, conflicts of interests, and outside business activities. The SEC will also conduct a thorough review of the firm's supervisory and procedures manual, client agreements, and required books and records.
As an advisor to a hedge fund, you may be anxious about the SEC's looming registration deadline; however we strongly recommend that you refrain from submitting the ADV Part I at this relatively early juncture (in late August) if your firm hasn't completed the entire ADV, established a written compliance program, and started to follow the SEC books and records requirements.
The rumor on the street is that the SEC is seeking opportunities to audit newly registered advisors to private funds. In fact, we have heard of at least one firm being audited within weeks of SEC approval. The key to surviving an SEC audit is to understand the Investment Advisers Act of 1940 and then prepare in detail your documents and procedures in accordance with these requirements.
In order to register, the SEC merely requires the submission of the Form ADV Part I, which is probably the simplest form to complete and file. Nonetheless, when the SEC conducts an examination, it will be focused upon ensuring that the advisor firm has properly completed the Form ADV Part II with sufficient details regarding advisory services, fees, conflicts of interests, and outside business activities. The SEC will also conduct a thorough review of the firm's supervisory and procedures manual, client agreements, and required books and records.
As an advisor to a hedge fund, you may be anxious about the SEC's looming registration deadline; however we strongly recommend that you refrain from submitting the ADV Part I at this relatively early juncture (in late August) if your firm hasn't completed the entire ADV, established a written compliance program, and started to follow the SEC books and records requirements.
Labels: Hedge Funds, Registration
posted by bhill at 9:25 PM
Advisors to Hedge Funds Need to Start Preparing for Registration As Investment Advisors
Is your firm an advisor to a hedge fund? If so, your firm must register (if it hasn't already done so) as an investment advisor by February 1, 2006.
Earlier this year, the SEC passed several rule amendments that require hedge fund advisors to register as investment advisors. In essence, the SEC is aiming to improve its knowledge and control of this growing segment of the financial industry. In its rule release, the SEC states in the last five years, hedge fund assets have grown 260%. Some have predicted that by the end of 2005 the amount of hedge fund assets will exceed $1 trillion. Hedge fund assets are growing faster than mutual fund assets and already equal just over one fifth of the assets of mutual funds that invest in equity securities.
However, more than just the recent boom in hedge fund activity, it is the number of fraud enforcement cases that is the driving force behind the registration requirements. In the last five years, the number of cases brought by the SEC against hedge fund advisors represented over 10% of its cases against investment advisors during the same period. The SEC also states that because hedge funds themselves are not registered, no governmental agency has any reliable data on even the number of hedge funds or the amount of their assets. By requiring the registration of hedge fund advisors, the SEC can begin to collect solid data on this industry.
So what does this all mean? It means that if your firm is an advisor to a hedge fund and not currently registered or cannot claim an exemption to registration, it will need to complete the Form ADV, implement written compliance controls, create a code of ethics, designate a chief compliance officer, and follow all of the other rules and regulations under the Investment Advisers Act of 1940.
The Act does exempt an advisor from registration if (1) it had less than 15 clients during the previous 12 months, (2) does not hold itself out to the public, and (3) is not an advisor to any registered investment company. Therefore, you may be asking, "Does my firm need to be registered since it is only an advisor to one hedge fund and does not hold itself out to the public?" In anticipation of that situation, the SEC specifically requires advisors to "look through" the hedge fund and include all investors within the fund when counting clients. For example, an advisor cannot evade registration by claiming that the limited partnership set up to run the hedge fund equals just one client. You need to "look through" the limited partnership and count the actual investors as your advisory clients. If that number is greater than 14 and your assets under management is greater than $25 million, your firm will need to register with the SEC. Firms will assets under management less than $25 million are required to register at the state level.
We suggest advisors to hedge funds begin implementing procedures to comply with the new rules now as opposed to waiting until the last minute. While the SEC can take up to 45 days to approve a registration, some firms have been approved in as little as two weeks. Keep in mind that once you are approved, you need to be in full compliance with the Investment Advisers Act of 1940. Therefore, filing the Form ADV should be the last step you take. Our recommendation is that you submit your Form ADV by no later than early December 2005.
If you need assistance with meeting these new requirements, please do not hesitate to give RIA Compliance Consultants a call today.
Earlier this year, the SEC passed several rule amendments that require hedge fund advisors to register as investment advisors. In essence, the SEC is aiming to improve its knowledge and control of this growing segment of the financial industry. In its rule release, the SEC states in the last five years, hedge fund assets have grown 260%. Some have predicted that by the end of 2005 the amount of hedge fund assets will exceed $1 trillion. Hedge fund assets are growing faster than mutual fund assets and already equal just over one fifth of the assets of mutual funds that invest in equity securities.
However, more than just the recent boom in hedge fund activity, it is the number of fraud enforcement cases that is the driving force behind the registration requirements. In the last five years, the number of cases brought by the SEC against hedge fund advisors represented over 10% of its cases against investment advisors during the same period. The SEC also states that because hedge funds themselves are not registered, no governmental agency has any reliable data on even the number of hedge funds or the amount of their assets. By requiring the registration of hedge fund advisors, the SEC can begin to collect solid data on this industry.
So what does this all mean? It means that if your firm is an advisor to a hedge fund and not currently registered or cannot claim an exemption to registration, it will need to complete the Form ADV, implement written compliance controls, create a code of ethics, designate a chief compliance officer, and follow all of the other rules and regulations under the Investment Advisers Act of 1940.
The Act does exempt an advisor from registration if (1) it had less than 15 clients during the previous 12 months, (2) does not hold itself out to the public, and (3) is not an advisor to any registered investment company. Therefore, you may be asking, "Does my firm need to be registered since it is only an advisor to one hedge fund and does not hold itself out to the public?" In anticipation of that situation, the SEC specifically requires advisors to "look through" the hedge fund and include all investors within the fund when counting clients. For example, an advisor cannot evade registration by claiming that the limited partnership set up to run the hedge fund equals just one client. You need to "look through" the limited partnership and count the actual investors as your advisory clients. If that number is greater than 14 and your assets under management is greater than $25 million, your firm will need to register with the SEC. Firms will assets under management less than $25 million are required to register at the state level.
We suggest advisors to hedge funds begin implementing procedures to comply with the new rules now as opposed to waiting until the last minute. While the SEC can take up to 45 days to approve a registration, some firms have been approved in as little as two weeks. Keep in mind that once you are approved, you need to be in full compliance with the Investment Advisers Act of 1940. Therefore, filing the Form ADV should be the last step you take. Our recommendation is that you submit your Form ADV by no later than early December 2005.
If you need assistance with meeting these new requirements, please do not hesitate to give RIA Compliance Consultants a call today.
Labels: Hedge Funds
posted by bhill at 5:01 PM
