Current SEC Priorities Regarding Hedge Fund Managers

by Stinson Leonard Street - Dodd-Frank and the Jobs Act
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Norm Champ, the SEC’s Director of the Division of Investment Management, recently gave a speech addressing the SEC’s priorities regarding hedge fund managers.

As to the JOBS Act and the elimination of general solicitation, Mr. Champ noted:

  • Advisers to private funds are subject to an anti-fraud rule that prohibits fraudulent and misleading conduct with respect to fund investors, including making untrue statements of material fact to those investors.  Accordingly, advisers should carefully review their policies and procedures to determine whether they are reasonably designed to prevent the use of fraudulent or misleading advertisements and update those policies where necessary, particularly if the hedge funds intend to engage in general solicitation activity.
  • Hedge fund sponsors intending to rely on the new rule should also consider whether their current practices for verifying accredited investor status meet the requirements of the new rule.
  • In order to assist the Commission’s efforts to assess developments in the Rule 506(c) market, an inter-Divisional group has been created within the Commission to review the new market and the practices that develop.  Staff from the Division of Investment Management will play a key role in this initiative, and will work closely with staff from the Division of Corporation Finance, the Division of Economic and Risk Analysis, or DERA,, formerly the Division of Risk, Strategy and Financial Innovation, the Division of Trading and Markets, the Office of Compliance Inspections and Examinations, or OCIE, and the Division of Enforcement.  As part of the work plan, staff will, among other things, evaluate the range of accredited investor verification practices used by issuers and other participants in these offerings, and endeavor to identify trends in this market, including in regard to potentially fraudulent behavior.  Commission staff will also develop risk characteristics regarding the types of issuers and market participants that conduct or participate in offerings involving general solicitation and general advertising and the types of investors targeted in these offerings.
  • He has instructed the Division of Investment Management rulemaking and risk and examination staff to pay particular attention to the use of performance claims in the marketing of private fund interests.  In particular, this review will endeavor to identify potentially fraudulent behavior and to assess compliance with the federal securities laws, including appropriate Investment Advisers Act provisions.  I

As to the “bad actor” rules, Mr. Champ spoke about:

  • For hedge funds, potential “bad actors” under the rule could include a hedge fund’s general partner or managing member, its investment adviser and principals, significant shareholders holding voting interests, affiliated issuers and any placement agent or other compensated solicitor.
  • The final rule provides an exception from disqualification for issuers that can show they did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.  Given the serious consequences of a bad actor finding, hedge  fund advisers should take care when hiring employees and screening investors, and conduct appropriate due diligence when retaining third party solicitors.

On other topics, Mr. Champ stated:

  • The Division of Investment Management’s Risk and Examinations Office, or REO, intends to conduct rigorous quantitative and qualitative financial analysis of the investment management industry, strategically important investment advisers and funds.  REO, in collaboration with the DERA, is using Form PF data to develop risk-monitoring analytics, as well as to provide internal periodic reports regarding the private fund industry and particular market segments.
  • Division staff also will use Form PF data to inform policy and rulemaking with regard to private funds, and the Division intends to use aggregated, non-proprietary data in its consultative work with other securities regulators on issues of mutual interest. Similarly, other divisions are beginning to utilize this data to advance their missions. For example, the Commission’s Asset Management Unit of the Division of Enforcement is working with DERA to develop analytic tools to integrate Form PF data into research and due diligence related to investigative work and other enforcement matters. Also, the OCIE anticipates using the information collected on Form PF for, among other things, conducting pre-examination research and due diligence.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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