SEC Examinations Target Private Equity and Hedge Fund Managers for 2013

Posted on February 25, 2013

Written by:  Jay Gould and Michael Wu 

On February 21, 2013, the Staff of the Securities and Exchange Commission (the “Staff” and the “SEC,” respectively) published its 2013 priorities for the National Examination Program (“NEP”) in order to provide registrants with the opportunity to bring their organizations into compliance with the areas that are perceived by the Staff to have heightened risk.  The NEP examines all regulated entities, such as investment advisers and investment companies, broker dealers, transfer agents and self-regulatory organizations, and exchanges.  This article will focus only on the NEP priorities pertaining to the investment advisers and investment companies program (“IA-ICs”) 

As a general matter, the Staff is concerned with fraud detection and prevention, corporate governance and enterprise risk management, conflicts of interest, and the use and implications of technology.  The 2013 NEP priorities, viewed in tandem with the “Presence Exam” initiative that was announced by the SEC in October 2012, makes it abundantly clear that the Staff will focus on the approximately 2000 investment advisers that are newly registered as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”).

Continue Reading

Tweet Like Email Email

Mutual Fund Lobby Trashes General Solicitation for Private Funds (Surprise!)

Posted on May 29, 2012

Written by:  Jay B. Gould 

The recently enacted JOBS Act[1] requires the Securities and Exchange Commission (“SEC”) to promulgate rules that would effectively repeal the ban on general solicitation and general advertising under Rule 506 of Regulation D by private issuers, including private funds.  Pursuant to the JOBS Act, the SEC has 90 days from the date of enactment (July 4, 2012) to adopt rules implementing this provision.   In advance of publishing proposed rules, the SEC has started accepting comment letters on all aspects of the JOBS Act, including the repeal of the ban on general advertising.  

Unsurprisingly, the Investment Company Institute (“ICI”), the lobby organization for mutual funds and other registered funds, has submitted a comment letter requesting that the SEC take a slow and deliberate approach to permitting private funds to generally advertise and solicit investors.  How slow and deliberate?  The ICI suggests that performance advertising by hedge funds should be prohibited altogether until the SEC has had the opportunity to study hedge fund advertising, “gain experience with private fund advertisements,” and craft a rule similar to Rule 482 to which mutual fund advertising is subject.  The ICI tells us that Rule 482 is the culmination of 60 years of experience and that the SEC “should follow the same path here,” referring to advertising by hedge funds and other private funds.  60 years?  Really? 

The ICI has a long and storied history of blocking financial innovation and expansion of investment opportunities for the investing public.  You may recall that the ICI sued the Office of the Comptroller of the Currency in an attempt to block banks from acting as investment advisers to mutual funds, a case that they ultimately lost at the Supreme Court.  It is hardly surprising then that the mutual fund lobby would line up against competition by the private funds industry, even at a time when the registered funds and private funds businesses are converging at a rapid pace in terms of product offerings, investment strategies, and regulatory oversight and reporting.  Last August the SEC issued a “concept release” that requested comment on whether registered funds should be able to use the same sorts of investment techniques and to the same extent as private funds, such as hedging, shorting, and use of leverage.  Further action in this regard, coupled with the new reporting obligations of private funds as a result of Dodd Frank (e.g., Form PF) will serve to further blur the lines between registered and unregistered funds. 

In addition to “urging” a ban on performance advertising and promoting the idea of other “content restrictions” by hedge funds and other private funds, the ICI suggests that private fund advertising should be subject to FINRA review to the same extent as mutual fund advertising, and that private fund advertising be clearly distinguished from mutual fund advertising.  The ICI further suggests that the SEC should raise the net worth threshold for “accredited investors” in order to insure that private fund investors have the requisite sophistication to withstand the riskiness associated with private funds (See legalaffairs March–April 2004 issue).  The ICI endorses a $600,000 annual income and $3 million net worth standard, a measure that would further reduce the potential private fund investor pool and drive more investors to the registered world. 

More balanced voices have also started to comment on this issue, so it remains to be seen how much weight the SEC will ultimately attribute to the ICI comment letter.  You may view all of the comment letters regarding the repeal of the ban on general solicitations here.    And you are encouraged to submit your own.

[1]   The Jumpstart Our Business Startups Act.

Tweet Like Email Email

Over $3.3 Million Charges Against Morgan Stanley Investment Management for Improper Fee Arrangement

Posted on November 18, 2011

Written by Jay Gould

On Wednesday, November 16, 2011, the SEC charged Morgan Stanley Investment Management (“MSIM”) with violating securities laws in a fee arrangement that costs a fund and its investors approximately $1.8 million in sub-adviser fees.

MSIM is the primary adviser to The Malaysia Fund (the “Fund”), a closed-end investment company that invests in equity securities of Malaysian companies.  AMMB Consultant Sendirian Berhad (“AMMB”) was an SEC registered adviser located in Malaysia.  AMMB is a wholly owned subsidiary of AM Bank Group, one of the largest banking groups in Malaysia.  Pursuant to a Research and Advisory Agreement entered into by the Fund with AMMB and MSIM in 1987, AMMB undertook to provide advice, research and assistance to MSIM for the benefit of the Fund.  Every year AMMB submitted a report to MSIM which MSIM provided to the Fund’s board of directors in its evaluation for the renewal of the advisory and sub-advisory agreements.  The board evaluated and approved AMMB’s sub-adviser agreement based on representations from MSIM that AMMB was providing advisory services to the Fund.  AMMB did not actually provide those advisory services.  MSIM also prepared and filed the Fund’s annual and semi-annual reports to investors that inaccurately represented AMMB’s services. 

The SEC found that “MSIM failed its duty to provide the fund’s board members with the information they needed to fulfill their significant responsibility of reviewing and approving the sub-adviser’s contract.”  In addition, MSIM did not adopt and implement policies and procedures governing the advisory contract renewal process and its oversight of AMMB.

According to the SEC’s order, MSIM willfully violated Section 15(c) and 34(b) of the Investment Company Act and Section 206(2) and (4) of the Investment Advisers Act of 1940, and Rule 206(4)-7 thereunder. 

The SEC ordered MSIM to pay the Fund $1.845 million as reimbursement of the advisory fees the Fund paid to AMMB from 1987 to 2008.  MSIM was also ordered to pay $1.5 million penalty fee.  MSIM agreed to pay over $3.3 million to settle the SEC’s charges. 

A full text of the SEC release and order are available here.

Tweet Like Email Email

President's Working Group Proposes Money Market Fund Reforms

Posted on November 02, 2010

Following the September 2008 run on money market funds, which began following the failure of Lehman Brothers Holdings, Inc., the Treasury Department requested that the President’s Working Group on Financial Markets (“PWG”) prepare a report on the regulatory changes needed to address systemic risk and to reduce the susceptibility of money market funds to runs. On October 21, 2010, the PWG responded with its report entitled “Money Market Fund Reform Options.” The policy options discussed in the report include:

  • requiring money market funds to have floating net asset values;
  • creating emergency liquidity facilities funded by the money market fund industry;
  • requiring large redemptions to be paid in kind, rather than in cash; and
  • mandating participation in an insurance system.

The report emphasized that new measures intended to mitigate money market fund risks would also likely reduce the appeal of money market funds to many investors and cause investors to shift assets to unregulated funds with stable NAVs, such as offshore money market funds, enhanced cash funds, and other stable value vehicles. As such funds are subject to little or no regulatory oversight, the growth of unregulated money market funds would likely increase systemic risks. Therefore, any policies intended to reduce the risks associated with money market funds would need to limit the potential for regulatory arbitrage by imposing enhanced constraints on unregulated money market fund substitutes (for example, by providing that the exemptions from registration under the Investment Company Act of 1940 provided by Sections 3(c)(1) and 3(c)(7) thereunder are not available to investment vehicles maintaining a stable net asset value).  

The Financial Stability Oversight Council will further examine the reform options discussed in the report in order to identify those most likely to reduce money market funds’ susceptibility to runs.

Tweet Like Email Email

Funds Need Better Derivatives Disclosure

Posted on August 26, 2010

Earlier this year the SEC staff commenced a review to evaluate the use of derivatives by mutual funds, exchange-traded funds and other investment companies, including, among other things, whether existing prospectus disclosures adequately address the particular risks created by derivatives.  In a July 30, 2010 letter to the Investment Company Institute, the SEC staff indicated that the initial results of its review are not encouraging.

It found that funds are providing generic disclosure about derivatives that is not adequately tailored to the specific investment strategies of the fund and does not emphasize the specific types of derivatives used by the fund, the extent of their use and the purpose of using derivatives transactions.  As a result, investors may not be receiving the disclosure they need in order to understand the risks associated with their investment in a fund.  The staff urged all funds that use derivatives to assess the accuracy and completeness of their disclosure, tailor their disclosure to include a description of the fund's expected uses of derivatives and their relative importance and ensure that such disclosure is presented in an understandable manner using plain English.

Although the staff's letter only addresses the disclosure provided by registered investment companies, hedge funds and other private funds are subject to anti-fraud principles requiring them to disclose all material information to investors and, therefore, should also take into account this guidance when preparing derivatives-related disclosure.

Tweet Like Email Email