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What to Expect When You’re Expecting the SEC

May 10, 2012

Last November, the SEC published new rules under the Investment Advisers Act of 1940 implementing the Dodd-Frank Act’s requirement that investment advisers advising one or more private funds and having at least $150 million in private fund assets under management file Form PF with the SEC.  We blogged about the SEC’s Form PF requirements last December.

Last week, Carlo V. di Florio, the SEC’s Director of the Office of Compliance Inspections and Examinations (“OCIE”), provided summary information concerning newly registered private fund advisers and also gave some hints as to what private fund advisers can expect in the way of examinations and inspections. OCIE has previously indicated that private fund inspections will be an area of focus in 2012. (A general outline of what an inspection is like can be found on pages 24-30 of OCIE’s February 2012 overview.)

Di Florio highlighted the need for private fund advisers to have:

  1. written policies and procedures which are annually reviewed and overseen by a chief compliance officer;
  2. accurate books and records; 
  3. current Form ADVs;
  4. an ethics code; and
  5. accurate advertising materials.

And he reminded advisers of their fiduciary duties regarding fees and expenses, and conflicts of interest.

OCIE is currently identifying the unique risks presented by private equity funds and hedge funds and is developing the information management systems to organize and evaluate the information it will collect via Form PF and Form ADV. Examples of the basic risk characteristics that it will track include any material changes in business activities such as lines of business or investment strategies, changes in key personnel, outside business activities of the firm or its personnel, any regulatory history of the firm or its personnel, anomalies in key metrics such as fees, performance, disclosures when compared to peers or to previous periods, and possible financial stress or weaknesses.

Risk areas that might be considered during an examination include (1) fund strategy; (2) whether the fund controls companies or holds minority positions; (3) product complexity; and (4) the fund’s lifecycle.

OCIE is particularly concerned by the possible conflicts of interest faced by private funds, especially for funds which co-invest with their clients or which play a role in a portfolio company. Other conflicts identified by OCIE include those involving fee and expense shifting or maximization.

In closing, di Florio emphasized the need for strong policies and procedures and risk controls. And when expecting the SEC, be prepared with documentation and the ability to access that documentation.

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