It is is important to note that the SEC’s relief in the 2012 ABA Letter applies only to entities affiliated with a registered investment adviser with its principal office and place of business in the U.S. The SEC indicated that, in the future, it may address questions about advisers with their principal offices and places of business outside the U.S., if provided with further information or fact patterns.

Advisers that are Special Purpose Vehicles (“SPVs”) Related to a Private Fund’s Registerd Investment Adviser.  The SEC confirmed its guidance in the 2005 ABA Letter that the SEC would permit an adviser to private funds to include general partners and similar special purpose vehicles (“SPVs”) of the adviser’s affilated funds on the registered investment adviser’s Form ADV filing under the following conditions:

• the SPV was established by the investment adviser to act as the private fund’s general partner or managing member;
• the SPV’s formation documents designate the investment adviser to manage the private fund’s assets;
• all of the investment advisory activities of the SPV are subject to the Advisers Act and the rules thereunder, and the SPV is subject to examination by the SEC; and
• the registered adviser subjects the SPV, its employees and persons acting on its behalf to the adviser’s supervision and control (e.g., they are subject to the registered adviser’s code of ethics and compliance policies and procedures), such that the SPV, all of its employees and the persons acting on its behalf would be “persons associated with” the registered adviser (as that term is defined in section 202(a)(17) of the Advisers Act).

If these conditions are met, the SPV could rely upon the registered adviser’s registration with the SEC in not registering itself, provided that any disciplinary history that the SPV would have been required to disclose had it registered separately is disclosed on the registered adviser’s Form ADV.

Multiple SPVs and SPVs with Independent Directors.  The 2012 ABA Letter extends the position above to a registered adviser with multiple SPVs.  In addition, the 2012 ABA Letter provides that an SPV with directors who are independent of the registered adviser or a related SPV (and thus are not subject to the registered adviser’s supervision and control) could nonetheless rely on the registered adviser’s registration if the other 2005 ABA Letter conditions (described above) are met. The staff acknowledged that independent directors “frequently are engaged to represent the interests of investors in a private fund or to permit the fund to satisfy certain legal obligations, such as engaging in certain transactions or practices that may otherwise be restricted under applicable law.”

Group of Related Advisers Conducting a Single Advisory Business. The staff recognized that, although, for various tax, legal and regulatory reasons, advisers to private funds may be organized as separate legal entities, these advisers may be part of a group of related advisers that in reality conduct a single advisory business.  If the advisers in the group meet the following conditions, the staff would consider the advisers to be conducting a “single advisory business” and would permit one of the advisers in the group (the “filing adviser”) to file a single Form ADV covering each adviser that is part of the group (each such adviser, a “relying adviser”):

• The filing adviser and the relying advisers advise only private funds and separate account clients (a) that are qualified clients (under Advisers Act Rule 205-3), (b) that are otherwise eligible to invest in the private funds advised by the advisers, and (c) whose accounts pursue investment objectives and strategies substantially similar or otherwise related to those private funds.

• Each relying adviser, its employees and the persons acting on its behalf are “persons associated with” the filing adviser because they are subject to the filing adviser’s supervision and control.

• The filing adviser’s principal office and place of business is in the U.S. so that all of the Advisers Act’s substantive provisions and rules apply to the filing adviser’s and each relying adviser’s dealings with each of its clients (without regard as to whether any client or the filing adviser or the relying adviser providing the advice is a U.S. person

• The advisory activities of each relying adviser are subject to the Advisers Act and rules and each relying adviser is subject to SEC examination

• All of the advisers operate under a single code of ethics adopted in accordance with Advisers Act rule 204A-1 and a single set of written policies and procedures adopted and implemented in accordance with Advisers Act rule 206(4)-7 and administered by a single chief compliance officer in accordance with that rule.

• The filing adviser discloses in its Form ADV (Miscellaneous Section of Schedule D) that it and its relying advisers are together filing a single Form ADV in reliance on the position expressed in this letter and identifies each relying adviser by completing a separate Section 1.B., Schedule D, of Form ADV for each relying adviser and identifying it as such by including the notation “(relying adviser).”

• To fulfill the Form ADV requirements, while using a single registration, the filing adviser must file, and update as required, a single Form ADV (Parts 1 and 2) that relates to, and includes all information concerning, the filing adviser and each relying adviser (e.g., disciplinary information and ownership information on Schedules A and B), and must include this same information in any other reports or filings it must make under the Advisers Act or the rules thereunder (e.g., Form PF).

• Note:  This single Form ADV on behalf of a group of advisers is available only if none of the advisers is prohibited from registering with the SEC by Advisers Act Section 203A (e.g., each of the advisers in the group individually must have sufficient assets under management to qualify to register with the SEC or qualify for an exemption from section 203A’s prohibition).

• Note:  Any facts or circumstances that would argue against such treatment should be considered in determining whether or not the advisers are conducting a “single advisory business.”

These recent actions evidence the SEC’s continued and increasing scrutiny of investment advisers and their compliance programs and of the SEC’s new focus on hedge funds and other pooled investment vehicles that appear to have abnormal investment performance. Advisers are urged to perform a critical review of their compliance programs on a periodic basis (no less frequently than annually).  This review should include confirming that they have remedied any deficiencies previously cited by SEC examiners.  In addition, advisers should carefully and continually review their funds’ valuation procedures, performance numbers and disclosure to confirm accuracy and consistency.

Late last month, the SEC charged three advisers for “failing to put in place compliance procedures to prevent securities law violations.” Earlier this month, the SEC announced enforcement actions against three separate advisory firms and six individuals charging them with misconduct, including improper use of fund assets, fraudulent valuations, and misrepresenting fund returns. This month’s enforcement actions are part of the SEC Aberrational Performance initiative to fight fraud at hedge funds and other private pooled investment vehicles, by using proprietary risk analytics to evaluate fund returns and focus on funds whose performance seems inconsistent with their investment strategies or other benchmarks. In the compliance program enforcement actions, the SEC specifically acknowledged the cooperation of their colleagues in the SEC’s Office of Compliance Inspections and Examinations (OCIE) National Exam Program.  The SEC’s Division of Risk, Strategy, and Financial Innovation; OCIE; and the Office of International Affairs have assisted the Asset Management Unit in the Aberrational Performance inquiries.

Representatives of  OCIE and of the Enforcement Division’s Asset Management Unit made a number of cautionary statements in their announcements of these actions. OCIE Director Carlo di Florio warned advisers that “[w]hen SEC examiners identify compliance deficiencies, firms are expected to remediate them…[and that the] Commission will take enforcement action against registrants that fail to do so.” The Asset Management Unit’s co-chair Robert Kaplan put advisers on notice, saying “there are additional [aberrational performance] cases in the pipeline,” including ones using data analysis against private equity and mutual fund advisers. The Asset Management Unit co-chairs announced that the SEC is “applying analytics across the investment adviser space — beyond performance and beyond hedge funds.”

Compliance Program Cases.  In two of the compliance program cases, SEC examiners previously had warned the firms about their compliance deficiencies, and the firms had failed to correct those deficiencies.

The following were among the deficiencies cited in the actions:

• Absence of any compliance program at all
• Adopting, but never fully implementing, policies and procedures
• Adopting, but never abiding by, a code of ethics
• Failure to supervise advisory representatives
• A chief compliance officer who was living abroad for a period of time
• Failure to collect required securities disclosure reports from employees
• Engaging in hundreds of principal transactions without informing advisory clients or obtaining their consent
• Improperly charging undisclosed commissions

Financial penalties and corrective actions imposed in the settlement of these actions included:

• payment by a CCO of a $50,000 penalty and permanent barring of that CCO from “acting within the securities industry in any compliance or supervisory capacity and from associating with any investment company”
• payments by two different advisers of  $50,000 and $20,000 penalties, respectively
• the return of money to certain clients
• one firm must provide a copy of the proceeding to anyone who was a client at any time during the three year period when there was no compliance program
• one firm must hire an independent consultant for an annual compliance program review for two years, provide a copy of the SEC’s order to past, present and future clients and post a summary of the order prominently on the adviser’s website
• one firm must cease operations, de-register with the SEC, and, with its clients’ consent, move advisory accounts to a firm with an established compliance program

Aberrational Performance Inquiry Actions.  The SEC described the returns of the advisers and portfolio managers charged in the Aberrational Performance inquiry actions as “extraordinary,” and as either “too good to be true” or as outlier returns that signaled a problem.

The firms and managers were charged with some or all of the following:

• fraudulent valuation of portfolio holdings
• misuse of fund assets
• misrepresentation of the adviser’s operating history, the number of management team members and the backgrounds of those people
• misrepresentation or failure to disclose material information to investors on matters such as one general partner’s negative regulatory history, compensation received by the general partners in connection with the fund’s investments and the conflicts of interest resulting from a general partner’s ownership interest in and control of some of the companies in which the fund invested.
• misrepresentations to investors about numerous other matters, including performance, assets, liquidity, investment strategy, valuation procedures, and conflicts of interest

Among the penalties imposed thus far:

• financial penalties to be paid by a firm and its managing director
• disgorging by the firm and the managing director of amounts to be determined
• permanent injunctions against the firm and the managing director from violating the securities laws’ anti-fraud provisions
• barring of the managing director from “association with any investment adviser, broker, dealer, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization”

HedgeOp will continue to monitor enforcement actions in these areas and update our blog accordingly.

The SEC has charged the former employee and his father with willfully violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Relief awarded could include disgorgement of ill-gotten gains, prejudgment interest, financial penalties, and other remedial relief.

The Securities and Exchange Commission (the “SEC”) unanimously approved the rule recently. In January 2011, the SEC and CFTC jointly proposed Form PF for use by SEC-registered investment advisers and dually-registered CFTC registrants advising private funds to confidentially report information that the Financial Stability Oversight Council (“FSOC”)  will use to analyze and monitor systemic risk.

Most private fund advisers will not be required to file their first Form PF until some time in 2013, based on fund information as of December 31, 2012.  As further described below, the frequency of, and deadlines for, Form PF filings will depend on the types of private funds the advisers manage.  Most Form PF filers, i.e., those that are not “large” private fund advisers (defined below), will only need to complete section 1 of the Form PF, providing certain basic information regarding private funds they advise, and information about their private fund assets under management, their funds’ performance and use of leverage. Large hedge fund advisers, large liquidity fund advisers and large private equity fund advisers will be required to complete additional sections 2, 3 and 4, respectively, with details tailored to each type of fund.

Effective Date.  The effective date for CEA rule 4.27, Advisers Act rule 204(b)-1 and Form PF is March 31, 2012.

Minimum Reporting Threshold.  SEC-registered advisers (and dually registered CFTC registrants) with at least $150 million in private fund regulatory assets under management as of the last day of their most recently completed fiscal year will be required to file Form PF.  ”Regulatory assets under management” are determined according to the Instructions in the Form ADV, and guidance regarding aggregation is described below and set out more fully in rule 204(b)-1.

“Large” Private Fund Advisers.  Three types of “Large Private Fund Advisers” will be required to complete additional sections of Form PF.  The thresholds differ based on the type of private fund managed.

• Large Hedge Fund Adviser.  Any adviser having at least $1.5 billion in regulatory assets under management attributable to hedge funds as of the end of any month in the prior fiscal quarter;
• Large Liquidity Fund Adviser.  Any adviser managing a liquidity fund and having at least $1 billion in combined regulatory assets under management attributable to liquidity funds and registered money market funds as of the end of any month in the prior fiscal quarter;
• Large Private Equity Fund Adviser.  Any adviser having at least $2 billion in regulatory assets under management attributable to private equity funds as of the last day of the adviser’s most recently completed fiscal year.

Aggregation.  In determining whether an adviser meets the $150 million minimum reporting threshold or is a Large Private Fund Adviser for purposes of Form PF, the adviser must aggregate together:

• assets of managed accounts advised by the firm that pursue substantially the same investment objective and strategy and invest in substantially the same positions as private funds advised by the firm (“parallel managed accounts”) unless the value of those accounts exceeds the value of the private funds with which they are managed; and

• assets of private funds advised by any of the adviser’s “related persons” other than related persons that are separately operated.  For purposes of Form PF, a “related person” is “separately operated” if the adviser is not required to complete Section 7.A. of Form ADV Schedule D for that related person.

The aggregation requirements are meant to prevent an adviser from re-structuring how it provides advice in order to avoid reporting on Form PF. The SEC decided to exclude parallel managed accounts if their value exceeds the value of the parallel private funds so that an adviser managing a relatively small amount of private fund assets does not cross the reporting threshold solely because it has a large separate account business with a similar strategy.

Deadlines for Filing:

• Large Hedge Fund Advisers. 60 days from the end of each fiscal quarter.
• Large Liquidity Fund Advisers. 15 days from the end of each fiscal quarter.
• Large Private Equity Advisers. 120 days from the end of their fiscal years.
• Smaller Private Fund Advisers (i.e., all other advisers). 120 days from the end of their fiscal years.

Compliance Dates: Two-Stage Phase-In Period.  The SEC and CFTC have adopted a two-stage phase-in period for compliance with Form PF filing requirements, based on the type of private fund assets and the dollar amount of the adviser’s private fund assets under management.

June 15, 2012 is the compliance date for the following advisers:

• Hedge Funds:  Any adviser having at least $5 billion in assets under management attributable to hedge funds as of  the last day of the fiscal quarter most recently completed prior to June 15, 2012.  For example, an adviser with $5 billion in hedge fund assets under management as of March 31, 2012, must file its first Form PF within 60 days following June 30, 2012. Note that if the adviser also exceeds the threshold for liquidity fund advisers, the adviser’s filing would be due within 15 days.

• Liquidity Funds: Any adviser managing a liquidity fund and having at least $5 billion in combined assets under management attributable to liquidity funds and registered money market funds as of the last day of the fiscal quarter most recently completed prior to June 15, 2012.  An adviser with $5 billion in such assets as of March 31, 2012, must file its first Form PF within 15 days following June 15, 2012.

• Private Equity Funds.  Any adviser having at least $5 billion in assets under management attributable to private equity funds as of the last day of its first fiscal year to end on or after June 15, 2012.  For example, an adviser having a June 30 fiscal year end and $5 billion in private equity fund assets under management as of June 30, 2012, must file its first Form PF within 120 days following June 30, 2012.  This time frame assumes the adviser does not also exceed the $5 billion threshold for hedge fund or liquidity fund advisers.

For purposes of the above calculations, advisers must calculate the value of assets under management in accordance with the instructions in Form ADV and aggregate assets under management according to the instructions for determining whether they satisfy reporting thresholds under Form PF.

December 15, 2012 is the compliance date for all other advisers required to complete Form PF.  Advisers will have until their respective deadlines following that date to file Form PF.

As noted above, most hedge fund advisers’ (i.e., smaller hedge fund advisers) first Form PF filings will not be due until April 2013; the largest hedge fund advisers (i.e., those with $5 billion or more in hedge fund assets under management) may have to file their first Form PFs by September 2012.

Large Advisers Managing More Than One Type of Private Fund. As described in the final rule release, a large hedge fund adviser (or large liquidity fund adviser) that also manages other types of funds must file quarterly updates with respect to its hedge funds (or liquidity funds, as applicable), but only needs to update information regarding its other funds when it files its fourth quarter update. Such an adviser may comply with its filing obligations by initially filing a fourth quarter update that includes only information about its hedge funds (or liquidity funds, as applicable) within 60 days (or 15 days, as applicable) and then amending its filing within 120 days after the end of the quarter to include information about its other funds.

Other Situations.  The Instructions to Form PF explain how the following entities should report, and how the following situations should be reflected, on the Form PF:

• subadvisers to private funds or advisers to private funds that engage subadvisers;
• parallel funds, parallel managed accounts, master-feeder arrangements and funds managed by related persons;
• private funds of private funds;
• private funds investing in companies that are not private funds;
• advisers using their own internal methodologies and/or their service providers’ conventions.

FINRA and IARD.  Financial Industry Regulatory Authority (“FINRA”) will develop and maintain the filing system for Form PF as an extension of the existing Investment Adviser Registration Depository (“IARD”).  FINRA is programming additional features for the extension, including features that reflect the Dodd-Frank Act’s heightened confidentiality protections for Form PF and that allow for secure access by FSOC and other regulators as permitted under the Dodd-Frank Act.  The SEC has approved filing fees of $150 for each quarterly or annual Form PF filing.

In recent years, financial crimes have been on the rise.

In the US government’s 2010 fiscal year, the FBI’s economics crime unit reports the bureau had 1,703 active securities and commodities fraud investigations, a 41 percent increase over the number of active investigations in 2008.  Over the past year, the amount of monetary penalties the SEC has imposed on wrongdoers has almost tripled…

Prior to the creation of the TCR Database tips would come in via phone calls, e-mails, faxes and even handwritten letters into the SEC’s 11 regional offices and Washington headquarters and often were not properly recorded or followed up. The TCR database now provides a systematic and organized approach to reviewing the information provided by tipsters, whistle-blowers and self-regulatory organizations.  Once a tip or complaint is entered into the system through the online questionnaire available in the TCR Database portal, about 2,300 SEC employees can see it, analyze the information and add to it.

While the TCR Database can not yet be cross-checked against other internal databases or against trading activity, company filings or news feeds, it is a start and a positive reform and improvement for the SEC.

The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Hopefully this will finally allow worried managers to know whether or not they will have until next year to file their Form ADVs. We will keep you posted of any developments coming out of the meeting.

The new rule will require the SEC to pay an award, subject to certain limitations, to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of federal securities laws that leads to successful enforcement of a covered judicial or administrative action, or a related action. Further, employers are prohibited to retaliate against employees that provide the SEC with information about possible violations.

The rule change can be found here.

Gallagher is currently a partner in the securities department of Wilmer Cutler Pickering Hale and Dorr LLP.  He previously worked at the SEC from 2006 through 2010.  Gallagher would replace Commissioner Kathleen Casey should he be confirmed.  Kathleen Casey’s term expires later this year.  She is one of two Republicans on the five-person Commission and Gallagher would keep the party split 3-2.

Current SEC Commissioner Luis Aguilar was appointed in 2008.  The term expired last year but he has continued serving in that position, as permitted by law.

Both nominations are subject to approval by the U.S. Senate.