If a hedge fund has had, in the preceding 12 months, more than 14 investors that are US residents, the offshore adviser to that hedge fund generally must register with the SEC under SEC Rule 203(b)(3)-2 Registration Under the Advisers Act of Certain Hedge Fund Advisers. With SEC registration comes the inevitable examination where SEC examiners (either alone or jointly with a local regulator) will want access to your policies and procedures, books and records and management personnel to assess compliance with applicable US rules and regulations. A major focus of the examination will centre on conflict management and how an organisation, identifies, monitors and mitigates conflicts of interests inherent in their business.
The SEC will have certain expectations when they announce their intent to visit your operations (although examinations may also be undertaken on an unannounced basis). The rules state that, "During an examination, the registered offshore adviser must provide to our staff any and all records required to be kept under our rules as well as any records the adviser keeps under foreign law". You will likely receive, in advance of the review, a detailed document request list setting out specifically what the SEC would like to review.Typically, at the commencement of the SEC's fieldwork, they will speak with member(s) of senior management to obtain an overall view of the organisation, business, control environment, and compliance culture. They may also want to interview persons responsible for certain functions such as portfolio management, trade execution, back office/administration, information technology, anti-money laundering, and marketing.
Specifically, the SEC examination staff will be interested in determining whether:
- Portfolio management decisions are consistent
with client mandates and/or private placement
memoranda;
- Decisions made and costs incurred in
maintaining registrant's brokerage arrangements
and placing orders (trades) for clients
are consistent with maximising the value
of clients' accounts and disclosures made
to clients;
- Allocations among clients accounts
of IPOs and blocked and cross trades in
issues traded on secondary markets are
fair and consistent with disclosures;
- Prices used to value positions in clients'
accounts reflect accurately current market
conditions and the process used to calculate
NAV per unit of commingled accounts results
in consistently accurate allocations of
the commingled accounts' net assets among
participants;
- Information provided to investors regarding
transactions in and balances of their
accounts reflects accurately the actual
transactions in and balances of those
accounts;
- Personal trading activities of advisory
representatives and proprietary accounts
of registrant are consistent with codes
of ethics, regulatory requirements, and
disclosures;
- Performance information used in advertisements
and other marketing materials is calculated
accurately and fairly and is used in ways
that are not misleading; and
- Data about registrant's operations and activity in investor accounts are accurately created, captured, and safeguarded from unauthorised access, use, and manipulation. Such data are used to provide accurate and timely information to management, advisory clients, investors, and regulators.
At the conclusion of the examination you will likely receive an exit interview and/or communication from the SEC examiners setting out areas of concerns and possible deficiencies. You should respond to any correspondence in a concise and accurate manner and within any time constraints set by the SEC.
The SEC have expressed an interest in working more collaboratively with registrants to jointly identify, assess and remedy industry issues in a timely manner and before they escalate into major issues. Such an approach would be widely embraced by many registrants, especially those undergoing such examinations for the first time.
