Get Ready…Cause Here They Come…

 The SEC announced today that its Office of Compliance Inspections and Examinations is launching the Never-Before Examined Initiative, an initiative directed at investment advisers that have never been examined.  Such initiative will focus on those advisers that have been registered with the SEC for three or more years.   These examinations will concentrate on the advisers’ compliance programs, filings and disclosure, marketing, portfolio management, and safekeeping of client assets.

Private Fund Advisers Get Custody Rule Relief With Respect To Certificated Privately-Offered Securities

On August 1, 2013, the SEC’s Division of Investment Management issued IM Guidance Update No. 2013-04 (Guidance).  The Guidance provides relief to private fund advisers with respect to the requirement to maintain certain certificated, privately-offered securities with a qualified custodian.  Specifically, the Guidance provides the following:

“The Division would not object if an adviser does not maintain private stock certificates with a qualified custodian, provided that (1) the client is a pooled investment vehicle that is subject to a financial statement audit in accordance with paragraph (b)(4) of the custody rule; (2) the private stock certificate can only be used to effect a transfer or to otherwise facilitate a change in beneficial ownership of the security with the prior consent of the issuer or holders of the outstanding securities of the issuer; (3) owner­ship of the security is recorded on the books of the issuer or its transfer agent in the name of the client; (4) the private stock certificate contains a legend restricting transfer; and (5) the private stock certificate is appropriately safeguarded by the adviser and can be replaced upon loss or destruction.”

Advisers wanting to rely on this relief should revise their compliance manuals and adopt additional policies and procedures related to the safeguarding of private stock certificates that are not maintained with a qualified custodian.


SEC Issues Additional FAQs Regarding Form PF

The SEC recently issued additional FAQs  related to Form PF.  SEC-registered investment advisers which advise one or more private funds and have at least $150 million in regulatory assets under management attributable to private funds are required to file Form PF with the SEC.  The breadth of the disclosure requirements and the frequency of filings on Form PF varies based on the types of private funds advised and the adviser’s assets under management. The purpose of Form PF is to allow the SEC and the CFTC to collect risk exposure information. Information reported on Form PF is not publicly filed and remains confidential.

The new FAQs address very specific questions regarding how to respond to questions contained in Form PF.  Accordingly, these FAQs should be reviewed prior to completing and submitting your next (or your initial) Form PF.  Some of the matters discussed in the new FAQs include:

  • Treatment of short positions, derivatives, repurchase agreements, total return swaps and other financial instruments: if the private fund has a balance sheet, the fund may rely on gross assets reflected on the balance sheet to calculate regulatory assets under management and gross asset value.  Therefore, the fund does not need to assess the value of these financial instruments in a manner different than applicable accounting standards.
  • If a filer reported private funds in a master-feeder arrangement on an aggregated basis on its Form ADV, then the filer must report the master-feeder arrangement on an aggregated basis on Form PF.
  •  If a filer elects to aggregate a master-feeder arrangement for reporting purposes in accordance with Instruction 6, the filer should treat the aggregated funds as if they were all one private fund.  Therefore, the filer should collapse the master-feeder structure and aggregate all investors in the master-feeder arrangement (but should not count the feeder funds themselves as investors) when responding to questions 15, 16 and 50 about investors of the master-feeder arrangement.
  • When reporting aggregate value of all derivatives positions of a reporting fund in questions 13(b) and 44, the filer should report the absolute value of all outstanding derivatives positions, and should not report a negative number.
  • Details on how to calculate the trade volume percentage of derivatives trades for purposes of Questions 24(b) and 24(c).
  • A filer should include derivatives exposure when measuring exposures to each sub-asset class under the “ABS/structured products” asset class.
  • A fund’s exposure to interest rate derivatives should be reported in terms of 10-year bond equivalents for purposes of questions 26 and 30. 
  • Details on how to calculate and report net asset value and percentages thereof.
  •  The breakdown of a fund’s investments in portfolio companies by NAICS codes should be based on the percentage of the total gross value of the fund’s investments in portfolio companies attributable to specific NAICS codes.

SEC Guidance on the Custody Rule

 In March, the SEC  issued a Risk Alert and an Investor Bulletin related to compliance with its custody rules for investment advisers.  The Risk Alert was issued following recent examinations of investment advisers which revealed various deficiencies related to compliance with the SEC’s custody rules.

 Custody by an investment adviser means holding client funds or securities, directly or indirectly, or having the authority to obtain possession of them. For example, an investment adviser has custody of its clients’ assets when an investment adviser has the power to withdraw funds or securities from its client’s accounts, including fees.  SEC-registered investment advisers who have custody of client assets must, subject to certain exceptions, (i) use qualified custodians to hold client assets, (ii) provide notice to their clients in writing of the qualified custodian’s name, address, and the manner in which the client’s funds or securities are maintained, (iii) have a reasonable basis to believe that the qualified custodian that maintains its clients’ funds and securities sends account statements at least quarterly to the adviser’s clients directly, (iv) must enter into a written agreement with an independent public accountant to examine client funds and  securities on a surprise basis every year to verify such funds and securities, and (v) comply with certain additional rules when the adviser uses a related qualified custodian.

The deficiencies identified in recent exams of investment advisers included:

  • failure of advisers to recognize that they had custody;
  • failure of advisers to comply with the custody rule’s surprise examination requirements;
  • failure of advisers to comply with the custody rule’s qualified custodian requirement; and
  • failure of advisers to comply with the audited fund exception to the surprise audit requirement for pooled investment vehicles.

 As a result of recent examinations, the SEC staff  has required advisers with custodial deficiencies to take various actions, including remedial measures, such as drafting, amending or enhancing their written compliance procedures, policies, or processes; changing their business practices; or devoting more resources or attention to the area of custody. In addition, in certain cases, the staff has made referrals to the SEC’s Division of Enforcement.  In connection with the annual review of their policies and procedures, investment advisers should pay particular attention to their custodial policies, procedures and actual business practices in light of this recently issued Risk Alert.


Chief of SEC’s Asset Management Unit Provides Compliance Tips for Private Equity Funds

On January 23, 2013, Bruce Karpati, Chief of the Asset Management Unit (“AMU”) of the Enforcement Division of the Securities and Exchange Commission, addressed the Private Equity International Conference held in New York.  The transcript of his presentation discusses potential compliance issues in the private equity industry on which the AMU may focus.  This presentation also serves as a useful guide for legal compliance professionals and executives serving the private equity industry highlighting certain areas on which they should focus.

In his comments, Mr. Karpati discussed the organization of the AMU and how the AMU has gained an expertise in the private equity industry.  Mr. Karpati explained that it is “not unreasonable to think that the number of cases involving private equity will increase” and he described a number of recent enforcement actions which highlight certain issues that may arise  at private equity firms.  Mr. Karpati stated that the AMU has found that some of the main industry stressors are fundraising and capital overhang.  In addition, Mr. Karpati indicated that many of the potential compliance issues in the private equity industry arise from conflicts of interest, such as the conflict between the profitability of the management company and the interests of investors, the shifting of expenses from one fund to another fund, and charging of additional fees to portfolio companies, especially where the permitted fees may be poorly defined by the fund’s limited partnership agreement.  In discussing conflicts of interests, Mr. Karpati stated that “Although conflicts of interest are a natural part of the private equity business, it is up to each manager to identify, control, and appropriately disclose material conflicts so that investors are informed and not harmed or disadvantaged.”     Finally, Mr. Karpati explained that private equity COOs and CFOs are critical in making sure that investors’ interests are paramount to the interests of the management company and its principals and discussed various ways that COOs and CFOs could reduce the risk of inquiry by the Division of Enforcement and ensure that their private equity firm and its principals are meeting their fiduciary responsibilities.

SEC Provides Further Relief in the Wake of Hurricane Sandy

On November 14, 2012, the Securities and Exchange Commission announced  the issuance of an order providing regulatory relief to publicly traded companies, investment companies, accountants, transfer agents and others affected by Hurricane Sandy.  To address compliance issues caused by the hurricane and its aftermath, the order conditionally exempts affected persons from the requirements of the federal securities laws with respect to:  (i) Exchange Act filing requirements for the period from October 29, 2012 to November 20, 2012 (and imposes a new deadline of November 21, 2012 for missed filings); (ii) proxy and information statement delivery requirements for companies attempting to deliver materials to affected areas; (iii) Investment Company Act requirements for the transmittal to shareholders in affected areas of annual and semi-annual reports during the period of  October 29, 2012 to November 20, 2012; (iv) transfer agent compliance with certain Exchange Act requirements for the period from October 29, 2012 to December 1, 2012; and (v) auditor independence requirements as they relate to reconstruction of previously existing accounting records of clients. 

The Commission has also directed the SEC staff generally to take the position that filings subject to and filed in compliance with the regulatory relief granted by the order be considered timely for the purposes of eligibility to use Form S-3 (and well-known seasoned issuer status, which is based in part on Form S-3 eligibility), and to consider companies making such filings to be current in their Exchange Act reporting requirements for purposes of Form S-3 and Form S-8 eligibility and availability of current public information under the Securities Act Rule 144.  The Commission has also directed the staff to take similar positions with respect to various investment company and investment adviser filing requirements.

SEC Issues Letter to New Investment Advisers Regarding Presence Exams

On October 9, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a letter directed to senior officers of newly registered investment advisers that manage private equity funds introducing them to the National Exam Program (NEP). The letter explains that the NEP is launching an initiative to conduct Presence Exams, which are focused, risk-based examinations of investment advisers to private funds.  In the letter, the SEC explains that the Presence Exams initiative will take place over the next two years and will be comprised of three phases: engagement, examination and reporting. 

Engagement Phase.  The NEP is currently engaged in an outreach program to inform newly registered investment advisers about their obligations under the Advisers Act.  As part of such outreach, the NEP has published various materials, including staff letters, risk alerts, special studies and speeches.  The letter contains a list of some of these resources and their reference links. 

Examination Phase.  The letter states that the NEP staff will contact advisers separately if and when they are selected for an examination.  If an adviser is selected for examination, the NEP staff will review one or more of the following higher risk areas: marketing, portfolio management, conflicts of interest, safety of client assets and valuation.   Upon completion of an on-site examination, the NEP staff may send the investment adviser a letter (i) indicating that the exam has concluded without findings, or (ii) describing the deficiencies identified and asking the firm to take corrective action.  Serious deficiencies may be referred to the Division of Enforcement of the SEC or other regulators.

Reporting Phase.  Upon completion of the examination phase, the NEP will report its observations, such as common practices and industry trends, to the SEC and the public.

SEC Extends Compliance Date for Third-Party Solicitor Provisions of Advisers Act Pay-to-Play Rule

On June 8, 2012, the SEC extended the compliance date for the third-party solicitor provisions of Rule 206(4)-5 of the Advisers Act (the “Pay-to -Play Rule”). The Pay-to-Play Rule, among other things, prohibits an adviser from providing or agreeing to provide, directly or indirectly, compensation to any person to solicit a government entity for investment advisory services on behalf of such adviser unless the person is an executive officer, general partner, managing member or employee of the adviser, or such person is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser. 

The SEC extended the compliance date for the third-party solicitor provisions of the Pay-to-Play Rule until nine months after the compliance date of a final rule adopted by the SEC related to the registration of municipal advisor firms. Once the final rule regarding the registration of municipal advisor firms is adopted, the SEC will issue the new compliance date for the ban on third-party solicitations.

Form PF Filing Fees

The SEC has approved filing fees for investment advisers registered with the SEC filing Form PF.  Fees are charged for Annual Reports and Quarterly Reports to Form PF ($150 for each Annual Report and Quarterly Report). Fees must be credited to the firm’s IARD Daily Account before the filing can be submitted. No fee is charged for filing an electronic amendment to Form PF, a final Form PF filing, or a transition to annual reporting filing.

SEC Issues New FAQs Related to Form ADV


The SEC recently issued two new FAQs clarifying certain reporting requirements in Form ADV.  The first new FAQ explains how assets are defined for purposes of responding to Form ADV’s question as to whether an adviser had $1 billion or more in assets as of the last day of the adviser’s most recent fiscal year end. The other new FAQ explains that an investment adviser registered with the SEC that files an annual updating amendment reporting that the adviser is not eligible for SEC registration must withdraw from registration within 180 days of its fiscal year end, unless the adviser then is eligible for SEC registration. Therefore, if a firm is registered with the SEC and reports having regulatory assets under management of less than $90 million on its annual updating amendment, but subsequently obtains $90 million or more in regulatory assets under management during the 180 day period, such adviser does not need to withdraw from SEC registration.