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.

Lessons From a Recent SEC Enforcement Matter

On July 18, 2012, the SEC announced that it entered into a deferred prosecution agreement with the Amish Helping Fund (AHF).  AHF was formed in 1995 by a group of Amish elders interested in furthering the Amish way of life.  AHF offered and sold securities, the proceeds of which were used to fund mortgage and construction loans to young Amish families in Ohio.  The SEC asserted that AHF’s offering memorandum, drafted in 1995, was not updated for 15 years and contained material misrepresentations about the fund and the securities being offered.  When the SEC informed AHF of the alleged violations, AHF immediately cooperated, updated its offering memorandum and provided existing investors with a corrected copy of the updated  memorandum, offered all existing investors the right of rescission, and retained a certified public accountant to perform ongoing audits, among other things.  In its press release, the SEC emphasized that the SEC acknowledged and rewarded AHF’s cooperation.

What lessons can we learn from this enforcement matter?  First, that the securities laws apply without regard to the underlying reasons you are seeking to raise money.  Even when raising money for a “good cause”, such as helping young Amish families, when selling securities, compliance with applicable securities laws is still critical.  Second, offering materials must be reviewed and updated on a regular basis to reflect changes.  A company may not simply prepare a disclosure document, and then keep reusing the disclosure document from year to year without reviewing and updating it.  Updating is critical to providing accurate and complete information to investors.

SEC Approves Rule Requiring a Single, Consolidated Audit Trail System to Track Trading Activity

On July 11, 2012, the Securities and Exchange Commission announced that it approved Rule 613 pursuant to the Securities Exchange Act of 1934 requiring the national securities exchanges and the Financial Industry Regulatory Authority (collectively, the “SROs”) to develop a detailed, comprehensive plan for creating, implementing, and operating a single, market-wide consolidated audit trail system.  The rule requires that the system, when implemented, collect and accurately identify every order, cancellation, and trade execution for all “National Market System” securities.  

Currently, there is no single, readily accessible database regarding orders and executions.  Instead, such information must be compiled from separate audit trail systems established by the various SROs that cover orders only in their respective markets.  Presently, preparing such a compilation can be a long and tedious process.  For example, according to comments from SEC Chairman Mary L. Shapiro, after the Flash Crash of May 6, 2010, it took dozens of highly-trained economists, financial professionals, and data technologists four months to assemble and process information necessary to fully analyze just a few hours of trading on a single day. 

While the rule was approved, Commissioner Aguilar did not support the rule, stating in part that “today’s rule falls short of establishing the process that investors deserve. . . . I am concerned that the [proposed rule] fails to set appropriately specific requirements to ensure the creation of a comprehensive market surveillance system . . . .”

The rule will become effective 60 days after publication in the Federal Register and requires the SROs to submit their plan for the consolidated audit trail system to the SEC within 270 days after publication of the SEC adopting release in the Federal Register.  The plan will not be implemented unless and until approved by the SEC.


Don’t Forget About Your FCPA Risk Factor

The Foreign Corrupt Practices Act (FCPA) is back in the news.  The Securities and Exchange Commission has a specialized unit established to enhance the SEC’s enforcement of the FCPA, and the SEC reports that it has brought more than 30 FCPA enforcement actions since the start of 2010.  Moreover, as my colleagues Shawn M. Wright and James R. Billings-Kang recently wrote in The National Law Journal, the United States Department of Justice has over 150 open FCPA investigations and together the SEC and the DOJ netted approximately $1.8 billion in fines, penalties and disgorgement of profits in 2010 alone for FCPA violations. 

Generally, the FCPA covers, among others, any company with securities registered under the Securities Exchange Act of 1934 and any company that is required to file reports under the Exchange Act or has its principal place of business in the United States.  The anti-bribery provisions of the FCPA prohibit corrupt payments to foreign officials for the purpose of procuring or maintaining business.  The FCPA is extremely broad in its scope and determining exactly what is prohibited by the FCPA can be very difficult.  Because the FCPA makes illegal many payments that individuals working in countries other than the United States may consider ordinary or customary, it can be particularly difficult to put a stop to the sorts of payments that may be covered by the FCPA, even where a company has a robust training and compliance program. 

If your company has significant operations outside the United States, especially where those operations are in countries where unofficial payments or gifts are a regular part of the business culture, a risk factor about your company’s FCPA exposure is likely to be warranted.