On December 1, the SEC announced enforcement actions against three advisory firms and six individuals as part of the Commission’s new initiative whereby the Commission’s Asset Management Unit uses proprietary risk analytics to evaluate hedge fund returns. Performance that appears inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further scrutiny. The enforcement actions allege that the firms and managers engaged in a wide variety of illegal practices in the management of hedge funds or private pooled investment vehicles, including fraudulent valuation of portfolio holdings, misuse of fund assets, and misrepresentations to investors about critical attributes such as performance, assets, liquidity, investment strategy, valuation procedures, and conflicts of interest.
The enforcement action filed against ThinkStrategy Capital Management LLC is particularly instructive. In this action, the SEC charged the New York-based firm and its managing director with fraud in connection with two hedge funds they managed. At its peak, ThinkStrategy reportedly managed approximately $520 million in assets. However, the SEC’s complaint filed on Nov. 9, 2011 alleges that ThinkStrategy engaged in a pattern of deceptive conduct designed to bolster the funds’ track record, size, and credentials. Specifically, the SEC alleges that ThinkStrategy materially overstated the funds’ performance and gave investors the false impression that their returns were consistently positive and minimally volatile. ThinkStrategy also allegedly inflated the funds’ assets, exaggerated the firm’s longevity and performance history, and misrepresented the size and credentials of firm’s management team.
Given the new information the SEC will acquire through Form PF, we can expect to see increased regulatory scrutiny against private fund managers rooted in suspiciously inflated performance returns.
For additional information please contact us at firstname.lastname@example.org or at (619) 298-2880.
The SEC and FINRA have issued a Risk Alert and a Regulatory Notice on broker-dealer branch inspections, and offered suggestions to help securities industry firms better perform this key supervisory function. The Risk Alert noted that the branch inspection process is a critical component of a comprehensive risk management program and can help protect investors and the interests of a firm. The SEC and FINRA offered the following tips to help perform robust branch inspections:
- Tailor the focus of branch exams to the business conducted in that branch and assess the risks specific to that business;
- Schedule the frequency and intensity of exams based on underlying risk (rather than on an arbitrary cycle) and examine branch offices at least annually;
- Engage in a significant percentage of unannounced exams, selected through a combination of risk based analysis and random selection;
- Deploy sufficiently senior branch office examiners who understand the business and have the gravitas to challenge assumptions; and
- Design procedures to avoid conflicts of interest by examiners that may serve to undermine complete and effective inspections.
To provide further guidance, the Risk Alert also identified certain shortcomings in firms’ branch office examination processes. The following were noted as significant deficiencies which impact the integrity of the overall branch inspection process. In these instances, firms:
- Utilized generic examination procedures for all branch offices, regardless of business mix and underlying risk;
- Attempted to leverage novice or unseasoned branch office examiners who do not have significant depth of experience or understanding of the business to challenge assumptions;
- Performed the inspection in a “check the box” fashion without questioning critically the integrity of underlying control environments and their effect on risk exposure;
- Devoted minimal time to each exam and little, if any, resources to reviewing the effectiveness of the branch office exam program;
- Failed to follow the broker-dealer’s own policies and procedures by not inspecting branch offices as required, announcing exams that were supposed to be unannounced, or failing to generate a written inspection report that included the testing and verification of the firm’s policies and procedures, including supervisory policies and procedures;
- Failed to have adequate written supervisory procedures, particularly in firms that used an independent contractor model and allowed registered personnel to conduct business away from the firm; and
- Lacked heightened supervision for individuals with disciplinary histories (both past and present).
While the Risk Alert pertains to broker-dealer branch office inspections, many of its tips and suggestions are equally applicable to the risk assessments and tests that should be conducted by investment advisers and private fund advisers.
For additional information on broker-dealer branch inspections, please contact Brent Cunningham, Associate Attorney by email at email@example.com by phone at (619) 298-2880.
On October 3, 2011, Rule 13h-1 went into effect which, among other things, requires “large traders” to begin identifying themselves to the SEC on December 1st by filing Form 13H. Under Rule 13h-1, a “large trader” is defined as a person, including affiliated entities, whose discretionary transactions in NMS securities (a) equal or exceed 2 million shares or $20 million during any calendar day, or (b) 20 million shares or $200 million during any calendar month. A large trader must file a Form 13H with the SEC within 10 days after reaching either one of these thresholds.
Upon receipt of Form 13H, the SEC will assign to each large trader an identification number that will uniquely identify the trader, which the large trader must then provide to its broker-dealers. After an initial filing, a large trader must file Form 13H as follows:
- Within 45 days after the end of each full calendar year; and
- Promptly after the end of any calendar quarter during which time any of the information contained in the previously filed Form 13H becomes inaccurate for any reason.
Investment advisers and broker-dealers with discretionary authority over client assets may want to consider performing a review of trading activity over the last 12 to 24 months to determine whether they may fall under the definition of large trader, thus being required to make Form 13H filings. Should such firms determine that filings maybe necessary, the following additional steps should be considered:
- Implementing controls to capture aggregated transaction information going forward; and
- Establishing policies and procedures covering requirements and compliance with Rule 13h-1.
For additional information on or assistance with Form 13H, please contact Brent Cunningham, Associate Attorney by email at firstname.lastname@example.org by phone at (619) 298-2880.
 NMS Securities are defined as “any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options.” This generally refers to the vast majority of publicly-traded securities in the U.S.