Hedge fund and private equity fund managers that use registered broker-dealers to raise capital on behalf of their funds should be aware of a recent report from the North American Securities Administrators Association (“NASAA”). The 2010 Broker-Dealer Coordinated Examination Report identifies the most prevalent compliance deficiencies by broker-dealers and offers a series of recommended best practices for broker-dealers to consider in order to improve their compliance practices and procedures.
Fund managers should conduct initial and ongoing due diligence on all of their agents and service providers, and no less so with third party marketers, which must be registered as broker-dealers. Agreements between fund managers and their third party marketers should include representations from the marketer that no information will be given to potential fund investors that is not approved by the fund manager. The agreement should include an indemnification by the third party marketer to the fund manager in the event a fund investor relies on information produced by the marketer that is not accurate and complete in all material respects.
A fund manager that understands the nature of past violations by a broker dealer/third party marketer will be in a better position to protect the reputation of his/her firm. When conducting due diligence of third party marketers, fund managers should view the FINRA “Broker Check” tool and information provided by the SEC, as well as request information regarding past engagements of the third party marketer. Fund managers should inquire about pending or ongoing regulatory investigations, customer complaints, and whether the third party marketer has implemented NASAA’s “10 Best Practices” for broker-dealers.
The NASAA Report took into account a total of 290 examinations conducted between January 1, 2010 and June 30, 2010, which found 567 deficiencies in five compliance areas. The greatest number of deficiencies (33 percent or 185 deficiencies) involved books and records, followed by sales practices (29 percent or 164 deficiencies), supervision (20 percent or 115 deficiencies), registration and licensing (10 percent or 56 deficiencies), and operations (8 percent or 47 deficiencies).
The three most commonly found problem areas involved failure to follow written supervisory policies and procedures, advertising and sales literature, and variable product suitability. Half of the examinations involved one-person branch offices, 19 percent were home offices, 18 percent were branch offices with two to five agents, 10 percent were branch offices with more than five agents and 3 percent were non-branch offices.