Published on:

By

Written by: Jay B. Gould

On December 12, 2013, the Securities and Exchange Commission (SEC) charged a London-based hedge fund adviser and its former U.S.-based holding company with internal controls failures that led to the overvaluation of a fund’s assets and inflated fee revenue for the firms.  The investigation came out of the SEC’s Aberrational Performance Inquiry, pursuant to which the Enforcement Division’s Asset Management Unit identifies suspicious performance through risk analytics.  The SEC searches for performance that is inconsistent with a fund’s investment strategy or other benchmarks and then conducts follow up inquiries.  In this case, the SEC worked with the United Kingdom’s financial regulator, the Financial Conduct Authority.

According to the SEC’s order instituting settled administrative proceedings, the GLG firms managed the GLG Emerging Markets Special Assets 1 Fund.  From November 2008 to November 2010, GLG’s internal control failures caused the overvaluation of the fund’s 25 percent private equity stake in an emerging market coal mining company.  The overvaluation resulted in inflated fees to the GLG firms and the overstatement of assets under management in the holding company’s filings with the SEC. 

The SEC order also stated that GLG’s asset valuation policies required the valuation of the coal company’s position to be determined monthly by an independent pricing committee.  On a number of occasions, GLG employees received information calling into question the $425 million valuation for the coal company position.  The SEC found that there were inadequate policies and procedures to ensure that such relevant information was provided to the independent pricing committee in a timely manner or even at all.  There also appeared to be confusion among GLG’s fund managers, middle-office accounting personnel, and senior management about who was responsible for elevating valuation issues to the independent pricing committee.  

The SEC’s order found that GLG Partners L.P. violated and GLG Partners Inc. caused numerous violations of the Federal securities laws.  It also required the GLG firms to hire an independent consultant to recommend new policies and procedures for the valuation of assets and test the effectiveness of the policies and procedures after adoption.  The GLG firms agreed to pay disgorgement of $7,766,667, prejudgment interest of $437,679, and penalties totaling $750,000.

The SEC has been targeting valuation cases recently as evidenced by the recent enforcement action against the Morgan Keegan fund directors and in the Ambassador Capital case.  Fund managers should review their valuation policies and procedures to make sure that such policies and procedures address current regulatory concerns, and to make sure that the disclosures in their fund documents are consistent with actual practice.

Published on:

By

This article was published by Investcorp and is reprinted here with permission.

Executive Summary

This paper analyzes correlations between credit spreads and interest rates across various sectors and credit ratings in the US. Our work was prompted by chairman Bernanke’s announcement this summer of possible tapering of the ongoing quantitative easing program which marked a turning point for interest rates from their historically low levels. We analyze data from 1990 to the present and use a statistically robust multi-factor risk model framework which can be calibrated to draw both long-term and short-terms conclusions. Our findings are relevant for credit portfolio managers contemplating the impact of rising interest rates and steepening Treasury curve on corporate bond portfolios.

Consistent with our earlier studies, we find strong negative correlation between sector spreads and rate shifts and twists. A uniform increase in rates is associated with tighter credit spreads, while a uniform drop in rates leads to wider spreads. In most industries, with the exception of the banking and brokerage and the consumer sector, lower credit quality is associated with stronger negative correlation.

We compare our current estimates with the results of a similar analysis we conducted in 2003 and find many similarities but also some notable differences. The long-term models estimated currently and 10 years ago show similar patterns. However, the short-term versions are quite different. The short-term correlation estimates in 2013 are much weaker than those from 2003 – likely a result of the Fed’s ongoing quantitative easing program which has weakened the normal relationships between the economic recovery (represented by spreads) and monetary policy (represented by rates). Moreover, correlation patterns in the banking and brokerage sector have changed prior and post the financial crisis. These results have important implications for risk management as well as for identifying relative value opportunities across sectors with different
rate sensitivities.

READ MORE…

 

Published on:

By

Written by: Jay B. Gould, Michael G. Wu and Jessica M. Brown

In January, 2010, the Securities and Exchange Commission (“SEC”) announced its Enforcement Cooperation Initiative (“Initiative”), which provided the SEC with the ability to offer certain individuals or entities immunity or other preferential treatment in exchange for information about illegal activities and/or cooperation with the SEC in connection with SEC enforcement actions. These techniques, such as cooperation and immunity agreements, or deferred and non-prosecution agreements were adopted by the SEC as a result of their effectiveness against organized crime investigations and the then recent hires by the SEC from the U.S. Attorney’s Office which regularly employs those tools. 

For a full description of the types of agreements in which the SEC may enter with an enforcement target or other “person of interest,” see the 2013 Enforcement Manual HERE.  Since the Initiative began, the SEC has entered into thirteen cooperation agreements, three deferred prosecution agreements and four non-prosecution agreements. See those agreements on the Initiative website HERE.

On November 12, 2013, the SEC announced its first deferred prosecution agreement with an individual. Scott Herckis (“Herckis”) had brought to the attention of the SEC certain fraudulent activities at the Heppelwhite Fund LP, where he acted as fund administrator through his financial and accounting services firm, SJH Financial, LLC. With the information and materials provided by Herckis, the SEC was able to bring an enforcement action against fund manager Berton Hochfeld for misappropriating over $1.5 million from the fund and overstating performance. The harmed Heppelwhite investors have since been granted a $6 million distribution by a federal judge.

After Herckis became aware of the fraudulent scheme, his actions and omissions enabled the scheme to continue for many months, yet without his cooperation and information, the scheme may have gone undetected. The deferred prosecution agreement provides for sanctions and penalties against Herckis for his role in the fraud but no further action will be taken against him for his violations, provided he does not violate the terms of the agreement.  This leaves industry participants pondering what further action the SEC would have taken against Herckis had he not cooperated and what the value of a deferred prosecution agreement might really be. Click HERE to read the Herckis deferred prosecution agreement.  

The SEC and federal prosecutors are continuing to explore alternative approaches to penalize companies and their principals for what they consider egregious securities law violations. In the recent criminal proceeding of SAC Capital Advisors LP (“SAC”), prosecutors considered whether criminal charges under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) would be appropriate. RICO allows for criminal charges, with substantial penalties, against the leader of an organization for acts that they ordered others to commit. Traditionally RICO has been successfully used against organized crime figures.  Federal prosecutors have taken the position that RICO may also be successfully used against the leaders of a legal entity, which could greatly increase the potential personal liabilities that an executive may face.  Although the SEC has now incorporated certain enforcement techniques used by criminal prosecutors, the SEC can only bring civil actions against alleged wrongdoers, but it can, and with increasing frequency does, refer cases over to the Justice Department for criminal prosecution.

Published on:

By

Written by:  Jay B. Gould and Jessica M. Brown

On October 28, 2013, the Securities and Exchange Commission (“SEC”)  brought enforcement actions and imposed sanctions on three different registered advisers and their principals for violations of Rule 206(4)-2 under the Investment Advisers Act of 1940 (the “Custody Rule”).  The circumstances that gave rise to each adviser being deemed to have custody differed, however, certain violations of the Custody Rule were present in each case.  These advisers were sanctioned for (i) incorrectly reporting their custody of client assets on their Form ADV, (ii) not conducting a surprise audit by an independent public accountant to verify client assets in custody, (iii) not having a reasonable belief that a qualified custodian was delivering account statements to fund investors at least every quarter, and (iv) a lack of properly written policies and procedures to protect client assets in custody.

This interest by SEC examination and enforcement staff should come as no surprise to investment advisers.  Each year, the SEC publishes a list of areas on which examiners will focus their efforts during the year.  The 2013 examination priority publication listed the Custody Rule as the first item on the priority list.  The SEC clearly stated to the industry that examinations of investment advisers would scrutinize the adviser’s (i) understanding of what constitutes custody, (ii) compliance with the “surprise exam” requirement of the Custody Rule, (iii) satisfaction of the “qualified custodian” provision and, (iv) if applicable, proper use of the exception for pooled investment vehicles.

Generally, any adviser that has access to a client’s account or assets, or has an arrangement in place that permits it to withdraw client assets, must comply with the Custody Rule.  An exception to the annual surprise audit and account statement delivery requirements are available for advisers that have custody of private fund or hedge fund assets, as long as certain conditions are met.

Because the definition of custody is both broad and somewhat convoluted, advisers should regularly review how client assets are maintained to determine if they have custody of client assets within the meaning of the Custody Rule and, if so, whether their compliance procedures, regulatory disclosures and marketing materials accurately reflect current business practice.  Investment advisers should always stay familiar with what the SEC has determined will be examination and enforcement priorities.

Published on:

By

This is a reminder that the 2014 IARD account renewal obligation for investment advisers starts this November.  An investment adviser must ensure that its IARD account is adequately funded to cover payment of all applicable registration renewal fees and notice filing fees.

Key Dates in the Renewal Process:

November 11, 2013 – Preliminary Renewal Statements which list advisers’ renewal fee amount are available for printing through the IARD system.

December 13, 2013 – Deadline for full payment of Preliminary Renewal Statements.  By December 10, 2013, an investment adviser should have submitted to FINRA through the IARD system, its preliminary renewal fee in order for the payment to be posted to its IARD Renewal account by the December 13 deadline.

January 2, 2014 – Final Renewal Statements are available for printing.  Any additional fees that were not included in the Preliminary Renewal Statements will show in the Final Renewal Statements.

January 10, 2014 – Deadline for full payment of Final Renewal Statements.

For more information about the 2014 IARD Account Renewal Program including information on IARD’s Renewal Payment Options and Addresses, please visit http://www.iard.com/renewals.asp

 

Published on:

By

Pillsbury was recently recognized for the second time as the “Best Onshore Law Firm – Hedge Fund Start-Ups” at the 2013 HFMWeek U.S. Hedge Fund Service Awards in New York City. This marks the fifth consecutive year Pillsbury has been honored by HFMWeek for its service to the hedge fund community. Pillsbury also won the HFMWeek Award for “Best Onshore Law Firm – Client Service” in 2009, 2010 and 2011.

The awards were established to recognize organizations that have outperformed their peers through the volatility of the last year, by demonstrating exceptional customer service or innovative product development. Winners are determined by a panel of independent industry experts who look at a combination of quantitative and qualitative measures.

Partner Jay Gould, leader of Pillsbury’s Investment Funds & Investment Management practice team, accepted the award on behalf of the Investment Funds & Investment Management team.

“HFMWeek’s recognition of Pillsbury and our work for clients organizing new investment advisers and offering new funds is even more meaningful because these are pivotal days for the industry, which faces relentless competition, global economic uncertainty and entirely new regulatory controls—particularly here in the U.S.,” Gould said. “This award reflects the understanding by both investors and fund managers that new hedge fund managers need to partner with the very best in class legal team in order to be and remain competitive in today’s highly scrutinized markets.”

HFMWeek serves the international hedge fund community, covering all aspects of operating a successful hedge fund. Pillsbury prevailed over top U.S. firms that also practice in the funds management area.

The team posts analysis of legal and business issues at Pillsbury’s Investment Fund Law Blog.

About Pillsbury Winthrop Shaw Pittman LLP

Pillsbury is a full-service law firm with an industry focus on energy & natural resources, financial services including financial institutions, real estate & construction, and technology. Based in the world’s major financial, technology and energy centers, Pillsbury counsels clients on global business, regulatory and litigation matters. We work in multidisciplinary teams that allow us to understand our clients’ objectives, anticipate trends and bring a 360-degree perspective to complex business and legal issues—helping clients to take greater advantage of new opportunities, meet and exceed their objectives and better mitigate risk. This collaborative work style helps produce the results our clients seek.

Published on:

By

Written by:  Jay B. Gould

On October 23, 2013, the Securities and Exchange Commission (“SEC”) brought charges against three different investment advisory firms for recidivist behavior.  The enforcement actions came out of the SEC’s Compliance Program Initiative, which targets firms that have been previously warned by SEC examiners about compliance deficiencies, but failed to effectively act upon those warnings.  The enforcement actions came out of the SEC’s Compliance Program Initiative, which targets firms that have been previously warned by SEC examiners about compliance deficiencies but failed to effectively act upon those warnings.  The SEC takes the view that investment advisory firms that ignore findings in deficiency letters, or represent that corrective action will or has been taken, and then do not take such corrective action, should be provided special treatment.  The SEC Enforcement Division’s Asset Management Unit has coordinated with examiners to bring several cases since the initiative began two years ago. 

The firms charged, Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC, agreed to settlements in which they will pay financial penalties and hire compliance consultants.  Since the adoption of Rule 206(4)-7 under the Investment Advisers Act (“Compliance Rule”), requiring an investment adviser to hire an outside compliance consultant has been a preferred remedy imposed by the SEC.  .

The SEC’s order against Modern Portfolio Management (“MPM”) and its owners found that they failed to correct ongoing compliance violations, such as failing to complete annual compliance reviews in 2006 and 2009, and making misleading statements on their website and investor brochure.  According to the SEC findings, one location on MPM’s website represented that the firm had more than $600 million in assets.  However, on its Form ADV filing to the SEC during that same time period, MPM reported that the firm’s assets under management were $359 million or less.  Asset inflation, as well as education and professional experience “enhancement” are two favorites among Advisers Act violators, and fairly easy to verify by SEC examiners. 

MPM and their owners agreed to be censured and pay a total of $175,000 in penalties.  The two principals of MPM were required to complete 30 hours of compliance training, a remedy seemingly very close to violating the 8th Amendment.  MPM also agreed to designate someone other than the two principals to be its chief compliance officer, and is also required to retain a compliance consultant for three years.

According to the SEC’s orders against New Orleans-based Equitas Capital Advisers and Equitas Partners as well as their owner, current chief compliance officer, and former owner and chief compliance officer, they failed to adopt and implement written compliance policies and procedures and conduct annual compliance reviews to satisfy the Compliance Rule.  The SEC charged the Equitas firms with making false and misleading disclosures about historical performance, compensation, and conflicts of interest, and repeatedly overbilled and underbilled their clients.  Many of these violations occurred despite warnings by SEC examiners during examinations of the Equitas firms in 2005, 2008, and 2011.  Equitas and the named individuals failed to disclose these deficiencies to potential clients in response to questions in certain due diligence questionnaires or requests for proposals.  

The former owner of Equitas, who later went on to form Crescent Capital Consulting, an investment advisory firm, was also found to have been responsible for Compliance Rule violations at his new firm (as well as at Equitas) by inflating the amounts of assets under management of both firms their respective Forms ADV by improperly removing and retaining nonpublic personal client information when he left Equitas.

Equitas Capital Advisers and Crescent reimbursed all overcharged clients, and agreed to pay a total of $225,000 in additional penalties, but presumable did not go back after the clients that they undercharged. The Equitas firms agreed to censures, and both the Equitas firms and Crescent were required to hire an independent compliance consultant.  Perhaps the most damaging sanction was that the Equitas firms and Crescent are required to provide notice to clients regarding the SEC enforcement actions. 

Published on:

By

Written by: Jay B. Gould

On October 23, 2013, the Securities and Exchange Commission (“SEC”) voted unanimously to propose rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding.

Crowdfunding describes an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects, products or artistic endeavors. Crowdfunding has generally not been used as a means to offer and sell securities because offering a share of the financial returns or profits from business activities would likely trigger the registration provisions of the federal securities laws relating to the offer or sale of securities.

Title III of the JOBS Act created an exemption under the securities laws so that this type of funding method can also be used to offer and sell securities without registration. The JOBS Act established the framework for a regulatory structure for this funding method. It also created a new entity – a funding portal – to allow Internet-based platforms or intermediaries to facilitate the offer and sale of securities without having to register with the SEC as brokers. Crowdfunding should not be confused with rules that were recently adopted under Regulation D that permits issuers of securities of private companies to engage in general solicitation or public advertising related to the sales of such securities.

The intent of the JOBS Act was to make it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. Critics, led by consumer groups and state securities administrators, have been critical of both the Regulation D amendments regarding general solicitation, as well as the crowdfunding provisions, as opening the floodgates for fraudster to prey on the financially unsophisticated. Accordingly, the challenge for the SEC is to establish a regulatory structure that both permits small companies and entrepreneurs to access investors in an efficient manner, while protecting the investors from scam artists.

Proposed Rules
The proposed rules would among other things permit individuals to invest subject to certain thresholds, limit the amount of money a company can raise, require companies to disclose certain information about their offers, and create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions.

Under the proposed rules:

  • A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
  • Investors, over the course of a 12-month period, would be permitted to invest up to:

$2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.

10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Certain companies would not be eligible to use the crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies (such as hedge funds), companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

Securities purchased in a crowdfunding transaction cannot be resold for a 12-month period. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Securities Exchange Act of 1934.

Disclosure by Companies
The proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.

In its offering documents, among the things the company would be required to disclose are:

  • Information about officers and directors as well as owners of 20 percent or more of the company.
  • A description of the company’s business and the use of proceeds from the offering.
  • The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
  • Certain related-party transactions.
  • A description of the financial condition of the company.
  • Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.

Companies would be required to amend the offering document to reflect material changes and provide updates on the company’s progress toward reaching the target offering amount.

Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

Crowdfunding Platforms
Title III of the JOBS Act requires that crowdfunding transactions take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.

The proposed rules would require these intermediaries to:

  • Provide investors with educational materials.
  • Take measures to reduce the risk of fraud.
  • Make available information about the issuer and the offering.
  • Provide communication channels to permit discussions about offerings on the platform.
  • Facilitate the offer and sale of crowdfunded securities.

The proposed rules would prohibit funding portals from:

  • Offering investment advice or making recommendations.
  • Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
  • Imposing certain restrictions on compensating people for solicitations.
  • Holding, possessing, or handling investor funds or securities.

The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

What’s Next?
The SEC will take public comments on the proposed rules for 90 days, after which it will review the comments and determine whether to adopt the proposed rules. Depending upon the tone and substance of the comments, the SEC may move quickly to adopt the rules as proposed, adopt the rules with certain modifications based on the comments, or re-propose the rule for additional public comment. Anxious market participants should not expect to start offering their crowdfunding securities.

Follow @Investment_Law on Twitter.

Published on:

By

This article was published by Business in Canada and is reprinted here with permission.

Business in Canada recently had the opportunity to interview Richard Taglianetti, a giant in the hedge fund universe who has raised millions of dollars for start-up managers over the course of his career. At present, Richard serves as the senior managing director of hedge funds at Corinthian Partners, where he connects institutional investors on both sides of the Atlantic with emerging managers who have logical, scalable processes and strong track records, to boot.

During the interview, we discussed the challenges facing the Canadian hedge fund industry and why its size pales in comparison to the United States and the United Kingdom. Consider this: the population of United States is roughly ten times that of Canada, but its hedge fund managers oversee roughly 45 times the assets. At the end of 2012, Canadian hedge funds managed about $35 billion while their counterparts in the United States had a cumulative AUM of over $1.5 trillion. In light of this vast discrepancy, Richard concluded that “there’s definitely something holding the Canadian hedge fund industry back.”

Shortly thereafter, Richard was kind enough to follow up with Business in Canada, sending an email in which he outlined a few things that are inhibiting the growth of hedge funds in the Great White North.

  • Underperformance

As Richard previously told us, “Performance is a magnet for assets.”  Unfortunately, in 2012, Canadian hedge funds did more to repel than attract investors.  As a whole, the industry gave back 5 percent last year, far underperforming the TSX, which advanced by 4 percent.

  • The End Of The Commodities Supercycle

Before ‘tapering’ became part of Wall Street’s lexicon, investors were rebalancing their portfolios in accordance with the notion that the commodities supercycle was drawing to a close.  Richard believes this development had a particularly deleterious effect on resource-focused managers in Canada.

  • The Cost Of Accessing FundSERV

FundSERV is an online hub that connects and facilitates transactions between funds, distributors, and intermediaries. Membership in this network doesn’t come cheap.  According to Richard, these costs unduly burden smaller managers, which reduces the size of the pool of managers in Canada. In addition, this restricts a hedge fund’s access to high net worth investors, who provide the vital money needed for expansion.

Richard is quite open to working with Canadian managers, saying, “If there was a team in Canada that is performing, I would love to talk to them.”  But after 13 years of putting out global searches for managers, only a handful of Canadians have answered his call. 

Author: BiC Editorial Board

Published on:

By

Written by: Michael G. Wu

The National Futures Association (“NFA”) recently implemented a new quarterly reporting requirement for commodity trading advisors (“CTAs”).  Under NFA Compliance Rule 2-46, CTAs must file on a quarterly basis NFA Form PR, which consists of the Commodity Futures Trading Commission’s Form CTA-PR together with additional information relating to the trading programs offered by the CTA, related monthly rates of return and assets under management for the trading programs.  The initial report will be due on November 14, 2013.  The NFA Notice to Members discussing the quarterly reports can be found here.