SEC Examinations of Investment Advisers and Privately-Managed Funds for Compliance with the Federal Securities Laws
The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminated the exemption from Securities and Exchange Commission (SEC) registration for investment advisers with fewer than fifteen clients, which previously had been widely relied upon by advisers to private funds, such as hedge funds, private equity funds and real estate funds. As a result, many such advisers had to register with the SEC as investment advisers for the first time.
While some provisions of the Investment Advisers Act of 1940 and related SEC rules apply to both registered and unregistered investment advisers, certain requirements apply only to those advisers that are registered. Accordingly, once registered, private fund advisers became subject to certain additional regulatory requirements. For example, registered investment advisers:
- Must adopt written compliance policies and procedures;
- Must prepare and file reports with the SEC;
- Must provide clients with a written brochure;
- Must have a code of ethics governing their employees;
- Must safeguard client assets in accordance with the custody rule; and
- Must ensure that contracts with advisory clients comply with the requirements of the Advisers Act
An SEC exam can be an intimidating prospect for an investment adviser experiencing it for the first time. However, forethought, organization, and adherence to best practices in the ongoing conduct of one’s advisory business go a long way toward preparing a firm to present itself effectively to SEC examiners when they arrive.
The Knowledge Group has assembled a panel of key thought leaders and regulators to help financial executives and compliance officers to understand all the important issues with respect to this significant topic. They will offer effective strategies and best practices to prepare for, and pass the hurdles of, SEC examinations. A LIVE Q&A session is also included in this event.
Marc Wyatt, Senior Specialized Examiner,
U.S. Securities and Exchange Commission
- Initial findings /feedback from the key risk areas as outlined in the Presence Exam letter by Director Drew Bowden (Marketing, Portfolio Management, Conflict of Interest, Safety of Client Assets and Valuation)
- Discussion in the Private Fund Space
- Initial finding/insight as the new registrants file Form PF
Bob Zink, CPA, Member,
Independent Verification of Funds and Securities (Rule 206(4)-2(a)
Books and Records Requirement (Rule 204-2(b)
- Brief overview of the SEC Custody Rule Requirements
- Initially went effective March 12, 2010
- Qualified custodian must maintain funds and securities
- In a separate account for each client under that client’s name, or
- In accounts that contain only your client’s funds and securities, under your name as agent or trustee for the clients
- Must send written notice to clients when you open an account with a qualified custodian on your client’s behalf
- Account statements – you must have a reasonable basis for believing, after due inquiry, that the qualified custodian sends an account statement, at least quarterly, to each of your clients for which it maintains funds or securities, identifying the amount of the funds and of each security in the account at the end of the period and setting forth all transactions in the account during the period. This requirement is designed so that clients will receive a statement from the qualified custodian that they can compare any statements they receive from the advisor to determine whether any account transactions, including deductions to pay advisory fees, are proper.
- Special rule for LPs and LLCs – if you are the GP or Managing Member of a LP or LLC, the account statements required under these regulations must be sent to each limited partner or member or other beneficial owner.
- Annual Surprise Examination of Client Assets
- Advisors with custody of client assets must undergo a surprise examination (or an audit, if applicable) of those assets by an independent public accountant.
- Each advisor subject to this rule must enter into a written agreement with an independent public accounting firm to conduct the examination. This agreement must also require the accountant to:
- Notify the SEC within 1 business day of finding any material discrepancy during the course of the examination
- Submit Form ADV-E to the SEC, accompanied by the accountant’s certification within 120 days of the time chosen by the accountant for the surprise examination, stating that the accountant has examined the funds and securities and describing the nature and extent of the examination.
- Upon resignation or dismissal, the accountant must file within 4 business days a statement regarding the termination along with Form ADV-E.
- Pooled Investment Vehicle Audits
- If the pooled investment vehicle is subject to an annual audit by an independent public accountant and the advisor distributes the audited financial statements prepared in accordance with US GAAP to the pool’s investors, the advisor is deemed to have satisfied the annual surprise examination requirement with respect to such pooled investment vehicles. Non-pooled assets are still subject to the annual surprise examination requirements.
- Audited financial statements should be distributed within 120 days (180 days if a fund of funds) to the investors.
- The auditor must be registered with, and subject to regular inspection, by the PCAOB.
- Liquidation audits – pooled investment vehicles that distribute the pool’s audited financial statements to its investors under the Custody Rule must, in addition to obtaining an annual audit, obtain a final audit of the pool’s financial statements upon liquidation of the pool and distribute the audited financial statements to the investors promptly after completion of the audit. The liquidation audits must also be performed by an independent public accountant that is registered with, and subject to regular inspection by, the PCAOB.
- Custody by Advisor and Related Party
- If the advisor, or a related party, serves as a qualified custodian and has custody of client funds and securities, there are additional requirements aside from the surprise examination requirements. This is because self custody is generally deemed to present higher risks.
- The advisor must also receive no less frequently than once every calendar year, a written report, which includes an opinion from an independent public accountant with respect to the advisor’s or related party’s controls relating to custody of client assets. A Type II SAS 70 report would generally meet this requirement. The accountant issuing such a report must be registered with, and subject to routine inspection, by the PCAOB.
- Scope of Surprise Examination Engagements
- Obtain advisor records that detail client funds and securities for which the advisor has custody and the identification of the qualified custodians of those funds and securities
- For a sample of client accounts, obtain records of the purchases, sales, contributions, withdrawals and any other debits or credits to each selected client’s account occurring since the date of the last examination
- Confirm with the qualified custodian of the client funds and securities as of the date of the examination and that the client’s funds and securities are held in either a separate account under the client’s name or in an account under the name of the investment advisor as agent or trustee for clients
- Confirm with the client of funds and securities held in the account as of the date of the examination and contributions and withdrawals of funds and securities to and from the accounts since the date of the last examination
- Reconcile confirmations received and other evidence obtained to the investment advisor’s records.
- Accountant’s examination report should include an opinion as to whether the advisor was in compliance with paragraph (a)(1) of Rule 206(4)-2(a) as of the examination date. Paragraph (a)(1) is the requirement that a qualified custodian maintain the funds and securities in a separate account for each client. Interestingly enough, while accountants will check during the surprise examination that the qualified custodian sends account statements directly to the clients at least quarterly, that is the requirement of paragraph (a)(3) and is not specifically addressed by the accountants surprise examination report.
- Rule 204-2(b) requires that an advisor who has custody or possession of funds and securities of any client must record all transactions for such clients in a journal and in separate ledger accounts for each client, plus maintain copies of confirmations of all transactions in such accounts and a position record for each security in a client that has an interest.
- Accountant’s examination report should include an opinion as to whether the advisor was in compliance with Rule 204-2(b) during the period since the prior examination date.
- Typical Issues Encountered During Surprise Custody Exams
- Qualified custodian did not send periodic account statements directly to the clients – not a surprise exam opinion issue but this will require the accountant to communicate the deficiency to the SEC within 1 business day
- Failure of advisor to enter into a written agreement with an independent public accountant once subject to the Custody Rule requirements – might represent a material non-compliance with Rule 206-4(2)
- RIA sponsored a pooled investment vehicle for which the audited financial statements were not prepared in accordance with US GAAP. As such, the audit could not be relied upon for purposes of the Custody Rule. Additional facts in this circumstance – qualified custodian did not send quarterly account statements to the investors and private securities were not placed with a qualified custodian.
Kris Easter, Counsel,
O’Melveny & Myers LLP and
Heather L. Traeger, Partner,
O’Melveny & Myers LLP
- Broker-Dealer Status
- Identify key activities
- Assess availability of safe harbor
- Evaluate relationships with portfolio companies
- Privacy Rules
- Interaction of SEC and FTC privacy rules to investment advisers and the private funds they manage
- Discuss privacy notices and opt outs, and analyze availability of exceptions
- Consider the application of recently adopted SEC and CFTC Red Flags Rules
Kimberly M. Versace, Counsel,
Richards Kibbe & Orbe LLP
- Preparation for an SEC exam must begin long before an exam letter arrives
- Tips for ensuring you are prepared for an SEC exam when it happens
- Understand that regulatory filings are the SEC’s introduction to your firm
- SEC staff will have reviewed your ADV, Form PF, other filings before they arrive for the exam
- Describe your business and conflicts of interest carefully and consistently
- Examples of areas where regulatory filings contain overlapping information
- Related persons and associated conflicts
- Brokerage practices and soft dollars
- Private fund information
- Ensure that investor disclosures are accurate and complete
- Examiners will want to see that what you are telling investors is accurate and reflects what you do, and that material conflicts are disclosed
- Make sure your offering materials and other investor-focused disclosures and communications are consistent
- Document compliance issues and exceptions appropriately
- Include substance of compliance review, decisions made, measures taken in response
- Understand SEC staff will be viewing in hindsight, often long after events took place
- Consider how to address privilege when your chief compliance officer and general counsel are the same person
- Show your work
- Document training, diligence, other activities undertaken on an ongoing basis
- If you don’t record it, the SEC staff’s view may be that you didn’t do it
- Ensure proper documentation when you outsource some of your compliance function to a third party compliance consultant or service
- Update policies and procedures on an ongoing basis
- Maintaining accurate, up to date policies and procedures that reflect your firm’s practices is very important
- Prepare senior personnel to provide an overview of the business and key risks
- Consider developing an orientation document
- Take an organized approach to maintaining required books and records
- Understand that regulatory filings are the SEC’s introduction to your firm
Who Should Attend:
Investment advisers, particularly those who advise private funds, private equity and real estate funds, and newly-registered advisers, are now subject to examination by the Securities & Exchange Commission. This program highlights some key compliance requirements for newly-registered advisers that may be of interest to compliance officers, senior management and counsel.
Marc Wyatt, CFA joined the SEC in December 2012 as a Senior Specialized Examiner focused on private funds. Most recently, Marc was a Partner and Senior Portfolio Manager at Stark Investments (a global multi-strat hedge fund) where he served as the co-head of the London office and was responsible for all aspects of the London office’s activities, including asset allocation, risk management, marketing, operations, and compliance. He also served as the Global Head of Credit and as a member of the Global Portfolio Committee at Stark. Prior to working in the hedge fund industry, Marc served as an investment banker (at Merrill Lynch and Alex. Brown) and as an analyst (at Fitch and Lehman). Marc earned a BS in Economics from University of Delaware and a MBA from Duke University.
Marc Wyatt, CFA joined the SEC in December 2012 as a Senior Specialized Examiner focused on private funds. Most recently, …
Bob joined Arthur Bell in October 1999 after seventeen years with Ernst & Young. As Member in charge of the Firm’s Audit & Assurance Group, he coordinates and oversees the Firm’s delivery of audit and attestation services to hedge funds, commodity pools, investment advisers, commodity trading advisors, and broker-dealers.
Bob has over 25 years of experience providing audits, performance capsule examinations, SAS#70 examinations, and consulting on the formation and design of alternative investment entities for the financial services industry, including banks and insurance companies. With extensive SEC, GAAP and statutory reporting experience, Bob also serves as the Firm’s Accounting and Auditing Technical Coordinator.
Bob earned his B.A. in Accounting from Loyola University Maryland. He is a member of the Managed Funds Association, the AICPA and the MACPA. Bob is licensed in Georgia, Illinois, Maryland, New Jersey, New York, and Wisconsin.
Bob joined Arthur Bell in October 1999 after seventeen years with Ernst & Young. As Member in charge of the …
Kris L. Easter is a counsel at O’Melveny & Myers LLP and a member of the Financial Services Practice, where she advises financial institutions on their regulatory and compliance obligations under the federal securities and commodities laws. Before joining O’Melveny, Kris was Assistant Director at the Securities and Exchange Commission (SEC), in the Chief Counsel’s Office of OCIE — the Office of Compliance Inspections and Examinations – where she focused on financial legislative reform and provided legal and policy advice to staff in the national examination program. Prior to her work at the SEC, Kris served for several years as a tax attorney at Deloitte & Touche.
Kris L. Easter is a counsel at O’Melveny & Myers LLP and a member of the Financial Services Practice, where …
Heather L. Traeger is a partner at O’Melveny & Myers and a member of the Financial Services Practice. Her practice involves advising financial institutions on regulatory developments that impact their businesses, developing and reviewing policies and procedures to assess compliance and internal controls and identify methods to strengthen them, and providing training to personnel at financial institutions. Prior to joining O’Melveny, Heather was an Associate Counsel at the Investment Company Institute (ICI). Previously, during nearly a decade at the SEC, Ms. Traeger served several positions, including Senior Counsel to Commissioner Roel Campos, Counsel to Commissioner Issac Hunt, and Senior Counsel in the Division of Market Regulation (now Trading and Markets).
Heather L. Traeger is a partner at O’Melveny & Myers and a member of the Financial Services Practice. Her practice …
Kimberly M. Versace is Counsel at Richards Kibbe & Orbe LLP. Kimberly’s practice focuses on securities regulatory and compliance matters, with an emphasis on Investment Advisers Act compliance. She provides ongoing advice to hedge fund advisers and other financial institutions in connection with the development of comprehensive compliance programs to address regulatory obligations imposed by federal laws and regulations, and advises investment firms on compliance with disclosure requirements, insider trading rules, conflicts of interest and other legal and regulatory requirements.
Kimberly M. Versace is Counsel at Richards Kibbe & Orbe LLP. Kimberly’s practice focuses on securities regulatory and compliance matters, …
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U.S. Securities and Exchange Commission
About U.S. Securities and Exchange Commission
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