SEC’s New Powers Affect Hedge Fund and Private Equity Advisors

 The statement summarizes some of the most important aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act that affect hedge fund and private equity advisors, and lists key requirements advisors must focus on when registering with the SEC. President Obama signed the act into law on July 21.

 “Not only will most investment advisors now be required to register, they will also be faced with more onerous reporting obligations,” Neil Morris, a member of the operational risk group at Kinetic Partners, said in the statement. “Therefore, advisors need to consider how they will respond to the heightened scrutiny and the SEC’s new demands.”

 The Dodd-Frank Act eliminates the so-called private advisor exemption, which many advisors have used to establish open-end hedge funds and unregistered private equity operations. According to Kinetic, the amount of assets under management and the types of clients or investors they serve will determine which investment advisors will have to register. Those with AUM of $150 million or more will be required to register with the SEC. Advisors with AUM between $25 million and $150 million will have to register with a state regulator.

 Non-U.S. investment advisors will be exempt from registration if they have no place of business in the country, have less than $25 million of investments from U.S. investors and fewer than 15 U.S. investors, and generally do not represent themselves to the public in the U.S. as investment advisors. Others exempt from registration are venture capital fund advisors, family offices and registered commodity trading advisors.

 Registration provisions will take effect on July 21, 2011.

 Kinetic said that under the new legislation, the SEC will be able to request information, other than records already required, as it deems necessary to protect investors and to assess systemic risk.

 The statement listed major requirements for registered advisors and for compliance with the Investment Advisors Act of 1940, as amended:

 ·      Compliance manual and code of ethics tailored to the advisor’s business

·      Employee investment policies

·      Appointment of chief compliance officer

·      Compliance monitoring program tailored to the adviser’s business

·      Submission of Form ADV I, and preparation of Form ADV II (and Schedule F)

·      Books and records retention

·      Risk assessment and annual compliance reviews

·      Employee training

·      Disclosure of conflicts to investors

 The compliance manual requirement deserves especially close attention, Morris wrote in an article in the June issue of Wall Street Letter. Its contents should include a discussion of the registration documents, an overview of fiduciary obligations, valuation policies, conflicts of interest policies, client suitability issues and client advisory agreements.

 The manual should also incorporate the firm’s code of ethics and employee investment policy, all records and policies related to communications with investors and the public, details on advertising and marketing, and policies related to complaints, privacy and proxy voting. In addition, the manual should clearly state anti-money laundering and know-your-customer policies.

 In the same article, Morris wrote that firms should prepare a Risk Assessment Matrix that clearly states policies regarding both perceived and actual risks. The matrix should set how in detail how the firm will mitigate each risk in all areas of the business; these include portfolio risk, cash controls and cash transfers, insider trading, reporting errors and client conflicts.

 Michael S. Fischer (msf7@columbia.edu) is a New York-based financial writer and editor and a frequent contributor to WealthManagerWeb.com.