RIA Compliance BlogThe SEC recently announced its intent to issue an order that will adjust the dollar amount necessary to be considered a “qualified client” under Section 205(a)(1) of the Investment Advisers Act of 1940 (“Advisers Act”). This increase, adjusted to reflect inflation, raises the minimum net worth or dollar amount of assets under management necessary for an investment adviser to charge a performance fee to the client.
Articles Posted in Hedge Funds
SEC Releases 2022 Examination Priorities
The Securities and Exchange Commission (SEC) recently released the 2022 Examination Priorities from the Division of Examinations, formerly known as the Office of Compliance Inspections and Examinations. This annual release provides insight into the areas that the SEC plans to highlight when examining investment advisers during the coming year.
While the SEC notes the continued impact of COVID-19 on investment advisers and the investment industry, the SEC reported an increase in examinations conducted during FY21, with the total number of completed examinations close to the pre-pandemic levels of FY19.
For FY22 examinations, the SEC will place a significant focus on (1) private funds; (2) environmental, social, and governance (ESG) investing; (3) standards of conduct: Regulation Best Interest (Regulation BI), fiduciary duty, and Form CRS; (4) information security and operational resiliency; and (5) emerging technologies and crypto-assets. Many of these focus areas, such as ESG and Regulation BI, are carried over from previous years and mark a multi-year emphasis for the SEC.
SEC Fines Investment Adviser Over the Use of Hedge Clause in Advisory Agreement
Last month, the SEC commenced an administrative enforcement action that highlights the significance of its change in guidance over the use of “hedge clauses” in investment advisory agreements. Recall that in IA-5248, the SEC’s 2019 interpretive release that addressed the standard of conduct for investment advisers, the Commission withdrew the 2007 No-Action Letter previously issued in Heitman Capital Management, LLC (Feb. 12, 2007) (“Heitman Letter”). Prior to IA-5248, the Heitman Letter had frequently been relied upon by investment advisers to permit the use of hedge clauses, or clauses purporting to limit an adviser’s liability, as long as the clause contained an affirmative statement that it should not be construed to waive unwaivable claims under federal and state securities laws. Because the SEC concluded that the Heitman Letter had been often misconstrued, IA-5248 expressly withdrew it.
Prior to the issuance of the Heitman Letter in 2007, the SEC had rather consistently prohibited the use of hedge clauses. The Heitman Letter, however, constituted a departure from that previous near-blanket prohibition. In Heitman, the SEC staff stated that the use of a hedge clause that limits the adviser’s liability except for gross negligence or willfulness may under some circumstances be permitted, depending on “all the surrounding facts and circumstances.” Among the circumstances to be considered were whether it was written in plain English, whether it had been highlighted and explained to the client personally, whether there was a heightened explanation of the types of claims that were not waived, and whether impacted clients had access to other professional “intermediaries” upon whom they relied. After the Heitman Letter, the use of hedge clauses by investment advisers proliferated, not always consistently with the Heitman guidance.
Investment Advisers to Private Funds Urged to Review SEC Risk Alert
Earlier this week, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert in which it discussed ongoing deficiencies identified during compliance examinations of investment advisers that advise private funds. This risk alert follows on the heels of other SEC activity relating to private fund advisers, including enforcement referrals, deficiency letters, and informal guidance.
The deficiencies discussed in the risk alert fall into three broad categories: disclosures relating to fees; disclosures relating to conflicts of interests; and sufficiency of a firm’s policies relating to nonpublic material information and its internal enforcement of such policies. The purpose of this risk alert was to provide guidance to private fund advisers regarding steps they should take to improve their compliance policies and program, while simultaneously advising investors in private funds of the types of issues to be aware of when dealing with private fund advisers. Many investors in private funds are pensions or other qualified retirement plans, charities and endowments, and families who have family offices.
This blog post focuses on the portion of the risk alert relating to fees and expenses. Continue reading ›
Court Orders Hedge Fund Advisers to Pay $12.9 Million in SEC Fraud Case
On August 2, 2017, a federal court in Connecticut ordered Steven Hicks (“Hicks”), a hedge fund manager, and his hedge fund advisory firms to pay almost $13 million. This payment includes disgorgement and a penalty. In 2010, the Securities and Exchange Commission (“SEC”) filed a complaint against Hicks and his two hedge fund advisers, Southridge Capital Management LLC (“Southridge Capital”) and Southridge Advisors, LLC (“Southridge Advisors”). The complaint alleged that Hicks, Southridge Capital, and Southridge Advisors committed fraud by placing investor money in illiquid securities when investors were told that “at least 75% of their money would be invested in unrestricted, free-trading shares.”
According to the SEC’s complaint, starting in 2003, Hicks started soliciting investors. He told them that 75% of any money they invested in two funds he was starting would be invested in unrestricted, free-trading shares. Free-trading shares are shares that are eligible to be sold. Evidence shows that some potential investors were also told that the funds would invest “in short-term transactions that would take only 10 or 15 days, such as equity line of credit (‘ELC’) deals.” Continue reading ›
SEC Charges Options Trading Instructor with Defrauding Investors in Private Funds
On May 24, 2017, the Securities and Exchange Commission (“SEC”) filed a complaint against an options trading instructor and unregistered investment adviser, Gustavo A. Guzman (“Guzman”). The complaint alleges that Guzman obtained more than $2.1 million from investors, assuring them that their funds would be invested in equity options and real estate. However, evidence showed that Guzman misappropriated a third of the funds “and lost the remainder through his options trading while misleading existing or prospective investors.”
Guzman was not registered as an investment adviser with the SEC or any state authority. However, he was tasked with managing investments in two private funds specializing in options trading and one real estate hedge fund. He also received management fees for managing these funds. As a result, Guzman met the definition of an investment adviser in the Investment Advisers Act of 1940 (“Advisers Act”) and was subject to its anti-fraud provisions. Continue reading ›
SEC Charges Georgia Based Fund Investment Adviser With Front-Running and Other Fraud
Last month the Securities and Exchange Commission (“SEC”) commenced an administrative proceeding against an Augusta Georgia investment adviser to a hedge fund called Geier International Strategies Fund, LLC (“GISF”). According to the SEC’s Order Instituting Administrative Proceedings, Christopher M. Gibson, the fund’s adviser, caused the fund to invest the majority of the fund’s assets in a single security, then personally profited and helped both his friends and a preferred investor in the fund to personally profit at the expense of the fund and its other members by engaging in frontrunning and other fraudulent conduct.
More specifically the Order alleges that in 2011 GISF had 21 investors and a total asset value of approximately $60 million. In early, Gibson, who had previously advised the fund through a Georgia registered investment adviser called Geier Group, LLC, caused the fund to purchase large quantities of Tanzanian Royalty Exploration Corporation (“TRX”), and Alberta, Canada based gold mining resource company that has never been profitable. The fund held 10.3% of all of TRX’s outstanding common stock by April 29, 2011, a holding that was valued at over $70 million at the time. However, as TRX’s value plunged from late April to late September, the fund’s value also declined precipitously.
SEC Bars Adviser for Misrepresenting Fund Performance
Last month, the Securities and Exchange Commission (“SEC”) brought and simultaneously settled administrative charges against an investment adviser and its owner for misleading clients regarding the historical performance of a private fund managed by the adviser and for making misleading statements regarding the fund’s investment strategy. Specifically, the SEC announced it had settled an administrative proceeding on January 28, 2016, against QED Benchmark Management LLC and its owner, Peter Kuperman, in which administrative proceeding the SEC alleged that QED and Kuperman represented that they would follow a scientific stock selection strategy.
According to the SEC, QED deviated from that strategy, which deviation resulted in heavy losses to QED’s fund. After experiencing the losses, according to the SEC allegations, QED and Kuperman provided investors in the fund with information about the fund’s performance and supported that misleading information with statements of returns that included both actual and hypothetical returns, in violation of SEC guidance prohibiting misleading performance advertising. Continue reading ›
Proposed SEC Amendments to Form ADV and Rules Under the Investment Advisers Act
Amendments have been proposed to form ADV and certain rules under the Investment Advisers Act of 1940 that would have significant effects on reporting requirements for investment advisers. In addition to codification of “umbrella registration” which was initially proposed in an SEC no action letter to the American Bar Association in 2012, new information would be required regarding separately managed accounts and general advisory business.
Umbrella Registration
Larger investment managers to private funds or other pooled vehicles are often comprised of many legal entities conducting a single advisory business. The proposed modifications to form ADV, which are a codification of the SEC no action letter, would if approved allow for umbrella registration which would permit multiple private fund investment advisers that operate as a single business, on an affiliate basis, to register on a single form ADV as opposed to individual registrations. This new codification would require that the principal office of the filing investment adviser be located within the United States, that each investment adviser operate under a single code of ethics under the Advisers Act, that each adviser be subject to the Advisers Act (and therefore subject to SEC examination), and that the filing advisor and each relying advisor would advise only private funds or qualified clients (as defined in Rule 205-3 under the Advisers Act). While this is a more efficient method of reporting, as only one Form ADV would be required to be submitted by the filing adviser, it would require additional information on proposed Schedule R to Form ADV which includes more detailed information on the ownership structure of each relying investment adviser falling under the umbrella of the filing investment adviser submitting the Form ADV. Under proposed Schedule R each relying adviser would be required to provide identifying information, basis for registration and ownership information.
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State Private Fund Adviser Exemption Update
In the past six months two states, Iowa and Texas, have adopted private fund adviser exemptions to their investment adviser registration requirements under their respective state securities acts. Another state, Washington, has proposed a private fund adviser exemption. These state actions reflect a continuing trend to exempt private fund advisers from registration under certain carefully circumscribed conditions.
The Iowa exemption, which became effective at the end of 2013, exempted advisers providing advice to one or more qualifying private funds so long as neither the advisers nor their affiliates are subject to the “bad boy” disqualification provisions of Rule 262, Regulation A and the adviser files the required exempt reporting adviser’s reports mandated by Rule 204-4 of the Investment Adviser’s Act of 1940 via the IARD filing system. The exemption further provides that representatives of exemption-eligible investment advisers are also exempt from the investment adviser representative registration requirements if they do not otherwise act as representatives, that is, if they only act as representatives in connection with the activities of the exempt private adviser. The Iowa rule also provides that private fund advisers that are registered with the SEC are ineligible for the state exemption and therefore must comply instead with the notice filing requirements under the Iowa Securities Act for federal covered advisers.
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