In March, OCIE Director Pete Driscoll promised private fund advisers that the SEC would this year issue a risk alert directed at them.
“That’s something we’ve been getting a lot of asks from compliance officers who are private fund advisers that, ‘Hey, we haven’t seen a risk alert,’” Driscoll told an audience at the Investment Adviser Association’s annual compliance conference in Washington, DC.
Private funds advisers might be careful what they wish for. In the weeks after Driscoll spoke, his words hung over the sector like a loaded pistol on Chekhov’s stage, with many speculating that we were about to see a wave of enforcements against private funds. At least nine separate enforcement actions against private fund advisers have been announced since early April.
Variance, but one signal
For the year, there have been 13 fresh enforcement cases, two of them new lawsuits, and the rest settlements, an analysis by sister title Regulatory Compliance Watch finds. They differ widely in tone, business models, type of violation and even penalties.
On February 24, for instance, Lone Star Value Management agreed to pay $100,000 and accept a censure to settle claims that it didn’t have proper P&Ps to address conflicts of interest (RCW, February 28). On April 30, former hedge fund wunderkind Marko Dimitrijevic and his former firm, Everest Capital, paid $3.2 million and accepted censure to settle claims neither Dimitrijevic nor Everest had properly disclosed risks to its investors (RCW, May 11).
Despite the variance, Philip Moustakis, a former senior counsel in the SEC’s Enforcement Division and now counsel at Seward & Kissel in New York, said he thinks he can discern at least one clear signal. In the February 24 settlement with Cannell Capital (RCW, February 11) and then the May 26 settlement with Ares Management (RCW, June 1), regulators dinged private funds for failures around material non-public information without any suggestion that insider trading or fraud had actually occurred, Moustakis said.
Heightened risk, heightened scrutiny
“Now that there’s two of the cases in a row, it’s not enough to make sure there’s no fraud in your shop, and no insider trading,” Moustakis told RCW. “The SEC is going to be making sure that your policies and procedures are suitable to your firm’s risk management.”
Each case, in their separate ways, suggests that compliance teams should make sure that they review their MNPI P&Ps and, among other things, not rely on individual fund employees to determine by themselves whether a given detail is material and non-public, Moustakis said.
‘Document the good work’
It may be just a matter of making sure you have regular, informal chats with staff about what they’re hearing, but what’s essential is to make sure you’re documenting those chats thoroughly and carefully.
“Ares at times failed to document the trade approval process and at times its entries in the order management system were inconsistent or incomplete. It doesn’t say that the company systematically failed to go through the compliance process… it says that it wasn’t well-documented,” Moustakis said.
For Ares, the heightened risk was that an employee sat on the board of a public portfolio company. For Cannell, the risk was the frequent contact that employees had with insiders. The important thing is the commission is clearly focusing on risk itself, not necessarily bad outcomes, Moustakis said.
David Tang, a former CCO who is also counsel to Seward & Kissel, agreed with Moustakis. He urged people to scrutinize the Ares settlement, and “pull it apart and use it for your road map.”
“It kind of reads like a self-assessment,” Tang said. “Did you give specific thought to specific circumstances that might lead to MNPI in your firm? Did you address them in your manual, or are they more generic?”
Be sure to have a solid “menu” of risk evaluation terms, so that there is at least consistency in the paper trail, Tang said. “I really do view it as an opportunity to review,” he continued. “Maybe in your annual review process, a lot of these questions can be asked.”
How are you managing MNPI and other compliance risks? Contact Bill Myers, editor of RCW, and share your best ideas with your peers