The headline-grabbing scandals of the past decade have transformed the hedge fund industry and given rise to an emphasis on compliance. For new hedge fund managers the challenge is to become familiar with and constantly monitor the rules and regulatory proposals coming out of myriad agencies here and abroad that are ever increasing their oversight of the industry.
New Hedge Fund Rules Abound
From hedge fund marketing to trading strategies to maintaining assets, every aspect of fund management has come under scrutiny, with new rules written or proposed to ensure managers remain compliant and operate in an increasingly transparent manner. According to E.J. Yerzak, CISA, compliance services consultant with Ascendant Compliance Management, Inc., the passage of Dodd-Frank legislation in 2010 has given rise to a tremendous number of new rules and regulations. “As of July 9, 2012, there are 224 rules promulgated as a result of Dodd-Frank, comprising a total of 7,365 pages,” he notes.
Industry Oversight Agencies
Given the litany of new rules and reporting obligations in this ever-changing environment, new managers need to familiarize themselves with the major regulatory bodies empowered with governance of the hedge fund industry. Yerzak suggests that managers become familiar with the Securities & Exchange Commission and the Commodity Futures Trading Commission, as well the U.S. Department of the Treasury, the Federal Reserve, the Department of Labor and the Federal Trade Commission.
Additionally, managers would do well to become familiar with the Financial Industry Regulatory Agency, the largest independent regulator for securities firms doing business in the U.S. “Although it may not be readily apparent to fund managers, familiarity with FINRA rules and guidance can lead to an improved compliance program,” says Yerzak. “I would also suggest paying attention to the CFA Institute’s guidance on claiming compliance with GIPS standards.”
Similarly, managers engaged in foreign market activities should become familiar with jurisdictional counterpart-agencies in the countries in which they carry out operations, thus ensuring they mitigate the risk of running afoul foreign regulatory authorities.
Major Areas of Concern
Determining whether a new fund must be SEC-registered and undertaking the process of doing so is a major issue for any manager, but there are a slew of additional concerns that must be addressed. “CFTC registration, if applicable, and changes to the ways capital can be raised pursuant to Regulation D, are certainly major issues at the moment,” offers Yerzak. “Form PF is the other significant issue on the horizon for many fund managers… Increasingly important are foreign proposals, regulations and directives as well, such as the Alternative Investment Fund Managers Directive (AIFMD) from the European Union, which may impact a fund.”
With so many agencies issuing rules and proposals directly impacting hedge fund marketing and operations, managers would do best to create a system allowing them stay abreast of the constant flow of compliance-relevant information. Yerzak suggests that fund managers make rules and regulations a component of their daily routine and that they leverage as many reliable sources of information as possible, including regulatory agency websites, industry publications and blogs, law firm regulatory alerts and experienced compliance consultants, to name a few.
While critical to do so, trying to monitor the various sources of information can be burdensome to managers already strained under the rigors inherent in fund management. “Automating as much of the regulatory and compliance research as possible will save you a significant amount of time and enable you to focus on your firm’s core competencies,” says Yerzak. “You can automate the process in a number of ways. Select a good RSS reader and use it. Subscribe to RSS feeds of regulatory alerts and information from the SEC, FINRA and law firms specializing in securities regulations. The SEC alone has numerous RSS feeds on everything from new rule proposals to new enforcement actions to notices of speeches and Congressional testimony. Compliance podcasts, webinars and the SEC’s outreach seminars are another great way to stay ahead of the curve on important issues as they arise.”
In addition to monitoring the information flowing from the various regulatory entities, there are numerous resources that managers should seek to leverage. As much of the newer regulations affecting the industry flow from the Dodd-Frank Act, Yerzak suggests that advisers take advantage of the “Dodd-Frank Burden Tracker,” a tool found on the U.S. House of Representatives Financial Services Committee website. The tracker provides detailed information about the vast number of pages of regulations stemming from provisions of Dodd-Frank and the agencies tasked with promulgating such regulations.
“Peer networking groups can be a valuable resource to new and existing fund managers,” he says. “Regional associations of investment advisers (e.g. the New England Broker/Dealer and Investment Adviser Association, Inc., or ‘NEBDIAA’) or compliance professionals are also fantastic resources to help you navigate the complex regulatory maze. LinkedIn and other social networking sites can be a great way to find relevant associations in your geographical or topical area.”
The best resource for many fund advisers is the use of an outside consultant specializing in regulatory compliance. Such firms can provide both insight and an outside perspective on industry and regulatory issues likely to impact a hedge fund’s business. “The benefits include peace of mind, more time to focus on your core competencies, access to industry expertise and resources to contact for compliance questions when they arise,” offers Yerzak. “Fund managers often say that they feel they are doing a good job when it comes to compliance, but that they ‘don’t know what they don’t know.’ An external consultant can help you bridge that gap.”
The bottom line when it comes to avoiding pitfalls is to remember that the information necessary to remaining compliant is out there and readily available. Yerzak encourages managers to read constantly and network with peers to remain ahead of the curve. He also suggests that new fund managers take advantage of the many compliance conferences held throughout the year. “They provide a wealth of information and resources on what to expect, as well as an opportunity to ask peers and panels of experts many questions regarding industry best practices.”