The Compliance Responsibilities of a New Fund Manager

October 30, 2012

Starting a new hedge fund is an all-consuming enterprise, even for seasoned hedge fund managers who’ve been through the start-up process previously. In every direction there are time-critical issues that must be attended to, ranging from hedge fund marketing to get the endeavor off the ground to creating infrastructure, such as IT, staffing, organizing ongoing fundraising efforts, attending to existing investors, establishing protocols for each area of operation, setting up and maintaining brokerage and custodial accounts, etc. Then there is the time and effort necessary to address the key endeavor at hand—that of making money within the fund.

All critical elements, indeed, but an area of real import often overlooked or given short shrift by many a new manager is that of compliance, which encompasses most areas of operations, according to Janaya Moscony, CFA, president and CEO of SEC3 Compliance Consultants, a provider of independent regulatory and compliance services to hedge fund companies.

“Determining your overall compliance responsibilities and establishing policies and procedures is extremely important from the very start,” says Moscony. “The issue of whether a fund must register with the SEC is actually one of the first questions that must be addressed by new fund managers.”

There are minimum thresholds involving the number of investors and assets under management that require fund managers to register as investment advisors with the SEC and/or separately at the State level. Those exceeding the thresholds who’re required doing so, or that anticipate growth that will precipitate such adherence, will have to file a number of key disclosures, including Form ADV and Form PF.

Form ADV must be filed and updated regularly, disclosing both general and material information about the firm, such as its business focus, ownership, management and key personnel background, advisory services offered, fees, assets under management, number of clients and employees, soft dollar policies, disciplinary information, conflicts of interest and assorted related-issues.

Form PF is targeted specifically to managers of private funds, including hedge and private equity funds. It focuses on portfolio risk and requires disclosure of issues such as performance, trade and investing strategies, gross and net asset values, liquidity, investor concentrations, borrowing and assorted other matters. Larger funds with assets in excess of $1.5 billion are required to perform more stringent disclosure.

Additionally, there is the issue of registration and licensing with individual state security agencies or foreign authorities, as well as governing regulatory agencies, such as FINRA, CFTC and assorted other bodies. Key factors range from the location of the firm to the type of trading activities undertaken.

Moscony cautions newly registered firms and those that anticipate registering in the future to be prepared for direct risk-based examinations carried out by the SEC, termed ”presence examinations” due to the Commission’s stated goal of making their “presence” known to new registrants.

According to Moscony, the SEC has provided guidance as of recent detailing their four primary areas of focus. “The SEC is focused in four key areas, including marketing and advertising, portfolio management, conflicts of interest and safety of client assets,” she says.  “We’re advising clients that given this is where the SEC is telling the industry they’re focused, it’s the first place that firms should be looking…they need to make sure they have these areas addressed.”

Whether registered or not, one of the most important steps a new fund manager must undertake is that of establishing a comprehensive compliance policy that goes beyond simply creating a compliance manual. “The best place to start is the SEC Rule 206(4)-7, deemed the Compliance Rule,” offers Moscony. “The Compliance Rule outlines 10 key areas, at minimum, that managers should be looking at…areas where they should adopt policies and procedures and have controls in place.” She cautions that the list is far from exclusive or exhaustive and should be treated as a starting point.

In addition to creating a solid compliance plan that spells out the firm’s procedures and policies, new fund managers need to add a dedicated compliance officer to their management team , either internally or outsourced. The compliance officer is responsible for implementation and testing of the plan, as well as keeping compliance records and reviewing the risks associated with the firm’s overall portfolio management process. According to Moscony, a good compliance officer creates “tone at the top,” demonstrating that the fund takes compliance seriously.

One of the biggest challenges overall for new fund managers in the area of compliance is that of determining the expectations of the SEC. “I think that many managers are mislead if they think that the SEC’s Compliance Rule is where it stops,” Moscony warns. “Often the SEC regulates and makes known their expectations through deficiency letters and through speeches.”

Bottom line, while establishing a comprehensive compliance program can be time consuming and seem daunting, especially for a new fund, it’s not rocket science, according to Moscony. “You have to spend some time up front and it may be worth working with an advisor or consultant to become familiar with what’s expected and required,” she says. “But once you do learn it, you’ll find it’s not that hard to comply… especially if you allocate the resources and time…and treat it seriously.”

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