On September 11, 2014, the SEC’s Director of the Division of Investment Management Norm Champ spoke at the Practising Law Institute’s Hedge Fund Management Seminar. Mr. Champ’s speech focused on the growth of registered fund advisers, SEC initiatives and the importance of having strong compliance programs. Additionally, Mr. Champ urged advisers to recognize the complicated nature of being an SEC-registered fund adviser and to consider the reasoning for entering the space carefully.
Mr. Champ acknowledged how much the regulatory landscape for hedge fund managers has changed over the past four years. Among things he referenced were:
- The significant growth of SEC-registered private fund advisers as a result of the Dodd-Frank Act (the “Act”). Title IV of the Act is the specific reason that the number of registered advisers has increased by 50% since 2010.
- All registered advisers combined represent around $5.4 trillion in assets.
- The SEC has been able to track significant changes in the hedge fund space through the expanded Forms ADV and PF. The SEC requires more reporting and information in these forms than in prior years and has expanded the usage of the two forms throughout the Commission.
Expansion of Forms and New Initiatives:
- The Forms ADV and PF are now strongly used by the Risk and Examination Office (“REO”) in attempts to preemptively combat industry risks. The REO’s efforts in tracking industry threats rely largely on information from industry stakeholders.
- The OCIE has a new initiative for 2014 to engage and examine around 20% of all advisers who have been SEC-registered advisers for more than three years. This new initiative complements the SEC’s 2012 “presence” examinations for newly registered advisers.
Importance of Compliance:
Due to the SEC’s initiatives and the expansion of the Forms ADV and PF, Mr. Champ advised the audience to be cautious when becoming advisers, especially to registered funds. His discussion highlighted the importance of managing conflicts of interest.
- Rule 206(4)-7 requires registered advisers to establish a CCO and a compliance program. The creation of Rule 206(4)-7 was based on the understanding that investment advisers are less likely to violate securities laws either purposefully or out of ignorance. Any instances of violations of the law are less likely to be seriously harmful to investors.
- It is the duty of the adviser to recognize potential conflicts of interest that may compromise his or her fiduciary duty. Mr. Champ recognized that there can be inherent conflicts of interest in the investment adviser model.
- Despite these issues, an adviser must never put their own interests above those of his or her investors. If there are any conflicts, Mr. Champ believes it is necessary to disclose this information.
- Champ opinioned that failing to disclose a fee to investors is not justified by “market standard” or “industry practice” excuses.
Mr. Champ urged those considering becoming investment advisers to think about their reasoning for doing so, including the significant amount of work involved in complying with the evolving regulatory landscape and the SEC’s increased access to information. For existing registrants entering the fund space, significant overhauls of their compliance programs may be necessary and some issues cannot be addressed by simply adding new policies.