Jun. 30, 2022
Jun. 30, 2022
Five Checklists to Help CCOs Do Their Jobs
The CCOs of private fund managers have a lot of responsibility. Ensuring the adequacy of managers’ compliance programs largely falls on their shoulders; thus, they are under tremendous pressure. Increased SEC focus on holding individuals accountable for securities violations has stoked fears among CCOs of being held personally liable for their firms’ compliance failures. Those fears are only enhanced when CCOs lack the support and resources needed to ensure compliance with an evolving regulatory landscape. The reality is that CCOs – particularly of smaller firms – continue to struggle to obtain sufficient resources to perform core compliance duties. Bottom line: CCOs need all the help they can get. See “Personal Liability and Compliance Resourcing Are Top Concerns Among CCOs, Surveys Show” (Jan. 13, 2022). In the spirit of trying to lighten the load of CCOs – and in light of the upcoming July 4th holiday in the U.S. – the Hedge Fund Law Report is highlighting five articles that include checklists that CCOs can adapt and use to evaluate their employee disciplinary policies and procedures; streamline their annual compliance reviews; prepare traders for interviews during SEC exams; preclear employees’ personal trading to avoid violating the pay to play rule; and ensure adequate vendor management.
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A Checklist for Evaluating Employee Disciplinary Policies and Procedures
Properly disciplining employees when they engage in misconduct or violate a private fund manager’s policies, such as by not preclearing a personal trade or by using an unauthorized messaging platform, is a necessary and useful part of remediation. In fact, SEC staff may view a manager’s failure to discipline employees who commit infractions as evidence of the inadequacy of the manager’s compliance program. Conversely, robust disciplinary practices can shine a positive light on a manager’s compliance program during an SEC examination or investigation. When an employee does engage in misconduct or breach some element of a manager’s compliance program, the manager should proceed with care to ensure a just and defensible outcome. This checklist provides managers – and their CCOs – with questions to ask about both their policies and specific procedures to ensure that disciplinary processes are running as smoothly as possible. For more on employee discipline, see our three-part series: “Best Practices for Fund Managers to Develop an Employee Discipline Framework That Fosters Predictability in the Face of Inconsistent Laws” (Feb. 8, 2018); “Best Practices for Fund Managers When Investigating and Documenting Employee Discipline” (Feb. 15, 2018); and “Best Practices for Fund Managers to Ensure a Fair Process When Disciplining Employees” (Feb. 22, 2018).
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A Checklist to Streamline and Organize Your Annual Compliance Review
Rule 206(4)‑7 under the Investment Advisers Act of 1940 requires registered investment advisers to evaluate, at least annually, the adequacy of their compliance policies and procedures and the effectiveness of the compliance program’s implementation. The SEC has focused on the annual compliance program review requirement in its examinations and enforcement actions. For example, a November 2020 risk alert on compliance issues observed in investment adviser compliance programs noted that SEC exam staff “observed advisers that were unable to demonstrate that they performed an annual review or whose annual reviews failed to identify significant existing compliance or regulatory problems.” See “Risk Alert on Compliance: Inadequate Annual Reviews, Poorly Implemented Policies and Other Key Takeaways (Part Two of Two)” (Feb. 25, 2021). This two-part series is structured as a checklist that investment advisers’ CCOs can adapt and use to streamline and organize their annual reviews. The first article analyzes Rule 206(4)‑7 and sources of guidance on complying with the rule; spells out who should be involved in conducting an adviser’s annual compliance program review, what information should be gathered for review and what areas should be covered; and notes the questions that SEC examiners are likely to ask about an adviser’s annual review during an examination – which advisers should be able to answer after having conducted their reviews. The second article provides a non‑exhaustive list of the questions advisers should answer for each substantive area covered in the review. See “Lax Annual Compliance Review Procedures May Draw SEC Enforcement Action” (Nov. 17, 2016).
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A Checklist to Prepare Traders for SEC Exam Interviews
When examiners from the SEC’s Division of Examinations conduct on-site exams of registered investment advisers, they typically ask to interview various employees. For example, examiners may want to interview traders to better understand how client trades are placed. Thus, it is important that advisers prepare their traders for those interviews. This article examines why SEC examiners may want to interview investment advisers’ traders; explains why advisers need to prepare traders to answer examiner questions; and provides a checklist of questions developed by a former SEC examiner that advisers can use to prepare traders for exam interviews, as well as review their overall trade procedures to ensure compliance with SEC rules and their own compliance programs. See “Private Funds Top the SEC’s 2022 Exam Priorities” (Jun. 9, 2022).
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A Preclearance Checklist to Avoid Violating the Pay to Play Rule
Private fund managers that have government entity investors, such as public pension funds, must be careful to ensure that employee political contributions do not run afoul of Rule 206(4)‑5 under the Investment Advisers Act of 1940 – the so-called “pay to play rule” (Rule). The Rule bars an investment adviser from collecting compensation for providing investment advice to government entities for two years after covered employees make more than a de minimis contribution to the campaign of officials who can influence the selection of investment advisers by those entities. The centerpiece of many pay to play compliance policies and procedures is a requirement that employees clear donations in advance. This article reviews the Rule’s requirements and restrictions; discusses the importance of preclearance; and provides a checklist that CCOs can use to approve or deny employee contributions. For a look at the consequences of violating the Rule, see “SEC Continues to Target Pay to Play Violations” (Aug. 30, 2018); “Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar” (Apr. 20, 2017); and “SEC Starts Year With Pay to Play Penalties” (Jan. 28, 2016).
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A Checklist to Ensure Adequate Vendor Management
Fund managers may outsource certain tasks or operations to third parties, such as fund administrators, auditors, cybersecurity experts, pricing services and valuation agents. If they do not adequately supervise or manage those vendors, however, they may run into problems – and even face enforcement actions. For example, a registered investment adviser was penalized $175,000 after a third-party service provider used inaccurate valuation dates and misapplied the adviser’s investment model during backtesting, which resulted in an overstatement in the adviser’s advertising of that model’s backtested results by more than 40 percent. See “Advisers Must Ensure the Accuracy of Backtested Performance Claims” (Jan. 31, 2019). Broker-dealers have a similar duty to properly supervise third-party vendors. In August 2021, FINRA released a regulatory notice to remind member firms of their supervisory duties as to those vendors. Regulatory Notice 21‑29 (Notice) reiterates the applicable regulatory obligations; summarizes recent trends in examination findings, observations and disciplinary actions; and provides questions member firms may consider when evaluating their systems, procedures and controls relating to vendor management. Although the Notice is geared toward broker-dealers, its guidance is generally applicable to fund managers’ oversight and management of their vendors. This article summarizes the Notice and provides a checklist created from the questions at the end of the Notice that all fund managers can use to assess the sufficiency of their vendor management procedures and controls. See “The Importance of Exercising Due Diligence When Hiring Auditors and Other Vendors” (Jun. 21, 2018).
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