As reported in the Wall Street Journal , federal regulators are examining whether hedge-fund managers abused tools known as “side pockets” that helped prevent clients from withdrawing billions of dollars of assets during the financial crisis.  More specifically, the examinations are being conducted by the Enforcement Division’s new “Asset Management Unit”, which is headed by co-chiefs Rob Kaplan and Bruce Karpati, and which was created to cover, among other things, hedge funds, private equity funds and investment advisers.  The Asset Management Unit is apparently looking into the possibility of disclosure and valuation issues surrounding the use of side pockets during the financial crisis.

It is well known that many hedge fund managers employ side pockets and that fact is disclosed in many fund offering documents.  Those side pockets are typically designed to separate illiquid securities from more liquid portfolio holdings, and are employed for reasons such as valuation, accounting and liquidity.  That said, the  article mentions that the Enforcement Division is looking into investor claims that, during the financial crisis, managers did not adequately disclose: (i) reasons for creating side pockets, (ii) the process used to value securities held in such side pockets, and (iii) which assets were being held in such side pockets.  The  article mentions two ongoing investigations into the use of side pockets which the SEC’s Enforcement Division “hopes to bring to the Commission for approval within the next six months.”  It also mentions that “(t)he SEC spokesperson wouldn’t comment on specific investigations.”