Compliance Avenue

Last week the International Organization of Securities Commissions’ (IOSCO) Technical Committee published the details of an agreed template for the global collection of hedge fund information, which it believes will assist in assessing possible systemic risks arising from the hedge fund sector.

The template (a copy of which is attached for your reference) was designed to create a comparable and consistent set of data to be collected by regulators from local hedge fund managers to monitor systemic risks and prevent gaps in regulatory reporting requirements. The data can then be exchanged amongst regulators and other competent authorities for the purpose of facilitating international supervisory cooperation in identifying possible systemic risks in the hedge fund sector.

The template, which was developed by the Task Force on Unregulated Financial Entities, contains eleven proposed categories of information. The proposed categories incorporate both supervisory and systemic data, and build on the data collection recommendations set out in the IOSCO Technical Committee’s Final Report on Hedge Fund Oversight, which was released in June 2009.

The list of data includes basic information such as the manager’s name, number of funds and equity owners; as well as the names of auditors, custodians, recent performance, redemptions, total assets under management and the value of long and short positions in different assets. Geographic spread, liquidity of a fund’s assets, the value of borrowings, net credit counterparty risk and the top 10 positions are also included.

The IOSCO Task Force has recommended that the first data gathering exercise should be carried out on a best efforts basis (given pending legislation in many jurisdictions) in September 2010.

Although the IOSCO Technical Committee recognizes that the legislative process is currently ongoing in many jurisdictions, it is publishing the template now to help inform any planned legislative changes currently being considered. As stated by IOSCO Technical Committee Chairman Kathleen Casey (who is also a U.S. SEC Commissioner):

“We recognize that the legislative process is ongoing in many jurisdictions and their outcomes could further influence the information needed to monitor systemic risk in the hedge fund sector, as well as who collects the data. Nonetheless, setting out these categories of information may help regulators in the assessment of systemic risk and help to inform the relevant legislative debates.”

It is unclear at this time whether or how the IOSCO disclosure template will inform or affect the ongoing Congressional debate on financial and regulatory reform, including whether it will impact the proposed hedge fund adviser legislation that was passed by the House in December and is currently pending in the Senate.

News from other other side of the globe …

Not to long after the SEC announced its new regulations on short sales, we have learned that the Securities and Futures Commission of Hong Kong (the “SFC”) that it will be introducing a short-position reporting regime to enhance transparency of short selling activities in Hong Kong.   There is little doubt that this stems from industry feedback and the SFC’s view of the current domestic market situation.

The SFC’s CEO, Mr. Martin Wheatley, claims that the “build-up of large short positions may be potentially disruptive to market stability” and that this “short-position reporting regime will not only complement Hong Kong’s robust short-selling regulatory framework but will also provide a more complete picture of short-selling activities in our market.”

Under the proposed regime, the reporting obligation will be triggered if a short position is equal to or exceeds, 0.02% of the issued share capital of a listed company, or a market value of $30 million, whichever is lower. Weekly reports must be submitted to the SFC until the short position falls below both trigger levels. The SFC will publish aggregated short positions of each stock on an anonymous basis a week later.

Managers should particulary note that only the constituent stocks of the Hang Seng Index, the H-shares Index, financial stocks and other stocks specified by the SFC will come under this new reporting regime.  Derivatives will not be included.

According to the Associated Press, lawmakers in Connecticut, may be gearing up to pass hedge fund legislation in their state.  Last year, the state legislature failed to pass a bill which would have required hedge funds and private equity firms to disclose certain conflicts of interest.  Some state lawmakers are looking to use that bill as a starting point for new hedge fund legislation.

Hedge fund regulation on the federal seems to be stuck in the Senate right now.  Although the house has already passed their financial reform bill (which includes hedge fund registration), the Senate version seems to be stuck.  It looks like some Connecticut legislators have gotten fed up with the slow progress and may take their own steps towards regulation for hedge funds in the state.

As SEC chairman, Schapiro pledged to quickly pursue new limits on short selling. In April, just two months after she took the job, the agency unveiled a proposal to crack down on the practice.

But more than a year after Schapiro took office, the SEC has not yet written into the Wall Street rulebook the short-selling limits — or most of the other measures that the agency has proposed to more tightly regulate the financial system. According to the Washington Post, whether Schapiro can achieve more of her reform agenda will be a test of how much she can change the SEC, which gained a reputation as a weak Wall Street regulator in the years leading up to the financial crisis………

According to a report from the Financial Times, Paulson & Co, a hedge fund that made billions of dollars betting against subprime mortgages, has received a request for information from the Securities and Exchange Commission in connection with an investigation into complex securities at the heart of the financial crisis, according to people familiar with the matter. In the months prior to the real estate crash, which pre-empted the global economic volatility, the company made $15 billion from investments in subprime deals.

For all of the SEC registered investment advisers out there, don’t forget that your annual ADV Part 1 update filing is due at the end of march (90 days after fiscal year end).  Update filings are made via the IARD system and AUM-based filing fees will be required this year.

While you’re thinking about Form ADV’s, don’t forget that some states require that you submit a copy of your ADV Part II to them (if you have made a notice filing in that state).  For example, New York State requires that advisers who have made notice filings to the state must submit a copy of their ADV Part II to the NYS Dept. of Law.  An updated copy of Part II must also be offered to your investors and advisory clients once a year.

Touching on a subject that we discussed back in August, FINRA has issued an advisory note stating that brokers must monitor their employees’ activity on social networking sites.  According to the Bloomberg article:

Firms that archive client communications including e-mails need to adopt similar policies for social networking sites and may use software to automatically log brokers’ Web messages…

With the proliferation of social networking sites and the privacy restrictions that most users utilize, it is difficult to imagine how brokers can possibly hope to monitor or record their employees activities on those sites.  The best they can hope for is to issue policies prohibiting the use of social networking sites for business.  As discussed in our earlier article on the subject, this is eventually going to become an issue for hedge funds and RIA’s as well.  Will the SEC eventually issue similar guidance?

The Securities and Exchange Commission is shaking up its enforcement division, establishing five priority areas, including one pointed directly at hedge funds and private equity firms.

Read more here

On December 16th, the SEC announced in a press release that they have approved certain amendments to the Advisers Act custody rule (Rule 206(4)-2). Amendments to this rule were originally proposed in May 2009. The final rule was released on December 20, 2009 and incorporates many of the amendments proposed in May, but also contains several modifications to the May 2009 proposal particularly with respect to the impact on advisers to pooled investment vehicles.

The Release actually makes a number of specific suggestions for additional compliance procedures that should be considered.

A few highlights of the final rule amendments include:

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George Canellos, the new New York SEC Regional director has not been shy in advising the investment adviser community about the changes that are being made on the examination front.  There is little doubt that the Bernard Madoff $65 billion Ponzi scam, and more recently, an alleged $20 million insider trading scheme at hedge fund firm Galleon Group, among others, has made regulators turn their attention even closer to the alternative investment industry.   It is  hard not presuppose that that SEC is trying to build back its credibility.

First, budgets have increased.  We have learned that the SEC is dedicating more resources to ensure that its examination staff is properly trained so that they can better understand the products that are now being offered to investors and improve their ability to assess financial and compliance risks.   We can also expect to see staff members, including commissioners developing areas of specialization .   Additionally, the SEC has been given more tools to better conduct and streamline  investigations but putting technology, among other things, to work to go through tips and complaints in a more efficient manner.

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