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Hedge Fund Launch: Legal Challenges Facing Startup Managers

By Jordan DeSantis | Thursday, April 7th, 2016

This week, we had the pleasure of speaking with Shelly Rosenweig, Partner at Haynes and Boone LLP, who discussed the importance of compliance as well as the 2016 examination priorities of the SEC. Throughout the webinar, Shelly reminded attendees about the importance of undertaking compliance measures right at the start of a launch, not only for regulatory purposes, but to demonstrate to prospective investors commitment to compliance.

2016 SEC Examination Priorities

There are four priorities for the SEC that any startup manager will want to be aware of:

Exempt Reporting Advisors (ERA) – An exempt reporting advisor is any advisor that takes advantage of the venture capital fund advisor exemption or the private fund advisor exemption. The private funded advisor exemption is available to investment advisors whose clients are solely comprised of private funds who have less than $150 AUM and are not required to be registered as an advisor in the state where their principal office is located. In November of 2015, OCIE began to examine ERAs as part of their routine examinations.

What can ERAs do to prepare?

  1. Ensure your information provided on your ADV application is accurate and consistent. The ADV application is required to be updated annually and when changes occur.

  2. Make sure marketing and advertising material are in compliance with the anti-fraud provisions of the Advisers Act preventing advisors from engaging in manipulative activity. For example, advisors are surprised to learn that performance returns may only be disclosed to prospective investors in certain instances​

  3. Confirm you are in compliance with the “pay to play” rule under the Advisers Act (Rule 205).  Pay-to-pay generally refers to various arrangements by which advisers may seek to influence the award of advisory business by making or soliciting political contributions to government officials charged with awarding such business.  

  4. Comply to the Books and Records Requirements under the Advisers Act. This technically only applies to registered advisors, but the SEC has championed the importance of organized record keeping. These records fall under two categories, the first being general accounting. These are business records, such as keeping ledger of sales. The second is additional records, such as memos describing disciplinary events.    

Other SEC Exam Priorities, Focus Areas in 2016

From D Filings – Form D is a filing required by private investment funds engaged in a regulation D offering under the Securities Act of 1933. Regulation D is the safe harbor exemption most private funds rely on to offer and sell interest. This filing is required to be made within 15 days after the first sale of interest and must be updated on an annual basis. The basic information required involves certain persons related to the fund, the total amount of sales, number of investors participating in the offering, etc. Shelly points out that no violation is too small for the SEC, therefore it is highly recommended to update your information in a timely manner.

Cybersecurity – This has become one of the biggest focuses of the SEC since April of 2015. They have proposed numerous measures that advisors should address in regards to cybersecurity, such as conducting periodic assessments of location and sensitivity of information and the vulnerability of the systems. The SEC also suggests creating a strategy to prevent, detect, and responded to threats.

For example, adopting an incidence response plan will help to mitigate the aftermath of a breach. Shelly conveys that while the SEC does not have any official regulations in regards to cybersecurity, they are using other regulations, such as Regulation S-P (a privacy regulation) to go after advisers who are alleged to have failed to effectively safeguard personal information of their clients or investors.

Insider Trading – Insider trading refers to when a person uses nonpublic information to make a trade. Insiders of an issuer, which include officers, directors, and other special classes of persons, are never allowed to trade on non-public material. Even non-insiders, including investment advisors, are prohibited from trading while in possession of non-public material. Unfortunately, the insider trading laws are in flux due to the case United States v. Newman. This case presented the classic “tipper-tipee” scenario, but Second Circuit overturned the decision dealt by federal prosecutors and therefore reduced the liability of remote tipees. Due to the confusing landscape that now exists, Shelly suggests developing and following written procedures and updating these policies as necessary. Employees must be trained to identify issues and alert appropriate supervisors. Shelly also encourages implementing information barriers to limit who has access to non-public information.

Watch the Full Q&A on Legal Considerations for Emerging Managers

 
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