Since the SEC voted to require many U.S. hedge fund managers to register as investment advisors, hedge fund managers have been looking to sort out what steps they need to take to adhere to the new regulation. To help them, Lipper of New York has just published "It's the Rule: The New SEC Advisor Regulation for Hedge Funds," a guide to what managers need to know in advance of the Feb. 1, 2006 deadline for registration.
According to Lipper, the hard part is complying with the recordkeeping requirements that are now part of the registered investment advisor package. The recordkeeping rule requires that advisors maintain copies of their policies and procedures along with any revisions. They must also conduct an annual review of these policies and maintain all records documenting this review. And they must retain all of these records for five years.
Some advisors have already begun executing an extensive compliance system, even before registration. At Alexandra Investment Management of New York, the documentation and all the manuals are prepared, and the firm has also installed an automated system to keep track of all of its trades, but the challenge lies in implementing the changes, said Mark Polemeni, chief legal and compliance officer.
Theresa Messina, a partner at Ernst & Young's hedge fund practice in New York, recommends that firms should set up a compliance committee, to set the tone starting from the top of the chain of command, in an effort to educate employees. She said that putting new rules into effect takes time, and for big firms this is especially true since they have to change their culture.
Carbon360, a consulting firm headquartered in New York, agreed that as hedge funds prepare to register with the SEC, setting a strong culture of compliance and good corporate governance is critical. Carbon360 recommends that firms place an emphasis on a philosophy that "acting in the client's best interest is in the advisor's best interest." Carbon360 also urges hedge funds to actively manage any and all risk exposure, to ensure that risk and return are balanced, to monitor compliance across jurisdictions and to install financial controls.
New York law firm Dechert also recommends that hedge funds develop a culture of compliance and a compliance infrastructure, in which violations are not tolerated, are immediately identified when they occur and are promptly remedied. In order to do so, Dechert said, a chief compliance officer must be appointed, appropriate policies should be put in place and hedge funds must have the necessary infrastructure to implement and monitor these systems.
Many consulting firms are taking advantage of the SEC rule, as they have begun offering services to hedge fund managers that are preparing to meet the SEC advisor registration requirements. For example, Eze Castle Integration of Boston and ACA Compliance Associates of Washington are offering firms instant messaging archiving, since many hedge fund managers use this as a source of communication, as well as disaster recovery tools and onsite compliance consulting.
Some technology vendors recommend banning the use of IMs altogether, while others say that cutting off IMs means cutting off a very important mode of communication, and that it would have a negative effect on efficiency and performance.
Technology may be one of the solutions to U.S. registration challenges. Financial software companies can offer institutional investors more frequent and more detailed reporting. Chris Grandi, managing director at Eze Castle Integration, said that many managers have shown an interest in the outsourced information technology model as the way to deal with the new regulations.
On the other hand, Peter Hess, senior vice president of the global accounts business at Advent Software of San Francisco, said bringing accounting systems in-house will become the new trend. "The technology is about error reduction and the safekeeping of data is in the best interest of investors," he said.
The new policies have also made the law firms prosper, as the demand for attorneys, is even more important now than ever before, since attorneys assist with registration compliance policies, and in the training, coordination and hiring of chief officers, said Ron Geffner, head of the financial services group at the law firm Sadis & Goldberg of New York.
The first step is to register, which requires the preparation of the SEC form ADV, according to Dechert. Due to the lead time required, it may not be possible for a manager to register and become fully compliant by the deadline if they wait much longer, according to Dechert. The first part of the form is electronically filed. However, to file it, the manager must obtain a filer ID and pay the arranged fee.
In this first part of the form, managers must list information having to do with the advisor, including its location, key personnel, any disciplinary history, ownership of the advisor and a list of funds advised.
Part two of the form must also be filled out, but it does not need to be on file with the SEC. It must only be made available to the SEC upon request, and must be provided to all clients of the advisor. Part two lists fee arrangements, products offered, research process, brokerage allocation policies, conflicts involving affiliates, conflicts involving other clientele, proxy voting policies and policies involving personal trading by employees of the advisor. The information on the second part of the form must be kept up to date and consistent.
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