Mock Exam Tips from ComplianceFocus.com

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Occasionally we will have the opportunity to post articles which originally appeared on other websites and today we are republishing an article from compliancefocus.com on the topic of mock examinations.

The following article can be found at the ComplianceFocus blog here.

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7 Tips to Get the Most Out of Your Mock Examination

A mock exam can be a useful tool in many contexts, for example taking the place of your annual review, or helping growing managers transition from exempt reporting advisers or state registrants to SEC registration. Most importantly, it is an invaluable exercise in preparing existing SEC registrants for the inevitable real thing. The following tips will help you make the most of the mock exam experience:

1. Retain a consultant to perform the exam. Ideally this will be a consultant who is not already familiar with your business – either another team member from your current consulting firm or an entirely new firm. A mock exam conducted by internal compliance personnel is likely to be less formal and, however inadvertently, less objective.

2. Think locally. Look first to consultants in your area, who will be able to perform onsite interviews and other tasks with a minimum of expense. If you do retain a consultant that must travel, be prepared to pay for airfare, lodging and related expenses. Depending on your budget, this could be a limiting factor both in your choice of consulting firms and in the scope and realism of the exam. Consultants are often willing to conduct interviews by telephone, but this may diminish the “real thing” experience.

3. Go through your counsel. Your counsel may have referrals to compliance consultants and will likely have valuable feedback on the report that is ultimately created based on the exam. It is also worth noting that your counsel can retain the consultant on your behalf, which makes the exam and its results confidential under the attorney-client privilege.

4. Treat it like the real thing. Particularly if the examiner is familiar with your business or has access to your information (e.g., another consultant at the firm you currently use), you should treat the mock exam like it is the real thing, including the following:

a. Do not expect the examiner to use or rely on information already in the consulting firm’s files. Instead, produce all documents and information relevant to the request. Do not assume that the examiner has any background or other information on the questions s/he asks.

b. Even if your examiner has not specified a deadline, set internal deadlines, such as the final deadline to produce all requested documents and any interim deadlines for information or documents to be gathered by particular employees or departments.

c. Make your written responses to the document/information request as professional as possible, as if you were responding to a regulator.

d. If a particular request is not applicable, mark it as such in your response to the document request. Do not assume that the examiner knows it is inapplicable.

5. Ask for a risk-based exam. If you are registered with the SEC and using your mock exam to prepare for the real thing, ask prospective consultants if they can conduct as a risk-based “presence exam” per the SEC’s new protocol. While the initial interview and document request may not differ significantly from the traditional format, the examiner will ultimately identify a few higher risk areas for your firm and focus the bulk of the exam on those areas, including additional interviews and document/information requests.

6. Think about what keeps you up at night. Is there anything that would help your compliance team do better, be more efficient or fill in gaps in your compliance program? Consider asking the examiner for recommendations in these areas and include them in your report (see also Tip no. 3 above if you’re concerned about keeping these confidential). A recommendation from a reliable and objective third party may help you obtain additional resources internally to beef up your compliance program, e.g., to improve archiving and search capabilities for email surveillance, additional personnel or an online solution for trade review and the like.

7. Toot your own horn. Most positions or departments, regardless of the business or industry, face a moment when they have to justify their existence to management. Positives in your mock exam report are evidence of what your compliance team is doing well and should be highlighted in periodic meetings, your own internal compliance reviews and anywhere else they can be useful to you and your firm.

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Cole-Frieman & Mallon LLP run the Hedge Fund Law Blog in addition to their hedge fund law firm. Bart Mallon can be reached directly at 415-868-5345.

ComplianceFocus.com is a project by Sansome Strategies LLC, a high-touch outsourced compliance company.  Sansome Strategies is owned by the principals of Cole-Frieman and Mallon LLP.

New Jersey Investment Adviser Annual Exam

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State Releases Web Version of Annual Written Examination for Registered Investment Advisers

Investment Advisers registered with the State of New Jersey will now be able to complete their Annual Written Examination online. In addition to answering the examination questions, advisers now have the ability to upload related documents online, negating the need to send paper mailings to the state.

A release issued by the New Jersey Bureau of Securities states that “the answers to [the examination] questions are used to determine the need for an on-site or desk examination, as well as to monitor the different approaches used to render the investment advice.”

The examination questions cover topics related to the adviser’s business model, including:

  • Clients and business activities
  • Policies and procedures that the adviser has in place
  • Personnel, associated persons and other business activities
  • Client complaints
  • Advertising and promotional activities
  • Custody and financial condition

Instructions and a link to the examination can be found here.  If you have questions or concerns about the new examination format or the questions contained in the examination, please do not hesitate to contact us.

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Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.

First Quarter 2013 Business & Regulatory Update

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Below is the first quarter update we have sent out to our mailing list.  If you would like to be added to the mailing list, please contact us here.

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Cole-Frieman & Mallon First Quarter Update

Clients and Friends:

The early months of 2013 have been a busy time in the world of investment management regulatory compliance.  As we head into the second quarter, we take this opportunity to provide you with a brief overview of some items that we hope will help you stay on top of the business and regulatory landscape in the coming months.

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Form ADV Annual Updating Amendment was due on March 31.  All registered investment advisers or managers filing as exempt reporting advisers with the SEC or a state securities authority must file an annual amendment to Form ADV within 90 days of the end of their fiscal year. For most advisers, this deadline passed on March 31, 2013. Registered investment advisers or exempt reporting advisers who have not filed their annual update should attend to the filing as soon as possible.

Foreign Account Tax Compliance Act (“FATCA”) Regulations Issued. The long-awaited FATCA regulations have been issued, and the timelines for fund compliance have been set. The regulations require certain financial institutions to either (i) identify and disclose direct and indirect U.S. investors and withhold U.S. income tax on nonresident aliens and foreign corporations, or (ii) be subject to a 30% FATCA tax.  Foreign financial institutions (“FFIs”), which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into agreements with the IRS by January 1, 2014 to avoid being subject to the FATCA tax. The IRS’s online registration portal will be available by July 15, 2013, and offshore funds and other FFIs must be registered by October 25, 2013 to be included on the IRS’s first list of FATCA compliant FFIs, which will be published on December 2, 2013. Managers should also consider updating their fund documents to include FATCA disclosures and representations.

Electronic Schedule K-1s. The IRS has authorized partnerships and limited liability companies taxed as partnerships to use exclusively electronic means to distribute Schedule K-1s to investors, as long as the partnership first obtains the investor’s affirmative consent. Partnerships must obtain consent in a manner that demonstrates that investors can access the electronic format in which the K-1 is furnished. States may have different rules regarding electronic K-1s, so funds should check with their counsel or service providers whether they may still be required to send state K-1s on paper. Partnerships must also provide each investor with specific disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is effective and the procedures for withdrawing the consent.

SEC Update.  The SEC has been extremely busy over the last quarter. The biggest news is the Obama administration’s nomination of Mary Jo White as the SEC’s new chairman. White, a former U.S. attorney in Manhattan, will be the first prosecutor to head the SEC, and her nomination signals the administration’s resolve to hold Wall Street accountable for any wrongdoings.  Other SEC related items include:

  • JOBS Act.  One purpose of the Jumpstart Our Business Startups Act (the “JOBS Act”) was to reduce the regulatory restrictions around the general solicitation and advertising of private securities offerings.  However, a year has passed since the bill was signed into law, and the SEC still has not promulgated rules to implement the JOBS Act. Absent guidance from the SEC, we caution fund managers against relying on the JOBS Act to engage in general solicitation and advertising of interests in their funds.
  • SEC Presence Exams.  The SEC’s two-year “Presence Exam” initiative is currently underway.  The initiative, which aims to examine the conduct of most newly registered investment advisers, gives the SEC the ability to reach a large percentage of new registrants by focusing on a limited number of higher risk issues, including: (i) marketing, (ii) portfolio management, (iii) conflicts of interest, (iv) safety of client assets and (v) valuation.  Most newly registered managers should expect to be examined within the next two years.  Information about Presence Exams can be found here.
  • Common Adviser Custody Rule Deficiencies.  The SEC recently released a risk alert that addresses the common deficiencies related to Rule 206(4)-2 under the Investment Advisers Act of 1940, known as the “Custody Rule”. The risk alert identifies four primary categories of deficiencies: (i) failure by an adviser to recognize situations in which it has custody under the Custody Rule; (ii) failure to meet the Custody Rule’s surprise examination requirements; (iii) failure to satisfy certain “qualified custodian” requirements under the Custody Rule; and (iv) failure to properly engage independent auditors or otherwise comply with the requirements for audits of pooled investment vehicles under the Custody Rule.  Managers should carefully review the requirements of the Custody Rule and make sure that the deficiencies highlighted by the risk alert do not apply to their firms.  The risk alert can be found here.
  • Form PF. While advisers with at least $1.5 billion assets under management were required to file their initial Form PFs by March 1, 2013, most other advisers are required to file an initial Form PF by April 30, 2013. Compiling the information necessary to prepare the Form PF is burdensome and may take substantial time and effort.  If you are looking for last-minute assistance with any aspects of the filing, please do not hesitate to contact us or your service providers.

Futures and Derivatives. Like the SEC, futures and derivatives regulators and self-regulatory organizations have been very busy over the last quarter.  Important developments include:

  • ISDA August 2012 Dodd-Frank Protocol. The International Swaps and Derivatives Association’s Dodd-Frank Documentation Initiative aims to facilitate compliance with the Dodd-Frank Act. The Documentation Initiative minimizes the need for bilateral negotiations and reduces disruptions to trading by providing a standard set of amendments, referred to as protocols, to update existing swap documentation. The D-F Protocol is the first of such protocols, and it facilitates industry compliance with seven final rulemakings.  Because certain final rules have an effective compliance date of May 1, 2013, managers whose portfolios include swaps and who have existing relationships with swap dealers should adhere to the D-F Protocol as soon as possible to give swap dealers ample time to integrate information provided through the protocol.  To indicate their participation in the protocol arrangement, market participants must submit an adherence letter and pay an adherence fee of $500.00 through the online ISDA Amend system.  Detailed instructions on the submission of the Adherence Letter through ISDA Amend can be found here.
  • Swap Data Reporting and Recordkeeping. Swap dealers registered with the CFTC are obligated to report all swaps to which they are a party.  Under new CFTC rules, investment funds that are U.S. persons may need to report swaps when trading with (i) other financial entities that are not swap dealers, (ii) non-financial entities or (iii) non-U.S. swap dealers.  The new rules require that all swap counterparties keep detailed records of their swaps for the life of the swap and for five years following its termination. All investment funds who intend to transact in swaps must obtain a CFTC Interim Compliant Identifier (“CICI”) by April 10, 2013.  Investment funds may obtain CICIs here.
  • ERISA Relief for Cleared Swap Transactions.   The U.S. Department of Labor recently issued an advisory opinion addressing the application of the Employee Retirement Income Security Act of 1974 (“ERISA”) to certain “cleared swap” transactions conducted pursuant to provisions of the Dodd-Frank Act.  The advisory opinion clarifies the ERISA fiduciary status of futures commission merchants and clearing organizations that perform swap transactions on behalf of ERISA plans.  It alleviates the concern that fiduciary obstacles could keep ERISA plans out of the swap market.  The full text of the opinion is available here.
  • CFTC CTA and CPO Reporting Deadlines.  All CTAs that were required to be registered on or before December 31, 2012, had to file a Form CTA-PR annual report with the NFA by February 14, 2013.  Each CPO that was required to be registered on or before December 31, 2012, was required to complete and file applicable schedules of CFTC Form CPO-PQR by March 31, 2013.  NFA Rule 2-46 requires each CPO member to file Form CPO-PQR on a quarterly basis.  If you are a CPO or CTA and have not met these obligations and would like our assistance with the filings, please do not hesitate to contact us.

Other Notes.

  • European Union’s Alternative Investment Fund Managers Directive (“AIFMD”).  Starting July 22, 2013, in order to continue marketing to EU investors, non-EU managers will be required to comply with reporting and disclosure obligations under the AIFMD for each fund that is marketed in one or more EU jurisdictions. These obligations consist of providing pre-investment and ongoing disclosures to investors, and annual and regular reports to an EU national regulator.  If you are marketing to EU investors, you should carefully review the directive’s provisions to make sure you comply with its requirements.
  • California LLC Penalties for Unregistered Companies.  The California Franchise Tax Board recently announced that it will assess a $2,000 penalty on unregistered limited liability companies that are conducting business in California. Advisers doing business in California should make sure that they have filed the necessary registration paperwork, and should remain current with all their tax payments. Advisers registered outside of California that do business within the state must make sure to file the required California Statement of Information, which must be renewed every two years. Many taxpayers are unaware that they are “doing business” in California. If you are unsure whether or not you are doing business in California you should consult your legal adviser or service provider. The Tax Board’s release can be found here.

Compliance Calendar.  As you plan your regulatory compliance timeline for the coming months, please keep the following dates in mind:

Deadline Filing
March 31, 2013 Form ADV annual updating amendment deadline
April 10, 2013 CFTC Interim Compliant Identifier deadline for all funds who intend to transact in swaps
April 30, 2013 Form PF deadline for smaller SEC registered private fund advisers
May 1, 2013 D-F Protocol adherence deadline
Variable Distribute annual audited financial statements and copies of Schedule K-1 to fund investors
Periodic Filings Form D and Blue Sky filings should be current

Please contact us with any questions or for assistance with any compliance, registration or planning issues on any of the above topics,

Sincerely,

Karl Cole-Frieman & Bart Mallon

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Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters.

Hedge Fund Events April 2013

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The following are various hedge fund events happening this month. Please email us if you would like us to add your event to this list.

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April 3

April 3-4

April 4

April 8-10

April 9

April 9

April 10

April 10-11

April 10-12

April 15-17

April 16

April 16

April 16-18

April 17

April 17

April 17-19

April 18

April 18

April 22

April 22

April 22-23

April 23

April 24

April 24

April 25

April 25-26

April 28-May 1

April 29-May 1

April 30

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Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.

SEC Action Against Manager for Related Party Transactions

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While this happened in the middle of last year, we thought it might be helpful to managers to review this particular case especially as registered investment advisers are currently in the process of updating Form ADV.

Overview of Case

On June 21, 2012, the SEC filed in action in the US District Court for the Northern District of California against Mark Feathers (“Feathers”) and Small Business Capital Corp. (“SB Capital”), Investors Prime Fund (“IPF”), and SBC Portfolio Fund (“SPF”). The SEC alleges that Feathers and SB Capital made material misrepresentations and omissions regarding both IPF’s and SPF’s investment activities. Feathers and SB Capital also allegedly violated broker-dealer registration provisions and created fraudulent management fees.

The SEC alleges Feathers and SB Capital used a Ponzi-like scheme to pay returns to investors. SB Capital allegedly misrepresented the portfolios of the funds at issue, the funds’ lending standards, the nature of the funds’ loans, and the existence of conflicts of interest between SB Capital and the funds. These misrepresentations appeared in advertisements in California publications, newsletters, and offering documents. In addition, SB Capital allegedly made transfers between IPF and SPF to increase management fees. Finally, the SEC claims that SB Capital never registered as a broker-dealer.

The SEC asserted causes of action under Section 17(a) of the Securities Act (prohibiting fraudulent interstate transactions), Section 10(b) of the Exchange Act and related rules (prohibiting the use of manipulative and deceptive devices in the buying and selling of securities); Section 15(a) of the Exchange Act (prohibiting unregistered broker-dealers from inducing the trading of securities); and Section 20(a) of the Exchange Act (creating liability for the person in control of an entity which violates Section 15(a) of the Exchange Act).

The SEC’s complaint is available here.

Takeaways for Managers

The alleged conduct included the following:

  • Never registering with the SEC as a broker-dealer.
  • Representing that the funds’ returns would be 7.5% per year;
  • When returns did not meet that threshold, using money from new investors to make up the difference;
  • Failure to disclose the use of investor money to pay SB Capital’s day-to-day expenses, conduct that was in direct conflict with materials provided to investors;
  • Stating that the funds would not make loans to SB Capital, when in fact they did;
  • Mischaracterizing the funds’ loan portfolios as secured, when in fact they were not;
  • Misrepresenting the audit procedures in place;
  • Causing IPF to purchase loans at a premium from SPF to generate management fees; and
  • Assuring investors SB Capital owed them a fiduciary duty, even though Feathers and SB Capital would cause the funds to engage in related party transactions to generate management fees.

The bottom line:

  • Broker-dealers should register with the SEC to avoid liability under Section 15(a) of the Exchange Act;
  • Be honest about the nature of the funds you manage, including the portfolios of the funds, the kinds of transactions the funds engage in, and how returns operate;
  • Be upfront with investors about potential conflicts and related party transactions; and
  • Take care that the materials you provide investors are accurate.

Conclusion

On the most basic level, Small Business Capital Corp. represents a warning to managers to not engage in fraudulent or exploitive conduct like taking advantage of conflicts of interest and related party transactions. More generally, it is a good reminder that providing truthful information to investors is paramount. The SEC approaches the anti-fraud provisions of the securities laws broadly. We recommend that managers have their attorney, in-house counsel or compliance consultant review all materials meant for distribution prior to distributing them, and that managers retain these materials and backup information in their files.

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Cole-Frieman & Mallon LLP provides a full suite of legal and advisory services to hedge fund managers and the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

BEA Reporting for Fund Managers: the SEC is not the only regulator gathering investment-related data.

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Background on the U.S. Department of Commerce, Bureau of Economic Analysis (“BEA”).

The BEA collects data on U.S. direct investment abroad, among other mandates. Its tools include Form BEA-11 (“BEA-11”) for U.S. persons that have ownership interests in foreign affiliates. Historically, these filings received almost no attention. Enforcement of the filing requirements was rare, but is expected to increase following the BEA’s announcement in May of 2012 that it would be more vigilant.  [Note: Enforcement penalties include civil and criminal fines and even imprisonment for failure to file.]

BEA-11 is due annually by May 31 for those who meet a two-pronged test. The filing is confidential and requires data points on employees, assets, expenses, share/interest structure and other financial information (much of it, such as imports and exports will be inapplicable to most fund managers).

Do I have to file?

The filing requirement is most likely to apply to larger U.S. fund managers (the term “Manager” includes U.S. managers, their principals, and any affiliated U.S. entities) that have full master-feeder structures, offshore blocker entities or other special purpose vehicles. The following events trigger a filing:

  • Meeting the below test, regardless of whether a Manager has been contacted by the BEA; or
  • If a Manager receives a letter from the BEA, it must either file if it meets the test, or submit a Claim of Not Filing (“Claim”). NB: A Claim is only required if the Manager is contacted by the BEA. Because the Claim contains much of the same information as required on BEA-11, we would not recommend filing it preemptively.

The First Prong – Reporting Thresholds:

Reporting is not required with respect to offshore affiliates where:

  • none of the following (each, an “Exemption Item”) exceeded $60 million for the offshore affiliate’s most recent fiscal year: (a) total assets, (b) sales or gross operating revenues excluding sales taxes and (c) net income (or loss) after provision for foreign income taxes; OR
  • the U.S. person’s interest in the offshore affiliate was acquired or established in the most recent fiscal year, and none of the Exemption Items exceeded $25 million for the affiliate’s most recent fiscal year.

The $60 million and $25 million thresholds are referred to as “Reporting Thresholds.”

The Second Prong – Ownership Level:

Filing is required of U.S. persons that own or control, directly or indirectly, 10 percent or more of an offshore affiliate’s voting securities (or equivalent). Consider the following examples (see note below):

  • Offshore Limited Partnerships (“LPs”): generally, LP interests in a master fund are structured as non-voting. Accordingly, its feeders would not be U.S. reporters. In contrast, the fund’s general partner would be considered to own 100 percent of its voting securities, and would be a U.S. reporter.
  • Offshore Companies: voting rights will vary depending on the share class in question. A company that has one class of shares, all with voting rights, may provide enough dilution such that a Manager owns less than 10% of total shares. On the other hand, it is common to issue one class of voting shares to the Manager, and another class of non-voting shares to outside investors (similar to the structure of a LP). In such a case, the Manager would be a U.S. reporter.

[Note: While these examples will be helpful in identifying potential reporters within your structure, we recommend reviewing your offshore entities’ constituent documents to determine the nature of any voting interests and related provisions.]

Putting It All Together:

Remember that both prongs must be met to trigger the filing. We suggest starting your analysis by determining the amount of your AUM attributable to offshore affiliates (“Offshore AUM”); if it is less than the $60 million Exemption Item for total assets, it is likely that the offshore affiliates would be under the Exemption Items for income and revenue (i.e., performance gains or other income, if any) as well. If your Offshore AUM exceeds $60 million, proceed to the rest of the analysis to determine whether a filing is required.

Disclosure and Reporting Requirements Continue to Evolve.

Post-crisis, we have seen an increase in disclosure and reporting requirements, particularly for larger fund managers. BEA reporting highlights the fact that regulators other than the SEC collect data and can penalize those who do not file. We encourage you to stay in touch with your outside counsel, compliance consultants and other service providers who can keep you apprised of regulatory developments.

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Cole-Frieman & Mallon LLP is a boutique hedge fund law firm focused on providing hiqh quality counsel for the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events March 2013

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The following are various hedge fund events happening this month. Please email us if you would like us to add your event to this list.

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March 3-5

March 3-6

March 4

March 4

March 5

March 5-6

March 6

March 6

March 7

March 7

March 7

March 7-8

March 11

March 12

March 13-15

March 14

March 14-15

March 14-15

March 18

March 18-19

March 20

  • Sponsor: Shift Forex
  • Event: FXIC 2013
  • Location: New York, NY

March 20-21

March 21

 

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Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events February 2013

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The following are various hedge fund events happening this month. Please email us if you would like us to add your event to this list.

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February 1

February 5

February 5

February 5-7

February 6

February 6

February 6-8

February 7

February 7

February 7

February 7

February 11-13

February 12-13

February 13

February 14

February 15

February 19

February 20

February 21

February 21

February 25

February 26-28

  • Sponsor: WBR
  • Event: Trade Tech
  • Location: New York, NY

February 27-28

February 28

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Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events January 2013

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The following are various hedge fund events happening this month. Please email us if you would like us to add your event to this list.

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January 7

January 7

January 7-8

January 8-10

January 9

January 10

January 15-16

January 15-17

January 16

January 16

January 16-17

January 17

January 17

January 17

January 21-24

January 22

January 23

January 23

January 23-25

January 24

January 24

January 28-29

  • Sponsor: Marcus Evans
  • Event: EMI Summit
  • Location: Palm Beach, FL

January 28-30

January 28-30

January 28-30

January 29

January 29-30

January 30

January 30 – February 1

January 30 – February 1

January 31

January 31

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Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.

SEC Compliance Manual Violations Mean Enforcement Action for Investment Adviser

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Manager Subject to Enforcement Action for Compliance Manual and Books and Records Violations

The SEC recently announced a settlement with a former federally registered Investment Adviser that will, among other things, bar the firm and its sole owner from the financial services industry for two years. Citing violations of the Investment Advisers Act, perhaps the SEC’s most impactful charge involved lack of compliance with Rule 206(4)-7, which requires a firm to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules.

Background

The respondent, Barthelemy Group LLC (“the firm”) and its sole owner and adviser Evens Barthelemy, was a SEC registered adviser from 2009-2011. Mr. Barthelemy formed the firm in 2009 after having worked as a registered representative for two broker-dealers since 2000. In 2011, the firm withdrew its SEC registration after the SEC found that it did not meet the multi-state exemption nor did it have the required amount of assets under management ($25 million at the time). Since then, the firm has been registered in New York and New Jersey.

Summary of Violations

Compliance Failures

The SEC found that the firm did not institute written policies and procedures in accordance with Adviser Act Rule 206(4)-7. That rule requires advisers to adopt written policies and procedures that are designed to prevent violation (by the principal and all supervised persons) of the Act and SEC rules related to it. The settlement order noted that Mr. Barthelemy prepared the firm’s compliance manual in 2010 but that he had “largely adopted it verbatim from a 2009 version he obtained from his prior employment at a registered broker-dealer”. Given that the broker-dealer did not engage in the advisory business, the SEC found that the firm’s compliance manual violated Rule 206(4)-7, noting that the manual referred to the Securities Act of 1933 and the Securities Exchange Act of 1934 but made no reference to the Advisers Act. In the same vein, the manual referred to duties of suitability and fairness but never mentioned the fiduciary duty that advisers owe their clients. The firm’s manual also referenced commission-based compensation and broker-dealer filings, none of which are relevant to comply with Rule 206(4)-7. Finally, the SEC found that the firm did not undertake an annual review of the adequacy of the compliance manual.

Books and Records Failures

The firm was found to be non-compliant with Rule 204-2(a) which requires advisers to make and keep true, accurate and current certain books and records relating to the advisory business. Specifically, the SEC stated that the firm did not have copies of the written acknowledgements of the firm’s code of ethics. Additionally, in connect with Rule 204-3 which requires delivery of a firm’s Form ADV to clients or prospective clients, the firm did not have records of such delivery also required by Rule 204-2(a).

Overstating Assets Under Management on Form ADV

The SEC found that the firm was not eligible for SEC registration under both the multi-state exemption or by meeting the minimum threshold test ($25 million at the time). The now rescinded multi-state exemption permitted those advisers subject to regulation by thirty or more states, to register with the SEC. However, the SEC found that the firm was subject to at most three states’ regulatory regimes. In addition, the SEC found that the firm managed nowhere near the $26.5 million it claimed, but rather the total was around $2.6 million. This misrepresentation violated Section 207 of the Act, which makes it unlawful for any person to willfully make untrue statements of material fact in a registration statement. In addition, this conduct violated Section 203A of the Act, which prohibits SEC registration as an adviser unless the firm meets a relevant exemption.

Penalties

Given the adviser’s inability to pay, no civil penalty was asserted. However, the following penalties were instituted:

  • The firm must furnish a copy of the SEC order to each existing client;
  • The firm must post a copy of the order on its website for a period of two years;
  • Certify evidence in writing of the steps taken to comply with all violations of the Act and its rules;
  • Mr. Barthelemy is barred from employment in the financial services industry for a period of two years; and
  • Mr. Barthelemy is censured.

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Cole-Frieman & Mallon LLP provides legal services to the investment management industry. The firm provides regulatory and compliance support and other legal services to hedge fund managers. The firm can be reached here and Bart Mallon can be reached directly at 415-868-5345.