Is Your Hedge Fund Too Successful for the SEC?

As part of the SEC’s attempt to increase the effectiveness of its enforcement program, the SEC has undergone a complete reorganization of the Division of Enforcement, which has resulted in more enforcement actions, including some which have been highly publicized. The SEC has indicated that it intends to continue its aggressive approach, with a particular focus on hedge funds. In a recent statement to the House Financial Services Committee, Robert Khuzami, the SEC’s Director of Enforcement, stated that the SEC will scrutinize any hedge funds that consistently generate returns that beat market indexes. Because a successful track record will draw attention from the Enforcement Division, hedge fund managers should take heed to carefully review all performance calculations prior to disseminating information to its investors and potential clients.

Several recent SEC enforcement actions have focused on private funds’ use of side pockets, inside information, and inaccurate information provided to investors, which if found liable, could have huge catastrophic consequences to any private fund. Accordingly, funds should be sure to carefully document and adhere to their stated procedures on the use of side pockets, and avoid improper for shielding of certain transactions from investors. In addition, funds should carefully review and revise their policies and procedures to protect against insider trading by ensuring that adequate precautions exist to prevent the use of material nonpublic information. Since many recent enforcement actions have turned on misrepresentations made in statements or reports provided to hedge fund investors, fund managers should carefully review all statements to ensure accuracy, and avoid promissory language or misstatements that can lead to allegations of fraud.

The SEC’s Division of Enforcement has indicated that one of its goals is to increase the total number of enforcement actions. Consequently, fund managers should be aware that the SEC will continue focusing on private fund activities for some time.  It is imperative to take steps now to address these areas.  For more information, please contact Zac Rosenberg, Compliance Consultant at zachary.rosenberg@corecls.com or at (619) 278-0020.