Category Archives: Investment Advisor

SEC Compliance Manual Violations Mean Enforcement Action for Investment Adviser

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.

Investment Adviser and IA Representative Registration Renewal 2013

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If your firm is registered as an investment adviser (IA) then you may have received notice from FINRA to renew your firm’s registration for 2013. If you have not received the notice or have not paid the renewal fees, the following provides an overview of the process.

Background

IA firms and IA representatives (RAs) should be aware that registrations expire annually on December 31. In order for an IA firm to maintain their active registrations and/or notice filing statuses and for RAs to maintain active registration statuses, the IA firms must pay applicable renewal fees annually. The IARD Renewal Program facilitates the annual renewal process. A Preliminary Renewal Statement which is made available on the IARD system, will include an amount that must be paid to FINRA by December 13, 2012. Remember to allow sufficient

time for payments made by check and sent through the postal service. Online payments made via E-Pay should be made by December 10, 2012 in order for the funds to be posted by December 13, 2012.

Submitting Payment

The preliminary renewal statement have been made available. IA firms can access this statement via IARD by following these steps:

1. Log onto IARD here.

2. Enter your firm’s ID and password.

3. Review and accept the terms and conditions.

4. Under the “Accounting” tab at the top of the page, select “Renewal Account.”

5. One the left column, select “Renewal Statement.”

The bottom of the page provides an itemized list of all applicable fees.

Payment by Check

If you choose to submit payment by check, print the statement and mail it, along with the check to the following address:

U.S. Mail:

FINRA

FINRA/CRD

P.O. Box 7777-9995

Philadelphia, PA 19175-0001

(Note: this P.O. Box address will not accept courier or overnight deliveries.)

Express Delivery:

FINRA/CRD

Attn: 9995

500 Ross Street 154-0455

Pittsburgh, PA 15262

(240) 386-4848

The check should be made payable to: FINRA. Be sure to write your CRD Number and the word “Renewal” on the face of the check. Be sure to also include the first page of the Renewal Statement.

Payment via CRD/IARD E-Pay

Payment can also be submitted online via CRD/IARD E-Pay. To do so, follow these instructions:

Go to the E-Pay website and:

1. Enter your login and password. If you have not yet created an account, do so by clicking “sign up.”

2. On the left column under “Payments,” click “Pay my accounts.”

3. Select the account and click “Continue.”

4. Enter the total Payment Amount and check “Renewal” under Account Type. Then enter the payment method and click “continue.”

5. Review the information and click “Make Payment.”

6. Log out and the money should post within about 2 days.

Automatic Daily Account-to-Renewal Account Transfer

If your firms has sufficient funds in the Daily Account to cover the total renewal amount, FINRA will automatically process the renewal payment by the payment deadline.

Other Payment Methods

Wire payments sent by 2 p.m. (ET), should post the next business day. Wire payments sent after 2 p.m., ET, may take up to 2 business days to post. Instructions for initiating a wire can be found here.

Confirming Payment

After payment is submitted, you will be able to retrieve your firm’s online Final Renewal Statement on IARD on or after January 2, 2013. These statements will reflect the final registration status of the IA firm and RAs. To do so, follow the instructions above to log onto IARD. Under the “Renewal Statement” link in the “Accounting” section, you can retrieve the Final Renewal Statement, which will state “Paid in Full” or “Amount Due.” If an amount is due, the balance must be paid by February 1, 2013.

It is important to make sure payment is made by the deadline, otherwise the registration may be terminated. The firm will then have to contact each regulator to request re-registration instructions.

More information about the Renewal Program can be found on the IARD website. FINRA has also posted a bulletin on the 2013 IARD Renewal Program, available here.

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Cole-Frieman & Mallon LLP provides legal services to hedge fund managers and investment advisers. Bart Mallon can be reached directly at 415-868-5345.

California Private Fund Adviser Exemption Approved

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California Hedge Fund Managers Relieved of IA Registration Requirement

On August 27, 2012 (“Effective Date”), the California Office of Administrative Law approved the long awaited private fund adviser exemption (“Private Fund Exemption”). The immediately effective exemption is only available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1), and Section 3(c)(7) funds. The Private Fund Exemption is not available to advisers who also manage separate accounts.

Currently, a California based adviser who manages less than $100,000,000 must either register as an investment adviser with the California Department of Corporations (“Department”), or rely on an exemption from registration. Under the new Private Fund Exemption advisers can file as “exempt reporting advisers” (“ERAs”) and thereby avoid the burdensome registration process.

Requirements Generally

To qualify for the Private Fund Exemption, the adviser must

have not violated any securities laws;
file and periodically update certain items on Part 1 of the Form ADV;
pay California’s investment adviser registration and renewal fees; and
fulfill any additional requirements when advising funds organized under Section 3(c)(1).

Additional Requirements for 3(c)(1) Fund Managers

The additional requirements for advisers advising 3(c)(1) funds include:

1. All investors in the fund must either (i) be accredited investors; (ii) be managers, directors, officers or employees of the adviser; or (ii) have received the fund interest via a transfer not involving a sale.

2. Advisers may only charge performance fees to qualified clients; and

3. Advisers shall provide each investor with annual audited financial statement of the fund within 120 days after the end of each fiscal year; provided, however, advisers who begin operations more than 180 days into a fiscal year may include the audit of the initial fiscal year in the fiscal year immediately succeeding the initial fiscal year.

Other Information

An adviser to 3(c)(1) funds that existed prior to Effective Date may take advantage of the Private Adviser Exemption if, as of the Effective Date, it complies with the requirements enumerated above. Any investors in funds existing prior to the Effective Date who do not meet the standards outlined in Item 1 above, will be allowed to remain in the funds provided that they do not make any additional capital contributions. Furthermore, as of the Effective Date, advisers must cease charging performance fees to any investors who do not meet the “qualified client” definition.

To take advantage of the Private Fund Exemption, an adviser must file a partial Form ADV with the Department via the IARD system no later than 60 days from the Effective Date. Advisers currently registered with the Department may choose to withdraw their registration and make a filing under the Private Fund Exemption.

For information on whether your firm may be able to claim an exemption from registration, please see the California Private Fund Adviser Exemption Chart.

If you would like help to utilize the California exemption, please contact us directly.

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Bart Mallon is

a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart can be reached directly at 415-868-5345.

Recent Enforcement Actions Illustrate the Need for Good Recordkeeping

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SEC v. Gold Standard Mining Corp.

SEC v. Orthofix International N.V.

In the Matter of Altamont Global Partners

Since the end of June, there have been three enforcement actions dealing with inadequate or improper accounting methods that did not follow generally accepted accounting practices (GAAP). Two enforcements were brought by the SEC and one by the NFA. Gold Standard Mining Corp. and Altamont Global Partners involve making false statements regarding the value of assets. Orthofix deals with the failure to adopt and follow appropriate internal procedures to ensure proper accounting. We are providing an overview of these actions and some of our thoughts below.

SEC v. Gold Standard Mining Corp.

Gold Mining Corp. made false and misleading statements in filings with the SEC regarding the acquisition, operations, and assets of a Russian subsidiary.
Gold Mining Corp. filed fraudulent financial statements from 2009-2011 that did not follow GAAP. Revenues were not reported accurately, and assets were grossly inflated. For example, one asset, a hotel, was valued as $3MM per room.
Gold Mining Corp. also failed to disclose a profit sharing agreement with the former owner of the Russian subsidiary.

The complaint can be found here.

SEC v. Orthofix International N.V.

Wholly owned Mexican subsidiary of Orthofix, Promeca, paid $317,000 in bribes to Mexican officials in order to obtain sales contracts from the Mexican government.
Promeca
acquisto cialis generico in italia

employees referred to the bribes as “chocolates” and fraudulently recorded the transactions as cash advances or promotional and training expenses.
Prior to the discovery of the bribery scheme, Orthofix did not have an effective Foreign Corrupt Practices Act compliance manual or training regime in place. The only anti-bribery materials given to Promeca were in English only.
Orthofix did not have an adequate internal auditing system in place and failed to conform with GAAP.

The complaint can be found here.

In the Matter of Altamont Global Partners

Funds managed by Altamont made loans to Altamont in violation of NFA Compliance Rule 2-45 which prohibits loans by commodity pools to its CPO/affiliated persons or entities.
Loan proceeds were used to pay operating expenses or paid directly to employees of Altamont.
Altamont falsified quarterly statements by hiding losses and inflating funds’ net asset value to make it appear as if trading had been successful.

The complaint can be found here.

Takeaways for Managers

Above all else, keep accurate and honest records. Managers should be sure to follow GAAP when creating financial records for their funds, and never falsify accounting documents. As Orthofix demonstrates, it is also crucially important that managers employ appropriate internal mechanisms to avoid fraudulent or harmful practices from developing. Rule 204-2 under the Advisers Act requires registered advisers to maintain true, complete, and current books and records relating to its investment advisory business. Generally, there are three categories of records to be maintained: (i) business records of the advisor, (ii) records of the adviser that relate to the adviser’s clients and the adviser’s advisory activities, and (iii) records relating to the adviser’s compliance program.

Conclusion

While Gold Mining Corp. and Orthofix involve the relationships between businesses and their subsidiaries, they offer good examples of the need to establish and maintain policies designed to prevent inaccurate recordkeeping. Altamont Global Partners represents a warning for fund managers to avoid falsifying their funds’ financial documents to hide losses or inflate net asset value.

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Cole-Frieman & Mallon LLP provides a full suite of legal and compliance services to investment managers. The firm can be reached through our contact page and Bart Mallon can be reached directly at 415-868-5345.

SEC Guidance on Registration of Investment Advisory Affiliates

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The SEC’s Division of Investment Management issued a no-action letter on January 18, 2012 that provides guidance for registered investment advisers who have multiple entities in control relationships. The no-action letter affirms prior SEC guidance for investment advisers who have entities that serve as general partners and managing members to private funds and other similar special purpose vehicles (“SPVs”). Additionally, other investment advisers who “conduct a single advisory business” through multiple separate legal entities may use a single registration (i.e. register on a single Form ADV) under certain circumstances.

Affiliates Serving as Fund General Partners, Managing Members and Similar SPVs

Entities that function as fund general partners, fund managing members, and similar SPVs are not required to separately register as an investment adviser, as long as the following conditions are satisfied:

1. The investment adviser to a private fund establishes the SPV to act as the fund’s general partner or managing member;

2. The SPV’s formation documents designate the investment adviser to manage the private fund’s assets;

3. All of the investment advisory activities of the SPV are subject to the Investment Advisers Act of 1940 (the “Advisers Act”), Advisers Act rules, and SEC examination; and

All employees and persons acting on behalf of the registered investment adviser and/or an SPV are subject to supervision and control of the investment adviser.

For SPVs that have independent directors, the independent directors are excepted from the condition that they be under the registered investment adviser’s supervision and control, and thus are not “persons associated with” the registered investment adviser.

Other Investment Advisory Affiliates Under Common Control

Under the SEC’s guidance, a registered investment adviser (the “filing adviser”) can file a single Form ADV on behalf of itself and each entity that is controlled by or under common control with the filing adviser (each, a “relying adviser”) as long as those entities are conducting a single advisory business. Under the no action letter, using a single registration is appropriate under the following circumstances:

1. The filing adviser and each relying adviser advise only private funds and separate account clients that are “qualified clients” (as defined in Rule 205-3 promulgated under the Investment Advisers Act of 1940 (the “Advisers Act”));

2. Each relying adviser, its employees and the persons acting on its behalf are subject to the filing adviser’s supervision and control;

3. The filing adviser has its principal office and place of business in the United States;

4. The advisory activities of each relying adviser are subject to the Advisers Act and SEC examination;

5. The filing adviser and each relying adviser operate under a single code of ethics and single set of compliance policies and procedures; and

6. The filing adviser discloses in its Form ADV (Miscellaneous Section of Schedule D) that it and its relying advisers are together filing a single Form ADV and each relying adviser is identified by completing a separate Section 1.B, Schedule D, with the notation “relying adviser.”

For more information on whether the above guidance applies to your firm, please contact us directly.

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Cole-Frieman & Mallon LLP provides investment adviser registration and compliance services. Bart Mallon can be reached directly at bmallon@colefrieman.com and by phone at 415-868-5345.

California Extends Hedge Fund IA Exemption Implementation

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Extension of Comment Period Delays Implementation of Private Adviser Exemption

As we have advised previously, states are responding to the Federal overhaul of investment adviser registration requirements by evaluating and in some

case changing their own laws governing investment advisers. This response, spearheaded by the National Association of Securities Administrators, or NASAA, includes exemptions for advisers to certain private funds.

In December, California’s Department of Corporations (the “Department”) released its own proposed exemption, which we discuss in detail here. In sum, the proposed rule, if

adopted, will exempt many hedge fund managers from registration with the state of California. The firm must provide advice solely to one or more “qualifying private funds,” which includes Section 3(c)(1), Section 3(c)(7) funds and certain other funds that fall under an Investment Company Act of 1940 exception. In addition, the adviser must:

have not violated securities laws;
file periodic reports (an abbreviated version of the Form ADV);
pay the existing investment adviser registration and renewal fees ($125); and
comply with additional safeguards when advising funds organized under Section 3(c)(1) (other than venture capital companies).

The initial deadline for comments on the proposal was February 20, 2012. However, the Department has extended that deadline to March 25, 2012.

While the rule is being considered, California has extended its existing private adviser exemption until April 19, 2012. If the new rule is not adopted by that time and the current exemption is not extended, those fund managers with over $25 million in assets under management must register in California. If however, the new rule is adopted, such managers will be exempt from registration. As long as their assets under management fall below $100 million, they will only have to file certain reports (similar to the reports filed by Exempt Reporting Advisers) with California. Once their assets under management exceed $100 million, they will have to register with the SEC unless an exemption applies (e.g. the Private Adviser Exemption).

The proposed exemption will significantly change the registration regime in California. Firms that solely manage qualifying funds and meet the additional requirements will not have to register and those that are currently registered may withdraw their registration. California fund managers with less than $100M in AUM generally will not be registered with any regulatory agency.

Conclusion

The original comment period ending February 20 gave California fund managers plenty of time to evaluate their current business, future plans and potential eligibility for the exemption prior to the deadline for the ADV Annual Updating Amendment (deadline March 31). With the comment period extended to March 25, and final adoption of the exemption likely pushed to early April, managers will now need to plan on filing their annual updating amendment as usual; managers whose registrations are pending should proceed with that process until the final rule is released.

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Cole-Frieman & Mallon LLP provides hedge fund and adviser registration services to managers throughout the United

States. Bart Mallon can be reached directly at 415-868-5345.

Investment Adviser Registration Presentation for Fund Managers

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Below is a press release on the investment adviser registration presentation we developed to help fund managers with the SEC registration requirements.

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Investment Adviser Registration Presentation for Fund Managers Released by Cole-Frieman & Mallon LLP

March 30, 2012 Deadline for SEC Registration Approaches

SAN FRANCISCO, CA – January 25, 2012 — Cole-Frieman & Mallon LLP, a leading boutique investment management law firm, is proud to announce the release of a presentation designed to help fund managers understand their registration obligations with the U.S. Securities and Exchange Commission. Many hedge fund managers who are not currently registered with the SEC will be required to be registered by March 30, 2012. Because of the application process, managers will need to submit their registration applications to the SEC by February 14, 2012. The presentation is posted on the Hedge Fund Law Blog at www.hedgefundlawblog.com/iaregistration2012.

The presentation, which includes a voice-over discussion, provides both hedge fund and private equity fund managers with a high level overview of the registration process and important compliance issues. “Most private fund managers have a general idea that they need to register with the SEC but many have delayed beginning the process,” said Bart Mallon, a partner with Cole-Frieman & Mallon LLP. “We developed this presentation to remind managers of the requirements but to also provide them with accurate information about what it means to go through the registration process and become registered with the SEC.”

In addition to information on the investment adviser registration process, the presentation also details compliance obligations of registered managers. “Fund managers tend to underestimate the importance of a proper SEC compliance program,” said Niel Armstrong, president of Gordian Compliance Solutions, a compliance consulting firm that offers fund managers outsourced SEC compliance solutions. “Implementing a robust compliance program that is tailored to a fund manager’s specific organizational structure is important from a regulatory perspective,

and many managers also find a business benefit when they employ compliance best-practices.”

Cole-Frieman & Mallon partner Aisha Hunt added “Fund managers generally have business specific needs that should be addressed during the SEC registration process. The presentation and supplementary information on the Hedge Fund Law Blog will provide those managers with the resources they need to understand the relevant business and compliance issues and begin the registration process.”

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About Cole-Frieman & Mallon LLP

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. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers, as well as multi-billion dollar firms. The firm provides a full suite of legal services to the investment management community, including: hedge fund, private equity fund, venture capital fund, and mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog (http://www.hedgefundlawblog.com), which focuses on legal issues that impact the hedge fund community. For more information please visit us at: www.colefrieman.com.

California Proposes Private Fund Adviser Exemption

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Hedge Fund Managers Exempt from Registration in California

As a general proposition, managers who are located in California order cialis must register as an investment adviser if they are providing investment advice for compensation. There are exemptions from the registration requirement which we have detailed previously. Because of the changes in the statutes and regulations at the Federal level, the states are changing their laws with respect to adviser registration. Some states, such as California (see post), have adopted interim orders for certain advisers to address gaps in the Federal and state laws until state laws or appropriate regulations can be adopted. California is proposing to adopt laws which would exempt many hedge fund managers from registration with the California Securities Regulation Division.

The proposed regulations if adopted would likely go into effect sometime in the first half of 2012. The California Department of Corporations has requested comments on the proposal which may be submitted by February 20, 2012. We have summarized the proposed exemption below and for more information, please see the following releases:

California Private Adviser Exemption Overview

If the proposed rule is approved, a manager would be exempt from registration as an investment adviser with the state of California if the manager meets the following requirements:

manager provides advice only to one or more “qualifying private funds” (includes Section 3(c)(1) funds and Section 3(c)(7) funds)
manager may not have not violated securities laws;
manager must file periodic reports with the Department of Corporations (an abbreviated version of the Form ADV);
manager must pay the existing investment adviser registration and renewal fees ($125); and
manager must comply with additional safeguards when advising funds organized under Section 3(c)(1) (other than venture capital companies). This includes:

only accredited investors may invest in the private fund;
the firm shall provided certain written disclosures about the services it provides, its duties, and other material information;
the firm shall obtain an annual audit of each fund and deliver them to each investor; and
performance fees can only be charged to qualified clients.

Firms may register with the SEC once they reach $100M in AUM. Therefore, the firm may rely on the California private adviser exemption and then, absent an exemption from SEC registration, register with the SEC at that point. Section 203(m) of the Adviser’s Act of 1940 (as amended by Dodd-Frank) provides such an exemption from such registration if the firm only manages private funds and has less than $150M AUM (the firm would be an exempt reporting adviser and would have to file the abbreviated Form ADV with the SEC).

Funds with Non-Accredited Investors

The proposed rule does have a grandfathering provision that will make the California private adviser exemption available to a firm that currently manages any Section 3(c)(1) fund that has non-accredited investors if the following requirements are met:

the fund existed prior to the effective date of the California private adviser exemption;
as of the effective date of the Private Adviser Exemption, the fund no longer accepts accredited investors;
the firm provides certain written disclosures about the services it provides, its duties, and other material information; and
as of the effective date of the Private Adviser Exemption, the firm delivers audited financials to the investors.

Currently, the proposed rule does not have an anticipated effective date. If approved, managers of funds with non-accredited investors may still qualify for the Private Adviser Exemption.

Conclusion

The California private adviser exemption will change the entire registration regime in California. Firms that solely manage qualifying funds and meet the requirements discussed above will not have to register with the DOC and those that are currently registered may withdraw their registration. So, hedge fund managers in California with under $100M in AUM generally will not be registered with any regulatory agency. Do keep in mind that if a manager manages even a single separate account, in addition to the qualifying funds, it will not be eligible for the private adviser exemption.

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Cole-Frieman & Mallon LLP provides investment adviser registration and compliance services to hedge fund managers. Bart Mallon can be reached directly at 415-868-5345.

Revised Form ADV Part 1 Now Available on IARD

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New Questions Added to Form ADV Part 1

The SEC has released a new Form ADV Part 1a which includes a number of additions as described in greater depth below. Please also see the the paper version of the new Form ADV Part 1 which is currently effective.

Since enactment of the Dodd-Frank Act, the SEC has adopted a series

of rules that have a significant impact on investment advisers and the IA registration process. Last year, amendments to the Form ADV Part 2 required registered investment advisers to provide new and prospective clients with a brochure and brochure supplements prepared using a “plain English” narrative approach. The new Form Part 2 became effective January 1, 2011 for new registrants and March 31, 2011 for registrants updating their Form ADV. Many states followed suit requiring the use of the new Form Part 2.

Overview of Major Changes to Form ADV Part 1

The new Form ADV Part 1 is now available on the IARD website. The changes reflect the new asset thresholds and the SEC’s effort to gather detailed information about investment advisers and their operations. For example, Section 7 now requires the following information about private funds (defined as “an issuer that would be an investment company as defined in section 3 of the Investment Company Act of 1940 but for section 3(c)(1) or section 3(c)(7) of that Act”):

a private fund identification number (which is assigned to the fund)
whether the fund is part of a master-feeder structure (and if so, information about the master and/or feeder funds)
whether the fund is a “fund of funds”
details about the beneficial owners of the fund
information about whether the fund relies on an exemption from registration under Regulation D of the Securities Act of 1933
details about the fund’s service providers

Next Steps

For firms who have not started the registration process, completion of the new Form ADV Part 1 will take longer because of the additional information that must be collected. For firms who have begun the process but have not yet been registered with the SEC or state, it is likely that the new information will be required to be submitted prior to registration being approved by the SEC or state securities commission. For advisers who are already registered with the SEC or state, the new questions will need to be completed as part of the Annual Updating Amendment (for more information, please see our post for the requirement in 2011 – we will have a similar post for 2012 after the new year). The due date for the Form ADV Annual Updating Amendment approaching is March 30, 2012.

Should you have any questions on the completion, submission, and/or reporting deadlines for Form ADV, please feel free to contact us or call Bart Mallon directly at 415-868-5345.

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Cole-Frieman & Mallon LLP provides investment adviser registration and compliance services to private fund managers. The firm has a robust investment management practice catering to hedge fund managers, mutual fund managers and institutional investors.

SEC Action Against Hedge Fund Manager for Marketing Misrepresentations

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SEC v. Andrey C. Hicks and Locust Offshore Management, LLC

Marketing, of course, is an issue close to the heart of every hedge fund manager. You spend so much time and effort making your pitchbook and other materials exactly right in terms of strategy, investment process and all the details that help you make the most of your investor meetings. It needs to look great; it needs to tell your story, and as the SEC recently reminded us, it needs to be the truth, the whole truth, and nothing but the truth.

Overview of Case

On October 26, 2011, the SEC filed an action in the US District Court for the District of Massachusetts against Andrey C. Hicks (“Hicks”) and Locust Offshore Management, LLC (“LOM”). Hicks and LOM purported to manage a British Virgin Islands-based investment vehicle named Locust Offshore Fund, Ltd. (the “Fund” and collectively with Hicks and LOM, “Locust”), which employed a strategy based on a quantitative model developed by Hicks. The SEC alleged that the Fund was in fact part of a fraudulent scheme that ultimately funneled incoming subscriptions into Hicks’ personal accounts.

According to the complaint (see SEC v. Hicks & Locust), the scheme depended on a number of misrepresentations found in LOM’s website, the Fund’s offering memorandum, Hicks’ email correspondence, Hicks’ verbal statements to at least one investor, post-subscription correspondence with investors.

The SEC asserted causes of action under Section 17(a) of the Securities Act (fraudulent interstate transactions), Section 10(b) of the Exchange Act and related rules (prohibiting the use of manipulative and deceptive devices); Section 206(4) of the Advisers Act (prohibiting act, practice or course of business that is fraudulent, deceptive or manipulative), and for equitable relief.

The District Court issued a temporary restraining order and asset freeze against Locust.

Takeaways for Managers

The alleged misrepresentations included the following:

Statements that the Fund was formed and registered as a professional fund in the British Virgin Islands, when in fact no such entity had existed or been registered there;
Flowing from the above, any statement identifying Hicks as the portfolio manager, director, or other principal of the Fund or LOM, as well as any statement that LOM was the manager of the Fund;
Identifying Ernst & Young as the auditor of the Fund, and Credit Suisse as the Fund’s prime broker, when in fact neither company had ever been retained to provide services to the Fund;
Statements that the 27 year old Hicks held an undergraduate degree and doctorate degree in applied mathematics from Harvard, when in fact he had only attended three semesters as an undergraduate, and was forced to withdraw due to repeated failure to meet academic standards. Hicks received a D minus in the only math course he took;
Statements that Hicks managed a book of futures, options and foreign exchange investments at Barclays, and grew his book nearly two-fold during his brief tenure, when in fact he had never been employed at Barclays; and
Assurances to at least one investor that his subscription monies had been received and were “entered into live trading,” and similar statements.

The first investor in the Fund, referred to as Investor A, met Hicks on an airplane and the two fell into conversation. The above statements, found in the offering documents, on the website and in other materials, were reinforced during their conversation. Hicks talked about his education and professional experience, showed Investor A LOM’s website on his Blackberry, and the two parted, exchanging their business cards. The chance meeting and follow-up emails were evidently persuasive; Investor A wired his subscription monies about a month later.

This action highlights several points for managers:

Do not lie in your marketing materials; in
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biographies especially, take care to avoid statements that exaggerate education, qualifications, experience and expertise;
Carefully check all facts, even basic data such as service provider information and fund formation details in all areas where they appear (not merely obvious places like your fund offering documents, but any presentations, pitchbooks, websites or other materials);
Maintain files of backup materials to document every factual statement made in your offering documents, marketing materials and on your website;
The anti-fraud provisions of the securities laws have a long reach and managers should be careful about all communications, not just in their marketing materials. Evaluate letterhead, business cards, email signatures and speak with all employees, but especially those involved in marketing, regarding appropriate parameters for meetings (planned or chance) with potential investors.

Conclusion

Although Hicks is an extreme example, all managers should ensure that their funds’ offering documents marketing materials, stationery, written correspondence, and verbal statements are accurate, including with respect to service provider information, fund formation details, and biographies. To the extent that managers provide such information on their websites, all of these details should be confirmed as accurate on the website itself, and in any linked or uploaded materials.

We recommend that your attorney, in-house counsel or compliance consultant review all marketing materials prior to distributing them, and retaining these materials and backup information in your files.

For more information please see the complaint above of the SEC litigation release.

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Cole-Frieman & Mallon is a boutique hedge fund law firm which provides fund formation, business and compliance services to fund managers. Bart Mallon can be reached directly at 415-868-5345.