33 Bell[1] - Hedge Fund: How History Repeats Itself and...

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Unformatted text preview: Hedge Fund: How History Repeats Itself and Investors Get a New Instruction Manual Stephen Bell Comments and opinions expressed by the speaker do not necessarily reflect the positions, opinions or beliefs of the AICPA and should not be construed or interpreted as such. Speakers retain the copyright for all of the following materials. Any replication without written consent is unlawful. Session 33 AICPA NATIONAL FORENSIC ACCOUNTING CONFERENCE AICPA National Forensic Accounting Conference Stephen C. Bell KPMG LLP September 23-25, 2009 The Swan Hotel, Orlando, Florida Hedge Funds: How History Repeats Itself and Investors Get a New Instruction Manual Presentation Agenda o o o o o o The Catalyst The Predictions History Repeating Itself The Old Instruction Manual The New Instruction Manual The Way Forward 33-1 The Catalyst “U. S. law generally does not require hedge funds or other private pools of capital to register with a federal financial regulator, although some funds that trade commodity derivatives must register with the CFTC and many funds register voluntarily with the SEC. As a result, there are no reliable, comprehensive data available to assess whether such funds individually or collectively pose a threat to financial stability. However, in the wake of the Madoff episode it is clear that, in order to protect investors, we must close gaps and weaknesses in regulation of investment advisors and the funds they manage. March 26, 2009 -Tim Geithner, Treasury Secretary The Predictions… In 2003, the premonitions about Hedge Fund fraud were already a concern o o o o o Making false or misleading statements in offering documents Misappropriating assets Market manipulation in a variety of guises Reporting false or misleading performance, including with respect to valuation of securities Fraudulently allocating investment opportunities Testimony Concerning Investor Protection Implication of Hedge Funds-4/10/03 -William H. Donaldson (former SEC Chairman) 33-2 History Repeating Itself… Fund Allegations Lipper & Company (2003) overstatement of of value of bonds and securities, materially false and misleading fund valuations and performance figures, and filing of false reports to the commission Lancer Management Group (LMG) (2003) over-inflate the performances and net asset values, manipulation of month-end closing prices of certain securities, provided unfounded and unrealistic valuation opinions to auditors to obtain audited financial statements, and materially false and misleading statements in offering and marketing materials Beacon Hill Asset Management (2004) misrepresentation and manipulation of of valuation procedures Bayou Capital Management (2005) asset misappropriation, and misleading audit results Wood River Capital (2007) material misrepresentations to investors regarding the oversight and diversification International Management Associates LLC (2007) quarterly statements that misrepresented both the amount of assets Maricopa investment fund (2008) false account statements and misappropriation Bernard L. Madoff Investments (2008) Ponzi scheme, misrepresentation Pequot Capital Management (2009) Insider Trading The Old Instruction Manual… Domestic Regulations 1.SEC 17a-3 and 17a-4 2. NASD rules 3010, 2210, 3110 for NASD members 3. NYSE rules 342 and 440 for NYSE members 4. Sarbanes Oxley rule 404 5. CFTC rule 1.3 for institutions involved in commodities trading 6. NFA rule 2-9 for institutions involved in futures trading 7. SEC Rule 206(4)-2 Custody Rule 8. SEC Rule 206(4)-8 Anti-Fraud Rule 33-3 The New Instruction Manual SEC’s Anti-Fraud Rule Under 206(4)-8, it is a Violation for the investment advisor of any pooled investment vehicle to: Prohibits advisers from (i) making false or misleading statements to investors or prospective investors in hedge funds and other pooled investment vehicles they advise, or (ii) otherwise defrauding these investors. **reaches conduct that is negligently deceptive as well as conduct that is recklessly or deliberately deceptive ** SEC Enforcement Division “The Asset Management Unit will focus on Investment Advisors, Investment Companies, Hedge Funds, and Private Equity Funds. These entities account for an ever-increasing share of public and private investment funds, and the lines between these various vehicles blur and overlap. More than ever, effective enforcement requires a comprehensive approach to these entities…. This Unit will work closely with our colleagues in the Office of Inspections, Compliance and Examinations, which has great expertise in investment advisers and companies. August 5, 2009 -Robert Khuzami, Director, Division of Enforcement, Securities and Exchange Commission 33-4 Now what? The Obama Administration wants hedge funds with $30 million AUM to register with the SEC, and set up new compliance programs. July 15, 2009-Reuters, Inc. Current Administration’s Proposal Goals Protect Investors From Fraud And Abuse Would require that all investment advisers with more than $30 million of assets under management to register with the SEC, and contain Substantial regulatory reporting requirements with respect to the assets, leverage, and off-balance sheet exposure of their advised private funds Disclosure requirements to investors, creditors, and counterparties of their advised private funds Strong conflict-of-interest and anti-fraud prohibitions Robust SEC examination and enforcement authority and recordkeeping requirements Requirements to establish a comprehensive compliance program Require Increased Disclosure Requirements. T he Administration's legislation would require that all investment funds advised by an SEC-registered investment adviser be subject to recordkeeping requirements; requirements with respect to disclosures to investors, creditors, and counterparties; and regulatory reporting requirements. 33-5 Current Administration’s Proposal Goals Protect Financial System From Systemic Risk Confidential reporting of amount of assets under management, borrowings, offbalance sheet exposures, counterparty credit risk exposures, trading and investment positions Other important information relevant to determining potential systemic risk and potential threats to our overall financial stability Require the SEC to conduct regular examinations of such funds to monitor compliance with these requirements and assess potential risk. SEC would share the disclosure reports received from funds with the Federal Reserve and the Financial Services Oversight Council Could be used if any of the funds or fund families are so large, highly leveraged, and interconnected that they pose a threat to our overall financial stability and should therefore be supervised and regulated as Tier 1 Financial Holding Companies. A World-wide Movement towards greater transparency New World-wide Hedge Fund Regulations Internationally, there’s a global shift towards risk mitigation, and countries are addressing some of the core investment strategies of hedge funds-effectively curtailing what used to be highly profitable. “G-20…aim to merge their national blueprints for strengthened regulation into a united front to rein in hedge funds, derivatives trading, executive pay and excessive risk- taking by financial firms.” -Bloomberg News G-20 Targets Hedge Funds as Leaders Near Consensus March 30, 2009 33-6 The Way Forward The push towards regulation is imminent, and SEC enforcement for hedge funds is increasing. Where does that leave the hedge fund industry? No… The Way Forward If registering, funds should consider… o o o o o o o o o o Advisory contracts; Fiduciary duty standards of care; Publicly available disclosures to the SEC of the adviser’s business, clients, industry affiliations and control persons; Detailed disclosures of investment strategies and products, education and backgrounds of advisory personnel and fee arrangements Maintenance of books and records relevant to the adviser’s business; Periodic inspections and examinations by SEC Staff Adoption and implementation of a written compliance program, Appointment of a Chief Compliance Officer, and an annual review of the effectiveness of the compliance program; Adoption and implementation of a written code of ethics designed to prevent “insider trading”’ and Adoption and implementation of written proxy voting policies 33-7 The Way Forward So why me, and why the AICPA conference? Potential Risks leading to Fraud 1. Establishment of side pocket investments 2. Make sure all statements in the hedge fund offering documents and collateral marketing materials are accurate 3. Always produce accurate portfolio statements 4. Make sure all appropriate disclosures relating to personnel are made. 5. Take care when going outside stated valuation policies 6. Personnel concerns: lack of segregation of duties, especially related to cash controls, and turnover of key personnel 7. Substantial change in assets under management 33-8 Something to Think About… Hedge Fund Formation Documents Legal documents -Offering Memorandum -Investment Management Agreement -LLP’s, LLC’s -Side Letters -Most Favored Nations Clauses Something to Think About… Communications to Clients Emails Communications Representations Advertisements 33-9 Something to Think About… Communications to 3rd Parties Representations Conversations Meetings Blogs T witter Facebook Social sites Private emails… Times are a changin’ o Investor Due Diligence o Operational Due Diligence o Financial Due Diligence 33-10 Both the AIMA and MFA provide best practices guidance for hedge funds on compliance programs and risk mitigation Investor Due Diligence Hedge Fund AML Programs and Investor Due Diligence 1 2 3 4 Internal Controls Designated AML Compliance Officer Ongoing Employee Training Independent Testing 33-11 Operational Due Diligence Taking a look at operational factors that may effect future performance… Operational Due Diligence Conflicts of Interests 33-12 Financial Due Diligence Valuations Due Diligence Hedge Funds, regardless of regulation, will be faced with a new dichotomy of focused concern: Investors Regulators It’s up to the funds to make both parties comfortable with their existing business model, or change it accordingly… 33-13 Questions? Stephen C. Bell KPMG LLP 345 Park Avenue New York, NY 10154 212-954-6831 scbell@kpmg.com 33-14 ...
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