Two Recent Enforcement Actions Against Private Fund Advisers

The industry should not misinterpret the SEC’s 2018 National Exam Program Priorities as a shift away from private fund advisers. As discussed during the SEC’s recent National Compliance Outreach Seminar for Investment Companies and Investment Advisers held on April 12, 2018, it is clear that private fund advisers have been “normalized” within the SEC‘s overall priorities with 37% of advisers managing at least one private fund. This is further supported by the broader, cross-section of private fund investors including 25% pensions, 11% individuals and 10% non-profits . For various reasons, including the broad authority private fund advisers (or their affiliates) have over the day-to-day operations of a private fund, expense allocation, revenue streams and valuation will always be focus areas during any routine examination of a private fund adviser.

When an asset manager’s secret sauce leaves a bad taste with investors in terms of poor performance, significant redemptions can follow. Below are two recent examples where the private fund adviser’s subsequent actions burnt their kitchens down. Last week, the SEC issued press releases involving serious misconduct by two private fund advisers including a failure to supervise settlement with the CFO of one of the advisers.

Visium Asset Management

Sham quotes, insider trading abuses and the CCO was not named

On May 8th the SEC announced that Visium Asset Management, a hedge fund advisory firm, agreed to settle charges related to mispricing assets and insider trading. Separately, the firm’s CFO agreed to settle charges that he failed to supervise the portfolio managers involved when, according to the SEC, there were a number of red flags that should have alerted the CFO to the asset mispricing.

The SEC claims two portfolio managers at the firm inflated the value of securities held by its hedge funds, resulting in $3.15 million in excess fees earned by the adviser. The SEC’s settlement with the CFO claims the CFO failed to supervise the portfolio managers as a result of not recognizing certain red flags including an excessive number of valuation over-rides that, more often than not, resulted in higher asset prices. The order involving the firm, found that certain portfolio managers traded in securities based on material non-public information gleaned from insiders working as paid consultants to the firm.

It is unclear exactly why the CCO was not named. We do know the SEC noted that Visium’s policies and procedures were:

“…reasonably designed to prevent the misuse, of material, nonpublic information by the firm and persons associated with it. Visium’s written policies and procedures concerning prevention of the misuse of material, nonpublic information were contained in its compliance manuals in effect at the relevant time. The policies prohibited employees from trading on any material, nonpublic information they obtained in the course of their employment, and listed types of information that could constitute material, nonpublic information. The policies also instructed employees to alert the Chief Compliance Officer (“CCO”) if there was a possibility information they obtained was material, nonpublic information, or if they had any questions about whether information they obtained was material, nonpublic information. Each employee was required to review Visium’s insider trading policies and procedures and to sign an acknowledgement that, among other things, he or she was prohibited from trading on the basis of material, nonpublic information. The procedures also addressed the use of outside consultants. Specifically, a “Checklist Resolving Issues Concerning Insider Trading” recommended, among other things, that employees should (a) ensure all agreements with third-party research consultants contain an insider trading prohibition disclosure, and (b) remind consultants that Visium should not be a recipient of actual or potential material, nonpublic information.”

However, the SEC does state that Visium 1–had inadequate measures in place to enforce its policies and to ensure the Checklist was followed, and 2–took inadequate steps to monitor employees’ communications with consultants.

While we do not have enough information concerning the CCO’s role in this case and Visium’s supervisory structure, every CCO should carefully examine their own firm’s supervisory structure and ensure that it is explicit in all compliance areas. CCOs are not required to be supervisors. CCOs should consider ensuring knowledgeable persons are clearly defined as supervisors and those supervisors understand their obligations.

Premium Point Investments

Conspired broker-quotes

On May 9th the SEC announced that it has charged investment adviser Premium Point Investments with fraudulently inflating the value of its private funds by hundreds of millions of dollars. The SEC also charged the CEO/CIO, a former partner/PM, and a former trader.

According to the SEC complaint, Premium Point was operating two schemes to inflate valuations. The more recent scheme, which ran from at least September 2015 through March 2016, during a period of poor performance and requests from large investors to redeem, involved a secret deal where, in exchange for sending trades to a broker-dealer, the adviser received inflated broker quotes from the broker-dealer for certain mortgage-backed securities which the SEC alleges were used to inflate the value of holdings, exaggerating returns. The longer running scheme involved Premium Point’s undisclosed policy of using “imputed” mid-point prices of securities even when actual mid-point prices were available and since 2015 included the “fixed” broker-quote to calculate the “imputed” values. The SEC also took exception to the fact that Premium Point mislead a prospect in 2011 who said they would not invest if Premium Point used “imputed” mid-points to value securities. Based on representations by Premium Point that imputed values would not be used, the prospect invested, and Premium Point used “imputed” mid-points.

The SEC’s complaint charges the defendants with fraud and/or aiding and abetting fraud, and seeks permanent injunctions, return of allegedly ill-gotten gains with interest, and civil penalties. No person in the complaint was identified as a compliance professional.

All advisers should interpret the National Exam Program’s annual priority list as “additional” focus areas. Private fund advisers are often viewed by examiners as having a business model where potential “higher-risk” activities may exist. The SEC typically will focus on those higher risk areas when examining private fund advisers and want to ensure adequate policies and procedures are in place.

Kristin Snyder, Co-National Associate Director, OCIE National Exam Program (San Francisco Regional Office), “Panel I: Insights from SEC Leadership Regarding Program Priorities” [replay Part 1, time index 1:40], National Compliance Outreach Seminar for Investment Companies and Investment Advisers (Washington, D.C.), April 12, 2018.