Anticipated SEC Disclosure Crackdown Underway, Sterne Agee Calms Fears

Anticipated SEC Disclosure Crackdown Underway, Sterne Agee Calms Fears

An expected Securities and Exchange Commission (SEC) crackdown that we first reported in ValueWalk April 30 may be underway, but this shouldn’t be cause for concern for shareholders in alternative asset stocks, says a Sterne Agee report.

The issue was recently ignited again when Andrew Bowden, the head of the SEC’s exam program, indicated that the SEC has identified “violations of law or material weaknesses in controls over 50% of the time”  in its reviews of funds.  The issues center around hidden fees, misallocation of expenses, and inaccurate asset valuations.

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SEC disclosure crackdown anticipated

ValueWalk had first reported on April 24 the SEC was conducting a review of alternative hedge funds offered to the general public.  Then on April 30 speculated that the SEC was about to engage in a crackdown.  The article, which was in part based on a source familiar with the regulatory structure, noted public comments from SEC Chairperson White:

“The Commission has continued to bring many significant enforcement cases across our entire regulatory spectrum,” White said in Congressional testimony. This could include “actions against exchanges… and actions against investment advisers and broker-dealers for a variety of offenses, including taking undisclosed fees and conflicts of interest, and for disrupting the markets through automated trading, actions against auditors and others who serve as gatekeepers in our financial system, landmark insider trading cases, and additional cases against individuals and entities whose actions contributed to the financial crisis.”

In the fund arena, the “undisclosed fees and conflicts of interest” to which White refers to recently came to light in reporting by Bloomberg’s David Evans in an article on fee disclosure in managed futures mutual funds.  In the article Evans, a former CFTC enforcement lawyer turned Bloomberg columnist, reported that these algorithmic trading funds would charge fees as high as 9% without clear disclosure to the investor.

The real story

ValueWalk reported the story behind the story.  The issue wasn’t so much with managed futures but more the general SEC fee disclosure policy, which was at odds with the CFTC.  CFTC Commissioner Bart Chilton, who was aware of the fight between the CFTC and SEC on the issue, advocated for transparent and simple fee disclosure. The fight centered around CFTC regulated direct managed futures accounts, which required clear and simple fee disclosure and accounting standards, vs the SEC’s more opaque mutual fund reporting standards and disclosure of fees.  When managed futures funds started offering the uncorrelated investment through securities brokerage firms for the first time, the fee and performance disclosure standards conflicted and the SEC prevailed over the CFTC on the issue.  The managed futures direct account mandated that performance was disclosed after all fees and expenses, net net, and that all account activity was transparent to the client.  Fee disclosure and the impact on performance followed a strict formula.  The SEC fee disclosure was extensive but legally dense for the average investor.  Critics have charged the complex disclosure was intentionally opaque so as to mask hidden fees, an issue first exposed on 60 Minutes.

According to a Bloomberg article, the CFTC was investigating the fee issue.  Indications are no report is immediately forthcoming.  Speculation is an internal CFTC report on the issue might have been critical of the SEC’s fee disclosure and performance reporting but is said to be withheld so as not to cause friction with the SEC.

Sterne Agee indicates large firms not in target zone

Sterne Agee views the overall alternative investment group as attractive.

“While there has been no indication whether the publicly traded firms have been examined, we would expect considerably stronger compliance standards than at smaller firms,” the report said.  “The publicly traded firms have large legal & compliance departments, have been SEC registered/regulated for a meaningful period of time (unlike many/ most private equity firms), and generally have larger, more sophisticated, and demanding limited partners.”

Using the common logic that the large firms have compliance to a much more rigorous degree than do small firms, a generally accepted principle, Sterne Agee doesn’t factor that the SEC may be shifting the game and tightening its once lose disclosure requirements for all.  In other words, what was accepted yesterday is no longer acceptable today.  But this remains to be seen.

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)

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