SEC’s Mary Jo White Hammers Hedge Funds Lack Of Fiduciary Duty


Beleaguered SEC Chair Mary Jo White came out swinging in a speech at the MFA Outlook 2015 Conference, New York on Friday, October 16th. Her speech, titled Five Years On: Regulation of Private Fund Advisers after Dodd-Frank, focused on the broad range of “risks” that exist in the hedge fund and private equity industry.

She did not pull any punches in describing the litany of sins committed by hedge funds and private equity funds, and made it clear that the SEC was both aware of the extent of the fiduciary duty violations and was planning enforcement actions.

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Mary Jo White highlights operational risks for hedge funds

In her comments on Friday, the SEC chair noted that one key area of operational risk among private funds that required strict attention was the transfer of client accounts from one adviser to another. She noted that the commission staff is developing recommendations to assist advisers in assessing and planning for mitigating impact on investors when an adviser can no longer serve its clients.

Mary Jo White also highlighted cybersecurity as another important operational risk. SEC guidance this spring suggested advisers take a good look at their ability to prevent, detect and effectively deal with network attacks given their obligations under federal securities laws, and presented several measures advisers should consider.

An enforcement case settled last month the problems investment advisers can face in terms of cybersecurity.  In this instance, a hacker broke into an investment adviser’s server and took personal information about over 100,000 clients. The adviser faced charges of violating Regulation S-P by not developing policies and procedures reasonably designed to protect customer records and information.

She also pointed to market stress as another operational risk to be considered by private fund managers. Commission staff is working on ways to implement the Dodd-Frank requirements for yearly stress testing by large registered investment advisers and registered funds. Moreover, international organizations including the IOSCO are also working on the development of stress tests for the asset management space. The SEC is currently focused on registered funds and advisers, but the commission is also considering how to  address this issue for other registered advisers that are included under the purview of Dodd Frank, including private fund advisers.

Risks within the firm

In her speech at the MFA Outlook 2015 Conference, SEC Chair Mary Jo White also highlighted a number of “risks within the firm” that fund managers need to remain cognizant of She noted that some hedge fund advisers have apparently used marketing materials based on back-tested performance numbers, portable performance numbers, and benchmark comparisons that did not include key disclosures.

Disclosure of conflicts is another “risk within the firm”.  SEC examiners have reported that some hedge fund advisers may not be sufficiently disclosing conflicts advisers’ proprietary funds and personal accounts of their portfolio managers. For example, examiners have seen advisers move profitable trades or investment opportunities to proprietary funds instead of client accounts in a violation of policies.

Mary Jo White noted that examiners also saw numerous instances of conflicts with fees and expenses among private equity advisers. There were also reports that some advisers were  shifting expenses away from the adviser and onto the funds or portfolio companies. For example, some advisers were reportedly charging a fund for the salaries of the adviser’s employees or employing the adviser’s former employees as paid “consultants”. In particular, SEC examiners noted that many advisers were taking in millions in accelerated monitoring fees without disclosing the practice as required.

The SEC’s Private Funds Unit is also in the process of completing a review of private fund real estate advisers, some of which are apparently hiring related parties. Moreover, it appears disclosure about these hiring arrangements is minimal or even potentially misleading, especially in terms of whether the related parties charge market rates.

Mary Jo White concludes by scolding senior execs in the hedge fund industry regarding the lack of focus on disclosure of conflicts: “I urge you to focus on a number of recent, important enforcement actions by the Commission against private fund advisers. Many of these actions also center on disclosure and conflicts of interest, including advisers misallocating expenses to funds;failing to disclose loans from clients; using funds to pay their operating expenses without authorization and disclosure; and failing to disclose fees and discounts from service providers.”

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