Recently, ACA’s Hedge Fund Practice hosted a breakfast event in Boston with local CCOs, where I moderated a fireside chat with senior staff from the Securities Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) and Division of Enforcement. The Q&A session was followed by a panel focused on practical considerations related to trade surveillance for fund managers.
During the fireside chat, the SEC staff from the Boston Regional Office discussed priorities pursued by OCIE and Enforcement, the SEC’s use of data analytics, challenges related to deficiencies (or a lack there of) stemming from exams, and expectations around firm’s trade surveillance policies, procedures, and practices. Find below the major takeaways and points of interest from our discussion.
According to the personal views conveyed by the Staff, priorities pursued by OCIE and Enforcement tend to overlap, and firms should continue to pay attention to conflicts (broadly), fee and expense allocations, cross-trades, portfolio management, and surveillance. Firms may expect to see a renewed focus on private fund managers specifically in the coming year, though the SEC staff emphasized that OCIE and Enforcement have certainly not lessened their scrutiny of private fund managers despite the explicit focus on Main Street investors noted in formal priority releases.
Valuation Process and Procedures
We discussed recent actions related to valuation of hard-to-value securities, and steps CCOs can and should take to avoid trouble with the regulator. It’s important for firms, and CCOs specifically, to pay close attention to processes and procedures around valuation. CCOs should be thinking about how such securities are valued. When actual market data is available, is it being utilized? Are there compliance policies and procedures around valuation? Do they make sense and are they practically implemented?
Exam Trends and “No Comment” Letters
In discussing recent trends in examinations, the Staff noted that “soup to nuts” examinations are no longer the norm – rather, firms are more likely to experience examinations that are narrower in focus. New registrants or firms that haven’t been examined in awhile may be subject to a risk assessment exam, while other firms may be subject to examinations where the Staff is already aware of the risk profile of the firm due to prior exams or other information gathered. We spent quite a bit of time discussing the observed up-tick in the amount of “no-comment” letters received by registrants post-exam. The Staff opined this may be due to the narrower scope of examination focus, the increased capabilities and knowledge of the examination staff, or a combination of both – but should not be perceived by a firm as a “clean bill of health,” by any means. Cutting compliance resources or de-prioritizing compliance at a firm as a result of a seemingly positive examination would be a massive miscalculation of the intent of a no-comment letter. It’s important for firms to realize that deficiencies, or a lack thereof, are relative only to those areas within the (narrower) scope of examination.
SEC’s Use of Data Analytics
Comments regarding the SEC’s use of data analytics, both in selecting firms for examination and during examinations by both OCIE and Enforcement, were enlightening. Firms would be remiss to think regulatory filings, explicitly including Form PF, are not an important source of data for the Staff. Anomalies in data reported in such filings may lead to an examination. OCIE seems to be gathering more and more data during examinations, and that data is being utilized across the Commission. Firms should think critically about their ability to produce their trading data to the SEC in the format requested; data needs to be compatible with “NEAT” (the SEC’s National Exam Analytics Tool). Enforcement, too, has had great success with analytics, specifically the use of “ARTEMIS,” which analyzes patterns and relationships in trading activity, and helps to identify potential anomalous performance and outlier returns. The Aberrational Performance Inquiry initiative is also alive and well and being utilized by the Asset Management Unit (“AMU”) to evaluate hedge fund returns and identify inconsistencies within stated strategies or compared to relevant benchmarks.
With respect to trade surveillance, expectations vary by firm size, strategy, and risk profile and firms need to critically think about firm-specific risks in crafting a surveillance program. It’s important for CCOs to truly understand the risks inherent in the firm’s investment strategy in order to adequately monitor trading activity and appropriately escalate potential issues with portfolio managers and other investment and trading personnel. If policies, procedures, and practices are inconsistent with the firm’s strategy (or don’t keep up with the evolution of a firm’s strategy), firms may find themselves in hot water.
Compliance officers and teams should have the ability to detect anomalies in trading activity, and the expectation is that firms need to consider broad ranges of potential issues in conducting surveillance: cross-trading, profitable trades, loss avoidance, marking the close, cherry-picking, trading in front of earnings, and trading after meetings with experts or issues, to name a few. In setting parameters for surveillance, firms need to determine what is reasonable (but a day or two before or after trades is certainly not enough)! While automated trade surveillance is not mandatory, firms should conduct manual surveillance at their own risk; such procedures simply may not be enough to detect anomalous trading activity. Finally, firms should consider all inputs when reviewing trading activity such as meetings with issuers, formal and informal research consultations, market data, electronic communications, research notes, and any other sources of information utilized in the investment process.
For More Information
If you’d like to discuss what was covered at our roundtable discussion in more detail or learn more about ACA’s services, including ACA’s holistic trade surveillance consulting and technology services, please contact Molly Yakubian at firstname.lastname@example.org or your ACA Consultant.
About the Author
Molly Yakubian is a Senior Principal Consultant & Hedge Fund Practice Specialist at ACA Compliance Group. In her role, Molly provides asset managers with various levels of tailored regulatory support services, including support during SEC examinations, SEC registration assistance, annual compliance reviews in accordance with Rule 206(4)-7, forensic testing, and development of policies and procedures. Molly has practical expertise in the day-to-day compliance operations, and seeks to assist her clients in developing, implementing, and maintaining a practical, effective, and comprehensive compliance program. Previously, Molly worked as part of the compliance team at an accomplished private equity firm in Boston, administering their in-house compliance program. Molly earned her Bachelor of Business Administration degree (Finance concentration) from the University of Massachusetts Amherst.