Some interesting news today out of the SEC about new
enforcement actions by the SEC against hedge funds - specifically, against
three separate advisory firms and six individuals for alleged violations
initially uncovered through the results of SEC proprietary data analysis.
That final point may be the most interesting since, evidently, the SEC is not
simply waiting for whistleblowers under the SEC's Dodd-Frank whistleblower
program, which financially compensates those who ring the alarm bells about
fraud and wrongdoing at their companies. Instead, it appears to be
proactively investigating hedge funds, using its proprietary data analysis.
These internal investigatory efforts may signal a new front in the SEC's
efforts to police hedge funds and probably other types of funds as well.
Read more after the jump, courtesy of Deborah Meshulam, Perrie Weiner, Nicolas Morgan and Joshua Briones:
The SEC's proprietary "Risk Analytics"
In addition to tips and complaints becoming the basis for
an SEC investigation, the SEC has also quietly embarked on an extensive internal
effort to generate investigative leads through what it is calling Risk
The agency is now relying on extensive data analysis -
the same kind of quantitative analysis that fund advisers may use to evaluate
potential investments. The SEC's "Aberrational Performance Inquiry,"
conducted by the SEC's Enforcement Division's Asset Management Unit, uses
proprietary techniques to evaluate hedge fund returns. Performance that
appears inconsistent with a fund's investment strategy or other benchmarks forms
a basis for further scrutiny. In other words, the SEC is looking for
returns that appear too good to be true, and then it is investigating.
Fraud allegations began with Aberrational
The enforcement actions announced by the SEC on December
1, 2011 against three separate advisory firms and six individuals were
uncovered through Aberrational Performance Inquiry analysis.1
The alleged misconduct includes:
In discussing these recent enforcement actions, Robert
Kaplan and Bruce Karpati, Co-Chiefs of the SEC Enforcement Division's Asset
Management Unit, explained, "[t]he extraordinary returns reported by these
advisors and portfolio managers were, in most cases, too good to be true.
In other cases, outlier returns were a telltale sign that something else was
amiss. We are applying analytics across the investment advisor
space-beyond performance and beyond hedge funds."
Not coincidentally, just days before the SEC's
announcement concerning its Risk Analytics enforcement actions, the Asset
Management Unit announced three unrelated actions against investment advisers
for violations of Rule 206(4)-7 of the Investment Advisers Act, which requires
registered investment advisers to adopt and implement written policies and
procedures that are reasonably designed to prevent, detect and correct
securities law violations. (See
the SEC's press release.)
Compliance procedures and documentation will
All these cases emphasize the need for all fund advisers,
whether registered or not, to adopt and follow compliance policies and
procedures, especially with regard to critical areas such as asset valuation,
performance reporting and communication with and disclosures to fund
Equally important, all fund advisors should thoroughly
document compliance efforts and the basis by which assets are valued and
returns are calculated. Such documentation can serve to rebut the
findings of risk analytics that may initially suggest to the SEC that something
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