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SEC Hits Hedge Funds
September 21, 2007
SEC Serves Document Requests on Numerous Hedge Funds
Following the SEC's recent formation of its "Hedge Fund Task Force," as highlighted in a prior Bracewell alert, the Commission has taken its initial steps to investigate potential fraud within the hedge fund industry. The SEC has sent document requests to over two dozen hedge funds across the country.
The Commission has requested an inordinate amount of information from these funds, including: records of client and other accounts that made private investments in public equities ("PIPE" transactions), identities of finders, brokers or promoters involved in the PIPE transactions, lists of companies where employees or affiliates of the hedge fund's investment adviser serve on a creditors' committee, a list of all "one-on-one" meetings arranged at conferences sponsored by brokerage firms, and any dates of meetings, names and titles of employees who attended, names of the brokers involved, and names of "corporate insiders" and their companies who were present.
The SEC also sought the identity of any relatives of any hedge fund personnel who work at brokerage firms, as well as a detailed description of any "deal'' that a fund manager "was asked to consider'' and turned down "because the proposal was deemed inadvisable, inappropriate, unethical, or possibly illegal."
In this overly broad request, the SEC is investigating, among other things, potential insider-trading violations by the hedge funds or accounts in their control.
Nuts and Bolts of an SEC Document Request
The SEC can inspect hedge funds, and demand detailed information about their investments and clients, provided that the fund is voluntarily registered with the agency under the Investment Company Act of 1940. A registered fund that receives a document request from the SEC is compelled to produce the requested documents. The SEC can also request documents from hedge funds where the fund is not registered, but these entities are not obligated to comply with the request.
An investigation by the SEC often begins as an “informal inquiry” and it issues a request for documents in lieu of a subpoena. In informal inquiries, the SEC staff relies on the cooperation of individuals and companies to obtain information, documents, and testimony. Informal inquiries are non-public, and the SEC cannot administer oaths or affirmations as it can in formal inquiries.
Although a non-registered fund is technically under no obligation to furnish information to the SEC in connection with an informal request for documents, such a decision should not be made without becoming fully informed of the potential risks. For example, after receiving a document request from the SEC, and refusing to comply, it may raise red flags with regulators even when no malfeasance has occurred. This could also lead the fund or its employees to becoming subjects of an official SEC inquiry or Department of Justice criminal investigation.
What To Do If A Fund Receives A Document Request From the SEC
The proper strategy to react to such a request is to have experienced counsel review the document request, so that the fund can fully appreciate the issues or transactions that are under inquiry. Appropriate counsel should have extensive experience in dealing with SEC requests and subpoenas, so that they can advise the fund, whether that fund is registered or not, on how best to negotiate with regulators to limit the scope and reach of an otherwise inordinate document request. This not only saves time but also limits excessive and wasteful expense in retrieving and analyzing documents that are irrelevant to the ultimate issues of interest to the SEC.
Further, an appropriately conducted internal review also gives the fund a great advantage because it alone can determine whether any untoward conduct was committed by any employees or affiliates and will allow a fund to stay one step ahead of regulators' concerns.
Once a fund is in the position to deal with any and all questions surrounding the issues, experienced counsel can properly disclose any relevant information to the SEC and shepherd the fund through any investigative process that may follow. However, a key aspect of this review process will be determining what, if any, information the fund should disclose to the SEC. By drawing on the resources of experienced counsel, a fund will also have the advantage of understanding the risks and benefits associated with refusing to comply with overly broad and onerous demands.
The Bracewell & Giuliani White Collar Defense and Special Investigations Group possesses the experience necessary to handle any regulatory inquiry. Our lawyers include former senior staffers in the SEC Enforcement Division and the U.S. Department of Justice and currently focus on advising hedge fund clients. When teamed with the attorneys of Bracewell's Private Investment Funds Practice, Bracewell is capable of advising you on all aspects of the issues associated with SEC information requests and investigations.