Problems that can trip you up with SEC

There's no single topic that trips up investment advisors or mutual fund companies again and again in SEC inspections. At least not in the experience of Michael Garrity, branch chief in the SEC's Boston District Office. He participated in the "Hot Topics for 2006" panel at the Jan. 25 "Financial Services Challenges in the New Year" conference presented by NICSA's East Coast Regional Committee.

Two other speakers ventured their opinions on likeliest hot spots.

"It's typically a new process or an activity that's new to a firm," said Nicholas D'Angelo, director, Pricewaterhouse Coopers LLP.

Stuart Fross, deputy general counsel and SVP, Fidelity Investments, said that your firm is probably in good shape if it is fully disclosing where its income is coming from and where its expenses are flowing.

Panelists focused on five topics:

1. Affiliated transactions (D'Angelo)
   
2. Fair valuation (Elizabeth Duggan, senior director, FT Interactive Data)
   
3. Hedge fund mainstreaming (Robert teDuits, director of offshore and alternative business development)
   
4. Performance fees (Fross)
   
5. Swaps standardization (Marlena Fitts, manager of product management, Advent Corp.)

Garrity commented on his inspection approach to each topic after giving the standard SEC disclaimer that his opinions were strictly his own.

Having policies and procedures is essential. Garrity seemed to mention that after each topical presentation.

Here are some additional areas that Garrity considers, by topic area.

Affiliated transactions
Garrity looks at a list of affiliates before visiting your company. He'll also ask you for a list of affiliates and he'll look at actual transactions.

Fair value
Is your process fair, verifiable and consistent? Do you use multiple pricing sources? Do you test the pricing services themselves?

Hedge funds
Hedge fund advisors are supposed to register with the SEC by February 1. "It used to be that hedge funds were run for rich people in Geneva by rich people in Greenwich," said Garrity. Now that their distribution has broadened, the SEC is more interested. Garrity would look at your investment process, types of investments, leverage (to ensure it's monitored by chief compliance officer), best execution practices, gift issues, derivatives, sideletters, performance fees and high water marks.

Performance fees
Garrity may run through actual payment calculations with you. He also looks at disclosure, allocation of hot IPOs (to see if you're favoring the account with the performance fee), risk.

Swaps
Garrity looks at disclosure and to see that you have a system for monitoring that's commensurate with risk.