Investors heightening ODD on manager compliance post-SAC Capital, says Seward & Kissel

30 Jul, 2013

Institutional investors are likely to heighten their already rigorous operational due diligence and analysis on hedge funds’ compliance policies in light of the SAC Capital indictment, a lawyer from Seward & Kissel has warned.

This comes following a recent survey of operational due diligence professionals by Deutsche Bank, which said unsatisfactory compliance policies and procedures at hedge funds was the second most common reason for failing managers, putting it marginally behind substandard operational infrastructure and technology. Nearly three quarters of the Deutsche Bank respondents confirmed regulatory compliance was their top priority for 2013.

“Investors are going to pay more attention to compliance and ensuring managers have proper compliance procedures and policies in place.  Hedge funds are likely to become even more cognisant about these issues going forward with all that has happened at SAC Capital and other investigations and prosecutions. I suspect managers will increase the educational awareness and training of employees, as well as conduct more spot checks on trading activity in light of these regulatory actions,” said Steve Nadel, partner at Seward & Kissel in New York.

SAC Capital was indicted by the FBI and US Attorney’s Office in Manhattan on charges of insider trading while the Securities and Exchange Commission (SEC) has filed civil charges against the firm’s founder Steve Cohen for failing to supervise properly his employees. 

The hedge fund, which has approximately $14 billion in Assets under Management (AuM), could transform into a family office if redemptions continue at their current rate, and there is speculation its prime brokers could eliminate its credit lines or force it to post more collateral.  However, the government’s decision not to freeze SAC Capital’s assets could alleviate prime brokers’ concerns about continuing their relations with the embattled hedge fund.

Regulators are also likely to be emboldened by the unfolding events, and will certainly have a renewed focus on enforcement. “The appointment of Mary Jo White as SEC chairman bought about a greater level of interest in enforcement matters at the SEC. Another, somewhat under-reported example of this aggression was the rejection of Philip Falcone’s offer of a settlement with the SEC,” said Nadel.

Falcone, who runs Harbinger Capital Partners, is accused by the SEC of improperly borrowing money from his fund to pay an income tax bill. His $18 million settlement was reportedly rejected by Mary Jo White as being insufficient.

However, Nadel said it would be wrong for the regulatory issues facing SAC Capital to tarnish the broader hedge fund industry. “SAC Capital is a well-known hedge fund but it is just one manager, and there are many hedge funds out there who are not accused of any wrong doing.” he said.

Regulatory reporting, namely though Forms ADV 1 and 2, as well as Form PF to the SEC, and Form CPO-PQR to the CFTC , means the authorities now have huge swathes of information and data about hedge funds, which could precipitate more investigations into managers. The SEC has made it no secret they are bolstering their enforcement division and antiquated technology systems to better collect and collate this data.

Nonetheless, experts point out regulators could suffer from information overload, which might cripple any potential enforcement actions and investigations. “The SEC has a huge amount of information now and they are going to have to digest it. There are a lot of filings that need to be reviewed, which they could find difficult. In the short-term, these regulatory reports are unlikely to be hugely useful as the SEC is still trying to get its head around the entire process, but they may prove useful in the longer-term,” said Nadel.


Seward & KisselSAC CapitalDeutsche BankFBISECHarbingerForm PFForm CPO-PQRCFTC