The irony of this cautionary tale is that these traders thought they were escaping compliance in mutual funds for greener pastures in a small hedge fund. They were very wrong!

The New SEC Registration and Compliance Rule.

The link below regarding a recent SEC rule is must reading for anyone interested in laws governing hedge funds and investment advisers. This SEC rule includes important changes in the law. It was controversial in the making and heavily debated among industry players. Kudos to the SEC; they responded to all parties with respect, proper explanations, and good logic for their rule changes. This SEC rule gives us a much richer experience and understanding about hedge fund law, the industry, and the future of hedge funds and investment advisers.

This SEC rule is excellent reading. It includes, all of the following:

Hedge funds formerly perceived as a private and secret domain for the wealthy, and exempt from much regulation and media attention. This latter, of course, is not true. Before the proliferation of the Internet, there was not much public information available to teach investors and managers about hedge funds and governing law.

That has all changed! The best Web sites in the business these days come directly from the SEC, CFTC, IRS, individual states, and other governmental agencies charged by Congress with implementing and enforcing the federal and state laws. The best way to insure laws are followed is to educate the public about such laws.

When it comes to trader tax, we helped get the word out, before anyone else became aware of trader tax law changes. At this stage of the game for hedge funds, it doesn't make much sense to write about hedge fund laws. It's best to go right to the "horse's mouth" and learn about hedge fund and investment adviser law on the web sites of the SEC, states, and other governing bodies.

Nonetheless, we always have a lot to say about our opinions, interpretations, advice, and strategies for success. The article above is an example. The law is clear, but also unclear, so we advise all investment advisers, registered or not, to adopt compliance programs. That is an original position.

Final Rule: Registration Under the Advisers Act of Certain Hedge Fund Advisers ...
AGENCY: Securities and Exchange Commission (the Commission or SEC ). ACTION: Final rule. SUMMARY: The Commission is adopting a new rule and rule amendments under the Investment Advisers Act of 1940. Size: 503511 Modified: 12/09/2004 /rules/final/ia-2333.htm.

Excerpt from above SEC Final Rules:

II. DISCUSSION; B. Matters Considered by the Commission
--4. Adoption of Compliance Controls. Click here

IV. COST-BENEFIT ANALYSIS; B. Costs;
-- 2. Cost of establishing a compliance infrastructure. Click here.

Final Rule: Compliance Programs of Investment Companies and Investment ...
SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 270 and 275 [Release Nos. IA-2204; IC-26299; File No. S7-03-03] RIN 3235-AI77 Compliance Programs of Investment Companies and Investment Advisers
Size: 163609 Modified: 12/17/2003 /rules/final/ia-2204.htm

General Information on the Regulation of Investment Advisers
Division of Investment Management.
Note: Information on this page may not be current or accurately reflect legal requirements. For more current information see:

* http://www.sec.gov/iard for investment adviser forms and registration information

* http://www4.law.cornell.edu/uscode/15/ch2D.html for Investment Advisers Act of 1940

* http://www.sec.gov/about/laws/secrulesregs.htm#invadva40 for Rules under the Investment Advisers Act of 1940

"Registration under the Advisers Act will require hedge fund advisers to adopt policies and procedures designed to prevent violation of the Advisers Act, and to designate a chief compliance officer.108 Hedge fund advisers that have not already done so must develop and implement a compliance infrastructure. We adopted this requirement last year for all advisers registered with us in recognition that advisers have the primary obligation to ensure compliance with the securities laws, and to foster more effective compliance practices.109 Our examination staff resources are limited, and we cannot be at the office of every adviser at all times. Compliance officers serve as the front line watch for violations of securities laws, and provide protection against conflicts of interests.

Comment letters opposing registration of hedge fund advisers did not challenge the benefits of compliance programs; rather, they complained of the costs of developing a compliance infrastructure, and of submitting to our compliance examinations.110 They asserted that these costs would make them less competitive, and would impose barriers to entry preventing new hedge fund advisers from starting their own hedge funds.111 We acknowledge that development and maintenance of compliance controls involves costs,112 but these are costs that today all advisers registered with us must bear, including advisers that are much smaller and have substantially fewer resources than many hedge fund advisers.113

Our 2003 Staff Hedge Fund Report noted that, while many unregistered hedge fund managers had strong compliance controls, others had very informal procedures that appeared to be inadequate for the amount of assets under their management.114 These lack of controls concern not only us, but also hedge fund investors. A recent survey of institutional investors reported that the adequacy of operational controls at hedge fund advisory firms was one of most frequently mentioned concerns.115 While these investors can request to see a hedge fund manager’s compliance policies and procedures, we are in a position to determine whether the hedge fund adviser’s operations seem to be in accordance with those policies and procedures.

Application of our recent rule requiring more formalized compliance policies administered by an employee designated as a chief compliance officer will serve to better protect hedge fund investors.116 We also believe it will well serve hedge fund advisers that, for business reasons alone, should have a compliance infrastructure commensurate with the nature of their operations and the risks involved.117 These costs appear small relative to the scale of the industry.118 The typical hedge fund fee structure, which involves both a management fee of two percent or more and a performance fee of twenty percent or more provides hedge fund advisers with a substantial cash flow.119 Today there are many investment advisers registered with us that manage a comparable amount of assets, charge substantially lower fees, and bear these same compliance costs. One recent study estimated that “in 1999, with $450 billion in assets under management, hedge funds’ fee revenues were higher than those of the whole U.S. equity mutual fund industry.”120

There are today “[e]xtremely low barriers to entry and tremendous monetary and non-monetary incentives for hedge fund [advisers],”121 and thus the cost of compliance with these rules should not present significant additional barriers to entry for new hedge fund advisers. Indeed some have suggested that our regulatory initiative may “play a positive role of increasing confidence in hedge fund use by further demystifying them.”122"

IV. COST-BENEFIT ANALYSIS
--B. Costs
----2. Cost of establishing a compliance infrastructure

New hedge fund adviser registrants will also face costs to bring their operations into conformity with the Advisers Act and the rules under the Act. In the Proposing Release, we estimated the cost of establishing a compliance infrastructure would primarily consist of establishing procedures and systems that address rules under the Advisers Act such as the books and records rule,325 the custody rule,326 the proxy voting rule,327 the compliance rule,328 and the code of ethics rule.329 While some commenters also focused on these factors,330 others identified additional cost considerations, as we discuss below.

Many unregistered hedge fund advisers have already built sound compliance infrastructures because their business compels it. These firms already have procedures designed to keep good records of all transactions, to keep their clients’ assets safe, to provide fair and full disclosure of conflicts of interest, and to prevent their supervised persons from breaching fiduciary duties.331 In the Proposing Release, we estimated these advisory firms should face little cost to modify their current compliance practices to comply with the Advisers Act rules. Comments from registered hedge fund advisers agreed.332 For other hedge fund advisers that have not yet established sound compliance programs, however, the costs will be higher.

In the Proposing Release, we estimated the cost for hedge fund advisers to establish the required compliance infrastructure will be, on average, $20,000 in professional fees and $25,000 in internal costs including staff time.333 These estimates were prepared in consultation with private attorneys who, as part of their practice, counsel hedge fund advisers establishing their registrations with the SEC. The estimates are averages, premised on the understanding that the costs will likely be less for new registrants that have already established sound compliance practices and more for new registrants that do not yet have good compliance procedures. Several law firms and attorneys representing hedge fund advisers challenged these estimates as being too low, but these firms did not provide any estimates of their own.334 The ICAA, based on the experience of its adviser members generally, commented that the costs of a compliance infrastructure are considerable, but that they are justified, especially considering the relative risks of hedge fund activities as compared to many other investment advisory activities.

Several hedge fund advisers estimated the costs to be in the range of $300,000, but most or all of the cost was attributable to compensation costs for hiring a dedicated chief compliance officer (CCO).335 Our compliance rule does not require firms to hire a new individual to serve as a full-time CCO, and the question of whether an advisory firm can look to existing staff to fulfill the CCO requirement internally is firm-specific. Firms may consider factors such as the size of the firm, the complexity of its compliance environment, and the qualifications of current staff.

While we recognize some hedge fund advisers will need to designate someone to serve as CCO on a full-time basis, we expect these will be larger firms – those with many employees and a sizeable amount of investor assets under management. Because there is no currently-available comprehensive database of hedge fund advisers, we cannot determine the number of these larger hedge fund firms in operation, but our staff estimates it is relatively few. Staff estimates approximately half of these hedge fund advisers are already registered with us, and have already designated a CCO. While the remaining, unregistered, larger hedge fund advisers may not have designated a CCO as such, many of these firms likely already have personnel who perform similar functions to a CCO, in order to address the firm’s liability exposure and protect its reputation.

In smaller hedge fund advisers, the designated CCO will likely also fill another function in the firm, and perform additional duties alongside compliance matters. Firms designating a CCO from existing staff may experience costs to the extent the individual is taking on additional compliance responsibilities or giving up other non-compliance responsibilities. These costs may include costs of shifting responsibilities among employees, and might in some cases include additional compensation costs. Some of these firms may need to add compliance capacity to their staffs. Costs will vary from firm to firm, depending on the extent to which firm staff is already performing some or all of the requisite compliance functions, the extent to which the CCO’s non-compliance responsibilities need to be lessened to permit allocation of more time to compliance responsibilities, and the value to the firm of the CCO’s non-compliance responsibilities. We do not have access to information that would allow us to determine these costs, and commenters did not provide estimates.

3. Ongoing costs of compliance and examination

Several comments on our Proposing Release identified additional cost considerations related to hedge fund advisers’ ongoing, annual costs of compliance and the costs of undergoing examination by the Commission. There may be a number of unregistered hedge fund firms whose operations are already substantially in compliance with the Advisers Act and that would therefore experience only minimal incremental ongoing costs as a result of registration.336 There are other unregistered hedge fund advisers, however, who will face additional ongoing costs to conduct their operations in compliance with the Advisers Act. These costs may be significant for some hedge fund advisers.

We do not have access to information that would enable us to determine these additional ongoing costs, which are predominantly internal to the firms themselves. Incremental ongoing compliance costs will vary from firm to firm depending on factors such as the complexity of each firm’s activities, the business decisions it makes in structuring its response to its compliance obligations, and the extent to which it is already conducting its operations in compliance with the Advisers Act.337 We received comments from small hedge fund advisers estimating that their annual compliance costs would be approximately $25,000 and could be as high as $50,000.338 These commenters and other small hedge fund advisers expressed concerns that compliance costs would be prohibitive in comparison to their management fee revenues.339 Other small hedge fund advisers commented that their existing staff could not accommodate the compliance responsibilities they would face as a result of registration.340 We also, however, received comments from investment advisory trade associations noting that thousands of small investment advisers currently operate under the same compliance burden.341 We note that more than 2,500 smaller advisory firms are currently registered with us.342 These firms have absorbed these compliance costs, notwithstanding the fact that their revenues are likely to be smaller than those of a typical hedge fund adviser.343

Some commenters asserted that there would be substantial costs associated with hedge fund advisers’ responses to our examinations. One hedge fund adviser reportedly estimated spending 160 hours of internal staff time during an SEC examination.344 We believe this does not reflect the typical experience of our registrants, with the possible exception of the very largest advisers, and few of the firms affected by the new rule are likely to be of this size.345 A law firm commented that two registered hedge fund advisers reportedly spent an estimated $300,000 to $500,000 in out-of-pocket costs preparing for and undergoing SEC examinations.346 We believe this also is not representative of our registrants’ experiences, who do not typically find it necessary to involve private counsel in extensive pre-examination review of their activities and records. Also, we note that one registered hedge fund adviser commented that the firm itself derived benefit from the examination process.347

(c) Improve compliance controls.

Hedge fund investors should benefit from their advisers’ improved compliance controls. Several commenters confirmed this assessment in their comment letters.297 Once registered, hedge fund advisers will be required to have comprehensive compliance procedures and to designate a chief compliance officer.298 Specific procedures governing proxy voting299 and a code of ethics including requirements for personal securities reporting will also be required.300 In addition, the obligation to commit to a program of compliance controls combined with our examinations foster adherence to a culture of compliance by advisers.301 These compliance measures are the first line of defense in protecting investors against an adviser’s misconduct.

BUILDING THE COMPLIANCE FUNCTION: What every registered hedge fund manager needs to know. By our © Hannah Terhune, JD LLM

“Regulation light,” the catch-phrase for Securities and Exchanges Commission (“SEC”) scrutiny of investment advisers, does not mean hedge funds won’t have to do some heavy lifting when it comes to compliance. To the contrary, there is an inverse relationship between effort exerted in building compliant operations and securities law exposure in this arena. This article addresses the cornerstones upon which hedge funds operated by SEC-registered investment advisers must be built to support a compliance program that will withstand scrutiny by the SEC. This article should also be of interest to the diminishing class of investment advisers for whom SEC registration is not required, as many of these principles apply both to SEC-registered and non-SEC-registered investment advisers, have been or will be adopted by state securities regulatory agencies and/or will be taken into consideration by institutional and savvy individual investors when making investment decisions.

Unlike broker-dealers and other financial institutions, there are relatively few specific guidelines and requirements by which hedge fund managers must abide. Most these guidelines and rules (many of which are discussed below) are found in regulations promulgated by the SEC under the Investment Advisers Act of 1940 or state securities laws. Chief among these rules:

• SEC registration where required (most others are subject to registration with one or more states, and SEC-registered advisers generally provide notice filing to states in which they maintain and office and/or more than 5 investors).
• Maintenance of form ADV.
• Limitations on advertisements.
• Use of written solicitation agreements where fees are paid to solicitors.
• Mandatory disclosure of financial and disciplinary information.
• Limitations with respect to agency cross transactions.
• Limitations on maintaining custody of client assets.
• Employ written advisory agreements incorporating termination clauses.
• Adhere to privacy policy notification requirements.
• Registered investment advisers in particular must
• Appoint a chief compliance officer.
• Establish and implement a code of ethics and written compliance procedures, including procedures for consent to principal transactions.
• Adhere to record retention and disaster recovery requirements.

These requirements present traps for the unwary; the compliance must clear these landmines in the course of fulfilling its officer. One of the most important principles guiding investment adviser behavior is disclosure: for the most part hedge funds can establish investment policies, fee policies and entity governance provisions and withdrawal policies as they please provided their practices are adequately disclosed to investors. Therefore, a hedge fund’s rulebook is its private placement or confidential offering memorandum (colloquially known as a “PPM”), and its compliance function must be designed to ensure that fund operations comport to the PPM.

Since the PPM is the principal source of information concerning a hedge fund, and serves as the most important marketing document, the first obligation of the compliance function is to ensure the adequacy of disclosure set forth in the PPM. Additional disclosure is required by SEC regulations to be set forth in a registered investment adviser’s Form ADV, and Part II of Form ADV must be included with the information provided to prospective investors and to all investors at least annually.

The PPM will provide information regarding the background of the investment adviser, particularly with respect to principals, portfolio managers and officers. This information also is required to be set forth in the ADV. Job one of the compliance function is to ensure that the ADV is kept up-to-date. The PPM and/or the ADV also should describe the extent to which the adviser, including principals and all supervised persons, may conduct investment affairs for their own account or the account of persons other than the hedge fund. In this regard SEC regulations require registered investment advisers to adopt a code of ethics requiring the disclosure of securities holdings and transactions of, and limiting the participation in certain private and initial public offerings by, key employees. This information must be collected and reviewed by the adviser’s chief compliance officer. To ensure the adequacy of such reporting, covered employees should be required to direct their financial institutions to send a copy of account statements to the compliance officer. Depending on the nature of the hedge fund’s investments, it may be necessary to bar trading in positions held or contemplated to be acquired by the hedge fund, and for additional securities, in some instances to develop and apply a restricted securities list that can be queried on a “blind” basis, i.e., to ensure maintenance of a “Chinese Wall,” a system by which an employee can query for possible acquisition particular securities without seeing a complete list of prohibited issues. Like all adviser business records, these should be retained on premises for two years and off-premises (or on premises) for an additional three years.

The PPM also sets forth the basis on which fees are charged, typically a management fee determined as a percentage of assets under management (“AUM”) and an incentive or performance fee based upon gains realized on a mark-to-market basis. The compliance officer will want to ensure that AUM and profits are computed properly, so procedures must be established for occasionally testing the accuracy of reporting AUM and profits. Even if the calculation is performed by an outside fund administrator, both bits of such data are the responsibility of the adviser and must be capable of review by the compliance officer, since they most certainly will be checked by the SEC upon inspection.

In addition to fees, the PPM will discuss expenses that will be borne by investors in the fund. The SEC has a couple of bugaboos in this area: “soft dollars” and cost absorption. Soft dollars in effect are credits that execution brokers provide to fund trading operations that can be applied to defray investment advisory costs such as research and systems. A full discussion of items that may permissibly be soft-dollared is beyond the scope of this article, but for these purposes fund managers should keep in mind that this practice must be fully disclosed to investors and the compliance officer must be able from time-to-time to verify that soft dollar policies are followed. Fund managers must be cognizant of the fact that these costs to the broker have an impact on execution and/or pricing, and it is customary for a compliance manual or code of ethics to limit the extent to which brokers lavishly entertain traders in order to capture execution business.

Cost absorption often places fund managers in a “damned if you do, damned if you don’t” position. If the operating costs properly borne by the fund are defrayed by the adviser/manager, the SEC may challenge cost practices as burnishing investment results. On the other hand, if costs inappropriately are shifted to the funds, the SEC may take the position that the adviser/manager is sopping the fund with hidden costs. The best practice in this regard is to carefully and fully itemize in the PPM the costs that the fund will bear, and the costs that will be borne by the adviser/manager. Thought should be given to identifying which entity will be responsible for such items as fund administration, brokerage commissions, research, printing, hardware and software, telecommunication, rent, mailing, legal, audit, tax and accounting fees, organizational costs and overhead. The compliance officer should work with the controller to have in place a system for verifying that policies in this regard have been followed.

The PPM also specifies the manner in which investors can make and redeem investments. Even if fund registrar and transfer agency functions are out-sourced to an administrator, the compliance officer will need to be able to verify that communications are dealt with on a timely basis. Problems often arise with mid-period (i.e., mid-month or mid-quarter) admissions or redemptions. If the administrator cannot accommodate account posting on an interim basis, investor contributions and redemptions need to be limited to the beginning and end of each month, and some provision should be made for giving proper credit to investor accounts for funds sitting idly in accounts awaiting investment.

The PPM describes a fund’s investment objectives, the strategies used to accomplish these objectives, and the policies which constrain the use of these strategies. These should all be set forth in the adviser’s compliance manual, and must be subject to verification by the compliance officer. The SEC will review the investment process, so establishing trading procedures and maintaining records that demonstrate adherence to these practices is an important part of the compliance officer’s job. Advisers should bear in mind that the SEC will review transactions for compliance with such procedures, so the compliance manual needs to be carefully tailored to adviser’s actual operations. This generally makes off-the-shelf compliance manuals a chancy proposition.

SEC regulations impose on advisers an obligation to establish and maintain disaster recovery systems. For business reasons as well, the adviser should be able to move its staff to an alternate site without a break in continuity of operations in the event of a calamity, with records fully preserved. The compliance officer should work with the information technology service provider to ensure back-up copies of important data can be accessed in such events. If an administrator is employed, the compliance officer should ensure that its back-up data systems also are up to this task.

Marketing efforts round out the adviser’s activities and tie together all of the functions set forth above. The compliance officer needs to be involved with signing off on all marketing material to ensure its accuracy. Attractive but inaccurate information is not “lipstick on the pig,” it’s a bulls-eye for the SEC inspection staff. Moreover, the compliance officer should work closely with marketing to ensure that marketing activities do not give rise to a public offering or entail providing information on a preferential basis to only some investors. A compliance officer also may be involved with reviewing the manner in which marketers are compensated, to ensure that broker-dealer licensing is not required. Also, a compliance officer should be involved with third-party marketers so that their practices are consistent with the securities laws to which the adviser is subject, including the requirement that solicitation agreements are in writing.

Marketing materials highlight risk management systems and performance data. Risk management systems generally are reflected in the compliance manual, a system that gets audited by the CCO. The CCO also needs to ensure the process for collecting and reporting performance data remains accurate and in compliance with securities laws, including the need to report data on a “net of fees” basis (although in certain instances information also may be provided on a “gross of fees” basis. Moreover, in some instances the CCO will need to make a determination as to whether prospective investors should be provided performance information about funds managed by the investment adviser other than the one presently marketed to such investor, to ensure the investor is aware of all material information. If an investment adviser runs several funds and provides information about only those with relatively strong performance results, the adviser could be viewed as “cherry-picking” the information provided to prospective investors and thus potentially deceiving them. Note, however, an investment adviser that also is a member of the National Association of Securities Dealers, perhaps because it has created a significant marketing staff that is compensated on a commission basis, will face some restrictions on the use of related fund performance data (the NASD generally doesn’t allow related entity performance data to be provided by its members, even though the SEC takes a different view). Under an exception established by the SEC, for funds that are marketed to institutional investors, at a minimum, this issue might be addressed by incorporating related performance data in the PPM.

Successful marketing efforts beget capital from investors. Ultimately the investment adviser serves as a fiduciary of the investor, but first the adviser must get to know its customer. Here the compliance officer’s charge is to implement a program that addresses the investment adviser’s anti-money laundering (“AML”) law responsibilities. Typically, the requisite information is collected when the prospective investor fills out the subscription documents, which are checked over by the compliance officer or by the transfer agent with compliance officer oversight (due diligence of a transfer agent is needed), and stored in hard and archived digitized copy. But few is the fund that doesn’t have a handful of oddball investor entities, involving trusts or foreign organizations requiring special due diligence. A fund is well-advised to explain its AML practices, policies and procedures in its PPM to avoid surprise. Even with such forewarning, diplomacy may become a requisite quality of the chief compliance officer if proposals that would require hedge funds to file suspicious activity reports in certain instances are adopted. AML compliance means that the investment adviser must know the identity of the investor and confirm that the investor is making the investment on its own behalf and not on behalf of someone else (or, if others, the identity of such others must be known).

Once investors are “in the door,” the role of the chief compliance officer shifts from gatekeeper to watchdog. The compliance function must keep an eye on communications with investors, which requires establishing a system to monitor correspondence (including emails), and must ensure that sensitive investor information is kept private, held in conformity with the adviser’s privacy policy and make sure that investors are made aware of such privacy policy. Investment advisers are required at inception of an advisory relationship and annually thereafter, to specify the kinds of nonpublic personal information that are collected about them and the manner in which such information may be disclosed. Certain “opt out” notices also must be provided. Notification also should provide information about policies and practices concerning how information will be protected and secured.

Monitoring email carries with it the responsibility of letting employees and investors know that email will be monitored and archived, and ensuring the integrity of the archival system. It should be noted that the use of email in communication with investors carries with it special needs. As with most matters pertaining to advisers, these are addressed through disclosure. First, an adviser should not use email to send confidential information to investors without their prior, informed consent, copies of which should be maintained for later inspection for the period of the investor’s investment plus five years. Informed consent would include a disclosure that emails by nature are not confidential, which is one reason that an increasing number of investment advisers are establishing password-protected websites on which investors can view account information, and sending such investors monthly links to the website rather than emailing monthly account balances. Second, an investment adviser needs to bear in mind that any information sent to clients via email may readily be distributed by such person to others. Lack of diligence with respect to restricting distribution of marketing-type materials brings the exposure of falling outside the private offering exemption afforded by Regulation D of the Securities Act of 1933. Finally, a compliance officer should ensure that employee training programs are in place to ensure that employees are sensitive to the exposures created by representations or factual statements made via email. Judgment may be hard to teach, but awareness is easy to build.

Many smaller advisers consider out-sourcing the compliance function, or ceding these responsibilities to existing team members. The SEC presently does permit advisers to out-source compliance functions, but such an arrangement will work only if the provider is fully-versed in the workings of the adviser and the fund. As noted above, the SEC views as problematic, but permits, appointment of a fund’s general counsel to the chief compliance officer slot. The SEC recognizes that general counsel’s obligations of confidentiality and duties of loyalty and zealous representation may conflict with a compliance officer’s responsibilities to the SEC.

The compliance function doesn’t exist in a vacuum. Employees must be trained not only on the systems and procedures involved, but also sensitized to the securities law issues that may arise and provided guidance on how to deal with them. They must also be provided advance notice of the likely consequences of deviating from established guidelines. Moreover, when violations do occur, and reports are made to management, management must be prepared to work with the compliance officer, first to fix the problem, if necessary to discipline the employee or employees involved, then take steps to make sure that the same or similar problems won’t arise in the future and, importantly, to train employees on changes that are needed. Besides training employees on compliance matters, the CCO’s role includes helping to instill a “spirit of compliance,” in essence an ongoing recognition of the fiduciary capacity in which the advisor manages client funds.

Because the obligations of the chief compliance officer include ensuring adherence to record retention as required by Investment Adviser Act regulations, he or she will have to work closely with many other members of an investment advisory team. This includes, for example, the chief financial officer, controller and/or other treasury staff, since journals, ledgers and documents generating entries thereon must be retained. Same, too, for checkbooks, bank statements, cancelled checks, trial balances, financial statements and working papers. The CCO similarly will work with the marketing and investor relations staff to ensure retention of notices, circulars, advertisements, investment letters, bulletins and other communications if distributed to ten or more people. And the CCO will need to work with portfolio managers and traders, to ensure retention of records concerning investment decisions (including reasons for same).

Not all of the record retention rules are purely intuitive. A common practice for businesses is to permit their counsel to hold and maintain organization articles, minute books and the like. However, Investment Adviser Act regulations require these items to be maintained at the adviser’s principal office. Note that special rules apply to foreign investment advisers, particularly with respect to record retention requirements.

The CCO “keeps the faith” of compliance, at the end of the day, by monitoring and at least annually testing compliance with the rules and procedures set forth in the investment adviser’s compliance manual. All of the functions specified above should be set forth in the compliance manual, and employees should be educated as to its edicts.

The CCO also maintains the investment adviser’s ADV. The basic form is maintained only through the IARD online reporting system, which can be readily searched by prospective investors and can be used to provide state so-called “notice filings,” i.e., notices provided to states that an investment adviser is registered with the SEC and provides investment advisory services within such state (generally because it has an office in that state or has more than a preset number of client from such state (generally, five or more).