NEW YORK (HedgeWorld.com)–Now that registration with the Securities and Exchange Commission is the law of the land, it’s time for hedge funds to grin and comply with it.

But first they have to figure just what the SEC means by “comply.” Divining the commission’s intent was the goal of a seminar held Wednesday in New York by the Managed Funds Association. Panelists and audience members at the gathering talked through the specifics of registration, the practicalities of compliance policies and what hedge funds might expect from SEC examiners as they implement the new regulatory framework. One dramatic exchange arose over what has been seen as a murky aspect of the new rule: proxy policies.

Concern about the supposed youth and inexperience of examiners became a motif through the day’s four panel discussions. It was the third panel, on “compliance policies and sound practices,” that saw the most vigorous panel/audience interaction of the day.

Panelist Kenneth Raisler, a partner in the New York law firm Sullivan & Cromwell, said that the SEC discourages off-the-shelf solutions. One can’t simply run off copies of some preexisting “compliance policies” booklet and stick one’s own name on it, he noted. Michael Neus, chief operating officer at RHG Capital LP, went further. In formulating a compliance policy, he said, an adviser is “telling the SEC ‘this is the blueprint, try to catch me on these standards.’”

This led another panelist, Joel Press, senior partner, global hedge fund practice at Ernst & Young, to give the discussion a different twist. He said that examiners, who don’t know much about the industry yet but can read, will likely ask not just about what is in a firm’s compliance policy, but what it left out. Mr. Press raised the issue of proxy voting by funds with corporate equity in their portfolios, and whether a policy on proxy voting now has to be committed to writing. Will examiners find silence on this point suspicious?

Mr. Neus broke in at this point and suggested that funds could say that they’ve outsourced their proxy voting decisions to Institutional Shareholder Services, Inc., Menlo Park, Calif., which offers proxy analysis and research and which provides objective proxy vote recommendations.

At this point a woman in the audience who identified herself as a manager of a quant fund interjected, “our policy is that it makes no sense for us to vote in proxy contests, so we don’t do so.” This stoked additional views from the panelists on whether the SEC, given the new rule and the mechanisms it’s establishing, is likely to regard that statement as a sufficient policy on proxy fights. The seminar’s keynote speaker, Paul Roye, director of the SEC’s Division of Investment Management, had left by this time, and Mr. Raisler drew some laughter by saying, “Paul is theoretically still here and his failure to object to that policy means that it’s fine.”

Mr. Press said, “I hope everybody here from the press writes that down.”

The seminar began with a few words of welcome from MFA President John G. Gaine. There was little indication of continued opposition to mandatory registration–the general perspective of industry participants on the various panels was that the rule is here to stay and the sensible thing to do is to adapt to it. The one brief reference to current litigation seeking a judicial nullification of the rule was rather disparaging.

Why Nobody Volunteers to be CCO

In his introductory remarks, Mr. Gaine spoke of his long friendship with Mr. Roye. “There’s no better person to have on the other side.”

Mr. Roye, for his part, stressed the flexibility the rule leaves to advisers in all issues of implementation. He also said regulators still have some work to do at reducing overlap of SEC and Commodity Futures Trading Commission registration systems. He reminded the hedge fund advisers present that the Investment Advisers Act provides an exemption from registration for commodity trading advisers whose business “does not consist primarily of acting as an investment adviser.” He added, “one of the things that we want to talk to the CFTC about is whether each of us needs to write a rule defining what ‘primarily’ means.”

The first panel, “a walk through the rule itself,” consisted entirely of a talk by Paul Roth, one of the founders of law firm Schulte Roth & Zabel, LLP, New York. He gave special attention to the two-year lock-up rule as the basis by which regulation distinguishes between hedge funds and private equity funds. He described the “basic thesis” behind that act of definition: that in private equity “you don’t have the right to redeem … it’s essentially out of your control when you get a liquidation.” Pressed by a member of the audience for a specific comment on “why two years?” Mr. Roth suggested that anti-money laundering regulations had already used a two-year lock-up as a demarcation point. (A terrorist, wanting to store money for use in some murderous activity, presumably wouldn’t lock it away for such a period, he said.) This aspect wasn’t especially relevant to the registration requirement but it did help make the two-year rule a familiar bright line, so it was transplanted into this context, he hypothesized.

The second panel, “preparing for the registration process,” led by another lawyer, Robert Van Grover, a partner at Seward & Kissel, LLP, New York, discussed how to complete the amended Form ADV and how to select a chief compliance officer.

“Selection of a CCO is a difficult decision,” Mr. Van Grover said. “You usually do ask for volunteers–’who wants to step forward?’–and you don’t get too many.” This panel also saw some disparagement of the qualifications of the SEC’s examiners. Terrance J. O’Malley, a partner at Schulte Roth & Zabel, said that an examiner would be a 24-year-old who “six months before was a college student hanging out at the off-campus bar.” Somebody suggested that a fund might hire his favorite bartender as a CCO.

Later, the third panel discussed the issue of valuation, again looking for how it might be seen through the eyes of examiners. “The problem,” Mr. Press said, “is that no one knows what valuation means anymore. Your accountants don’t know.” In this context, he critiqued recent decisions by the Financial Accounting Standards Board, Norwalk, Conn.

Such observations helped prepare the ground for the final panel on the SEC examination process. This panel presented a slide show, which allowed them to put on the wall in outsized letters the words of Lori Richards, director of the SEC’s Office of Compliance, Inspections and Examinations:

“If we find … compliance programs that are ill-suited to the firm’s business and ineffective, our examiners will assume that compliance is not well respected by these firms, determine that these firms are at high risk of violations, and will likely conduct a top-to-bottom, in-depth review of the firm’s entire operations.”

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.