Inspecting A Hedge Fund 2010 NASAA IA Training

Preparing for the Inspection  Getting over your fears  Treat as any other advisor  Preparation  Obtain as much information as possible prior to the Inspection  Review Form ADV Part I and Part II prior to the inspection  Perform an internet and CRD search for firm and employees

Preparing for Inspection  Review and understand the NASAA Hedge Fund instructions. ( See Exhibit A)  Write down as many questions as possible prior to the inspection. ( See Exhibit B & C)  Discuss any issues or concerns with your manager prior to the inspection.

Preparing for Inspection  Obtain and review a copy of Reg D filing  Review pre-exam requirements

Conducting Examination 1. Advisor Interview process 2. Hedge Fund interview questions 3. Discuss in great detail if the advisor is conducting any other business. 4. Ask for a break down by types of business. 5. Before or after the interview ask for a tour of the office. The purpose is to try and obtain a greater understanding of the business of the advisor.

Conducting Examination 6. You should have prepared a list of things to obtain and to request prior to the inspection. (See Exhibit D) 7. Determine if there are additional things that should be requested based upon your interview. 8. Organize and determine who is going to be responsible for meeting with different staff members or if you are going to meet as a group.

Obtaining Books and Records Reviewing and obtaining books and records: Determine what books and records are required to be maintained and what you want to obtain based upon your rules and regulations. Private Placement Memorandum ( See Exhibit E ) Subscription Agreement (See Exhibit F) Limited Partnership Agreement (See Exhibit G)

Obtaining Books and Records Investor Questionnaires (May be a part of the Limited Partnership Agreement) Obtain a copy of the firm’s most current ADV I and ADV II (Compare to what is on file with your agency) List of registered personnel including job responsibilities List of unregistered personnel including job responsibilities and or titles. List of terminated personnel within a certain period of time (i.e. last 12 months) Client Correspondence and/or communications

Obtaining Books and Records Client Complaints Obtain Financial records (i.e. balance sheets, profit and loss statements) Any audited financials (Determine if audited financials of the Hedge Fund are required by the Private Placement Memorandum) Written Supervisory Procedures Advertisements and Sales Literature Determine custodian and/or clearing firm Obtain trade tickets and or order memoranda Determine how fees are charged and obtain supporting documentation

Obtaining Books and Records Obtain copies of brokerage statements for period being inspected. Obtain copies of bank statements for period being inspected. (Important to try and obtain copies of cancelled checks and wire information during the inspection). Remember many of the required books and records are now maintained in an electronic format. (Determine your ability to obtain information and secure information in this format).

Obtaining Books and Records Obtain client information. This would be advisory contracts, investor questionnaires, side letters, customer complaints, trust agreements, new account forms ( All written agreements) Obtain a copy of advisory representatives’ and officers’ personal securities transactions. Obtain copies of internal correspondence (Be prepared, if the Compliance Officer is an attorney they may want to declare privilege). They may be unable to claim privilege. Check with your counsel.

Obtaining Books and Records Obtain documentation supporting the distribution of privacy policies and the offering of the disclosure statement. Determine if advisors have outside solicitor arrangements. (Obtain copies of solicitor agreements, contracts and all documentation supporting solicitor and advisors obligations)

Obtaining Books and Records Obtain documentation about performance of the fund. The advisor is required to maintain all books and records to support performance numbers. (We will discuss later) Obtain documentation on performance numbers that was distributed to the Limited Partners about the fund and its performance and fees.

Trade Tickets Review Trade tickets or order memoranda to get an understanding of trading strategy. Don’t get hung up on the sophistication of the strategy. Remember at the end of the day 1+1 must = 2

Follow the money Review process for charging fees Does advisor charge fees directly? Are fees charged by the custodian? Who is responsible for calculating fees. Determine if they have third party administrator calculating fees. (Advisor is ultimately responsible for fee calculation) How does advisor return money to clients? Talk to operations or administrative staff.

Reviewing the Private Placement Memorandum How critical is the private placement memorandum? What should you look for? What do you do with the information you find?

Reviewing the Limited Partnership Agreement Looking through the Hedge Fund Reviewing the Investor Questionnaire Are the investors: Retail Investors, Accredited Investors or Qualified Investors What are you trying to discover about the investors in the fund and why?

Calculating Performance What is the modified dietz? What if the advisor disagrees with my calculation? Who is responsible for proving the numbers? What type of documentation should the advisor maintain?

Calculating Performance Important to calculate performance at the Advisors office. Resolving any conflict Looking for disclosures