As we have previously reported, the SEC is increasingly scrutinizing hedge funds and other private funds and has suggested that it will pursue enforcement actions against advisers to such funds as appropriate. The SEC’s increased scrutiny flows in large part from Dodd-Frank’s elimination of the private adviser exemption, which has meant that most investment advisers to hedge funds have had to register with the SEC for the first time. Indeed, as noted in our prior post, some 1,500 previously unregistered fund advisers have registered since this provision of Dodd-Frank became effective. These newly registered advisers now find themselves subject to disclosure obligations and compliance examinations. As Chair White indicated in a speech to the Managed Funds Association last October, the SEC will be examining newly registered advisers and will pursue enforcement actions where it believes it has discovered fraud.

The SEC’s focus on hedge funds shows no signs of slowing. As reported just this week in Reuters and Law360, the SEC has now created a new private fund unit within the Office of Compliance Inspections and Examinations (OCIE) that will focus on hedge funds and private equity funds. According to those sources, the new unit will be run by former industry participants, thus demonstrating the SEC’s commitment to hiring industry insiders to use their expertise to help the Commission better regulate alternative funds. As Bruce Karpati, the former chief of the Asset Management Unit, explained in a speech back in 2012, former industry participants “know where the bodies are buried — and understand how they got there.”

Further, the reporting indicates that this unit will pay particular attention to issues such as asset valuation, fee disclosures and communications with investors. This focus is consistent with what the SEC has been stating for months. As we noted previously, Chair White advised in her October 2013 speech that in examining fund advisers, the SEC’s examination staff would focus on (1) marketing, (2) portfolio management, (3) conflicts of interest, (4) safety of client assets and (5) valuation. OCIE confirmed these same “five key focus areas of examinations” via the National Examination Program’s Examination Priorities for 2014. The Examination Priorities also reiterate the staff’s commitment to the SEC’s initiative to promptly conduct “presence exams” of a significant percentage of fund advisers who registered for the first time after Dodd-Frank.

In creating a new private fund unit within OCIE, the SEC is homing further in on the hedge fund industry. And while it’s fair to say that the Commission is trying to be transparent with newly registered fund advisers regarding the issues it is most concerned about, it’s also a fair bet that this increased scrutiny will lead to increased enforcement actions against hedge funds and private equity funds. Thus, as we’ve cautioned before, it is critical that fund advisers understand and take appropriate steps to comply with their newfound regulatory obligations. For most advisers, the question is not if the SEC will examine them, but when. The creation of a new unit focused on private funds and the continuation of the presence exams initiative suggest the answer is “soon.”