SEC Rings in the New Year with a Bang for Liquid Alternative Funds

The SEC is currently investigating so called "liquid alt" funds ("Liquid Alts"), demanding documents and information from registrants by December 29, 2015. Liquid Alts are registered investment companies that, according to the SEC, may not be as liquid as their name implies. The SEC is concerned that Liquid Alts may not be adhering to the liquidity requirements under the Investment Company Act of 1940, as amended. In September of 2015, the SEC's Division of Economic and Risk Analysis issued a white paper entitled "Liquidity and Flows of U.S. Mutual Funds". In the white paper, the SEC stated that Liquid Alts are growing faster than any other category of mutual fund.[1] The SEC also noted that Liquid Alts use investment strategies typically associated with hedge funds and other private funds (e.g., long/short, distressed debt, special situations).

Moreover, the SEC's Office of Compliance Inspections and Examinations issued its Priorities List for 2015 on January 13, 2015 (the "OCIE List"), which included references to Liquid Alts, as a regulatory priority. The OCIE List stated that the SEC will continue to assess Liquid Alts "with a particular focus on: (i) leverage, liquidity, and valuation policies and practices; (ii) factors relevant to the adequacy of the funds' internal controls, including staffing, funding, and empowerment of boards, compliance personnel, and back-offices; and (iii) the manner in which such funds are marketed to investors."

In summary, if the SEC's concerns are justified, millions of retail investors could be exposed to "gating", which is typically applicable to private funds and sophisticated investors who generally appreciate the risk that their money may be subject to significant redemption restrictions. The typical retail investor in a registered fund expects that his or her money is freely available on a daily basis, which may not turn out to be the case for investors in so-called "liquid" alternative funds.

If you have questions about this Alert, please contact Daniel G. Viola at 212.573.8038 or dviola@sglawyers.com. ---- [1] See https://www.sec.gov/dera/staff-papers/white-papers/liquidity-white-paper-09-2015.pdf

Cheryl Spratt