During the summer, the SEC launched its previously announced sweep examination focused on so-called “alternative mutual funds” that employ hedge-fund-like strategies, including funds that invest in non-traditional asset classes (such as currencies), employ non-traditional investment strategies (such as long/short equity positions), or invest in illiquid assets (such as private debt).
The SEC appears to be using these sweep exams to gather a variety of information about alternative mutual funds, including information about board oversight of these funds, their use of derivatives and leverage, and their risk management and compliance testing policies and practices. Specifically, “sweep letters” from the SEC have requested information from these funds’ investment advisers such as the following:
- A description of the additional or heightened risks relating to alternative investments and the controls in place to mitigate these risks;
- Internal reports on portfolio holdings’ liquidity, including assessments of the adviser, and details of access to lending facilities in the event of unexpected redemptions;
- Valuation and risk management policies, documentation of forensic testing used to determine the appropriateness of prior valuations and pricing service valuations overridden by the adviser, sub-adviser(s) or the board;
- Results of stress tests and scenario analyses on the funds; and
- The funds’ use of derivatives and leverage, such as internal reports on borrowing and leverage exposure for different categories of instruments by fund, an asset segregation report that demonstrates compliance with Section 18 of the 1940 Act, and a description of any limits on the amount of economic leverage to which alternative mutual funds may be exposed.