Transcript ICI Legal Forum: May 1, 2013 - Cipperman Compliance Services
Regulatory & Enforcement Update ICI General Membership Meeting
May 1, 2013
Recent Activity
• SEC Enforcement focus on compliance programs • Mutual fund directors’ liability • Expensive disclosure cases • CPO/CTA registration and compliance • Misleading marketing (not just performance) • Focus on Private Equity • FINRA active 2
Compliance: SEC Positions
• Record number of enforcement actions; focus on compliance programs • di Florio tells firms to strengthen conflicts of interest practices: sales practices, outside business activities, wrap programs, side-by-side management, affiliations, valuation practices • Aguilar: protect investors • Walter: problems with small firms • IM Division focusing on “strategically important advisors” 3
Compliance Programs
• • • • Firm must hire outside provider to fix compliance program (
In re IMC Asset Management
) – Not just testing – 2 incumbent employees with little compliance experience – WSPs rather than compliance manual – No evidence of compliance reviews conducted – No underlying violation BD WSPs ≠ RIA compliance manual (
In re Evens Barthelemy
) P/P should have required 2 signatures to move client funds (
SEC v. Resources Planning Group
) Failure to verify pitchbook valuations (
In re Oppenheimer Asset Management
) 4
Compliance Rules • Reg S-ID: Identity Theft Red Flags Rule
– Transaction accounts – Board approval
• Custody rule violations in 1/3 of exams • Regulation SCI (IT)
5
Compliance and Operations
• • • Trading through affiliated BD (
In re Tilden Loucks & Woodnorth
) – Conflict disclosed – Higher commission rates – Principals benefitted Failure to disclose deteriorating financial condition (
SEC v. Aletheia Research
) – Item 18 of Form ADV – Factors: significant litigation, creditor liens, a rapid decline in AUM, negative shareholder equity, and/or material operating losses MBS trader lied about mark-ups and counterparties (
SEC v. Litvak
) – TARP funds involved – Criminal prosecution 6
Mutual Funds: Directors
• SEC sues independent directors for failing to oversee fair valuation (
In re Alderman et. al.
) • Scrutiny of sub-adviser fees (
Kasilag v. Hartford
) – Split of fees between adviser and sub-advisers – Comparable funds (Vanguard comparison) • Federal court says that directors not independent (
PRSSA Welfare Plan v. UBS
) – Fund sponsor so pervasive in local market – Placement agent in past deal – Puerto Rico exempt from ICA • Fund sponsor suing directors in class action (
Third Avenue v. Reserve
) 7
Mutual Funds
• SEC must file enforcement actions within 5 years of conduct, not discovery (
Gabelli v. SEC
) • Filing of social media content – Fund performance – Investment merits • Derivatives: Hedging vs. speculation – Notional amount > value of underlying securities (
In re Top Fund Management
) 8
Disclosure
• Failure to disclose impact of derivatives strategy (
In re Claymore Advisors
) – Trying to juice returns with put options and short variance swaps rather than covered calls – $45 Million in fines, etc.
• Prospectus did not adequately describe minimum benefit feature (
In re Mass Mutual Life
) – $1.625 MM fine – Section 34(b) of Investment Company Act 9
CFTC and NFA
• Court upholds CPO registration for registered funds (
ICI v. CFTC
) – Deference to administrative agencies – Considered costs/benefits: protection of markets/public; market efficiency, competitiveness and financial integrity; price discovery; risk management; and the public interest • Fund managers must ensure sub-advisers are properly registered – FCMs also have obligation 10
Marketing
• May use social media to disseminate information (Netflix) • Compensating unregistered solicitors (
In re Ranieri Partners
) • Using software to pass off hypothetical backtested performance (
In re New England Investment and Retirement Group
) • Misleading website claims (
B&T Securities
) • Inflating AUM (
In re Tandon
) • Misleading about co-investing (
In re Aladdin Capital
) • Misleading GIPS performance claims (
In re ZPR Investment Management
) 11
Private Funds
• SEC launches Private Equity Initiative: identify higher risk firms – Karpati: more enforcement cases against private equity firms • Valuation – FAS 157 (
In re KCAP Financial
) – Audit firm liability (
In re Aesoph and Bennett
) • Cross-trading between funds (
SEC v. Commonwealth Advisors
) • Preferential redemption rights to large investor (
SEC v. New Stream Capital
) • SEC regulating pre-Dodd Frank conduct (
In re Lawton
) • Portfolio companies controlled by affiliated fund • Form PF (21 pages of FAQs) • BD registration for salespeople 12
FINRA
• Focusing on high-yield products: BDCs, CMBS, high yield debt, structured products, exchange-traded funds and notes, closed-end funds, and variable annuities • Will take adviser arbitrations • Rule 8210 gives FINRA broad authority to obtain documents – Outside business activities – Possession, custody, or control – Includes info about unregulated third parties (
In re Goldstein
) 13
Lessons
• Get a professional compliance program • Re-examine independent directors • Refresh disclosure documents • Review marketing materials like a regulator • Implement CPO/CTA compliance • Prepare for private equity exams/enforcement • Don’t forget FINRA (and states) 14
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