Our Take Live: June 19, 2012 - Cipperman Compliance Services

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Transcript Our Take Live: June 19, 2012 - Cipperman Compliance Services

Regulatory & Enforcement
Update 2012
“Our Take” LIVE
June 19, 2012
Regulatory Focus
New regulations, more registrants
Less focus on registered funds
Hedge and Private Equity funds
Enforcement of compliance programs
Operational breakdowns
Federal court hostility toward regulators and private plaintiffs
States exerting regulatory authority
Surveillance of marketing and advertising
FINRA regulating distribution
Third party liability
New Regulations
New Regulation: CPOs
• CFTC registration for fund managers
• Limited exemption
– Bona fide hedging
– Margin/premium < 5% or notional value < 100%
– Investing in stock index futures not exempt
– Not marketed as vehicle for trading futures
• ICI and Chamber Sue to Stop Rules
– Cost/benefit analysis
– Mutual funds already highly regulated
New Regulation:
Swaps & ABS
• Swaps
– SEC regulates securities-based swaps
– CFTC regulates other swaps
– “Insurance” defined narrowly
• CFTC adopts anti-fraud rule for swaps and
commodities (like 10b-5)
• SEC proposal questions 1940 Act exemption for MBS
• More ABS filings and disclosure
New Regulation:
Performance Fees & Large Traders
• Increased thresholds for charging performance fees
– Net worth: $1.5 → $2 Million
• Excludes personal residence
– Assets with manager: $750,000 → $1.5 Million
– Effect on private funds
• Large trader filing/reporting (Rule 13h-1; Form 13H)
– 2 Million shares or $20 Million in a day or 20/$200
Million in a month
– Burden on BDs to monitor
New Regulation: More RIAs
• Managers of private funds with > $150 AUM must register
– 1400 newly registered private fund advisers (4000 total)
– Approx. 1/3 of all advisers manage a private fund
• Limited single family office exception
– Service only family members
– 10 generations of lineal descendants
• Non-US advisers must register
– < 15 U.S. clients & $25 Million AUM
– Total private fund assets less than $150 Million
• May have to file as “exempt reporting adviser”
New Regulation:
Transition and Disclosure
• Advisers with less than $100 Million must
transition to states
– NASAA announced coordinated review
• SEC will cancel registration for insufficient
assets (In re Gravity Partners)
• New ADV Part 2
– Material risks for private funds
– Material financial conditions
– Publicly available
New Regulation:
Who Regulates RIAs?
• SEC Study on adviser exams
– Insufficient resources
– Self-funding, SRO, FINRA
• Bachus/McCarthy bill for Adviser SRO
• FINRA wants an adviser SRO operated by FINRA
• GAO: SEC must enhance FINRA oversight
• Fiduciary standard for BDs
– Ketchum: put client’s interests first
New Regulation:
• Whistleblower program launched
– Bounty of 10%-30% of awards
– Bypass internal reporting
• Sullivan v. Harnisch (NYS): Compliance officer can’t
sue for wrongful termination
– Personal trading violations
– Never claimed to be whistleblower
– Equity owner in firm
• Fund service providers’ employees do not get SOX
whistleblower protections (Lawson and Zang v. FMR)
Registered Funds
• Fund Adviser pays over $3.3 Million for failing to
oversee sub-adviser (In re Morgan Stanley)
• ICI/IDC: risk management and compliance
• Derivatives (See In re Oppenheimerfunds)
• Money market fund regulation
• SEC proposes red flags rule (identity theft)
• CPO registration
• Eighth Circuit Supports Jones (Gallus v. Ameriprise)
• Global/Intl fund must invest 40% in 3 countries
• SEC Chief Accountant: more AC oversight of auditors
Hedge and Private Equity Funds
Hedge and Private Equity:
Registration and Disclosure
• Registration of Hedge and Private Equity Managers
– More than $150 Million AUM
– Limited venture capital exemption
– Extensive ADV disclosure
• Reliance on single registration for affiliates
• Form PF
– File detailed info about funds managed
– More info for hedge > $1.5 Billion and PE > $2 Billion
– Quarterly filings if AUM > $5 Billion
– SEC says it may use data in enforcement actions
• SEC seeking to fill 102 new positions focused on hedge and PE
Hedge and Private Equity:
OCIE Lists PE Issues
• Fund-raising: placement fees, side letters,
performance claims, overstating fund size
• Investment: allocations, insider trading, transaction
• Management: valuation, highlighting specific
investments, fees
• Conflicts of interest: allocations, portfolio compliance,
performance/advertising, custody
• Norm Champ announces sweep of new private fund
Hedge and Private Equity:
• PE insider trading
– Using info ahead of fund (SEC v. Duffel)
• Allocating investment opportunities (In re
– Personal interest in other fund
• Exemptive relief application to allow coinvestments for BDC and other funds
Hedge and Private Equity:
Hedge Funds
• Side-by-side management (In re Martin
Currie): Registered fund buys securities to
bail out hedge fund
• Marking the close (SEC v. RKC Capital
• Use of expert network firms
• Side pockets (SEC v. Baystar)
• Fabricating audit(or) (SEC v. Murray)
• Removes ban on general solicitation for
private funds
• 3(c)(7) funds can have 2000 investors
• Should private funds register under
Investment Company Act?
• Boon for fund-of-funds
• Awaiting SEC rules
Compliance and Operations
Compliance Programs:
Enforcement Lessons
• Actions against firms for weak compliance programs (In re Asset
Advisors et. al.; In re Wunderlich; In re JSK Associates; In re
Alpine Woods)
• Template or incomplete compliance manuals (BD WSPs)
• Inadequate testing and annual reviews
• No training
• Inexperienced or absent CCO
• No implementing procedures
• Failure to properly resource
• Ignoring Code of Ethics
Compliance Programs:
SEC Focus
• CCO charged with primary liability
– Failure to supervise (In re Manual Lopez-Tarre)
– Failure to file SARs (In re Pagliarini)
• Compliance failures leading to underlying violations
– Misleading statements about principals investing in funds (In
re Quantek)
• IAA Study shows compliance burden
– More work, fewer resources
– 5% of revenues; 1 basis point
• Firm fined $200 Million because it hid errors in quant
model (In re AXA Rosenberg)
• Fund sponsor pays $300 Million for mis-pricing subprime
bonds (In re Morgan Keegan)
– Allowing PM to override broker quotes
• Unreasonable fair valuation (In re Bunzel)
• Receiving kickbacks from prop trading firm to aggregate
trades (In re Pegasus)
• Lying about use of org expenses to Board, administrator,
investors (SEC v. Juno Mother Earth Asset Mgt)
• OCIE Risk Alert on Unauthorized Trading
• New Series 99 for Ops Professionals
Federal Court Hostility
Federal Court Hostility
• Proxy access rule vacated (Business
Roundtable v. SEC; D.C. Cir.)
– Effect on efficiency, competition, and
capital formation; empirical benefits
• Fund Adviser not liable for prospectus
disclosure (Janus v. First Derivative Traders;
U.S. Supreme Court)
– Cf. In re Oppenheimer Funds: adviser has
regulatory responsibility for prospectus
Federal Court Hostility
• Class action plaintiffs foreclosed because
NAV was correct (Yu v. State Street;
– No loss causation despite weak disclosure
• FINRA can’t sue to enforce fines (Fiero v.
FINRA; 2nd Cir)
– FINRA is a membership organization
Federal Court Hostility
• No private right of action under fund compliance rule
(Smith v. OppenheimerFunds Distributor; S.D.N.Y.)
• Fund-of-fund investors can’t sue underlying funds
(Curran v. Principal Management; S.D. Iowa)
• Offshore hedge fund can’t sue CDO sponsor (Basis
Yield v. Goldman Sachs; S.D.N.Y.)
– Failed to prove U.S. sales activities
State Regulation & Enforcement
• NASAA Announces State Enforcement Stats
– 51% increase in enforcement actions
– 200% increase in funds returned
– > 7000 investigations; > 3000 actions
• NASAA lists deficiencies in coordinated IA exams
– Form ADV, suitability docs, safeguarding client
records, supervision, advertising
• Failing to register in Mass. (In re Eagle Trades and
Osirix FX)
– rescission
State Regulation & Enforcement
• Registration of private fund managers
– Mass. exempts only 3(c)(7) funds and 3(c)(1)
funds for qualified clients
• NASAA model custody rule requires delivery of
account statements even if fund is audited
• NASAA President vows to defend states’ authority,
criticizes NSMIA
• NASAA wants renewed power to review private
Marketing and Advertising
Marketing and Advertising:
• Pay-to-Play rule implementation
– FINRA fines firm for MSRB violations (Southwest Securities)
– SEC Sues Detroit city officials (SEC v. Kilpatrick)
– Solicitor payment prohibition postponed
• Social Media
– OCIE Risk Alert/FINRA guidance
– Content not media is what’s relevant
– Supervision and retention
– SEC sweep (includes personal use)
• FINRA rule re point-of-sale disclosure for mutual fund revenue
Marketing and Advertising:
• Lying about SEC deficiencies in RFPs (In re Aletheia)
• Claiming eligibility to register with SEC (In re Delta Global
– Didn’t really manage UITs
– Several cases where advisors inflated AUM
• Exaggerating background (SEC v. Hicks)
– Quant model developed at Harvard
• Back-Tested Hypothetical performance (In re GMB Capital
• Falsifying solicitor disclosures (SEC v. ARVCO)
• Overvaluing equity in sale to client (In re Oxford Investment
FINRA Regulates Distribution
• New content standards as of February 2013
• FINRA sanctions 8 firms for insufficient private
placement due diligence (In re Next Financial et.al.)
– Need on-site visits
– Document due diligence
– Review financials and red flags
• Fund wholesaler fined because marketing materials
were misleading (In re Wells Fargo Investment
• European bank pays $7 Million for failing to register
as BD (In re Banco Espirito Santo)
FINRA Regulates Distribution
• FINRA charges BD for not second-guessing
NAVs (David Lerner & Associates)
– Declining real estate market
• Late prospectus delivery (Wells Fargo
• FINRA proposes rule to file PPMs (5123)
– Content requirements (use of proceeds,
offering expenses, solicitor compensation)
Third Party Liability
• Audit firms
– Clean audit opinion violated Martin Act (Cuomo v. Ernst &
– Failing to verify assets caused securities fraud (In re Sofo)
– PCAOB considers mandatory auditor rotation
– Only PCAOB firms avoid surprise custody audits
• Collateral manager sued for allowing hedge fund to participate
(SEC v. Steffelin)
• Failure to oversee due diligence vendor (In re Calhoun Asset
• Independent directors too close to management (SEC v. Krantz)
Predictions for 2012
PE and Hedge fund firms will ignore compliance obligations
SEC will give new registrants a grace period
Non-U.S. fund sponsors ignore registration requirements
FINRA will win jurisdiction over (retail) advisors
Mary Schapiro will resign after election
More SEC cases that firms don’t qualify
States will begin interstate exam cooperation
Whistleblower program will be a non-issue
More compliance program cases
Expanding third party liability
Cipperman Compliance Services provides CCO and compliance
outsourcing services to registered funds and money managers. CCS
develops, implements, and operates complete and customized
compliance programs that include ongoing review, testing,
management, training, and regulatory response. CCS boasts an
experienced team of seasoned investment management professionals
that offer an independent compliance perspective tailored to your
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