Transcript CIPPERMAN & COMPANY

Regulatory Overview
Todd Cipperman, Esq.
Cipperman & Company
September 25, 2007
Overview









SEC Examinations and Compliance
22c-2
12b-1
Revenue Sharing
Valuation
Soft Dollars
Best Execution
Disclosure
Other
–
–
–
–
Insider Trading
Hedge Funds
Market Timing
Advisers/Broker-Dealers
SEC Exams: NYRO Examination Request List





Comprehensive: Due Diligence List/Audit
Requires specific data formats
Focus on individuals: Who is responsible?
Work Papers: output from daily work flow
RFI: Disclosure, Portfolio Mgt, Brokerage, Trade
Allocation, Conflicts, Valuation, Custody, Marketing,
Data Protection, Compliance Program, BCP, Service
Providers, Pooled Products
 Compliance: current inventory of risks; exception
reports; annual review
 Roadmap for compliance program
Compliance Priorities
 OCIE Compliance Alert re common deficiencies:




performance advertising, “as-of ” trading, overcharging SMA
accounts
Advisor Regulation (Donohue): e-mail retention, ADV Part
II, Merrill Rule, accredited investor defn
Broker-Dealer Exams (Gadziala): branch supervision, hedge
fund sales practices, data security, net capital, best execution,
AML, books/records
NASD Exams (Errico): branch supervision, AML, new
product sales, hedge fund suitability, BCP, non-cash
compensation
State Regulators esp. Massachusetts and New York
– Hedge fund hotels
– Sufficiency of disclosure
– Sales practices (cold calling)
 GAO Report: SEC should require submission of compliance
reviews to better segment firms into risk categories
In re CapitalWorks and Correnti
 First (only) case under 206(4)-7
 Correnti headed Marketing and Compliance
 RFP responses said that CapitalWorks never
had a deficiency
 SEC warned the firm to implement P/P
 Firm violated 206(4)-7
 Correnti personally liable as CCO for
aiding/abetting violations of 206(4)-7
22c-2
 SEC to ICI: Funds can’t use shareholder data for
marketing
– Regulation S-P limits use of personal information
– Who owns shareholder data?
– Intermediary Agts
 ICI letter to intermediaries “reminding” them of
rule requirements and deadlines
– Market Power and Intermediaries
 Relief to foreign intermediaries from delivering
government issued identification
12b-1
 SEC considering 12b-1 rescission (roundtable in
June)
– Cox: a substitute for front-end loads
– Tax on current shareholders without benefit
– Drag on performance
 ICI: 12b-1 fees are good
– pay for advice, administrative support, and recordkeeping
– help smaller funds
 Who will compensate the broker-dealers?
 Back to front-end loads?
Revenue Sharing
 In re Morgan Stanley: must disclose receipt of revenue
 Directed Brokerage – See In re John Hancock (not
enough Board disclosure of conflict of interest)
 No private right of action against fund advisors
(See In Re Franklin Mutual Funds)
– Who benefits from “shelf-space” arrangements?
 Wells settlement: detailed Prospectus and SAI
disclosure including names of firms and amounts
 NASD Non-Cash Compensation Rules: NASD
fined 3 mutual fund distributors for entertaining
third party reps who sold funds
Valuation
 Focus of sweeps: See NYRO Exam Request
 Sub-Prime contagion
 In re Allied Capital: Private Equity Firm BDC did not value
portfolio companies as required by ASR 118
– Valuation committee was not independent
– No books and records
 SEC v. Sentinel: Run on the cash manager during the sub-
prime liquidity crisis
– Commingling and leveraging client assets
– Misrepresentations about leverage and valuation
 IOSCO valuation principles: documentation, consistency,
independent review, vendor due diligence, transparency
 Responsibility for valuation
– In re McCurdy: concurring audit partner knew financials were
incorrect
– In re Seghers: delivering inflated valuations to administrator
Soft Dollars
 2006 Interpretive Release
–
–
–
–
Narrowed scope to advice, analysis, reports
Computer hardware out
Clear allocation of mixed use items
Defines “effecting a trade”
 Cox has suggested outlawing soft dollars
 SEC guidance re when a research provider can avoid BD
registration: create a pool of credits and avoid linkage
 Goldman XPRESS No-Action Letter: Money Manager must
determine value of research
 In re Schulze: Provide enforcement order to investors and
prospective investors (the “Scarlet Letter” approach)
– Shell “research” company to pay for non-28(e) expenses e.g. salary,
rent, health insurance
 Remaining issue: What is within 28(e) after last year’s
guidance
Best Execution
 See Soft Dollars
 In re Morgan Stanley: Trading system failed to ensure
best execution
–
–
–
–
Embedded mark-ups/downs
Delayed settlement
In-house system replaced commercial applications
No compliance review of in-house system
 In re Folger Nolan: Use of BD affiliate to execute
trades without demonstrating best execution
 Can a firm ever trade through an affiliate?
Disclosure
 Donohue calls for electronic 2-page profile
– Prospectus/SAI available on internet
– Tagged data would allow easier access to
information
– Will SEC exempt issuers from liability?
 XBRL initiative: tagging data for access
– Who benefits: shareholders, advisors, plaintiffs’
lawyers?
Hedge Funds, Insider Trading
 Insider Trading: SEC focus esp. w/ hedge funds
– PIPEs
– UBS/Morgan Stanley ring
– Safeguards: SEC v. Suman: E-Mail Administrator bought
target company stock ahead of tender offer
 Hedge Funds
– Clawbacks in bankruptcy: redemption proceeds, margin
payments, service provider payments
– Risk Disclosure - SEC v. Wood River et. al.: failure to
disclose overly concentrated position in EndWave stock
– Proposed definition of “accredited natural person” ($2.5
Million in assets exclusive of real estate)
– Hedge Fund Hotels: really soft dollar cases in disguise
– Short sales: covering with public offering allocations
Market Timing, Advisers/Broker-Dealers
 Market Timing
– Fair Fund distributions continue at slow pace
– In re Byck et. al: Using Fund/SERV to late trade for hedge
fund clients
 Advisers/Broker-Dealers
– Anti-fraud rule applicable to unregistered advisers
– Merrill Rule etc.: discretionary BDs must become RIAs
– Reverse Churning: need to monitor accounts
Final (Discomforting) Thoughts
 SEC exams have become increasingly comprehensive and











forensic; everything is a “priority”
Post-Spitzer SEC remains aggressive
Regulation through enforcement action
Focus on personal liability
State regulators very active
How will fund companies compensate distribution channels?
Lacking clear guidance on valuation, best execution and soft
dollars
Cox wants to outlaw 12b-1 and soft dollars
Donohue wants to re-structure disclosure (again)
Bad actors with technology have increased systemic risk
What will happen when data starts flying on October 16?
New sheriffs in town in 2009?
Cipperman & Company is a unique law firm devoted exclusively to the investment
management industry. Our lawyers have spent their careers in the investment
management industry, including significant experience at major industry players. Our
shared heritage and experience make our lawyers unique and creative industry partners
who can give you practical, real-world advice for making informed business decisions
and controlling your legal risk. We have worked on a wide range of transactional and
regulatory matters, but we concentrate on three core areas - Distribution, Technology
and Fund Formation:
Distribution: Broker-Dealer Regulatory Matters, Dealer, Solicitation, and Referral
Agreements, Asset-Gathering Strategies and Structures, Wrap Programs, Marketing
Materials
Technology: Licensors and Licensees, Installed and ASP, Portfolio Management
Systems, Trading Utilities and Platforms, Compliance Tools
Fund Formation: Hedge Funds, Fund-of-Funds, Institutional Products, ETFs, Variable
Insurance Products, Cash Sweep Vehicles
150 S. Warner Road, Suite 140, King of Prussia, PA 19406, 610.687.5320, [email protected], www.cipperman.com