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Regulatory Update 2010 - Post-Madoff Enforcement - Dodd-Frank & the New Regulators - Compliance 2.0. Todd Cipperman, Esq. December 1, 2010. Nothing herein should be construed as legal advice. This presentation may constitute an advertisement under U.S. law.

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regulatory update 2010 post madoff enforcement dodd frank the new regulators compliance 2 0

Regulatory Update 2010- Post-Madoff Enforcement - Dodd-Frank & the New Regulators - Compliance 2.0

Todd Cipperman, Esq.

December 1, 2010

Nothing herein should be construed as legal advice.

This presentation may constitute an advertisement under U.S. law.

Cipperman Compliance Services is not a law firm and does not render legal advice.

dodd frank
  • The Players
    • RIA registration and supervision
    • Registration of municipal advisers and solicitors
  • The Markets
    • Derivatives
    • Short-sale reporting and regulation
    • Money market funds
  • The Process
    • Proxy vote reporting
    • Shareholder nominations
  • Distribution
    • Accredited investor defn
  • Enforcement and Litigation
    • Whistleblowers
    • Private rights of action
new registrants
New Registrants
  • Private fund sponsors (>$150 Million)
    • Private Equity firms
      • Venture Capital exemption limited
      • Based on committed capital
      • Market valuations
    • Hedge Fund sponsors
    • “ADV lite” for VC and small fund advisers
  • Multi-family offices
  • SRO for Advisers?
  • Remove BD exemption from Advisers Act?
  • State vs. Federal regulation
private funds infrastructure
Private Funds: Infrastructure
  • Valuation
    • Overvaluing illiquid securities in side pockets (SEC v. Mannion et. al.)
      • Internal valuations were lower
      • Methodology differed from PPM
    • BDC investments overvalued (SEC v. Brantley Capital)
      • Impacted fee calculation
      • Affected financials, Board reports, SEC filings
    • Over-paying for MBS to maintain values (SEC v. ICP Asset Mgt)
  • Long and short in same securities (In re Carlson Capital)
    • Rule 105: access to information
  • LP has right to list of other LPs (Parkcentral v. Brown)
    • LPA could have prohibited
  • Processing clerk made unauthorized trades (SEC v. Kass)
private funds conflicts of interest
Private Funds: Conflicts of Interest
  • Cherry-picking for personal account (In re Dawson)
    • Irrelevant that Manager reimbursed fund or that clients didn’t express concern
  • Undisclosed payments to key BDC employee (In re Douglas and Moore)
  • Collusion between PE fund manager and underlying companies to ensure committed capital (SEC v. Onyx Capital)
    • Money funneled back to manager
    • Fraudulent statements to pension plan investors
  • Hedge fund manager created fake administrator and auditor (SEC v. Finvest)
    • Delivered performance information and financials
insider trading
Insider trading
  • Galleon
  • Dozens of cases against hedge fund managers
  • Mutual fund manager tipped family members to sell his fund (In re Baldt)
    • Muni market declining
    • Knew about redemptions
  • Fund exec sold fund shares after learning about re-pricing (SEC v. Marquardt)
  • Proposed anti-fraud rule for swaps
  • Swaps reporting to SDRs
  • Alternative uptick rule for shorts
  • Funds must review derivatives disclosure
  • CorpFin letter re: repos and securities lending
    • More MD&A disclosure
  • Leveraged ETFs
    • IM Staff won’t approve ETFs that use derivatives
  • Can’t delegate review of affiliated transactions under 17e-1, 17a-7, 10f-3 (IDC Letter)
    • CCO is a service provider, not a substitute
  • 12b-1 proposal
  • Jones v. Harris and its progeny
    • Review of mutual fund fees
  • New rule for money market funds
  • Evaluate 12b-1 fees based on whether services were reasonable in relation to fees (In re American Mutual Funds)
    • Board process
compliance programs
Compliance Programs
  • Failing to follow your own procedures (In re Buckingham)
    • Wall between BD research for nonpublic info
    • Creating records upon SEC exam request
  • Template compliance manual (In re Sierra Financial)
    • P/P not tailored to business
    • No annual review
    • Investing in controlled entities
  • BD CCOs
    • failing to stop use of personal e-mail account used in stock manipulation scheme (In re Campanella)
      • Recklessness = intent
    • Failing to supervise re variable annuity recs (In re Prime Capital)
      • Authority to impose discipline
    • Failure to supervise brokers who churned (Westpark Capital)
  • SEC to leverage compliance pros (Schapiro speech)
    • Duty to investors
    • CCO’s job to ensure compliance with securities laws
  • Ignoring back-office ops (In re Busacca)
    • Cutting corners and costs
    • BD Pres focusing on sales, not ops
  • Books and Records
    • Storage facility destroyed records for nonpayment of fees (SEC v. Envision)
  • Status questions
    • Function, not title triggers licensing reqs (JP Morgan Securities)
      • Investment banker that supervised municipal dealer
    • 28(e) research provider is not investment adviser (BNY ConvergEx)
  • IM Staff interps
    • Same audit firm permissible for surprise exams
    • May use same independent rep for all LPs
  • Guidance for surprise exams
    • Confirm assets with clients
    • SEC notification and filing
  • Compliance guidance
    • Background checks
    • Two persons to move assets
    • Segregate custody duties
    • Reconcile account and custody statements
  • Audit firm liable for negligent surprise exam (In re Altschuler)
    • Ignored commingling
    • Gave notice of exam
    • 1.5 billable hours
  • Action against private fund manager (In re Sands Brothers Asset Mgt)
    • Auditor disclaimer
    • Failure to deliver financials
    • Incorrect ADV
shareholders and proxies
Shareholders and Proxies
  • Proxy process and reporting
    • Form N-PX for executive compensation matters for 13F filers (Proposal)
    • Oversight of proxy advisory firms (Schapiro speech)
    • SEC Concept Release: proxy plumbing
      • Access to intermediary data
      • NOBO/OBO system
      • Use of technology
  • Shareholder Proposals
    • Closed-end fund must include proposal to convert to interval fund (Swiss Helvetia Fund)
      • Board had already considered and rejected
    • Fund must include proposal to fire adviser that overvalues ARS (Boulder Growth and Income)
    • Shareholder-nominated directors (Rule)
      • 3% for 3 years
      • 1 director or 25% of Board
disclosure point of sale
Disclosure: Point-of-Sale
  • Product Disclosure
    • Include brokerage costs in fund expense ratio (FASB proposal)
    • IFRS
    • Failure to disclose that counterparty influenced collateral pool (SEC v. Goldman Sachs)
    • Changing investment objectives without shareholder approval under 13(a) (In re Charles Schwab)
      • Is “MBS” an industry classification?
    • Misreps about RMBS delinquency data (Deutsche Bank Securities)
      • FINRA action against underwriter
  • Adviser Disclosure
    • New ADV
      • Personnel supplement
      • Financial disclosure
      • Publicly available
    • Point-of-sale disclosure for BDs
    • IAR information available online
disclosure ongoing
Disclosure: Ongoing
  • Summary annual reports (Donohue speech)
  • MD&A disclosure about short-term borrowing
  • Short sale reporting for 13F reporters
  • 13F information not protected by 5th Amendment’s “Takings” clause (In re Wynnefield)
  • Reg FD violation for selective disclosure to private fund manager (SEC v. Presstek)
    • Earnings info during blackout
marketing product specific
Marketing: Product-specific
  • SEC regulation
    • Target Date funds proposal
      • No suitability statements
    • Suitability (SEC v. Life Wealth Management)
    • Best practices report for working with Seniors
  • Fund marketing
    • Marketing multi-strat fund/funds as conservative and liquid (In re Greenberg)
      • Concentration in two underlying funds
      • Suitability
      • See also In re S4 Capital: using unhedged options in “absolute return” fund
    • Misreps in fund fact sheets for enhanced cash fund that invested in subprime (In re Flannery and Hopkins)
      • CIO and Product Manager charged
marketing sales misreps
Marketing: Sales Misreps
  • Failure to disclose that wrap program was more costly than brokerage account (SEC v. Sage)
    • Moving clients to new RIA firm from BD
    • Misrep that clients couldn’t stay with underlying manager
  • Failure to disclose additional commission comp for switching classes (In re Valentine)
    • Investment rationale not relevant
    • Prospectus disclosure not enough
  • Options trader barred for claiming competence (In re Jafari)
    • Average loss of 52%
  • Public Plans
    • Pay-to-play rule for public plans
      • May only pay registered BDs and federal RIAs
      • Limits on political contributions
    • FINRA sweep
    • State laws
      • CA requires solicitors to register as lobbyists
        • No contingent compensation for public plans
    • PE Firm and Exec to pay $13.2 Million in fines for undisclosed comp to public plan solicitor (SEC v. Quadrangle; SEC v. Rattner)
      • “Chooch”
      • Section 17(a)(2)
      • What about 206(4)-3?
  • Cap Intro
    • Law firms
      • A “salesman’s stake” (Brumberg, Mackey & Wall)
        • Law firm sought no-action relief
        • Cf. Manatt, Phelps & Phillips: no contingent compensation
    • BD registration (Donohue speech)
broker dealers
  • Sales Practices
    • Segregation of BD and RIA activities (Ketchum)
    • Suitability: leveraged ETFs, ARS, UITs, closed-end funds
    • Due diligence of private placements (Reg Notice 10-22)
    • Obligation to verify QIB reps (In re Merrill Lynch)
    • Obligation to deliver due diligence info (In re Securities America)
    • Implied reps and the “shingle theory" (Capital Management v. Bennett)
  • Disclosure
    • More disclosure in U4s and U5s
      • Termination details
      • Broker awarded $5 Million for defamatory U5 (Beck v. SunTrust)
        • Politics not sales practices
    • FINRA considering broker-dealer ADV
    • More information required in BD applications (Reg Notice 10-01)
broker dealers con t
Broker-Dealers con’t
  • Operations and Infrastructure
    • Liquidity risk management (Reg. Notice 10-57)
      • No excuses for loss of funding
    • Licensing of Ops personnel (Proposal)
    • E-Mail retention (Piper Jaffray)
    • Expansion of TRACE
    • Protection of customer information from hacker (D.A. Davidson)
    • Insufficient resources devoted to AML (Penson and Pinnacle)
    • Social Networking (NtM 10-06)
  • Market participation
    • Naked access
      • Inadequate customer ID (In re Pinnacle)
    • CDS market manipulation (Phoenix Derivatives)
    • Best execution should include multiple venues (Ketchum)




enforcement power
Enforcement Power
  • New Whistleblower rule
    • 30%, $1 Million
    • Not required to use company procedure
    • Employment law implications
  • SEC Argues that SOX protects third-party whistleblowers (Klopfenstein v. DoL)
  • $1 Million bounty awarded to insider trading informant (SEC v. Pequot)
    • Ex-wife of tipper who misled SEC
  • Asset Management Unit
    • Specific initiatives (Bond Fund, Problem Adviser, Mutual Fund Fees)
  • Virginia Financial and Securities Fraud Task Force
    • Ability to bring criminal charges
  • Enforcement will offer cooperation agreements
  • Increased enforcement activity (2009)
    • 496 vs. 233 investigations
    • $2.09 BN v. $774 MM in disgorgements
    • $345 MM vs. $256 MM penalties
private rights of action
Private Rights of Action
  • Extending “conduct and effects” test to non-US transactions
  • Must show stock price movement for “fraud-on-the-market” theory in class action (Berks County ERF v. First American (SDNY))
  • No private right of action under Section 13(a) (Northstar v. Schwab (9th Cir))
who s liable aka madoff con t
Who’s liable? (aka Madoff con’t)
  • Liable
    • Adviser that suspected Madoff fraud (Cuomo v. Ivy Asset Management (NYS))
    • Custodian for Madoff feeders (Pitkin v. Westport National Bank (CT))
    • RIA for failing to conduct proper due diligence of Ponzi scheme (In re Yosemite)
    • Fund manager for blindly relying on performance information provided by sub-adviser (SEC v. Moody)
    • Fund accounting head for allowing PM price overrides (In re Morgan Asset Mgt et al)
    • SEC/DoJ argue that advisers liable for fund prospectuses (Janus v. First Derivative Traders)
      • Civil and criminal penalties
who s liable aka madoff con t28
Who’s liable? (aka Madoff con’t)
  • Not Liable
    • Auditor of Madoff feeder (CRT v. BDO Seidman (NYS))
    • Auditor or any other service provider with interest in the offering (Malack v. BDO Seidman (3rd Cir))
      • No “fraud created the market” theory
    • Law firm in securities offering (PIMCO v. Mayer Brown (2nd Cir))
      • May only apply to private rights of action
    • Lender to ponzi scheme not liable to Receiver (Marion v. TDI)
    • BD GC for failure to supervise (In re Urban)
      • Not a supervising principal
      • Reported issues
jurisdictional battles finra and nasaa
Jurisdictional Battles: FINRA and NASAA
  • SEC v. FINRA
    • Ketchum Wants SRO for RIAs; SEC launches study to determine if it should eliminate broker exemption from Advisers Act
    • FINRA assumes enforcement for NYSE
  • SEC v. NASAA
    • SEC action against adviser had <$25 Million AUM (In re FreedomTree)
    • SEC suit against state-registered adviser for PPM fraud uncovered by FINRA (SEC v. Vallett)
    • State regulatory standards
      • SEC standard
      • NASAA resource
    • 1940 Act trumps MD takeover statute (Boulder Total Return Fund)
    • DF moves mid-sized advisers ($25-$100 AUM) to states
      • Must have examination program
      • >4000 advisers
      • New quasi-SRO?
    • Deference to arbitration awards (Wiederhorn v. Merkin (NYS))
      • Large award for investors in Madoff feeder
jurisdictional battles fdic and dol
Jurisdictional Battles: FDIC and DoL
  • SEC v. FDIC
    • Collective funds
      • Funds did not disclose subprime investments and leverage (In re State Street)
        • SEC fraud case
      • Donohue questions rationale for 1940 Act exemption
  • SEC v. DoL
    • New disclosure about plan and investment options
      • More transparency
    • Expanded definition of “Fiduciary”
      • More than just providing “regular advice”
      • RIAs
    • DoL sues Madoff feeders (Solis v. Beacon et. al.)
      • Feeder managers were fiduciaries
      • Jurisdictional issues
final thoughts
Final Thoughts
  • Dodd-Frank changes everything
  • Nothing left unregulated
  • Private funds business will segment
  • Zero tolerance for insider trading
  • Derivatives less available
  • Need for professional compliance and ops
  • More transparency in disclosure, sales and marketing
  • More (costly) enforcement actions
  • Jurisdictional battles = more regulators

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