© Copyright 2014 by K&L Gates LLP. All rights reserved.

An Update on the Extra-Territorial Impact of U.S. Regulation

Cary J. Meer, Partner, New York and Washington, D.C. C. Todd Gibson, Partner, Pittsburgh and BostonRobert Hadley, Partner, London

8 July 2014

DC #9803012v5

Presentation Overview Private Offerings of Non-U.S. Funds to U.S. Investors JOBS Act Bad Actor Registration as a U.S. Investment Adviser and

Exemptions for Non-U.S. Advisers Commodity Pool Operator (“CPO”)/Commodity Trading

Advisor (“CTA”) Registration and Regulatory Update “Covered Funds” under the Volcker Rule SEC/UK Enforcement Cases

Private Offerings of Non-U.S. Funds to U.S. Investors

Choices Regulation S Regulation D Only Regulation D has changed recently Investment Company Act of 1940 (“1940 Act”)

Exemptions

Regulation S

Keys are: Offshore transaction No directed selling efforts Distribution compliance period varies based on

category of issuer/security “U.S. person” definition is different than in Internal

Revenue Code of 1986, CFTC Regulation 4.7 and in CFTC Cross-Border Guidance Equity securities of domestic securities are generally

“restricted securities”

Securities Exchange Act of 1934 Section 12(g)(1) requires issuers whose securities are traded by means of interstate

commerce to register under the Securities Exchange Act of 1934 (“1934 Act”) if the issuer has assets over US$10 million and if it is held of record by more than 1999 persons

1934 Act requires issuers to make periodic filings with the SEC to disclose information about their business operations, financial condition, and management

Rule 12g3-2 exemption for “foreign private issuers” (as defined in Rule 3b-4) if a fund’s shares are held by fewer than 300 shareholders resident in the United States

“Foreign Private Issuer” (as of last business day of most recent second fiscal quarter):− 50% or less of its outstanding voting securities are held by U.S. residents; OR− If more than 50% of its outstanding voting securities are held by U.S. residents and none of the

following three circumstances applies:• The majority of its executive officers or directors are U.S. citizens or residents;• More than 50% of the issuer’s assets are located in the United States; or• The issuer’s business is administered principally in the United States

Need to “look through” U.S. omnibus/nominee accounts for calculation purposes

Investment Company Act of 1940 Applies to pooled investment vehicles that invest primarily

in “securities” Requires registration unless there is an exemption Most private funds have substantial investments in

securities that would cause them to fall within the definition of investment company under the 1940 Act

Private funds generally rely on Sections 3(c)(7) or 3(c)(1)

Investment Company Act of 1940 – 3(c)(1) Requirements of Section 3(c)(1)

− Not more than 100 beneficial owners• Counted differently for publicly traded partnership (“PTP”) purposes

− Must “look through” certain entities when counting number of beneficial owners• Formed for the purpose

− More than 40% of its committed capital is invested in the Section3(c)(1) fund

• The “look-through” rule − Count owners rather than entity if (1) the investing company

owns 10% or more of the Section 3(c)(1) fund’s voting securities,and (2) the investing company is itself an investment company orprivate fund

− If fund is a non-U.S. fund, generally do not need to count investors that are not U.S. persons within the meaning of Regulation S

Investment Company Act of 1940 – 3(c)(7) or “Qualified Purchaser” Funds Section 3(c)(7) excludes any pooled investment vehicle from the

definition of investment company if:− All the beneficial owners are “qualified purchasers” or “knowledgeable

employees” and it does not make or propose to make a public offering of its securities

In general, qualified purchasers are: − Natural persons with not less than $5 million in investments; and − Certain institutions with more than $25 million in investments

Not subject to the 100 beneficial owner limitation (in practice, generally cannot have more than 1,999 recordholders)

Limited look-through rules Do not need to qualify investors that are not U.S. persons within the

meaning of Regulation S if a non-U.S. fund

Securities Act of 1933 Under Section 5 of the Securities Act of 1933 (“1933

Act”), unless a registration statement is in effect as to a security, it is unlawful to offer and sell such security –unless an exemption applies − LLC and LP interests typically are securities− Shares of corporate stock are securities

Section 4(a)(2) states that Section 5 does not apply to transactions by any issuer not involving any public offering

Securities Act of 1933 – Regulation D Compliance with Regulation D provides a “safe harbor”

for sale not involving a public offering− Applies to offers and sales

Private funds generally rely on Rule 506 of Regulation D − Sales must be to “accredited investors”− No public offering (but for JOBS Act)− Transfer restrictions− Can have up to 35 non-accredited investors but must

supply same information as would be required in a registration statement

− SEC allows a non-U.S. Regulation S public offering contemporaneously with a Regulation D private offering

JOBS Act

Securities Act of 1933 – General Solicitation Regulation D

− Prohibition on general solicitation and general advertising for offerings conducted under Rule 506 of Regulation D

“General solicitation” can encompass range of activities

Securities Act of 1933 – General Solicitation (cont’d)JOBS Act Changes: Regulation D

− Permits general solicitation and general advertising (collectively “general solicitation” unless indicated otherwise) in securities offerings under new Rule 506(c) of Regulation D provided that all purchasers are “accredited investors” as defined in Rule 501(a) of Regulation D• Purchaser in fact comes within one or more enumerated categories of Rule

501(a), or • Issuer reasonably believes purchaser comes within an enumerated category

− Issuer must “take reasonable steps” to verify accredited status of purchasers as a condition of safe harbor exemption in Rule 506(c) in which general solicitation is used (objective, principles-based approach)

− Verification requirement is in addition to requirement that purchasers be accredited, unless issuer has actual knowledge that purchaser meets requirements

Securities Act of 1933 – General Solicitation (cont’d)

JOBS Act Changes: (cont’d)− All terms and conditions of Rule 501 and Rules 502(a) and

(d) of Regulation D must be satisfied• Qualification and numerical thresholds for accredited investors;

rules regarding integration of offerings; and limitation on resales

− Preserves issuer option to conduct private offering without general solicitation under existing rule, renamed Rule 506(b) – no verification requirement

− Amends Form D to provide Rule 506(b) and Rule 506(c) boxes

− General solicitation still not defined− Availability of CFTC Regulations 4.7(b) and 4.13(a)(13)

Bad Actor

Securities Act of 1933 – Bad Actor Issuer is disqualified from relying on Rule 506 exemption if any of its “covered

persons”:− Has an undisclosed “disqualifying event” that occurred prior to 23 September 2013;

or− Is subject to a “disqualifying event” that occurs on or after 23 September 2013

Unless:− The issuer did not know and could not reasonably know of the “disqualifying event”− That is, if the issuer has exercised reasonable care to discover any “disqualifying

event” by “covered persons,” then the exemption is not lost If an issuer cannot rely on Rule 506:

− For Rule 506(b) offerings, Section 4(a)(2) is potentially available, but • Securities are no longer “covered securities” under Section 18(b) of the 1933 Act• State law requirements

− For Rule 506(c) offerings, Section 4(a)(2) is not available− If no exemption is available, then possible rescission

Securities Act of 1933 – Bad Actor (cont’d)Covered Persons: Issuer and any predecessor of the issuer Affiliated issuers

− Under Rule 506(d), an “affiliated issuer” of the issuer is an affiliate (as defined in Rule 501(b) of Regulation D) of the issuer that is issuing securities in the same offering, including offerings subject to integration pursuant to Rule 502(a) of Regulation D

Securities Act of 1933 – Bad Actor (cont’d)Covered Persons (cont’d): Affiliated issuer ─ timing of the event

− Events that occurred prior to the affiliation will not be a “disqualifying event” if the affiliated entity is not:• In control of the issuer• Under common control of the issuer by a third party that was in control of the

issuer at the time of the event

Directors, general partners, and managing members of the issuer Executive officers of the issuer

− President − Vice President in charge of a principal business unit, division, or function− Officer who performs a policy-making function or any other person who

performs a similar policy-making function

Securities Act of 1933 – Bad Actor (cont’d)Covered Persons (cont’d): Officers of the issuer who participate in the offering

− President, vice-president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any person who routinely performs a corresponding function

− More than transitory or incidental involvement − Could include due diligence activities, preparing disclosure documents

and communications with the issuer, prospective investors, and other offering participants

Securities Act of 1933 – Bad Actor (cont’d)Covered Persons (cont’d): 20% beneficial owners ─ defined as beneficial owners of 20% or more of an

issuer’s outstanding voting equity securities, calculated on the basis of voting power − Analysis would apply to all investors in any fund sold pursuant to

Regulation D, including U.S. and non-U.S. persons− Who is a beneficial owner?

• Interpreted the same way as under Rule 13d-3 under the Securities Exchange Act of 1934 (“Exchange Act”)

• Any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, under Exchange Act Rule 13d-3, has or shares, or is deemed to have or share: (1) voting power, which includes the power to vote, or to direct the voting of, such security; and/or (2) investment power, which includes the power to dispose, or to direct the disposition of, such security

− What is a voting security?• Includes the ability to control or significantly influence the management or policies of the issuer

through the exercise of voting rights, such as the right to elect or remove directors or the right to approve significant transactions

• Would not include rights limited solely to approvals or changes to the rights or preferences of a class

Securities Act of 1933 – Bad Actor (cont’d)Covered Persons (cont’d): Promoters connected with the issuer in any capacity at the time of

such sale Placement agents ─ any person that has been or will be paid (directly

or indirectly) remuneration for soliciting purchasers and their principals− Directors, general partners, managing members, executive officers, and

other officers participating in the offering Investment manager and principals of a fund

− Investment advisers and other investment managers of the fund− Directors, general partners, managing members, executive officers, and

other officers participating in the offering− Directors, executive officers, and other officers participating in the offering

of the investment manager’s general partners or managing members

Securities Act of 1933 – Bad Actor (cont’d) Disqualifying Events include:

− Certain criminal convictions− Certain court injunctions and restraining orders− Final orders of certain state and federal regulators− Certain SEC disciplinary orders− Certain SEC cease-and-desist orders− SEC stop orders and orders suspending the Regulation A exemption− Suspension or expulsion from membership in a self-regulatory organization

(“SRO”), such as FINRA, or from association with an SRO member− U.S. Postal Service false representation orders

Many disqualifying events include a look-back period (for example, a court injunction that was issued within the last five years or a regulatory order that was issued within the last ten years)

The look-back period is measured from the date of the disqualifying event—in the example, the issuance of the injunction or regulatory order—and not the date of the underlying conduct that led to the disqualifying event

Who Must Register as an InvestmentAdviser With the SEC?

Overview of Investment Adviser Definition The definition of “investment adviser” in the

Investment Advisers Act of 1940 (“Advisers Act”) is broad and includes:− “Any person who, for compensation, engages in the

business of advising others . . . as to the value of securities or as to the advisability of investing in, purchasing, or selling securities . . . .”

− Generally, a general partner or manager of a pooled investment vehicle that (i) purchases or sells securities and (ii) pays the general partner/manager management fees and/or carried interest

− SEC’s position is that selection of other managers is the provision of investment advice

SEC Registration Generally, persons with regulatory assets under

management (“RAUM”) of $100 million or more must register with the SEC

Private fund advisers must register with the SEC if they have RAUM of $150 million or more

Advisers with their principal office and place of business outside the United States may register with the SEC without regard to RAUM

Many non-U.S. advisers do not need to register with the SEC because they rely on (1) the foreign private adviser exemption or (2) the private fund adviser exemption

Private Fund Adviser Exemption Applies differently to U.S. vs. non-U.S. advisers

depending on whether the adviser has its principal office and place of business (defined in Advisers Act Rule 222-1) in the United States

Qualifying Private Fund Clients− A “qualifying private fund” includes all funds exempt from

investment company registration under any of the exemptions in Section 3 of the Investment Company Act

Assets Managed in the United States− $150 million threshold tested annually− Does not apply to non-U.S. advisers who do not manage

assets from a place of business in the United States

Private Fund Adviser Exemption (cont’d) Although exempt from registration, a private fund adviser:

− Must make certain publicly available reports through the Investment Adviser Registration Depository (“IARD”) system

− Is subject to inspection by the SEC staff − Must file certain limited information on Form ADV Part 1A

initially no later than 60 days after the adviser begins to rely on the exemption and must update the information within 90 days of its fiscal year end or “promptly” if certain responses become inaccurate

Foreign Private Adviser Exemption Exempt from SEC registration if it:

− Has no place of business in the United States− Has fewer than 15 clients and investors in the United States in private

funds advised by it− Has less than $25 million in aggregate assets under management

(“AUM”) attributable to U.S. clients and investors in the United States in private funds advised by it and

− Does not hold itself out as an investment adviser to any registered investment company (“RIC”) or any business development company (“BDC”)

Not subject to reporting or recordkeeping rules or to inspection by SEC staff

Key issues:− Less flexible than private fund adviser exemption; lower AUM limit− Permits separate account clients, but must count U.S. investors even in

non-U.S. funds

Relying Advisers Under a 2005 no-action letter issued to the American Bar

Association, certain special purpose entities (“SPVs”) serving as general partners or managing members to private funds do not need to register as investment advisers if there is a registered investment adviser to the fund and:− The adviser establishes the SPV to act as the fund’s general partner or

managing member− The SPV’s formation documents designate the adviser to manage the

fund’s assets− All advisory activities of the SPV are subject to the Advisers Act, and the

SPV is subject to SEC examination− The SPV, its employees, and persons acting on its behalf are associated

persons of the adviser and are subject to the adviser’s supervision and control

Contrast with the CFTC’s position on the delegation of the CPO function

Relying Advisers (cont’d) Affiliates (“relying advisers”) may rely on the SEC adviser

registration of one adviser (the “filing adviser”)− ABA, SEC No-Action Letter (Jan. 18, 2012)

Relying advisers do not need to separately register with the SEC if:− The relying adviser is controlled by or under common control with the

filing adviser− The relying adviser and filing adviser collectively conduct a single

advisory business− The relying adviser and filing adviser advise only private funds and

separate accounts with substantially the same objectives− The relying adviser and its personnel are subject to the filing adviser’s

supervision and control− The filing adviser’s principal office and place of business is in the United

States− The filing adviser and relying adviser are subject to the same Code of

Ethics and Compliance Manual− The relationship is disclosed on the Form ADV

Unibanco and Participating Affiliates Prior to the Dodd-Frank Act, the SEC staff permitted unregistered,

non-U.S. advisers to provide investment advice with respect to U.S. clients of an SEC-registered affiliate subject to certain conditions, based on staff no-action and interpretive guidance− Most widely known is the “Unibanco” no-action letter – Uniao de Bancos

de Brasileiros S.A., SEC No-Action Letter (28 July 1992) In the release adopting the private adviser exemption and the foreign

private adviser exemption, the SEC affirmed its previously issued Unibanco guidance

SEC also stated that it expects to provide guidance, as appropriate, on the application of the Unibanco letters in the context of the private adviser and foreign private adviser exemptions (not issued yet)

This relief is useful if you set up a separate U.S. entity and your non-U.S. management company provides advice to the U.S. entity

Unibanco and Participating Affiliates (cont’d) Unibanco line of letters requirements – participating affiliate must:

− Be (and act as) separate legal entity from registered adviser − Appoint a U.S. agent for service of process (and must maintain such an

agent until six years after it ceases providing advice to the registered adviser’s U.S. clients)

− Submit to the jurisdiction of the U.S. courts for actions arising under the U.S. securities laws in connection with investment advisory activities for U.S. clients of registered adviser

− Maintain certain records required by the Advisers Act (outside the United States)

− If any books and records are not kept in English, translate records into English upon reasonable advance request by SEC

− Agree to provide records and staff (including testimony) to SEC

Unibanco and Participating Affiliates (cont’d) Personnel of a participating affiliate whose duties or

functions relate to the determination and recommendation of securities trades made with respect to the U.S. clients, or who have access to any information concerning securities being recommended to U.S. clients prior to dissemination of such recommendations:− Are treated as “associated persons” of the registered

adviser and − Are treated, when applicable, as “supervised persons” or

“access persons” under the registered adviser’s code of ethics and policies and procedures

Registration as an Investment Adviser

SEC Registration: Form ADV Form ADV Part 1 and Part 2A are accessible online

− www.adviserinfo.sec.gov/IAPD/Content/Search/iapd_Search.aspx File both parts, and deliver Part 2A to investors annually Must amend Part 1 promptly for certain items and annually for others Must amend Part 2A if materially inaccurate (and redeliver if any

change to disciplinary information) Part 1 – SEC’s Monitoring and Examination Blueprint

− General identifying information about the firm, its advisory business (including employees, clients, compensation, assets under management, advisory activities, and other business activities), financial industry affiliations, participation or interest in client transactions, custody, control persons, and ownership and disciplinary history

− Exempt reporting advisers also complete certain portions of Part 1 of Form ADV

SEC Registration: Form ADV (cont’d) Part 2 – Client Brochure

− Part 2A – plain English narrative disclosure about the business practices, investment strategies and risks, fees, conflicts of interest, and disciplinary information

− Must disclose:• The facts of the conflict; practices or transactions where the adviser’s interests are not

aligned with the client’s; must be specific enough for client to assess• What are the potential consequences of the conflict? How could a client be harmed?• How firm handles the conflict? Eliminate it, mitigate it, disclose it? Must summarize

procedures for dealing with conflicts • The brochure should discuss only conflicts the adviser has or is reasonably likely to have,

and practices in which it engages or is reasonably likely to engage• Conflicts include but are not limited to those related to compensation, allocation, trading,

dealings with affiliates, conflicts among client interests, personal and proprietary trading • Must disclose any financial condition of the adviser that is reasonably likely to impair the

adviser's ability to meet contractual commitments to clients− Part 2B – advisory personnel biographies

Contrast with Form 7−R, which is not publicly available and has more limited information

Substantive Requirement Under the Investment Advisers Act of 1940

Substantive Requirements Fiduciary duty (applies to registered and unregistered

advisers) Anti-fraud Advisers Act Rule 206(4)-8 Compliance policies and procedures Chief compliance officer (“CCO”) Code of ethics Applicability to non-U.S. clients

Antifraud Provisions Advisers Act Rule 206(4)-8

− Applies to:• Untrue statements of material fact and material omissions• Otherwise engaging in any act, practice, or course of business

that is fraudulent, deceptive, or manipulative− No need to show scienter (intent to deceive, manipulate, or

defraud)− Applies to pooled investment vehicles: hedge funds, venture

capital funds, private equity funds, and registered funds with respect to both investors and prospective investors

Investment Adviser Compliance Program Advisers Act Rule 206(4)-7

− Written policies and procedures reasonably designed to prevent violations by the adviser and its supervised persons of the Advisers Act and the rules thereunder

− “Supervised person”• Any partner, officer, director, employee of the adviser• Or other person who provides investment advice on behalf of

the adviser AND the adviser supervises and controls that person

CCO− Competent and knowledgeable regarding the Advisers Act− Position of sufficient seniority − Authority to develop and enforce the compliance program

Investment Adviser Compliance Program (cont’d)

Compliance Policies and Procedures typically address the following (as applicable to the adviser’s business):− Portfolio management processes− Trading activities – including execution, allocation, and soft dollars− Trading of the adviser and its supervised persons− Trade error policies− Private placement procedures− Accuracy of disclosures− Advertising – marketing advisory services/solicitation arrangements− Social media− Electronic communication policies− Red flags− Calculation of and deduction of advisory fees

Investment Adviser Compliance Program (cont’d) Compliance Policies and Procedures (cont’d):

− Safeguarding of client assets− Recordkeeping− Valuation process− Customer privacy and information security− Business continuity plans− Conflicts of interest – dealing with affiliates, gifts, and entertainment− Pay-to-play− OFAC/anti-money laundering− Proxy voting procedures− Foreign Corrupt Practices Act/gifts and entertainment− Outside employment− Annual review

Code of Ethics and Standards of Conduct Code of Ethics Requirements

− Rule 204A-1 requires a written code of ethics to include, at a minimum:• A standard of business conduct • Compliance with applicable federal securities laws – e.g.,

insider trading• Reporting violations of code of ethics and any actions

taken against violators• Providing supervised persons with a copy of code of ethics• Address personal securities transactions

− Quarterly reporting of personal securities transactions and initial and annual holding reports of “access persons”

− Pre-approval of certain transactions

• Recordkeeping for the code of ethics− Applies to “access persons”

Custody Rule: Definition of Custody The Custody Rule (Rule 206(4)-2) regulates the custody

practices of advisers The Custody Rule defines custody as “holding, directly or

indirectly, client funds or securities, or having any authority to obtain possession of them” An adviser may have custody through the activities of a

related person Authority to obtain possession of client funds or securities

is custody, even if the adviser does not exercise that authority March 2013 “Risk Alert”

Custody Rule: Examples of Custody Possession of client funds or securities, unless an adviser

receives them inadvertently under certain circumstances, e.g., an adviser may forward a check drawn by the client and made payable to a third party without being deemed to have custody

Any arrangement that authorizes or permits an adviser to withdraw client funds or securities, e.g., check-signing authority, a general power of attorney, direct debiting of advisory fees, possession of client login and password information, etc., and

Acting in any capacity, e.g., general partner of a limited partnership, trustee, etc., that gives an adviser, or supervised person, legal ownership or access to client funds or securities

Custody Rule: Annual Surprise Examination All advisers with custody of client assets must undergo an annual

surprise examination by an independent public accountant to verify the client assets, with the following exceptions:− Advisers deemed to have custody solely because they have authority to

deduct advisory fees− Advisers deemed to have custody merely as a result of a related

custodian holding client assets and that are “operationally independent” of the related custodian

− Advisers to unregistered pool investment vehicles that (i) are subject to an annual financial statement audit by an independent public accountant registered with and inspected by the Public Company Accounting Oversight Board (“PCAOB”); and (ii) distribute audited financial statements prepared in accordance with GAAP to investors within 120 days of fiscal year-end (180 days for funds-of-funds)

Custody Rule: Custody Through Activities of Related Persons Advisers will be deemed to have custody of securities that are held,

directly or indirectly, by a related person in connection with advisory services provided by the adviser to its clients

Custody Rule: Other Provisions Advisers must maintain client funds and securities with a qualified

custodian (with limited exceptions) Advisers must have a reasonable basis to believe after due inquiry that

clients are receiving account statements from the qualified custodian− Receiving duplicate statements is one way to meet this requirement;

simply accessing client statements on the custodian’s website is not sufficient

When establishing a custodial account for the client, the adviser must notify the client that the account is being established

If the adviser also sends account statements to the client, the initial notification and all subsequent statements to the client must urge the client to compare the adviser’s statement to the custodian’s

The surprise examination must also verify any funds or securities not required to be maintained with a qualified custodian, such as privately offered securities and mutual fund shares

Policies and Procedures to Safeguard Assets Compliance Program Rule requires advisers to

implement written policies and procedures designed to ensure safeguarding of client assets

The SEC’s adopting release for 2009 amendments to the custody rule includes suggested best practices for advisers with actual or constructive custody of client assets (e.g., background checks on employees, rotation of duties, segregation of duties, etc.)

Advisers deemed to have custody because they deduct fees are expected to have policies and procedures in place that address the risk that the adviser or its personnel could deduct fees to which the adviser is not entitled under the terms of the advisory contract

General Form PF Requirements A Form PF must be filed by all advisers that:

– Are registered or required to be registered under the Advisers Act

– Advise one or more “private funds” – issuers exempt from registration under 1940 Act Sections 3(c)(1) or Section 3(c)(7) and

– Manage at least $150 million RAUM attributable to private funds as of end of the adviser’s most recent fiscal year

Note: exempt reporting advisers do not file Form PF

General Form PF Requirements (cont’d) “Regulatory Assets Under Management”

− Same definition as under Form ADV− Gross of outstanding indebtedness and other accrued but

unpaid liabilities Series/Classes

− Two or more series/classes of interests, each valued based on separate investment portfolios, should each be regarded as a private fund and reported on separately

− Does not apply to side pocket or similar arrangements (including in vehicles such as SPVs), which should be aggregated with same series/class portfolio strategy

General Form PF Requirements (cont’d)

Who Completes Which Form PF Sections?− Section 1a and Section 1b – All private fund advisers− Section 1c – Private fund advisers that advise one or more hedge funds− Section 2 – Large hedge fund advisers− Section 3 – Large liquidity fund advisers− Section 4 – Large private equity advisers

Large” Fund Adviser Thresholds:− Large Hedge Fund Advisers = at least $1.5 billion in RAUM attributable to

hedge funds as of the end of any month in the prior fiscal quarter− Large Liquidity Fund Advisers = at least $1 billion in RAUM attributable to

liquidity funds and registered money market funds as of the end of any month in the prior fiscal quarter

− Large Private Equity Fund Advisers = at least $2 billion in RAUMattributable to private equity funds as of the end of any month in the prior fiscal quarter

CPO/CTA Registration and RelatedRegulatory Update

Remaining Available Exemptions CFTC Regulation 4.13(a)(3) – Conditions:

− Pool interests exempt from 1933 Act registration− No marketing to the public in the United States or as a

vehicle for trading commodity interests• Impact of JOBS Act on CFTC Regulation 4.13(a)(3) pool

offerings− Investors must be “accredited investors,” family trusts,

“knowledgeable employees,” qualified eligible persons (“QEPs”), certain persons associated with the CPO, and“Non-United States persons”

− Must reaffirm notice annually

Remaining Available Exemptions (cont’d) Subject to trading limitations:

− 5% Test• Aggregate initial margin and premiums required to establish

commodity interest positions may not exceed 5% of the “liquidation value” of the fund’s portfolio, taking into account unrealized profits and unrealized losses

− 100% Net Notional Test• Aggregate net “notional value” of commodity interest positions

may not exceed 100% of the liquidation value of the fund’s portfolio, taking into account unrealized profits and unrealized losses

− Measured each time a new position is established

Remaining Available Exemptions (cont’d)

CFTC Regulation 3.10(c)(3)(i) Conditions:

− CPO is a non-U.S. person− Fund is a non-U.S. person− Directors (or at least a majority) are non-U.S. persons− Investors are all non-U.S. persons− No definition of non-U.S. person for purposes of this rule− Commodity interest transactions executed bilaterally or on

or subject to the rules of a designated contract market or swap execution facility must be submitted for clearing through a registered futures commission merchant (“FCM”)

CFTC Regulation 4.7(b) – Exemption for Persons That Operate Pools Composed Solely of “QEPs”

CFTC Regulation 4.7(b) provides an exemption from almost all the disclosure, reporting, and recordkeeping requirements otherwise applicable to registered CPOs

However, this exemption is available only to a registered CPO and only with respect to a pool composed solely of persons that the CPO “reasonably believes” are QEPs

Under CFTC Staff FAQ, do not need to requalify existing investors Furthermore, the pool must be sold in an offering exempt from the

registration requirements of the 1933 Act pursuant to Section 4(2) (for example, under Rule 506 of Regulation D) or Regulation S

These pools may not be marketed to the public− So CFTC Regulation 4.7(b) “exempt” pools cannot engage in general

solicitation under the JOBS Act

CFTC Regulation 4.7(b) – Compliance Obligations File notice before the date any offer or sale of any participation in the

exempt pool is made to obtain all of the relief Regulation 4.7(b) provides Quarterly reports within 30 days of quarter-end Annual reports within 90 days of year-end (180 days for funds-of-funds)

− No ability to waive − Recordkeeping – CPO must maintain:

• Reports listed above• All books and records prepared in connection with its activities as CPO of the

exempt pool (including, without limitation, records relating to the qualifications of QEPs and substantiating any performance representations) at its main business address

CPO must make such books and records available to any representative of the CFTC, the National Futures Association (“NFA”) and the Department of Justice (“DOJ”)

Supervisory Procedures for Associated Persons (“APs”)

Procedures should cover: − Hiring policies− Registration− Customer information− Account activity− Discretionary accounts− Promotional material− Customer complaints− Ongoing training

Should consider listening to sales pitches and reviewing trading in customer and employee accounts

NFA Bylaw 1101 “Self-policing” mechanism that requires that registered CPOs and

CTAs transact business only with persons who are:− NFA members (FCMs, introducing brokers (“IBs”), CPOs, CTAs, swap

dealers (“SDs”), major swap participants (“MSPs”)) or − Exempt from registration or not required to be registered

Impacts fund managers primarily in four ways:− Affects their due diligence process with their own investors and/or clients− Affects their due diligence process with underlying managers (if a fund of

funds)− Affects their FCM, IB, and SD relationships − Affects their use of solicitors

CPOs of registered funds do not need to conduct NFA Bylaw 1101 diligenceon fund investors

NFA Bylaw 1101 (cont’d) The CFTC has proposed a new regulation that would

require all persons registered with the CFTC as IBs, CPOs, and CTAs to become members of at least one registered futures association (i.e., NFA)

Promotional Materials and Solicitation Need written marketing materials review procedures Appropriate supervisory personnel must approve, in

writing, each piece of promotional material Review should be performed by someone other than the

person who prepared the piece Maintain records of each piece and its approval, including

spreadsheet indicating how performance numbers are calculated

NFA is currently accepting substituted compliance for registered fund marketing materials, with respect both to content and review procedures

Promotional Materials and Solicitation (cont’d) CFTC and NFA have specific guidance regarding:

− Testimonials (CFTC Regulation 4.41)− Hypothetical or simulated performance (NFA Compliance

Rule 2-29) (does not apply to CFTC Regulation 4.7 pools and/or accounts)

− If possibility of profit is mentioned, must also mention risk of loss

− If performance is included, must say past performance is not necessarily indicative of future results

− Performance must be calculated consistent with CFTCguidance (but can continue to show gross of manager fees performance in one-on-one presentations generally consistent with SEC guidance)

Bunching/Allocation of Trades CFTC Regulation 1.35(b)(5) permits CTAs to submit bunched orders

(without identifying specific discretionary clients) Orders may be allocated post-execution if:

− Allocation is made as soon as practicable after execution and no later than sufficiently before end of trading day to permit clearing records to identify the ultimate customers

− Fair and equitable allocation− Sufficiently objective and specific to permit independent verification by the

CFTC, NFA, and outside auditors No affirmative disclosures required, but should disclose whether

proprietary accounts are included− Must disclose if asked− Must provide composite or summary data to allow client to compare

results of executions− Best practice is to disclose in PPM and/or Form ADV

CPO may also rely on this guidance if it also executes trades

Customer Complaints Procedures should cover:

− Name of individual responsible for handling customer complaints

− Types of records to be maintained in customer complaint file− Process to be followed by responsible individual for

determining whether disciplinary action is required Keep a log including names of customer and personnel

involved, time frame, description of complaint, and description of resolution

If complaint is settled, keep settlement agreement in file

Branch Offices Branch office: Any location, other than the main business

address, at which a CPO or CTA employs persons engaged in activities requiring AP registration− Even if only one employee

Each branch office must have a branch office manager Branch office manager must pass Series 30 examination

unless sponsored by a registered broker-dealer and qualified to act as a branch office manager or designated supervisor under FINRA’s rules

Branch office manager must supervise the APs located at his or her branch office

CPO/CTA Self-Examination Checklist Must complete annually general section and

supplemental section relating to registration category (CPO, CTA, FCM, or IB)

Must be signed and dated by appropriate supervisory personnel

Separate attestation for each branch office SEC annual review is not sufficient

Annual Questionnaire and Ethics TrainingAnnual Questionnaire: Completed online Must be done at least annually on the anniversary of NFA

membership date Should be updated as business changesEthics Training: CPO/CTA can determine frequency, duration, and

provider Still need a policy Need to keep records of program, date, name of provider,

and personnel who attended

Larger Trader Reporting/Position Limits Form 40 (for futures and options) and Form 40S (for

swaps) There are position limits for futures and options on

certain agricultural commodities− CFTC recently reproposed limits for additional agricultural

commodities and certain exempt commodities that incorporate swaps that are economically equivalent

− Exchanges are aggressively enforcing their position limits Trading by certain persons is aggregated

Anti-Money Laundering and Part 162 (Red Flags) CPOs/CTAs are not currently required to adopt “know your customer”

procedures Must comply with Office of Foreign Assets Control directives,

including checking Specially Designated Nationals and Blocked Persons list

CPOs and CTAs must have red flags procedures for:− Accounts offered or maintained primarily for personal, family, or

household purposes that involve or are designed to permit multiple payments or transactions (i.e., accounts held for individuals); and

− Any other account that the financial institution or creditor offers or maintains for which there is a reasonably foreseeable risk to customers or to the safety of soundness of the financial institution or creditor from identity theft

Virtually identical to SEC red flags rule

Business Continuity Plans NFA will expect CPO/CTA to have a business continuity

or disaster recovery plan and to test it periodically Should not generally need to have something different

than what is acceptable to the SEC Under NFA Compliance Rule 2-38(b), must provide NFA

with name and contact information for an individual that NFA can contact in an emergency, as well as a backup individual

These persons must be authorized to make key decisions in an emergency

Swaps Recordkeeping A party to a swap that is neither an SD or an MSP was required to begin

complying with recordkeeping requirements for swaps as of 10 April 2013 Non-SDs/MSPs must “keep full, complete, and systematic records, together

with all pertinent data and memoranda, with respect to each swap” Also, certain recordkeeping requirements for “historical swaps”

− “Pre-enactment swaps” – swaps that were entered into prior to the enactment of Dodd-Frank on 21 July 2010 and remained open as of that date (even if now closed)

− “Transition swaps” – swaps entered into on or after 21 July 2010 and prior to the 10 April 2013 compliance date

Non-SD/MSPs may keep records in either paper or electronic form so long as they are retrievable and reportable as required

For all swaps – maintenance of records throughout the existence of the swap and for five years following expiration of the swap

Non-SDs/MSPs must be able to retrieve records within five business days throughout retention period

Form 7-R/8-R Updating Must be done annually Amend promptly to correct deficiencies or inaccuracies Track new principals and APs File Form 8-T when principal or AP leaves – within 30

days

Forms CPO-PQR and CTA-PR CFTC adopted CFTC Regulation 4.27(d), which

establishes new reporting requirements with respect to commodity pools:− Requires CPOs and CTAs to report certain information to the CFTC on Forms

CPO-PQR and CTA-PR, respectively− CPOs dually registered with the SEC and CFTC that file Sections 1 and 2 of Form

PF, as applicable, must generally file Schedule A of Form CPO-PQR only− Non-dually registered CPOs must file all relevant sections of Form CPO-PQR

based on certain reporting thresholds− All CTAs, regardless if SEC-registered, must complete Form CTA-PR annually− Only file Form CPO-PQR for funds for which firm is acting as a registered CPO (no

reporting with respect to CFTC Regulation 4.13(a)(3) or 4.5 funds)− Both forms must be filed via NFA’s EasyFile System− Beginning with forms due 30 June 2013, CPOs can use XML upload in EasyFile,

which should significantly reduce the amount of data entry necessary for each filing

Form NFA-PQR Requires each CPO NFA Member to file Form NFA-PQR

quarterly for each pool it operates and for which it has any reporting requirement under CFTC Regulation 4.27− Except for cover page question regarding total pool assets,

do not generally need to include pools for which the CPO can rely on Regulation 4.13(a)(3) exemption

Provides that each CPO NFA Member that is required to file Form CPO-PQR quarterly does not need to file Form NFA-PQR− If CPO only has annual reporting requirement with CFTC,

must still file Form NFA-PQR quarterly Filed via NFA’s EasyFile System

Form NFA-PQR (cont’d) All registered CTAs must file Form NFA-PR quarterly

within 45 days from end of quarter Filed via NFA’s EasyFile System

CPO Delegation CFTC staff takes the view that the CPO of

− a corporate fund, is its board members− a limited partnership or limited liability company fund is its

general partner or managing member/manager This position does not apply to registered investment

companies Under CFTC Staff Letter No. 14-69 (12 May 2014),

delegating CPOs must get individualized no-action relief to delegate the CPO function to the designated CPO(usually the investment manager)

Staff Letter creates a procedure to get no-action relief

Staff Letter – Conditions CPO function and investment management function are

delegated to the designated CPO pursuant to a legally binding document

Delegating CPO does not participate in solicitation or portfolio management activities for the pool (even if registered as an AP of the designated CPO)

Designated CPO is registered as a CPO Business purpose for delegation – not just to avoid

registration Books and records of the delegating CPO with respect to

the commodity pool are maintained by the designated CPO in accordance with CFTC Regulation 1.31

Staff Letter – Conditions (cont’d) If delegating and designated CPOs are not natural

persons, must be “affiliates” Joint and several liability only for delegating CPOs and

affiliated natural person delegating CPOs (management directors), but not for independent directors

Staff Letters – Issues Management board members cannot be involved in

solicitation or portfolio management Potential solutions:

− Reconstitute the Board− Apply for no-action relief outside of the Staff Letter− Register the natural person directors as CPOs individually

Delegation of investment management function Keeping books and records of the delegating CPO in

accordance with CFTC Regulation 1.31

“Covered Funds” Under the Volcker Rule

The Volcker Rule The Volcker Rule applies to:

− “Banking entities”: FDIC-insured depository institutions, companies that control FDIC-insured depository institutions, bank holding companies, and savings and loan holding companies

− “Foreign banking organizations”: foreign banks that engage in banking activities in the United States, such as • Operating a branch or agency office in the United States; • Controlling an FDIC-insured U.S. subsidiary bank; or• Any affiliates of the above entities

− Other entities associated with either of the above

The Volcker Rule (cont’d) All banking entities must be in conformance with the

Final Rule by 21 July 2015 Regulatory Agencies responsible for writing the Final

Rule, which was adopted in December 2013, and enforcing it:− The Federal Reserve Board, which has individual authority

to grant or deny extensions of the compliance period− Office of the Comptroller of Currency− Federal Deposit Insurance Corporation− SEC− CFTC

The Volcker Rule (cont’d) No grandfathering past the conformance date; all

entities must be in compliance by then Individual extensions may be granted on a case-by-

case basis for up to two one-year periods or up to 5 years for divesting investments in illiquid funds

The Volcker Rule’s Purposes

The Final Rule primarily:− Bans proprietary trading, with exceptions;− Limits banking entities from acquiring or retaining an

investment in, or “sponsoring,” “covered funds”; and− Prohibits various transactions with a private equity or hedge

fund if the banking entity is the fund’s sponsor, investment adviser, CPO or investment manager, or if the banking entity “organized and offered” the fund (also known as “Super 23A & B” restrictions)

Trading Outside the United States §___6(e) Foreign banking entities can trade as principal if

those transactions are “solely outside the United States,” which means that: − The banking entity’s personnel who “arrange, negotiate or

execute” the trade are not located in the United States;− The banking entity itself is not located in the United States

or organized under U.S. law;− The banking entity or its branch, affiliate, or subsidiary

located in the United States does not trade as principal;

Trading Outside the United States §___6(e) (cont’d)

− The banking entity or its branch, affiliate, or subsidiary located in the United States does not finance the trade; and

− No entity located or organized in the United States, including branches of foreign banks in the United States or entities controlled by another U.S. entity, conducts the trade, except:• A U.S. entity’s foreign operations may conduct the trade if no

U.S. personnel are involved; and• Foreign banking entities may use a market intermediary

located in the United States as: The trade’s principal, as long as the transaction is followed by

the prompt clearing and settlement; or An agent to effect an anonymous trade as long as there is

prompt clearing and settlement of the trade

The Effects of §_.6(e)

Foreign banking entities can trade with a U.S. entity’s non-U.S. operations, if no U.S. personnel are involved in the trade

The definition of U.S. entity reaches U.S.-based broker-dealers and other U.S.-based affiliates, so foreign banking entities must avoid trading with those entities

Trading Sovereign Debt §_.6(a & b) The ban on proprietary trading has several

exclusions for trading sovereign debt:− Foreign and U.S.-based banking entities are allowed to

proprietarily trade U.S. government obligations − Foreign banking entities are allowed to proprietarily trade

the obligations of the country under which they were organized, such as:• Obligations of a multinational central bank where the foreign

sovereign is a member, and• The foreign sovereign’s agency or political subdivision’s

instruments − Not exempt: a foreign banking entity’s U.S.-based and

FDIC-insured entity

Trading Sovereign Debt §_.6(a & b) (cont’d) Permitted U.S. obligations:

− Obligations issued or guaranteed by the United States − Obligations, participations, or other instruments issued or

guaranteed by a U.S. agency or certain government-sponsored enterprises

− Obligations of any state, political subdivision, or municipality, and

− Obligations directly or indirectly issued by the FDIC

Sponsoring Covered Funds §_.13(b) Foreign banking entities may “sponsor” a “covered fund”

if that activity occurs solely outside the United States (“SOTUS”)

“Covered funds” under the Final Rule include:− Entities that fall under Sections 3(c)(1) and 3(c)(7) of the

1940 Act− Commodity pools under Section 1a(10) of the CEA− Certain foreign funds if sponsored, managed, or organized

by U.S. banking entities− Exemptions from “covered funds” include securitization vehicles

that rely on 1940 Act exemptions of Rule 3a-7 or Section 3(c)(5); foreign public funds (such as UCITs); and foreign pension or retirement plans

Sponsoring Covered Funds §_.13(b) (cont’d) Sponsor” includes any:

− Covered fund’s general partner, managing member, or trustee (with exceptions) that has investment discretion or a covered commodity pool’s operator;

− Entity that selects or controls a majority of a covered fund’s directors, trustees, or management; or

− Entity that shares the same or a variation of a covered fund’s name

Sponsoring Covered Funds §_.13(b) (cont’d) “Ownership interest”: any equity, partnership, or “other

similar interest” in a covered fund − Excludes:

• Generally, any debt security unless the debt “exhibits specific characteristics that are similar to those of equity or other ownership interests”

• “Restricted profit interests”: where a banking entity has an interest in a covered fund and the entity or the entity’s employee serves a covered fund in some capacity with the purpose of sharing in the profits of the covered fund as performance compensation for such services

Sponsoring Covered Funds §_.13(b) (cont’d) Inclusions:

− Cash collateral pools, pass-through REITs, municipal securities tender option bond vehicles, venture capital funds, credit funds, and employee securities companies

− Also financial market utilities -- examples: securities clearing agencies, derivatives clearing organizations, securities exchanges, derivatives board of trade, and alternative trading systems

Sponsoring Covered Funds §_.13(b) (cont’d)

Exclusions:− Securitization vehicles:

• Entities that are not investment companies• Entities that rely on other exemptions under the 1940 Act (Ex:

Rule 3a-7)• Loan securitization vehicles• Asset-backed commercial paper conduits• Collateral pools for covered bonds

Sponsoring Covered Funds §_.13(b) (cont’d)− Pooled investment vehicles:

• U.S.-registered investment companies• U.S. business development companies• Foreign public funds • Foreign pension or retirement plans• Funds that rely on another exemption under the 1940 Act• Public welfare funds and small business investment

companies− Corporate structure vehicles:

• Wholly owned subsidiaries

Sponsoring Covered Funds §_.13(b) (cont’d)• Joint ventures• Acquisition vehicles

− Other: insurance company separate accounts (that are not for the benefit of a banking entity other than the insurance company), bank-owned life insurance (“BOLI”), and issuers formed by or on behalf of the FDIC for the purpose of facilitating the disposal of assets acquired in the FDIC’s capacity as a conservator or receiver

Exemption: Foreign Public Funds (§_.10(c)(1))

Foreign public funds are exempt from the Volcker Rule Foreign public funds are issuers that:

− Are organized or established outside the United States;− Are authorized to offer and sell interests to retail investors in

its country of origin; and− Sell interests predominately through public offerings outside

the United States (predominately = 85%) Examples: UCITS, non-U.S. mutual fund equivalents,

foreign exchange-traded funds, foreign unit trusts, and non-U.S. issuers of asset-backed securities

Investing in Covered Funds Outside the United States (§_.13(b)) Foreign banking entities may acquire or retain an ownership interest in

covered funds as long as that activity takes place SOTUS, which means: − The banking entity is not organized under U.S. law, located in the

United States, or controlled by a U.S. entity located or organized in the United States;

− The banking entity and its relevant personnel investing in a covered fund are not located in the United States;

− The investment or sponsorship principal is not a foreign banking entity’s U.S.-based branch or affiliate or organized under U.S. law;

− None of the financing for the investment or sponsorship is provided by a foreign banking entity located in the United States or organized under U.S. law; and

− The banking entity must take reasonable steps to ensure that ownership interests in the covered fund are not offered to U.S. persons

“Super 23A & B” Restrictions− Prohibits various transactions with a private equity or hedge

fund if the banking entity is the fund’s sponsor, investment adviser, or investment manager, or if the banking entity “organized and offered” the fund

− No geographical limitation− However, if a would-be “covered fund” falls under the

SOTUS exemption, then presumably foreign banking entities can transact with it without implicating the Volcker Rule

Reporting Requirements (§_.20(d))

− Foreign banking entities that engage in proprietary trading in the United States will have to submit reports to various U.S. government agencies about their affiliated entities operating in the United States or organized under U.S. law

− Affects foreign banking entities whose U.S. operations gross at least $50 billion • Initial filing must be within 30 days of the 21 July 2015

conformance date• Starting in January 2016, foreign banking entities must file

within 10 days• The reporting threshold will decrease in the future to amounts

lower than $50 billion

Noncompliance Certain compliance provisions concentrate on a

foreign banking entity’s U.S. assets − Entities with assets less than $50 billion must adopt

standard compliance procedures− Entities with assets greater than $50 billion and companies

that are subject to reporting requirements must adopt “enhanced” compliance• This includes annually affirming via a “CEO attestation” that

compliance procedures are in place and have been reasonably maintained, enforced, reviewed, tested, and modified

Noncompliance (cont’d)− Foreign banking entities that do not employ Volcker Rule

activities are required to adopt compliance procedures only prior to engaging in any Volcker Rule activities

− Does not apply to funds that are SOTUS

Some compliance provisions consider an entity’s total global assets− All entities (U.S.-based and foreign) with greater than

$10 billion in assets must retain documents explaining why funds that it sponsors, acquires, or retains an ownership interest in are not “covered funds”

SEC/UK Enforcement Cases

In the Matter of Steven A. Cohen (SEC, 19 July 2013) The SEC charged hedge fund adviser Steven Cohen for failing to

supervise two senior employees and prevent them from insider trading under his watch

The SEC alleged that he received suspicious information that should have caused a reasonable hedge fund manager to investigate the basis for trades made by two portfolio managers who reported to him; instead of scrutinizing their conduct, he rewarded one with a $9 million bonus

The SEC said, “After learning about red flags indicating potential insider trading by his employees, Steven Cohen allegedly failed to follow up to prevent violations of the law”

Eight former or current SAC employees have been charged with insider trading, six of whom have pled guilty, and two of whom were convicted

Cohen settled the SEC case and transformed SAC Capital into a “family office” that manages only Cohen’s money

SEC v. Mark Megalli (N.D. Ga., 14 Nov. 2013) Allegation that adviser to hedge fund manager traded

shares of Carter’s Inc. based on material nonpublic information from Carter’s former Vice President of Operations

The adviser had retained the former Carter employee as a consultant, after which he allegedly began providing Megalli with material nonpublic information regarding Carter’s anticipated financial results

Megalli allegedly then directed the adviser to trade on that information

Criminal charges have also been brought

In the Matter of Thomas E. Meade (SEC, 11 June 2014) Cease and desist against a CCO for failure to prevent,

detect or respond to insider trading by a vice president Vice president’s father served on the board of a public

company SEC alleged that the CCO failed to design adequate

compliance policies and procedures, to collect and review personal trading by employees, and to maintain restricted or watch lists

Even after he learned of insider trading by company, no investigations were conducted by him

Industry bar; $100,000 fine

In the Matter of Credit Suisse Group AG (SEC, 21 Feb. 2014) The SEC charged Swiss firm with violating the federal

securities laws by providing cross-border brokerage and investment advisory services to U.S. clients without registering with the SEC

Credit Suisse had to admit wrongdoing, pay $196 million to settle and hire an independent consultant

These services started in 2007; many trips to the United States; 8500 U.S. client accounts; $85 billion in assets

Lack of internal controls Were aware of issue in 2008 (as a result of UBS case)

but took until mid-2013 to exit the business

In the Matter of GLG Partners, Inc. (SEC, 12 Dec. 2013) The SEC charged a London-based hedge fund adviser

and its former U.S.-based holding company with internal controls failures that led to the overvaluation of a fund’s assets and inflated fee revenues for the firms

The charges related to allegedly inadequate policies and procedures around the $425 million valuation assigned to a position in a coal company; in particular, there were inadequate policies to ensure that relevant information was provided to the independent pricing committee and there was confusion about who was responsible for elevating issues to the independent pricing committee

GLG agreed to pay nearly $9 million to settle

In the Matter of A.R. Schmeidler & Co. (SEC, 31 July 2013) The SEC charged a dually registered investment adviser and broker-

dealer with violating its duty to provide best execution to its advisory clients when it negotiated more favorable terms with its clearing firm

The negotiation with the clearing firm resulted in the adviser retaining a greater share of the commissions it received from clients

The SEC said, “Investment advisers must carefully analyze whether their clients are obtaining the most beneficial terms reasonably available for their orders, particularly if those orders are executed through affiliated broker-dealers”

ARS agreed to pay more than $1 million to settle

In the Matter of Navigator Money Management, Inc. and Mark Grimaldi (SEC, 30 Jan. 2014) The SEC charged a New York-money manager and his firm with making

misleading claims about the success of their investment advice and a mutual fund that they managed

For example, they stated that their Sector Rotation Fund was ranked no. 1 out of 375 World Allocation funds tracked by Morningstar; but the time period they picked, October 13, 2010 to October 12, 2011, was “cherry-picked” and did not reflect their performance in other periods

In addition, the SEC said that the adviser’s claim that it was a “five-star (Morningstar) money manager” was misleading because Morningstar rates funds rather than investment managers

The SEC said that the claim that the adviser’s model portfolios “doubled the S&P 500 in the last 10 years” was misleading because the adviser was not involved in the model portfolio performance for the first three years

The adviser settled by paying a penalty of $100,000 and agreeing to certain undertakings, including the retention of an independent compliance consultant for three years

SEC Charges Three Firms With Violating Custody Rule (SEC, 28 Oct. 2013) The SEC charged Further Lane Asset Management, GW and Wade, and

Knelman Asset Management Group with violating the “custody rule” Although most advisers do not maintain custody of client assets, advisers

must comply with the custody rule if they have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets

They also must have a reasonable basis to believe that a qualified custodian is sending account statements to fund investors at least quarterly

The SEC found that the three advisers failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct surprise exams

The matters were settled

In the Matter of Clean Energy Capital, LLC (SEC, 25 Feb. 2014) The SEC charged a private equity fund manager and his

investment advisory firm with misallocating expenses to the funds they managed

The SEC alleged that the adviser paid more than $3 million of the firm’s expenses by using assets from 19 private equity funds; expenses included rent, salaries, employee benefits, and bonuses, and were in addition to management fees

The adviser did not disclose that it was charging these expenses to the funds

The SEC said, “Private equity advisers can only charge expenses to their funds when they clearly spell that out for investors”

In the Matter of Transamerica Financial Advisors (SEC, 3 Apr. 2014) The SEC charged the investment adviser with improperly

calculating advisory fees and overcharging clients The adviser offered breakpoint discounts to reduce the fees

that clients owed the firm when they increased their assets and permitted clients to aggregate the values of related accounts

The SEC found that the adviser failed to process some of the aggregation requests and had conflicting policies on when clients were entitled to breakpoint discounts

The adviser reimbursed 2,304 current and former clients and paid a penalty of $533,624 to settle

In the Matter of Paradigm Capital Management, Inc. and Candace King Weir (SEC, 16 June 2014) Retaliation against a Dodd-Frank whistleblower Weir caused Paradigm to engage in principal transactions with a

broker-dealer affiliated with Weir without obtaining client consent Whistleblower, Paradigm’s head trader, made a voluntary

whistleblower submission to the SEC Once Paradigm found out about reporting, he was removed as

head trader, asked to prepare a report, and then denied access to certain computer systems at the firm; ultimately Paradigm refused to return him to the position of head trader and otherwise marginalized him

$1,700,000 payment to investors plus interest, retention of independent compliance consultant, $300,000 civil penalty, cease-and-desist orders against Paradigm and Weir

FCA Enforcement 2013/14 Credible Deterrence Market Abuse Insider Dealing Criminal Prosecution Higher Fines More Prohibitions Senior Management

FCA Enforcement 2013/14 (cont’d) Impact of wholesale firms on consumer outcomes Remuneration - not to incentivise poor consumer

outcomes Open and Co-operative

klgates.com159

FCA Enforcement 2013/14 (cont'd)Once again more cases on… CASS client money - £10.275 million

(reduced to £7.192 million after 30% discount) Anti-money laundering controls - £10.915 million

(reduced to £7.640 million after 30% discount) More thematic and enforcement work

Anti-bribery controls - £2.684 million (reduced to £1.876 million after 30% discount)

Transaction reporting - £8.029 million (reduced to £5.62 million after 30% discount)

Prohibition OrdersAnthony Verrier Prohibition Order Civil litigation findings Not fit and proper due to concerns over integrity

David Hobbs Prohibition Order Tribunal found him not guilty of market abuse Not fit and proper – “lacking in integrity” because of

responses to FSA in investigation

Senior ManagementGatekeepers – Compliance Officer David Davis Broker’s Senior Partner and CF10, CF11 Goenka Trades in the final seconds of the LSE closing auction Suspicious per compliance manual No STR £94,816 (reduced 30% to £66,371) plus £3,442

disgorgement Prohibition from CF10, CF10a, CF11

Invesco Asset Management Limited

Invesco Asset Management Limited / Invesco Fund Managers Limited: Final Notice on 24 April 2014

£26.32 million financial penalty (reduced to £18.643 million after 30% discount)

Investor protection Disclosure Prospectus Simplified Prospectus/KIIDs

Systems and controls Order allocation Valuation

Invesco Asset Management Limited

Final Notice at 4.22“Investments in the Fund may include financial derivative instruments. Such instruments may be used to obtain, increase or reduce exposure to the underlying assets and may create gearing: therefore their use may result in greater fluctuations of the Net Asset Value of the Fund. The Manager will ensure that the use of derivatives does not materially alter the overall risk profile of the Fund.”

Market Abuse: Improper DisclosureIan Hannam v FCA

Chairman of Capital Markets and Global Co-Head of UK Capital Markets

s118(3) FSMA - two alleged improper disclosures of inside information to third parties “update you on discussions … ongoing with a potential

acquirer of … business … engaging … Thursday of next week … they are very excited about the recent drilling results of Heritage Oil … I believe that the offer will come in … at £3.50-£4.00 per share” “PS – Tony has just found oil and it is looking good”

Ian Hannam v FCA (cont’d)Contentions Not inside information Can’t be inside information because of DTR

Disclosed in the proper course of employment Section 123(1) FSMA FCA “satisfied that [he] believed, on reasonable

grounds, that his behaviour did not … amount to his engaging in market abuse”

Ian Hannam v FCA (cont’d)

“We consider that it could never be in the proper course of a person’s employment for him to disclose inside information to a third party, where he knows that his employer and client would not consent to the public disclosure of that information, unless he knows that the recipient is under a duty of confidentiality and that he knows that the recipient understands that to be the case.”

FCA Enforcement 2014Upper Tribunal upheld FSA decision Penalty pending (Financial penalty of £450,000 in FSA final notice of 2012)

FCA Enforcement 2014

International co-operation – U.S. Consumer outcomes Senior management/ Approved persons/Gatekeepers Continued enthusiasm for enforcement action

Questions

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