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