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 Boston
Robert Hadley, Partner, London
8 July 2014
DC #9803012v5
© Copyright 2014 by K&L Gates LLP. All rights reserved.
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
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Private Offerings of Non-U.S. Funds to
U.S. Investors
Choices
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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):
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50% or less of its outstanding voting securities are held by U.S. residents; OR
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If more than 50% of its outstanding voting securities are held by U.S. residents and none of the
following three circumstances applies:
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•
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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)
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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 Section
3(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 or
private 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
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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
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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
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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
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Issuer is disqualified from relying on Rule 506 exemption if any of its “covered
persons”:
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Unless:
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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
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
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Securities are no longer “covered securities” under Section 18(b) of the 1933 Act
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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:
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•
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):
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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?
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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)
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Disqualifying Events include:
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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 Investment
Adviser 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:
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“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 nonU.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)
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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:
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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
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What are the potential consequences of the conflict? How could a client be harmed?
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How firm handles the conflict? Eliminate it, mitigate it, disclose it? Must summarize
procedures for dealing with conflicts
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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
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Conflicts include but are not limited to those related to compensation, allocation, trading,
dealings with affiliates, conflicts among client interests, personal and proprietary trading
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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:
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Untrue statements of material fact and material omissions
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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):
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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:
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A standard of business conduct
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Compliance with applicable federal securities laws – e.g.,
insider trading
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Reporting violations of code of ethics and any actions
taken against violators
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Providing supervised persons with a copy of code of ethics
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Address personal securities transactions
− Quarterly reporting of personal securities transactions and initial and
annual holding reports of “access persons”
− Pre-approval of certain transactions
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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:
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Are registered or required to be registered under the
Advisers Act
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Advise one or more “private funds” – issuers exempt from
registration under 1940 Act Sections 3(c)(1) or Section
3(c)(7) and
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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?
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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 RAUM
attributable to private equity funds as of the end of any month in the prior
fiscal quarter
CPO/CTA Registration and Related
Regulatory 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 diligence
on 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 CFTC
guidance (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 Training
Annual Questionnaire:
 Completed online
 Must be done at least annually on the anniversary of NFA
membership date
 Should be updated as business changes
Ethics 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-bycase 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 brokerdealer 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)
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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
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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
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SEC Charges Three Firms With Violating Custody Rule
(SEC, 28 Oct. 2013)
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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
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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
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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 Orders
Anthony 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 Management
Gatekeepers – 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
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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 Disclosure
Ian 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 2014
Upper 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
klgates.com