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Regulatory Update 2009
Todd Cipperman, Esq.
Kreischer Miller
Annual Investment Industry Update
December 9, 2009
Nothing herein should be construed as legal advice.
This presentation may constitute an advertisement under U.S. law.
Cipperman Compliance Services is not a law firm and does not render legal advice.
SEC Enforcement
Regulatory “Reform”
Pay-to-Play and Solicitors
Conflicts of Interest
Insider Trading
Personal Liability
Compliance Programs
Proxy Voting
Hedge Funds
Mutual Funds
 Complicit actors
– IT pros (SEC v. O’Hara and Perez)
• Programs to produce false reports
• SEC must prove knowledge for aiding/abetting
• What are the “ill-gotten gains”?
– Solicitor (SEC v. Cohmad Securities)
• Solicitor liable for aiding/abetting advisor’s failure to disclose solicitation
payments under Rule 206(4)-3
• See also In re Cohmad Securities: Mass. revokes BD registration before hearing
after defendants invoked 5th Amendment rights
– Audit Firm: allowed use of financials (SEC v. Friehling and Horowitz)
– Manager of feeder funds (In re Fairfield Greenwich (Mass.))
• Failure to conduct due diligence described in offering docs
• Blaming the victim?
 Sweep exams: affiliate-held assets, smooth/large returns, unknown
 OCIE will contact clients to verify assets
 Proposal to require surprise exams to verify assets
– Invoice clients for fees
SEC Enforcement
 Schapiro stresses Enforcement and new toughness
– Bob Khuzami – former prosecutor
– Increased enforcement activity through 9/30
• 448 vs. 181 enforcement cases
• $1.8 BN v. $865 MM in disgorgements/penalties
 Prosecutorial tactics
– Enforcement may open cases without full Commission approval
– Enforcement has power to issue subpoenas without approval
– Use of plea deals in exchange for cooperation
– Taping telephone conversations
 5 new specialized enforcement units including Asset Management Unit
 SEC increases maximum enforcement penalties
 SEC gets bigger budget
 SEC may consider administrative action while pursuing civil action i.e.
acting as prosecutor and judge (In re Vancook)
Regulatory “Reform”
 Expand SEC authority: fiduciary standard, point-of-sale disclosure,
compensation practices
 Proposals to register hedge fund advisers and disclose hedge fund info
– Impact on state regulators
– <15 clients?
– Venture capital?
 Regulation of derivatives
 SEC/CFTC harmonization: fiduciary standard, point-of-sale disclosure,
performance reporting for CTAs and FCMs (or one regulator?)
Fiduciary standard for brokers (Who will be the regulator?)
Protecting and rewarding whistleblowers
Schapiro wants 40 Act for ABS
More disclosure for target date funds
Summary prospectus for variable insurance products
Cf. American Equity v. SEC: SEC prohibited from regulating equity
indexed annuities
Pay-to-Play and Solicitors
 Public Plans and Rule 206(4)-3
 New York Common Fund
– Code of Conduct/Proposed legislation: No solicitors, campaign contribution
restrictions, disclosure, certifications, etc.
– 4 private equity firms returned $4.5 Million in fees
– SEC suit (SEC v. Morris et. al.)
• Money manager paid solicitors that didn’t perform services; Solicitors aided and
• Note: Rule 206(4)-3 does not require the performance of services, only disclosure
 SEC Proposal
– No solicitors for public plans, government employee retirement plans, 529 plans
– No campaign contributions to pols in position to influence the selection of the adviser
 State Codes of Conduct (e.g. Illinois requires extensive disclosure of anybody
bidding on a state contract worth more than $50,000)
 BD pays $75 Million/forfeits $647 in swap fees for failing to disclose payments
made to locally connected firms to win muni business (In re JP Morgan Securities)
– Recipients performed no services
– Disclosure may not have made a difference
 SEC Claims that wholesaling and marketing support create obligation to register
as BD (SEC v. Big Apple Consulting)
– Respondent took below-market stock as compensation
Conflicts of Interest
 Wrap Programs: Wrap sponsor fined/censured for recommending
money managers that didn’t go through due diligence process (In re
Morgan Stanley)
– Kickbacks via brokerage commissions and referred clients
 Commission Recapture: Advisor (to fund) ordered to pay over $34
Million because affiliated broker took 80% of recapture program (In re
Value Line)
– CEO and CCO also fined and censured
– SEC charges that BD must provide some execution, clearing or settlement
 Net Trading: Hedge fund traders used net trading to conceal higher
commission and personal benefits (SEC v. Travis)
 Pension Consulting: Pension consultant recommended affiliate directed
brokerage and transition management programs (In re Merrill Lynch)
 Disclosure, Disclosure, Disclosure
Insider Trading
 Hedge Funds: Hedge fund portfolio manager (SEC v.
Stephanou) received tips from investment banker
– Benefiting fund investors; See Galleon case
 Derivatives: Bond trader tipped hedge fund portfolio
manager about bond issues that would impact CDS (SEC v.
Rorech and Negrin)
– Trader earned more commissions; manager earned more fees
 Private Equity: CFO of private equity firm (SEC v. Tang)
– Firm would acquire, knew negative info
– Firm not charged: notified blackout periods and trading restrictions
 Regulation FD: Reg FD violated for negative info delivered
to analysts (In re Black)
– No personal benefit to CFO
– Reg FD as tipper enforcement tool
– Note: SEC FD Interps allow some guidance
 Open questions:
– Who has a duty?
– What is the benefit accruing to the wrongdoer?
Personal Liability
 Aiding and abetting employer’s misconduct
– CCO aided and abetted principals’ misuse of funds (SEC v. Duffy)
• Bookkeeper who wired funds, documented transfers
• CCO benefitted through salary and bonus
– In-house lawyers at Enron fined for not disclosing related party transactions
in proxy statement (SEC v. Mintz and Rogers)
– President and GC of fund admin company charged with aiding/abetting for
concealing payment to clients in exchange for Board recommendations (In re
Huber and In re Hurley (Bisys))
• SEC alleges personal benefit was bonus
– Portfolio manager falsified investment committee notes provided in response
to SEC exam request (In re Keefe)
• Anti-fraud liability for all books and records
 Primary liability
– Financial adviser jailed for selling tax shelters (U.S. v. Coplan)
– Mutual fund wholesaler arranges market timing (In re Brugman)
• Use of 10b-5 even though respondent didn’t sell securities
 Participation in unlawful activity (and personal benefit)
Personal Liability
 Privilege: Corporate officer can’t claim privilege for
statements made to lawyers conducting internal investigation
(U.S. v. Ruehle (stock-options backdating))
– Communication to audit firm broke privilege
– Resulted in criminal indictment
 No personal liability
– SEC v. Papa: Individuals not liable for failing to disclose as-of transactions
• No ongoing obligation
• No “contemporaneous assurance” to hide fraud
• Low-level employees with no personal benefit?
– U.S. v. Cioffi and Tannin: Hedge fund managers not guilty of criminal fraud
because prosecution couldn’t prove they intentionally misled investors
• SEC has lower burden of proof in civil actions
 Insurance: Corporation cannot claim under D&O policy for
acts of officers (Medical Mutual Ins. v. Indian Harbor Ins.
(disability disc.)
– D&O protects individuals not companies
– Importance of E&O policies
Compliance Programs
 IDC Task Force
– Importance of an independent CCO; benefits of outsourcing
– 5 elements: tone at the top, collaborative, customized,
transparency/communication, good people/resources
 SEC Statements
– SEC considers requiring third-party compliance reviews of big firms
– Schapiro wants CCOs to lead enterprise risk management
 CCO liability
– In re Bauman: CCO failed to implement Reg S-P P/P
• Personal records sitting in Rep’s trash
• Firm had no P/P to safeguard customer info
– In re CentreInvest: CCO banned for referring business to controlling foreign
affiliate that was not registered
• Active participation in the securities law violations
 SEC v. Envision: Firm violated 206(4)-7 by thwarting CCO’s efforts to
stop overcharging
 Fair Valuation Guidance
– SEC Declares to Congress that fair value accounting did not cause financial
– Bibliography of SEC Fair Valuation guidance (Division of Investment
– ASU 2009-12: Fund-of-funds cannot simply rely on provided NAVs
• Must add disclosure re redemption restrictions and fair value inputs
– FASB proposals
• disclose changes to Level 3 inputs
• Movement away from strict mark-to-market
– Include only Impairment in earnings
– 8 factors to determine whether market is inactive
 Fair Valuation Cases
– Money Market Fund manager sued because it falsely assured the Board and
investors that fund would maintain $1.00 NAV (SEC v. Reserve Management)
• Respondent told investment bankers that buyers would not have to
stand behind credit support agreement
– Mutual fund manager agreed to pay $40 Million for withholding pricing
information from Valuation Committee (In re Evergreen)
– Importance of a process and transparency
Proxy Voting
 Adviser fined for failing to disclose pro-union
polices to win Taft-Hartley biz (In re Intech)
 SEC allows exclusion of union proposal re
succession planning (American Capital NAL)
– Proposal related to ordinary business operations
 SEC requires funds to include shareholder
 Counting broker non-votes for quorum
(NYSE proposal)
 Regulation S-AM: limits on customer solicitation
 RIA/BD firm failed to implement anti-virus
software for contractors (In re Commonwealth Equity)
– Hacker obtained customer info
– IT Dept knew of the problem
 Model privacy notice issued by 8 regulators
– Two forms: opt-out and no opt-out
– Safe harbor
Hedge Funds
 Concealing bad performance
– SEC v. Paramount Partners: SEC uses Rule 206(4)-8 to close unregistered hedge fund
adviser that provided misleading account and performance information
– SEC v. Ponta Negra: Hedge fund/principals doctored prime brokerage statements in
response to asset verification due diligence performed by third party selling agent
 Concealing compensation: Hedge fund manager took warrants (PIPE
deals) from funds as compensation (In re M.A.G. Capital)
 Hedge Fund Distributors
– Hedge fund consultant fined for failing to conduct its own advertised due diligence
and investing in Bayou (In re Hennessee)
• No review of portfolio; No contact with auditor
• What is an advisor’s duty of diligence?
• Cf. South Cherry Street v. Hennessee: Defendant not liable for securities fraud because
no actual knowledge of fraud even though due diligence may have revealed fraud
– Class action filed against RIA for failing to perform due diligence on PPM statements
(Toomey v. Summit Retirement Advisors)
• Claim that RIA is “seller” of securities
• No special compensation i.e. commissions
– Feeder fund that invests in commodity pool must register as CPO (CFTC v. Equity
Financial Group)
• Focus on solicitation of funds to invest in commodities
– Large firm agrees to pay $200 Million for failing to register as RIA or BD even though
it solicited and maintained US clients (SEC v. UBS)
Mutual Funds
 Money Market Funds
– Credit ratings for underlying paper
– $1.00 NAV
– Weekly reporting if NAV drops below $.9975
– Reporting of holdings
– Minimum liquid assets
– Shortened WAM
 Adviser Fees
– Fund manager pays over $6 Million for charging high fees because of
principal guarantee feature (In re New York Life)
• Disclosure docs said shareholders received principal guarantee feature at no
additional cost
• Brought as a disclosure case, not a fiduciary duty case
– Standard of care in reviewing fund fees (Jones v. Harris Associates, Gallus v.
 More regulation of fund use of derivatives (Donohue speech)
Final (Discomforting) Thoughts
Madoff: Bad facts make bad law
A prosecutorial SEC
Insider trading construed broadly
Focus on personal liability
More regulation of public plans
Solicitors need to perform services
Disclosure cures many problems but not all conflicts
Need more valuation guidance
Proxy voting and Privacy remain hot topics
Adviser due diligence obligations
Money market funds
New regulatory regime in 2010
Cipperman & Company is a unique law firm devoted exclusively to the investment
management industry. Our lawyers have spent their careers in the investment
management industry, including significant experience at major industry players. Our
shared heritage and experience make our lawyers unique and creative industry partners
who can give you practical, real-world advice for making informed business decisions
and controlling your legal risk. We have worked on a wide range of transactional and
regulatory matters, but we concentrate on four core areas – Fund Formation,
Distribution, Compliance, and Technology.
Cipperman Compliance Services provides CCO and compliance outsourcing services to
registered funds and money managers. CCS develops, implements, and operates
complete and customized compliance programs that include ongoing review, testing,
management, training, and regulatory response. CCS boasts an experienced team of
seasoned investment management professionals that offer an independent compliance
perspective tailored to your business.
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150 S. Warner Road, Suite 140, King of Prussia, PA 19406, 610.687.5320, [email protected],