Regulatory & Enforcement Update

1. Regulatory & Enforcement Update ICI General Membership Meeting May 1, 2013

2. 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

3. 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 advisors”

4. 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 Management)

5. 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)

6. 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 Research) • 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

7. 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. Reserve)

8. Mutual Funds • SEC must file enforcement actions within 5 years of conduct, not discovery (Gabelli v. SEC) • Filing of social media content • Fund performance • Investment merits • Derivatives: Hedging vs. speculation • Notional amount > value of underlying securities (In re Top Fund Management)

9. Disclosure • 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

10. CFTC and NFA • Court upholds CPO registration for registered funds (ICI v. CFTC) • 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

11. Marketing • May use social media to disseminate information (Netflix) • Compensating unregistered solicitors (In re Ranieri Partners) • 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)

12. 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

13. FINRA • Focusing on high-yield products: BDCs, CMBS, high-yield debt, structured products, exchange-traded funds and notes, closed-end funds, and variable annuities • Will take adviser arbitrations • Rule 8210 gives FINRA broad authority to obtain documents • Outside business activities • Possession, custody, or control • Includes info about unregulated third parties (In re Goldstein)

14. Lessons • 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)

15. 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. Read and respond to "Our Take" on important industry developments at http://blog.cipperman.com or contact us to be added to our daily e-mail alert distribution list. 500 E. Swedesford Road, • Suite 104 • Wayne, PA 19087 • 610.687.5344 • www.cippermancs.com