Managers Implementing a Compliance Program

Transcription

1 Registration ti of Private Fund Managers Implementing a Compliance Program Michael R. Butowsky Michele L. Gibbons Olga A. Loy November 12, 2009 Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

2 Topics to be Covered Investment Advisers Act Compliance Rules Disclosures Allocation and Trading Best Execution and Soft Dollars Code of Ethics Custody Proxy Voting Privacy and Safeguarding Valuation Advertising and Marketing Books and Records Solicitors and Placement Agents E Policies Business Continuity i Anti Money Laundering 2

3 U.S. Investment Advisers Act 3

4 Differences in Regulation Advisers Act Provision Topic Unregistered Advisers? Rule Books and Records No Rule Brochure Delivery No (but 206) Section 204A Insider Trading Procedures No (but state/other) Section 205 Contracts No (but 206) Rule Performance Fees No (but 206) Section 206(1) Fraud Yes Section 206(2) Fraud Yes Section 206(3) Principal/Agency Transactions Yes Rule 206(4)-2 Custody No Rule 206(4)-3 Solicitor Rule No (but 206) Rule 206(4)-44 Disclosure of Adviser Financial i and Disciplinary i Matters No (but 206) Rule 206(4)-6 Proxy Voting No (but 206) Rule 206(4)-7 Compliance Officer and written Compliance Procedures No Rule 206(4)-8 Anti-Fraud (applicable to investors in the fund) Yes

5 Compliance Procedures and Chief Compliance Officer Rule 5

6 Investment Advisers Act Rule 206(4)-7 Adopt and Implement Policies and Procedures Designate a Chief Compliance Officer Recordkeeping Annual Review 6

7 Compliance Manuals 7

8 SEC Suggested Policies and Procedures Portfolio Management Process (including allocation of investment opportunities among clients and consistency of portfolios with clients investment objectives, disclosures by the Adviser and applicable regulatory restrictions); Trading Practices (including procedures by which the Adviser satisfies its best execution obligation, uses client brokerage to obtain research and other services ( soft dollar arrangements ) and allocates aggregated trades among clients); Proprietary Trading of the Adviser and Personal Trading Activities of Supervised Persons; Accuracy of Disclosures made to investors, clients and regulators, including account statements and advertisements; Safeguarding of Client Assets from conversion or inappropriate use by advisory personnel; Books and Records (The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction); Marketing advisory services, including the use of solicitors; Valuation (Processes to value client holdings and assess fees based on those valuations); Safeguards for Privacy Protection of client records and information; i and Business Continuity Plans. 8

9 Additional Policies that may Apply Anti Money Laundering Private Placement Supervision of Service Providers (administrators, accountants, etc.) Anti bribery and Foreign Corrupt Practices Act Regulatory Filings (including 13D, 13G and 13F) 9

10 Implementation and Testing Monitoring and reporting including means testing Analysisofinformationcollected information collected, which mayinclude analysis by outside sources. Information should be analyzed over time to identify unusual patterns that may point to compliance problems or dfii deficiencies; i Prompt investigation and documentation of any patterns of complianceexceptions exceptions, customer complaintsor or other suspicious activities; and Reporting up the chain as required by the compliance program or as otherwise appropriate. 10

11 Compliance Manuals Each policy in the compliance manual should address the following: Identify risks policy addresses. Detect, address and prevent violations. Designate who will implement the policies. Designate who will supervise the policies. Designate who will monitor the policies. How will the policies be tested? How often will the policies be tested? Who will test the policies? How will the policies be documented? Who will be responsible for amending the policies? How will policy compliance be documented? What other policies does this policy affect this policy? What tdisclosures should be aligned with this policy? 11

12 Disclosures 12

13 Disclosures As a fiduciary, an adviser has an affirmative duty of utmost good faith to act in the best interest of the client and to make full and fair disclosure of all material facts, particularly where the adviser s interests may conflict with the client s. Form ADV Fund Offering Materials Marketing and Advertising Materials Client Reports New Disclosure Requirements under Proposed Legislation

14 Allocation and Portfolio Management 14

15 Allocation of Trades Formula Required Fair and Equitable. Deviations from formula for: De minimus reallocations. No specified methodology (SEC favors objective, mechanical Priority to clients of the portfolio criteria over subjective manager who located opportunity. methodologies). Client/investment objective Pro rata based on account differences. size. Self Dealing Rotational clients are provided fair access to Offer to client first. opportunities over a reasonable period. Disclosure. Percentage Allocation based on a stated percentage interest client is to receive in issuer (based on market value of client s account). Disinterested consent. Favoring Certain Clients Several SEC proceedings. Disclosure. 15

16 Allocation of Trades Bunching of Client Orders: Not required. Disclosure. Aggregation (Bunching) and Affiliates. Benefiting one client at the expense of another: Contra trades. Different timing (selling or buying ahead). Short sales. 16

17 Focus on Impact of Trades on Other Clients Benefiting one client at the expense of another. Contra trades. Different timing (selling or buying ahead). Short sales. Procedures. Information barriers (no good if same portfolio manager). Prohibitions on transactions (short or long) in same security until after an intervening event. Trading volume cut off. Disclose trading limitations imposed by procedures. Employment arrangements (e.g., no bonus based on hedge fund performance for portfolio manager who manages both a mutual fund and a hedge fund unless the mutual fund achieves certain benchmarks). 17

18 Portfolio Management and Other Transactions Principal Transactions Agency Transactions (sequencing) Process for Identifying and Approving Transactions Trade Error Procedures Investment Guidelines and Restrictions Portfolio Pumping and Window Dressing 18

19 Best Execution and Soft Dollars 19

20 Best Execution Defined An adviser s obligation to obtain best execution has been defined by the SEC as to execute securities transactions for clients in such a manner that the clients total costs or proceeds in each transaction is the most favorable under the circumstances. Advisers, as fiduciaries, have an obligation to seek best execution of clients transactions. ti 20

21 Product or Service Valuation/Transparency Advisers Act Best Execution Determination (Release 23170) Best execution definition: The money manager must: execute securities transactions for clients in such a manner that the client s total cost or proceeds in each transaction is the most favorable under the circumstances. What gets taken into account: A money manager should consider the full range and quality of a broker s services in placing brokerage including, among other things the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness to the money manager. Best execution is relevant to private equity funds as well as to hedge funds Soft dollaring is present in situations where the adviser benefits from the portfolio transactions of the client (e.g., obtaining proprietary or third party products and services) in exchange for the direction of client transactions. Conceptual basis for the permissibility of soft dollaring is disclosure and knowing consent Section 28(e) vs Non Section 28(e) 21

22 Evaluating Best Execution Factors Best execution committee should periodically and systematically review best execution determinations and approve brokers and other service providers. Best execution can be based upon a variety of factors, including among others: The value of the research provided (soft dollar arrangements) Execution capability Commission rates Financial responsibility Responsiveness Reputation and Integrity Facilities Financial Services Offered Willingness and ability to commit capital Access to underwriting offerings and secondary markets Reliability in executing trades and keeping records Fairness in resolving disputes The timing and size of particular orders Available liquidity Current market conditions Trading Experience 22

23 Code of Ethics and Insider Trading 23

24 Code of Ethics Rule 204A 1 (Compliance Date February 1, 2005) Standards of Conduct Require advisory personnel to comply with applicable U.S. Securities Laws Provisionsdesigned to prevent the disclosure of inside information (recommendations, holdings, transactions) Access Persons must report personal securities holdings Pre clearance of IPOs and private placements Require Advisory personnel to report violations of the Code Signed Acknowledgements Provide Code of Ethics to clients upon request 24

25 Insider Trading Material use of non public information Information walls Restricted lists Rumor controls Monitor trading and trends Identify risks and prepare for contingencies 25

26 Custody 26

27 The Custody Rule Client assets over which an investment adviser has custody must be held by a qualified custodian (e.g., a registered broker dealer). Clients need to be given certain information about the custodian (i.e., name, address and the manner in which h the assets are held). Clients must receive account statements tt t either from the custodian or from the adviser. If sent by the adviser, there must also be a surprise audit by an independent accountant. 27

28 Custody and Private Investment Funds General partner, managing members and others who have access to the assets of the private investment funds they operate are deemed to have custody, and thus must comply with the revised Custody Rule. If a private investment fund s assets are maintained with a qualified custodian and the fund is audited at least annually and audited financial statements are provided to investors within 120 days of the end of the fund s fiscal year, (180 days for fund of funds) there is no need for the custodian or adviser to provide periodic account statements to the investors. Proposed amendments to the Custody Rule would require surprise audits if adviser fees are withdrawn from the investor s account. 28

29 Proxy Voting 29

30 Proxy Voting Rule 206(4)-6 Fiduciary Duty to vote proxies in the best interests of clients Adopt and implement written policies and procedures for voting proxies (Identify and resolve conflicts of interest) Describe proxy voting policies and procedures to clients and provide a copy to clients upon request Disclose to clients how they may obtain information about how the adviser voted Exceptions (foreign securities) ERISA 30

31 Privacy 31

32 Privacy Rules and Regulations for Investment Advisers Under the Gramm Leach Bliley Act, the SEC adopted regulations which require: Establish a Privacy Policy All regulated institutions must clearly, conspicuously, and annually disclose their policies for collecting and sharing customers nonpublic, personal information. Suchpolicies should describe: information that is collected; information that is disclosed to affiliates and non affiliated third parties; and, persons within the financial institution who receive such information; how the information of former customers is shared; procedures to protect the security and confidentiality of information; and, disclosures required by the Fair Credit Reporting Act. 32

33 Privacy Rules and Regulations for Investment Advisers Delivery of Privacy Policy This notification written or electronic must be provided to: Consumers (those who do not have an ongoing relationship with the firm, as customers do), with certain exceptions, before this information is shared with non affiliated third parties; and Customers when they establish a relationship with a financial institution and annually thereafter. Provide an Opportunity to opt out Both consumers and customers must be given notice of procedures and a reasonable means to prevent their financial institutions from transferring their nonpublic, personal information to a nonaffiliated third party. Establish prohibitions onaccount information disclosures All financial institutions may not disclose account numbers for credit card, deposit, or transaction accounts to any non affiliated third parties for use in phone, mail, and marketing. 33

34 The Safeguard Rule The SEC s Standard for Safeguarding Privacy Registered investment advisers must adopt policies and procedures that address administrative, i i technical and physical safeguards for the protection of customer records and information. These policies and procedures must be reasonably designed to: Ensure the security and confidentiality of customer records and information; Protect against any anticipated threats or hazards to the security or integrity of customer records and information; and Protect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to any customer. 34

35 Advertising and Marketing 35

36 Definition of an Advertisement An Advertisement includes any written communication addressed to more than one person; any notice or announcement in any publication, or by radio or television which offers any analysis, report, or publication regarding securities; or any graph, chart, formula or other device for making securities decisions, or any other investment advisory services regarding securities. 36

37 Advertising Rules Testimonials Past Specific Recommendations Graphs, Charts, Formulas, and other Devices Presentation of Performance Information* Actual and Model Results Calculating Composites Manner of Selection of Accounts No Untrue Statements of Material Facts or Statements that are otherwisefalse ormisleading Disclosure of all Material Information 37

38 Valuation 38

39 Valuation Uses Calculation of NAV Calculation of Fees Allocations and Investment Guidelines Methodology Market Data Fair Valuation Conflicts Fees Independence Procedures No Requirements or Guidelines Verification Pricing Services and Audits FASB

40 Books and Records 40

41 Books and Records Rule In general, under the Advisers Act all required books and records must be maintained and preserved in the adviser s office for two years after the last entry date and three additional years in an easily accessible place Records for performance must include background and calculations and must be retained for 5 years after the dt date of last use (grandfathering for new registrants?) it t?) The fund s records are considered to be part of the adviser s s records No specific format required, but electronic records must be preserved to prevent alteration or destructions 41

42 Books and Records Business Accounting Records Journals and ledgers. Order and trade tickets. Bank statements and checks. Bills and statements. Balance sheets and financial statements. Custodial records, if applicable. Adviser Related Records Communications to and from clients. Advisory agreements (and all other advisory related agreements). Adviser s publications and recommendations. Adviser advertisements (with basis for advertising performance). Personal and proprietary p security transaction records Retain records. 42

43 Third Party Solicitors and Placement Agents 43

44 Solicitors Rule Advisers Act Rule 206(4)-3 Cash solicitations may not be made to a disqualified person (found to have violated U.S. securities laws within the last 10 years). Agreement must be in writing. Unaffiliated solicitors must obtain client acknowledgement: Describe the nature of the relationship with adviser; Disclose that the solicitor will be paid by the adviser Describe paymentterms; terms; Describe additional fees, if any, client will pay as a result of the solicitation and Dli Deliver Form ADV Part tii Non cash disclosures. Does it apply to solicitations for private funds? 44

45 Electronic Communication and Information Security Policies 45

46 E-Policies E policies are critical to recordkeeping, privacy, custody and business continuity it compliance User policies (passwords, access, remote use, etc) Firewall and security policies Electronic communications policies Social networking policies Website policies Test policy frequently Update policies as technology and practices change 46

47 Supervision of Service Providers 47

48 Supervision of Service Providers Advisers may delegate some compliance tasks, but remain responsible for ensuring compliance. Due diligence procedures for hiring service providers Assess all service providers Make sure agreements are consistent with Advisers Act requirements (books and records, privacy, AML, etc.) Conduct periodic reviews and/or receive periodic certifications of compliance Test compliance and ability to receive necessary records 48

49 Anti Money Laundering 49

50 Anti-Money Laundering Legal Provisions Applicable to Investment Advisers Statutes International Money Laundering Abatement and Anti terrorist Financing Act of 2001 (Title III of U.S.A. Patriot Act, Public Law ). Bank Secrecy Act (31 U.S.C (Chapter 53)) (as amended by Title III of USA Patriot Act). Federal Criminal Money Laundering Statutes (18 U.S.C ). Regulations: USA Patriot Act Regulations Final, Interim and Proposed: Financial Crimes Enforcement Network; Anti Money Laundering Programs for Unregistered Investment Companies, 31 CFR Part 103 (Proposed Rule). Financial Crimes Enforcement Network; Special Information Sharing Procedures To Deter Money Laundering and Terrorist Activity, 31 CFR Part 103 (Final Rule). OFAC Regulations (31 C.F.R ). Principal Regulators SEC Treasury FinCEN IRS OCC SROs: FINRA, CFTC 50

51 Proposed Rule for Registered Advisers and Private Investment Funds On September 18, 2002, the U.S. Treasury Department s Financial Crimes Enforcement Network (FinCEN) released a set of proposed rules under the USA PATRIOT Act which would expand the application of the USA PATRIOT Act to registered investment advisers and a wide range of unregistered investment companies. FINAL RULES HAVE NOT YET BEEN ADOPTED. The rules will require each adviser and fund which is subject to the Act to: Develop internal policies, procedures and controls; Designate an Anti Money Laundering Compliance Officer; Provide for independent and periodic testing of the anti money laundering program; and Establish an ongoing training program. 51

52 Why Adopt Procedures Before the Rule is Adopted? Final Rule is imminent Current obligations i under the Bank ksecrecy Act Representations to Banks and Brokers Representations to Third Parties (SEC No Action Letter) Fund of Funds Offshore Funds Protect Investor Identities 52

53 Business Continuity 53

54 Business Continuity Plans No specific requirement under the Advisers Act (yet) Fiduciary duty requires that client assets and transactions are reasonably safeguarded from foreseeable delay or harm Disclosure (not insurance) Key man and successor provisions Essential for compliance with other fiduciary duties: privacy, custody, insider trading, code of ethics and books and records 54

55 Please join us for the continuation of this series Thursday, November 19 Advertisement Rules and Pi Private Placement Compliance Thursday, December 3 SEC Examinations Please register and submit questions 55

56 Thank you IRS CIRCULAR 230 NOTICE. Any advice expressed within as to tax matters was neither written nor intended by the sender or Mayer Brown LLP to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties that may be imposed under US tax law. If any person uses or refers to any such tax advice in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any taxpayer, then (i) the advice was written to support the promotion or marketing (by a person other than Mayer Brown LLP) of that transaction or matter, and (ii) such taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor. Disclaimer: This Mayer Brown LLP presentation provides comments and information on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Participants should seek specific legal advice before taking any action with respect to the matters discussed herein. 56

57 Michael R. Butowsky, Partner Mitch L. Gibbons, Partner New York Houston, New York y Olga A. Loy, Partner Chicago Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.