Dodd-Frank Bill affecting Hedge Funds and Private Equity Firms

Email Archiving... What is the rule?

noreply@blogger.com (Unknown) — Mon, 16 Jan 2012 23:54:00 +0000

Archiving of Emails The Rule:

Statements by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) staff suggests that the OCIE is taking the position that it is entitled to review all e-mails retained by the adviser, regardless of whether they are covered under the Rule 204-2. This includes personal e-mails. If an adviser does not retain all email, then it should implement a policy to ensure that all required e-mails are being retained and not deleted.

An SEC examination request list presented to an adviser recently requested:

“For individuals to be selected upon commencement of the examination, or shortly

thereafter, please be prepared to provide all e-mails, including their corresponding

attachments, sent and received during a period to be specified. This information should be

provided in an electronically searchable format. In identifying e-mails that are responsive to

our needs, please be mindful that e-mails may be stored both on servers and on individual hard drives of the persons selected.”

Electronic communication must be kept for the same length of time as if the record was a

written/printed record. Generally, records should be kept in an easily accessible place for a

period of not less than five full fiscal years after the last entry was made in that record, the

first two years in an appropriate office of the investment adviser. Be mindful that if the email

pertains to documentation demonstrating the calculation of performance, for example,

it may be subject to retention for five full fiscal years after the adviser stops advertising the

performance.

Advisers must:

Arrange and index the records in a way that permits easy location, access, and retrieval of any particular record;
Provide promptly any of the following:

§ A legible, true, and complete copy of the record in the medium and format in which it is stored;

§ A legible, true and complete printout of the record; and

§ Means to access, view, and print the records; and Separately store, for the time required for preservation of the original record, a duplicate copy of the record;

Maintain and preserve the records, so as to reasonably safeguard them from loss, alteration, or destruction; Limit access to the records to properly authorized personnel; and Reasonably ensure that any reproduction of a non-electronic original

Therefore, when selecting an Email Archiving product, the following areas should be considered.

To be properly prepared for legal discovery and regulatory compliance, Hedge Funds and Private Equity Firms must maintain a well-controlled environment over emails and be able to search through and retrieve the data.
The Firm needs to ensure that it automatically preserves all electronic business records and the records should be stored securely on tamper-proof media for their designated retention period(s).
The system should have a facility (search) that will easily locate and produces electronic communications and prepare them for SEC examinations or other requests.
The Firm should be able to customize supervision policies without technology limitations. The product the Firm chooses should:

o Configure company-approved keyword lists

o Automate policy enforcement and streamline compliance review procedures with systemized search criteria

The company will need to ensure they have well documented records of supervisory procedures and that the product is able through detailed audit trails to demonstrate that the policy was properly enforced

Retention Capabilities:

The system that the Firm chooses should be able to capture and automate the unique retention policy of each Firm.
Determine how the product manages retention policies. For instance the management of the retention policy should be easily maintained and updated by the user. With that stated, the Firm needs to understand what happens with the old policy(s) and the associated legacy emails.
The product should be able to maintain multiple retention policies for each type of message across companies.
Every policy change should be properly tracked in an unalterable audit trail, ensuring an accurate record of the Firm’s policy changes.
Determine how the product disposes messages from the archive. So for instance, when a message reaches its retention time frame does it automatically delete or does the system alert the authorized user who then can extend the period or delete the messages. Once disposed, can the data be restored?

Capturing Information

§ Determine whether the messages and associated attachments are captured on a real-time basis or is it on a batch basis. In either case, how does the product ensure that all messages were indeed captured?

§ Determine what the informational data that the email archiving system is actually capturing? As an example, the product should capture:

o Header data

o Message date and time, IP addresses, types of servers, etc.

o Attachments

o To/From, cc’s, bcc’s. etc..

o Type of message, as an example, you might have a different retention policy for voice mail that is emailed through an IP address compared with regular emails

§ The product should allow the Firm to import legacy emails and combine them into one system. This will facilitate in creating a consolidated archive for rapid retrieval and review.

§ The product should be flexible enough to upload on a multi-company basis and manage each company uniquely or on a consolidated basis.

§ The product should automatically encrypt all emails and other messages so only authorized individuals can view the information.

§ When capturing messages, the product should time stamp and index each message.

§ If the Email service is down for a period of time, what mechanism is in place to ensure that all emails are subsequently captured?

§ Does the ability to capture emails change based on the platform used (Remote access, PC, Mac, droid, ipad, blackberry, etc...)

Technology

§ The service should have redundant data centers.

§ The Email service should use WORM (write once read many) technology ; to satisfy the rule that records should not be altered any manner.

The Firm should determine how each product encrypts email messages. All messaging Information should be properly encrypted. As an example, one product has the feature of ensuing that messages are decrypted only when an authorized user on the Firm’s network conducts a search. A further protection of the information is that the encryption keys are created and maintained by the Firm and separate from the encrypted data stored within the vendor’s control. Therefore, the Firm’s messaging data can never be viewed by the vendor without the Firm’s permission.

§ The product should have the flexibility to securely download Emails to a PC and have them properly encrypted.

§ Can the service be hosted?

Search Engine

§ Overall the Firm should determine the type of criteria and the method in which the Firm prefers to initiate these searches. Each product will have varying ways to conduct a search.

§ The product should index each message and attachments using a full-text index/catalog to permit searches in the application

§ The product should allow administrators to be able to search across their email and electronic message archives based on virtually any criteria including:

o text/HTML body, subject, sender, recipient (including CC, BCC & distribution lists), message date and time, headers (including IP address), attachment type(s), attachment name, attachment contents, keywords or phrases.

§ The system should allow the user to run robust ad-hoc discovery searches for one-time instances and be able to save these searches for future use.

§ Once the search is completed, does the method in which the search results are displayed or reported meet the expectations of the company? The search results should also have the feature to download the information directly to a PC or Mac or encrypted and copied to portable electronic media.

§ The system should also allow Personal archive access. End-users should have access to their personal email archive securely from any web browser, mobile device or an integrated email client plug-in.

§ End users should also have access to customizable saved searches and other tools to conveniently provide access to historical messages.

§ When a legal or regulatory event occurs, the product should allow the Firm to define a litigation hold period for each matter which groups messages for the duration of the event. The product should also have the ability to set the date parameters of the event and capture new emails that are relevant to ongoing event.

§ The product should ensure that during a search that it does not return duplicate email messages

Supervision and Security

The supervision procedures should have a flexible technology foundation. The software should be customizable to your particular firm's supervision policies and procedures. The system should take advantage of its flexibility for optimal efficiency in message review and effectiveness in identifying and mitigating risk.

The system should allow a workflow hierarchy that can be configured to model the authorization structure of the organization.
The product should allow the granting of temporary permissions or access to consultants or outside legal counsel or other individuals.
The product should have the capability to track similarities of emails from multiple individuals.
The product should track the administrator session and any action taken throughout the entire lifecycle of a message should be documented.
Administrators should have the ability to annotate, flag, open/close or escalate messages.
To ensure data meets the highest evidentiary standards, the product should have safeguards that would prevent any records to be deleted or altered once they have been archived and before their termination date.
The product should track and report on incoming and outgoing messages (from any platform) based on the Firm’s predefined filtering parameters (e.g. key words/phrases, email addresses, web sites, etc…).
Is the service a fully managed SAS70 Type II-certified service.
The operations of vendor should follow strict procedural controls that are clearly documented, and undergoes annual audits to ensure that the documented procedures of the vendor are properly followed.

Reporting

The product should be able to produce analytical reporting on corporate email usage, system audit history and message archive data.
Ad hoc reports and standard reports should be available.
A report or audit trail to demonstrate that the policy(s) that the Firm employs are actually being followed.

MF Global…. How could this happen.

noreply@blogger.com (Unknown) — Sun, 04 Dec 2011 19:23:00 +0000

What we know. Not a whole lot

MF Global can trace its roots to the sugar trading business started by James Man in England in 1783. Jon Corzine took over MF Global Ltd. in March 2010 with the hopes of turning the Company into a formidable Wall Street firm. But in little over one and a half years the dream crumbled and the Firm filed for bankruptcy. As usual in these cases, the death Knell of the Firm was caused by a lack of confidence and liquidity. A 228 year old firm wiped off the map in the blink of an eye because of bad senior management, risk controls and an overleveraged portfolio. But as you know that is not the worst of it. This time-honored Firm is mired in an investigation that it misappropriated customer funds. The entire outside board resigned on December 2.

During the last week of October, the rating agencies downgraded the firms rating twice. The impetuous for this action was MF Global’s $6.3 billion exposure to European sovereign debt, growing losses and concerns with risk management. MF Global tapped credit lines for over a billion dollars, presumably to meet the growing margin calls. We cannot be sure what the mark to market loss is/were, however as indicated on the June 30, 2011 quarterly SEC filing we know that the equity was only $1.4 billion. As every Monday morning pundit has indicated, this was a risky bet under most circumstances.

Where was Risk Management?

Michael Stockman the Chief Risk officer (“CRO”) at MF Global has 25 years of risk experience and co-authored a paper on the credit crisis that included risk management insights and recommendations to avoid the next crisis. Here is a seasoned expert who understands risks in a crisis market and yet MF still managed to fall apart directly related to being long in a crisis market. What did Michael Stockman really mean when during a March 31, 2011 interview with Risk Magazine, he said, “We are going to be actively and aggressively seeking to take risks in a broad fashion. In our client-facing businesses – this is no surprise as we build out – I would suggest we are not taking enough risk,”

In the MF’s public filings, the Company states “ The Company’s Board-approved risk appetite and strategic objectives translate to defined risk tolerances and oversight processes and, subsequently, strictly enforced delegations of authority and concomitant controls, which are designed to ensure its operation within those risk tolerances. The CRO, who reports to the Company’s President and Chief Operating Officer (Bradley Abelow), leads the Risk department and is delegated certain authorities from the Board. The CRO reports and advises on market, credit, issuer and operational risk matters. The CRO and senior management promote company wide compliance to its enterprise risk management framework”.

Did MF Senior Management ignore the warning signs and how much did risk management push back? We will find out the answers as this case evolves.

Why was there a breakdown in Controls?

The most fundamental mantra at a broker dealer is to protect their customer’s assets (currency and securities). It is the first and most important lesson you learn when starting in an operations or finance department. All licensed individuals in this industry know that you do not compromise the integrity of the customer’s well-being. Every day at a regulated entity, the operations department ensures that the firm has possession or control of customer assets. At least once a week, the Finance department will ensure that the firm has sufficiently segregated cash in a Special reserve bank account for the exclusive benefit of its customers. The Finance department acts in an independent manner to ensure that customer funds were not used by the Firm for Firm business. The SEC and the CFTC are of one mind on this issue, the customer comes first and foremost.

I had been a financial principal for a broker dealer for over 20 years. This means that I had the responsibility to sign off on certain regulatory reports. Every time I signed, I would review every amount and investigate any anomaly. My license and reputation and the reputation of the firm were always the first and last thought as pen met paper. Certainly small mistakes were made over the years, but when the regulators reviewed the work papers and the calculations, the information I provided would be clear, concise and transparent. I might sound self-serving, but I am not unique in how I approached my responsibilities. I learned this from my predecessors and passed these lessons to my own staff. I also worked in the Operations department during part of my career. I assure you the head of operations had a similar approach in ensuring that the customer was protected.

As of today, a team of regulators and consultants are trying to find the $1.2 billion of customer funds. This should not be such a difficult task, especially if the customer funds were transferred out of customer accounts over a period of a day or two. However, Scott D. O’Malia, a commissioner at the Commodity Futures Trading Commission, the agency leading the investigation of the firm, recently said that MF Global’s records were “a disaster.” Between not being able to easily follow the money and an indication that the records are a disaster, the likelihood that the alleged misappropriation of customer funds has been going on for a longer period of time than first believed.

So, how could the CFO, (Henri J. Steenkamp 35 years of age assuming the role of CFO in April 2011) or the Head of Operations (David Simmons, started with MF on July 05, 2011) allegedly allow the most fundamental rule of a commodities broker dealer to be ignored and how could those who should have stood as the stewards of the firm break the customers trust?

It will be interesting when the investigation is concluded who gave the orders, who pulled the trigger and who had a lapse of conscience?

It is all about Compliance

noreply@blogger.com (Unknown) — Wed, 30 Nov 2011 01:37:00 +0000

I have been saying for a long time, that the SEC is getting serious sending cases to enforcement as it relates to the investment advisers, hence hedge funds and private equity funds. On November 28, 2011 The Securities and Exchange Commission charged three investment advisers for failing to put in place compliance procedures designed to prevent securities law violations.

Unbelievable

The cases stem from an initiative within the SEC Enforcement Division’s Asset Management Unit to proactively prevent investor harm by working closely with agency examiners to ensure that viable compliance programs are in place at firms. Investment advisers are required by law to adopt and implement written compliance policies and procedures.

When SEC examiners identify deficiencies in a firm’s compliance program, those deficiencies need to be corrected before they lead to other securities law violations that could harm investors. Investment advisers that essentially ignore SEC examination warnings risk being the subject of SEC enforcement actions.

So in two of the cases — OMNI and Asset Advisors — SEC examiners previously warned the firms about their compliance deficiencies. Why and how these two Firms did not remediate these deficiencies or think that the SEC would not take these infractions to enforcement is mindboggling. Carlo di Florio, Director of the SEC’s Office of Compliance Inspections and Examinations, added, “When SEC examiners identify compliance deficiencies, firms are expected to remediate them. The Commission will take enforcement action against registrants that fail to do so.”

“Not all compliance failures result in fraud, but many frauds take root in compliance deficiencies,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “That simple truth underlies our renewed focus on identifying and charging firms and individuals that fail their legal obligations to maintain adequate compliance programs.”

“The failure to adopt and maintain adequate compliance policies and procedures is a significant violation of the federal securities laws,” said Robert Kaplan, Co-Chief of the SEC Division of Enforcement’s Asset Management Unit. “We will continue to work with our counterparts in the national exam program to identify investment advisers that put their investors at risk by failing to take their compliance obligations seriously.”

FORM PF ON LINE "BEEP"

noreply@blogger.com (Unknown) — Sat, 29 Oct 2011 21:58:00 +0000

The SEC finally woke up after a 3 month coma, so I’m back. As you all probably know, on October 26, 2011, the SEC approved the form PF, changed the rules on the frequency of filing and delayed the filing requirements for certain hedge funds and private equity firms.

In no way does the change or delay in filing Form PF effect the registration deadline. The deadline for registering with the SEC or states is still set at March 31, 2012.

Private fund advisers will be divided by size into two broad groups – large advisers and smaller advisers. The amount of information reported and the frequency of reporting depends on the group to which the adviser belongs.

The data collection form that we have adopted will address the dramatic lack of private fund information available to regulators today while easing the burden on private fund managers producing the data,” said SEC Chairman Mary L. Schapiro.

“Large private fund advisers” are:

Advisers with at least $1.5 billion in assets under management attributable to hedge funds.
Liquidity fund advisers with at least $1 billion in combined assets under management attributable to liquidity funds and registered money market funds.
Advisers with at least $2 billion in assets under management attributable to private equity funds. All other respondents are considered smaller private fund advisers.

Smaller private fund advisers must file Form PF only once a year within 120 days of the end of the fiscal year, and report only basic information regarding the private funds they advise. This includes limited information regarding size, leverage, investor types and concentration, liquidity, and fund performance.

Large hedge fund advisers must file Form PF to update information regarding the hedge funds they manage within 60 days of the end of each fiscal quarter (instead of 15 days in the rule proposal). These advisers must report on an aggregated basis information regarding exposures by asset class, geographical concentration, and turnover by asset class. In addition, for each managed hedge fund having a net asset value of at least $500 million, these advisers are required to report certain information relating to that fund’s exposures, leverage, risk profile, and liquidity. Large hedge fund advisers are not required to report position-level information.

Large private equity fund advisers must file Form PF annually within 120 days of the end of the fiscal year. They must respond to questions focusing primarily on the extent of leverage incurred by their funds’ portfolio companies, the use of bridge financing, and their funds’ investments in financial institutions.

Most private fund advisers will be required to begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after December 15, 2012.

However, the following advisers must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after June 15, 2012:

Advisers with at least $5 billion in assets under management attributable to hedge funds.
Liquidity fund advisers with at least $5 billion in combined assets under management attributable to liquidity funds and registered money market funds.
Advisers with at least $5 billion in assets under management attributable to private equity funds.

Crickets and Dodd Frank what do they have in common?

noreply@blogger.com (Unknown) — Thu, 14 Jul 2011 00:58:00 +0000

Curious?

A cricket will rub its hind legs together and produce a chirping sound at night. In mass it is almost a soothing sound that will lull you to sleep. (BTW one in your house can drive you mad). It also is sometimes analogous to dead silence. Well now I put to you, the incredible stir that the Dodd-Frank Wall Street reform bill had a year ago when a Democratic congress passed it and the president signed it into law. One year has passed and the I ask you what happened to the teeth of this law. Dead Silence.

Registration has been delayed rules have been watered down and the SEC has yet to really come out with a game plan for moving forward. The house of Reps. has shifted and the law is in jeopardy of being repealed in part or whole. So is it no wonder that Hedge Funds, Private Equity firms as well as the derivative trading firms are sitting back to see what finally happens.

The SEC really dropped the ball on this one. They were slow with finalizing the rules (which in fact are probably a year from being finalized) and apparently bent to political pressures. So Firms are still unregulated and the SEC is all talk and no action. Nothing will happen over the next month and a half with congress on break, elections to think about and the 14.3 trillion dollar deficit to worry about. So I will be back when there is something to really to discuss.

Thanks

New Swap proposal under Article VII

noreply@blogger.com (Unknown) — Tue, 05 Jul 2011 22:55:00 +0000

On June 29, 2011 the Securities and Exchange Commission today voted to propose rules that would impose certain business conduct standards upon security-based swap dealers and major security-based swap participants when those parties engage in security-based swap transactions. The SEC’s proposed rules stem from Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

“The rules we are proposing would level the playing field in the security-based swap market by bringing needed transparency to this market and by seeking to ensure that customers in these transactions are treated fairly,” said SEC Chairman Mary L. Schapiro. “The standards we propose are intended to establish a framework that protects investors and also promotes efficiency, competition, and capital formation.”

The proposed rules would require security-based swap dealers and major security-based swap participants to communicate in a fair and balanced manner and make certain disclosures, including conflicts of interest and material incentives to potential counterparties.

Proposal

Verify whether a counterparty is an eligible contract participant and whether it is a special entity.
Disclose to the counterparty material information about the security-based swap, including material risks, characteristics, incentives and conflicts of interest.
Provide the counterparty with information concerning the daily mark of the security-based swap.
Provide the counterparty with information regarding the ability to require clearing of the security-based swap.
Communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith.
Establish a supervisory and compliance infrastructure.
Designate a chief compliance officer that is required to fulfill the described duties and provide an annual compliance report.

The proposed rules also would require security-based swap dealers to:

Make reasonable efforts to obtain information that it needs to determine that the recommendation is in the “best interests” of the special entity.

In addition, the proposed rules would require security-based swap dealers and major security-based swap participants acting as counterparties to special entities to reasonably believe that the counterparty has an independent representative who meets the following requirements:

Has sufficient knowledge to evaluate the transaction and risks.
Is not subject to a statutory disqualification.
Is independent of the security-based swap dealer or major security-based swap participant.
Undertakes a duty to act in the best interests of the special entity.
Makes appropriate disclosures of material information concerning the security-based swap.
Provides written representations to the special entity regarding fair pricing and appropriateness of the security-based swap.

The SEC is finalizing the Dodd-Frank Rules

noreply@blogger.com (Unknown) — Fri, 24 Jun 2011 22:00:00 +0000

On Wednesday, June 22 the SEC approved two sets of rules to implement amendments to the Dodd-Frank Wall Street Reform and Consumer Protection Act. One set of rules requires advisers to hedge funds and other private funds to register with the SEC, establishes new exemptions from SEC registration and reporting requirements for certain advisers and transfers regulatory responsibility for certain advisers between the SEC to the state level. The other rule defines “family offices” that are to be excluded from the Investment Advisers Act.

The rules implementing the amendments to the Investment Advisers Act include a transitional exemption period so that private advisers, including hedge fund and private equity fund advisers, newly required to register do not have to do so until March 30, 2012. The rules regarding exemptions for venture capital fund and certain private fund advisers are effective July 21, 2011. Family offices that do not meet the terms of the exclusion under the new rule must register with the SEC or applicable state securities authorities by March 30, 2012.

During the public comment period, the SEC received 70 comment letters on their proposed rules. Note at this post writing I will address on the definition of the “Mid-Sized Advisor”. Over the next few posts I will abstract the remainder of the rule changes.

The Mid-sized Advisor

The SEC added a new category for the advisor called “Mid-Sized Advisers”. In effect, the Mid-sized advisor would be considered those funds with assets under management of between, $25 million to $100 million. These Mid- Sized Advisors would no longer register with the Commission but instead be under the auspice of state regulators. Those who already registered with the SEC will have to withdraw their registration. The only exemption from state registration (therefore still be under SEC) is where a state would not perform an examination of the Funds.

Note: advisers with their principal office and place of business in Minnesota, New York and Wyoming with between $25 million and $100 million in AUM won’t have to switch to state regulation and instead must register with the SEC. New York did not provide confirmation that it conducts exams of advisory firms when surveyed by the SEC; Minnesota reported it doesn’t conduct exams; and Wyoming doesn’t have an investment adviser law.

The SEC stated that this amendment will force about 3,200 of the current 11,500 registered advisers to switch from registration with the SEC to registration with the states.

I am attaching a link to the 238 page report on the amendments to Dodd Frank http://www.sec.gov/rules/final/2011/ia-3221.pdf

and the 52 page report on

http://www.sec.gov/rules/final/2011/ia-3220.pdf

on the definition of a “Family Office”

SEC Announces Steps to Address One-Year Effective Date of Title VII of Dodd-Frank Act

noreply@blogger.com (Unknown) — Sun, 12 Jun 2011 22:24:00 +0000

Relief is on the way for SWAPS

On June 10, 2011 the SEC indicated they will take a series of actions in the coming weeks to clarify the requirements that will apply to security-based swap transactions as of July 16 (the effective date of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act) and to provide appropriate temporary relief.

Title VII is the portion of the Dodd-Frank Act that establishes a comprehensive framework for regulating over-the-counter derivatives. In particular, it authorizes the SEC to regulate “security-based swaps” while also authorizing the CFTC to regulate other swaps.

The portion of Title VII referred to as Subsection B, which deals with the new regulatory regime for security-based swaps, will take effect on July 16 (360 days after the date of the Dodd-Frank Act’s enactment).

The SEC will:

"Provide guidance regarding which provisions of Subtitle B of Title VII will become operable as of July 16, and, where appropriate, provide temporary relief from several of these provisions.
Provide guidance regarding and where appropriate, temporary relief from – the various pre-Dodd-Frank provisions of the Exchange Act that would otherwise apply to security-based swaps on July 16. Under Dodd-Frank, security-based swaps would be included in the definition of “security” under the Exchange Act. While such swaps will be subject to provisions addressing fraud and manipulation, the Commission intends to provide temporary relief from certain other provisions of the Exchange Act so that the industry will have time to seek, and the Commission can consider, what if any further guidance or action is required.
Take other actions such as extending existing temporary rules under the Securities Act, the Exchange Act, and the Trust Indenture Act, and extending existing temporary relief from exchange registration under the Exchange Act. This will help to continue facilitating the clearing of certain credit default swaps by clearing agencies functioning as central counterparties."

Speech by SEC Commissioner: Remarks at the Symposium on “Hedge Fund Regulation and Current Developments”

noreply@blogger.com (Unknown) — Wed, 08 Jun 2011 22:22:00 +0000

Troy A Paredes

On June 8, 2011 a commissioner of the SEC, Troy A. Paredes addressed the Center for Law, Economics & Finance (C-LEAF), in New York. For reference sake, Mr. Paredes was appointed a Commissioner by George W. Bush in 2008. I have highlighted a few key sections of his speech that I feel is somewhat news breaking.

Short Sales and Public Comments

“Because short selling was such a focal point during the peak of the financial crisis in 2008, I should also note that Dodd-Frank calls upon the Commission to conduct two studies of short sale disclosure that hedge funds undoubtedly have an interest in.

Dodd-Frank requires the SEC to study the effects of requiring the reporting of short sale positions in real time, either publicly or confidentially to the SEC. Second, the statute requires the agency to study the prospect of a pilot program that would require that trades be marked as “long,” “short,” “market maker short,” “buy,” or “buy-to-cover” in real time on the Consolidated Tape. The Commission has issued a request for comment to receive input on these studies."

Can we really define Systemic Risk?

“Title I — including which nonbank financial companies will be designated as “systemically important” (that is, as “SIFIs”) and thus subject to heightened prudential supervision and more intrusive government dictates — is still uncertain.

Personally, I am concerned about the ability of even a conscientious and well-intentioned systemic risk regulator to accurately identify when a firm is “systemically important” and to properly calibrate the source of future danger to the financial system.

And questions persist, at least to my mind, as to what the limits are on the government’s authority to regulate under the Financial Stability Act once SIFIs are designated".

Too much information might compromise a hedge fund’s competitive edge

When regulating, we need to account for the risk that these economy-wide benefits could be sacrificed if the regulatory regime unduly burdens and constricts the activities of hedge funds. It would be concerning, for example, if hedge funds were required to make public disclosures that compromise their proprietary investment strategies or if the regulation of our equity markets changed so that it became more costly to provide liquidity.

Let’s not rush into anything

"I also want to emphasize my view that, in advancing the numerous Dodd-Frank rule makings that the SEC is charged with, the agency cannot rush. The scope and complexity of the rulemaking is daunting and unprecedented. Trying to adopt too many rules and regulations too quickly is fraught with risk. Nor should we rush the implementation of the new rules and regulations, whatever their substance may be when enacted. Market participants, including hedge funds, will need to evaluate their business and investment options in light of the new regulation; structure their operations and activities accordingly; and develop and implement the systems, procedures, policies, and controls they will need to comply with the new regulatory regime.

This will take time. Thus, we need to be realistic about how quickly after being adopted the new rules and regulations should become effective in order to ensure that the transition to the new regulatory environment is orderly and workable in practice."

Another instance why we need regulations Bernie Madoff

noreply@blogger.com (Unknown) — Tue, 07 Jun 2011 22:04:00 +0000

The Securities and Exchange Commission charged Eric Lipkin, a longtime employee of Bernard Madoff with assisting Madoff’s firm deceive and defraud investors and regulators about the massive Ponzi scheme.

“Eric Lipkin helped create the detailed and entirely phony trading and business records that contributed to the success of Madoff’s fraud,” said George S. Canellos, Director of the SEC's New York Regional Office. “The SEC is committed to holding accountable those who helped to perpetrate and conceal Madoff’s scheme.”

Lipkin, 37, pleaded guilty on June 6^th 2011 to six criminal counts, including conspiracy, falsifying records and bank fraud. Lipkin agreed to cooperate with the government in its investigation of the fraud at Bernard L. Madoff Investment Securities LLC.

“I’d like to first apologize to my family, my friends and all the victims in the case,” Lipkin told U.S. District Judge Laura Taylor Swain.

Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures

noreply@blogger.com (Unknown) — Sat, 04 Jun 2011 19:59:00 +0000

OPERATIONS SECTION

I abstracted the operations section of the Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures. This is a long post but this should be required reading for investors and hedge funds.

Organization and Control Environment

The firm should have a clear corporate organization chart presenting; parent companies, subsidiaries and other affiliated entities.

The firm should be structured to allow for adequate oversight of the primary functions within the firm. Investors will want to see a clear organization chart showing, at a minimum, reporting lines, team numbers, and the names of key professionals in order to understand how the team is organized by function.

The back office should have a strong voice in the firm, with a high level of authority and influence in the organization. There should be a senior chief operating officer (“COO” hereafter)/chief financial officer (“CFO” hereafter) independent of the investment process, with authority over operational processes.

The organization should demonstrate clear segregation of duties and levels of staffing given the complexity of strategy and risks.

The firm should re-evaluate resources as it grows or changes. Managers should explain where employees are located, how personnel in different locations interact and how their knowledge base is kept up to date.

Turnover is a reality, and often healthy, but should be manageable. Investors will expect to be notified of key hires and departures as well as want to understand the reasons behind recent turnover.

Internal organizational procedures, controls and systems should be documented,

Conflicts

Investors will want to see a documented conflicts policy, together with an understanding of what steps have been taken to identify and resolve conflicts, and the existence of a conflicts or compliance committee to manage conflicts and develop a framework for disclosure of conflicts

While managers will produce standard documentation that complies with legal and regulatory obligations, investors will expect substantially more disclosure in the form of due diligence questionnaires, historic reports and sample documentation such as operations manuals, valuation policies and samples of board meeting minutes (redacted if necessary).

Compliance

Investors expect to see a strong compliance culture at a firm starting at the top and a robust compliance

Where managers are preparing to become registered for the first time, a proper gap analysis and implementation plan should be in place. Investors will want to understand, in outline, the results of regulatory visits and may ask to see copies of key reports. Even if a firm is unregistered with a regulatory body, it still should operate to the same standards as if it was registered.

Investors will want to review the compliance manual that documents the procedures and controls. The compliance manual should be updated regularly as a “live document”, is tailored to the business and that the policies in key areas are appropriate. When new policies are implemented, the manual should be updated accordingly with a copy given to every member of staff.

In addition investor Expectations and Preferences

• Annual declarations from employees to confirm they have read and complied with firm policies and procedures.

• Appropriate level of compliance oversight into issues such as personal account dealing, AML, KYC and employee gift reporting, as well as investment strategy issues.

• Written code of workplace ethics with adequate training.

• If preferential side letter terms to selected investors exist (e.g., fees, liquidity, transparency) those terms should be approved by fund board of directors and disclosed to all potential and existing investors of the fund.

Trade Processes

Managers should ensure that the infrastructure is appropriately tailored to the business, and they should assess the market, frequently, for new products or enhancements. The suite of portfolio systems should allow, where appropriate, for a high degree of automation and straight-through processing for reliable books and records.

There should be a centralized location for all portfolio data (data warehouse), with an extensive security master file and real-time reporting through direct market feeds. Managers should have systems that maintain comprehensive trading data (i.e., corporate actions, realized/unrealized gains, commissions, etc.) and a complete general ledger with partnership accounting; updated for current accounting requirements.

Timely reconciliation and resolution of reconciling items is an essential requirement to promptly identify duplicate, missing or incorrect transactions.

Investors expect hedge funds to be independently audited by a specialist audit firm with a recognized record for auditing hedge funds. Likewise, investors expect for the hedge fund to have an independent third party fund administrator

Investors expect the hedge fund manager to undertake a thorough due diligence process when recommending a service provider to ensure that they have the essential level of experience and expertise to carry out their roles to the required level.

Valuation

The process of valuing the hedge fund’s investments is at the forefront of every hedge fund operational due diligence review. Pricing is probably one of the most sensitive and important areas in hedge fund controls. There is room for manipulation, fraud, or even simple errors in valuing assets, with valuations artificially boosting fund performance or smoothing “mark to market” returns.

1. Separation from the front office: While the front office may be instrumental in the valuation of some assets, final authority should reside with the back office.

2. External oversight: External to the manager’s organization

The manager’s valuation committee should consist of senior management, with the majority represented by members who are independent of the investment team. Given that the pricing policy within the fund offering documents is generally vague, there should be a detailed documented pricing policy that describes the material aspects of the valuation process and valuation procedures and controls for each asset type.

The treatment of side pockets is often a source of contention, and there are some best practices that all funds should follow:

1. The fund should have clear documentation that defines a side pocket.

2. The fund should provide investors with a description of assets which have been side pocketed and pricing at the point of side pocketing.

3. Where possible, multiple price sources should be used to verify the valuation of each position in a fund’s portfolio.

Administrator

A good administration relationship can provide important third party oversight, but the administrator must have the appropriate capabilities and the fund manager should have the proper controls in place to monitor the quality of the administrator’s work. Roles and responsibilities should be defined in a clearly written SLA, and the manager should have a formal process to allow for a regular evaluation of their administrator’s performance.

Fund–specific monthly report independent of the manager which details the pricing sources used (including the reliance on manager prices quantified as a percentage of NAV) and fund counterparties for both liquid and illiquid portions of the fund portfolio and fund counterparties.

Business Continuity/Disaster Recovery

Business continuity planning (“BCP” hereafter) refers to a hedge fund manager’s ability to continue operating in the event of a disruption to its business. Disaster recovery (“DR” hereafter) relates to a hedge fund manager’s ability to restore itself back from a disaster event to the point where it was before the disaster occurred. BCP and DR planning spans all areas of the hedge fund organization.

All firms need to implement best practice procedures and infrastructure in order to protect the business in the event of natural disaster, terrorism, pandemics and other disruptions, although the BCP and DR plans should be bespoke in that they consider the risks of the manager’s strategy.

Investor Expectations and Preferences

• Well documented BCP and DR.

• Dedicated DR/BCP crisis team for oversight of key issues.

• Plan is managed by senior management (COO, CFO).

• Proprietary data appropriately backed up and housed at an offsite venue.

• Appropriate level of documentation on the firm’s recovery plan, with step by step guide to facilitate best return to operations.

• BCP/DR plan is regularly stress tested.

• Key person(s) risk of the firm is considered, with appropriate policies in place

Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures

noreply@blogger.com (Unknown) — Thu, 02 Jun 2011 01:20:00 +0000

Governance:

This is my 2^nd post in a series, abstracting the white paper issued by the Alternative investment management association “AIMA”. This document reflects the views of investors and is written to educate the AIMA’s constituents (investors). The section on governance is is authored by Luke Dixon of Universities Superannuation Scheme.

“Their is a growing importance of good fund governance and by association, high quality independent "directors". Conflicts of interest frequently exist between the hedge fund’s board of directors (if they are any), investment managers and the fund’s advisors.” These conflicts can often lead to decisions being taken in the interests of the hedge fund’s investment manager rather than in the interests of the fund and its shareholders as a whole. The threat is this governance is contrary to the fiduciary obligations of the fund’s directors.

Investors recommend that governance structures and oversight responsibilities should be in place to protect them, and want all oversight responsibilities to be undertaken by responsible, knowledgeable and independent fiduciaries. Despite the private nature of hedge fund investments, the trajectory of their governance is towards the public market model of strong, independent boards and democratically empowered investors.

The section continues to outline what investors would consider an ideal governance platform.

Investor shares should provide relevant voting rights. As an example the voting rights might include

"the appointment and removal of the investment manager; the election of directors; approval of directors’ fees; In addition, these fund shareholders should be able to nominate directors; file a resolution at general meetings; convene an extraordinary general meeting; while the fund’s registrar should facilitate investor communications, solicitations and proxies, in this respect."

• Service providers periodically report directly to the board.

• Information prepared by service providers should be delivered directly by them to the board. This reporting distinction explicitly recognizes that the service providers are contracted by the fund rather than by the investment manager.

• The” board” should have much more of a say in the valuation of securities. Security pricing should not be left to the discretion of the investment manager.

• The board should be empowered to monitor and replace the fund’s service providers, including the investment manager.

The hedge fund’s Offering Memorandum should be sufficiently precise when describing the fund’s investment strategy and appropriate investment restrictions, to serve as a guide for director and investor oversight.

Investors would also like to see that decisions to invoke fund gating mechanisms and side pockets, or to suspend fund redemptions and net asset value (“NAV” hereafter) calculations, to be also the responsibility of the board of directors

How much of this idealistic view of what investors want will become reality is yet to be seen. However, it is very clear that hedge funds are moving from a private organization structure to a more transparent model.

Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures

noreply@blogger.com (Unknown) — Wed, 01 Jun 2011 01:17:00 +0000

The Alternative Investment Management Association (AIMA) has written a guide for investors and managers aimed at highlighting preferences and priorities for institutional investors.

The guide is called “A Guide To Institutional Investors’ Views And Preferences Regarding Hedge Fund Operational Infrastructures” outline the views and preferences on a number of operational and organizational issues which are increasingly become the subject of due diligence reviews. The paper is divided into 5 sections. I will list the contents of the sections below and starting tomorrow I will abstract each section. Investors are organizing and will have a large impact on how the hedge funds will be organized in the future.

As an example the guide, recommends that hedge funds issue voting units so investors have a say on material changes or events in the hedge funds. More to come tomorrow. Keep reading

GOVERNANCE

Relevance

Board of Directors

RISK

Reporting

Portfolio Risk

Operational Risk

Counterparty Risk

Liquidity risk

INVESTMENTS

Performance

Terms

Economics

Control of Assets

Transparency

CAPITAL

Firm Ownership

Fund Investors

Investor Relations

Sales and Marketing

OPERATIONS

Organization and Control Environment

Corporate Structure

Oversight and Reporting Lines

Separation of Duties

Whistle blowing rules finalized by SEC

noreply@blogger.com (Unknown) — Thu, 26 May 2011 20:18:00 +0000

Not only can you look yourself in the mirror for doing the right thing by turning potential “violator” of the rules into the SEC, but you will also be handsomely rewarded for your efforts. Caution read the fine print of the 305 page final rule document before you blow that whistle. See the attached link http://www.sec.gov/rules/final/2011/34-64545.pdf for the final rule.

On May 25, 2011 the SEC finalized the whistleblower rules. The Act establishes a whistleblower program that enables the SEC to pay an award, under regulations prescribed by the SEC and subject to certain limitations, to eligible whistleblowers who:

voluntarily provide the SEC original information about a violation of the federal securities laws in writing that leads to the successful enforcement of a covered judicial or administrative action, or a related action resulting in monetary sanctions exceeding $1 million.

Awards will be paid out of the statutorily-created Investor Protection Fund. The SEC will independently determine the appropriate award percentage for each whistleblower, but total award payments, in the aggregate, will equal between 10 and 30 percent of the monetary sanctions collected in the Commission’s action and the related action.

Under the final rule, when determining the percentage of a whistleblower award, the following required criteria may increase a whistleblower’s award percentage:

(1) Significance of the information provided by the whistleblower

(2) Assistance provided by the whistleblower

(3) Law enforcement interest in making a whistleblower award (BTW this one is a little vague)

(4) Participation by the whistleblower in internal compliance systems

Oh and by the way your award might be decreased by the following:

(1) Culpability of the whistleblower

(2) Unreasonable reporting delay by the whistleblower

(3) Interference with internal compliance and reporting systems by the whistleblower.

SEC is requesting Public Comment on Proposed NSRO rating rules

noreply@blogger.com (Unknown) — Sun, 15 May 2011 17:52:00 +0000

On May 10, 2011 the SEC requested for public comment ideas that will ultimately reduce the potential conflict of interest of a NRSRO assigning a credit rating for a structured product instrument. The comment period will end on or about September 10, 2011.

The study will be asking the public to comment on four areas:

The credit rating process for structured finance products and the potential conflicts of interest associated with the issuer-pay and the subscriber-pay models.

The feasibility of establishing a system in which a public or private utility or an SRO assigns an NRSRO(s) to determine the credit ratings for structured finance

The range of metrics one could use to determine the accuracy of credit ratings for structured finance products.

Alternative means for compensating NRSRO(s) that would create incentives for accurate credit ratings for structured finance products.

In addition, Section 939F provides that, after submission of the report to Congress resulting from the study, the Commission shall, by rule, as the Commission determines is necessary or appropriate in the public interest or for the protection of investors, establish a system for the assignment of NRSRO’s to determine the initial credit ratings of structured finance products, in a manner that prevents the issuer, sponsor, or underwriter of the structured finance product from selecting the NRSRO’s that will determine the initial credit ratings and monitor such credit ratings.

Macroprudential theories or "it's a small world after all"

noreply@blogger.com (Unknown) — Sun, 08 May 2011 22:33:00 +0000

On May 5^th Ben Bernanke addressed the Federal Reserve Bank of Chicago about implementing a “Macroprudential” approach to Supervision and Regulation. Though the term macroprudential and associated policies have been around for decades, I feel that the term will now be infused in our lexicon. Mr. Bernanke indicated that a central element of the Dodd Frank Reform bill is the requirement that the Federal Reserve as well as other financial regulatory agencies adopt a so-called macroprudential approach--that is, an approach that supplements traditional supervision and regulation of individual firms or markets with explicit consideration of threats to the stability of the financial system as a whole. In other words, the “macro-prudential” approach to supervision of the financial industry will require that all US and Global regulatory agencies work in concert with each other to provide oversight and exchange information.

Relative to traditional regulation and supervision, executing a macroprudential approach to oversight can involve heavier informational requirements and more-complex analytic framework. So start getting prepared.

Moreover, broadly speaking, macroprudential regulators will be concerned with at least two types of risks. The first type encompasses aspects of the structure of the financial system--such as gaps in regulatory coverage or the evolution of shadow banking--that pose ongoing risks to financial stability. The second class of risks are those that vary over time with financial or economic circumstances, such as widespread buildups of leverage in good times that could ultimately unwind in destabilizing ways.

My view

We have heard the coordinate oversight approach from the SEC and now from the Fed. With the world getting smaller and the financial industry becoming more complex, we will eventually need one set of rules that will govern the world financial markets. It is time that financial industry firms realize this and look for ways stay ahead of the regulations rather than begrudgingly reacting to them.

The House Agriculture subcommittee recommends delaying the Dodd-Frank rules surrounding derivatives under Article VII

noreply@blogger.com (Unknown) — Thu, 05 May 2011 00:19:00 +0000

What a surprise, the House Agriculture Committee controlled by republicans voted to delay the enactment of Article VII by an additional 18-months. According to the Agriculture Committee chairman, Frank Lucas, republican from Oklahoma the delay will allow more time to write and review the rules. Yes I am sure the Agriculture committee really understands the systemic risk to the country and the world for the exotic derivative market place.

Lucas says the legislation is in response to “concerns from businesses across the country about what they say is the rushed pace of rule making by the Commodity Futures Trading Commission (CFTC)”.

"This does not kill the bill,”stated Lucas. “We need to acknowledge that Dodd-Frank set impractically tight deadlines for the implementation of dozens of regulations that will touch every segment of the economy. We can't ignore the concerns of businesses that we're relying on to further our economic recovery.”

Though chances are even if the full house votes to delay the promulgated rules and regulations of Article VII, the democrat controlled senate would not pass the bill.

Anyone reading this knows that the rules in Article VII will be difficult to follow by July. What is YOUR view from a business prospective or from a regulatory control prospective. Let’s hear from you.

SEC Proposes Product Definitions for Swaps

noreply@blogger.com (Unknown) — Sat, 30 Apr 2011 00:01:00 +0000

The Securities and Exchange Commission on April 27^th voted unanimously to propose rules further defining the terms “swap,” “security-based swap,” and “security-based swap agreement.”

The rules were proposed jointly with the Commodity Futures Trading Commission (CFTC)

The joint proposal of the SEC and the CFTC would add rules under the Securities Exchange Act of 1934 and provide interpretive guidance regarding which products would – and would not – be considered a “swap” or a “security-based swap” (referred to collectively in the proposing release as “Title VII instruments”).

Transactions considered “Swaps” or Security-Based Swaps”

Foreign exchange forwards, foreign exchange swaps, foreign currency options (other than foreign currency options traded on a national securities exchange), non-deliverable forward contracts involving foreign exchange, currency and cross-currency swaps, forward rate agreements, contracts for differences, and certain combinations and permutations of (or options on) swaps and security-based swaps.

In its proposed interpretive guidance, the SEC would clarify whether particular agreements, contracts or transactions are swaps, security-based swaps, or mixed swaps. Among other things, the proposed guidance would provide that such a determination is to be made at the inception of the Title VII instrument and that such a characterization would remain throughout the life of the instrument unless the instrument is amended or modified.

Interest Rates, Other Monetary Rates and Yields: Under the proposed interpretive guidance, Title VII instruments on interest rates and other monetary rates would be swaps. And, Title VII instruments on “yields” – where “yield” is a proxy for the price or value of a debt security, loan, or narrow-based security index – would be security-based swaps, except in the case of certain exempted securities.

Total Return Swaps: Under the proposed interpretive guidance, a Total Return Swap, or TRS, on a single security, loan, or narrow-based security index generally would be a security-based swap. Where counterparties embed interest-rate optionality or a non-securities component into the TRS (e.g., the price of oil, a currency hedge), it would be a mixed swap.

Title VII Instruments Based on Futures: Under the proposed interpretive guidance, Title VII instruments on futures (other than futures on foreign government debt securities) would generally be swaps and Title VII instruments on security futures would generally be security-based swaps.

Swaps and Security-Based Swaps Based on Security Indexes

The SEC proposed rules and interpretive guidance regarding the applicability of the “narrow-based security index” definition to certain products, including proposed rules regarding the definition of “narrow-based security index” and “issuers of securities in a narrow-based security index” for index credit default swaps (index CDS).

The SEC also proposed rules and interpretive guidance regarding the definition of a security index and the evaluation of Title VII instruments based on security indexes that migrate from broad-based to narrow-based and vice versa.

If a broad-based index CDS requires mandatory physical settlement, it would be a mixed swap.

If a broad-based index CDS requires cash settlement or auction settlement, it would be a swap, and would not be considered a security-based swap or a mixed swap solely because the determination of the cash price to be paid is established through a security or loan auction.

Mixed Swaps

The SEC proposed interpretive guidance regarding the scope of the mixed swap category, which both the SEC and CFTC believe to be narrow.

The SEC also proposed rules and interpretive guidance that mixed swaps would remain subject to the entirety of the SEC and CFTC regulatory regimes, but that for bilateral uncleared mixed swaps entered into by at least one dually-regulated swap and security-based swap dealer or major swap and security-based swap participant, certain regulatory requirements would apply.

In addition, the SEC proposed a rule establishing a process, for all other mixed swaps, by which persons may request modified regulatory treatment by joint order of the SEC and CFTC.

Security-Based Swap Agreements

The SEC proposed interpretative guidance regarding certain products that are security-based swap agreements (SBSA). It also proposed a rule requiring market participants to maintain the same books and records for security-based swap agreements as they would under the CFTC’s proposed books and records requirements for swaps.

Interpretation of the Characterization of a Product

The SEC proposed a rule establishing a process that would allow market participants or either the SEC or CFTC to request a determination from the SEC and CFTC of whether a product is a swap, security-based swap, or both (i.e., a mixed swap).

What’s Next?

The proposal seeks public comment and data on a broad range of issues relating to the proposed rules and interpretive guidance, including the costs and benefits associated with the proposal. After careful review of comments, the SEC and the CFTC will consider whether to adopt the proposed rules and interpretive guidance or modify them. Comments should be received on or before 60 days after the date of publication in the Federal Register.

Deputy secretary Wolin KNOCKS them down! You gotta LOVE it

noreply@blogger.com (Unknown) — Mon, 25 Apr 2011 23:54:00 +0000

On April 19, 2011, Deputy Secretary Neal S. Wolin delivered a prepared statement to address the critics of the Dodd-Frank Act. The comments were so hard hitting I dare not change the tenor of what Mr. Wolin so aptly conveyed. It is rather long but worth the read. Here is a guy who is tired of hearing rhetoric and tired of individuals having a short memory. 10 and out Mr. Wolin.

Speaking about the fiscal crisis of 2008, “There was no alternative to reform. Not only our economy but also the lives and livelihoods of tens of millions of American families were devastated by the crisis. And it was manifestly clear that the financial system that led us to the edge of the abyss was broken and needed to be fixed.

The system we had favored short-term gains for individual firms over the stability and growth of the economy as a whole. The system we had was weak and susceptible to crisis. And the system we had left taxpayers to save it in times of trouble.

The Dodd-Frank Act creates a comprehensive and robust regulatory framework. The statute creates a structure for the government to monitor and respond to systemic risk. It makes clear that no firm will be considered “too big to fail.” It requires regulators to impose heightened prudential standards on large, interconnected financial firms. It provides for the comprehensive regulation of the derivatives markets for the first time. And the statute establishes a single agency dedicated to protecting consumers.

For the past nine months, regulators have been hard at work implementing these and many other critical reforms contained in Dodd-Frank.

Yet today, even as millions of Americans are still recovering from the crisis, some on Wall Street, K Street, and Capitol Hill seek to slow down, roll back, or even repeal these crucial reforms.

I want to address these criticisms one by one.

First, the pace of reform.

After the Dodd-Frank Act was signed into law last summer, many in Washington and in the financial services industry said that the legislation lacked details, and that the uncertainty of the shape of final regulations made it difficult for businesses to plan for the future. They called for clarity, and they wanted it fast.

We said that regulators would move quickly but carefully to implement the legislation. We said that we would seek public input. We said it’s critical to get the details right.

Recently, some of these very same critics – those who previously demanded clarity as quickly as possible – are saying that we’re moving too quickly. They now suggest that too many details are coming too fast. They say that regulators aren’t setting aside sufficient time to study the issues and make the right decisions, and that businesses won’t have time to adjust to the new regulations.

Although there may be reasonable debate about the substance of Dodd-Frank implementation work, there is no question that regulators have been implementing the statute in a careful, considered, and serious manner.

The second criticism is that implementation of the law is uncoordinated.

Our financial regulatory system is built on the independence of regulators, and given the importance of Dodd-Frank implementation, independent regulators will have different views on complicated issues – working through differences is an important part of getting the substance right.

At the same time, Dodd-Frank forces regulators, more than ever before, to work together to close gaps in regulation and to prevent breakdowns in coordination – this is a central change brought about by the law. Beyond joint rules and consultation required on specific rulemakings, we have been and will continue working together where issues cut across multiple agencies, to make the pieces of reform fit together in a sensible, coherent way.

The Financial Stability Oversight Council, which is a key component of Dodd-Frank, has a mandate to coordinate across agencies and instill joint accountability for the strength of the financial system. Already, we have worked through the FSOC to develop an integrated roadmap for implementation, to coordinate an unprecedented six-agency proposal on risk retention, and to develop unanimous support for recommendations on implementing the Volcker Rule. As Chair of the FSOC, Treasury will continue to make it a top priority that the work of the regulators is well-coordinated.

Third, critics claim that reforms to the derivatives markets will harm liquidity and inhibit effective allocation of capital.

Regulation of the over–the-counter derivatives markets is a critical element of the Dodd-Frank Act. The financial crisis demonstrated that without adequate transparency and capital reserves, derivatives can allow hidden risks to build and leave counterparties without sufficient buffers to sustain losses.

The critics argue that requiring standardized contracts to be traded on open, transparent markets will harm liquidity. This position ignores the history and the basic structure of our financial system. The equities market, where stocks are traded publicly and price information is readily available, is one of the most liquid markets in the world – because of, not in spite of, transparency.

Increased transparency in the derivatives markets will tighten spreads, reduce costs, and increase understanding of risks for market participants. Now, a transparent structure like this might not improve the bottom line of certain market participants – but it promotes efficient markets, capital formation, and growth in the broader economy, while reducing the risk and potential costs of another destabilizing financial crisis.

Critics also say that margin requirements for derivatives tie up capital unnecessarily, diverting it away from investments that promote economic growth.

Requiring the largest participants and dealers in derivatives markets to hold capital and margin is critical to improving the resilience of the financial system. The margin requirements for financial entities are, then – like derivatives themselves – a “risk-management tool,” serving as important bulwark against losses infecting the system and contributing to another crisis.

Fourth, critics say that unless we achieve harmonized policies across borders, we should hold off or go slow on moving forward with Dodd-Frank, lest there be an unlevel playing field internationally. They also argue that if our reforms are too strong or different, U.S. firms will not be able to compete on a global scale.

I disagree. We have already enacted comprehensive legislation, and others are now putting their legal and regulatory frameworks in place. We are working hard at the international level to make sure that others put in place similar frameworks on the key issues where international consistency is essential – such as OTC derivatives, liquidity, leverage, and capital.

Now, it’s true that the devil lies in the details, and that when different jurisdictions implement commonly-agreed-to international principles, problems and disagreements may arise. That is why in addition to our work in international fora like the G-20 and the Financial Stability Board, we work every day with our foreign counterparts, especially in Europe, through our financial market and regulatory dialogue.

But as we work in the international sphere to promote a level playing field, we must not fail to implement our reforms at home. Ultimately, if we fail to do what is necessary to reform and protect our system, we put at risk its fundamental strength and resilience.

Critics don’t want to hear any of this. They simply say if our financial system is different from our partners, U.S. firms won’t be able to compete. It’s not a credible argument, because our systems have never been identical, and they never will be.

A great deal of their criticism is focused on enhanced capital requirements.

More and higher-quality capital, especially at the biggest and most interconnected financial institutions, is essential to providing better buffers against shock. Indeed, as the international community has recognized, the lack of such buffers was a core problem in the crisis we’ve just experienced. Implementation of Dodd-Frank and the work of the Basel Committee are critical to ensuring that firms are better insulated from stress.

We believe, of course, that it’s important to strike the right balance. We need a capital regime that strengthens firms so that they can withstand stress, but also one that allows U.S. firms to compete effectively on a global basis.

Detailed rules about capital requirements and other aspects of financial regulation will always vary among sovereign nations. What’s important, what we have made good progress on – and what we are committed to – is closing regulatory gaps, ending opportunities for geographic arbitrage, and preventing a global race to the bottom.

Fifth, critics suggest that the Consumer Financial Protection Bureau will stifle consumer choice and innovation, or interfere with the role of existing regulators. And they also claim that the agency isn’t accountable.

Rather than limiting choice, the CFPB will be essential to creating real choice for consumers. The system we had before allowed lenders to hide the true costs of financial products in hidden fees and interest rate changes. Consumers often didn’t get the information they needed to understand the loan they were taking out or the credit card agreement they were signing. That’s not choice.

Real choice is about having the information to make the right decisions. The CFPB’s job is to deter deceptive and abusive practices, promote clear disclosure, and help consumers get the information they need. With that information, consumers will have real choice – they will be able to understand what products and services are best for them and to make fully informed financial decisions.

And as consumers begin to make more informed financial decisions, it will raise the bar for the products and services offered to them. More empowered consumers will motivate the financial sector to offer new and better options. Rather than stifling innovation, the CFPB will catalyze it.

I want to emphasize that the CFPB’s mission – helping consumers get good information and cracking down on deceptive and abusive practices – in no way interferes with the role of prudential regulators. What we had before – a patchwork system where too many agencies were responsible for consumer protection, but none of them actually focused on it – that system simply didn’t work.

The existence of the CFPB allows prudential regulators to focus on their core tasks – making sure that banks have the capital, the liquidity, and the risk-management tools to ensure safety and soundness in the system. It allows the CFPB to focus on its own single task – to make sure that consumer financial products are offered in a fair, transparent, and competitive way.

Public Appearances by SEC Officials

noreply@blogger.com (Unknown) — Sun, 24 Apr 2011 15:24:00 +0000

When:	Wednesday, April 27 (12:30-1:45 p.m.)
Who:	Carlo di Florio Director - Office of Compliance, Inspections and Examinations
What:	Cross-Border Issues Facing Investment Advisers After Dodd-Frank
Where:	DC Bar, DC Bar Office, Washington, D.C.
Contact:	Robin Bergen (202) 974-1514 begin_of_the_skype_highlighting (202) 974-1514 end_of_the_skype_highlighting rbergen@cgsh.com

When:	Thursday, April 28 (12:30-1:45)
Who:	Eileen Rominger Director, Division of Investment Management
What:	Mutual Fund Directors Forum, 2011 Policy Conference
Where:	Washington, D.C.
Contact:	Susan Ferris Wyderko, Executive Director, MFDF (202) 507-4488 begin_of_the_skype_highlighting (202) 507-4488 end_of_the_skype_highlighting Susan.Wyderko@MFDF.org

When:	Friday, April 29 (10:45-12 p.m.)
Who:	Merri Jo Gillette Regional Director, Chicago Regional Office
What:	Northwestern University School of Law Practical Advice for Responding to Enforcement Initiatives
Where:	Chicago, Illinois
Contact:	Juliann Cecchi (312) 503-0192 begin_of_the_skype_highlighting (312) 503-0192 end_of_the_skype_highlighting

When:	Friday, April 29
Who:	George Canellos Director, New York Regional Office (9:15-10:45 a.m.) Robert Khuzami Director, Division of Enforcement (11:00 a.m.) Carlo di Florio Director - Office of Compliance, Inspections and Examinations (4-5 p.m.)
Where:	Practising Law Institute, PLI Conference Center, New York, New York
Contact:	Laura Shields (212) 824-5797 begin_of_the_skype_highlighting (212) 824-5797 end_of_the_skype_highlighting lshields@pli.edu

SEC Seeks Public Comment on Effective Investor Education Programs

noreply@blogger.com (Unknown) — Sun, 24 Apr 2011 15:13:00 +0000

On April 19, 2011 the Securities and Exchange Commission published a request for public comment (see link attached http://www.sec.gov/rules/other/2011/34-64306.pdf) on the effectiveness of existing investor education efforts as part of a review mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Commission is seeking public comment to better understand the details and effectiveness of current programs, and help ensure that the study includes all relevant programs. “We want to know more about what’s out there and what’s working in the world of investor education,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy.

As part of its investor education effort, the SEC recently upgraded its Investor.gov website devoted exclusively to investor education. The site has been redesigned and expanded with more information about a variety of topics including how to research investments and investment professionals, understand fees, and prepare for life events.

Obviously the SEC wants the investors to be more sophisticated. This process is not so much for hedge fund investors, which are by definition sophisticated, but for the retail investor. However, it will be interesting to see what the comments are and ultimately what if any pressure the SEC levy’s on the hedge fund industry regarding education.

SEC Form ADV starts to open the kimono of Hedge Fund practices

noreply@blogger.com (Unknown) — Wed, 20 Apr 2011 22:58:00 +0000

Want to know more about registered investment advisers?

You will obtain a plethora of information on registered investment adviser firms on the SEC web site, http://www.adviserinfo.sec.gov This website will have the firm’s Form ADV for those Firms registered with the SEC. Form ADV contains information about an investment adviser and its business operations. See below for a list of what is included in Form ADV.

The Web site will also allow you to search for an individual investment adviser representative (RIA) and view that individual's professional background and conduct including current registrations, employment history, and disclosures about certain disciplinary events involving the individual.

Part 1A This form is filed by all member firms. The form asks many yes or no questions but it also includes some interesting aspects of the member Firm's makeup. See below for areas in part 1A

Identifying Information
SEC Registration
Form Of Organization
Successions
Information About Your Advisory Business
Other Business Activities
Financial Industry Affiliations
Participation or Interest in Client Transactions
Custody
Control Persons
Disclosure Information
Small Businesses

Part 2 Disclosures. Here are the typical disclosures a firm will make. This is not an exhaustive listing.

Material Changes
Advisory Business
Fees and Compensation
Performance-Based Fees and Side-By-Side Management
Types of Clients
Method of Analysis, Investment Strategies and Risk of
Disciplinary Information Item
Other Financial Industry Activities and affiliates
Code of Ethics, Participation or Interest in Client Transactions and Personal
Trading
Brokerage Practices
Review of Accounts
Client Referrals and Other Compensation
Custody Investment
Discretion Voting
Client Securities
Financial Information
Management Persons
Soft Dollar Vendors
Advisory Business

Given the industry history of opaque practices and closely guarding as much information as possible, it is no wonder that 1/3 of the hedge funds over $1 billion have yet to register. Maybe it will all go away????NOT

Part 4 of the SEC is getting Serious

noreply@blogger.com (Unknown) — Sat, 16 Apr 2011 21:14:00 +0000

Valuation Committees

At the 100 women in hedge fund conference a question was posed; “What are the Areas that the SEC will focus on during an examination?” The answer highlighted that since the financial crisis the member firm’s “valuation process and results” is an area of importance.

The SEC indicated that since the valuation of assets has a direct relationship to the performance that the member firm reports to its investors and to regulators and the fees it collects, the SEC will review the process that is in place at the member firm. The SEC would like to see the member firm employ a formalized valuation process with a documented rational of pricing of its illiquid and/or hard to price securities.

Though side pocket pricing might be less of an issue because they are usually held at cost until an event occurs or at realization, the SEC will be reviewing the pricing process to ensure that an other than temporary impairment is considered during the pricing cycle.

The SEC will “take a lot of stock in good faith valuation procedures”. In my opinion this means the member firms should have a written policy for pricing each of its investment types, have an independent committee to compliment the business pricing and documentation/minutes of the valuation results.

The SEC will also ensure that what is stated in the valuation policy manual and at the valuation committee meetings are in fact actually occurring. The SEC stated that “Misrepresentations in valuation policies and procedures…will be taken very seriously”.

Part 3 The SEC is getting Serious

noreply@blogger.com (Unknown) — Thu, 14 Apr 2011 15:30:00 +0000

Whistle blower program

A question regarding the Whistle Blower Program was posed to the SEC on how they plan on analyzing the tips, complaints and referrals that they receive. The SEC indicated that the Whistle Blower program is indeed underway, a new head of the department has been appointed and new rules should be announced next month.

The SEC indicated that it is essential each member firm’s compliance manual, include a program which covers Whistle blowers. The SEC is stressing that employees and the Firm should rely on their own internal compliance programs to monitor improprieties.

Tips complaints and referrals

James Capezutto indicated that market intelligence “is all about enhancing the information we

get”. The SEC indicated that in the past they were criticized that information was trapped in a divisional silo. Now there will be much more cooperation across divisions.

“As you could imagine, the SEC is receiving thousands of complaints from investors, employees and others”. They will review each tip, referral or compliant and will readily act on information that is believable and from a quality source. The SEC will cross check the information received from these tips, complaints and referrals with risk analytics they have collected on the company.

Other information received

Enforcement will also look at the results of the examinations to determine whether to start an enforcement action and/or dive deeper into a fund. And obviously someone on the inside of the company would be a quality tip which the SEC will take advantage of.

Risk analytics

Bruce Karpati stated that the SEC is using a risk analytics approach as another factor in “assessing whether we should be approaching the firm for more information or to start an examination”. Further, the risk analytics are being shared with exam staff prior to their arrival at the member firm.

The SEC also indicated that they will look closely at a firm where its performance is an outlier to that of the rest of the member firms. However they also indicated that they will not just rely on the 3% rule but use other sophisticated risk methods to determine if a firm is an outlier in its product and hedge fund class.

Tomorrow I will wrap of this series with Valuations

Part 2 of the SEC is getting serious

noreply@blogger.com (Unknown) — Tue, 12 Apr 2011 23:29:00 +0000

A question was asked "what is important to the SEC while preparing and conducting an exam of a private fund". The answer was very succinct. A good compliance and internal control program, a good valuation program and a good program to monitor conflict of interests.

Compliance Program and internal Controls

When the SEC is preparing for an exam, they will request the compliance manual from the Chief Compliance Officer (“CCO”). The SEC will also request from the hedge fund or obtain through the web, things like client letters or disclosure documents. James Capezzuto, Associate Director, SEC stated “All is fair game in the pre-exam work” Once in the field the SEC will ensure that the CCO is informed and conversant in these materials.

Bruce Karpati, Co-chief, Asset Management Unit, SEC Enforcement Division stated that compliance programs and internal controls “are very important to us and will be more important in upcoming exams”. The exam method will include a top down approach starting with the CCO. The SEC would like to see that the CCO and compliance function has support from the highest level(s) within the firm.

The SEC will want to know that the CCO is knowledgeable of the rules and that the CCO “is engaged in the business” James Capezzuto further stated the they will be looking to see that the CCO “knows what the risks are in the business and that they effectively communicate those risks to upper management” The SEC also indicated that the stronger the compliance program the better feeling they will have about the firm. However, they will not only rely on discussions with the CCO and the business lines, but will conduct testing surrounding the compliance program.

Good Faith points

The SEC indicated that a good faith effort to follow these programs goes a long way. Bruce Karpati stated that if charges are brought against a firm and they firm had made a good faith attempt to deal with those issues both in a procedures manual and in practice (monitoring and testing) that the SEC will give the firm some credit for that.

It is clear that the SEC is saying that they want the firms to be knowledgeable and to have support from the top. Look at your procedures look at your business model and make sure they line up.

Outsourcing the Compliance Function

The SEC recognizes that some firms because of their size or lack of resources might outsource its compliance function. This is allowed, but the SEC will review the compliance program and procedures manual just the same. If the Firm outsources its compliance function they still need to ensure that it is germane to the business model and asset classes of the hedge fund. If you outsource compliance and the program is off the shelf and does not have anything to do with the business the SEC will have concerns. Further it was stated that if the compliance provider is far (not in geographical terms but from understanding the business model and related issues) the SEC will have concerns. These outsourcing professionals need to know your business and need to ensure that there is good communication to all levels of the firm.

Tomorrow I will discuss the SEC's view on conflict of interest and valuation models.