Tag Archives: SEC

Cole-Frieman & Mallon 2017 Second Quarter Update

Below is our quarterly update which went out via email today to our firm’s clients and friends.

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August 23, 2017

Clients, Friends, Associates:

We hope you are enjoying the summer. Although the second quarter is typically not as busy as the first quarter from a regulatory/compliance standpoint, we saw many regulatory developments this quarter, as well as a surge in digital asset investment activity. Below is an overview of noteworthy items, as well as what to expect as we move into the third quarter.

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SEC Matters:

Proposed SEC Amendment to Advisers Act for VC and Private Fund Advisors. On May 3, 2017, the SEC proposed a rule to amend the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”), that would amend the definition of a “venture capital fund” and the definition of “assets under management” with respect to the private fund adviser exemption. For purposes of the exemption for advisers to venture capital funds, small business investment companies (“SBIC”) would be included in the definition of a venture capital fund. This would expand exemption coverage for advisers solely relying on the SBIC adviser’s exemption. Eligible advisers would file as an “exempt reporting adviser,” reducing the extra costs and burdens of recordkeeping required of registered investment advisers. Additionally, with respect to the private fund adviser exemption, currently firms that advise solely private funds and that have less than $150 million of regulatory assets under management are exempt from registration with the SEC. The proposed rule would exclude SBIC assets from the calculation of private fund assets used to determine if the $150 million threshold has been crossed. The SEC closed requests for comment on the proposal on June 8, 2017.

SEC Seeks Input Regarding Department of Labor (“DOL”) Fiduciary Rule. SEC Chairman Jay Clayton issued a statement on June 1, 2017 welcoming public input to help the SEC formulate its assessment of the impact the DOL’s Fiduciary Rule (as discussed further below) may have on investors and entities regulated by the SEC. The statement was released in anticipation of a DOL request for information from the SEC to promote consistency and clarity with respect to implementation of the rule between the two agencies. Interested individuals can respond to SEC questions about the rule’s impact on investment advisers and broker-dealers via email or an online webform. Public submissions remain open and are currently available for review.

SEC Action Against Outsourced CCO.  On August 15, 2017, the SEC reached a settlement with an outsourced CCO and his consulting firm, which offered compliance consulting and outsourced CCO services to investment advisory firms. The outsourced CCO served as CCO for two registered investment advisers (collectively, “Registrants”). The SEC found the Registrants either filed their Form ADV annual amendments late or not at all, and the outsourced CCO relied on estimates provided by the Registrants’ CIO. It was established the AUM and number of advisory accounts reported on the Form ADV were greatly overstated, and the outsourced COO did not confirm the accuracy of the information. The SEC held the outsourced CCO violated the Investment Advisers Act by failing to amend the Form ADV annually and willfully submitting a false statement. The SEC suspended the outsourced CCO from association or affiliation with any investment advisers for one year and ordered him to pay a $30,000 civil penalty. The action indicates that outsourced compliance persons solely relying on internal estimates of AUM and number of advisory contracts, without further confirmation, are at risk of filing false reports and subject to enforcement with the SEC.

CFTC Matters:

CFTC Requests Input to Simplify and Modernize Commission Rules. In response to President Trump’s executive order to reform regulations to stimulate economic growth, the CFTC is requesting public input in an effort to simplify and modernize CFTC rules and make complex CFTC regulations more understandable for the public. Rather than rewrite or repeal existing rules, a primary goal of Project Keep it Simple Stupid (“Project KISS“) is to find simpler means of implementing existing rules. The CFTC will review rules with an ultimate goal of reducing regulatory burdens and costs for industry participants. The solicitation period for comments began on May 3, 2017 and will close on September 30, 2017. Comments can be submitted via the Project KISS portal on the CFTC’s website.

CFTC Approves Amendments to Strengthen Anti-Retaliation Whistleblower Protections. The CFTC unanimously approved new amendments to the “Whistleblower Incentives and Protection” section of the Commodity Exchange Act of 1936, as amended (the “CEA”) on May 22, 2017. The amendments provide for greater anti-retaliation measures against employers who attempt to retaliate against employees that report employer CEA violations. Further, the amendments help clarify the process of determining whistleblower awards. The amendments will become effective July 31, 2017.

CFTC Unanimously Approves Recordkeeping Amendment Requirements. On May 23, 2017, the CFTC unanimously approved amendments to Regulation 1.31 to clarify the rule and modernize the manner and form required for recordkeeping. Specifically, the amendment will allow the manner and form of recordkeeping to be technology-neutral (i.e. not requiring or endorsing any specific record retention system or technology, and not limiting retention to any format). The amendments do not expand or decrease any existing requirements pertaining to regulatory records covered by other CFTC regulations.

Digital Asset Matters:

CoinAlts Fund Symposium.  Cole-Frieman & Mallon LLP is pleased to announce that it is hosting, along with fellow symposium sponsors Arthur Bell CPAs, MG Stover & Co., and Harneys Westwood & Riegels, the CoinAlts Fund Symposium on Thursday, September 14, 2017, in San Francisco. This one-day symposium is for managers, investors and service providers in the cryptocurrency space and discussion points will include cryptocurrency investment, as well as legal and operational issues pertaining to this new asset class. The key-note speaker will be Olaf Carlson-Wee, Founder and CEO of Polychain Capital, and the symposium will include a number of other speakers representing the perspectives of investment management, fund administration, audit and tax, custody of funds, offshore fund formation and compliance. Early bird registration for investors, manager and students ends August 31st.

California Proposes a BitLicense via the Virtual Currency Act. Following in New York’s footsteps with its implementation of a BitLicense to regulate virtual currency activity in New York, California has proposed A.B. 1123 (or the “Virtual Currency Act”), its own version of a BitLicense. If passed, any persons involved in a “virtual currency business” must register with the California Commissioner of Business Oversight (the “Commissioner”). Under the Virtual Currency Act, a “virtual currency business” is defined as maintaining full custody or control of virtual currency in California on behalf of others. The application and registration process includes an extensive review of the business by the Commissioner, maintenance of a minimum capital amount, annual auditing, and an application fee of $5,000 with a $2,500 renewal. Currently aimed at those offering exchanges or wallet services we do not believe digital asset fund managers will need to obtain this licence. More information can be found here.

SEC Grants Review of Initial Rejection of Winklevoss Bitcoin Exchange-Traded Fund. In March, the SEC rejected a proposed rule change to list and trade shares of the Winklevoss Bitcoin Trust as commodity-based trust shares on the Bats BZX Exchange. In the disapproval order, the SEC claimed that the bitcoin market was too unregulated at the time, and the BZX Exchange would therefore lack the capability of entering into necessary surveillance-sharing agreements that are required of current commodity-trust exchange traded products. Bats BZX Exchange filed a petition for review of the disapproval order. The SEC granted the petition in April and has yet to release any further comments. As digital asset trading has increased over the past few months, many are looking at the review of the petition as a potential indicator of future cryptocurrency regulation to come.

SEC Petitioned for Proposed Rules and Regulation of Digital Assets and Blockchain Technology.  A broker-dealer operating an alternative trading system (“ATS”) for unregistered securities, petitioned the SEC for rulemaking regarding guidance on digital assets. The Petitioner argued that some digital assets should be considered securities, and that current regimes in the United Kingdom and Singapore can be modeled domestically to successfully facilitate the issuance and trading of digital assets. The model currently used by those countries is known as a “regulatory sandbox,” in which companies are allowed to operate without significant regulatory interference, so long as they do so within a set of established rules. As of today, the SEC has not responded to the petition, but we expect the frequency of petitions and requests for no-action letters to increase as this space continues to grow.

Other Items:

Department of Labor (“DOL”) ‘Implements’ Fiduciary Rule. On June 9, 2017, the DOL partially implemented its amended fiduciary rule (the “Fiduciary Rule”), which expands the definition of a “fiduciary” subject to important exemptions.  On August 9, 2017 the DOL submitted proposed amendments to these exemptions thereby delaying enforcement; and extending the transition period and uncertainty over the ultimate fate of the fiduciary rule by another eighteen months to July 1, 2019. Managers with questions regarding the applicability of these exemptions should discuss with counsel.

Generally, anyone that makes a “recommendation” as to the value, disposition or management of securities or other investment property for a fee or other compensation, to an employee benefit plan or a tax-favored retirement savings account such as an individual retirement account (“IRA”) (collectively “covered account”) will be deemed to be providing investment advice and, thus, a “fiduciary,” unless an exception applies. Many fund managers and other investment advisers may unintentionally be deemed to be fiduciaries to their retirement investors under the amended rule. Fund managers with investments from covered accounts or that wish to accept contributions from covered accounts will need to consider whether their current business activities and communications with investors could constitute a recommendation, including a suggestion that such investors invest in the fund. Under certain circumstances, fund managers may be deemed fiduciaries.  Notably, the Fiduciary Rule provides an exception for activity that would otherwise violate prohibited transaction rules which is applicable to investments made by plan investors who are represented by a qualified independent fiduciary acting on the investor’s behalf in an arms’ length transaction (typically for larger plans). For clients or investors that do not have an independent fiduciary, managers must evaluate whether they are fiduciaries and what actions must be taken to comply with ERISA’s fiduciary standards or the prohibited transaction rules.  The Fiduciary Rule also contemplates a Best Interest Contract (“BIC”) Exemption, which permits investment advisers to retail retirement investors to continue their current fee practices, including receiving variable compensation, without violating prohibited transactions rules, subject to certain safeguards.

We recommend that investment advisers contact their counsel regarding making any necessary updates to the applicable documents.

MSRB Establishes Continuing Education Requirements for Municipal Advisors. Beginning January 1, 2018, the Municipal Securities Rulemaking Board (“MSRB”) will implement amendments requiring municipal advisors to have a continuing education program in place for “covered persons” and require such persons to participate in continuing education training. The amendment will require an annual analysis to evaluate training needs, develop a written training plan, and implement training in response to the needs evaluated. The amendments also provide for record-keeping of the plans and analysis to promote compliance. Municipal advisors will have until December 31, 2018 to comply with the new requirements. To further clarify the requirements, the MSRB will be hosting an education webinar for municipal advisors on Thursday October 12, 2017, from 3:00 p.m. to 4:00 p.m. EDT.

Full Implementation of MSRB Series 50 Examination. The grace period for municipal advisor representatives and municipal advisor principals that have not passed the Series 50 examination to qualify as a municipal advisor representative or principal will be ending on September 12, 2017. Thereafter, all municipal advisor professionals who either engage in municipal advisory activities or engage in the management or supervision of municipal advisory activities will be required to pass the Series 50. The MSRB has a content outline which specifies eligibility, the structure of the exam, and the regulations to be tested.

Form ADV Technical Amendment Including Wyoming for Mid-Size Advisers. On July 1, 2017, a technical amendment to Form ADV was implemented to reflect a new Wyoming law that now requires investment advisers with $25 million to $100 million in AUM and a principal place of business in Wyoming to register with the state as an investment adviser instead of the SEC. The technical amendment will also appear on Form ADV-W.

Further Updated CRS Guidance Notes. The Cayman Islands Department for International Tax Cooperation (“DITC”) and the Cayman Islands Tax Information Authority (“TIA”) issued further guidance notes on April 13, 2017 for compliance with Automatic Exchange of Information (“AEOI”) obligations. Among some of the more important notes are the following:

  • US FATCA notification and reporting deadlines will now parallel the Common Reporting Standard (“CRS”) deadlines. The notification deadline was June 30, 2017, and the reporting deadline will be July 31, 2017.
  • The deadline for correcting any FATCA report errors for 2014 and for 2015 will be July 31, 2017.
  • CRS reporting must be completed with the CRS XML v1.0 or a manual entry form on the AEOI portal.

We recommend contacting your tax advisors to discuss any potential issues regarding the above updates and deadlines.

Compliance Calendar. As you plan your regulatory compliance timeline for the coming months, please keep the following dates in mind:

Deadline – Filing

  • July 15, 2017 – Quarterly Form PF due for large liquidity fund advisers (if applicable).
  • July 30, 2017 – Collect quarterly reports from access persons for their personal securities transactions.
  • August 14, 2017 – Form 13F filing (advisers managing $100 million in 13F Securities).
  • August 29, 2017 – Quarterly Form PF due for large hedge fund advisers (if applicable).
  • September 30, 2017 – Review transactions and assess whether Form 13H needs to be amended.
  • October 2017 – Revised Form ADV 1A goes into effect for advisers filing an initial ADV or an annual updating amendment.
  • October 16, 2017 – Quarterly Form PF due for large liquidity fund advisers (if applicable).
  • November 14, 2017 – Form 13F filing (advisers managing $100 million in 13F Securities).
  • November 29, 2017 – Quarterly Form PF due for large hedge fund advisers (if applicable).
  • Ongoing – Amendment due on or before anniversary date of prior Form D filing(s), or for material changes.
  • Ongoing – Due on or before anniversary date, and promptly when material information changes


Please contact us with any questions or for assistance with any compliance, registration or planning issues on any of the above topics.

Sincerely,
Karl Cole-Frieman, Bart Mallon & Lilly Palmer

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Mr. Mallon can be reached directly at 415-868-5345.

Hedge Fund Manager Registration to Cost Taxpayers $140 Million (at least)

CBO Calculates Cost of House Hedge Fund Bill

This past week the Congressional Budge Office (“CBO”) released a cost estimate of H.R. 3818, the Private Fund Investment Advisers Registration Act of 2009.  In a number of private conversations I have had about hedge fund registration over the last 9-12 months one of the issues that was continually raised was appropriate funding for the SEC.  As we have seen recently (most notably from the Inspector General’s Madoff report), the SEC’s budget is not large enough to adequately fulfill their investor protection mandate.  Adding hedge fund registration would obviously further burden the cash-strapped agency (for more see Schumer Proposal to Double SEC Budget).  According to the CBO, and based on the SEC’s estimates that it will need to add 150 employees, the estimated outlays over four years will be equal to $140 million.

However, taxpayers should understand that this assumes that registration will only be required for those managers with at least $150 million in assets under management.   At the $150 million AUM level, the CBO expects that 1,300 hedge fund managers would be required to register.  The current draft of the Senate hedge fund registration bill calls for managers with $100 million in AUM to register – lowering the AUM exemption threshold will increase the amount of managers required to register.  Additionally, there are outstanding political issues.  First, it is unclear whether the final bill will require private equity fund managers and venture capital fund managers to register – we do not necessarily understand the arguably arbitrary carve-out for these industries.  Second, it is clear that a majority of the state securities commissions are unable and unwilling to be responsible for overseeing managers with up to $100 million in assets.  Hedge fund managers who would subject to state oversight would rightly want to be subject to SEC oversight (which does not say much for many state securities commissions).  These issues will continue to be addressed during the political sausage-making process.

Of additional interest – the CBO estimates that hedge fund registration is likely to cost around $30,000 per each SEC registrant which is welcome news to investment adviser compliance consultants and hedge fund lawyers!

For full report, please see full CBO Hedge Fund Cost Estimate.

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Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and provides hedge fund manager registration service through Cole-Frieman & Mallon LLP He can be reached directly at 415-868-5345.

Hedge Funds and Insider Trading after Galleon

By Bart Mallon, Esq. (www.colefrieman.com)

High Profile Case Highlights Issues for Hedge Fund Managers to Consider

Insider trading is now an operational issue for hedge fund managers.  The high profile insider trading case involving RR and the Galleon hedge fund has put the spotlight directly on hedge funds again and has also sparked a debate of sorts on the subject.  Given the potential severity of penalties for insider trading, it is surprising that we still periodically hear about such cases, but nevertheless it is something that is always going to be there – human nature is not going to change.

As such hedge fund managers need to be prepared to deal with this issue internally (through their compliance procedures) and also will need to be able to communicate how they have addressed this issue to both the regulators and institutional investors.  While managers always need to be vigilant in their enforcement of compliance policies and procedures, during this time of heightened insider trading awareness, managers need to be even more vigilant about protecting themselves.  As the Galleon liquidation too vividly shows, a lapse in operational oversight can and will take down an entire organization.

Insider Trading Overview and Penalties

We have discussed insider trading before, but as a general matter insider trading refers to the practice of trading securities based on material, non-public information.  Whether information is material depends on case law.  In general information will be material if “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision (see TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).  Information is non-public if it has not been disseminated in a manner making it available to investors generally. An insider is generally defined as officers, directors and employees of a company but it can also refer to a company’s business associates in certain circumstances (i.e. attorneys, accountants, consultants, and banks, and the employees of such organizations).  Additionally, persons not considered to be insiders may nevertheless be charged with insider trading if they received tips from insiders – such persons generally are referred to as tippees and the insider is generally referred to as the tipper.  [HFLB note: more information on insider trading generally can be found in the discussion of Regulation FD on the SEC website.]

The penalties for insider trading are potentially harsh – censures, cease and desist orders, fines, suspension and/or revocation of securities licenses are all potential penalties.  Depending on the severity of the insider trading there may be criminal sanctions in addition to the listed civil penalties.  Securities professionals (or other business professionals like an attorney or accountant) may jeopardize their ability to work in their industry if they are caught engaging in insider trading which, for most people, would be a large enough deterrent to engage in such activity.

Addressing Compliance Inside the Firm

Insider trading is usually addressed in the firm’s compliance policies and procedures.  Indeed, Section 204A of the Investment Adviser Act of 1940 requires SEC registered investment advisers to maintainpolicies and procedures to detect against insider trading.

Usually such policies and procedures forbid employees from trading on material non-public information (as well as “tipping” others about material non-public information).  Additionally, employees typically are required to disclose any non-public material information they receive to the chief compliance officer (“CCO”) of the firm.  The employee is generally prohibited from discussing the matter with anyone inside or outside of the firm.  The policies and procedures may require the CCO to take some sort of action on the matter.  There are a number of different ways that the CCO can handle the situation including ordering a prohibition on trading in the security (including in options, rights and warrants on the security).  The CCO may also initiate a review of the personal trading accounts of firm employees.  Usually when the CCO is informed of such information the CCO would contact outside counsel to discuss the next course of action.

Dealing with Regulators

While many large hedge fund managers are registered as investment advisors with the SEC, many still remain unregistered in reliance on the exemption provided by Section 203(b)(3).  With the Private Fund Investment Advisers Registration Act likely to be passed within the next year, managers with a certain amount of AUM (either $100 million or $150 million as it now stands) will be forced to register with the SEC.  Of course, this means that such managers will be subject to examination by the SEC and insider trading will be one of the first issues that a manager will likely deal with in an examination.

As we discussed in an earlier insider trading article, the SEC has unabashedly proclaimed war against insider trading and they will be aggressively pursuing any leads which may implicate managers.

Some compliance professionals believe that the SEC comes in with a view that the manager is guilty until proven innocent.  While I do not necessarily subscribe to this blanket viewpoint, I do believe that managers, as a best practice, should be able to show the SEC the steps they have taken to ensure that compliance with insider trading prohibitions is a top priority of the firm.  The firm and CCO should be prepared to describe their policies and structures that are in place to deal with this issue.

Institutional Standpoint

Potentially more important than how a firm deals with the SEC, is how a firm describes their internal compliance procedures to institutional investors.  The question then becomes, how are institutional investors going to address this risk with regard to the managers they allocate to – what will change?

Right now it appears a bit unclear.  Over the past week I have talked with a number of different groups who are involved hedge fund compliance, hedge fund consulting, and hedge fund due diligence and I seem to get different answers.  Some groups think that institutional investors will be focusing on this issue (as many managers know, one of the important issues for institutional investors is the avoidance of “headline risk”); other groups seem to think that this is an issue that institutional groups are not going to focus on because there are other aspects of a manager’s investment program and operations which deserve more attention.

We tend to agree more with the second opinion, but we still believe that robust insider trading compliance policies and procedures are vital to the long term success of any asset management company.  We also encourage groups to discuss their current procedures with their compliance consultant or hedge fund attorney.

Outsourcing and Technology solutions

Many large managers have implemented compliance programs which have technology solutions designed to track employee trading.  Presumably there will be technology programs developed to address this concern for manager.  Although I do not currently know of any specific outsourced or technology solutions which address this issue, I anticipate discussing this in greater depth in the future – perhaps there is some data warehousing solution.  [HFLB note: please contact us if you would like to discuss such a solution with us.]

Final Thoughts

The Galleon insider trading case could not have happened at a worse time for the hedge fund industry which is trying to put its best face forward as Congress determines its future regulatory fate.  However, increased awareness of this issue will force managers to address it from an operational standpoint which will only help these managers down the road.  While the full effect of this case will not be understood for a while, in the short term it is likely to cost managers in terms of time and cost to review and implement increased operational awareness and procedures.

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Other related hedge fund law articles:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and the Series 79 exam website.  He can be reached directly at 415-868-5345.

Insider Trading Overview

In light of the recent focus on insider trading, we are publishing the SEC’s discussion on Insider Trading which can also be found here.  The information below contains a broad overview of some of the important aspects which hedge fund managers should understand about the insider trading prohibitions.

For a greater background discussion on the legal precedents which helped shaped the state of law today, please see Insider Trading—A U.S. Perspective, a speech by staff of the SEC.

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Insider Trading

“Insider trading” is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC. For more information about this type of insider trading and the reports insiders must file, please read “Forms 3, 4, 5” in our Fast Answers databank.

Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.

Examples of insider trading cases that have been brought by the SEC are cases against:

  • Corporate officers, directors, and employees who traded the corporation’s securities after learning of significant, confidential corporate developments;
  • Friends, business associates, family members, and other “tippees” of such officers, directors, and employees, who traded the securities after receiving such information;
  • Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
  • Government employees who learned of such information because of their employment by the government; and
  • Other persons who misappropriated, and took advantage of, confidential information from their employers.

Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.

The SEC adopted new Rules 10b5-1 and 10b5-2 to resolve two insider trading issues where the courts have disagreed. Rule 10b5-1 provides that a person trades on the basis of material nonpublic information if a trader is “aware” of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. The rule permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.

Rule 10b5-2 clarifies how the misappropriation theory applies to certain non-business relationships. This rule provides that a person receiving confidential information under circumstances specified in the rule would owe a duty of trust or confidence and thus could be liable under the misappropriation theory.

For more information about insider trading, please read Insider Trading—A U.S. Perspective, a speech by staff of the SEC.

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Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and the Series 79 exam website.  He can be reached directly at 415-868-5345.

Public Comments on SEC Proposed “Pay to Play” Rules

SEC Proposed Pay to Play Rules Draw Many Comments

Earlier this year the SEC proposed so-called “pay to play” rules which would restrict SEC registered investment advisers from managing money from state and local governments under certain circumstances.  According to the SEC press release, “the measures are designed to prevent an adviser from making political contributions or hidden payments to influence their selection by government officials.” The rule would do four major things:

  1. Restricting Political Contributions
  2. Banning Solicitation of Contributions
  3. Banning Third-Party Solicitors
  4. Restricting Indirect Contributions and Solicitations

The comment period, which ran for 60 days, produced some very good points.  As a general matter most groups opposed the proposed rules for some reason or another.  Below I have gathered some of the more interesting or important points which were raised in the comments which are publicly available here.  All of the following quotes are directly from the comments of the submitters which are identified.

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Joan Hinchman – Executive Director, President and CEO, of NSCP (National Society of Compliance Professionals Inc.)

  • The practical result of the ban will be that an adviser will be economically compelled to end its relationship with a governmental entity.
  • The ban will deprive participants and beneficiaries of public funds of well qualified advisers and drive up the cost of investment advisory services due to higher compliance costs.
  • The Rule will affect at a minimum all registered investment advisers that not only advise governmental public pension funds, but also may cover investment companies in which governmental pension funds choose to invest.
  • Advisers lacking capital to hire employees to obtain government clients or the experience and sophistication to do so would be placed at a material competitive disadvantage.

These comments can be found here.

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Jeffrey M. Stern and Robert W. Schwabe – Managing Partners of Forum Capital Securities, LLC

Forum Capital Concurs wholeheartedly with those persons and entities that have commented on the Proposed Rule to date that banning investment advisers from compensating third-party placement agents for securing capital commitments from public pension fund investors would:

  • Unfairly advantage private investment firms large enough to employ an internal marketing and investor relations staff over those firms that cannot afford to employ such a staff internally;
  • Limit the universe of investment opportunities presented to public pension funds for their consideration;
  • Deprive private investment firms of the services of legitimate placement agents that have contributed to the success of many investment advisers already existing and thriving prior to the promulgation of the Proposed Rule, thereby limiting the opportunities of new private investment firms to successfully raise funds, execute their investment strategies and grow into market leading investment firms;
  • Reduce competition within the investment advisory business in general and the various alternative investment asset classes in particular; and
  • Reduce the amount of capital available to companies that rely on private investment firms for their financial support.

These comments can be found here.

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Sue Toigo – Chairman of Fitzgibbon Toigo Associates in Los Angeles California

  • Without placement agents, the ability of emerging asset management firms, the majority of which are minority- and women-owned firms, to gain the business of the large public pension funds becomes virtually impossible.
  • Under the proposed regulation, small emerging companies will find it increasingly challenging to market their investment products to pension funds.

These comments can be found here.

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William J. Zwart – BerchWood Partners, LLC

  • Emerging managers would not be able to effectively access or approach the public entity investment community without the support of the placement agent community.

These comments can be found here.

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R. Dean Kenderdine – Executive Director and Secretary to the Board of Trustees of State Retirement and Pension System of Maryland

  • The strict outright prohibition of investment management firms’ use of placement agents to implement their marketing efforts to public pension funds would result in increased costs to the investment firms and a reduction in viable investment opportunities being presented to public pension funds.
  • Public funds will not be presented with the broadest array of investment opportunities and hinder the competitiveness of the investment management marketplace.
  • Placement agents being prohibited would have an adverse impact on our return potential and increase our cost of operations.

These comments can be found here.

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Fernando Ortiz Vaamonde – Managing Partner of ProA Capital de Inversiones

  • An outright ban on placement firms would unfairly disadvantage small- and mid-size firms, many of which are unlikely to be able to recruit and retain significant in-house fund-raising capabilities.

These comments can be found here.

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Keith Breslauer – Managing Director of Patron Capital Limited

  • With the new rule, Patron would not be able to without great difficulty, expand its investor base to include public pension plans.
  • The effect of the new rule is to harm the fund raising abilities of funds like Patron and materially impact the investing opportunities of public pension plans.

These comments can be found here.

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Brian Fitzgibbon – CEO of Fitzgibbon Toigo & CO., LLC

  • Without placement agent assistance, some of the best fund managers may never get to market.
  • A ban on placement agents is unfair, irrational and harmful to Private Equity. There will always be some corrupt public officials and organizations that want to game the system.

These comments can be found here.

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B. Jack Miller – General Motors Asset Management

  • Many partnerships are too small to have their own marketing staff and rely on third party PA’s to introduce them to investors.

These comments can be found here.

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Jake Elmhirst – Global Co-Head Private Funds Group of UBS Securities, LLC

USB strongly believes that:

  • Registered placement agents play a beneficial role in the capital markets;
  • The proposed ban would be detrimental to both private equity managers and their public pension plan investors;
  • The proposed ban in lA-291O is unnecessary and overbroad, and the Commission can regulate registered broker-dealer placement agents through other means;
  • The placement agent ban in IA-2910 purports to be modeled on MSRB Rule G-38 but is in fact inconsistent with that rule and the policies supporting it; and
  • The Commission should consider alternatives to a ban on all intermediaries, including an exemption for registered broker-dealer placement agents, and increasing regulation of properly registered placement agents.

These comments can be found here.

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Thomas P. DiNapoli – State Comptroller

  • Under the proposed SEC rule, it is not clear if the investment adviser would subsequently be prohibited from earning compensation for advisory services provided to the Fund.
  • It is important that the final rule adopted by the SEC clearly articulate what behavior is prohibited in making contributions or soliciting or coordinating payments to state or local political parties.

These comments can be found here.

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Melinda Gagyor – Fulcrum Financial Inquiry, LLC

The proposed placement agent ban should be eliminated because:

  • It will devastate the placement agent business and cause severe job losses in an already troubled economy;
  • The vast majority of emerging, small and middle-market investn1ent managers will simply not survive or be forced to operate at a huge disadvantage;
  • Pension funds will see a significant reduction in their access to potential investment opportunities; and
  • Pension funds will no longer be able to use placement agents to help them pre-screen potential investment manager candidates

These comments can be found here.

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Ron S. Geffner – Partner of Sadis & Goldberg, LLP

While we strongly support the SEC’s efforts to eliminate corruption in connection with “pay to play” practices, the proposed ban on placement agents’ solicitation of government investors is overreaching and will:

  • Deprive government investors of the benefits provided by placement agents, namely access to a broader range of potential investment opportunities and assistance with due diligence efforts, and
  • Hinder smaller advisory firms in their efforts to attract government investors, as smaller firms generally have less in-house resources and rely more on the use of placement agents in soliciting government investors.

These comments can be found here.

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Fred Gortner – Managing Director of Paladin Realty Partners, LLC

  • Without quality placement agents like Triton Pacific, emerging small and mid-cap investment management firms like ours would be forced to operate at a significant and inequitable disadvantage to larger investment managers that have the financial resources to employ large, experienced teams of investor relations and in-house placement professionals.

These comments can be found here.

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Drew Maxwell

  • Your proposed ban on placement agents will unjustly penalize a huge percentage of emerging, small, minority-owned and middle-market investment managers, as these firms rely extensively on placement agents to help them.

These comments can be found here.

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Joseph M. Velli – Chairman and Chief Executive Office of BNY ConvergEx Group, LLC

  • While we believe that the general ban on third-party solicitors is unnecessary, we are concerned in particular about the vagueness of the rule’s definition of “related person”.
  • We believe it is critical for the SEC to clarify the test for control included in the definition of “related person”.

These comments can be found here.

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Frode Strand-Nielsen – Managing Partner of FSN Capital Partners A.S.

  • It would be highly challenging for us to raise capital from international in institutions unless we had the assistance of a legitimate placement agent.
  • If you take away the role of a placement agent, you will deprive firms like ours of the ability to raise capital in the United States, and you will also seriously impair the pension funds’ capacity to invest with the best private equity firms internationally.

These comments can be found here.

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Mark G. Heesen – President of National Venture Capital Association

  • It is in the interest of the entire venture capital community if firms retain the option of using placement agents for marketing to all potential investors, including public pension funds.

These comments can be found here.

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Richard H. Hurd, Jr. – President of Strategic Capital Partners

  • We know first hand the value that qualified placement agents can provide particularly to emerging, small and mid-cap investment management firms. Without such services, smaller firms have limited access to the institutional market. Likewise, pension fund will be prohibited from participating in the entrepreneurial strategies and success of companies like ours.

These comments can be found here.

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Other related hedge fund law articles:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog.  If you are a hedge fund manager who is looking to start a hedge fund or if you have questions about your investment advisor compliance program, please contact us or call Mr. Mallon directly at 415-868-5345.

House Committee Votes for Hedge Fund Registration

Bart Mallon, Esq. (http://www.hedgefundlawblog.com)

Private Equity Funds Not Excluded

Today the House Financial Services Committee voted to require hedge fund managers to register with the Securities and Exchange Commission.  While private equity firms are also required to register under the proposed bill, managers to venture capital funds are excluded from this registration requirement.

The bill will next be presented to the House of Representatives and if it passes there it will move onto the Senate and eventually to President Obama to sign into law.  The name of the bill is the Private Fund Investment Advisers Registration Act of 2009.  For the full text please see H.R. 3818.

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For Immediate Release: October 27, 2009

Committee Approves Private Advisor Registration Bill with Bipartisan Support

Washington, DC – Today, the House Financial Services Committee passed H.R. 3818, the Private Fund Investment Advisers Registration Act, introduced by Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises.  The Committee passed H.R. 3818 with extensive bipartisan support by a vote of 67-1.  Tomorrow, the Committee is expected to vote on Chairman Kanjorski’s H.R. 3817, the Investor Protection Act and H.R. 3890, the Accountability and Transparency in Rating Agencies Act.

“The Private Fund Investment Advisers Registration Act, which passed today with wide-ranging bipartisanship support, will force many more financial providers to register with the Securities and Exchange Commission,” said Chairman Kanjorski.  “The past year has shown that the deregulation or in many cases, lack of regulation, of financial firms is an idea of the past.  Advisors to financial firms must receive government oversight and we must understand the assets of financial firms, including for hedge funds, private equity firms, and other private pools of capital.  Under this legislation, private investment funds would become subject to more scrutiny by the SEC and take more responsibility for their actions.  I look forward to moving this legislation to the House floor for a vote.”

A summary of H.R. 3818 follows:

  • Everyone Registers. Sunlight is the best disinfectant. By mandating the registration of private advisers to private pools of capital regulators will better understand exactly how those entities operate and whether their actions pose a threat to the financial system as a whole.
  • Better Regulatory Information. New recordkeeping and disclosure requirements for private advisers will give regulators the information needed to evaluate both individual firms and entire market segments that have until this time largely escaped any meaningful regulation, without posing undue burdens on those industries.
  • Level the Playing Field. The advisers to hedge funds, private equity firms, single-family offices, and other private pools of capital will have to obey some basic ground rules in order to continue to play in our capital markets. Regulators will have authority to examine the records of these previously secretive investment advisers.

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Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include:

Bart Mallon, Esq. of  Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and can be reached directly at 415-868-5345.

Hedge Fund Manager Charged with Insider Trading

SEC Brings Case Against Raj Rajaratnam

Below is another case of a hedge fund manager who was alledgedly engaged in insider trading. The SEC seems particularly excited about this cased because of the high profile nature of the manager who was involved. The major charge is against Raj Rajaratnam who reportedly has a net worth in excess of $1 billion and who is a member of the Forbes 400 richest persons in the world.

There will undoubtedly be continued press in this case which is not good news for the hedge fund industry. The industry has been subject to criticism and increased calls for regulation for the last year and high profile cases like this one only serve to rile up members of congress. The SEC seems to be particularly proud about this “catch” as the agency has itself been under increasing scrutiny as the details of the fumbled Madoff case have been made public.

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SEC Charges Billionaire Hedge Fund Manager Raj Rajaratnam with Insider Trading

FOR IMMEDIATE RELEASE
2009-221

High-Ranking Corporate Executives Also Charged in Scheme That Generated More Than $25 Million in Illicit Gains

Washington, D.C., Oct. 16, 2009 — The Securities and Exchange Commission today charged billionaire Raj Rajaratnam and his New York-based hedge fund advisory firm Galleon Management LP with engaging in a massive insider trading scheme that generated more than $25 million in illicit gains. The SEC also charged six others involved in the scheme, including senior executives at major companies IBM, Intel and McKinsey & Company.

The SEC’s complaint, filed in federal court in Manhattan, alleges that Rajaratnam tapped into his network of friends and close business associates to obtain insider tips and confidential information about corporate earnings or takeover activity at several companies, including Google, Hilton and Sun Microsystems. He then used the non-public information to illegally trade on behalf of Galleon.

“This complaint describes a web of fraud that has been unraveled,” said SEC Chairman Mary L. Schapiro.

“What we have uncovered in the trading activities of Raj Rajaratnam is that the secret of his success is not genius trading strategies. He is not the astute study of company fundamentals or marketplace trends that he is widely thought to be. Raj Rajaratnam is not a master of the universe, but rather a master of the rolodex,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “He cultivated a network of high-ranking corporate executives and insiders, and then tapped into this ring to obtain confidential details about quarterly earnings and takeover activity.”

In addition to Rajaratnam and Galleon, the SEC’s complaint charges:

  • Danielle Chiesi of New York, N.Y. — a portfolio manager at New Castle Funds.
  • Rajiv Goel of Los Altos, Calif. — a managing director at Intel Capital, an Intel subsidiary.
  • Anil Kumar of Saratoga, Calif. — a director at McKinsey & Company.
  • Mark Kurland of Mount Kisco, N.Y. — a Senior Managing Director and General Partner at New Castle.
  • Robert Moffat of Ridgefield, Conn. — a senior vice president at IBM.
  • New Castle Funds LLC — a New York-based hedge fund

According to the SEC’s complaint, Rajaratnam and Galleon traded on inside information about the following events or transactions:

  • An unnamed source, identified in the SEC’s complaint as Tipper A, obtained inside information about earnings announcements at Polycom and Google, as well as a takeover announcement of Hilton. Tipper A then allegedly provided this information to Rajaratnam, who used it to trade on behalf of Galleon.
  • Goel provided inside information to Rajaratnam about certain Intel quarterly earnings and a pending joint venture concerning Clearwire Corp., in which Intel had invested. Rajaratnam then used this information to trade on behalf of Galleon. As payback for Goel’s tips, Rajaratnam, or someone acting on his behalf, executed trades in Goel’s personal brokerage account based on inside information concerning Hilton and PeopleSupport, which resulted in nearly $250,000 in illicit profits for Goel.
  • Kumar obtained inside information about pending transactions involving AMD and two Abu Dhabi-based sovereign entities, which he shared with Rajaratnam. Rajaratnam then traded on the basis of this information on behalf of Galleon.
  • Chiesi obtained inside information from an executive at Akamai Technologies and traded on the information on behalf of a New Castle fund, netting a profit of approximately $2.4 million. Chiesi also passed on the inside information to Rajaratnam, who then traded on behalf of Galleon.

The SEC also alleges that Moffat provided inside information to Chiesi about Sun Microsystems. Moffat obtained the information when IBM was contemplating acquiring Sun. Chiesi then allegedly traded on the basis of this information on behalf of New Castle, making approximately $1 million in profits.

The SEC’s complaint charges each of the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and, except for Kumar and Moffat, violations of Section 17(a) of the Securities Act of 1933 and. The complaint seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay financial penalties. The complaint also seeks to permanently prohibit Goel, Kumar and Moffat from acting as an officer or director of any registered public company.

The SEC acknowledges the assistance and cooperation of the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation.

The SEC’s investigation is continuing.

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For more information, contact:
David Rosenfeld
Associate Director, SEC’s New York Regional Office
(212) 336-0153

Sanjay Wadhwa
Assistant Director, SEC’s New York Regional Office
(212) 336-0181

http://www.sec.gov/news/press/2009/2009-221.htm

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Other related hedge fund law articles:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund or if you are a current hedge fund manager with questions about the securities laws, please contact us or call Mr. Mallon directly at 415-868-5345.

OTC Derivatives Markets Act of 2009 Passes House Committee Vote

CFTC Chairman Gensler Applauds “Historic Progress”

In a first step towards increased regulation of the over-the-counter derivatives markets, the House Financial Services Committee approved the Over-the-Counter Derivatives Markets Act of 2009.  The act is one of several initiatives to increase regulatory oversight of the financial markets and if passed by Congress would be signed into law by President Obama. Among other things the act would require Swap dealers and major swap participants to register with either the CFTC or the SEC.

Below I have reprinted press releases from both the House Financial Services Committee and the CFTC.

UPDATE: The Securities Industry Financial and Markets Association (SIFMA) just issued a press release reposted below as well.

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Financial Services Committee Approves Legislation to Regulate Derivatives

Committee completes work on a key element of President Obama’s plan to bring accountability and responsibility to Wall Street

Washington, DC – {The House Financial Services Committee today approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) derivatives marketplace. Today’s bill, which was approved by a vote of 43-26, represents a key part of a broader effort by Congress and President Obama to modernize America’s financial regulatory system in response to last year’s financial crisis.

Under the bill, all standardized swap transactions between dealers and large market participants, referred to as “major swap participants,” would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring. OTC derivatives include swaps, which are contracts that call for an exchange of cash between two counterparties based on an underlying rate, index, credit event or the performance of an asset.

The legislation then sets out parallel regulatory frameworks for the regulation of swap markets, dealers, and major swap participants.  Rulemaking authority is held jointly by the Commodity Futures Trading Commission (CFTC), which has jurisdiction over swaps, and the Securities and Exchange Commission (SEC), which has jurisdiction over security-based swaps.   The Treasury Department is given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within 180 days. Subsequent interpretations of rules must be agreed to jointly by the Commissions.

Description of the Over-the-Counter Derivatives Markets Act of 2009

Clearing

The legislation provides a mechanism to determine which swap transactions are sufficiently standardized that they must be submitted to a clearinghouse. For transactions that are clearable, clearing is a requirement when both counterparties are either dealers or major swap participants.  Clearing organizations must seek approval from the appropriate regulator—either the CFTC or the SEC—before a swap or class of swaps can be accepted for clearing.

Transactions in standardized swaps that involve end-users are not required to be cleared. Such customized transactions must, however, be reported to a trade repository.

Mandatory Trading on Exchange or Swap Execution Facility

A standardized and cleared swap transaction where both counterparties are either dealers or major swap participants must either be executed on a board of trade, a national securities exchange or a “swap execution facility”—as defined in the legislation.  If none of these venues makes a clearable swap available for trading, the trading requirement would not apply.  Counterparties would, however, have to comply with transaction reporting requirements established by the appropriate regulator.  The legislation also directs the regulators to eliminate unnecessary obstacles to trading on a board of trade or a national securities exchange.

Registration and Regulation of Swap Dealers and Major Swap Participants

Swap dealers and major swap participants must register with the appropriate Commission and dual registration is required in applicable cases.  Capital requirements for swap dealers’ and major swap participants’ positions in cleared swaps must be set at greater than zero.  Capital for non-cleared transaction must be set higher than for cleared transactions.  The prudential regulators will set capital for banks, while the Commissions will set capital for non-banks at a level that is “as strict or stricter” than that set by the prudential regulators.

The regulators are directed to set margin levels for counterparties in transactions that are not cleared.   The regulators are not required to set margin in transaction where one of the counterparties is not a dealer or major swap participant.  In cases where an end user is a counterparty to a transaction, any margin requirements must permit the use of non-cash collateral.

Reporting and Public Disclosure of Swap Transactions

Reporting and recordkeeping is required for all over-the-counter derivative transactions.  Clearing organizations must provide transaction information to the relevant Commission and a designated trade repository.   Swap transactions that are not cleared and for which no trade repository exists, must be reported directly to the relevant Commission.   The legislation also provides for public disclosure of aggregate data on swap trading volumes and positions—in a manner that does not disclose the business transactions or market position of any person.  Large positions in swaps must also be reported directly to regulators.

Swap Execution Facilities

Swap execution facilities, or facility for the trading of swaps that are not Boards of Trade or National Securities Exchanges, must register with the relevant regulator as a swap execution facility (SEF).  SEFs must also adhere to core regulatory principles relating to enforcement, anti-manipulation, monitoring, information collection and conflicts of interest, among others. The CFTC and SEC are required to prescribe joint rules governing the regulation of swap execution facilities.  A Commission may exempt a SEF from registration if it is subject to comparable, comprehensive supervision and regulation by another regulator.

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Statement of Chairman Gary Gensler on House Financial Services Committee Passage of OTC Derivatives Regulatory Reform Legislation

October 15, 2009

Washington, DC – U.S. Commodity Futures Trading Commission Chairman Gary Gensler today commented on the OTC Derivatives Markets Act of 2009, passed this morning by the House of Representatives Committee on Financial Services.

Chairman Gensler said:

“Today’s vote by the House Financial Services Committee represents historic progress toward comprehensive regulatory reform of the over-the-counter derivatives marketplace. The Committee’s bill is a significant step toward lowering risk and promoting transparency. Substantive challenges remain. I look forward to building on this Committee’s hard work with Chairman Frank, Chairman Peterson and others in the House and Senate to complete legislation that covers the entire marketplace without exception and to ensure that regulators have appropriate authorities to protect the public.”

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Release Date: October 15, 2009

Contact: Andrew DeSouza, (202) 962-7390, adesouza@sifma.org

SIFMA’s Bentsen Statement on Committee Passage of Derivatives Regulation

October 15, 2009, Washington, DC—The Securities Industry and Financial Markets Association today released a statement from Ken Bentsen, Executive Vice President, Public Policy and Advocacy in response to the House Financial Services Committee’s passage of the Over-the-Counter Derivatives Markets Act of 2009.

“Bringing greater regulatory transparency and oversight to derivatives markets and products is a key component of reforming our financial system. That oversight must also recognize the important role these risk management tools play for countless companies across the country and for our broader economy. Mandating particular transaction modes, as this bill does, could raise transaction costs while not necessarily reducing risk in a commensurate amount—results that we believe are contrary to our shared reform goals. As the legislative process continues we look forward to working with the Congress toward a bill that strikes a balance between the need for transparency and risk management efficiency.”

The Securities Industry and Financial Markets Association brings together the shared interests of more than 550 securities firms, banks and asset managers. SIFMA’s mission is to promote policies and practices that work to expand and perfect markets, foster the development of new products and services and create efficiencies for member firms, while preserving and enhancing the public’s trust and confidence in the markets and the industry. SIFMA works to represent its members’ interests locally and globally. It has offices in New York, Washington D.C., and London and its associated firm, the Asia Securities Industry and Financial Markets Association, is based in Hong Kong.

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Other related hedge fund law articles:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about investment adviser registration with the SEC or state securities commission, please call Mr. Mallon directly at 415-868-5345.

Hedge Fund Investors to Sue SEC

SEC’s Madoff Failure Cited in Lawsuit

Just a quick note that the New York Times has written an article about two Madoff investors who are suing the SEC for not doing its job.  It will likely be a tough case for the investors/plaintiffs to prevail upon because of the doctrine of sovereign immunity (i.e. government agencies cannot be sued for actions made pursuant to their legislative mandate).  However, the inspector general’s Madoff report, which in no uncertain terms castigates the SEC, is likely to be the basis of many of the investors’ complaints.

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Other related hedge fund law and Madoff stories:

Hedge Funds and Insider Trading

Hedge Fund Manager/Trader Settles Charges with SEC

Insider trading cases pop up every now and again and most cases do not warrant highlighting – post-Boesky everyone in the securities industry is well aware that trading on inside information is illegal.  However, it warrants emphasis that the SEC will crack down on hedge fund managers or traders involved with insider trading and the penalties are harsh.  The individuals (including a hedge fund manager) involved in the action described in the SEC litigation release reprinted below were subject to fines and disgorgement, of course, but were also barred from the securities industry.  The severity of such a penalty underscores the importance of understanding and abiding by the insider trading rules.

As noted below, trading on insider information is illegal under both civil (Section 17(a) of the 1933 act, Section 10(b) of the 1934 act, and Rule 10b-5 thereunder) and criminal laws (generally securities fraud, but depending on the facts charges may also include wire fraud and commercial bribery).

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U.S. Securities and Exchange Commission
Litigation Release No. 21244
October 8, 2009

SEC v. Mitchel S. Guttenberg, Erik R. Franklin, David M. Tavdy, Mark E. Lenowitz, Robert D. Babcock, Andrew A. Srebnik, Ken Okada, David A. Glass, Marc R. Jurman, Randi E. Collotta, Christopher K. Collotta, Q Capital Investment Partners, LP, DSJ International Resources Ltd. (d/b/a Chelsey Capital), and Jasper Capital LLC, C.A. No. 07 CV 1774 (S.D.N.Y) (PKC)

Three Defendants in Wall Street Insider Trading Ring Settle SEC Charges

The Securities and Exchange Commission announced today that on September 29, 2009, the Honorable P. Kevin Castel, United States District Judge for the Southern District of New York, entered final judgments against defendants Erik R. Franklin, Q Capital Investment Partners, LP (“Q Capital”), and David M. Tavdy, in SEC v. Guttenberg, et al., C.A. No. 07 CV 1774 (S.D.N.Y.), an insider trading case the Commission filed on March 1, 2007. The Commission’s complaint alleged illegal insider trading in connection with two related schemes in which Wall Street professionals serially traded on material, nonpublic information tipped by insiders at UBS Securities LLC (“UBS”) and Morgan Stanley & Co., Inc. (“Morgan Stanley”), in exchange for cash kickbacks.

The Commission’s complaint alleged that from 2001 through 2006, Mitchel S. Guttenberg, an executive director in the equity research department of UBS, illegally tipped material, nonpublic information concerning upcoming UBS analyst upgrades and downgrades to two Wall Street traders, Franklin and Tavdy, in exchange for sharing in the illicit profits from their trading on that information. The complaint also alleged that Franklin was a downstream tippee in another scheme in which, in 2005 and 2006, Randi Collotta, an attorney who worked in the global compliance department of Morgan Stanley, illegally tipped material, nonpublic information concerning upcoming corporate acquisitions involving Morgan Stanley’s investment banking clients.

The complaint alleged that Franklin illegally traded on the inside information for two hedge funds he managed, Lyford Cay Capital, LP and Q Capital, and in his personal accounts. Tavdy illegally traded on the inside information (i) for Andover Brokerage, LLC and Assent LLC, registered broker-dealers where Tavdy was a proprietary trader, (ii) in his own personal account, (iii) in the accounts of a relative and friend, and (iv) in the accounts of Jasper Capital LLC, a day-trading firm with which Tavdy was associated. Franklin and Tavdy also had downstream tippees who traded on the inside information. Without admitting or denying the allegations in the complaint, Franklin, Q Capital, and Tavdy settled the Commission’s insider trading charges.

Franklin and Q Capital consented to the entry of a final judgment which (i) permanently enjoins them from violating Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), Rule 10b-5 thereunder, and Section 17(a) of the Securities Act of 1933 (“Securities Act”); and (ii) orders, on a joint and several liability basis, disgorgement of $5,400,000, with all but $290,000 waived based on a demonstrated inability to pay. In a related administrative proceeding, Franklin consented to the entry of a Commission order barring him from future association with any broker, dealer, or investment adviser. In a parallel criminal case, Franklin previously pled guilty to charges of securities fraud and conspiracy to commit securities fraud and is awaiting sentencing. U.S. v. Erik Franklin, No. 1:07-CR-164 (S.D.N.Y.).

Tavdy consented to the entry of a final judgment which (i) permanently enjoins him from violating Section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and Section 17(a) of the Securities Act; and (ii) orders him to pay disgorgement of $10,300,000. In a related administrative proceeding, Tavdy consented to the entry of a Commission order barring him from future association with any broker or dealer. In a parallel criminal case, Tavdy previously pled guilty to charges of securities fraud and conspiracy to commit securities fraud, and was sentenced to 63 months in prison. U.S. v. Mitchel Guttenberg and David Tavdy, No. 1:07-CR-141 (S.D.N.Y.).

The Commission also announced that Samuel W. Childs, Jr., a former general securities principal at Assent LLC, consented to a Commission order barring him from future association with any broker or dealer, based on his criminal conviction for conspiracy to commit securities fraud, wire fraud and commercial bribery. U.S. v. Samuel W. Childs, Jr. and Laurence McKeever, No. 1:07-CR-142 (S.D.N.Y.). In that case, the criminal indictment alleged that Childs accepted bribes from traders at Assent LLC in exchange for not reporting their illegal trading to Assent management.

The Commission acknowledges the assistance and cooperation of the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation.

For further information, see Litigation Release Nos. 20022 (March 1, 2007), 20367 (November 20, 2007), 20725 (September 18, 2008), and 21086 (June 16, 2009).

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Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund or if you are a current hedge fund manager with questions about the securities laws, please contact us or call Mr. Mallon directly at 415-868-5345.  Other related hedge fund law articles include: