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Never-Before-Examined Initiative

May 8, 2014

Presented By:Amelia Stoj, Partner & VP, CordiumJillian Timmermans, Partner & VP, Cordium

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© Copyright APRIL 2, 2014

Agenda

o Regulatory Landscapeo OCIE National Exam Programo Common Types of Examso Examinations by the Numberso The Never-Before-Examined Initiative

o Overviewo Approacheso Areas of Review

o What to Expect from a SEC Examo Document Productiono Notice/Durationo Onsite Visito After the Onsite

o What Can Your Firm Do Now?

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Regulatory Landscape

o As of February 2014:o There were over 4,000 private fund advisers registered with the

SEC.o Close to 40% of all RIAs manage one or more private funds.o Of these 4,000 private fund advisers:

o Over 2,000 registered with the SEC since July 21, 2010, when the President signed the Dodd-Frank Act into law.

o Of these private fund advisers, 352 (8%) are domiciled in a foreign country.

o Most of these are domiciled in the United Kingdom.

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OCIE National Exam Program (“NEP”)

o Andrew J. Bowden - Director of the agency's Office of Compliance Inspections and Examinations (“OCIE”)

o Missiono Improve Industry Compliance

o Local and national outreach seminars, risk alerts, recruitment of industry experts, etc.

o Identify and Prevent Fraudo Focused, risk-based examinations of registered advisers,

specialized working groups, coordination across SEC offices and Divisions of Risk, Strategy and Financial Innovation and Enforcement

o Monitor Risko Specialized units (Office of Risk Analysis and Surveillance, Office of

Large Firm Monitoring and Quantitative Analytics Unit, etc.)o Inform Policy

o Utilize results/findings to inform future rulemaking and provide guidance to the industry

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OCIE National Exam Program (“NEP”)

o In her formal statement for a Congressional hearing on the SEC’s proposed FY 2015 budget, SEC Chair Mary Jo White includes “[b]olstering examination coverage for investment advisers” at the top of her list of four “key and pressing” priorities

o "A top SEC priority under the FY 2015 request is to add 316 additional staff to the examination program in its Office of Compliance Inspections and Examinations (OCIE). This would allow the agency to examine more registered firms, particularly in the investment management industry”

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Common Types of Exams

o Routine Exams o May be based on the passage of time since last exam

o Presence Exams

o Risk-based, focused examinations of newly registered adviserso Common areas of focus include: (a) marketing, (b) portfolio management, (c)

conflicts of interest, (d) safety of client assets, and (e) valuation procedures o Usually average 3-6 months from announcement to resolution, ½ as long as

typical examo Onsite time is limited

o Industry Sweeps/Special Purpose Exams

o Focus on a narrow issue and seek to determine how the industry is handling that issue

o Recent examples include firm use of social media and disaster recovery preparedness

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Common Types of Exams

oCorrespondence Exams

o Certain regional offices have been asking firms to submit documents for review (e.g., trade blotters, marketing materials)

o Review may determine whether the firm merits an onsite examination

oCause Examso May be based on a tip or investor complainto Typically unannounced

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Examinations by the Numbers

o RIA Examso FY 2012: The SEC was able to examine only about 8% of

registered investment advisers. o As of April, 2013, over 40 percent of advisers (including

relatively recently registered advisers) have never been examined.

o As of April, 2013, an estimated 20% of all advisers that have been registered for more than three years have never been examined.

o Focus throughout 2013 was on conducting Presence Exams.o New Focus on Never-Before-Examined advisers!!

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The Never-Before-Examined Initiative

o SEC announced on February 20, 2014 that they will be commencing their Never-Before-Examined Initiative

o Introductory Letter directed to senior officers at advisers that have been registered for at least three years, have never been examined, and are not subject to the Presence Examination Initiative

o Two-year project o Goal is to examine 25-40% of this Never-Before-Examined

population

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Two Different Approaches

o Risk-Assessments o Involves a high-level review of an adviser’s business activitieso Will focus on adviser’s compliance program and any other

documents that will enable examiners to determine the accuracy of representations in disclosure documents

o GOAL: Improved understanding o Will likely include:

o Request for documents to help examiners determine the adviser’s risk ratingo Would generally include policies and procedures, trading information

and a handful of other information

o May include interviews

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Two Different Approaches

o Focused Reviews o “Comprehensive, risk-based” exams of one or more of the areas described as higher-

risk. o Similar to the Presence Exam approach. The SEC noted that its new Never-Before-

Examined Initiative will bear similarities with OCIE’s recent Presence Exam Initiative.o Areas of Review include

o Compliance Program: an evaluation of the program’s effectiveness will include reviewing books and records to determine if the adviser has (i) adequately identified conflicts of interest and compliance-related risks; (ii) adopted policies and procedures to mitigate and manage these; and (iii) put in place a Chief Compliance Officer who has the necessary degree of knowledge and competence to fill that role and empowered that person to administer the program.

o Filings/Disclosure: this review will focus on whether the RIA has disclosed “all material facts regarding conflicts or potential conflicts of interest,” covering all areas of the RIA’s business, investment activities and conflicts of interest.

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Areas of Review (continued)

o Marketing: a review of marketing materials will assess whether the RIA has (i) has presented its business and performance records without false or misleading statements; (ii) made any untrue statements of material facts; (iii) omitted any material facts; (iv) made any other misleading statements; or (v) engaged in any manipulative, fraudulent or deceptive activities.

o Portfolio Management: a review of the RIA’s portfolio decision-making practices to evaluate issues such as allocation of investment opportunities, and consistency with disclosures to clients.

o Safety of Client Assets: a review of the RIA’s compliance with the Investment Advisers Act of 1940 (“Advisers Act”) custody rule and other laws aimed at prevent loss or theft of client assets.

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What to Expect from a SEC Exam

o How Does it Start?o Notification – usually by phone/emailo Request Letter

o What Does Life of an Exam Look Like?o Document Production – often on a rolling basiso Timing/Durationo Onsite Visito After the Onsite

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What am I Required to Produce?

o Document Productiono Usually 15 to 25 requests in the initial request (normal exam could be

from 40 to 50 requests in initial request)o Examples of Information Requested:o Org charts – including ownership % and list of affiliateso List clients, type, AUM, name of custodian, type of strategy, types of fees (in EXCEL)o List of private funds, number of investors, domicile, master/feeder, nature of lock-up,

amount of leverage, etc. (in EXCEL)o QTRs and all other personal trading records (in EXCEL if you use software to track)o Trade blotter/ ten most and least profitable tradeso List of JVs (this should include outside business activities of key employees)o Written policies and procedureso Violations of Policieso Investor complaintso Committee minutes (if any)o ADV Part 2Bs, marketing materials, Pitchbooks, etc.

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What am I Required to Produce?

o Below is guidance on what to expect from a typical SEC examination, in large part based on Cordium’s experience assisting numerous advisers through recent Presence Exams

o Document Productiono Could be 5 to 10 additional requests (could be another 20 to 30 in a normal

exam)o If you don’t understand something on a request list - call and ask o Prepare a written response to each requested item

o If an Examiner asks for something orally – ask to get the request in writing and formally respond to the request

o Should Consider:o Attorney Client Privilegeo Freedom of Information Acto Bates Stamping and other Logistics

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How Far Back Will They Look?

o Will they request information that pre-dates registration?o YES!

o How should you respond to those inquiries?o Rule of thumb – produce the documentso Discuss with counsel if there are problem areaso Key is to get the exam off on the right foot

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Notice and Duration

o How much notice are advisers given?o Likely 4 to 7 days – but production may be rolling

o How long should advisers expect the exam to last?o Onsite

o Typically 2 to 3 days

o Additional requestso Our experience has been that additional requests have stretched

out months from last onsite day.

o Conclusion o Exit interview – Be proactive with what you learn

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Onsite Visit & Follow-Up Requests

o Typical Exam onsite time ranges from 2-3 dayso Helpful Tips:

o Do not try to delay the visito Present your “story” to the SEC on day 1o Prepare your partners and key people – the SEC will want to talk with

certain people (CCO, CFO, IR, Head Trader, etc.)o Keep the office clean, file cabinets locked, no papers outo Set up a room for the examinerso Make yourself availableo Discuss potential issues with counsel/compliance consultants in advance!o It’s ok to say “let me get back to you on that”o Ask for it in writing if they have follow-up document requests

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Onsite Visit & Follow-Up Requests

o After the Onsiteo Exit Interview

o Clarify questions/correct any perceived inaccuracies during the call

o Be proactive – if an issue is identified– work to remedy it ASAPo Consider responding with the manner in which you have

corrected or are in the process of correcting any issues identifiedo A proactive written response to the Exit Interview may

affect the content/substance of your firm’s Deficiency Letter

o Could be additional requests for information weeks after

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Onsite Visit & Follow-Up Requests

o Potential for Deficiency/”Findings” Lettero Generally received within 120 days of the exam (although not

required)o Generally have 30 days to respondo Next examination will likely address issues raised by examiners – Need

to follow-through on corrections!o Should include manner in which any deficiencies were corrected as

part of firm’s annual review

o Referral to Enforcemento If an exam reveals serious deficiencies, the SEC staff may refer the

problems to the SEC’s Division of Enforcement, state regulatory agency, or other regulator for possible action

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What can Your Firm do Now?

o Things to Start Doing NOW:o Create a “First Day” presentation o Proactively identify conflictso Proactively identify gaps and possible problemso Critically Review Compliance Manual – are policies in line with practices?o Review Marketing Materialso Test P&P throughout the year o Beef up Annual Reviews – SEC is concerned that firms may only be doing

cursory annual reviews of policies and procedureso Consider conducting Audit Prep or Mock Audit exerciseo Conduct periodic trainings

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What is Cordium seeing?

o As a firm we have recently supported over 25 of audits. Below are a few real life examples of issues that have appeared in request letters and/deficiency letters:o Marketing Deficiencies – exact adherence to the manualo Expense Allocation – what is being charged to the fundso Focus on Insider Trading – Expert Networks and Research o Adherence to fund documents – monitoring investment and risk parameterso SEC continues to ask for emails to be produced – as such email review is an

important part of being prepared for an SEC examo Recent Cyber Security Sweep – request letter has been circulated

o Review the lettero Reach out to admin and IT personnel to confirm adequate policies and procedures are in

placeo Revise policies as neededo Implement a testing protocol if there is not one already

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Questions?

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Presenter Biographies

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Jillian Timmermans, Partner | Vice President Jillian is Co-Manager of Cordium US’s Compliance Consulting Team and a Partner at the firm. In addition to supporting clients with meeting their regulatory needs, Jillian assists in overseeing the consulting department, which includes resource management, training, and product development. Jillian has worked as an analyst in the Public Finance Department at Bear Stearns where she focused on fixed-income issuance for city and state housing agencies. Jillian received a B.S., magna cum laude, in Applied Economics and Management from Cornell University and a JD, magna cum laude, from New York Law School. Jillian is also certified as an Investment Adviser Certified Compliance Professional (IACCP) by National Regulatory Service's Center for Compliance Professionals.

Amelia Stoj, Partner | Vice President Amelia is a Vice President of Cordium’s compliance consulting division and a Partner of the firm. She currently runs the San Francisco office. Amelia helps investment managers successfully implement and maintain a comprehensive compliance program. Her clients utilize a broad range of investment strategies including but not limited to private equity, venture capital, real-estate related and fund of fund strategies. Prior to Amelia joining Cordium as a compliance associate in 2010, she was an associate in the Private Investment Fund practice group at Proskauer Rose LLP. While at Proskauer she represented general partners and limited partners of private equity funds in connection with the structuring, formation, offering and on-going operations of a variety of domestic and offshore private equity funds. Amelia received a J.D., with honors, from the University of Connecticut School of Law in 2008 and a B.A. from Wesleyan University in 2002. Amelia is certified as an Investment Adviser Certified Compliance Professional (IACCP) by National Regulatory Service’s Center for Compliance Professionals.