Calpers Investigates Hedge Fund Oversight, Legal & Financial Risk

The California Public Employees’ Retirement System, the nation’s biggest pension fund with $200 billion, has launched an internal investigation into its own oversight of hedge fund deals, The Los Angeles Times reported.

Calpers found that it had paid $36 million to two hedge fund advisors who were working without contracts, exposing the fund to legal and financial risk. The head of its hedge fund portfolio, which manages $5.8 billion in assets, was temporarily placed on leave and fined, The Times said, citing people briefed on the matter.

Calpers told the newspaper that it was investigating its ties to two hedge fund advisers, Paamco and a unit of Swiss banking giant UBS. Both firms had contracts with Calpers, but they lapsed two years ago, The Times said.

Go to Article from The LA Times »

FINRA Examiners: More Time in Member offices

"We need to become more nimble and faster about doing our cases," Finra Chief of Enforcement Susan Merrill said. She said she's taken to reciting the nursery rhyme "Jack be nimble, Jack be quick" around the office.

As reported by Dow Jones FINRA is likely to spend more time in broker-dealer offices. On-site inspections and examinations are "something we're going to use a lot more going forward," Merrill said at an industry conference Wednesday. "Announced on-site inspections, I think, will become more common."
Unannounced visits from the regulators are rare, she added.

Finra staff can more quickly request and receive information when they're in a broker-dealer's office, Merrill said. Several major auction-rate cases are still under investigation, she added. Enforcement division investigations, which are focused on potential wrongdoing, are separate from the ongoing exams conducted by Finra's member regulation division.

Ponzi schemes have become a priority for the regulators this year, Merrill said. Enforcement division is also looking at due diligence practices around the sale of private placements.

Additionally, it's looking into Stock Lending from retail accounts to short sellers and disclosures made to those customers. Finra's enforcement division is looking broadly at the way it operates and has made some changes - big and small and structural and philosophical, Merrill said. These include this spring's creation of a whistleblower office and this autumn's formation of an overarching fraud detection and market intelligence unit to oversee all fraud-related issues. Finra must be more diligent about its coordination with the SEC, Merrill said, adding that Finra is also focused on how it identifies new enforcement cases.

Should HFs buy and sell what they buy and sell for clients?

With hedge fund now the target of insider trading allegations, the alternative investments industry is again in the eye of a storm: PMs in handcuffs and wiretaps, cash payments in briefcases and 007 code names are tantalizing the public. Ron Resnick, of financial consulting firm CounselWorks, contends there is a smarter way to regulate hedge funds.

Resnick writes that there is a way to address common misconceptions and encourage productive public dialogue about hedge fund practices. The smarter way to address public policy concerns about fraud on investors, conflicts of interests and the risks of hedge funds is the opposite of the S.E.C. philosophy that portfolio managers should separate their personal investing from client investing.

S.E.C. holds the view that it is a conflict if a manager buys or sells for himself what he buys or sells for his clients.

Rather than separating managers’ personal investing from their client investing, the S.E.C. should require all managers to buy and sell precisely what they buy and sell for their clients. Read More » from NYT Dealbook.

Don’t Throw the Baby out with the Bath Water

Financial regulatory reform is poised to emerge in a form that risks being just more of the same, if clear segmentation of oversight duties is not set-out in bright line separation of duties. Says Pat O’Mara, CEO of New York’s Cardinal Compliance Services (www.cardinalcompliance.com), “Instead of more ambiguity there must be a clear road-map for industry professionals to follow, outlining all specific regulatory responsibilities.”

‘Shooting the Messenger’ and SEC and FINRA Background
Arguably, Mary Shapiro, as head of NASD (having once been head of the CFTC) was on the right track at the NASD when it changed to FINRA. Because of Madoff and Stanford, FINRA (the SEC’s primary Self Regulatory Organization), the lethargic attention of the U.S. Congress only recently began looking at capital markets regulatory structure, mandate and budget. Now that it’s awakened from its stupor, hopefully Congress does not resort to a ‘shoot-the-messenger’ approach. The State Securities Administrators rightly conclude that the SEC (and FINRA should be included here as well), are over-taxed with work, underfunded, and out-manned by those they are trying to regulate. But more regulation by the States is not the answer.

SEC Commissioner Shapiro’s Vision
Not unlike Europe, particularly the UK, the NASD, was thinking globally. In its merger, or takeover of the New York Stock Exchange’s regulatory body, essentially the NYSE, the NASD sought an approach that could poise the new self regulatory organization (one “SRO” from what was once two SROs), into an “Authority” (hence the name ‘Financial Institutions Regulatory Authority’, or FINRA), that could address all securities related issues in the United States, while allowing for increased international reach of the broker-dealers it is responsible for regulating. Though no super-model of regulatory perfection, Europe at least has the notion of a regulatory ‘authority’ which conveys just that, a regulatory body that has the authority to permit, shut down, discipline, fine, sanction and otherwise, effectively regulate. Drawn from a capital markets trade execution level, on up, the Financial Services Authority in London, has gained a reputable track-record of effective regulation. This concept is clearly what was on the mind of Shapiro and others at the time of the NYSE and NASD merger. In this day and time, we should not go back to a provincial system of delegating some securities regulation to the state level, and the rest to the national level. After all, it is the 21st century and what’s more, the States seem themselves to be mired in their own financial crisis, not to mention, that from one State to another, the States are far too fragmented to regulate securities commerce which almost always crosses state borders (as well as national borders).


SEC and FINRA Mandate and Capabilities
In the cases of Stanford and Madoff, clearly existing regulation should have been brought to bear in full measure. The recent report concerning the missed opportunities in bringing the two scoundrels to justice shows that a simple upgrade to capabilities (e.g., to examination staff-qualifications, training, pay and experience) would have nipped the fraudulent schemes in the proverbial bud. All regulation was properly in place… in writing – statute, rules, regulation, petition, arbitration, down to enforcement and Wells Submissions – all are still a legitimate process designed to find and prosecute wrongdoing in the financial capital markets. Such process gets little recognition when it runs smoothly and flushes out many of the scam artists, and even the wrongdoers who may unwittingly ‘step-over-the-line’. (One should read the monthly enforcement notices and bulletins that are published regularly in this highly regulated industry). In fact, with the proper funding, training, and personnel expertise, and coordination among entities, the argument can be made that the existing regulatory system would have caught Madoff and Stanford quickly in the due course of regulatory examination and scrutiny. SEC and FINRA mandates are incredibly well written and with the proper intention and would be impossible to duplicate today, if Congress sought to somehow go back to the drawing board. What was shown to be lacking however, was a basic lack of shear capability to execute their mandate. Such funding and willingness to regulate has to come from…that’s right, the U.S. Congress. Congress should look directly into the mirror if they seek to isolate the true cause of any regulatory failure in the Capital Markets.

Banking Crisis effect on U.S. Capital Markets

Just a couple of years after Shapiro and the broker-dealer community constituted the new ‘FINRA’ regulatory body (out of the NYSE and NASD), we fast forward to March of 2008, and Bear Stearns, with its primary businesses that of a broker-dealer, as it teeters on the brink of collapse. With the case of Bear Stern we can see that, from a timing standpoint, broker-dealer regulation showed its preeminence in having flagged an institution's shortcomings, early on in the overall financial crisis. Because of Bear Stern’s ‘early warning’ requirement, pursuant to SEC rules, regulators knew it was in trouble. What should be understood is the effectiveness of SEC Rule 15(c) in obligating a broker-dealer institution to rigorous net capital requirements. Unable to meet such requirements, Bear Sterns had to notify regulators and of course we know the rest of story. Further, it could be said that it was because of looser standards in the banking arena, that Goldman Sachs and others quickly converted from broker-dealer investment banks, to commercial bank status, organizing themselves under Federal Reserve jurisdiction. Shortly after the Bear Sterns debacle (which took place under the watch of the prior SEC Commission Chairperson), an unprecedented decision was made. Investment Banks were allowed to temporarily borrow at the Federal Reserve Discount Rate. The real lesson to be taken is that it was the more nebulous approach to regulation that existed in the world of bank regulation (even of the products in which Bear Sterns was dealing) that is clearly seen to be at fault in the recent economic crisis. The questionable application of how banking products were valued (and thus what rules and oversight were applicable) is truly what needs to be reformed.

Concluding Recommendations

The broker-dealer and managed funds regulatory world should continue to follow an SEC rule making methodology that garners industry consensus (because the honest brokers and managers will always seek a level playing field), and self regulation is effective, as long as rules are rigorously applied and vigorously enforced. Congress should ensure that in its approach to hedge fund advisers, broker-dealers and money-managers, at all levels, they all fall under the SEC’s jurisdiction. From a regulatory standpoint, parsing the securities community based on size or product would only fragment a regulatory system that already suffers from a lack of communication among the existing departmental silos that have set-up, by mandate. SEC enforcement should, if anything, be given more range (i.e., of everything securities related, perhaps even more insurance products) along with a staff and a budget that would make all of the Madoff want-a-be’s cringe and cower at the thought. Few ever successfully challenge an SEC enforcement action. As for honest capital markets professionals, we should all be concerned with the morass of banking reform legislation, seek that it not pervert capital markets legislation, and welcome the leveling-of-the-field-of-play with a beefed-up SEC and FINRA.

SEC Registration Bill Advances, But Now What ? Practical Advice on How to Prepare

Following last week's House Committee on Financial Services clearing a bill that would require most alternative investment fund managers to register with the SEC you may wish to read an overview of how and what to do to prepare your Firm for Registration.

In a column late this summer Thomson's BuyoutsNews prodded buyout shops to take a stronger stand against proposed legislation requiring them to register as investments advisers with the SEC. That article was titled "Will Industry Accept SEC Registration Without A Fight?" In it you can read how many firms may be tempted to tap a CFO or other partner as chief compliance officer, rather than hiring a full-time CCO. But that could prove short-sighted, given the complexity of the job, and the fact the SEC tends to stop by for examinations every two to four years. "One of the ways to get into big trouble is to adopt policies and procedures off-the-shelf and not to follow them," cautioned a Partner at Ropes & Gray.

Registering as investment advisers, following the compliance policies and procedures, dealing with regular inspections-all these activities absorb yet more time and energy. These are among the main areas that firms would likely need to change how they do things and you can read below on what and how to do it. Read more.
To see all DRAFTS of the Financial Regulatory Reform now being considered by the House Financial Services Committee click here Click here to write to your Representative about issues relating to the Financial Services Committee.

SEC may raise RIA threshold to $100M, moving many under state regulation

Some 4,200 advisory firms can expect more oversight and higher costs under legislation that would remove them from SEC oversight and place them under state regulation. Investor Protection Act of 2009, which the House Financial Services Committee is expected to approve this week, contains an amendment by Rep. Barney Frank (photo), that would raise the threshold for SEC registration of investment advisory firms to $100 million, from $25 million.

That would result in state regulators' gaining oversight of about 4,200 of the 11,300firms now registered with the SEC. The act also contains new rules to harmonize regulations between broker-dealers and investment advisers.

Under the amendment, “examinations could happen more frequently and more rigorously” for firms moving to state regulation as well as for larger firms remaining under the SEC. The SEC examines about 9% of its regulated advisory firms annually.

If it is able to concentrate on larger firms, the SEC will have more time to conduct exams, states currently examine advisory firms more frequently than the SEC does. The bill also contains provisions to more than double funding for the SEC, raising the budget to $2.25 billion and authorizing the commission to impose fees on investment advisory firms to cover the cost of inspecting and examining firms for which the agency retains jurisdiction.

For firms moving from SEC to state registration, regulation would likely become more complicated and expensive. Many of those firms would have to register with more than one state.

Currently, SEC-registered firms need not register in states in which they have few clients. State-registered firms with locations in more than one state will find themselves subject to different state requirements concerning custody rules, capital requirements, advisory contracts and privacy regulations.

Although some think it will be more costly to them, some advisers said that they think that state regulators are easier to deal with than the SEC. More at Investment News.

S.E.C.'s Madoff Investigation Exhibits

S.E.C. inspector general, H. David Kotz concluded in his full report that inexperienced and sometimes incompetent staff members had failed to adequately investigate numerous warnings and tips about the enormous Ponzi scheme.

New exhibits consist of 6,157 pages of interviews, letters, e-mail messages, telephone records and other background material gathered during a 10-month investigation of how the commission handled, and mishandled, numerous tips and warnings it received about Madoff over the years. His full report,released last month, found the agency had received six substantive complaints since 1992 — and botched the investigation of every one of them. He found no evidence of any bribery, collusion or deliberate sabotage of those investigations.

Among the exhibits are transcripts or reports on more than 160 other interviews conducted during the extensive internal investigation, including conversations with four former S.E.C. chairmen, a number of former top officials at the agency and dozens of current and former staff members involved in the various botched investigations examined in the original report.

E-mail messages, letters, memoranda, telephone records and other bits of evidence are also included in the Madoff trove were posted on the agency’s Web site

While the exhibits add no new charges to Mr. Kotz’s unofficial indictment of the nation’s top market regulators — the worst documented failure in the 75-year history of the S.E.C. — they do provide a vivid sense of the tensions, confusions and petty squabbles that derailed each failed inquiry.

The paperwork gathered from the agency’s files also tell a tale of unseasoned, poorly managed people who were uncertain about what to do and unwilling to ask for help. In numerous instances, employees would share their doubts about Mr. Madoff in notes or e-mail messages, but then never take steps to press for more information.

In a memo from March 2004, several senior S.E.C. staff members reported that “it seems clear” that Mr. Madoff had “absolute discretion” over the accounts of his clients. Nevertheless, they said, “Bernard Madoff himself has categorically denied being an investment adviser.”

Go to Madoff Exhibits from the S.E.C.
http://www.sec.gov/news/studies/2009/oig-509/oig-509_exhibits.htm
Article from NY Times

FINRA Calls for Surveillance by “Unified Single Regulator” & Studying Facebook

Rick Ketchum, FINRA chairman and CEO called for the creation of a single repository of data on all trades on all markets so that the financial industry could be “surveilled by a unified single regulator.” A single regulator can “bring the best technology, the best people, and a unified set of rules” to bear on markets. He called his proposal “somewhat daunting” but “a significant undertaking and a baby step” at the same time.

Sure as with other updated and proposed Reguatory matters the primary goal is enhanced Regulation - but SRO mergers like any other will produce headcount reduction to achieve resultant cost-cutting.

Ketchum said FINRA “would do a good job” at creating and surveilling a single data base. But there are alternatives, he told Securities Industry News.


“If you don’t, things will fall through” the cracks, he said in comments delivered at SIFMA's annual meeting. The problem that the single database and the single “surveilling” body would respond to is increasing “fragmentation we see in the markets and the increasing number of genuine liquidity centers, and what these do to the ability of regulators to oversee the markets,’’ said Ketchum. Ketchum is a former regulator of multiple markets at NYSE Regulation. A decade ago, a single market – the NYSE – dominated trading and that made surveillance relatively easy. But, in 2009, the majority of trading is occurring on electronic networks and dark pools. The exchanges have been empowered to police trading and activities, but that is getting more difficult, Ketchum said, as market activity disperses.

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In another regulatory news, FINRA has set up a task force of to explore how regulation can embrace technology advancements to improve the flow of information between firms and customers without compromising investor protection. Bankers and analysts increasingly want to use social networking to connect and interact with customers. Ketchum said Social networking sites like Facebook and LinkedIn raise "serious new challenges."

Most firms prohibit their employees from using sites like Facebook for business, partly because of the difficulties they pose for firms' ability to meet supervision and record-keeping requirements. Ketchum said "Nevertheless, interest in these sites is inevitable and will not go unabated," he said.

Mark Zuckerberg (pictured) founder and CEO of Facebook, delivers a keynote address at the company's annual conference on July 23, 2008.

Registration Bill Includes One-Year ‘Transition,’ Requires Compliance Officers

Hedge fund registration in the U.S. again approaching. House Committee yesterday approved a bill that includes a one-year transition period before registration with the S.E.C is mandatory. The bill’s author, Rep. Susan Kosmas (picture from FinAlternatives) said the delay is needed to allow both sides to get their ducks in a row.

“The SEC will need time to prepare for the additional responsibilities that will come from the registration of potentially thousands of new managers,” Kosmas claimed, despite the fact the SEC has itself imposed mandatory registration of hedge funds four years ago before that rule was tossed by the courts. Kosmas also said that hedge funds needed time to set up the infrastructure for registration and the inspections that will follow it: Among other things, the bill would require hedge funds to hire chief compliance officers.

The head of the agency charged with overseeing hedge funds threw her support behind requiring the hedge fund managers to register. Speaking at the 2009 SIFMA Annual Meeting, Mary Schapiro said that hedge funds “have flown under the radar for far too long” and that she “will work with Congress to avoid creating broad new carve-outs or exceptions that could come back to haunt investors in later years.”

When you need a Partner to staff for Compliance, be sure to contact Rosenthal Recruiting at (973) 826-0537, via
Facebook Page ,Website or LinkedIn.

Goldman Meets and Makes its Case to SEC: Dark Pools, Short Sales Help Cut Costs

“Dark Pools” benefit both institutional and retail trading by bringing down transaction costs, Goldman Sachs said in a memo to the S.E.C.

Last week the S.E.C. voted to make dark pools more transparent, such as revealing electronic trading messages that are sent to a limited group of market participants.

Tiny Memo URL is http://tiny.cc/ozoom
From: Smeeta Ramarathnam, Office of Commissioner Aguilar
Date: October 22, 2009
Re: Meeting with Representatives from Goldman Sachs

On September 24, 2009, Smeeta Ramarathnam and Zak May, Counsels to Commissioner Aguilar, met with the following representatives from Goldman Sachs: Paul Russo, Managing Director, Equities Division; William Conley, Managing Director, Global Securities Lending, and C. Annette Kelton, Managing Director, Associate General Counsel to discuss issues involving market structure including short selling, dark pools and Reg ATS, high frequency trading and exchange co-location, sponsored access, flash trading and IOIs. The representatives provided the attached materials entitled, “Market Structure Overview.”Bloomberg Article

The Wall Street Employment Scene

Q&A w/Bill Singer:Do you think we've seen the worst?

Rosenthal: Although improved since the Bear and Lehman crises, I don't think we will ever return to the staffing levels of the last bull market, at least, not for this generation. We are still adjusting to the new world order.

Singer: What are the chances of Wall Street embarking upon the rehiring of the tens of thousands of folks who have been laid off during the Great Recession? Read more at Bill Singer's BrokeandBroker.com

“This should serve as a wake-up call for Wall Street”

Insider trading case brought against Raj Rajaratnam, self-made billionaire who founded the Galleon Group

Case is fascinating on multiple levels. Sheer size of the purported network, with unnamed co-conspirators and tipsters, is tantalizing. Who was the unnamed investor-relations employee who allegedly illegally spilled the beans on Google earnings? Who was the Akamai executive who did the same? Moody’s analyst who divulged that Hilton Hotels was about to be acquired by the Blackstone Group ahead of the formal announcement?

Shown above are Danielle Chiesi, former Bear Stearns executive who played a major role in the purported scheme; Robert Moffat of I.B.M. who fed information into the network; Mark Kurland, Ms. Chiesi’s colleague hedge fund New Castle Partners; and Anil Kumar, a McKinsey & Company executive who also tipped the insider traders. The fifth named defendant is Rajiv Goel, an Intel executive.

“This case should serve as a wake-up call for Wall Street,” Preet Bharara, US attorney, said at a news conference. “These people were privy to inside information, but they didn’t know one secret, that we were listening.” Click to go to NYT Recap.

Prosecutors were quick to point to the development as a sign of how seriously they took white-collar crime, using techniques employed in investigations of the Mafia and drug cartels. That they intended today’s case as a shot across the bow of hedge funds is unmistakeable.

Who is Raj Rajaratnam ? As of early 2009 the richest Sri Lankan-born person in the world. He studied engineering at the University of Sussex in England. Rajaratnam moved to the US in 1981 and earned an M.B.A. from Wharton.

Rajaratnam started his career as an analyst at Needham & Co.. Promoted to president in 1991 then launched Galleon six years later. He says his best ideas come from frequent visits with companies and conversations with execs who invest in his fund. Hatip Wikipedia.

OVER 20% Of Hedge Funds Misrepresent Something To Clients

More than one in five hedge fund managers are lying to their investors, according to a new report.

The study, conducted by a quartet of academics, founded that 21% of hedge funds misrepresent past legal or regulatory problems, while nearly three in 10 offer incorrect or unverifiable information about other topics, including assets under management and performance, the study shows.

The study looked at 444 due-diligence reports on 403 different hedge fund managers commissioned by investors between 2003 and 2008, and found that 42% contained “verification problems.”

Of that 42%, half are cases where “the manager verbally stated incorrect information.” This was reported by FINalternatives.

Wall St. on Trial: E-mail-Heavy Case Could Benefit The Defense

Several former prosecutors say that the coming criminal trial of former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin, brought up on fraud charges in connection with the implosion of two funds, is far from a slam dunk. And they say that any attempt by the government to build a case based on anti-Wall Street sentiment could backfire.

For the blood-thirsty, there’s the specter of retribution for an act that some believe tipped the first domino in the global financial crisis. For those who think bailout-happy Washington has taken it too easy on the financial sector, the prosecution of two hedge fund managers, ­ the era’s shadowy and iconic Wall Street players, ­ represents the first instance of government pushing back. And then there’s the legal community, eager to see whether an indictment so rich in seemingly damning e-mail messages will in fact yield guilty verdicts. NYT has a former litigator's analysis of the coming trial.

Next-Gen NYSE Trading Floor: Hybrid of Live and Electronic

NYSE redesign, already under way at the Big Board's main trading room, is part of a broader strategic shift at the exchange. The exchange wants to lure more electronic traders directly to the floor, creating a hybrid world where they can take in the person-to-person "buzz" of live traders while still executing trades by computer.

The changes could bring about another big cultural change: traders will be able to sit at stations similar to desks used throughout Wall Street, instead of standing or perching on stools, as is Big Board custom. WSJ has more and provides rendering from Perkins Eastman Architects. The Architects, who also designed newly renovated Times Square half-price Broadway ticket booth, said the plan could "bring back some of the excitement" to the room. "We're taking out the blocky booths and replacing them with something nice," said Lou Pastina, EVP of NYSE operations.

Third of Wall St Expects Bigger 2009 Bonus

Bloomberg reports on survey from a leading Career website: “This finding may rile regulators who have concluded that compensation arrangements often created incentives for risk- taking with insufficient regard to longer-term risks.” Of the quarter of respondents who anticipate a smaller bonus, 54% attribute it to their firm’s performance and 20% to a change in pay structure. Citi, Morgan Stanley and UBS increased salaries for some while adjusting bonus policies.