Latest Regulatory Changes and Their Impact on Financial Reporting


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Joint presentation by Renee Ford and Beth Biega with Decosimo, and Sal Shah with McGladrey.

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Latest Regulatory Changes and Their Impact on Financial Reporting

  1. 1. Regulatory Changes:Impact on Financial ReportingSal (Kislay) Shah, Partner, Financial Services GroupMcGladrey & Pullen, LLPKislay.shah@mcgladrey.com212.372.1201 Renee B. Ford, Assurance Principal Decosimo CPAs 423.266.1495
  2. 2. Amended Custody Rules for Registered Investment Advisers
  3. 3. What is Custody? Holding client funds or securities directly or indirectly Having any authority to obtain possession of client funds (i.e. POA) Having authorization to withdraw client funds or securities held by custodian Acting as a general partner or equivalent of a private investment vehicle Related person has custody in connection with adviser’s services 2
  4. 4. Exceptions “Custody” solely because of authority to deduct fees Related person has custody but is operationally independent - SEC presumes lack of operational independence - Advisor must overcome presumption by meeting five requirements 3
  5. 5. Qualified Custodian Requirement Client assets must be maintained with a qualified custodian (QC) Separate account for each client in the client’s name Private securities no longer exempt Includes banks, broker-dealers or futures commission merchants QC does not have to be independent of adviser, but if not, - Internal control report required (Type II SAS 70) 4
  6. 6. Qualified Custodian Requirement“Custody does not turn on whether thesecurities are maintained with a qualifiedcustodian.” 5
  7. 7. Pooled Investment Vehicles Annual Audit Option Advisers to pooled investment vehicles are deemed to have satisfied the requirement for a surprise exam if- - Annual financial statement audited by PCAOB- registered firm (GAAP and GAAS) • Some exceptions available for non-US advisers - Distributes audited statements to investors within required time frame annually (120 or 180 days) - Provides audited financial statements upon liquidation 6
  8. 8. Private Investment Funds If audit exception is not met: - QC must send account statements to each investor of the PIV - Statement must include transactions and holdings of the entire pool - Surprise examination is required Unable to meet 120 day requirement - Unforeseeable circumstances 7
  9. 9. Surprise Examinations – Independent Verifications Requirements are contained in Rule 206(4) – 2 Sets up in the context of: - A registered investment adviser can’t have custody of client funds or securities unless, among other things: • Client funds and securities of which you have custody are verified by actual examination at least once during each calendar year • Exam is pursuant to a written agreement • At a time that is chosen by the accountant without prior notice and that is irregular from year to year 8
  10. 10. Surprise Examinations – Independent Verifications SEC Release regarding Independent Public Accountant Engagements performed pursuant to Rule 206(4) - 2 - Engagement objectives - Reporting - Scope of verification Concept of “surprise” - Without prior notice - Show up on client premises - Vary from year to year 9
  11. 11. Important Dates Surprise examination must commence prior to December 31, 2010 Must be completed within 120 days of selected examination date For PIVs, the effective date is years beginning on or after January 1, 2010 10
  12. 12. Effective Dates Compliance date for internal control reports was September 12, 2010 for advisers subject to the requirement on March 12, 2010 Newly registered advisers – within six months of becoming subject to the requirement Recurring Custody-Related SAS 70 report timing considerations 11
  13. 13. Compliance Issues Custodians lack information to produce and deliver individual client account statements - Must comply by third quarter 2010 statement delivery - Must notify clients with first quarter 2010 statements of plan to comply 12
  14. 14. Compliance Issues Auditors don’t meet PCAOB-registered requirements. - Required for PIV audits, internal control examinations, and surprise exams for advisers with related custodians - Requirement first applicable to 2010 audits for PIVs - SEC No-Action Letter issued 10/12/10 • Non-qualified auditor engaged for most recently completed year • Auditor PCAOB-registered by 7/10/10 and engaged to audit broker-dealer • Written notification to each investor of auditor status • Only short-term relief 13
  15. 15. Clarification Can the audit firm of a PIV act as the independent representative for investors in the pool? Generally not. 14
  16. 16. Some Clarification on “Custody” Online access to client’s pension account to rebalance and adjust investments? Yes Limited authority to transfer client funds between client’s accounts? No Authority to instruct QC to remit funds to client? No, if certain rules followed Do rules apply to advisory clients from which no compensation is received? Yes 15
  17. 17. Clarification Under what circumstances must an adviser still provide an audited balance sheet to its advisory clients? If adviser charges fees six or more months in advance 16
  18. 18. Dodd-Frank Act
  19. 19. Who has to register pursuant to the provisions of the Dodd-Frank law Old Law - Private Adviser Exemption - Holding out - Fewer than 15 clients - No look through to fund - SEC’s prior attempt at forcing registration - Goldstein decision Dodd-Frank eliminates Private Adviser Exemption Dodd-Frank establishes dollar thresholds of AUM for registration - AUM between $25 and $100 million - AUM over $100 million - AUM $150 million and over 18
  20. 20. Who has to register pursuant to the provisions of the Dodd-Frank law cont’d Venture Capital Fund - Exempt from registration Private Equity Fund - No exemption Foreign Advisers - Generally required to register CFTC Registered Advisers - Exempt unless/until business becomes primarily securities related Family Office - Exempt from registration SBIC - Exempt from registration 19
  21. 21. Short Sale and New Derivatives RulesShort Sale And New Derivatives Rule 20
  22. 22. SEC Short Selling rule Three elements - Uptick rule - Circuit breaker - Waiting for further regulations 21
  23. 23. Uptick Old vs New Rule Old rule – Can sell short after the stock price rises, an “uptick.” - Sell above the last traded price or after the last price was higher than the previous price. New rule was adopted in February 2010 22
  24. 24. Uptick Old vs New Rule New rule – cannot sell short unless buyer pays more than nations best bid SEC believes best bid is better reflection of current price than the last sell price Much harder to sell short 23
  25. 25. Circuit Breaker An equity security declines 10% or more Short sale may not be executed at or below the national best bid - That trading day and the following day SEC expects 1.3% stocks to hit the 10% barrier on a normal day 24
  26. 26. Further Regulations – Dodd-Frank Act Mandates that the SEC adopts rules for the monthly reporting of short sales - Not certain who will report - Not certain what will be reported Stay tuned - SEC (Division of Risk, Strategy, and Financial Innovation) currently initiating studies of the market – due by July 2012 • Impact of recent rule changes • Incidence of failure to deliver shares sold short • Feasibility of real time reporting 25
  27. 27. Swap Dealers / Major Swap Participant Registration required with the CFTC / SEC On-going reporting requirements - Transactions, positions, and financial condition - Trading records for each customer / counterparty Capital and margin requirements for non- cleared swaps 26
  28. 28. Clearing and Exchange Trading All swaps must be submitted to a clearing house for clearing Designated OTC contracts markets Note that the EC published its proposals for the regulation of OTC derivative contracts Benefits: - Achieve greater transparency and reduce systemic risk in OTC derivative markets - Greater price discovery - Reduced counterparty risk - New regulatory oversight - Modification to operational processes 27
  29. 29. Example: Credit Default Swaps Fixed coupon rates Standardized payment frequency Harmonizing effective dates Clarifying credit events Settlement price determination procedure Trade compression, central clearing and faster trade processing 28
  30. 30. Level 3 Documentation Need better documentation supporting valuations. Disclosure in footnotes. LP communications. 29
  31. 31. Post Registration Compliance Requirements Written Compliance Program Designate CCO & Required Annual Review of Compliance Procedures System of Internal Controls & Conflicts of Interest Supervision Books and Records Advertising, Performance Fees and Solicitation 30
  32. 32. Post Registration Compliance Requirements (Cont.) Code of Ethics (Personal Securities Transactions/ Insider Trading) Business Continuity Plan Custody and AML Proxy Voting and Privacy Other Relevant Requirements 31
  33. 33. SEC Areas of Focus Management fees Incentive fees – allocation and distribution Fees from portfolio companies Carry fee offset Valuation In kind distribution Advertising Fund Raising Personal trades Soft Dollars Trade allocations Non compliance record and corrective measures 32