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Operation and Regulation of Investment Vehicles

GEARING FOR THE FUTURE IN RISK MANAGEMENT PANEL DISCUSSION SEPTEMBER 19, 2014 STRADLEY RONON STEVENS & YOUNG, LLP: FABIO BATTAGLIA, III CHRISTOPHER J. ZIMMERMAN PROMONTORY FINANCIAL GROUP, LLC: NICHOLAS KIRITZ

This presentation is for educational purposes only. It should not be construed as legal advice or opinion or as a substitute for the advice of counsel.

Agenda 1 WHAT WE WILL COVER: 1. HEDGE FUNDS 2. MUTUAL FUNDS 3. EXCHANGE-TRADED FUNDS

4. RECENT DEVELOPMENTS RELATED TO RISK

Introduction 2 

Pooled Investment Vehicles  



Different Types of Vehicles 

 



Efficient Delivery of Investment Management Services Diversification

Types of Investments Types of Investors Purpose of the Pooled Investment Vehicle

Assets under Management (2013) 

 

Hedge Funds – $2 trillion Mutual Funds – $15 trillion Exchange-Traded Funds – $1.7 trillion

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Basic Structure of Pooled Investment Vehicles 3

Investors

Custodian Bank

Administrator

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Fund

Auditor

Investment Advisor

Counsel

Key Regulatory Provisions 4

 Investment Company Act of 1940  Investment Advisers Act of 1940  Securities Act of 1933

 Securities Exchange Act of 1934

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Hedge Funds 5

 Exempt Offerings and Exclusion from “Investment Company” Status ●

Section 3(c)(1) of the Investment Company Act - Beneficially Owned by Not More than 100 Persons

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Section 3(c) (7) of the Investment Company Act - Owned Exclusively by “Qualified Purchasers”

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Private Offerings under the Securities Act - Private Placement to “Accredited Investors”

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Hedge Funds 6

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Less Regulation Results in More Flexibility

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Greater Flexibility in Implementing Investment Strategies ● Use of Leverage ● Lock Up Provisions and Limited Liquidity

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Generally Higher Fees and Expenses; Different Types of Fees ● Fees Not Subject to the Regulatory Restrictions that Apply to Mutual Funds

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Less Regulation Also Results in Decreased Visibility to Regulators ● Information on Form ADV and Form PF ● Registration of Hedge Fund Advisers

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Mutual Funds 7

 Key Characteristics ● Extensive Regulation ● Direct Purchase and Redemption of Shares at Net Asset Value ● No Limits on the Number or Type of Investors  SEC Registration and Disclosure Requirements ● Investment Company Act ● Securities Act ● With Registration Comes Regulation and Oversight by the SEC Staff  The “Retail” Investment Vehicle ● Daily Liquidity ● Professional Money Management ● Diversification at Lower Asset Levels © 2014 Stradley Ronon Stevens & Young, LLP

Mutual Funds 8

Basic Regulatory Principles Applicable to Mutual Funds  Restrictions to Ensure Liquidity ● Generally Limited to 15% of Fund Assets Invested in Illiquid Securities  Requirements Relating to Diversification and Concentration ● Limitations on Amount of Assets Invested in Any One Issuer ● Limitations on Concentration of Investments in Any One Industry or Sector  Requirements Designed to Ensure Accurate and Timely Disclosure ● Annual Registration Statement Updates ● Semi-Annual Shareholder Reports

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Mutual Funds 9

Basic Regulatory Principles Applicable to Mutual Funds (cont’d)  Restrictions on Transactions with Affiliates ● ●

Restrictions on Cross Transactions Restrictions on Purchases in IPOs with Affiliated Underwriters

 Regulation of Fee Structures ●

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Investment Advisory Fees Distribution-related Fees (Rule 12b-1)

 Board of Directors Oversight

 Requirements for Safekeeping of Assets

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Exchange-Traded Funds 10

What is an ETF?  Fund Registered under Investment Company Act

 Issues and Redeems Shares in Large Aggregations  Transacts Directly with “Authorized Participants” (APs)  Creation Unit Purchases/Redemptions Are Generally Exchanged for Specified

Portfolio Securities  Listed on an Exchange and Trade in Secondary Market

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Exchange-Traded Funds 11

ETF Advantages  Cost Efficiency: Lowering Shareholder Services Costs; In-Kind Transactions

Can Reduce Portfolio Transaction Costs  Tax Efficiency: In-Kind Redemptions May Allow ETF to Avoid Realization of

Capital Gains  Trading Flexibility: Intraday Trading and Shorting  Generally Lower Distribution Expenses

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Exchange-Traded Funds 12

ETF Exemptive Relief  Necessary under the Investment Company Act  Operation of the ETF Would Violate Various Provisions of the Investment

Company Act  Active ETFs Require Specific Exemptive Relief  In 2008, the SEC Proposed Rule 6c-11 and Rule 12d1-4 under the Investment

Company Act • Relief for Index-Based and Fully Transparent Active ETFs

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Regulation 13  SEC’s Division of Investment Management:

Risk and Examinations Office  Separate from Office of Compliance Inspections and Examinations (OCIE)  Formed in October 2012; Mandated by Dodd-Frank  Supports Division by Performing Quantitative and Qualitative Financial

Analysis −

Industry Analysis and Monitoring

−

Examination Program

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Regulation 14

 Division of Economic and Risk Analysis (DERA) 

Formed in 2009



Intended to Bring Together SEC Staff to Provide Data-Driven Analyses in Support of the Staff’s Work

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SEC Recently Announced Formation of Office of Risk Assessment within DERA



Creation and Implementation of Data-Driven Tools

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Some Recent Regulatory Developments…

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 Alternative Investments (“Liquid Alts”)  Money Market Fund Reform  Cybersecurity

 Financial Stability Oversight Council

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