OPERATIONAL DUE DILIGENCE

Morning Briefing

March 28, 2019

Moderated by:

Greg Florio

Jim Leahy

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Table of Contents

About Orical ................................................................................................................................................ 3

About The Operational Due Diligence Breakfast Briefings .................................................................... 4

Topic 1: Inside Trading .............................................................................................................................. 5

Theory Of Liability ................................................................................................................................... 5

Elements Of Insider Trading ..................................................................................................................... 6

Penalties For Insider Trading .................................................................................................................... 7

Investment Adviser Compliance ............................................................................................................... 7

Conclusion ................................................................................................................................................ 9

Timeline .................................................................................................................................................. 10

Case Studies ............................................................................................................................................ 12

Topic 2: Electronic Communications ...................................................................................................... 17

Observations From Investment Adviser Examinations ........................................................................... 17

Topic 3: Regulatory Update ..................................................................................................................... 19

Owner Biographies ................................................................................................................................... 23

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About Orical

The Orical family of companies provides investment advisory legal and compliance

services, as well as leading investment management compliance technology, in one unified

offering1. Orical LLC is an investment management compliance consulting firm founded in 2010.

With clients in the U.S. and abroad, Orical services some of the financial industry’s most well-

respected firms, including investment managers, broker/dealers, family offices and banks. The

premier law firm and extensive in-house industry experience of our professionals enables Orical

to provide timely, practical advice and hands-on assistance that reflects a comprehensive

understanding of the real-world issues facing today’s industry participants. Our business model is

to provide extremely responsive and cost-effective expert compliance services. Orical, together

with its affiliates, Florio Leahy LLP, an investment management law firm, and Real World

Compliance LLC, a compliance software firm, provides a full suite of investment management

services, including the following:

• Registration Services with low Start-Up Costs (RIA, CPO/CTA, B/D);

• Development and Administration of Customized Compliance Programs that Represent

the Industry’s Best Practices;

• Compliance Software;

• Forensic Trading Reviews (Anti-Insider Trading and Market Manipulation Surveillance);

• Assistance with Investor Due Diligence;

• Assistance through Regulatory Examination;

• Mock Examinations (SEC/FINRA/CFTC);

• CCO Training Programs, Guidance and Education;

• Periodic Regulatory Updates;

• Compliance Training;

• Compliance Initiatives, Including in the Areas of Marketing and Performance Reporting,

Investment Allocation, Expense Allocation, Conflicts of Interest, Disclosure, SEC

Readiness, Custody, Cybersecurity, Disaster Recovery and Books and Records

Compliance; and

• Expanding the Bandwidth of our Client’s Internal Personnel.

1 Legal services are provided by Florio Leahy LLP and compliance technology is provided by Real World

Compliance LLC, both of which are under common ownership and control with Orical LLC.

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About the Operational Due Diligence Breakfast Briefings

Orical’s Operational Due Diligence Breakfast Briefings are a series of informative conferences

designed to cover the topics of most significance to the alternative asset operational due diligence

community and investors. Briefings are open to all alternative asset ODD professionals, as well as the

principals and operational staff of Orical’s clients, which include hundreds of alternative assets managers.

Topics are chosen with input from the ODD professionals, Orical’s clients and Orical’s broader network,

with 2-3 topics to be covered in each Briefing.

Orical’s goal in conducting the Briefings is to foster an exchange of information in an open and

“off the record” format, to help those who participate obtain a better understanding of how the industry’s

best practices apply in different settings, and, ultimately, to increase the likelihood of success for alternative

asset ODD professionals, investment managers and investors alike.

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Topic 1: Inside Trading

THEORY OF LIABILITY

The term “insider trading” is not defined in the federal securities laws, but generally is used to refer to the

use of material non-public information obtained in violation of a duty of confidentiality or which was

otherwise misappropriated, to trade in securities (whether or not one is an “insider”) or to communicate

material non-public information to others.

Fiduciary Duty:

In 1980, the U.S. Supreme Court found that there is no general duty not to disclose before trading on

material, non-public information, but that such a duty arises only where there is a fiduciary relationship2.

That is, there must be a relationship between the parties to the transaction such that one party has a right to

expect that the other party will not disclose any material non-public information or refrain from trading.

In Dirks v. SEC3, the U.S. Supreme Court stated alternate theories under which non-insiders can acquire

the fiduciary duties of insiders:

i. They can enter into a relationship with the company through which they gain information (e.g.,

attorneys, accountants), or;

ii. They can acquire a fiduciary duty to the company’s shareholders as “tippees” if they are aware

or should have been aware that they have been given confidential information by an insider

who has violated his fiduciary duty to the company’s shareholders.

However, in the “tippee” situation, a breach of duty occurs only if the insider personally benefits, directly

or indirectly, from the disclosure. The benefit does not have to be pecuniary, but can be a gift, a reputational

benefit that will translate into future earnings, or even evidence of a relationship that suggests a quid pro

quo.

Misappropriation Theory:

Another basis for insider trading liability is the “misappropriation” theory, where liability is established

when trading occurs on material, nonpublic information that was stolen or misappropriated from any other

person in breach of a duty owed to the source of the information, by defrauding such person of the exclusive

use of such information.

In U.S. v. O’Hagan4, the Court found that an attorney defrauded his law firm and its client when he traded

on knowledge of an imminent tender offer while representing the company planning to make the offer.

Rather than premising liability on a fiduciary relationship between the company insider and the attorney,

2 Chiarella v. U.S., 445 U.S. 22 (1980). 3 Dirks v. SEC, 463 U.S. 646 (1983) 4 U.S. v. O’Hagan, 117 S. Ct. 2199 (1997)

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the Court based misappropriation liability on fiduciary attorney’s deception of those who entrusted him

with access to confidential information. It should be noted that the misappropriation theory can be used to

reach a variety of individuals not previously thought to be encompassed under the fiduciary duty theory.

Tipping Chains:

In a tipping chain, the first tippee communicates the material, non-public information to a second tippee—

the so called "remote tippee"—and so on. A tipper will be liable if he or she tips material, non-public

information, in breach of a fiduciary duty, to someone he or she knows will likely (1) trade on the

information, or (2) disseminate the information further for the first tippee's own benefit.

The first tippee must both know or have reason to know that the information was obtained and transmitted

through a breach of a fiduciary duty, and intentionally or recklessly tip the information further for his or

her own benefit. The final tippee must both know or have reason to know that the information was obtained

through a breach of a fiduciary duty and trade while in possession of the information. In theory, a tippee

removed from the primary tipper by several links in the tipping chain could face insider trading liability.

ELEMENTS OF INSIDER TRADING

While the law concerning insider trading is not static, it is generally understood that the law prohibits:

1. Trading by an insider, while in possession of material nonpublic information; or

2. Trading by a non-insider, while in possession of material nonpublic information, where the

information either was disclosed to the non-insider in violation of an insider’s duty to keep it

confidential or was misappropriated; or

3. Communicating material nonpublic information, obtained through a breach of an insider’s duty

to keep it confidential or which was otherwise misappropriated, to others, and the insider

personally benefits, directly or indirectly, from the disclosure.

Who is an Insider?

The concept of an “insider” is broad. It includes officers, directors, and Supervised Persons of a company.

In addition, a person can be a “temporary insider” if he or she enters into a special confidential relationship

in the conduct of a company’s affairs and as a result is given access to information solely for the company’s

purposes.

What is Material Information?

Trading on insider information is not a basis for liability unless the information is material. “Material

information” generally is defined as information for which there is a substantial likelihood that a reasonable

investor would consider it important in making his or her investment decisions, or information that is

reasonably certain to have a substantial effect on the price of a company’s securities.

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What is Non-public Information?

Information is non-public until it has been effectively communicated to the market place. One must be able

to point to some fact to show that the information is generally public. For example, information found in a

report filed with the SEC, or appearing in Bloomberg, Dow Jones, The Wall Street Journal or other

publications of general circulation would be considered public. In addition, a sufficient period of time must

elapse for the information to permeate the public channels to be considered public.

PENALTIES FOR INSIDER TRADING

Penalties for trading on or communicating material non-public information are severe, both for individuals

involved in such unlawful conduct and their employers. A person can be subject to some or all of the

penalties below even if he or she does not personally benefit from the violation.

Penalties include:

a. Civil injunctions;

b. Disgorgement of profits;

c. Jail sentences;

d. Fines for the person who committed the violation of up to three times (treble damages) the

profit gain or loss avoided, whether or not the person actually benefited; and

e. Fines for the employer or other controlling person of up to the greater of $1,000,000 or three

times the amount of the profit gained (or loss avoided), if the employer either fails to maintain

compliance procedures or fails to take appropriate steps to prevent the likely commission of

acts constituting a violation.

INVESTMENT ADVISER COMPLIANCE

Insider trading is prohibited primarily by Section 10(b) and Rule 10b-5 of the Securities Exchange Act of

1934. In addition, Section 204A of the Advisers Act requires investment advisers to adopt, maintain, and

enforce written policies and procedures reasonably designed to prevent the misuse of MNPI by the Firm or

any of its Employees or affiliates.

Procedures and Controls:

An adviser’s insider trading policy should apply to every employee and extend to activities outside the

scope of his or her duties of employment. Any questions regarding a firm’s insider trading policy should

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be referred to the firm’s chief compliance officer (“CCO”). Before trading for themselves or others, each

employee should ask himself or herself the following questions regarding information in his or her

possession:

1. Is the information material?

2. Is the information nonpublic? If, after consideration of the above, an Employee believes that the

information is material and nonpublic, or if an Employee has questions as to whether the

information is material and nonpublic, he or she should take the following steps:

a. Report the information and proposed trade immediately to the CCO.

b. Do not purchase or sell the securities either on behalf of yourself or on behalf of others.

c. Do not communicate the information inside or outside of the Firm, other than to the CCO.

Areas of Heightened Risk:

1. Insiders as investors: By virtue of their positions, investors that are public company insiders may

possess MNPI about their respective companies. Given this risk, the an Adviser should require its

employees who come into contact with insiders investors to inform the CCO immediately if:

i. The Employee becomes aware that any actual or perspective investor serves, or is about to

serve, as a director, officer or consultant to any company where the Firm has, or is

considering a securities investment or transaction; or

ii. The employee obtains any MNPI from such an investor.

2. Industry Experts: The Firm recognizes the possible risk that analysts may receive material, non-

public information when speaking with industry experts and has therefore implemented policies

and procedures designed to mitigate this risk.

Whistleblower Policy:

Employees of adviser should be instructed to report any violation of the firm’s insider trading policies and

procedures contained in the code of ethics or the federal securities laws promptly to the CCO. Retaliation

against an individual who reports a violation is prohibited, both as a matter of firm policy and under Section

21F of the Exchange Act, the federal Whistleblower Incentives and Protection Act.

Typical Situations:

The need to address insider trading issues may come up in a number of different circumstances during the

course due diligence conducted on a potential investment. As part of information gathering, material non-

public information may inadvertently be received which could create exposure to insider trading liability

as a tippee. The following are some examples of situations in which an investor may unintentionally acquire

material, non-public information:

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i. Gathering information from company representatives. Directors, officers and employees of a public

company are frequently in possession of material, non-public information regarding their own

company and their customers, suppliers and competitors. Directors, officers and employees of a

company as well as "temporary insiders" such as lawyers, accountants and financial advisors almost

always have a duty of trust and confidence to the company. Company representatives may be in

breach of such duty when they share confidential information with outsiders.

ii. Talking to investment bankers and sell side firms such as brokers. Investment bankers and brokers

are often in possession of material, non-public information and other confidential information

regarding their clients and may have duties of trust and confidence to their clients and the financial

services firms that employ the investment bankers and brokers.

iii. Talking to other market participants and representatives of buy side investors (such as analysts and

portfolio managers at hedge funds). Information about a buy side investor's plans to purchase or

sell securities or other plans with respect to a security may constitute material, non-public

information. For example, information about a buy side investor's plans to liquidate a large position.

Representatives of buy side investors are usually subject to duties of trust and confidence to the

firms that employ them and may not be authorized to discuss confidential information with

outsiders.

iv. Use of expert networks. Expert networks are firms that connect buy side investors with industry

experts. The industry experts may be current or former senior employees of or consultants to public

companies or current or former government officials. These industry experts may be in possession

of material, non-public information and subject to duties of trust and confidence. In speaking with

industry experts, there should not be an assumption that the industry experts are properly trained

with respect to insider trading compliance or know that they should not share material, non-public

information.

CONCLUSION

Recent SEC enforcement actions demonstrate that even casual disclosures of material, non-public

information between individuals risk drawing regulatory scrutiny if the recipient of the information trades

or further disseminates the information to someone who does trade. Individuals who are entrusted with

material, non-public information, as well as firms who engage in information gathering must take care to

avoid becoming inadvertent tippers and tippees. Firm’s need to be aware of insider trading laws, properly

train and educate employees concerning insider trading compliance, develop policies and procedures

surrounding insider trading compliance and, when necessary, consult with legal counsel.

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1 Securities Exchange Act of 1934 (Section 10b not self-executing and Section 16)

2 In re Cady, Roberts & Co., 40 S.E.C. 907 (1961): A Case of First Impression

3 SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969): Equal Access Policy

4 Chiarella v. U.S., 445 U.S. 222 (1980): Justice Powell rejects Equal Access; Justice Burger foreshadows misappropriation

5 Rule 14e-3 (1980) The SEC responds to merger mania

6 Dirks v. SEC, 463 U.S. 646 (1983): Justice Powell affirms rejection of Equal Access and explains tipper liability and personal

benefit

7 Carpenter v. U.S., 484 U.S. 19 (1987): First look at misappropriation

8 Basic Inc. v. Levinson, 485 U.S. 224 (1988): Materiality (probability/magnitude) and the TSC standard

9 U.S. v. O’Hagan, 521 U.S. 642 (1997): Misappropriation theory adopted; Rule 14e-3 affirmed

10 Rule 10b5-2 (2000) The SEC clarifies Chestman

11 Stop Trading on Congressional Knowledge Act (STOCK Act): Congress closes a loophole

12 Salman v. U.S., 137 S. Ct. 420 (2016): Another look at the personal benefit requirement

13 Failure to Supervise Cases:

i. In the Matter of Steven A. Cohen, Advisers Act Release No. 4307 (Jan. 8, 2016)

ii. In the Matter of Federated Global Investment Management Corp., Advisers Act Release No. 4401 (May 27,

2016)

iii. In the Matter of Artis Capital Management, L.P., Advisers Act Release No. 4550 (Oct. 13, 2016)

iv. In the Matter of Deerfield Management Company, L.P., Advisers Act Release No. 4749 (Aug. 21, 2017)

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CASE STUDIES

Chiarella v. U.S., 445 U.S. 222 (1980): Justice Powell rejects Equal Access; Justice Burger foreshadows

misappropriation

Vincent Chiarella was an employee of Pandick Press, a financial printer that prepared tender offer

disclosure materials. Pandick used code names to conceal the name of the companies involved but

Chiarella broke the code. He purchased target company shares before the tender offer was announced and

sold at a profit following the public announcement.

Chiarella was convicted in federal district court for violating Rule 10b-5 for trading on the basis of MNPI.

His conviction was affirmed by the Second Circuit based on its Texas Gulf Sulphur equal access policy.

Chiarella was not an employee, officer, or director of any of the companies he traded. He worked for

Pandick which was not an agent of any of those companies. Pandick worked for the acquirers.

The Supreme Court reversed the conviction and rejected the notion that Section 10(b) was intended to

ensure all investors have equal access to information. Citing Cady, Roberts, the Court said that the

obligation to disclose or abstain derives from an affirmative duty to disclose material information, which

has been traditionally imposed on corporate insiders, particularly officers, directors and controlling

stockholders. The Commission emphasized that the duty arose from (i) the existence of a relationship

affording access to inside information intended to be available only for a corporate purpose (not a

personal benefit), and (ii) the unfairness of allowing a corporate insider to take advantage of that

information by trading without disclosure. The duty to disclose arises when there is a fiduciary or other

similar relation of trust and confidence.

Justice Burger’s dissent foreshadows the misappropriation theory of liability.

Dirks v. SEC, 463 U.S. 646 (1983): Justice Powell affirms rejection of Equal Access and explains tipper

liability and personal benefit

Equity Funding of America appeared to be a successful company that sold financial services such as life

insurance and mutual funds. A former officer, Ronald Secrist, thought otherwise. He told Raymond Dirks,

a securities analyst, about fraudulent valuations at the company so that the fraud could be exposed. Dirks

interviewed Equity Funding employees who verified the existence of fraud. Dirks contacted the Wall

Street Journal and attempted to have them write a story about the fraud but they declined. Though neither

Dirks nor his firm traded Equity Funding, he did discuss the fraud with his clients and investors. The SEC

censured Dirks for violating Rule 10b-5 by repeating the allegations of fraud.

The Court reviewed Cady, Roberts and Chiarella and again rejected the notion of a general duty to

disclose and the equal information policy. A tippee assumes a fiduciary duty to the shareholders of a

corporation not to trade on material nonpublic information only when the insider has breached his

fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or

should know that there has been a breach. Thus, the tippee’s duty to disclose or abstain is derivative from

that of the insider’s duty.

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Whether a disclosure is a breach of duty depends in large part on the purpose of the disclosure or tip. This

standard identified by the SEC itself in Cady, Roberts: a purpose of the securities laws was to eliminate

the use of inside information for personal advantage. Thus the test is whether the insider personally will

benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of

duty to stockholders. And absent a breach by the insider, there is no derivative breach.

To determine if there has been a breach by the insider courts must focus on objective criteria, i.e. whether

the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a

reputational benefit that will translate into future earnings. The Court cited a 1979 Harvard Law Review

Article (“The theory…is that the insider, by giving the information out selectively, is in effect selling the

information to its recipient for cash, reciprocal information, or other things of value for himself…”).

There are objective facts and circumstances that often justify such an inference. For example, there may

be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an

intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic

information also exist when an insider makes a gift of confidential information to a trading relative or

friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the

recipient.

Footnote 14 Identifies underwriters, accountants, lawyers or consultants as constructive insiders who may

become fiduciaries to the stockholders who have entered into a special confidential relationship in the

conduct of the business and have been given access to information solely for corporate purposes.

Determining whether an insider personally benefits from a particular disclosure, a question of fact, will

not always be easy for courts.

Carpenter v. U.S., 484 U.S. 19 (1987): First look at misappropriation

The Supreme Court first took up the misappropriation theory in this case in which R. Foster Winans, a

Wall Street Journal (Heard on the Street) reporter and others misappropriated information belonging to

the WSJ and traded on it prior to publication of the relevant Heard on the Street column which affected

the stock price of the companies discussed. The Supreme Court upheld convictions on the mail and wire

fraud statutes. With respect to the securities fraud convictions the Court split 4-4. This permitted lower

courts to reject the misappropriation theory which the Fourth and Eighth Circuits did.

U.S. v. O’Hagan, 521 U.S. 642 (1997): Misappropriation theory adopted; Rule 14e-3 affirmed

James O’Hagan was a partner in the law firm of Dorsey & Whitney in Minneapolis, Minnesota

(“Dorsey”). In 1988, London based Grand Metropolitan PLC (Grand Met) retained Dorsey to represent

Grand Met regarding a potential tender offer for the stock of Pillsbury Company (“Pillsbury”),

headquartered in Minneapolis. O’Hagan did not work on the transaction but heard about it and purchased

Pillsbury call options. By the end of September, O’Hagan owned 2500 call options, more than any other

investor! O’Hagan also purchase 5,000 shares of Pillsbury common. The tender offer was publicly

announced on October 4, 1988. As a result of the announcement the stock rose from $39 to $60 and

O’Hagan made in excess of $4.3 million.

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The SEC investigated O’Hagan’s transactions which resulted in a 57 count indictment. A jury convicted

him on all 57 counts. The Court of Appeals for the Eighth Circuit reversed all of O’Hagan’s convictions

and rejected the misappropriation theory of liability. The court also ruled that the SEC exceeded its

authority in promulgating Rule 14e-3, which prohibits trading while in possession of material nonpublic

information relating to a tender offer.

Justice Ginsburg delivered the opinion of the Court. Under the traditional or classical theory of insider

trading liability, Section 10b and Rule 10b-5 are violated when a corporate insider trades in the securities

of his corporation on the basis of material, nonpublic information. Trading on such information qualifies

as a “deceptive device” under Section 10b because “a relationship of trust and confidence” exists between

the shareholders of a corporation and those insiders who have obtained confidential information by reason

of their position with that corporation [Chiarella]. That relationship we recognized, “gives rise to a duty

to disclose or to abstain from trading because of the necessity of preventing a corporate insider from

taking unfair advantage of uninformed stockholders. The classical theory applies not only to officers,

directors, and other permanent insiders of a corporation, but also to attorney, accountants, consultants and

others who temporarily become fiduciaries of a corporation [Dirks].

The misappropriation theory holds that a person commits fraud in connection with a securities transaction

when he misappropriates confidential information for securities trading purposed in breach of a duty

owed to the source of the information. Under this theory, a fiduciary’s undisclosed, self-serving use of a

principal’s information to purchase or sell securities, in breach of a duty of loyalty and confidentiality,

defrauds the principal of the exclusive use of that information.

Salman v. U.S., 137 S. Ct. 420 (2016): Another look at the personal benefit requirement

In this case a unanimous Court affirmed the conviction of Bassam Salman for insider trading. In this case,

the flow of MNPI about mergers and acquisitions originated with Maher Kara, an investment banker at

Citigroup. He passed this information along to his brother (with whom he had a very close relationship),

Mounir Kara (“Michael”). Michael traded on that information and also passed it along to his friend

Salman (who was also Maher’s brother in law).

Citing Dirks, the Court said that the tippee acquires the tipper’s duty to disclose or abstain from trading if

the tippee knows the information was disclosed in breach of the tipper’s duty, and the tippee may commit

securities fraud by trading in disregard of that knowledge. A tippee’s liability for trading on inside

information hinges on whether the tipper breached a fiduciary duty by disclosing the information. A

tipper breaches such a fiduciary duty when the tipper discloses the inside information for a personal

benefit. A jury can infer a personal benefit—and thus a breach of the tipper’s duty—where the tipper

receives something of value in exchange for the tip or “makes a gift of confidential information to a

trading relative or friend” [Dirks at 664].

U.S. v. Martoma (2018):

This case arose out of the Government's investigation of a prominent hedge fund. Mathew Martoma, a

portfolio manager at the fund, had had dealings with two doctors who had been involved in the clinical trial

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of a drug for Alzheimer's disease. The doctors had entered into paid consulting arrangements with the fund

under contracts through expert-networking agencies. The Government alleged that at least one of the

doctors had shared confidential safety data about the drug with Martoma, leading Martoma and the hedge

fund to build and maintain positions in the securities of the two companies that owned rights to the drug.

The Government also alleged that the doctor had given Martoma advance information of the drug trial's

failure and that the fund had then sold off its positions in the two drug companies' stock before the news

became public. Martoma was convicted of insider trading and conspiracy to commit securities fraud.

The Second Circuit confirmed that a "meaningfully close personal relationship" is not required for insider-

trading liability where a tipper discloses inside information as a gift with the intent to benefit the tippee.

The court in United States v. Newman had previously refused to infer a tipper's intent to benefit a tippee in

the absence of a meaningfully close relationship and a pecuniary or similarly valuable benefit in exchange

for the tip. The decision in Martoma provides that the requisite relationship described in Newman can be

established by proving "either [i] that the tipper and tippee shared a relationship suggesting a quid pro quo

or [ii] that the tipper gifted confidential information with the intention to benefit the tippee."

This decision means that insider-trading liability can be established by evidence that the tipper's disclosure

of inside information was intended to benefit the tippee, regardless of the nature of the tipper's and tippee's

personal relationship.

SEC v. Blaszczak (2017):

The SEC charged four individuals in an alleged insider trading scheme involving tips of nonpublic

information about government plans to cut Medicare reimbursement rates, which affected the stock prices

of certain publicly traded medical providers or suppliers. The complaint alleges that David Blaszczak, a

former government employee turned political intelligence consultant, obtained key confidential details

about upcoming decisions by the Centers for Medicare and Medicaid Services (CMS) from his close friend

and former colleague at the agency, Christopher Worrall. According to the SEC's complaint, Worrall serves

as a health insurance specialist in the Center for Medicare and tipped Blaszczak about at least three pending

CMS decisions that affected the amount of money that companies receive from Medicare to provide

services or products related to cancer treatments or kidney dialysis. The complaint’s detailed analysis

appears designed to firmly establish the existence of a personal benefit necessary to establish the tipper’s

breach of a fiduciary duty.

Blaszczak allegedly tipped two analysts at a hedge fund advisory firm that paid him as a consultant. The

analysts, Theodore Huber and Jordan Fogel, allegedly used the nonpublic information to recommend that

the firm trade in the stocks of four health care companies whose stock prices would likely be affected by

the decisions once CMS announced them publicly. The alleged scheme resulted in more than $3.9 million

in illicit profits. According to the SEC's complaint, Blaszczak's firms were paid at least $193,000 in a 19-

month period by the hedge fund where the analysts worked.

The 2 hedge fund analysts (partners at Deerfield) were convicted of counts including wire fraud, securities

fraud and conversion of government property, as was David Blaszczak. Blaszczak got 1 year in prison and

had to forfeit approximately 700k. Deerfield agreed to pay $4.6 million to settle with SEC. Insider

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Christopher Worrall, who worked for the U.S. Centers for Medicare and Medicaid Services (CMS), was

also convicted of wire fraud and conversion of government property, but acquitted of securities fraud.

SEC v. Artis Capital Management, LP (2016):

The SEC cited a registered investment adviser and a senior analyst for failing to supervise a research analyst

that made trading recommendations based on MNPI he received from a public company a short time before

significant public announcements were made by that company. Artis Capital and specifically the

employee’s supervisor Michael W. Harden failed to respond appropriately to red flags that should have

alerted them to the misconduct. The employee, Matthew G. Teeple, was later charged along with his source

David Riley as part of the SEC’s broader investigation into expert networks and the trading activities of

hedge funds.

The adviser also violated Advisers Act Section 204A for failure to adopt policies or procedures to address

the risk presented by the research analyst’s frequent communication with public companies. The adviser

did not require its analysts to report their interactions with employees of public companies and it did not

have policies to track or monitor these interactions. Artis Capital agreed to settle the SEC’s charges by

disgorging the illicit trading profits that Teeple generated for the firm totaling $5,165,862, plus interest of

$1,129,222 and a penalty of $2,582,931.

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Topic 2: Electronic Communications

OBSERVATIONS FROM INVESTMENT ADVISER EXAMINATIONS

On December 14, 2018, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a

Risk Alert to share its observations from a recent exam initiative that focused on investment adviser

personnel’s use of electronic messaging, including text messaging, instant messaging and personal or

private email, for business purposes. OCIE’s examinations surveyed firms to learn the types of electronic

messaging used by advisers and their employees, and reviewed firm policies and procedures to understand

how advisers were addressing the risks presented by evolving forms of electronic communication. The staff

provided a few example practices that may assist advisers to meet their record retention obligations under

Rule 203-2(a)(7) of the Advisers Act.

Policies and Procedures

o Permitting only approved forms of electronic communication for business purposes.

o Prohibiting business use of apps and other technologies that can be readily misused by

allowing an employee to send messages or otherwise communicate anonymously, allowing

for automatic destruction of messages, or prohibiting third-party viewing or back-up.

o Requiring employees to move business-related messages received using a prohibited

platform to an approved electronic system.

o Adopting policies and procedures related to the use of personally owned mobile devices

for business purposes, if permitted.

o Adopting policies procedures for use of social media, personal email accounts or websites

for business purposes, if permitted.

o Including a statement in policies and procedures informing employees that violations may

result in discipline or dismissal.

Employee Training and Attestations

o Requiring training on adviser’s policies and procedures, including those related to the use

of electronic communications and provide regular reminders of those policies and

procedures thereafter.

o Obtaining attestations from employees at the commencement of employment and regularly

thereafter.

o Having employees provide feedback as to what forms of communication are requested by

clients and service providers in order to assess how these platforms may be incorporated

into the adviser’s policies.

Supervisory Review

o If use of social media, personal email, or personal websites for business purposes is

permitted, contracting with software vendors to (i) monitor the social media posts, emails,

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or websites, (ii) archive such business communications to ensure compliance with record

retention rules, and (iii) ensure that they have the capability to identify any changes to

content and compare postings to a lexicon of key words and phrases.

o Regularly reviewing popular social media sites to identify if employees are using the media

in a way not permitted by the adviser’s policies.

o Running regular internet searches or setting up automated alerts to notify the adviser when

an employee’s name or the adviser’s name appears on a website to identify any

unauthorized use.

o Establish a program for employees to report concerns or findings of employee misuse.

Control over Devices

o Requiring approval for employees to access firm email services or other business apps on

personally owned devices.

o Loading certain security apps or other software on company-issued or personally owned

devices prior to allowing them to be used for business communications.

o Allowing employees to access the adviser’s email servers or other business applications

only by virtual private networks or other security apps to segregate remote activity to help

protect the adviser’s servers from hackers or malware

Advisers should review their firm’s practices, as well as policies and procedures, concerning the use of

personal devices, social media and texting/IM for business purposes.

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Topic 3: Regulatory Update

SEC Charges Investment Adviser with Long-Running Fraud

On March 22, 2019, the SEC charged registered investment adviser Direct Lending Investments, LLC

(“DLI”) with a multi-year fraud that resulted in approximately $11 million in over-charges of management

and performance fees to its private funds, as well as the inflation of the private funds' returns. According to

the SEC's complaint, DLI advises a combination of private funds that invest in various lending platforms,

including QuarterSpot, Inc., an online small business lender. The SEC alleges that for years DLI's owner

and then-chief executive officer, arranged with QuarterSpot to falsify borrower payment information for

QuarterSpot's loans and to falsely report to Direct Lending that borrowers made hundreds of monthly

payments when, in fact, they had not. The SEC alleges that many of these loans should have been valued

at zero, but instead were improperly valued at their full value, because of the false payments Ross helped

engineer. As a result, between 2014 and 2017, Direct Lending cumulatively overstated the valuation of its

QuarterSpot position by approximately $53 million and misrepresented the Funds' performance by

approximately two to three percent annually.

The complaint seeks disgorgement of allegedly ill-gotten gains along with interest, monetary penalties, and

permanent injunctions.

https://www.sec.gov/litigation/litreleases/2019/lr24424.htm

SEC Charges Former Municipal Officer with Fraud in Connection with Public Pension Funds

On March 15, 2019, the SEC charged Dale M. Walker, the former County Manager of Macon-Bibb County,

Georgia, with misleading three Macon-Bibb County public pension fund boards in connection with their

selection of an investment adviser to manage over $400 million of pension fund assets. The SEC's complaint

alleges that Walker improperly provided an unfair competitive advantage to one investment adviser due to

his romantic interest in an individual associated with the adviser. According to the complaint, Walker

provided the confidential proposals of other investment adviser candidates to the adviser and asked the

associated individual to analyze and rank the candidates. The completed analysis ranked the adviser first

above all other applicants. The complaint further alleges that Walker attached the analysis to his memo

recommending the adviser to the three pension fund boards, falsely representing that he prepared the

analysis. Neither the adviser nor Walker disclosed the conflict of interest inherent in the adviser's

preparation of those materials. The complaint alleges that each of the pension fund boards followed

Walker's recommendation and selected the adviser as the investment adviser for their respective pension

funds.

Without admitting or denying the allegations in the complaint, Walker consented to the entry of a final

judgment permanently enjoining him from violating the antifraud provision of Section 206(2) of the

Investment Advisers Act of 1940 and ordering him to pay a $10,000 civil penalty. The final judgment

further enjoins Walker from participating on behalf of a government entity in the decision to select or retain

an investment adviser or broker-dealer.

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https://www.sec.gov/litigation/litreleases/2019/lr24432.htm

Court Grants Partial Summary Judgment in Fraud Case Against Advisor and Two Advisory Firms

On January 17, 2019, a US District Court granted in part and denied in part the SEC's motion for partial

summary judgment against Thomas Conrad, Jr. and two unregistered advisory firms he controlled,

Financial Management Corporation ("FMC") and Financial Management Corporation, S.R.L. ("FMC

Uruguay"). The SEC charged Conrad, FMC, and FMC Uruguay in July 2016. The SEC's complaint alleges

that, from 2010 to 2014, Conrad directed preferential redemptions and other disbursements from funds

advised by FMC and FMC Uruguay for himself, his extended family, and certain favored investors, while

representing to other investors that redemptions were suspended. The complaint also alleges that Conrad

failed to disclose conflicts of interest arising from loans made to Conrad's family members and Conrad's

appointment of himself as a sub-manager for a fee. The complaint further alleges that, in offering materials

given to prospective investors, defendants touted Conrad's significant experience in the securities industry,

but failed to disclose his disciplinary history.

The court ruled that the SEC was entitled to summary judgment on its fraud claims based on the fraudulent

redemption practices and failure to disclose Conrad's disciplinary history. The court found that Conrad,

FMC, and FMC Uruguay repeatedly made material misrepresentations about the funds' redemption

practices and that the failure to disclose Conrad's disciplinary history was material because Conrad, FMC,

and FMC Uruguay touted Conrad's experience and expertise when soliciting investments in the funds. The

SEC did not move for summary judgment as to all claims, and the court has yet to fully adjudicate them.

https://www.sec.gov/litigation/litreleases/2019/lr24390.htm

SEC Obtains Fraud Judgment Against Co-Owner of Defunct New York-Based Investment Adviser

On January 11, 2019, the U.S. District Court for the Southern District of New York entered a judgment

against Andrew B. Scherr, the co-owner of Southport Lane Management, LLC, a now defunct New York-

based private equity firm. The SEC charged Scherr in October 2018 with aiding and abetting a fraud

perpetrated by Southport Lane's majority owner, Alexander C. Burns. According to the SEC's complaint,

from March 2013 to February 2014, Scherr acquired assets for Southport Lane that were worthless or

overvalued. The complaint alleges that Scherr knew or should have known that Burns intended to and did

sell the overvalued assets to the clients of his affiliated registered investment adviser, Southport Lane

Advisors, LLC. Without admitting or denying the allegations in the SEC's complaint, Scherr consented to

the entry of a judgment enjoining him from violating the antifraud provisions of Sections 206(1) and (2) of

the Investment Advisers Act of 1940. The judgment provides that the amount of any disgorgement and civil

monetary penalties to be imposed will be determined by the court at a later date.

https://www.sec.gov/litigation/litreleases/2019/lr24388.htm

SEC Obtains Final Judgments Against Australia-Based Investment Adviser

On January 2, 2019, a federal district court entered final consent judgments against an Australia-based

investment adviser, Goldsky Asset Management, LLC, and its owner, Kenneth Grace, for making false and

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misleading statements about its business in filings with the Commission and on its website. The SEC's

complaint, filed on September 27, 2018 in the Southern District of New York, alleged that Goldsky's Forms

ADV for 2016 and 2017, which Grace signed, falsely stated that Goldsky's hedge fund, Goldsky Global

Alpha Fund, LP, had an auditor, a prime broker and custodian, and an administrator. The complaint further

alleged that, in its Forms ADV and ADV Part 2A, Goldsky stated that it managed over $100 million in

discretionary assets under management, when it in fact had no assets. According to the complaint, Goldsky's

website falsely claimed that Goldsky Global Alpha Fund earned 19.45% compounded annual returns since

inception, 70.33% compounded monthly returns since inception, and 25.30% returns for the year ended

September 30, 2017.

Without admitting or denying the allegations in the company, Goldsky and Grace agreed to the entry of

final judgments enjoining them from violating the antifraud provisions of Sections 206(4) and 207 of the

Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder, and ordering Goldsky and Grace to pay

civil monetary penalties of $50,000 and $25,000, respectively.

https://www.sec.gov/litigation/litreleases/2019/lr24418.htm

SEC Charges Atlanta Investment Adviser with Defrauding a Private Fund and Its Investors

The SEC's complaint, filed in federal district court in Atlanta, alleges that, beginning in August 2009 and

continuing until at least June 2018, Joseph A. Meyer, Jr., and Statim Holdings, Inc. offered and sold four

classes of limited partnership interests in Arjun, L.P., a private fund. The complaint alleges that Meyer

promised investors that, in return for giving up substantial portions of their profits, investors in one class

would be protected from losses, a feature he called "No Loss Protection," and investors in two other

classes would receive guaranteed fixed returns. The complaint further alleges that Meyer told investors

that the relinquished profits would be used to fund the No Loss Protection and guaranteed returns when

Arjun had insufficient profits. According to the complaint, Meyer withdrew most of the relinquished

profits and used the funds to pay his living expenses. The complaint alleges that, to deceive investors,

Meyer recorded on Arjun's books a receivable due from Statim. According to the complaint, Meyer

claimed to pay down Statim's receivable, but did so by directly or indirectly borrowing money from the

fund, therefore making the guarantees and No Loss Protection illusory because they were backed by

nothing other than the receivable that sometimes grew to $2.9 million, or 11.5% of Arjun's net asset

value.

The SEC's complaint alleges that Meyer and Statim violated the antifraud provisions of Section 17(a) of

the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5

thereunder, and Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule

206(4)-8 thereunder, and that Meyer aided and abetted Statim's violations of these provisions. The SEC

seeks permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, and civil

penalties

https://www.sec.gov/litigation/litreleases/2019/lr24383.htm

SEC Charges Firm With Deficient Cybersecurity Procedures

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“This case is a reminder to brokers and investment advisers that cybersecurity procedures must be

reasonably designed to fit their specific business models. They also must review and update the procedures

regularly to respond to changes in the risks they face.”

- Robert A. Cohen, Chief of the SEC Enforcement Division’s Cyber Unit

In September 2018, the SEC announced that a Des Moines-based broker-dealer and investment adviser

agreed to pay $1 million to settle charges related to its failures in cybersecurity policies and procedures

surrounding a cyber intrusion that compromised personal information of thousands of customers.

In the first SEC enforcement action charging violations of the Identity Theft Red Flags Rule, the SEC

charged Voya Financial Advisors Inc. (VFA) with violating the Safeguards Rule and the Identity Theft Red

Flags Rule, which are designed to protect confidential customer information and protect customers from

the risk of identity theft. According to the SEC’s order, cyber intruders impersonated VFA contractors over

a six-day period in 2016 by calling VFA’s support line and requesting that the contractors’ passwords be

reset. The intruders used the new passwords to gain access to the personal information of 5,600 VFA

customers. The SEC’s order found that the intruders then used the customer information to create new

online customer profiles and obtain unauthorized access to account documents for three customers.

The SEC found that VFA’s failure to terminate the intruders’ access stemmed from weaknesses in its

cybersecurity procedures, some of which had been exposed during prior similar fraudulent activity.

According to the order, VFA also failed to apply its procedures to the systems used by its independent

contractors, who make up the largest part of VFA’s workforce.

“Customers entrust both their money and their personal information to their brokers and investment

advisers. VFA failed in its obligations when its deficiencies made it vulnerable to cyber intruders accessing

the confidential information of thousands of its customers.”

- Stephanie Avakian, Co-Director of the SEC Enforcement Division

https://www.sec.gov/news/press-release/2018-213

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Owner Biographies

Gregory Florio & James Leahy

Gregory Florio, Founder, Co-Managing Partner/Member

Gregory L. Florio is the founder of Florio Leahy LLP and Orical LLC. With over 20 years

of legal and regulatory experience, Mr. Florio is an expert in all aspects of investment

management law and regulation, including the Investment Advisers Act of 1940, the

Investment Company Act of 1940 and all other laws, rules and regulations that govern the

securities industry. His practice focuses on the private fund industry, including formation,

structuring, offering terms, private funds, separately managed accounts, compliance

programs, regulatory examinations, investigations, enforcement actions and compliance technology. He

routinely advises and represents investment mangers, broker/dealers, family offices and other financial

institutions in connection with their legal and compliance needs. Mr. Florio also directs the Firm’s technical

solutions effort, Real World Compliance LLC (“REAL”), a product he designed and developed. Before

founding the Firms in 2010, Mr. Florio was a Senior Counsel and the Chief Compliance Officer of a multi-

billion-dollar global fund manager, Marathon Asset Management, LP (“Marathon”). Before joining

Marathon, Mr. Florio was an associate and regulatory specialist in Seward & Kissel (“S&K”) LLP’s

Investment Management Division and, before S&K, was an attorney for the Investment Funds Group at

Sidley Austin LLP. After graduating from Fordham University School of Law in 1995 with honors, Mr.

Florio began his career serving as an assistant district attorney in New York City. Mr. Florio holds a

Bachelor’s degree in Consumer Economics from Cornell University and is a member of the New York State

Bar Association.

Experience Highlights

• Successfully assisted hundreds of firms through the SEC/CFTC registration and examination

process;

• Assisted Marathon through the financial crisis commonly referred to as the “Great Recession”,

during which time the firm not only gained assets, but was also selected to manage assets for the

U.S. Treasury as part of the U.S. Government’s Legacy Securities Public-Private Investment

Program, after an application process that included well over 100 institutional asset manager

applicants;

• Qualified as an expert witness in high profile criminal cases related to SEC enforcement actions;

• Commonly referenced as an expert in investment adviser regulatory compliance, and anti-insider

trading and market manipulation surveillance;

• Since 2002, has been a leader in designing technical solutions to address operational difficulties in

the investment adviser and broker/dealer compliance arenas, including designing and developing

Orical’s compliance software, REAL.

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James M. Leahy, Co-Managing Partner/Member

James M. Leahy is Co-Managing Partner of Florio Leahy LLP and Co-Managing Member

of Orical LLC with 29 years of capital markets, securities, operations, and legal experience.

Mr. Leahy prepares his clients for and assists them with regulatory examinations. He has

extensive experience assisting firms to identify enterprise and compliance risks and

conflicts; he also assists with the development, implementation and testing of firm-specific

policies, procedures and disclosures tailored to mitigate those risks and conflicts. Mr.

Leahy is a frequent author and speaker concerning regulatory developments impacting the fund industry.

He conducts due diligence for several active fund investors, drafts fund offering documentation and

negotiates a variety of contracts on behalf of funds and fund service providers.

Prior to joining Orical in 2013, Mr. Leahy served as Chief Financial Officer of Marathon Asset

Management, LP where he managed teams of professionals responsible for tax, accounting, operations and

internal audit. Mr. Leahy’s responsibilities included monitoring cash, profit and loss as well as financing

lines and relations with external service providers such as prime brokerage, ISDA counterparty, audit,

valuation and fund administration. Mr. Leahy met regularly with investor due diligence teams. He also

spent significant time on governance, conflicts, allocation, valuation, best execution, cross trade, side

pocket and liquidating fund issues, particularly during the last financial crisis. Prior to Marathon, Mr.

Leahy was a Vice President, Senior Credit Officer and Team Leader at Moody's Investors Service and was

also a member of the CDO team. He helped found the Hedge Fund Operations Quality business where his

group was responsible for assigning Operational Quality Ratings to hedge funds. Prior to Moody’s, Mr.

Leahy was a lawyer at Skadden, Arps, Slate, Meagher & Flom LLP and Milbank, Tweed, Hadley & McCloy

LLP in New York City. His legal practice involved corporate, securities and financing transactions. He

has comprehensive knowledge regarding public and private placements of securities and has negotiated

many lending facilities, debt instruments and structured finance transactions. Prior to practicing law, Mr.

Leahy was a Surface Warfare Officer in the United States Navy. He served aboard three warships, designed

curriculum and taught at the Navy’s Gas Turbine Engineering School in Newport, Rhode Island. Mr. Leahy

holds an honors law degree from Boston College Law School and an undergraduate degree in English from

Dartmouth College. Mr. Leahy is a member of the Bar in New York and Massachusetts.