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Second Annual Report to

JPMorgan Chase Bank, N.A.

On Activities Related to

Securities Act

Rule 506 of Regulation D

December 13, 2017

Respectfully Submitted:

Paul V. Bruce

Beth E. Weimer

Waterside Enterprises, LLC.

Second Annual Report to JPMorgan Chase Bank, N.A.

December 13, 2017

Waterside Enterprises, LLC, the Independent Compliance Consultant (“Waterside” or “ICC”)

engaged pursuant to a waiver of disqualification granted by the Securities and Exchange

Commission (“SEC” or “Commission”) in 2015,1 hereby submits the second annual review of

the JPMorgan Chase Bank, N.A. (“JPMCB” or “Bank”) and its subsidiaries, the “Rule 506

Entities,”2 activities with regard to transactions entered into in accordance with Rule 506 of

Regulation D under the Securities Act of 1933 (“Securities Act”).3

Waterside conducted the second annual comprehensive review of the JPMorgan Wealth

Management platform policies and procedures applicable to compliance with Rule 506,

reviewing those policies and procedures in place in 2016 and testing a statistically valid random

sampling of transactions conducted in 2016 in reliance on Rule 506 of Regulation D.

In order to accomplish the ICC work as required by the SEC Order, Waterside reviewed:



Business processes applicable to private placement activity relying on Rule 506 of

Regulation D;

Offerings relevant to the Order;

Requirements of Regulation D; and

Written policies and procedures pertaining to the requirements of Regulation D.4

The Rule 506 Entities act as investment manager, placement agent or issuer in offering hedge

funds, private equity funds and structured notes that rely on the Rule 506 of Regulation D

exemption from registration.

Securities Act of 1933, Release No. 9993, December 18, 2015 (“Order”).

The “Rule 506 Entities” are JPMorgan Chase Bank, N.A. including the Singapore, Hong Kong and Paris Branches

and the following of its subsidiaries or affiliates: J.P. Morgan International Bank, Ltd., J.P. Morgan (Suisse) S.A.

and J.P. Morgan Securities (Far East) Limited, Seoul Branch. J.P. Morgan Securities LLC (a U.S. registered

broker/dealer) is not a Rule 506 Entity; therefore its Regulation D placements are out of scope for this review. In

addition, placements relying on an exemption from registration offered by Regulation S of the Securities Act are not

in scope for this review.

For additional background information on the Order and the ICC review, See, Appendix A, attached.

Waterside conducted the annual review of the Wealth Management platform business processes, written policies

and procedures and transactions closing in 2016. During the course of the review, the Asset Management or

institutional platform of the Far East Rule 506 Entity identified four additional private equity and real estate funds,

with a total of six client transactions that were also in scope for this review. As noted below, Waterside was able to

review two transactional files from Asset Management.

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Background

Under the federal securities laws, a company or private fund may not offer or sell securities

unless the transaction has been registered with the SEC or an exemption from registration is

available. Rule 506 of Regulation D is considered a "safe harbor" for the private offering

exemption of Section 4(a)(2) of the Securities Act. Companies relying on the Rule 506

exemption can raise an unlimited amount of money and under Rule 506(b), a company can be

assured it is within the Section 4(a)(2) exemption by satisfying the following five standards:

1. Companies must decide what information to give to “accredited investors,” as long as the

information does not violate the antifraud prohibitions of the federal securities laws;5

2. The company may sell its securities to an unlimited number of accredited investors and

up to 35 other purchasers;6

3. The company may not use general solicitation or advertising to market the securities;7

4. Companies relying on the Rule 506 exemption must file an electronic “Form D”

containing certain sales information with the SEC after they first sell their securities;8 and

5. Companies must disclose certain regulatory actions and exercise reasonable care that no

“Bad Actor” is participating in the Rule 506 offering by, among other things, monitoring

the level of client holdings in the offering.9

II.

Process of the Review

In 2017, Waterside met with several members of Compliance, Legal and business department

management in order to refresh our familiarity with business processes relevant to the private

placement businesses of the Rule 506 Entities. The transactions in scope for the review were

private placement offerings relying on the Rule 506 of Regulation D exemption from registering

including: private equity funds, hedge funds (including the Global Access Portfolio or “GAP”

funds) and structured notes. We reviewed background information for Rule 506 Entities

Unlike offerings registered with the SEC in which certain information is required to be disclosed, companies and

private funds engaging in exempt offerings to “accredited investors” do not have to make prescribed disclosures.

Clients in private placement offerings generally are made aware of information and risks through offering

memoranda such as private placement memoranda and marketing documents. The company must be available to

answer questions by prospective purchasers and must make financial statements available to potential investors.

According to the SEC, one principal purpose of the accredited investor concept is to identify persons who can bear

the economic risk of investing in unregistered securities. An accredited investor, in the context of a natural person,

includes: anyone who has earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the

prior two years, and reasonably expects the same for the current year, or has a net worth over $1 million, either

alone or together with a spouse (excluding the value of the person’s primary residence).

In 2013, the SEC adopted amendments to Rule 506 of Regulation D (Release No. 33-9415; No. 34-69959; No. IA3624; File No. S7-07-12) that, among other things, allow general solicitation of the private placement as long as the

issuer takes reasonable steps to verify that the purchasers are accredited investors (Rule 506(c) of Regulation D).

None of the funds within the scope of this review relied on Rule 506(c) of Regulation D.

Form D is a brief notice that includes the names and addresses of the company’s promoters, executive officers and

directors, and some details about the offering, but contains little other information about the company.

Adopted in 2013, this requirement is referred to as the “Bad Actor” provision of Regulation D. See, Release No.

33-9415; No. 34-69959; No. IA-3624; File No. S7-07-12.

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including process schematics outlining private equity and hedge fund business and supervisory

processes for pre-offering approval, marketing and subscription activities.

Waterside examined written policies and procedures, guidelines, training materials, subscriber

forms and “Frequently Asked Questions” relating to:



Marketing Guidelines and Review Procedures

Alternative Investment Procedures, including onboarding and offering funds

Alternative Investments Middle Office Procedures, including processing and reconciling

client transactions

Accredited Investor Attestations, including Subscriber Information Forms, Instructions to

Subscribe and Accredited Investor/Qualified Purchaser forms for Discretionary Accounts

Procedures for the Global Access Portfolio

Procedures and Intermediary Agreements for Structured Notes issuance

Investment Manager/Discretionary Account Guidelines

Supervisory Management Overview Procedures and additional procedures.10

Waterside reviewed written policies and procedures relevant to the scope of the Order that were

in effect during our sample test period of calendar year 2016.11

During the course of the review, Waterside interviewed business management, supervisors and

staff as well as Compliance and Legal management and staff focusing on the Rule 506 of

Regulation D private placement business. We met with one of the outside law firms responsible

for reviewing subscription documents for private equity funds and reviewed their internal

procedures for reconciling transactions. Waterside observed the application of various processes

used by the Rule 506 Entities as well as control points, supervisory review practices, and systems

used.

Waterside conducted testing, as required by the Order and described more fully in Appendix B,

of a statistically valid random sampling of private equity transactions and all hedge fund

transactions in scope that closed in 2016 to help ascertain whether the policies and procedures

were reasonably designed to achieve their stated purpose, namely, compliance with Rule 506 of

Regulation D.

The private placements relying on Rule 506 of Regulation D in scope for this review include:

Private Equity – The Rule 506 Entities served as placement agent for 21 private equity

offerings that closed in 2016 from the Wealth Management platform. From the 21 funds,

Additional procedures include Terms and Conditions of the E-signature program, and Monitoring Compliance

with the Bad Actor Rule.

Waterside was also made aware of relevant new and amended 2017 policies and procedures during the course of

the review.

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Waterside determined that 1,32112 private equity transactions would be subject to the statistical

sampling methods described in Appendix B. From that sampling methodology, Waterside

requested 392 sample transactional files. Waterside reviewed an additional 17 private equity

files bringing the total reviewed to 409.13 Waterside also reviewed two institutional placements

from a Rule 506 Entity.14

Hedge Funds – The hedge funds offered in 2016 within the scope of the Order were developed

by non-affiliated hedge fund managers and offered by Rule 506 Entities serving as placement

agents. During 2016, the Rule 506 Entities had four hedge fund offerings that were made in

reliance on Rule 506 of Regulation D in which 193 client transactions closed. Due to the small

number of transactions, Waterside reviewed information for each of the 193 transaction files,

which were in both brokerage accounts and in managed or discretionary accounts. Written

policies, procedures and paperwork requirements differ with regard to brokerage and

discretionary accounts.

Global Access Portfolio funds – This Rule 506 private placement offering consists of a variety

of hedge funds or funds of funds designed to meet broad investment criteria for accredited

investors depending on their investment risk tolerance. In 2016, there were seven Global Access

Portfolio funds, with 94 transactions that closed for the Global Access funds. For these

offerings, JPMCB served as Investment Manager, so these offerings are in scope for the review

of selected policies and procedures such as marketing guidelines. However, these offerings were

made either to U.S. persons residing in the U.S. via J.P. Morgan Securities LLC, an entity

outside the scope of the Order, or to non U.S. persons outside the U.S. under Regulation S, so no

client transaction files were in scope for this review.

Structured Notes – Generally, structured bank notes are securities whose returns are based on,

among other things, an index or indices based on the market performance of a basket of equity

securities, interest rates, commodities, and/or foreign currencies. The investment’s return is

For 18 private equity transactions that closed in 2016, clients were directed to submit subscription agreements and

other information directly to the fund administrator, thus bypassing internal subscription processing by the Rule 506

Entities. Upon review, three of these direct investment subscriptions representing one of the 21 funds had been

made in reliance on Regulation S, thus making the transactions and the fund out of scope for this review, reducing

the overall number of private equity funds to 20 and reducing the number of direct investments to 15. Waterside

was able to review marketing information as well as client attestations regarding accredited investor status for each

direct investment transaction.

We were originally provided a list of 1,339 private equity transactions, but as noted above, three were made in

reliance on Regulation S and pulled from the population. After selecting the statistically valid random sample,

Waterside added two files that represented small funds and added back the 15 direct investments to review. See,

Appendix B.

Two Asset Management, or institutional, transaction files were made available for our review, out of a total of six

transactions. As to the other four transactions, Waterside was provided a memo stating that the Far East branch had

general knowledge that the four investors were regulated entities that made institutional investments in the funds

ranging from $20 million to $150 million that clearly exceeded the accredited investor requirements of Rule 506 of

Regulation D. In addition, the memo contained a chart that listed the institutional clients and the amounts of their

investments and stated that based on general knowledge, the Korean branch had a reasonable belief that each of

these investors had assets of at least $5 million, and therefore was an accredited investor. The most recent publicly

available statements confirm that each entity had asset levels of at least $5 million.

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linked to the performance of a reference asset or index. In 2015, the Bank issued over 100

structured notes, but in 2016 the bulk of the structured note business consisted of registered

products so the Rule 506 Entities issued only 12 structured notes in reliance on Rule 506 of

Regulation D. The notes were developed for and marketed by intermediaries that were not Rule

506 Entities.

For each of the 12 structured products in 2016, JPMCB served as issuer only, not as placement

agent; therefore, Waterside reviewed product offering information as well as intermediary

agreements, but did no review of client transaction information since the Rule 506 Entities did

not act as placement agent for the products.

III.

Findings/Conclusions/Recommendations

As discussed above, requirements of Rule 506 of Regulation D relevant to this review briefly

include:

 Complying with the anti-fraud requirements of the Securities Act;

 Limiting sales of unregistered products to accredited investors;

 Not engaging in general solicitations of sales for the unregistered products;

 Filing a Form D when sales commence and periodically thereafter; and

 Complying with the Bad Actor provisions of the Rule.

Complying with the Anti-fraud Requirements of the Securities Act

Waterside reviewed Private Placement offering memoranda and marketing documents describing

private equity, hedge funds, Global Access Portfolio funds and structured notes for compliance

with the anti-fraud prohibitions of the Securities Act. The funds were routinely described as

speculative with a high degree of risk, such as counter-party risk, credit risk, and market risk.

Further, each subscription and marketing document made it clear there was no assurance that the

investment objectives of the fund would be met. The offering documents also explained that the

funds and structured notes had not been registered with the SEC and that they were being offered

as unregistered private placements, in reliance on Regulation D.

We reviewed written policies, procedures and guidelines outlining requirements for marketing

documents, as well as onboarding procedures. We interviewed due diligence department

management about initial and maintenance due diligence procedures for fund issuers and met

with structuring department management about on-boarding procedures as well. Accordingly,

Waterside was satisfied that marketing, onboarding and offering policies, procedures and

guidelines were designed to ensure compliance with Rule 506 of Regulation D.

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Limiting Sales of Unregistered Products to Accredited Investors

Key to compliance with the requirements of Rule 506 of Regulation D is developing and

following procedures to establish a reasonable belief that clients subscribing to the unregistered

offerings are accredited investors. For private equity funds, the Rule 506 Entities served as

placement agent and Waterside reviewed 409 client transaction files of the 1,339 transactions

that closed in 2016.15

For private equity brokerage account transactions, policies generally require a valid Subscriber

Information Form (“SIF”)16 or similar document and a Subscriber Agreement that includes

certain attestations, representations and warranties by authorized persons, whether individuals or

authorized representatives of legal entities. In our first annual review of transaction taking place

in 2015, Waterside reviewed approximately 400 private equity transactions and had questions on

17, which questions were all resolved with further feedback from the Rule 506 Entities.

In this second annual review, Waterside reviewed 409 private equity transactions and found that

37 files needed further clarification. We asked for and received additional information (such as

more legible copies of signatures or documents with permissible Power of Attorney or signature

verification processes) 17 and were satisfied with responses on all but one file. 18 We discussed

resolution of these issues with Compliance and we believe that the process of determining that

the transactions for the Rule 506 Entities are “in good order” would benefit from enhanced

oversight of internal middle office and outside counsel processes, which we document as a

recommendation, below.

These include transactions from the Wealth Management platform of the Rule 506 Entities, including 392 files

from the statistically valid random sample and 17 additional files. This calculation does not include the two

institutional transactions we reviewed from the Asset Management platform.

The SIF is used to determine whether a client who is a prospective investor for an interest in a hedge fund, private

equity fund or other private investment company is an accredited investor and is otherwise eligible to invest in a

fund. By signing the SIF, or other similar document, a prospective subscriber is representing and warranting that the

information in the form is accurate and complete as of the date of the signature and that the subscriber will notify the

Rule 506 Entity promptly of any change in information. Each SIF form is valid for a year ending the first of the

month following the client’s signature, and a single signed SIF will suffice for all subscription made within the 12month period. Part A of the SIF requires certain subscriber information (i.e., name, contact information, ownership

type and tax information); Part B defines accredited investor status and requires subscribers to attest whether they

meet the qualification requirements for natural persons or for entities. The SIF includes a signature page that

represents, warrants and covenants that the information contained in the form is accurate and complete. An

individual is required to print the name of the subscriber, any joint subscriber and sign and date the form. An entity

representative must print the name of the subscriber, sign and date the form as an authorized signatory, and print the

name of the authorized signatory.

In several instances, Waterside noted that we could not read the signed or printed name of an agent signing on

behalf of an entity and we were assured that either the outside law firm or the middle office were comfortable that

the documents were properly executed.

For one private equity transaction, Waterside found that the account number on the files we reviewed was not the

same account number for which the transaction had been consummated. We received assurances from outside

counsel and front office staff that the appropriate client had entered into the subscription, but the documentation we

reviewed does not reflect that conclusion.

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The requirements for hedge fund transactions in brokerage accounts are similar to those for

private equity – generally there must be a SIF (or other similar document) as well as a Subscriber

Agreement (or an “Instruction to Subscribe” document in EMEA jurisdictions [Europe, Middle

East, Africa] including Switzerland) on file with attestations as to the accredited investor status

of the client.19

With regard to hedge fund transactions in managed or discretionary accounts, the requirements

are that each client must meet certain accredited investor and client suitability standards and

must enter into an Investment Adviser agreement with the Rule 506 Entity to open a

discretionary or managed account. Once a client has agreed to the terms of the fiduciary

account, individual transactions in hedge funds are entered into at the direction and discretion of

the Portfolio Manager. For specific private placements, the investment manager submits an

Accredited Investor/Qualified Purchaser form attesting to the client’s eligibility for the

transaction.

For our first annual review of transactions taking place in 2015, Waterside reviewed all 43 hedge

fund transactions in brokerage as well as managed or discretionary accounts. We had follow-up

questions with one transaction that was resolved to our satisfaction.

In this second annual review, Waterside reviewed all 193 hedge fund transactions20 and had

questions or comments on 53 transactions. 21 We asked for and promptly received additional

documents and explanations from the Rule 506 Entities after which we were satisfied with

responses on all but one file. 22

Waterside reviewed written policies and procedures related to the accredited investor status of

prospective clients for private placements, as well as subscription documents, marketing

materials and subscriber identification forms used by the Bank, and following testing as required

by the Order. Waterside believes that the written procedures are being followed and are

reasonably designed to assure compliance with Rule 506 of Regulation D.

General Solicitations for Unregistered Products

Waterside found that marketing documents for private placements for private equity and hedge

fund subscriptions routinely included language to make prospective subscribers aware that the

The Instruction to Subscribe form used in EMEA was replaced in mid 2017 with a requirement to use a SIF or

other similar document and a Subscription Agreement, which Waterside endorses as an improvement in crossjurisdictional consistency.

Using the statistically valid random sampling methodology and table found in Appendix B, sampling for the 2016

population of 193 hedge fund transactions within the scope of the Order for this review, Waterside could either

sample 144 hedge fund transactions or review all 193 files. We elected to review all transactions rather than use the

sampling approach.

For example, we were given only a signature page instead of a complete Subscriber Agreement, or the Signature

Verification stamp (required in some jurisdictions) was not showing on the documentation we reviewed.

In one hedge fund transaction the signature for a responsible party is illegible with no printed name or agent

showing. We were assured by Compliance that the front office staff had followed up on the signature, but the

documentation remains unclear, with notes “Follow up on signature” on the document Waterside reviewed.

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funds were unregistered and were being offered only to known prospects without a general or

public solicitation of sales. We also found that almost all Subscriber Agreements submitted by

brokerage clients for private equity offerings included language referencing accredited investor

status, and frequently included attestation language that stated that the client had not been made

aware of the offering through a general solicitation.

Filing a Form D with the SEC

With regard to filing the required Form D for the products within scope for this review,

Waterside found that all required forms had been filed with the SEC, as required by Rule 506 of

Regulation D and as required by the written policies and procedures of the 506 Entities.

Compliance with “Bad Actor” Rule

Waterside found that appropriate disclosures of the Rule 506 Entities regulatory actions had been

included in marketing and subscription documents for private equity and hedge funds in 2016.

The Bank, in 2017, adopted new policies and procedures to reflect existing practice regarding the

requirements of the “Bad Actor” portion of the SEC rules, and the policies and procedures

appear to be reasonably designed and are being followed. Additionally, there are procedures and

checkpoints in place to require disclosure by a client approaching a 20% ownership level in a

private placement vehicle, giving the Bank appropriate notice.

***

In the first annual review of policies and procedures from 2015 and testing of transactions made

in 2015, Waterside made recommendations for changes to existing policies and procedures

including:

 enhancing controls over structure, numbering and version tracking of the written

documents;

 making procedures more consistent across worldwide jurisdictions (where permissible

and appropriate);

 clarifying which documentation requirements apply to private equity transactions when

subscribers are directed to send documents directly to a third-party fund administrator

bypassing the Rule 506 Entities’ processing;

 clarifying requirements for specific documentation in individual jurisdictions to make it

readily apparent when differences apply; and

 clarifying whether specific procedures apply to brokerage or discretionary accounts or

both.

Bank management accepted all of our recommendations for changes to the policies and

procedures, and acted to implement amendments prior to year-end 2016.

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During the course of this second review of written policies and procedures applicable to

transactions that closed in 2016, Waterside reviewed amendments and updates to written policies

and procedures that were made in 2016 and 2017. We posed questions and comments on

selected policies and procedures and saw evidence that amendments had been made to address

our earlier concerns.

During the testing of 2016 private placement transactions, Waterside noted that three

transactions initially identified as in scope (made in reliance on Regulation D) were actually

made in reliance on Regulation S, and thus not in scope. Six other transactions were added from

the Asset Management platform and considered in scope for this review. Accordingly, we make

a recommendation below as to the efficiency and accuracy of identifying transactions made in

reliance on Regulation D.

Waterside had questions or comments, or required additional documentation and research for

approximately 10% of the sample population of private equity transactions, and more than 25%

of the hedge fund transactions. Almost all of the issues were addressed to our satisfaction, but

this leads to a recommendation regarding enhancing oversight of the business acceptance and

documentation processes for these types of transactions.

Accordingly, following review and testing of over 600 private placement transactions made in

reliance of Rule 506 of Regulation D that closed in 2016, as well as extensive document review,

Waterside makes the following recommendations for changes to existing policies and

procedures:

Continue to monitor compliance with recommendations made in the first annual

review to assure that policies and procedures remain current, relevant and consistent

across international jurisdictions, where possible.

Enhance oversight of new business acceptance processes for both private equity and

hedge fund private placement transactions to improve quality and consistency of

creating and maintaining completely documented transaction files, whether in-house

or with outside counsel.

In light of the continuing review of compliance with Rule 506 under the Order,

enhance processes to readily identify individual private placement transactions done

in reliance on Rule 506 of Regulation D and to readily identify the areas of the Rule

506 Entities that have transactions made in reliance on Rule 506 of Regulation D for

the applicable time frame.

* * *

For this second Annual Report, Waterside conducted a comprehensive review of the policies and

procedures relating to compliance with Rule 506 of Regulation D including but not limited to,

policies and procedures relating to the Rule 506 Entities’ activities as investment manager and

placement agent to private funds relying on Rule 506 of Regulation D.

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In this second Annual Report, Waterside states that we have tested the Rule 506 Entities policies

and procedures relating to Rule 506 of Regulation D by conducting a statistically valid random

sampling of transactions conducted in reliance on Rule 506 of Regulation D that closed in

calendar year 2016.

Waterside hereby certifies that:

“JPMCB’s policies and procedures designed to ensure compliance by the Rule 506 Entities with

their obligations under Rule 506 of Regulation D are reasonably designed to achieve their stated

purpose.”

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Second Annual Report to JPMorgan Chase Bank, N.A.

December 13, 2017

Appendix A

Background

On December 18, 2015, the Securities and Exchange Commission granted a waiver of

disqualification under Rule 506(d)(2)(ii) of Regulation D under the Securities Act of 1933 at the

request of JPMorgan Chase Bank, N.A.23 The waiver of disqualification was requested because

on the same date, the U.S. Commodity Futures Trading Commission (“CFTC”) instituted

proceedings pursuant to Sections 6(c) and (d) of the Commodity Exchange Act making findings

and imposing remedial sanctions as a result of JPMCB’s failure to adequately disclose certain

conflicts of interest to clients.24 Because of the CFTC proceedings, JPMCB requested and

received a waiver of disqualification pursuant to Rule 506(d) of Regulation D by the SEC for

JPMCB and its subsidiaries, the “Rule 506 Entities.”25

Rule 506(d)(2)(ii) of Regulation D provides that disqualification from certain regulated

activities, in this instance, participation in private placements of select unregistered offerings,

“shall not apply…upon a showing of good cause and without prejudice to any other action by the

Commission, if the Commission determines that it is necessary under the circumstances that an

exemption be denied.”

In granting the waiver, the Commission determined that as part of the Rule 506(d)(2)(ii) showing

of good cause, JPMCB would retain a qualified independent compliance consultant not

unacceptable to Commission staff, 26 to conduct a comprehensive review of the policies and

procedures relating to compliance with Rule 506 of Regulation D. The ICC is required to

complete its review and submit a written report to JPMCB on an annual basis for a period of five

years following the Order.

The ICC is charged with reviewing policies and procedures by the Rule 506 Entities including

but not limited to, activities as investment manager and placement agent to private funds relying

on Rule 506 of Regulation D. According to the Order, JPMCB must require the ICC to test the

Securities Act of 1933, Release No. 9993, December 18, 2015.

CFTC Docket No. 16-05, December 18, 2015.

The Rule 506 Entities are JPMorgan Chase Bank, N.A. including its Singapore, Hong Kong and Paris Branches

and the following of its subsidiaries or affiliates: J.P. Morgan International Bank, Ltd., J.P. Morgan (Suisse) S.A.

and J.P. Morgan Securities (Far East) Limited, Seoul Branch.

In addition, the Order requires the Consultant to enter into an agreement that provides for the period of the

engagement and for a period of two years from completion of the agreement, the ICC shall not enter into any other

professional relationship with the Rule 506 Entities.

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Rule 506 Entities’ policies and procedures relating to compliance with Rule 506 of Regulation D

by conducting a statistically valid random sampling of transactions conducted in reliance on Rule

506 of Regulation D. If the Consultant finds that Rule 506 Entities’ policies and procedures

have been reasonably designed to achieve compliance with their obligations under Rule 506 of

Regulation D then the ICC shall certify annually to that finding.

Waterside Enterprises, LLC was engaged as the Independent Compliance Consultant in March

2016. Waterside is a financial services consulting firm established in 2003 by its two principals,

Paul Bruce and Beth Weimer. Paul and Beth have over 60 years combined experience in the

securities and insurance industries including working for regulators (SEC and FINRA [NASD]),

and working as Chief Compliance Officers, corporate officers and regulatory and compliance

consultants. For this engagement, Waterside also retained two experienced independent

consultants (Michael Raney and Robert Arndt) who have many years of broad financial services

experience and who have worked with Waterside on other engagements.

According to the terms of the Order, in 2016 Waterside conducted the first annual

comprehensive review of the policies and procedures in place in 2015 applicable to compliance

with Rule 506 of Regulation D by the Rule 506 Entities. The first annual report was submitted

to JPMCB in December 2016 and after review and acceptance, JPMCB submitted the report to

the SEC. The SEC published the first annual report on March 14, 2017.27

Accordingly, in 2017 Waterside conducted the second annual comprehensive review of policies

and procedures applicable to compliance with Rule 506, reviewing those policies and procedures

in place in 2016 and testing a statistically valid random sampling of transactions conducted in

2016 in reliance on Rule 506 of Regulation D. The process of the review as well as findings and

recommendations are presented in the body of the report.

See: sec.gov/divisions/corpfin/cf-noaction/2017/jpmorgan-chase-na-waterside-report-031417.pdf.

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Second Annual Report to JPMorgan Chase Bank, N.A.

December 13, 2017

Appendix B

Statistically Valid Random Sampling Methodology

for 2016 Wealth Management Private Equity Transactions

Language in the Order states: “JPMCB shall require that the Consultant test the Rule 506 Entities

policies and procedures relating to Rule 506 of Regulation D by conducting a statistically valid

random sampling of transactions conducted in reliance on Rule 506 of Regulation D.”

As discussed in the Report, JPMCB prepared a list of all private equity fund offerings that closed

in 2016, refined to reflect the offerings for which the Rule 506 Entities acted as placement agent

and relying on Rule 506 of Regulation D. From that list, a population of client transactions that

closed in 2016 was determined, and Waterside applied the following statistical review approach

to select a random sample from that population of transactions.

The generally accepted purpose of utilizing a statistically valid random sampling process is to be

able to review an abbreviated subset of a population and use the results of that review to draw

conclusions about the entire population. To comply with the statistically valid random sampling

requirements of the Order, Waterside used a methodology that was intended to optimize the

sample size while maintaining statistical integrity.28 The approach we chose is based on a

normal approximation to a binomial distribution and the Central Limit Theorem, adjusted for a

finite population.

For any given population, a Central Limit Theorem approach states that regardless of the

distribution of the underlying population, any set of sufficiently large samples reviewed will

follow an approximately normal distribution. Even if we do not know the distribution of the

underlying population, this approach should routinely produce a valid sample. The method used

allows us to determine a sample size for a given population based on three key criteria:



Confidence Level relative to the standard normal distribution;

Population Proportion estimate; and

Margin of Error.

Any number of statistical sampling approaches may be applied. Based on the education, training and experience

of the Waterside review team, we selected a standard approach from a 1970 article by Krejcie and Morgan and

documented in the Penn State University online course website under course 414/415: “Estimating a Proportion for

a Small, Finite Population.”

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Confidence Level

A confidence level or confidence interval gives an estimated range of values that are likely to

include an unknown population parameter, the estimated range being calculated from a given set

of sample data.29 Relative to statistical sampling and sampling distributions of population

proportions, a 95% confidence level means that 95% of confidence intervals constructed from

samples of a given size (n), will contain the true population proportion parameter. This implies

that only 5% of confidence intervals constructed with the specified criteria will not contain the

true population proportion. This also equates to an assumption that the population parameter

being tested falls within two standard deviations of the predicted value of the parameter.

II.

Population Proportion

If we know nothing about the underlying population vis-a-vis the criteria for which we are

sampling, we need to use a population proportion estimate, (“ ”) of .5. This is a common

approach for situations such as election sampling where we anticipate about a 50/50 response for

each of two candidates. This of .5 leads to the largest sample size, since for every sample data

element selected we are unable to predict whether we will get a positive or negative result.

If, however, we know or believe the population is skewed in one direction or another, in other

words, we expect the clear majority of the items in the sample will be either positive or negative,

we can select a more informed estimate of and reduce the sample size while maintaining the

accuracy and integrity of the sampling process. In other words, the better we can predict the

population parameter for which we are testing, the smaller the required sample size.

For our purposes and to meet the terms of the Order, we reviewed the firm’s policies and

procedures, conducted interviews and observed control points applicable to the private equity

private placement business of Rule 506 Entities relying on Rule 506 of Regulation D within the

scope of our review. We also applied our experience in brokerage and other client focused

businesses in which we see that if policies and procedures are reasonably designed to achieve

their stated purposes, we generally find that client files contain the appropriate documents and

signatures well in excess of 90% of the time.

Based on our review of the Rule 506 Entities policies, procedures and control points, including

documents, interviews and observation, we concluded that those policies, procedures and

processes would lead to similarly accurate and complete client files.

Using these inputs, we set our estimated sampling population proportion at 0.90. The ultimate

test of that assumption is whether our sampling results demonstrated that at least 90% of the

sampled files met the population parameter we were testing, i.e., do the transaction files show

that the Rule 506 of Regulation D requirements are being met. If so, it should indicate that our

population proportion assumption is accurate.

Definition of confidence interval is from Valerie J. Easton and John H. McColl's Statistics Glossary v 1.1.

(Available at: http://www.stats.gla.ac.uk/steps/glossary/confidence_intervals.html).

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III.

Margin of Error

The next key sampling criteria is Margin of Error. In other words, how predictive are our

results? To refer again to election polling type sampling, we often see a result that is noted to be

accurate within “plus or minus” 2% or 3%. This is the margin of error for that poll. We decided

to use a margin of error of 2.5%, which is more conservative than the 3% frequently utilized in

practice. Thus, a result of 95% of files in good order in a sample would be indicative of a

population proportion falling within the interval 92.5% to 97.5%.

IV.

Using These Criteria to Set a Sample Size

Accordingly, for the purpose of this review, to test compliance with written policies and

procedures as they pertain to the requirements of Rule 506 of Regulation D, we predicted (based

on experience in the industry) that the required paperwork for at least 90% (Population

Proportion) of the client transactions reviewed will be “in good order” (defined here as signed

and dated by an appropriately authorized party and containing assertions that the client is an

accredited investor, and that appropriate relevant disclosures were made to each investor).

Additionally, we selected a Confidence Level for the population of “in good order” transactions

of 95% with a 2.5% Margin of Error.

Wealth Management Private Equity Population and Sampling Results

Waterside was provided a population of 1,339 Wealth Management private equity transactions

that closed in 2016. Of those 1,339 transactions, it was observed that 18 of those transactions

were not completed via the normal JPMCB entity conduit process, which requires JPMCB

paperwork. Those transactions were instead issued to Rule 506 Entity clients but placed directly

with the offering fund. We anticipated a variety of forms and processes and so we pulled those

18 out of the population and reviewed each one individually.

Via that analysis we determined that three of the transactions for one fund family had actually

been issued under Regulation S, rather than Regulation D, and so were out of scope for this

review. That left us with 1,336 reviewable transactions, with 15 segregated out for separate

review, leaving 1,321 in our sampling population.

We numbered those 1,321 private equity transaction files from 1 to 1,321 and we used the table

below to determine that the minimum sample size to meet our criteria was 391. We thus divided

1,321 by 391, arriving at a ratio of approximately 3.3785. In other words, to develop the

minimum sample from the 1,321 we would need one transaction out of every 3.3785. To ensure

adequacy of sample coverage, we truncated that ratio to 3.37. We next used a standard random

number generator to generate a random number between zero and one. We multiplied that

random number by 3.37 to arrive at a starting point of 1.41. Finally, we added 3.37 successively

to 1.41 to arrive at our sample, as follows (using standard rules of rounding):

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

1 (closest to 1.41),

5 (closest to 4.78),

8 (closest to 8.15),

12 (closest to 11.52),

15 (closest to 14.89), and so forth,

until we had identified a sample of 392, which is more than the minimum sample size of 391 that

our process would require for a statistically valid random sample.

Once we selected our random sample of 392, we reviewed that sample for adequate

representation of the population. Through this process, we added two transactions to the sample

to ensure coverage of all fund families, including those with small transaction volumes. 30

Accordingly, we have a general population of 1,336 Wealth Management private equity

transactions of which we reviewed 409:

Beginning Population

Minus Direct Investments

Used to Sample Population

Sample Selected

Additional Selections

Adjusted Direct Investments

Total Wealth Management

Transactions Reviewed

1,339

1,321

392

409

The table below illustrates the application of the statistical criteria to arrive at the minimum

sample size.

In addition, we were informed of six transactions initiated by the Asset Management platform of the Far East Rule

506 Entity. Of those six transactions, Waterside reviewed two, as addressed in the body of the report. These two

files are not represented in the chart above.

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Illustration of required minimum sample sizes based on: (1) Confidence Level,

(2) Population Proportion estimate and (3) Margin of Error:

This table clearly illustrates that for very large population sizes we see the most optimum

leveraging abilities of statistical sampling. However, a sampling procedure still provides

benefits to a population of 1,321.

We subsequently made the following observations regarding the sample set:

At the culmination of the transactional review of private equity files, we found 37 files (or about

9% of the files reviewed) for which we had questions or comments that required follow-up with

JPMCB. We noted that, using these criteria, over 90% of the files were found to be in good

order, i.e., complying with policies and procedures reflecting Regulation D control points.

Further, all but one of the files for which we had questions have subsequently been resolved or

clarified by JPMCB to Waterside’s satisfaction, bringing the ‘in good order’ percentage to just

slightly less than 100%.

Finding most of the files in the sample in good order allows us to make the same conclusion

about the population from which the sample was drawn, i.e., that we would expect to find the

majority of any files we might select to be in good order and thus we can extrapolate the same

conclusion to the entire population.

The conclusions of the review are discussed further in the body of the report.31

Using the statistically valid random sampling methodology described above and illustrated in the table, sampling

for the 2016 population of 193 hedge fund transactions within the scope of the Order for this review, Waterside

could either sample 144 hedge fund transactions or review all 193 files. We elected to review all transactions rather

than use the sampling approach.

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This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.