Waterside Enterprises, LLC

Waterside Enterprises, LLC

Fourth Annual Report to

JPMorgan Chase Bank, N.A.

On Activities Related to

Securities Act

Rule 506 of Regulation D

December 5, 2019

Respectfully Submitted:

Paul V. Bruce

Beth E. Weimer

Waterside Enterprises, LLC.

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

December 5, 2019

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 fourth 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 from 2018 in accordance with Rule 506 of

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

Waterside conducted the fourth annual comprehensive review of the JPMorgan Chase Bank

Wealth Management policies and procedures applicable to compliance with Rule 506, reviewing

those policies and procedures in place in 2018 and testing a statistically valid random sampling

of transactions conducted in 2018 in reliance on Rule 506 of Regulation D.

In order to accomplish the ICC work as required by the SEC Order for 2018 transactions,

Waterside reviewed:

•

•

•

•

Requirements of Regulation D;

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

Regulation D;

Written policies and procedures pertaining to the requirements of Regulation D; and

Offering and marketing documents for products within the scope of the Order.

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

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

exemption from registration.

I.

Background

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

the securities have been registered with the SEC or an exemption from registration is available.

Rule 506 of Regulation D is such an exemption and 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 from registration must satisfy the following five standards:

1

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. In

past years, J.P. Morgan Securities (Far East) Limited, Seoul Branch was also a Rule 506 Entity, but in 2018, there

were no activities in scope from this entity. 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.

3

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

2

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;4

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

up to 35 other purchasers;5

3. The company may use general solicitation or advertising to market the securities only if,

among other things, it takes reasonable steps to verify that investors meet accredited

investor standards;6

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

SEC after they first sell their securities;7 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.8

II.

Process of the Review

In 2019, Waterside spoke with members of Compliance, Legal and business department

management in order to become aware of any changes to business processes or compliance

procedures relevant to the private placement businesses of the Rule 506 Entities. The fourth

annual review includes private placement offerings relying on Rule 506 of Regulation D that

closed in calendar year 2018 including: private equity funds, hedge funds, Global Access

Portfolio or “GAP” funds and structured notes.

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

in effect during 2018 including manuals, training materials, order taking procedures, middle

office procedures, subscriber forms and “Frequently Asked Questions” relating to:

•

Communications and Marketing Materials for Private Placements of Private Equity

Funds and Hedge Funds;

4

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.

5

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).

6

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, allows general solicitations 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.

7

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.

8

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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•

•

•

•

•

•

Alternative Investment Procedures for Onboarding and Offering Private Equities and

Hedge Funds;

Order Taking and Middle Office Procedures, including processing and reconciling client

transactions;

Accredited Investor Attestations, including Subscriber Information Forms, Instructions to

Subscribe and the Electronic Subscriber Information Form User Guide;

Compliance Manual with respect to the Global Access Portfolios;

Procedures for Monitoring Compliance with the Bad Actor Rule; and

Discretionary Account Investments in Hedge Fund and Private Equity and Conflicts

Policy.

During the course of the review, Waterside had extensive discussions with Compliance and

Legal personnel focusing on the Rule 506 of Regulation D private placement business.9

Waterside discussed with business management the due diligence, onboarding and marketing

processes that are followed with the issuers of private equities and hedge funds. We also

discussed best practices for compliance with Regulation D.

After file review, Waterside interviewed the outside law firms and middle office personnel in

New York City responsible for reviewing subscription documents for private equity funds.

Waterside also interviewed middle office and compliance personnel in Geneva, Switzerland and

Edinburgh, Scotland who have responsibility for processing hedge fund transactions. In these

interviews, Waterside discussed the application of various middle office processes that included

control points, review practices, and systems used for compliance with the requirements of

Regulation D.

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

of a statistically valid random sample of private equity transactions, all hedge fund transactions

and one GAP fund trade that were in scope from 2018 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 Funds – Waterside was provided a population of 1,386 Wealth Management

transactions in 22 different private equity funds that closed in 2018 and for which the Rule 506

Entities served as Placement Agent. Waterside applied a statistically valid random sampling

process, described in more detail in Appendix B, to the 1,386 private equity fund transactions.

From that sampling methodology, Waterside selected 396 transaction files. Waterside also

9

In the last two reviews, the J.P. Morgan Securities (Far East) Limited, Seoul Branch conducted transactions in

scope for those reviews. Last year, Waterside recommended the development of policies and procedures in any

jurisdiction where a fund was relying on the exemption from registration under Rule 506 of Regulation D and the

Rule 506 Entities were participating in such an offering. The Bank agreed with that recommendation and in 2019

Waterside reviewed the policy put in place by the Asset Management area of the Bank and the procedure applicable

to the Seoul branch.

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reviewed an additional 11 private equity files (to include at least one transaction from each of the

22 fund families as well as small and large transactions) bringing the total reviewed to 407.

Hedge Funds – The hedge funds offered in 2018 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 2018, the Rule 506 Entities had four (4) hedge fund offerings that were made in

reliance on Rule 506 of Regulation D in which 298 client transactions closed.10 Due to the

limited number of transactions, Waterside reviewed information for each transaction file, which

were in both brokerage accounts and investment management accounts.

Global Access Portfolio funds – The GAP private placement offerings consist of a variety of

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

depending on their investment risk tolerance. In 2018, there were three (3) offshore and four (4)

onshore Global Access Portfolio funds for which the Bank served as Investment Manager, that

offered securities in reliance on Rule 506 of Regulation D. For these offerings, Waterside

reviewed policies and procedures as well as marketing documents, subscription agreements and

placement agent agreements for compliance with the requirements of Regulation D. These

offerings were made primarily 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 in the past reviews, none of those client transaction files were in scope for this

review. In 2018, however, one client (a U.S. citizen residing in a foreign country) purchased a

GAP fund that had been issued relying on Regulation D for which the Bank acted as placement

agent so Waterside reviewed that client transaction.

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 equity securities, a

basket of equity securities, interest rates, commodities, and/or foreign currencies. Each

investment’s return is linked to the performance of a selected set of reference assets or

indices. In 2018, the Rule 506 Entities issued five (5) 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 five structured products in 2018, JPMCB served as Issuer. Waterside reviewed

policies and procedures, marketing and 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 and thus were out of scope for this review.

10

Originally Waterside was informed that there were 299 hedge fund transactions that closed in 2018 and were in

scope for this review. Subsequently, one Geneva-based transaction was removed from scope since it was a

transaction done in a special advisory program where the Rule 506 entity does not serve as placement agent, and

thus not in scope. Removal of this transaction brought the in-scope hedge fund transactions to 298 transactions to

review. Waterside also reviewed one GAP hedge fund transaction that is discussed elsewhere in this Report.

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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.

A.

Complying with the Anti-fraud Requirements of the Securities Act

Waterside reviewed Private Placement offering memoranda and marketing documents describing

private equity funds, 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, and the investments were described as offering limited or no liquidity in resale.

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. Accordingly, Waterside was satisfied that

marketing, onboarding and offering policies, procedures and guidelines were designed to ensure

compliance with the anti-fraud requirements of Rule 506 of Regulation D.

B.

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.

Private Equity Fund Transactions

For private equity funds, the Rule 506 Entities served as placement agent and Waterside

reviewed 407 client transaction files of the 1,386 transactions that closed in 2018. For brokerage

transactions, policies require a valid Subscriber Information Form (“SIF”)11 and a Subscription

11

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 completing and signing the SIF, 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 following the first of the

month after the date of the client’s signature, and a single signed SIF will suffice for all subscriptions entered into

within the 12-month period. Part A of the SIF requires certain subscriber information (i.e., name, contact

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Agreement that includes certain attestations, representations and warranties by authorized

persons, whether individuals or authorized representatives of legal entities. In order to verify

that authorized persons (for example, individuals related to account owners or signers authorized

to act on behalf of legal entities) have signed subscription documents, for international

transactions the Bank requires review of the client signature and a signature verification (such as

an “ACT” stamp, which may include the initials of the Bank employee who verified the

signature) on the signature page of the document. The signature verification is generally

accomplished by the client’s JPMCB investor (sales representative) or by the jurisdiction’s

onboarding team.

When processing private equity fund transactions for acceptance, the outside law firms or U.S. based middle office Alternative Trade Order Management (“ATOM”) team checks that

information and signatures on the Subscription Agreement are complete and consistent within

the document, and that the client has a valid SIF on file before they process the transaction.

Policies and Procedures for onboarding international private equity fund brokerage transactions

require the signature verification process12 and the Bank’s operations procedure identifies this

step in its Risk Matrix as High Risk if the signature verification stamp is missing. The risk

matrix states that if the signature verification is missing, the sales representative needs to go back

to the onboarding team to obtain it.13

Waterside also noted that while the procedures for the international middle office (“IATOM”)

require checking for evidence of signature verification for the funds that they process, the U.S.based middle office ATOM procedures do not require a review for such documentation for

international private equity fund transactions, notwithstanding the fact that the originating

jurisdiction may require a signature verification in its procedures.

File review of brokerage transactions disclosed several instances of documents with no signature

verification notation and accordingly, Waterside recommends that a notice be issued to the law

firms and the ATOM team about the requirement to see evidence of signature verification for

international transactions in private equity funds, or alternatively, to eliminate this requirement in

the written procedures if the Bank concludes this step is no longer necessary. In addition,

Waterside recommends that the U.S. - based middle office procedures be made consistent with

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 his/her name and the name of 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 February 2017, the SIF was revamped to consolidate

previous U.S. and non-U.S. person forms and in 2018 the use of the paper SIF was transitioned to an Electronic SIF

for managed accounts.

12

For example, the procedures for processing transactions in private equity funds and hedge funds in Asia require

the ACT team to perform signature verification on all relevant documents, such as subscription documents and SIFs.

See Global Wealth Management Asia Procedure for Private Equity dated 12/8/16; updated 5/31/2019; Section 15.

13

See International Alternative Trade Order Management procedures, dated 9/8/2017; updated 2/20/2019; ATOM

Risk Matrix – Subscriptions.

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the IATOM procedures with regard to checking for evidence of signature verification for

international clients during their review.

After file review, Waterside had a small number of private equity fund brokerage transactions

that required additional clarification from either the Rule 506 Entities or the outside counsel that

reviewed the transactions for the funds or the fund issuers, and our questions were answered

satisfactorily.14 For the most part, Waterside found that the paperwork for the 407 private equity

fund transactions reviewed was in good order, with signed and dated SIFs and Subscription

Agreements in place for each transaction. Subscribers were required to attest in each document

that they met the accredited investor monetary thresholds and to keep the issuer updated should

their status change.

Hedge Fund Transactions

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

private equity – there must be a SIF as well as a Subscription Agreement (and an “Instruction to

Subscribe” document in Switzerland) on file with attestations as to the accredited investor status

of the client.15 For hedge fund brokerage transactions, procedures also call for the JPMCB

investor or on-boarding team to verify the client’s signature.

With regard to hedge fund transactions in managed (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 managed

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

the investment manager. In 2018, investment managers were using Electronic SIFs (“ESIFs”)

where the investment manager attests to the fact that the client is an Accredited Investor and

submits an electronic record (ESIF) into the system.

In this fourth annual review period, Waterside was provided one GAP transaction completed in

2018, for which the Bank acted as placement agent in a Rule 506 offering. The documentation

provided for this transaction was found to comply with the policies and procedures the Bank uses

to meet the requirements of Rule 506 of Regulation D.

Waterside reviewed all 298 hedge fund transactions16 from 2018 and had several transactions for

which we needed to request additional information or clarification from JPMCB. As in prior

14

Generally, follow-up questions for private equity transactions were related to indecipherable signatures, lack of

printed names, missing forms or out of date forms. Waterside received documentation for all private equity files

that we requested.

15

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

to use a SIF as well as a Subscription Agreement. Switzerland is the only area that still requires an Instruction to

Subscribe from brokerage clients.

16

Using the statistically valid random sampling methodology and table found in Appendix B, sampling for the 2018

population of 298 hedge fund transactions within the scope of the Order for this review, Waterside could either

sample 194 hedge fund transactions or review all of them. We elected to review all transactions rather than use the

sampling approach.

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years, we found discussions with Compliance and management met our needs for clarifying

issues and we were generally able to review additional documentation as well.

We had questions with regard to the transition to the ESIF. In prior years, for hedge fund

transactions in managed accounts, the Bank required a form be filled out in which the investment

manager attested to the Accredited Investor/Qualified Purchaser status of the client (“AI/QP

Form”). The AI/QP forms were valid for a year. In late 2017, the Bank discontinued use of that

form and transitioned to use of the ESIF that included an attestation to the Accredited

Investor/Qualified Purchaser status of the client, which is also valid for a year.

After file review, Waterside had questions about dates of input, review and approval of select

ESIFs. In one instance, Waterside found that the input date for the ESIF was the day after the

document was reviewed and approved. The middle office determined that all of the dates were

accurate, but made from different time zones. In addition, Waterside found one form where a

sales representative deleted a client name and substituted his own name in error. Waterside

discussed with Compliance and management what additional system controls could be

introduced and the Bank agreed to make system changes to address these issues.

In addition, our review disclosed that in one jurisdiction we were unable to review select

transactional documentation and had to rely on summary “audit trail” data to demonstrate

compliance with Regulation D requirements. The document retention repository did not

maintain “PDF” copies of past Subscriber Information Forms, for client privacy concerns, and

instead, a summary of data reflecting dates of previous SIF forms was retrieved and produced for

Waterside.

When we reviewed the summary dates of previous SIF forms, we found two instances where

there appeared to be no valid SIF on file when the transaction occurred. The Bank explained

that a technical issue in the Bank’s standard processing in October 2018 had caused the inability

to update ESIFs in these two accounts, and Waterside reviewed additional documentation

regarding procedures used during that technology problem to ascertain that the clients were

indeed accredited investors. We also received assurances that the technology issue from 2018

had been resolved satisfactorily and the ESIFs had been input into the data repository shortly

after the system fix. Waterside will be able to continue to review system output in our next

review period.

Accordingly, Waterside recommends that system-related improvements (reference to time zones

or an international date; system controls regarding over-writing critical information in files; and

retention of PDF copies of appropriate documents) be implemented as promptly as practicable.

To summarize, Waterside reviewed written policies and procedures related to the accredited

investor status of prospective clients for private placements including private equity, hedge funds

and the one GAP transaction. We reviewed subscription documents, marketing materials and

subscriber identification forms used by the Bank, and we tested transactions as required by the

Order. Although we are making two recommendations regarding procedural consistency and

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systems processing, Waterside believes that written policies and procedures are being followed

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

C.

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

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

public solicitation of sales. Since 2013, Rule 506(c) permits the use of general solicitation and

advertising if all purchasers are accredited investors and the unregistered fund has taken

reasonable steps to verify that all purchasers are accredited investors. None of the Issuers with

relevant transactions in this review period availed themselves of that particular subsection.

In our last annual review, Waterside noted that the Global Access Portfolio funds’ Subscription

Agreements contained appropriate language regarding subscribers being Accredited Investors,

but the documents were silent with regard to the funds being marketed via a general solicitation

and we recommended that the language be amended going forward to include such language.

During this review period, the Bank provided Waterside with GAP offering documents that had

been developed in 2019 and contain the “No general solicitation” language. Compliance also

commented that business management committed to add the “No general solicitation” language

to any new subscription documents when they are developed.

D.

Filing Form D with the SEC

The Bank produced several of the required Form D filings for the private placements within

scope for this review. For the other funds, Waterside checked with the SEC database and found

all of the required forms. Waterside also reviewed the policies and procedures that require the

filing of a Form D and believes that the Bank is complying with this requirement of Rule 506 of

Regulation D.

E.

Compliance with the “Bad Actor” Provision of Regulation D

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

included in marketing and subscription documents for private placements in 2018. We noted

that in every case where the Rule 506 Entities acted as placement agents, appropriate disclosures

regarding the Rule 506 Entities regulatory actions had been appropriately disclosed.

In last year’s review, Waterside noted that there was a difference in approach with regard to

language included in Subscription Agreements to put the subscriber on notice of the 20%

threshold ownership level that is the trigger for disclosing or investigating whether a

“disqualifying event” had taken place as described in the Bad Actor provision. Last year we

recommended that for all newly developed Subscription Agreements, language be included to

put clients on notice of the disqualifying event disclosure requirements. The Bank agreed with

this recommendation and provided examples of Subscription Agreements from 2019 that include

the language.

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The Bank’s written policies and procedures appropriately reflect the requirements of the “Bad

Actor” provision of the SEC rules, and the policies and procedures appear to be reasonably

designed and are being followed.

***

Summary of Prior Recommendations

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,

primarily regarding consistency across various jurisdictions. Bank management accepted all of

the recommendations for changes to the policies and procedures, and acted to implement

amendments prior to year-end 2016.

During the second annual review, Waterside recommended that the Bank enhance oversight of

new business acceptance processes for private placement transactions to improve quality and

consistency of transaction files. Management accepted our recommendations from the second

review and enhanced its processes for signatures by implementing a new signatory template and

holding training for U.S. and international trade order review teams. Additionally, JPMCB took

steps to enhance its data identification and reconciliation processes.

In the third annual review, Waterside identified three areas for enhancement: include language in

Subscription Agreements to describe a “disqualifying event” for the Bad Actor provision of

Regulation D; develop policies and procedures for institutional business in any jurisdiction

where a fund is relying on the exemption from registration under Regulation D; and include “no

general solicitation” language in GAP subscription agreements. The Bank agreed with all

recommendations during the current review, and the Bank provided Waterside documents that

addressed our recommendations.

Current Recommendations

In the fourth annual review, Waterside found that the 2018 Policies and Procedures continue to

be current, relevant and largely consistent across jurisdictions. Waterside is making a

recommendation to make procedures checking for signature verifications on client documents

more consistent.

With regard to select hedge fund transactions, Waterside’s file review disclosed systems-related

follow-up questions, largely with regard to documentation of transactions in managed accounts

and the use of ESIFs. Our questions were largely resolved satisfactorily, but we made systemsrelated recommendations.

Accordingly, in this fourth annual review, Waterside makes the following recommendations:

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1. Waterside recommends that a notice be issued to the law firms and the ATOM team

about the requirement to see evidence of signature verification for international

transactions, or alternatively, to eliminate this requirement in the written procedures if

the Bank concludes this step is no longer necessary. In addition, Waterside

recommends that the U.S. - based middle office procedures be made consistent with

the IATOM procedures with regard to checking for evidence of international funds’

signature verification during their review.

2. Waterside recommends that system-related improvements (reference to time zones or

an international date; system controls regarding over-writing critical information in

files; and retention of PDF copies of appropriate documents) be implemented as

promptly as practicable.

* * *

For this Fourth 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 for transactions that closed

in 2018. Waterside 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 2018.

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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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.17 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.18 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.19

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 (“ICC” or

“Consultant”) not unacceptable to Commission staff,20 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. This is the fourth annual review pursuant to the

requirements of 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

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

17

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

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

19

In 2018, the Rule 506 Entities were 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., and J.P. Morgan

(Suisse) S.A.

20

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.

18

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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 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 75 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, 2017.21

In 2017 and 2018, Waterside similarly conducted the second and third annual comprehensive

reviews of policies and procedures applicable to compliance with Rule 506 of Regulation D.

The second annual report was submitted to JPMCB in December, 2017 and after review and

acceptance, JPMCB submitted the report to the SEC. The SEC published the second annual

report on March 20, 2018.22

The 2018 report was submitted to JPMCB in December 2018. After review and acceptance,

JPMCB submitted the report to the SEC.

In 2019, Waterside has completed the fourth annual review of compliance with Regulation D and

the description of the process of the review as well as findings and recommendations are

presented in the body of the report.

21

22

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

https://www.sec.gov/divisions/corpfin/cf-noaction/2018/jpmorgan-chase-na-waterside-report-121317.pdf.

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Appendix B

Statistical Sampling Methodology for 2018 Rule 506 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.”

There are three types of Rule 506 transactions that fall within the scope of our review: Private

Equity, Hedge Funds and Global Access Portfolio (GAP).

Private Equity Fund Transactions

As discussed in the Report, JPMCB prepared a list of all private equity fund offerings in 2018,

for which the Rule 506 Entities acted as placement agent and relied on Rule 506 of Regulation

D. From that population of client transactions that closed in 2018, Waterside applied the

following statistical review approach to select a random sample.

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.23 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.

23

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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I.

Confidence Level

A 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. The

confidence level is the probability value associated with a confidence interval.24 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, (“P”) of 0.5. This is a common

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

each of two candidates. Or, another example would be a coin toss, where we define a “heads”

result as positive (“P”) and a “tails” result as negative. This P of 0.5 leads to the largest sample

size, since for every sample data element selected, e.g., head or tail, we are unable to predict a

positive result with a higher level of certainty than the negative result or vice versa.

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

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

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

accuracy and integrity of the sampling process. An example of this would be to roll a standard

six-sided die and declare that rolling a “one” would be a negative result and all other results are

positive. We now know that 5/6 of the time we would expect a positive result. 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 discussed control points applicable to the 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 files containing the appropriate documents, disclosures and

signatures well in excess of 90% of the time. In addition, we are informed by the results of our

transaction sampling from prior years of this review.

24

Definitions of confidence interval and confidence level are 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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Based on our review of the Rule 506 Entities policies, procedures and control points, including

documents, interviews, observation and prior experience in performing this review, we

concluded that those policies, procedures and processes would lead to similarly accurate and

complete transaction 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 demonstrate that at least 90% of the

sampled files met criteria above. If so, it should indicate that our population proportion

assumption was appropriate.

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%, 3% or 4%. This is the margin of error for that poll.

Waterside decided to use a margin of error of 2.5%, which is a margin of error among a common

range of selection (2%-4%) that leads to a fairly conservative (larger) sample size. Thus, a

result of 95% of files in good order in a sample would be indicative of an assumed population

accuracy rate 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 all the discussed above in this Appendix) that the required paperwork for at least 90%

(Population Proportion) of the client transactions reviewed would 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.

V.

The population and sampling results

Waterside was provided a population of 1,386 Wealth Management private equity transactions

that closed in 2018. Using that population of 1,386 transactions, we used the criteria described

above, and the following table, to reach a minimum sample size of 396.

The table on the following page clearly illustrates that for very large population sizes we see the

most optimum leveraging abilities of statistical sampling. However, a population of 1,386 still

lends itself to providing the benefits of random sampling.

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

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

Using the results of this table, we numbered the 1,386 private equity transaction files from 1 to

1,386 and proceeded to select a sample of 396 transactions. To start the sample selection

process, utilized a random number generator to select a number between 0 and 3.5 (the ratio of

1,386 to 396 which is the ratio of the population to the minimum sample size). The result of that

selection was the number 1.92. To establish our sample to test, we added 3.5 to that starting

point repeatedly, and in each case, rounded the result to the nearest integer.

Accordingly, we selected file numbers (using standard rules of rounding):

• 2 (closest to 1.92),

• 5 (closest to 5.42),

• 9 (closest to 8.92),

• 12 (closest to 12.42),

• 16 (closest to 15.92), and so forth,

until we had identified a sample of 396, which is equal to the minimum sample size that our

process requires for a statistically valid random sample.

Once we selected our random sample of 396, we reviewed that sample for adequate

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

sample to enhance coverage of all fund families, including those with very small transaction

volumes. In each instance if we had a choice, we selected the largest previously unselected

transaction for the fund family in question. We also added a transaction in each of two fund

families that was the smallest or one of the smallest transactions. In three instances, we added

the sole transaction in a fund family if it was not selected via our random sampling approach.

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Accordingly, we have a general population of 1,386 Wealth Management private equity

transactions of which we reviewed 407:

Beginning Population

Random Sample Selected

Additional Selections

Total Transactions Reviewed

1,386

396

11

407

We subsequently made the following observations regarding the sample set: at the culmination

of the transactional review of Private Equity files, we found 17 files (or about 4% of the files

reviewed) for which we had questions that required follow-up with JPMCB. We thus noted that

using this criteria, over 90% of the files were in good order, i.e., complying with policies and

procedures reflecting Regulation D control points. Further, all the files for which we had

questions have subsequently been resolved, clarified or discussed with JPMCB to Waterside’s

satisfaction, bringing the ‘in good order’ percentage to 100%.

Finding all 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 a statistically

significant percentage of any files we might select to be in good order.

GAP and Hedge Fund Transactions

We were provided one GAP transaction completed in 2018, for which the Bank acted as

placement agent in a Rule 506 offering. The documentation provided for this transaction was

found to comply with the policies and procedures the Bank uses to meet the requirements of Rule

506 of Regulation D.

In each of the prior years of this review, the volume of hedge fund transactions in scope was low

enough to provide little to no real advantage for statistical sampling, so we reviewed the entire

population of transactions. For 2018, the number of hedge fund transactions was higher, with

298 in scope. Using the same statistical sampling table that we used to determine the Private

Equity transaction sample, but using the line for a population of 298, (see table on previous page)

we concluded that there was limited value in going through the process of generating a random

sample. So instead of “de-selecting” about one third of the hedge fund transactions, Waterside

reviewed each hedge fund file. We can therefore treat the 298 hedge fund transactions as our

sample as well as our population.

As a result of our hedge fund transaction file review, we had a variety of questions for which we

needed to request additional information or clarification from JPMCB. As in prior years, we

found those further discussions generally produced the file documentation that we needed.

However, for two of those transaction files the response indicated a technology issue in the

company’s standard processes in one jurisdiction. Our observations on those two accounts and

subsequent recommendations are included in the body of the report. For statistical purposes, two

issues from 298 files are well within the statistical norms used for this analysis.

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