1. Selection of Asset Managers and Alternative Investments Due Diligence for Plan Sponsors Jaqueline M. Hummel, IACCP®, AIFA® Managing Director Hardin Compliance Consulting LLC

2. Jaqueline M. Hummel, Esq. is a Managing Director at Hardin Compliance Consulting LLC.. She counsels clients on a wide variety of investment management issues including risk management, compliance with SEC regulations, and development of compliance programs. She has extensive experience as an in-house attorney in the areas of investment adviser, broker-dealer and investment company regulation and compliance. Prior to joining Hardin Compliance Consulting LLC, in January 2011, Ms. Hummel held the position of Chief Compliance Officer for investment adviser affiliates of PNC Financial Services Group, Inc. and National City Corporation. In addition to her role as a regulatory compliance consultant, Jaqi is a securities attorney, licensed to practice law in Ohio and Massachusetts Jaqi can be reached by sending an email to jhummel@hardincompliance.com, or calling 216-965-0062. jhummel@hardincompliance.com Speaker Biography: 7/7/20142HARDIN COMPLIANCE CONSULTING LLC

3. Agenda 1.Initial considerations for investing in alternative investments vehicles 2.Characteristics of alternative investments 3.Evaluating alternative investments 4.Due diligence considerations 5.Monitoring 7/7/20143HARDIN COMPLIANCE CONSULTING LLC

4. INITIAL CONSIDERATIONS FOR INVESTING IN ALTERNATIVE INVESTMENTS VEHICLES 7/7/20144HARDIN COMPLIANCE CONSULTING LLC

5. Plan Fiduciary’s Obligations for Selecting an Investment Vehicle ERISA requires: – Plan fiduciaries engage in a “prudent process” to select and monitor service providers – Evidence process is followed (documentation) DOL requires: – Objective process for evaluating service providers – Process should address qualifications of service providers, the product quality, and the reasonableness of fees charged Post-selection: ongoing monitoring required to ensure services are being performed as promised. 7/7/20145HARDIN COMPLIANCE CONSULTING LLC

6. Initial Considerations For Alternative Investments Determine whether plan documents permit the investment (allowed by investment policy statement?) Assess whether investment provides sufficient liquidity for plan needs (lock up periods and periodic redemption rights) Review whether investment meets the plan’s diversification objectives Analyze risk/return characteristics of investment Assess potential for prohibited transaction 7/7/20146HARDIN COMPLIANCE CONSULTING LLC

7. Other Considerations for ERISA plans Investing in Private Equity or Hedge Funds Plan Asset Look-Through Rules: – General partners and advisers to private equity or hedge funds with less than 25% ownership by ERISA plans are NOT ERISA fiduciaries – Venture capital operating companies (VCOC) and real estate operating companies (REOC) are also exempt from being classified as ERISA plan assets Private Fund managers may – Not be subject to “prohibited transaction” prohibitions – Receive incentive and other performance based fees – Not be bonded 7/7/20147HARDIN COMPLIANCE CONSULTING LLC

8. CHARACTERISTICS OF ALTERNATIVE INVESTMENTS 7/7/20148HARDIN COMPLIANCE CONSULTING LLC

9. Characteristics of Alternative Investments Limited partnership, LLC or collective trust (bank-sponsored) Private investment company, qualified for an exemption from SEC-registration No prospectus: offering made through confidential private placement memorandum, limited partnership agreement, and subscription agreement 7/7/20149HARDIN COMPLIANCE CONSULTING LLC

10. Characteristics of Alternative Investments U.S. Regulations limit investments in hedge funds and private equity funds to “accredited investors” and “qualified purchasers” – Individuals with investments in excess of $5 million; or net worth of at least $1 million; or income of at least $200,000 in last two years – Institutions with total assets over $5 million; or no less than $25 million in investments or investable assets Hedge funds and private equity funds are not registered with the SEC 7/7/201410HARDIN COMPLIANCE CONSULTING LLC

11. Characteristics of Alternative Investments Higher management fees than mutual funds and/or separate account structure Less disclosure than a registered mutual fund Performance data and calculations are not standardized Generally no independent board of directors Manager may receive other fees (consulting fees, break up fees) Larger investors may get more favorable terms (side letters) May use different accounting methods (U.S. GAAP, IFRS) May invest in illiquid or hard to value securities Restrictions on fund redemptions May be domiciled offshore 7/7/201411HARDIN COMPLIANCE CONSULTING LLC

12. Characteristics of Alternative Investments Large commitments, long term investors can negotiate better terms “most favored nations”: find out what other investors have obtained – managers may have undertaken to provide similar terms upon request Key Items: liquidity, reporting, pricing, notice How broad is investment mandate? Potential for style drift? Additional risk: use of derivatives, leverage and hedging 7/7/201412HARDIN COMPLIANCE CONSULTING LLC

13. Private Equity Funds vs. Hedge Funds Private Funds – Specified term, limited investment period – Longer term investments (private equity, buy-out, venture capital, real estate) – Investments made in hard to value assets – Capital calls – Redemptions limited, distributions made at time of sale of assets – Management fees changes: during the commitment period fee is a specified percentage of total capital commitments and after the commitment period is a specified percentage of total capital contributions. – Offsets to management fee (sometimes) for transaction fees received by manager from portfolio companies (such as advisory fees, break-up fees for unconsummated deals, investment banking fees, directors fees for serving on the board of a portfolio company, etc.) – Performance fee for fund manager based on the profits realized sale of fund investments. 7/7/201413HARDIN COMPLIANCE CONSULTING LLC

14. Private Equity Funds vs. Hedge Funds Hedge Funds – Open-end fund with no specific term – More liquid: allows admission and redemption at regular intervals – Investments in more liquid securities (marked to market) – Management fee based on Net Asset Value of fund – Performance fee based on increase in NAV 7/7/201414HARDIN COMPLIANCE CONSULTING LLC

15. Investment Strategies for Hedge Funds Sample: – Convertible arbitrage – Dedicated short bias – Distressed – Emerging markets – Fixed-income arbitrage – Global macro – Long/short equity directional – Long/short equity market neutral – Managed futures – Merger & acquisition arbitrage – Risk arbitrage – Multi-strategy 7/7/201415HARDIN COMPLIANCE CONSULTING LLC

16. Fee Structures of Private Funds Hedge Fund Fee Structures: – Management and Performance Fees for fund managers (1-2% management fees based on Net Asset Value of an investor’s interest in the fund, and 20% of gains over some base return or “hurdle rate”) – Management Fees: designed to pay for investment manager’s expenses, such as employee salaries, office space, technology, utilities 7/7/201416HARDIN COMPLIANCE CONSULTING LLC

17. Fee Structures of Private Funds Performance Fees (incentive fees, carried interest) – Performance Fees are paid only if the Net Asset Value of the fund increases over specified period of time – “High Water Mark” (when fund has losses, managers do not get performance fees until loss has been made up) – “Hurdle Rate”: minimum rate of return to be reached before fund manager receives performance fee – Clawback provisions: return of incentive fee previously paid if fund fails to return to its high-water mark, or if fund fails 7/7/201417HARDIN COMPLIANCE CONSULTING LLC

18. Private Equity Fund Fees Waterfall structure, paid to private equity fund investors upon sale of an asset: – First distribution is made to investors until they receive all their capital contribution for the investment sold – Second distribution is made to investors until they receive a specified return – Third distribution is made to the sponsor (or g.p./adviser) until sponsor receives 20% (or other incentive fee) of distribution of profits – Last distribution is split: 20% goes to sponsor as its incentive fee, and remaining 80% to investors May or may not have loss carryforward, where investors receive return of invested capital, plus their full preferred return, before the Sponsor/GP/Adviser receives incentive fee 7/7/201418HARDIN COMPLIANCE CONSULTING LLC

19. Fund Expenses Organizational expenses: paid by investors out of capital commitments, usually capped. Includes formation expenses such as legal, accounting, filing, and travel Operating expenses: management fees, costs for purchasing, holding and disposition of investments, third- party services providers (fund administrator, custodian, counsel, accountants and auditors), insurance, indemnity and litigation expenses, taxes and other government fees Manager expenses: fund manager bears costs of administrative and overhead expenses in running the fund (employee compensation, rent) 7/7/201419HARDIN COMPLIANCE CONSULTING LLC

20. Buyer Beware: Other private equity fund fees and expenses A private equity fund manager may earn additional fees from the companies it invests in, such as transaction fees (for putting together the deal), advisory fees (for providing advice to portfolio companies), “breakage fees” (for deals that don’t go through) SEC has scrutinizing these fees, stating that many newly-registered private equity fund advisors fails to adequately disclose their fees* SEC noted: – Payments to “operating partners”, engaged by fund managers to provide assistance to portfolio companies, and get paid by the fund (not illegal, SEC doesn’t like this practice since it appears that these individuals look like employees of the fund manager (whose salaries would be borne by the fund manager) – Characterization of expenses changes over life of fund – expenses change from manager expenses to fund expenses without appropriate disclosures to investors SEC has also found that fund advisers have material weaknesses in their controls related to allocation of fees and expenses *“Spreading Sunshine in Private Equity,” remarks of Andrew J. Bowden, Director, Office of Compliance Inspections and Examinations, Private Equity International (PEI), Private Fund Compliance Forum 2014, (New York, NY, May 6, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370541735361#.http://www.sec.gov/News/Speech/Detail/Speech/1370541735361# 7/7/201420HARDIN COMPLIANCE CONSULTING LLC

21. EVALUATING ALTERNATIVE INVESTMENTS 7/7/201421HARDIN COMPLIANCE CONSULTING LLC

22. Basic Questions How are fees calculated/charged? Off sets? How does the fund manager address risk management? How often, who is responsible, and what procedures are used to value assets? What are the fund manager’s trading policies, including allocation, aggregation, soft dollars and best execution? How is leverage used, measured and monitored? How does the fund manager address key person risk? What type of internal controls does the fund manager have? How often updated? Does the firm have continuity/succession plans? Business continuity process? How are fund service providers chosen, evaluated and monitored? 7/7/201422HARDIN COMPLIANCE CONSULTING LLC

23. Consideration of Investment Strategy Understand the investment strategy – What is the investment universe? – How diverse/liquid are the securities the strategy invests in? – How much money is in the strategy and how much more can it absorb? – What is the niche, and what is this manager’s competitive advantage? – Is there a benchmark, and how does performance of strategy compare? – How does the manager control risk? – How is leverage used in the portfolio? – What types of hedging strategies are used? 7/7/201423HARDIN COMPLIANCE CONSULTING LLC

24. Consideration of Investment Strategy Prior performance – Is there a track record, and is that record based on same strategy, same type of investment vehicle? (are we comparing apples to oranges) – Was prior performance obtained using same team, same resources? – How was that record achieved – is it based on process that can be clearly articulated and reproduced? Was it based any unusual opportunities or market conditions? – How has the strategy performed over time; can it adapt and perform under different market conditions? – How is performance presented – are terms understandable, is GIPS used? 7/7/201424HARDIN COMPLIANCE CONSULTING LLC

25. Analysis of Investment Process Based on Prudent Practices TM for Investment Fiduciaries developed by Fi360 in conjunction with the Center for Fiduciary Excellence (CEFEX). Organization Formalization Implementation Monitoring 7/7/201425HARDIN COMPLIANCE CONSULTING LLC

26. DUE DILIGENCE CONSIDERATIONS 7/7/201426HARDIN COMPLIANCE CONSULTING LLC

27. Due Diligence on Organization Which entity is managing assets of the private fund (general partner, investment adviser, etc.) If G.P. or affiliated adviser is registered with SEC, review Form ADV (Investment Adviser Registration Form) Parts 1A, 2A and 2B Review Form to determine ownership of firm, firm management, any disciplinary actions, experience of investment team, assets under management, types of clients (Part 1) and conflicts of interest (Part 2A) Review organization chart 7/7/201427HARDIN COMPLIANCE CONSULTING LLC

28. Due Diligence on Fund Manager Form ADV Part 1A (Schedule D) lists – Affiliated entities – Private funds managed by registered investment adviser, including AUM and %age owned by related parties, directors – Service providers for private funds: custodian, prime broker, administrators, independent accountants, marketers – Discloses whether financial statements contain unqualified opinions 7/7/201428HARDIN COMPLIANCE CONSULTING LLC

29. Due Diligence on Fund Manager Form ADV Part 2A Brochure discusses: – Structure of firm and description of business – Compensation, including performance-based fees and side-by- side management – Firm’s investment strategies and associated risks – Conflicts of interest and how managed (soft dollars, personal securities trading) – Brokerage practices (best execution, investment aggregation and allocation) – Proxy voting practices – Referral arrangements and other compensation – Disciplinary information – Financial information (not much) 7/7/201429HARDIN COMPLIANCE CONSULTING LLC

30. Due Diligence on Fund Terms and Operations Review L.P. agreement, subscription agreement and confidential private offering memorandum Analyze key terms: – Fees and other expenses paid by fund, including management fees, performance allocation – Payment waterfall – Calculation of fees – Valuation of assets – Lock-up period and redemption terms – Controls in place to manage risk (concentration by issuer, sectors) – Trading allocation – Leverage – Derivatives usage 7/7/201430HARDIN COMPLIANCE CONSULTING LLC

31. Due Diligence on Fund Terms and Operations Offering Memorandum should address: – Investment manager has time, resources, knowledge and skills to appropriately monitor the portfolio investments – Process and tools used by investment manager to implement and monitor portfolio investments – Identification of duties and responsibilities of parties and service providers (custodian, prime broker, investment manager, board of trustees/directors, limited partners, fund administrator) – Investment and operational risks and how addressed – Specifics of investment process, including investment selection criteria due diligence criteria for selecting investments 7/7/201431HARDIN COMPLIANCE CONSULTING LLC

32. Due Diligence on Fund Terms and Operations Offering Memorandum should address – Fees charged by investment manager and how calculated – Expenses borne by investors in fund – Conflicts of interest between investment manager and investors, – Best execution and trading practices – Valuation of fund assets – Referral arrangements 7/7/201432HARDIN COMPLIANCE CONSULTING LLC

33. Due Diligence on Fund Terms: Valuation Understand manager’s valuation practices Recognize difference between assets with a readily ascertainable market value, and assets that require fair valuation Review process for fair valuation – Is there any independent evaluation of pricing? – How often is valuation performed? – How does independent auditor review and confirm valuations? Request reports of manager evaluations of its valuation process (if the manager doesn’t evaluate the efficacy of its valuation process, that’s a red flag) 7/7/201433HARDIN COMPLIANCE CONSULTING LLC

34. Implementation Understand the fund manager’s trading policies and procedures Understand the fund manager’s compliance policies and procedures to monitor trading activity Understand the fund manager’s risk controls 7/7/201434HARDIN COMPLIANCE CONSULTING LLC

35. MONITORING 7/7/201435HARDIN COMPLIANCE CONSULTING LLC

36. Monitoring Review financial statements of independent auditor (provided annually) Review monthly/quarterly statements Review custody statements Hire an independent investment adviser with expertise to review fund performance Onsite visits Due diligence questionnaires quarterly 7/7/201436HARDIN COMPLIANCE CONSULTING LLC

37. Questions? 7/7/201437HARDIN COMPLIANCE CONSULTING LLC

38. Additional Resources Fund manager information on SEC’s Investment Adviser Public Disclosure website Managed Funds Association www.managedfunds.org www.managedfunds.org www.greenwichroundtable.org www.sec.gov (http://www.sec.gov/investor/alerts/ib_hedge funds.pdf) www.sec.govhttp://www.sec.gov/investor/alerts/ib_hedge funds.pdf www.finra.org 7/7/201438HARDIN COMPLIANCE CONSULTING LLC