We believe that internal controls and supporting technology are vital to successful investment management. We have made major commitments in these areas, such as in risk management and assessment, separation of front and back office functions, regulatory compliance, and adherence to high ethical standards. In addition, unlike most other investment managers, we are Sarbanes-Oxley compliant.

Risk Management

We believe that in order to achieve long-term investment performance consistent with our clients’ expectations, we must consider the investment risks in each portfolio relative to the corresponding liability and return profile, as well as the risks inherent in the increasingly complex global capital markets. Our risk management process emphasizes:

• Trading system and data integrity.
• Counterparty creditworthiness.
• Adherence to client investment guidelines.

We use risk monitoring to support our portfolio management and operational activities. Our risk management program seeks to address not only the risks of unexpected portfolio losses but also the operational risks that can significantly impair investment performance. Portfolio risks include potential losses due to price volatility, position sizing and leverage. Operational risks include proper recording, settlement and clearing of all transactions for client accounts, accurately valuing account positions, supervising traders, approving and monitoring the counterparties to our trades for client accounts, timely completion of custodian reconciliations, data accuracy and availability, and compliance with all relevant accounting and regulatory requirements.

Our Risk Management Committee is the focal point of our risk management efforts. It is headed by our Chief Risk Officer and composed of senior professionals, including several individuals not involved in portfolio management The Committee’s main functions are to identify relevant risks, devise tools to monitor them, review the current state of various risk indicators and report to management on its activities.

Our risk management effort uses various systems, including a proprietary trade processing system with numerous built-in protective monitoring and reporting functions such as counterparty authorization, timely trade entry and trader limits. These systems provides real time reporting to our various groups, including the trading desks, Operations, Counterparty Credit and Accounting.

Separation of Front and Back Offices

We strictly separate our front office portfolio management function from the back office functions of trade confirmation, trade recording, position valuation, fund accounting, and risk management.  We accomplish this by conducting the back office functions through a system of separate departments in which front office personnel (portfolio managers and analysts) have no involvement, and committees in which such personnel have only an advisory function.   For example, our Operations Department, which reports to our Chief Operating Officer and is composed solely of back office personnel, conducts all of our trade confirmation, and our Valuation Committee, which is headed by our Chief Financial Officer, conducts all of our portfolio asset pricing.

Regulatory Compliance

Our regulatory compliance program is designed to achieve adherence with the federal securities and other laws applicable to our management of client accounts and related activities. The program is administered mainly by our Compliance Department. Its main objective is to prevent securities law and related violations—particularly of the SEC requirements applicable to registered investment advisers—and detect and cure such violations should they occur. The program is risk-based, reflecting the types of client accounts we manage, the instruments we trade for them, and our structure and operations. The program’s controls include various procedures for:

• Equitable allocation of aggregated orders among accounts.
• Equitable allocation of investment opportunities among accounts.
• Custody of client funds and securities.
• Best execution.
• Compliance with client investment guidelines.
• Cross trades.
• Trade error resolution.
• Review of promotional materials.

We periodically train our employees in their responsibilities under the program, and we annually review the program for its continuing effectiveness.  The program is fully documented in our Compliance Manual and related written manuals, such as our Information Security Policy and Anti-Money Laundering Policy.  The Compliance Department is headed by our Chief Compliance Officer, who has 30+ years of applicable securities law experience, including five years with the SEC in Washington, D.C.

Ethical Standards

In addition to requiring our employees to adhere to all legal requirements, we also require them to observe additional, ethical standards in their relationships with clients. These standards are in our Code of Ethics (the “Code”), which is administered by our Compliance Department.

The Code standards include:

• Treating clients honestly, fairly and professionally.
• Avoiding personal business or financial relationships that could conflict with the employee’s loyalty to our clients.
• Maintaining the confidentiality of non-public client information.
• Observing the Code’s limits on accepting gifts from brokers, dealers and other third parties.
• Not engaging in “pay to play” activities.
• Reporting to us any Code violation of the Code by any other employee.

Sarbanes-Oxley Compliance

Unlike most investment managers in our peer group, we are Sarbanes Oxley compliant-in that we are a subsidiary of a public company (DFR) into which our financial results are consolidated-and we believe our Sarbanes compliance materially benefits our investment management clients.  Central to our Sarbanes compliance is our maintenance of a comprehensive system of internal controls for the reporting (through DFR) of our financial results.  Because our management of client accounts is the main driver of our financial results, these Sarbanes controls need to address many aspects of that activity, including:

• Safeguarding of client account funds.
• Execution, confirmation and settlement of transactions for client accounts.
• Recording of client account transactions.
• Valuation of client account securities.
• Calculation of advisory fees payable by client accounts.
• Avoidance of conflicts of interest.
• Preventing and detecting employee misconduct in managing client accounts. 

We believe our clients further benefit from the testing of these controls by our Internal Audit Group, which operates independently from our other functions and reports directly to the Audit Committee of DFR’s board of directors, which is composed solely of independent DFR directors.

Safeguarding of Client Account Assets

We have no access to client-account assets, whether for payment of our advisory fees or otherwise. All funds and securities of our client accounts are deposited and maintained with major securities custodians, which are independent of DCM and the other Deerfield entities. In addition, we also have numerous controls that are designed to safeguard the movement of account assets, particularly with regard to the transfer of cash and securities between the account custodian and transaction counterparties. These controls include our Operations Department and other non-trading personnel having the exclusive authority within our internal structure to effectuate such transfers; requiring the signatures of two non-trading personnel (designated by our CEO or COO) for cash transfers; and sending updates of the signatory list to the custodian banks.

Safeguarding of Client Information

We strive to preserve the confidentiality of the non-public information we possess about our clients and the investors in the collective funds we manage, including the identities of such persons, their personal information, their investments with us and the holdings of their portfolios (“Client Data”). We endeavor to safeguard the Client Data from any unauthorized access, use or disclosure. Our main Client Data control is our Information Security Policy. It contains various procedures intended to prevent any unauthorized access to Client Data, including:

• Procedures for access to our network, the custody of the hardware/software and procedures that constitute the network and its internal and external connections, and for securing the network from unauthorized access.
• For Client Data in electronic format--including databases, flat files, document images, graphical files, Web pages, and non-volatile RAM--the use of passwords, data encryption, and restrictions on physical access to electronic equipment.
• For Client Data in hardcopy format, procedures for restricting physical access to such information, including physical destruction of handwritten documents and computer printouts.
• Ongoing audits of adherence to our Client Data information security procedures.

Approval of Transaction Counterparties

An important control in safeguarding client assets is the selection of the counterparties to our principal transactions for client accounts, as the insolvency or payment delay could jeopardize client account assets. Accordingly, our employees may transact for clients only with counterparties that have been approved by our Risk Management Committee, or in the case of cash-only counterparties our Counterparty Credit Group.  Portfolio management personnel have only an advisory role in these approvals, consistent with our policy of segregating front and back office functions.The approval process generally includes the following safeguards:

• Researching the creditworthiness of each proposed new counterparty, with the level of review based on the instruments to be traded with the firm and other factors.
• Monthly review of credit ratings of approved counterparties.
• Daily review of each account's credit exposure to each counterparty, and of collateral  and cash movements between accounts and counterparties.
• Limiting an account's exposure to any counterparty to a specified percentage of the account's NAV, the percentage depending on such factors as the counterparty's credit rating.

Portfolio Transparency

Our policy is to provide each client with the portfolio transparency it desires, accessible from our password protected website. Such transparency may include:

• Position level detail.
• Daily posting of transaction activity.
• Month-end mark-to-market pricing.
• Profit attribution reports.
• Various types of asset category bucket reports.
• Current NAV of fund and of investor's interest in the fund.

Compliance with Client Investment Guidelines

Full compliance with clients' investment guidelines is a vital part of an investment manager's operations, and we have numerous controls designed to achieve that.  Where investment guidelines are quantitatively complex, as in the case of CDOs, we use third-party software where we deem it appropriate to enhance our guideline compliance.

Conflicts of Interest

We believe it vital to our clients' objectives that we and our employees refrain from personal interests that conflict with the interests of our clients.  We maintain numerous policies and procedures in that regard.  They include:

• Strict avoidance of soft dollar, directed brokerage and related arrangements.  We have no affiliation with any securities brokers or dealers, or any of the counterparties we use for client account transactions;
• Not engaging in proprietary trading.
• Prohibitions on employees having business or financial relationships with portfolio companies or counterparties we use for trading client accounts.
• Compliance Department review of employees' personal securities transactions;
• Transacting only with counterparties approved by our Risk Management Committee or Counterparty Credit Group.
• Valuation Committee oversight of security valuation, with valuations arrived at pursuant to specified valuation methodologies.
• Compliance Department review of best execution.

Disaster Recovery

Our systems are backed up nightly, with data stored offsite a with a third-party disaster recovery provider. Our disaster recovery plan is designed to allow for a complete return of critical operations within 24 hours. It is tested and updated periodically and lists the processes required for full systems recovery. The plan includes access to an offsite facility and an alternative regional disaster center, and daily offsite storage of systems data with automatic systems backup.

Technology

We have devoted significant resources to developing and maintaining information technology systems specific to our client accounts. We have numerous full-time technology professionals devoted to the proprietary data systems that support our client portfolios. We maintain robust information processing systems designed around a client/server architecture that distributes computing power to each trading and trading support desk. The foundation is a set of servers that perform the transaction processing needed to support real-time portfolio management, accounting and risk management. Our systems staff provides the design, development, and maintenance of our technology, as well as integration with vendor products.