Year: 2009

Iceland’s Meltdown

iceland-flag

With all of the focus in the United States on the collapse of Bear Stearns, AIG, Lehman Brothers, and Merril Lynch, we may be a bit myopic in not noticing other issues around the world. Iceland stands out as a country that has really run into trouble. As Michael Lewis wrote in Wall Street on the Tundra: “Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’”

The collapse has been so big that Iceland is abandoning its own currency to join the European Union. Until the collapse, Iceland had little interest in joining the EU. They do want the bureaucrats in Brussels messing with their fishing. Iceland put some excellent regulatory controls on fishing that have lead to stable fish populations and rich fishermen.

They failed to do the same with their financial system. They ended up having fisherman quitting the sea to engage in currency trading.

There are lots of lessons to be learned from a compliance and risk management perspective.

Legend has it that Joe Kennedy cashed out of the stock market when his shoeshine boy gave him stock tips. Maybe a warning sign should be fishermen engaging in currency trading. We saw similar events in the U.S. as people quit their jobs to be real estate entrepreneurs. I heard a success story from an acquaintance who told of buying a house for 100, putting in 10 and selling it for 120. I didn’t have the heart to tell him that house prices has risen by 15% during that same time frame. A rising market makes everyone look like a genius.

As Michael Lewis points out “One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem.” You saw that with Iceland’s collapse and you saw that with the collapse in the United States. The most publicity shined on Goldman Sachs for its profits in September 2007 made from shorting mortgage positions. I am sure that there were quite a few mortgage originators who knew they were peddling garbage. But they had no incentive to stop the income coming from origination fees.

The three biggest banks in Iceland, a country of only 310,000, made loans totaling over 850% of Iceland’s Gross Domestic Product.  Only 1/5 of the loans were in Iceland’s currency. They instead borrowed from their banks in cheaper currencies such as yen and Swiss francs. To compare, the balance sheet of Britain’s banking system was at 450% of GDP and the US at 350%. Clearly, carrying too much debt is a problem. Especially when their are few alternative sources of capital besides more debt.

Iceland’s debt load increased from 200% of GDP in 2003 to almost 1000% in 2008. That is an enormous growth curve. Even steeper than the rise of housing prices in the United States.

Economic cycles are part of human nature. We overbuy into good times and oversell in bad times. It easy enough to look back a few years to the Dot-Com bubble focusing on market share and eyeballs at the expense of the bottom line.

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Madoff’s Auditor Arrested

madoff

With Madoff in jail, it is time for the rest of his crew of fraudsters to join him.  Next up….

David G. Friehling, the sole practitioner at Friehling & Horowitz, CPAs, PC, has been charged with securities fraud, aiding and abetting investment adviser fraud and four counts of filing false audit reports with the Securities and Exchange Commission. The complaint alleges that Friehling enabled Madoff’s Ponzi scheme by falsely stating that the firm had audited the financial statements. Friehling & Horowitz also made representations that Friehling reviewed internal controls, including controls over the custody of assets, and found no material inadequacies. The complaint alleges that all of these statements were materially false because Friehling did not perform a meaningful audit. The SEC alleges that (1) Friehling merely pretended to conduct minimal audit procedures to make it seem like he was conducting an audit, (2) he failed to document his findings and conclusions, and (3) if properly stated, those financial statements would have shown that Madoff owed tens of billions of dollars in additional liabilities to its customers.

“Although Mr. Friehling is not charged with knowledge of the Madoff Ponzi scheme, he is charged with deceiving investors by falsely certifying that he audited the financial statements of Mr. Madoff’s business,” said acting U.S. Attorney Lev Dassin.

If you are wondering about the Horowitz half of Friehling & Horowitz, he was apparently the Madoff auditor for many years before handing the account to his son David G. Friehling in the early 1990’s. If Madoff’s wrongdoing goes far enough back, Horowitz may need to worry about ending up in a prison cell next to his son-in-law. (UPDATE: Maybe not, since he passed away recently.)

See:

You’re a Victim of a Ponzi Scheme, But What About Your Taxes?

IRS_Logo

You missed the warning signs and got suckered into a Ponzi scheme. Can the IRS help by giving you some tax relief? This is a critical issue for long-term Ponzi scheme investors (like some of the Madoff victims) who have paid taxes on gains from the investment. After all, they have been paying real taxes on fictional gains.

The IRS has stepped up with guidance on what to do. They clarified the federal tax law governing the treatment of losses in Ponzi schemes. They also set out a safe harbor method for computing and reporting the losses.

The revenue ruling (2009-9) addresses the difficulty in determining the amount and timing of losses from Ponzi schemes and the prospect of recovering the lost money.  Some of the older guidance from the IRS on these losses is somewhat obsolete.

The revenue procedure (2009-20) simplifies compliance for taxpayers by providing a safe-harbor for determining the year in which the loss is deemed to occur and a simplified means of calculating the amount of the loss.

The first question is whether a loss from a Ponzi scheme is a “theft loss” or a “capital loss” under IRC §165? With the criminal intent of a Ponzi scheme, it is a theft loss. That also results in it being an itemized deduction that is not subject to the deduction limits in IRC §67 or IRC §68. You can read further in Revenue Ruling 2009-9 for more information.

Even with the clarification in the revenue ruling there many factual issues that have to be addressed to properly take the deduction. Given the ongoing investigations, it is hard to know the facts. So the safe-harbor in the revenue procedure draws some bright lines around what you need to take the deduction.

The first thing you need to determine is whether the Ponzi scheme was a theft. The revenue procedure provides that the IRS will deem the loss to be the result of theft if:

    • the promoter was charged under state or federal law with the commission of fraud, embezzlement or a similar crime that would meet the definition of theft; or
    • the promoter was the subject of a state or federal criminal complaint alleging the commission of such a crime, and
    • either there was some evidence of an admission of guilt by the promoter or a trustee was appointed to freeze the assets of the scheme.

      That seems to work very nicely with the facts for the Madoff scheme.

      Now that you can claim the theft loss, you need to calculate the amount of the loss. It may take years to find any assets and distribute them to the victims. Therefore, you have a problem figuring out the actual amount of the loss and the prospect of recovery. The revenue procedure generally permits taxpayers to take a deduction in the tax year they discover the loss and to deduct 95% of their net investment (less the amount of any actual recovery in the year of discovery and the amount of any recovery expected). If you are an investor suing persons other than the promoter (like the Madoff feeder funds), then your deduction is reduced by substituting “75%” for “95%”.

      This new guidance seems to address the phantom income concerns, but are predicated on the victims not filing amended returns for prior tax years. Are there other concerns that the IRS did not address?

      See:

      Can You Prevent Ponzi Schemes?

      Charles Ponzi
      Charles Ponzi

      With Madoff, Nadel and Stanford in the news, people are wondering why the government does not prevent Ponzi schemes. The government should protect us from these frauds.

      How can they?

      Ponzi scheme sponsors are thieves. Common criminals. They just wear suits instead of black masks.

      The government has not been able to prevent bank robberies, car-jackings or pick-pockets. (I lump Ponzi schemes in with these.) What government can do is deter and punish. An effective detection and prosecution program may deter some bad guys. If you feel certain you will get caught and punished then you are less likely to commit the bad act. On the other side, if you feel certain that you will not get caught or punished, then you are more likely to commit the bad act.

      The inspiration of this post is an article from Tresa Baldas summarizing some of the current steps being taken: Wave of anti-Ponzi laws coming — but will they work? The US Congress has already introduced two bills in the last few weeks trying to increase transparency and registration of private investment funds: The Hedge Fund Transparency Act and the Hedge Fund Adviser Registration Act of 2009.

      Don’t forget that Madoff and Stanford were both registered with the SEC and subject to some form of SEC oversight. Clearly registration and transparency were not effective at stopping them. They will increase the paperwork. They will make it harder for private investment funds to execute their business plans.

      I guess as a compliance professional more regulation would be good for me. More regulatory oversight means more work for compliance. But I would rather focus my efforts on helping my company execute its business plan and making sure that nobody is cutting any corners to achieve that execution.

      But with a new administration and issues in the financial marketplace, I expect to see some form of new regulatory requirements. Will they prevent Ponzi schemes? No, the government cannot prevent Ponzi schemes.

      Investors prevent Ponzi schemes. If it sounds too good to be true, it probably isn’t true. Guaranteed returns with no risk? It better be a bank with FDIC insurance (or the equivalent).

      Thanks to Bruce Carton of Securities Docket for pointing out the Baldas article in his post: Wave of “Anti-Ponzi” Legislation May be Coming.

      See :

      France Decides Not to Criminalize International Bribery

      eiffel tower

      “France has severely restricted its jurisdiction and its ability to prosecute cases with an international dimension, which, given the country’s importance in the international economy and the scale of many of its companies, is very regrettable,” according to a report by GRECO. The Group of States against Corruption (GRECO) was established in 1999 by the Council of Europe to monitor States’ compliance with the organization’s anti-corruption standards.

      In June of 2000, France introduced legislation related to the OECD Convention. However in the GRECO report the evaluation team wonders “why, despite the economic weight of France and its close historical links with certain regions of the world considered to be rife with corruption, it has not yet imposed any penalties for bribing foreign public officials.” (¶ 76)

      France ratified the Criminal Law Convention on Corruption (ETS 173) on April 25, 2008 with an effective date of August 1, 2008. France entered two reservations as part of enacting the law.

      France’s Reservation on the Offense:

      “In accordance with Article 37, paragraph 1, of the Convention, the French Republic reserves the right not to establish as a criminal offence the conduct of trading in influence defined in Article 12 of the Convention, in order to exert an influence, as defined by the said Article, over the decision-making of a foreign public official or a member of a foreign public assembly, referred to in Articles 5 and 6 of the Convention.”

      France’s Reservation on Jurisdiction:

      “In accordance with Articles 17, paragraph 2, and 37, paragraph 2, of the Convention, the French Republic declares that it reserves the right to establish its jurisdiction as regards Article 17, paragraph 1.b, of the Convention, only when the offender is one of its nationals and the offences are punishable under the legislation of the country where they have been committed, and that it reserves the right not to establish its jurisdiction regarding the situations referred to in Article 17, paragraph 1.c, of the Convention.”

      In my reading of the GRECO report, it sounds like France dropped the international bribery charge because it is too hard to prove and obtain conviction. (¶ 83)

      To be fair to France, GRECO has not yet completed the Third Evaluation Round for all 46 members. So other countries many take a similar position. But the 11 made public so far have not excluded bribery of foreign officials.

      France causes other problems with compliance programs. France blocks traditional SOX whistleblower programs because of concerns abut worker’s privacy.  If you want a whistleblower program in France, you need to register it with the CNiL and it must be limited to reports about the “vital interests of the company or it its employee’s physical or mental integrity”

      See:

      Approaching the Sphinx: The DOJ’s Opinion Release Procedure under the FCPA

      wrageblogAlexandra Wrage of the WrageBlog shares her experiences using the Department of Justice’s opinion release procedure under the Foreign Corrupt Practices Act: Approaching the Sphinx: The DOJ’s Opinion Release Procedure.

      Ms. Wrage takes us through the experiences of TRACE International in obtaining FCPA Opinion Procedure Release 08-03.

      The opinion release procedure for the Foreign Corrupt Practices Act is fairly unique for a criminal law. You can ask the government if your proposed action is potentially criminal.

      Betting the Corporation: Compliance or Defiance

      Lawrence D. Finder, Ryan D. McConnell & Scott L. Mitchell drafted a paper surveying the sixteen corporate deferred prosecutions and non-prosecution agreements entered into by the Department of Justice in 2008.

      Betting the Corporation: Compliance or Defiance? Compliance Programs in the Context of Deferred and Non-Prosecution Agreements – Corporate Pre-Trial Agreement Update – 2008

      In 2008, every agreement contained some sort of corporate compliance reform provision – continuing a trend we have seen over the last few years. This trend is the focus of this update. Aside from building on prior observations, this piece attempts to draw empirical observations about the types of compliance programs that come out of corporate pre-trial agreements. The authors recognize there is no one-size fits all template for corporate compliance programs. But by examining compliance programs in the context of DPAs and NPAs, the authors strive to provide a picture of what types of compliance measures are negotiated by the DOJ and corporate targets to resolve internal control and other business deficiencies that resulted in criminal wrongdoing. We hope that this will provide some guidance for attorneys and other professionals who deal with compliance issues.

      The authors note that one of the big changes in 2008 was the DOJ’s implementation of a new charging policy. (You can find it at 9-28.000 of the U.S. Attorney’s Manual.) Although the policy is no longer associated with a particular person (like the 2006 McNulty memo, the  2003 Thompson memo and the 1999 Holder memo), the nine factors for charging a corporation are still the same:

      1. the nature and seriousness of the offense;
      2. pervasiveness of wrongdoing;
      3. the company’s history of similar conduct;
      4. the company’s timely and voluntary disclosure;
      5. the existence and effectiveness of a pre-existing compliance program;
      6. the company’s remedial actions;
      7. the collateral consequences (including harm to shareholders) of a conviction;
      8. the adequacy of prosecution of individuals; and
      9. the adequacy of civil or regulatory remedies

      There is a new statement in USAM 9-28.200:” In certain instances, it may be appropriate, upon consideration of the factors set forth herein, to resolve a corporate criminal case by means other than indictment. Non-prosecution and deferred prosecution agreements, for example, occupy an important middle ground between declining prosecution and obtaining the conviction of a corporation.”

      A second change in 2008 was the issuance of the Morford Memo that addresses the use of corporate monitors, providing guidance on issues that may arise in the selection of a monitor and the monitor’s duties.

      2008 STATISTICS:

      Total Number of Agreements: 16
      Number of Privilege Waivers: 2   (13%)
      Number of Agreements with Compliance Monitors: 6   (38%)
      Number of Agreements With Compliance Reforms: 16 (100%)

      The link above is to a draft copy of the paper. The final version is scheduled to be published in the South Texas  Law Review in May 2009.

      Let’s Get Ethical!, Ethical!, I Want To Get Ethical…

      Those of you that watch NBC’s “The Office” see some of the best examples of what NOT to do in business every week. They also tackled what not NOT to do in an Ethics Training course. The clip shows some of the worst training skills (reading from the binder, HR-speak, etc.).

      It also provides an unusual example of a compliance problem, with Meredith sleeping with a supplier in exchange for a discount.

      Unfortunately, the ethical lapses are not limited to the rag-tag Scranton office, but also exist in the main office. The response to Meredith’s confession from the home office?: “I’m not sure that these circumstances warrant any action…this seems like a grey area.”

      Twitter and Presentations

      Follow me on Twitter
      Follow me on Twitter

      At President Obama’s State of the Union address, there was a fair amount coverage by the media and by the Congressman in attendance. Several dozen Congressmen have twitter accounts and many were sending out messages during the address.

      Is this Good or Bad?

      What about people in the audience when you are giving your next presentation?

      Is this Good or Bad?

      At my recent presentation with Bruce Carton, Web 2.0 – Leveraging New Media to Maximize Your Securities & Compliance Practice, Bruce and I kept an eye on the Twitter backchannel. I had published the #SecuritiesD hashtag and publicized it on a blog post and Twitter. There were a handful of twitter users during the presentation asking questions and publishing notes about the webinar to their followers. One tweet corrected an outdated statistic I cited. David Hobbie of Caselines used Twitter to keep his notes about the webinar and to capture soundbites from me and Bruce.

      I also had the experience of participating in a conference through Twitter. I did not attend LegalTech New York this year, after having attended it the last few years. Fortunately, several people I know and several people I follow on Twitter did attend. They were able to relay their thoughts about the speakers, relay soundbites and communicate with each other during the conference. I even asked a question on Twitter that got relayed to speaker, answered and relayed back to me through Twitter. The use of Twitter spread the conference beyond the four walls of the convention hall. That is very powerful.

      Is Twitter a good thing during presentations? Yes!

      Try integrating it during your next presentation. I will.

      See also: