2009 – Page 54 – Compliance Building

Top Ten Individuals We Won’t Miss from 2008

In addition to its list of the 100 Most Influential People in Business Ethics for 2008, Ethisphere also published a list of the Top Ten Individual We Won’t Miss from 2008.

Bernard Madoff
David Colby – Colby was the former CFO of Wellpoint who was caught carrying on multiple affairs on the side, even once texting “ABORT!!” to one of his many girlfriend’s after discovering she was pregnant. He carried on relationships with over 30 women and proposed to at least 12 of them.
Rod Blagojevich
Heinz-Joachim Neubürger, Karl-Hermann Baumann, and Johannes Feldmayer – The two former CFOs and former Chairman of Siemens, respectively.
Ted Stevens – the Senator from Alaska who was found guilty of failing to report gifts given to him by various contractors.
Bruno A. Kaelin – a former senior vice president and head of corporate compliance at Alstom, arrested in Switzerland in August 2008 for a joint Franco-Swiss-Italian investigation for his alleged role in running a bribery slush fund and laundering hundreds of millions of euros.
Adam Vitale – Vitale was sentenced to 30 months in prison and $180,000 restitution to be paid to AOL after he found a way to spam 1.2 million AOL users in a way that avoided being caught by AOL’s spam filter.
Robert Rubin – Rubin, like it or not, became one of the faces tied to the 2008 financial crisis. His position of deregulation when he was Treasury Secretary is now faulted by some for many of the problems of today. He also became the fall guy for Citigroup’s business strategy of leveraging more risk.
Marco Benatti – Benatti was a former Italian director of advertising for WPP. Benatti, who was accused of libel last year for calling WPP chief executive Sir Martin Sorrell a “mad dwarf,” was alleged to have secretly pocketed millions of pounds from a deal he helped to broker. WPP’s lawyers, claiming up to ₤12.5 million for breach of “fiduciary duty,” alleged at a court hearing in London that Benatti was the “secret beneficiary” of most of the proceeds from a ₤17 million takeover of Media Club, an Italian advertising company.
James M. DiBlasio – DeBlasio makes the list for going on a three day bender and hacking into the computers of his company, Ski.com, while drunk.

100 Most Influential People in Business Ethics 2008

Ethisphere has published its list of the 100 Most Influential People in Business Ethics for 2008.

The winners are broken down into the following nine core categories:

Government and Regulatory
Business Leadership
Non-Government Organization
Design and Sustainability
Media and Whistleblowers
Thought Leadership
Corporate Culture
Investment and Research
Legal and Governance

Here is the list:

1. Liu Qi
2. Neelie Kroes
3. Heinrich Kieber
4. Kim Yong-chul
5. Mark F. Mendelsohn
6. Lee Scott
7. Shan Ramburuth
8. Bobby Jindal
9. Myron Steele
10. Philip Collins
11. David Steiner
12. Angel Gurría
13. Ronald Luri
14. Barack Obama
15. Christoph Frei
16. Jeff Immelt
17. Nguyen Van Hai & Nguyen Viet Chen
18. David L. Stub
19. David Parker
20. Thomas Friedman
21. Davor Harasic
22. Anne M. Mulcahy
23. Dawn Primarolo
24. Ben W. Heineman, Jr.
25. Nicolas Sarkozy

26. Dong Zhengqing
27. Leslie Gaines-Ross
28. R. Alexander Acosta
29. Cui Fan
30. Masamitsu Sakurai
31. Paul Krugman
32. Alexandra Wrage
33. Michael Hershman
34. Jed Rakoff
35. Dr. Anwar Nasution
36. Michael Johnston
37. Jim Senegal
38. Mike Barry
39. Marc Gunther
40. Neville Isdell
41. Eric Schmidt
42. Danny Wegman
43. Larry Thompson
44. H. Dean Steinke
45. James Jurwa
46. Sven Holmes
47. Lucas Benitez
48. Anonymous Chinese apartment owner
49. Earl E. Devaney
50. Nancy Boswell

51. Haruka Nishimatsu
52. Henry Waxman
53. Sudhanshu Pokhriyal
54. Virginia D. Klein
55. James A. Mitchell
56. Tim Costello
57. Jim Koch
58. Jim Tyree
59. Ken Livingstone
60. Kathleen M Hamann
61. Victor Marrero
62. Ben Popken
63. Howard Schultz
64. Klaus Töpfer
65. Harry Halloran
66. Le Hien Duc
67. Peter Kinder
68. Bernard Listiza
69. Joseph Keefe
70. Magnus Berglund
71. Manny A. Alas
72. Max Bazerman
73. Bob Langert
74. Patrick Fitzgerald
75. Thomas Boone Pickens

76. Dave Welch
77. Edward J. Zore
78. R. Edward Freeman
79. Mr. Frédéric Wehrlé
80. Greg Valerio
81. Chris MacDonald
82. James Goodnight
83. Brenda C. Barnes
84. Simon Ho
85. Gavin Newsom
86. Nobutaka Machimura
87. Anders Dalhvig
88. Odell Guyton
89. David Crawford
90. Patricia Werhane
91. Paul Newman
92. Barbara Krumsiek
93. Amy Domini
94. Richard McClellan
95. Rob Cameron
96. Harry Woolf
97. Tensie Whelan
98. Jack Grynberg
99. Alexander Solzhenitsyn
100. Kim Hun-sung and Park Jin-shik

Madoff Litigation: Can the Lost Billions be Recovered? How?

This post contains my notes from the webinar: Madoff Litigation: Can the Lost Billions be Recovered? How? The Webinar was sponsored by NERA Economic Consulting and produced by The Securities Docket. The slides are available on Securities Docket.com: Materials from Madoff Litigation Webcast.

Brad Friedman of Milberg LLP
Gerald Silk of Bernstein Litowitz Berger & Grossmann LLP
Dr. Fred Dunbar of NERA Consulting

Brad divides the world into those invested direftly through a Madoff account and those that invested through a feed fund or a fund of funds. The two groups of investors have different causes of actions and different approachs. Brad is representing both but focused his piece on direct investors.

The direct investors are in the worst position. Their biggest hope of recovery is from the SIPC. The limit is $500,000 for securities. The SIPC may also take the position that the limit is $100,000 (the cash limit) since Madoff apparently never invested in securities. Recovery is also limited to the dollars put in less the cash returned over time. Of course the direct investors will also have claims against the Madoff bankruptcy estate and should file a claim.

In an audience vote, 70% though Madoff should not be free on bail.

Gerald focuses on the issues arising from indirect Madoff investors. The feeder funds offer a deep pocket for recovery. In the case of a limited partnership structure, they will need to prove gross negligence or willful misconduct. Recovery will be governed by the partnership agreement and related documents. The other problem is that the general partner may be able to use the assets of the limited partnership to defend and indemnify themselves. You end up suing yourself.

Fred pointed out that there are lots of “losses”, but also lots of “damages” and probably very little “recovery.” Among the factors are (1) choice of law, (2) allocation among the parties based on conduct and causation and (3) time at which damages are estimated. The starting point for damages is going to be the differences between the reported value on the account statement and the actual value of the securities in the account.

Losses Due to Fraudulent Reported Value = Loss on Subscriptions – Gain on Redemptions (similar to 10b-5 damage valuations)

Fred cites the case of Goldstein v. SEC (DC Cir. 2006):

If the investors are owed a fiduciary duty and the entityis also owed a fiduciary duty, then the adviser will inevitablyface conflicts of interest. Consider an investment adviser to ahedge fund that is about to go bankrupt. His advice to the fundwill likely include any and all measures to remain solvent. Hisadvice to an investor in the fund, however, would likely be tosell. …It simply cannot be the case that investment advisers are theservants of two masters in this way.

It was a great panel. Thanks to the panelists, sponsors and publishers of the webcast.

New York State Bar Position on Carried Interest

Besides the position of Professor Bankman on carried interest, the New York State bar submitted a very detailed report and recommendations to the House Committee on Oversight and Government Reform: New York State Bar Tax Section Report on Carried Interest and Fee Deferral Legislation (.pdf) September, 2008

Joseph Bankman Testimony on Hedge Fund Tax Treatment

The House Committee on Oversight and Government Reform held a hearing on hedge funds and the financial market on November 13, 2008. Among those testifying was Professor Joseph Bankman, the Ralph M. Parsons Professor of Law and Business at Stanford Law School: Testimony of Joseph Bankman.

Professor Bankman points out that the carried interest of a private equity fund sponsor is typically taxed as capital gains (assuming the underlying assets are held long enough). professor Bankman points out his dislike of the tax advantages and proposes a legislative change:

The Alternative Minimum Tax Relief Act of 2008 contained a provision that would have taxed carry at ordinary income rates. That Act passed the House of Representatives in June, 2008, but died in the Senate. Thus, carry remains tax-favored. I recommend that Congress eliminate the tax advantage given to carry by again passing a measure similar to that contained in the Alternative Minimum Tax Relief Act of 2008. I recommend, though, that such a measure be amended to address the concerns expressed in the New York State Bar Association Report on Proposed Carried Interest and Deferred Fee Legislation.

Thanks to the Hedge Fund Law Blog for pointing out this resource: Hedge Fund Taxation – Law School Professor Perspective.

The SEC v. Mark Cuban Insider Trading Case

McDermott Will & Emery put together an excellent peice on insider trading: The SEC v. Mark Cuban Insider Trading Case (.pdf) by Stephen E. Older and Seth T. Goldsamt.

Insider trading under U.S. law has developed through a case-by-case interpretation of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 in the federal courts. There are three basic elements to an insider trading claim. The elements include purchasing or selling a security after receiving information that is material, nonpublic, and obtained or used in breach of a fiduciary or similar duty.

There are two major theories of insider trading under federal law flowing from two different types of duties: the “classical” theory and the “misappropriation” theory. Under the classical theory of insider trading, the agents of an issuer of securities may be corporate insiders (e.g., directors, officers, employees or controlling shareholders) or they may be “temporary” insiders by virtue of a professional relationship giving the agent access to nonpublic information about the issuer. A temporary insider is typically a lawyer, banker, accountant or consultant. If someone falls into either category and receives material, nonpublic information, then that person must either disclose such information to his counterparty before trading or abstain from trading. Under the misappropriation theory, a person will be held liable if he or she traded on material, nonpublic information and owed a duty to maintain trust and confidence to the source of that information.

The authors take you through the elements of insider trading and how it relates to the public information about the Mark Cuban case.

They also take us through the industry practice for PIPE transactions.

In a typical PIPE transaction, the placement agent will contact an investment fund’s compliance officer or in-house counsel and disclose limited information about the PIPE issuer. The compliance officer then runs this information against the fund’s restricted list, which is a list of investments in which the fund currently has a position. This is done to ensure that the fund will be able to freely trade investments it has already made. If the compliance officer finds the issuer’s name on the fund’s restricted list, he generally will decline to learn anything further about the offering. If the issuer’s name is not on a restricted list and the potential investor is interested in participating in the PIPE transaction, currently, best practices call for the placement agent either to have such investor sign a confidentiality agreement or a securities purchase agreement that includes a confidentiality provision, or to read a detailed script regarding confidentiality and have the investor consent in the presence of witnesses. This procedure is meant to prevent the circumstances now being litigated between the SEC and Mr. Cuban.

Bingham Presentation on Massachusetts Data Security Law

bingham_logo Bingham McCuthen LLP put together a panel presentation on the Complying with Massachusetts New Data Security Regulations.

Mark Robinson, a partner at Bingham, started with an introduction of the law and panel. He called the law “perilous.”

Beth Boland, a partner at Bingham, went through the requirements of the new law. OCBR and the business community seem to be at a disconnect over the law. OCBR thinks that they are not a big deal. They cite a statistic that there were over 318 reported breaches that affects more than 500 Massachusetts residents during a 10 month period when they were considering the law. [See Report of M.G.L. Chapter 93h Notifications (.pdf)]

Beth highlighted the limitation that data should only be collected that is “reasonable necessary to accomplish the legitimate purpose for which it is collected” 201 CMR §17.03(g) is unique to Massachusetts.

Beth highlights one of the pitfalls being the cascading certifications. First, there is no standard for certification. She expects there will be some battle over acceptable forms. Second, you need to folow the certification process all the way down the chain of custody to your providers, the sub-providers, the sub-sub providers, etc.

Beth highlighted that May 1, 2009 is deadline for getting contractual agreement that service providers will comply and January 1, 2010 is the deadline for getting a compliance certification.

Doug Schwarz, a partner at Bingham, pointed out that in some organizations, the requirements will mostly affect Human resources and that HR may end up driving the process instead of IT.

Enforce Your Email and Web Acceptable Usage Policies

MessageLabs (now part of Symantec) published a whitepaper Not Just Words: Enforce Your Email And Web Acceptable Usage Policies. The Whitepaper was written by Nancy Flynn, Executive Director of the ePolicy Institute.

Email & Web Rule #1:
Comply with Legal and Regulatory Rules
Email & Web Rule #2:
Enforce Acceptable Usage Policy with Training and Technology
Email & Web Rule #3:
Control Written Content to Control Risk
Email & Web Rule #4:
Protect Resources, Preserve Productivity and Prevent Lawsuits
Email & Web Rule #5:
Personal Use Heightens Risk
Email & Web Rule #6:
Exercise Your Legal Right to Monitor
Email & Web Rule #7:
No Reasonable Expectation of Privacy
Email & Web Rule #8:
Lock Out Malicious Intruders
Email & Web Rule #9:
Annual Review of Acceptable Usage Policies

Irrational Exuberance

In an essay in the Wall Street Journal, Stephen Greenspan explains some of the psychology behind the success of Ponzi schemes: Why We Keep Falling For Financial Scams.

The basic mechanism explaining the success of Ponzi schemes is the tendency of humans to model their actions — especially when dealing with matters they don’t fully understand — on the behavior of other humans. This mechanism has been termed “irrational exuberance,” a phrase often attributed to former Federal Reserve chairman Alan Greenspan (no relation), but actually coined by another economist, Robert J. Shiller, who later wrote a book with that title. Mr. Shiller employs a social psychological explanation that he terms the “feedback loop theory of investor bubbles.” Simply stated, the fact that so many people seem to be making big profits on the investment, and telling others about their good fortune, makes the investment seem safe and too good to pass up.

In Mr. Shiller’s view, all investment crazes, even ones that are not fraudulent, can be explained by this theory. Two modern examples of that phenomenon are the Japanese real-estate bubble of the 1980s and the American dot-com bubble of the 1990s. Two 18th-century predecessors were the Mississippi Mania in France and the South Sea Bubble in England (so much for the idea of human progress).

Mr. Greenspan has model of four explanatory factors for “foolish action.”

situation – a social challenge you need to solve
cognition – a deficiency in knowledge and/or clear thinking
personality – trust and niceness
emotion – greed or the desire to not lose