Year: 2010

Cheap Sunglasses and Compliance

Can cheap sunglasses affect your ethical behavior?

An important part of a compliance program is monitoring and improving the ethical behavior of your workforce. I’m always intrigued by ethics experiments.

Francesca Gino of Chapel Hill, Michael Norton of Harvard Business School, and Dan Ariely of Duke tested the effect of wearing knock-off designer sunglasses. They wanted to see if knowing you were wearing knock-offs would affect your behavior.

It did. Those subjects told they were wearing knock-off designer sunglasses cheated more than those who were not told.

The scientists asked two groups of young women to wear sunglasses taken from a box labeled either “authentic” or “counterfeit.” (All the eyewear was authentic.) Then the researchers put the participants in situations in which it was both easy and tempting to cheat.

People still cheat when its easy and tempting. Of those in the “authentic” group, 30% inflated their scores. But in the “counterfeit” group 71% inflated their scores.

They ran a bunch of other tests using the same theory that knowingly wearing knock-off designer sunglasses leads to degraded ethical behavior. It seems to have a very significant impact.

A lesson for compliance professionals: Don’t use knock-off goods in your program.

Dan Ariely talks about the findings in this video:

Sources:

Image of Knockoff Shades is by sparktography.

SEC Votes on Pay to Play

At Wednesday’s Open Meeting the Securities and Exchange Commission took up the discussion of their proposed rules on pay-to-play for investment advisers. The proposal is a new Rule 206 (4)-5 under the Investment Advisers Act. The Commission voted unanimously to adopt the rule.

The rule will have three main prongs:

Two Year Time-Out

An investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser would be barred for two years from providing advisory services for compensation, either directly or through a fund.

There will be two de minimis exceptions. For an official the person can vote for, you can contribute up to $300 350. That exception is lowered to $150 if you are not entitled to vote for the official.

There is a limited ability to get a return of a political contribution for inadvertent violations. It sounds like this will be difficult.

There was a mention that the political contributions limitation may not affect all employees of an investment adviser.

Coordination

The proposed rule also would prohibit an adviser from coordinating, or asking another person or political action committee to:

  1. Make a contribution to an elected official (or candidate) who can influence the selection of the adviser.
  2. Make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to the government.

The SEC does not want investment advisers to be gatekeepers or aggregaters for political contributions to elected officials who select investment advisers for government funds.

Placement Agents and Solicitors

The third prong would prohibit advisers from hiring third party persons to act as agents or solicitors for an investment adviser unless the third party is a regulated person subject to pay-to-play regulation similar to this rule. The placement agents will need to a registered investment adviser or broker-dealer.

The comments to the flat ban resulted in the most comments to the rule. This is the biggest change to the final rule will vary from proposed rule.

They are going to keep a close eye on placement agents. If there continues to be a problem, the SEC is prepared to put a complete ban in place.

Catch-All

There is a catch-all provision is the rule that prohibits indirect violation of the rules.

Applicability

Rule 206 (4)-5 will apply to registered investment advisers and unregistered investment advisers who are relying on the small adviser exception to registration. (Of course, that exception is likely to be eliminated shortly as part of the financial reform legislation.) Private equity fund managers and their employees will be subject to this rule.

There will be a one year period before the placement agent limitations are effective. This is designed to give FINRA time to enact its new regulations on pay-to-play.  It’s not clear if the one-year period is applicable for the other parts of Rule 206 (4)-5.

First Amendment

Commissioner Casey raised a concern that the rule not violate the first amendment rights to engage in the political process. She thought the rule struck a good balance. Commissioner Parades was concerned about rogue employees making contributions in violation of the policy.

Full Text

As is typical with the SEC rules, the final text of Rule 206 (4)-5 was not released at the time of the vote. Keep an eye out for the final release and its detailed requirements.

Sources:

Should Private Funds Have more than $10 Billion?

The current draft of the Dodd-Frank Wall Street Reform and Consumer Protection Act has a surprise in it for big hedge funds. By “surprise” I mean tax.

Title XVI: Financial Crisis Special Assessment has a $19 billion fee ready to be assessed against financial companies institutions with more than $50 billion in assets and hedge funds with more than $10 billion under management. This $19 billion in “fees” is being assessed to support the new government initiatives in the financial reform legislation.

Section 1601(f)(2) leaves up to the new Financial Stability Oversight Council to define a hedge fund (in consultation with the SEC). The amount owed by any particular hedge fund manager will depend on a matrix of contributing factors. Section Section 1601(g) lays out thirteen factors the Council will need to take into account.

Before you start handing money back to limited partners to get under the $10 billion threshold you may want to wait for the legislative process to continue. Senator Brown of Massachusetts is opposed to new taxes and is threatening to withhold his vote. (I didn’t vote for him.) With the death of Senator Byrd, the Democrats need to pull in more Republican votes to get the financial reform bill passed in the Senate.

Update: The Boston Globe is reporting that the $19 billion tax has been removed from the bill: Brown’s Threat Gets Bank Tax Removed.

Sources:

Image of Money series 2 is by Mokra

GRC Professional Survey

The folks at the Open Compliance & Ethics Group have been developing a professional education and certification program for governance, risk management and compliance professionals. Basically, it’s a program that helps to build on existing credentials and “round out” an executive’s skills so that they are more effective at integrating all of these processes (e.g., internal auditors learn basic legal and investigation skills; lawyers learn basic auditing skills; everyone learns leadership skills).

To ensure that the education and certification models are valid, they conducted a series of job analyses with experts and member organizations over the past 5 years. As a final step, they broadened this study to include their entire membership and even those outside of their membership.

Please help them by participating in a confidential survey. The survey takes 15 to 45 minutes to complete. (It took me 45.) Anyone who completes the survey by Friday, July 2nd will receive $200 credit toward the education and certification program when it is complete.


http://surveys.oceg.org/s3/grc-job-analysis

Please take a few moments to participate.

Final Text of the Private Fund Investment Advisers Registration Act of 2010

There is a lot happening in the Dodd-Frank Wall Street Reform and Consumer Protection Act. (Yes, that appears to be the agreed upon name of the financial reform bill.)

I’m most interested in its Title IV: Private Fund Investment Advisers Registration Act of 2010(.pdf).

The act will remove the current exemption from SEC registration for “small” investment advisers. If you have more than $30 million under management and fewer than 15 clients, you were exempt from registration with SEC under section 203(b)(3).

If the bill is enacted, that exemption will be removed and private fund managers will have to register. If the manager has more than $150 million under management they will register with SEC.

The final text of the Private Fund Investment Advisers Registration Act of 2010has been released.

The Senate-House Conference Committee has released all 2319 pages of the the final text of its conference report: Dodd-Frank Conference Report. I’ll get to the rest of it at some point.

As of this morning, it sounds like the bill is still short of the votes necessary to get it passed in the Senate. One of my Senators, Scott Brown, is unhappy with the new tax imposed by the too-big-to-fail regime. He would be vote 41 and could prevent a filibuster from stopping the bill from a final vote in the Senate.

Sources:

  • Conference Report on Private Fund Investment Advisers Registration Act of 2010.
  • Dodd-Frank Wall Street Reform and Consumer Protection Act conference report and votes from the House Financial Services Committee

Updated pdf file with text of the Private Fund Investment Advisers Registration Act of 2010

PCAOB is Fixed – May Take Other Agencies Down (or get Fixed)

In the Free Enterprise vs. PCAOB decision, the Supreme Court found that a double layer of limitation of firing for cause is unconstitutional. You can’t have an agency where the officers are only removable for cause under another federal agency whose members are only removable for cause. One level of protected tenure is acceptable, but two is not.

In his dissent, Justice Breyer argued that PCAOB is not the only agency that had two level of protected tenure. He goes on to name names. He identifies four other appointments that have more than one level of protection.

Federal Labor Relations Authority: Foreign Service Labor Relations Board
“The Chairperson [of the FLRA, who also chairs the Board] may remove any other Board member . . . for corruption, neglect of duty, malfeasance, or demonstrated incapacity to perform his or her functions . . . .” 22 U. S. C. §4106(e)

General Services Administration: Civilian Board of Contract Appeals
“Members of the Civilian Board shall be subject to removal in the same manner as administrative law judges, [i.e., ‘only for good cause established and determined by the Merit Systems Protection Board.’] ” 41 U. S. C. §438(b)(2)

Postal Service: Inspector General
“The Inspector General may at any time be removed upon the written concurrence of at least 7 Governors, but only for cause.” 39 U. S. C. §202(e)(3)

Social Security Administration: Office of the Chief Actuary
“The Chief Actuary may be removed only for cause.” 42 U. S. C. §902(c)(1)

I think Justice Breyer just removed tenure from these positions.  In reading the PCAOB decision, I don’t think these positions are unconstitutional. Merely, they have lost their tenure and can now be removed at-will by the independent boards that appoint them.

PCAOB is Ruled Unconstitutional

This morning, the United States Supreme Court issued its opinion in the case of Free Enterprise Fund v. PCAOB. For me in the compliance world, the case was about the viability of PCAOB under Sarbanes-Oxley. For the constitutional scholars it is an important separation of powers case.

Responding to concerns about accounting that led to the collapses of Enron and WorldCom, Sarbanes-Oxley established PCAOB as an independent body to oversee the firms that do accounting for public companies. The law gave the Securities and Exchange Commission power to name the members of the Public Company Accounting Oversight Board.

The trouble is that the President has no power to remove the Commissioners of the SEC, other than the Chair. The President can only appoint them. Similarly, the SEC selects the board members of PCAOB, but cannot remove them. The Free Enterprise group says that violates a clause of the Constitution giving the president the power to appoint government officials except for certain instances involving inferior officers.

The Supreme Court ruled that the limitations on the power to remove the members of the board is unconstitutional under the separation of powers doctrine. The board members are inferior officers, and the method of appointment under the Sarbanes-Oxley Act violates the Appointments Clause.

The ruling does not seem to shut down PCAOB immediately since the Court declined to allow a broad injunction against PCAOB’s continued operation. The challengers to the method of PCAOB board-member appointment are entitled to a declaratory order “sufficient to ensure that the reporting requirements and auditing standards to which they are subject will be enforced only by a constitutional agency accountable to the Executive.”

The Court also found the PCAOB provisions severable from the rest of Sarbanes-Oxley, so they did not invalidate the entire law.

There will have to be some quick tinkering by the SEC and Congress on how to deal with the ruling.

Administrative law professors will need to tinker with their classroom teaching and casebooks to address this case and its implications.

Update – Some key quotes from the Opinion:

We hold that the dual for-cause limitations on the removal of Board members contravene the Constitution’s separation of powers.

The Act before us does something quite different. It not only protects Board members from removal except for good cause, but withdraws from the President any decision on whether that good cause exists. That decision is vested instead in other tenured officers—the Commissioners— none of whom is subject to the President’s direct control.The result is a Board that is not accountable to the President, and a President who is not responsible for the Board.

Second Update

[T]he existence of the Board does not violate the separation of powers, but the substantive removal restrictions imposed by §§7211(e)(6) and 7217(d)(3) do. Under the traditional default rule, removal is incident to the power of appointment. … Concluding that the removal restrictions are invalid leaves the Board removable by the Commission at will, and leaves the President separated from Board members by only a single level of good-cause tenure. The Commission is then fully responsible for the Board’s actions, which are no less subject than the Commission’s own functions to Presidential oversight.

That leaves the 15 U.S.C. §7211(e)(6) and 15 U.S.C. §7217(d)(3) out in the cold, but saves PCAOB and Sarbanes-Oxley from destruction in a very narrow ruling. It seems that Congress will not need to take any action since the decision merely grants the SEC the right to remove any Board member for any reason. No longer is removal limited to a firing “for cause.”

There may be some argument that the past rulings and standards set by PCAOB were made by an unconstitutional. That’s heading down a path way beyond my expertise (or interest).

So life will continue on, but the PCAOB board members have  less job security.

Sources:

Chief Compliance Officers and Private Investment Funds

If you are running a private investment fund, do you need a chief compliance officer?

If you are not registered with the SEC, it’s a gray area. If you are registered with SEC, then “yes.”

Rule 206(4)-7 requires a registered investment adviser to “[d]esignate an individual (who is a supervised person) responsible for administering the policies and procedures that you adopt under paragraph (a) of this section.”

Since the financial reform bill is going to remove the small adviser exemption from registration, hundreds (thousands?) of private fund managers will need to register with the SEC once the bill is finalized and signed by the president.

Do you need to hire a new person to serve as CCO? The rule does not require advisers to hire an additional executive to serve as compliance officer. [See Footnote 74 of SEC Release No. IA-2204] You merely have to designate someone to serve in the role.

What are the requirements for a CCO for private equity fund?

  • Must be competent and knowledgeable regarding the Advisers Act.
  • Must be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the firm.
  • Must have sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.

Having the knowledge about the act is going have many firms look toward their general counsel to act as CCO.

A dual role of general counsel and CCO may put the individual into conflict with their obligations to maintain attorney-client privilege.

Sources:

Image is Yes from Administration by Ranken Jordan

SEC’s Rule on Pay to Play is Coming

It’s been almost a year, but it looks like the SEC is ready to issue its rule on political contributions by investment advisers. They announced the subject matter for the Wednesday June 30 10:00 am open meeting:

The Commission will consider whether to adopt a new rule and related rule amendments under the Investment Advisers Act of 1940 to address “pay to play” practices by investment advisers. The new rule is designed to prohibit advisers from seeking to influence the award of advisory contracts by public entities by making or soliciting political contributions to or for those officials who are in a position to influence the awards.

Since private equity funds will have to register as investment advisers, the rule will be applicable.  Actually, the proposed rule was drafted to be applicable to registered investment advisers or those unregistered in reliance on the exemption under Section 203(b)(3), so it would have been applicable to most private equity funds anyhow.

Back in April, the SEC engaged FINRA to craft rules for registered broker-dealers when acting as a placement agent soliciting investments from government investors. That would make it likely that placement agents will not be banned, but merely subject to some additional regulatory requirements.

The proposed rule limited political contributions to $250 per election per candidate if the contributor is entitled to vote for the candidate. Otherwise, the investment adviser would be subject to a two-year ban on providing advisory services for compensation to that government investor.

Private equity firms gearing up for registration will need to include a policy on political contributions. Next week we will not what need to be in that policy.

Sources:

Compliance Bits and Pieces for June 25

Here are some recent stories that I found interesting:
Officially our best-ever cease and desist from ThinkGeek

But what makes this cease and desist so very, very special is that it’s for a fake product we launched for April Fool’s day.

No Fund for States to Oversee Advisers? by Mark J. Astarita, Esq. on SECLaw.com

If the legislation that is currently moving through Congress passes, state regulators will take responsibility for the oversight of all investment advisers who manage less than $100 million dollars, a change from the current benchmark of $30 million dollars. While the state regulators have been pushing hard to increase their power through this piece of legislation, there is one small problem – they don’t have the funds to regulate all of these additional advisers.

Why You Should Care About Derivatives Reform by Matt Kelly in Compliance Week‘s The Big Picture

Like most human beings, I somewhat wish derivatives had never been invented—not because they aren’t useful (they are), but because discussion of how to regulate the derivatives trade makes my head hurt. I’m sure I am not alone on this. Nevertheless, how derivatives are created, traded, and disclosed to the public is indeed an important discussion to have.

Blogging for Law Firms by Jordan Furlong in the Law Firm Web Strategy blog

I still think that the benefits of blogging tend to accrue to the blogging lawyer more than to the firm where he or she works, and that a lawyer’s voice and personality are the key elements of a truly successful blog. But I’m no longer prepared to say that a law firm can’t use blogs as effective marketing and communication tools. My opinion has evolved because both blogs and the profession have evolved since then too.

Damn.