Year: 2010

Nominations Open for the 2010 Clawbies

Nominations are open for the 2010 Clawbies, , honoring the best in Canadian legal blogs.

My old blog, KM Space, was a past two-time winner of a Clawbie: Friend of the North 2007 and Friend of the North 2008. Compliance Building stayed on the Clawbie list for 2009.

It looks like I didn’t pay much attention to Canada during 2010, since I only published two Canada posts:

With the flurry of regulatory changes happening south of the 49th Parallel, I have not paid much attention to the Canadian law blogs dealing with compliance, privacy, ethics and other topics that interest me here at Compliance Building.

I will throw two blogs in for nominations:

  1. Brian Bowman – On the Cutting Edge. This was the only Canadian blog that made it into one of my blog posts for 2010. It’s only fair that I nominate it.
  2. The Business Ethics Blog by Chris MacDonald. He has a Ph.D. instead of a JD and business ethics is not a pure legal topic. However, if business lawyers are not thinking about business ethics, then they are not doing their jobs very well. Just because something is legal, does not mean it is ethical or a questionable move by the company.

I would also throw Stem Legal’s Law Firm Web Strategy blog and Jordan Furlong’s Law 21 into pool, but since they are sponsors, I assume they are not eligible. (Oddly, Law 21 garnered a nomination from the American Bar Association for their Blawg 100. I guess the ABA is looking to annex Canada.)

Which Real Estate Fund Managers are Registered with the SEC?

After looking at whether a fund manager is an investment adviser and whether real estate is a security, I looked at the Private Equity Real Estate News list of the 30 biggest private equity real estate firms in the world (.pdf). (Disclosure: my company is on the list.)

How many of them are already registered with the SEC.

1 The Blackstone Group Yes
2 Morgan Stanley Real Estate Investing Yes
3 Tishman Speyer
4 Goldman Sachs Real Estate Principal Investment Area Yes
5 Colony Capital Yes
6 LaSalle Investment Management Yes
7 Beacon Capital Partners
8 The Carlyle Group Yes
9 MGPA
10 Lehman Brothers Real Estate Private Equity Yes
11 CB Richard Ellis Investors Yes
12 Westbrook Partners
13 Starwood Capital Group Yes
14 AREA Property Partners
15 Prudential Real Estate Investors Yes
16 Rockpoint Group
17 daVinci Advisors
18 Grove International Partners
19 Hines
20 Lubert-Adler Real Estate Yes
21 RREEF Alternative Investments Yes
22 Walton Street Capital Yes
23 Citi Property Investors Yes
24 Angelo, Gordon & Co Yes
25 Bank of America Merrill Lynch Global Principal Investments Yes
26 Shorenstein Properties
27 Lone Star Funds Yes (Hudson Advisers)
28 Heitman Yes
29 Aetos Capital Yes
30 Rockwood Capital

If you do the math, 19 of the top 30 are already registered with the SEC as Investment Advisers. I expect to see several more in the “yes” column before July 21, 2011, the registration deadline under Dodd-Frank.

The PERE 30 measures capital raised for direct real estate investment through commingled vehicles, together with co-investment capital, over the past five years.

Compliance Bits and Pieces for December 3

Here are some recent compliance-related stories that caught my attention:

Transparency International Alleges Intimidation in Pakistan by Joe Palazzolo in WSJ.com’s Corruption Currents

Transparency International says its branch in Pakistan has received death threats from government officials, in connection with the anti-corruption organization’s agreement with the U.S. to monitor aid flows to the country. Syed Adil Gilani, chairman of Transparency International Pakistan, told The Wall Street Journal the threats came from “high-level” Pakistani officials, telling him to halt his organization’s anti-graft investigations.

Imagining a World of Legalized Insider Trading by Bruce Carton in Compliance Week‘s Enforcement Action

There are arguments for legalizing insider trading that revolve around promoting the free flow of information–I get that. There are also arguments against legalizing insider trading that equate insider trading with the theft of information and conclude that it should be punished for the same reasons that we punish other forms of theft of property–I get that, too (and tend to agree). But put all that aside, for a moment, and join me in imagining a world where insider trading is completely legal. Here is how I see life in Legalized Insider Trading (LIT) World. …

Big 4 Bombshell: “We Didn’t Fail Banks Because They Were Getting A Bailout” by Francine McKenna in re: The Auditors

The leadership of the Big 4 audit firms in the UK has admitted that they did not issue “going concern” opinions because they were told by government officials, confidentially, that the banks would be bailed out.

SEC Relies On Questionable Legislative History In Proposed VC Definition by Keith Paul Bishop in California Corporate & Securities Law blog

The SEC considered California’s definition of “venture capital companies” in 10 CCR § 260.204.9 but felt that California’s rule was inconsistent with Congressional intent because the California rule doesn’t limit investments to companies that are not publicly traded. This sounds plausible, but the SEC’s evidence of Congressional intent is surprisingly weak. Essentially, it consists of the testimony of two individuals before the Senate Banking Subcommittee on Securities, Insurance and Investment Hearing a year before the enactment of the Dodd-Frank Act and several months before the Dodd-Frank Bill was even introduced into Congress.

5 Important Fraud Investigation Interview Tips by Lindsay Khan in FCPA Compliance and Ethics Blog

To conduct an investigation interview, you don’t need to be Sherlock Holmes- but it wouldn’t hurt to channel your inner detective. Fraud investigation interviews are a lot of work, but can take your investigation from ho hum to awesome. A successful investigation interview isn’t just a question and answer period. Asking good questions is just a small piece of a very big puzzle. To get the most out of your fraud investigation interviews, remember these 5 important steps: …

Budget Forces SEC to Shelve Whistleblower Office, For Now by Bruce Carton

In October, an 18% budget increase that the SEC was supposed to receive under Dodd-Frank was not included in a stopgap spending bill to fund government operations through early December. Now, the WSJ reports, the SEC has been forced to shelve its plan to open a new whistleblower office as mandated by Dodd-Frank. The agency says that it cannot open that office, and four other new offices created under Dodd-Frank, without an increased budget.

The Perfect Christmas Present: Your Own Aircraft Carrier

The Office Holiday Party – Alcohol-Induced Stupidity Can Lead to Serious Sexual Harassment Claims by Daniel Schwartz

There are no statistics out there to prove this point, but the traditional office holiday party has to be among the top places where claims of sexual harassment and hostile work environment start. Indeed, just a cursory look at some federal employment cases shows a common thread that run through each of them: alcohol-induced stupidity leading to serious sexual harassment claims.

Job Description For CCOs of Advisers to Private Investment Funds

help wanted join the insanity now

Back in 2005, Associate Director Office of Compliance Inspection and Examinations of the SEC, Gene Gohlke gave a speech addressing hedge funds who would soon have to register under the doomed hedge fund rule. He focused on what the funds needed in a Chief Compliance Officer.

Rule 206(4)-7 requires a registered investment adviser to designate an individual responsible for administering the policies and procedures required to avoid violation of the Investment Adviser Act and its rules. That’s all the rule requires of a CCO.

The release adopting the Rule 206(4)-7 provides some more background on the requirement:

An adviser’s chief compliance officer should be competent and knowledgeable regarding the Advisers Act and should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the firm. Thus, the compliance officer should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures. [C.1.]

The release also makes it clear that the adviser does not have to hire an additional person to take on the rule.

Knowledgeable

A CCO must have a good understanding of the requirements imposed by the Advisers Act, the related rules, and other aspects of the regulatory regime for advisers. A CCO should also remain current regarding changes to the regulatory requirements as the SEC changes and adds to them.

Competent

Gohlke lays out the need to have familiarity with the steps needed to create a compliance program:

  • Risk identification and assessment.  Know how to identify conflicts and other compliance factors creating risk exposure for the firm and its clients in light of the firm’s particular operations.
  • Creating policies and procedures. Address the risks identified. The policies and procedures should address all conflicts of interest and other risks the firm is exposed to and not a set of risks that advisers in general may have.
  • Implementation. Recognizing the principles of good management and controls.

Position in Organizational Structure

The compliance officer should have a position of sufficient seniority and authority within the organization to be able to compel others to adhere to the firm’s compliance policies and procedures. CCOs should be a member of the senior management of a firm.

The 24 Functions

Gohlke lays out a list of 24 functions that CCOs of advisers should perform or consider performing. (He admits that this ia an ambitious list and that they are above and beyond what is required by Rule 206(4)-7.)

  1. Advises senior management on the fundamental importance of establishing and maintaining an effective culture of compliance within the firm.
  2. Confers with and advises other senior management of the firm on significant compliance matters and issues.
  3. Is not only available but is sought out on a “consulting” basis regarding compliance matters and issues by business people throughout the firm. Should become known as the “go to person” on compliance matters.
  4. Becomes involved in analyzing and resolving significant compliance issues that arise.
  5. Ensures that the steps in the firm’s compliance process – risk identification, establishing policies and procedures and implementing those policies and procedures – are appropriate and are undertaken timely by staff of the firm to whom those functions have been assigned.
  6. Becomes personally involved in various steps of the process such as serving on risk or policies and procedures committees when necessary and appropriate.
  7. Ensures that compliance policies and procedures are comprehensive, robust, current and reflect the firm’s business processes and conflicts of interest.
  8. Ensures that appropriate principles of management and control are observed in the implementation of policies and procedures. These principles include separation of functions, clear assignment of responsibilities, measuring results against standards and reporting outcomes.
  9. Ensures that all persons within the firm with compliance responsibilities are competently and fully performing those functions.
  10. Ensures that quality control (transactional) testing is conducted as appropriate to detect deviations of actual transactions from policies or standards and that results of such tests are included on exception and other management reports and are promptly addressed, escalated when necessary, and resolved by responsible business people.
  11. Ensures there is timely and appropriate review of material and repetitive compliance issues as indicators of possible gaps and weaknesses in policies and procedures or risk identification processes and facilitates the use of such information in keeping the firm’s compliance program evergreen.
  12. Undertakes periodic analyses and evaluation of compliance issues found in the regular course together with the results of appropriate forensic testing conducted by compliance staff as a means for obtaining additional or corroborating evidence regarding both the effective functions of the firm’s compliance program and the possible existence of disguised or undetected compliance issues.
  13. Ensures that compliance programs of service providers used by the adviser are effective so that the services provided by these firms are consistent with the adviser’s fiduciary obligations to its clients.
  14. Establishes a compliance calendar that identifies all important dates by which regulatory, client reporting, tax and compliance matters must be completed to ensure that these important deadlines are not missed.
  15. Promotes a process for regularly mapping a firm’s compliance policies and procedures and conflicts of interest to disclosures made to clients so that disclosures are current, complete and informative.
  16. Manages the adviser’s compliance department or unit in ways that encourages proactive work, a practice of professional skepticism and “thinking outside the box” by compliance staff.
  17. Manages the adviser’s code of ethics which is a responsibility given to CCOs of advisers by rule 204A-1 under the Advisers Act.
  18. Undertakes or supervises others in performing the required annual review of an adviser’s compliance program. Every adviser is required to conduct at least an annual review of its compliance program. The review should consider any compliance matters that arose during the previous year, any changes in the business activities of the adviser or its affiliates, and any changes in the Advisers Act or applicable regulations that might suggest a need to revise the policies or procedures. Although the rule requires only annual reviews, advisers should consider the need for interim reviews in response to significant compliance events, changes in business arrangements, and regulatory developments.
  19. Reports results of the annual review to senior management and ensures that recommendations for improvements that flow from the review are implemented as appropriate.
  20. Is a strong and persistent advocate for allocating an appropriate amount of a firm’s resources to the development and maintenance of an effective compliance program and compliance staff.
  21. Recognizes need to remain current on regulatory and compliance issues and participates in continuing education programs.
  22. Ensures that staff of the firm is appropriately trained in compliance-related matters.
  23. Is the adviser’s liaison and point of contact with SEC examination staff, both during exams and as part of the SEC’s CCOutreach program.
  24. Is active in industry efforts to develop and implement good compliance practices for advisers to private investment funds.

That’s  a big list of things to take on.

Although the SEC does not require a separate individual to take on the role of CCO, I occasionally hear some skepticism when a person assumes this role as an additional part of their job. The question the SEC asks is “what responsibilities did you relinquish in order to have time to take on the CCO role?”

Sources:

Help Wanted image is by Andi Szilagyi

Calculating Regulatory Assets Under Management for Private Funds

For private fund managers, one troubling aspect of Form ADV had been the calculation of  “assets under management” in item 5.F. If securities are less than 50% of the portfolio then the portfolio would not be a securities account.

Except for real estate debt funds, most real estate funds would end up with $0. (I’m not sure whether that would mean you do not have to register since you are then not giving advice for a securities portfolio or whether that would push you into state registration.)

As a private equity fund or real estate fund purchased assets and sold assets, the manager could be ping-ponged in and out of SEC registration.

In the Proposed Changes to Form ADV published on November 19, the SEC has  proposed revisions to Form ADV that better addresses the reality pf private funds.

In the proposed changes, the SEC has come up with a new method for calculating values that makes much more sense for private funds.

5(b)(4). Determine your regulatory assets under management based on the current market value of the assets as determined within 90 days prior to the date of filing this Form ADV. Determine market value using the same method you used to report account values to clients or to calculate fees for investment advisory services.

In the case of a private fund, determine the current market value (or fair value) of the private fund’s assets and the contractual amount of any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.

In the release, the SEC states the an adviser should include “in its regulatory assets under management the value of any private fund over which it exercises continuous and regular supervisory or management services, regardless of the nature of the assets held by the fund.”

This calculation makes it very clear that private fund managers with even a small amount of securities in their funds are going to be forced to register with either the SEC or their state regulators as an investment adviser.

Sources:

Yes, the SEC Wants Real Estate Fund Managers to Register

Earlier I had pointed out how a real estate fund manager could be considered an investment adviser and have to register with the SEC under the Investment Advisers Act.

In the Proposed Changes to Form ADV published on November 19, the SEC has made it clear that real estate funds are part of the mix.  They have proposed  revisions to Form ADV that better deal with more private funds being covered by the Investment Advisers Act.

In the proposed new Schedule D to Form ADV, the SEC requires you to designate the type of fund.  If you are still wondering if a real estate fund might need to register, look through the list of fund types:

Question 10: Type of Private Fund: For purposes of this question the following definitions apply:

“Hedge fund” means any private fund that:

a. Has a performance fee or allocation calculated by taking into account unrealized gains;
b. May borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or
c. May sell securities or other assets short.

A commodity pool is categorized as a hedge fund solely for purposes of this question. For purposes of this definition, do not net long and short positions. Include any borrowings or notional exposure of another person that are guaranteed by the private fund or that the private fund may otherwise be obligated to satisfy.

“Liquidity fund” means any private fund that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors.

“Private equity fund” means any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund, or venture capital fund and does not provide investors with redemption rights in the ordinary course.

“Real estate fund” means any private fund that is not a hedge fund, that does not provide investors with redemption rights in the ordinary course and that invests primarily in real estate and real estate related assets.

“Securitized asset fund” means any private fund that is not a hedge fund and that issues asset backed securities and whose investors are primarily debt-holders.

“Venture capital fund” means any private fund meeting the definition of venture capital fund in rule 203(l)-1 under the Advisers Act.

“Other private fund” means any private fund that is not a hedge fund, liquidity fund, private equity fund, real estate fund, securitized asset fund, or venture capital fund.

“Real estate fund” made the list. I take that as a clear sign that the SEC wants real estate fund managers to register under the Investment Advisers Act.

Sources:

Image of the Empire State Building is by Christian Mehlführer

The Newspaper Rule and a Massachusetts Politician

One of the classic statements in a compliance program is “don’t do something if you would be embarrassed to see a story about it on the front page of the newspaper.” Just because something is legal, it does not mean it’s ethical or a good thing to do.

A recent example popped up in Massachusetts politics involving Middlesex County Sheriff James V. DiPaola. (I just voted for him in November.) He was planning to retire, even though he had just been re-elected. Retire, but continue working as the Sheriff.

It turns out there is an exception in the Massachusetts Pension Law that allows retirees to run for paid elective office without losing their pensions.

DiPaola was a Malden police officer for 18 years before being elected a state representative in 1992. He then became Middlesex sheriff in a 1996 and was re-elected three times (including 2010). If he had kept working his pension would have remained mostly flat, since he has enough years of service to receive the maximum benefit allowed.

It turns out, if he retired before the election and didn’t collect his salary for the rest of 2010, he could collect his pension and receive his salary as Sheriff. A legal, but ethically troubling position.

Instead, he did the right thing.

“I’d always be remembered for this, for double-dipping, that that would be my legacy,’’ … crediting a Globe reporter’s question for his spark of conscience. “From a financial perspective it was great. It was legal. But I tossed and turned all night. I did put myself first this time, and I don’t want it to end that way.’’

In part his decision was forced by reporter from the Boston Globe. Sean Murphy had confronted DiPaola. With the real threat of having his action end up on the front page of the newspaper, DiPaola changed his mind.

Unfortunately, the revelation ended tragically when DiPaola died from apparent suicide this past weekend.

Sources:

Happy Thanksgiving

That means an extra long weekend for me.

Down the road at Plimouth Plantation they hold onto the belief that the first Thanksgiving in the United States happened in 1621 at their location:

The history of Thanksgiving goes much further back than Plymouth and 1621. In fact, people across the world from every culture have been celebrating and giving thanks for thousands of years. In this country, long before English colonists arrived, Native People celebrated many different days of thanksgiving. “Strawberry Thanksgiving” and “Green Corn Thanksgiving” are just two of kinds of celebrations for the Wampanoag and other Native People.

In 1621, the English colonists at Plymouth (some people call them “Pilgrims” today) had a three-day feast to celebrate their first harvest. More than 90 native Wampanoag People joined the 50 English colonists in the festivities. Historians don­t know for sure why the Wampanoag joined the gathering or what activities went on for those three days. Form the one short paragraph that was written about the celebration at the time, we know that they ate, drank, and played games. Back in England, English people celebrated the harvest by feasting and playing games in much the same way.

The English did not call the 1621 event a “thanksgiving.” A day of “thanksgiving” was very different for the colonists. It was a day of prayer to thank God when something really good happened. The English actually had their first thanksgiving in the summer of 1623. On this day they gave thanks for the rain that ended a long drought.

Enjoy the long weekend, if you can.

The First Thanksgiving by Jean Leon Gerome Ferris

The US Private Equity Fund Compliance Guide

One of the struggles with implementing a compliance program for a private equity fund is that the Investment Advisers Act is targeted at retail operations dealing with relatively liquid investments. Neither fits well with the private equity model of institutional investors and large, illiquid transactions. Most of the guidance and discussion about how to implement a compliance program focuses on the retail side. Given the changes coming from Dodd-Frank, most private fund managers will need to register with the SEC as investment advisers.

Private equity firms are going to need some good guides to help them out. PEI Media just published The US Private Equity Fund Compliance Guide. It is a useful resource to private equity firms putting together a compliance program.

Since it was just put together this year, the guide includes most of the new laws and regulations coming out of Dodd-Frank as they relate to private equity fund compliance. Of course, given the huge slate of rule-making in the pipeline, the guide will start getting out-of-date. You need to start sometime and the regulatory framework will continue to evolve.

Charles Lerner of Fiduciary Compliance Associates took the helm as editor of the guide and farmed out the individual chapters to a talented group of contributors. Most chapters do a great job of trying to translate the regulatory regime of the Investment Advisers Act to the realities of a private equity fund manager. A few chapters come up short. They merely tack on a paragraph at the end of the chapter pointing out that much of the preceding is irrelevant for most private equity firms or fail to provide a meaningful discussion for private equity.

Some chapters do a great job of addressing the problems that are more closely associated with private equity. The “Side Letters” chapter does a great job putting those agreement in the context of potential conflicts and the requirements of the Investment Advisers Act. I would give the same praise to the “Identifying Potential Conflicts of Interest” chapter.

Overall, I found the guide to be a great resource in helping me to craft my compliance program. My copy is already getting filled with notes and annotations. The downside it that it’s expensive: $795.

You can take a look at the table of contents for the guide and see how it fits into what you are doing and whether it would be worth the price.

The SEC Defines Venture Capital

The SEC is moving much faster in releasing proposed rules after the SEC Open Meetings. After Friday morning’s open meeting discussing the exemption from registration for venture capital funds, the SEC has released the full text of the proposed rule merely several hours later.

I have been waiting to see how broad this exemption will be. I’m still holding on to the slim chance that I could squeeze into the exemption. Given that the SEC is still looking for some broad reporting and subjecting venture capital firms to examination, I’m not sure the exemption will offer much benefit.

Here is the SEC’s proposed definition of a venture capital fund for purposes of the exemption:

A venture capital fund is any private fund that:

(1) Represents to investors and potential investors that it is a venture capital fund;

(2) Owns solely:

(i) Equity securities issued by one or more qualifying portfolio companies, and at least 80 percent of the equity securities of each qualifying portfolio company owned by the fund was acquired directly from the qualifying portfolio company; and

(ii) Cash and cash equivalents, as defined in § 270.2a51-1(b)(7)(i), and U.S. Treasuries with a remaining maturity of 60 days or less;

(3) With respect to each qualifying portfolio company, either directly or indirectly through each investment adviser not registered under the Act in reliance on section 203(l) thereof:

(i) Has an arrangement whereby the fund or the investment adviser offers to provide, and if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of the qualifying portfolio company; or

(ii) Controls the qualifying portfolio company;

(4) Does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage, in excess of 15 percent of the private fund’s aggregate capital contributions and uncalled committed capital, and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 calendar days;

(5) Only issues securities the terms of which do not provide a holder with any right, except in extraordinary circumstances, to withdraw, redeem or require the repurchase of such securities but may entitle holders to receive distributions made to all holders pro rata; and

(6) Is not registered under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-8), and has not elected to be treated as a business development company pursuant to section 54 of that Act (15 U.S.C. 80a-53).

SEC Release IA-3111 Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers