Year: 2011

Three Compliance Officers Walk Into a Bar…..

The professional recruiters of Howard-Sloan must have been up really late one night to come up with the idea of trying to find America’s Funniest Compliance Professional. Mitchell Berger, Howard-Sloan’s chief executive, said that for several years in the 1980s to ’90s, the firm put on a similar contest for accountants. I suppose if you can find funny accountants, you can find funny compliance officers.

It sounds like the pickings were slim. Compliance officials from around the country sent in demo tapes of their comedic skills. A mere 15 were submitted. From those, six performers were selected.

Give a round a round of applause and a belly laugh to Michael L. Shaw from pharmaceutical giant GlaxoSmithKline PLC, who earned the title of America’s Funniest Compliance Professional.

Even better, the event raised over $11,000 for juvenile diabetes research.



Thanks to Dennis Liu for highlighting the story for me.

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Fund Adviser Not Liable for False Statements in Fund Prospectus

A recent ruling in favor of the Janus mutual funds’ adviser in the Supreme Court is continued fall out from the mutual fund market timing scandal from almost a decade ago. The prospectuses for several Janus funds represented that the funds were not suitable for market timing and could be read that Janus Capital Management LLC, the mutual fund’s investment adviser, would implement policies to curb market timing. They didn’t and certain traders were able to engage in market timing.

First Derivative Traders represented a class of plaintiffs who owned the stock of the Janus Capital Group, the publicly traded company that owned the investment adviser. After the allegations of market timing surfaced the share price of Janus fell precipitously.

First Derivative alleges that JCG and JCM “caused mutual fund prospectuses to be issued for Janus mutual funds and made them available to the investing public, which created the misleading impression that [JCG and JCM] would implement measures to curb market timing in the Janus [mutual funds]. … Had the truth been known, Janus [mutual funds] would have been less attractive to investors, and consequently, [JCG] would have realized lower revenues, so [JCG’s] stock would have traded at lower prices.

That sounds like very tentative claim to me, especially when you insert the legal fiction that a mutual fund is separate from the fund’s advisers.

The issue is whether the adviser can be held liable in a private action under Rule 10b-5 for false statements in the mutual fund’s prospectus. Under Rule 10b–5, it is unlawful for “any person, directly or indirectly, . . . [t]o make any untrue statement of a material fact” in connection with the purchase or sale of securities. 17 CFR §240.10b–5(b). To be liable, the adviser must have “made” the material misstatements in the prospectuses.

The US Supreme Court says no. It was the fund itself that made the false statement, not the investment adviser. They are legally separate entities with separate boards. In fact, the board of the Janus fund was more independent than required by statute. Only the fund, not the adviser, has the obligation to file the prospectuses with the SEC.

This rule follows from Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164 (1994).  The Court held that Rule 10b–5’s private right of action does not include suits against aiders and abettors. Suits against entities that contribute substantial assistance to the making of a statement may be brought by the SEC. Private parties can only bring suit for direct statements. A broader reading of “make,” including persons or entities without ultimate control over the content of a statement, would substantially undermine Central Bank, said the Court, If persons or entities without control over the content of a statement could be considered primary violators who “made” the statement, then aiders and abettors would be almost nonexistent.

It’s not that Janus didn’t suffer for allowing market timing. In 2004, Janus reached a settlement with the SEC for market timing allegations Janus paid $100 million in disgorgement and civil penalties. A big chunk of that cash was returned to the fund shareholders.

The Supreme Court decision merely draws the line at a derivative lawsuit by the adviser’s corporate shareholders.

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Image is As janus rostrum okretu ciach by Ultima Thule in Wikimedia Commons

Corruption and Twitter

“If someone is being hit for a bribe, isn’t the easiest thing just to put it on Twitter? It goes round the world in next to no time.”

Richard Alderman, head of the U.K.’s Serious Fraud Office, is apparently serious about Twitter. After self-congratulating themselves for organizing the government overthrows in North Africa and the Middle East, social media sites are apparently ready to stop global corruption.

So I decided to search through Twitter to see what it had to say about bribery. I started with what I thought would be the most obvious using #bribe. The most common messages using that hashtag looked something like this example:

Had to resort to the best method of all just to get my niece to come to Target with me #bribe #sparklynailpolish

Not exactly focusing on the world’s problems.

But I did notice a message from @IPaidABribe, connected to the IPaidaBribe.com the Indian website mentioned in the Financial Times article. That led to this message:

I suppose that is closer to what Mr. Alderman was talking about.

On the other hand Mr. Alderman is in charge of enforcing the UK Bribery Act which makes it a crime to pay a bribe. So if you do report a bribe on Twitter, Mr. Alderman would be responsible for bringing charges against you. The SFO has said they would use prosecutorial discretion when bringing charges, so from a practical matter it would seem unlikely that you would end up with charges against you. But still, would you publicly announce that you just broke the law?

A few days ago, I heard about the Bribespot app for your smartphone that allows you to report bribery and see where it happening using the mapping tool. That would hide your identity when making your bribery report.

Sources

Compliance Bits and Pieces for June 10

Here are some recent compliance-related stories that caught my eye.

Investment Advice from George Carlin by Kent Thune in The Big Picture

Try not to live in a hypothetical world.

“What if there were no hypothetical questions?” ~ George Carlin

Regulatory Delay Stokes Unease Over Dodd-Frank by Deborah Solomon and Victoria McGrane in the Wall Street Journal

Banks, investors and companies are scrambling to cope with uncertainty caused by regulators’ delays in fleshing out the Dodd-Frank financial-overhaul law, amid fears the holdup might disrupt the $583 trillion derivatives market and spark a wave of lawsuits. More than 100 new derivatives requirements in the law take effect on July 16, even though regulators have yet to issue final rules in the affected areas. The holdup raises concerns that a large swath of the financial system might be thrown into legal gray areas.

Lockheed Martin Gets Into Step With UK Bribery Act With New Policy by Samuel Rubenfeld in WSJ.com’s Corruption Currents

In one of the first examples of a multinational company publicly adapting its compliance procedures to the U.K. Bribery Act, Lockheed Martin Corp. said in a regulatory filing late Monday on behalf of a former subsidiary that it is changing its internal policy in light of the new law.

US Senators and Rep. Frank Urge SEC to Exclude Banks from Municipal Advisor Regulatory Regime in Jim Hamilton’s World of Securities Regulation

In the view of the Senators and Rep. Frank, this broad requirement would move the regulations beyond the intent of the legislative language and have the unintended consequence of subjecting many banks and bank personnel to onerous regulation regardless of whether they provide the type of advice that would warrant regulation under Dodd-Frank. Many banks provide a broad range of banking services to municipalities, they noted, including deposit, basic cash management, lockbox, and short-term lending services.

Finally, Some SEC Action on the July 21 Deadline for Fund Managers

If you’re a private fund manager you have been worried about the looming July 21 deadline for registration. Given the 45 day review period, the filing deadline was June 6. That came and went without the SEC having the rules in place for registration. Sure, the SEC commissioners and staff have been saying the plan to extend the deadline. But, still no extension.

Looking ahead to June 22, it looks like the SEC will finally take up the formal action. The Open Meeting for June 22 is all about the Investment Advisers Act.

Agenda:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an investment adviser under the Investment Advisers Act of 1940.

Hopefully, they won’t change their mind about extending the deadline.

Crowdsourcing the Purchase of a Beer Company

Some beer lovers who were fans of Pabst Blue Ribbon heard that its parent company, the Pabst Brewing Co., was up for sale. The previous owner had died, leaving it to a charitable trust. Charities couldn’t hold on to the asset so they had to sell it.

The beer lovers were a few hundred million dollars short on the purchase price. This is the 21st Century, so they decide to create a website, buyabeercompany.com, to crowdsource the purchase price. They even set up a Twitter account and Facebook page. Each investor would receive a “crowdsourced certificate of ownership,” as well as beer of a value equal to the amount invested.

Those of you with even a vague understanding of securities laws will see that this will not end well.

The fundraising effort was relatively successful. They elicited $14.75 million in pledges during their first few weeks. Apparently, they eventually raised $200 million in pledges from more than 5 million pledgors.

That was not enough money to purchase the company, but it was enough to get in trouble with the Securities and Exchange Commission.

Under Section 5(c) of the Securities Act, it’s unlawful to offer to sell a security unless it is registered with the SEC or there is an applicable exemption. There is no exemption for beer lovers.

From the SEC Administrative Order, it sounds like the beer lovers thought that by merely asking for pledges to eventually buy the company they were not offering securities for sale. The SEC disagreed and pointed to Section 2(a)(3) of the Securities Act that defines “offer to sell” as “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.”

So how does Kickstarter not violate Securities Law? Those projects involve selling a product, not selling securities. I pledged for a trebuchette project on Kickstarter. I get two of the Trebuchettes; I don’t get an interest in the company making the product.

I suppose the beer lovers could merely have pre-sold cases of PBR to raise capital. But if you think the securities laws are tough to deal with, try dealing with interstate liquor sales.

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Does it Matter Where the Signature Is?

Just about every compliance certification has the employee sign at the bottom. We have been signing letters and contracts at the end for millenia.

But maybe there is a way to increase ethical performance by moving that signature to the top.

Lisa L. Shu, Nina Mazar, Francesca Gino, Dan Ariely, and Max H. Bazerman recently published a paper that found differences in compliance/ethical performance depending on whether the participant signed first or at the end.

In one experiment, the subjects took a test and scored it themselves. They would be paid based on their performance and reimbursed for their expenses incurred in attending the test. After self-scoring the test they went into another room to self report their income on a tax form. There were three forms:

  • One with a certification at the beginning that all information is true
  • A second with the same certification, but at the end
  • A third with no certification

The test and reporting was set up to be very easy to cheat, with a simple and immediate cash reward for cheating. You should not be surprised that cheating was rampant.

With the third form, with no certification, cheating occurred 64% of the time. With the certification at the bottom, the cheating actually rose to 79%. The winner, with the certification at the beginning, only had a 37% cheat rate.

Moving the certification to the beginning had a dramatic, positive effect on reducing cheating.

The paper includes several other similar experiments with the same results. A slightly different test involved word puzzles. Those that signed an honesty pledge before engaging in the cheating experiment ended up solving more of the ethics-related words than the others.

The authors theorize that the certification at the top pre-sets the person to start thinking more ethically. If they don’t hit the certification until the end, they have already supplied the information with whatever ethical slant they may have.

I’m going to re-think how I design my certification. At the top will be a certification that all of the information is true and correct, before they start filling in the information.

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Compliance Lessons from Weinergate

In a tearful statement to the media, Rep. Anthony Weiner admitted he posted a lewd picture of his anatomy to Twitter. Not only that, he says he’s engaged in “inappropriate” online communications with at least six other women.

It was just a few days ago that I revisited the Fabulous Fab Rule:

Don’t write emails so provocative that they wind up reproduced on the front page of the Wall Street Journal.

That rule is focused on email which for many companies is archived for years. That means it could end up in litigation or an enforcement action. The rule is really applicable to any type of publishing.

The internet has turned us all into publishers, or at least given us the ability to be publishers. Traditional publishers have layers of review before information, stories, and pictures get published. On the internet, the only layer of review is your common sense. That’s all that stands between you and that send button.

Weinergate is just another example of failed common sense. He never should have hit that send button.

I have not found anything new in the scandal. I don’t think you need a new policy prohibiting people from sending pictures of themselves in their underwear. (I suppose there is an exception if you are in the adult entertainment industry.) Common sense should take care of that.

I suppose its useful to compare this to Eliot Spitzer. He had his own sex scandal, but it required a government investigation. Weiner merely shot himself by sending out a public message.

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Image of Meet Congressman Weiner is by David Boyle
CC BY 2.0

Lessons from Wunderlich

I don’t take pleasure from others’ failings, but I do try to learn lessons. The recent settlement between Wunderlich Securities and the Securities and Exchange Commission is full of lessons to be learned.

  • overcharged advisory clients for commissions and other transactional fees in violation of Section 206(2) of the Advisers Act
  • failed to satisfy the disclosure and consent requirements of Section 206(3) of the Advisers Act when WSI engaged in principal trades with advisory clients;
  • failed to adopt, implement and review written policies and procedures as required by Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder; and
  • failed to establish, maintain, and enforce a written code of ethics as required by Section 204A of the Advisers Act and Rule 204A-1 thereunder.

It seems some of the failings, at least according to the order was that Wunderlich hired a CCO with a background in Broker-dealer compliance, but at the same time, the firm moved from a broker-dealer model to an investment adviser model. That left the CCO in a new regulatory scheme.

Under Section 206(3) of the Advisers Act, an investment adviser must disclose to its clients in writing before the completion of each transaction that it acts as a principal. Wunderlich failed to follow this rule in over 3,00 instances according to the order. The issue is that the investment adviser can both collect a fee and realize a difference between its cost of the security and the price it’s sold to the the client. That difference in price is a conflict that needs to be managed. Wunderlich even hired a consultant to to review their operations who highlighted the principal trading problem. That still did not lead to a correction.

Wunderlich failed to have written compliance policies or a written code of ethics. That leads to the follow up failure of an annual review of the written compliance policies and procedures. Its hard to update something that is not in place. Wunderlich was using its broker-dealer manual and failed to update it to meet the requirements under the Investment Advisers Act. Once again, this failure was highlighted in a consultant’s report and the firm failed to fix the problem.

A long true lesson in compliance is when a problem is highlighted, you need to fix it. The spotlight is on the problem.

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Compliance Bits and Pieces for June 3

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

Launching Into Unethical Behavior: Lessons from the Challenger Disaster by Ann E. Tenbrunsel and Max H. Bazerman in Freakonomics

On the night before the Challenger was set to launch, a group of NASA engineers and managers met with the shuttle contracting firm Morton Thiokol to discuss the safety of launching the shuttle given the low temperatures that were forecasted for the day of the launch. The engineers at Morton Thiokol noted problems with O-rings in 7 of the past 24 shuttle launches and noted a connection between low temperatures and O-ring problems. Based on this data, they recommended to their superiors and to NASA personnel that the shuttle should not be launched.

The Big Lesson From Compliance Week 2011 by Matt Kelly in Compliance Week

This year I can boil that lesson down to one telling insight, that sprang to mind thanks to two particular moments that happened during the conference: the superb keynote address given by U.S. Attorney Preet Bharara on Tuesday morning, and an outburst later that day from our first-ever Compliance Week protester.

“Profound personal integrity, repeatedly demonstrated and openly valued, is absolutely critical … The best-conceived compliance programs and practices and policies in the world will be too weak to stave off scandal if the core principles are not internalized, if there is not from the top a daily drumbeat for integrity.”

Hedge Fund Industry Asks for Global Regulatory Coordination as EU Implements Alternative Investment Fund Directive in Jim Hamilton’s World of Securities Regulation

During 2013 to 2015 there will be a passport for sales of EU alternative investment funds to investors within the EU. For US and other non-EU funds and managers, national private placement regimes will continue to operate. However, noted ESMA Chair Steven Maijoor, for these regimes to be used, appropriate co-operation arrangements will have to be put in place between the EU regulator concerned and the authority of the third country.

A Trader, an F.B.I. Witness, and Then a Suicide by Peter Lattman and William K. Rashbaum in the New York Times’ Dealbook

But the federal authorities’ techniques have rarely been seen on Wall Street before.

Late last year, F.B.I. agents conducted three simultaneous raids of large hedge funds. Two of those funds have since closed. And for the first time in an insider trading inquiry, the government has been using wiretaps — a method typically reserved for drug crimes and organized crime cases — to record the telephone conversations of Wall Street traders.

Be Careful Playing with Your New Things – Homeownership:

From XKCD