Year: 2011

Placement Agent Limitations on Gifts

The Municipal Securities Rulemaking Board is continuing to tighten the limits on what placement agents can do as part of their fundraising activities for private funds.  Dodd-Frank created a new category of “municipal advisors” and placed them under the regulatory oversight of the MSRB. If your fund uses a placement agent and has government-sponsored investors or is seeking government-sponsored investors then they need to be registered with the MSRB and you need to pay attention to these rules.

The MSRB is proposing a new limitation in Rule G-20:

(a) General Limitation on Value of Gifts and Gratuities.

(ii) Municipal advisors.  No municipal advisor shall, directly or indirectly, give or permit to be given any thing or service of value, including gratuities, in excess of $100 per year to a person other than an employee or partner of such municipal advisor, if such payments or services are in relation to the municipal advisory activities of (including but not limited to solicitation of potential engagements on behalf of) the municipal advisor.

(b) Normal Business Dealings. Notwithstanding the foregoing, the provisions of section (a) of this rule shall not be deemed to prohibit occasional gifts of meals or tickets to theatrical, sporting, and other entertainments hosted by the broker, dealer, municipal securities dealer, or municipal advisor; the sponsoring by the broker, dealer, municipal securities dealer, or municipal advisor of legitimate business functions that are recognized by the Internal Revenue Service as deductible business expenses; or gifts of reminder advertising; provided, that such gifts shall not be so frequent or so extensive as to raise any question of propriety.

Amendments to Rule G-8 and Rule G-9 would require a municipal advisor to keep a record of each gift or gratuity given and keep those records for six years.

Even though the MSRB is seeking comments on the proposed changes, I’m skeptical they will be changed. They are merely taking the existing limitations for municipal securities dealers and porting them over to the new class of municipal advisors.

From the fund managers perspective, it would make sense to make sure that your placement agent is complying with the rules and to get copies of their records.

Sources:

Egypt, Mubarak and Politically Exposed Persons

Egypt’s top prosecutor requested the freezing of the foreign assets of ousted president Hosni Mubarak and his family. I expect that is one step in trying to figure out how much of Mubarak’s fortune was derived from corruption. I’ve read reports that his assets could be worth $3 billion and upwards of $70 billion.

That highlights a messier part of the investor due diligence process. Everyone is aware of the blocked-persons list from FinCEN. Those are the bad guys that you are prohibited from doing business with.

Mubarak falls into the category of “politically exposed person.” Those are senior foreign political figures.  They have not necessarily done something wrong, but should be subject to a higher level of scrutiny.

31 CFR 103.179

“In the case of a private banking account for which a senior foreign political figure is a nominal or beneficial owner, the due diligence program required by paragraph (a) of this section shall include enhanced scrutiny of such account that is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption.”

That is the US standard. The standard will differ from country to country. Switzerland enacted a new law giving officials the ability to freeze accounts belonging to any former leader suspected of corruption.

If you are taking money from foreign leaders you need to be careful and figure out where the money is coming from. If it’s cash from bribes you need to refuse it. The hard part is figuring out where the money came from. The leader could be independently wealthy. They could own successful business. They could be siphoning billions of dollars of foreign aid or skimming from an oil for food program.

If Mubarak showed up with wheelbarrows full of cash, theoretically, these accounts should already have been frozen when the money came in. But I suppose that’s a question of the winners making the rules. Bankers didn’t want to take steps while he was in power. Now that the money is sitting in their vaults, they are happy to freeze it. Especially now that Mubarak doesn’t control a half million soldiers.

Just as a reminder, FinCEN send out an advisory that: “Financial institutions should be aware of the possible impact that events in Egypt may have on patterns of financial activity when assessing risks related to particular customers and transactions.”

Sources:

Image of Muhammad Hosni Mubarak, President of Egypt addressing the Opening Plenary session of the World Economic Forum on the Middle East 2008 held in Sharm El Sheikh, Egypt is by the World Economic Forum

The SEC is Looking at Advisers’ Use of Social Media

According to a story in Investment News, the Securities and Exchange Commission began a sweep of investment advisers’ use of social media and social networking last month.

The story hast a quote from Doug Flynn, an adviser at Flynn Zito Capital Management LLC, that is exactly on target for traditional investment advisers:

“I’d love to start tweeting to the general public once they can clearly tell me what I can and can’t do. However, putting yourself out there too much without specific guidelines is just not worth the risk.”

I don’t think the same is true for private fund managers who will soon have to register with SEC as investment advisers. How does the SEC’s regulation of Web 2.0 affect private fund managers once they register as investment advisers?

Not much.

Private funds are limited by the prohibition on general solicitation and advertisement.  They usually rely on Regulation D to keep from having to register the interests in their funds. Rule 502(c) of Regulation D states that “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

1. Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and

2. Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising. . . “

The very public nature of social media and social networking sites are going to put them squarely in the box limited by this regulation. Even though there is some ability for a fund manager to use social media under the Investment Advisers Act, that ability is curtailed by the limitations under the Securities Act. Certainly, fund managers and their personnel can use web 2.0 tools for personal reasons and business reasons not related to advertising their firm or its funds. (You will notice that I don’t publish posts about my firm or its funds.)

Sources:

Read a Free Book

I have an extra copy of All the Devils are Here by Bethany McLean and Joe Nocera.

They put together an insightful look at the many factors that created the housing bubble and amplified the destruction when it popped. Pundits and purists have tried to pin the blame on a single element. It seems clear that many “devils” were at work. It’s not just institutions that failed in the crisis. The authors paint the pictures of key individuals who helped inadvertently build up the housing bubble or allowed for it cause mass destruction.

I thought it was a great book, but I don’t need two copies sitting on my bookshelf. If the book is on your reading list and you have not yet purchased it, here is a chance to get a free copy.

To enter the giveaway,

  1. leave a comment in this post, or
  2. send a message to my contest email address [email protected].

[button link=”mailto:[email protected]?subject=Contest Entry” color=”red”]Enter the Contest[/button]
The entry deadline is February 21, 2011. I’ll randomly pick a winner from the entries I receive by the deadline. If you are the winner, I’ll contact you for your mailing address.

The Amish Madoff

The Securities and Exchange Commission filed charges against Monroe L. Beachy, a 77-year-old Amish man from Sugarcreek, Ohio. They found the Bernie Madoff of the Amish.

Beachy targeted his fellow Amish in his alleged fraud. He raised more than $33 million from as early as 1986. Beachy enticed investors by promising interest rates that were greater than banks were offering at the time. Beachy told his investors that their money would be used to purchase risk-free U.S. government securities. Many of Beachy’s investors treated their investment accounts with Beachy like money market accounts, from which they could withdraw their money at any time. In reality, Beachy used the money to make speculative investments in junk bonds, mutual funds, and stocks.

By the time Mr. Beachy filed for bankruptcy in June 2010, less than $18 million of the original $33 million of investor money remained.

I would guess that Beachy started off doing the right thing, but made a bad investment along the way. Rather than be honest with his investors, he took greater risks to try and make back the earlier loss, missing again and again.

Like Madoff, it sounds like he was offering a modest rate of return. That would allow this Ponzi scheme to go on longer and longer.

Like Madoff, the fraud continued for decades. Because of the length of Mr. Beachy’s alleged scheme, generations of families were affected. Older generations of Amish investors would referred their children to Beachy.

Unlike Madoff, Beachy had actually invested the money. Just not in the safe investments he promised to his investors.

UPDATED: The Washington Post has a great story with some background on the fraud: In an Amish village, the SEC alleges a Madoff-like fraud by David S. Hilzenrath.

Sources:

Amish Buggy Sign is by Daniel Schwen

Looking at the Residential Mortgage Crash

Matt Phillips at WSJ.com’s Market Beat put together some great charts showing the problems with the residential mortgage market: Fannie and Freddie: The Saga in Charts.

The first one that caught my eye shows how Wall-Street took such a quick, big chunk of the market share of residential mortgage-backed securities during the housing boom.

Fannie Mae and Freddie Mac’s share of mortgage-backed securities issuance plummeted from 70% to 40% during the housing boom. We have seen in many companies and markets that rapid growth comes without a similar growth in market controls and compliance. I think the lack of market systems and compliance contributed to the crash. It’s hard to understand the market when it barely existed a few years earlier.

Did Wall Street take business away from Fannie Mae and Freddie Mac? It looks like Freddie Mac and Fannie Mae’s origination activity was relatively stable. The private mortgage-backed securities were tapping into a new market.

As Joe Nocera and Bethany McClean noted in All the Devils are Here, the vast majority of that subprime activity was refinancings or second home purchases.

For those trying to pin the blame for the 2008 Crisis on Fannie Mae and Freddie Mac theses charts point in a different direction. Not that Fannie Mae and Freddie Mac are without blame, it’s clear that Wall Street excess carries a big chunk of the blame.

The last question, and the last chart, help answer the question of whether we need Wall Street in the mortgage business.

The answer seems to be yes. There are not enough deposits in the banks to cover all of the outstanding US home mortgage debt.

Are ETFs Reportable Securities?

As a compliance officer for a registered investment adviser, you need to verify transactions where the account has a “reportable security” to make sure your employees are not violating your insider trading policy. That means checking you employees’ securities accounts at least quarterly. You’re compelled by Rule 204A-1 (b)(2) to do this for access persons.

The big exclusions from the definition of reportable security are US Treasuries and open-end mutual funds (assuming they are not funds where you act as the investment adviser).

The question I had was how Exchange Traded Funds fit into that definition. Index funds fit into the open end fund exclusion. Exchange Traded Funds act sort of like index funds so should they be reportable securities?

The answer turns out to be yes and no.

National Compliance Services asked this same question in 2005, shortly after Rule 204A-1 came out.

ETFs are structured as either an open-end fund or a unit investment trust. The SEC’s response in a no action letter was that the open-end fund variety is not a reportable security and the UIT variety is a reportable security.

Is the UIT variety of ETF rare enough that you don’t need to worry about them? No. Actually, it’s the opposite. Some of the largest ETFs are Unit Investment Trusts: SPY, QQQ, DIA and MDY. That means you should probably just through all ETFs under the “reportable securities” label.

Sources:

Celebrate Valentine’s Day with a Regulatory Twist

As someone who stares at a lot of regulations, this Valentine’s Day message caught my eye. If you are a fan of NPR, they have several other ways to share Valentine’s Day with an NPR flavor.

And don’t forget about the compliance issues you can run into. Dan Schwartz compiled a bunch of bungled romance issues in Employers: Think Your Competition is Tough? Watch Out for the Valentine’s Day Card.

UPDATE: The obscene and indecent material restriction is 47 C.F.R. 73.3999.

Blogoversary and Why I Blog

Instead of substantive information, today’s post focuses on me and this website.

Compliance Building went public on February 12, 2009. Since then, I have managed to publish a blog post every business day. Sometimes, more than one. I hope at least some of those 1250 posts were useful to you, whether you are a subscriber or one of the other 200,000 or so visitors to Compliance Building over the past two years.

Thanks for reading.

If you haven’t done so already, you can subscribe and have my posts sent to you. It’s free, except on the Kindle. (I can’t convince Amazon to change the price.)

I started my first blog, KM Space, on this day in 2007. I set up Real Estate Space a few months later. Now I’m moving into my fourth fifth year blogging.

Why do I do this?

Mostly, I publish because the information is useful to me. This blog is a personal knowledge management tool. It’s all about trying to capture information that interest me and has relevance to my day-to-day work. I find that writing my thoughts adds some clarity to my thinking. By putting all of that information into the blog, it’s in a place where it is easy to find.

The secondary reason is that it’s good for the industry to be focused on compliance and ethics. If it’s good for the industry then it’s good for my company and good for me personally. If a fellow private equity real estate company gets into compliance or ethical trouble that will reflect poorly on the industry as a whole. Inevitably, that will make my job harder. It will likely make it harder to raise capital and to get deals done. That’s bad. So I try to share information that will benefit the industry because that benefits me.

I admit this blogging experiment is self-centered, but I’m happy to have you along for the ride.  If you want more detail on this you can read my Why I Blog page.

For those of you who know me from KM Space, I will continue to publish a subset of my Compliance Building posts to the KMspace feed. No need to say goodbye. Unless I’m boring you.

Image is from Cake Wrecks: Close Enough.

Compliance Bits and Pieces for February 11

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

FIFA, the World Cup Selection and the FCPA by Tom Fox

I was very interested in the allegations of bribery and corruption leveled at FIFA during the selection process, known, these days, as the “world’s richest and most influential single-sport ruling body”. As has been reported extensively throughout the world, two members of FIFA’s 24 member executive committee were suspended for allegedly offering their votes to determine which countries would host the 2018 and 2022 World Cups. Both men were caught on videotape by the UK Sunday Times asking for specific sums of money, apparently in exchange for their votes.

Compliance Community to DoJ: More Info Please by Melissa Aguilar in Compliance Week

Members of the compliance and ethics profession are pushing the U.S Department of Justice to provide more information about when and how it gives credit to organizations for ethics and compliance programs in its enforcement actions.

SEC’s Sovereign Wealth Fund Probe Is More Than Name Suggests by Joe Palazzolo in WSJ.com’s Corruption Currents

The Securities and Exchange Commission’s foreign bribery probe of banks and private-equity firms is looking beyond their dealings with sovereign-wealth funds to other types of sovereign investment, said a lawyer familiar with the investigation. The lawyer said the SEC has made it clear that investigators are interested in a broader set of data than that associated with traditional sovereign-wealth funds, including information on dealings with national pension funds.

Tyson Foods Settles FCPA Enforcement Action Involving Mexican Veterinarians And Their No-Show Wives in FCPA Professor

Yet another FCPA enforcement action raises the issue of whether the FCPA’s “obtain or retain business” element means anything anymore or whether the FCPA, contrary to Congressional intent, has morphed into an all-purpose corporate ethics statute and – in a game of chicken – companies opt to settle rather than mount a legal defense. Yesterday, Tyson Foods, one of the world’s largest processors of chicken and other food items, agreed to resolve an FCPA enforcement action focused on payments to Mexican veterinarians (and their no-show wives) responsible for certifying product for export.

The diamond soccer ball is offered by Gem Stone King