Year: 2011

Sovereign Wealth Funds, Bribery, Corruption, Hospitality and the FCPA

The FCPA seems to be most closely associated with shady oil operations, mining, defense contractors and infrastructure transactions.  The image is a big company coming in and bribing an official for access to the country’s resources.

The other side to that investment is that the countries build up big supplies of capital. Many deploy some of that capital into funds for investing using sovereign wealth funds. During the credit crisis of 2008, some of the big Wall Street firms got injections of capital from sovereign wealth funds.

This is the flip side of the FCPA. Instead of a US company trying to get the rights to invest in the foreign country, it’s getting the foreign country to invest in the US company. And cash payments to foreign officials are still going to be considered bribes in violation of the FCPA, regardless of which direction the capital flows.

The problem is that the people running the sovereign wealth funds are going to be considered “foreign officials” under the Foreign Corrupt Practices Act. That should not come as surprise. In 2008 the Department of Justice said it was taking a look at “passive and active investments by U.S. securities firms into sovereign funds, and vice versa.” They clearly stated that a sovereign wealth fund is a “State-Owned Enterprise” and that securities firms should treat employees of sovereign wealth funds as government officials for purposes of the FCPA.

Dionne Searcey and Randall Smith published a big headline in the Wall Street Journal about the launch of a new investigation by the Securities and Exchange Commission into whether US banks and private equity firms violated the FCPA in their dealings with sovereign wealth funds.

Clearly, under-the-table payments in exchange for the investment are going to be trouble. But even typical hospitality shown to investors will be under tighter scrutiny. If it’s too lavish, it could be considered a bribe.

There is an affirmative defense under the FCPA if

the payment, gift, offer, or promise of anything of value that was made, was a reasonable and bona fide expenditure, such as travel and lodging expenses, incurred by or on behalf of a foreign official, party, party official, or candidate and was directly related to the promotion, demonstration, or explanation of products or services [§ 78dd-1 (c)(A) and § 78dd-2 (c)(A)]

The investment officer for the SWF comes to your office, you put him (or her) up at a nearby hotel, shown him around the office to meet management, discuss investment strategies and take him out to dinner after a full day of diligence. The question will be whether the lodging expenses and dinner expenses were “reasonable” and “bona fide.”

I doubt that the DOJ and SEC would consider the cost of putting up the official at a Holiday Inn and dinner at Denny’s to be so excessive as to not be “reasonable” and “bona fide.” Then start increasing the quality of those offerings. Instead of the Holiday Inn, it’s the Ritz-Carlton, or the 1,900 s.f  Central Park Suite at the Ritz Carlton. Instead of Denny’s, it’s dinner at Le Bernadin, with a $500 bottle of wine. Now you you need to be concerned that the dinner and lodging are not “reasonable” and “bona fide.” Throw in a few party favors just to give your compliance officers ulcers and sleepless nights.

Wall Street is still an easy target. The excesses of Wall Street make great headlines. If there really is some wrongdoing it will be an interesting story.

However, some of those investments helped save those Wall Street firms from collapse. We would be much worse off today if Citibank or Morgan Stanley followed Lehman into bankruptcy. I’m not saying that corruption would be warranted in this situation. But we also need to be careful not to spook away foreign investors with a witch hunt. Otherwise, they may not be there for a legitimate investment when we need them.

Sources:

Image of Wall Street is used under a creative commons license.

Compliance Bits and Pieces for January 14

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

“Foreign Official” Limbo … How Low Can It Go? in FCPA Professor

Move over 49%, there is a new “foreign official” “limbo low” – 43%.

In the recent Alcatel-Lucent enforcement action (see here for a complete analysis) paragraph 21 of the DOJ’s information (here) states as follows.

“Telekom Malaysia Berhad (‘Telekom Malaysia’) was a state-owned and controlled telecommunications provider in Malaysia. Telekom Malaysia was responsible for awarding telecommunications contracts during the relevant time period. The Malaysian Ministry of Finance owned approximately 43% of Telekom Malaysia’s shares, had veto power over all major expenditures, and made important operational decisions.

Facebook Tries to Befriend the Public Markets by Matt Kelly in Compliance Week

The modern U.S. regime of regulatory compliance is not easy, not cheap, and not popular—until you consider the alternatives. Then you can see that, as Winston Churchill once said in a somewhat different context, it’s the worst system in the world, except for all the others.

Judges Berate Bank Lawyers in Foreclosures by John Schwartz in the New York Times

With judges looking ever more critically at home foreclosures, they are reaching beyond the bankers to heap some of their most scorching criticism on the lawyers. In numerous opinions, judges have accused lawyers of processing shoddy or even fabricated paperwork in foreclosure actions when representing the banks.

Personal criminal liability, the nuclear deterrent: What every director, senior officer & General Counsel needs to know in The Bribery Act .com

The SFO is fond of saying that criminal liability under the Bribery Act is brought straight into the Board Room.

It is an attention grabbing headline and it’s meant to be.

A key weapon in the SFO’s armoury (akin to a nuclear deterrent) is the focussing of the mind in the Board and senior management levels (including General Counsel) which inevitably flows from the risk they face of a very lengthy (up to 10 years) prison sentence and an unlimited fine if the corporate engages in bribery.

The SFO hopes this threat will motivate the Boards and senior officers of corporates subject to the Bribery Act to adopt and implement Adequate Procedures to prevent bribery.

The Impact of the UK Bribery Act on U.S. Companies

Securities Docket put on another fantastic webcast on topics relevant to compliance professionals. Today’s focused on the upcoming Bribery Act in the United Kingdom. If your company has operations in the United Kingdom, you need to pay attention to this law.

The upcoming law applies to individuals and companies and outlaws bribes to public officials and private individuals. That makes it broader than the US FCPA. There is also a new corporate offense for failure to prevent bribery. Conviction can have jail sentences up to 10 years and provides for unlimited fines.

Webcast Presenters:

  • Vivian Robinson QC, general counsel to the UK’s Serious Fraud Office
  • Barry Vitou, partner in Winston & Strawn’s London office
  • Richard Kovalevsky QC, 2 Bedford Row
  • David Childers, CEO of EthicsPoint

For compliance professionals, the key will be putting “adequate procedures” in place inside the business to prevent bribery. We are still waiting for the UK government to publish guidance on that standard.  One recommendation from the panel was to look at Transparency International’s Adequate Procedures – Guidance to the UK Bribery Act 2010.

It’s not an offense if you lack “adequate procedures.” It is merely a defense to the charge against the company for violation of the Bribery Act.

You can watch a rebroadcast of the webcast and download the materials

Stay on Target

Don’t stray from your investment strategy. Don’t chase yields. Make sure your investment strategy follows your marketing materials.

According to SEC charges, Charles Schwab failed to do this with its YieldPlus Fund in 2007. The fund was marketed as a Short Term Bond fund and described the Fund as a cash “alternative” that generated a higher yield with slightly higher risk than a money market fund.

The Fund was not “slightly riskier” than money market funds, CDs and other cash alternatives to which it was compared. CDs are insured. Investments in the Fund were not insured. The maturity and credit quality of the Fund’s securities were significantly different than those of a money market fund.

The big problem was that the fund was mostly invested in mortgage-back securities. That means its investments got hammered in late 2007. That was coupled with widespread redemptions. Only 6% of the funds assets were scheduled to expire in those six months meaning they also had a liquidity crunch.

The SEC claims that executives made misstatements about the fund’s performance and the amount of redemptions. That makes the problem worse.

They made it even worse, according to the SEC by allowing insiders and other Schwab funds to redeem their shares in the Fund before the extent of the decline was disclosed to the public. Essentially, they had inadequate procedures to prevent insider trading.

There are some good lessons in this case for CCOs.

Sources:

Snow and Compliance

Dilbert.com

I’m staring out my front door at a half foot of snow, swaying branches heavily laden with wet snow, and an un-plowed street.

The latest weather report for Boston:

A Blizzard Warning remains in effect until 8 PM EST this evening.

* Locations… the East Coast of Massachusetts from Scituate northward.

* Hazard types… snow and blowing snow.

* Accumulations… 12 to 16 inches of snow.

* Timing… the heaviest snow will fall through noon time. Snowfall rates of 2 to 3 inches per hour are possible at times.

* Impacts… hazardous travel conditions expected. Heavy snow will significantly impact the morning commute. Strong northeast winds will combine with heavy snow to create blizzard conditions at times.

* Winds… north 20 to 30 with gusts up to 45 mph.

* Visibilities… one quarter mile or less at times.

Precautionary/preparedness actions…

A Blizzard Warning is issued when sustained winds or frequent gusts over 35 mph are expected with considerable falling and/or blowing and drifting snow. Visibilities will become poor with whiteout conditions at times. Those venturing outdoors may become lost or disoriented…
so persons in the warning area are advised to stay indoors.

I will take that advice and stay indoors.

Sometimes compliance means a day working at home with the kids.

Repeal of Dodd-Frank?

Most compliance professionals have trepidation about parts of the Dodd-Frank Wall Street Reform and Consumer Protection Act. I would bet that most of the Representatives and Senators who voted for it (and against it) did not read the whole law and do not understand the changes being made.

But should it be repealed in it’s entirety?

Since the Republicans have taken over the House of Representatives there is growing backlash against the law. Take a look at the new Republican-authored House Committee on Financial Services website. Here are the headline topics:

  • Collateral Damage – the real impact of the Democrat’s bailout bid
  • Financial Regulatory Reform
  • Fannie and Freddie Reform
  • What’s NOT in the Dod-Frank?
  • What’s Really in Dodd-Frank?

Along with the changes to the website comes a H.R. 87: To repeal the Dodd-Frank Wall Street Reform and Consumer Protection Act from Representative Bachman:

“I’m pleased to offer a full repeal of the job-killing Dodd-Frank financial regulatory bill. Dodd-Frank grossly expanded the federal government beyond its jurisdictional boundaries. It gave Washington bureaucrats the power to interpret and enforce the legislation with little oversight.

“Dodd-Frank also failed to address the taxpayer-funded liabilities of Fannie Mae and Freddie Mac. Real financial regulatory reform must deal with these lenders who were a leading cause of our economic recession.”

Speaking personally, I don’t like Dodd-Frank. But repealing it would be worse. I think needs the SEC needs more funding and a longer time frame to promulgate the new regulations. The SEC normal produces just a handful of new rules each year. Dodd-Frank tasks them with dozens that need to be in place in the next few months.

As for Fannie Fae and Freddie Mac being the cause of the crisis, I think Representative Bachman should take the time to read All the Devils Are Here by Bethany McLean and Joe Nocera. (I’m halfway through it.) Fannie and Freddie played a role, but lots of things went wrong to get us into the trouble of 2008.

Putting companies into a limbo of whether they need to change or not is bad. I may not like the law, but uncertainty is worse.

On the other hand, I think the repeal is unlikely. It’s merely a political football to throw around.

Sources:

Compliance and Foreclosures in Massachusetts

Why is the foreclosure machinery of our nation’s largest banks grinding to a halt? Failure to follow the legal rules. In other words: Compliance Failure.

The latest comes from my home state of Massachusetts. The state’s highest court rulet that two foreclosures were invalid because they were not properly assigned to the foreclosing party.

The theory of simply trading mortgage notes ran into the reality of real estate law. The foreclosure process and laws are different in every state. There are 23 states that require approval of a court to get a foreclosure order. These have been labeled the “judicial states.” The remaining states do not require court action. In non-judicial states, banks aren’t required to submit anything to the court until they are sued by a homeowner seeking to stop a foreclosure.

These homeowners sued because the assignments to the foreclosing lender were missing at the time of foreclosure. The financial institutions finally sorted out the mess and executed the assignments after the foreclosure sale.

We agree with the judge that the plaintiffs, who were not the original mortgagees, failed to make the required showing that they were the holders of the mortgages at the time of foreclosure. As a result, they did not demonstrate that the foreclosure sales were valid to convey title to the subject properties, and their requests for a declaration of clear title were properly denied.

The decision does not seem to extinguish the mortgage debt, it merely invalidates the foreclosure process. There is some doctrine that the mortgage follows the note. That seems to be brushed aside when it comes to the foreclosure process.

I don’t think it’s the lenders who are the ultimately the losers in this case. Now that the assignments are in order, they can go back and re-start the foreclosure process. For sure they are losing money. But it’s not the nuclear effect of having to walk with empty hands.

The group with the problem are the people who bought foreclosed property from lenders. If an assignment is missing, the foreclosure is improper and the lender never obtained good title to the property. That means there was no transfer to the purchaser. If that person did not purchase an owner’s policy of title insurance, they are in trouble. At best, they will have trouble refinancing the home and selling at home. At worst, the original property owner is going to come back for the property.

Sources:

Image: Sign Of The Times – Foreclosure by Jeff Turner

Compliance Bits and Pieces for January 7

Here are some recent compliance-related stories that I found interesting:

Dodd-Frank: Too Many Regulations Too Fast? by Thomas Gorman in SEC Actions

The average annual rate of rulemaking per year prior to Dodd-Frank for the SEC was 9.5, the CFTC 5.5, the FDIC 8 and the Federal Reserve 4.5 Post Dodd-Frank the average for the SEC is 59, the CFTC 37, the FDIC 6, and the Federal Reserve 17.

U.S Claims Some of Scott Rothstein’s Choicest Trinkets; Creditors Moan

Federal forfeiture laws allowed the government to seize the proceeds of Rothstein’s $1.2 billion Ponzi scheme, and the government can do what it likes with the proceeds, keeping some—or a lot—for itself, according to WSJ, which notes that the law does not require that one cent of seized assets be set aside for Rothstein’s legitimate business creditors.

The First Amendment, the securities laws and hedge funds by Larry Ribstein in Truth on the Market

I have been writing for some time about the First Amendment and the securities laws. In a nutshell, the formerly inviolate notion that the securities laws are a First-Amendment-free zone has always been constitutionally questionable. The questions multiply with the expansion of the securities laws. The Supreme Court’s recent broad endorsement of the application of the First Amendment to corporate speech in Citizens United signals that we may finally get some answers. The bottom line is that securities regulation that burdens the publication of truthful speech is subject to the First Amendment.

Massachusetts Attorney General Reviews 2010 Data Breach and Data Security Regulations Compliance in Littler’s Workplace Privacy Counsel

With the first anniversary of the Massachusetts Data Security Regulations, 201 CMR 17 (pdf)(“Regulations”), coming in March, the International Association of Privacy Professionals (IAPP) recently hosted a panel discussion providing direct access to the Massachusetts Attorney General’s Office and the Office of Consumer Affairs and Business Regulation to discuss their investigations to date and their current approach to enforcement. Panelists included Scott Shafer, Chief of the Consumer Protection Division, Massachusetts Attorney General’s Office; Shannon Choy-Seymour, Assistant Attorney General, Consumer Protection Division, Massachusetts Attorney General’s Office; Jason Egan, Deputy General Counsel, Massachusetts Office of Consumer Affairs and Business Regulation; and Lam Nguyen, Director (Digital Forensics), Stroz Friedberg LLP.

Should Workplaces Ban Lotteries? by Chris MacDonald in The Business Ethics Blog

Lots of offices feature “pools” of various kinds, with groups of employees joining together collaboratively or competitively to speculate on, e.g., the outcome of the NFL playoffs. Very likely lots of managers regard it all as harmless fun, boosting morale by giving employees a break from the tedium of their cubicle farms. But a lottery pool is unlike, say, a hockey or football pool. In a hockey or football pool, there are winners and losers, but typically the dollar amounts are pretty small. But when employees band together to buy lottery tickets, the possibility is there for all hell to break loose.

Facebook, Capital and Liquidity

There have been many stories written about the Goldman Sachs investment in Facebook. On one hand, there is the chatter about the investment placing the valuation at $50 billion. On the other, there hand there is the talk about how this affects a possible IPO by Facebook.

There are two main reasons for an public offering of stock: liquidity and capital.

If you need capital, a public offering of common stock is merely one of many ways to raise capital. The benefit of this option is that the capital does not need to be repaid. A bank loan, a bond offering, venture capital or private capital will generally need to be repaid at some point. Each source of capital has a price and repayment terms that you need to align with the company’s needs and business plan.

It sounds like Facebook has ready access to capital in many forms. So an initial public offering may not be the best or the cheapest source of capital.

The liquidity of public stock is useful for rewarding employees and cashing out earlier sources of capital. Employee stock is great, but in a private company is very illiquid. It does you very little good to be a millionaire on paper if you can’t access the wealth. Early round investors, like venture capital funds, want to be cashed out at some point. They need to return capital to their investors. It sounds like some of the private trading of Facebook stock is being done by employees and early investors.

The third reason for a public offering stock was the reason faced by Google. Once you have more than 499 investors, you need to start making reports public. So you may as well get the benefits of liquidity in the stock.

The cash from a public offering does not need to repaid, but there are costs to the capital. That means complying with Sarbanes-Oxley. The CEO and CFO has potential criminal liability for false reporting. The board of directors will now need to include independent directors. The company will be subject to shareholder lawsuits. There are lots of costs.

To me it sounds like Facebook and Goldman have come up with an ingenious solution to the address the capital needs for Facebook and to avoid a public offering of stock. I assume the Goldman investment and its new fund will be used to provide some capital for expansion and growth. I also suspect that some of it will be used to cash out early investors, purchase employee stock, and repurchase stock that has been privately traded. Gobbling up the stock would be an opportunity to keep the number of investors well below the 499 trigger point. Early investors may take their money and run.

Assuming Goldman can provide $2 billion and charge its investors a 4% fee for investing, they have already made $80 million on their $450 million investment.

Sources: