Author: Doug Cornelius

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Compliance Bricks and Mortar for January 24

These are some of the compliance-related stories that caught my attention.

Two Anti-Corruption Items of Note
Matt Kelly
Radical Compliance

Good news for anti-corruption enthusiasts looking for something to read — we have two fresh pieces of literature this week that you can study and shoehorn into your compliance programs. First, Transparency International just released its 2019 Corruption Perceptions Index, which is one of the go-to benchmarks to help compliance officers perform a corruption risk assessment. The short version: lots of countries are backsliding into more corruption. Second, Britain’s Serious Fraud Office has quietly released its in-house guidance for how investigators should assess corporate compliance programs, akin to the U.S. Justice Department’s own guidance on how to evaluate compliance programs. The SFO material is much shorter and probably less informative, but still, it’s now available to the public.

http://www.radicalcompliance.com/2020/01/23/two-anti-corruption-items-note/

New Year Brings New Responsibilities for Some Asset Managers Who Are Exempt from Registration with the CFTC
Ropes & Gray

With the New Year comes new responsibilities for certain asset managers who are exempt from registration with the U.S. Commodity Futures Trading Commission (“CFTC”) as commodity pool operators (“CPOs”) or commodity trading advisors (“CTAs”). Following recent amendments to CFTC rules applicable to asset managers (discussed further here), family offices, operators of business development companies (“BDCs”) and certain operators of registered investment companies (“RICs”) should reevaluate their CPO registration exemptions and, with respect to family offices, CTA registration exemptions. Asset managers affected by the rule amendments may be required to take additional action. In addition, as in years past, certain CPO and CTA registration exemptions, including those claimed under CFTC Rule 4.5, 4.13(a)(3) and 4.14(a)(8), must be renewed by March 2, 2020.

https://www.ropesgray.com/en/newsroom/alerts/2020/01/New-Year-Brings-New-Responsibilities-for-Some-Asset-Managers-who-are-Exempt-from-Registration?

So Maybe The SEC Does Need Whistleblowers’ Help?
Jon Shazar
DealBreaker

Ah, right, those whistleblowers the SEC has made as clear as possible it neither needs nor wants nor intends to compensate. Surely, then, Jay Clayton’s boys can’t have missed too much, right?

https://dealbreaker.com/2020/01/tca-hedge-fund-shuts

Preventing Phishing Attacks
Michele R. O’Brien
The Compliance & Ethics Blog

Your organization’s staff should always be considered the first line of defense against cyber threats. Unfortunately, they can also be the biggest risk factor when it comes to phishing. It takes just one employee to take the bait and that’s enough for attackers to steal intellectual data. 

https://complianceandethics.org/preventing-phishing-attacks/

Fried Frank Discusses Delaware Chancery’s Latest Decision on Material Adverse Change Clauses
By Gail Weinstein, Warren S. de Wied, David L. Shaw, Steven Epstein and Andrew J. Colosimo
The CLS Blue Sky Blog

Channel Medsystems, Inc. v. Boston Scientific Corporation (Dec. 18, 2019) is the Delaware Court of Chancery’s first decision issued since the Delaware Supreme Court’s 2018 Akorn decision to evaluate whether an acquiror had a right, under a merger agreement, to terminate a pending acquisition on the grounds that there was a “Material Adverse Effect” or “Material Adverse Change” in the target company. (We use “MAE” and “MAC” interchangeably in this memorandum.) Akorn was the first case in which the Court of Chancery, post-trial, found the existence of an MAE and the first post-trial Delaware decision to find that an acquiror had the right to terminate a merger agreement based on an MAE. In Channel, by contrast, Chancellor Bouchard ruled, after trial, that there was not an MAE and that the acquiror was required to close the merger.

https://clsbluesky.law.columbia.edu/2020/01/21/fried-frank-discusses-delaware-chancerys-latest-decision-on-material-adverse-change-clauses/

SEC/Telegram Litigation Commentary & Compendium (A Must Read for FinTech Players)
John Reed Stark

[T]he SEC Telegram matter is more than just the typical SEC emergency enforcement action. The SEC Telegram docket does not just provide a rapid-fire presentation of just about every issue facing cryptocurrency market participants today. The matter also offers a rare and vivid glimpse into the dramatic disparity between on the one hand, how the SEC enforcement division views digital token offerings (they should all be registered!) and on the other hand, how the so-called fintech bar views digital token offerings (they are not always securities!). 

https://www.linkedin.com/pulse/sectelegram-litigation-commentary-compendium-must-read-stark

The One with the Fake ComplianceGuard

Compliance; solve it with the blockchain. Operational due diligence; solve it with the blockchain. Shortcomings of separately managed accounts; solve it with the blockchain. Financial audits; solve it with the blockchain.

Shaun MacDonald, managed to squeeze $30 million in ICO funding from investors for his idea to create ComplianceGuard, a blockchain based tool for funds, and a blockchain terminal, crypto-focused version of the ubiquitous Bloomberg Terminal. According to the SEC complaint, the tools were not in production. That and other materially false and misleading statements were made in the illegal sale of securities that was the ICO.

The first problem is that Shaun MacDonald is really Boaz Manor. In 2010, Mr. Manor pleaded guilty in Ontario, Canada to the crimes of laundering the proceeds of a crime and disobeying an order of a court. Both charges related to the 2005 collapse of the hedge fund firm Portus Group. Mr. Manor darkened his hair, grew a beard, and used aliases to hide his identity and conceal the fact that he had served a year in prison.

It started with ComplianceGuard. A box-shaped device that was supposed to do something compliance-y. It was enough to convince people to give him $775,000 through a token offering. It looked something like this. The whitepaper is full of great compliance-related themes. But I don’t see any actual description of a solution to those compliance requirements

Mr. Manor managed to put the device in the hands of a few hedge funds. But according to the SEC complaint, none of them actually used it. It basically functioned as an extra electronic hard drive for the storage of manually entered transaction data. None of the funds paid for the devices.

Then the company pivoted harder to blockchain with the blockchain terminal. That caught the attention of token purchasers and the company raised $30 million.

Clearly, it was more sexy than compliance.

The company actually made a product and sent it to to funds for use. It’s not clear than anyone actually used those terminals or even if they did anything useful.

I’m going to guess that the ICO fundraising was better than the terminals.

In the end, the SEC has all of the alleged fraud. But it also has the fraud of the disguised Mr. Moran.

On top of that, it has a claim for the unregistered sale of securities. The company did file a for Form D for 506(c) offering. But that form of offering requires you to take reasonable steps to verify that the purchaser is an accredited investor. The SEC claims that those steps were not taken.

Sources:

The Economic Effects of Private Equity: Good or Bad?

It depends.

But it’s certainly not the scourge portrayed by the Stop Wall Street Looting Act. That bill is clearly myopic in equating private equity with leveraged buyouts. Even with that subset of private equity, the results of leveraged buyouts are not bad for the underlying companies.

In a recent paper a group of economists looked at the data. They jumped in data from CapitalIQ and collected a sample of 9,794 private equity led leveraged buyouts. They divided those deals into four groups: the buyout of an independent, privately held firm (private-to-private), the buyout of a publicly listed firm (public-to-private), the buyout of part of a firm (divisional), and the sale of portfolio firms from one PE firm to another (secondary).

Does a PE buyout result in job losses. According to the paper, relative to control firms:

  • In private-to-private buyouts employment at targets rises 13 percent
  • In secondary buyouts, employment rises 10 percent
  • In public-to-private deals employment falls by 13 percent
  • In divisional buyouts, employments falls by 16 percent

That’s a push. One would assume that one of the reasons a public company ends up under-valued and in the sights of PE firms is that its underperforming.

To support that, the research shows a rise in labor productivity of eight percent at target firms. The researchers note that as striking given that the target firms tend to be mature firms in mature industries.

I think the problem is the public perception of private equity caused by poor results in public-to-private deals, like Toys ‘R Us, catch all the headlines, while the run of the mill deals with good success or great success don;t make the headlines.

Sources:

Compliance Bricks and Mortar for January 17

These are some of the compliance-related stories that have caught my attention.

Investment Funds – Year-end Compendium of Our 2019 Client Updates
Sidley Austin

As the developments affecting the investment management industry continue to unfold, we have once again prepared our semiannual compendium of relevant Sidley Updates for our investment fund and adviser clients and friends. The compendium includes a summary of each Sidley Update year-to-date, in reverse chronological order, along with a link to its full text. We have included all of the updates, making the compendium repetitive in instances where we revisited a topic to report on emerging information and breaking news in the industry.

https://www.sidley.com/en/insights/newsupdates/2020/01/year-end-compendium-2019

Samsung Signs on the Compliance Line
Matt Kelly
Radical Compliance

Quite the compliance moment was witnessed in Korea this week, when the executive team at Samsung Electronics made a public display of signing a pledge to obey anti-corruption laws and build a new culture of compliance at the firm. The firm’s top three executives — president Kim Hyun-seok, vice chairman Kim Ki-nam, and mobile communications head Koh Dong-jin — signed the pledge at a publicity event at Samsung headquarters on Monday. Like, in front of the cameras. With reporters around and publicity photos issued.

http://www.radicalcompliance.com/2020/01/14/samsung-signs-compliance-line-pledge/

The Astros Cheating Scandal and Compliance
Tom Fox
FCPA Compliance & Ethics

Over the next few blogs, I will be exploring the MLB Report in detail, how it demonstrates that culture must be on the forefront of every Chief Compliance Officer (CCO) and corporation, what it means for the compliance community and how the MLB Report informs enforcement of anti-corruption laws such as the Foreign Corrupt Practices Act (FCPA).

Part 1 – The Cheating Scheme
Part 2 – Hinch and Luhnow

Private equity firms fear a Democrat topping Trump in 2020
Dan Primack
Axios

What’s happening: The result is that private equity investors are talking about clearing the portfolio decks this year, locking in profits under the current taxation scheme.

The big picture: This is different than the decades-long debate over carried interest, which was about if PE investment profits should be taxed as capital gains or as ordinary income. If you no longer have a difference between the two rates, it no longer matters how carried interest is classified.

https://www.axios.com/private-equity-fears-democrats-2020-presidential-election-79b046d3-78a7-44ed-ade6-be93d02528cb.html?

Into the Mainstream: ESG at the Tipping Point
 Rakhi Kumar, Nathalie Wallace, and Carlo Funk
Harvard Law School Forum on Corporate Governance

In 2017, we conducted a major global survey to give deeper insight into the increasingly important Environmental, Social and Governance (ESG) market. Performing for the Future revealed a picture of ESG investment driven by performance beliefs, coupled with challenges and evolving pathways to adoption. …

Our latest research uncovers the views of more than 300 institutional investors and world-leading institutions, revealing what is driving organizations to adopt ESG, how this is influencing adoption, and the barriers that must be overcome to deliver the best outcomes.

https://corpgov.law.harvard.edu/2020/01/13/into-the-mainstream-esg-at-the-tipping-point/

Compliance Alert: Expensive watches raise red flags
Harry Cassin
The FCPA Blog

One luxury item is showing up more often in alleged graft-related asset seizures: wrist watches, especially the high-end variety with eye-watering price tags. In November 2018, Venezuela’s former national treasurer Alejandro Andrade was sentenced in the United States to ten years in prison for his role in a plot to launder $1 billion in bribes. He also forfeited $1 billion in personal assets, including bank accounts, aircraft, real estate, vehicles, horses, and watches. Andrade used watches to pay some of the bribes.

https://fcpablog.com/2020/01/08/compliance-alert-expensive-watches-raise-red-flags/

Marginalization of counsel … and compliance officers
Jeff Kaplan
Conflict of Interest Blog

Years ago, a firm I knew moved its chief compliance officer from a relatively nice office to a decidedly not nice one. The move was intended to send a message and it was received that way. I noted at the time that this would not end well for the firm. Sadly, I turned out to be right. In a recent post on the Harvard Corporate Governance Blog, “Bernie Ebbers and Board Oversight of the Office of Legal Affairs,” Michael W. Peregrine, McDermott Will & Emery LLP revisits the once-famous World Com accounting fraud scandal from the early 2000s and particularly the aspect of it that entailed the CEO (Ebbers) marginalizing corporate counsel. The details of this matter are less important (to me) than are the author’s very useful recommendations for mitigating this sort of risk.

http://conflictofinterestblog.com/2020/01/marginalization-of-counsel-and-compliance-officers.html

OCIE’s 2020 Exam Priorities — Key Takeaways for Private Fund Managers
Proskauer

Last week, the SEC’s Office of Compliance Inspections and Examinations released its 2020 Exam Priorities with a number of areas of interest to private fund managers. OCIE reported that it examined 15% of registered investment advisers (RIAs) during fiscal year 2019, down from approximately 17% of RIAs during FY 2018 but consistent with FY 2017’s 15% coverage rate. The four-week government shutdown in January 2019 reduced exam activity last year, but we expect the numbers to trend upward in 2020.

https://www.proskauer.com/alert/ocies-2020-exam-priorities-key-takeaways-for-private-fund-managers

OCIE’s 2020 Examination Priorities

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations announced its 2020 examination priorities. OCIE has been publishing its examination priorities annually in an effort to enhance the transparency of its examination program and to provide insights into its approach to examination. With its current risk-based approach, the exam priorities highlight areas that OCIE thinks present greater potential risks to investors and the integrity of the U.S. capital markets.

OCIE identified eight overarching priority areas

1. Retail Investors, Including Seniors and Those Saving for Retirement – OCIE again will focus on the protection of retail investors, including the various intermediaries that serve and interact with retail investors and the investments marketed to, or designed for, retail investors. Examinations in these areas will include reviews of disclosures relating to fees, expenses, and conflicts of interest.

2. Information Security – OCIE will continue to prioritize cyber and other information security risks across the entire examination program.

3. Financial Technology and Innovation, Including Digital Assets and Electronic Investment Advice – OCIE will keep a close eye on those in the digital asset space, as well as RIAs that provide services to clients through automated investment tools and platforms, often referred to as “robo-advisers.”

4. Focus Areas Relating to Investment Advisers, Investment Companies  – OCIE will continue its risk-based examinations for each type of these registered entities. In particular, examinations of registered investment advisers will focus on RIAs that have never been examined, including new RIAs and RIAs registered for several years that have yet to be examined. These examinations will include RIAs advising retail investors as well as private funds.  Investment company examinations will focus on mutual funds and exchange-traded funds, the activities of their RIAs, and the oversight practices of their boards of directors. 

5. Focus Areas Relating to Broker-Dealers, and Municipal Advisors – OCIE will continue its risk-based examinations for each type of these registered entities. Broker-dealer examinations will focus on issues relating to the preparation for and implementation of recent rulemaking, along with trading practices. Municipal advisor examinations will include review of registration and continuing education requirements and municipal advisor fiduciary duty obligations to municipal entity clients.

6. Anti-Money Laundering Programs – OCIE will continue to review for compliance with applicable anti-money laundering requirements, including whether entities are appropriately adapting their AML programs to address their regulatory obligations.

7. Market Infrastructure – OCIE will continue its focus on entities that provide services critical to the functioning of our capital markets, including clearing agencies, national securities exchanges, alternative trading systems, and transfer agents. Particular attention will be focused on the security and resiliency of entities’ systems.

8. FINRA and MSRB – OCIE will continue its oversight of the Financial Industry Regulatory Authority by focusing examinations on FINRA’s operations, regulatory programs, and the quality of FINRA’s examinations of broker-dealers and municipal advisors. OCIE will also continue to examine the Municipal Securities Rulemaking Board to evaluate the effectiveness of its operations and internal policies, procedures, and controls.

As for private funds, on page 16 of the Priorities:

“OCIE will continue to focus on RIAs to private funds that have a greater impact on retail investors, such as firms that provide management to separately managed accounts sideby-side with private funds. Moreover, OCIE will review RIAs to private funds to assess compliance risks, including controls to prevent the misuse of material, non-public information and conflicts of interest, such as undisclosed or inadequately disclosed fees and expenses, and the use of RIA affiliates to provide services to clients.”

As for examination coverage:

“OCIE has increased its examination coverage of RIAs over the past several years from 10 percent in FY 2014 to a high of 17 percent in FY 2018. OCIE’s coverage of RIAs in FY 2019, a year in which the RIA population continued to increase and the SEC experienced a 35-day lapse in appropriations, was 15 percent.”

If these priorities sound familiar, they are not very different from the 2019 priorities. I think that’s because it’s the right set of priorities using a risk-based approach.

The 2021 priorities may change with the regulatory pipeline. The changes in marketing and Regulation BI will alter the compliance landscape.

Sources:

Modernization of Auditor Independence Rules

For private funds to comply with the Custody Rule, they usually rely on the annual, independent audit prong for compliance. That rule requires an audit from an auditor that is subject to audit as defined in Regulation S-X. The SEC has proposed some changes to Regulation S-X that affect the auditor independent framework.

“Many of the current independence requirements have not been updated since their initial adoption in 2000 and amendments in 2003.  Since that time, the Commission and our staff have, through several consultations per year, continued to learn about the application of our independence rule set and the efficiency and effectiveness of our independence requirements as market conditions and industry practices have changed.  The proposed amendments to Rule 2-01 are designed to respond to these changes, reflect the SEC staff’s experience administering the independence requirements, and incorporate consideration of the recent and longer term feedback received from the public. “

The changes look like they will mostly be at the edges of compliance and not have a significant impact on auditor independence for fund managers.

I had some questions about auditor independence a few years ago and found the decision-making about independence to be very opaque with almost no public guidance. This modernization may help improve this process.

Sources:

Compliance Bricks and Mortar for January 3

Happy New Year! Here are some of the year-end and start-of-the-year stories for you.

SEC And CFTC Regulatory Priorities To Watch In 2020

The Securities and Exchange Commission and the Commodity Futures Trading Commission expect to tackle a busy regulatory slate in 2020. For the chairs of both agencies — Jay Clayton at the SEC and Heath Tarbert at the CFTC — this year could also be their final opportunity to leave their mark given the looming presidential election and potential change in administration.
While both bodies share certain concerns, including confronting regulatory challenges posed by the growth of digital assets, each have distinct priorities that appear ripe for action in 2020. Lawyers also note that regulators are facing a tight time frame to complete priorities given that the nation’s attention will shift to the presidential campaign by Labor Day.

https://www.law360.com/securities/articles/1228214

7 Compliance Items to Watch for 2020
Matt Kelly
Radical Compliance

Welcome to 2020, everyone! This has been a long winter break, but before we return to the grind of emails to answer and staff meetings to avoid, let’s spare a few moments to ponder how the corporate compliance landscape in the coming year.

Without further delay, then: my annual list of compliance issues worth watching in the next 12 months. In no particular order…

http://www.radicalcompliance.com/2020/01/01/7-compliance-items-watch-2020/

My 2020 Legal Market Predictions
Ron Friedmann
Prism Legal

Clickbait titles don’t appeal to me but my original idea for a title here – “Incremental Change in 2020” – just sounded too lame. Unlike many other commentators, I shy away from bold predictions of big changes coming soon. I’ve worked for three decades in the corporate legal market and have witnessed many incremental changes but few dramatic ones. Yet Big Law today does look rather different than it did when I started in the 1980s. The new look, however, flows from many small changes.

https://prismlegal.com/my-2020-legal-market-predictions/

2019 FCPA Enforcement Index
Richard L. Cassin
The FCPA Blog

Last year 14 companies paid a record $2.9 billion to resolve FCPA cases. That includes amounts assessed in resolutions with the DOJ or SEC or both. There were four enforcement actions last year in the mega category — Ericsson at $1 billion, MTS at $850 million, Walmart at $282.7 million, and Fresenius at $231.7 million. Both Ericsson and MTS landed on our list of the ten biggest FCPA enforcement actions of all time.

https://fcpablog.com/2020/01/02/2019-fcpa-enforcement-index/

31 Days to a More Effective Compliance Program –
Day 1| What 2019 Brought to Compliance Programs
Tom Fox
FCPA Compliance & Ethics

2019 was a very significant year for every compliance practitioner and compliance program. Not only was it the year with the single highest amount of FCPA enforcement actions, fines and penalties assessed against corporations but it also saw the greatest number of individual prosecutions. Yet perhaps most significantly there were three noteworthy releases of information by the federal government which directly impacted compliance professionals in 2019. Two came from the Department of Justice (DOJ) and one came from the Department of Treasury, Office of Foreign Asset Control (OFAC). These three guidance’s contributed to the continued evolution of what constitutes a best practices compliance program.

http://fcpacompliancereport.com/2020/01/31-days-effective-compliance-program-day-1-2019-brought-compliance-programs/

Compliance Bricks and Mortar for December 20

Here is my Star Wars: The Rise of Skywalker spoiler-free collection of compliance-related stories that I’m reading while waiting to watch the movie.

The Intersection of Star Wars and Compliance
Tom Fox and Jay Rosen

The Hallmark of New Stakeholder Risk
Matt Kelly
Radical Compliance

I always enjoy a good drama, and what happened at the Hallmark Channel this week did not disappoint. Ethics and compliance officers might want to consider what happened there since the same basic plot line seems to be happening at lots of large organizations.

You might already have heard what happened, although the whole thing happened so fast that maybe you didn’t. Hallmark had agreed to air several ads from Zola Inc., a wedding planning firm, including one ad that featured a same-sex couple. That ad (with two women) started airing several weeks ago, during what is normally Hallmark’s busy season of broadcasting schlocky Christmastime romance movies. 

http://www.radicalcompliance.com/2019/12/19/hallmark-new-era-stakeholder-risk/

Court Finds Fund a “Beneficial Owner” Subject to Section 16 Despite Delegation to Investment Adviser
Sidley Austin

A federal district court found a private fund to be a “beneficial owner” subject to Section 16 of the Securities Exchange Act of 1934, even though the fund had delegated voting and investment power to its investment adviser.1 Delegation has been relied upon by private funds in taking the position that the fund is a not a “beneficial owner” subject to Section 16. This ruling is likely to attract the interest of the Section 16(b) plaintiff’s bar, which reviews SEC filings for potential theories of private litigation.

https://www.sidley.com/en/insights/newsupdates/2019/12/court-finds-fund-a-beneficial-owner-subject-to-section-16-despite-delegation

Proposed Changes to Accredited Investor Definition

On Wednesday, the Securities and Exchange Commission proposed changes to the definition of “Accredited Investor” under Regulation D. The reason for the changes is to open the private market to a broader group of individual and institutional investors.

For those hoping for a dramatic change in how to determine accredited investor, you’ll be disappointed. The change eats at the edges and covers a few small openings.

The key to the accredited investor definition is that it limits who can invest in a private placement under Rule 506. If you don’t meet the accredited investor standard you can’t invest.

One expansion is to allow certain credentialed people to be automatically included as an accredited investor. The initial credentials are for registered representatives who have Series 7, 65 or 82 license. The rule notes that there are over 700,000 people who hold those designations, but has no data on how many of these were not previously qualified.

For private funds, there is an application of the “knowledgeable employee” definition over to accredited investor status. The SEC established Rule 3C-5 to allow “knowledgeable employees” to invest in their company’s private fund without having to be a qualified purchaser. The rule also exempts these knowledgeable employees from the 100 investor limit under the Section 3(c)(1) exemption from the Investment Company Act. However, currently the knowledgeable employee still has to be an accredited investor. This rule change will cover that gap.

Commissioner Jackson was opposed to the expansion. He is concerned about the lack of investor protection. He thought there was a lack of analysis in the release. In one instance he cites that the use of brokers expected to protect investors under the proposal. However, the data he looked at found that there was higher instance of fraud when brokers were involved. No vote.

Commissioner Peirce found the current bright-line tests of income and net worth are too simplistic, keeping out qualified people and allowing in more that may not be qualified. She also noted that the geographic disparities in cost of living results in lower salaries and therefore a geographic disparity in accredited investors. Yes vote.

Commissioner Roisman pointed out that he is not currently an accredited investor and would not qualify under the proposed changes. He stated that the definition should be broader. He is also concerned about the lack of investor protections. Yes vote

Commissioner Lee found the changes merely go to expanded the pool of private investors without the data on fraud. She is concerned that the current net worth and income levels are not indexed to inflation, expanding the pool of investors who could enter into private transactions without the protections of the public markets. No vote.

Chairman Clayton noted that there is a consensus that the current definition is less than satisfactory. Yes vote.

Once published, the proposal will be open for comments for 60 days.

Sources: