Author: Doug Cornelius

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Compliance Bricks and Mortar for December 13

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

Do Private Equity Managers Raise Funds on (Sur)real Returns?
by Niklas Huether
The CLS Blue Sky Blog

By analyzing valuations at the deal-level, I do not find any evidence of window dressing in private equity. The key factor for performance peaks lies in the deal composition rather than in inflated NAVs.

http://clsbluesky.law.columbia.edu/2019/12/10/do-private-equity-managers-raise-funds-on-surreal-returns/

The Incomparable Value of Service in Secret: Lessons from the SEC’s Office of the Whistleblower
by Jordan A. Thomas
NYU Law’s Compliance & Enforcement blog

Nearly ten years ago, following a global financial collapse spurred by serial wrongdoing, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act. Within its 2,000 pages of sweeping reform was the charge to establish an investor protection initiative, which emerged as the SEC Whistleblower Program. Its three pillars—anonymity safeguards, substantial monetary bounties, and significant employment protections—shaped a first-of-its-kind paradigm to encourage individuals to report suspected violations of the federal securities laws. The formidable combination of these programmatic mainstays and an enforcer armed with early actionable intelligence has proven to be a game changer. It’s not just recoveries and reform, however. Behind the results, including in the just-released Office of the Whistleblower’s Annual Report to Congress, stand everyday people willing to take a bold step forward, to be the outsider and the anti-hero, no matter the size of Goliath and his balance sheet.

https://wp.nyu.edu/compliance_enforcement/2019/12/03/the-incomparable-value-of-service-in-secret-lessons-from-the-secs-office-of-the-whistleblower/

Betrayed by the Big Four: whistleblowers speak out
by Madison Marriage
Financial Times

These individuals worked for four of the most renowned names in the business world: EY, Deloitte, KPMG and PwC. They are among 20 former employees from the Big Four accounting firms who have spoken to the Financial Times about their experience of harassment, bullying and discrimination in the workplace over the course of a year’s investigation into how these firms treat whistleblowers within their ranks.
The FT identified a disturbingly common pattern in terms of how complainants were treated: most initially felt ignored, then isolated and were eventually pushed out. Legal clauses aimed at silencing them swiftly followed; nine of those interviewed said they were pressured into signing restrictive non-disclosure agreements. Others were asked to sign but resisted.

https://www.ft.com/content/78f46a4e-0a5c-11ea-bb52-34c8d9dc6d84

Women in Compliance 2020 Finalists

Recognising and celebrating the achievements female compliance professionals make every day in the world of compliance and business from every industry around the world.
Bringing together female compliance professionals to provide practical learning skills in the compliance world as well as worthwhile opportunities for networking and mentoring.
25-26 March 2019 | London, UK
Discover more information

The Securities and Exchange Commission wants bad guys to know: ‘We’re watching’
by Bob Pisani
CNBC

I spent a day at SEC headquarters with the regulators Chairman Jay Clayton and the co-directors of the Division of Enforcement, Stephanie Avakian and Steven Peikin. The highlight was a visit to the Forensics Lab, a copper-lined room where the SEC extracts data from cell phones and computers from traders and others who may be engaged in suspicious activity.

https://www.cnbc.com/2019/12/11/the-sec-wants-bad-guys-to-know-were-watching.html

New List: The FCPA Top 40
by Richard L.Cassin
The FCPA Blog

There’s a surprisingly wide geographical distribution of the companies in the top 40. Ten come from the United States and five from France. Four companies are from Germany, followed by three each from Switzerland, Japan, Brazil, the Netherlands, and the United Kingdom.

https://fcpablog.com/2019/12/12/new-list-the-fcpa-top-40/
Photo by Evan Nitschke at Pexels.
https://www.pexels.com/photo/brick-leading-line-lines-snow-1009302/

Form CRS for Private Fund Managers

As part of Regulation BI package of regulatory changes, the Securities and Exchange Commission created a new Form CRS that needs to be delivered to “retail investors.” Of course there are questions from the industry. The SEC’s Division of Investment Management and Division of Trading and Markets created a website that answers Frequently Asked Questions on Form CRS. The question for pooled funds whether whether the rule would look through to retail investors in a fund.

Pursuant to new rules adopted by the SEC under the Securities Exchange Act of 1934 and the 1940 Act in connection with Regulation BI, registered broker-dealers and registered investment advisers will be required to deliver a relationship summary to retail investors. This summary is Form CRS.

Form CRS will require a firm to provide information about the relationships and services the firm offers to retail investors, fees and costs that retail investors will pay, specified conflicts of interest and standards of conduct, and disciplinary history.

One FAQ addresses a question I had regarding pooled funds:

Q: My firm is an investment adviser to pooled investment vehicles, such as a hedge funds, private equity funds and venture capital funds.  The investors in these funds include natural persons who may be “retail investors” as defined in Form CRS. Am I required to deliver a relationship summary to these funds?

A:  An investment adviser must initially deliver a relationship summary to each retail investor before or at the time the adviser enters into an investment advisory contract with the retail investor.  “Retail investor” is defined as “a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family or household purposes.” In the staff’s view, the types of pooled investment vehicles described above would not meet this definition and a relationship summary would not be required to be delivered.

So, the manager doesn’t have to deliver a Form CRS to the fund itself. It’s less clear if you have to deliver it to the “retail investors” in the fund. Does Rule 206(4)-8 pass the Form CRS requirement through the pooled investment vehicle?

Sources:

Compliance Bricks and Mortar for December 6

These are some of the compliance-related stories I’ve been reading while digging out of the snow this week.

Can the S.E.C. Force Repayment of Ill-Gotten Gains?
by Peter Henning
DealBook

The issue before the Supreme Court will be whether a District Court can order a defendant to repay money obtained by fraud or trading on confidential information, or whether it is a penalty beyond the “equitable” power of the courts to require. The S.E.C. is sure to argue that a defendant who engages in fraud or insider trading should not be allowed to keep the profits, much as a thief has no claim to the money that is stolen.

https://www.nytimes.com/2019/11/29/business/dealbook/sec-fraud-disgorgement.html

A Common-Sense Approach to Corporate Purpose, ESG and Sustainability
by Frank B. Glassner
Harvard Law School Forum on Corporate Governance and Financial Regulation

The [Business Roundtable] lists stakeholders in the order of “customers” first, followed by “employees,” “suppliers,” “communities” and finally “shareholders.” This sequence does not alter the longstanding presumption that shareholders occupy the position of first among equals. As equity owners and providers of capital, shareholders have always required a high and continuous level of attention from companies. Voting power gives shareholders a direct voice in corporate governance; their investment decisions determine a company’s stock price and cost of capital. Accordingly, shareholders remain the primary audience for a company’s sustainability story. It is also important to remember that a company’s creditors, specifically investors in its fixed income securities, rank with shareholders at the top of the stakeholder list.

https://corpgov.law.harvard.edu/2019/12/01/a-common-sense-approach-to-corporate-purpose-esg-and-sustainability-2/

Compliance Under Fire: Two More Tales
by Matt Kelly
Radical Compliance

Neither of these stories is good. They, along with other tales of retaliation against CCOs I’ve collected over the years, are a reminder that corporate compliance must be important after all — because when you do the job well, you can piss people off. Let’s stand by those compliance folks who do the right thing. Attention must be paid.

http://www.radicalcompliance.com/2019/11/27/compliance-under-fire-two-more-tales/

Does ethics training actually affect business conduct?
by Jeff Kaplan
Conflict of Interest Blog

In “Can Ethics be Taught? Evidence from Securities Exams and Investment Adviser Misconduct,” forthcoming in the Journal of Financial Economics,  Zachary T Kowaleski of University of Notre Dame, Andrew Sutherland of the Massachusetts Institute of Technology, and Felix Vetter of the London School of Economics “study the consequences of a 2010 change in the investment adviser qualification exam that reallocated coverage from the rules and ethics section to the technical material section. Comparing advisers with the same employer in the same location and year, we find those passing the exam with more rules and ethics coverage are one-fourth less likely to commit misconduct. The exam change appears to affect advisers’ perception of acceptable conduct, and not just their awareness of specific rules or selection into the qualification. 

http://conflictofinterestblog.com/2019/11/does-ethics-training-actually-affect-business-conduct.html

Why complying with Reg BI can’t wait for the last minute
by Jeff Benjamin
InvestmentNews

The good news is, the Securities and Exchange Commission’s upcoming Regulation Best Interest is not expected to dramatically change most daily business activities for financial advisers and registered representatives.

The good news is, the Securities and Exchange Commission’s upcoming Regulation Best Interest is not expected to dramatically change most daily business activities for financial advisers and registered representatives. The bad news is, advisers and broker-dealer reps will still need to prepare for Reg BI, and that preparation might be expensive and time-consuming.

https://www.investmentnews.com/article/20191204/FREE/191209976/why-complying-with-reg-bi-cant-wait-for-the-last-minute

SEC 2019 Whistleblower Program Report

Section 924(d) of Dodd-Frank requires the Securities and Exchange Commissions Office of the Whistleblower to report annually to Congress on Office’s activities, whistleblower complaints received, and the response of the SEC to those complaints. In addition, Section 21F(g)(5) of the Exchange Act requires the SEC to submit an annual report to Congress. The SEC published the whistleblower report on November 15.

According to the report, the Office received slightly fewer tips and awarded significantly less to whistleblowers in FY 2019, as compared to FY 2018.

This past year, the SEC received 5,212 tips. That’s a slight decrease from FY 2018. That brings the total number of tips since the program started to over 33,000.

California, Pennsylvania, New York, Texas and Florida had the highest number of tips domestically. The only surprise in that list is Pennsylvania. The other four states would be on this list based on population. It seems to me that the Pennsylvania whistleblowers are more active.

For the year, the SEC handed out $60 million in awards to whistleblowers. That is a decrease from the $168 million in FY 2018. Most of that was taken by the $37 million award granted in March 2019 and $13 million award to another person for the same action. The other six recipients split the remaining $10 million.

The numbers are not good for whistleblowers. Over 5,000 complaints were made and that lead to only 8 awards. Of those 8, seven reported the problems internally before going to the SEC. That should eb a warning to ignoring internal whistleblowers.

Sources:

SEC’s Rulemaking Agenda

The Securities and Exchange Commission released its Fall Regulatory Flexibility Agenda, showing its expected rulemaking activity over the next year and updating the Spring edition of its agenda.

I highlighted three items from the Spring Agenda:

  1. Amendments to the Marketing Rules
  2. Amendments to the Custody Rules for Investment Companies and Investment Advisers
  3. Harmonization of Exempt Offerings

The proposed amendments to the marketing rules came out two weeks ago. This puts is solidly in the proposed rule stage. The proposed new regulation is in the release.

Amendments to the Custody Rule is still on the Agenda. It seems to be generously designated as being in the “proposed rule stage.” Maybe I missed it, but I don’t remember seeing any proposed changes.

The Harmonization of Exempt offerings had a concept release this summer. It too is generously designated as being in the “proposed rule stage.”

What’s new that caught my eye?

Accredited Investor Definition. This gets a designation of “proposed rule stage.” I assume this will end up being a part of the harmonization of exempt offerings. But the SEC may end up treating this separately if the Commissioners have trouble coming to agreement on the larger harmonization. The agenda also lists Regulation Crowdfunding Amendments and Regulation A Amendments separately.

Amendments to the Whistleblower Program Rules are listed as being in the final rule stage. The proposed changes to the whistlebower program were published over a year ago in July 2018.

Sources:

Compliance Bricks and Mortar for November 22

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

Death Knell for Regulatory Guidance Hits Most Federal Agencies…
Broc Romanek
TheCorporateCounsel.net

We’ve been covering the Administration’s gradual squeeze on regulatory guidance for some time (here’s our latest from April). As noted in this DLA Piper memo, President Trump signed two ‘Executive Orders’ recently that limit the practice of “regulation by guidance.” Here’s the “improved agency guidance” order that requires each agency to post its guidance documents on an indexed, searchable website after the OMB has issued implementing guidance about how to accomplish that (here’s a comprehensive Davis Polk memo on this order).

https://www.thecorporatecounsel.net/blog/2019/11/death-knell-for-regulatory-guidance-hits-most-federal-agencies.html

How co-working magnifies compliance perils
Richard L. Cassin
The FCPA Blog

Here’s the problem. Some people here lack, um, situational awareness. They forget (or don’t care?) that when they talk to colleagues in the common areas — at the big open work tables, in the community lunchroom, around the water cooler — other people might be listening in. When they yell into their phones while walking the halls, or put their calls on speaker, it all reaches the ears of outsiders. When they hold meetings in the conference rooms scattered throughout the workspace, the walls aren’t nearly thick enough to keep all the sound inside.

https://fcpablog.com/2019/11/14/how-co-working-magnifies-compliance-perils/

Sexual Harassment Prevention Lessons from the Television’s “Survivor”
by Daniel Schwartz
Connecticut Employment Law Blog

Why?  Here are a few things that stood out to me from an employment perspective:
First, a female player (Kellee) complained to a producer that another male player (Dan) was a little too “touchy” and made her feel uncomfortable. To be sure, there was plenty of video evidence to back her up.   The male player was given a “warning” and play continued.  But here’s the thing: The female player never knew that a warning was issued and Dan worked with others to get Kellee voted out of the game immediately thereafter.  Not telling the complainant what was going on with her complaint is just one of the ways the producers seem to have mishandled things.

https://www.ctemploymentlawblog.com/2019/11/articles/sexual-harassment-prevention-lessons-from-the-televisions-survivor/

2019 Was Big for the SEC. 2020 Will Be Huge.
By John Manganaro
PlanAdviser.com

Given its broad authority, the SEC is normally engaged in a wide range of rulemaking and regulatory activities in any given year—and that has certainly been the case in 2019. For plan advisers, three or four of the SEC’s ongoing regulatory activities should take precedence while planning for compliance in 2020. These are the Regulation Best Interest (Reg BI) package, the new advertising rules for advisers and brokers, and the revised approach to rules and requirements related to proxy voting and the use of proxy advisers.

https://www.planadviser.com/2019-big-sec-2020-will-huge/

SEC Enforcers Continue to Focus on Undisclosed Fees
by Joshua M. Newville & Brian Hooven

In a series of enforcement cases over the past few months, the SEC has continued to bring actions focused on undisclosed fees charged to clients. Many of these cases have charged firms with fraud and other violations based on fees that were not adequately disclosed. While some attention has focused on retail wealth managers, institutional advisers to private funds have attracted scrutiny for undisclosed fees, leading to the following enforcement actions:

https://www.lexblog.com/2019/11/12/sec-enforcers-continue-to-focus-on-undisclosed-fees/

Paul Weiss Discusses Delaware Decisions Showing Renewed Focus on Board Oversight

Breach of the duty of oversight claims against Delaware directors are known as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”[1]  The plaintiff must successfully argue that the directors either “utterly failed to implement any reporting or information system or controls” or “having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.”[2]  These “Caremark claims”—named after the Court of Chancery’s seminal decision in this area, In re Caremark International Inc. Derivative Litigation—require well-pled allegations of bad faith (i.e., that “the directors knew that they were not discharging their fiduciary obligations,” a standard of wrongdoing “qualitatively different from, and more culpable than . . . gross negligence”) to survive dismissal.[3]  As a result of these high pleading standards, Caremark claims have historically had limited success.

http://clsbluesky.law.columbia.edu/2019/11/20/paul-weiss-discusses-delaware-decisions-showing-renewed-focus-on-board-oversight/

Thoughts on Compliance Career Risk
by Matt Kelly
Radical Compliance

Career success is always about demonstrating how you add value to an organization larger than yourself. In our case, it’s about refashioning what you do away from executing a task (testing controls, bargaining with regulators, training employees, writing policies) toward providing a resource executive management needs: a greater awareness of the company’s overall risk posture, so that managers can make better decisions. 

http://www.radicalcompliance.com/2019/11/21/thoughts-on-compliance-career-risk/

CCO Barred for Lying on Form ADV

Gregory M. Prusa was the Chief Compliance Officer of the Salus, LP, a hedge fund. Among other problems, Mr. Prusa made false or misleading statements in the Form ADV filing for Salus. Now he is barred from the securities industry.

The general rule is the the CCO should only be subject to an action if he or she was involved in the wrongdoing, impeded the investigation or completely failed in the compliance program.

Mr. Prusa was also the CEO of Salus and its general partner S.A.I.C., Limited. Two hats can lead to trouble. The problem here was fundraising.

Mr. Prusa and is partner Brandon E. Copeland launched Salus in October 2107 and filed a Form ADV in November 2017. The filing indicated $20 million in RAUM and reasonable expectation to reach the higher RAUM required with filing with the SEC within 120 days.

In April 2018 and January 2019, Salus filed Form ADVs stating that it was a “large advisory firm” with $178 million in RAUM. Some of filings indicated that in addition to the Salus fund the firm also had high net worth individual clients that had a mix of bonds and equities. All of the Form ADV filings stated the auditor, custodian and prime broker for the hedge fund.

None of that information in the Form ADV was true. Salus never had any RAUM or reasonable expectation of having sufficient RAUM. It never had any individual clients. The fund never had any of those key relationships.

Unsurprisingly, the lies carried over to the Confidential Offering Memorandum for the hedge fund. The fund never received any capital commitments, so it never had any investments and never an auditor, custodian or prime broker.

It does have a website. https://www.salushedgefund.com/

The facts lay out Mr. Prusa being involved in the wrongdoing. So it seems appropriate to bring an action against him.

Sources:

CCO Is Barred and Faces Jail Time for Overbilling

The Securities and Exchange Commission charged Cameron G. High of Yellowstone Partners, LLP, of Idaho Falls, for fraudulently overbilling the firm’s clients and charging fees for work not performed. That amount to a total of over $11 million in excess charges from more than 100 of the firm’s clients. Mr. High faces up to 20 years in prison for wire fraud in connection with the overbilling.

The primary bad actor in the case is David Hansen, the former CEO of Yellowstone Partners. He is also on fraud charges and facing jail time.

It’s the CCO charges that caught my attention. High also held a 5% interest in Yellowstone and was a registered investment adviser representative.

According to the SEC complaint, it was Hansen who masterminded and ordered the overbilling. It was a combination of double charging and adding extra charges to the bills.

Certainly, a CCO should be subject to charges if he or she was involved in the wrongdoing. According to the complaint, and I infer from the criminla charges, Mr. High was involved in the wrongdoing.

Mr. High knew the overbilling was improper, but still followed the orders of Mr. Hansen. Hr. High also lied to clients when the overbilling was discovered and blamed it on the custodian. There was a clear pattern of bad behavior and culpability.

Sources:

SEC 2019 Enforcement Report

The Securities and Enforcement Commission’s Division of Enforcement release its 2019 Annual Report highlighting the 862 actions and $4.3 billion in disgorgement and penalties.

The report emphasized actions against individuals. Excluding the Share Class Initiative cases, 69% of the standalone cases were against individuals. This is in line with cases filed during the past few years. Included in this individual accountability is the suspension or barring of nearly 600 people from the securities industry.

Actions against investment advisers and investment companies in FY 2019 nearly doubled from the year before. That sounds ominous. But this increase includes 95 settlements that resulted from self-reports in the SEC’s Share Class Selection Disclosure initiative. Removing those cases, removes the over-allocation of cases to advisers.

For FY2019, the Division had __ ares of focus:

  1. Retail investor protection, the most vulnerable to bad actors in the industry.
  2. Cyber-related misconduct – hacking and ICO failures
  3. Unlawful trading – new SEC tech to spot problems.

The Report highlights some of the Division’s difficulties.

The Kokesh case made it clear that the SEC’s power to impose penalties and disgorgement is subject to a five-year statute of limitations. The Report estimates that this has resulted in the SEC foregoing over $1 billion in disgorgement.

The SEC had been subject to a two-year hiring freeze, which was lifted in the Spring of 2019. The freeze is effectively a reduction in size because personnel leaving for retirements and departures can not be filed.

Sources: