Author: Doug Cornelius

You can find out more about Doug on the About Doug page

Is a Note from a Real Estate Wholesale a Security?

I saw the recent case against Landon M. Smith for operating a real estate offering fraud and Ponzi scheme and jumped in to see if I could learn anything from the case.

According to the SEC complaint, Smith held himself out as a “property wholesaler” who could earn significant returns on any funds invested with him for purported property deals.

Smith explained that a property wholesaler is a person who identifies property and then agrees to buy property for a certain price, signs a real estate purchase contract with the property owner, and pays the property owner an earnest money deposit to hold the property under contract until the sale can close. The wholesaler then finds a third-party buyer who is willing to pay more for the property than the wholesaler agreed to pay in the purchase contract

That’s not a real thing. There is no pool of real estate owners willing to sell for wholesale (less than market) or sellers willing to pay more than market. He faked the real estate contracts he was showing to his “investors.”

Needless to say he was taking money from people. They forked it over with his promise of a 100% return when he flipped the property.

Smith was offering his “investors” unsecured promissory notes. Are those promissory notes securities?

The Securities and Exchange Commission thinks so.

  1. Investors provided Smith with money to purchase promissory notes with the potential to earn returns of up to 100% on their investment.
  2. Smith sold the promissory notes to a wide distribution of unsophisticated investors.
  3. Smith represented the opportunity as a short-term investment.
  4. The promissory notes were all unsecured and uninsured.
  5. Smith pooled investor funds in a common bank account.
  6. Investors expected profitability from the wholesaling efforts of Smith.

I assume they are using the Howey test of investment contract, “investment of money” in “a common enterprise” with the “expectation of profits from the effort of others”. Or may just be using the term “note” from the definition of security.  

Statements 2, 3, and 4 seem irrelevant to the argument that the “notes” are securities. Statement 5 seems to indicate that there was a common enterprise. But the mixing in the bank account may just be a byproduct of the Ponzi scheme. Smith pooled the money to pay back earlier investors.

It’s not clear if multiple “investors” were expecting their money to mixed in with other “investors” to fund the investment or whether each was expected to be freestanding.

It’s a relatively weak argument that the notes are securities. But Smith settled with the SEC so the argument doesn’t need to stand up to scrutiny.

Sources:

Compliance Bricks & Mortar for July 26

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

Proskauer Launches Private Equity SEC Enforcement Tracker

The tracker contains key information from the actions, including summaries of key issues, settlement terms, and relevant statutory provisions.  The tracker will be an important resource for us and our clients, providing us with quick access to comparable cases and allowing us to identify important enforcement trends impacting private equity advisers as they develop.  We are also making available summary information from the database for all SEC enforcement actions against private equity advisers over the last 6 years.
Click here to view the tracker.

Upcoming Deadline for Form SHL – Foreign Ownership of US Securities
Ropes & Gray

Very generally, Form SHL is required to be completed by, among others, U.S. resident issuers (including pooled investment vehicles such as private investment funds, hedge funds, mutual funds and other similar commingled vehicles), the securities of which are held by foreign residents, to the extent the total fair value of such securities equals or exceeds $100 million.1Investment advisers and managers typically file Form SHL on behalf of the U.S. resident issuers they advise.2 As a result, if a U.S. fund has foreign investors with a value of $100 million or more, the fund’s investment adviser will need to complete a Form SHL.

https://www.ropesgray.com/en/newsroom/alerts/2019/07/Upcoming-Deadline-for-Form-SHL-Foreign-Ownership-of-US-Securities

Tipper X: The Wall Street Informant
by Andrew Thomas
The Epoch Times

Hardin told them that insider trading was rampant in the industry. The agents gave him their card, and told him that he had an opportunity to build bigger cases. He called them the next day, and told them he would help.
The agents told him that he was going to have to wear a wire to record conversations with anyone who was involved in the insider trading game whenever he had the opportunity. Hardin went home, and made a list of who he felt were the worst of the worst.

https://www.theepochtimes.com/tipper-x-the-wall-street-informant_3007726.html

Assessing Risks and Potential Liability in Responding to a Crisis
Cleary Gottlieb Steen & Hamilton LLP

A company faced with a crisis needs to act quickly to assess and determine the scope of any potential liability in order to guide its first response and frame the forthcoming investigation.  Issues overlooked in the early phases of an investigation could prove very costly down the road, limiting options or potentially subjecting a company to greater penalties.  Understanding the full scope of potential liability early in an investigation allows a company to develop a plan of action through consideration of how such penalties can potentially be mitigated and whether it is sensible to set aside reserves for potential fines and other expenses associated with an investigation.  The severity of such penalties may also shed light on who needs to be informed, including for example, whether any public disclosures will be necessary. 

https://wp.nyu.edu/compliance_enforcement/2019/07/22/assessing-risks-and-potential-liability-in-responding-to-a-crisis/

Cryptocurrency Investor Gets Second Chance to Show AT&T Liability in $24M Hack
by Nathan Solis
Courthouse News Service

Hackers attacked blockchain and cryptocurrency investor Michael Terpin’s cellphone on two separate occasions, according to his initial complaint filed in the Central District Court of California in August 2018. Following the hacks, Terpin says he told AT&T he was also the victim of a SIM card swap.
The relatively low-tech hacking technique involves a hacker posing as a customer and asking the mobile carrier to transfer the phone number to a separate phone SIM card, which then gives the hacker access to the victim’s online accounts – including bank accounts and cryptocurrency wallets used to store digital currency.

https://www.courthousenews.com/cryptocurrency-investor-gets-second-chance-to-show-att-liability-in-24m-hack/

Kansas Supreme Court limits the extraterritorial application of state’s Blue Sky law
by Brad Rosen
Jim Hamilton’s World of Securities Regulation

The Kansas Supreme Court reversed the criminal convictions of the principals of a Kansas limited liability corporation for selling or offering to sell unregistered securities and committing fraud in selling or offering to sell securities. The prosecution had alleged that jurisdiction applied even though the defendants used intermediaries residing in California who made sales presentations in California and sold the securities from California to individuals who did not reside in Kansas (State v. Lundberg, July 19, 2019, per curiam).

https://jimhamiltonblog.blogspot.com/2019/07/kansas-supreme-court-limits.html

Gibson Dunn Offers 2019 Mid-Year Securities Enforcement Update
by Mark K. Schonfeld and Amy Mayer
The CLS Blue Sky Blog

The first half of 2019 has seen a continuation of the Securities and Exchange Commission’s emphasis on protecting the interests of Main Street investors. Chairman Clayton reiterated these themes in his testimony in May before the Financial Services and General Government Subcommittee of the U.S. Senate Committee on Appropriations.[1] In addition to the no less than 43 references to Main Street investors, the Chairman’s testimony highlighted: (1) the Retail Strategy Task Force, formed in 2017, to use data-driven strategies to generate leads for investigation of industry practices that could harm retail investors, as well as (2) the mutual fund share class initiative as an example of returning funds to retail investors through a program to incentivize self-reporting and cooperation. To be sure, the Commission brought a number of enforcement actions focusing on various offering frauds, often with themes related to some form of cryptocurrency or digital asset.[2] The Chairman also noted in his Congressional testimony that the Commission’s FY 2020 budget request contemplates adding add six positions to the Commission’s investigations of conduct affecting Main Street investors.

http://clsbluesky.law.columbia.edu/2019/07/24/gibson-dunn-offers-2019-mid-year-securities-enforcement-update/

Taking Insider Trading Too Far: What’s Left of the ‘Personal Benefit’ Requirement After ‘U.S. v. Martoma’?
by Benjamin Gruenstein and Miriam Rosenbaum 
New York Law Journal

Courts in the Southern District of New York are now instructing juries that intent to benefit the tippee is sufficient to establish the personal benefit requirement. In United States v. Chow, 17-cr-667 (S.D.N.Y. 2018), a case in which a partner of a private equity firm provided a material, nonpublic tip to his friend and business associate, the court instructed the jury on the personal benefit test as follows: …

https://www.law.com/newyorklawjournal/2019/07/23/taking-insider-trading-too-far-whats-left-of-the-personal-benefit-requirement-after-u-s-v-martoma/?slreturn=20190625132356

If you enjoy reading Compliance Building, please consider throwing a few dollars to a charity I support: the Pan Mass Challenge. It’s a bike ride across Massachusetts to raise money in the fight against cancer. 100% of your contribution goes to the Dan-Farber Cancer Institute. I could use your support when I start the ride next weekend: https://profile.pmc.org/DC0176

“May” May Not Be Adequate Disclosure

I’m sure you heard that Facebook is paying a $5 billion fine for privacy violations to the Federal Trade Commission. You may not have heard that the Securities and Exchange Commission decided to pile on and fine Facebook another $100 million for disclosure failures.

As Matt Levine of Bloomberg says “Everything is securities fraud.”

[T]he Risk Factor disclosures in its Form 10-Q filed on October 30, 2014, Facebook cautioned that “Improper access to or disclosure of user information, or violation of our terms of service or policies, could harm our reputation and adversely affect our business.” In the same Form 10-Q, the company advised that if developers “fail to comply with our terms and policies . . . our users’ data may be improperly accessed or disclosed.” This, the company acknowledged, “could have a material and adverse effect on our business, reputation, or financial results.”

My emphasis and the emphasis of the SEC in its press release

The problem was that Facebook knew that the users’ data had in fact been improperly accessed and disclosed. The SEC is taking the position that this phrasing of a risk creates a false impression that it is merely hypothetical and not actually happening.

The SEC had this fight over “may” in the Robare case. That ended up being a bad strategy for that case. If you remember, Robare’s disclosure was that it may be earning other fees, when it was always earning those fees. One court overturned the SEC. But it had a long history after the case and the SEC ended up winning anyhow.

In the Facebook case, the company made press releases that were incorrect or misleading because they failed to disclose the Cambridge Analytica problem.

The SEC tops this off by pointing out that the Facebook stock price fell from $185 to $159 after the Cambridge Analytica problem was disclosed to the public. That reinforces that the problem was material and should have been disclosed.

Sources:

The Supervision Initiative

In 2017, the SEC’s Office of Compliance Inspections and Examination conducted exams of investment advisers that previously employed, or then currently employed, any individual with a history of disciplinary events. According to a just released Risk Alert, this was the Supervision Initiative.

The initiative examined over 50 advisers, with a total of $50 billion in assets and 220,000 clients, most of who were retail investors. The firms were selected based on disclosures of disciplinary events. The Supervision Initiative was announced as part of the 2016 Examination Priorities.

With credit to OCIE, they use the results of these initiatives to guide firms on how to improve their compliance programs. This Risk Alert has five suggestions for firms that have an employee with disciplinary histories.

1. Adopt written policies and procedures that specifically address what must occur prior to hiring supervised persons that have reported disciplinary events. Those procedures should trigger investigations of the disciplinary events and ascertain whether barred individuals were eligible to reapply for their licenses.

2. Enhance due diligence practices when hiring to identify disciplinary events. Conducting background checks on employment histories, disciplinary records, financial background and credit information. Conducting internet and social media searches.

3. Establish heightened supervision practices when overseeing supervised persons with disciplinary histories. The staff found that advisers with written policies and procedures specifically addressing the oversight of supervised persons with disciplinary histories were far more likely to identify misconduct by supervised persons than advisers without these written protocols.

4. Adopt written policies and procedures addressing client complaints related to supervised persons. The staff observed that advisers with written policies and procedures addressing client complaints related to their supervised persons were more likely to have reported the receipt of at least one complaint related to their supervised persons. In addition, these advisers were consistently more likely to escalate matters of concern raised in these complaints than advisers without written protocols.

5. Include oversight of persons operating out of remote offices in compliance and supervisory programs, particularly when supervised persons with disciplinary histories are located in branch or remote offices. Don’t let out of sight mean out of mind.

Sources:

The Stop Wall Street Looting Act of 2019

United States Senators Elizabeth Warren (D-Mass.), Tammy Baldwin (D-Wisc.), and Sherrod Brown (D-Ohio), Ranking Member of the Senate Banking Committee, along with Representatives Mark Pocan (D-Wisc.), and Pramila Jayapal (D-Wash.) unveiled the Stop Wall Street Looting Act last week. I don’t think there is any chance it will become law. But it will create talking points and speeches as we continue on what will be an endless election campaign.

I took a few minutes to traipse through the bill to see if anything caught my eye.

Most of the provisions attack “private funds” and the bill uses the same definition of a “private fund” that was added to the Investment Advisers Act by Dodd-Frank:

a company or partnership that (i) would be considered an investment company under Section 3 of the Investment Company Act of 1940 but for the application of paragraph (1) or (7) of subsection (c) of such section 3; …(iii) is not a venture capital fund, as defined in 17 C.F.R. section 275.203(l)-1…

Title I imposes a piercing of the liability shields of private funds by making them jointly and severally liable for all liabilities of portfolio companies, including debt, government fines, WARN Act violations, ERISA withdrawal liability and unfunded pensions.

That doesn’t just stop “looting”; that ends the private fund business. If you can’t isolate liabilities, it makes investing nearly impossible. With the fund manager responsible for the debts of the portfolio companies, the manager will have trouble obtaining third-party capital for the portfolio companies. That capital would have to underwrite not only the target, but also the fund manager and all of its other portfolio companies.

The isolation of corporate liability has been the core of capitalism for a few centuries allowing tremendous growth in technology, manufacturing. It allows you to make riskier bets knowing that only your invested capital is at risk.

The bill relies on that murky definition of “private fund.” I would fear that conglomerate operating companies could get pulled into the definition.

Assuming the private fund business found a way to continue after Title I, Title II stops certain activities labeled as “looting.”

The portfolio company can’t make a capital distribution to the private fund during the first two years after a change in control. Another section bans monitoring fees by imposing a 100% tax on monitoring fees.

Section 204 attacks excessive debt by reducing the ability to deduct interest if the debt to equity ratio for a portfolio company exceeds 1.

Title III imposes greater worker protection and limits executive compensation during bankruptcy, gives greater rights under the WARN Act, and gives priority to gift cards in bankruptcy.

Title IV tries to close the “carried interest loophole.” Of course, it’s not a loophole; it’s a feature of partnership taxation for all types of partnerships and the disparate treatment of ordinary income and capital gains.

In the case of an “investment services partnership interest”, any net capital gain is treated as ordinary income and net capital losses are treated as ordinary losses. The definition of “investment services partnership interest” is broad enough to capture any type of partnership, not just private equity funds, but also real estate funds, hedge funds and venture capital funds. It’s probably broad enough to beyond that as well.

Title V creates a whole new disclosure regime for private funds. Here are some of the disclosure highlights:

  • names of each limited partner in the fund
  • debt held by the fund
  • Gross performance
  • Performance net of fees
  • Income statement
  • balance sheet
  • cash flow statements
  • Total amount of debt of each portfolio company
  • Disclosure of all fees paid to the fund manager

All of that information would be publicly available.

It’s obvious that the bill’s proponent are lumping all private funds into the category of highly leveraged buyout firms. There is a broad spectrum of funds with different investing styles, different levels, different uses of debt and different fee structures. In my view, this bill would kill the entire private fund industry.

Sources:

Compliance Bricks and Mortar for July 19

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

REIT Manager Overpaid Itself When Calculating Incentive Fee
Cipperman Compliance

A large REIT manager, together with its CEO and CFO, agreed to pay over $60 Million in disgorgement, interest and penalties for inflating incentive fees and taking reimbursement for significant expenses.  The SEC asserted that the defendants, contrary to disclosures and agreements, used their insider positions to calculate incentive fees in a manner that unjustly enriched themselves over the investors to whom they owed a fiduciary duty.  The SEC also charged the defendants with collecting millions in expense reimbursements as part of various merger transactions.  The SEC accused the defendants of securities fraud and falsifying books and records.

https://cipperman.com/2019/07/18/reit-manager-overpaid-itself-when-calculating-incentive-fee/

SEC Staff Statement on LIBOR Transition

The expected discontinuation of LIBOR could have a significant impact on the financial markets and may present a material risk for certain market participants, including public companies, investment advisers, investment companies, and broker-dealers.  The risks associated with this discontinuation and transition will be exacerbated if the work necessary to effect an orderly transition to an alternative reference rate is not completed in a timely manner.[6]  The Commission staff is actively monitoring the extent to which market participants are identifying and addressing these risks.

https://www.sec.gov/news/public-statement/libor-transition

Summer compliance reading for boards of directors
by Jeff Kaplan
Conflicts of Interest Blog

A recent post by attorneys at the Sullivan & Cromwell law firm on the blog of the Harvard Law School Forum on Corporate Governance and Financial Regulation examined an important decision issued last month by the Delaware Supreme Court which “reversed the dismissal of a stockholder derivative lawsuit against the members of the board of directors and two officers of Blue Bell Creameries USA, Inc., a leading manufacturer of ice cream products. The lawsuit arose out of a serious food contamination incident in 2015 that resulted in widespread product recalls and was linked to three deaths. The Delaware Supreme Court, applying the ‘duty to monitor’ doctrine enunciated in In re Caremark International, Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), and noting the very high hurdle to claims under it, nonetheless ruled that the plaintiff had adequately alleged the requisite bad faith by the members of the Blue Bell board. 

http://conflictofinterestblog.com/2019/07/summer-compliance-reading-for-boards-of-directors.html

How Good Training Finds Its Wings
by Matt Kelly
Radical Compliance

[O]ne of the biggest challenges for compliance training is how to keep the material fresh, so employees pay attention to the lessons you want to impart. That’s true of the FCPA, social media policy, or collusion, just as much as it’s true of flight safety videos. We go through the lessons once or twice, absorb the main points, and then start to tune out during future lessons. 
Compliance officers know this is true. How often do we need to be told that in the event of a water landing, we should pull on the red tube to inflate our safety vest? Or that the nearest exist might be behind us? Or that we should adjust our own oxygen mask before helping the child next to us? 

http://www.radicalcompliance.com/2019/07/15/how-good-training-finds-its-wings/

Political Connections and Insider Trading
By Thuong Harvison
The CLS Blue Sky Blog

I use political contributions as a proxy for political connections. Corporate insiders can build these connections personally (i.e., individual contributions) or through their firms (i.e., PAC contributions). For each publicly traded firm and each of its corporate insiders, in each election cycle from 1988 to 2016, I compute political connection measures based on political donation history as well as the power of the political candidates supported. Overall, about 10 percent of the firms make some political contributions to at least one candidate in an election cycle. Firms also support more candidates than do individual insiders. While a typical firm donates to about 50 candidates in each cycle, a typical insider donates to only two candidates. To examine the trading activities of these insiders, I use the sample of all their trades from 1988 to 2016.

http://clsbluesky.law.columbia.edu/2019/07/12/political-connections-and-insider-trading/

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Compliance Bricks and Mortar for July 12

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

Allison Herren Lee Sworn In As SEC Commissioner

Allison Herren Lee was sworn into office on July 8 as an SEC Commissioner.
Ms. Lee was nominated to the SEC by President Donald J. Trump and unanimously confirmed by the U.S. Senate.
“Allison’s expertise in securities law, including from her prior tenure at the Commission, will be invaluable to our efforts to advance the interests of investors and our markets,” said Chairman Jay Clayton. “Many of Allison’s former – and as of Monday, current – colleagues have expressed to me their support for Allison’s return. On behalf of all of my colleagues, Commissioners and staff alike, I am pleased to welcome her back.”
“I’m honored to return to the SEC and to work with the dedicated public servants on the staff, and my fellow Commissioners, to carry out the SEC’s critical mission,” Commissioner Lee said.

https://www.sec.gov/news/press-release/2019-121

D&O Liability Insurance: Hazards for the CCO
Janaya Moscony and Julie DiMauro 
The FCPA Blog

Whether a chief compliance officer (CCO) is required to be indemnified by a company depends on the state of incorporation, so it is important to make sure that the CCO is properly recognized as a corporate officer of the insured entity.
Some states require that CCOs need only be appointed in the bylaws of the insured entity as a corporate officer, while other states might additionally require that the CCO also be appointed as a corporate officer in state filings.

http://www.fcpablog.com/blog/2019/7/10/do-liability-insurance-hazards-for-the-cco.html

Statement Regarding Offers of Settlement
SEC Chairman Jay Clayton

When the Securities and Exchange Commission is considering filing (or has filed) an action alleging violations of the federal securities laws, it often is in the public interest to pursue a timely, reasonable and consensual resolution of the matter. The Commission has long recognized that an appropriately-crafted settlement can be preferable to pursuing a litigated resolution, particularly when the settlement is agreed early in the process and the Commission obtains relief that is commensurate with what it would reasonably expect to achieve in litigation. In plain language, the sooner harmed investors are compensated, the offending conduct is remediated, and appropriate penalties are imposed, the better.

https://www.sec.gov/news/public-statement/clayton-statement-regarding-offers-settlement

Revisiting Compliance Program Reporting Relationships
by Michael W. Peregrine
The CLS Blue Sky Blog

Corporate leaders may wish to revisit the important yet sensitive topic of reporting relationships in compliance programs following the release of new guidance from the Department of Justice’s Criminal Division.
That guidance, entitled Evaluation of Corporate Compliance Programs[1], (The “New Guidance”) discusses in detail the three main thematic questions that prosecutors should apply in evaluating corporate compliance programs and how those questions can be used to elicit information as to compliance program adequacy and effectiveness. One of those thematic questions is whether the corporation’s compliance program is being implemented effectively. The autonomy of compliance program leadership is one of several cited indicia of effective implementation. This is certainly consistent with the significant value historically attributed to the organization’s compliance function and to the role of chief compliance officer (“CCO”).

http://clsbluesky.law.columbia.edu/2019/07/05/revisiting-compliance-program-reporting-relationships/

Massachusetts Securities Division Proposes Uniform Fiduciary Standard; Could Create Patchwork of Obligations Across State Lines
Sidley’s Securities and Derivatives Enforcement and Regulatory Update

On June 14, 2019, the Massachusetts Securities Division proposed and offered for public comment a state regulation to apply a fiduciary standard of conduct to broker-dealers, agents, investment advisers and investment adviser representatives (collectively, Investment Professionals) when they advise their customers.1 The fiduciary standard would require Investment Professionals to make recommendations and advice — including recommendations related to the selection of account types — solely in the best interest of their customers and clients, without regard to the interests of the Investment Professional. The fiduciary standard would also apply to all clients of Investment Professionals, including not only retail but also some institutional clients. The Division’s proposal appears to be a clear reaction to Secretary of the Commonwealth William Galvin’s disappointment with the new Regulation Best Interest (Regulation BI) from the U.S. Securities and Exchange Commission (SEC).

https://www.sidley.com/en/insights/newsupdates/2019/07/massachusetts-securities-division-proposes-uniform-fiduciary-standard

Lawyers as compliance officers: a behavioral ethics perspective
by Jeff Kaplan
Conflict of Interest Blog

What role do corporate lawyers play in preventing wrongdoing by executives in their client organizations? And how is this role impacted by behavioral ethics?
In “Behavioral Legal Ethics Lessons for Corporate Counsel,” to be published in the Case Western Reserve Law Review, Paula Schaefer of the University of Tennessee College of Law  first examines “the corporate lawyer’s consciously held conceptions and misconceptions about duty owed to her corporate client when company executives propose a plan that will create substantial liability for the company—when and if it is caught.” As she shows, lawyers often have an unduly limited view of what that duty is.

http://conflictofinterestblog.com/2019/06/lawyers-as-compliance-officers-a-behavioral-ethics-perspective.html

Theranos: Too Good To Be True
Jonathan T. Marks
Board And Fraud

Adept individuals, like Holmes, with widespread access to corporate information, a mindset of entitlement, and the confidence to pull it off compound the risk of fraud. Moreover, placing these individuals in a culturally lax environment with poor tone from the top and weak or poorly designed internal controls is a recipe for disaster. A company with such conditions could become the lead scandal in tomorrow’s news just like Theranos, Enron, WorldCom, Adelphia, HealthSouth, and others (name your favorite).

https://boardandfraud.com/2019/07/02/theranos-too-good-to-be-true/
I ride in the Pan Mass Challenge because of Jeff, Dave, my dad, uncle, aunt and Nana. I ride to help save the next person diagnosed with cancer. If you enjoy reading Compliance Building, please consider a donation: https://profile.pmc.org/DC0176 100% of your donations go to the Dana-Farber Cancer Institute.

Compliance Bricks and Mortar for June 28

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

SEC Enforcement Against Private Equity Firms in 2018: Year in Review
James E. Anderson, Elizabeth P. Gray, Justin L. Browder, and Jonathan Tincher

In 2018, the Securities and Exchange Commission (the “SEC”) continued to pursue a series of enforcement actions against private equity fund sponsors. The issues raised by the cases reflect the SEC’s ongoing scrutiny of expense allocation practices, application of management fee offset provisions, acceleration of consulting and advisory fees, unauthorized principal, agency and affiliate transactions, and compliance with regulatory and investor reporting requirements. Many of these issues were first brought to the fore in two notable SEC staff speeches in 2014 and 2015,1 and the 2018 cases demonstrate that they continue to be of central importance. Private equity sponsors should continue to remain focused on enhancing their compliance programs in these areas as they move forward in 2019.

https://www.willkie.com/~/media/Files/Publications/2019/03/SEC_Enforcement_Against_Private_Equity_Firms_in_2018_Year_in_Review.pdf

How to Design an Ethical Organization
Nicholas Epley and Amit Kumar
Harvard Business Review

Creating an ethical culture thus requires thinking about ethics not simply as a belief problem but also as a design problem. We have identified four critical features that need to be addressed when designing an ethical culture: explicit values, thoughts during judgment, incentives, and cultural norms.

https://hbr.org/2019/05/how-to-design-an-ethical-organization

A Fraudster Loses to the SEC But Beats the Clock on Penalties
Matt Robinson
Bloomberg

Over the course of 12 years, Charles Kokesh quietly misappropriated more than $30 million from investors, a jury found in 2014. Kokesh, now 71, cultivated some expensive and unusual hobbies, such as importing Argentine polo ponies and participating in cowboy-style shooting competitions, according to trial testimony. But the really unusual part of the story is how the U.S. Supreme Court decided he wouldn’t have to pay back most of the cash.

https://www.bloomberg.com/news/articles/2019-06-25/a-fraudster-loses-to-the-sec-but-beats-the-clock-on-penalties

Real Meaning of the Walmart Case
Matt Kelly
Radical Compliance

So what lessons can we learn from the Walmart case? The same lessons we’ve been learning for the last 10 years. They’re good lessons, and important lessons. Dropping the phrase “Walmart, largest company in the world” will always help when you talk about FCPA risks to your board, employees, or third parties. I’m delighted we have Walmart to dissect and discuss for years to come.

But the Walmart settlement broke no new ground for the enforcement of ethics and compliance; so no, it’s not a landmark.

It’s a bookend.

http://www.radicalcompliance.com/2019/06/24/real-meaning-walmart-fcpa-case/

Statement of Concerned Securities Law Professors Regarding Investment Advisers and Fiduciary Obligations
The CLS Blue Sky Blog

We circulate this statement as law professors specializing in the field of securities regulation who are concerned that the Securities and Exchange Commission (the “Commission”) has moved in a new direction that is both contrary to its past practice and harmful to the interests of investors. In Release No. IA-5248 (“Commission Interpretation Regarding Standard of Conduct for Investment Advisers”) (June 5, 2019) (“Release 5248”), the Commission has turned its back on its history and reinterpreted the case law in a surprising manner that reverses what it said only a year ago. 

http://clsbluesky.law.columbia.edu/2019/06/25/statement-of-concerned-securities-law-professors-regarding-investment-advisers-and-fiduciary-obligations/
I ride in the Pan Mass Challenge because of Jeff, Dave, my dad, uncle, aunt and Nana. I ride to help save the next person diagnosed with cancer. If you enjoy reading Compliance Building, please consider a donation: https://profile.pmc.org/DC0176 100% of your donations go to the Dana-Farber Cancer Institute.

Compliance Bricks and Mortar for June 21

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

Day of Reckoning for KPMG – Failures in Ethics
Tom Fox
FCPA Compliance Report

How bad was KPMG’s conduct? It was so bad that I had to interrupt my previously started blog post series on continued allegations of bribery and corruption against US and other companies selling medical equipment into China, to blog about KPMG. In short, the conduct outlined in the Order is so egregious, detailing a culture which is completely unmoored from any ethical foundation, that any company using KPMG as an auditor must ask some very serious questions about not only the quality of the services they have received but also the very foundation of those services.

http://fcpacompliancereport.com/2019/06/day-reckoning-kpmg-failures-ethics/

CFTC Whistleblower Alert: Be on the Lookout for   Insider Trading or Improper Use of Information

The Whistleblower Office of the Commodity Futures Trading Commission (CFTC) is issuing this alert to  inform members of the public about how they may make themselves eligible for both financial awards  and certain protections while helping stop the improper use confidential information. 

https://whistleblower.gov/sites/whistleblower/files/2019-06/Insider%20Trading%20WBO%20Alert.pdf

Understanding the Money Laundering Risks in the Capital Markets
Financial Conduct Authority

The aim of this thematic review was to carry out a diagnostic piece of work looking at the money-laundering risks and vulnerabilities in the capital markets and, where possible, to develop case studies to help inform the industry. …

We visited 19 participants covering different segments of the market. Our population included investment banks, recognised investment exchanges, trade bodies, a custodian bank, clearing and settlement houses, inter-dealer brokers and trading firms. When we refer to ‘firms’ in this report, we are referring to the full range of firms involved in the market transaction chain. When we refer to ‘participants’, we mean those firms we included in our sample for this project. Our visits were diagnostic; we sought information and examples to further inform and enhance our view of the risks and vulnerabilities in the capital markets. We did not assess the systems and controls of participants.

https://www.fca.org.uk/publication/thematic-reviews/tr19-004.pdf

Compliance and Inconsistent Discipline
Matt Kelly
Radical Compliance

Because inconsistent discipline smacks of privilege undeserved. The company has one set of rules that apply to some people; and another set of rules that apply only to a select few. Those privileged few get special treatment, when most of the organization believes they shouldn’t — and that’s what drives employees bananas. That’s what ruins corporate culture and turns your corporate compliance program into a laughingstock.

http://www.radicalcompliance.com/2019/06/14/compliance-inconsistent-discipline/

Prequin Special Report: Subscription Credit Facilities

Subscription credit facilities: angels or demons? A legitimate and valuable tool for managing liquidity and streamlining transactions in a competitive market, or a cynical ploy for massaging IRRs? The debate continues in private equity and wider private capital circles.

https://docs.preqin.com/reports/Preqin-Special-Report-Subscription-Credit-Facilities-June-2019.pdf
PMC 2019
Please support my ride to fight cancer. On the first weekend in August, I’ll be riding across Massachusetts to raise money for cancer research. I could use your support:
https://profile.pmc.org/DC0176

ZuckBucks and Securities

Facebook is looking to get into banking. Or Cryptocurrency. Whatever you call it, Facebook is looking to launch a global currency: Libra.

The big problem is mashing together the current lack of trust in Facebook with the hype of blockchain technology. As a result, Libra talks little about Facebook and lots about blockchain.

It’s not clear that Libra is using blockchain like other cryptocurrencies and it’s not clear that it can be used outside of Facebook.

Bitcoin and other cryptocurrencies have failed as currency because so few merchants will take it as payment. Facebook is potentially allowing the widespread use of Libra by making it the payment of choice through the Facebook platform.

Unlike Bitcoin, Libra is intended to be stable in price. It’s value will be pinned to an underlying portfolio of bank deposits and government securities. The focus is spending Libra, not investing in Libra.

As for the investment part, the underlying Libra asset returns will be used to fund investments in the platform and any remaining returns would be paid as dividends to the early investors.

The details are a bit sparse, but it sounds like Libra would not be a security to the everyday purchaser, but could be a security to the early investors.

Those early investors are a consortium of participants that will provide the governance and manage the currency. They will also need to pony up at least $10 million in initial funding.

I assume that Facebook and rest of the Libra Consortium are going make sure Libra does not trip over securities laws.

The big problem is going to be money laundering, sanctions limits, and cross-country transfers. Libra is being touted as panacea for the unbanked. However, the unbanked include the criminal elements who do not have access to banking system. I suspect this will be the bigger challenge of Libra.

Sources: