Author: Doug Cornelius

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Compliance Bricks and Mortar for August 16

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

Woodstock 50th and Succession Planning in Compliance
by Tom Fox
FCPA Compliance & Ethics

The Woodstock music festival informs today’s topic of succession planning from the compliance perspective and is another area where compliance can play a key role. A.G. Lafley and Noel M. Tichy, in a 2011 Harvard Business Review (HBR)article,“The Art and Science of Finding the Right CEO”, discussed the issue of succession planning at Procter & Gamble (P&G). Many of the concepts and issues that Lafley discusses within the context of succession planning in general are applicable to the concern of compliance within this area.

http://fcpacompliancereport.com/2019/08/woodstock-50th-succession-planning-compliance/

Do Fiduciary Duties Matter?
By A. Joseph Warburton
The CLS Blue Sky Blog

I analyze fiduciary duties in a unique setting – the British mutual fund industry – where trusts and corporations exist within the same industry.  Prior to 1997, all British mutual funds had to be organized legally as trusts, and fund managers were subjected to a strict (trust) fiduciary standard.  In 1997, this regulatory restriction was changed.  Funds were permitted to organize as either trusts or corporations, and fund managers were subjected to the applicable fiduciary standard.  (In contrast, the U.S. applies a uniform fiduciary standard under the Investment Company Act of 1940 regardless of the fund’s organizational form).  Hence, the British fund industry offers a unique laboratory for empirical study of fiduciary standards.

http://clsbluesky.law.columbia.edu/2019/08/13/do-fiduciary-duties-matter/

Other Lessons in Verwaltung Case
By Matt Kelly
Radical Compliance

Don’t get me wrong; I’m all for any enforcement action that underlines the importance of heeding a compliance officer’s advice. But the misconduct in question happened 10 years ago, in a foreign country with a deep culture of bank secrecy. One can’t be too surprised that Verwaltung executives behaved the way they did at that time. 

That, to my thinking, is the better point to ponder here. Verwaltung is about the maturity of a corporate compliance function. Compliance officers can use the facts here to diagram an immature compliance function, and gain a better understanding of how mature your own organization’s approach to compliance truly is. 

http://www.radicalcompliance.com/2019/08/12/other-lessons-verwaltung-case/

SEC Stops Recidivist’s Fraud Before Investors Are Harmed

On August 13, 2019, the Securities and Exchange Commission (“SEC”) charged Antonio M. Bravata, of Ferndale, Michigan, a recidivist securities law violator and convicted felon, with securities fraud conducted while serving a sentence for an earlier investment fraud. Bravata was previously charged by the SEC, and later by criminal authorities, for his participation in a $50 million securities fraud conducted through BBC Equities, LLC. In 2013, Bravata was found guilty in a jury trial, sentenced to 5 years of incarceration, and ordered to pay restitution. In the SEC case, Bravata was found liable for securities fraud, enjoined from future violations, and ordered to pay disgorgement and penalties. [my emphasis]

https://www.sec.gov/litigation/litreleases/2019/lr24559.htm

SEC Targets a Venture Capital Fund Manager

Frost Management Company was what seems like a typical venture capital fund complex that had raised five private funds and invested the capital in a portfolio of start-up companies.  The SEC says it found undisclosed affiliate payments and brought a suit against Frost.

Frost was an “exempt reporting adviser” with a filing from 2017. It apparently failed to file to renew the filing.

Before jumping into the charges, the first item to note is that the anti-fraud provisions of the Investment Advisers Act apply to all advisers. It doesn’t matter if you’re registered, unregistered, or exempt reporting. Those undisclosed fees will get you in troubled regardless of the firm’s registration status.

Frost caused its portfolio companies to pay incubator fees and, in some instances, monitoring fees that were not properly disclosed to investors. The SEC claims that those fees impacted the performance of the portfolio companies. That poorer performance affected the investors in the Frost venture capital funds and therefore was fraudulent, deceptive or manipulative.

The SEC seems to be hedging its argument by also claiming that the fees charged were”excessive.” In some of the five funds there appears to be some instance of disclosure. The actual process for determining the fees did not match the disclosure.

Mr. Frost apparently lost an investor arbitration case at the end of 2018 and wound down its incubator.

Sources:

Compliance Officer Barred for Audit Failures

Regulatory actions against compliance officers catch my attention. I don’t think compliance should be the target unless compliance engaged in the wrongdoing. I saw the action against Joseph Storms, identified as a “compliance associate” and dove in.

Mr. Storms entered the securities industry as a compliance intern in 2005 with FINRA member firm Raymond James & Associates, Inc. I’m not sure what happened during the next ten years, but he is identified as being a compliance associate and was registered with Raymond James as a general securities representative and general securities principal from November 19, 2015 to March 24, 2017.

He was terminated and Raymond James filed the Form U5 in April 2017 reporting that it had discharged Storms for “improperly editing internal branch audit documents.” It took two years, but FINRA filed a complaint in January 2019.

During his time as a compliance associate, Storms’s primary responsibility was to audit branch offices and to perform any follow-up work that resulted from the audits. He would sent out online questionnaires and follow-up with the person depending on the answers.

An example given in the decision is an undisclosed outside business activity. If the response was yes, Storms had to find out more and make sure the firm approved it.

Apparently, that was too much work for Mr. Storms. He would dump the questionnaire responses into a spreadsheet and change the data. He changed 524 questions from 145 registered representatives for 60 branch audits. Instantly, he was caught up on his work.

Apparently his supervisor was not so easily fooled and questioned Mr. Storms about the altered data. I assume that lead to termination.

FINRA followed up with a possible disciplinary action. Apparently it was also too much work for him to respond to FINRA.

This all paints Mr. Storms in a bad light. He failed to even bother defending himself. I’m not sure there is a good defense.

Sources:

Compliance Bricks and Mortar for August 9

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

Board Members Should Take Note — Delaware Supreme Court Issues Important Decision on Caremark Compliance Standard
by Michael Volkov
Corruption, Crime & Compliance

The Delaware Supreme Court returned to this issue in a recent case – Marchand v. Barnhill et al, HERE, a case involving Blue Bell Creameries  and a listeria outbreak.  The facts, while compelling, involve a serious health and safety issue but nonetheless has significant implications for overall ethics and compliance functions. 
In 2015, Blue Bell, a large ice cream manufacturer, experienced a listeria outbreak, which caused the death of three individuals.  Blue Bell had to recall its products and shut down production.  Shortly after that, Blue Bell suffered a “liquidity crisis,” and the company was forced to secure financing that caused a fall in its stock price.  A stockholder brought a derivative suit alleging that the directors breached their fiduciary duty of loyalty under Caremark.  The trial court granted defendants’ motion to dismiss finding that plaintiffs did not plead any facts to support the claim that the board “utterly failed to adopt or implement any reporting and compliance systems.”

https://blog.volkovlaw.com/2019/08/board-members-should-take-note-delaware-supreme-court-issues-important-decision-on-caremark-compliance-standard/

Diversified Portfolios Do Not Reduce Competition
by Barbara Novick, BlackRock, Inc.
Harvard Law School Forum on Corporate Governance and Financial Regulation

Theories about the incentives of company executives due to common owners fail to consider the metrics by which the performance of executives is measured and the composition of pay packages, which is primarily in company stock. For example, according to their 2018 annual proxy filing, American Airlines’ CEO has had 100% of his direct compensation paid in the form of equity since 2015. Further, airline executives’ performance is measured by metrics such as pre-tax income, margin improvement, and stock price—all measures driven by own-company performance. 

https://corpgov.law.harvard.edu/2019/08/07/diversified-portfolios-do-not-reduce-competition/

Corzine Hedge Fund Firm Granted SEC Registration With Limits
by Limes Weiss
Bloomberg

The SEC order includes “trading parameters” that bar JDC-JSC from engaging in proprietary trading and require it to have a “reasonable basis” to expect that, under normal conditions, each of its funds could be “orderly liquidated” within five trading days. That could restrict Corzine to trading in only the most liquid of markets, such as those for currencies and large-cap stocks, said David Tawil, co-founder of Maglan Capital, a New York-based hedge fund.

https://www.bloomberg.com/news/articles/2019-08-06/corzine-s-hedge-fund-firm-granted-sec-registration-with-limits?

Final Volcker Rule Regulation Eases Hedge Fund and Private Equity Fund Restrictions
by Deborah J. Enea and Elizabeth R. Glowacki

The final rule also eased the Volcker Rule’s restrictions on affiliations between investment advisers and hedge funds or private equity funds. Investment advisers can have the same name or a variation of the same name as the hedge funds and private equity funds that they sponsor and in which they invest, subject to the following conditions: …

https://www.pepperlaw.com/publications/final-volcker-rule-regulation-eases-hedge-fund-and-private-equity-fund-restrictions-2019-08-01/

Chief compliance officer liability and the opioid epidemic
by Jaclyn Jaeger
Compliance Week

In a period of three months, two chief compliance officers have been charged for their individual roles in the opioid epidemic—a clear indication the Department of Justice continues to expand the scope of prosecutions to those who fail in their compliance responsibilities.

https://www.complianceweek.com/regulatory-enforcement/chief-compliance-officer-liability-and-the-opioid-epidemic/27512.article#.XUhsorrCtdg.twitter

Revenue Sharing Disclosure Problems

The SEC charged Commonwealth Equity Services, LLC (d/b/a Commonwealth Financial Network), a registered investment adviser and broker-dealer, with failing to disclose material conflicts of interest related to revenue sharing Commonwealth received for certain client investments. According to the SEC’s complaint, Commonwealth had a revenue sharing agreement with its clearing broker for trades in their accounts. Under the agreement, Commonwealth received a portion of the money that certain mutual fund companies paid to the clearing broker to be able to sell their funds through the clearing broker’s programs, if Commonwealth invested its clients’ assets in certain share classes of those funds.

Commonwealth has not agreed to settle the SEC’s charges. At this point we just have the SEC’s side of the case. I thought it would be useful to look at the charges to see what bothered the SEC.

The SEC’s complaint alleges that Commonwealth negligently breached its fiduciary duty to its clients because Commonwealth failed to tell its clients that there were (i) mutual fund share class investments that were less expensive to clients than some of the mutual fund share class investments that resulted in revenue sharing payments to Commonwealth, (ii) mutual fund investments that did not result in any revenue sharing payments to Commonwealth, and (iii) revenue sharing payments to Commonwealth under the clearing broker’s “transaction fee” program.

There is no inherent problem with revenue sharing as long as it properly disclosed. Using different share classes are okay as long as there disclosure and the reason for choosing the different classes. What savings you get from lower cost shares may be eaten up my more brokerage and custody costs.

The SEC alleges that Commonwealth’s advisory clients invested without a full understanding of the firm’s compensation motives and incentives. The complaint also alleges that Commonwealth violated Section 206(4) and rule 206(4)-7 because it failed to adopt and implement policies and procedures reasonably designed to ensure that Commonwealth identified and disclosed these conflicts of interest.

Here is the disclosure that the SEC didn’t like:

Additionally, NFS offers an NTF [no transaction fee] program composed of noload mutual funds. Participating mutual fund sponsors pay a fee to NFS to participate in this program, and a portion of this fee is shared with Commonwealth. None of these additional payments is paid to any advisors who sell these funds. NTF mutual funds maybe purchased within an investment advisory account at no charge to the client. Clients, however, should be aware that funds available through the NTF program may contain higher internal expenses than mutual funds that do not participate in the NTF program and could present a potential conflict of interest because Commonwealth may have an incentive to recommend those products or make investment decisions regarding investments that provide such compensation to Commonwealth.

The SEC didn’t like it because it used the world “may” indicating a potential instead of an actual conflict. I wish the SEC would get away from its hatred of “may” in disclosures.

Secondly, the SEC felt that the disclosure failed to point out that there were instances when lower fee funds were available but Commonwealth had an incentive to put investor into higher fee funds and would get revenue sharing.

The disclosures evolved and the arrangements got more complicated. The case will drag on. It’s far from a slam-dunk for the SEC. There does some seem to ways that Commonwealth’s disclosure could have been clearer.

Sources:

Compliance Bricks and Mortar – Pan Mass Challenge 2019 Edition

If you’re reading this on Friday morning, I’ll be on my bike riding from New York border to Sturbridge for the unofficial Day Zero ride of the Pan Mass Challenge. The official start is Saturday morning, when I’ll ride from Sturbridge to Bourne, and then from Bourne to Provincetown on Sunday. That will be almost 300 miles of bike riding, surrounded by thousands of other riders raising money to fight cancer.

Thanks to so many of you who read Compliance Building for your generous donations and kind words. I have my donor list and those kind words printed and tucked into the back pocket of my jersey. I’ll keep them with me over the three days of cycling I have to complete this weekend.

If you have not contributed, there is still plenty of time to make a donation to fight cancer. I love seeing donation messages pop up while I’m riding. Donate here: http://pmc.org/egifts/DC0176

As for compliance-related matters, here are some of the stories that recently caught my attention.

Let’s Ride, Walmart’s Compliance Chief (and Cyclist) Urges Company Employees
by Sue Reisinger 
Law.com

Daniel Trujillo, Walmart Inc.’s executive vice president and global chief ethics and compliance officer, is a triathlete who can often be seen riding his bike to work. Now Walmart is using Trujillo’s love for the sport by having him lead its new bike-to-work program.
…
He recently blogged about the program, noting that only a small group of employees, including several in-house counsel, now bike to the office in Bentonville, in northwest Arkansas. The company already supports a popular “bike-to-work Fridays” concept, and the goal of the new program is to have 10% of the home office workforce riding bikes to work by 2023.

https://www.law.com/corpcounsel/2019/07/30/lets-ride-walmarts-compliance-chief-and-cyclist-urges-company-employees/?slreturn=20190701073035

When Sanctions and Cybersecurity Collide
By Matt Kelly
Radical Compliance

Compliance professionals talk constantly these days about cybersecurity, third-party risk, and sanctions compliance. Now we have an example from the news that is one headache-inducing brew of all three — and also, I fear, a harbinger of compliance and risk challenges to come. 
The company in question is Hikvision, a Chinese maker of security cameras. Last year Congress passed the National Defense Authorization Act, which bans the use of Hikvision cameras by U.S. government agencies, for fear that the Chinese government might hack into the cameras to spy on American interests. 

http://www.radicalcompliance.com/2019/07/31/when-sanctions-cybersecurity-collide/

Disclosure and Notification Considerations When Managing a Crisis
by Cleary Gottlieb Steen & Hamilton LLP
NYU Law’s Compliance & Enforcement blog 

One of the first things a company should consider in a crisis is whether disclosure to authorities is mandatory.  Mandatory disclosure obligations vary widely across legal regimes and may be imposed by Congress, government regulators, self-regulatory bodies, or even stock exchanges.  For example, regulated entities may face immediate disclosure obligations to report violations of financial laws to FINRA (Rule 4530) or annual disclosure obligations to report misconduct to the CFTC in the entity’s chief compliance officer report (although earlier disclosure of a crisis may be advisable).  Often the relevant laws, rules, and regulations do not specify what information must be disclosed, injecting substantial discretion into what is otherwise a mandatory obligation.

https://wp.nyu.edu/compliance_enforcement/2019/07/31/disclosure-and-notification-considerations-when-managing-a-crisis/

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: