Author: Doug Cornelius

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

The Continued Rise of Professional Whistleblowing

The Securities and Exchange Commission announced awards totalling $50 million to whistleblowers who brought high-quality information to the SEC and assisted in bringing a successful enforcement action.

As with all whistleblower awards, the order is heavily redacted as to the company involved, what happened, and when it happened. I’m not sure I can identify which case the awards tie to.

Two things caught my attention about the awards.

One, the order discusses approval or rejection of awards for Claimant #1, Claimant #2, Claimant #4, and Claimant #7. I take it that at least seven people submitted tips to the SEC for the bad acts involved in the case. That is a lot of people sending information to the SEC. I’m not if it’s because a lot of people knew about the problem or a lot of people knew they could make money by reporting the problem.

Second, the two successful claimant had attorneys involved in the whistleblowing process.

Claimant #1 had his or her attorney approach the SEC first before formally submitting the tip. That ended up hurting the award because the SEC found the delay unreasonable and investors were continuing to be harmed. Somehow, Claimant #1 “passively financially benefited” from the misconduct during the delay.

Claimant #2 met with the SEC with his or her attorney. According to the order, Claimant #2 had the “smoking gun” evidence that indisputably showed the problem.

Claimant #2 also received a whistleblower award from another agency in connection with the action. I would guess it was this CFTC award.

Putting those two things together, lots of whistleblowing and lots of lawyers, whistleblowing is becoming a new industry and there is growing population of professional whistleblowers and their service providers.

Matt Kelly pointed out the slick graphic the SEC now seems to be appending to whistleblower award press releases. I have to be a bit snarky and point out the shortcomings of the fancy map showing the quantity of tips by state.

In my snarkiness, I’m going to point out that that the map also shows the most populous states. More people=>more companies=>more tips.

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Compliance Bricks and Mortar for March 22

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

The Federal Courts Are Running An Online Scam by Seamus Hughes in Politico

But I’m here to tell you that PACER—Public Access to Court Electronic Records—is a judicially approved scam. The very name is misleading: Limiting the public’s access by charging hefty fees, it has been a scam since it was launched and, barring significant structural changes, will be a scam forever.

The U.S. federal court system rakes in about $145 million annually to grant access to records that, by all rights, belong to the public. For such an exorbitant price—it can cost hundreds of dollars a year to keep up with an ongoing criminal case—you might think the courts would at least make it easy to access basic documents. But you’d be wrong.

https://www.politico.com/magazine/story/2019/03/20/pacer-court-records-225821

Cyber Breach Disclosures: A Mess by Matt Kelly in Radical Compliance

Craving more information about how companies are disclosing cybersecurity breaches? Audit Analytics has a new report examining what publicly traded firms have been reporting in SEC filings — and you won’t get much guidance there, because those disclosures vary so widely.

http://www.radicalcompliance.com/2019/03/20/cyber-breach-disclosures-total-mess/

The Weakness in Two-Factor Authentication—Your Lost Phone Policy by Avi Gesser, John R. Kapp, and Michelle Adler in NYU Law’s Compliance & Enforcement

Hackers always look for the weak link, and they have learned to get around MFA by exploiting gaps in companies’ lost phone protocols.  They do this by calling the IT help desk, saying they are employees who have lost their phone, so they can’t use the MFA app to login, and they have some emergency that requires them to get immediate access to the network.

https://wp.nyu.edu/compliance_enforcement/2019/03/18/the-weakness-in-two-factor-authentication-your-lost-phone-policy/

SEC Ends 2018 Signaling Its Approach to Regulating the Cryptocurrency Markets from Latham & Watkins

These orders — one against a token exchange, two against token issuers, and two against promoters — clarify the SEC’s approach for:

-Determining whether token transactions constitute unregistered securities offerings or unregistered broker-dealer or exchange activity

– Resolving unregistered token offerings

The Commission’s recent actions also signal the potential next frontier for SEC enforcement as the new year begins.

https://www.lw.com/thoughtLeadership/lw–sec-signals-its-approach-to-regulating-the-cryptocurrency-markets

The SEC, Compliance, Tone at the Top and Volkswagen by T. Gorman in SEC Actions

VW did have compliance systems. During his rise through the ranks the CEO was at one point in charge of Quality Assurance as well as head of Technical Development. Even after becoming CEO he continued to focus on the technical details of the vehicles as illustrated by photos in the complaint. Yet the scheme launched and continued. The failure of compliance here traces directly to the top. Under the circumstances here the “tone at the top” appears to have focused on something other than compliance.

http://www.secactions.com/the-sec-compliance-tone-at-the-top-and-volkswagen/

LIBOR, Again (Sorry!) by Rick Jones in Crunched Credit

A couple things are, at this point, clear. The Secured Overnight Financing Rate (SOFR) is a lock for the new and improved LIBOR. We are going to have a wide range of complex, often subjective triggers prompting the switch out of LIBOR, and regrettably, we are going to have a waterfall of prospective alternate SOFR rates to choose from when we switch. It’s pretty clear that when 2022 rolls around, we’re not going to have a single trigger or a single, easily understood, alternative rate. What we need is broadly agreed, clear, bright lined rules as to the date on which we switch rate and clear bright lined rules on what the index will be. We’re not getting it.

https://www.crunchedcredit.com/2019/03/articles/libor/libor-again-sorry

Compliance Bricks and Mortar for March 15

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

Listing Gaps, Merger Waves, and the Privatization of U.S. Equity Finance by Gabriele Lattanzio, William L. Megginson and Ali Sanati in The CLS Blue Sky Blog

The number of U.S. listed companies declined by almost half between 1996 and 2012, from 8,090 to 4,102, and had risen only slightly, to 4,336, by year-end 2017. However, the real market valuation of these listed companies tripled over the same period, from $10.2 trillion in 1996 to $32.1 trillion in 2017[1], implying that the average market valuation of a U.S. listed firm has increased six-fold over the past two decades. In other words, the U.S. public stock market has become populated exclusively by behemoths. Over the same period, the U.S. has experienced historically high levels of merger and acquisitions (M&A) activity and private investments of equity. We show that a new model of equity finance has emerged in the United States over the past quarter-century, which differs significantly from both late-20th century norms and the equity model observed in other advanced economies.

http://clsbluesky.law.columbia.edu/2019/03/11/listing-gaps-merger-waves-and-the-privatization-of-u-s-equity-finance/

What is ‘Compliance Training,’ Anyway? A Simple Explanation of What it is—and isn’t. by Ricardo Pellafone in SCCE’s The Compliance & Ethics Blog

In one sentence, compliance training is (1) a tool (2) that you use to drive behavior (3) of willing people (4) by helping them make decisions.

http://complianceandethics.org/what-is-compliance-training-anyway-a-simple-explanation-of-what-it-is-and-isnt/

Fidelity’s new cryptocurrency company is up and running despite a bear market for digital coins by Kate Rooney in CNBC


Fidelity Digital Assets, a new company created by the investing giant last year, has quietly rolled out its cryptocurrency custody and trade execution operations. In the past few months it has been up and running with institutional investors like hedge funds and family offices, according to its top executive.

https://www.cnbc.com/2019/03/08/fidelitys-new-cryptocurrency-company-is-up-and-running-despite-a-bear-market-for-digital-coins.html

Commissioner Peirce on CCO Liability

Enforcement actions by financial regulators can cause compliance professionals to rethink their career choice.

In the majority of cases the SEC brings against CCOs, (1) the compliance officers are involved in misconduct that is unrelated to their compliance function or (2) the CCOs have engaged in efforts to obstruct or mislead the investigation. Typically in these cases, the targeted compliance officers wore more than one hat.

But not always. Take a look at the Southwind Case.

Court E. Golumbic, a Participating Managing Director and the global head of Financial Crime Compliance for the Goldman Sachs Group, Inc. put it this way:

“Regardless of the cause, the resulting ‘chilling effect’ on financial sector compliance officers should raise an alarm. The level of ensuing ‘brain drain’ could diminish significantly the efficacy of financial sector compliance programs, and the integrity of the industry more generally.”

http://www.hastingslawjournal.org/wp-content/uploads/Golumbic-69.1.pdf

SEC Commissioner Hester Peirce tried to assuage fears at the National Membership Conference of the National Society of Compliance Professionals. She agreed that the SEC should tread carefully when bringing enforcement actions against compliance personnel and should not pursue enforcement actions based on strict liability for CCOs under Rule 206(4)-7.

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Compliance Bricks and Mortar for March 8

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

The Fall of the Alamo: Analogy for Compliance Officers by Tom Fox in FCPA Compliance & Ethics

[March 6] is the anniversary of the most historic day of many in the history of the great state of Texas, the date of the fall of the Alamo. While March 2, Texas Independence Day, when Texas declared its independence from Mexico and April 21, San Jacinto Day, when Texas won its independence from Mexico, probably both have more long-lasting significance, if it is one word that Texas is known for around the world, it is the Alamo. The Alamo was a crumbling Catholic mission in San Antonio where 189 men, held out for 13 days from the Mexican Army of General Santa Anna, which numbered approximately 1,800. But on this date in 1836, Santa Anna unleashed his forces, which over-ran the mission and killed all the fighting men. Those who did not die in the attack were executed and all the deceased bodies were unceremoniously burned. Proving he was not without chivalry, Santa Anna spared the lives of the Alamo’s women, children and their slaves. But for Texans across the globe, this is our day.

http://fcpacompliancereport.com/2019/03/19018/

SEC Investigations 101: The Wells Notice (Part 1) by  Dan Portnov
in Grand Jury Target

The process by which the Enforcement staff notifies you of impending proceedings against you – either in federal court or its in-house administrative process – begins with the Wells Notice.
The Wells Notice is named after the chair of 1972 SEC special committee that gave the following recommendation to the Commission:
Except where the nature of the case precludes, a prospective defendant or respondent should be notified of the substance of the staff’s charges and probable recommendations in advance of the submission of the staff memorandum to the Commission recommending the commencement of an enforcement action and be accorded an opportunity to submit a written statement to the staff to be forwarded to the Commission together with the staff memorandum.

https://grandjurytarget.com/2019/03/01/sec-investigations-101-the-wells-notice-part-1/

$2 Mill Fine for Weak Compliance by Matt Kelly in Radical Compliance

FINRA today hit broker-dealer firm Cantor Fitzgerald with a $2 million fine for sloppy compliance practices that lasted at least five years, in an enforcement action sure to warm a compliance officer’s heart.
The offenses related to naked short selling, where an investor first borrows stock to sell at a high price, then buys it back at a lower price to return to the original owner — except the investor doesn’t first obtain the borrowed stock before selling it. (That’s the “naked” part.)

http://www.radicalcompliance.com/2019/03/05/2-mill-fine-weak-compliance/

McKenna On Buffett, Berkshire Hathaway, and Kraft Heinz in re: The Auditors

Has Warren Buffett run out of long-run?
The stars aligned and Warren Buffett issued an annual shareholder letter that was forced to include an embarrassing charge for significant losses on Berkshire Hathaway’s investment in Kraft Heinz.
Buffett’s letter was a rant against GAAP, and a 180 degree turn from his typical long-term focus.

http://retheauditors.com/2019/03/03/mckenna-on-buffett-berkshire-hathaway-and-kraft-heinz/

Is willful blindness an affliction that can be cured? by Martin Kenney in The FCPA Blog

SNC-Lavalin senior managers were allegedly aware of the shenanigans afoot in their company, with some individuals operating offshore companies as a means to “facilitate” certain payments and launder funds. Indeed, if some of the allegations are true, including an historical plot to smuggle Colonel Gadhafi’s son to a safe place in order to avoid capture, then we have the makings of a Hollywood blockbuster here.

http://www.fcpablog.com/blog/2019/3/1/is-willful-blindness-an-affliction-that-can-be-cured.html

Compliance Bricks and Mortar for March 1

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

CCOs Facing Retaliation by Matt Kelly in Radical Compliance

So how should a compliance or audit professional handle retaliation? When should you take your concerns to regulators, or contemplate a lawsuit against your employer? To explore those questions I spoke with Jason Zuckerman, a lawyer in Washington who represents whistleblowers in retaliation cases. You can hear the full podcast at the top of this post. Meanwhile, here are my impressions.

http://www.radicalcompliance.com/2019/02/27/podcast-ccos-facing-retaliation/

Training Compliance Officers by Justin Muscolino, Head of Compliance Training, GRC Solutions in SCCE’s The Compliance & Ethics Blog


Think about it. Could a training program for compliance officers shift the culture of compliance? Yes, it could. By delivering a consistent message and approach you can change the culture. What are the benefits of creating a Compliance Officer program? …

http://complianceandethics.org/training-compliance-officers/

Robert Kraft, The NFL and Compliance by Tom Fox in FCPA Compliance & Ethics

There are lessons from the compliance practitioner from this Kraft saga. While most would say that the charges against Kraft are of a personal nature and not a business nature, this line is becoming increasing blurred. The Jeff Bezos divorce announcement, as much as the alleged extortion claim, put a spotlight not so much on his private life but rather how much his private life could impact Amazon.com. Does character matter? Of course it does and if the background of someone who will become your CEO has indicia that their actions might negatively impact on your organization, even if it is of a personal nature, then it has to be considered.

http://fcpacompliancereport.com/2019/02/robert-kraft-nfl-compliance/

Company Settles Unregistered ICO Charges After Self-Reporting to SEC

According to the SEC’s order, Gladius conducted an ICO in late 2017, after the Commission had warned in its DAO Report of Investigation that ICOs can be securities offerings.  Gladius, a Washington, DC-based company, raised approximately $12.7 million in digital assets to finance its plan to develop a network for renting spare computer bandwidth to defend against cyberattacks and enhance delivery speed.  Gladius did not register its ICO under the federal securities laws, and the ICO did not qualify for an exemption from registration requirements. 

https://www.sec.gov/news/press-release/2019-15

Protecting Attorney-Client Privilege and Respecting Fifth Amendment Rights While Cooperating with the Government by John F. Savarese and Carol Miller in NYU Law’s Compliance & Enforcement

In 2018, two cases illustrated the potential hazards that can arise when companies’ efforts to cooperate with the government later provide a basis for individuals questioned during internal investigations to claim that their Fifth Amendment rights against self-incrimination were compromised.  While these cases, which we summarize below, have the greatest impact in connection with the representation of individuals in such investigations, companies responding to white collar inquiries need to keep these new developments in mind, particularly in conducting internal investigations and working in a cooperative mode with the government.  Companies and their counsel must be mindful of these issues both to insure that individual employee rights are protected and to protect as much as possible the confidentiality and integrity of the company’s review.

https://wp.nyu.edu/compliance_enforcement/2019/02/20/protecting-attorney-client-privilege-and-respecting-fifth-amendment-rights-while-cooperating-with-the-government/

The Top Ten Regulatory and Litigation Risks for Private Funds in 2019 in Proskauer’s The Capital Commitment

An increasingly sophisticated and active OCIE division, innovative market disruptors, a maturing credit cycle, and a philosophical change in how the private fund industry views and utilizes litigation are likely to lead to increased regulatory scrutiny and litigation risk for advisers (and their funds) in 2019.  With that backdrop, we are pleased to present our Top Ten Regulatory and Litigation Risks for Private Funds in 2019.

https://www.privateequitylitigation.com/2019/02/the-top-ten-regulatory-and-litigation-risks-for-private-funds-in-2019/

How I Learned to Stop Worrying and Learned to Love Form ADV by Hardin Compliance Consulting LLC

After last year’s material amendments to the Form ADV, investment advisers can breathe a sigh of relief; the SEC made no changes to the form this year.  That said, completing the Form ADV remains a major data-gathering project with important regulatory implications.  So, take a few deep cleansing breaths and read our tips for completing your annual update.

https://www.jdsupra.com/legalnews/how-i-learned-to-stop-worrying-and-76134/

Failure to Launch Means Cancellation

The SEC cancelled the adviser registration of an internet investment adviser because it never launched its website.  

Kevin Ajenifuja registered his firms with the SEC by filing its Form ADV on May 28, 2015. He stated the eligibility for registration was because the firm was an “Internet Investment Adviser.”

Internet investment advisers typically are not eligible to register with the SEC. They do not manage the assets of their clients and therefore do not meet the statutory threshold for registration with the SEC. That would mean they would have to register in the states where they do business. For an internet investment adviser that would mean as a practical matter having to register in all 50 states. The SEC passed the internet adviser exception to fix this problem in 2003.

A year and a half later, in September 2016, the SEC contacted Mr. Ajenifuja because it thought he should withdraw the registration. He was still developing the website. The SEC said he should he withdraw and apparently he said he would do so.

The SEC gave notice in December 2016 that it intended to cancel the registration. Ajenifuja challenged the cancellation and had a hearing a year and half later in April 2018. He apparently still did not have an operational interactive website.

Mr. Ajenifuja argued that the internet adviser exception allows a grace period for development. In the adopting release the SEC “recognized the need for internet investment advisers to register with the Commission early in their development and testing phase in order to obtain venture capital.” Further that “many of these advisers may not even be fully operational 120 days after the registration has been granted.”

The SEC conceded that an internet adviser may be allowed some leeway beyond 120 days. However, there is no explicit grace period after the 120 days. The SEC would consider an extension based on facts and circumstances. Clearly, the SEC is looking for a firm to “reasonably expect to have a fully functional interactive website within a relatively short period” to prevent de-registration.

This decision may be the first time that SEC has said that internet advisers may get more than 120 days to launch so long as they can demonstrate significant progress. 

Unfortunately for Mr. Ajenifuja, the SEC found that three years was too long to still not have an operational website.

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Custody Rule Failure for Lack of Independence

The Custody Rule is full of foot-faults. The concept is easy: have a third party make sure that the investment adviser is not stealing money. That turns out to be a bit harder in execution.

Mohlman Asset Management Fund was using the accounting firm Katz, Sapper & Miller, LLP to help with its funds’ financial statements. Mohlman asked the firm to also audit the funds.

A fund manager can satisfy the Custody Rule requirements if it completes and distributes annual audited financial statements prepared in accordance with GAAP to each limited partner within 120 days of the end of the partnership’s fiscal year. The audit must be done by an independent public accountant that is registered with, and subject to regular inspection by the PCAOB. To be considered independent, a public accountant must meet the standards of independence described in Rule 2-01(b) and (c) of Regulation S-X.

KSM was already drafting the fund’s financial statements. KSM used the bank statements and other records provided to create a trial balance and then the financial statements, including the notes to the financial statements. Then it was auditing its own work.

That is certainly efficient for GAAP purposes. But it is not independent under Regulation S-X. The Custody Rule’s use of Regulation S-X imposes a higher level of independence than GAAP.

As you might guess, the reason the SEC came after KSM is because Mohlman was accused of fraud.

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Nevermind, That ICO Was a Securities Offering

Apparently, the blockchain makes everything cooler as a way to invest. Even securities laws shouldn’t get in the way. Reginald Buddy Ringgold, III thought he had escaped from the grasp of the SEC when a court refued to issue a preliminary injunction against his Blockvest ICO. The court changed its mind and slapped an injunction in place.

Back in October, the SEC brought charges against Mr. Ringgold, alleging that that they were planning to raise funds through an initial coin offering for financial products that would generate double-digit returns based on misrepresentations about the firm’s regulatory status. He used the SEC seal without permission and falsely claimed that their crypto fund was “licensed and regulated.” He also promoted the ICO with a fake regulatory agency he created, the “Blockchain Exchange Commission,” with a seal similar to the SEC seal and the same address as SEC headquarters. (It was that last bit that caught my attention.)

In looking at whether the Blockvest ICO was a securities offering, the court said no to the SEC because Mr. Ringgold said that the ICO was just a test platform and people were not really investing money. The court found that moving enough to find it not a securities offering.

In its new strategy, the SEC targeted the website advertising of the ICO. An offer of unregistered securities can be enough.

Section 17(a) applies to the “offer” or “sale” of securities. 15 U.S.C. § 77q. A violation of Section 17(a) does not require a completed sale of securities. See SEC v. American Commodity Exch., 546 F.2d 1361, 1366 (10th Cir. 1976) (“actual sales [are] not essential” for liability to attach under § 17(a) and § 10(b)); S.E.C. v. Tambone, 550 F.3d 106, 122 (1st Cir. 2008) (noting that “because section 17(a) applies to both sales and offers to sell securities, the SEC need not base its claim of liability on any completed transaction at all”).

Under securities law and caselaw, the definition of “offer” is broad. There is no requirement that performance must be possible or that the issuer must be able to legally bind a purchaser. That “Buy Now” button on the BlockVest website, along with the whitepaper and other descriptions were enough for the court to conclude that it was an offering.

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Weekend Reading: None of the Above

There were massive problems at the schools in Atlanta. Funding problems choked schools from needed capital investments and programming dollars. There was pressure to perform well on standardized tests under the No Child Left Behind Law, with fewer resources.

That pressure was too much for some principals and school teachers. They cheated and changed answers on their students tests.

Shanti Robinson is one of the teachers who went to trial for cheating on the standardized tests. She tells her story in None of the Above.

The cheating was discovered with statistics. The tests for the whole school system were reviewed to see how often there were signs of erasure which resulted in answers being changed from wrong to correct. They found some statistical anomalies where some classrooms had a much larger amount of those correcting erasures. So much so, that the only way it could have happened was someone changing the answers.

Post-test, Ms. Robinson and other teachers were told to erase “stray marks” from the test booklets. Some teachers interpreted that to mean fix the wrong answers. Ms. Robinson claims that she just erased the doodles in the test booklets.

The problem is that Ms. Robinson’s class was one of those with a statistically high number of erasures from wrong to right answers. Someone changed her students’ answers.

She goes down a common path of criminal mentality by loading up None of the Above with all of the other problems with the Atlanta school system and all of the other people who are doing things that hurt the students in the school system. The authors attack real estate deals that use a projected increase in tax revenue in an area to help fund a real estate development project. They attack charter schools and the state bureaucrats. There were lots of problems in the Atlanta school system greater than Ms. Robinson’s alleged cheating.

Spoiler alert: Ms. Robinson goes to trial after prosecutors play hardball with the principals, teachers and administrators accused of cheating. They bring RICO charges. Ms. Robinson complains about the prosecutor’s zeal and overly harsh charges. She complains about the fairness of the judge.

I didn’t find Ms. Robinson’s story compelling or believe her claims of innocence. I’m not sure she made the changes, but she fails to acknowledge that someone clearly made changes.

There are better sources for discussions of public education, testing and charter schools. I found the authors’ discussion of them to merely be a distraction from the cheating scandal.

Disclosure: The publisher sent me a copy of the book and asked for a review.