Doug Cornelius

Another CCO Liability Case and the SEC Complains about “May” Instead of “Will”

The SEC’s complaint against Temenos Advisory, Inc. and George L. Taylor paints a very bad picture for the firm and its Chief Compliance Officer. In this case, the CCO is also the CEO, founder and majority owner of Temenos.

A few years ago, the SEC had expressed an unwillingness to prosecute CCOs, except in three extreme circumstances:

Participating in the wrongdoing
Hindering the SEC examination or investigation
Wholesale failure

The Temenos case falls clearly in category 1. The CCO participated in the alleged wrongdoing. I’m not going to lose any sleep over this case.

And the picture painted by the SEC is one of blatant wrongdoing. Taylor concealed from clients that he and the firm were pocketing high commissions from the sales of the investment recommendations. Taylor is also accused of misleading clients about the risks and prospects of the investments. To top things off, the SEC alleges that Temenos grossly overbilled some of their advisory clients using an inflated value for the investment.

It’s not wrong for advisers to take commissions from the sale of products. But it needs to be disclosed to clients. In the complaint, the SEC once again expresses its displeasure of an adviser saying it “may” receive a commission from the sale of a product. The SEC claims that Temenos should have told its clients that it was routinely receiving fees for investments in the private placement offerings and that the fees were many times larger than the advisory fees the clients were paying for advice.

I thought this “may” versus “will” was killed with the Robare case. The ruling stayed away from the distinction between “may” and “will” by pointing out that the disclosure was inadequate to explain the fee sharing arrangement and how it could influence Robare to recommend one fund over another.

According to the complaint, Temenos did disclose the commission scheme in some instances, but not others, and in some cases understated the commission.

Of course, if you are going to get paid a commission, you need to be registered as a broker-dealer. Temenos was not. According to the complaint, Temenos was not conducting the basic level of diligence required by broker-dealers when selling private investment products.

Temenos also had a valuation problem. The firm carried the private placement interests at the cost of the original investment and never adjusted the value up or down. Of course, a firm can do that if it’s disclosed to investors and it’s part of its policies and procedures. The SEC states that the Temenos policy was to value a hard-to-price or illiquid securities at $0.

According to SEC complaint Temenos went ever further down the fraud curve and used values based on overstated cost. In one instance, the statement said the client had made a $200,000 investment when she had only made a $100,000 investment.

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Compliance Issues Related to Best Execution

Under the Investment Advisers Act, investment advisers selecting broker-dealers for executing client trades have an obligation to seek to obtain “best execution” of those transactions. The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a new risk alert highlighting many of the most common deficiencies that the OCIE staff has cited in recent examinations of advisers’ compliance with their best execution obligations.

Best execution requires taking the circumstances of the particular transaction into consideration. A best execution analysis is whether the transaction represents the best qualitative execution for the client, rather than whether the transaction has the lowest possible commission cost. In directing brokerage, an adviser should consider the full range and quality of a broker-dealer’s services including:

the value of research provided,
execution capability,
commission rate,
financial responsibility, and
responsiveness to the adviser.

It’s not just the cost. But be sure, that OCIE will look at the cost first, and it’s likely the adviser will have to justify using a higher cost.

The OCIE alert highlights the top eight issues their staff encounters during exams:

Failure to perform best execution reviews
Failure to consider materially relevant factors during best execution reviews
Failure to seek comparisons from other broker-dealers
Failure to fully disclose best execution practices
Failure to disclose soft dollar arrangements
Failure to properly administer mixed use allocations
Failure to implement best execution policies and procedures
Failure to follow best execution policies and procedures

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Compliance Issues Related to Best Execution July 11, 2018

Weekend Reading: The Spider Network

When I was a junior corporate lawyer, I sat in a debt training session. One of the partners mentioned LIBOR. The explanation confused me. But as a young lawyer I didn’t know very much about the workings of high finance.

It turns out that the benchmark is hodgepodge of figures voluntarily submitted by banks with little market check or control. I’ve heard plenty of stories in the news. For a detailed look, I recently read The Spider Network: The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History.

LIBOR—the London interbank offered rate, determines the interest rates on trillions in loans worldwide. LIBOR is supposed to reflect the interest rate at which member banks could borrow from one another that day. LIBOR is a global benchmark used to price all types of debt from credit cards, to variable rate mortgages, to complex derivatives and to corporate loans.

Very few people knew exactly how the rate was calculated. (That included that partner giving my training.) Even among the member banks there was widespread confusion as to its exact definition.

David Enrich of The Wall Street Journal manages to make Libor interesting in The Spider Network. His key to the story is telling the story of UBS interest rate derivative trader, Tom Hayes. This socially inept, if not autistic guy, is set up to be the fall guy for the LIBOR scandal.

Banks had lots of internal conflicts on their LIBOR submission. The rate a bank submits is indication of its credit worthiness. If it submits a rate that is higher than its peers, people may wonder if there is a problem at the bank.

The other major conflict is that the banks have traders, like Tom Hayes, who could make money or lose money on their positions depending on whether LIBOR goes up or down.

“LIBOR is a widely utilized benchmark that is no longer derived from a widely traded market. It is an enormous edifice built on an eroding foundation—an unsustainable structure,” stated CFTC Chairman J. Christopher Giancarlo in his opening remarks at the CFTC’s Market Risk Advisory Committee meeting last week. At the same meeting Commissioner Rostin Behnam identified noted that “LIBOR has been subject to pervasive fraud, abuse, and manipulation. Since June 2012, the CFTC has levied sanctions of more than $3.3 billion for LIBOR-related misconduct.”

I would recommend The Spider Network to learn more about the LIBOR mess.

Compliance Bricks and Mortar for July 20

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

Compliance 101: Defining a Control by Matt Kelly in Radical Compliance

Last week I was speaking at an ethics and compliance event in Houston, where one of the other speakers stumped the crowd with a deceptively simple question: What is a control?

After all, compliance officers talk about controls constantly. Effective controls are the lifeblood of what makes a compliance program work. Most of us can rattle off examples of controls, or recognize a control when we see one.

So my fellow speaker asked the audience: What is a control? [More…]

Demise of LIBOR benchmark takes center stage at MRAC meeting by Brad Rosen, J.D.

“LIBOR is a widely utilized benchmark that is no longer derived from a widely traded market. It is an enormous edifice built on an eroding foundation—an unsustainable structure,” stated CFTC Chairman J. Christopher Giancarlo in his opening remarks at the agency’s Market Risk Advisory Committee (MRAC) meeting held in Washington, D.C. In a similar vein, Commissioner Rostin Behnam, the committee’s sponsor, identified the rampant misconduct incited by the benchmark’s decline, noting that “LIBOR has been subject to pervasive fraud, abuse, and manipulation. Since June 2012, the CFTC has levied sanctions of more than $3.3 billion for LIBOR-related misconduct.” [More…]

6th Circ.: Crime Policy’s Computer Fraud Section Covers Email Scheme Losses by Kevin LaCroix in The D&O Diary

In the second policyholder-favorable federal appellate court decision on the issue in a matter of days, the Sixth Circuit has held that the Computer Fraud provisions of a commercial crime policy cover a company’s losses from an email payment instruction fraud scheme. Just last week, the Second Circuit ruledin the Medidata case that Computer Fraud coverage applied to losses incurred in a similar email scam. However, the Sixth Circuit’s decision may be even more helpful for policyholders as, unlike the Second Circuit’s decision, the policyholder-favorable ruling is not as dependent on very specific factual determinations about the way the fraudster manipulated the harmed company’s email program. The Sixth Circuit’s July 13, 2018 decision in the American Tooling Center (ATC) opinion can be found here. [More…]

The Premium for Money-Like Assets by Marco Cipriani and Gabriele La Spada in Liberty Street Economics

Several academic papers have documented investors’ willingness to pay a premium to hold money-like assets and focused on its implications for financial stability. In a New York Fed staff report, we estimate such premium using a quasi-natural experiment, the recent reform of the money market fund (MMF) industry by the Securities and Exchange Commission (SEC). [More…]

Two Recent Cases Highlight the Insider Trading Risks Associated with Cyber Breaches by Avi Gesser, James H.R. Windels, Joseph A. Hall, Laura Turano, and Zachary Shapiro in NYU Laws Compliance Enforcement

The recent convictions of two traders for using hacked press releases and the settlement of SEC insider trading charges against a former Equifax manager highlight the significant insider trading risks companies face when dealing with a cyber event. These risks come in two forms.

First, there is the risk that someone (either inside or outside the company) has gained unauthorized electronic access to material nonpublic information (“MNPI”) about the company or one of its business or transaction partners, and will use that information for illegal securities trading purposes. [More…]

Pan Mass Challenge
On Pan-Mass Challenge weekend, August 3 – 5, I will bike across Massachusetts to raise money for life-saving cancer research and treatment at Dana-Farber Cancer Institute. 100% of your donation will go to cancer research and treatment at Dana-Farber Cancer Institute through its Jimmy Fund. I have made a personal commitment to raise $8000.00. I hope, that as a reader of Compliance Building, you will support my fundraising effort. You can donate through any of the following links:

Thank you,
Doug

The Continuing Rise of the Professional Whistleblower

In 2016, the Securities and Exchange Commission opened its doors to the professional whistleblower when it first granted a whistleblower award to a company outsider. It’s becoming more lucrative.

Last week the Commodity Futures Trading Commission announced an award of approximately $30 million to a whistleblower who voluntarily provided key original information that led to a successful enforcement action. Previously, the highest award amount paid to a CFTC whistleblower was in March 2016 of more than $10 million (see CFTC Press Release 7351-16 CFTC Announces Whistleblower Award of More Than $10 Million.)

The SEC has preliminarily approved a $48 million payout in the same matter.

Unlike many whistleblowers, the recipient of those award came forward. Edward Siedle is a former lawyer for the Securities and Exchange Commission who has turned forensic investigator.

The award comes from a $267 million settlement between JPMorgan and the SEC. In a parallel action, JPMorgan Chase Bank agreed to pay an additional $40 million penalty to the U.S. Commodity Futures Trading Commission. The bank was investigated for steering high-net-worth clients toward its own proprietary investment funds that could cost more rather than those managed by other institutions. OF course, that could have been (maybe) addressed in a disclosure to clients.

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Monster’s ICO

Before all my music was digital and playing out of bluetooth speakers, I was a big fan of Monster Cables for connecting my audio and video equipment. Now those cables just sit in a plastic bin in the basement. I hadn’t thought about Monster Cables until the SEC has published the first “bedbug” letter on EDGAR and it was aimed at Monster. The letter from the Division of Corporation Finance is in response to a proposed monster money offering by Monster Products, Inc. Rather than providing a detailed examination and issuing comments, the staff letter to Monster suggests trying again.

Public company filings are not in my area of expertise so I’m not sure what the SEC was concerned about.

What caught my attention was the crazy scheme that Monster is trying to put together. Monster wants to offer up to three hundred million of its to-be-created Monster Money Tokens (“MMNY”) for gross proceeds of $300,000,000.

Monster plans to use the Ethereum blockchain technology on its E-commerce website to create the new Monster Money Network where consumers may use either MMNY Tokens or fiat currencies to purchase Monster products and services. The company intends to utilize the blockchain technology to its marketing, accounting and audit, internal control and shipping management functions.

In the event of an “ICO Failure” investors in the tokens may convert them into Monster common stock at the rate of four tokens per share of stock. The “ICO Failure” means that i) MMNY Tokens not have been traded on a cryptocurrency exchange or a U.S. stock exchange by June 30, 2020 because either this registration statement is not declared effective by the SEC or MMNY Tokens are not approved for trading on any such exchange market; or ii) MMNY Tokens have ceased trading on or before June 30, 2020 due to legal or administrative enforcement actions by the SEC, the CFTC, or any other government authorities.

The ICO seems a Hail Mary to turn the company around. It was acquired by a blank check company earlier this year. It as unable to timely file its latest 10Q. It fired its auditor. It replaced its CFO.

Monster trying something new by basically pre-selling Monster products and services through the MMNY offering. It’s issuing gift certificates, tarted up with blockchain.

I saw this at the same time I saw the UBI Blockchain fraud. That company was originally JA Energy, but reincorporated as UBI Blockchain Internet. Its business was to encompasses the research and application of blockchain technology with a focus on the internet of things covering areas of food, drugs and healthcare. UBI had no revenues and has yet to develop any products for sale. The stock price shot up from $3.70 per share to over $87 at one point on a surge of buying just because the company had blockchain in its name. The SEC temporarily suspended trading in UBI Blockchain stock earlier this year due to concerns about the accuracy of assertions in its SEC filings and unusual and unexplained market activity.

Unlike UBI Blockchain, Monster has an operating business. It’s just not doing well. As a turnaround, it proposes to sell tarted up gift certificates for products that are mostly in bins in the basement.

What type of monster is it?

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Compliance Bricks and Mortar for July 13

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

SEC Investor Advocate’s 2019 objectives include broker-dealer standards of conduct, Kokesh concerns by Amanda Maine, J.D. in Jim Hamilton’s World of Securities Regulation

The SEC’s Office of the Investor Advocate (OIA) has submitted a report on its objectives for fiscal year 2019, which begins on October 1, 2018. The report expects the Commission to examine the impact on investors from proposed changes in the standards of conduct for broker-dealers, updates to its transfer agent and ETF rules, and enhancements to disclosures by mutual funds and variable annuities. The report also states that the SEC is considering possible approaches to help restore its ability to impose disgorgement orders after five years in the wake of the Kokesh decision, which may require legislative intervention. [More…]

A tiny nugget from the SEC’s new FOIA rules by Cydney Posner in Cooley Pubco

Yesterday, the SEC posted final amendments to its rules related to FOIA, the Freedom of Information Act, to conform to the FOIA Improvement Act of 2016 and to otherwise update and streamline the regulations. The changes will become effective 30 days after publication in the Federal Register. Due to the scope of the amendments, these final FOIA rules replace the SEC’s existing FOIA rules in their entirety, revamping the organization of the rules. What does that mean? It means that your standard form FOIA SEC rule references are probably soon to be out of date. [More…]

Three Insider Trading Cases by T. Gorman in SEC Actions

Despite the plethora of often complex judicial opinions the basic offense has remained the same: a corporate insider with confidential, material, non-public information that belongs to the firm converts it to his or her personal use either trading for their own account or furnishing the information to a relative or friend who trades and obtains the profits. Two new cases filed by the Commission and one jury verdict in a criminal case illustrate the point. [More…]

The Jim Jordan Compliance Angle… by Matt Kelly in Radical Compliance

Interesting detail about the proto-scandal swirling around Jim Jordan, the Republican congressman accused of turning a blind eye to sexual misconduct on the Ohio State wrestling team when he was assistant coach there: Jordan might have violated the school’s sexual harassment Code of Conduct.

For those not following this story, Jordan has represented Ohio’s 4th congressional district since 2007, and is a leading voice in the Tea Party wing of the party. He also worked as an assistant coach for the Ohio State wrestling team from 1987 to 1995. Earlier this month, numerous former wrestling students from that era accused Jordan of ignoring complaints they tried to raise about sexual abuse from a team doctor, Richard Strauss, who committed suicide in 2005. [More…]

Assessing compliance training by Kaplan & Walker

Training is not just another part of every C&E program; it is generally the part that touches the work lives of more of a company’s employees than do other elements. It should therefore be a significant focus of any program assessment. The possible avenues of inquiry here are broad, as one would imagine, and each assessment will have its own areas of particular focus. But a partial list of core training assessment questions might include the following. [More…]

U.S. Finance Watchdog Takes Aim at Cryptocurrency

The Financial Industry Regulatory Authority (FINRA), a self-regulatory body for broker-dealersm has released a regulatory notice to mandate its member to notify the authority if they engage in any cryptocurrency activity. Though the notice outlines what constitutes cryptocurrency activities, it does not detail how FINRA would use these disclosures nor does its website show any explanation. Since the self-regulatory body focuses on protecting retail investors in all financial markets, it can be assumed that the disclosures would help in this goal. [More…]

Thank you,
Doug

Beware of Social Media Consultants

The Securities and Exchange Commission packaged together five separate settled proceedings against registered investment advisers, investment adviser representatives, and a social media consultant for violations of the Testimonial Rule the use of social media and the internet.

If you get a pitch from someone to increase your firm’s presence in search results ask that person if they can gather up reviews from clients to publish. Read the rest of this post and we will revisit what to do with the answer.

SEC Rule 206(4)-1(a)(1) states that:

It shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business . . . for any investment adviser registered or required to be registered under [the Advisers Act], directly or indirectly, to publish, circulate, or distribute any advertisement which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser.

When it adopted the rule, the SEC stated that, in the context of investment advisers, it found that testimonial “advertisements are misleading; by their very nature they emphasize the comments and activities favorable to the investment adviser and ignore those which are unfavorable.” The staff has stated that the rule forbids the use of a testimonial by an investment adviser in advertisements “because the testimonial may give rise to a fraudulent or deceptive implication, or mistaken inference, that the experience of the person giving the testimonial is typical of the experience of the adviser’s clients.”

But marketing consultant Leonard S. Schwartz and his company Create Your Fate, LLC ignore the rule and looked for investment advisers as clients.

The first victim went unnamed in the SEC Order. Schwartz reached out to the clients of “Adviser A” and solicited testimonials. Schwartz then published some of those testimonials on “Adviser A”‘s Facebook page and Twitter feed. He also sprinkled in some videos on YouTube. “Adviser A” realized there was a problem, sent Schwartz information on the Testimonial Rule and asked for the testimonials to be deleted.

Schwartz continued the practice with other investment advisers: Greenfield, Eyster and Biel.

I would guess that the last three did not ask Schwartz to remove the testimonials as “Adviser A” did.

There is additional guidance form the SEC on social media. You can’t stop third parties from providing ratings on your firm on Yelp or other services. But if you control the page and publish the content, that’s prohibited. Recommendations posted by the adviser or its employees are strictly prohibited. Similarly, an adviser can’t pay for recommendations or offer discounts to clients to post commentary.

So if your marketing consultant/social media consultant/ search results consultant says to go ahead and solicit those reviews. Stop right there and show the consultant the door. It’s clear that publishing reviews of your firm is very problematic. Any “yes” answer with out a careful analysis of the SEC’s marketing rules and Testimonial Rule can lead to trouble.

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I’m Looking for Donations

Compliance Building is a resource I publish for me, and share with you, to help the compliance profession. It’s free. I’m not looking for any of your compliance budget.

But I am hoping you will consider allocating a piece of your charitable donation budget to one of the charities I support: the Pan Mass Challenge.

The Pan Mass Challenge is a charity bike ride across Massachusetts to raise money for cancer research. 100% of your donation to my PMC ride will go the Dana-Farber Cancer Institute.

[Click here to make a donation]

Your donations create success. My Pan Mass Challenge team gets matched up each year with a kid suffering cancer to help provide support. Last year and this year, our Pedal Partner is Maya. The picture below is inspiring proof.

In January 2017, Maya turned five years old. A month later, doctors found a large mass on one of her kidneys. The diagnosis was Clear Cell Sarcoma, a very rare renal cancer. Maya went through surgery to remove the mass, completed six days of radiation and seven months of chemotherapy to fight her cancer.

Look at that smile and look at that success.

I ride the Pan-Mass Challenge because I believe the money it raises makes a difference in the fight against cancer. It’s making a difference for Maya.

If you’ve read this far, you are either a very dedicated reader of Compliance Building or have also been touched by cancer. Unfortunately, most people have been touched by this terrible disease.

Compliance Building readers have already been very generous. So many of you have donated in the past and have already contributed this year to help me achieve my fundraising goal. (I apologize for this additional request.)

If everyone who reads Compliance Building donated a few dollars I would exceed my fundraising goals. If you think Compliance Building worth $1 a week. Then, please contribute $50…(Or More)

My Pan Mass Challenge ride will start in less than a month and will be 192 miles over two days from Sturbridge to Provincetown. If I hit my fundraising goal, I will add another day of riding to Sturbridge on the day before the official start.

Donations can be made by clicking on any of the links below, or sending a check to my mailing address:

Doug Cornelius
15 Lockwood Rd
West Newton MA 02465

Click here to make $25 donation

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Thank you,
Doug

Can You Help Guide Petronia?

Alain Lille, CEO of Petronian Industries is not happy with the new government. He wants to protect his investment in the country of Petronia. His oil firm deployed a great deal of capital looking for oil in Petronia and had a contract with the government for production. A roadblock appeared in last year’s election. The new president was elected, in part, beacuse of her promise of a of a better deal for the people. She wants to make sure this newfound wealth provides the best benefits to the country.

Mr. Lille fears she will reopen negotiations hurting revenue for his company and possibly revenues for the country. The new president invited foreign “experts” to advise her.

If you’re still looking for Petronia on the map, you can stop. It’s a fictional country in a new online game created by the Natural Resource Governance Institute: https://petronia.games/. This thinktank wants to improve the management of oil, gas and mineral wealth in developing countries.

As a player in Petronia, you take on the role of that pesky foreign adviser.

Petronia is available free and on demand. It’s published to be a more accessible and less time sensitive alternative to NRGI’s in-person learning courses or the massive open online course.

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