Author: Doug Cornelius

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

Real Estate Broker Guilty of FCPA Violations

I’m not sure how I missed the sad tale of Joohyun Bahn before now. He agreed to an SEC order last week for FCPA violations. This was in connection with his criminal sentencing that also happened last week, after first being arrested in January 2017.

It’s uncommon for real estate to insect with the FCPA, but this tale involved a building in Vietnam and the potential acquisition by a Middle East sovereign wealth fund. The tale also ends up ending the political career of Ban Ki Moon, the former U.N. Secretary General who was expected to run for president of South Korea.

Mr. Bahn moved around in various real estate jobs around New York before landing a nice job at a real estate firm. Shortly after joining the firm, his father offered him an opportunity. His father was involved with company that built a trophy building in Vietnam known as Landmark 72. This would be Mr. Bahn’s first international deal, the opportunity to earn a big commission, help his father, and help a big company.

Mr. Bahn was clearly in over his head.

He fell in the treacherous circle of Malcolm Harris who claimed he could help with the Landmark 72 deal for a cut of the commission. He told Bahn to focus on Middle East sovereign wealth funds. He claimed to have a contact at the Qatar Investment Authority who was interested.

Then Harris made his play and told Bahn that his contact at the QIA required a bribe to facilitate the purchase. Bahn brought this news to his father and the company apparently agreed to make the $500,000 up front payment. Harris pocketed the money. Harris continued to play Bahn along while spending the bribe.

As part of his sentencing, Bahn said that he knew the bribe was wrong. He didn’t realize it was an FCPA violation. He signed an anti-bribery policy at the real estate firm. He just thought bribery was a necessary part of international business, a business he had little exposure to.

While Bahn was getting strung along by Harris, he in turn was stringing along the building owner. Harris gave Bahn a forged letter of intent from QIA. Bahn gave the building owner a letter he had forged from a UK bank showing that the QIA had put funds into an escrow account as a deposit.

It seems that QIA had some interest in the Landmark 72. But that all fell apart when the building owner came under scrutiny for corruption. The chairman committed suicide and detailed bribes he had paid in his suicide note. The $500,000 bribe by Bahn was revealed in the underlying investigation.

The timing of Mr. Bahn’s arrest coincided with the conclusion of Mr. Bahn’s uncle’s term as U.N. Secretary-General and reports that Ban Ki Moon intended to run for the presidency of South
Korea. Mr. Bahn was arrested the day before Ki Moon was scheduled to fly from New York back home to South Korea. Because of the timing, instead of focusing on his run, Ki Moon was forced to respond to the indictment against his brother and nephew instead of his candidacy. A month later, he withdrew from the race.

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Compliance Bricks and Mortar for September 7

These are some of the compliance-related stories that recently caught my attention or I missed while on vacation.

SEC Ratifies Appointment of ALJs and Lifts Stay on Pending Administrative Proceedings

The Securities and Exchange Commission (“SEC” or “Commission”) has issued an order clearing the way for cases to proceed before its own administrative law judges (“ALJs”), notwithstanding a Supreme Court decision issued earlier this year that declared the SEC’s prior appointment of ALJs to be unconstitutional. Respondents in nearly 200 SEC proceedings with pending cases will now be granted the opportunity to have their case reheard by a different ALJ. Through the ratification order, the Commission has also attempted to comply with the Appointments Clause of the Constitution. Whether this post hac ratification passes constitutional muster, however, remains to be tested in the courts. [More…]

Compliance, Monitoring, and Future CCOs by Matt Kelly

“Do you think I need to be a lawyer to be a chief compliance officer?”

Oh boy. That question again. [More…]

Respondents denied recovery of legal fees in first post-Lucia ALJ decision by Amanda Maine, J.D. In Jim Hamilton’s World of Securities Regulation

An SEC administrative law judge (ALJ) rejected an application for recovery of legal fees and expenses from two firms who had prevailed against the SEC’s Division of Enforcement last year and successfully had proceedings against them dismissed. While the ALJ found that the applicants had demonstrated their eligibility for recovery of legal fees and expenses under the Equal Access to Justice Act (EAJA), the SEC’s action had been substantially justified, even though it was eventually dismissed. The decision was the first initial decision issued by an ALJ following the Supreme Court’s Lucia decision, which determined that the ALJ in that proceeding was not appointed by the Commission in conformity with the Constitution. The Commission stayed all administrative proceedings following Lucia, but the stay was allowed to expire on August 22. The applicants waived their rights under Lucia to a new hearing before a different judge (In the Matter of Donald F. (“Jay”) Lathen, Jr., Release No. ID-1259, Patil, S.). [More…]

Adviser Pays $1.9 Million SEC Penalty For False Ads by T. Gorman in SEC Actions

In 2003 the firm created an analysis internally known as “research proof.” It calculated annualized returns from February 1995 — the earliest point for which the firm had stored fundamental ratings –for six hypothetical baskets of stocks. In 2006 MFS began using the research proof analysis in advertisements. The charts compared annualized returns from February 1995 through the date of publication for research proof’s hypothetical baskets. The charts showed that the hypothetical portfolios of “buy” stocks at the fundamental quant intersection performed better than either the hypothetical portfolio stocks rated “buy” by the firm’s quantitative models or the hypothetical portfolio of stocks rated “buy” by the adviser’s fundamental research. The same was true on the sell side. Stated differently, the charts illustrated the point that over time blended stock ratings provided better return potential than either fundamental or quantitative ratings alone. [More…]

What Happened to “Meaningfully Close Personal Relationship” in Insider Trading? by Peter Henning in The CLS Blue Sky Blog

An interesting question is whether the convictions in Newman of the two hedge fund portfolio managers might have survived after Martoma. The government’s lack of evidence of their knowledge of the benefit would likely defeat the prosecution, especially as they were third- and fourth-level tippees.  But the relationship between the sources of the information and the initial tippees might have been enough to establish the quid pro quo under Martoma’s analysis.  So long as there is an intention to benefit the recipient, there is unlawful tipping. [More…]

 

First Full Day of a Full Strength SEC

Yesterday, the Senate voted to confirm the nomination of Elad L. Roisman to be a member of the Securities and Exchange Commission. Mr. Roisman fills the vacant seat left by Michael Piwowar. This is the fourth Commissioner appointed by President Trump. I expect we will see pictures of the swearing in ceremony this morning.

Mr. Roisman was the chief counsel of the Senate Banking Committee. Before joining the Banking Committee, Roisman was counsel to former SEC Commissioner Daniel Gallagher.

Mr. Roisman will join Republican Commissioner Peirce and Chairman Clayton to likely bring a more de-regulatory stance to the agency

Commissioner Piwowar left the SEC in July and joined the Milken Institute on Wednesday.

The days of a full strength SEC may not last into 2019. Commissioner Stein is serving beyond her term and must step down at the end of the year. There seems to be little incentive for President Trump to speedily re-fill that Democratic spot.

If your wondering who the 15 Nay votes on the confirmation, they are the Senators you would expect.

NAYs —14
Baldwin (D-WI)
Blumenthal (D-CT)
Booker (D-NJ)
Durbin (D-IL)
Feinstein (D-CA)
Gillibrand (D-NY)
Harris (D-CA)
Markey (D-MA)
Menendez (D-NJ)
Merkley (D-OR)
Sanders (I-VT)
Schumer (D-NY)
Warren (D-MA)
Whitehouse (D-RI)

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Broken Windows at Wells Fargo

Getting a free meal is one of the few perks of staying late at the office for many financial services firms. The firm is willing to pay some set amount if the employee stays after some deadline. Most figure that the person is going to be more productive if he or she is not starving.

I initially found it strange that Wells Fargo fired a dozen employees of the Wells Fargo Securities division for violating the policy.

Wells Fargo has been in the news for all the wrong reasons. My first reaction is that it was taking the broken windows approach: target small crimes to create an sense of order and compliance as a deterrence to bigger problems. What could be a smaller crime than ordering a free dinner before the 6:30 dinner policy time? You get hungry at 6:15 and order, knowing that it will take time to get delivered and that you are planning to work for another few hours.

Did Wells Fargo really bring down the hammer for ordering dinner early?

I don’t think so.

The employees that were fired were accused of altering their receipts to show an order time in compliance with the policy. The headlines were missing the point.

Wells Fargo fired a dozen employees for forgery. It was stupid forgery. These bankers could afford the $20 for dinner. Something was wrong with the culture if employees feel that forgery is acceptable.

If you remember back to the bigger problems at Wells Fargo, employees were forging account opening documents to meet their sales quota. That is clearly a bigger problem than the $20 dinner receipt. But a financial firm cannot tolerate any level of forgery.

The fired employees must feel stupid. Losing a job over not wanting to pay for cheap sushi is a terrible way to start a career.

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10 Red Flags that an Unregistered Offering May Be a Scam

Since it’s back-to-school day for my community, I thought I would go back to the basics.

The SEC’s Office of Investor Education and Advocacy 2014 Investor Alert identifies potentially fraudulent unregistered offerings with features that indicate a problem. The alert goes through 10 red flags for you to note about private placements.

Private placements are not inherently problematic. Recently, more money has been raised through private placements than through IPOs and secondary offerings.

But scammers are going to use a private placement, where there is no established market for the sale of the investment offering. You don’t have liquidity.

For me, two of the ten really stand out as the most problematic.

  1. Claims of High Returns with Little or No Risk

The basics of investing are that you get a better expected return for more expected risk and a lesser expected return for a lesser expected risk. A private placement already has more risk. You don’t have liquidity. There is no market to sell your investment.

If the proposed investment is such a good deal on risk/return basis why are they offering it to you?

  1. No Net Worth or Income Requirements 

The federal securities laws generally limit private securities offerings to accredited investors.  Be highly suspicious of anyone who offers you private investment opportunities without asking about your net worth or income.

An individual is considered an accredited investor, if he or she:

(a) earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year,
OR
(b) has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence or any loans secured by the residence (up to the value of the residence)).

If you’re not an accredited investor, the federal securities laws say that you shouldn’t be allowed in invest in a private placement.

Here are the other eight red flags:

  1. Unregistered Investment Professionals
  2. Aggressive Sales Tactics
  3. Problems with Sales Documents
  4. No One Else Seems to be Involved
  5. Sham or Virtual Offices
  6. Not in Good Standing
  7. Unsolicited Investment Offers
  8.  Suspicious or Unverifiable Biographies of Managers or Promoters

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The One with Video Problem

If you are running a Ponzi scheme, don’t send a video to your investors that you are running a Ponzi scheme.

According to the Securities and Exchange Commission Complaint, EquityBuild was selling notes secured by real estate by promising safety and high returns. (Hopefully, you realize those things don’t go together.) In reality, EquityBuild was charging high fees to investors by valuing real estate well above cost and using new investor money to pay returns to older investors.

The wheels fell off earlier this year and EquityBuild finally told investors that there were issues.

According to the SEC complaint, Equitybuild emailed a video recording to investors telling them about the problems.

(a) states that Equitybuild’s properties are “negatively cash flowing,” (b) acknowledges that investor interest payments have stopped and that principal has not been returned, (c) discloses that Equitybuild had funded investor interest payments using “fee income” from later investors, but that fees charged to later investors could no longer satisfy the interest payments to earlier investors, (d) warns investors not to file lawsuits against Equitybuild, (e) states that investors will not receive payments until Equitybuild’s rental income exceeds its expenses, and (f) advises that Equitybuild was cutting staff down to a “skeleton crew” and would not be able to respond to investor inquiries.

Read (c) again.

I’ve not been able to get my hands on a copy to hear exactly what was said. But according to the SEC complaint, EquityBuild admitted to being a Ponzi Scheme.

EquityBuild and its principals are currently fighting the charges, so we will have to wait to hear their side of the story.

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The One with Bookrunning in Exchange for Not Removing a Platform

Merrill Lynch has lots of relationships and is trying to manage an advisory business, a brokerage business and an investment banking business. It got into trouble for letting the last two interfere with the normal operations of its advisory business.

In general during the time of the SEC action, a material change in any product on Merrill’s advisory platforms, such as replacing the product’s portfolio manager, results in Merrill’s Due Diligence team conducting an in-depth review of the product. If they give it a thumbs down, the analysts put together a termination recommendation. It eventually ends up with Merrill’s Governance Committee for the ultimate decision. The Governance Committee had apparently always approved termination recommendations.

In 2012 one of the products in platform managed by a U.S. subsidiary of a foreign multinational bank announced a change in portfolio manager. It was a big change. The product was run by a single portfolio manager with accounts having a minimum of $100,000 invested in portfolios of 20-25 bonds specifically selected by the portfolio manager. The new manager was a team that had been responsible for institutional accounts with a minimum of $100 million invested in diversified portfolios of approximately 150 bonds.

That was a big change and had no track record for the new investing style. It seems like an easy termination and due diligence recommended the termination.

The problem is that a Merrill employee contacted the platform before the Governance Committee vote. The employee was trying to get in front of the operational issues from inevitable termination.

But that proactive communication gave the platform time to lobby Merrill management for a reconsideration. Apparently, that also included discussion of a possible active bookrunner role in a registered offering associated with the platform. Senior management apparently intervened in the termination process.

The most unusual part was the person who ran the agenda for Merrill’s Governance Committee got an email from a platform employee telling the Merrill person that the item was going to removed from the agenda.

The Due Diligence Employee received this email on the morning of January 16 and forwarded the email to another Merrill executive, stating, “Here is a first. An external manager telling an internal product staffer what can go on an internal governance agenda” to which the recipient responded, “[A]stonishing.”

The Governance Committee did not vote on the termination and instead diligence went back for more review.

Merrill ended up with non-active bookrunner rule in the offering, getting a smaller allocation.

Ultimately, the product stayed on hold for a year. The performance was satisfactory. It performed as well and in some instances better than the products that would have replaced it.

Investors were not harmed, but Merrill had a breakdown in procedure. It’s decision-making was clearly in conflict. The SEC came down hard, forcing Merrill to disgorge the fees it earned on the platform over the year and pay an equivalent fine.

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Quarterly Reporting or Semi-Annual Reporting

According to a tweet from President Trump, he asked the Securities and Exchange Commission to study the possibility of moving from quarterly to semi-annual reporting for public companies.

In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. “Stop quarterly reporting & go to a six month system,” said one. That would allow greater flexibility & save money. I have asked the SEC to study!

— Donald J. Trump (@realDonaldTrump) August 17, 2018

From a compliance perspective, the issue is more about quarterly guidance, than quarterly reporting.

The broader argument is about short-term focus on reported numbers than the long term focus of the company. I’m not sure that would work out that way or change things. There are many people smarter than me that have written detailed research papers on the topic. They don’t seem to have reached a conclusion.

According to a story in Wall Street Journal, the impetus of Trump’s tweet was a meeting with outgoing PepsiCo CEO Indra Nooyi. During a dinner with the President, he asked “What can we do to make it even better?” According to the Wall Street Journal: “she said, ‘Two-time-a-year reporting, not quarterly.’”

Will companies switch if you make the regulatory change?

Probably not.

The European Union made this change in 2014. Less than 10% of UK companies switched from quarterly to semi-annual.

Institutional investors report their results quarterly and expect their underlying investments to report quarterly. Companies would need to convince shareholders to accept less frequent reporting.

The other aspect is contractual obligations for quarterly reporting. Most companies have a obligations to their lenders for quarterly reporting. That would not go away just because of the regulatory change.

Then there is the question of whether President Trump’s tweet amounts to an official action by the White House. We seem to have a mixed message form some sources as to whether its an official order or not.

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Weekend Reading: Can You Outsmart an Economist?

Can I outsmart the economist Steven Landsburg? I tried getting the answers right in his new book: Can You Outsmart an Economist?

The answer: No. I can’t.

Mr Landsburg’s book present us with 100+ puzzles to illustrate some principles of economics. The puzzles bleed into understanding the interpretation of those principles in statistics, law, math, science and philosophy. You can see the political implications of some of these puzzles as well.

The publisher provided me with a review copy and I felt ready for the challenge.  I felt pretty good as I went through the warm-ups questions in chapter 1. I didn’t get them all correct, but I quickly realized my errors.

The questions got harder and more in depth. Sometimes I got the right answer. Other times I did not. But I learned quite a bit. The book is less about the quizzes than it is about the principles each question is trying to get across to the reader.

You can test yourself.  Can You Outsmart an Economist? goes on sale September 25.

Compliance Bricks and Mortar for August 17

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

Compliance Activists vs. Effective Compliance Professionals by Roy Snell

Some of the most ineffective compliance professionals I have met run up and down the hall with their hair on fire over every little thing. Ineffective compliance professionals see their role as that of an activist. They are very visible and vocal. They see all that is wrong with the world, and they don’t recognize much of what is right with the world. They see the bad in people and seem to ignore the good in people. [More…]

The Summer of Ben DiPietro by Tom Fox in FCPA Compliance & Ethics

Last week Ben DiPietro announced his retirement from the Wall Street Journal (WSJ) Risk and Compliance Journal via Twitter. For a journalist practicing his trade in the realm of compliance in the early 21stcentury, it certainly was an appropriate manner to communicate with his readers. Ben wrote, “OK, some breaking personal news: I’ve given notice to @wsj, my last day is Aug. 14. What’s next? Stay tuned!!!!!”.

Even if you were not lucky enough to meet Ben in person, if you are in the compliance field you are certainly familiar with his work on the Risk and Compliance Journal. It is the only major US publication reporting on compliance, its enforcement and risk on a daily basis. It is required reading for all compliance professionals to keep abreast of the top stories of the day. But more than simply the daily news, the Risk and Compliance Journal is able to get some truly must-readpieces in with a ridiculous low word limit which I find nothing short of phenomenal. [More…]

Do Import Tariffs Help Reduce Trade Deficits? by Mary Amiti, Mi Dai, Robert C. Feenstra, and John Romalis in Liberty Street Economics

The fact that the United  States imports far more than it exports is viewed by some as unfair, so the idea is to try to reduce the amount that the nation imports from the rest of the world. While more costly imports are likely to reduce the quantity and value of imports into the United States, the story does not stop there, because we cannot presume that the value of exports will remain unchanged. In this post, we argue that U.S. exports will also fall, not only because of other countries’ retaliatory tariffs on U.S. exports, but also because the costs for U.S. firms producing goods for export will rise and make U.S. exports less competitive on the world market. The end result is likely to be lower imports and lower exports, with little or no improvement in the trade deficit.  [More…]

The Pension Hole for U.S. Cities and States Is the Size of Germany’s Economy by Sarah Krouse in the Wall Street Journal

Many cities and states can no longer afford the unsustainable retirement promises made to millions of public workers over many years. By one estimate they are short $4 trillion, an amount that is roughly equal to the output of the world’s fourth-largest economy.

Certain pension funds face the prospect of insolvency unless governments increase taxes, divert funds or persuade workers to relinquish money they are owed. It is increasingly likely that retirees, as well as new workers, will be forced to take deeper benefit cuts. [More…]

Bullet-Proof Vest Whistleblower Aaron Westrick Receives Pillar Award by Ben Kostyack & Michael Ellis in the Whistleblower Protection Blog

Dr. Aaron Westrick was formerly the Director for Research and Marketing at Second Chance Body Armor (SCBA), which was the largest bullet proof vest company in the United States at the time. In 2001, a Japanese company, Toyobo, informed SCBA that the vests they were selling to American police departments, federal law enforcement agencies, and the U.S. military were unsafe. [More…]

Crime Policy Doesn’t Cover Employee Credit Card Overcharge Losses by Kevin LaCroix in The D&O Diary

A recent coverage dispute involving a Nevada club’s losses resulting from its employees’ theft from the club’s customers’ credit cards raises interesting issues with implications for coverage questions for other kinds of losses for which policyholders are seeking crime policy coverage. In the recent Nevada club credit card fraud case, District of Nevada Judge Andrew Gordon held that the club’s crime policy did not cover the club’s losses from the employees’ theft of funds from the customers’ credit card accounts because the losses did not result directly from the employees’ theft.  [More…]