Author: Doug Cornelius

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

Compliance Bricks and Mortar for January 26

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

Say on Pay: Is It Needed? Does it Work? by Stephen F. O’Byrne

In this article, we’ll show that there is substantial evidence that directors do a poor job overseeing executive pay and that directors have weak incentives to pursue shareholder interests in executive pay. We’ll then look at Say on Pay and present evidence that Say on Pay voting is sensitive to differences in pay for performance, but so forgiving that extraordinary pay premiums are required to elicit a majority “no” vote. We will show that three quarters of institutional investors have lower SOP voting quality—that is, less informed and fair voting ‐ than the average investor and almost all have a short‐term focus, with much greater vote sensitivity to current year grant date pay premiums than to long‐term pay alignment and cost. We’ll conclude with a proposal explaining how institutional investors can improve their SOP voting. [More…]

Cybersecurity and Third-Party Risks by Michael Volkov

A global company conducting business with third parties may increase the risk of cybercriminals circumventing cyber protections through the third party. I know it sounds scary but the fact is that third parties could be the proverbial back door into a company resulting in a major cyber-attack and hack of company data. [More…]

Whistleblowers Beware: Your Work Computer Is Probably Monitored by Christopher Easton

Picture this: while at work you become aware of conduct that you believe is unethical, illegal, or qualifies as government waste, fraud, or abuse. You decide you want to blow the whistle. But before you act, be careful! Most corporate and government networks log traffic. Your work computer and phone are not private. When you use a company or department computer, assume everything you do is monitored. These computers are an easy way for your employer to determine you are the whistleblower.[More…]

Kokesh v. SEC: Half a Year On by Matthew C. Solomon, Alex Janghorbani & Richard R. Cipolla

More than six months have passed since the Supreme Court held, in Kokesh v. SEC, 137 S. Ct. 1635 (2017), that the Securities and Exchange Commission’s (SEC or Commission) disgorgement power constitutes a penalty subject to a five-year statute of limitations. As expected, the Supreme Court’s holding on the penal nature of SEC disgorgement has spurred defendants to seek to broaden its application to other contexts. Most fundamentally, this includes whether the SEC has the statutory authority to seek disgorgement at all. To date, courts have mostly turned aside these challenges. At the same time, however, litigants have grown more creative in their attacks, evidenced by a class action suit seeking reimbursement of nearly $15 billion from the SEC of certain historical disgorgement payments. [More…]

An ethical obscenity by Jeff Kaplan

The absurdity of the notion that giving up control of an asset mitigates conflicts of interest arising from ownership of such asset will be evident to anyone who has filled out a COI questionnaire – meaning not just those in the public sector but private sector as well (including those involved in the above “hypo”). On such forms, employees must disclose asset ownership AND asset control – not one or the other. As long as an owner can know who is spending money in ways that benefit his asset – and if Public Citizen can know such things President Trump surely can too – then the conflict is there. Period. [More…]

About Those Tax Reform Bonuses… by Matt Kelly

Today we step away from corporate compliance for a short detour into financial reporting, tax policy, and corporate governance. All those companies announcing bonuses, raises, and new employee benefits as a result of tax reform may not be as honest about their motives as their breathless press releases say. [More…]

Disclosing Private Fund Expenses to Investors – You Can’t Fix it With Form ADV

Private Fund CCOs have been focused on the disclosure and reporting of fund expenses for years. The Securities and Exchange Commission made it a centerpiece of exams of private fund managers. A handful of cases came out in 2015-2016 on that first wave of private equity fund manager exams:

  • Blackstone failed to fully inform investors about benefits it received from accelerated monitoring fees.
  • Apollo failed to adequately disclose the acceleration of monitoring fees upon the sale or initial public offering of portfolio companies.
  • WL Ross failed to disclose to funds and their investors certain fee allocation practices that resulted in the funds paying the manager approximately additional, undisclosed management fees.
  • First Reserve failed to disclose conflicts of interest related to fees and expenses charged to funds under its management, and other undisclosed benefits.

Last month, TPG Capital was the latest firm to fall under the wrath of the SEC for what the SEC decided was inadequate disclosure on fees. The focus was on acceleration of portfolio company monitoring fees.  The SEC has stated that it does not like these fees unless they are fully disclosed.

TPG charges each of its portfolio companies an annual fee in exchange for rendering a consulting and advisory services. These monitoring fees paid by each Portfolio Company to TPG are in addition to the annual management fee paid by the Funds’ limited partners to TPG. However, a certain percentage of the monitoring fees are used to offset a portion of the annual management fees that the Funds’ limited partners would otherwise pay to TPG. The standard agreement for the monitoring fee was for 10 years, with full acceleration on the sale of the company.

The SEC acknowledge that TPG disclosed its ability to collect monitoring fees to the Funds’ limited partners prior to their commitment of capital, it did not disclose its receipt of accelerated monitoring fees in the PPMs and LPAs. TPG did make fee disclosures LPAC reports, portfolio company Form S-1 filings, and TPG’s Form ADV. But the SEC took the position that by the time these disclosures were made, the limited partners had already committed capital to the Funds.

One point that had been rolling around compliance circles was how to remedy fund documents for legacy funds that did provide the level of detail on fees and expenses that the SEC now seems to require. One method was to make the disclosure in the ADV Part 2 Brochure. This case seems to blow-up that tactic.

Regardless, it would seem as a result of this action, TPG’s Form ADV Part 2 Brochure has one of the lengthiest and most detailed fee disclosure I have seen.

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Federal Shutdown and Compliance

With Congress showing more of its ineptitude, it was unable to pass spending legislation over the weekend. There are reports of limited impact over the weekend. With today’s start of the work week, thousands of federal employees will be home instead of doing their jobs.

The Securities and Exchange Commission is still operational. At least in the short-term.

SEC Operating Status

Should there be a federal government shutdown after January 19, the SEC will remain open for a limited number of days, fully staffed and focused on the agency’s mission.

Any changes to the SEC’s operational status will be announced here. In the event that the SEC does shut down, we will pursue the agency’s plan for operating during a shutdown. As that plan contemplates, we are currently making preparations for a potential shutdown with a focus on the market integrity and investor protection components of our mission.

The SEC has a chunk of cash in reserve to keep operational. Some of its services are outsourced and will keep operating.

EDGAR

The Commission’s EDGAR system is operated pursuant to a contract and thus will remain fully functional as long as funding for the contractor remains available through permitted means. SEC personnel will be able to process requests for EDGAR access codes and password resets; answer questions about fee-bearing EDGAR filings and other emergency questions regarding EDGAR submissions. However, the Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of Compliance Inspections and Examinations will be unable to process filings, provide interpretive advice, issue no-action letters or conduct any other normal Division and Office activities. As a result, new or pending registration statements or applications for exemptive relief will not be processed regardless of the status of any review of those filings.

IARD

The Commission’s IARD system is operated pursuant to a contract and thus will remain fully functional and will continue to accept filings as long as funding for the contractor remains available through permitted means. However, the Office of Compliance Inspections and Examinations will be unable to approve applications for registration by investment advisers, the Division of Investment Management will be unable to provide interpretive advice regarding the Advisers Act, rules, or forms, or consider applications for exemptive relief under the Advisers Act. As a result, new or pending investment adviser applications will not be processed. The IARD system will continue to accept annual and other-than-annual amendments to Form ADV, Form ADV-W, and Form ADV-E filings.

It seems like any exams scheduled for this week could still happen. If you are looking start drafting your Form ADV filing, that system is still operational.

If the shutdown drags over into next week, the SEC will start its shutdown program. Anyone taking bets on that happening?

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Compliance Bricks and Mortar for January 19

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

Financial Institutions Are Playing Catch-Up in AML and Sanctions Compliance by Michael Volkov

A recent survey of financial institutions conducted by Alix Partners on AML and Sanctions compliance (here) contains informative results that support some of my general concerns about ethics and compliance programs – board members do not receive adequate training and compliance officers are continuing to struggle with lack of adequate resources. [More…]

A Sense of Purpose by Larry Fink

Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders. It will succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth. It will remain exposed to activist campaigns that articulate a clearer goal, even if that goal serves only the shortest and narrowest of objectives. And ultimately, that company will provide subpar returns to the investors who depend on it to finance their retirement, home purchases, or higher education.  [More…]

The New Digital Wild West: Regulating the Explosion of Initial Coin Offerings by Randolph A. Robinson, II

In order to provide the necessary context to understand this new decentralized world, this paper provides a non-technical legal audience with a foundational understanding of how public blockchains work. The paper begins with an introduction to the coming decentralized world, including an overview of both public blockchain technology as well the Ethereum platform, the primary public blockchain upon which ICOs are being deployed. [More…]

 

The SEC Administrative Law Judges Are Heading to the Supreme Court

The use of administrative law judges by the Securities and Exchange Commission has been strained since the jurisdiction was expanded under Dodd-Frank. There have been a series of cases challenging the ALJs under the the Appointments Clause of the Constitution. The problem was that the judges were appointed by an internal panel instead of by the President or the SEC Commissioners.

An advertising case that led to an adviser being barred is now headed to the U.S. Supreme Court. In the Lucia case, the lower court used a three prong test to determine if an ALJ is an “Officer” under the Appointments Clause:

  1. significance of the matters resolved by the government official
  2. discretion the official exercises in reaching the decision
  3. the finality of the decision

On Jan. 12th, the Supreme Court granted an appeal to hear Lucia v. SEC. This was likely based on two factors.

One was a split in the courts on whether the SEC’s administrative law judges were properly appointed. The 10th Circuit Court of Appeals came to the opposite conclusion in Bandimere v. SEC. That court used a different three part analysis to determine if an ALJ is an “inferior officer”:

(1) the position of the SEC ALJ was “established by Law,”;
(2) “the duties, salary, and means of appointment . . . are specified by statute,”.; and
(3) SEC ALJs “exercise significant discretion” in “carrying out . . . important functions,” .

The Bandimere decision rejected the argument in the Lucia case that ALJs do not have final decision-making power. They have enough power to make them an “inferior officer.”

The second was that the Department of Justice decided that the ALJ appointment process was flawed. That position dropped in the Solicitor General’s Brief on Writ of Certiorari for Lucia the argument is now to hear the case and overturn the Lucia ruling.

“[T]he government is now of the view that such ALJs are officers because they exercise ‘significant authority pursuant to the laws of the United States.’ Buckley v. Valeo, 424 U.S. 1, 126 (1976)”

In response, the SEC ratified all the ALJ appointments. This should fix the problem and erase the constitutional problem.

In the reply brief, Lucia argued that the government’s change of its position and its revised procedures did nothing for him.

“Although the government now agrees that SEC ALJs are Officers, it has afforded petitioners no redress for having subjected them to trial before an unconstitutionally constituted tribunal… On the contrary, petitioners remain subject to draconian sanctions—including a lifetime associational bar—resulting from the tainted proceedings below”

It looks like the SEC has fixed the problem with its ALJs going forward. The problem will be what to do with all of the cases that have already been decided. It seems likely that the SEC is going to agree that the ALJs were a problem. The big question is how to fix that problem for the cases that have already been adjudicated. I would guess that there are a lot of cases that going be expunged, people no longer barred and cash fines repaid.

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Full Speed Ahead for the SEC

Commissioners Hester M. Peirce and Robert J. Jackson, Jr. are, According to Jay Clayton’s math the 96th and 97th Commissioners of the Securities and Exchange Commission after being sworn in last week.

It’s been two years since the SEC has been at full strength. Perhaps this means that rule-making will proceed ahead. Based on the SEC’s regulatory agenda, Chair Clayton is planning to have the commissioners focus on a much smaller set of rules in the near term.

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Compliance Bricks and Mortar for January 12

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

Five Things to Think About Before a Surprise SEC Exam

by Joshua M. Newville, Robert E. Plaze, Christopher Wells and Alexandra V. Bargoot

If a team from the SEC arrives at your office and says, “We are conducting an on-site examination and would like to talk to the CCO right now,” are you prepared? A handful of registered investment advisers have faced surprise SEC exams in recent months. These exams come in two flavors: either a “for cause” exam arising from SEC staff concerns relating to a specific ongoing issue, or a standard exam that for some reason has a surprise component. [More…]

Are You Ready for Your Next Regulatory Exam?

by Patty P. Tehrani, Esq.

I know regulatory examinations can be stressful but without a defined process even more so. I’ve lived through exams managed without a process and those guided by one and not surprisingly having a process inevitably garnered better results. Below I share some practical tips to help you develop an examinations process or improve one that you already have. [More…]

Eight Compliance Events to Watch in 2018

by Matt Kelly

Without further delay, then, my annual list of compliance issues that should be worth watching in 2018. In no particular order…

SEC guidance on cybersecurity.  [More...]

“The Big Chill”: Personal Liability and the Targeting of Financial Sector Compliance Officers

by Court E. Golumbic

Prominent law enforcement and regulatory officials have referred to financial sector compliance officers, as “essential partners” in ensuring compliance with relevant laws and regulations, whose “difficult job[s]” merit “appreciat[ion] and respect.” Officials have noted the critical role these professionals play in shaping the culture of financial institutions, as well as the industry more generally. However, a series of recent enforcement actions in which financial sector compliance officers have been personally sanctioned has strained this partnership, fueling concerns among financial sector compliance officers that they are being unfairly targeted. [More…]

Court Rejects SEC Request For “Obey The Law” Injunction

in SEC Actions

[A] district court has granted summary judgment against the Commission in a Securities Act Section 5 case centered on a years long Ponzi scheme based on the statute of limitations and refused to enter an injunction, although Kokesh is not actually cited. SEC v. Jones, Civil Action No. 17-11226 (D. Mass. Opinion Jan. 5, 2018).[More…]

Discretionary Management of IRAs: Prohibited Transaction Issues for RIAs

However, there is a caveat. That is, BICE only applies to non-discretionary investment advice. In other words, if the financial institution or its advisors have the responsibility or authority to make the decisions, or if they actually make the investment or transaction decisions, and there is a financial conflict of interest (that is, a prohibited transaction), BICE does not provide relief. To make matters even worse, there are very few exemptions for prohibited transactions resulting from discretionary decisions. Based on conversations with RIAs over the last few months, I have learned that many of them are not aware that, where they have financial conflicts (for example, 12b-1 fees or payments from custodians) for discretionary investment management for IRAs, there is usually not an exemption and the compensation is prohibited. [More…]

Some bitcoin foolishness:

Miami Bitcoin Conference Stops Accepting Bitcoin Due to Fees and Congestion
Next week the popular cryptocurrency event, The North American Bitcoin Conference (TNABC) will be hosted in downtown Miami at the James L Knight Center, January 18-19. However, bitcoin proponents got some unfortunate news this week as the event organizers have announced they have stopped accepting bitcoin payments for conference tickets due to network fees and congestion. [More..]

Long Island Iced Tea shares soar after changing name to Long Blockchain
A visit to the new website shows that Long Blockchain is in the “preliminary stages of evaluating specific opportunities” in the blockchain space. At this time, the company has no agreements with any blockchain entities, nor does it have assurance that an agreement will be forthcoming, the website said. [More…]

The 7-11 Compliance Conondrum

Immigration and citizenship employee compliance requirements are fairly straightforward, although awkward. You can’t usually ask whether or not a job applicant is a United States citizen before making an offer of employment. But you do need to verify the identity and employment eligibility of all employees, by completing the Employment Eligibility Verification (I-9) Form, and reviewing documents showing the employee’s identity and employment authorization. Then you need to hold onto the I-9 while the person is employed.

U.S. Immigration and Customs Enforcement agents targeted nearly 100 of 7-Eleven stores in 17 states before dawn Wednesday to deliver audit notifications of their I-9 paperwork. In the process, it made 21 arrests of employees on suspicion of being in the U.S. illegally.

But why 7-11?

A press release from 7-11 HQ pointed out:

“7-Eleven Franchisees are independent business owners and are solely responsible for their employees including deciding who to hire and verifying their eligibility to work in the United States.”

So effectively, ICE deployed hundreds of agents at almost 100 locations at what are essentially each a separate business. I would guess that each location employs a few dozen employees at the most. That seems like a huge deployment of resources for a small amount of potential targets.

I suppose this does send a message to franchisees and franchisors of all industries to make sure they follow the I-9 requirements because ICE is willing to dedicate a ludicrous amount of resources to make a statement.

ICE indicated that this sweep was a “follow-up” of a 2013 ICE action that resulted in the arrests of nine 7-Eleven franchise owners and managers in New York and Virginia on charges of employing undocumented workers. That was one of the largest criminal immigrant employment investigations ever conducted.

Meanwhile the Office Inspector General released a report the raised concerns about ICE detainee treatment and care at detention facilities and ICE’s Screening Protocol of Aliens Who May Be Known or Suspected Terrorists is Limited and Risks National Security.

It still looks a huge of amount of resources deployed against the 7-11 franchises. In contrast, ICE raided an Iowa meatpacking plant in 2008 and detained nearly 400 undocumented workers. That plant owner, Sholom Rubashkin, recently had his prison sentence commuted by President Trump.

You can look at the 7-11 raid as a follow-up to a prior action.

“Today’s actions send a strong message to U.S. businesses that hire and employ an illegal workforce: ICE will enforce the law, and if you are found to be breaking the law, you will be held accountable,” said Thomas D. Homan, ICE Deputy Director and Senior Official Performing the Duties of the Director. “Businesses that hire illegal workers are a pull factor for illegal immigration and we are working hard to remove this magnet. ICE will continue its efforts to protect jobs for American workers by eliminating unfair competitive advantages for companies that exploit illegal immigration.” –  ICE Deputy Director Thomas D. Homan

So according to ICE statement, 7-11 draws illegal immigrants into the US and those illegal workers are taking away jobs from Americans who want to work at 7-11.

For those in compliance like me, our job is not to question the wisdom of the rule, but make sure our companies are following the rule. That means running the I-9 process and keeping the paperwork to avoid an ICE raid.

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Compliance Bricks and Mortar – Blizzard Edition

I’ve just come inside after digging out from yesterday’s blizzard. These are some of the compliance-related stories I’m going to read by the fire.

Is Bitcoin Really in a Bubble? in Knowledge@Wharton

[T]he cryptocurrency community is divided on whether bitcoin is a “side show or the show.” However, he believes that the “fundamental breakthrough is not necessarily bitcoin but the blockchain technology,” which is the distributed ledger that tracks these transactions. [More…]

The SEC and Securities Plaintiffs’ Bar Take Aim at Initial Coin Offerings

However, its recent investigative report addressing the initial coin offering (“ICO”) of a virtual organization (“21(a) Report”)1 marks a dramatic increase in the SEC’s focus that will have a profound impact on how this emerging market will be regulated. The report also signals an eventual uptick in enforcement activity and supplies plaintiffs’ attorneys with a new weapon for their complaints. As discussed in this article, the 21(a) Report therefore has far-reaching implications to the creation, offer, and sale of ICOs as well as the promotional and investment activities relating to them. [More…]

Global Magnitsky Sanctions Target Human Rights Abusers and Government Corruption Around the World
by David S. Cohen, Kimberly A. Parker, Jay Holtmeier, Ronald I. Meltzer, David M. Horn, Lillian Howard Potter, and Michael Romais

On December 20, 2017, President Trump issued a new Executive Order (EO) targeting corruption and human rights abuses around the world. The EO implements last year’s Global Magnitsky Human Rights Accountability Act (the Global Magnitsky Act), which authorized the president to impose sanctions against human rights abusers and those who facilitate government corruption.[1] The US Department of the Treasury’s Office of Foreign Assets Control (OFAC), which will administer the EO, also added 15 individuals and 37 entities to its Specially Designated Nationals and Blocked Persons List (SDN List).  [More…]

CCO Authority and Independence by Tom Fox

In the 2012 FCPA Guidance, under Hallmark Three of the 10 Hallmarks of an Effective Compliance Program, the focus was articulated by the title of the Hallmark, Oversight, Autonomy, and Resources. In it the 2012 FCPA Guidance focused on the whether the CCO held senior management status and had a direct reporting line to the Board; stating “In appraising a compliance program, DOJ and SEC also consider whether a company has assigned responsibility for the oversight and implementation of a company’s compliance program to one or more specific senior executives within an organization. Those individuals must have appropriate authority within the organization adequate autonomy from management, and sufficient resources to ensure that the company’s compliance program is implemented effectively. Adequate autonomy generally includes direct access to an organization’s governing authority, such as the board of directors and committees of the board of directors.”[More…]

Start Your Compliance Year Right

After a long weekend, and perhaps a vacation, compliance professionals are coming back into the office with 2018 on the calendar. It’s a clean slate. The possibilities are endless.

Where to start?

I don’t have the answer. There is so much to get done and so many challenges ahead.

No organization has has the same risks, regulatory requirements, or challenges as any other organization. It would be foolish for me to tell you where to start the year.

I can give the simple advice to start. I’m sure you have plenty of things left from 2017 that need to be completed on top of all the other things coming down the pipeline. Start doing something. Get it done and move on to the next. Repeat as necessary.

Compliance is different things to different people, to different organizations, and to different regulators.

But getting something done is always a good step.

So go get something done today.