Category: Compliance Programs

Politics and Conflicts of Interest

Politicians and their staff are prone to conflicts of interest. Legislative, executive, and regualtory actions will affect the value of companies and their investors.

Hillary Clinton failed to address the conflicts between her actions as Secretary of State and the fundraising of the Clinton Foundation. One of the campaign promises of Donald Trump was to tackle these conflicts of interest and “drain the Washington swamp.” Either candidate would have to address the conflicts when taking over the presidency.

Mr. Trump won, whether you are for or against him, and now its time to figure out how to deal with the conflicts. His task is many times larger than that of any modern candidate. He has extensive business holdings, most of which are based on his name and run by his family, and extensive overseas investments.

Perhaps there is a role for a compliance program here.  It’s not just for good ethics. There is a Constitutional requirement in the Emoulments Clause and the Foreign Gifts and Decorations Act.

The standard political solution to wealth management for the president is is a blind trust. The trustees are independent of the candidate and the politician does not know what is in the trust. That would prevent the politician from achieving direct financial gain from his or her time in office.

A blind trust will not work for an active business like the Trump organization. Having it run by his children makes it even less blind. It’s hard to miss the investments made by the company when the Trump name is plastered all over the holdings. Look at his financial disclosures. He listed hundreds of companies that he owns or controls.

In addition, serving as president will not make Mr. Trump immune from private lawsuits. He could easily be dragged into court for a deal gone bad. I would expect that he will be magnet for litigation.

He has extensive holdings overseas. That is going trigger anti-corruption regimes in those countries. Some of his lenders are state controlled organizations.

Put on your compliance hat and offer some advice.

I agree with the Wall Street Journal opinion page’s advice. (I admit that this is an uncommon event for me.)

Mr. Trump needs to sell. He needs to liquidate his interest in the Trump Organization. It’s the only way. If he does not, he is just another alligator in the swamp of Washington DC.

I’m doubtful he will take the right path. To do so would put an actual valuation on the organization. I think he is happy to say he is extremely wealthy. I think he is even happier to not know what that number is.

Selling the organization would place a clear dollar value on his organization and on him. I’m sure Mr. Trump thinks that the value is many times higher than what a third party would be willing to pay, or through an IPO.

I think the chances of a sale is close to zero.

How should Mr.Trump arrange his holdings to avoid a conflict of interest or accusation of kleptocracy. One would be to prove that he not actually receiving financial gain. Unfortunately, that would require a level disclosure that gets him closer to the information he would have to provide in an IPO.

You may agree with some, all, or none of Mr. Trump’s policies, whether actual or perceived. Nobody wants the US president to have the appearance of a kleptocrat. Nobody wants the president to be using the office for overt, personal financial gain while in office.

trump-conflicts

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The Downside to Advertisement Restrictions

Going back over my notes in search of guidance on when advertising for a private equity firm is advertising restricted under the Investment Advisers Act and when it is advertising for the firm’s products and services, I’m left uncertain.
half-price advertisement

I was hoping that the gun jumping interpretations would offer some meaningful guidance. So far, I have not found much hope.

My concerns arose from some second-hand rumors about what the Securities and Exchange Commission has been attacking during examinations of private equity firms and real estate firms that are registered as investment advisers. One story was about a fund manager having to take down references to a real estate industry award on the firm’s website. The award sounded like one focused on real estate operations. Using my earlier standard, the award sounded like an award for making good soup not for having good securities.

That leaves real estate fund managers registered as investment advisers at a competitive disadvantage to real estate sponsors who are not registered as investment advisers. The public real estate companies have some guidance under Rule 168 and Rule 169 as to what is advertisement.

Registered real estate fund managers may have to operate in a gray area trying to decide when an advertisement is about the real estate soup. Otherwise they risk the vagaries of an SEC examiner deciding an advertisement violates the Investment Advisers Act.

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CCO Needs To Be a Jack of All Trades

Andrew Donahue, the Chief of Staff of the Securities and Exchange Commission gave a speech earlier this month to the National Society of Compliance Professionals National Conference. He was attempting to share his thoughts on the current and future challenges that compliance professionals in the financial services area face.

He envisions that CCOs will need to be a “jack of all trades with access to a wide array of skillsets.”

jack-of-trades-bigest-swiss-army-knife

In the past, compliance merely required an expertise in the applicable laws and regulations.

Now it requires expertise in technology, operations, market, risk, and auditing. Firms are changing rapidly, and markets are rapidly evolving and regulations are only getting more voluminous. Mr. Donahue points out that staying up to date is one of the biggest challenges for complaince professionals.

“It is critical that you make it a priority to develop the necessary technical expertise, keep up with changing market dynamics, fully appreciate all of the firm’s businesses and follow regulatory developments and their impact on your firm and its operations.”

I fear that Mr. Donahue should remember, and compliance professionals shoudl strive to avoid, the second half of the phrase: Jack of all trades and master of none.

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The SEC’s Pay-to-Play Rule and California Labor Law

Keith Bishop chimed in on Campaign Contributions and the SEC in the context of California law: Pay-To-Play Meets The California Labor Code at the California Corporate & Securities Law blog.

He point to  California Labor Code:

Section 1101.
No employer shall make, adopt, or enforce any rule, regulation, or policy:

(a) Forbidding or preventing employees from engaging or participating in politics or from becoming candidates for public office.
(b) Controlling or directing, or tending to control or direct the political activities or affiliations of employees.

Section 1102.
No employer shall coerce or influence or attempt to coerce or influence his employees through or by means of threat of discharge or loss of employment to adopt or follow or refrain from adopting or following any particular course or line of political action or political activity.

Obviously there is some conflict from the face of the code with SEC Rule 206(4)-5 that limits certain employees of registered investment advisers from making campaign contributions to certain elected officials.

You may disagree with the rulings, but political campaign contributions are considered political activities. The SEC rule therefore limits political activities.

That puts the CCO of a registered investment adviser in a precarious position. On the one hand, violating the SEC rule could result in the loss of a great deal of money for the adviser.  On the other hand the CCO’s policy may be violation of California law.

Mr. Bishop cites Couch v. Morgan Stanley & Co., a 2016 federal court decision that looked at those sections of the California Labor Code. That court found that it was okay to fire someone for legitimate, non-political reason even though the underlying action was related to political activity. In that case, Mr. Couch was elected to the county board of supervisors. Morgan Stanley told him he could not hold both jobs based on time constraints.

I suppose that helps a bit. The limit on campaign contributions is set by a federal agency, not an employer made rule. It’s not the employer imposed rule. The rule is non-political in that, on its face, it does not apply to a political position, but to a political office.

One problem is the perception cast by advisers who want to do business with Indiana. They are telling their employees that donations to the Republican presidential candidates are limited, but there are no limits on the other candidates. It’s to meet the standards of the rule, but comes across as very political.

Of course that does leave the problem of how to implement the rule and Goldman Sachs’ implementation of the rule. Goldman banned contributions. That seems to be more than required by the federal rule and could be seen as unduly limiting the employee’s activities.

I know many advisers have taken the same position as Goldman Sachs and banned all political contributions by all employees. The intricacies of the SEC rule make anything more tough to manage. Others have pointed out that such a position may be in conflict with California law. Thanks to Mr. Bishop for pointing out the law on the issue.

Post Debate Campaign Contributions and the SEC

With the first of the presidential debates over, I thought it would be a good time to refresh myself on the SEC’s limits on political campaign donations by investment advisers. SEC Rule 206(4)-5 was put in place to limit political influence on government pension plan investment choices.

candidates

Under the rule:

1. All political campaign contributions should be reported.
2. Employees can contribute up to $150 to any candidate.
3. Employees can contribute a larger amount to certain candidates after checking make sure it does not violate the SEC rule.

Number three is the tricky part.

SEC regulations limit the ability of certain employees at an investment adviser from donating to candidates who could influence the decision-making of a state or local government retirement plans if you want that plan as a fee paying client.

You need to figure out which employees are subject to the rule. That’s what led to Goldman Sachs banning all contributions by the firm’s partners. The rule is unclear on which employees of an adviser are subject to the limitation. It’s clear that the very top and fundraisers are included. It’s clear that administrative staff are excluded. Then there are a lot employees in the grey area.

Then you need to figure out which political offices actually influence the decision-making of state or local pension funds. In most states that is the political offices appoint officers or trustees to the state fund’s board. Generally, that sweeps up the governor and treasurer. Good luck figuring out how that works with local boards.

You get really tough ones like Pennsylvania State Employees’ Retirement System. Two members are appointed by the President Pro Tempore of the Pennsylvania Senate and two members are appointed by the Speaker of the Pennsylvania House of Representatives. Those positions are voted on by the Senators and Representatives, not the general public. So I think every state Senator and Representative in Pennsylvania is affected by this rule since any of them could end up in that position.

Back to the major party presidential candidates and the Rule’s impact:

Clinton – Kaine: Neither of them are in an office that would be limited by the SEC rule.

Trump-Pence: Because Mr. Pence is the governor of Indiana, contributions to this campaign are limited by the SEC.

For those of you looking further down the ballot:

Johnson-Weld (Libertarian Party): Neither is currently in an elected office so contributions are not limited. Both were governors and would have been limited in those offices.

Stein-Baraka (Green Party): Neither is currently in an elected office so contributions are not limited.

Castle-Bradley (Constitution Party): Neither is currently in an elected office so contributions are not limited.

The effect of SEC Rule 206(4)-5 is to limit donations to the Trump campaign. CCOs across the country are telling their employees they can contribute fully to the Clinton-Kaine ticket but are limited in donating to the Trump-Pence ticket.

The SEC Wants To Know If You Have An Outsourced CCO

Continuing this week on the changes to the Form ADV is a revision to Item 1.J that lists the chief compliance officer.

Folder with the label Compliance

The new Form ADV will require a registered investment adviser to disclose whether the firm’s CCO is compensated or employed by someone other than the adviser. That is, the SEC wants to know if the CCO is outsourced.

The SEC has previously noted that it has observed a wide spectrum of quality and effectiveness with outsourced CCOs. Clearly, having an outsourced CCO will be a risk factor when deciding to examine a firm.

I think that is true in part, but depends on the outsourcing itself.

I believe the SEC is looking for trends and will be able to see which firms do a good job of acting as an outsourced CCO and which do a bad job. If the SEC sees a trend that a particular outsourcing firm is doing a bad job, it will certainly take a closer look at the advisers that used that outsourcing firm.

The disclosure will work to identify both the good outsourcing firms and the bad outsourcing firms in the eyes of the SEC.

There is one small flaw in the disclosure. That is the instance in which the outsourced CCO is not employed by a firm, but is self-employed. The new question asks for the name of the “person” (corporations are people too) and the IRS EIN that employs or compensates the outsourced CCO. The self-employed outsourced CCO would not disclose the other firms that have hired him or her. And the person would definitely not want the SSN to be used as the EIN.

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The SEC Wants To Know About Your Social Media

The Securities Exchange Commission published an update to Form ADV last week. I’m going to devote this week’s stories to some of the new requirements. Today, I’m looking at reporting of social media.

SOCIAL MEDIA DATABASE

Item 1.I of Part 1A of Form ADV currently requires registered investment advisers to list their websites. The SEC is casting a wider net.

Instead of just websites, the SEC is requiring the listing of accounts on social media platforms such as Twitter, Facebook and LinkedIn. We will be required to include the address of the registered adviser’s social media pages. (see page 34 of the release)

There were comments to the proposed release about the scope of this listing requirement. It’s limited to accounts on social media platforms where the adviser controls the content. You are not required to disclose information on employee social media accounts. It’s also limited to publicly available social media platforms.

Twitter, Instagram, and Facebook all fall clearly into this requirement.

LinkedIn is little fuzzy. A company can update the company page on LinkedIn. But many firms just have the default company page on LinkedIn. A firm can control the content, to some extent, but may not have exercised any control. That being said, those pages that have not been edited don’t provide much information. It would be unlikely to be of interest to the SEC. But if you are publishing information, then clearly the SEC is going to take a look at when it comes to exam time.

I do have a question about dormant accounts. I know many firms signed up for an account to control a particular account name, without intending to actually publish information. I remember back in the early days of Twitter, Lexis Nexis ignored the platform. Some yahoos grabbed the handle and started publishing strange stuff on the @LexisNexis twitter account. Lexis would eventually get it back because it was its trade name. I think you would need to list these unused accounts.

A hitch will be updating this social media information. If you add a new account or create an account on a new platform you will need to file an update to Form ADV, just as you would if you created a new website.

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DLA Piper Takes a Look at Compliance

DLA Piper conducted its first compliance survey. I assume they reached out to some subset of the law firm’s clients seeking responses to the 34 questions. The answers came from not just the biggest companies. Although 38% of the companies had more than 5,000 employees, 20% had 100 or fewer. The companies were split 60/40 public private.

There is a bunch of stuff packed into the responses. I’m not sure I found anything new or surprising about the answers.

I did look at the four biggest compliance risks according to the survey:

  • Increased regulatory risk
  • Cybersecurity
  • Data breaches, data privacy
  • Regulatory risk

compliance risks

Okay, so maybe those are really just the two risks worded in two different ways.

Compliance is worried about cybersecurity which means avoiding date breaches and keeping data private. Regulators and hackers have made them worried about not taking the right approach. The survey does not say which worries compliance more.

Regulatory risk is the other big concern. Government regulators continue to pile on regulations. Compliance professionals and their firms are having a hard time figuring out how the new regulations apply and how to best attempt compliance.

You can read the entire compliance survey: CCOs Under Scrutiny (.pdf)

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How Good Is Your Business Continuity and Transition Plan?

The Securities and Exchange Commission had indicated that it was going to tackle operational issues at investment advisers. It just released a proposed rule on business continuity and transition plans for registered investment advisers. The proposed rule would require SEC-registered investment advisers to have written business continuity and transition plans reasonably designed to address operational and other risks related to a significant disruption in the investment adviser’s operations.

SEC Seal 2

First some stats. According to the release:

“[T]here are approximately 12,000 investment advisers registered with the Commission that collectively manage over $67 trillion in assets, an increase of over 140% in the past 10 years.” – Based on data from IARD as of 1/4/2016

The SEC is proposing a new Rule 206(4)-4 that makes it unlawful for registered investment advisers to provide investment advice unless it has a written business continuity plan and transition plan that is reviewed at least annually.

The easy one is business continuity planning requirement. That requirement was tucked into the release for Rule 206(4)-7. It should not come as a surprise to fund managers and investment advisers that they should have a continuity plan. The SEC has found many BCPs are inconsistent and lacking robustness across those 12,000 advisers.

The SEC is requiring that a BCP have at least the following elements:

  • maintenance of critical operations and systems, and the protection, backup, and recovery of data
  • pre-arranged alternate physical location(s) of the adviser’s office(s) and/or employees;
  • communications with clients, employees, service providers, and regulators;
  • identification and assessment of third-party services critical to the operation of the adviser.

The transition plan is a bit trickier and much more vague. Frankly, in my opinion, I don’t think the two should be included in the same rule.

The transition plan covers a broad swath of possibilities. The pool of registered investment advisers is very broad, from small retail investment advisers, large financial services companies and private fund managers. The SEC alludes to the “resolution plans” in Dodd-Frank, a/k/a the living wills.

These are the five elements the SEC is looking for in the transition plan:

  1. policies and procedures intended to safeguard, transfer and/or distribute client assets during transition;
  2. policies and procedures facilitating the prompt generation of any client-specific information necessary to transition each client account;
  3. information regarding the corporate governance structure of the adviser;
  4. the identification of any material financial resources available to the adviser; and
  5. an assessment of the applicable law and contractual obligations governing the adviser and its clients, including pooled investment vehicles, implicated by the adviser’s transition.

I think the transition plan is very important for a small retail adviser that is reliant on a single person. I think it’s a bit tougher to see how this would work for a medium-sized or larger private fund manager that is not reliant on a single person or a few people to safeguard and manage the fund assets.

Hopefully, the SEC will carve out the transition plan to a separate rule for a longer and more thoughtful rule-making process.

The business continuity part of the rule is no-brainer. Frankly it’s long over due to have been elevated from a paragraph in s rule release to a its own rule.

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Compliance Lawyers and Legal Education

I had an interesting discussion on the possible role of law schools in helping train law students for jobs in the compliance field. Compliance does not require a law degree, but there seems to be a demand for compliance professionals with legal degrees in the mid and higher levels, particularly in highly regulated industries.

legal education law school

Part of the discussion was about compliance as a distinct discipline. There seemed to be little disagreement about. There were differing viewpoints about the nature of discipline and the profession. That seems normal because there are differing requirements depending on the field and the role within a particular organization.

Can law students be taught compliance? The answer, in part, depends on an approach to teaching the law.

When I was a law student, the basic approach was case law. We studied appellate case decisions. These were instances where something went wrong, someone was angry enough to bring a case, fought it out in court and then appealed the decision. To me, that seems the opposite of compliance. That teaches you how to deal with a situation and argue the positions after the bad thing happened. Compliance is about preventing the bad thing from happening.

Several people mentioned that they had gotten letters to supplement their compliance credentials. I got my IACCP®. Others mentioned CCEP and other credentialed designations.

There is a demand for something beyond or different than a legal degree to grow a compliance professional. There is a potential role there for law schools.  I know that Seton Hall has certification programs in compliance for healthcare.

I also note that several law school are involved with the Compliance Certification Board Accrediting Program:

 Charlotte School of Law, Charlotte, NC

 Cleveland Marshall College of Law, Cleveland, OH

 Cumberland School of Law – Samford University, Birmingham, AL

 DePaul University College of Law, Chicago, IL

 George Washington University, Washington DC

 Mitchell Hamline School of Law, St. Paul, MN

 Widener University Delaware Law School, Wilmington, DE

I would guess that more law schools are looking at compliance as way to add value to the legal education. The classic role of placing graduating law students into the big law firms is a shrinking market. I heard that one law school has gone from placing 70% of its graduates into the biggest law firms to only 30%, while at the same time shrinking class size and maintaining its rankings.

UC Irvine Law School
By Mathieu Marquer
CC BY SA