Category: Compliance Programs

Compliance and St. Patrick’s Day

My office is next door to Boston’s famous Irish pub, The Black Rose. It’s hard to ignore the celebrations, with patrons going in for a pint, while I’m going into my office. So I had to find a compliance angle.

BLACK ROSE AND COMPLIANCE

One of the miracles attributed to St. Patrick as part of his sainthood was driving all the snakes out of Ireland. Legend has it that St. Patrick chased all the snakes into the ocean after snakes attacked him during a 40-day fast.

St. Patrick gets credit for the absence of a problem. No snakes, no problem.

Compliance often works in celebrating the absence of a problem. Employees are not caught doing bad things so compliance is working. Employees sit through compliance training, sign certifications, get subjected to email review. So compliance must be working. It’s a miracle!

The problem with the legend of St. Patrick is that there is no evidence that snakes were ever in Ireland. He is credited with for fixing a problem that never existing.

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Compliance Pie

Sometimes I’ve heard that the reward for a job is like winning a pie eating contest and finding out the prize is a pie. Is compliance like a pie eating contest?

pie pi

It seems to me that compliance only continues to get more complex and demanding. Companies will continue to do bad things. Legislators and regulators will continue to respond to those bad things by enacting new statutes and new regulations.

As compliance has become more of an accepted department within a company, more duties are being pushed to compliance. Regulators push more duties to compliance. The reward for a job well done is more of the job.

Nobody thinks that compliance is “as easy a pie.” It’s more like making a pie, rather than the much easier and enjoyable act of eating a pie.  You start with a recipe. Of course, your recipe may be different than another pie maker. You may have a different list of ingredients; you may have a different preparation method; you may have a different cooking method. Pie is never simple and is never easy to make.

Since it’s March 14 (3/14) I had to include a reference to pi today.

Image of the Pi Pumpkin Pie is by Paul Smith CC BY

Adviser is Fined For Shortchanging Himself on Fees

Anyone in compliance and anyone running a fund knows that the Securities and Exchange Commission is laser-focused on fees being charged to investors. Marco Investment Management got it wrong and was subject to an order by the SEC. But, the firm actually short-changed itself.

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Marco’s advisory agreements with its clients called for a fee to be paid based on the “market value of all gross assets.” Some of these clients also had margin accounts. Investment proceeds were supposed to be used to repay margin loans. However, Marco believed that some of his clients wanted the proceeds to be reinvested. Marco charged a fee on the proceeds in the accounts.

The margin accounts also caused some time delays in calculating the asset value since Marco deducted the value before the liquidation was complete. That meant Marco undercharged for fees.

Given these problems, it should not be a surprise that the SEC found that Marco was mis-stating its assets under management in its Form ADV filings.

The net result of the over-charging and under-charging was a net negative to Marco according to the firm’s letter to its investor.

Even though Marco did not profit from its mistakes, it still made a mistake in calculating fees. This case shoes that the SEC expects advisory firms to be exacting when charging fees to its clients

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Dodd Frank and Industry Consolidation

Enhancing regulations is meant to protect consumers. The side effect is often to protect the large incumbent firms and make it more difficult for smaller firms to thrive. This theory is proving true under Dodd-Frank.

Dodd-Frank-Act

A study by Marshall Lux and Robert Greene on community banks found that since Dodd-Frank community banks have lost market share, especially small community banks.

The top 5 largest banks also lost market share.

Community banks have also suffered a significant decline in assets while the large banks have grown. Again the five biggest banks also suffered a smaller decline in assets.

However, the five biggest banks had an increase in commercial banking, while the other banks suffered declines and the community banks suffered declines.

For private equity firms, the data is unclear.

Marc Wyatt looked at the size of the funds being marketed and noted a decrease in size. He concluded that the cost of SEC registration and regulation is not stifling the formation of smaller managers. Perhaps he missed this comment from Prequin:

The stumbling block, however, has been the number of managers able to hold a final close, with this being at the lowest level since 2010. It is evident that the private equity fundraising market is still in a state of bifurcation. The largest, brand-name managers are receiving the majority of investor commitments, with smaller managers – particularly first-time funds – finding it difficult to raise capital.

This would seem to support my opening statement. Regulation is generally better for incumbent firms. Bigger firms can absorb the regulatory overhead, with the hurdle being bigger for smaller and start-up firms.

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Compliance Across Industries

One of the puzzling aspects of compliance is that it means vastly different things across industries. What compliance means to a bank is very different from what compliance means to a drilling company.

Folder with the label Compliance

I think the reasons are obvious: regulatory requirements.

In a highly regulated industry, there will be a greater focus on complying the regulatory mandate. A broker-dealer compliance officer is going to be focused primarily on the FINRA rules for broker dealers. An investment adviser compliance officer is going to be focused on compliance with its regulatory scheme. A drilling company is going to be focused on a different set of rules.

I see the difference in the junk mail I receive each day. I get flyers on FCPA compliance, OSHA compliance, Clean Water Act compliance… Someone is clearly checking the compliance box without thought to the substance behind it.

Most compliance as a discipline starts with the Department of Justice’s Sentencing Guidelines. That is a good base framework. But in regulated industries, the regulations go into much more detail about what needs to be done. It’s not about right or wrong, but what the government says you have to do.

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Compliance and the Super Bowl Victory

Defense wins championships.

It’s an old sport cliche. However, the Denver Broncos proved it last night in the Super Bowl. The Orange Crush neutralized the NFL’s MVP, Cam Newton. Peyton Manning rounded off his career, landing win 200. Mr. Manning still has the most playoff losses of any quarterback. Of course that is because he has been to the playoffs so many times.

broncos

As with football, defense wins compliance.

It’s what you prevent that counts, not what you catch. The number one goal of compliance is to convince your employees to not even think of doing something wrong. A catch means that the employee did something wrong. Your compliance was good enough to see the violation, just not good enough to prevent it from happening in the first place.

That means measuring the effectiveness of compliance is hard. With the best compliance, nothing happens, so there is nothing to measure. If you measure a decrease in catches, that could be because the compliance is better or it could mean your detection is worse.

You could argue the same bias in football. The league MVP and college’s Heisman trophy are disproportionately awarded to quarterbacks and running backs. It was refreshing to see Von Miller, a defensive player, win the Super Bowl MVP.

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Happy Start to Your Compliance New Year

I hope you were able to enjoy the long weekend. Perhaps an extra long weekend if you found December 31 to be an optional work day. Today is obviously not the first day of the new year, but it is the first day of work in the new year.

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With the new year, come the resolutions to do things differently this year, to do better, to meet goals.

That all starts with setting goals and expectations. There is no magic to choosing the beginning of January, as opposed to any other month.

Except you will write the wrong year at least three times today.

We often get to stages in our life where we want change. Maybe today is that day for you. Maybe you have already written “2015” three times today.

Here in Boston, today means that winter has arrived. After a flirtatious light snow, the cold has come and wrapped me in its icy grip.

But I already went for a bike ride in the cold and went to the gym. So I’m still on track for some personal goals.

When it comes to compliance, there are many tasks we need to address. It’s time to get at least one done today and stay on track.

Enjoy 2016.

Looking Ahead – Five Compliance Predictions for 2016

With my 2015 almost gone, I was thinking about what to expect in 2016 in the private fund and real estate fund compliance area. My crystal ball is not very reliable. If it was fully operational, I would have bought Apple stock in 2002 before the iPod came out.

Hand drawing New Year concept with white chalk on blackboard. Going ahead to year 2016 and leaving the year 2015 behind.

Real Estate Fund Enforcement Actions

There was a focused review of real estate fund advisors that wrapped up about a year ago. Given how enforcement actions work through the SEC, I expect the enforcement actions from the bad apples will come out in 2016. One area he noted was problematic was when a fund manager claimed to providing services at market rate, but had no evidence that the rate used was actually market rate. I had the chance to ask a member of the private funds unit if we could expect these actions. The response was a strict “no comment.”

Succession Planning

Several speeches coming from the SEC have pointed to certain operational risks becoming part of the compliance mandate. The SEC staff is developing recommendations to help advisers assess and plan for the impact on investors when an investment adviser is no longer able to serve its clients. For most fund managers, investors already cast a wary eye on firms that don’t have succession plans in place. The SEC is going to stick its thumb into this tricky area. This will be an area that compliance will loath as they have to talk to their firms’ principals about death and disability.

Fees and Expenses

This area is a continuing area of focus for private fund exams. I expect more enforcement actions will come out in 2016. I’m sure there will be new types and approaches that will require firms to react to the SEC’s interpretation of what is fair.

Anti-Money Laundering

If you are opposed to anti-money laundering requirements then you will get labeled as pro-terrorism. FinCEN will come out with new regulations imposing anti-money laundering requirements on investment advisors and fund managers.

Employees, Consultants and Expenses

I suspect we will see more cases brought by the SEC against firms that are dedicating employees to portfolio companies and charging those expenses to investors instead of the management company.

 

The Compliance of the Winter Solstice

The winter solstice marks the longest night and shortest day of the year with the latest dawn and the sun at its lowest point in the sky. Its the shortest day of the year. But that is not entirely true and we see a problem of scope, bias, and definition.

solsitice

The solstice happens at the same instant for all of us, everywhere on Earth. This year the solstice occurs on Tuesday December 22nd at 04:49 GMT (Universal time).

The first problem with my opening paragraph is bias. It’s not winter for everyone. In the Southern Hemisphere its summer. Explorers in the Antarctic are enjoying long, long hours of sunlight.

The second problem is using a singular time to define something else. The December Solstice marks a single point in time. The longest day or night may fall on either side of the event time.

It’s not true that it’s the earliest sunset and latest sunrise of the year. Earth’s orbit is not round so sunsets have already begun to be later in the North Hemisphere.

What does this have to do with compliance?

Are you describing things accurately in your program? Sometimes you need to rethink the description to make things work and meet your obligations.

It also means that the we are coming out to of the darkness. Hopefully you will have some time to celebrate the end of the year and the longer daytime hours. At least if you are North of the Equator.

Jedi Training and Compliance Training

As I was gently caressing my tickets for tonight’s early premier of Star War: The Force Awakens, another compliance thought came to mind. The Star Wars saga shows three examples of Jedi training. One of which falls far short of the compliance standard.

yoda

We see glimpses of the younglings training at the Jedi Temple. That was the standard method at the time, giving their plastic young minds the right message from early on. We don’t know how well the training went because Anakin slaughtered them in Episode III.

In Episode V, we see Yoda’s training of Luke in the swamps of Dagobah. That seems to work, even though the training seem incomplete. At the end of Episode VI, Luke is tempted by the Emperor to come to the Dark Side. Doing so will save his friends. Luke is tempted, but does not cross the line.

We see Obi-Wan Kenobi’s training of Anakin Skywalker in Episodes II and III. Young Anakin was already too old for the Jedi Council’s standards, but they relented to Obi Wan’s plea to take Anakin under his wing.

He is beloved as a character, but Obi Wan falls short in compliance training.

He pushed the Jedi Council to break its rules and allow Anakin to begin training. As we see in Episode III, he was too old and had become too attached to his mother.

The one key to Jedi training is to avoid the Dark Side. Obi-Wan failed to see the signs and put Anakin into remedial training.  Anakin is tempted to the Dark Side and crosses the line.

The key goal to compliance training is teaching employees where the line of good and bad is and to stay away from the line. The employee may perform well or not, but you don’t want the employee to cross the line to the dark side.

Obi Wan was lured by the prospect that Anakin was supposed to be the “chosen one,” restoring balance to the Force. He broke the rules to get him into Jedi training. He overlooked Anakin’s shortcomings and misteps because he thought he was the “chosen one.”  In the end, the training failures lead to the destruction of the Jedi, the rise of the Galactic Empire and the loss of millions of lives.