Category: Compliance Programs

New Workplace Posters – EEO is the Law

EEO Law

Starting November 21, 2009, you need a new workplace poster: EEO is the Law.pdf-icon

There are two new federal workplace laws the Genetic Information Non-Discrimination Act and the ADA Amendments Act. Federal law requires all employers covered by the federal anti-discrimination laws (those with 15 or more employees) to post multilingual notices describing the federal laws against job discrimination.

If you want a fresh poster you can use print out and use the “EEO is the Law“pdf-icon poster. If you already have a EEO poster, you can just add the “EEO is the Law” Poster Supplement.pdf-icon

References:

Criticism and Praise

drunkards walk

Do criticism and praise work to affect performance?

Leonard Mlodinow briefly addressed this topic in The Drunkard’s Walk: How Randomness Rules Our Lives. He explores the studies of Daniel Kahneman who was lecturing the Israeli air force flight instructors on behavior modification. Kahneman was trying to make the point that rewarding positive behavior works, but punishing mistakes does not.

One of the students called him out. He had praised people warmly for beautifully executed maneuvers and the next time they do worse. He screamed at people for badly executed maneuvers and they improve the next time. The other flight instructors agreed. But Kahneman’s research demonstrated that rewards worked better than punishment.

So what was going on?

Regression toward the mean. In a random series of events, an extraordinary event is most likely to followed by an ordinary one. Due purely to chance, it’s hard to have two extraordinary events in a row.

The fighter pilots have a certain level of ability. An extraordinarily good performance is most likely to be followed by an ordinary performance. So the praise would seem to fail to maintain the extraordinarily good performance. Similarly, an extremely bad performance is most likely to be followed by an ordinary performance, which in this case would be better than the bad performance. So the screaming criticism would seem to cause an improvement in performance.

So it appears that the criticism does some good and the praise does no good. What is really happening is a misconception of uncertainty and probabilities. The connection between actions and results is not as direct as we might think.

In compliance, we eschew lots of data. It’s good to step back every now and then to think about the implications of the data and the underlying assumptions.

Trust and Financial Regulation

colombo

Ronald J. Colombo of Hofstra University School of Law wrote a great paper on The Role of Trust in Financial Regulation.

Trust is an important part of our financial markets. Scandals, massive incompetence, massive irresponsibility, massive fraud, have shaken trust in the financial markets. Commentators, policy makers, and industry leaders have all recognized the need for trust’s restoration.

Consistent with financial scandals in the past, the public officials are looking for increased regulation to restore trust in the markets. The last round of financial scandals in the Enron-WorldCom era brought us Sarbanes-Oxley.

Professor Colombo thinks the advocates for increased regulation have it half right.

“A critical set of questions should be considered. Can regulation serve to bolster and repair relationships dependent upon trust? And in the absence of trust, can regulation serve as an effective substitute to trust? In short, are there limits to the ability of regulation to resuscitate an economy that has suffocated due to lack of trust?

Conversely, can regulation work to “crowd out” trust, effectively transforming relationships that once were close and trustworthy to arm’s length and legalistic? Could regulation serve to displace relationships of trust with transactions subject merely to the “morals of the marketplace”?”

The Role of Trust in Financial Regulation applies trust scholarship to examine the current U.S. financial regulatory regime and some of the proposed reforms. I focused on a few sections.

Private Offering Regulation

In addressing the difference in treatment between the regulation of public offerings and private offerings, Mr. Colombo thinks the difference can be justified on grounds relating to the issue of trust.

A private offering is more like a personal contract between the issuer and the investor, free of public advertising. Also, a private offering is more likely to have a pre-existing relationship. “Interpersonal relationships and communications are conducive to such trust, and such relationships and communications are often found among the parties to a private offering.”

He concludes that the current regulation of private offering strikes the correct balance from a trust-favoring perspective.

Regulation of Investment Advisers

I found it interesting that Mr. Colombo spends some time focused on the 15 client rule exemption from registration. He finds that much of the investment adviser regulation has developed a heavy band of regulation that “can crowd out trust in a relationship, converting expectations and behavior based upon honor and integrity to those based on the letter of the law.”

Investment advisers with a small number of clients can have “closer, more personal and more lasting relationships with their small number of clients than those advisers with a much larger client base.” The small adviser exemption from regulation when you have fewer than 15 clients facilitates the trust aspect.

The Private Fund Investment Advisers Registration Act, just approved by the House Financial Services Committee, eliminates this exemption.

Hedge Funds

From a trust perspective, Mr. Colombo thinks the lack of hedge fund regulation seems sensible. As with the world of investment advisers, the hedge fund industry is marked by repeat players. Frequent and historical interactions among the parties can “lay the foundation for affective and generalized trust to develop.” After all, the original legislative intent of the U.S. securities laws was to protect the layperson, unfamiliar with the financial markets, with sophisticated investors fending for themselves. Give the high financial thresholds for investment in private funds, the investors are either sophisticated or have easy access to sophisticated investment advice.

Regulatory Reforms

Mr. Colombo does not seem to like the removal of the small adviser exemption from investment adviser regulation. For larger advisers, the increased disclosure and reporting requirements may be a good things.

As for hedge funds he thinks that hedge funds currently operating successfully on the basis of trust, with little regulation, have little to benefit their investors by registering with the SEC  and submitting themselves to the regulatory oversight. However, for funds that have not been able to develop that trust, voluntarily registering and submitting themselves to the regulatory oversight could help develop that trust. (I’m skeptical that investors think SEC registration carries any value in the world of private funds.)

The paper concludes that the existing financial regulatory regimes do a pretty good job with our understanding of trust. Greater regulation is imposed upon those sectors of the financial services industry where such regulation is trust enhancing, and lesser regulation is imposed upon those sectors where such regulation is trust defeating.

“In those areas where high quality trust relationships exists (or have the greatest potential to exist), we have, relatively speaking, the lowest levels of regulation: private offerings, investment advisers, and hedge funds. In those areas where only lower quality trust relationships are likely to exist (that is, relationships of cognitive and specific trust), we witness the highest levels of regulation: public offerings, secondary market trading, and banking.”

He also points out the more important areas of the capital markets are more heavily regulated. After all, we cannot wait to see if trust can be developed if the failure will lead to a systemic breakdown. The turbulence after the Lehman collapse was in part caused by the lack of trust. Nobody was sure if they could trust the stated financial stability of their counterparty.

References:

Colombo, Ronald J., Trust and Financial Regulation (October 1, 2009). Villanova Law Review, Forthcoming; Hofstra Univ. Legal Studies Research Paper No. 09-22. Available at SSRN: http://ssrn.com/abstract=1481327

Some other references from The Role of Trust in Financial Regulation:

Windex and Compliance

Katie Liljenquist

People are more fair and more generous when they are in clean-smelling environments, according to a soon-to-be published study: The Smell of Virtue.

The experiment had participants engage in several tasks, the only difference being that some worked in unscented rooms, while others worked in rooms freshly spritzed with citrus-scented Windex.

The first experiment was a test of whether clean scents would enhance reciprocity. Participants received $12 of real money. They had to decide how much of it to either keep or return to their partners who had trusted them to divide it fairly. Subjects in clean-scented rooms returned a significantly higher share of the money. The average amount of cash given back by the participants in the unscented room was $2.81. But the participants in the Windex room gave back an average of $5.33.

The second experiment evaluated whether scents would encourage charitable behavior. Test participants indicated their interest in volunteering with a campus organization for a Habitat for Humanity service project and their interest in donating funds to the cause. Participants surveyed in a Windex room were significantly more interested in volunteering (4.21 on a 7-point scale) than those in a normal room (3.29). In the Windex room, 22% participants said they’d like to donate money, compared to only 6% of those in a unscented room.

Follow-up questions confirmed that participants didn’t notice the scent in the room.

The results are consistent with the “broken windows” theory of crime that argues disrepair in the environment promotes lawless behavior.

Katie Liljenquist, assistant professor of organizational leadership at BYU’s Marriott School of Management, is the lead author on the piece in an upcoming issue of Psychological Science, with co-authors are Chen-Bo Zhong of the University of Toronto’s Rotman School of Management and Adam Galinsky of the Kellogg School of Management at Northwestern University.

References:

Thanks to Mary Abraham of Above and Beyond KM for pointing out this study.

Compliance and Solitaire

solitaire

Compare playing solitaire on your computer against using a deck of cards to play solitaire. The computer won’t let you cheat. You can’t put the card on a stack if it doesn’t belong on that stack. The rules are embedded in game’s software.

Ultimately, that should be one of the goals for compliance. You want the business rules to be embedded in the software applications that run your business processes.

Of course, for many things that is really hard to do. The rules of solitaire are simple. The rules for compliance are often not. (Maybe that means you need to simplify some of your rules.)

Richard Susskind, author of The End of Lawyers?: Rethinking the Nature of Legal Services, uses this concept in explaining the future evolution of legal services. I found it equally useful when thinking about embedding compliance into business processes.

What do you think?

FINRA Is Thinking About Changing Its Communications Rules

finra_logo

Financial Industry Regulatory Authority (FINRA) posted a regulatory notice  on proposed new rules governing member communications with the public: Regulatory Notice 09-55.pdf-icon

The new rules would replace current NASD Rules 2210 and 2211, the Interpretive Materials that follow NASD Rule 2210, and portions of Incorporated NYSE Rule 472.

The proposal would replace the existing six categories of communication with three new communications categories and revises certain approval, filing and content requirements. These changes make the rules easier, but seem to make it harder for FINRA members to participate in social media. I am surprised that FINRA did not try to squarely address the use of the popular internet and web 2.0 tools.

Communications Categories

Currently NASD Rule 2210 divides communication into six separate categories:

  1. advertisement
  2. sales literature
  3. correspondence
  4. institutional sales material
  5. independently prepared reprint
  6. public appearance.

The principal approval, filing and content standards apply differently to each category.

FINRA is proposing to consolidate those six categories into the following three:

  1. institutional communication, which would include communications that fall under the current definition of “institutional sales material,”
  2. retail communication, which would include any written communication that is distributed or made available to more than 25 retail investors
  3. correspondence, which would include any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors

Communications that currently qualify as advertisements and sales literature generally would fall in the proposed retail communication.

Approval Requirements

The proposed rule changes would require an appropriately qualified registered principal of the firm to approve each retail communication before the earlier of its use or filing with FINRA.

Filing Requirements for New Firms.

FINRA rules currently require a firm that has previously not filed advertisements with FINRA to file its initial advertisement with FINRA at least 10 business days prior to use, and continue the practice for one year after the initial filing. The proposed rule would require filing of all retail communications  (the new category), rather than just advertisements. The proposal would have the one-year filing requirement beginning on the effective date a firm becomes registered with FINRA, rather than on the date an advertisement is first filed with FINRA.

Pre-Use Filing Requirement.

The proposal would expand the current pre-use filing requirements so that communications concerning any registered investment company that includes self-created rankings, and retail communications that include bond mutual fund volatility ratings would have to be filed with FINRA at least 10 business days prior to first use and withheld from use until changes specified by FINRA staff have been made. The proposal would expand the filing requirements for materials relating to closed-end investment companies to include retail communications distributed after the fund’s initial public offering.

Press Releases

The proposal eliminates a current filing exclusion for press releases that are made available only to members of the media. Most firms post press releases on their Web sites, making them available to the general public.

Content Standards

The Proposal reorganizes, but largely incorporates, the current content standards applicable to communications with the public. Content standards that currently apply to advertisements and sales literature generally would apply to retail communications.

Public Appearances

Public appearances would have to meet the general “fair and balanced” standards and the standards applicable to recommendations
if the public appearance included a recommendation of a security. If you recommend securities in public appearances generally you would be subject to the same disclosure requirements under proposed FINRA Rule 2210(f) as research analysts that recommend securities in public appearances pursuant to NASD Rule 2711(h). The proposal requires firms to establish appropriate written policies and procedures to supervise public appearances, andmakes clear that scripts, slides, handouts or other written and electronicmaterials used in connection with public appearances are considered communications with the public for purposes of proposed FINRA Rule 2210.

The comment period for the proposed rules ends November 20.

References:

The CFO’s and CCO’s Role in Fundraising

PERE Real Estate CFOs Forum

Yesterday, I attended the PERE Real Estate CFOs Forum. These are my notes from this session:

  • Moderator: Steve Felix, Head of Client Relations-Real Estate, Aviva Investors
  • Ira Bergstein, Principal & CFO, Palisades Financial, LLC
  • Jack Foster, Head of Real Estate, Franklin Templeton Real Estate Advisors
  • Asha Richards, Vice President & General Counsel for the Private Equity Funds Group, Brookfield Asset Management Inc.

What is the compliance officer’s role in fund-raising?

Number one is creating a system and process for creating consistent marketing materials and messages to investors. Process and consistency are key. You need to push on the distribution team to be consistent.

What’s changed in fund-raising?

There is a lot of focus on track records and how the firms have dealt with the issues over the last 12 months. There is an increased focus on real estate and investors are paying closer attention to the real estate investments. Part of this is the personal nature of real estate. People inevitably compare their house and the residential real estate markets to the commercial real estate markets.

What’s changed about what investors and potential investors are looking for?

Investors are looking for information to be delivered faster. Investors are looking for projections of distributions, even if they are speculative. Investors are looking for more standardization in the reports.

Managing Private Real Estate Funds – The Changing Role of the CFO and Chief Compliance Officer

PERE Real Estate CFOs Forum

Yesterday, I attended the PERE Real Estate CFOs Forum. These are my notes from this session.

  • Moderator: Gary Koster, Americas Leader- Real Estate Fund Services, Ernst & Young LLP
  • Peter C. Cluff, Principal, Europa Capital LLP
  • Stuart Koenig, Global CFO & Chief Administrative Officer, AREA Property Partners
  • Dominic Petrucci, Chief Financial Officer, Buchanan Street Partners

What are the most demanding issues confronting the CFO role? The panel came up with these:

  • Investor relations
  • Compliance
  • Valuations
  • Liquidity management
  • Debt refinancing

Investor relations is not a new concept, but investors are looking closer at their investments in real estate. Investors want transparency from their investments. There is a need to be proactive instead of reactive and increase disclosure. Investors are being reactive to the financial crisis news. So there were requests for amount of Lehman exposure, Madoff exposure and custody procedures that came out of last year’s crises.

Regulatory compliance is looming in front of the industry. Some of this was a reaction to hedge funds, but the regulatory proposals do not define “hedge funds” and end up putting real estate funds in the splash zone. There is lots of uncertainty on how the regulations are going to affect the business model for private equity real estate funds.

Valuations are an issue because there is so little trading of properties. Tenant rental rates are also greatly in flux. There is increased use of third party appraisals above and beyond the requirements in the fund agreements. The most recent property sales varied widely and offered little help in determining values.

There is some concern that interests are getting out of alignment with more assets getting underwater. Firms need to be aware of the potential conflicts and deal with it head-on. It’s important to emphasize that the general partner sponsors also have money invested and is as much at risk as the investors. The concern is that you might lose good people who are looking for more entrepreneurial opportunities, leaving behind a more asset management focused model. It’s important to keep younger people in the organization because of the valuable lessons they have learned about the commercial real estate market in a downturn.

Debt: The Missing Link

PERE Real Estate CFOs Forum

Yesterday, I attended the PERE Real Estate CFOs Forum. These are my notes from this keynote session by Schecky Schechner, Managing Director, US Head of Real Estate Investment Banking, Barclays Capital.

There is a wave (a wall?) of real estate debt maturities coming due over the next three years.

He started talking about the private markets. There are banks and insurance companies lending to commercial real estate. Lenders are making debt offers are becoming more reasonable. There is less availability over $100 million. Since the valuation of commercial real estate is difficult giving the lack of transactions, lenders are looking more to debt yield. They are basing the amount of the loan on cash flow.

There has been some REMIC relief [See New Rules Ease the Restructuring of CMBS Loans] so that securitized lenders can alter the terms of the loans when there is reasonable likelihood of default. But servicers are somewhat overwhelmed. There are increasing numbers of loans going to special servicing.

TALF is now eligible for CMBS. But there is almost no activity. No deals have priced. There are some questioning whether commercial real estate debt presents a systemic risk

The unsecured debt markets have come back. But this is mostly limited to the public REITs. The credit spread for REIT debt is narrowing form 491bps over 10 Treasury notes earlier this summer to 275bps today.

Mortgage REITs are coming to life. Since June there have been 12 blind pool mortgage REITs filed with the SEC that were looking to raise $5 billion. The cover a spectrum of different business plans. There are some people thinking that the blind pool model may not work. Some think you need to have a partially identified pool of assets. There are also some concerns over the incentive fees put into place. The window seems to be closed right now. The mortgage REITs are using leverage. They are getting REPO facilities and credit lines based on a borrowing base.

The Mezzanine market has lots of money sitting on the sidelines looking for opportunities. But opportunities are scarce.
Subscription lines are scarce. But they are out there. The terms are shorter. There is some concerns that limited partners may be defaulted on their capital calls.

What are the implications for private equity real estate funds?

One is the pretend and extend approach. Lenders and investors are hoping to get through it, with time healing the problems.
Another option is TALF. But access seems limited.

The last and most interesting is the public option. The buy side of the market is looking for internally managed with a focused market approach. You may be able to recapitalize with public equity. The volatility of the public equity market has declined. Mutual fund flows have turned positive. Risk appetite has increased. Public company implied cap rates are trading tighter than their private counterparts.

There is also increased activity in “Make-a-REIT” filings. Sponsors are looking to expand their current portfolio and bulking up the portfolio in connection with the public offering.