I read about a new red flag in the Securities and Exchange Commission’s exam process for investment advisers. Examiners are looking for Chief Compliance Officers with web-based email addresses. So, if your CCO uses a gmail, or yahoo.com email address on your Form ADV filing, the SEC will treat that as a red flag.
This comes from a story in IA Watch. According to the story, a senior person in the SEC’s Office of Compliance Inspections and Examinations mentioned the email address as part of the red flags for cybersecurity sweeps.
I would guess the alternate address for a contact on the Form ADV is subject to this same red flag.
Personally, I’m not sure I completely understand why this is a red flag. Some of the web-based email are just as secure as firm-run email server. For smaller shops, it may be even more secure. I feel certain that Gmail has better tech than a small IA shop.
I can see the web-based email as indicator of an outsourced CCO. Of course, the Form ADV now requires a firm to flag that it has an outsourced CCO. Perhaps it’s a red flag to see web-based email and not state that the firm has outsourced CCO. I can also see searches of “compliance” in the email address as another way to potentially find firms that did not state their CCO role was outsourced.
It was a brutal year for the cyclists in this year’s edition of the Tour de France. It’s always a brutal three weeks of racing, but teamwork helps separate the winners from the rest. Geraint Thomas came across the finish line in Paris as the first winner from Wales. His teammate and favorite to win, Chris Froome came in third. Tom Dumoulin came in second place which is the position he finished in earlier this year in the Giro d’Italia.
The big suffering came in the group of the fast men competing for stage wins and the green jersey competition during the Tour de France. Mark Cavendish, Andre Greipel, Fernando Gaviria, Dylan Groenewegen, and Marcel Kittel never made it to Paris. Peter Sagan had a huge margin of victory in the green jersey competition, but a crash on stage 17 descending the Col de Val Louron-Azet in excess of 40 mph left him battered and bruised.
I would give the award for the most suffering to the American Lawson Craddock. He crashed hard on the first day and fractured his scapula. He finished riding that day and got on his bike every day to reach the streets of Paris. He used his suffering for good, raising money for his favorite charity, by asking donors to pledge money for each day he continued to ride.
It’s teamwork that gets the riders to the finish line. Geraint Thomas had Team Sky pacing him up the mountains for as long as they could, burying themselves to give the yellow jersey as much help as possible, then leaving him to finish strong over his rivals.
The team mechanics have the bikes in perfect condition. When a flat occurs or a crash happens, the mechanics quickly jump to help and get the rider back into the race.
The team chefs get needed nutrition into the cyclists for the brutal three weeks. Just keeping calories in your body and recharging your body for another day on the bike is a huge task.
Compliance is the same way. The lone cyclist on the road is unlikely to achieve success. It takes a team to be successful. Not just a team of compliance personnel, but a multi-disciplinary team across the whole organization.
One failing of the Tour de France is not having a female equivalent. That didn’t stop Donnons des elles au Velo Jour-1 from riding the entire route of the Tour de France. J-1 are a group of high-level amateurs riding the day before. There is a short La Course for professional racers. But it was just a single day of racing on a much shorter route than the men. It’s time to change this.
I realize that only a handful of you have likely read this far. The venn diagram between cycling and compliance is very small. (Hello Tom!)
Like Lawson Craddock, I too will be biking for charity. I’m riding across Massachusetts to raise money in the fight against cancer. I’m only riding 300 miles over 3 days, compared to the 2,082 miles in the Tour de France. Donations can be made here: http://profile.pmc.org/DC0176
Alain Lille, CEO of Petronian Industries is not happy with the new government. He wants to protect his investment in the country of Petronia. His oil firm deployed a great deal of capital looking for oil in Petronia and had a contract with the government for production. A roadblock appeared in last year’s election. The new president was elected, in part, beacuse of her promise of a of a better deal for the people. She wants to make sure this newfound wealth provides the best benefits to the country.
Mr. Lille fears she will reopen negotiations hurting revenue for his company and possibly revenues for the country. The new president invited foreign “experts” to advise her.
If you’re still looking for Petronia on the map, you can stop. It’s a fictional country in a new online game created by the Natural Resource Governance Institute: https://petronia.games/. This thinktank wants to improve the management of oil, gas and mineral wealth in developing countries.
As a player in Petronia, you take on the role of that pesky foreign adviser.
One of the 2018 exam priorities for the Securities and Exchange Commission is “matters of importance to retail investors.” The SEC has found many problems with advisers selling their clients higher cost share classes of mutual funds that paid the adviser a fee.
It’s not that a registered investment adviser can’t take that 12b-1 fee. But it has to be fully disclosed to the clients.
The SEC found that many respondent investment advisers disclosed that they “may” receive 12b-1 fees from the sale of mutual fund shares and that 12b-1 fees “may” create a conflict of interest. However, the investment advisers failed to disclose that they had a conflict of interest because the funds offered a variety of share classes, including some that paid 12b-1 fees and others that did not for eligible clients, and failed to disclose that they were, in fact, receiving 12b-1 fees due to the mutual fund shares they bought for or recommended to their clients.
The SEC has found this to be such a widespread problem that it launched the Share Class Selection Disclosure Initiative. Under the SCSD Initiative the SEC’s Division of Enforcement will recommend favorable settlement terms for investment advisers that self-report possible securities law violations relating to their failure to make necessary disclosures concerning mutual fund share class selection.
If the adviser self-reported, it would have to disgorge the fees plus interest, enter into a cease and desist, enter into an undertaking to fix disclosure documents. But the SEC will not impose a penalty for advisers that self-report
For additional information regarding the adequacy of mutual fund share class selection disclosures see the following:
PwC released the results of its latest State of Compliance survey. In this seventh iteration, PwC polled 825 risk and compliance executives worldwide about their organizations’ compliance polices and procedures, training, monitoring and technology.
Only 17% said they are very satisfied with the effectiveness of their compliance programs. Another 45% said they were somewhat satisfied.
Personally, I don’t find that result interesting. The survey covers a large swath of organizations across different industries, different sizes, different geographies and different risks. Only a few firms, if any, are like mine and only a few, if any, are like yours.
What I found most interesting is what PwC gathered about the compliance programs at the 17% of the firms that were satisfied with the effectiveness of their compliance programs. PwC identified four ways those 17% do things differently:
Invest in tech-enabled infrastructure to support a modern, data-driven compliance function
Increase compliance-monitoring effectiveness through analytics and the use of technology
Streamline policy management to increase responsiveness and boost policy and procedure effectiveness
Take advantage of information and technology to provide targeted, engaging and up-to-date compliance training
Given that three of these four factors are technology driven, I would guess that these are focused on larger organizations that need technology to deal with larger flows of information and data than a small or mid-sized firm.
I would also guess that dashboard and data to show compliance functions helps assure that the organization is being effective.
I’ve argued in the past that determining effectiveness is hard because you are try to prove that the absence proves the point. If compliance program is 100% effective, there will be no reporting events. Of course the problem is that the lack of reportable events is either because there were none, or you were just unable to discover them.
My nay-saying aside, it’s clear that having data leads to better compliance. Good technology tools to help extract and interpret that data are incredibly helpful to compliance programs. This survey proves the point.
With the statutory changes from Dodd-Frank, the Securities and Exchange Commission started gathering basic information about private fund managers and their funds on Form ADV.
The SEC increased that information flow by requiring Form PF. Unlike Form ADV, Form PF provides detailed information about the private fund’s activities and performance. That left many reluctant to release this information.
Apparently many managers followed through on this reluctance. According to a story in IA Watch, the SEC is matching up Form ADV Filings for private funds and identifying the lack of filing in Form PF.
You need a private fund identification number for the private fund in Form ADV. That makes it easy to search through the Form PF database for those filings or lack thereof. Someone in data analytics at the SEC decided to do just that.
That has resulted in at least a few dozen firms getting a letter from the SEC explaining why they didn’t file Form PF.
I understand why some firms may have had confusion over how to identify their funds on Form PF. Those definitions are problematic. But I have not run into anyone saying that they didn’t have to file.
The SEC brought action against WCAS Management which runs the Welsh, Carson, Anderson & Stowe private equity funds.
According to the order, WCAS entered into an agreement with an unidentified group purchasing organization. That organization aggregates companies’ spending to obtain volume discounts from participating vendors. Presumably this would save money for the portfolio companies owned by the private equity funds.
Under the agreement with the Group Purchasing Organization, it paid compensation to WCAS based on a share of the fees the GPO received from vendors as a result of the WCAS portfolio companies’ purchases through the GPO.
That is extra income coming to WCAS indirectly from the portfolio companies. WCAS could have prorated the fee and sent it back to the portfolio companies. But it didn’t.
WCAS could keep the fee income if that was the deal with investors. The SEC claims that WCAS did not disclose the agreement, the fee income it generated and the conflicts of interest associated with the agreement. The fee earned by WCAS was $623,035.
The administrative order fails to point out whether the net savings to portfolio companies was more or less than that fee paid to WCAS. If the savings was less, then that looks bad for WCAS. WCAS is better off and the portfolio companies are wore off.
If the savings was greater, then I’m not sure I would hear the investors complaining. They were coming out ahead on a net basis. Yes, WCAS was getting additional income. But the portfolio companies would be paying less on a net basis.
But WCAS was also coming out ahead without disclosing the additional income stream. That was the problem.
Shocking mostly because the issues are mostly mechanical procedural errors that were contrary to the investment advisory agreement:
Using a different valuation method (cost versus fair value)
Using the market value at the end of the billing cycle instead of an average value
billing monthly instead of quarterly
billing in advance instead of in arrears
These are obvious mistakes, but not necessarily adverse to the client.
Others deficiencies did lead to increase costs to investors:
Failure to prorate for a partial billing cycle
Applying a higher rate
Charging additional fees
Charging more that the agreed to maximum rate
failing to aggregate client accounts for members of the same household which would have qualified the accounts for a discounted fee
Although the Risk Alert is focused on retail investment advisers, private funds do not get by unscathed.
OCIE staff has observed advisers to private and registered funds that misallocated expenses to the funds. For example, staff observed advisers that allocated distribution and marketing expenses, regulatory filing fees, and travel expenses to clients instead of the adviser, in contravention of the applicable advisory agreements, operating agreements, or other disclosures.
Each of those big buckets is separated into further classifications.
I found the name “separately managed accounts” to be confusing because it sounds a lot like the insurance term “separate accounts.”
I heard a lot of uncertainty on how to treat a fund of one. It could be a pooled investment vehicle. Or it could be a separately managed account. I have not heard anything to help draw the line. The best advice I’ve heard is to just be consistent. If you treat the fund of one operationally like you treat your other funds, then label it that way on the Form ADV. If you treat it operationally like you treat your separately managed accounts, then label it that way on the Form ADV.
For real estate managers, it sounds like they have some investment vehicles that are not private funds. Some of this discussion goes back to the 2012 thoughts on whether to register with the SEC or not. A straight real estate investment with a couple of investors with major action consent sounds like it falls out of the “private fund” definition. That real estate investment does not have securities, so it should fall outside the definition of an investment company. Even if it were so treated, it would be entitled to the 3(c)5 exemption. That would keep it outside the “private fund” definition.
BMW issued a voluntary recall of all BMW i3 electric cars ever sold in the U.S. and has sent a stop-sale order to its U.S. dealers for any new or used i3 vehicles. There have only been 30,000 sold. That’s not very many, but it’s all of them. The reason is a “compliance issue” with federal regulators over a failed National Highway Traffic Safety Administration crash test.
Compliance issue caught my attention in connection with its electric car. (I don’t drive a BMW and think the i3 is a weird looking car.)
“While BMW’s compliance testing showed results well below the required limits, more recent testing has shown inconsistent results. Consequently, BMW has issued a recall and is working with the agency to understand the differences in the test results.”
This is not a Volkswagen fake-testing issue. The company saw slightly different results than the government tests.
The test failures are very specific. The tests resulted in a marginally higher neck load on 5% of the population. That 5% is adult females who are around five feet tall and weigh about 110 pounds. The failure also only applies to someone sitting in the driver’s seat and not wearing a seatbelt.
Being in New England, I’m reminded that “Live Free or Die” New Hampshire is the only state that does not mandate seat belt use. In every other state there is a law requiring seat belt use.
To protect petite women who live in New Hampshire, BMW has to recall all of the i3 cars. It’s a tough penalty for getting the company’s crash results wrong.
Of course, the answer would seem to be: “Wear a seatbelt.”
That leaves me with a libertarian conundrum. Impose a regulation requiring seatbelt use? or impose a regulation requiring additional design cost so that people don’t have to wear seat belts?
