Massachusetts Adopts Crowdfunding

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Add Massachusetts to the growing list of states that are sidestepping the unusable federal crowdfunding alternative.

“The Crowdfunding Exemption is designed to foster job creation by helping small and early-stage Massachusetts companies find investors and gain greater access to capital with fewer restrictions. The exemption is also intended to provide necessary investor protections by requiring key disclosures, and by making the exemption unavailable to bad actors that have violated the securities laws or committed financial fraud.”

The federal crowdfunding provisions in the Jumpstart Our Business Startups Act of 2012 was supposed to be a panacea for crowdfunding. But the final language of the law was amended at the last minute. The Securities and Exchange Commission was vocally opposed to it, but issued proposed regulations in October 2013 to implement the exemption. The SEC received about 300 written comments to the proposed regulations, but there is no sign that the final regulations will come out any time soon. The Federal crowdfunding regime will not be effective until the SEC issues those regulations. Even then, the regime is likely to be unwieldy.

A May 1, 2014 Wall Street Journal article, entitled “Frustration Rises Over Crowdfunding Rules,” describes efforts in the U.S. Congress to amend the JOBS Act even before the federal regime takes effect. However, many states have decided that crowdfunding is worth trying and are not waiting for the SEC.

The new Massachusetts crowdfunding regime is limited to $1 million a year, which can be increased to $2 million with audited financial statements. The company must set a fundraising minimum and must keep funds in escrow at a Massachusetts bank until it reaches the target.

The investment amount limitations are a bit messy. For those with net worth and income of less than $100,000, an investment is limited to the greater of $2000 or 5% of annual income or net worth. For the wealthier, it can go up to 10% of income or net worth. The Massachusetts regulation looks to the SEC accredited investor standard for calculating those amounts (i.e. exclude the home).

There is a limitation on form. The business must be formed under Massachusetts law, have its principal place of business in Massachusetts and authorized to do business in Massachusetts. It’s too bad the regime excludes the Delaware formed organizations from crowdfunding. That limits future growth of the company. Bigger money investors will want a Delaware entity for the certainty under the Delaware corporate laws for protection of their shareholder rights.

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Preparation for SEC Examinations

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Ascendent Compliance put together a presentation on Preparation for SEC Examinations.

Last year the SEC examined 9% of advisers which represent 25% of the RAUM. Of those exams, 87% had deficiencies, 25% had significant findings, and 14% were referred to enforcement.

The SEC has implemented a new telephone assessment for offsite remote exams. The examiners do not end up in your office. Unless they find something that catches their attention.

The Never Before Examined Initiative is continuing for advisers registered before 2012.

The Presence Exam Initiative may be winding down. The SEC is still continuing its lengthy routine exams.

“Enhancing Risk Monitoring and Regulatory Safeguards for the Asset Management Industry” speech by SEC Chair Mary Jo White on December 11, 2014 talks about new rule makings and possible wide reaching changes.

In the SEC Report on Objectives 2015 from the Office of Investor Advocate recommends investment advisers being examined every three years and longer than five years without a comprehensive exam.

OCIE is continuing to develop technology to help them with exams to identify fraud, manipulation, and compliance failures. If they have new tools, it’s likely that they will be using them in the exam process.

Based on the 2015 initiatives, the SEC will focus on issues affecting investors’ retirement accounts, including marketing practices and recommendations. There will likely be a focus on placing assets in a firm’s sponsored investment vehicle.

What’s New with the OCIE Document Request Lists?

  • Longer exam period for information – 2 years
  • New questions
  • Slide deck presentation on the firm, affiliated entities and services
  • List of all committees, including description, meeting frequency, membership, and keeping of written minutes
  • Summary of valuation process
  • All emails form particular individuals over a period of time

2015 Examination Initiatives

Based on the 2015 initiatives, the SEC will focus on issues affecting investors’ retirement accounts, including marketing practices and recommendations. There will likely be a focus on placing assets in a firm’s sponsored investment vehicle. OCIE announced three broad areas of priority for 2015:

Retail Investors – Retail investors are being offered products and services that were formerly characterized as alternative or institutional, including private funds, illiquid investments, and structured products.  Additionally, financial services firms are offering a broad array of information, advice, products, and services to help retail investors plan for and live in retirement. OCIE will assess risks to retail investors that can arise from these trends.

Market-Wide Risks – OCIE will examine for structural risks and trends that involve multiple firms or entire industries, including: monitoring large broker-dealers and asset managers in coordination with the SEC’s policy divisions, conducting annual examinations of clearing agencies as required by the Dodd-Frank Act, assessing cybersecurity controls across a range of industry participants, and examining broker-dealers’ compliance with best execution duties in routing equity order flow.

Data Analytics – Over the last several years, OCIE has made significant enhancements that enable exam staff to analyze large amounts of data efficiently and effectively. OCIE will use these capabilities to focus on registrants and registered representatives that appear to be potentially engaged in illegal activity.

First Impressions

  • Set a tone of cooperativeness
  • Set a tone of compliance
  • Let them know that you thought about the issues ahead of time

Exam Plan

  • What do you do after you get the call from the examiner
  • Organization of materials
  • FOIA Protection
  • Role of consultant
  • Role of counsel
  • Prepare key personnel for interviews

Improving Your Next Exam

  • Fix deficiencies from prior exam
  • Respond to deficiencies from current exam
  • Set up a training plan to fix problems
  • Implement testing and documentation

Weekend Riding – Facing the Cold

That’s me, bundled up for my first bike ride of 2015 on Saturday. I was going to ride first thing in the morning, but shied away when I saw a 9 degree reading on the thermometer. I waited for the balmy afternoon temperature of 22 degrees before enduring a 15 mile ride.

Why ride?

first ride of 2015

I’m riding the 2015 Pan-Mass Challenge this summer to raise money for the Dana-Farber Cancer Institute. (Click here to make a donation of any amount.) I would appreciate your financial support.

pmc-text-stacked

Compliance Bricks and Mortar for January 16

black and white bricks

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

RBS Loses Senior Compliance Staff, Some Poached by HSBC by Margot Patrick And Rachel Louise Ensign in the Wall Street Journal

The departures come as RBS, 80%-owned by the British government, faces a potential multibillion-dollar settlement with the Federal Housing Finance Agency over mortgage-backed debt it sold to Freddie Mac and Fannie Mae before the 2008 financial crisis.

Say Hello to the SEC’s Digital Currency Working Group (.pdf) by Marco Santori and Jeffrey Jacobi from Pillsbury

Now that enforcement agencies have determined that digital currencies are more than a passing fad, they are establishing more permanent efforts focused on the novel legal issues digital currencies present. The SEC’s formation of its multi-office Digital Currency Working Group may foreshadow an increase in the agency’s exercise of regulatory authority over entities offering interests in Bitcoin and other digital currencies

Justice Department Files First FCPA Case of 2015, Reminds Lawyers to Watch Out by David Smyth in Cady Bar The Door

Last week, the Justice Department filed the first FCPA case of 2015 when it indicted Dmitrij Harder, the former owner and president the Chestnut Consulting Group in Huntingdon Valley, Pa…

The case is interesting to me for at least four reasons. First, the European Bank for Reconstruction and Development is based in the United Kingdom, not a high-risk country for corruption issues. Second, the case doesn’t involve third party sales agents, as so many FCPA cases tend to do in one way or another. Instead, if the indictment is to be believed, here we have a company president’s single-minded determination to pay some bribes to win business, one way or the other. Third, the case invokes the “public international organization” facet of the foreign official element to establish jurisdiction over the conduct at issue. Doesn’t happen very often!

SEC Enforcement – An Analysis of Key Developments in 2014 by Bruce Carton in Compliance Week

In a webcast I moderated yesterday, a panel consisting of four former senior SEC enforcement attorneys and accountants–including former SEC Enforcement Director Bill McLucas of law firm WilmerHale–analyzed the most important developments in SEC enforcement from 2014, and looked ahead at what they expect in 2015.

Black & White Bricks is by Mike

SEC Exam Priorities for 2015

SEC National Exam Program

In 2013 the Office of Compliance Inspections and Examinations at the Securities Exchange Commission laid out their examination priorities for 2013 and did so again last year with its 2014 Examination Priorities. OCIE just released its Examination Priorities for 2015.

One item jumps out for a focus for private funds:

Fees and Expenses in Private Equity. Given the high rate of deficiencies that we have observed among advisers to private equity funds in connection with fees and expenses, we will continue to conduct examinations in this area.

Given the resources focused on this last year, it’s no surprise that this remains an initiative for the national exam program.

What is surprising is how different the priorities look from last year’s release. It is much more sparse and focused than in the past.

OCIE announced three broad areas of priority:

Retail Investors – Retail investors are being offered products and services that were formerly characterized as alternative or institutional, including private funds, illiquid investments, and structured products.  Additionally, financial services firms are offering a broad array of information, advice, products, and services to help retail investors plan for and live in retirement. OCIE will assess risks to retail investors that can arise from these trends.

Market-Wide Risks – OCIE will examine for structural risks and trends that involve multiple firms or entire industries, including: monitoring large broker-dealers and asset managers in coordination with the SEC’s policy divisions, conducting annual examinations of clearing agencies as required by the Dodd-Frank Act, assessing cybersecurity controls across a range of industry participants, and examining broker-dealers’ compliance with best execution duties in routing equity order flow.

Data Analytics – Over the last several years, OCIE has made significant enhancements that enable exam staff to analyze large amounts of data efficiently and effectively. OCIE will use these capabilities to focus on registrants and registered representatives that appear to be potentially engaged in illegal activity.

 

 

Sources:

Private Equity Funds and Broker-Dealer Registration

Broker concept.

There was a lots of hand-wringing after a speech by David Blass indicated that the SEC was focusing on transaction based fees that private equity funds were earning on securities transactions. Since then, there has been rumblings during presence exams, but no official enforcement action or ruling from the SEC.

One group of fees at issue was compensation paid to the fundraising team. If your sales team was paid a commission on fund commitments, it raised an issue of broker/dealer registration for the employee. The second group was the fund or fund manager receiving fees for arranging debt or equity for a portfolio company. This raised broker/dealer issues for the fund manager.

Gretchen Morgenson wrote a story in the New York Times that was focused on the hiring of an independent adviser to monitor a private equity fund’s practices. That oversight was triggered by an SEC exam in April 2013, according to the story.

Although the monitoring aspect is interesting, I also found the trigger events to be more interesting. The firm was “reaping fees from investment-banking-type transactions without fulfilling the regulatory requirement of being registered as a broker-dealer.” This seems to be evidence that the SEC is (or was) looking at this issue during private fund exams.

But, the story also notes that the firm was failing to share those fees with the funds as apparently required by the fund documents. So that leaves it unclear if the SEC was continuing to focus on broker/dealer registration or was merely noting a violation of fee calculations. (Not that violating fee calculations is okay.)

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Cheating In Ethics Class

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Is this the worst ethics teacher?

64 Dartmouth Students Charged With Cheating In Ethics Class

According to the story, attendance in religion professor Randall Balmer’s “Sports, Ethics and Religion” was measured using handheld devices known as “clickers.” In late October, some students passed their clickers to fellow classmates. Those classmates then used the clickers to answer questions which made it appear as though they were present in class.

The ethics course was originally intended to help student-athletes. In its second year, the class grew to more than 280 students. Attendance and cheating became a problem.

Balmer discovered the problem when he noticed a discrepancy in the number of student responses to in-class questions using handheld clickers and the number of students in the classroom on Oct. 30, 2014. Balmer presented both a hard copy version and a clicker version of certain questions, and noted that 43 students did not respond to the paper version of the questions but did respond using clickers.

Obviously the students are at fault for breaking the school’s honor code. Clearly, professor Balmer did not make an impression on his students’ ethics during the first few classes. They felt they could cheat and still get a good grade.

Sources:

Compliance Bricks and Mortar for January 9

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

Majority of RIAs should move under state regulation: Study by Mark Schoeff Jr. in InvestmentNews

Shifting oversight of more registered investment advisers from the Securities and Exchange Commission to states would increase exam coverage at less cost than establishing third-party reviewers, a new report asserts. A study by the compliance firm RIA in a Box calls for advisers with less than $500 million in assets under management to transition to state regulation, a move that would involve about 7,250 of the approximately 11,400 investment advisers currently registered with the SEC.

D&O Insurance: No Coverage for Enforcement Action Because Claim First Made When SEC Subpoena Served Before Policy Inception by Kevin LaCroix in The D&O Diary

A recurring D&O insurance coverage issue involves the question of whether or not a subpoena constitutes a claim, as I have noted on prior posts (for example, here). When this issue comes up, the dispute is usually over whether or not there is coverage under the policy for the costs of responding to the subpoena and ensuing costs. But there are other implications if a subpoena is a claim, as was demonstrated in a January 6, 2015 decision (here) by District of Massachusetts Judge Rya Zobel.

SEC Use of Administrative Proceedings Challenged Again by Thomas O. Gorman in SEC Actions

Bebo v SEC, Case No. 15-cv-00003 (E.D. Wis. Filed Jan. 2, 2015) is another suit challenging the decision to bring an action as an administrative proceeding rather than in Federal District Court. The underlying administrative proceeding named as Respondents Laurie Bebo and John Buono, respectively, the CEO and CFO of Assisted Living Concepts, Inc. In the Matter of Laurie Bebo and John Buono, Adm. Proc. File No. 3-16293 (December 3, 2014). The firm is a publicly-traded assisting living and senior residence firm based in Wisconsin. The Order, which alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)B) and 13(b)-5, centers on claimed false disclosures in the SEC filings of the company. Those filings represented Assisted Living was in full compliance with a lease for certain properties when in fact the Respondents had falsified certain occupancy data to deceive the lessee into believing that the company was in compliance, according to the Order.

The Bebo complaint alleges due process and equal protection violations, a violation of the right to a jury trial and presents a separation of powers issue.

SEC Fights ‘Pre-taliation’ Against Dodd-Frank Whistleblowers by Bruce Carton in Compliance Week

According to whistleblower lawyer Erika Kelton, companies that fear Dodd-Frank whistleblower programs are aggressively trying to squash potential tips to the SEC through a practice the agency has dubbed “pre-taliation.”
Kelton, a partner at law firm Phillips & Cohen LLP who recently helped one of her clients obtain the largest SEC whistleblower reward ever ($30 million), says that companies are attempting to intimidate employees from coming forward as whistleblowers in the first place by requiring employees to enter into confidentiality agreements, separation agreements and other employment agreements that may prevent or deter employees from doing so…
Image of bricks is by Peter Alfred Hess
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