Do You Need to Know Enforcement Cases for Compliance?

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Are you familiar with SEC investigations pertaining to the following companies?

  1. Aladdin Capital
  2. Diamondback Capital
  3. Liquidnet
  4. Paradigm Capital
  5. SAC Capital
  6. Galleon Capital

I admit that I only recognized SAC Capital and Galleon Capital. In a recent survey about half of alternative investment managers said that they were also familiar with those two cases. Half said they were not familiar with any of them.

Private Equity International pointed out this survey by Cipperman Compliance Services. Cipperman cited unfamiliarity with the cases as a indicator of adequate resources to address increased regulatory obligations.

I scratched my head a bit to figure out if I missed the cases or merely didn’t link the substance of the case with the firm name.

I searched the Compliance Building website to see if had mentioned the four cases.

It turns out that I wrote about Paradigm Capital in June 2014. The substance of the case was a whistleblower claim by a trader against his firm, Paradigm Capital. The firm was engaged in some principal trades that were violating 206(3)-2. The trader reported the problem to the SEC and the firm handled it poorly.

I also wrote about the Aladdin case in December 2012. It involved a false claim by the fund manager that its principals were investing in the fund alongside investors. I don’t remember the case being particularly remarkable. They were lying to investors.

Diamondback Capital was linked to SAC Capital and was allegedly involved in insider trading. The firm settled by paying a fine and entering into a non-prosecution agreement. The firm ultimately returned investor’s capital and dissolved. This was one of the expert network abuse cases. I remember the expert network investigations and still get questions from investors about the use of expert networks. I remember the issue, but not the case.

Liquidnet is a dark pool high speed trading case. The exchange settled the charges that it allowed outside traders to have access to the trading inside the dark pool. It’s an interesting look into the complex world of high-speed trading and dark pools. I don’t remember the case.

Circling back to the original question, I’m not sure knowing the case name is particularly necessary to understand compliance concerns. I find cases to be instructive on what is found to be bad acts. That’s why I write about them.

Yes, it’s a good thing for compliance officers to read the SEC’s enforcement actions. But I don’t think you need to be quizzed on cases.

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Combining Immigration Fraud and Investment Fraud

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The EB-5 Immigrant Investor Program sounds like a scam so I’m not surprised to see it pop up in actual scams. The EB-5 program provides foreign investors who can demonstrate that their investments are creating jobs in this country with an expedited path to lawful permanent residency in the United States. EB-5 is not common with real estate investors because construction does not provide the permanent jobs required by the program. (The exception is hotels.)

The Securities and Exchange Commission brought charges against Justin Moongyu, Rebecca Taewon Lee and Thomas Edward Kent for combining an EB-5 program with an investment scam. The three raised $11.5 million for investment in a Ulysses, Kansas ethanol production plant. According to the SEC complaint the three were promoting a positive investment return coupled with a path to legal residency in the United States.

The SEC alleges that the three diverted over $7 million of the investor’s money to unrelated projects and personal use. The plant was never built.

As you might expect, the SEC complaint spends a chunk of the pleading showing that the fraud involves securities. The SEC states a case that (1) there was investment of money, (2) there was a common enterprise, and (3) profits were to be derived from the efforts of others.

Although it’s not clear from the case filings, I assume the investors not only lost their money, but also lost their path to citizenship.

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By: Ingfbruno

 

Compliance Bricks and Mortar for September 5

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

Fantasy Football: A Real and Present Danger to the Workplace? by Daniel Schwartz in Connecticut Employment Law Blog

So to answer my own question in the title: No, fantasy football is not a critical threat to your business. But sometimes, fantasy football can be used support a claim of harassment or discrimination.

Fantasy football, despite its name, is a real industry and those companies that treat it as mere child’s play, do so at their own risk.

Pro Football and the FCPA Professor by Tom Fox in the FCPA Compliance and Ethics Blog

In football players certainly want to play hard but face penalties for playing too aggressively. I would add that sometimes there are grey areas in the rules that can get players into trouble. Moreover, just as each football team will have its own risk tolerance, businesses will as well. The Professor states, “The same is true for FCPA compliance. Business organizations, particularly those accountable to shareholders to increase value, should aggressively compete in the global marketplace to gain a competitive edge over competitors. Yet the practical reality is that much of what happens in the global marketplace can also fall into a gray area given the FCPA’s provisions, which have frequently been found to be vague and ambiguous when subjected to judicial scrutiny.

For Hedge Fund Whistleblower, Waiting Was the Hardest Part by Lillian Rizzo in WSJ.com’s Risk and Compliance Journal

When Frank Harrison decided in 2009 to go to the Federal Bureau of Investigation with allegations of fraud at hedge fund New Stream Capital LLC, he wasn’t prepared for one of the most nerve-wrecking aspects of being an informant—a long wait with little inkling of action being taken

The FBI’s Interesting Endgame with Michael Lucarelli by Bruce Carton in Compliance Week

Based on his trading patterns related to other client information, the FBI anticipated that Lucarelli might trade based on the Trex information. Indeed, a few days after the search, Lucarelli did purchase shares of Trex, and allegedly made nearly $90,000 in illegal profits when he sold the stock after the public disclosure of Trex’s improved sales and income caused its stock price to increase nearly 15%.

The SEC Brings Another Case Centered on the EB-5 Immigration Program by Thomas O. Gorman in SEC Actions

The government’s EB-5 program is supposed to be a win win for everyone. For immigrants seeking admission to the United States it is supposed to provide a path to citizenship if the requirements, centered on the investment of $500,000 or more in select projects, are met. For the U.S. it is a job creation mechanism since the investments from those seeking admission under the program, administered by the United States Citizenship and Immigration Service, are supposed to be used to create jobs in this country. Unfortunately the program is now at the center of yet another SEC enforcement action and a parallel criminal case. SEC v. Lee, Civil Action No. 2:14-cv-06865 (C.D. Cal. Filed September 3, 2014).

What Does Delaware’s Wal-Mart Decision Mean for the Attorney-Client Privilege and Internal Investigations? by Chip Phinney in Mintz Levin’s Securities Litigation and Compliance

In some respects the Wal-Mart decision is disconcerting for corporate counsel. It suggests that counsel conducting internal investigations of allegations of corporate wrongdoing should bear in mind the possibility that someday their privileged communications, which they assume to be confidential, may be subject to review by a shareholder plaintiff’s counsel seeking grounds to sue the corporation’s directors and officers. But the Walmart case involved unusual circumstances and should not be read as opening privileged communications by corporate counsel to widespread discovery in most shareholder litigation.

Failing to Disclose Fees

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The Securities and Exchange Commission has been focused on fees charged by investment advisers and fund managers. The latest target is Robare Group Ltd. based in Houston. The SEC alleges that the firm was receiving a fee from certain investments made for its clients but failed to properly disclose that it was receiving the fee.

According to the SEC order, an unnamed broker agreed to pay the Robare Group a fee for client funds invested in funds sold by the broker. There is nothing inherently wrong with that arrangement. However, it should be disclosed to clients. The concern is that the adviser would direct clients to invest in those funds because it is good for the adviser, not necessarily because it is good for the client.

One interesting thing about the alleged violation is that the SEC is not stating any harm to Robare Group’s clients or even that the clients were invested in the fund for a disproportionate amount. The SEC is focused solely on a violation for failure to disclose. The disclosures were not adequate because they said the Robare Group “may” receive compensation from the broker for selling the mutual funds, when it was definitely receiving payments, the SEC said. In my opinion, that’s a very thin distinction to make.

The interesting thing about the press release for the alleged violation is the statement that the SEC’s asset management unit has enforcement initiative focused on undisclosed compensation arrangements between investment advisers and brokers. This is sounds like a similar effort focused on undisclosed compensation to private equity fund managers from portfolio companies.

 

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How Does the SEC Use Form PF in Adviser Exams?

Form PF

You slave over Form PF trying to get the information demanded by the Securities and Exchange Commission. What happens to that data?

The Dodd-Frank Wall Street Reform and Consumer Protection Act Section 404 directed the SEC to establish reporting requirements for investment advisers to private funds as necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk by the Financial Stability Oversight Council. Form PF was the result of Section 404. That section of Dodd-Frank also requires the SEC to submit an annual report to Congress on how the SEC is using the data.

According to the latest annual report, the SEC uses Form PF data in its examination and enforcement programs.

Prior to an examination of a private fund adviser that files Form PF, OCIE staff generally reviews the adviser’s Form PF filing as a part of a routine pre-examination evaluation. This review, in conjunction with other data sources, provides OCIE staff with an understanding of the nature of an adviser’s business and investment strategy.

I did not find this to be the case. The Form PF data is locked away from OCIE and examiners need permission to access the data. At least that was the case in the Boston office six months ago.

It’s good that potentially sensitive data is hard to access. That was supposed to be the case with Form PF data. Examiners are already deep into a fund manager’s business operations do the Form PF data would not likely contain any secrets that the examiners are not already looking at.

The examiners will compare the Form PF data to what shows up in due diligence reports, pitch books, offering documents, operating agreements and books and records. Exam staff will look for discrepancies between an adviser’s Form PF filing and any publicly-available documents related to the adviser, including Form ADV.

According to the report, the SEC is collecting Form PF data on 21,542 funds. Of those, 2,888 are large private equity fund advisers (over $2 billion in RAUM) of a pool of 7,004 private equity funds. There are 1,397 real estate funds reporting with $354 billion in RAUM.

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Weekend Reading: Capital

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In Capital in the Twenty-First Century, Thomas Piketty argues that if the rate of return on capital is persistently greater than the rate of economic growth this will cause wealth inequality to increase in the future. The theory is that wealth accumulated in the past grows more rapidly than output and wages.

It’s a great macroeconomics book, rich with data and insight. But it’s still about macroeconomics. So it’s not going to keep you up late into the night turning pages to see what happens.

I came to the book with some base beliefs. I think inequality is a good thing. I believe you should be able to elevate your wealth through hard work and education. That’s the American Dream. (Conversely, I believe your wealth should decrease through a lack of hard work and a lack of education.)

Measurements of inequality are imperfect because the distribution of the have and have-nots changes over time. If you look at the Forbes 400 ranking of the wealthiest Americans from 1987 to 2013, there is a great deal of turnover. New wealth moves up and old wealth is lost through heavy spending, large-scale philanthropy, and bad investing. Only 35 people from the original 1982 list remained on it in 2013. Piketty blows up this belief.

I believe there are two problems with wealth inequality. Obviously too much of a good thing is bad thing. We should not live in a world of lords and peasants. Too much inequality is a problem. Moderate inequality should give you an incentive to strive for more. Stark inequality could lead to a violent political reaction.

The bigger problem with inequality is when the boundaries become impermeable, leaving a person unable to move up on the scale on wealth. Through hard work and education you should be able in increase your wealth. If wealth inequality becomes too extreme that mobility disappears.

There are two elements to wealth: income and capital. Trends in income are relatively easy to obtain data. Income tax filings provide a wealth of information for researchers. Capital is harder to work with because the measurements are bit less reliable.

That has been the sources of some controversy. The Financial Times looked at different data sources and came to a different position on the disparity. Piketty has made his data available: http://piketty.pse.ens.fr/en/capital21c2. He admits that the data is imperfect and incomplete. He is not trying to prove mathematical certainties, but create social science research for open debate.

Piketty’s central thesis is that we should be concerned when the concentration of capital attains extremely high levels and that we are heading towards that concentration. The western countries were approaching high levels of concentration at the beginning of the 20th Century. WWI and WWII annihilated millions of lives. The wars also destroyed accumulated wealth, crushing the accumulated inequality.

Piketty’s data indicates that in the decades since end of WWII wealth is once again concentrating. In the United States the upper decile’s share of the national income increased from 20 to 35 percent in the 1970s to 45-50 percent in the 2000s.

The data is is incomplete because there is no regular accounting of wealth on a regular basis as there is for income with income tax filings. One of the reasons Piketty proposes a tax on capital is so that wealth can be tracked.

A tax on capital is not that unusual. Most people in the United States are already subject to one: real estate property taxes. The government regularly reviews the value of real estate and levies a tax based on the value.

Obviously, a tax on securities and cash is much, much harder to implement since those forms of capital can move so easily and quickly across borders. That means a tax on capital would have to be implemented uniformly across international borders.

One interesting aspect of Piketty’s book is that so many have started reading it but not finished. As I said above, it’s a best selling macroeconomics book, but it’ still a macroeconomics book. An analysis of Amazon Kindle users found that just 2.4% of readers highlighted passages beyond the 26th page, with the Wall Street Journal proclaiming it the summer’s “Most Unread Book.” I

The first 250 pages are background and macroeconomic analysis that builds his case for the second half of the book. It’s this second half where all of his interesting ideas and analysis occur.

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Compliance Bricks and Mortar for August 22

 

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

Ebola tragedy is also a story of graft by Richard L. Cassin in the FCPA Blog

One reason the fatality rate is so high — up to 90% in some regions, according to WHO — is because intensive care facilities are needed to administer treatments but are “rare in west Africa.”

Although an estimated $3 trillion is spent worldwide on heath services every year, WHO said the money “is a powerful magnet for corruption.”

How Do I Respond to a Wells Notice? in The Securities Law Blog

There is no legal requirement for a regulator to provide a Wells Notice to you, however it is the practice of the SEC and FINRA to provide such notice. Procedurally, the SEC and the FINRA Staff (the people you are dealing with during the investigation) do not have the authority to commence proceedings. They need to obtain approval to commence proceedings. The approval process is handled without any input from the prospective defendant.

Dodd-Frank Anti-Retaliation Provisions Do Not Protect Overseas Whistleblowers by Kevin LaCroix in the D&O Diary

However, based on a recent Second Circuit decision, prospective foreign whistleblowers thinking about making a whistleblower report had better be prepared to watch out for themselves, as according to the appellate court’s August 14, 2014 decision in Liu Meng-Lin v. Siemens AG (here), the Dodd-Frank Act’s whistleblower anti-retaliation protections do not apply extraterritorially — that is, they do not protect whistleblowers outside the U.S. This ruling obviously could dampen the interest of prospective foreign tipsters from making whistleblower reports.

 

Compliance, Ethics and The Godfather by Adam Turteltaub in the SCCE’s Compliance and Ethics Blog

But one line from the film stands out above the rest because it’s the line that is probably the most oft-recited in business, and the line that has often permeated people’s thinking: “It’s not personal. It’s just business.” For the record, the actual line is “It’s not personal, Sonny. It’s strictly business.”

This line gets used a lot in jest, but also when people are discussing business decisions. And there’s a great deal of risk there, starting with the presumption that because Michael Corleone said it in The Godfather it’s somehow a valid rule of business. As seductive as his character is, let’s not forget that he ran a criminal syndicate, which is not a business likely to win awards for its ethics and citizenship. Last I looked, they didn’t have a compliance and ethics program that met the standards in the Federal Sentencing Guidelines.

SEC’s Municipal Advisor Exam Initiative

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The Securities and Exchange Commission announced a new examination initiative directed at newly regulated municipal advisors. The examinations are designed to establish a “presence” with the newly regulated municipal advisors.

We’ve seen this blueprint before. It looks a lot like the presence exam initiative for newly registered private fund managers and the never before examined initiative for unexamined advisers. The SEC is trying to knock on as many doors as they can.

The SEC is working with the Municipal Securities Rulemaking Board (MSRB) and the Financial Industry Regulatory Authority (FINRA) to facilitate a coordinated approach to oversight of municipal advisors. SEC’s OCIE will examine municipal advisors for compliance with applicable SEC rules and applicable final MSRB rules once the MSRB rules are approved by the SEC and become effective.

Section 975 of Dodd-Frank added a new requirement that “municipal advisers” register with the SEC. Municipal Advisor is defined in 15 U.S.C. 78o-4(e)(4)(E)(4) as:

(A) means a person (who is not a municipal entity or an employee of a municipal entity) that—

(i) provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues; or

(ii) undertakes a solicitation of a municipal entity;

(B) includes financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and swap advisors, if such persons are described in any of clauses (i) through (iii) 5 of subparagraph (A); and

(C) does not include a broker, dealer, or municipal securities dealer serving as an underwriter (as defined in section 77b(a)(11) of this title), any investment adviser registered under the Investment Advisers Act of 1940 [15 U.S.C. 80b–1 et seq.], or persons associated with such investment advisers who are providing investment advice, any commodity trading advisor registered under the Commodity Exchange Act [7 U.S.C. 1 et seq.] or persons associated with a commodity trading advisor who are providing advice related to swaps, attorneys offering legal advice or providing services that are of a traditional legal nature, or engineers providing engineering advice;

Starting later this year, OCIE in coordination with FINRA and the MSRB will hold a Compliance Outreach Program for newly regulated municipal advisors where they will learn more about the examination process and their obligations under the Dodd-Frank Wall Street Reform and Consumer Protection Act and related rules.

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Another Tale of Golf Course Stock Tips Ending Up in a Sand Trap of Insider Trading

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The Securities and Exchange Commission brought another insider trading case where the tips were allegedly traded on the golf course.

“Country clubs or similar venues may give people a false sense of security that leads them to think they can get away with trading on unlawful stock tips,” said Paul G. Levenson, director of the SEC’s Boston Regional Office. “But as in any social setting, people who trade securities based on confidential information they receive are taking a huge risk that their illegal tipping and trading will be identified by the SEC.”

Robert Bray triggered the FINRA warning lights with a large order of a thinly traded stock. According to an SEC complaint, Bray placed an order for 25,000 shares in Wainwright Bank & Trust Company. That was several days worth of volume in that stock. He started his buying spree on June 14. It several days to accumulate that much stock for his order.

On June 28 Wainwright announced that it was going to be acquired by Eastern Bank for a share price almost double what Bray had paid. That put almost $300,000 of profit in his pocket when the acquisition closed on November 18.

Of course that kind of excessive trading close to a transaction is going to trigger a FINRA inquiry. Bray’s name was on a list of 30 individuals who purchased Wainwright stock during the pre-announcement period. That list was circulated to employees at Eastern Bank for them to disclose if they knew anyone on the list.

According to the SEC, J. Patrick O’Neill, a Senior Vice President at Eastern Bank did not respond to the initial request. O’Neill also did not respond to the second request. Then he called in sick. Finally, he met with his supervisor who demanded that O’Neill respond or be subject to employment-related discipline. O’Neill resigned the next day. He also transferred title on his house to his wife that same day.

Now the SEC had a trader in one hand and in the other hand had an employee with access to the inside information who was acting suspiciously. The SEC just needed to find the link. O’Neill had the information but did not trade. Bray had the trading profits but no direct connection or confidential obligation to the inside information.

The SEC found the connection at the country club. Both O’Neill and Bray were members of the same local county club. The SEC also found a tiny business arrangement between Bray and O’Neill’s son.

That is all the SEC had to build its case. When questioned about his relationship with Bray, O’Neill pleaded the fifth and didn’t answer the SEC questions during his testimony. Bray did the same when he was questioned by the SEC. Apparently that really annoyed the SEC because they forwarded the case on to the Justice Department who brought criminal charges against O’Neill.

Once again, the cliche is proven. But it sounds like the SEC will have a hard time proving the transfer of information from O’Neill to Bray.

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