The First Days of the UK Bribery Act

It’s a been a few days since the UK’s Bribery Act became effective, making some questionable corporate behavior become clearly illegal. There have been thousands of news stories, legal alerts, and dire warnings about the line in the sand drawn on its date of effectiveness, July 1.

Now, there is a bit a waiting, a calm before the storm, until we hear the first government action. Companies with a UK presence have most likely taken a look at their operations and implemented the changes needed to comply with the new law. (Perhaps that is optimistic.) The SFO now has a loaded gun and is likely on the hunt for behavior that violates the new law.

It took decades before the FCPA became actively enforced. I don’t expect it will take as long to see the first action under the Bribery Act. The SFO has already seen how effective FCPA has been in the United States. (If you consider “effective” to be good headlines and relatively easy wins.)

When will the first action happen? Will it be a government investigation or self-reporting? What industry will be first?

Sources:

Fourth of July and Compliance

What better way to celebrate the independence of the United States than by taking the day off from work, grilling meat, and watching stuff blow up.

In colonial Boston, official proclamations were read from the Old State House balcony, looking down State Street towards Long Wharf.

Each July 4th, the Captain Commanding of the Ancient and Honorable Artillery Company reads the Declaration of Independence from the balcony of the Old State House. The reading of the Declaration of Independence dates back to July 18, 1776, when Colonel Thomas Crafts performed this duty for the first time.

Compliance Bits and Pieces for July 1

These are some compliance-related stories that caught my eye.

Okay, so this first one is not about compliance, but about the Tour de France that starts on Saturday morning for its three week race across France.

Top 10 Reasons Geeks Should Love the Tour de France in Wired’s GeekDad.

Fraud in Commercial Real Estate: Tips & Red Flags on Money Laundering & Terrorist Financings by Keith Mullen in Tough Times for Lenders

In the late 2006, FinCEN issued a study highlighting money laundering trends in the commercial real estate industry. In the information reviewed for this study, the most commonly reported suspected illicit financial activity associated with the commercial real estate sector is money laundering to promote tax evasion. … This should NOT be a surprise: Federal examiners have issued a 439 page manual on this topic. One good way to jump into the topic is to examine Appendix F to the manual, which contains a nice list of red flags for money laundering and terrorist financing. Here are some of the topics covered in the list –

How ‘Bad Boy’ Guarantees Can Make a Non-Recourse Loan Suddenly Become Recourse by Robert A. Silverman in National Real Estate Investor

Recent court decisions should serve as a warning to borrowers to carefully review the wording of recourse carve-out guarantees in both existing and proposed mortgages, lest they be held fully liable for real estate loans. While “non-recourse” loans typically require carve-out guarantees allowing the lender to pursue the guarantor’s assets in instances of “bad-boy” acts — such as waste, funds misapplication, environmental issues and voluntary bankruptcy filings — the precise wording of the guarantees is crucial.

The Bribery Act – Foreign public officials & why you should care who they are

Certain countries will contain many publicly owned businesses. For example, some corporations take the view that there is strong likelihood that local partners in China may constitute a public official. As a result they err on the side of caution and treat all local partners they deal with in that jurisdiction as state owned enterprises and the people they work for as foreign public officials.

5 Things to Know When Merging Compliance and Ethics Programs by John Martin, Bill Hughes and Edward Applegate in Corporate Compliance Insights

Corporate America has tried the stick and is now trying the carrot approach. Why is it so hard to integrate compliance with ethics? Here are five things to consider when attempting to integrate or combine compliance with ethics.

Creating a “Gap” Analysis and Sharing Issues with Management by Michael Portorti in FCPA Complaince and Ethics Blog

The Gap Analysis document can then be used to track status of deficiencies and used as a source to update Executive Management as necessary. It also can expose bottlenecks and identify potential revisions for controls that need additional tailoring to fit in with the Company’s operational environment. Accumulating deficiencies in this manner keeps all parties up-to-date on remediation progress so overall compliance efforts can move along at an acceptable rate.

Insider Trading: A Dirty Business

One of the major tactics of hedge funds is to “arbitrage reality”, operating with a better understanding of a company and its stock price than other participants in the market. In a legitimate operation, that means lots of research. On the wrong side it means getting inside information about a company’s earnings, upcoming deals, and other inside information.

The hedge fund most notably found to be operating on the wrong side was the Galleon Group run by Raj Rajaratnam. On May 11th he was found guilty on all fourteen counts of securities fraud and conspiracy to commit securities fraud. His sentencing is scheduled for July 29th. His appeals will go on for years.

George Packer puts together an insightful look at the Rajaratnam as a lens to explore the difficulties in getting a guilty verdict for insider trading and for prosecutions coming out of the financial crisis in a long article in The New Yorker: A Dirty Business.

I don’t think Rajaratnam’s guilty verdict was a surprise to anyone. Maybe it was a surprise to him and his lawyer. The feds had wiretaps and what appeared to me to be very solid evidence. One of the biggest difficulties is showing the flow of information to show that the trade happened based on material, non-public information. For a company insider or company adviser that is more straightforward than finding that information with a third-party trader. Without the flow of information you can’t show that the use of the information was in breach of a duty.

The death blow in the Rajaratnam trail was Rajat Gupta, a member of the Goldman Sachs’ board of directors. At a board meeting they discussed Warren Buffett’s proposed investment of five billion dollars in Goldman Sachs. The meeting ended at 3:54 P.M. Sixteen seconds later, Gupta called Rajaratnam’s office. At 3:58, just two minutes before the markets closed, Rajaratnam gave an order to buy three hundred and fifty thousand shares of Goldman stock. Fit him for a pinstripe jumpsuit.

Goldman Sachs chairman and chief executive, Lloyd Blankfein was in the witness stand at the Rajaratnam trial. But he was merely there to say that Rajat Gupta had violated the company’s confidentiality rules.

Did insider trading cause the 2008 financial crisis? Did it even play a role?

I’m in the camp with Charles Ferguson, the director of Inside Job, that the financial crisis was caused primarily by shoddy mortgages and trading of those bad loans. But unlike Ferguson, I think the ultimate crisis was caused by greed and stupidity.

The top executives of financial institutions were likely unaware or perhaps willfully ignorant of the low-level players who were originating the toxic mortgages and the packaging of the toxic mortgages into even more toxic mortgage-back securities. Delusion, stupidity and greed are not illegal.

Going back to insider trading, the push for information arbitrage is really a push to the edges of ethical and legal operation. Pushing back from the edge is a person’s morality, their sense of right and wrong. The hammer to that morality is potential prosecution for going past the edge. Packer refers to a 2007 of twenty-five hundred Wall Street professionals.

They were asked if they would use inside information to make ten million dollars if the chances of getting caught were fifty per cent. Seven per cent said yes. But, if there was zero chance of getting caught, fifty-eight per cent said that they would break the law.

That is the real problem with under-funding of the SEC. Without sufficient resources, their hammer of prosecution seems like a negligible risk. If traders see their peers trading on inside information and not getting caught, they are more likely to push past that legal edge. The  Rajaratnam is an important signal that you can get caught.

To be effective the SEC needs more cases, not just bigger cases.

Sources:

Nobody Expects The Spanish Inquisition

The most dangerous parts of managing risk are the risks you don’t expect. Looking back at my old four-box analysis, there are really two types of unexpected risks, the risk that you know that you don’t know and the risk that you don’t know that you don’t know. In the first case you know there is an unexpected risk. In the second, you missed that there was an even a risk.

The second case has been labeled the Black Swan. Those type of risks are well written about by Taleb.

While staying up late and watching some Monty Python, I came to the conclusion that the first case is the “Spanish Inquisition.” You know the Spanish Inquisition is out there roaming the countryside. You just don’t now when or where they will appear.

You also don’t know the danger. Their two weapons are fear and surprise…and ruthless efficiency.

What do Wyoming, New York, and Minnesota Have in Common?



They don’t examine investment advisers.

Wyoming has long been on this list because it does not have a law regulating investment advisers. In Item 2 of Form ADV there was a box to check if your principal office and place of business was Wyoming. That kept you in SEC registration.

The importance of whether a state does exams affects mid-sized advisors. Dodd-Frank allows mid-sized advisors to stay with SEC registration instead of state registration if their home state doesn’t do exams.

At last week’s SEC Open Meeting on the new investment adviser act rules, Bob Plaze, associate director of the SEC’s Division of Investment Management, revealed that New York did not respond in writing to the SEC’s question about investment adviser examinations. The SEC took the position that a non-response was a statement that the state doesn’t examine investment advisers.

Minnesota responded that they don’t conduct exams.

This means mid-sized advisers in Wyoming, New York, and Minnesota won’t have to switch to state supervision if they have between $25 million and $100 million in assets under management.



Will Private Equity Fund Managers Register or be Exempt?

The SEC extended the deadline for private fund managers to register with the Securities and Exchange Commission as investment advisers from July 21, 2011 to March 30, 2012. That’s a long enough period of time for legislation to intervene and grant a new exemption for private equity fund managers.

Dodd-Frank has a new exemption for venture capital fund managers.  There was an exemption for private equity fund managers in early drafts of the legislation, but that exemption never made it into the final law.

Now the Republican-controlled House is trying to re-create the exemption.

The Small Business Capital Access and Job Preservation Act was approved by a House Committee on Financial Services.

“Given the costs of registration and compliance, subjecting private equity advisers to this regulation diverts capital, time, talent and effort from activities that result in job creation. By tailoring registration requirements to exempt advisers to private equity funds, the bill strikes a better balance between the benefits of adviser registration and its costs.”

The bill is not without its critics. The North American Securities Administrators Association sent a comment letter to the committee.

First, NASAA attacks the failure to define the term “private equity fund.” The bill delegates this task to the SEC. This was the same approach used for venture capital fund managers in Dodd-Frank. However that common label is better understand than the broad range of investment strategies and risks that fall under the private equity label.

Second, NASAA is concerned that the bill is unclear as to what, if any, reporting requirements would be required for this new defined group of private equity fund advisers. The bill exempts “private equity” from the registration and reporting requirements. That means venture capital would have some reporting obligations, but private equity would not. NASAA believes that the proposed exemption contained in Section 203(o)(1) would likely have the unintended consequence of depriving the SEC of regulatory information critical for assessing risk and protecting investors.

Third, NASAA observed that the bill’s scope appears to cover all investment advisers who advise “private equity funds.” The exemption is not limited to those who solely advise private equity funds. Theoretically, an adviser could set up a private equity fund and cover all of its operations that would otherwise be exempt.

I have an interest in this bill so my opinion is biased. I think many private equity fund managers are a poor fit under the requirements of the Investment Advisers Act. Registration and reporting will impose a regulatory burden that will do little to reduce risk or protect investors.

However, the bill is taking such a blatantly partisan and over-broad approach to a sensible exemption. It also seems to be packaged with the Small Company Capital Formation Act (H.R. 1010) and the Burdensome Data Collection Relief Act (H.R. 1062). The Small Company Capital Formation Act would raise the regulatory thresholds for exemption for registration with the SEC from $5 million to $50 million. The Burdensome Data Collection Relief Act repeals the obligations under Section 953(b) of Dodd-Frank for public companies to disclose the ratio of executive compensation to the median compensation of all corporate employees.

Two other bills, the Asset-Backed Market Stabilization Act and the Business Risk Mitigation and Price Stabilization Act were originally introduced with these three, but I haven’t seen any further action of those two.

Sources

Image of Washington DC – Capitol Hill: United States Capitol is by Wally Gobetz
CC BY-NC-ND 2.0

Compliance Bits and Pieces for June 24

These are some recent compliance-related stories that caught my eye:

What ‘Inside Job’ got wrong by Ezra Klein in the Washington Post

And ultimately, that’s what makes the financial crisis so scary. The complexity of the system far exceeded the capacity of the participants, experts and watchdogs. Even after the crisis happened, it was devilishly hard to understand what was going on. Some people managed to connect the right dots, in the right ways and at the right times, but not so many, and not through such reproducible methods, that it’s clear how we can make their success the norm. But it is clear that our key systems are going to continue growing more complex, and we’re not getting any smarter, or any less able to ignore risks that we know we should be preparing for. “Inside Job” may have missed that story, but the rest of us can’t afford to.

Flawed Incentives and Dubious Morals: JPMorgan & CDOs That Were “Built to Fail” by Matthew Philips in Freakonomics

See, the bankers at JPMorgan who sold these CDOs got paid regardless of how the things performed, whether every one of the thousands of mortgages stuffed into them paid off, or whether they all defaulted. So the incentive for the bankers was to sell as many CDOs as possible, even if they knew they were going to blow up in a year or two. It wasn’t their problem because it wasn’t their money. This raises an obvious moral question: were bankers morally remiss in pumping these mortgage bombs out into the world when they knew the wreckage they would cause? Or were they simply being good at their job?

Private Equity: compliance risk for portfolio company bribery? in The Bribery Act .com

Richard Alderman, Director of the SFO, has confirmed that in the SFO’s view Private Equity could have liability for the conduct of its investment portfolio businesses under the Bribery Act. … Speaking to an audience of Private Equity professionals Richard Alderman said that he assumed that those in the Private Equity industry have “a level of knowledge and due diligence that is very high because of the nature of what you do. You are, therefore, very well informed investors  with a high degree of knowledge of what happens in the companies you invest in. In any dealings we have with you on cases we are likely to start from that assumption.”

What Does The SEC FCPA Unit Chief Do? in the FCPA Professor

Given Cheryl Scarboro’s recently announced departure from the FCPA Unit Chief position (see here for the prior post), the SEC recently posted (here) the opening for the position. The “Major Duties” portion of the job posting is actually an interesting and informative read. Want proof that the SEC executes “targeted sweeps and sector-wide investigations.” It is in the job description.

SEC Extends Deadline and Adopts Rules for Advisers and Private Funds

At an open meeting on June 22, the Securities and Exchange Commission adopted new rules under the Investment Advisers Act of 1940 aimed at investment advisers, private fund managers, venture capital funds, and family offices.

Based on the statements at the meeting, there will be three new rules would:

Delay Registration Deadline and a New Form ADV. The new registration/reporting deadline for new Advisers Act registrants and “exempt reporting advisers” will be March 30, 2012. Previously exempt private advisers, particularly those to hedge funds and private equity funds, will not be required to register until March 30, 2012. All advisers will be required to make a filing in the first quarter of 2012. Those previously registered advisers who no longer qualify for SEC registration will be required to withdraw by June 28, 2012.

The SEC staff pointed out that 2012 is a leap year, so the 90 day deadline is March 30 instead of March 31 in 2012.

Form ADV is going to change. No surprise. Under the amended adviser registration form, advisers to private funds will have to provide:

  • Basic organizational and operational information about each fund they manage, such as the type of private fund that it is (e.g., hedge fund, private equity fund, or liquidity fund), general information about the size and ownership of the fund, general fund data, and the adviser’s services to the fund.
  • Identification of five categories of “gatekeepers” that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers).
  • More information about conflicting or potential conflicting relationships.

Define Venture Capital Funds. Under the definition, a venture capital fund is a private fund that:

  • Invests primarily in “qualifying investments” (generally, private, operating companies that do not distribute proceeds from debt financings in exchange for the fund’s investment in the company); may invest in a “basket” of non-qualifying investments of up to 20 percent of its committed capital; and may hold certain short-term investments.
  • Is not leveraged except for a minimal amount on a short-term basis. Borrowing is limited in time as well.
  • Does not offer redemption rights to its investors.
  • Represents itself to investors as pursuing a venture capital strategy.
  • Is not registered under the Investment Company Act.

There will be a rule on grandfathering substantially as proposed in November, with the three conditions that the fund had been represented to be a “venture capital fund,” that the first closing was prior to December 31, 2010 and that no new capital commitments are made after July 21, 2011.

The new category of venture capital fund advisers and other “exempt reporting advisers” will file portions of Part 1 of Form ADV. Commissioner Schapiro noted that there was no current intention to subject exempt reporting advisers to routine examinations, while also noting that the SEC retains the authority to examine those advisers in its discretion. The Staff noted that the Form ADV will include a uniform calculation for “assets under management.”

Family Office Exemption. This exemption should be consistent with no-action relief previously provided and the proposed rule. It sounds like there will be some expansion to address a broader universe of permitted family clients and ta longer transition period (through December 31, 2013) for the termination of relationships with charitable entities that were not exclusively funded by the family.

These rules will have completed most of the rulemaking required under Title IV of Dodd-Frank, the Private Fund Investment Advisers Registration Act.

My printer is still cranking out the text of the new rules and I need to dive deeper into the details.

Sources:

Sometimes You Get Stuck and Can’t Get Out

Finally, the SEC is going to take some action today on the regulation of investment advisers, venture capital funds, and private fund managers.

For years, they’ve been trying to get regulatory control of private funds. Now they are going to get it.

Do they really want it?

Sometimes what you want to do is not a good a choice. As a case in point, I give you a kitten crawling inside a hamster ball.

Sure it’s cute. But you end up with a pissed-off kitten.

The Open Meeting for June 22 is all about the Investment Advisers Act.

Agenda:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an investment adviser under the Investment Advisers Act of 1940.

The word I’ve heard is that the July 21, 2011 deadline will be extended to March 31, 2012.