Attacking Wall Street in 1920

I don’t often include fiction books in my book reviews on this site. But I was drawn to The Death Instinct because its historic fiction is centered around an event on Wall Street. So I thought the book would be interesting for a compliance professional.

A horse-drawn wagon passed through Wall Street’s lunchtime crowds on September 16, 1920. Inside the wagon was 100 pounds of dynamite and 500 pounds of cast-iron slugs to act as shrapnel. The wagon exploded in front the Morgan Bank and the US Treasury building, killed 38 people and seriously injured hundreds.

It was the most destructive terrorist attack on US soil until the Oklahoma City bombing. Jed Rubenfeld draws some analogies between the 1920 attack and the 9-11 attacks. Unlike those attacks, the 1918 attack went unsolved. There were some vague accusations of plots by Italian anarchists, but nobody was ever charged.

Rubenfeld puts together a sweeping storyline to find his explanation for the bombing. He inserts many subplots branching out from the main story line. He also includes several real-life characters, fictionalized for the book. This includes Marie Curie, Sigmund Freud, Senator Albert Bacon Fall, and former Treasury Secretary William G. McAdoo. The main protagonists are Dr. Stratham Younger, Colette Rousseau – a radium scientist, and James Littlemore a detective with the NYPD.

There is a lot going on and I thought the story might go spinning out of control at a few points, but Rubenfeld manages to keep it together.

My biggest quibble is with the title.  When the publisher offered me  copy I almost passed on it. The “Death Instinct” is one of Freud’s theories. He came to the conclusion that humans have not one but two primary instincts: the life-favoring instinct and the death instinct. In other words, humans strive for both tenderness and thrills. Personally, I found the whole Freud sub-plot to be a distraction to the story and the title merely reinforces an aspect that I did not like.

Otherwise, I enjoyed the main characters and the twisting storyline as it jumps from plot-to-plot and character-to-character. There is romance, financial intrigue, and police procedural elements all mixed in.

Compliance Bits and Pieces for January 21

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

The Swiss Compliance House: a Model for FCPA Compliance? by Thomas Fox

The Compliance House is a model which has been developed by Swiss businesses to use as the foundation of effective compliance management by ensuring that by “binding values and appropriate compliance management they can safeguard their integrity, and avoid or contain breaches of the law.” Buhr believes that it is the basic legal responsibility of any company board of directors to make certain breaches of law are either avoided or, if they occur, are detected early enough so that the company may remedy the situation.

Ex-JPMorgan banker loses whistleblower case by Jonathan Stempel for Reuters

A federal judge dismissed a whistleblower lawsuit by a former JPMorgan Chase & Co private banker who said she was fired for questioning the dealings of a lucrative client. …. In his ruling, [U.S. District Judge Robert] Sweet said the plaintiff failed to properly allege a Sarbanes-Oxley claim because she did not identify the specific illegal conduct forming the basis of her whistleblower complaint.

Why Did Goldman Blink? in DealBook

Goldman Sachs’s decision to offer shares of Facebook only to offshore investors is simple risk management. The risk here can be attributable to the scrutiny that this transaction, and Goldman Sachs generally, are now under. …. The media hoopla surrounding the announcement of the sale could be characterized as coordinated in a way to create the type of hype that the securities rules are trying to avoid. The stampede of Goldman clients seeking to invest is evidence of this hype. In other words, Goldman arranged the mechanics of this sale to create a media fury that constituted a “general solicitation.”

Advice for Young Compliance Officers by Matt Kelly in Compliance Week

Congratulations on finishing your education and entering the workforce. If corporate compliance is where you want to make your career, you’re in a superb position to attract the attention of global corporations. Those businesses are desperate for skilled labor to bolster their ethics and compliance departments. With some thoughtful career moves now, you can have a bright future for a long while.

Global Hedge Fund Association Comments on Implementing EU Hedge Fund Legislation in Jim Hamilton’s World of Securities Regulation

A global hedge fund association has called for the national implementation of the EU hedge fund adviser legislation to be flexible and proportionate and based on the principles of openness and transparency. The Alternative Investment Fund Managers Directive was passed by the European Parliament last year. The Alternative Investment Management Association (AIMA) comments were a consultation response sent to the new European Securities and Markets Authority (ESMA). The authority released a Call for Evidence ahead of the rule-making Level 2 of the legislative process. The industry was asked to respond in January to the main issues raised in the Directive and AIMA immediately established a working group of member firms to study the proposals and contribute to the response.

Image of Old Swiss House by LinksmanJD

The Role of Compliance in Criminal Cases

handcuffs

Plan Now or Pay Later.

Compliance failures are expensive. Failures result in big fines, expensive investigative costs and expensive legal fees. Plus you end up diverting valuable management resources from managing the business to managing the damage. Executives would much rather be sitting in the boardroom than in a deposition. Compliance has become a key consideration for under the federal sentencing guidelines for companies convicted of violating federal law.

Charlotte Simon of University of Houston Law Center, Ryan D. McConnell of Haynes and Boone LLP and Jay Martin of Baker Hughes, Inc. put together a paper on the role of compliance in criminal cases: Plan Now or Pay Later: The Role of Compliance in Criminal Cases

The DOJ’s focus on compliance has forced both U.S. and foreign companies that access U.S. capital markets to reevaluate their approaches toward compliance. Companies have begun to reassess, formalize, and improve what have historically been only informal or general codes of conduct. Faced with the reality that compliance is both a key federal charging consideration and a determinative factor in sentencing, companies today must ensure that their compliance programs contain carefully crafted policies and procedures tailored to minimize the risk of civil and criminal liability.

The article provides an excellent analysis and background on the role of compliance in federal criminal prosecutions.

However, they miss the point of having a compliance program. It’s to avoid ending up with criminal liability. If the case ends up with that the Department of Justice, that means the regulators found the conduct so egregious that civil liability was insufficient given the severity of the activity. Of course it also means that the activity was bad enough to catch the eyes of a regulator for action.

The authors use a chart showing that only three companies of 1349 charged from 1996 to 2009 received a culpability score reduction for having an effective compliance program. If they had an effective compliance program, they would not have ended up in the federal sentencing guidelines to begin with.

A compliance program should not be in place to reduce the sentence, it should be in place to prevent problems from occurring.

Pay to Play Rules for Placement Agents

The SEC imposed strict limitations on the ability of investment advisers to make political contributions when their clients include government bodies when it issued Rule 206(4)-5. They don’t want government investment decisions decided campaign contributions. This limitation also applies to private investment funds under the language of the rule and the changes to the Investment Advisers Act made by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The SEC carried this limitation over to placement agents used by investment advisers. The placement agent needs to be subject to similar limitations. That means the placement agent would need to be a registered investment adviser or otherwise regulated. At first the SEC expected FINRA to create a new rule to govern pay-to play. Instead, Section 975 of Dodd-Frank Wall Street Reform and Consumer Protection Act created a new category of regulated persons called a “municipal adviser.” This new category will regulated by the Municipal Securities Rulemaking Board.

The MSRB has issued a proposed draft of new Rule G-42 that would limit a placement agent’s ability to make political contributions.

One major difference between this draft of Rule G-42 and SEC Rule 206(4)-5 is the definition of de minimis political contribution. The SEC allows a contribution of $350 per election cycle for candidate you can vote for or $150 for a candidate you can’t vote for. The MSRB definition would be $250 for candidate that you can vote for.

Violating the rule means you are banned from

  • engaging in municipal advisory business with a municipal entity for compensation,
  • soliciting third-party business from a municipal entity for compensation, or
  • receiving compensation for the solicitation of third-party business from a municipal entity,

for two years after any contribution to an official of such municipal entity in excess of the de minimis amount.

Proposed Rule G-42 for municipal advisers is similar to Rule G-37 for those in the municipal securities business. I expect that comments will argue that the de minimis amount should match up with the SEC’s de minimis amount.

Sources:

Sovereign Wealth Funds, Bribery, Corruption, Hospitality and the FCPA

The FCPA seems to be most closely associated with shady oil operations, mining, defense contractors and infrastructure transactions.  The image is a big company coming in and bribing an official for access to the country’s resources.

The other side to that investment is that the countries build up big supplies of capital. Many deploy some of that capital into funds for investing using sovereign wealth funds. During the credit crisis of 2008, some of the big Wall Street firms got injections of capital from sovereign wealth funds.

This is the flip side of the FCPA. Instead of a US company trying to get the rights to invest in the foreign country, it’s getting the foreign country to invest in the US company. And cash payments to foreign officials are still going to be considered bribes in violation of the FCPA, regardless of which direction the capital flows.

The problem is that the people running the sovereign wealth funds are going to be considered “foreign officials” under the Foreign Corrupt Practices Act. That should not come as surprise. In 2008 the Department of Justice said it was taking a look at “passive and active investments by U.S. securities firms into sovereign funds, and vice versa.” They clearly stated that a sovereign wealth fund is a “State-Owned Enterprise” and that securities firms should treat employees of sovereign wealth funds as government officials for purposes of the FCPA.

Dionne Searcey and Randall Smith published a big headline in the Wall Street Journal about the launch of a new investigation by the Securities and Exchange Commission into whether US banks and private equity firms violated the FCPA in their dealings with sovereign wealth funds.

Clearly, under-the-table payments in exchange for the investment are going to be trouble. But even typical hospitality shown to investors will be under tighter scrutiny. If it’s too lavish, it could be considered a bribe.

There is an affirmative defense under the FCPA if

the payment, gift, offer, or promise of anything of value that was made, was a reasonable and bona fide expenditure, such as travel and lodging expenses, incurred by or on behalf of a foreign official, party, party official, or candidate and was directly related to the promotion, demonstration, or explanation of products or services [§ 78dd-1 (c)(A) and § 78dd-2 (c)(A)]

The investment officer for the SWF comes to your office, you put him (or her) up at a nearby hotel, shown him around the office to meet management, discuss investment strategies and take him out to dinner after a full day of diligence. The question will be whether the lodging expenses and dinner expenses were “reasonable” and “bona fide.”

I doubt that the DOJ and SEC would consider the cost of putting up the official at a Holiday Inn and dinner at Denny’s to be so excessive as to not be “reasonable” and “bona fide.” Then start increasing the quality of those offerings. Instead of the Holiday Inn, it’s the Ritz-Carlton, or the 1,900 s.f  Central Park Suite at the Ritz Carlton. Instead of Denny’s, it’s dinner at Le Bernadin, with a $500 bottle of wine. Now you you need to be concerned that the dinner and lodging are not “reasonable” and “bona fide.” Throw in a few party favors just to give your compliance officers ulcers and sleepless nights.

Wall Street is still an easy target. The excesses of Wall Street make great headlines. If there really is some wrongdoing it will be an interesting story.

However, some of those investments helped save those Wall Street firms from collapse. We would be much worse off today if Citibank or Morgan Stanley followed Lehman into bankruptcy. I’m not saying that corruption would be warranted in this situation. But we also need to be careful not to spook away foreign investors with a witch hunt. Otherwise, they may not be there for a legitimate investment when we need them.

Sources:

Image of Wall Street is used under a creative commons license.

Compliance Bits and Pieces for January 14

Here are some recent compliance related stories that caught my attention:

“Foreign Official” Limbo … How Low Can It Go? in FCPA Professor

Move over 49%, there is a new “foreign official” “limbo low” – 43%.

In the recent Alcatel-Lucent enforcement action (see here for a complete analysis) paragraph 21 of the DOJ’s information (here) states as follows.

“Telekom Malaysia Berhad (‘Telekom Malaysia’) was a state-owned and controlled telecommunications provider in Malaysia. Telekom Malaysia was responsible for awarding telecommunications contracts during the relevant time period. The Malaysian Ministry of Finance owned approximately 43% of Telekom Malaysia’s shares, had veto power over all major expenditures, and made important operational decisions.

Facebook Tries to Befriend the Public Markets by Matt Kelly in Compliance Week

The modern U.S. regime of regulatory compliance is not easy, not cheap, and not popular—until you consider the alternatives. Then you can see that, as Winston Churchill once said in a somewhat different context, it’s the worst system in the world, except for all the others.

Judges Berate Bank Lawyers in Foreclosures by John Schwartz in the New York Times

With judges looking ever more critically at home foreclosures, they are reaching beyond the bankers to heap some of their most scorching criticism on the lawyers. In numerous opinions, judges have accused lawyers of processing shoddy or even fabricated paperwork in foreclosure actions when representing the banks.

Personal criminal liability, the nuclear deterrent: What every director, senior officer & General Counsel needs to know in The Bribery Act .com

The SFO is fond of saying that criminal liability under the Bribery Act is brought straight into the Board Room.

It is an attention grabbing headline and it’s meant to be.

A key weapon in the SFO’s armoury (akin to a nuclear deterrent) is the focussing of the mind in the Board and senior management levels (including General Counsel) which inevitably flows from the risk they face of a very lengthy (up to 10 years) prison sentence and an unlimited fine if the corporate engages in bribery.

The SFO hopes this threat will motivate the Boards and senior officers of corporates subject to the Bribery Act to adopt and implement Adequate Procedures to prevent bribery.

The Impact of the UK Bribery Act on U.S. Companies

Securities Docket put on another fantastic webcast on topics relevant to compliance professionals. Today’s focused on the upcoming Bribery Act in the United Kingdom. If your company has operations in the United Kingdom, you need to pay attention to this law.

The upcoming law applies to individuals and companies and outlaws bribes to public officials and private individuals. That makes it broader than the US FCPA. There is also a new corporate offense for failure to prevent bribery. Conviction can have jail sentences up to 10 years and provides for unlimited fines.

Webcast Presenters:

  • Vivian Robinson QC, general counsel to the UK’s Serious Fraud Office
  • Barry Vitou, partner in Winston & Strawn’s London office
  • Richard Kovalevsky QC, 2 Bedford Row
  • David Childers, CEO of EthicsPoint

For compliance professionals, the key will be putting “adequate procedures” in place inside the business to prevent bribery. We are still waiting for the UK government to publish guidance on that standard.  One recommendation from the panel was to look at Transparency International’s Adequate Procedures – Guidance to the UK Bribery Act 2010.

It’s not an offense if you lack “adequate procedures.” It is merely a defense to the charge against the company for violation of the Bribery Act.

You can watch a rebroadcast of the webcast and download the materials

Stay on Target

Don’t stray from your investment strategy. Don’t chase yields. Make sure your investment strategy follows your marketing materials.

According to SEC charges, Charles Schwab failed to do this with its YieldPlus Fund in 2007. The fund was marketed as a Short Term Bond fund and described the Fund as a cash “alternative” that generated a higher yield with slightly higher risk than a money market fund.

The Fund was not “slightly riskier” than money market funds, CDs and other cash alternatives to which it was compared. CDs are insured. Investments in the Fund were not insured. The maturity and credit quality of the Fund’s securities were significantly different than those of a money market fund.

The big problem was that the fund was mostly invested in mortgage-back securities. That means its investments got hammered in late 2007. That was coupled with widespread redemptions. Only 6% of the funds assets were scheduled to expire in those six months meaning they also had a liquidity crunch.

The SEC claims that executives made misstatements about the fund’s performance and the amount of redemptions. That makes the problem worse.

They made it even worse, according to the SEC by allowing insiders and other Schwab funds to redeem their shares in the Fund before the extent of the decline was disclosed to the public. Essentially, they had inadequate procedures to prevent insider trading.

There are some good lessons in this case for CCOs.

Sources:

Snow and Compliance

Dilbert.com

I’m staring out my front door at a half foot of snow, swaying branches heavily laden with wet snow, and an un-plowed street.

The latest weather report for Boston:

A Blizzard Warning remains in effect until 8 PM EST this evening.

* Locations… the East Coast of Massachusetts from Scituate northward.

* Hazard types… snow and blowing snow.

* Accumulations… 12 to 16 inches of snow.

* Timing… the heaviest snow will fall through noon time. Snowfall rates of 2 to 3 inches per hour are possible at times.

* Impacts… hazardous travel conditions expected. Heavy snow will significantly impact the morning commute. Strong northeast winds will combine with heavy snow to create blizzard conditions at times.

* Winds… north 20 to 30 with gusts up to 45 mph.

* Visibilities… one quarter mile or less at times.

Precautionary/preparedness actions…

A Blizzard Warning is issued when sustained winds or frequent gusts over 35 mph are expected with considerable falling and/or blowing and drifting snow. Visibilities will become poor with whiteout conditions at times. Those venturing outdoors may become lost or disoriented…
so persons in the warning area are advised to stay indoors.

I will take that advice and stay indoors.

Sometimes compliance means a day working at home with the kids.