Another CCO in Trouble

With failure, comes learning. As a compliance officer, disciplinary actions against other compliance officers can be a road map showing me what not to do. Recently, the SEC charged affiliated firms and their former chief compliance officer with failing to have adequate policies and procedures to prevent misuse of nonpublic information.

Section 204A and Rule 204A-1 make it very clear that every investment adviser must have written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information. Buckingham Capital Management Inc. and its broker-dealer parent company, The Buckingham Research Group Inc. apparently did not.

BRG and BCM’s policies and procedures were deficient in a number of ways. BRG had a written procedure to address the misuse of material, nonpublic information, but did not follow its written procedure in practice. Important compliance policies and procedures were not contained in BCM’s written policies and procedures. Further, in some instances, BCM’s written policies and procedures were so unclear that employees did not understand their responsibilities. In other instances, the practices BCM employed varied materially from its written policies and procedures. These failures led to inadequate implementation and enforcement of the firms’ written compliance policies and procedures.

That’s bad, but more likely to result in a deficiency letter than an enforcement action, assuming they were not misusing the information. The problem was that these deficiencies were discovered during a 2003 SEC examination. BCM said they would fix the problem.

Trouble

In preparation for a 2006 SEC exam,  BCM discovered it was missing more that 100 pre-approval forms for trades and that its compliance review logs for 2005 and 2006 were incomplete.

Rather than deliver incomplete records, BCM staff altered the records. This apparently angered the SEC and they moved the case from examination into enforcement.

The former CCO, Karp was censured and agreed to pay a $35,000 penalty.

Lessons

If the SEC tells you there is deficiency, fix it and make it a priority. The first thing they will look at on their next visit is the area of the deficiency. I’m still surprised that the SEC reported only 90% of deficiencies get cured.

Don’t falsify records. That will get the problem moved from the inspection side to the enforcement side of the SEC. That would be a CCO Failure. (The complaint indicates that Mr. Karp did not participate in the falsification.)

Sources:

Securities and Exchange Commission’s FY 2010 Performance and Accountability Report

In June 2010, the SEC approved a new strategic plan for its fiscal years 2010 – FY 2015. The plan set out the agency’s mission, vision, values, and strategic goals. It also had a detailed list the outcomes the SEC wanted to achieve and the performance measures that will be used to gauge the agency’s progress.

The SEC has released its 2010 Performance and Accountability Report, the first to measure the SEC performance against its strategic plan.

I thought it would be useful to look at some portions of the report to see if it could offer some insight into what to expect from the SEC as real estate private equity moves into the SEC registration regime.

The first that caught my eye was GoalL 1 Measure 3: Percentage of firms receiving deficiency letters that take corrective action in response to all exam findings.

The Office of Compliance Inspections and Examinations missed its target of 95%, achieving only 90%. This was a drop from 94% in FY2009. I’m not sure what factors I would attribute to the decrease. Were the examinees less afraid of SEC action?

This is one that compliance professionals need to focus on. If the SEC identifies deficiencies, you need to fix them. Failure to fix them is a big red flag that could move the problem from OCIE to enforcement.

On the education side, the SEC’s CCOutreach program failed to meet its goal of having attendees rate the program as “useful” or “extremely useful.”

I attended a 2009 edition of CCOutreach in Boston and it was excellent. Looking back at my notes, it was a spot-on roadmap for the upcoming SEC initiatives. I still hate the name.

I think it’s worth spending some time to look through the report. I would guess that the SEC is going to step up its efforts in areas where it failed to meed the goals in its strategic plan.

That would mean more inspections, more enforcement actions. It will also mean more educational efforts and quicker resolution. One measure is the percentage of non-sweep and non-cause exams concluded in 120 days. The goal was 75%, but they only achieved 48%.

Sources:

SEC to Consider New Rules for Fund Managers

On Friday, The Securities and Exchange Commission will be considering rules that should be of interest to private investment fund managers.

It looks like we may have the first look at how the SEC will define a venture capital fund and who will fit into that new exemption to registration under the Investment Advisers Act. Section 407 of Dodd-Frank puts the onus on the SEC to define ‘venture capital fund.’

My guess is that the definition will be very narrow and many venture capital fund managers will not be happy with the definition.

Open Meeting – Friday, November 19, 2010 – 10:00 a.m.

The subject matter of the Open Meeting will be:

  • The Commission will consider whether to propose 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 by 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.
  • The Commission will consider whether to propose 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 proposed rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.
  • The Commission will consider whether to propose new rules under Section 763(i) of the Dodd-Frank Wall Street Reform and Consumer Protection Act governing the security-based swap data repository registration process, the duties of such repositories, and the core principles applicable to such repositories.
  • The Commission will consider whether to propose Regulation SBSR under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act to provide for the reporting of security-based swap information to registered security-based swap data repositories or the Commission and the public dissemination of security-based swap transaction, volume, and pricing information.

At times, changes in Commission priorities require alterations in the scheduling of meeting items. For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact: The Office of the Secretary at (202) 551-5400.

Have you been Dodd-Franked?

On Thursday, December 2nd, 2010, I will be part of panel discussing some of the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act on real estate investment management firms.

The session is open to the public, but not free.

Panelists

John Schneider, Principal, KPMG LLP
Paul D. Schwartz, Partner, Goodwin Procter LLP
Doug Cornelius, Chief Compliance Officer, Beacon Capital Partners

Have you been Dodd-Franked?
If you invest other people’s money in real estate you may have been. The Dodd Frank legislation’s impact on real estate investment managers is far reaching and evolving. Our panel of experts will discuss the legislation and answer these key questions:

  • Who will need to register or unregister with the SEC and State?
  • What is the timeline for compliance and rules making?
  • Will the SEC visit you and what is their focus?
  • What is a Compliance Program and CCO?
  • What reporting will be required regardless of registration requirements?
  • How is the definition of an “Accredited Investor” changing?
  • Other timely issues such as the “Pay to Play” rules.

Thursday, December 2nd, 2010
Wilmer Cutler Pickering Hale & Dorr LLP
60 State Street, 26th Floor, Boston
Registration 7:30 a.m.; Program 8:00 – 9:30 a.m.

Cost: $50 REFA Member | $80 Non-member
Members Register Online |  Faxable Registration Form | **72 HOUR CANCELLATION POLICY**

Questions? Please call Kayla Burmeister at 617-399-7863

Europe’s New Directive on Alternative Investment Fund Management

The European Parliament has approved the Directive on Alternative Investment Fund Managers. European countries will now be setting up a framework for regulating hedge funds and private equity funds. The AIRM Directive passed with 513 votes to 92 with 3 abstentions on November 10.

Under the Directive, an “alternative investment fund” is any collective investment undertaking which raises capital from a number of investors and is not registered under the EU’s Directive on Undertakings for Collective Investment in Transferable Securities (UCITS). So along with hedge funds, the directive sweeps up private equity funds, real estate funds and commodity funds.

One key and contentious provision is the inclusion of a single EU passport for fund managers. An alternative investment fund manager can register under the legislation in one Member State that complies with the rules of the Directive. Then the manager can manage or market funds to professional investors throughout the EU after notification. It will also eventually allows US and other non-EU fund managers to get a passport. There will be a dual system for three years during which US and other non-EU hedge funds and fund managers will be governed by national private placement regimes under each jurisdiction, until the passport rules take effect.

The directive has some limitations on the use of leverage by the funds and fund managers will be required to notify regulators about their use of leverage.

Here is a rough timeline for the directive and its effects:

January 2011 Entry into force of the directive
January 2013
(2 years after entry into force)		 Deadline for transposing the directive’s rules into national law, including those on granting
passports to duly-registered, EU-based, AIFs and AIFMs.
January 2015
(2 years after transposition)		 ESMA reports on functioning of passport system for EU AIFs and AIFMs, national private
placement regimes, and possible extension of passport system to non-EU AIFs and AIFMs.
April 2015
(at the latest 3 months after ESMA report)		 Commission adopts a delegated act, based on ESMA advice, specifying date when passports
for non-EU AIFs and AIFMs will be available.
April 2018
(3 years after entry into force of delegated act)		 Second ESMA report on the functioning of the passport and the possible ending of national
private placement regimes.
July 2018
(at the latest 3 months after ESMA report)		 Commission adopts a second delegated act, based on ESMA advice, specifying date
when national private placement regimes must be terminated.

I’m going to spend some time reading the Directive in more detail to figure how it will affect me. One thing is clear: It’s going to be more time-consuming and more expensive to market and manage private funds in the EU.

Sources:

Compliance Bits and Pieces for November 12

Here are some compliance-related stories that I found interesting:

Stanford Moved After More Fisticuffs Leaves Him Bruised and Bloodied by Ashby Jones in WSJ.com’s Law Blog

He was granted a transfer Monday from a private Texas jail to a federal one closer to his lawyers in downtown Houston. The transfer came in the wake of news that Stanford got into a fight with an inmate on Thursday, in which he suffered a concussion, two black eyes and a broken nose, according to his lawyer, Kent Schaffer.

NASAA Urges SEC to Adopt “Investments Owned” Accredited Investor Test in Jim Hamilton’s World of Securities Regulation

In a comment letter to the SEC, the North American Securities Administrators Association (NASAA) has urged the Commission to adopt an “investments owned” test for accredited investors in private offerings conducted under federal Regulation D.

The End of the FCPA Facilitation Payment Exception? by Tom Fox

The only countries that permit facilitation payments are the United States, Canada, Australia, New Zealand and South Korea. Facilitation payments, however, are illegal in every country in which they are paid. They have come under increasing fire under the FCPA as inconsistent with the totality of US policy on anticorruption.

New FTC portal to assist businesses in complying with privacy and security laws in the Office of Inadequate Security

The Federal Trade Commission has a new Business Center at Business.ftc.gov that gives business owners, attorneys, and marketing professionals the tools they need to understand and comply with the consumer protection laws, rules, and guides the FTC enforces.

The Facade of FCPA Enforcement by Mike Koehler in FCPA Professor

I am pleased to release (here) my paper, “The Facade of FCPA Enforcement,” recently published by Georgetown Journal of International Law.

Joseph Brenner to join SEC as Chief Counsel of Enforcement Div. in Securities Docket

Joseph K. Brenner is joining the SEC as Chief Counsel of the Division of Enforcement. The SEC announced today that Brenner expects to begin his employment with the agency in the next several weeks. Brenner joins the SEC from law firm Wilmer Cutler, where he has been a partner since 1990. At Wilmer, Brenner was Vice Chair of the firm’s Securities Department and a member of its Securities Litigation and Enforcement Practice Group.

Salute a Veteran

U.S. President Woodrow Wilson first proclaimed an Armistice Day for November 11, 1919.

“To us in America, the reflections of Armistice Day will be filled with solemn pride in the heroism of those who died in the country’s service and with gratitude for the victory, both because of the thing from which it has freed us and because of the opportunity it has given America to show her sympathy with peace and justice in the councils of the nations…”

The United States Congress passed a resolution seven years later on June 4, 1926, requesting the President issue another proclamation to observe November 11 with appropriate ceremonies. An Act approved May 13, 1938, made the 11th of November in each year a legal holiday:

“a day to be dedicated to the cause of world peace and to be thereafter celebrated and known as ‘Armistice Day’.”

Congress amended this act on November 8, 1954, replacing “Armistice” with Veterans, and it has been known as Veterans Day since.

My thoughts go out to Marine Corps Sergeant Jason Cohen, currently serving.

Do You need State Licensing if You’re an SEC Registered Investment Adviser?

With Dodd-Frank‘s elimination of the 15 client exemption, thousands (my guess) of private fund managers will need to register with the Securities and Exchange Commission as investment advisers to their funds. For alternative investment funds, like real estate, you’ll need to look at whether you are giving advice regarding securities.

If you have less than $100 million you will be in the state registration system and may need to have individuals licensed with the state. If you have over $100 million, you be registering with SEC. The deadline is July 21, 2011.

That leaves the question of whether you need a state license for the firm or individuals in the firm, like the Series 65.

One benefit of SEC registration is that the Investment Advisers Act preempts some state licensing for private fund management companies. Section 203(A)(b) prohibits the states from licensing an investment adviser registered with the SEC (or exempt from definition of Section 202(a)(11)).

The exception is that a state may require licensing for an “investment adviser representative” who has a place of business in that state. For a private fund manager, you need to determine if any of the management company employees fit into the definition in Rule 203A-3.

“(a)(1) “Investment adviser representative” of an investment adviser means a supervised person of the investment adviser:

i. Who has more than five clients who are natural persons (other than excepted persons described in paragraph (a)(3)(i) of this section); and

ii. More than ten percent of whose clients are natural persons (other than excepted persons described in paragraph (a)(3)(i) of this section).”

For a private fund manager, the key part of the definition is whether they have any clients who are natural persons. The manager’s funds are the clients and those funds are not natural persons. Employees of the fund manager should fall outside the definition of “investment adviser representative” and therefore not need a license.

Sources:

Disciplinary Actions Against Chief Compliance Officers

The Chief Compliance Officer should be a model for employee conduct. I don’t thing there is any better way to lead and educate than to set an example.

Not all Chief Compliance Officers succeed in this role and some get subject to discipline. Here are some ways to get in trouble.

Participation in Wrongful Conduct

David A. Zwick, chief executive officer and chief compliance officer of Suncoast Capital Group, Ltd. was held liable for participating in a scheme with a salesperson he supervised to provide kickbacks to a bond trader.  In exchange for the kickbacks, Suncoast received securities transactions at prices favoring Suncoast and provided signification compensation to Zwick. He was found to have knowingly or recklessly approved fraudulent prices on Suncoast trades.

Failure to Supervise

In its release for Rule 206(4)-7 SEC Release No. IA-2204 the SEC stated:

Having the title of chief compliance officer does not, in and of itself, carry supervisory responsibilities. Thus, a chief compliance officer … would not necessarily be subject to a sanction by us for failure to supervise other advisory personnel. … Section 203(e)(6) provides that a person shall not be deemed to have failed to reasonably supervise another person if: (i) the adviser had adopted procedures reasonably designed to prevent and detect violations of the federal securities laws; (ii) the adviser had a system in place for applying the procedures; and (iii) the supervising person had reasonably discharged his supervisory responsibilities in accordance with the procedures and had no reason to believe the supervised person was not complying with the procedures.

Clearly a CCO has a role in addressing serious misconduct by employees. For an investment adviser, the CCO could be a supervisor and the failure to adequately supervise could subject the CCO to discipline for failure to supervise.

Pre-packaged policies and procedures manual

Consulting Services Group did that and failed to meet the SEC’s standards. Unfortunately for them, the pre-packaged manual did not match up to its business. They provide consulting services to mostly institutional clients. It helps them search for and select money managers, allocate assets, review performance, and design investment policies. The pre-packaged policies and procedures manual “failed to address adequately the conflicts of interest unique to CSG’s operations as a pension consultant, and many of the sections within these generic forms were completely inapplicable and irrelevant to CSG’s provision of investment advisory services to clients.” I would guess they manual they bought was designed for a retail investment adviser.

Email server

Among the things Richard Campanella was disciplined for was the failure to stop the use of non-company email. He received several emails from an employee and told him to stop using the outside email address. Even after three warnings, he field to discipline the employee. Apparently, the employee used the email extensively for business purposes. The end result was record-keeping failure.

Background checks

Westpark Capital’s Chief Compliance Officer was William Morgan. “Among other things, Morgan was responsible for maintaining and updating the Firm’s written supervisory procedures, supervising the branch office managers, performing background investigations and participating in hiring decisions, and determining whether representatives required heightened supervision and the parameters of that heightened scrutiny.” Unfortunately, the company hired some representatives who engaged in churning and made unauthorized and unsuitable trades in customer accounts.

Reporting

Tim Poulus, the Chief Compliance Officer for Olympia Asset Management, failed to report customer complaints to FINRA. (FINRA Case #2008011806301) That statistical and summary information required by NASD Rule 3070(c). The violation lead to a $10,000 fine.

Sources:

Fail is by Amboo who?

Fraud Awareness Week

The Association of Certified Fraud Examiners is urging organizations worldwide to participate in International Fraud Awareness Week, November 7-13, 2010 to help cast a spotlight on the problems arising from fraud.

This weeklong campaign encourages business leaders and employees to proactively take steps to minimize the impact of fraud by promoting anti-fraud awareness and education.

In its 2010 Report to the Nations on Occupational Fraud & Abuse the ACFE found that:

  • Fraud schemes are extremely costly. The median loss caused by the occupational fraud cases in the ACFE study was $160,000. Nearly one-quarter of the frauds involved losses of at least $1 million.
  • Schemes can continue for months or even years before they are detected. The frauds in the study lasted a median of 18 months before being caught.
  • Occupational fraud is a global problem. Though some findings differ slightly from region to region, most of the trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred.
  • Small businesses are especially vulnerable to occupational fraud. These organizations are typically lacking in anti-fraud controls compared to their larger counterparts, which makes them particularly vulnerable to fraud.
  • Tips are key in detecting fraud. Occupational frauds are much more likely to be detected by tips than by any other means. This finding reinforces the need for promoting awareness to foster an informed workforce.

The 2010 Report to the Nations is available for download online at the ACFE’s website: ACFE.com/RTTN. The Report is in PDF format

Become an Official Supporter
There’s no charge to become an official supporter of International Fraud Awareness Week. You will receive downloadable anti-fraud resources, as well as a logo to post on your company or organization’s web site. You will also be provided with a customizable press release to send to local media announcing your involvement in this important movement.

Influence Future Professionals
Speak to local university students enrolled in business, management and accounting courses about the importance of being trained in the detection and prevention of fraud.

Reduce Risk
Send an email to clients outlining the risks and cost of fraud. Encourage them to reduce their fraud risk.

Spread the Word
Encourage other colleagues and students to become involved with the ACFE in the fight against fraud.

Host an Anti-Fraud Seminar
Hold a free fraud prevention seminar in your community. Download anti-fraud resources or contact [email protected] for more information.