Weekend Listening: Lincoln in the Bardo

George Saunders’s first novel is a weird, wonderful and woeful book about young Willie Lincoln, son of the President, who is trapped in the “bardo.” That is a Tibetan term for the intermediate state or gap we experience between death and our next rebirth. 

Willie has died and been taken to Oak Hill cemetery, buried in a marble crypt. Based on true historical data, on at least two occasions the president visits the crypt to mourn the loss of his son. The cemetery is populated by the spirits of the dead who have been unwilling to complete their journey to the afterlife and in the bardo. They have continued to remain near their corpses.

The spirit’s narrative is interspersed with quotations from primary and secondary sources about Lincoln’s life. They paint conflicting depictions of the president and his mental state. The spirits themselves are conflicted, referring to their coffins as “sick boxes”, as part of their strategy to avoid facing the reality of their deaths.

The spirits are motley assortment: soldiers, rapists, slaves, drunks and a hundred others. Their advice is also an assortment of conflicting advice on whether to stay or go.

I’ve been consuming a great number of books year as audiobooks. Lincoln in the Bardo is one of the best produced audiobooks. It has a cast of dozens voicing the spirits who are the main characters of the book. That includes the wonderful Nick Offerman and David Sedaris as the lead spirits. There are different voices for the main historical quotes. In total the audiobook production has a 166-person cast.

The narrative readings are as compelling as the words in the novel themselves. This a book you should add to your to-read stack or to-listen library.

Compliance Bricks and Mortar for October 6

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

The Effectiveness of SEC Enforcement in Deterring Financial Misconduct by Shiu-Yik Au

This paper examines how the Securities and Exchange Commission’s (SEC) enforcement actions and whom they target deter future financial misconduct. An enforcement action reduces the incidence of misconduct in other firms in the same industry and metropolitan statistical area (MSA) in the future. Furthermore, an enforcement that punishes a guilty company has a larger deterrence effect on future misconduct than punishing an officer, auditor, attorney, or other entity. In addition, the results are robust to using alternative measures of financial misconduct such as restatements and Fscore. These results have several policy implications on how regulatory agencies can maximize the value of their enforcements. [More…]

Simple Ethics Lesson of Tom Price by Matt Kelly in Radical Compliance

More than anything else, Price’s misconduct is an object lesson in where compliance policies come from. Someone does something stupid, everyone else recognizes it as stupid, and the ensuing clamor results in a new control. The control applies to everyone, makes the organization less efficient, and leaves employees grumbling. [More…]

Annual Reviews and Compliance’s Role: Annual Reviews of Policies and Procedures by Bailey Naples

One option, if you have the support, is to set up a policy review committee. If you are fortunate enough to have a Compliance Committee already established you can tie this right into your normal routine. The committee can divide up the policies between members to review and then they’ll report back to the committee at the next meeting. Forming a committee divides the work-load and holds all members to the deadline of review keeping the process moving along. [More…]

The lay of the law and private funds risk by Rebecca Akrofie in PFM

There’s no doubt private fund managers are becoming increasingly exposed to legal action, with portfolio company-related litigation being the most common. So far this year, big names like Benchmark Capital, Sycamore Partners and Apollo Asset Management have all become involved in lawsuits related in some way to the assets they own.
Marco Pierettori, general counsel at InvestIndustrial, a Europe-focused private equity firm, and Timothy Mungovan, a partner at Proskauer, an international law firm, share their thoughts on this trend, and the other legal headwinds fund managers should be aware of.

Concern: Fund liability for portfolio company problems …

Concern: Conflicts in co-investments …

Concern: Unicorn valuation mis-steps ….

Concern: Cybersecurity …

[More…]

From Saturday Morning Breakfast Cereal:

This comic’s author has a new book coming out:
Soonish
Ten Emerging Technologies That’ll Improve and/or Ruin Everything
By Kelly and Zach Weinersmith
From a top scientist and the creator of the hugely popular web comic Saturday Morning Breakfast Cereal, a hilariously illustrated investigation into future technologies–from how to fling a ship into deep space on the cheap to 3D organ printing. Order it today

The One With A Cascade of Bad Choices

Rusty Tweed may have been trying to make good investments for his clients. He knew a guy that had a new quantitative trading strategy for blue chip stocks. Rusty raised money form his clients to invest with the quant manager.

Problems started right at the beginning, according the complaints filed by FINRA and the Securities and Exchange Commission.

Tweed could not open the brokerage account because of financial arbitration complaints against him. Instead of opening the account, he created a feeder fund to invest in a master fund that would be invested by the quant manager.

Tweed raised $1,635,000 from 23 of this clients. However, the PPM for the fundraising failed to disclose the fees charged by the quant manager. FINRA also decided that Tweed should have disclosed that he had to set up the feeder/master structure because of the disciplinary problems. I guess that it did not work in the real world.

The quant manager’s strategy apparently didn’t work and Tweed withdrew the money. That quant strategy was theoretical and based on backtested performance. The strategy was still in the testing mode when Tweed made the investment.

After the quant strategy, Tweed sent the cash to QAMF as a replacement master fund. Tweed failed to update the PPM to describe this new strategy and apparently failed to tell his existing investors about the change. QAMF was also more expensive, taking a 3.5% annual fee and 20% of the profits.

Six months later, Tweed felt that QAMF was under-performing and asked for a return of capital. QAMF was willing to return 2/3 of the capital, but 1/3 was invested in an illiquid asset. That turned out to be an investment in a gold venture in Ghana. Rather than being honest with investors, Tweed merely told them that the “the money was locked up for another year.” QAMF transferred the investment directly to Tweed’s fund.

Tweed failed to write down the value of the Ghana gold for two years and then only partially. Tweed has not recovered anything from that investment.

A year later, still stuck with gold investment, the principal behind QAMF was arrested for bank fraud charges and plead guilty.

Of the 2/3 returned to Tweed’s fund, he caused $200,000 to be invested in a software company owned by a friend that was to pay 18% interest quarterly. None of the interest was paid, nor was the loan re-paid before the software company went into bankruptcy. Tweed never disclosed the bankruptcy filing to fund investors.

Tweed had issued financial statements to investors that showed positive returns. Tweed allowed investor redemptions at the inflated values. One of those was Tweed’s profit sharing plan, benefiting Tweed and his employees. Tweed began to prioritize redemptions over others, allowing his family members to redeem.

Tweed was hit by a state regulator with a deficiency letter for failing to issue audited financial statements.

The SEC commenced an examination of the investment advisory firm that Tweed was associated with. During the exam, the IA’s CCO discovered Tweed’s misconduct. The CCO ordered corrective action be taken. According to the SEC’s complaint, that corrective action was incomplete and failed to fully disclose the problems.

That is a long list of poor decisions and misconduct piled on top of poor decisions and misconduct.

Sources:

The First Ever Cryptocurrency Back By Real Estate

The First Every Cryptocurrency Back By Real Estate, REcoin, is a big scam. At least according to the Securities and Exchange Commission.

Several weeks ago the SEC posted an Investor Bulletin in Initial Coin Offerings. In the bulletin, the SEC raised the issue that an initial coin offering could easily be considered an offering of securities, which would require compliance with the securities laws. The SEC warned that fraudsters had begun using ICOs as fraudulent investment schemes.

It seems easy to paste together some mumbo-jumbo to make it sound like the blockchain could be something useful and disrupt an industry. You can add dash of hope for the conspiracy freaks by noting the ICO is free from government fiat and the Federal Reserve. Add in the lure of big profit. Then rope in the suckers.

You can see all of that in the white paper for REcoin.

  • 100% (less the cost of maintenance) of proceeds from the sale of REcoin are invested in real estate
  • REcoin Trust guarantees 70% of the investors’ market value, against the US Federal Reserve’s 10%

The SEC alleges that REcoin misstated to investors that it had a “team of lawyers, professionals, brokers, and accountants” that would invest REcoin’s ICO proceeds into real estate. In fact none had been hired or even consulted.

REcoin was “backed by secure real estate investments in the world’s most advanced economies” and touted that the asset’s “security is ensured through the use of one of the soundest and most reliable currency backings there is: real estate.” REcoin never purchased any real estate, either before, during, or after the REcoin ICO, with the proceeds of the REcoin ICO or otherwise

REcoin misrepresented that it had raised between $2 million and $4 million from investors when the actual amount is approximately $300,000. Sadly, I suspect it has all been pilfered or misused. Investors who transferred funds to REcoin never received any form of digital asset, token, or coin, and no token or coin for REcoin has ever been developed.

I think there will be some interesting uses for the blockchain technology. None of them involve coins.

Sources:

 

The Triumph of Lynn Tilton

Lynn Tilton and her firm, Patriarch Partners, are known for their high-risk, high-return investments in distressed companies. The Securities and Exchange Commission brought a case against her and the firm claiming that they were using improper valuations, failing to mark down assets when the investment became more distressed. Ms. Tilton chose to fight the charges and had to on the SEC’s home turf. The SEC chose to bring the case as an action in its administrative court’s instead of federal district court.

She fought a two-prong attack. The first was challenging the SEC’s use of an administrative court. The US Supreme Court September denied hearing the appeal of Lynn Tilton in her case arguing that the appointment of administrative law judges was Unconstitutional under the Appointments Clause.

That lead her back to fight her case in front the ALJ. Tilton won her case last week. Administrative Law Judge Carol Fox Foelak dismissed the SEC’s case. The judge concluded that the SEC failed to prove Tilton deceived the highly sophisticated institutional investors in her funds about the finances of the troubled companies in her underlying portfolio.

“I feel truly grateful to Judge Foelak,” Tilton said. “But it doesn’t change my opinion that cases like these belong in federal court. I absolutely feel my rights were compromised.”

According to Reuters, Tilton lawyer Randy Mastro of Gibson Dunn said he filed dozens of motions to obtain discovery that defense lawyers would have been entitled to see under the Federal Rules of Civil Procedure. Most were denied. Nor could Gibson Dunn lawyers depose SEC witnesses. (The SEC changed its rules in 2016 to give more discovery to defendants in administrative proceedings, but the new rules didn’t apply to discovery in Tilton’s case.) At trial, defense lawyers had to cross-examine SEC witnesses without prior knowledge of what they might say.

This is not quite the final say in the matter. Judge Foelak’s initial decision can be overturned by the SEC commissioners. That is part of what currently saves the ALJs under the Appointments Clause. It ultimately comes done to what the Presidentially-appointed SEC Commissioners decide.

Sources:

By No One’s Math Is 50 Percent a Vast Majority

There is no place for hyperbole or fudging numbers in disclosure of investment returns. The Boston office of the Securities and Exchange Commission made that point with Aegerion Pharmaceuticals in its enforcement case.

According to the SEC complaint, Aegerion’s CEO said that the “vast majority of patients” who were given prescriptions for one of its drugs were taking the drug. However, the more accurate statement was that approximately 50% were taking it.

The problem was that in order to start the drug therapy, patients needed to maintain a low-fat diet and to seek regular liver monitoring. As for side effects, patients could experience nausea, vomiting, and stomach pain. Plus there was the enormous cost of the treatment: approximately $250,000 to $300,000 annually. Patients’ medical insurance may not agree to extend coverage.

Therefore, stock analysts covering the company were very focus on this conversion rate from prescription to treatment. On the first quarter 2013 earnings call, when asked about the conversion rate, Aegerion’s CEO said that the percentage of patients who did not convert: “[i]t’s a very small number. It’s not material.” On the second quarter 2013 earnings call, Aegerion’s CEO stated about the conversion rate: “We haven’t given that percent. It’s high. It’s very high.” He further asserted that the “vast majority of patients” who were given prescriptions actually followed through and began therapy.

I will be the first to admit that those are fuzzy statements. But I agree that saying “very high” or “vast majority” is far more than 50%. According to the SEC complaint, analysts plugged 85% or 90% into their financial analysis of the company.

Things began to fall part on the fourth quarter 2013 earnings call when Aegerion admitted that more patients were reluctant to start taking the treatment than previously anticipated. It was not until the third quarter 2014 earnings call that Aegerion was more exact and more accurate when it disclosed that the conversion rate was in the “range of 50%-60%.” It should be no surprise that Aegerion’s stock price plummeted on the next trading day after that call. Clearly, analysts thought the “vast majority” was much higher than 50%-60%.

“By no one’s math is 50 percent a vast majority,” said Paul Levenson, Director of the SEC’s Boston Regional Office.  “When companies publicly discuss their financial data, they must be truthful.  Whether they supply hard numbers or give broader descriptions, they cannot mislead investors.”

The SEC’s actions is just part of Aegerion’s problems. It also is pleading guilty to criminal liability under HIPPA and civil liability for make false claims to a federal program. In a deferred prosecution agreement to resolve the HIPAA violations, Aegerion admitted that it obtained patients’ personally identifiable health information, without patient authorization, for commercial gain. Under the civil false claims settlement, Aegerion is paying a civil penalty for false claims submitted to government healthcare programs arising from its promotion of its therapy without a proper diagnosis.

Sources:

Weekend Reading: Behold the Dreamers

Imbolo Mbue created a great novel on immigration and the American Dream in her 2016 Behold the Dreamers. I admit that I only came to read this book because of a reading challenge. Book Riot’s Read Harder Challenge number 5 was to read a book by an immigrant or with a central immigration narrative. Behold the Dreamers was my choice for the challenge. It’s not a book I would have naturally grabbed to read. But that is the point of the challenge.

I found the book to be wonderful. The central character of Jende Jonga grapples with the financial crisis as Lehman Brothers collapses. It’s not that Jende, an immigrant from Cameroon, was working for Lehman Brothers. Jende had started driving a cab to support his family while waiting for his asylum application to be approved. His wife is with him on a student visa.

Jende knows that he may have to return to Cameroon if his application is unsuccessful. He has left that country for the hope of prosperity in America. Jende is joyous at being in America and believes in the American dream that hard work will lead to success.

His hard work allows him to move from driving a cab to working as a personal chauffeur for a Lehman Brothers executive. As you might expect, problems arise.

The writing is spectacular. The characters are wonderful. The depiction of the American dream and immigration are thought provoking. Behold the Dreamers will be an excellent addition to your reading list.

Compliance Bricks and Mortar for September 29

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

SEC forced to try new ways of pursuing bad financial advisers by Bruce Love in the Financial Times

The US investment regulator’s powers to recoup losses from financial advisers who break the law were dealt a blow by a landmark Supreme Court decision this summer. But the Securities and Exchange Commission has stressed to the FT that the court’s decision will have a limited impact on its ability to go after wrongdoers. In a June case, the court unanimously agreed that the SEC can recover money from individuals found guilty of violating federal securities laws only within five years of the incidents taking place. Previously there was no time limit. [More…]

SEC Probes Departure of PepsiCo’s Former Top Lawyer by Andrew Ackerman, Joe Palazzolo and Jennifer Maloney in the Wall Street Journal

Federal securities regulators are investigating an allegation by PepsiCo Inc.’s former top lawyer that the company fired her in retaliation for the way she handled an internal probe into potential wrongdoing in Russia, according to people familiar with the matter and internal documents. [More…]

Compliance Apologists: Being Liked vs. Being Respected by Roy Snell in the SCCE’s Compliance & Ethics Blog

You can’t have it both ways. You can either stop the problem and not be liked or you can back off, have big problems, and not be liked. When I was a compliance officer, I was not liked by everyone, particularly the people whose integrity was a little suspect. But, I was respected by people with integrity. [More…]

SEC Data Breach: Not Insider Trading, and Not Necessarily Subject to SEC Jurisdiction by John Reed Stark

In other words, with cyber thieves who trade on information stolen during a data breach, the SEC is extending unlawful insider trading to a third and new category of securities miscreant — “outsiders” — who do not work for (or with) the company, and who do not owe a duty to anyone. [More…]

3(c)(1) Funds vs. 3(c)(7) Funds by Alexander Davie

Indeed, avoiding investment company registration under the Act is often one of the critical first steps for a new private fund because it allows the fund to avoid the Act’s requirements of SEC registration, ongoing disclosure, disinterested directors, and its prohibitions on affiliated transactions and trading activities such as short sales and derivatives trading. In order to be exempt from registering as an investment company under the two most frequently used exemptions under the Act, the fund must (1) not make, or propose to make, a public offering of its securities and (2) either (a) limit the fund to no more than 100 investors (the 3(c)(1) exemption) or (b) limit the fund to “qualified purchasers” (the 3(c)(7) exemption).[More…]

The Evolution of the Private Equity Market and the Decline in IPOs by Michael Ewens, California Institute of Technology, and Joan Farre-Mensa, Cornerstone Research in the Harvard Law School Corporate Governance and Financial Regulation Blog

Taken together, our results suggest that the growth in the supply of private capital has allowed late-stage startups to continue financing their growth while remaining privately held. A natural question then follows: Are these startups increasingly staying private as a second-best response to their inability to go public—or are they choosing to stay private even though the option to go public remains open to them?[More…]

Diamonds Are A Sanctions Violation

On four separate occasions, an individual purchased jewelry from one of the Cartier boutiques located in California or Nevada for shipment to Shuen Wai Holding Limited in Hong
Kong. I’m sure the store routinely ships purchases around the world. The problem is that Shuen Wai Holding Limited is named as a Specially Designated Narcotics Trafficker pursuant to the Foreign Narcotics Kingpin Designation Act. Shuen Wai Holding Limited is associated with Wei Hsueh Kang and the United Wa State Army that produce opium out of Golden Triangle in Burma.

If a person is on the sanctions list, you can’t do business with them in the United States.

I had never thought about the sanctions list in the context of consumer transactions. It did bring to mind a story I heard while attending the FBI’s Corporate Compliance Officer Outreach Event several years ago. An agent told the story of a border guard who flagged through a car with a suitcase full of gift cards. The border guard was looking for cash and didn’t think twice about the gift cards. Of course the gift cards, have some limitations, but are just as good as cash in most instances.

The same could be true of Cartier. They many never have thought that their customers would be drug kinpin associates trying to launder money.

There is no background in the sanctions notice about the circumstances of the purchases, so I used my imagination to think of scenarios that I thought likely.

The first scenario that came to mind would be one of mistaken name. Cartier was audited and the shipping to Shuen Wai Holding Limited was a false positive. Cartier should have resolved it and did not. Assuming Cartier even checks shipments against the SDN list. That seems unlikely given that there was an enforcement action.

The second scenario was a foolish associate of Wei Hsueh Kang spending time in the US and looking for some fancy jewelry. The associate foolishly uses a real address instead of an anonymous one.

The third scenario is Wei Hsueh Kang actively used a weakness in Cartier’s shipping policies to launder money. The Cartier boutiques were located in California or Nevada. I assume that means Las Vegas, the home of gambling and lots of cash transactions. The casinos are going to check off-shore wires against the SDN list. With that path blocked, the associate chose instead to walk into the Cartier in the casino. There is one in the Wynn hotel. Or the associate could have walked down the street to the Las Vegas Forum or the The Shops at Crystals. The associate purchases a suitcase full of jewelry that can easily be resold. Or perhaps its unset diamonds or other precious items.

That looks like some a soft spot that money laundering syndicates could take advantage of. The Office of Foreign Assets Control points that out in the enforcement press release:

This enforcement action highlights the risks for companies with retail operations that engage in international transactions, specifically including businesses that ship their products directly to customers located outside of the United States. OFAC encourages companies to develop, implement, and maintain a risk-based approach to sanctions compliance, and to implement processes and procedures to identify and mitigate areas of risks. Some of the multitude of factors that a company could consider with respect to its compliance program is an assessment of its products and services, frequency and volume of international transactions and shipments, client base, and size and geographic location(s).

Sources:

New SEC Cyber Enforcement Initiative

Now that the Securities and Exchange Commission has some first-hand experience with cybersecurity and getting hacked, it has launched a new initiatives to address cyber-based threats.

There is new Cyber Unit originating in the enforcement division. Robert A. Cohen will be Chief of the Cyber Unit, stepping away from being Co-Chief of the Market Abuse Unit. The cyber unit will focus on:

  • Market manipulation schemes involving false information spread through electronic and social media
  • Hacking to obtain material nonpublic information
  • Violations involving distributed ledger technology and initial coin offerings
  • Misconduct perpetrated using the dark web
  • Intrusions into retail brokerage accounts
  • Cyber-related threats to trading platforms and other critical market infrastructure

According to Francine McKenna, one hacking case may involve the SEC itself. According to Ms. McKenna, the enforcement lawyers had a case based on non-public information stolen from the SEC’s system. It was this case that forced them to tell SEC Chairman about the breach.

Sources: