The Republican Agenda and Private Real Estate

Since President Trump is deep in private real estate, maybe there will be some good things coming to the industry during his administration. 

There were six major themes that President Trump campaigned on the most:

  1. Immigration and the wall
  2. Trade fairness
  3. Tax changes
  4. Healthcare changes
  5. Dodd-Frank changes
  6. De-regulation in general

Other than immigration, President Trump has proven himself to prefer to make policy through the 140 characters in Twitter, instead getting deep into the policy weeds. We need to look to Congress for a legislative blueprint, since President Trump does not seem to have one.

What does the Republican leadership in Congress want do? Specifically what do Paul Ryan in the house and Mitch McConnell in the Senate?

What can they convince the House and Senate to do? 

That is the big question right now with the American Health Care Act. The Republican house is torn between those who think the bill goes too far and those who think it doesn’t go far enough. Many campaigned on just the repeal part. Many others learned that what their constituents didn’t like about Obamacare is that is too expensive. The American Health Care Act only does one of those.

Speaker Ryan has promised a vote on the Republican healthcare bill on Thursday to coincide with the 7 year anniversary of the Affordable Care Act. We’ll see if Speaker Ryan is able to shepherd this very unpopular bill through the House and get enough votes.

Then what?

Most likely tax reform. Speaker Ryan published his “A Better Way” white paper in June of 2016. Unlike the American Health Care Act, legislators have been able to look at this already. Here are some of the highlights. 

  • Biggest change is the Border Adjustment Tax (unlikely to affect real estate directly.
  • Fewer tax brackets
  • Top rate of 33% for individuals 
  • Limit pass-through income from partnerships and LLCs to 25%
  • Lower corporate tax rate to 20%
  • Eliminate deductibility of interest expenses.
  • Individuals only taxed on half of their dividend and capital gains
  • Immediate cost recovery for investments instead of a depreciation schedule. (not clear on real estate)
  • Net Operating Losses can be carried forward and be adjusted for inflation
  • Eliminate the Alternative Minimum Tax,
  • Eliminate the estate tax
  • Eliminated Obamacare taxes (the last one is the healthcare bill)

President Trump mentioned removing favorable treatment of carried interest during the campaign. That is not Speaker Ryan’s blueprint. It’s been threatened before and survived.

After that, or during that, is financial de-regulation. Chairman Jeb Hensarling of the House Financial Services Committee has been working hard on his Dodd-Frank off-ramp for the last six years pushing bits of legislation through his committee and on to the House floor. The  Financial Choice Act has been floating around for a year and packages that work into one package.

“As the dust begins to settle on the post-crisis response, however, there has been a growing recognition that financial regulation has become far too complex and too intrusive and places too much faith in the discretion and wisdom of bank regulators.”

Here are some highlights:

  • Pitch is to help community banks.
  • Adjust capital requirements – removing Basel requirements
  • Make credit more available
  • New Bankruptcy code for financial institutions
  • Repeal FSCO’s Systemically Important Financial Institution designation powers
  • Reform Consumer Financial Protection Bureau
  • Federal Reserve Reform
  • Repeal the Volker Rule
  • Repeal Dodd-Frank registration requirements for private equity firms
  • Expand definition of accredited investor: Same income and net worth tests, but adds financial services experience or some sort of qualifying experience.

As much as the Republicans are campaigning against de-regulation the Financial Choice Act does not define “private equity firms” and requires the SEC to promulgate a new regulation to define it. SEC registration was on the edge during Dodd-Frank, The house version of the bill and the Senate version of the bill took opposite approaches on whether to subject private equity firms to SEC registration. During hearings, private equity kept being equated to leveraged buyouts that bankrupted companies and put people out of work to enrich corporate raiders.

 

I presented the above to PartnerConnect East 2017 yesterday. 

 

Sources:

A Better Way” white paper

Compliance Bricks and Mortar – St. Patrick’s Day Edition

Since I work in Boston and my office is next to the Black Rose, it’s hard to ignore St. Patrick’s Day. And yes, the Black Rose was already full of drinking patrons at 9:00 am. Getting past all the Irish cheer, these are some of the compliance related stories that recently caught my attention.

Super Hedge Fund by Sharon Hannes in Harvard Law School Forum on Corporate Governance and Financial Regulation

Activist hedge funds revolutionized corporate America and generated both excitement and criticism alike. This article suggests that a novel market mechanism, a “super hedge fund,” would maintain the benefits of hedge fund activism, while curbing its downsides. The super hedge fund would not really be a fund but, rather, a contractual arrangement among a broad group of institutional investors and a task force of financial experts. The task force would pool together the potency of the institutional shareholders in a sophisticated manner and then unleash its sting on target corporations. [More…]

Besides greed, what motivates insider traders? by Andrew Snyder

Insider trading is strikingly similar to espionage: stealing information for personal gain or spying for the benefit of another entity. The magnitude of a tipper passing confidential company information and a government insider such as Edward Snowden who hands over national classified secrets are incomparable, but what’s similar is who’s doing the lying, cheating, stealing and why they’re doing it. [More…]

“And” Or “Or” – This Ninth Circuit Opinion Highlights The Difference by Keith Paul Bishop in California Corporate Securities Law

“And” and “or” are classified as conjunctions. They are classified as such because they yoke together words, phrases, clauses and sometimes even sentences. They are not interchangeable, however, as illustrated by the recent opinion by the Ninth Circuit Court of Appeals in Zetwick v. County of Yolo, 2017 U.S. App. LEXIS 3260 (9th Cir. Cal. Feb. 23, 2017). [More…]

Connecting Fraud, Pressure, and Culture by Matt Kelly in Radical Compliance

My theme was fitting the fraud triangle to your organization’s risks—and as sometimes happens, I stumbled into an insight while speaking that was so useful, I wanted to share here.

First, let’s remember the fraud triangle itself. That’s the device auditors use to help think about how fraud might strike an organization. It has three legs: rationalization, opportunity, and pressure.

My contention is that for each leg of the fraud triangle, an opposite force exists.

[More…]

Image: Copyright: xmocb / 123RF Stock Photo

The Case of the Security Guard with Ketchup on his Hands

With the flow of announcements from the Securities and Exchange Commission, odd things will catch my eye for further review. For the insider trading case against Todd David Alpert, it was because the SEC said that he “worked as a security professional at the home of a Heinz board member.” A tilt of my head left me wondering what kind of securities professional was working at the home of a board member.

That was me confusing “security professional” with “securities professional.” Of course, I realized that “security professional” was a fancy term for security guard. But by the time I realized my mistake, I was deep into the complaint against Todd David Alpert.

Once I realized he was a security guard I immediate thought of the railroad insider trading case. I was ready to give Mr. Alpert credit for leveraging his position. I assumed he had identified the comings and goings from his post and tied that into what was going on behind the scenes.

I was thinking of the defenses from the railroad workers noticing the action in the railyards or counting cars at WalMart.

Then my jaw dropped.

The problem was the board member. The unnamed board member would forward emails to the Mr. Alpert in his role as a security professional, and ask him to print the email and attachments.

The Board Member forwarded an email regarding the potential Heinz acquisition with a direction to “print now”. The attachments to the email contained materials that would be discussed on an upcoming Heinz board of directors’ call, including a copy of the revised acquisition proposal letter, which included the word “CONFIDENTIAL” in boldface and stated that the proposed price for Heinz for $72.50 per share.

From the timeline presented in the case, Mr. Alpert read the attachment and quickly bought Heinz stock and options.

I can’t believe the board member was forwarding this incredibly sensitive information to the security guard to print. Who was this board member that was too lazy or incompetent to print a document on his own?

I pulled up the list of board of directors to see.  I couldn’t pull the pieces together. Then I got distracted when I saw that Lynn Swann, the ex Pittsburgh Steeler was on the board. One of those 12 does not know how to print email attachments.

Sources:

Financial Choice Act

Congress is currently occupied with health care. That is just one item on the agenda for the Republican leadership in Congress and President Trump. All have mentioned in one way or another to undo some of the evils of Dodd-Frank.

The big questions is how long will it take to move the American Health Care Act through Congress and deliver a bill that President Trump will be willing to sign. The second question is whether Congress will be able to move forward with any other legislation while dealing with health care.

Whenever Congress is ready to work on other legislation, Jeb Hensarling, Chairman of the House Financial Services Committee, has a law he is ready to move forward: The Financial Choice Act.

The Financial Choice Act is the bill that he sees as undoing many of the evils of Dodd-Frank.

“As the dust begins to settle on the post-crisis response, however, there has been a growing recognition that financial regulation has become far too complex and too intrusive and places too much faith in the discretion and wisdom of bank regulators.“

It has many of the things you might expect: repealing the Volker Rule, adjusting bank capital requirements, limiting the powers of the Consumer Financial Protection Bureau, limiting the powers of the Financial Stability Oversight Council, limiting regulatory limits on community banks.

Two items struck me as particularly relevant to private funds: SEC Registration and the definition of accredited investor.

Section 452 changes the definition of “Accredited Investor.” It keeps the two current brightline tests of income and net worth. I think those are key tests given the illiquid nature of private placements. It fixes those standards and removes Dodd-Frank’s requirement that the SEC adjust the amounts every four years.

The bill adds in a third test, allowing anyone licensed as a broker or investment adviser to also be an “accredited investor.” It adds a fourth test, allowing the SEC to create a regulatory regime for individuals to prove that the knowledge, education or job experience to allow them to invest in private placements.

We have seen from SEC Acting Commissioner Piwowar that he on board with opening up the definition of accredited investor.

The bigger change for private equity funds and probably for real estate funds is that it exempts “private equity fund” managers from the registration and reporting obligations of the Investment Advisors Act.

As you might expect, the bill does not take the time to define “private equity fund.” It gives the SEC six months to issue a rule for the definition.

The arguments are that private equity should be treated like venture capital. Private equity does not pose systemic risk. Private equity investors are generally sophisticated. The SEC would be more effective focusing its exam efforts on retail investment advisers.

Obviously this bill is a long way from being enacted. These two small provisions could easily be eliminated from the final law during the legislative process. I expect health care is going to bog down Congress for a long time.

Sources:

Compliance Bricks and Mortar for March 10

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

SEC Reduces Whistleblower Bounty Based On Culpability And Delayed Reporting by Harris Mufson, Steven J. Pearlman and Amy Blackwood in Proskauer Whistleblower Defense

On February 28, 2017, in an Order almost entirely devoid of detail, the SEC announced that a whistleblower will receive 20% of any monetary sanctions collected in an enforcement action commenced as a result of the whistleblower’s tip. The SEC is giving this “reduced” award while acknowledging that the whistleblower (1) was “culpable” in the securities violation at issue, and (2) unreasonably delayed reporting the company’s wrongdoing to the agency. [More…]

Beware of “Virus-Infected” Emails Purportedly From the SEC!!! in TheCorproateCounsel.net

Whoa! Last week, a member received an email claiming to be from EDGAR/SEC that had an attachment for revised 10-K filing instructions. She forwarded the email to her IT department – & it turned out the attachment was a “very nasty piece of malware” that could have infected the entire company. It was a phished email that came from a SEC email address ([email protected]) with a subject line of “Important changes to Form 10-K and Instructions.”

So beware! This is quite a tailored type of malicious email for an in-house lawyer to be receiving! Yesterday, the SEC posted a notice about this phishing scam.

You get what you ask for by Jack Vinson in Knowledge Jolt with Jack

This topic is familiar in many management circles: If you look for something, you will likely find it. If people know you are monitoring or looking for something, they will make an effort to supply that thing. And on the other side, if you don’t ask for that thing / report / result, you won’t get it. [More…]

SEC Enforcement Arm Braces for Cutbacks

The SEC’s enforcement arm is bracing for budget cutbacks that may result in fewer enforcement cases, Bloomberg writes.

Already, the department has halted non-essential travel and the hiring of outside contractors who help in-house lawyers with cases, sources tell the publication. [More…]

Terrorism Financing Via Bitcoin May be Exaggerated by MARA LEMOS STEIN

Law enforcement and regulators best take a measured approach in tackling the potential increase in the use of virtual currencies to finance terrorist activities, as there is still scant evidence the nascent technology will become a preferred method of cash transfer and other means of funding remain readily available and hard to track, said a U.K. intelligence think-tank. [More…]

Inadvertently Obtaining Custody

The concept behind the custody rule is simple. The adviser needs to hold client assets safely and needs a third -party to verify that the adviser is actually holding the assets. But as it’s been put in place, the Custody Rule is complicated. At times the SEC has needed to provide guidance, and then provide further guidance  to the guidance.

In fairness, part of the problem is that there are so many different business models employed by registered investment advisers that it is hard to have things work for all of them.

The latest guidance under the Custody Rule has to do with some of the arrangements in place between advisers and their custodians. It turns out that some standard custody agreements grant advisers broader access to client funds and securities than the advisers’ agreements with their clients.

The SEC’s Division of Investment Management issued a Guidance Update discussing situations when an investment adviser may inadvertently have “custody” of client assets pursuant to Rule 206(4)-2 under the Advisers Act of 1940.

The Guidance warns advisers to look for custody agreements that permit an adviser to instruct the custodian to disburse or transfer assets. That creates “custody” even if the adviser does not actually give those instructions or the advisory agreement with the client does not permit the adviser to do so.

The fix? The Guidance says to send a letter to the custodian that limits the adviser’s authority and to have the client and custodian provide written consent to acknowledge the arrangement.

The way I read that is to fix the custody agreement.

Staying on the custody theme, the SEC staff issued a no-action letter to the Investment Adviser Association on the use of a standing letter of authorization with a client to transfer assets to a designated third party.

The SEC takes the position that a SLOA grants access to the client’s assets. The transfer instructions come from the client, but the adviser is involved so that invokes custody.

To fix that custody problem, the SEC lays out seven steps that need to be implemented and requires a n update to Form ADV Item 9 next year.

One theme is that the SEC is indicating a willingness to provide relief under the Custody Rule when an adviser has taken steps to mitigate the mitigate potential harms to its clients by these Custody Rule foot-faults.

Sources:

The Fearless Girl

The sculpture, titled “The Fearless Girl,” was made by Kristen Visbal and photographed by Federica Valabrega.

State Street Global Advisors conspired in the middle of the night to drop a statue in Bowling Green Park of a girl facing off against the famous Wall Street Charging Bull. It’s part of a campaign by SSGA to emphasize that companies with women in top positions perform better financially.

SSGA manages nearly $2.5 trillion for institutional investors, predominantly in index funds. It has the power to exert enormous influence if it chooses to do so.

“State Street Global Advisors is issuing new gender diversity guidance to the more than 3,500 companies we invest in across three major regions (US, UK and Australia), designed to increase the number of women on corporate boards. As one of the largest investment managers in the world and a significant shareholder we believe that board diversity enhances board quality and effectiveness as it brings together directors with different skills, backgrounds and expertise.”

SSGA is bringing the hammer:

“In the event that companies fail to take  action to increase the number of women on their boards, despite our best efforts to actively engage with them, we will use our proxy voting power to effect change — voting against the Chair of the board’s nominating and/or governance committee if necessary.”

One compliance concern is SSGA’s role as an investment adviser, and therefore a fiduciary. SEC rules give advisers great latitude to set its own proxy voting policy. See Rule 206(4)-6. I would assume from the press release that SSGA has implemented a new written proxy voting policy. I expect that we will see a new description of the policy in the Form ADV filing later this month.

SSGA pulled together research to show that having more women on boards is a better financial choice for companies. MSCI ESG Research’s research shows that companies in the MSCI World Index with strong female leadership generated a Return on Equity of 10.1% per year versus 7.4% for those without (as of September 9, 2015, measured on an equal-weighted basis)

Sources:

The SEC Is Using Satellites To Hunt For Fraudsters

I did not find the headline to be remarkable: SEC Charges Mexico-Based Homebuilder in $3.3 Billion Accounting Fraud. The subtitle caught my attention:

SEC Uses Satellite Imagery to Crack Case

We learned from the Rajaratnam insider trading case that the SEC was using wire taps and informants as part of its securities fraud investigations. The SEC is clearly stepping up a notch by using satellites to hunt for fraudsters.

The Securities and Exchange Commission caught Mexico-based homebuilding company Desarrolladora Homex S.A.B. de C.V. in a lie and forced it to admit that it had reported fake sales of more than 100,000 homes during a three-year period. From at least 2010 through 2013 Homex improperly recognized billions of dollars of revenue by systematically and fraudulently reporting revenue from the sale of tens of thousands of homes annually that it had neither built nor sold.

This all comes to late for investors in Homex. Its securities were, until April 2014, dually listed on the New York Stock Exchange and the Mexican Stock Exchange. In 2013 Homex had begun defaulting on its debt obligations and repeatedly failed timely to file quarterly and annual reports with the SEC. In April 2014, Homex filed for the Mexican equivalent of bankruptcy reorganization.

Homex’s Real Estate Project 877 (named “Benevento” and located in the Mexican state of Guanajuato) is illustrates the fraud. Homex’s senior management identified Benevento to the SEC as one of the Company’s top ten real estate development projects by revenue. Homex provided Benevento’s project plan (identifying the location, block and lot number of each planned housing unit), and details (by block, lot number, sale price and sale date) of the Benevento sales that Homex had included in its financial statements. These documents stated that all of Benevento’s planned units had been built and sold, and that Homex had recognized and reported that revenue by December 31, 2011.

However the SEC pulled up satellite images taken in March 2012 that reveal that hundreds of those very same Benevento units remained unbuilt.

Sources:

Compliance Bricks and Mortar for March 3

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

Detecting Managed Earnings With CEO Profiles by Tri Nguyen, Chau Duong and Sunitha Narendran in the CLS Blue Sky Blog

We offer the PSCORE, a composite grouping of individual characteristics linked with a higher likelihood of earnings management by prior research. We identified nine individual variables or signals from existing research to develop the PSCORE. These signals or variables can be sorted into four categories: financial expertise, personal reputation, internal power, and age. We used finance-related working experience and qualifications as the signals for financial expertise. The length and performance of a CEO’s tenure as well as how often the media mentioned the CEO were used as signals for personal reputation. The signals for internal power included information about other significant positions a CEO held in a company (e.g. chairman, founder). Age was captured from curricula vitae in the public domain disclosing the actual age and distance from retirement of a CEO. [More…]

SEC Opinions Underused by Enforcement Targets, Official Says by Rob Tricchinelli in Bloomberg BNA

Parties accused of wrongdoing by the SEC don’t take full advantage of the commission’s opinions in guiding their defense, a top agency enforcement official said Feb. 24.

As it handles enforcement cases, the Securities and Exchange Commission often issues legal opinions, which cover many areas of securities laws that federal-court cases don’t reach as frequently.

“It’s really a missed opportunity to not be aware of what they are,” Joseph K. Brenner, chief counsel in the SEC’s Enforcement Division, said at a panel during the Practising Law Institute’s “SEC Speaks” event in Washington. [More…]

Will Blockchain Transform Compliance? by Tom Fox in the FCPA Compliance Report

This is made even more powerful in the area of financial reporting. Typically, a search is “horizontal (across the web) and vertical (within particular websites). What you find can be out-of-date or inaccurate in other ways. On a blockchain, though, there’s a third dimension: sequence. In addition to being able to obtain a historical picture of the company since it was incorporated, you can see what has occurred in the last few minutes.” The authors correctly note, “The opportunity to search a company’s complete record of value will have profound implications for transparency as it brings to light off-book transactions and hidden accounts. People responsible for records and reports will be able to create filters that allow stakeholders to find what they are searching for at the press of a button. Companies will be able to create transaction ticker tapes and dashboards, some for internal use”. This would be extremely helpful in the difficult vetting of third parties around financial information. [More…]

And the Oscar for Control Failures Goes to… by Matt Kelly in Radical Compliance

If a company has multiple versions of a report floating around (which, in abstract terms, is what happened here), that tells me to look more at the risk assessment and control activities. Someone handing an announcer the wrong envelope is not a far-fetched risk to imagine; when you include the sky-high reputation consequences for PwC, it seems like a singularly easy risk to identify and anticipate. (COSO Principle 7: “Identify and analyze risks.”)[More…]

The SEC Is Serious About Protecting Seniors

It was a real estate fraud action that caught my eye, but the victims that kept me reading. The Securities and Exchange Commission filed charges against Paul Garcia and his fund management company, Caliber Capital, for defrauding investors.

Since it was a real estate fraud, it caught my eye. But I didn’t have to dive into the murky waters of what is a security and what isn’t a security. Garcia is alleged to be selling interests in a fund and then not using the money as he said he would. I don’t see any argument that passive interests in an investment fund could be anything other than securities.

Mr. Garcia enticed investors to invest in a golf course purchase and shuffled money to keep things going. Things did not go well and Caliber Partnership filed for bankruptcy in January 2016. The lender foreclosed and the investors are likely left with no assets from the partnership. Even with the underlying asset being real estate, it does not change the nature of the interests.

What caught my eye in the case was the SEC inclusion of one investor in particular in the press release and the complaint:

“The investors included an eighty two-year-old who invested $250,000 in Caliber.”

This may be a common tactic for the SEC to gain sympathy for the investors and to paint the alleged fraudster as being particularly sinister.

I went back to the SEC’s 2017 priorities. One of the priorities for examinations is senior investors and the issues around them. I expect we may see more SEC press releases mentioning the little old lady from Pasadena who got bilking by a fraudster.

If your investors include that little old lady from Pasadena, the SEC is going to use that fact.

Sources: