Compliance Bricks and Mortar for December 16

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

An Insider-Trading Ruling that Delights Prosecutors – And One Manhattan Judge by Roger Parloff in The New Yorker

Last week, prosecutors rejoiced when the U.S. Supreme Court decided an insider-trading case called Salman v. United States, and in doing so clarified that leaking confidential information so that friends and relatives can make money in the stock market is a crime, even when the leaker doesn’t get an economic benefit. Perhaps the person most pleased with the decision, however, was not a prosecutor but a certain white-haired Manhattan judge with a neatly trimmed, white beard. [More…]

US v. Newman – Not Quite Dead Yet by Gregory Morvillo in NYU Law’s Compliance & Enforcement

Last week the Supreme Court handed down a unanimous opinion in United States v. Salman.  It was a highly anticipated opinion by those of us who follow the evolution of insider trading law … and yes I recognize that following insider trading law is, at the least, a little bit geeky.  Nevertheless, many observers eagerly awaited the Supreme Court’s ruling.  As it turned out, the ruling was kind of a dud. [More…]

Trump’s businesses could trip insider-trading law by Isaac Arnsdorf in Politico

When Trump told the New York Times “the president can’t have a conflict of interest,” he was probably referring to the Ethics in Government Act, which exempts the president, vice president, members of Congress and judges, according to Brett Kappel, an attorney at the law firm Ackerman who specializes in politics and ethics. But the text of the STOCK Act explicitly includes the president. [More…]

This Weird United Airlines Case Just Happened by Matt Kelly in Radical Compliance

I speak of the SEC’s recent sanction against United Airlines, where the agency applied the spirit of the Foreign Corrupt Practices Act to a bribe United gave to a domestic government official here in the United States. That violation of United’s internal policies against bribery then became a books-and-records violation of the Securities Act, and presto: a $2.4 million fine against United on Dec. 2. [More…]

 

Compliance and Conflicts with Exxon Mobil and the Trump Administration

President-Elect Trump has many conflicts of interest as he prepares to take office. It’s been a long time since the president-elect has been so deeply involved in a active businesses. His appointment of Rex Tillerson as Secretary of State creates another batch of conflicts for the administration and for Exxon-Mobil.

As is typical with many public companies, Exxon-Mobil grants large chunks of deferred compensation to its executives. Mr. Tillerson is eligible for $175 million is stock compensation when he turns 65 in March.

The board of directors of Exxon is faced with a tough choice of granting the compensation early, before he becomes Secretary of State. That would deviate from company policy and be perceived as granting a favor as he assumes one of the most powerful posts in government.

This is not new territory. Halliburton suffered a big loss in reputation when it granted early retirement to Dick Cheney when he was elected vice-president.

If it does not grant early vesting, then Exxon will be in the position of granting a fortune to the Secretary of State while in office.

Although Mr. Trump controls his organization and can largely do what he wants at whim, Exxon is a public company and subject to tigher rules on what it can do. According to the 2016 proxy statement, Mr. Tillerson held almost 2 million shares in the company. He was granted another $18 million in stock at the end of 2015.

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What Kind of Car Does Your Fund Manager Drive?

In a new paper, researchers found that hedge fund managers who own powerful sports cars take on more investment risk and are more likely to engage in fraudulent behavior. The inverse is also true: Drivers of minivans tend to deliver less volatile returns, according to the study.

“Specifically, sports car drivers deliver returns that are 1.80 percentage points per annum more volatile than do non-sports car drivers. This represents a 16.61 percent increase in volatility over that of drivers who shun sports cars. Similarly, drivers of high horsepower and high torque automobiles exhibit 1.14 and 1.25 percentage points per annum more volatility, respectively, in the funds that they manage than do drivers of low horsepower and low torque automobiles.”

The researchers used four sets of hedge fund databases from 1994 to 2012 that included 58,068 hedge funds, of which 33,680 are still in existence. Then they tapped into vehicle purchase databases to try to match fund managers to their cars. Thye ended up with a set of 1774 vehicles to 1,144 hedge managers. Of those, they identified 163 sports cars and 101 minivans.

I’m a bit skeptical of the studies methodology at this point given how they have narrowed down the set to be studied.

But I continued on to the operational, and complaince aspects.

The study found that sports car drivers are 17.3% more likely to have a violation report on their Form ADV than the owners of other cars. Minivan owners are 44.6% less likely to a violation reported on Form ADV.

Some of this is attributable to marriage status. Minivan drivers are much more likely to be married. After looking at the impact the study still found that the results are not just a by-product of marriage.

Given limited complaince budgets, perhaps it may be useful on the next compliance report to ask your employees what kind fo car they drive to help you focus your compliance efforts on the sports card drivers.

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The Duchess and the Mouse Hole Cheat for Russian Athletes

Widespread cheating by Russian athletes has been uncovered. One of the key figures was Russian Dr. Rodchenkov who had breakthrough work on the detection of peptides and long-term metabolites of prohibited substances.

In the jargon of espionage, Dr. Rodchenkov was a double agent. While operating at the forefront of doping detection, he was secretly developing a cocktail of drugs with a very short detection window.

The doping was referred to as “Duchess.”

This was in connection with the mouse hole breach in the testing facility. In the dead of night, Russian officials exchanged the tainted urine from their athletes who had been doping with clean samples by passing them through a “mouse hole” drilled into the wall of the anti-doping lab.

The bottles were supposed to be tamper-proof. The Russian agents were able to open the tamper-proof bottles and replace the contents without detection. Upon closer inspection, investigators were able to identify bottles that were tampered with by identifying scratches on the inside of the bottle caps.

695 Russian athletes can be identified as benefiting from the manipulation to conceal potential positive doping controls. They have not yet been identified.

The reports reveals that the Russian Ministry of Sport manipulated the doping control process of the 2014 Sochi Games; the 2013 IAAF World Championships in Moscow; the 2013 World University Games in Kazan; and, put measures in place to circumvent anti-doping processes before the 2012 London Games.

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Compliance Bricks and Mortar for December 9

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

Luis Aguilar recalls harrowing times at SEC by Jeff Benjamin in Investment News

Mr. Aguilar, who served as an SEC commissioner from July 2008 through December 2015, recalls his first year as being “the most active period with internal restructuring and changes in the regulatory environment. And this was all before Dodd-Frank.” On dealing with such high-profile regulatory fumbles as Bernie Madoff’s infamous Ponzi scheme, Mr. Aguilar said there was plenty of confusion and fear. [More..]

Finra Fines Credit Suisse Unit Over Money-Laundering Failures by Samuel Rubenfeld in the Wall Street Journal

Credit Suisse expected its registered representatives to flag suspicious transactions for the anti-money laundering compliance department, which was then required to investigate the activity, Finra said. But the firm’s systems and procedures were not designed to detect transactions in order to cause the filing of a suspicious-activity report with the U.S. Treasury Department, Finra alleged. [More…]

The Domestic Corrupt Practices Act Arrives According to the SEC by Steve Quinlivan in Dodd-Frank.com

The Securities and Exchange Commission announced that the parent company of United Airlines has agreed to pay $2.4 million to settle charges for providing a public official with more convenient flight options. The parent company did not admit or deny the SEC’s findings …
Wow. So the books and records provisions can be interpreted like it’s the Domestic Corrupt Practices Act. I wonder if it will become in vogue to self-report these sorts of issues and spawn another web of FCPA, Inc. like practices to advise on these matters.[More…]

How Will the SEC Reach Quorum With Only Two Commissioners? by Broc Romanek in TheCorporateCounsel.net

No worries. Back in the 90s, President Clinton was slow to nominate new members to federal agencies and the SEC dropped down to a level of two Commissioners for a spell – Chair Levitt & Commissioner Wallman. In order to get business done, the SEC amended its rules to accommodate the Commission when it drops to such a low level. “The Rule of 2” – adopted in 1995 – is still on the books: [More…]

What We Learned About The Pay to Play Rules After The Election

CCOs did not sleep well for one. Monitoring employee contributions to political candidates is difficult. The political contributions do not originate from the firm, so there is no accounting control that you can put in place.

You can’t ban political contribution if you have an office in California. California labor law seems to make such a ban illegal.

You also risk a non-employee spouse making a donation in the name of both. Or you may think less of giving a donation to personal friend or friend of friend running for office.

That makes it easy to trip over the rule with a $500 donation. That happened to Pershing Square. Maybe.

An analyst gave a contribution to a failed candidate for the Governor of Massachusetts. The Governor appoints board members to the state pension fund. That pension fund was a client of Pershing Square.

But the candidate in question failed to garner support at the state convention and never made it onto the ballot. No voter ever had the opportunity to vote for this candidate.

It is not clear if the analyst was a “covered associate” under the rule. He occasionally participated in client meetings to discuss Pershing Square’s strategy and approach. But it does not look like his activities should be considered soliciting investments under Rule 206(4)-5.

Plus, the contribution was made after the state pension fund had already committed to the investment with Pershing Square. The contribution was made in 2013 and the state pension fund had made its investments in 2011 and 2012.

Once again we see that the breadth of the SEC pay to play rule is implicating actions that seem far removed from trying to buy influence. Pershing Square is having expend tremendous resources to avoid Rule 206(4)-5’s draconian penalty of forfeiting two year’s worth of management fees.

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The Supreme Court Weighs in Insider Trading

If you were expecting a tidal wave of changes from the Supreme Court, you will be disappointed. On Tuesday, the Court delivered its opinion in Salman v. U.S. Prosecutors can see a glimmer of upside because they do not have to prove that something valuable changed hands in order to prove the crime of insider trading.

Supreme Court

Newman was a setback because the U.S. Court of Appeals for the 2nd Circuit, that the insider must “also receive something of a ‘pecuniary or similarly valuable nature’ to prove illegal insider trading.

In a 1983 case, Dirks v. SEC, the Supreme Court had ruled that  someone who receives confidential information from an insider and then uses the information to trade can be held liable under insider trading laws when the insider violates his duty to shareholders by disclosing the information. But that depends on whether the insider receives “a direct or indirect personal benefit from the disclosure.” In Dirks, the Court said that jurors could infer a “personal benefit” when the insider either (1) receives something of value in exchange for the tip or (2) “makes a gift of confidential information to a trading relative or friend.”

Newman was under the first option. The prosecutors did not prove that the information was passed between friends or relatives and did not prove that there was an exchange of value. The Salman case is under the second option when the material non-public information was passed between friends and relatives.

The Court’s reasoning is simply that “giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.” You are not likely to give a gift to a stranger so there needs to be some other value. You are likely to give a gift to a friend or relative.

I think the Court used the Salman case to state that Dirks is still the standard for insider trading and Newman did not change it. The opinion was forcefully narrow and limited itself to insiders passing material non-public information to friends and relatives.

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Compliance Bricks and Mortar for December 2

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

Trump Risk Factors Begin to Appear in SEC Documents by Steve Quinlivan in Dodd-Frank.com

Risk factors related to uncertainties resulting from possible policies that may be implemented by President-elect Trump have begun to appear in SEC filings:

TPI Composites, Inc. Form 10-Q:

The results of the 2016 United States presidential and congressional elections may create regulatory uncertainty for the wind energy sector and may materially harm our business, financial condition and results of operations.

[More…]

Dodd-Frank critic Paul Atkins in frame for top SEC post by Kara Scannell in Financial Times

The Securities and Exchange Commission may come to resemble its pre-crisis self under Donald Trump, if the legacy, testimony and votes of the man advising the president-elect on financial regulation are any guide to the policies investors and Wall Street can expect. Paul Atkins is a vocal critic of the Dodd Frank post-crisis regulations, believes in fewer rules for private investment funds and small businesses and opposes corporate penalties because, he says, they are ultimately paid by shareholders.  [More…]

Donald Trump and the Indiana Carrier factory, explained by Matthew Yglesias in Vox

Americans still don’t know exactly what Trump and Pence offered or threatened. And the larger implications of the move are hotly disputed. Is this a first step toward Trump governing as a true champion of production workers? An alarming slide into crony capitalism? Or something worse? Most likely it’s something much more boring — a relatively minor piece of presidential public relations in which an important politician uses his Twitter feed to highlight a relatively small development that nonetheless reflects well on him. [More…]

Evaluating the U.S. Performance Against Money Laundering by Samuel Rubenfeld in WSJ’s Risk and Compliance Journal

Ashsish Kumar is a policy analyst for the Financial Action Task Force, an international standard-setting body that provides the roadmap for countries on anti-money laundering and counter-terrorist financing. The body on Thursday released its latest evaluation report on the U.S., and Mr. Kumar discussed its findings. The conversation was lightly edited for clarity. [More…]

An Efficient Investment-Risk Model of Compliance by Robert Bird and Stephen Park in the CLS Blue Sky Blog

The EIR model provides an analytical framework for addressing the effectiveness of different approaches to business regulation. It equips regulators with a dynamic understanding of how compliance functions respond to different kinds of regulatory mandates. We categorize regulatory rules as three basic archetypes of regulation. Direct Regulation consists of traditional command-and-control rules promulgated and enforced by government agencies through sanctions and penalties. Collaborative Regulation consists of hybrid public-private approaches to regulation that use non-coercive measures and often incorporate private standards. Market Contingent Regulation seeks to influence firm behavior by providing incentives or signals to regulated firms, such as market-leveraging taxes, fees, and permits and mandatory disclosure requirements. [More…]

Bold and Unrelenting SEC Enforcement

We are in a time of transition at the Securities and Exchange Commission. There are two vacancies on the Commission and Chair Mary Jo White has announced her departure. Although there are changes coming to the highest level of the SEC, the vast majority of the SEC personnel are staying in place and continuing their efforts to protect investors.

mary-jo-white

Chair White gave a speech to the NYU Program on Corporate Compliance and Enforcement and the NYU Pollack Center for Law and Business about the SEC’s enforcement program.

During Chair White’s confirmation hearings, she pledged to would pursue a “bold and unrelenting” enforcement agenda as SEC Chair. That was combined with a change in the way enforcement approached cases.

Investigate to Litigate – The SEC staff is coached to conduct all investigations with litigation in mind. During investigations, staff will focus on acquiring admissible and persuasive evidence

Use of Data Analytics to Uncover and Investigate Misconduct – These efforts have resulted in at least nine insider trading cases originating solely from leads generated by these types of tools, many others in the pipeline, and dozens of other cases being expanded using these tools to identify additional unlawful trading

Using Whistleblowers to Detect Misconduct – The SEC recently surpassed the $100 million mark for awards to whistleblowers, and tips in fiscal year 2016 surpassed 4,200, rising over 40 percent from 2012, the first fiscal year the program was in place.

Focusing on Individuals – Holding individuals liable for wrongdoing is a core pillar of any strong enforcement program.

The SEC’s Admissions Policy – In a first for a civil financial regulator, we announced in June 2013 that the SEC would begin to require admissions as a condition for settlement in certain types of cases, including cases with harm to large numbers of investors or significant risk of harm to the market, where the settling party engaged in egregious conduct or obstructed Commission investigations, or where admissions would significantly enhance the deterrent message of the action.

Impact of SEC Enforcement Activity – We have also, however, increasingly brought cases – including those involving negligent actions – that harm investors in other important ways that can be remedied through changes in industry practices in response to our actions, thus benefiting huge segments of investors beyond those harmed in a specific case.

In this last area, Chair White highlights the effect of enforcement on private equity.

“Over the past three years, we have brought 11 actions against private equity advisers for undisclosed fees and expenses, impermissible shifting and misallocation of expenses, and failure to adequately disclose conflicts of interests to clients. Our strong sense from exams and industry discussions is that, through the Commission’s focus on these problematic practices, we have helped to transform the level of transparency of fees, expenses, and conflicts of interest, and have prompted very meaningful change for the benefit of investors.”

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“May” or “Will” is Less Important Than Completeness

The Robare case popped to my attention last year because the Securities and Exchange Commission was focused on the use of the word “may” instead of “will” as adequate disclose of a fee arrangement. My eyes rolled at such distinction. The administrative law judge felt the same way and dismissed the case. Now the Commission has heard the appeal of the case and found the adviser at fault.

Cash in the grass.

According to the SEC charging order, The Robare Group would receive a fee for client funds invested in certain mutual funds. Of course, there is nothing inherently wrong with that arrangement as long as it is disclosed to clients. Obviously, the concern is that the adviser would direct clients to invest in those funds because it is good for the adviser, not necessarily because it is good for the client.

The original decision seemed centered around the SEC raising a fuss that Robare said in the Form ADV that is “may receive compensation from some mutual funds”. The SEC thought it should say “will” to highlight the conflict. The ALJ was not moved by this argument.

He also found that Robare was not negligent because it had engaged a compliance consultant to help with the disclosures. Surely this was a boon to compliance consultants.

The Commissioners overturned the ALJ. The ruling stayed away from the distinction between “may” and “will” by pointing out that the disclosure was inadequate to explain the fee sharing arrangement and how it may influence Robare to recommend one fund over another.

The disclosure mentioned individuals getting sales commissions. That was not accurate. Robare was paid based on the assets in certain funds.

The disclosure did not let clients know which funds generated the extra fee. A client would not be able to cast a skeptical eye on the arrangement of his or her portfolio. The case notes that there was no evidence that Robare’s clients were dispoportionally invested in funds that paid an extra fee to Robare.

The SEC seems moved that Fidelity reviewed the Robare Form ADV and did not find adequate disclosure and made the firm redo it.

In a blow to compliance consultants, the Commission did not allow Robare to escape a charge of negligence merely because it used a compliance consultant.

The ALJ found that Robare was not negligent in part because Robare relied on “experience and competent compliance consultants” to help ensure that it met the disclosure requirements. The Commission acknowledged that there is defense available at times for reliance on defense counsel. But there is not necessarily such a defense available for reliance on compliance consultants. Even if there were such a defense, the Commission felt than Robare did not demonstrate that the firm had met the equivalent standards.

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