Crash!

I had my first cycling crash of the season this weekend. My fault. No cars involved. I was complying with traffic laws. I just made a mistake. We all make mistakes. This one left me on the tarmac.

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I spent the weekend dropping off The Girl at sleep-away camp in the Berkshires. (Her first time at sleep-away camp). To keep up my bike training regime for the Pan-Mass Challenge I decided to bike back home.

It was cool and sunny at the start, but the rain came in, turning a pleasant ride into a cold, wet, tortuous ride.

I was not familiar with the route. I was not lost, but was relying on memorization of route and occasional glances at the GPS. Since the roads were unfamiliar, I never knew if there was a big hill up ahead or how much longer to get home. It was getting dark. To the extent I had actually been on the roads before, the features were melting away as the sun set.

When I saw the sign for Davis Mega Maze I finally knew where I was. Now that I knew how much further I had to go, I felt some more energy flow back into my legs. I was excited to see that I only had 30 miles to go.

Perhaps I was too excited. I saw the railroad tracks ahead. I knew they would be wet and slippery. I knew I should slow down.

But I didn’t.

I came up on the tracks too fast. They were at a 45 degree angle to the road, making them even more treacherous. The bike and I went sideways, slipping and sliding down the road.

By slipping and sliding, I mean sliding my skin on the roadway. I stood up bloodied and battered.

Rule #5 was in effect. So I pulled myself back up, wiped off some blood and pedaled the rest of the way home.

That’s what I do to train for the Pan Mass Challenge.

There is still time to sponsor my Pan Mass Challenge ride: http://www2.pmc.org/profile/DC0176

100% of your donation goes to the Dana Farber Cancer Institute to fund its fight against cancer,

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Compliance Bricks and Mortar for July 8

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

Bricks Tanzania

One Thought on Blockchain in Money Compliance

Blockchain could make AML obsolete, in theory. Blockchain is the decentralized database system that allows for recordkeeping of transactions nearly impossible to fake. And because of it, it sort of creates a world that is zero sum. It isn’t completely zero sum, especially in the beginning because no sources of transaction have been recorded, but eventually so many transaction have been recorded that whatever currency is being tracked could be traced to its original source, in this case the first transaction on the database. [More…]

Farewell to Ralph Stanley and Success in Repatriation by Tom Fox in FCPA Compliance Report

I thought about Stanley’s genius when considering one of the challenges in anti-corruption going forward; which is the issue of repatriation of the funds stolen from a country through bribery. Matt Stephenson, over at the Global Anti-Corruption Blog (GAB), has been a persistent commentator of the difficulties of such a repatriation. However, an article in the Financial Times (FT) by Kara Scannell, entitled “Moving money out of purgatory”, detailed one of the success stories in this area while also reporting on many of the difficulties outlined by Stephenson in the GAB. [More…]

Small Firm Cybersecurity Checklist

FINRA has created a Cybersecurity Checklist (Excel 114 KB) to assist small firms in establishing a cybersecurity program to identity and assess cybersecurity threats, protect assets from cyber intrusions, detect when their systems and assets have been compromised, plan for the response when a compromise occurs and implement a plan to recover lost, stolen or unavailable assets. This checklist is primarily derived from the National Institute of Standards and Technology (NIST) Cybersecurity Framework and FINRA’s Report on Cybersecurity Practices. Use of this checklist does not create a “safe harbor” with respect to FINRA rules, federal or state securities laws, or other applicable federal or state regulatory requirements.

Legislators Boast That Shrinking Size of GE Capital Proves Dodd-Frank Is a Success by Steven Lofchie in Cadwalder Cabinet

Facts belie the legislators’ political assertion that Dodd-Frank has had the effect of shrinking big firms and increasing market share for smaller firms. A look at the three most significant types of Dodd-Frank-regulated financial intermediaries: banks, broker-dealers and futures commission merchants (“FCMs”) makes this clear: [More…]

The average American woman now weighs as much as the average 1960s man by Christopher Ingraham in The Washington Post

The average American woman weighs 166.2 pounds,according to the Centers for Disease Control and Prevention. As reddit recently pointed out, that’s almost exactly as much as the average American man weighed in the early 1960s. [More…]

If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer. You can read more and donate here: https://www2.pmc.org/egifts/DC0176

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The Wild West of Wyoming

I run across compliance stories that make me scratch my head when I find something odd.  I just came across another that made me remember one of the quirks of registration with the Securities and Exchange Commission as an investment adviser.

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The SEC was after Timothy Sexton and his advisory firm, Bantry Bay Capital. Examiners showed up at Bantry Bays offices and were surprised to find no office. The address was listed at 3465 N Pines Way in Jackson, Wyoming in its Form ADV filing as its principal place of business. The examiners found a UPS Store instead of an operating office.

One aspect of registration between state and SEC registration is that investment advisers in Wyoming register with the SEC, regardless of the amount of assets under management. Some advisers try to sneak into Wyoming. It looks like Bantry Bay had rented a post office box at that UPS Store. That is not enough for a principal place of business.

Wyoming does not have a state level regulator of investment advisers so all Wyoming investment advisers are under SEC jurisdiction.

That will change next year. Wyoming passed a securities law and is implement a regulatory regime for investment advisers. On June 1, 2017, those 21 investment advisers in Wyoming will be required to state registration.

Wyoming will no longer be the wild, wild west for investment advisory firms.

Sources:

Buildings in Jackson, Wyoming, located at the crossing of Deloney Avenue and Center Street
By DXR
CC BY SA

Brexit and the Real Estate Markets

I don’t know and don’t pretend to know what the long term effects of the UK leaving the European Union will be. We saw in the short term that it sent the financial markets into turmoil and send the British pound to the lowest levels in years. The U.K property market looks like it is now suffering the fallout from Britain’s vote to leave the European Union.

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M&G Investments stopped trading in a £4.4 billion U.K. property fund. Aviva Investors suspended trading in a U.K. property fund. Standard Life Investments was the first to cancel trading in its U.K. Real Estate Fund.

The funds were receiving an increase in redemption requests. At some point the funds would need to start selling assets to meet the redemption requests. Investors these ‘open-ended’ funds can get redemptions even though the underlying buildings will several months or longer to sell.

The compliance aspect is the same as that for any fund that can put gates in place to halt redemptions. The key is that a gate is allowed by the fund documents. Then the fund manager needs to make sure that the gate is being lowered to protect the investors overall. I assume the fund managers are taking the position that forced sales for liquidity will depress asset prices and hurt the fund as a whole.

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Happy Original Brexit Day

When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature’s God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

Those words were true in 1776 and they are true today. Our forefathers fought to pull themselves out from under the weight of British rule, to enjoy better social and economic freedom. I’m thankful for them and all that fought for freedom over the centuries.

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Compliance Bricks and Mortar – Canada Day Edition

Today marks the joining of the British North American colonies of Nova Scotia, New Brunswick, and the Province of Canada into a federation of four provinces on July 1, 1867.

These are some compliance-related stories that caught my attention recently, even though they have nothing to do with Canada.

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BREXIT and Compliance by Jonathan Armstrong in SCCEs The Compliance Ethics Blog

In the short-term the change will be minimal. Longer term there is likely to be lots to do on the separation and with the UK putting in place agreements to replace current EU deals – many variations are currently possible. UK politicians have talked of a 6-month scoping exercise as the work on separation starts. Then there is effectively a notice period of two years as the UK exits the EU. [More…]

AIFMD Meets Brexit by Debevoise Plimpton

It is the uncertainty that now exists, and that will continue to exist during the transitional period that will begin on the day that the United Kingdom exits the European Union and end on some unknown date thereafter, that will be destabilising for the UK funds industry and potentially damage the popularity of the United Kingdom as a fund manager jurisdiction of choice [More…]

How to Hire Honest People By Bruce Weinstein, Ph.D. The Ethics Guy® in SCCEs The Compliance Ethics Blog

There are two downsides to asking a direct question about dishonesty. First, it immediately strikes fear in the candidate’s heart, even if the candidate is fundamentally an honest person. I don’t like the idea of making a job candidate squirm. The second is that the question seems to present a no-win situation for the candidate. [More…]

BATTLE OF THE SOMME WEEK – PART V: WHAT DID IT ALL MEAN? by Tom Fox in the FCPA Compliance Report

Today, July 1 is the 100th anniversary of the first day of the Battle of the Somme. As I have written this week, there is no single battle in modern British history that has made a greater impression on the British psyche. The five month long battle cost the British some 420,000 casualties. For territory, it was worth a few miles. Daniel Todman, writing in the Financial Times (FT) article entitled “Stories of the Somme”, said, “Both in its scale and duration, the Somme was different to anything the British had done before. With wartime volunteers involved en masse in the most intense combat for the first time, the impact of the battle was felt throughout the Empire. The second world war saw combat that was just as horrific — and a global slaughter that was much worse — but Britain avoided the same enormous and prolonged commitment of its army to the task of breaking the strength of a great power opponent on land.” [More…]

‘Hold’ everything: SEC may be stuck at three commissioners for a while by Bruce Carton in Compliance Week

As I have been following here for many months, President Obama nominated Hester Peirce and Lisa Fairfax to be SEC commissioners in October 2015 to fill open Republican and Democrat seats on the Commission, respectively. Peirce is currently a senior research fellow at the Mercatus Center at George Mason University and Fairfax is a law professor at the George Washington University Law School. The story of how basically nothing has happened with their nominations is chronicledhere and elsewhere on this site, and is comparable to watching paint dry.

Yesterday, Andrew Ackerman of the WSJ reported, these two nominations were delayed even further by the Senate when an unidentified Democratic Senator moved to block any confirmation vote on Peirce through a procedural step known as a “hold.” The WSJ reported that “overcoming a hold generally requires the high hurdle of support from 60 senators.”  [More…]

How Good Is Your Business Continuity and Transition Plan?

The Securities and Exchange Commission had indicated that it was going to tackle operational issues at investment advisers. It just released a proposed rule on business continuity and transition plans for registered investment advisers. The proposed rule would require SEC-registered investment advisers to have written business continuity and transition plans reasonably designed to address operational and other risks related to a significant disruption in the investment adviser’s operations.

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First some stats. According to the release:

“[T]here are approximately 12,000 investment advisers registered with the Commission that collectively manage over $67 trillion in assets, an increase of over 140% in the past 10 years.” – Based on data from IARD as of 1/4/2016

The SEC is proposing a new Rule 206(4)-4 that makes it unlawful for registered investment advisers to provide investment advice unless it has a written business continuity plan and transition plan that is reviewed at least annually.

The easy one is business continuity planning requirement. That requirement was tucked into the release for Rule 206(4)-7. It should not come as a surprise to fund managers and investment advisers that they should have a continuity plan. The SEC has found many BCPs are inconsistent and lacking robustness across those 12,000 advisers.

The SEC is requiring that a BCP have at least the following elements:

  • maintenance of critical operations and systems, and the protection, backup, and recovery of data
  • pre-arranged alternate physical location(s) of the adviser’s office(s) and/or employees;
  • communications with clients, employees, service providers, and regulators;
  • identification and assessment of third-party services critical to the operation of the adviser.

The transition plan is a bit trickier and much more vague. Frankly, in my opinion, I don’t think the two should be included in the same rule.

The transition plan covers a broad swath of possibilities. The pool of registered investment advisers is very broad, from small retail investment advisers, large financial services companies and private fund managers. The SEC alludes to the “resolution plans” in Dodd-Frank, a/k/a the living wills.

These are the five elements the SEC is looking for in the transition plan:

  1. policies and procedures intended to safeguard, transfer and/or distribute client assets during transition;
  2. policies and procedures facilitating the prompt generation of any client-specific information necessary to transition each client account;
  3. information regarding the corporate governance structure of the adviser;
  4. the identification of any material financial resources available to the adviser; and
  5. an assessment of the applicable law and contractual obligations governing the adviser and its clients, including pooled investment vehicles, implicated by the adviser’s transition.

I think the transition plan is very important for a small retail adviser that is reliant on a single person. I think it’s a bit tougher to see how this would work for a medium-sized or larger private fund manager that is not reliant on a single person or a few people to safeguard and manage the fund assets.

Hopefully, the SEC will carve out the transition plan to a separate rule for a longer and more thoughtful rule-making process.

The business continuity part of the rule is no-brainer. Frankly it’s long over due to have been elevated from a paragraph in s rule release to a its own rule.

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Broker-Dealer Customer Protection Rule versus Investment Adviser Custody

A recent enforcement case highlighted the stark difference between the custody requirements of a broker-dealer and an investment adviser. Merrill Lynch was smacked with over $400 million in disgorgement and penalties for putting customer assets at risk.

Custody hands holding cahs in handcuffs

Private fund managers and investment advisers are well aware of the limits on the custody. The purpose is to keep customer assets safe in the event the investment adviser goes out of business or its malfeasance.

On the broker-dealer side it’s the Customer Protection Rule under Section 15(c)(3) of the Securities Exchange Act and Rule 15c3-3 thereunder. The Customer Protection Rule is designed to protect clients in the event of a broker-dealer failure from a delay in returning a customer’s securities or a shortfall in which customers are not made whole. Rule 15c3-3(e) requires a broker-dealer to maintain a reserve of funds or qualified securities in an account at a bank that is at least equal in value to the net cash owed to customers.

Fortunately, Lehman Brothers was in compliance with the rule in the fall of 2008 so its customers were made whole.

Merrill Lynch was not in compliance with the rule at times between 2009 and 2015. By violating the rule, the firm was able to finance its own trading activities by keeping fewer reserves for customer cash. The SEC dismissed some options trade that it deemed to lack economic substance allowing the firm to artificially reduce the amount of customer cash required in the firm’s reserve accounts.

“The rules concerning the safety of customer cash and securities are fundamental protections for investors and impose lines that simply can never be crossed,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.  “Merrill Lynch violated these rules, including during the heart of the financial crisis, and the significant relief imposed today reflects the severity of its failures.”

Merrill Lynch did not lose any customer cash. But the cash was at risk if the firm failed. It was at risk because the firm failed to follow the rules for protecting that cash.

Both the Customer Protection Rule for broker-dealers and the Custody Rule for investment advisers are complex. Most of that complexity is at the edges to deal with specific situations. One should not get lost in following the the reason behind the rules: protecting the clients’ funds and assets.

Sources:

If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer. You can read more and donate here: https://www2.pmc.org/egifts/DC0176

 

Compliance Bricks and Mortar for the Brexit

These are some of the compliance-related stories that caught my attention while waiting for the results from the Brexit vote.

brexit

BEST PRACTICES FOR TODAY’S CCO by Julie DiMauro in the FCPA Blog

In addition to knowing their regulatory-reporting obligations, compliance officers should understand what their managers do, what products and services their company offers and the systems that sustain these products and services.

If a compliance officer lacks this background, it can be acquired through research, on-the-job training, observing business associates, and asking for outside educational opportunities. [More…]

General Solicitation Under Rule 506(b) After Citizen VC: Guiding Principles and Best Practices by Richard M. Leisner in the D&O Diary

It is too soon to know the-long term compliance effects of Citizen VC and the Companion C&DIs. Today is a good time, however, for careful analysis of these recent SEC pronouncements and their underlying rationale and regulatory provenance.

With this analytical foundation, this article suggests how best practices for conventional issuers might evolve for permissible general solicitation activities in future Rule 506(b) private offerings that will not violate the prohibitions of Rule 502(c). [More…]

HERE ARE THE TOP 5 SONGS ABOUT COMPLIANCE by Nicole Rose

The fastest way to change someone’s state is through music. The rhythm and pitch are managed in areas of the brain that deal with emotions and mood. Even the thought of a song is actually enough to stimulate the senses and ignite a positive response. For example, if I mention “You’ll Never Walk Alone” by Rodgers & Hammerstein or “For once in my life” by Stevie Wonder, you’ll probably have it in your head for at least a few minutes.  [More…]

Four Points on AML Compliance by Matt Kelly in Radical Compliance

We might dismiss contradictory regulators as a fact of life in compliance, but beware the larger point: if compliance officers get mixed messages about what regulators expect, you cannot develop a sound strategy to implement global AML programs. You can’t easily place big bets on new technology, or adopt global policies and procedures. Instead, you’re trapped reacting to one regulator’s request after another. And without an effective strategy, you can’t implement cost-effective techniques to manage compliance—you just throw bodies and money at the problem of the day. [More…]

SEC Charges Fund Administrator as a Failed Gatekeeper

The Securities and Exchange Commission charged Steven Zoernack and his firm EquityStar Capital Management with fraud for stealing investor money and hiding his criminal past. The SEC brought fraud charges against ClearPath Wealth Management and its principal, Patrick Evans Churchville, for operating a fraudulent scheme that resulted in at least $11 million in losses to investors. One thing in common between the two firms was that both used the same fund administer.

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SEC investigations found that Apex Fund Services missed or ignored clear indications of fraud while record-keeping and preparing financial statements and investor account statements for funds managed by ClearPath Wealth Management and EquityStar Capital Management.

This is another case of the SEC charging a gatekeeper for failing to identify and stop fraud.

The SEC’s order finds that in regard to ClearPath Apex failed to act appropriately after detecting undisclosed brokerage and bank accounts, undisclosed margin and loan agreements, and inter-series and inter-fund transfers made in violation of fund offering documents. Apex failed to correct previously issued accounting reports and capital statements and continued to provide materially false reports and statements to the funds’ independent auditor. Apex should have known that ClearPath would use Apex’s false reports to communicate financial positions and performance to the ClearPath funds’ investors.

The SEC’s order finds that in regard to EquityStar and Zoernack, Apex accounted for more than $1 million in undisclosed withdrawals as receivables owed to the funds, despite no evidence that it was able or willing to repay the withdrawals. Apex confronted Zoernack about the withdrawals and concluded he was unlikely to repay the funds. But Apex still did not properly account for Zoernack’s withdrawals even as they started to consume a significant portion of the funds’ assets. Apex sent monthly account statements to investors that it knew or should have known materially overstated the investors’ true holdings in the funds.

Apex was a failed gatekeeper. The SEC will bring charges for not taking appropriate steps. In this case, Apex knew its reports were false and still sent them to investors or to the funds knowing that they would be given to investors.

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Château de Crécy-la-Chapelle: Gate by Baishiya 白石崖
CC BY SA