Compliance and Supreme Court Nomination

One of the most important roles of the President is appointing judges to the bench, with an opening on the Supreme Court being the most important. We are set for another battle over an opening because the process lacks a set of policies and procedures.

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The vast majority of Supreme Court cases are uninteresting except to the set of practitioners in that legal area. A few cases each term have broader social issues and attract the headlines. It’s those cases on abortion and marriage and gun rights that attract the most attention.

Justice Scalia took a very dogmatic approach to his view of the US Constitution. He was an originalist and textualist who believed in a static view of the Constitution. Conservatives loved this approach since it mostly aligned with their beliefs. Scalia would have been the first say that his view was not political, but a pure legal view.

He would also likely view with disdain some of the posturing coming out of Washington on how his open spot should be filled.

The Constitution grants the President the power to appoint Justices, “by and with advice and consent of the Senate.”

Scalia himself had an easy route to appointment as a Justice because the Senate opposition had focused its efforts on Rehnquist’s appointment as Chief Justice. It’s hard to fight a battle on two fronts.

The current appointment will also be about politics, and not legal theory. I’m sure the nominee will have a brilliant legal mind. He or she will likely have a short judicial record with few, if any, decisions on controversial issues. I would also guess that the nominee will not be a white male.

Leaving the Supreme Court seat open means that there are an even number of justices. Therefore, a tie is possible and impossible to reach a decision. Any governance practitioner will tell you the perils of an even numbered board.

Compliance practitioners should note that there is an insider trading case before the court. In the Salman case, the Supreme Court will try to decide if personal benefit to the insider is necessary as required in the Second Circuit’s Newman case or whether it is sufficient that there was a close family relationship as decided in this case. It would be a shame to not have a decision because of a vacancy on the bench.

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Supreme Court of the United States Building, Washington, DC, as seen from the west side of 1st St NE.
by 350z33
CC BY SA

Compliance Bricks and Mortar for February 12

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

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CFTC Can’t Give Whistleblower Money Away by Jean Eaglesham in the Wall Street Journal

Since its Whistleblower Program was launched in 2011, the Commodity Futures Trading Commission has spent more on administrative costs than it has paid out in bounties, according to a Wall Street Journal analysis of the agency’s data. [More…]

An SEC investigation: to disclose, or not disclose? by Patrick Hunnius, Perrie Michael Weiner, Robert D. Weber, Caryn G. Schechtman of DLA Piper

In a recent decision, the Ninth Circuit addressed for a second time the question of whether an issuer’s disclosure of a Securities and Exchange Commission investigation can provide a sufficient basis for a plaintiff to plead “loss causation” in a securities class action. The court’s ruling – that disclosure of an investigation combined with “a subsequent revelation” can suffice to plead loss causation in a later civil action alleging securities fraud – should lead issuers to think more carefully about disclosure of such investigations at all.[More…]

6 Lawyers and Staff Caught in the Insider Trading Crosshairs by Casey Sullivan in Bloomberg DNA

With constant access to corporate information, lawyers can feel the urge to use it to their own financial advantage. We compiled a list of some of the lawyers and employees who have been caught in the prosecutors cross-hairs and pulled information about them from various media publications. [More…]

Compliance Across Industries

One of the puzzling aspects of compliance is that it means vastly different things across industries. What compliance means to a bank is very different from what compliance means to a drilling company.

Folder with the label Compliance

I think the reasons are obvious: regulatory requirements.

In a highly regulated industry, there will be a greater focus on complying the regulatory mandate. A broker-dealer compliance officer is going to be focused primarily on the FINRA rules for broker dealers. An investment adviser compliance officer is going to be focused on compliance with its regulatory scheme. A drilling company is going to be focused on a different set of rules.

I see the difference in the junk mail I receive each day. I get flyers on FCPA compliance, OSHA compliance, Clean Water Act compliance… Someone is clearly checking the compliance box without thought to the substance behind it.

Most compliance as a discipline starts with the Department of Justice’s Sentencing Guidelines. That is a good base framework. But in regulated industries, the regulations go into much more detail about what needs to be done. It’s not about right or wrong, but what the government says you have to do.

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Compliance and the Presidential Candidates

With the New Hampshire primary complete, the field of presidential candidates will continue to become smaller. Some of those dropping out may lower their expectations to Vice President or go back to their day jobs. Registered investment advisers have to worry about those day jobs when it comes to campaign donations.

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Under SEC Rule 206(4)-5, investment advisors are limited in their ability to give campaign contributions to political candidates who can directly or indirectly influence the hiring of an investment advisor by a government-sponsored investment entity. A campaign contribution in violation of the rule means the investment advisor can not collect fees from the applicable government-sponsored investor for two years. The rule applies to registered investment advisors and fund managers that had been exempt under the now-repealed, private fund manager exemption.

The president of the United States is not an office that can directly or indirectly influence the hiring of an investment advisor, so that position is not one that is limited by the SEC Rule. However, you also need to look at the candidate’s current office to see if that position is one that is limited.

Two of the remaining national candidates hold state offices: John Kasich and Chris Christie. They are both subject to SEC Rule 206(4)-5 because they appoint members to the state pension fund board in their states.

It’s not clear how the addition of a state governor (or other politician subject to  Rule 206(4)-5) would affect past donations.

These are just the national candidates. As points out on his blog, there are dozens of candidates on the state primary ballots with over forty on California’s List of Generally Recognized Presidential Candidates for California Primary.

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Compliance and the Super Bowl Victory

Defense wins championships.

It’s an old sport cliche. However, the Denver Broncos proved it last night in the Super Bowl. The Orange Crush neutralized the NFL’s MVP, Cam Newton. Peyton Manning rounded off his career, landing win 200. Mr. Manning still has the most playoff losses of any quarterback. Of course that is because he has been to the playoffs so many times.

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As with football, defense wins compliance.

It’s what you prevent that counts, not what you catch. The number one goal of compliance is to convince your employees to not even think of doing something wrong. A catch means that the employee did something wrong. Your compliance was good enough to see the violation, just not good enough to prevent it from happening in the first place.

That means measuring the effectiveness of compliance is hard. With the best compliance, nothing happens, so there is nothing to measure. If you measure a decrease in catches, that could be because the compliance is better or it could mean your detection is worse.

You could argue the same bias in football. The league MVP and college’s Heisman trophy are disproportionately awarded to quarterbacks and running backs. It was refreshing to see Von Miller, a defensive player, win the Super Bowl MVP.

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Weekend Watching

You may have missed Madoff on ABC this week. It’s four hours on the life of the fraudster, portrayed by Richard Dreyfuss. If you have a few hours this weekend, it’s worth watching.

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Mr. Dreyfuss does a great job portraying Madoff, capturing him lying, cheating and stealing, but looking upstanding in the eyes of his investors. A con man in a fancy office. He nails it.

Blythe Danner is even better as Ruth Madoff, enjoying the luxuries of life and clueless about her husband’s deception. Then she is torn when her sons make her choose between them and Bernie.

Frank Whaley is over the top as Harry Markopolos. He is portrayed with an extra bit of lunacy spewing out indecipherable phrases to the SEC about uncovering Madoff’s fraud.

I didn’t like how the movie painted a stark line between the legitimate Madoff brokerage and the fraud in the management side. The main trading floor is full of rich furniture and decoration. The fraud center on the 17th floor is a smoke-filled, windowless den of iniquity. Why are there no windows? (There were windows.) Michael Rispoli, as Frank DiPascali, is straight out of the Sopranos. The rest of the fraud crew are poorly dressed and unkempt, while the trading floor remains beautiful.

The show also fails to show much of the greed of the feeder funds who were happy to take big management fees while Madoff was content to live off the brokerage fees. There is one pair of fund managers who nearly jump with joy when they find out the arrangement.

The movie also fails to add the color that many investors thought Madoff was cheating. But they thought he was front-running trades in the brokerage. That group of investors was happy to have their money with a cheater, as long as he was cheating someone else and not them.

Compliance Bricks and Mortar For February 5

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

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The Most Thankless Job on Wall Street Gets a New Worry: Recent enforcement actions find compliance officers personally liable
by Emily Glazer in the Wall Street Journal

Those officers on Wall Street in charge of ensuring that traders and other employees stay on the right side of laws and regulations are increasingly in the cross hairs themselves.

Several recent enforcement actions found compliance officers personally liable for mistakes within their firms. Meanwhile, New York’s principal financial regulator, backed by New York Gov. Andrew Cuomo, wants the power to seek criminal charges against compliance officers in some cases. [More…]

Implications of Mutual and Private Fund Convergence by Wulf Kaal in the CLS Blue Sky Blog

Mutual funds are becoming more like hedge funds as a matter of investment strategy while hedge funds are becoming more like mutual funds as a matter of the regulatory framework. The growth of the private fund industry and the proliferation of retail alternative funds in combination with the fundamental regulatory reform of the private fund industry through the Dodd-Frank Act and the JOBS Act make the convergence of mutual and private funds possible. Such convergence has large implications for the evolution of the private fund industry and the growth of the retail alternative fund market.[More…]

The Perils of Combining Audit and Compliance by Matt Kelly in Radical Compliance

Few compliance and audit executives believe that integrating those two functions is a wise idea, but good news for those of you forced by your CEO to march down that dubious path—you have some fresh guidance on how to make the trip with minimal missteps. [More…]

Crowdfunding Portals Begin to Register With the SEC by Steve Quinlivan in Dodd-Frank.com

The SEC registration process for Title III crowdfunding portals was recently commenced. So far we are aware of one Form Funding Portal that has been filed to begin the registration process. So that is good news.

The Rise of “Culture of Compliance” in Numbers in WSJ.com’s Risk & Compliance Journal

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New ILPA Fee Reporting Template

Investors look for transparency in fees. The Institutional Limited Partners Association published a Fee Reporting Template Last Week to encourage uniformity in the fee disclosures being made to private fund investors.

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The aim of this proposed template is to encourage increased uniformity in the fee disclosures the fund managers provide to limited partners in private funds. ILPA proposes two benefits:

  1. Providing limited partners with an improved baseline of information that lends itself to more streamlined analysis and informed internal decision making
  2. Reducing the compliance burden on fund managers, who face a variety of bespoke template formats

Only two fund managers have signed on as endorsing the template.

Already, the California controller is pitching the SEC to mandate the template as a reporting obligation.

Fees in all investments have disclosure problems. How much are you paying in fees for your mutual funds? I, like many of you, don’t know. Most investors look at overall performance. Low fees are great, but not if it’s for low performance.

Private funds are obviously different form mutual funds. It’s not easy to sell and re-invest the money.

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The Good, Bad and the Ugly of Lending

In browsing through the Wall Street Journal I ran into three stories side by side:

Each is a different side of specialty loans.

Cash in the grass.

The Ezubo fraud story caught my attention first. That is a lot of money for a Ponzi scheme. There is no proof that it is actually a fraud at this point. But employees of legitimate companies do not generally bury the firm’s accounting books in a field.

I found the LendingClub loan story to be interesting because the loans were sold at premium to the outstanding balance. The buyer thought it would get its money back and then generate more revenue through those borrowers.

The liar loans are a vestige of the housing boom when lenders were underwriting loans on value and not the borrowers’ ability to repay the loan. There is some need for these products for borrowers whose income is hard to document. But largely they are known as liar loans for poor documentation and cheating on behalf of the borrower. I though they had gotten buried in hole, never to be seen again.

It’s the liar loans and the Ezubo loan that are most alike. The loans (or “loans” in the case of Ezubo) are driven by lender demand. It’s Wall Street banks that are looking for pools of liar loans. In Ezubo’s case its the small investors looking generate returns for peer-to-peer loans. In neither case is an increase in loans being driven by legitimate consumer demand. Its lenders searching for yields.

The LendingClub loans are driven by consumer demand. These loans are also better documented and have credit worthy borrowers. The story states that the average FICO score was about 700.

Good documentation and controls generated the best returns. I think that makes any compliance professional happy.

It’s Hard to Tell What the Next Form of Cheating Will Look Like

One of the problems with compliance is that the fraudsters seem to be one step ahead of the regulators. The regulators try to push out rules to prevent bad behavior. Regulators look at their charges to find cheating. But the cheaters are often one step ahead. We saw this in professional cycling over the weekend.

Femke Van den Driessche

Professional cycling has been rife with cheating throughout its history. It’s a brutal sport so contenders are always looking for a little edge to get them to the finish line first.

Of course, there was Lance Armstrong and the doping of the 1990s. Cycling was not alone. Baseball had its own issues at the same time. Regulators seem to have caught up with cheaters, flushing a lot of the doping out.

This weekend regulators found a new kind of cheating.

Race officials found a motor in the bike of Belgian cyclist Femke Van den Driessche. Yes, a motor. In her bike frame.

A rumor about motor doping popped up last year. During the 2015 Tour de France race officials checked several bikes, but never found anything. It seemed like a possibility that battery technology could catch up to make a motor and power sources small enough to fit unnoticed in a bike frame. The key would reducing the weight so that whatever power was generated would not be overcome by the additional weight of the machinery.

Apparently that time has come. Although Ms. Van den Driessche denies she cheated:

“I didn’t know anything about it. I don’t know how that bike got there. I was surprised to see that bike standing there. It’s not my bike. There’s been a mistake.”

Incidentally, Van den Driessche’s brother Niels is currently suspended for doping.

Regardless of whether she cheated, it is clear that the technology is here. Regulators will have a new round of checks on race winners, looking at their bikes as well their blood.

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