Compliance Building

Happy Hanukkah

How Hanukkah Came to the White House by Jonathan D. Sarna in Forward.com

The first president who took official notice of Hanukkah was one of the Jewish community’s least-favorite occupants of the White House, Jimmy Carter. In 1979, he ended 100 days of self-imposed seclusion over the Iran hostage crisis by walking to Lafayette Park, lighting the new “National Menorah” erected there by Chabad-Lubavitch, and delivering brief remarks. Sensitized to the fact that Jews celebrate their own holiday in December, he carefully directed his next annual Christmas message only “to those of our fellow citizens who join us in the joyous celebration of Christmas.” Every president since has recognized Hanukkah with a special menorah-lighting ceremony, and limited his Christmas messages to those who actually observe the holiday.

Hanukkah came to the White House itself, in 1989, when President George H.W. Bush displayed a menorah there, given to him by the Synagogue Council of America. But the first president to actually light a menorah in the White House was Bill Clinton. In 1993, he invited a dozen schoolchildren to the Oval Office for a small ceremony. The event made headlines when 6-year-old Ilana Kattan’s ponytail dipped into the flame. Clinton ran his hands through her hair to snuff out the smoke. [more…]

Compliance Bricks and Mortar for December 4

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

Your next PR battle is brewing in Private Funds Management

Last week, the California Public Employees’ Retirement System (CalPERS) released carried interest data that several media outlets were quick to spin as private equity somehow being more expensive than investors had realized, and that fees charged for outsized performance were egregious (when in fact they were shown to be below industry standards). It was yet another reminder that often the reporters writing such stories don’t understand the core concepts and structures of the asset class. [More…]

Making It Harder to Prove White-Collar Crimes by Peter J. Henning in the NY Times’ DealBook

But one provision tucked in the legislation could have a significant impact on prosecuting regulatory offenses, the type often pursued against businesses and corporate managers. The law would require that if a federal criminal offense did not specifically set forth the intent needed to establish a violation, then prosecutors must show the defendant’s state of mind was “knowing.” A further requirement is that “if the offense consists of conduct that a reasonable person in the same or similar circumstances would not know, or would not have reason to believe, was unlawful, the government must prove that the defendant knew, or had reason to believe, the conduct was unlawful.” [More…]

Is the City Link verdict a win for the industry? in Private Equity International

Former City Link directors must have breathed a sigh of relief. Last week a UK court found them not guilty of failing to notify the government of upcoming redundancies following the collapse of the company. [More...]

Investment Advisers Don’t Need Mystery Monitors by Norm Champ in the Wall Street Journal opinion section

Mandating examinations of investment-management firms by third parties presents all of the risks of these earlier failed attempts to outsource government power. These examinations would cost investment managers, and ultimately their clients, a great deal of money. The firms conducting the examinations would have a guaranteed revenue source with little incentive to produce quality exams or keep costs down. As with proxy advisory firms, the examining firms could develop their own agendas for examinations that have nothing to do with safeguarding investors. [More…]

Fairness of SEC Judges Is in Spotlight by Jean Eaglesham in the Wall Street Journal

The SEC won against 86% of defendants in contested cases in its own courts from October 2010 through September 2015, according to an updated analysis by The Wall Street Journal—significantly higher than the agency’s 70% win rate in federal court. A page-one Wall Street Journal article in May reporting the agency’s different win rates has since been cited in numerous legal challenges. [More…]

U.S. and UK risk assessments differ on real estate-related AML by Alex Zerden and Sarah Freuden in the FCPA Blog

The United States and United Kingdom recently published comprehensive money laundering risk assessments through the UK’s National Risk Assessment and the U.S.’s National Money Laundering Risk Assessment. The UK’s National Risk Assessment (NRA) and U.S.’s National Money Laundering Risk Assessment (NMLRA) provide insight into anti-money laundering vulnerabilities from real estate in two of the five largest global economies. [More…]

Pigeon at Castelvecchio, Verona is by Andy Hay
CC BY

The SEC Goes After the Gatekeepers: Grant Thornton Edition

“Audit firms must be held responsible when systemic failures such as inadequate engagement procedures, staffing, or supervision cause the firms’ work to fall significantly short of expected standards, particularly when multiple audits and engagements are involved.”

– Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.

The SEC recently brought separate cases against senior housing provider Assisted Living Concepts and alternative energy company Broadwind Energy for disclosure violations.

When a fraud is uncovered, the Securities and Exchange Commission not only wants to get the fraudsters, it also wants to get those who should have stopped the fraud: the gatekeepers. The SEC also brought a companion case against those firm’s external auditors: Grant Thornton.

Assisted Living Concepts and Broadwind Energy both had the same engagement partner. The SEC brought charges against the engagement partner, Melissa Koeppel, and Jeffrey Robinson who worked on the Assisted Living Concepts audits.

Assisted Living Concepts had faked occupancy levels by including employees and other non-residents as occupants to meet loan covenants. The SEC order claims that the auditor was aware of this red flag and should have done more. If the firm had done so, it would have spotted the fraud.

“Grant Thornton was aware of red flags suggesting audit quality issues in the audits conducted by one of its engagement partners and its audit quality more generally, but failed to remedy the situation,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement

The SEC charges that the auditor should have spotted the issue with an impairment at Broadwind.

“They also failed to exercise due professional care and skepticism or obtain adequate audit evidence related to a significant bill-and-hold transaction. The revenue from this transaction allowed Broadwind to meet its debt covenants.”

Without admitting or denying the SEC’s findings, Koeppel agreed to pay a $10,000 penalty and be suspended from practicing before the SEC as an accountant for at least five years, and Robinson agreed to pay a $2,500 penalty and be suspended from practicing before the SEC as an accountant for at least two years.

Sources:

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

New York’s Proposed Anti-Money Laundering Regulations Could Send CCOs to Jail

To start with the obvious, helping terrorists and drug kingpins with their finances is bad. The US regulatory machine has been clamping down tighter on financial institutions who engage in this bad behavior. As the bad acts continue, the regulators keep tightening the regulatory requirements. The latest tightening of the screws comes from New York.

Governor Andrew M. Cuomo announced that New York is proposing a new anti-terrorism and anti-money laundering regulation that includes a requirement modeled on Sarbanes-Oxley that the chief compliance officer certify that their institutions has sufficient systems in place to detect, weed out, and prevent illicit transactions. That potentially opens the certifying officer to criminal charges if the certification is incorrect or false.

It’s hard to argue against anti-money laundering regulatory requirements. The regulator’s stock response is “Then you are in favor of financing terrorists.” Nobody is in favor of that. A few greedy financial executives have gone bad and that causes the rest to endure increasing scrutiny.

The key question is who is going to get caught up in these proposed regulations.

§504.3 Transaction Monitoring and Filtering Program Requirements.
(a) Each Regulated Institution shall maintain a Transaction Monitoring Program…

§ 504.2 Definitions.
(e)“Regulated Institutions” means all Bank Regulated Institutions and all Nonbank Regulated Institutions.

(b) “Bank Regulated Institutions” means all banks, trust companies, private bankers, savings banks, and savings and loan associations chartered pursuant to the New York Banking Law (the “Banking Law”) and all branches and agencies of foreign banking corporations licensed pursuant to the Banking Law to conduct banking operations in New York.

(d) “Nonbank Regulated Institutions” shall mean all check cashers and money transmitters licensed pursuant to the Banking Law.

That moves the regulatory requirements into an area I’m no longer familiar with. New York banking law licensing and charters is outside my scope of knowledge.

The regulations go on to require the Chief Compliance Officer or functional equivalent to file an annual certification.

[T]he undersigned hereby certifies that they have reviewed, or caused to be reviewed, the Transaction Monitoring Program and the Watch List Filtering Program (the “Programs”) of (name of Regulated Institution) as of ___________ (date of the Certification) for the year ended________(year for which certification is provided) and hereby certifies that the Transaction Monitoring and Filtering Program complies with all the requirements of Section 504.3.

This is most likely not applicable to most fund managers not associated with licensed banks. We still need to keep an eye on FinCEN who is working on a new anti-money laundering requirement for registered investment advisers.

Sources:

proposed Transaction Monitoring and Filtering Program regulation
Press Release on proposed regulations
Cuomo Proposes Tough Anti-Money-Laundering Rules by Christopher M. Matthews in the Wall Street Journal
Proposed Anti-Money Laundering Regulations for Investment Advisers and Fund Managers

Laundering Dollar Bills is by TaxRebate.org.UK
CC BY

Dealing With Leftovers

If your Thanksgiving was anything like mine, you have leftover food. It’s a poor allocation of resources, but Thanksgiving has turned into a weekend of excess. Excess food, excess shopping, excess football, excess dessert, excess waistline. Perhaps your compliance program is also filled with leftovers.

Very few compliance officers would say that they have more resources than they could possibly need or put to good use. Compliance departments are not packed full of tupperware with stuff to be used later. Compliance is a cost center.

Most firms are not starving their compliance programs, trying to trim fat. A typical fund manager wants to bountiful compliance program that addresses the risks to the firms. Regulators and, more importantly, investors expect and demand a robust compliance program.

Are there items on your compliance program that are related to risks no longer present at the firm. Do you have that container full of leftovers from 2009 hiding in the back of your fridge taking up room?

Leftover Turkey by Andrew Nash
CC BY SA

When a Compliance Officer Breaks Bad

There has been considerable discussion in the compliance community around the Securities and Exchange Commission bringing charges against compliance officers. There are three areas that the SEC feels it is justified in bringing charges: (1) when the compliance officer is involved in the wrongdoing; (2) when the compliance officer impedes the examination or investigation; and (3) when the compliance officer is in wholesale failure. The latest SEC charges against a compliance officer fall into the first area.

Yue Han was an associate in the compliance department of Goldman Sachs. That gave him access to the emails of the investment bankers to look for potential misconduct. The SEC claims that Mr. Han broke bad and used the information he gathered from those emails to spot upcoming M&A activity for his own personal gain.

Mr. Han has not settled the charges so this story is based only the SEC’s allegations. He left the country and may not dispute the charges. The SEC has gotten an asset freeze, so he will have to fight the claim if he wants the cash back.

The SEC claims that its case stems from its Market Abuse Unit’s Analysis and Detection Center, which uses data analysis tools to detect suspicious patterns. The SEC claims that its enhanced detection capabilities enabled SEC enforcement staff to spot Han’s unusual trading activity in two different accounts.

Four companies are at the center of the SEC’s case: Yodle, Zulily, Rentrak, and KLA. In each case, he bought out-of-the-money options cheaply just before an acquisition was announced and recognized a big gain after an acquisition was announced. Goldman Sachs was an adviser in each of the deals.

In one of the Han trading accounts, the broker-dealer barred him from acquiring further trading in the account. I assume the firm noticed the suspicious trading.

The complaint leaves out whether or not Mr. Han cleared his trades with Goldman. I would assume not since the firms would have been on the blocked list.

I would guess that Mr. Han is not going to dispute the charges and try to re-gain his trading profits.

Sources:

Happy Thanksgiving

That means an extra long weekend for me. In Boston, the big traffic rush was on Tuesday night to avoid the traffic on Wednesday. I think most people have a half day on Wednesday or the day off. I hope you get to enjoy a long weekend before the push for year-end.

I’m going for the #OptOutside Friday instead of Black Friday. Look for me on bike, heading somewhere.

It would not be a holiday without some kind of government action. On Thanksgiving we get the presidential pardon of a turkey (or two): The Definitive History of the Presidential Turkey Pardon.

US Private Equity Fund Compliance Guide

If you are looking for something to read during the long Thanksgiving Weekend or a great holiday present, pick up a copy of the newly released The US Private Equity Fund Compliance Guide, Volume III. PEI Media just released this follow up that updates the original 2012 edition with the ongoing review and actions of the SEC.

Once you get your hands on the Guide, you should feel free to marvel at Chapter 8: SEC Examinations: How to Successfully Handle the Process. I’m sure the author of that chapter is brilliant. I’m also sure he is ruggedly handsome and kind to animals.

If you agree, I can offer you a 15% discount. Use the code AUT_COM3 when ordering.

compliance guide

TABLE OF CONTENTS:

Introduction

Section I: SEC focus areas

1. US regulatory developments and areas of increased SEC focus applicable to private equity fund advisers since 2012
Erik A. Bergman, Justin J. Shigemi and Reed W. Balmer, Finn, Dixon & Herling LLP

2. Must-know current SEC issues
Julia D. Corelli and Stephanie Pindyck-Costantino, Pepper Hamilton LLP

3. Valuation practices
James E. Anderson and Justin L. Browder, Willkie Farr & Gallagher LLP

4. Cybersecurity
Kari M. Rollins, Winston & Strawn LLP

5. Marketing in the US and EEA
Laura S. Friedrich and John Adams, Shearman & Sterling LLP

6. Due diligence and fundraising
David A. Smolen and Caroline Schimmelbusch, GI Partners

7. Form PF and Annex IV regulatory reporting requirements
Jeanette Turner and Paul Yau, Advise Technologies, LLC

8. SEC examinations: How to successfully handle the process
Doug Cornelius, Beacon Capital Partners LLC

9. SEC enforcement actions against private equity firms
Richard D. Marshall, Katten Muchin Rosenman LLP

10. Compliance officer liability: How to protect the compliance officer
Richard D. Marshall, Katten Muchin Rosenman LLP

11. Compliance roundtable
James Gaven, Welsh, Carson, Anderson & Stowe, Christopher Anderson,
KPS Capital Partners, Joel Wattenbarger, Ropes & Gray LLP

Section II: Appendices

1. Spreading Sunshine in Private Equity
Andrew J. Bowden, director, Office of Compliance Inspections and Examinations

2. Private Equity: A Look Back and A Glimpse Ahead
Marc Wyatt, acting director, Office of Compliance Inspections and Examinations

3. Conflicts, Conflicts Everywhere – Remarks to the IA Watch 17th Annual IA Compliance Conference: The Full 360 View
Speech by Julie M. Riewe, co-chief, Asset Management Unit, Division of Enforcement

4. Cybersecurity Examination Sweep Summary
National Exam Program Risk Alert issued by the Office of Compliance

5. Cybersecurity Guidance
Issued by the Division of Investment Management

6. OCIE’s 2015 Cybersecurity Examination Initiative
National Program Risk Alert issued by the Office of Compliance Inspections and Examinations (OCIE)

7. Examination Priorities for 2015
Issued by the Office of Compliance Inspections and Examinations

SEC Brings Charges Against CCO for Custody Failure

Last week at the Coping With Regulatory Failure conference, representatives from Securities and Exchange Commission repeated the SEC’s line that the SEC is not after compliance officers. But yet another case of CCO liability came out and this one kicks the CCO out of the industry and levels a $60,000 fine.

Failure stamp over white background. High detail in high resolution.

The SEC panelists repeated the line that the SEC only goes after CCOs in three circumstances:

The CCO participated in the fraud
The CCO hinders the exam or investigation
Wholesale failure of the CCO

It’s the “wholesale failure” standard that has left many CCOs wondering if the SEC understands that term.

With a new enforcement action ruling out that pins liability on the CCO I thought it was worth a look to see if it meets the SEC standard.

The SEC announced charges against Sands Brothers Asset Management last year. The charge itself was a fairly technical violation of the Custody Rule. Sands Brothers managed private funds. According to the SEC’s order instituting an administrative proceeding, Sands Brothers was at least 40 days late in distributing audited financial statements to investors in 10 private funds for fiscal year 2010. The next year, audited financial statements for those same funds were delivered anywhere from six months to eight months late. The same materials for fiscal year 2012 were distributed to investors approximately three months late.

That’s not good. But it is a bit technical.

The really bad part is the SEC has been after the firm to fix this problem for years. Sands Brothers and its co-founders first landed in trouble in 1999. The exam noted a deficiency for custody rule procedures. The firm thought it did not have custody, but as a manager of a private fund, it does have custody.

Sands Brothers landed in trouble again 2010 when the firm was the subject of an enforcement action for custody rule violations. The firm failed to submit an adequate audit and did not timely distribute audited financial statements.

“There is no place for recidivism in the securities markets… so now they [the Firm] face more severe consequences,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.

So it’s hard to have any sympathy for the firm for the Custody Rule violations.

But what about the CCO? These are the factors that apparently caused the CCO to be a “wholesale failure.”

The CCO knew or was reckless in not knowing about, and substantially assisted,
SBAM’s violations of the custody rule. (The CCO had executed the notarized offer of settlement to enter into the 2010 Order on behalf of Sands Brothers.)
The compliance manual tasked the CCO with “ensur[ing] compliance with the restrictions and requirements of Rule 206(4)-2 adopted under the Advisers Act.”
Kelly engaged the auditors for full audits (but not surprise examinations)
The CCO signed representation letters to, and was a principal contact for, the auditors.
The CCO knew that the audited financial statements were not being distributed on time.
The CCO implemented no policies or procedures to ensure compliance with the custody rule – even after the 2010 Order and after Sands Brothers continued to miss its custody rule deadline year after year.
The CCO simply reminded people of the custody rule deadline without taking any more substantial action.
The CCO did not make any attempt to notify the staff of the Commission of any difficulties Sands Brothers was encountering in meeting the custody rule deadlines.

It’s hard to have much sympathy for the CCO in this situation. The Principals of the firm were also subject to bar and monetary fines, so the CCO was not singled out.

The ALJ decision had blamed the CCO for being “reckless” for not doing more to prevent the custody violations. The Settlement Order with the COO also said that he “knew or was reckless in not knowing about” the custody violations.

If we go by the SEC’s earlier standard, then the SEC is equating “reckless” with “wholesale failure.” It would have been much better for the SEC to use the standard is has been espousing: “wholseale failure”; rather than using the “reckless” standard in the order.

Sources:

Failure is from Graphic Leftovers under license

Compliance Bricks and Mortar for November 20

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

Attributes of a Great Ethics and Compliance Leader by Jean-Marc Levy in Corporate Compliance Insights

The three most important qualities of a CECO are courage, a deep understanding of his/her business and emotional intelligence. These qualities go beyond the traditional role of an in-house lawyer at most organizations. As a CECO, spending time with as many leaders of other functions as possible can help hone these skills and support their usage.[More…]

Want to Avoid “General Solicitation?” Focus on Relationships! by William Carleton in Counselor @ Law

The theme of the new SEC guidance is this: a “pre-existing, substantive relationship” can be a terrific antidote to the virus⁴ of “general solicitation.”

Now, the concept of the pre-existing, substantive business relationship has been around for a long time. It’s been a way of demonstrating that a given deal is indeed private, and prior guidance from the SEC has long held that an issuer can extend the utility of the concept by including, not only persons the issuer knows, but also the relationships of a broker dealer participating in a given offering. [More…]

SEC’s Piwowar Takes Another Shot at ‘Flawed’ Enforcement Statistics by Bruce Carton in Compliance Week

In his remarks this week at the 34th Annual Current Financial Reporting Issues Conference, SEC Commissioner Michael S. Piwowar took another wisecrack at the way the SEC measures the effectiveness of its enforcement efforts. Speaking to an audience of primarily non-lawyers who prepare financial statements, Piwowar asked them to

imagine a world where GAAP or other reporting standards did not exist – where management could develop its own numbers based on its own poorly-defined criteria. Management might be tempted to create numbers that provide the illusion of performance but in reality are largely irrelevant to measuring the actual performance of that organization. Reported numbers might be distributed for public consumption without clear disclosure as to how they were derived.

[More…]

Whistleblower Tips Rise Again in 2015 by Christopher M. Varano in Securities Compliance Sentinel

The Securities and Exchange Commission released its 2015 Annual Report on its Whistleblower Program this week and announced another rise in the number of whistleblower tips that it received. The SEC reported receiving 3,923 tips during its 2015 Fiscal Year, which is up from 3,620 in 2014 (as we previously reported), and up over 30% from 2012, which was the first full year that these numbers were reported. Additionally, in its FY 2015, the SEC paid out $37 million to whistleblowers, which included a whopping reward of over $30 million to just one whistleblower. The SEC’s Office of the Whistleblower (OWB) rewards whistleblowers for “their provision of original information that led to a successful Commission enforcement action with monetary sanctions totaling over $1 million” and can net tipsters between 10% and 30%, which is the statutory maximum allowed under the Dodd-Frank Act.[More…]