Happy Start to Your Compliance New Year

I hope you were able to enjoy the long weekend. Perhaps an extra long weekend if you found December 31 to be an optional work day. Today is obviously not the first day of the new year, but it is the first day of work in the new year.

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With the new year, come the resolutions to do things differently this year, to do better, to meet goals.

That all starts with setting goals and expectations. There is no magic to choosing the beginning of January, as opposed to any other month.

Except you will write the wrong year at least three times today.

We often get to stages in our life where we want change. Maybe today is that day for you. Maybe you have already written “2015” three times today.

Here in Boston, today means that winter has arrived. After a flirtatious light snow, the cold has come and wrapped me in its icy grip.

But I already went for a bike ride in the cold and went to the gym. So I’m still on track for some personal goals.

When it comes to compliance, there are many tasks we need to address. It’s time to get at least one done today and stay on track.

Enjoy 2016.

Compliance Bricks and Mortar for the New Year

Happy New Year! May 2016 be better for you than 2015.

These are some of the compliance related stories that caught my eye before the end of 2015.

Happy New Year 2016

Compliance Fiction by Roy Snell in SCCE’s Compliance & Ethics Blog

Let me tell you a completely fabricated compliance story. [More…]

The Father of Texas and Leadership in Compliance by Thomas Fox in the FCPA Compliance Report

Today we celebrate leadership, which comes from a different place than we usually see. On December 27, 1836, the Father of Texas, Stephen F. Austin, died. Most people think Sam Houston was the father of this great state but it was the person for whom our state capital is named. Austin was the man who led the colonization of Texas in the early 1830s and was one of Texas’ earliest political leaders. He was appointed by Sam Houston as the first Secretary of State for the Republic of Texas but only served two months before his death at the age of only 43. On his deathbed, Austin’s last words were “The independence of Texas is recognized! Don’t you see it in the papers?…” Upon hearing of Austin’s death, Houston ordered an official statement proclaiming: “The Father of Texas is no more; the first pioneer of the wilderness has departed.” [More…]

Why does the SEC care about elder clients by Joshua Horn in Securities Compliance Sentinel

The SEC is conducting an exam sweep that focuses on retirement advice being given to clients of investment advisors and broker-dealers. Some commentators see this as a turf war between the SEC and the Department of Labor (DOL) because the sweep focuses on things that may come under the DOL’s jurisdiction. Whether the exam sweep intrudes upon the DOL’s purview is really not the point. [More…]

Happy New Year 2016 (Plenty of opportunities)
by Miquel Angel Pintanel Bassets
CC BY SA

Looking Ahead – Five Compliance Predictions for 2016

With my 2015 almost gone, I was thinking about what to expect in 2016 in the private fund and real estate fund compliance area. My crystal ball is not very reliable. If it was fully operational, I would have bought Apple stock in 2002 before the iPod came out.

Hand drawing New Year concept with white chalk on blackboard. Going ahead to year 2016 and leaving the year 2015 behind.

Real Estate Fund Enforcement Actions

There was a focused review of real estate fund advisors that wrapped up about a year ago. Given how enforcement actions work through the SEC, I expect the enforcement actions from the bad apples will come out in 2016. One area he noted was problematic was when a fund manager claimed to providing services at market rate, but had no evidence that the rate used was actually market rate. I had the chance to ask a member of the private funds unit if we could expect these actions. The response was a strict “no comment.”

Succession Planning

Several speeches coming from the SEC have pointed to certain operational risks becoming part of the compliance mandate. The SEC staff is developing recommendations to help advisers assess and plan for the impact on investors when an investment adviser is no longer able to serve its clients. For most fund managers, investors already cast a wary eye on firms that don’t have succession plans in place. The SEC is going to stick its thumb into this tricky area. This will be an area that compliance will loath as they have to talk to their firms’ principals about death and disability.

Fees and Expenses

This area is a continuing area of focus for private fund exams. I expect more enforcement actions will come out in 2016. I’m sure there will be new types and approaches that will require firms to react to the SEC’s interpretation of what is fair.

Anti-Money Laundering

If you are opposed to anti-money laundering requirements then you will get labeled as pro-terrorism. FinCEN will come out with new regulations imposing anti-money laundering requirements on investment advisors and fund managers.

Employees, Consultants and Expenses

I suspect we will see more cases brought by the SEC against firms that are dedicating employees to portfolio companies and charging those expenses to investors instead of the management company.

 

Another Potential Reason for Companies Not to Go Public

Cybersecurity is a real threat and needs to be taken seriously. But is it a Board of Directors level issue for all public companies? I don’t think so. But apparently Senators Jack Reed and Susan Collins think that is. That would mean another headache for public companies.

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Of course there may be some companies that need cybersecurity as a priority for a seat in the boardroom. Does a pharma company trying to create a new drug need to devote a precious board seat to a cybersecurity expert?

The legislation imposes an obligation on the Securities and Exchange Commission to implement this concept.

It also requires the SEC to work with the National Institute of Standards and Technology to define what constitutes expertise or experience in cybersecurity. That of course is whole other issue. There are lots of people out there claiming to be cybersecurity experts. The best are likely trying to hack into your system right now.

I’m sure cybersecurity experts are frothing at the concept of getting board seats. Unfortunately, it will take away a seat from someone who might bring better expertise to the company.

Like the conflict minerals legislation, it’s another rule that brings little protection to investors but imposes large costs and difficulties on public companies.

As you might expect, the SEC has it’s own cybersecurity issues. I wonder if one of the SEC Commissioners will be required to have cybersecurity expertise.

Sources:

Brian Klug: Anonymous Hacker
CC BY SA

This Year’s Most Popular Posts

top 20

As 2015 comes to an end, I looked back at some website wonkiness and saw a report for the top stories this year based on the number of views. Maybe you missed some of these.

Qualified Purchasers under the Investment Company Act

What is a Security? Is Real Estate a Security?

Private Equity Real Estate Top 50 – 2014 Edition of Who Is Registered

Private Fund Exemptions under the Investment Company Act

Private Equity Real Estate Top 50 – 2015 Edition of Who is Registered

SEC Exam Document Request Examples

Real Estate Funds and the Investment Company Act

Is a Note a Security?

Social Media Policies Database

Yes, the SEC Wants Real Estate Fund Managers to Register

Hypothetical Backtested Performance

The NFL Teaches Us the Difference Between Ethics and Compliance

Is a Fund Manager an Investment Adviser?

Corporate Compliance Scam Continues. . .

Corporate Compliance Fraud in Georgia, Florida and Massachusetts

Is a General Partnership Interest a Security?

Kleptocracy Asset Recovery Initiative

The Knowledgeable Employee Exemption for Private Funds

Ethics and the Sales Relationship in World-Class Bull

Ethical Integrity Leadership – Setting the Tone From The Top

Shkreli Gets His Holiday Gift… Handcuffs

One of the most hated men in American business was grabbed by the FBI and put in handcuff. The Securities and Exchange Commission slapped a “me too” suit on him as well. Martin Shkreli did the perp walk last week for running a ponzi scheme.

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Shkreli became the face of what is wrong with the American health industry when he jacked the price of treating a life-threatening parasitic infection from $13.50 a tablet to $750.

With his engorged wallet he spent $2 million to purchase the sole copy of Wu Tang Clan’s latest album. To prove that it was just an expensive trinket, he claimed to have not listened to it.

That all just makes him gross, but not a criminal.

But it turns out that he got there through running a ponzi scheme. He pulled off the rare ability to exit from a ponzi scheme.

The vast majority of ponzi schemes collapse under the weight of promised payouts exceeding the inflow from new investors. The original investment scheme fails and the sponsor is scrambling to find anything that might work to score the redemptive returns. Given that the supply of capital is significantly smaller, the returns need to be astronomical.

Skreli had lost all of his investors’ money. He had just settled a FINRA Arbitration over naked short-selling that took the last few dollars out of his hedge fund accounts.

He started MSMB Capital, a hedge fund company, in his 20s and drew attention for urging the Food and Drug Administration not to approve certain drugs made by companies whose stock he was shorting. The strategy did not work.

Nonetheless he send a message out to investors that he had doubled their money.

Mr. Shkreli started Retrophin, which also acquired old neglected drugs and sharply raised their prices. The company was wildly successful and went public.

As a public company, Retrophin can’t pay off Mr. Shkreli’s disgruntled hedge fund investors. But fiduciary obligations were apparently not important to him and he caused the company to write the checks.

Retrophin’s board fired Mr. Shkreli a year ago. Last month, it filed a complaint in Federal District Court in Manhattan, accusing him of using Retrophin as his personal piggy bank to pay back disgruntled investors in MSMB Capital.

The DOJ and SEC piled on and brought their own suits.

Sources:

SEC Takes a Look at the “accredited investor” definition

The Securities and Exchange Commission left a new Report on the Review of the Definition of “Accredited Investor” as an early Christmas present under your compliance tree. [Feel free to replace Christmas with New Years or the year end celebration of your choice.] We will need to keep an eye on what happens with this report.

 

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The accredited investor definition falls right into battle zone of the SEC where it needs to balance capital formation on one side and investor protection on the other. I expect there will a Festivus feats of strength contest to see who wins the battle over the definition.

Section 413(b)(2)(A) of Dodd-Frank requires the SEC to study the accredited investor definition every four years.  This is the first study. It’s not a SEC inspired review, but one mandated by Congress.

SEC Chair Mary Jo White encourages “investors, companies and other market participants to provide comments as public input will be very valuable as the Commission considers the definition.” The report considers alternative approaches to defining “accredited investor,” provides staff recommendations for potential updates and modifications to the existing definition and analyzes the impact potential approaches may have on the pool of accredited investors.

Few people think that the current income and net worth tests for an accredited investor have much to do with the ability to judge the risks of a private investment. Of course, it also does not mean that non-accredited investors can judge a publicly listed security either.

But the current tests do offer a bright-line than makes it easy toe evaluate a potential investor’s eligibility to participate in the offering.

“Clarity and certainty in the accredited investor definition foster greater confidence in unregistered markets and ultimately could reduce the cost of capital, thereby promoting increased capital formation, particularly for small businesses.”

Given that Regulation D offerings still raise more money than registered offerings, you have to wonder if Congress and the SEC have made it more palatable to stay private.

As for private placements being more risky than registered investments, I will disagree. They may be more or less risky on whether the investment will produce a return. The risk is not in the return. The risk is one of liquidity. A private placement by Exxon may not be any more risky than the public stock. The risk is that there is no market to resell the security. If you suddenly need the cash back from the investment you may have no ability to get it until a liquidation event.

Here are the two groups of recommendations from the Report:

The Commission should revise the financial thresholds requirements for natural persons to qualify as accredited investors and the list-based approach for entities to qualify as accredited investors. The Commission could consider the following approaches to address concerns with how the current definition identifies accredited investor natural persons and entities:

  • Leave the current income and net worth thresholds in place, subject to investment limitations.
  • Create new, additional inflation-adjusted income and net worth thresholds that are not subject to investment limitations.
  • Index all financial thresholds for inflation on a going-forward basis.
  • Permit spousal equivalents to pool their finances for purposes of qualifying as accredited investors.
  • Revise the definition as it applies to entities by replacing the $5 million assets test with a $5 million investments test and including all entities rather than specifically enumerated types of entities.
  • Grandfather issuers’ existing investors that are accredited investors under the current definition with respect to future offerings of their securities.

The Commission should revise the accredited investor definition to allow individuals to qualify as accredited investors based on other measures of sophistication. The Commission could consider the following approaches to identify individuals who could qualify as accredited investors based on criteria other than income and net worth:

  • Permit individuals with a minimum amount of investments to qualify as accredited investors.
  • Permit individuals with certain professional credentials to qualify as accredited investors.
  • Permit individuals with experience investing in exempt offerings to qualify as accredited investors.
  • Permit knowledgeable employees of private funds to qualify as accredited investors for investments in their employer’s funds.
  • Permit individuals who pass an accredited investor examination to qualify as accredited investors.

Personally, I think some increase in the income and asset tests are okay if it also includes an ability for an investor to prove financial sophistication to gain access to private offerings.

Sources:

Wrapped Gifts Under Tree is by Jimmie
CC BY