Compliance Bricks and Mortar for October 23

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

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Two Games about Gifts for Corporate Compliance & Ethics Week by Ricardo Pellafone in SCCE’s The Compliance & Ethics Blog

You know that your employees are competitive, so you know that a game show is more engaging than a Powerpoint lecture.

But you’ve also got other stuff to do, so spending the time to put together the mechanics and questions for a new game show isn’t going to happen.

And so you end up playing Jeopardy. Again.

Well, not this time. As we head into Corporate Compliance & Ethics Week—and towards the holiday season—here are two ideas for in-person game shows that will help your employees build their judgment on gifts and entertainment. [More…]

Inside Swiss Banks’ Tax-Cheating Machinery by Laura Saunders in the Wall Street Journal

Dozens of Swiss banks have been spilling their secrets this year as to how they encouraged U.S. clients to hide money abroad, part of a Justice Department program that lets them avoid prosecution. It is part of a broader U.S. crackdown on undeclared offshore accounts that has ensnared big Swiss banks such as UBS Group AG, but has received scant attention because it mostly involves little-known firms and relatively small fines. [More….]

DOL supports ESG fund use in 401(k) plans by Greg Iacurci in InvestmentNews

Fiduciaries had been wary of introducing ESG investments — also known by such names as economically targeted, and sustainable, responsible and impact (SRI) investing — to retirement plans due to previous guidance from the department, according to Secretary of Labor Thomas Perez. A 2008 rule said fund consideration based on factors other than risk and return, such as ESG, should be rare, which set a higher but unclear standard of fiduciary compliance, the DOL said.

That guidance “gave cooties” to impact investing and had a “chilling effect” on its use in plans governed by the Employee Retirement Income Security Act of 1974, said Mr. Perez, speaking Thursday in New York.

According to the new guidance — Interpretive Bulletin 2015-01, which is scheduled to be published in the Federal Register on Oct. 26 — “fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social or other such factors.” [More…]

Yates and Outsourcing Government Investigations by Michael Volkov in Corruption, Crime & Compliance

With the dramatic sea-change from the Yates memorandum, I predict (and fully expect) individuals who end up being prosecuted (civilly or criminally) to challenge more aspects of the corporate internal investigation. As companies conduct internal investigations under the “supervision and direction” of DOJ prosecutors, defendants will seek access to internal investigation documents, notes, and seek to portray outside counsel as agents of DOJ prosecutors.

I recognize that this will be a real stretch but I expect there to be more litigation in this area, under which defendants will claim they need access to such materials in order to adequately defend themselves. [More…]

SEC Faces New Attack on In-House Judges by Jean Eagleshem in the Wall Street Journal

Legislation to give defendants the right to opt out of the Securities and Exchange Commission’s in-house court is expected to be introduced in Congress on Thursday, ramping up pressure on the agency to further reform its controversial tribunal. [More…]

Private Fund Statistics

If you manage a private fund and are registered with the Securities and Exchange Commission, you spend a good chunk of April (and maybe more) filling out Form PF. Ever wonder what the SEC does with all that data? They publish an annual report on fund statistics, which was recently released.

Form PF

Form PF implemented Section 404 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which directed the SEC to establish reporting requirements for advisers to private funds. That reported information was to be sent on for use by the Financial Stability Oversight Council in monitoring risk to the U.S. financial system. The SEC also purports to use information obtained from Form PF in its regulatory programs and investor protection efforts relating to private fund advisers.

As of the end of 2014, there were 24,725 private fund reporting to the SEC. About 1/3 were labeled hedge funds and another 1/3 were private equity funds. There were 1,789 real estate funds.

Managing those funds were 2,694 advisers. Of those, 260 were real estate fund managers.

Gross assets for all private funds just missed the $10 trillion mark of gross value. ($9.956 trillion to be more exact). Real estate funds comprised $350 billion of that total.

One surprise is that the biggest owner of private funds is other private funds. (see Table 10) Private funds hold 20% of all private funds, with government pension plans holding 12.8% and private pension plans holding 12.5%.

There is some other interesting data in the report. It’s worth spending a few minutes flipping through it.

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The Female SEC Will be Taking on the Old Boys’ Club of Wall Street

President Obama nominated Lisa Fairfax and and Hester Peirce to fill the two vacant positions on the Securities and Exchange Commission. They will join May Jo White and Kara Stein. That leaves Michael Piwowar alone with his Y-Chromosome.

fairfax and peirce

Fairfax is a law professor and director for programs at George Washington’s Center for Law, Economics and Finance.  Fairfax is an expert on shareholder activism.

Peirce is a senior research fellow at George Mason and director of the financial markets working group at the university’s Mercatus Center. Peirce served on Senator Richard Shelby’s staff on the Senate Committee on Banking, Housing, and Urban Affairs. In that position, she worked on financial regulatory reform following the financial crisis of 2008 as well as oversight of the regulatory implementation of the Dodd-Frank Act. Peirce served at the Securities and Exchange Commission as a staff attorney and as counsel to Commissioner Paul S. Atkins

If confirmed, Fairfax would take the Democrat slot by replacing Luis Aguilar, whose term has expired. Peirce would take the Republican slot and replace Daniel Gallagher who stepped down in early October.

The President is able to placate both the right and the left with the two nominations. It will be interesting to see what direction the SEC turns to once the two new commissioners take their seats.

 

Compliance Bricks and Mortar for October 16

I have been busy and not been able to post any of my own stories this week. Here are some other compliance-related stories that recently caught my attention.

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The Right Wing’s Assault on the Post Office – Smashing the Myth That It’s in Financial Trouble by Yves Smith in Naked Capitalism

That year, the Congress passed the Postal Accountability and Enhancement Act of 2006 (PAEA). Under the terms of PAEA, the USPS was forced to “prefund its future health care benefit payments to retirees for the next 75 years in an astonishing ten-year time span” – meaning that it had to put aside billions of dollars to pay for the health benefits of employees it hasn’t even hired yet, something that “no other government or private corporation is required to do.”The problem with the Post‘s argument starts in its thesis: that the post office is in some sort of deep fiscal hole of its own making – a result of being left behind in the Internet Age and a shrinking consumer base. The truth is that almost all of the postal service’s losses can be traced back to a single change in the law made by the Republican Congress in 2006. [More…]

Compliance at the Tipping Point, Part V – Protection Afforded From a Compliance Program by Tom Fox in the FCPA Compliance Report

Finally, is the last tipping point the Schrems decision from the European Court of Justice (ECJ), which invalidated the Safe Harbor provision through which American companies brought information developed through hotlines and internal information back to the US? The decision is much more far-reaching than simply the FCPA. For instance, Sarbanes-Oxley (SOX) mandates that a company have a hotline. But similarly to the response to the whistleblower provisions of the Dodd-Frank Act, companies must now be in a stronger position to quickly and accurately assess any potential violations that might be detected, reported or arise. This means not only thoroughly training your compliance function but it also puts more pressure on the underlying internal controls to give the compliance function the underlying information, on a more real-time basis about high-FCPA risk issues. Further, if you tie the Schrems decision together with the Yates Memo which requires a company to turn over information on individuals in very short order, to receive any credit from the DOJ, you see the need for a more robust prevention system in addition to other sources of information. [More…]

Sports Organizations Need Effective Integrity and Compliance Programs by David Dodge in SCCE’s The Compliance & Ethics Blog

Scandals have become as much a part of sports as players, officials, and spectators and surely it won’t be long before today’s outrage is replaced by fresh indignation over some other antics, be they on-field or after hours. Ben Franklin once noted, “It takes many good deeds to build a good reputation and only one bad one to lose it.”

Well-designed, effective integrity and compliance programs eliminate the embarrassments that roil sports every season. Well-structured programs that have the support of top leaders in the organization would be a huge first step towards making it clear that ethical behavior is expected and there will be consequences for transgressors.[More….]

Compliance Officers Call for SEC Enforcement Guidelines by Randi Val Morrison in the CorporateCounsel.net

On the heels of recent SEC enforcement actions against Chief Compliance Officers (CCO) and associated statements by Commissioners Gallagher and Aguilar and Chair White, the National Society of Compliance Professionals, a financial services industry trade group for compliance officers, sent this letter to SEC Director of Enforcement Andrew Ceresney requesting that the Commission establish policy that permits initiation of enforcement proceedings against CCOs only if they acted intentionally or recklessly – not negligently – to facilitate the underlying primary securities law violation.

Compliance Bricks and Mortar for October 9

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

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The Unsophisticated Sophisticated: Old Age and the Accredited Investors Definition by Tao Guo, Michael S. Finke and Chris Browning in the CLS Blue Sky Blog

Using two large nationally-representative data sets that include financial literacy tests, we find that financial literacy scores decline in old age consistently among both accredited and non-accredited investors in both data sets. Average scores for accredited investors age 80 and older are significantly lower (45.7% in one data set and 57.1% in the other) than average scores for respondents age 60-64 (60.4% and 63.8%) who do not meet the accredited investor income and wealth thresholds. [More…]

DOJ Says Pursuing ‘Higher-Impact’ Bribery Cases by Stephen Dockery in the Wall Street Journal

Spokesman Peter Carr said after years of handling smaller cases coming from corporate self-reporting, the unit is now putting more at stake and going after blockbuster cases.  Initiatives to boost foreign corruption enforcement personnel and resources are being used to go after that high-profile wrongdoing, Mr. Carr said. Many of those programs began years ago.

His comments came in response to news that the Department’s anti-bribery efforts were eclipsed by the Securities and Exchange Commission in the third quarter. [More…]

The Psychology of Cheating and FCPA Compliance by Thomas Fox in the FCPA Compliance Report

In the movie Margin Call, Jeremy Irons intones that there are three ways to win in business: (1) be the smartest; (2) be the fastest; and (3) cheat. I am currently out at the SCCE 2015 Compliance and Ethics Institute and as you might guess the Volkswagen (VW) emissions-testing scandal is a major topic of conversation. One of the more interesting observations is that the VW scandal was not a failure of compliance but an intentional design to cheat emissions standards testing on a worldwide basis. [More…]

 

The image is from the Apollo 17 Archive on FLickr

Fund Managers, Legal Fees, and Fund Expenses

The Securities and Exchange Commission brought an action against Blackstone for failing to disclose fees received from portfolio companies and for discounts from legal firms that it worked with, but without passing these savings on to investors. The monitoring fee issue has been discussed in compliance circles for some time. The legal fees action is new and caught my eye.

Cash in the grass.

I had heard of an instance where the SEC gave a deficiency for charging in-house lawyers’ time to a fund and its investments without properly disclosing that practice. This is different.

According to the order, Blackstone received a larger discount on legal fees as fund manager than the funds received. Blackstone told investors that the differential reflected the different mix of work performed by the unnamed law firm for the fund manager and the fund.

Other items I noted on the issue is that the differential was in place between 2008 and 2011. Blackstone’s internal audit discovered the problem in 2011 and Blackstone changed practices. So this issue was discovered and corrected years ago. So why is the SEC bringing an action now? Maybe this is just a “pile-on” by the SEC to express its displeasure.

I’m confused about how the arrangement for legal fees worked. Blackstone said it was based on the mix of work.

Perhaps the law firm was offering a 25% discount on HR/employee work, 10% on fund formation, and 5% on M&A deals. The fund, the fund formation, and fund investments would use these legal services in different amount and so the discount would not be uniform. That would result in a disparate discount. Maybe that is what happened?

Clearly a fund manager cannot have its law firm provide discounted services for the fund manager in exchange for allowing full pricing for the fund. That’s shifting costs from the fund manager to the fund. (Of course if it’s disclosed ahead of time, a fund manager could do so.)

The frustrating thing about the order is that its not clear what Blackstone did. So other compliance professional cannot use it to figure out what the SEC wants fro mfund managers.

As to the monitoring fees:

“This SEC matter arose from the absence of express disclosure in marketing documents, 10 or more years ago, about the possible acceleration of monitoring fees,” Blackstone said, calling the practice common in the industry. Blackstone voluntarily made changes to the applicable policies before the inquiry began, according to a spokesperson.

Obviously, the SEC continues to focus on fees and expenses for private fund managers.

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What Does the Future Hold for the Regulation of Private Equity Funds?

The Chair of the Securities and Exchange Commission offered a sneak peak of upcoming regulations. Mary Jo White was speaking at the 75th Anniversary Celebration: Investment Company and Investment Advisers Acts and offered a few tidbits.

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Chair White spoke about the history of the Acts and offered a glimpse into the future:

Today, as many of you know, the Commission has an ambitious agenda to address evolving risks for funds and advisers, recently proposing enhanced data reporting by investment companies and advisers, and, just last week, proposing to require open-end funds to enhance funds’ liquidity risk management. As we speak, Commission staff is also developing recommendations that I hope to advance for the Commission’s consideration by the end of this year related to the use of derivatives by funds, including measures to appropriately limit the leverage these instruments may create, as well as enhancing risk management programs for such activities.

Beyond that, the staff is developing recommendations regarding transition planning for advisers, annual stress testing by large investment advisers and funds, a program of third party examinations for investment advisers and a uniform fiduciary duty for investment advisers and broker-dealers.

Talk about a full plate of critical initiatives.

The SEC wants to limit the use of derivatives by funds. It’s not clear whether that would applicable to all funds or focused on mutual funds.

Transition planning for advisers is a hot button. It’s certainly an issue for small retail advisers. It’s also a question for many private fund managers. It will be interesting to see what the SEC will propose.

Annual stress testing for large funds will be tricky. I wonder how the SEC will define “large.”

Third-party exams for investment advisers is back on the table. That will mean more costs to registered advisers having to pay for the service of being examined more regularly. I’m sure FINRA popped its head up when it saw that line in the speech.

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Fortune Telling
by Russ Allison Loar
CC BY SA

Compliance Bricks and Mortar for October 2

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

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The Curious Incident of the ‘Life Coach’ and the Press Release by Bruce Carton in Compliance Week

As I’ve observed before, the SEC loves to craft press release headlines that feature defendants’ interesting or high-profile jobs. For example, past SEC headline highlights include:

All of this makes it quite mystifying to me how the SEC’s case filed last week…[More]

Where I Think the Yates DOJ Memo Will Take Us by Roy Snell in SCCE’s Compliance & Ethics Blog

On one side of the room will be top leadership; on the other, the lead investigators. The DOJ may ask that the Board Chair be involved. At some point during the meeting, the DOJ will share their recent memo/policy that, paraphrased, states, “If you turn over internal investigations of individuals involved in the alleged wrongdoing, you will get more credit.” (“More credit” is a euphemism for, in some cases, millions of dollars in reduced penalties.) But beyond the discussion of credit, leadership will need to be prepared for a discussion of discipline.[More…]

Reflections on the Hitachi FCPA Enforcement Action by Thomas R. Fox in FCPA Compliance & Ethics

Perhaps the most interesting aspect of the Hitachi matter is that it involved bribery of a political party, the African National Congress (ANC). The SEC Press Release stated, “Hitachi sold a 25-percent stake in a South African subsidiary to a company serving as a front for the ANC. This arrangement gave the front company and the ANC the ability to share in the profits from any power station contracts that Hitachi secured. Hitachi was ultimately awarded two contracts to build power stations in South Africa and paid the ANC’s front company approximately $5 million in “dividends” based on profits derived from the contracts. Through a separate, undisclosed arrangement, Hitachi paid the front company an additional $1 million in “success fee”.”[More…]

The Volcker Rule as Structural Law by John C. Coates in the Harvard Law School Forum on Corporate Governance and Financial Regulation

Alongside these banking laws, another set of structural laws grew in importance in the 20th century: administrative law—the body of statutes and court doctrines channeling and controlling the use of delegated law-making power by government officials and agencies. To control and improve the functioning of agencies, Congress adopted a number of legal constraints, including the Administrative Procedures Act, which together with an assertive judiciary gives private actors the ability to challenge regulation in court. To this list, cost-benefit analysis (CBA) has been increasingly advanced—in advocacy, in Congress, and in court—as an additional tool for improving financial regulations, and holding financial regulatory agencies accountable to the public. [More…]

The Compliance Dangers of Cheerleaders and Nay-Sayers by Michael Volkov in Corruption, Crime & Compliance

Many senior executives are smart people –we all understand that. But too often senor executives embrace an interpersonal style of cheerleading. It allows them to appear to be on the “team” and prevent them from “rocking the boat.” Unfortunately, such an attitude prevents them from being a value add and problem solver for real management issues. [More…]

 

Failing the Family

Some Securities and Exchange Commission cases catch my attention because of their headlines or their focus on a real estate investments. The case against Lee Dana Weiss caught my attention because it was from my home town.

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The story is one of alleged self-dealing and failure to disclose conflicts. In a complaint filed in U.S. District Court for the District of Massachusetts, the SEC alleges that Family Endowment Partners LP and its owner, Lee Dana Weiss, of Newton, Massachusetts, urged their clients to invest more than $40 million in illiquid securities issued by several related companies without disclosing that Weiss had an financial interest in the investments.

 

This was not the first round of trouble for Mr. Weiss and Family Endowment. In April, they lost an arbitration and had to repay $48 million to clients. The firm had recommended a series of private investments in a company that owned a Polish tobacco company and patents on a cigarette filter that it claimed would revolutionize the tobacco industry. Not only was it a sketchy investment, but apparently Mr. Weiss had an undisclosed performance interest in the success of the company.

Browsing through the Form ADV, you can see that it is filled with subsidiaries and the multiple hats that Mr. Weiss was wearing.  Given all of the existing disclosures, it seems that it should have been easier to include the additional disclosures that would have helped his case.

Given that Mr. Weiss had an ownership interest, and not just an incentive payment, the principal transactions rule would apply requiring explicit consent by the advisory client.

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New SEC Rulemaking Database

Strong rulemaking is central to the mission of the Securities and Exchange Commission. Transparency to the process is important so the affected parties can provide input and see changes coming. To help with mission and to improve transparency, the SEC launched a new database intended to provide better transparency.

SEC Seal 2

I applaud any effort the SEC takes to make it easier for compliance professionals to find, understand and implement its regulatory scheme.

I decided to try out the index/database and share my initial thoughts.

The new database does provide a better single source for lots of the SEC rules. It’s better than the current chronological listing of rules. But not not that much better.

The rules have three sortable fields:

  • Last action
  • File number
  • Title of rulemaking

The first two are not useful. Anyone remember the date the rule was proposed or the file no.? No I didn’t think so. The title is useful if you know the name and the name is descriptive.

I decided to look for two rulemaking that interest me: Crowdfunding implementation under the JOBS Act and General solicitation amendments to Form D and the private placement regime.

I had trouble. I didn’t know the date or the file number or the name. I have the choice to limit the rules displayed by Status: “All”, “complete” or “Proposed”. I also had the choice to limit the display by SEC division. None of these choice are particularly useful for the layperson. I’m not sure any of the database choices are even useful for compliance professionals.

The database lacks a separate search.

Fortunately, I have this website so I could search for the post about the changes, find the relevant SEC document and locate the file number on the document so I could use the database.

I found my post on the proposed amendments to Rule 506 and Form D that were released at the time the SEC issued the new Rule 506(c) allowing general solicitation. In the SEC’s database I see that the database shows the proposed rule and second rule re-opening the comment period.  I’m not sure I could have found that entry if it were not for this website.

Fortunately, the crowdfunding regulation was actually called “Crowdfunding” so it was easier to spot by sorting the “rulemaking” column.

I did notice that the Naked Short Selling Anti-Fraud rule is out of order because it is titled “Naked” Short Selling Anti-Fraud, with the punctuation disrupting the alphabetical sort.

 

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