The Lure of Wyoming

1000px-Flag_of_Wyoming.svg

There is a long history of splitting financial regulatory oversight between state regulators and federal regulators. For investment advisers the split is based on Assets Under Management and Dodd-Frank raised the AUM level from $25 million to $100 million. Above that level you register with the SEC and below that level you register with the state regulator.

The exception is the state of Wyoming. Wyoming is the only U.S. state that does not regulate investment advisers. So if you are an adviser in that state, you register with the SEC regardless of assets under management.

The Securities and Exchange Commission published a trio of cases in involving Wyoming last week. In each of the three cases, the firm improperly claimed Wyoming as its principal office and principal place of business.

David Nagler organized New Line Capital in Santa Fe, New Mexico in 2007. In March 2012, just before Dodd-Frank’s change in registration, New Line re-organized as a Wyoming company and amended its Form ADV to reflect its new place of business.

Just changing the state of organization and renting an office in the new state does not make the new state a firm’s principal place of business.

Nagler did not direct, control, or coordinate the activities of New Line from Wyoming. During all relevant times, Nagler resided in New Mexico and used his residence there as a base of operations. Nagler never met clients in Wyoming and rarely used the small office space that New Line rented in Wyoming.

SEC Rule 222-1 For purposes of section 222 of the Act:

(a) Place of business. “Place of business” of an investment adviser means:

(1) An office at which the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and

(2) Any other location that is held out to the general public as a location at which the investment adviser provides investment advisory services, solicits, meets with, or otherwise communicates with clients.

(b) Principal office and place of business. “Principal office and place of business” of an investment adviser means the executive office of the investment adviser from which the officers, partners, or managers of the investment adviser direct, control, and coordinate the activities of the investment adviser.

Arete Ltd. d/b/a Sky Peak Capital Management initially registered with the SEC in November of 2012 claiming Cheyenne, Wyoming as its principal place of business. But all of its operations were California.

The most extraordinary of the three is Wyoming Investment Services, organized as a Wyoming limited liability company and filed with the SEC in February 2013. But its actual place of business was at the home of its president in Ft. Collins, Colorado.

All three were lured to Wyoming to gain registration with SEC and to avoid registration with state regulators.

Sources:

 

Testing for the Avalanche

IMG_2197[1]

As Nassim Nicholas Taleb famously explained in The Black Swan, it is the unexpected that is most unexpected. For compliance professionals, testing is one of the tools that tries to expose the unexpected.

I was thinking about testing as I was out in the snowpack in my front yard. I tried out some of the avalanche tests I remembered from my mountaineering days.  As you can see from the cracks above, the snow failed the test and had a slab release. Fortunately, it was only my snowblower that fell victim to the unstable snow.

The six feet of snow in the last 30 days is pushing the infrastructure limits in Greater Boston. The subway system is failing, the roads are clogged with snow, nearly every roof has ice dams.

Perhaps the avalanche of snow is not a true Black Swan event. Huge amounts of snow are not unprecedented. Boston was subject to five feet snow in 30 days in 1978. (Of course, that event crippled Greater Boston for weeks.) It is more of a statistical anomaly than an unexpected and unforeseeable event.

How robust, or Antifragile, do you design the infrastructure to deal with an event that only happens every 30 years? How do you test your systems for an event that only happens once every few decades?

I’m not sure I have an answer. I’m sure that I have a sore back from shoveling so much snow.

Making a Bigger Compliance Mistake After Making a Big Compliance Mistake

face palm head in hands by Alex Prolmos

Total Wealth Management became one of the whipping boys for the Securities and Exchange Commission when it started its focus on private fund fees last year. The firm settled with the SEC and agreed to pay the fine. But the firm exacerbated the problem by allegedly misappropriating the money from its clients.

Last year, the SEC accused Total Wealth of wrongfully taking revenue sharing fees. It’s not that the fees themselves are wrong, but they must be disclosed and the some effort made to make sure that clients are put ahead of the revenue sharing. Total Wealth apparently failed on both counts.

The SEC accused Total Wealth of not disclosing the revenue sharing. According to the complaint, the revenue sharing severely distorted the firm’s behavior. About 92% of Total Wealth’s fund assets were invested in entities that had revenue sharing arrangements.

Total Wealth agreed to settle the charges and put $150,000 into escrow in advance of the SEC’s consideration of the order. The firm did so.

[Face to Palm]

The firm “borrowed” the $150,000 from the fund it managed.

[Head shake.]

Clearly, Jacob Cooper, the head of Total Wealth has little appreciation for conflicts of interest. There is no instance in which a loan to the fund manager is in the best interest of the fund. There is no may that the principals themselves can be the ones to make that decision because the decision-making itself is a conflict of interest.

The loan also shows that there is a lack of internal controls that prohibit the misuse of client funds.

I, and many others, thought the SEC was off-base when it brought charges against Total Wealth and headlined the action on the use of “may” instead of “will”. The firm had said in its documents that it may enter into revenue sharing arrangement. The SEC though this was a disclosure fail because the firm had actually entered into those arrangements.

I still think it was a reach by the SEC to carry that headline. But clearly, there are issues at Total Wealth and it appears it was right of the SEC to try to bring the firm in line.

Sources:

Compliance Bricks and Mortar for February 6

Woodberry - Snowy Brick Wall

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

Alstom Gets Break on Fine by Rachel Louise Ensign and Ted Mann in the Wall Street Journal

When the U.S. Justice Department announced a record $772 million foreign-bribery settlement with Alstom SA in December, there was a hitch: The French engineering company couldn’t pay without hurting its ability to do business.

So Alstom got a break: approval from a court to wait until its $17 billion deal with General Electric Co. closes before making the payment.

A Day In The Life Of Private Equity Giant TPG by Ben Walsh and Ryan Grim in the Huffington Post

At a 2012 investor conference, private equity giant TPG, which manages about $65 billion, showed a video documenting a day in the life of the firm to the audience of pension fund managers and other large, institutional investors. ” The video is set to the chords of Coldplay’s “Viva La Vida” and zooms around to TPG’s global offices.

The video, which has not previously been made public and was obtained by The Huffington Post, tries hard to make that day seem like an ostentatiously unglamorous, elite, ultra-competent corporate mission where value is delivered to investors with a smile.

As Regulators Focus on Culture, Wall Street Struggles to Define It by Emily Glazer and Christina Rexrode in the Wall Street Journal

As they emerge from years of bruising fines, layoffs and losses, big banks are trying more than ever to monitor employee attitudes and values to avoid future problems.

But they also have little choice: Senior officials with the Federal Reserve and other agencies in recent weeks have made it clear that they believe bad behavior at banks goes deeper than a few bad apples and are advising firms to track warning signs of excessive risk taking and other cultural breakdowns. Still, even regulators acknowledge culture is a difficult thing to measure.

Image of Snowy Brick Wall is by Kathleen Conklin

What Ever Happened to the SEC’s Cybersecurity Sweep?

univac

The Securities and Exchange Commission put the financial sector in a tizzy when it announced a sweep exam addressing cybersecurity last April. Along with the announcement came a detailed document request list that would make most compliance officers’ heads spin.

The problem with the cybersecurity sweep is that it seems to be coming from the wrong people and is addressed to the wrong people. When I think of the Securities and Exchange Commission I don’t think of hacking and data security. I think of lawyers and accountants. When I think of financial services compliance officers, I also think of lawyers and accountants.

Maybe that is overly specific. But I don’t think of cybersecurity experts in either case.

It’s not that cybersecurity is not important to the industry. It’s very important. Clients must have faith that their investments will not be stolen. Historically, the role of the SEC has been to make sure the financial professional is not stealing from its clients. Cybersecurity imposes a requirement that unknown hackers are not stealing from the financial professional’s clients.

The cybersecurity sweep went to 57 registered broker dealers and 49 registered investment advisers and looked at the legal, regulatory, and compliance issues.

The SEC’s Risk Alert on Cybersecurity details the findings.

I’m going to guess that that each bullet point is now a new standard that a firm will need to meet. The alert does not say so, but I’m going to use it as a blueprint for an additional review of cybersecurity.

Sources:

Compliance and the Super Bowl

super bowl

As a long time Patriots fan, it’s a great morning.

But the Patriots and the NFL were not without compliance failures. Clearly, something went wrong with the Patriots’ footballs in the Indianapolis game. I keep hearing conflicting reports and the investigation is not complete so it’s hard for me to draw any conclusions.

But the Patriots are tainted by the organization’s past rules violation. That makes the current claims all the more damning. Past failures will haunt an organization’s reputation for a long time.

For now, I’m enjoying the crazy win.

Image by Jim Moynihan

Compliance Bricks and Mortar for January 30

IMG_2186[1]

I have finally dug myself out from the 2+ feet of snow that buried me this week. These compliance-related stories caught my eye in between snow shoveling sessions.

SEC Co-Chief of Division of Enforcement’s Asset Management Unit Identifies 2015 Exam Priorities for Hedge and Private Equity Funds in the National Law Review

On November 18, 2014, Julie M. Riewe, Co-Chief of the Division of Enforcement’s Asset Management Unit of the Securities and Exchange Commission (the “SEC”), spoke at a Practicing Law Institute seminar and identified 2015 SEC examination priorities for investment managers of private funds. Ms. Riewe identified three themes on which the SEC will focus in its examinations of hedge and private equity funds: (i) conflicts of interest, (ii) valuation and (iii) compliance and controls. She discussed how these thematic issues related to both hedge funds and private equity funds.

S.E.C. Faces Challenges Over the Constitutionality of Some of Its Court Proceedings by Peter J. Henning in NYTimes.com’s DealBook

It is probably not a stretch to say that the Securities and Exchange Commission likes to win every case that it decides to bring.

But a recent push by the agency to bring more cases before its administrative law judges rather than filing charges in federal district court is drawing increased attacks from defense lawyers claiming that the entire process is not just unfair, but also unconstitutional. Those criticisms could call into question the legality of the process used by a number of federal agencies that have in-house judges who decide whether laws were violated.

Welcome to COSO and the World of Internal Controls – Part I and Part II by Tom Fox in the FCPA Compliance and Ethics Blog

[T]here is one area of FCPA enforcement, which I think underwent a sea change in 2014 and has significant implications for the Chief Compliance Officer (CCO) and compliance practitioner in 2015 and far beyond. That change will be in the enforcement by the Securities and Exchange Commission (SEC) of the internal controls provisions of the FCPA. Last fall we saw three SEC enforcement actions, where there was no corresponding Department of Justice (DOJ) enforcement action yet there was a SEC enforcement action around either the lack or failure of internal controls. Those enforcement actions were Smith & Wesson, Layne Christensen and Bio-Rad.

What’s in your Wallet? Insider Trading

Jennifer_Garner_Capital_One

It’s clearly insider when a company’s high-level executive trades on pending earnings data not yet released to the public. It’s clearly not insider trading when you count cars in a retailer’s parking lot to get insight to sales. A recent SEC case falls somewhere in the middle.

The Securities and Exchange Commission brought charges against two men who worked at a credit card company. The two crafty traders tracked credit card use to determine revenue trends for retailers and then traded based on that data.

Their plan was solid. They made over $2.8 million on a $147,300 investment, a return of 1,819%, according to the complaint. Those returns are too good. I would bet that their brokerage accounts were flagged by compliance.

The credit card company was not disclosed in the complaint, but Capital One has acknowledged that they’ve “been working closely with the SEC on this investigation, which involves two former employees.”

This case reminds me of the Railroad Insider Trading case where an employee noticed a bunch of “suits” walking around the railroad and some unusual activity in the office. He surmised that the railroad was getting sold, traded on that assumption, and made some money on the trade. The SEC thought he was engaged in illegal insider trading. A jury thought otherwise.

In this current case, the two men were subject to the credit card company’s rules on protection of this information. According to the SEC, they broke those rules.

They “knew or were reckless in not knowing that they owed their employer a fiduciary duty, or an obligation arising from a relationship of trust and confidence, to maintain the confidentiality” of the data.

In looking at the portions of Capital One’s insider trading policy, it probably should have addressed this particular topic. The portion of the code excerpted in the SEC complaint is a rather standard ban on illegal insider trading. It seems to fail to address the use of data at the company.

What the two traders did is certainly enough to get them fired. It was enough to get them charged by the SEC. It may be harder to get a jury to agree. Unlike some other recent insider trading cases, this one was filed in federal court. So it will be up to a jury, not one of the SEC’s administrative judges, to determine guilt.

Sources:

Compliance Bricks and Mortar for January 23

bricks 15

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

Equity Crowdfunding: A Market for Lemons? by Darian M. Ibrahim in the CLS Blue Sky Blog

Before reaching the more difficult Title III, I reveal that the less-radical Title II, which allows general solicitation of accredited investors, seems to have proven successful for entrepreneurs and investors in its first year of operation. Online platforms such as AngelList, FundersClub, and CircleUp have successfully matched entrepreneurs and accredited investors and raised significant cash for startups. This is somewhat surprising, at least on first analysis, considering: 1) that moving operations online would appear to weaken the close networks and geographic locality that explain traditional angel/VC success; and 2) that the first Internet matching service for startups and accredited investors, ACE-Net, failed miserably over a decade ago.

SEC Gets Busy With Accounting Investigations by Jean Eaglesham And
Michael Rapoport in the Wall Street Journal

But the new cases are on a smaller scale and typically involve conduct that is far less egregious than the accounting scandals of the early 2000s, such as the implosion of energy giant Enron Corp.

In addition, the agency’s computerized system for sniffing out accounting fraud has so far proved to be less revolutionary than many expected when it was unveiled in 2012.

’123456′ Again: The Most Popular Passwords Aren’t Changing by Rani Molla in the Wall Street Journal

Despite the high-profile hacking attacks last year, people are still using passwords that security analysts say should have been in the dustbin years ago. Both “123456″ and “password” have been the top two passwords since security-app provider SplashData began measuring the most frequently used passwords in 2011.

KKR

Refunds Some Fees to Investors by Mark Maremont in the Wall Street Journal
KKR & Co. refunded money to investors in some of its buyout funds after regulators found it overcharged them, marking one of the highest-profile results yet of regulators’ increased scrutiny of the private-equity business.

Meet The 80 People Who Are As Rich As Half The World by Mona Chalabi in FiveThirtyEight.com

Eighty people hold the same amount of wealth as the world’s 3.6 billion poorest people, according to an analysis just released from Oxfam. The report from the global anti-poverty organization finds that since 2009, the wealth of those 80 richest has doubled in nominal terms — while the wealth of the poorest 50 percent of the world’s population has fallen.

11 of the wealthiest people on the planet were simply born into their money (19 others inherited their wealth and then made it grow). The remaining 50 names on the list, according to Forbes, are self-made billionaires.