Tag: Bruce Carton

Is Bitcoin a Security?

bitcoin

You may have noticed that I focus on SEC actions against real estate companies. At the core of that interest is a look at whether the Securities and Exchange Commission has jurisdiction. The SEC is limited to securities. Commodities get covered by the CFTC and real estate gets covered by …..

Bruce Carton pointed to another item in the news that also addresses the realm of what is and is not a security: Bitcoin.

The SEC brought charges against Trendon T. Shavers, who is the founder and operator of Bitcoin Savings and Trust (BTCST). The SEC alleged that he was running a Ponzi scheme based on a “virtual currency” arbitrage on Bitcoin. Shavers apparently used the handle Pirateat40.

Beginning in November of 2011, Shavers began advertising that he was in the business of
“selling Bitcoin to a group of local people” and offered investors up to 1% interest daily “until
either you withdraw the funds or my local dealings dry up and I can no longer be profitable” Shavers obtained at least 700,467 Bitcoin in principal investments from BTCST investors, or $4,592,806 in U.S. dollars, based on the daily average price of Bitcoin.

Shavers argued that the BTCST investments are not securities because Bitcoin is not money, and is “not part of anything regulated by the United States. Shavers also contends that his transactions were all Bitcoin transactions and that no money ever exchanged hands.

The SEC argued that the BTCST investments are both investment contracts and notes, and therefore are securities. The SEC said that Shaver returned about 500,000 Bitcoins to investors, but made off with another 200,000

Bad news for Shavers. A decision in the case this week ruled that BTCST investments meet the definition of investment contract, and as such, are securities. The court concluded that it had subject matter jurisdiction to hear the SEC’s case.

15 U.S.C. § 77b of the U.S. Code defines “security” as “any note, stock, treasury stock, security future, security-based swap, bond…[or] investment contract…”  Under the Howey line of cases, an investment contract is any contract, transaction, or scheme involving (1) an investment of money, (2) in a common enterprise, (3) with the expectation that profits will be derived from the efforts of the promoter or a third party.

Investment of money

Bitcoin can be used to purchase stuff. The only limitation (and its a big one) is that it is limited to places that accept it as currency. Bitcoin can also be exchanged for conventional currencies, such as the U.S. dollar. It was that recent spike in the exchange rate between Bitcoin and the US dollar that attracted so much attention.

Common enterprise

A common enterprise requires interdependence between the investors and the promotor, for example where the investors colelctively rely on the promotor’s expertise. The investors were giving Shaver their bitcoins and he was supposed to trade them and get more value back them.

Expectation of profits from efforts of others

In this case, the investors were not taking an active role in the investment. They were relying on Shavers.

The court’s finding that it has subject matter jurisdiction means that the SEC’s case against Shaver can  move forward. The SEC still has not proven fraud and will likely face another round of arguments on jurisdiction.  The SEC still has to prove fraud.

The interest rate Shavers gave to investors was a staggering 7% per week for large investments. That smells like a Ponzi scheme. Personally, I don’t think I’d hand any money, bitcoin or US dollars, to someone named “Pirate.”

References:

The SEC’s Asset Management Unit

Yesterday, Bruce Carton of Securities Docket hosted a webinar: The SEC’s Asset Management Unit and Strategies for Avoiding Trouble in 2011 and Beyond. He managed to get Bruce Karpati, the co-head of the SEC’s Asset Management unit, to participate. Also joining the presentation were John Reed Stark, Managing Director of Stroz Friedberg and former Chief, SEC Office of Internet Enforcement; and Bradley J. Bondi, a litigation partner at Cadwalader, Wickersham & Taft LLP and former counsel to SEC Commissioners Troy Paredes and Paul Atkins for enforcement matters.

The SEC’s Asset Management Unit focuses on investment advisers and investment companies. If you run a private fund, this unit is keeping an eye on you.

You can see replay of the presentation yourself, but here are the things that caught my attention:

Private fund registration under Dodd-Frank is very important to his unit. They work closely with OCIE. They are looking forward to the new data that will come from fund registration and Form PF.

They are especially concerned about the level of transparency, even for private funds, and the information given even to institutional investors.

Weak and fraudulent valuation processes are high on his list of concerns. In particular, he is concerned about private funds with an incentive to overvalue assets. He mentioned the Palisades funds use of side pockets that lead to an enforcement action. He also mentioned the

Another highlight was “investment drift.” Make sure that your investment activity is not wandering from the areas that you told your investors you were going.

Of course, insider trading and expert networks are taking up a fair amount of his unit’s time and energy.

He raised the “suspicious performance investigation” where the SEC is looking at funds that have consistently outperformed market. The leading example is the Madoff scandal. Madoff’s outlying performance should have been a red flag for investors. The SEC wants to spot these kind of problems.

He is looking at adviser background misrepresentation. It sounds like they are ready to bring fraud charges for misstating educational background and experience.

Stark praised the unit. As a lawyer who would be on the opposite side of the table he would prefer someone with specialized knowledge of the investment management industry than a generalist enforcement lawyer.

Stark focused on the In the Matter of AXA Rosenberg Group LLC, et al.(Feb.2011) involving a flaw in the computer model for a quantitative fund. The model’s algorithm had a flaw that resulted in under-performance. This is tough one for compliance because the compliance geeks are rarely in the room with the math geeks.

Bondi laid out a series of compliance policies and issues that new investment adviser registrants should be concerned about.  He spent a great deal of time focusing on privacy and security breaches. (Maybe too much for the focus of this presentation.)

Sources:

participants in April 5 Webcast, Karpati, Stark and Bondi

Corporate Compliance after Dodd-Frank: Dealing with Whistleblower Bounties

Securities Docket produced a webcast “Corporate Compliance after Dodd-Frank: One Voice; How Many Masters?” that focused on the SEC’s proposed new whistleblower rules and their implications for internal controls and compliance programs, investigations, self-reporting incentives and employer/employee relations, including executive compensation and employee reporting responsibilities.

The panelists:

  • Byron Egan, Partner Jackson Walker L.L.P.
  • Jeffrey Sone, Partner Jackson Walker L.L.P.
  • Gary Kleinrichert, Senior Managing Director FTI Consulting

Section 922 of Dodd-Frank provides an expanded whistleblower program that allows the whistleblower to get part of the money paid to the SEC for the violation.

There is a lot of gnashing of teeth among compliance professionals because this provision would encourage an employee to ignore internal complaint processes and head directly to the Feds. Those internal whistleblowing program came out of Sarbanes-Oxley, the legislation enacted as a result of the last financial crisis.

The new program is not applicable to private companies that are not subject to registration under the Securities Act of 1934. Section 922 of Dodd-Frank is an amendment of that law.

Employees with a legal, compliance, audit, supervisory or governance responsibility have limited eligibility for the whistleblower bounty. They are not eligible if the information was communicated to them with the reasonable expectation that they would take steps to respond to the violation. They are then eligible if the company does not disclose the information to the SEC within a reasonable time or proceeds in bad faith.

———

In prognosticating the impact, we can look at the False Claims Act which has a similar whistleblower bounty program. Under that legal framework, most people don’t report to the government until they have given their company a chance.

Much of the whistleblower program is in SEC Release 34-6323. Comments are open until December 17, 2010. Certainly, the proposed rule could change significantly bases on the comments.

Sources:

Don’t Lie to the Feds When Caught for Insider Trading

The “classical theory” of insider trading targets “a corporate insider’s breach of duty to shareholders with whom the insider transacts[, and the] misappropriation theory outlaws trading on the basis of nonpublic information by a corporate ‘outsider’ in breach of a duty owed not to a trading party, but to the source of the information.” See United States v. O’Hagan, 521 U.S. 642, 651-53 (1997). The extra element that the government must prove in a criminal insider trading case, beyond what it is required in a civil action, is that the defendant acted “willfully.” 15 U.S.C. § 78ff.

The Securities and Exchange Commission is limited to fines and injunctions, but when the Department of Justice gets involved they will be seeking jail time for insider trading. Although their enforcement authority mostly overlaps, the DOJ exercises their jurisdiction sparingly. After all, the DOJ generally gets the case when the SEC refers the case to them.

Don’t lie to the SEC when they are investigating an insider trading case against you. It makes them angry and more likely to refer the case for criminal prosecution. You can always be quiet.

Case in point is the indictment filed against Peter Talbot and Carl Binette in connection with trading in the stock of securities for Safeco Corporation. Talbot worked at Hartford Investment Management Company. He saw some co-workers putting in long hours and concluded they were working on a potential acquisition. Talbot snooped around the company’s network and found files from those co-workers identifying Safeco as the target of the acquisition. Talbot told his nephew, Binette.

Talbot instructed Binette to buy call options on Safeco stock for $37,260,85 in a newly opened brokerage account. A week later, a competitor announced it was acquiring Safeco, sending up the stock price. The two sold their call options and realized a 1653% profit of $615,833.06.

The SEC looked closely at Binette because of all the red flags in that account. Binette was a 28 year old finance manager at a car dealership. It would certainly be odd that he would suddenly plop down over $30,000 on a speculative investment. It turns out he had borrowed $10,000 from his home equity line, $10,000 from his aunt, and $10,000 from each of his supervisors.

Binette lied to the SEC about whether he had spoken to anyone else about the Safeco securities. That’s obstruction of justice. That’s what landed in jail. In this case, it sounds like they have good case for actually proving insider trading against Binette and Talbot, something they failed to do for Martha.

Binette even claimed that the trades were based on a dream. That’s another big red flag for the SEC. I could imagine a few chuckles coming from the SEC investigators when they heard that terrible excuse.

It’s  also likely to land him in jail, instead of merely returning his ill-gotten gains and paying a fine.

Sources:

Winding Down From Compliance Week

My head is full of compliance goodness after spending 2.5 days at Compliance Week 2010. The Mayflower Hotel is a great place for a conference this size, with plenty of places to run into people.

Substance

The agenda was full of great substantive information from fellow compliance professionals. There were sessions on metrics, social media, corporate governance, ROI, organizational structures and communications. There were lots of closed door sessions that have not made their way into the blog, where compliance professionals could have more open discussions without the presence of media or vendors.

On top of that, we heard some great perspectives from top government officials, like Lanny Breur, Gary Grindler, Shelley Parratt, Barney Frank and Luis Aguilar.

Of course the best part of any conference is being able to interact with your peers. This was a great gathering of people in the compliance field.

Matt Kelly, Francine McKenna and Me

Old Friends

For me, it was great to once again spend time face-to face with old friends like Scott Cohen, Matt Kelly, Bruce Carton, Francine McKenna, Melissa Klein Aguilar, Bill Piwonka, Carole Switzer, Kathleen Edmond, and Scott Giordano.

New Friends

One of the great things about have a blog, or micro-blogging on Twitter is being able to get in touch with people prior to meeting them in person and then staying in touch with them.

Here are some of the Twitterati I was finally able to meet face-to-face:

tfoxlaw Tom Fox
@tfoxlaw
http://tfoxlaw.com
David Seide
@davidSeide
Scott Mitchell
@mitchell360
Doug Jacobson
@tradelawnews
Doug Chia
@dougchia

Of course, I met more people who don’t blog or use Twitter. It’s just harder to keep those weak ties.

Behind the Scenes

Gina Imperato, Elizabeth Busch, Anne Frey-Mott, Beckie Jankiewicz and the rest of the Event Studio team did a great job of running the conference, getting the attendees where they need to go and making the speakers look good.

Next year

…..

Social Media and Compliance

Compliance, ethics, and legal executives at Johnson & Johnson, Best Buy, and The Travelers Companies will provide details on their social media policies, programs, and experiences, focusing on a variety of cultural, legal, and disclosure-related issues.

    Featuring:

  • Johnson & Johnson Senior Counsel & Assistant Corporate Secretary Douglas K. Chia
  • Best Buy Chief Ethics Officer Kathleen Edmond
  • The Travelers Companies, Inc. SVP, Chief Compliance Officer & Group General Counsel David Baker
  • Compliance Week Columnist; President, Docket Media LLC; Founder and Editor, Securities Docket, the ubiquitous Bruce Carton (moderator)

I introduced Bruce and the rest of this panel. Then I helped to control the rambunctious crowd.

Travelers is using social media for complaints. You make a claim through their iPhone app. They also use it as a tool for customer service and advertising. They will push out an update on Twitter and Facebook when a catastrophe van in the area of a natural disaster.

Doug is active in social media so he can look at how the company could use social media. Currently their prime use is for their retail products. They are going to where their customers are hanging out. They use the JNJ BTW blog to publish current events at Johnson & Johnson. They are using the corporate twitter (JNJcomm) account to push out information from the shareholder meetings.

Doug highlighted a list of legal, compliance, reputational and logistical issues to consider when a company steps into social media.

Kathleen created her blog to help educate her workforce about what could get you fired. Retail companies have a huge employee turnover. The industry average is close to 100%. If someone is going to tell her story, she wants to be the person to tell it.

Best Buy has lots of social media outlets: Twelpforce, CEO’s Whiteboard, CEO’s Twitter, CMO’s Twitter, CMO’s blog.

She also used internal social media to help develop policies. She used an internal wiki to get feedback on potential policies and issues. She thinks feedback from employees is important in developing good, enforceable policies.

There is the fear of litigation. What you say could cost you and subject you to a lawsuit. Of course, if it’s effective it can save you lots of money by avoiding the bad situations.

It’s tough to work in a conservative company when facing something as innovative as social media.

One company assemble a social media task force to draft a social media policy. They managed to create a user reference manual to give detailed guidelines to the employees.

The audience expressed some concern about the improper disclosure of company information. The panel pointed out that social media is merely a newer avenue for disclosure. People have been able to improperly disclose information for years.

One of the panelists stated that they do block access to social media sites. Another pointed out that employees could just go to their mobile phone or find other ways to waste time.  It seems silly to block access to the sites if you are using the sites to market your company.

An interesting audience question was whether a privacy failure at a social media site would impact the company. Could you be tainted by a Facebook failure. It seems remote.

How do you manage the boundaries between personal and professional uses of social media. Make it clear that you are not stating the company position. Don’t use the company name in your handle or profile name. It’s @dougchia, not @J&JDougChia.

Materials:

David Baker:

Doug Chia

Kathleen Edmond

Questions and Answers with Robert Khuzami

After the news conference announcing the Rearrangement of its Enforcement Program, the Securities and Exchange Commission offered a group of bloggers the chance to ask questions to Robert Khuzami, the Director of Enforcement. (It must have felt like Obi-Wan stepping into the cantina full of low-life scoundrels.)

The blogging participants:

Mr. Khuzami let us know that the specialized units and cooperation initiatives came out of the self-assessment they conducted last year. Now that the heads of the new units have been made, those heads will start filling out their ranks.

Bruce started off questions by asking for more information on the new Office of Market Intelligence. This unit is combining two existing units, Market Surveillance and Internet Enforcement. It sounds like this will be a big source of information flow for the SEC with lots of complaints and charges coming in one place, getting filtered and sent to the right people for the appropriate action.

I asked about the creation of the new specialized units which are great for expertise, but may push information into silos. Mr. Khuzami pointed out that one of the current problems is that information is currently too diffuse across the SEC. There is a going to be hybrid approach. Not everything is going to end up in these units. He thinks expertise is very important. These units are going to be national in scope, so the people will spread out across the regional offices.

Laura Richman wanted to know if the SEC Commissioners are going to be comfortable with the new cooperation protocols. The enforcement division can only make a recommendation. It’s up to the Commission to decide whether to prosecute or settle. (This is unlikely to give the warm fuzzies to someone who is thinking about acting as a whistleblower or a company cooperating with an issue.)

Todd Sullivan was surprised that the cooperation initiatives were not already available to the SEC. Mr. Khuzami pointed out that criminal prosecutions have used cooperation strategies for a long time. It’s a new concept to civil proceedings.

Cate wanted to know if the SEC could develop the experience or tools to differentiate between proprietary trading versus market making. The SEC wants better information.

Francine wanted to know if the SEC will step up its enforcement actions against the accounting firms. Timeliness is key. If there is a long time between the misconduct and the prosecution, then there is a lost opportunity to stop others by setting an example.

Mr. Khuzami pointed out the SEC has been through a tough year but his group wants to use their professional skills and do good work. He thinks the Division is coming together and moving forward in a positive direction.

I want to thank Mark Story, the SEC’s Director of New Media, for inviting me to the press conference and Rob (I think I can call him that now) for taking the time to talk with us.

SEC News Conference on its Enforcement Program

Bruce Carton of Securities Docket, Francine McKenna of Re: The Auditors and I are attending the SEC’s news conference virtually and taking notes using the CoverItLive tool embedded below.

FCPA: Overcoming the Toughest Issues

FCPA panel

Bruce Carton and SecurtiesDocket presented this informative webinar. The panelists were:

securitiesdocket

– Hank Walther, Dept. of Justice
– Larry Urgenson, Kirkland & Ellis
– Elliot Leary, KPMG Forensic
– Phil Desing, KPMG Forensic

The panel started of with parallel international investigations. This is a new topic because for years there was no other country enforcing anti-bribery laws. There are some limitations on investigations. In particular, there is the secrecy of grand jury information. The Justice Department is willing to get a court order for the benefit of a foreign government’s prosecution.

As for self-reporting in jurisdictions outside the US, the panelists see instances of disclosures to other governments. Companies want a one stop shop for disclosure.

Due diligence on agents, distributors, and in connection with M&A activity continues to be a challenge, In a KPMG Survey, 82% respondents found performing effective due diligence on foreign agents/third parties “somewhat” to “very” challenging. Two of the three DOJ FCPA opinion releases in 2008 address merger and acquisition due diligence matters: 08-01 and 08-02.

Of course, the current global financial crisis may increase opportunities for corruption, given the greater competitive atmosphere and fewer resources being available.

You want to conduct proactive due diligence. Require the third party to fill out a Questionnaire that will include among other things, FCPA representations and warranties, disclosure of government affiliations, employment information, company ownership. Conduct media and public record searches. Also conduct due diligence evaluations on company personnel. Agreements should contain FCPA specific language, including audit rights.

In high risk countries, be sure to focus on the safety of your employees. If there is a concern for physical safety, pay and get out.

After an acquisition, make sure that you quickly roll out your policies and procedures. Start the monitoring as soon as you can.

References:

Madoff Hearing at the Senate Banking Committee

I will be covering today’s Senate Hearing (”Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance“) along with several guest panelists via the interactive discussion below. Please visit this page today at 2:30 pm to join me, Bruce Carton of Securities Docket, Compliance Week editor Matt Kelly, and others as we follow the hearing – and bring your questions!