Tag: Securities Docket

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

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

Fair Value Accounting: What Lawyers Need to Know

securitiesdocket

Bruce Carton of Securities Docket put together a great panel of securities and accounting experts to discuss the evolution of fair value accounting regulations and the impact of the guidelines in accounting and legal contexts.

Presenters

These are my notes from the webcast.

Fair value accounting records the estimated market value of many assets and liabilities on balance sheets. Although sometimes called “mark-to-market” but that is a misnomer. You need to estimate the value if there is no market for the asset. Fair value estimation methods were standardized by SFAS 157 (ASC Topic 820 –Fair Value Measurements and Disclosures) issued by FASB in 2007.

The standard came out just in time for the financial meltdown.

There are three types of measurement:

Level 1: Based on quoted prices in active markets for identical instruments.

  • Listed stocks, actively traded bonds.

Level 2: Based on observable (auditable) inputs used to estimate an exit value.

  • Two similarly situated buildings in a downtown real estate market.
  • OTC interest-rate swap, fair valued based on observable data such as the contract terms and the current LIBOR forward rate curve.
  • Contracts with option-like features, fair valued based on contract terms, observed volatility, interest rates.

Level 3: Based only on unobservable inputs and assumptions used by the company to estimate an exit value (i.e., where markets don’t exist or are illiquid).

  • CDOs, many financial derivatives, stock in unlisted companies.
  • Level 3 fair value estimates usually employ the company’s own models, notably variants of Discounted Cash Flow (Present Value) models.

Huge losses reported by financial firms on subprime assets led to a debate over the implementation of SFAS 157 when markets become illiquid and price inputs aren’t readily available. During the crisis, banks and investment banks were required to reduce the book value of mortgage-backed securities to reflect their current prices.Those prices declined severely with the collapse of credit markets as mortgage defaults escalated. Banks were forced to raise capital and quickly jettison some of thee securities to raise capital, further providing downward pressure on the values. So, banks and politicians have blamed fair value accounting for contributing to the crisis.

On the other side, fair value accounting gave a more realistic view of the financial health of an institution. One of the factors in the financial crisis was that parties did not trust the credit-worthiness of their counterparties. Fair value provides important information about the values of financial assets and liabilities, as compared to their historical costs (original price). There should be greater transparency allowed for better informed decisions. It also limits the ability to manipulate earnings by timing the sale of assets.

But there are downsides to fair value accounting. When markets are illiquid, fair value is a hypothetical transaction price that cannot be measured reliably. When fair values are provided by sources other than liquid markets, they are unverifiable and allow firms to engage in discretionary income management. By recognizing unrealized gains and losses, fair value accounting creates volatility in a company’s equity. This is particularly important for financial institutions because it affects their regulatory capital.

There is also the quirk of the fair value accounting for one’s own liabilities. Some banks reported gains because of a decline in quality of their debt. They recorded an income gain because they were more likely to default on their debt.

One of the issues in the financial crisis is that mortgage-back securities moved from Level 1 valuations to Level 3 valuations very quickly. Models were not established for valuations of these assets when they went toxic and cash flows dried up.

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!

New Frontier: Best Practices in Fraud Investigations and EmergingTrends in SEC and DOJ Enforcement

securitiesdocket

Securities Docket sponsored a webinar addressing critical questions about recent changes in the economic and political climates, emerging trends in SEC and DOJ enforcement, and the potential impact on lawyers, accountants, investigators, and other consultants who perform fraud investigations. It also outlined best practices when conducting investigations for the DOJ and SEC.

Panelists:

  • Gary Kleinrichert, Senior Managing Director in FTI Consulting’s Forensic and Litigation Consulting Practice
  • Pravin Rao, formerly an Assistant U.S. Attorney in the Northern District of Illinois and currently a partner in the Litigation group of Perkins Coie
  • Jose A. Lopez, formerly a Senior Attorney at the United States Securities and Exchange Commission’s Division of Enforcement and currently a partner at Schopf & Weiss LLP

The webcast is available for replay. But if you want to browse, these are my notes:

Gary started the presentation by noting there is a change in regulatory focus and likely to be a new regulatory framework. He also pointed out that the SEC has become aggressive in bringing securities cases.

He noted that the hedge funds and other pooled investments will be regulated although the scope is still uncertain.

After a lengthy run through some other potential and recent regulatory changes, Gary pointed out a few things that you can do right now:

  • Be preventative
  • Review Sarbanes-Oxley, financial reporting, and securities compliance
  • Whistleblowers – Speak with lawyers to ensure internal policies are effective

Jose took over and highlighted President Obama’s impact on the SEC. Again, they are getting more aggressive. How can you survive in this hostile environment:

  • Master the SEC’s Enforcement Manual (.pdf)
  • Conduct an Effective Investigation
  • If Charges Are Filed, Aggressively Seek Information and Documents

Jose advocated requesting a Termination Notice from the SEC. The SEC’s Enforcement Manual (.pdf) provides that the Division should notify individuals and entities at the earliest opportunity when the staff has determined not to recommend an enforcement action against them to the Commission.

There was discussion about witness assurance letters, providing civil immunity for witnesses. In limited circumstances and with specific authorization of the Commission, SEC staff may provide a witness with a letter assuring him or her that the SEC does not intend to bring an enforcement action. There seems to have been little use of this procedure. In practice its use has not materialized.

Pravin focused on the Department of Justice enforcement activities. The DOJ had a focus on terrorism. He has seen a shift back to financial crimes. There is also more white collar crime legislation coming out of Washington.

he offered up two guiding principles for internal investigations:

  • “One size does not fit all“
  • “What you don’t know can hurt you”

You want to conduct an internal investigation:

  • Identify and limit harm to the company
  • Obligations under laws, regulations to self-disclose
  • Assist in criminal defense of company
  • Puts company in better light with government regulators
  • Puts company in better light with shareholders, public

He stressed the need for an developing a game plan for the investigation. You need to define the scope and decided who should be interviewed.

The materials are available on the Securities Docket website: Today’s Webcast (June 15): Materials Available Here for “A New Frontier: Best Practices in Fraud Investigations and Emerging Trends in SEC and DOJ Enforcement”

SEC Enforcement Update: A Wounded Animal is a Dangerous Animal

securitiesdocket Securities Docket presented this webcast with Michael MacPhail, of Holland & Hart LLP and Patrick Hunnius of White & Case LLP. “In a sharp detour from the era of Chairman Christopher Cox, the SEC under new Chairman Mary Shapiro’s leadership has obtained big budget increases that will be used to increase the number of enforcement lawyers. It has also empowered its staff by streamlining procedures relating to the issuance of formal orders of investigation and negotiating civil penalties with corporations. The staff has responded enthusiastically to the change in regime by bringing an unprecedented number of emergency civil actions, cases involving Foreign Corrupt Practices Act violations, and cases targeting lawyers.” The materials are available on Securities Docket. These are my notes.

Michael MacPhail of Holland & Hart LLP started off by pointing out the beating the enforcement division has taken over the last year. The new administration has brought in some strong new leadership. (and its pissed off and wants some victories.) The SEC is touting its litigation victories and enforcement actions. It wants to be tough and is taking a “Get Tough” approach.

The SEC is also seeking lots of Temporary Restraining Orders. The TRO is ex parte so the company has no chance to present its case at the TRO hearing. The TRO also usually includes an asset freeze. These are “draconian” measures. Since the SEC is limiting funds, they are also limiting the defendants’ access to cash for legal fees. That makes it hard to keep lawyers in place. One example is the Stanford case where his lawyers quit and Stanford now has to defend himself.

How do you avoid a TRO? Talk with the SEC staff and let them know that you have removed the risk factors. Show proof that the bad acts have stopped. Convince the SEC that assets and funds are not moving. Try using escrow accounts and transparent accounts. You will also need to prove that you are actually taking those steps. The Wells Process has started changing from office to office and case to case on the defendants access to information about the case against them.

Patrick took over to focus on enforcement priorities that are likely here to stay and some likely new trends. He pointed out that FCPA enforcement has been on the increase. They are also look at attorneys and other professionals. These are attractive scalps. One of the likely areas of enforcement is the FCPA in the era of Sovereign Wealth Funds and the use of government bailout funds. Many Sovereign Wealth Funds can fall under the definition of foreign controlled enterprise under the FCPA.

There is no clear line of what amount of foreign ownership makes an entity an instrumentality of a foreign government. Majority ownership is probably enough. But minority interests may still be enough. Increased Sovereign Wealth Fund investment activity could transform ordinary business partners into a foreign government instrumentality. For example, 10% of Daimler is owned by a Sovereign Wealth Fund. Another example is the City Center project in Las Vegas which is joint venture of MGM and Dubai World. The owner of that project may be subject to the FCPA. There are very few compliance programs in place to deal with that scenario. You have to be cautious about the foreign government ownership of banks and financial companies. Icelandic banks are probably instrumentalities of a foreign government. Looking inward, Citibank, AIG, and Bank of America could be thought of as instrumentalities of the United States.

The SEC has raised the flag that they are going after gatekeepers, especially if it can be seen that the gatekeepers was heavily involved in the bad acts. Patrick pointed out how lawyers have got dragged into the back-dating of stock options scandal. Patrick looked at two cases. In US v. Collins, the attorney was found to have been involved in drafting loan documents to hide some of the REFCO losses. The attorney was also involved in drafting the SEC disclosure documents and did not disclose the bad things he saw or should have seen. In US v. Offill he worked with his client to get around the registration requirements in order to sell securities. He was accused of being part of a “pump and dump” schemes.

The Subprime Boomerang: After the Writedowns Comes the Litigation

boomerang

Securities Docket put on a great webinar on The Subprime Boomerang: After the Writedowns Comes the Litigation.

Bruce Carton moderated a panel of Veronica Rendon of Arnold & Porter, Richard Swanson of Arnold & Porter and Jeff Nielsen of Navigant Consulting, Inc.

Jeff started off my showing how much complicated the picture is for securitized lending compared to traditional lend hold lenders. There is now a dozen + parties involved with very different interests. There are lawsuits between many of these relationships with fingers being pointed in many different directions.  There are also lawsuits within the parties as shareholders are bringing securities class action suits against the investors. Some of the parties changed roles through the the lifecycle of the loan. (Such as the originator becoming an investor.) Here is a snapshot of the parties:

securitization

Jeff identified 866 subprime related federal filings, including borrower class actions, securities class actions, contract claims, employee class actions and bankruptcy related claims. Of those 576 are in 2008. California has 17% of the suits and New York has 33%. (California has some tough laws that are the basis of borrower lawsuits.) They are also seeing two new cases for every case that is resolved.

Veronica pointed out that the securitization market grew from $157 billion in 200 to $1200 billion in 2006. That was staggering growth over a very short period of time.

Now we are in a period of rising interest rates, declining home prices, rising unemployment and forced sales.

Unfortunately 50% of adjustable rate mortgage originations over past four years have been subprime. There was some bad underwriting with lots of no-doc loans and high debt-to-income ratios.

The current bulk of suits are now “stock drop” case because the institutions failed to disclose their exposure to subprime risk.

Richard focused on some interesting aspects of the pleadings, hearings and decisions coming out of the cases.

There are increasing suits by purchasers of subprime assets. Lots of the focus on misrepresentations in the offering documents and a failure to disclose risks. These are generally very sophisticated parties doing war including state law claims.

There are also criminal investigations on the horizon. Both the FBI and SEC are looking at possibly bringing charges.

You can listen to webcast and see the slides on the  Securities Docket Webcasts page.

Web 2.0 – Leveraging New Media to Maximize Your Securities & Compliance Practice

On February 17, 2009, Securities Docket is sponsoring a webcast that will look at the numerous ways that securities and compliance counsel and professionals can now use web 2.0 to promote, market, and network themselves, their practices and their firms as never before.

Please join Bruce Carton, Editor of Securities Docket, and me for a webcast that will discuss the best new tools and strategies available to securities and compliance counsel and professionals, including:

  • RSS;
  • Social Media, such as Twitter, LinkedIn, and Facebook;
  • Blogs;
  • and much more.

To attend this webcast scheduled for February 17, at 2 pm Eastern, please sign up on the Securities Docket website.

Madoff Litigation: Can the Lost Billions be Recovered? How?

This post contains my notes from the webinar: Madoff Litigation: Can the Lost Billions be Recovered? How? The Webinar was sponsored by NERA Economic Consulting and produced by The Securities Docket. The slides are available on Securities Docket.com: Materials from Madoff Litigation Webcast.

Brad divides the world into those invested direftly through a Madoff account and those that invested through a feed fund or a fund of funds. The two groups of investors have different causes of actions and different approachs. Brad is representing both but focused his piece on direct investors.

The direct investors are in the worst position. Their biggest hope of recovery is from the SIPC. The limit is $500,000 for securities. The SIPC may also take the position that the limit is $100,000 (the cash limit) since Madoff apparently never invested in securities. Recovery is also limited to the dollars put in less the cash returned over time. Of course the direct investors will also have claims against the Madoff bankruptcy estate and should file a claim.

In an audience vote, 70% though Madoff should not be free on bail.

Gerald focuses on the issues arising from indirect Madoff investors.  The feeder funds offer a deep pocket for recovery. In the case of a limited partnership structure, they will need to prove gross negligence or willful misconduct. Recovery will be governed by the partnership agreement and related documents. The other problem is that the general partner may be able to use the assets of the limited partnership to defend and indemnify themselves.  You end up suing yourself.

Fred pointed out that there are lots of “losses”, but also lots of  “damages” and probably very little “recovery.” Among the factors are (1) choice of law, (2) allocation among the parties based on conduct and causation and (3) time at which damages are estimated. The starting point for damages is going to be the differences between the reported value on the account statement and the actual value of the securities in the account.

Losses Due to Fraudulent Reported Value = Loss on Subscriptions – Gain on Redemptions (similar to 10b-5 damage valuations)

Fred cites the case of Goldstein v. SEC (DC Cir. 2006):

If the investors are owed a fiduciary duty and the entityis also owed a fiduciary duty, then the adviser will inevitablyface conflicts of interest. Consider an investment adviser to ahedge fund that is about to go bankrupt. His advice to the fundwill likely include any and all measures to remain solvent. Hisadvice to an investor in the fund, however, would likely be tosell. …It simply cannot be the case that investment advisers are theservants of two masters in this way.

It was a great panel. Thanks to the panelists, sponsors and publishers of the webcast.