Tag: Sovereign Wealth Funds

Sovereign Wealth Funds, Bribery, Corruption, Hospitality and the FCPA

The FCPA seems to be most closely associated with shady oil operations, mining, defense contractors and infrastructure transactions.  The image is a big company coming in and bribing an official for access to the country’s resources.

The other side to that investment is that the countries build up big supplies of capital. Many deploy some of that capital into funds for investing using sovereign wealth funds. During the credit crisis of 2008, some of the big Wall Street firms got injections of capital from sovereign wealth funds.

This is the flip side of the FCPA. Instead of a US company trying to get the rights to invest in the foreign country, it’s getting the foreign country to invest in the US company. And cash payments to foreign officials are still going to be considered bribes in violation of the FCPA, regardless of which direction the capital flows.

The problem is that the people running the sovereign wealth funds are going to be considered “foreign officials” under the Foreign Corrupt Practices Act. That should not come as surprise. In 2008 the Department of Justice said it was taking a look at “passive and active investments by U.S. securities firms into sovereign funds, and vice versa.” They clearly stated that a sovereign wealth fund is a “State-Owned Enterprise” and that securities firms should treat employees of sovereign wealth funds as government officials for purposes of the FCPA.

Dionne Searcey and Randall Smith published a big headline in the Wall Street Journal about the launch of a new investigation by the Securities and Exchange Commission into whether US banks and private equity firms violated the FCPA in their dealings with sovereign wealth funds.

Clearly, under-the-table payments in exchange for the investment are going to be trouble. But even typical hospitality shown to investors will be under tighter scrutiny. If it’s too lavish, it could be considered a bribe.

There is an affirmative defense under the FCPA if

the payment, gift, offer, or promise of anything of value that was made, was a reasonable and bona fide expenditure, such as travel and lodging expenses, incurred by or on behalf of a foreign official, party, party official, or candidate and was directly related to the promotion, demonstration, or explanation of products or services [§ 78dd-1 (c)(A) and § 78dd-2 (c)(A)]

The investment officer for the SWF comes to your office, you put him (or her) up at a nearby hotel, shown him around the office to meet management, discuss investment strategies and take him out to dinner after a full day of diligence. The question will be whether the lodging expenses and dinner expenses were “reasonable” and “bona fide.”

I doubt that the DOJ and SEC would consider the cost of putting up the official at a Holiday Inn and dinner at Denny’s to be so excessive as to not be “reasonable” and “bona fide.” Then start increasing the quality of those offerings. Instead of the Holiday Inn, it’s the Ritz-Carlton, or the 1,900 s.f  Central Park Suite at the Ritz Carlton. Instead of Denny’s, it’s dinner at Le Bernadin, with a $500 bottle of wine. Now you you need to be concerned that the dinner and lodging are not “reasonable” and “bona fide.” Throw in a few party favors just to give your compliance officers ulcers and sleepless nights.

Wall Street is still an easy target. The excesses of Wall Street make great headlines. If there really is some wrongdoing it will be an interesting story.

However, some of those investments helped save those Wall Street firms from collapse. We would be much worse off today if Citibank or Morgan Stanley followed Lehman into bankruptcy. I’m not saying that corruption would be warranted in this situation. But we also need to be careful not to spook away foreign investors with a witch hunt. Otherwise, they may not be there for a legitimate investment when we need them.

Sources:

Image of Wall Street is used under a creative commons license.

Special Report on Sovereign Wealth Funds

Pensions and Investments

Pensions & Investments published a Special Report on Sovereign Wealth Funds. The report is based on a survey conducted in April by the Oxford University Center for Employment, Work and Finance: Oxford SWF Project.

Sovereign wealth funds are perceived to be shrouded in mystery because, like many private investment funds, they do not publicly report their investment activity. One item that attracts attention is the size of these funds. They are collectively a pool of capital estimated to be somewhere between about three trillion to nearly seven trillion dollars. The largest individual fund is believed to have assets of over $600 billion.

The special report was based on interviews of investment managers who routinely work with sovereign investment funds, not directly with officers of the funds themselves. So, the information is second hand.

The report predicts a movement away from U.S. Treasuries and towards equities and real estate.

References:

GAO Report on Sovereign Wealth Funds

gao-logo

The U.S. Government Accountability Office has released its second report on Sovereign Wealth Funds: Laws Limiting Foreign Investment Affect Certain U.S. Assets and Agencies Have Various Enforcement Processes (.pdf). This report was sent to the Committee on Banking, Housing, and Urban Affairs in the U.S. Senate.

The Report found the United States is generally open to foreign investment, except for sector-specific restrictions. The banking, agriculture, transportation, natural resources and energy, communications, and defense sectors have federal laws that apply to foreign investment specifically. These sectors have laws that contain provisions that either restrict the level of foreign investment, limit the use of a foreign-owned asset, or at least require approval or disclosure of any foreign investments.

In addition to these specific limitations, there is the broad power under the Defense Production Act of 1950 granted to the CFIUS to review a foreign acquisition, merger, or takeover of a U.S. business that is determined to threaten the national security of the United States.

Restrictions on foreign investment in real estate also exist in many states. According to a Alien Land Ownership Guide from the National Association of Realtors, 37 U.S. states had some type of law affecting foreign ownership of real estate. Most of the laws are merely a requirement that a foreign investor register as a company doing business in the state before purchasing property. Some states specifically prohibit foreign ownership of certain types of land. One common type of real property restriction was for agricultural land. Fifteen states having some law governing foreign ownership in this area.

The Report’s recommendation for Executive Action:

To enhance their oversight of sectors subject to laws restricting or requiring disclosure of foreign investments, we recommend that the Chairman of the FCC and the Secretaries of Agriculture and Transportation review the current sources of the information their agencies currently monitor to detect changes in ownership of U.S. assets— which are subject to restriction or disclosure requirements applicable to foreign investors—and assess the value of supplementing these sources with information from other government and private data sources on investment transactions.

References:

Is CalPERS a Sovereign Wealth Fund?

Ashby H. B. Monk wrote Is CalPERS a Sovereign Wealth Fund? (He ends up saying no.)

Sovereign Wealth Funds have come under increased scrutiny with countries concerned that an investment by a SWF could be used as a political tool and not a mere investment. The underlying concern is that many of the SWFs come from countries that at times are hostile to the United States and often lack a substantive rule of law. Ashby notes that there is some confusion as to what constitutes a sovereign wealth fund.

While all seem to agree that the China Investment Corporation and the Abu Dhabi Investment Authority are SWFs, there is a lively debate as to whether public pension funds, such as the California Public Employees Retirement System (CalPERS), are also SWFs. While CalPERS itself is adamant that it is not, others disagree. The stakes are high for a fund like CalPERS, as the SWF label could come with a high cost.

Ashby starts with several of the SWF definitions and creates this definition:

SWFs are government-owned and controlled (directly or indirectly) investment funds that have no outside liabilities or beneficiaries (beyond the government or the citizenry in abstract) and that invest their assets, either in the short or long term, according to the interests and objectives of the sponsoring government.

Based on this definition, Ashby concludes that CalPERS is not a SWF.

Ashby H. B. Monk is a Research Fellow at the Center for Retirement Research at Boston College (CRR) and the University of Oxford.

Sovereign Wealth Funds That Are Part of the IWG and Santiago Principles

The following sovereign wealth funds are part of the Internal Working Group of Soverign Wealth Funds and the Santiago Principles:

Australia
The Future Fund

Azerbaijan
State Oil Fund of the Republic of Azerbaijan

Botswana
Pula Fund

Canada
Alberta Heritage Savings Trust Fund

Chile
Economic and Social Stabilization Fund / Pension Reserve Fund

China
China Investment Corporation

Ireland
National Pensions Reserve Fund

Korea
Korea Investment Corporation

Kuwait
Kuwait Investment Authority

Libya
Libyan Investment Authority

New Zealand
New Zealand Superannuation Fund

Norway
Government Pension Fund-Global

Qatar
Qatar Investment Authority

Russia
Reserve Fund
National Wealth Fund

Singapore
Temasek Holdings Pte. Ltd.
Government of Singapore Investment Corporation Pte. Ltd.

Timor Leste
Petroleum Fund of Timor-Leste

Trinidad and Tobago
Heritage and Stabilization Fund

The United Arab Emirates
Abu Dhabi Investment Authority

The United States
Alaska Permanent Fund

[IWG Member Sites]

The Santiago Principles

The International Working Group of Sovereign Wealth Funds created a set of 24 best practices called the Generally Accepted Principles and Practices (GAPP) or the Santiago Principles:

  • GAPP 1. Principle
    The legal framework for the SWF should be sound and support its effective operation and the achievement of its stated objective(s).

    • GAPP 1.1 Subprinciple The legal framework for the SWF should ensure the legal soundness of the SWF and its transactions.
    • GAPP 1.2 Subprinciple The key features of the SWF’s legal basis and structure, as well as the legal relationship between the SWF and the other state bodies, should be publicly disclosed.
  • GAPP 2. Principle
    The policy purpose of the SWF should be clearly defined and publicly disclosed.
  • GAPP 3. Principle
    Where the SWF’s activities have significant direct domestic macroeconomic implications, those activities should be closely coordinated with the domestic fiscal and monetary authorities, so as to ensure consistency with the overall macroeconomic policies.
  • GAPP 4. Principle There should be clear and publicly disclosed policies, rules, procedures, or arrangements in relation to the SWF’s general approach to funding, withdrawal, and spending operations.
    • GAPP 4.1 Subprinciple The source of SWF funding should be publicly disclosed.
    • GAPP 4.2 Subprinciple The general approach to withdrawals from the SWF and spending on behalf of the government should be publicly disclosed.
  • GAPP 5. Principle
    The relevant statistical data pertaining to the SWF should be reported on a timely basis to the owner, or as otherwise required, for inclusion where appropriate in macroeconomic data sets.
  • GAPP 6. Principle
    The governance framework for the SWF should be sound and establish a clear and effective division of roles and responsibilities in order to facilitate accountability and operational independence in the management of the SWF to pursue its objectives.
  • GAPP 7. Principle
    The owner should set the objectives of the SWF, appoint the members of its governing body(ies) in accordance with clearly defined procedures, and exercise oversight over the SWF’s operations.
  • GAPP 8. Principle
    The governing body(ies) should act in the best interests of the SWF, and have a clear mandate and adequate authority and competency to carry out its functions.
  • GAPP 9. Principle
    The operational management of the SWF should implement the SWF’s strategies in an independent manner and in accordance with clearly defined responsibilities.
  • GAPP 10. Principle
    The accountability framework for the SWF’s operations should be clearly defined in the relevant legislation, charter, other constitutive documents, or management agreement.
  • GAPP 11. Principle
    An annual report and accompanying financial statements on the SWF’s operations and performance should be prepared in a timely fashion and in accordance with recognized international or national accounting standards in a consistent manner.
  • GAPP 12. Principle
    The SWF’s operations and financial statements should be audited annually in accordance with recognized international or national auditing standards in a consistent manner.
  • GAPP 13. Principle
    Professional and ethical standards should be clearly defined and made known to the members of the SWF’s governing body(ies), management, and staff.
  • GAPP 14. Principle
    Dealing with third parties for the purpose of the SWF’s operational management should be based on economic and financial grounds, and follow clear rules and procedures.
  • GAPP 15. Principle
    SWF operations and activities in host countries should be conducted in compliance with all applicable regulatory and disclosure requirements of the countries in which they operate.
  • GAPP 16. Principle
    The governance framework and objectives, as well as the manner in which the SWF’s management is operationally independent from the owner, should be publicly disclosed.
  • GAPP 17. Principle
    Relevant financial information regarding the SWF should be publicly disclosed to demonstrate its economic and financial orientation, so as to contribute to stability in international financial markets and enhance trust in recipient countries.
  • GAPP 18. Principle
    The SWF’s investment policy should be clear and consistent with its defined objectives, risk tolerance, and investment strategy, as set by the owner or the governing body(ies), and be based on sound portfolio management principles.

    • GAPP 18.1 Subprinciple The investment policy should guide the SWF’s financial risk exposures and the possible use of leverage.
    • GAPP 18.2 Subprinciple The investment policy should address the extent to which internal and/or external investment managers are used, the range of their activities and authority, and the process by which they are selected and their performance monitored.
    • GAPP 18.3 Subprinciple A description of the investment policy of the SWF should be publicly disclosed.
  • GAPP 19. Principle
    The SWF’s investment decisions should aim to maximize risk-adjusted financial returns in a manner consistent with its investment policy, and based on economic and financial grounds.

    • GAPP 19.1 Subprinciple If investment decisions are subject to other than economic and financial considerations, these should be clearly set out in the investment policy and be publicly disclosed.
    • GAPP 19.2 Subprinciple The management of an SWF’s assets should be consistent with what is generally accepted as sound asset management principles.
  • GAPP 20. Principle
    The SWF should not seek or take advantage of privileged information or inappropriate influence by the broader government in competing with private entities.
  • GAPP 21. Principle
    SWFs view shareholder ownership rights as a fundamental element of their equity investments’ value. If an SWF chooses to exercise its ownership rights, it should do so in a manner that is consistent with its investment policy and protects the financial value of its investments. The SWF should publicly disclose its general approach to voting securities of listed entities, including the key factors guiding its exercise of ownership rights.
  • GAPP 22. Principle
    The SWF should have a framework that identifies, assesses, and manages the risks of its operations.

    • GAPP 22.1 Subprinciple The risk management framework should include reliable information and timely reporting systems, which should enable the adequate monitoring and management of relevant risks within acceptable parameters and levels, control and incentive mechanisms, codes of conduct, business continuity planning, and an independent audit function.
    • GAPP 22.2 Subprinciple The general approach to the SWF’s risk management framework should be publicly disclosed.
  • GAPP 23. Principle
    The assets and investment performance (absolute and relative to benchmarks, if any) of the SWF should be measured and reported to the owner according to clearly defined principles or standards.
  • GAPP 24. Principle
    A process of regular review of the implementation of the GAPP should be engaged in by or on behalf of the SWF.

There is also a Full Report on the Santiago Principles (.pdf).

Sovereign Wealth Funds Adopt Voluntary Best Practices

Adam O. Emmerich of Wachtell Lipton Rosen & Katz put together a summary published on The Harvard Law School Corporate Governance Blog on the Santiago Principles and the potential impact of these on investments by sovereign wealth funds: Sovereign Wealth Funds Adopt Voluntary Best Practices.

Intended to demonstrate that SWFs are soundly established and that investment decisions will be made on an economic and financial basis, the Santiago Principles address three broad areas of concern regarding SWFs: (i) their legal structure and relationship with the state, policy and investment objectives, and degree of coordination with their sovereign’s macroeconomic policies; (ii) their institutional structure and governance mechanisms; and (iii) their investment and risk management framework. While much will turn on how SWFs actually implement these aspirational guidelines (and it is worth noting that all of the principles are well caveated and subject to home country laws, regulations, requirements and obligations), the Santiago Principles may help reduce political influence in SWF investing and encourage the flow of sovereign wealth across borders.

Are Sovereign Wealth Funds State-Owned Enterprises?

Steve Tyrrell, Chief of the Fraud Section in DOJ’s Criminal Division, has observed that the DOJ may treat employees of sovereign wealth funds as government officials for purposes of the FCPA

Sovereign wealth funds have been playing a larger role in the domestic securities markets as companies search for increasingly scarce supplies of capital. Mr. Tyrrell was quoted: “recent boom of sovereign wealth funds is an area at the top of the Justice Department’s hit list.”

Mr. Tyrell told Financial Week that “the DOJ was looking at both passive and active investments by U.S. securities firms into sovereign funds, and vice versa.” [Cash crunch could result in more corruption cases. October 7, 2008]

At a recent Securities Industry and Financial Markets Association conference, Mr. Tyrell indicated that securities firms should treat employees of sovereign wealth funds as government officials for purposes of the FCPA.

Who Is a Foreign Official After the Government Bailout of Financial Instiutions?

We have all read about the bailout of US financial institutions by the US government. This is not happening in other countries.  This complicates the analysis under the Foreign Corrupt Practices Act.

As Joel M. Cohen, Michael P. Holland, and Adam P. Wolf of Clifford Chance examined in Under the FCPA, Who Is a Foreign Official Anyway?, the FCPA does not define a foreign official. An employee of a state-owned enterprise is a foreign official. But the FCPA does not define a state-owned enterprise. The Anti-Bribery Convention of OECD does a better job of defining. See International Standards for the Bribery of Public Officials.

In some of these government bailouts, the governments are purchasing equity and equity-like interests in the financial institutions. Is AIG a state-owned enterprise? The US government has the right to purchase majority ownership!

Morgan Lewis put out LawFlash on this issue: Financial Turmoil and the Expanding Reach of the FCPA.

Morgan Lewis points out that the DOJ will likely treat sovereign wealth funds as state-owned enterprises and therefore their employees are foreign officials under the FCPA.

If a government has a small passive interest in a company, then the company is probably not a state-owned enterprise. As the ownership interest increases and the management control increases the company starts looking more like a state-owned enterprise.

Merely buying assets (like crappy CMBS and CDO interests) or guaranteeing loans should not affect the treatment of the company.