Month: July 2011

Weekend Humor: Dodd-Frank Update

Jon Stewart helps celebrate the one year anniversary of Dodd-Frank (for those of you who grew up on Schoolhouse Rocks.)

Compliance Bits and Pieces for July 29

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

Backyard Hens: A Trend Coming Home to Roost? by James McWilliams in Freakonomics

These anecdotes remind us that, when it comes to the safety of chicken eggs, what matters is not so much the setting in which the birds are raised (factory or backyard), but rather quality control and managerial acumen. To thus boldly assert that the eggs of backyard hens are safer–something I hear all the time– is to place faith ahead of evidence. Again, we might very well, based on personal experience, have the grounds to claim that the backyard hen is a safe hen. But, by this measure, anyone who regularly eats factory eggs and avoids sickness can say the same thing about factory eggs. Bottom line is that we just don’t know.

Bribery, Legal Clarity, and Lame Excuses by Chris MacDonald in The Business Ethics Blog

Bribery is quite probably among the very oldest of unethical business practices, right up there with short-changing your customers and adulterating your products. Many modern economies have recognized that bribery has no place in a fair and efficient market, and have rightly taken action to prohibit what is widely acknowledged to be a pernicious practice. But not everyone is consistently appreciative of legislative efforts at curbing bribery. Take the U.S. Chamber of Commerce, for example. To see why the Chamber isn’t altogether happy about the U.S. government’s anti-bribery efforts, see this story from the Washington Post’s David S. Hilzenrath: “Quandary for U.S. companies: Whom to bribe?”

SEC Charges Liquor Giant Diageo with FCPA Violations

The SEC found that London-based Diageo plc paid more than $2.7 million through its subsidiaries to obtain lucrative sales and tax benefits relating to its Johnnie Walker and Windsor Scotch whiskeys, among other brands. Diageo agreed to pay more than $16 million to settle the SEC’s charges. The company also agreed to cease and desist from further violations of the FCPA’s books and records and internal controls provisions.

Image is backyard chicken by Steven Johnson /
CC BY 2.0

Twitter Fail and Compliance


FINRA has long regulated and limited the ability of broker/dealers to communicate with the public. One of their missions is to protect the investing public from unscrupulous securities brokers. Twitter is a communications tools and any messages posted to Twitter will need to be in compliance.

It was inevitable that we would see a FINRA regulated party make a mistake using Twitter. The time has come.

FINRA also found that during eight months in 2009, the registered representative maintained a Twitter account and had more than 1,400 followers. Without notifying a principal of her employer firm, the registered representative posted 32 “tweets” related to a particular security. The tweets were unbalanced, overly positive and often predicted an imminent price increase. In the tweets, the representative failed to disclose that she and her family held a significant number of shares of the security. FINRA concluded that this conduct violated NASD Rules 2210 (communications with the public) and IM-2210-1 (guidelines to ensure that communications with the public are not misleading), and FINRA Rule 2010 (ethical standards).

To me, this sounds exactly like the behavior FINRA is trying to prevent by imposing Rule 2210 on financial representatives.

I don’t want to overstate the effect of this Twitter failure on the discipline. The registered representative was doing some other things in violation of the rules. I would guess that once a registered representative is under investigation FINRA takes a look at that person’s social networking activity to see if they have been doing other bad things.

Sources:

Image is 2008wmonroe by Liza P
CC BY-NC-ND 2.0

Soros Doesn’t Want Your Money

In one of the most visible moves as a result of the new SEC regulations on investment advisers, George Soros is closing his $25 billion Quantum Endowment Fund to outside investors and returning their money.

Why?

“We have relied until now on other exemptions from registration which allowed outside shareholders whose interests aligned with those of the family investors to remain invested in Quantum. As those other exemptions re no longer available under the new regulations, SFM will now complete the transition to a family office….”

The Soros fund management company would have to register as an investment adviser and it doesn’t want to do that. They are kicking out non-family money and using the family office exemption to avoid registration.

Is this a good thing? Soros is a controversial figure, reviled for some because of his currency bets. For his investors, he returned about 20 percent a year, on average, since 1969. If some of those investors invest your retirement money, then you may be worse off.

It’s clear that the regulatory regime changes resulting from Dodd-Frank are going to change the business models for many money managers. Some, like Soros, will pull back operations to avoid the regulatory oversight.

Sources:

Image is George Soros – World Economic Forum Annual Meeting Davos 2010
DAVOS/SWITZERLAND, 27JAN10 – George Soros, Chairman, Soros Fund Management, USA, captured during the session ‘Rebuilding Economics’ of the Annual Meeting 2010 of the World Economic Forum in Davos, Switzerland, January 27, 2010 at the Congress Centre.
Copyright by World Economic Forum.
swiss-image.ch/Photo by Sebastian Derungs

The SEC, “Spousal Equivalents” and the Family Office

The SEC now recognizes “spousal equivalents” defined as “cohabitants occupying a relationship generally equivalent to that of a spouse.” Before wondering if the federal government is making big strides, keep in mind that this recognition is limited to the new Family Office Rule (.pdf).

Dodd-Frank created a new exemption for Family Offices. Previously they typically operated under the 15 clients rule that was repealed by Dodd-Frank or a private ruling from the SEC. Dodd-Frank left it up to the SEC to define a “family office.”

Rule 202(a)(11)(G)-1 contains three general conditions to fitting into the Family Office Exemption. First, the family offices may only provide advice about securities to certain “family clients.” Second, family clients must wholly own the family office and family members and/or family entities must control the family office. Third, a family office cannot hold itself out to the public as an investment adviser.

Th rule inevitably leads to a definition of “family.” Too narrow and many family offices would be excluded. Too broad and every investor will find an ancestor from the Mayflower. The SEC decided on a 10 generation limit.

The rule treats lineal descendants and their spouses, spousal equivalents, stepchildren, adopted children, foster children and persons who were minors when another family member became their legal guardian as family members.

I think it was bold move of the SEC to include spousal equivalents. They brush aside the Defense of Marriage Act argument: Because the term “spouse” is not defined in the rule and a “spousal equivalent” is identified as a category of person, separate and distinct from a “spouse,” that meets the definition of a “family member”….  DOMA provides that in “determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States…the word ‘spouse’ refers only to a person of the opposite sex who is a husband or wife.” 1 U.S.C. 7.

The failure of a family office to be able to meet the conditions of the new rule will not preclude the office from providing services to family members. But, the family office will need to find another exemption, register under the Advisers Act or seek an exemptive order from the SEC.

Sources:

The image is the Spousal Equivalent Badge available from Zazzle.

Compliance Lessons from the Tour de France

I would guess that most of you reading this story do not share my love of the Tour de France. It can be a confusing mix of skinny guys, tarted up with sponsors like a NASCAR racer, with hard to pronounce names, following tactics unusual outside of cycling. But I since I became a fan a decade ago, I continue to be enthralled by drama and athletic heroism on display.

I also saw compliance lessons.

Stage 18 was a brutal day of riding up big mountains in the Alps. The riders started with the Col Agnel, a climb of almost 24km, averaging 6.6 percent, but most importantly averaging 10 percent for the final 9km. Down, then up the Col d’Izoard 15km at 7.1 percent gradient. Down and then up to the 23km to the finish on top of the Col du Galibier. A moonscape at 8,678 feet that had a fresh snowfall just days before the cyclists arrived.

One of the rules of the Tour is that riders who finish too far behind the winner get eliminated from the race. In these big mountain stages the non-climbers fall off the back of the peloton and form a group of riders form that just hopes to finish the stage. Their primary concern is beating the elimination time to ensure the can ride the next day. effectively, the riders self-organize to fight the rule.

At the end of stage 18, 80 riders (nearly half the racers) arrived in the grupetto more than 35 minutes after the winner. This was after the cut-off time. They were not kicked out of the rice, but some were given meaningless penalties.

Stage 19 was another brutal climbing day, going up the Col du Telegraph, back up Galibier, and then scampering up the legendary Alp d’Huez. For the second day in a row, the huge grupetto finished beyond the time cut, with 82 riders crossing the line beyond the limit. The day’s time cut was set at 13 percent of the winner’s time. The race officials allowed the group to remain in the race. All riders in that group were penalized 20 points in the points classification, but both green jersey contenders, Mark Cavendish and Jose Rojas, were in the group. The one poor victim was Bjorn Leukemans, who finished well behind the grupetto and was eliminated.

A rule was broken by almost half the participants but there was no meaningful discipline. How would that work inside your company? If the rule is being broken by that many people, maybe it’s a bad rule?

Photo: Casey B. Gibson | www.cbgphoto.com

Compliance Bits and Pieces for July 22

These are some recent compliance-related stories that caught my attention.

Source: World Gold Council
Credit: Alyson Hurt

The Gold Boom, Then and Now by Jacob Goldstein in Planet Money

[o]n Jan. 21, 1980, gold hit what is still its all-time high in inflation-adjusted dollars. To match that high in today’s dollars, gold prices would have to rise by another 50 percent, to more than $2,400 an ounce.The core themes driving up the price were the same then as now: Inflation fears, global instability, and a lack of faith in governments and the currencies they back.

News Corp. May Be On Its Way To Voluntarily Disclosing Its Worst Secrets To The U.S. Government by Nathan Vardi in The Jungle

Now the independent directors of News Corp. have hired former Manhattan U.S. Attorney Mary Jo White, former U.S. Attorney General Michael Mukasey, and their law firm, Debevoise & Plimpton, to advise them. News Corp. itself has hired Mark Mendelsohn, who ran the Justice Department’s FCPA unit and helped turn the statute from a backwater into a prosecution machine and a gold mine for lawyers and accountants. Mendelsohn reportedly has been hired to advise on a potential investigation.

Private sector joins calls for anti-corruption mechanisms in arms trade treaty by Maria Gili in Space for Transparency

Last week, the 192 member states of the United Nations (193 from mid-week onwards, as South Sudan was admitted on July 14) met in New York to continue their negotiations towards an “Arms Trade Treaty” (ATT). States are keen to agree on an ATT in 2012, reaching a long overdue international agreement to finally regulate the global trade in arms. We represented Transparency International’s Defence and Security Programme and participated along with more than 100 other NGO representatives.

Happy Birthday Dodd-Frank!

This happened one year ago:

Since then, it’s been a whirlwind of regulatory production. It was a huge bill. (My copy goes on for 848 pages.) The Regulations it requires are many times more massive that the bill itself.

We will experience the repercussions for years. So we may as well keep count.

Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf 2MB)

Private Equity Exemption Bill Moves Ahead

The Small Business Capital Access and Job Preservation Act, H.R. 1082, took another step forward this week when it was approved by the House Committee on Financial Services. It still has a long way to go before coming law so this is no time to stop getting your compliance infrastructure in place.

The bill still defers the definition of “private equity fund” to the Securities and Exchange Commission and gives the SEC six months to come up with that definition. Even assuming the bill passes and passes quickly, you would not know if you fit into this exemption until very close to the March 30, 2011 filing deadline under the Investment Advisers Act.

The bill has been revised and now imposes a leverage limitation.

“provided that each such fund has not borrowed and does not have outstanding a principal amount in excess of twice its invested capital commitments.”

I think that limitation would prohibit the use of a subscription secured credit facility by a private equity fund if they wanted to take advantage of this exemption. That borrowing is used prior to calling capital and to provide liquidity without calling capital. It makes it easier for the fund manager to smooth out capital calls to investors.

Beyond that facility, It’s not clear to me whether that limitation would include debt at the portfolio level. In reading the minority view at the end of the committee report (.pdf), they think the leverage limitation excludes leverage in the portfolio companies.

Unfortunately, the committee report comes across as very partisan and attacks Dodd-Frank as a whole. To me that would only seem to decrease the likelihood that the House as a whole will take the bill seriously.

Sources:

Who Caught Them? Compliance or the SEC?

The SEC announced they had obtained an emergency freeze against three Swiss-based traders under an allegation of insider trading. The SEC claims that Compania International Financiera S.A., Coudree Capital Gestion S.A., and Chartwell Asset Management Services purchased more than a million common shares of Arch Chemicals just prior to the announcement that it was going to be purchased by Lonza Group Ltd.

It does not take much detective work to look at this chart and see that there was some suspicious trading leading up to the July 11 announcement date.

You see the stock price rising and an increase in trading volume. According to the SEC complaint, about 1 million shares in that increased volume came from three defendants. The average trading volume for Arch leading up to the merger announcement was just under 200,000 shares per day.

The hard part will be the SEC proving that the defendants had material, non-public information and used it in breach of some obligation. Clearly, their trading looks suspicious. Proving it was illegal will take more work.

The big question I have, and that compliance professionals that deal with insider trading should have, is how did the trades get flagged?

The SEC has said they are increasing market surveillance and market intelligence to spot suspicious activity. Did the SEC catch this on their own?

Was it compliance? It would seem that the activity coincided very closely with the merger and could easily have been flagged as suspicious by a vigilant broker/dealer compliance department. When a stock usually only trades 200,000 per day, seeing hundreds of thousands of shares being purchased with big public news should be a red flag.

Was it a whistleblower? The SEC has created a new bounty program. Perhaps an insider discover the activity and alerted the SEC in hopes of a financial windfall.

Was it a wiretap? It’s clear from the case against the Galleon Group and Raj Rajaratnam that the government is suing wiretaps to investigate insider trading.

To me the most interesting part of this case will be finding out how the trades got flagged. The rest of the case tied to proving insider trading is not interesting.

Sources: