Month: January 2012

Changes Coming With Anti-Money Laundering Requirements

James H. Freis, Jr., Director of the Financial Crimes Enforcement Network, let us know that his agency is working on anti-money laundering requirements for investment advisers. At a November 15, 2011 speech at the American Bankers Association/American Bar Association’s Money Laundering Enforcement Conference he highlighted many of the issues of money-laundering in the various financial sectors. FinCEN‘s rules currently apply to broker-dealers and to mutual funds, but not to investment advisers.

On May 5, 2003, FinCEN published a notice of proposed rulemaking in the Federal Register proposing that investment advisers establish anti-money laundering programs. But it never went anywhere. On November 4, 2008, FinCEN announced that it was withdrawing the proposed regulations and would not proceed with regulations for these entities without publishing new proposals and allowing for industry comments.

“FinCEN is currently revisiting the topic of investment advisers, building on the changes to that industry pursuant to the Dodd-Frank Act, the SEC rules implementing Dodd-Frank and other changes, and is working on a regulatory proposal that would require investment advisers to establish AML programs and report suspicious activity.”

The investment adviser line of business has lots of business models. Shortly, the ranks of investment advisers will be flooded with private fund managers. Fries cites these statistics:

“According to the Investment Advisers Association, the number of investment advisers registered with the SEC totaled 11,539 in 2011, and the total assets under management reported by all investment advisers increased 13.7% to $43.8 trillion in 2011, from $38.6 trillion in 2010.28 According to the SEC, there are more than 275,000 state-registered investment adviser representatives and more than 15,000 state-registered investment advisers.29 Approximately 5% of SEC-registered investment advisers are also registered as broker-dealers, and 22% have a related person that is a broker-dealer. Additionally, approximately 88% of investment adviser representatives are also registered representatives of broker-dealers.”

Clearly, it’s a big industry. Clearly, working with “bad guys” on any of the blocked persons lists would be a big problem.

However, the private equity fund vehicle is an unlikely choice for someone to launder money. The investment is highly illiquid, the subscription commitment requires you to contribute money infrequently over a long period of time, and the money is distributed back irregularly.

I welcome some clarity from FinCEN, but hope they are realistic about the burdens they will impose in contrast to the risk.

Defending Jacob

Being a lawyer, I like a good legal thriller. If you’re looking for a legal thriller to keep you up at night, try William Landay’s latest novel: Defending Jacob. Jacob is a fourteen year old boy whose classmate is found murdered. Jacob’s father is an assistant district attorney. You can guess from the title that Jacob gets accused of the crime.

Before I go on, I should point out a few of my biases. I’m friends with the author. Our sons went to daycare and preschool together for many years. So I see bits and pieces of him and his family in the story. (But not that I think Bill’s son will grow up to be accused of murder.) I think I see flashes of Bill, his family, and the community in the book. Maybe that distracted me from the characters or maybe it made me like them more. I’m not sure.

Not being a trial lawyer, I can’t vouch for authenticity of investigative procedures or the trial. Again, with a title like “Defending Jacob” you would expect there to be a trial. You end up with the expected clash between the clash of guilty and not guilty against the question of whether Jacob actually committed the crime.

That’s what kept me reading chapter after chapter. Who was Jacob? Could he have committed the crime? Did Jacob’s father really know who he was? Facts quickly start being revealed, twisting the story through reveals and lies. It pushes the father, son, and mother to the edge until…

Defending Jacob should be on the bookshelf of your local bookstore on January 31 and is also available through Amazon.

Compliance Bits and Pieces

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

Charles Ponzi

 

Ponzi Scheme and Investment Fraud Red Flags by Tracy Coenen in the Fraud Files Blog

How do you know if you’re considering investing in a Ponzi scheme? The promoters will never come out and tell you they are running a pyramid scheme, so the investors have to be smart enough to recognize them on their own. The good news is it is easy to spot a Ponzi scheme.

Here are some red flags about the “investment” you’re considering that might indicate it is a Ponzi scheme. (There were many red flags related to infamous scammer Bernie Madoff.) You can find out more about spotting Ponzi schemes and investment schemes in my book, Expert Fraud Investigation: A Step-by-Step Guide.

Four convicted for commercial (not government) bribery by SFO in thebriberyact.com

Amounting to around £70 million, the contracts affected were for engineering and procurement projects based in Iran, Egypt, Sakhalin Island (Russia), Singapore and Abu Dhabi, over the period 2001 to 2009….The confidential information supplied to bidders was held by companies acting as procurement agents for the projects. It is an industry where individuals who work for such companies often do so on a short term basis. Crucially, the defendants had access to inside information which they passed on to targeted bidding companies who either made, or agreed to make, corrupt payments for the information. Disguised as “consultancy services”, the illicit payments were shared out amongst the co-conspirators.”

Riverside’s Hendrickson wins PEI Leadership Award

Pam Hendrickson receives PEI’s Leadership Award for her work as an industry advocate in Washington DC and for her crucial contributions to Riverside as its chief operating officer. Pam Hendrickson, chief operating officer of global mid-market firm The Riverside Company, was last week awarded the 2012 Leadership Award by Private Equity International sister title Private Equity Manager.

Making Sense of Jones by Scott Greenfield in Simple Justice

Since the opinions were released yesterday morning, the blawgosphere has cranked out a ton of posts about what the Jones v. United States decision means. The majority decision was written by Scalia, with concurrences by Alito and Sotomayor. While it was 9-0 on outcome, it was anything but on rationale.  …

That one justice of nine seems to have some appreciation of the danger ahead, how poorly law developed to deal with normal-sized coaches and full-height constables applies in the digital age, is better than nothing.  But given how the Court broke down here, it’s clearly not good enough.

Does the plant of a GPS device on a car require a warrant? Under the particular facts of Jones, yes. (Addendum: this is the net result, not the holding of the case, which skirted the issue entirely.) Under other facts, who knows. And how does that translate to the next shiny device? Only lone Justice Sotomayor even cares, while the rest seem determined to ignore the digital age at all costs.

New York City “Pay-to-Play” Law is Upheld

The U.S. Court of Appeals for the Second Circuit upheld a New York City “pay-to-play” law against various constitutional challenges: Ognibene v. Parkes. The Pay to play law is in Local Law 34 and it:

  1. Lowers the caps applicable to campaign contributions from parties that have “business dealings” with New York City
    • to $400 (otherwise $4,950 applies to contributors not within the purview of the Law) for candidates for city-wide offices,
    • to $320 (otherwise $3,850) for candidates for borough offices, and
    • to $250 (otherwise $2,750) for candidates for city council,
  2. Prohibits public matching for contributions from the Affected Persons, and
  3. extends a ban on contributions from corporations to apply to partnerships, LLCs, and LLPs.

“Business dealings” include, among other things, “contracts for investment of pension funds” and transactions with “lobbyists”.

The plaintiffs in Ognibeneh include Republican Party members, the New York State Conservative Party, lobbyists, and other business interests. They challenged the Law as a violation of the First Amendment, the Fourteenth Amendment, and the Voting Rights Act. They lost in the district court and made this appeal. In affirming the district court’s decision, the Second Circuit considered whether the aforementioned provisions of the Law were “closely drawn to address a sufficiently important state interest” and found that each was sufficiently closely-drawn.

The Second Circuit agreed with the district court that the “doing business” contribution limits are “closely drawn” because combating corruption and the public perception of corruption is a sufficiently important justification for placing limits on donations to a candidate. The court draws a distinction from restrictions on independent corporate campaign expenditures which were struck down in Citizens United as overly burdensome limitations on speech.

The court was not persuaded that actual “evidence of recent scandals” was needed to justify the contribution limits. “[T]o require evidence of actual scandals for contribution limits would conflate the interest in preventing actual corruption with the separate interest in preventing apparent corruption.” Finding “no doubt that the threat of corruption or its appearance is heightened when contributors have business dealings with the City” and citing studies by the City Council on the issue, the court held that it is “reasonable and appropriate” to place additional limitations on contributions by Affected Persons.

The court drew another distinguish between the Green Party case in Connecticut and this law. The Connecticut law challenged in Green Party put in place a total ban on contributions, as opposed to mere limits.  However, “if the appearance of corruption is particularly strong due to recent scandals, therefore, a ban may be appropriate.”

Of course, pay-to-play laws are not unique to New York City. The SEC’s Rule 206(4)-5 enacted a similar limit on campaign contributions. Anyone challenging the SEC rule would have to look at this case and realize the SEC rule would like stand up to court scrutiny.

Sources:

Image is New York City celebrating the surrender of Japan. They threw anything and kissed anybody in Times Square., 08/14/1945 from the US National Archives

Private Fund Managers and SEC Registration

The SEC has provided a no action letter in response to an American Bar Association request on guidance for private fund managers. The ABA requested clarification that a group of funds could use a singe registration where the fund managers are in a control relationship and conduct a single advisory business subject to a unified compliance program. The theory is that permitting a single registration (and a single Form ADV filing) to cover the entire group of related advisers would more accurately reflect the full nature and scope of the single advisory business conducted by the group. Therefore it would be more informative for advisory clients and private fund investors as well as the SEC.

The SEC agreed, subject to the following limits:

  1. The filing adviser and each relying adviser advise only private funds and separate account clients that are qualified clients (as defined in Advisers Act rule 205-3) and are otherwise eligible to invest in the private funds advised by the filing adviser or a relying adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds.
  2. Each relying adviser, its employees and the persons acting on its behalf are subject to the filing adviser’s supervision and control and, therefore, each relying adviser, its employees and the persons acting on its behalf are “persons associated with” the filing adviser (as defined in section 202(a)(17) of the Advisers Act).
  3. The filing adviser has its principal office and place of business in the United States and, therefore, all of the substantive provisions of the Advisers Act and the rules thereunder apply to the filing adviser’s and each relying adviser’s dealings with each of its clients, regardless of whether any client or the filing adviser or relying adviser providing the advice is a United States person.9
  4. The advisory activities of each relying adviser are subject to the Advisers Act and the rules thereunder,and each relying adviser is subject to examination by the Commission.10
  5. The filing adviser and each relying adviser operate under a single code of ethics adopted in accordance with Advisers Act rule 204A-1 and a single set of written policies and procedures adopted and implemented in accordance with Advisers Act rule 206(4)-(7) and administered by a single chief compliance officer in accordance with that rule.11
  6. The filing adviser discloses in its Form ADV (Miscellaneous Section of Schedule D) that it and its relying advisers are together filing a single Form ADV in reliance on the position expressed in this letter and identifies each relying adviser by completing a separate Section 1.B., Schedule D, of Form ADV for each relying adviser and identifying it as such by including the notation “(relying adviser).”

If I’m reading this right, it looks like you may be able to wrap the registration requirement for the general partners of funds into a single Form ADV Registration. Prior to this no action letter, I assumed you needed to have each general partner enter into an investment management agreement with the management company.

Given this, it looks like you may be able to take that item off your list of things to do in the next few weeks and merely list the general partners on the Form ADV (assuming you meet the other requirements).

Sources:

Why How We Do Anything Means Everything

An acquaintance in the compliance field sent me a copy of Dov Seidman’s How and I let it sit around  for months. (My “To Read” stack has grown very tall.)  I assumed How was vanity book and would rattle on and on about Seidman’s company: LRN. I recently moved and my “To Read” stack was tumbled around in a plain cardboard box.  How resurfaced in the stack and I noticed the forward was by President Bill Clinton. That was enough to catch my eye.

Seidman spends the first half of the book talking about transparency, trust, reputation, and the new inter-connected world. He does a fine job with these topics, but I’ve seen them handled better elsewhere. The second half of the book, which focuses more on Seidman’s philosophy of business, is when the book becomes more valuable.

Seidman highlights an empirical study about reputation using eBay’s seller reputation information. Chrysanthos Dellarocas used eBay as an experiment. In a study selling the same product, in the same way, through eBay sellers with different levels in the site’s reputation scores, the researchers found a measurable difference in price. A seller with a high reputation on average would get a measurable price premium over a seller who did not.

As you might expect, the book is full of stories as examples. One that really caught my eye was the description of four factories as examples of four types of corporate culture. The factories are to be toured and the measuring stick is the use of hard hats. At the first factory, one of lawlessness and anarchy, the factory tour guide does not offer hard hats to the visitors and many workers are seen without hard hats. At the second factory, an example of blind obedience, all workers wear hard hats and the tour guide says everyone has to wear one or they get fired. The tour guide admits that he doesn’t know why he needs to wear it or why the boss also makes him wear blue pants.

The third factory is the next step up the corporate culture ladder as an example of informed acquiescence. Hard hats are there for everyone with big signs saying everyone must wear one. But when one member of the tour group asks to be excused from wearing one, the tour guide scampers off trying to find a higher-up to approve the lack of a hard hat.

At the top of the corporate culture is the fourth factory, an example of Seidman’s self-governance. The tour guide insists that everyone wears a hard hat and when that same member of the tour group asks to be excused the tour guide says no. “I take personal responsibility for what happens to you. I don’t want to offend you, and you can call my boss or the owner if you like, but I believe your safety and the safety of everyone are paramount. “

The how of culture is broken into five parts: how we know, how we behave, how we relate, how we recognize, and how we pursue.

One common theme in the book is an indictment of a rules-based culture. Rules-makers “chase human ingenuity, which races along generally complying with the rules while blithely creating new behaviors that exist outside of them.” The example that caught my eye was the clerk who insisted on wearing ties with cartoon characters. His bosses fought him and finally insisted that he obey the rules on permissible neckwear. The clerk acquiesced and showed up the next day with Tasmanian Devil suspenders.

Ultimately, a rules-based governance focuses on the things you can’t do, while a values-based governance focuses on what is desirable.

This ends up with Seidman’s Leadership Framework. I think that is better left for more to readers of the book.

If this sounds interesting to you, I ended up with a second copy of How. Rahter than have it sitting on my bookshelf, I want to share it with one of my readers. If you are interested, leave a comment on this blog post or send an email to [email protected]. I’ll pick a winner on February 1.

Ethisphere’s 100 Most Influential People in Business Ethics


The Ethisphere Institute unveiled its “100 Most Influential People in Business Ethics,” an annual list of individuals who have made a significant impact in the realm of corporate citizenship over the course of the previous year.

Some are world famous and some are little unknown. Here are some that caught my attention:

#48 Stephen Colbert – Satirist, The Colbert Report
Category: Media and Whistleblowers

#64 Jack Dorsey – Founder and Executive Chairman, Twitter
Category: Business Leadership

#77 Chris MacDonald – Author, Business Ethics Blog
Category: Media and Whistleblowers

#85 Dick Cassin – Author, FCPA Blog
Category: Media and Whistleblowers

#91 Matt Kelly – Editor-in-Chief, ComplianceWeek
Category: Media and Whistleblowers

Compliance Bits and Pieces for January 20

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

Bruce Carton’s “2011: The Year in Enforcement” in Securities Docket

2011 was another difficult year for the Securities and Exchange Commission, even though another Madoff or Stanford-like scandal didn’t emerge to bring new embarrassment. Indeed, the SEC seemed to be under attack from all sides throughout the year—by Congress, by the judiciary, by its own inspector general, by private litigation, and, of course, by the media. Here is my look back at 2011, including the good, the bad, and the ugly in the world of securities enforcement.

California Proposes Private Fund Adviser Exemption in Hedge Fund Law Blog

As a general proposition, managers who are located in California must register as an investment adviser if they are providing investment advice for compensation.  There are exemptions from the registration requirement which we have detailed previously.  Because of the changes in the statutes and regulations at the Federal level, the states are changing their laws with respect to adviser registration.  Some states, such as California (see post), have adopted interim orders for certain advisers to address gaps in the Federal and state laws until state laws or appropriate regulations can be adopted.  California is proposing to adopt laws which would exempt many hedge fund managers from registration with the California Securities Regulation Division.

TRACE Global Enforcement Report (.pdf)

International anti-bribery enforcement continues to increase worldwide, as more countries move slowly from
enacting anti-bribery laws to initiating actions to identify and prosecute the individuals and companies who break
them. The TRACE GER 2011 summarizes known international enforcement actions by countries to date. New
developments and ongoing trends are highlighted below…

Amending the Ban on General Solicitation and Advertising

There seems to be some momentum for changes to the  Regulation D’s prohibition on advertising a private fund offering. The Managed Funds Association has asked the SEC to start a rulemaking and one of the SEC’s new advisory committees has also recommended a change.

The SEC’s new Advisory Committee on Small and Emerging Companies approved its first recommendation on January 6. It urged the Commission to “relax or modify” the restrictions under Reg D to permit general solicitation and advertising of private fund offerings, but only to accredited investors.

3. The Advisory Committee is of the view that the restrictions on general solicitation and general advertising prevent many privately held small businesses and smaller public companies from gaining sufficient access to sources of capital and thereby materially limit their ability to raise capital through private offerings of securities; and

4. The Advisory Committee is of the view that the investor protections afforded by the existing restrictions on general solicitation and general advertising are not necessary in private offerings of securities whereby the securities are sold solely to accredited investors.

In a petition filed with the SEC last week, the Managed Funds Association states eliminating the general and advertising solicitation ban would “promote investment and enhance economic growth,” add new transparency to hedge funds and free up resources the agency could reallocate.

The House has passed a bill that would eliminate the advertising. It still needs support and action from the Senate.

Personally, I find the current ban hard to deal with because of uncertainty about what you can and cannot do. On the other hand, a broad allowance of advertising would likely perpetrate fraud. Currently, if you see an ad to invest in a private company or unique investment opportunity, it’s a red flag that the offer could be a fraud.

Sources:

Stop SOPA

Based on the White House statement about Stop Online Piracy Act (SOPA), the PROTECT IP Act and the Online Protection and Digital ENforcement Act (OPEN), those bills may be in serious trouble.

The Stop Online Piracy Act (SOPA), H.R. 3261, as originally proposed bill would allow the U.S. Department of Justice to take action against websites accused of enabling or facilitating copyright infringement. The court order could include barring online advertising networks and payment facilitators from doing business with the allegedly infringing website, barring search engines from linking to such sites, and requiring Internet service providers to block access to such sites. This creates a huge compliance headache for website publishers and the internet infrastructure.

Then there is the further erosion of civil liberties by allowing government intervention based on content. (Granted, the content is supposed to be illegal, but who determines it’s illegal?)

The bill would also make unauthorized streaming of copyrighted content a crime. We don’t need more criminal laws. Unfortunately, I think many members of Congress are taking positive positions on the legislation without understanding the implications.

Here are links about SOPA and the protest against it:

Compliance Building will shut down for most of the day, as will wikipedia, Boing Boing, the Cheezbuger network of sites and many other internet sites.