Compliance Bricks and Mortar for March 29

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

Kathleen Edmond of Best Buy Receives ERC’s Carol R. Marshall Award for Innovation in Corporate Ethics

Established last year as a posthumous honor to former ERC Board member Carol R. Marshall, the award recognizes a chief ethics and compliance officer for innovation and leadership in building or enhancing a corporate ethics and compliance program. The ERC selects an honoree who is a national leader who advances the ethics and compliance field and serves as a role model in the profession.

The Crystal Ball: What Might Top the SEC’s Agenda? by Dave Lynn in TheCorporateCounsel.net

Mary Jo White’s nomination to be the 31st Chair of the SEC was approved last week by the Senate Banking Committee, in a vote of 21 to 1, and as noted in this article, her nomination goes on to the full Senate for consideration at some point soon after the Easter recess. With the possibility of a new Chair arriving soon, the question inevitably arises as to what will (or should) top the Corp Fin rulemaking agenda?

FBI has cooperating witness for soccer fraud probe

An FBI probe into alleged corruption in international soccer has recently intensified after investigators persuaded a key party to be a cooperating witness, U.S. law enforcement sources said…..The deepening of the probe indicates that a succession of corruption scandals involving FIFA and other international soccer bodies in the past few years may continue to cast a cloud over the sport for some time.

File Your Fund’s PPM With FINRA?

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FINRA Rule 5123 requires each FINRA member firm that sells securities in a private placement, subject to certain exemptions, to file with FINRA a copy of any private placement memorandum, term sheet or other offering document the firm used within 15 calendar days of the date of the sale, or indicate that it did not use any such offering documents. If you are using a placement agent to help with fundraising, the placement agent will be subject to the FINRA rules. Then the fundraising is potential subject to the FINRA disclosure, unless if falls into an exemption. The exemptions for a private fund split the world into two.

For funds exempt under Section 3(c)(7) of the Investment Company Act, all of the buyers will be “qualified purchasers.” Rule 5123 has an exemption for the filing requirement for offerings sold to qualified purchasers.[5123(b)(1)(B)]

For funds using the Section 3(c)(1) exemption, the analysis in not as clean. Rule 5123 has an exemption for the filing requirement for offerings sold to some types of accredited investors. [5123(b)(1)(J)] It leaves out items 6 and 7 in the definition of accredited investor.

A fundraising triggers the filing requirement if you sell to natural persons who are accredited investors, but don’t meet the standard of qualified purchaser.

In talking with a placement agent, they are including representations that the offering will be a 3(c)(7) offering so that they are protected from having to make the FINRA filing.

Antifragile – Things That Gain from Disorder

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Taleb is back, and he is even more brash and brilliant. Nassim Nicholas Taleb’s fame grew from his second book, The Black Swan, being timely released just before the 2008 financial crisis. Antifragile continues his narrative on probability and risk. The Black Swan took on the theory that the highly improbable was a lot more probable than we thought. Antifragile takes the next step and proposes that it’s good to be subject to black swan events and other disorder.

He coins the term “antifragile” to address the situation where something improves as it is subject to disorder or stress. I goes beyond robust. I thought the best explanation was through the use of mythology.

The sword of Damocles is fragile. All it takes is a small amount of damage to sever the horsehair and send the sword plummeting into the person sitting beneath it.

The phoenix is robust. Once it dies, it is reborn from its ashes to live again.

The hydra is antifragile. If you mange to cut off one of its heads, two sprout in its place. The more damage it takes, the more powerful it becomes.

The next step is to realize that the effects of fragility are not linear. As the overload increases, the damage increases dramatically. Getting hit by by one rock weighing 50 pounds will hurt a lot more than getting hit by 1000 rocks that weigh 0.05 pounds. There is an acceleration of harm. The black swan comes when you get hit by the 50 pound rock, when you had been expecting another pebble.

The book is an excellent reading choice for anyone involved in compliance or risk management

The publisher sent me a free copy of the book in hopes of a review.

One Week Left to File Your Form ADV Update

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Most advisory firms and fund managers end their fiscal year on December 31. Under the SEC Advisers Act Rule 0-4, you have 90 days to file your Form ADV update after the end of your fiscal year.

Last year that put the filing deadline on March 30 because it was a leap year. The next leap year does not come until in 2016.

This year that 90th day falls on March 31st. But that’s a Sunday. So we have one extra day this year. The filing deadline is April 1.

“Filings required to be made through the IARD on a day that the IARD is closed shall be considered timely filed with the Commission if filed with the IARD no later than the following business day.”

Compliance Bricks and Mortar for March 22

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

NoDoz: Early Birds Needed to Work at SEC by Bruce Carton in Compliance Week

What impact will White will have on the SEC? For one thing, it appears that those at the agency who work closely with the chairman will need to set their alarm clocks to go off quite a bit earlier. White is known to be a tireless, “24/7” worker who often sends detailed emails to her colleagues at 3 a.m.

You Might Be Surprised By Who Counts (And Who Doesn’t) In California by Keith Paul Bishop in California Corporate and Securities Law

Many issuers continue to rely on California’s limited offering exemption to avoid the necessity of qualifying the offer and sale of their securities. The exemption, found in Corporations Code Section 25102(f), requires that sales be made to not more than 35 persons. Thus, it is important to know who counts and who doesn’t.

The Telltale Signs of Corporate Fraud by Stephen J. Dubner in Freakonomics

A new working paper (abstract; PDF) by Tanja Artiga Gonzalez, Markus Schmid, and David Yermack looks for the telltale signs of corporate fraud. The paper is called “Smokescreen: How Managers Behave When They Have Something To Hide”:

SEC Issues Guidance Update on Social Media Filings by Investment Companies

The Securities and Exchange Commission today published a guidance update from its staff to clarify the obligations of mutual funds and other investment companies to seek review of materials posted on their social media sites.

Additional Materials:

Massachusetts Proposes New Regulations Related to Investment Adviser Representative Registration

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On March 15, 2013, the Massachusetts Securities Division started the process to amend the  regulations for investment adviser representative (“IAR”).

The proposal would require an IAR applicant to submit to a review of the Massachusetts Criminal Offender Record Information (CORI) of the applicant.

The Division believes that it is in the public interest and for the protection of investors to conduct criminal background checks of those individuals seeking IAR registration in order to ensure that the applicant is not subject to a statutory disqualification and has truthfully and accurately disclosed any criminal background required on Form U-4. The Registrations, Inspections, Compliance and Examinations (“RICE”) Section of the Division has recently been granted access to utilize the Massachusetts “iCORI system,” an electronic criminal history database, in order to conduct these reviews.

However, the CRD system for submitting Form ADV is not able to accept the required CORI acknowledgement. So Massachusetts registered investment advisers will have to send the form directly to the state regulators.

Also, Massachusetts is cleaning up its regulations as to Form ADV to comply with the SEC’s 2010 changes to the form. The proposed language is based upon the NASAA model brochure rule. Along with that ate a bunch of other small changes that clean up the Massachusetts investment adviser regulations.

The Request for Comment and the Proposed Regulations are available on the Division’s website at http://www.sec.state.ma.us/sct/sctidx.htm.

The comment period will end on Wednesday, May 15, 2013.  A public hearing on these proposed changes will be held at 10:00 a.m. on Wednesday, May 15 at One Ashburton Place, 17th Floor, Boston, MA 02108.

Sources:

How to Do Everything Wrong in a Securities Offering

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I first looked at the First Choice Investments action by the Securities and Exchange Commission because it involved a real estate investment company. I thought it would be another to case to help me explore ““. Instead I found a train wreck, at least if what the SEC alleges is true. The company was selling high-yield notes that could be converted to shares in the company. This was a real estate based investment, but the company was not selling real estate interests. There is no argument that the company was selling securities.

In the SEC complaint, First Choice is accused of misusing funds and misleading advertising. The misuse of funds comes across as standard corporate fraud, raising cash for one purpose but pocketing it for your own compensation and outside uses.

The advertising and promotion was blatantly in violation of securities laws and shows some of the concerns of crowdfunding and removing the ban on general advertising.

Right on the public webpage, First Choice offers a 10% return paid quarterly and touts that First — Choice is about to go public shortly. With the ban on general advertising, there is a big red flag on this company’s web page.  First Choice is advertising the securities offering. Also, according to the SEC complaint, First Choice was cold calling potential investors. So they are violating both the general advertising and general solicitation restrictions currently in place for Regulation D Rule 506 offerings.

Also targeted in the complaint is an affiliated company, Acorp Development. It was offering $5 million of equity. It decided to put the SEC logo on its investor’s lounge with a link to its Form D filing. You should not use the SEC logo in a way that indicates something is approved by the SEC.

The Investor Presentation is a strange mix of concepts, questionable math, and false promises. After a handful of case studies, the presentation shows the pro forma returns for an investment, showing a target cap rate of 13.41%. All of the preceding case studies had lower cap rates.

The First Choice “Investor Principal Protection” caught my as incredibly strange. Somehow through a consulting agreement, Goldberg-Goldberg offers an “Investment Enhancement Program” that provides an “assured return of investment during the high risk stage of the business.” I scratch my head wondering how a consulting agreement is supposed to offer investor principal protection.

The First Choice notes state that they can be converted to equity. But with no formula for conversion, the windfall touted by First Choice would seem to be non-existent.

In a world where non-accredited investors should be shielded from private offerings, the First Choice materials are full of red flags that should make any reasonably savvy investor walk away. However, First Choice was still able to raise $3 million. The public availability of information is a red flag to regulators that the company is operating outside the bounds of the securities laws.

Post-repeal of the advertising ban and the post-enactment of equity crowdfunding, this types of fraudulent offering may be more common and more public. Hopefully, the SEC can find the right balance to limit the ability of bad actors that play in the securities offering playground.

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Compliance Bricks and Mortar for March 15

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The card above comes courtesy of the House Financial Services Committee lamenting the failure to prosecute individuals and companies in the financial industry. Last week Chairman Hensarling and Oversight & Investigations Subcommittee Chairman McHenry sent a letter to Attorney General Holder and Treasury Secretary Lew seeking any and all documents related to the consideration of economic factors in the decision to prosecute large banks for financial crimes. The committee’s investigation comes out of Mr. Holder’s recent comments at a Senate Judiciary Committee Hearing in which the Attorney General suggested some large financial institutions are now “too big to jail.”

Here are some of the other compliance related stories that recently caught my attention:

Lessons from Bill Belichick for the Compliance Practitioner by Tom Fox

One of the things that struck me about the Belichick player evaluation system and how it was used by all three men for their respective teams is that is a building block system. It takes a system and builds that system, building block by building block until the overall system is completed. This is then fine-tuned and updated through continuous monitoring, assessment and review. For the compliance practitioner, I found this approach to have several valuable lessons.

BEA Reporting for Fund Managers: the SEC is not the only regulator gathering investment-related data in the Hedge Fund Law Blog

The BEA collects data on U.S. direct investment abroad, among other mandates. Its tools include Form BEA-11 (“BEA-11”) for U.S. persons that have ownership interests in foreign affiliates. Historically, these filings received almost no attention. Enforcement of the filing requirements was rare, but is expected to increase following the BEA’s announcement in May of 2012 that it would be more vigilant. [Note: Enforcement penalties include civil and criminal fines and even imprisonment for failure to file.]

JPMorgan Hid Trades Banned by Volcker Rule, Senate Probe Finds by Cheyenne Hopkins in Bloomberg

JPMorgan Chase & Co. engaged in high-risk proprietary trading under the guise of ordinary hedging, said Senate investigators, who urged U.S. regulators to strengthen the proposed ban on such trades known as the Volcker rule. Regulators should require banks that hold federally insured deposits to explicitly link positions in derivatives to the underlying risk they are hedging, the Senate’s Permanent Subcommittee on Investigations recommended in a 300-page report released yesterday.

Anti-Corruption Enthusiasts, We Need Your Help! by Matt Kelly in Compliance Week

Calling all FCPA and anti-corruption enthusiasts, Compliance Week needs your help! Compliance Week and Kroll Advisory have teamed up to undertake a major survey on corporate anti-corruption programs, and we’re asking compliance executives to participate. The survey itself—the 2013 “Global Anti-Bribery Benchmarking Report”—can be found here: http://surveys.harveyresearch.com/se.ashx?s=0D146E2D11F8D225.

This Is Not a Story About Last Place by Jason Gay in the Wall Street Journal

This is a story about a guy who finished last. Which is technically true. You can look up the results of the race, and you’ll see his name, right there, lonely at the bottom. Taylor Phinney. USA. Finishing time of six hours, twenty-two minutes, fifty-four seconds. One hundred-and-ninth place. Last.

But this story is better than that.

Make Sure Your Placement Agent is Registered

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The Securities and Exchange Commission cracked down on a fund manager and its placement agent because the placement agent was not registered as a broker-dealer. The federal securities laws require that an individual who solicits investments in return for transaction-based compensation be registered as a broker. There is a fine line between a “finder” and “placement agent.” A line that most fund managers would be best served to stay away from.

An SEC investigation found that William M. Stephens of Hinsdale, Ill., solicited investors as a hired consultant for Ranieri Partners. He was paid fees by the firm, but never registered as a broker. Stephens’ longtime friend Donald W. Phillips, a senior managing director who headed up capital raising efforts for Ranieri Partners, was responsible for overseeing Stephens’ activities. His role supposed to be acting as a “finder” who would merely make initial introductions to potential investors.

Since Stephens was paid a commission on his successful introductions, it looks like he stepped far over the line into the activities of a broker-dealer. He was not supposed to deliver documents or discuss the merits of the fund investment. But he did.

The simple remediation was to only use third party finder, marketing agent, or placement agent that is registered as a broker-dealer. Stephens had to pay a disgorgement of pay disgorgement of $2,418,379.20, the money he earned while acting as unlicensed broker-dealer. Ranieri, the fund manager, was ordered to pay a $375,000 penalty. Stephen’s supervisor was subject to a $75,00 fine and a suspension.

Sources:

Seaman Theodore Marion of Philadelphia, PA, uses a bullhorn to instruct a line-handling party in the hangar bay aboard USS Enterprise By U.S. Navy photo by Photographer’s Mate 3rd Class Jason W. Pfiester [Public domain], via Wikimedia Commons.