For the past seven years, LRN has conducted its annual survey of Ethics and Compliance programs in search of benchmarking data, suggestions of leading practices, and trends. In 2012 LRN adopted the Program Effectiveness Index as a tool to determine the impact of compliance programs.
The challenge with index is figuring out the difference between correlation and causation. The report is quick to point out the difference. For example, the public celebration of ethical leadership is a characteristic of programs with extremely high Program Effectiveness Indexes. But having a public celebration will not necessarily make your compliance program more effective.
I found the spending and staffing section useful. The average spend on compliance was $100 per employee, with highly regulated industries such as financial services averaging $130 per employee. As for headcount the average was 2.3 FTE per one thousand in highly regulated industries, above the 1.4 FTE overall average. You should note that the survey did not find a correlation between spending/staffing and effectiveness.
Annual assessments were highly correlated with effective programs. Of course if you are registered as an investment adviser, you are compelled conduct an annual assessment under the Compliance Rule 206(4)-7.
Since the Securities and Exchange Commission set up its whistleblower program in 2011, 6500 people have stepped forward as “whistleblowers.” Maxwell Murphy of the Wall Street Journal made a Freedom of Information Act request to find out more.
How successful has the program been and are the people filing really “whistleblowers”?
Of those 6500, only 42 listed themselves as executives or board members. Retirees were the largest group with 365 reports, followed by investors with 290 complaints and engineers coming in third.
According to the 2013 annual report, there were 334 whistleblower reports in 2011, with 3001 in FY2012 and 2013 in FY2103.
The SEC has doled out six whistleblower bounties. Discounting the time it takes to bring a case and investigate, the bounties may not have caught up with the complaints filed. Perhaps the ratio will become better than 1 in 1000.
It sounds like Madoff and Ponzi fell into the same trap. At some point early on they did not realize their promised investment goals. Instead of being honest with their investors, they posted a fake return. The hope was that they could make up for the miss later on.
The central characteristic of a Ponzi scheme is that current returns to investors are paid from new investments instead of a return on the invested capital.
The duration of a Ponzi scheme is dependent on a few factors.
The first factor is the promised return rate. The higher the promised return the shorter the duration. One of the reasons Madoff continued for so long is that his promised return was typically low. He was generally in the 15% range. Since Ponzi was promising returns of 50% in three months, he had a short fuse on the length of his scheme.
The second factor is the redemption rate. The promised return is only meaningful when you have to pay out cash. The better the schemer is at getting investors to keep rolling over returns, the longer the duration. Madoff was undone by the 2008 financial crisis, crushed by a wave of redemptions as people were desperate for cash.
The third factor is the investment rate. The better Ponzi schemers can keep the cash flowing in. As long as the investment rate of cash flowing is in excess of the redemption rate, the scheme will not collapse unless discovered. Once the redemption rate exceeds the investment rate, the schemer will not have the cash to make payouts and the scheme will likely be discovered.
The fourth factor is discovery. This is a wild card. Once an accusation of fraud is made, there will likely be an sharp increase in the redemption rate and a reduction in the investment rate. Ponzi has high profile and attracted attention. Madoff was very secretive. If you can’t stand up to scrutiny, the less scrutiny the better.
The fifth factor is actual returns. I would theorize that many Ponzi schemes start as a legitimate investment proposals. So there may be some actual investment returns that could offset the need for a higher investment rate. Ponzi never made a legitimate investment so this factor was zero for his scheme. Madoff was apparently investing legitimately at some point, but ended up at zero for many years leading up to the collapse. Stanford was generating returns in his banking empire. Just not enough.
The obvious exit is to increase the actual returns to meet the promised return rate before the redemption rate exceeds the investment rate. You can look at Sam Israel who seemed to think he was always just a few trades way from making back all of the promised money.
What do you do when the whistleblower sitting in front of you is an unreliable drug addict? Maybe you see some nugget of truth in the story. Maybe you see some way to find reliable evidence that proves that nugget of truth.
Wendy Ruderman and Barbara Laker, reporters at Philadelphia’s Daily News were confronted with this situation when Benny Martinez walked into the newsroom with a tale of police misconduct. He claimed that narcotics-unit officer Jeffrey Cujdik fabricated evidence in at least two dozen cases. But Benny was not a reliable witness. He was a drug addict and criminal.
One nugget was that officer Cujdik was renting an apartment to Benny. That’s an indication that something was wrong. Benny was being evicted so there was a court hearing coming up that could prove at least one aspect of his story. After attending the hearing, Ruderman and Laker started digging through warrants and found problems.
Those bad arrests lead to more problems with the Philadelphia police department. There were rumors about another police officer sexually assaulting women during police raids. Another group of police officers were raiding corner stores, stealing from them and destroying the video camera coverage. A lawyer for one of the police officers couldn’t understand why they would write a story based on a drug dealer turned informant.
“What do you guys think you are going to do? Win a Pulitzer Prize?” he sneered.
Ruderman and Laker won the Pulitzer Prize for the “Tainted Justice” investigative reporting they did for the police corruption. Busted: A Tale of Corruption and Betrayal in the City of Brotherly Love tells the story of how they discovered, investigated and wrote the story. It documents their shoe leather journalism.
Unfortunately, at the time the book was punished all of the police officers still had their jobs. Some were relegated to desk duty. However in May, Police Commissioner Charles Ramsey fired Jeffrey Cujdik, just weeks after officials announced no charges would be brought in the Tainted Justice case.
Besides the true crime aspect of the book, it’s also an elegy for newspapers. Ruderman ended up at the Daily News after a devastating round of staffing cuts at the sister publication, the Inquirer, threatened her job. Brian Tierney paid $515 million for the newspapers in 2006. They sold for $139 million in bankruptcy in 2010 and then for $55 million in 2012. At times during the story it seemed like the newspaper would close before they finished writing their stories.
The book highlights the importance of the news media and whistleblowers in uncovering corruption.
Minecraft is teaching a whole generation of “kids” (and not so “kids”) about the value of teamwork in a corporate culture.
Moreover, there is now a large segment that will have this joint experience together. A generation that will come up building things and doing things online in a joint way that many of us will just not understand. At all.
That, of course, is one of the big problems with bribery as a business strategy. It doesn’t always work. You may drop an envelope full of cash on a foreign official’s desk, without knowing that someone else has already dropped off an even fatter envelope. And given that bribery is illegal everywhere — even in places where it is reputed to be common — it’s not like you can go complaining to the police that you’ve been cheated. It’s really an extreme case of buyer beware.
There are many aspects of the law on which Democrats and Republicans disagree. But there is one area in which the two sides are largely in agreement: “Too Big to Fail” is still with us.
While not explicit in the statutory framework, it is also illegal for an employer to refuse to accommodate an employee’s religious belief or practice that may run contrary to an employment requirement, unless such accommodation would cause an undue burden on the operation of the employer’s business.
Sounds simple enough, right?
So what’s the problem? Well for most employers, the problem is determining whether an employee’s religious belief is bona fide. In other words, is the employee’s religious belief “sincerely held?”
Indeed, if a religious belief is not sincerely held, then an employer does not have to provide an accommodation.
For the remainder of this week, I will have a four-part episode on your Code of Conduct and anti-corruption compliance policies and procedures. In today’s post I will review the underlying legal and statutory basis for the documents as a foundation of your overall anti-corruption regime. In subsequent posts, I will review how to go about drafting your Code of Conduct and anti-corruption compliance policies and procedures and how to assess, review and revise them on a timely basis.
One of the critical moments of the 2008 financial crisis was caused by Lehman Brothers and its effect on the Reserve Fund, a money market fund. The fund had a significant amount of short-term debt issued by Lehman. Enough that the fund had to ‘break the buck.’ Now even “cash” was not a safe place to invest capital.
The Securities and Exchange Commission has been looking at this problem for years and issued final rules yesterday in an attempt to fix the problem.
The first fix is removing the fiction that a money market fund has a share price of $1. Money market funds had an exemption from valuation and could keep a stable net asset value. To appease retail investors, the change only affects institutional class funds.
Second, the SEC granted money market funds the right to impose redemption restrictions. The fund can charge a liquidity fee or suspend redemptions if the fund encounters liquidity problems. The SEC wants to stop any potential bank run like events on money market funds.
I have to admit that I have not finished reading the rule. It’s an 869 page behemoth of a regulatory release.
I’m trying to figure out the implications for cash management operations. A company needs to hold onto a stockpile of cash to help fund future operations. Bank deposits are only insured up to $250,000. Any stockpile bigger than $250,000 was a risk if the bank failed. We have been in a period where bank failure was at the forefront of everyone’s mind.
Dodd-Frank alleviated that concern by granting unlimited protection for non-interest bearing checking accounts. That’s any easy choice. Interest rates are excruciating low for cash deposits. (Fantastically low if you are borrowing.)
That unlimited protection expired at the end of 2012. It was easy to get diversification and reduce exposure to bank failure by putting the cash in a money market fund. There is little interest earned, but the diversification reduces risk.
There are other alternatives to money market funds, but they take more resources to manage, cost more, or carry more risk. In this low interest rate environment there is little gain in trying to more actively manage the cash. Any interest rate gains will be chewed up by transaction costs.
The SEC has made the lives of corporate treasury groups more difficult. I don’t think they feel any safer and I don’t think the financial markets are any safer.
Progress Rail is under criminal investigation for failures in its railcar and locomotive repairs operation. Investigators claim that it was charging owners of rail equipment for making unnecessary repairs and replacements. There is also an environmental claim because the investigation indicates that workers were dumping parts in the ocean to hide them from auditors. That environmental claim caught the attention of what otherwise may have been a billing dispute.
Railcar owners and the railroads hire Progress Rail to make repairs or replace worn brake shoes, wheels and other components. Ten thousand railcars a month roll into the Port of Los Angeles County, the busiest port in the United States. While here, most are inspected by Progress Rail.
Progress Rail bills the railcar owners for repairs and looks to employee performance based on the billables they generate. According to early reports of investigators, managers made it clear that workers could lose their jobs if they didn’t generate enough repair revenue.
What happens on a day when the railcars coming thorugh are all in good shape? Make repair work: smash something, remove a bolt, or report a missing part you remove.
There are auditors that review operations to try to keep Progress Rail’s employees honest.
What is the issue from a compliance perspective? Culture.
Middle management was focused on increasing revenue and instilled this focus on its employees. The focus should have been on keeping the railcars well-maintained. Part of the problem is ties back to how the railcar owners structure their contracts with Progress Rail. Presumably they pay for work done, instead of a fee based on performance of their railcars.
It’s been four years since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. President Obama sat down on July 21, 2010 to sign the behemoth of a bill that was the most dramatic change to financial industry in years. Besides the hundreds of pages of text in the law itself, the law also mandated almost 400 regulatory rulemakings. All of this has made compliance professionals in the financial industry very busy.
Of the 398 rulemaking requirements in the law, 280 had specific deadlines. Of those, 127 have missed their deadlines. Of those 127, regulators have not even released proposals for 42 of the missed deadlines. There are another 54 rulemakings without deadlines that have not been proposed. Dodd-Frank is far from being implemented.
The Securities and Exchange Commission had the biggest burden placed in it. Daniel Gallagher, a Republican member of the SEC, said the commission can’t spend all of its time writing Dodd-Frank rules. “To pretend we can process the rules in a thoughtful way, in a period of a year or two, or even five or 10, I think is crazy.”
“Of the 535 members of the House and Senate, those who have a sophisticated understanding of the financial markets and their regulation could probably fit on the twenty-five man roster of a Major League Baseball team.”
The financial crisis of 2008 was catastrophic, so of course Congress had to pass a law. That allowed all kinds of other stuff to be piled into the law even if it had nothing to do with the financial crisis. (How did conflict minerals affect the financial markets?)
There is a strong push to enact some changes to Dodd-Frank, but that will likely hinge largely on the results of the upcoming election and whether the Republicans are able to gain control of the Senate. That will just mean changes to the changes.
Compliance professionals are going to be busy implementing Dodd-Frank for the foreseeable future.
Recent white-collar settlements are case studies in how compliance officers are ignored, circumvented and sidelined. But that’s likely having the effect of giving these staffers more stature.
A handful of companies have cropped up that provide these outsourced CCOs, who may fill the role at a number of companies at once. Proponents of the approach say it allows a smaller company to have the expertise of a full-time, independent compliance professional. But even they concede that the outsourcing option isn’t the best choice for all firms.
The House of Representatives approved a spending bill Wednesday that denies the Securities and Exchange Commission the funding it says it needs to strengthen investment adviser oversight.
In a 228-195 vote, the House passed a $21.3 billion appropriations bill that funds the SEC, Treasury Department and many other agencies. The measure gives the SEC a $50 million budget increase, about $300 million less than the agency requested. Under the bill, the SEC would operate on a $1.4 billion budget in fiscal 2015, which begins on Oct. 1.
Teaching about insider trading is always a pleasure. The law in this area is ridiculous. What seems to be insider trading may not be; what seems like it is often isn’t. Sometimes the facts of actual cases provide exam style questions that would otherwise seem almost too contrived to be real.
Private equity firms were put on notice last year that they may be subject to registration as broker dealers when David Blass, head of the Division of Markets and Trading at the Securities and Exchange Commission (“SEC”), provided his insights at an industry conference. Since that time, the SEC has published their examination priorities list, which included the presence exams of new registrants, a portion of which would review that status of private equity fund managers under the broker dealer rules. Following up on this warning to the industry, the SEC has also targeted unregistered brokers for enforcement action.
For you cyclists, the watercolor above is part of Kickstarter project that I’ve supported: Book de Tour by Greig Leach. Can you lend your support?
Movies about compliance officers are few and far between. It may surprise you to find Chris Pine playing that role in Jack Ryan: Shadow Recruit.
Jack Ryan is the protagonist in Tom Clancy’s cold war thrillers. I read most of his books back in the 1980s. They were so cold war based I wondered how the story telling would work in the current era where national security is focused more on anti-terrorism. I wonder no more.
Jack Ryan has been through many good actors: Alec Baldwin, Harrison Ford and Ben Affleck. This time its Chris Pine rebooting the character. Ryan joins the Marine Corps after 9/11 interrupts his college career. He’s recruited by Kevin Costner to work on terrorist financing. He goes back to school to finish his PhD in economics and goes to work undercover on Wall Street.
He ends up as a compliance officer at a big Wall Street firm. Of course his role is to look for suspicious activity.
“I’m a compliance officer, I do everything by myself.”
He spots some suspicious activity with a Russian business partner. That moves him from analyst to operative. A compliance officer with a gun. Shoot outs and car chases ensue.
The movie is mediocre. It’s not horrible, just bland. But make your spouse sit through it and maybe, just maybe, he or she will raise an eyebrow, wondering if you are actually an undercover operative.
on Amazon (affiliate link)
