Compliance Bricks and Mortar for January 30

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I have finally dug myself out from the 2+ feet of snow that buried me this week. These compliance-related stories caught my eye in between snow shoveling sessions.

SEC Co-Chief of Division of Enforcement’s Asset Management Unit Identifies 2015 Exam Priorities for Hedge and Private Equity Funds in the National Law Review

On November 18, 2014, Julie M. Riewe, Co-Chief of the Division of Enforcement’s Asset Management Unit of the Securities and Exchange Commission (the “SEC”), spoke at a Practicing Law Institute seminar and identified 2015 SEC examination priorities for investment managers of private funds. Ms. Riewe identified three themes on which the SEC will focus in its examinations of hedge and private equity funds: (i) conflicts of interest, (ii) valuation and (iii) compliance and controls. She discussed how these thematic issues related to both hedge funds and private equity funds.

S.E.C. Faces Challenges Over the Constitutionality of Some of Its Court Proceedings by Peter J. Henning in NYTimes.com’s DealBook

It is probably not a stretch to say that the Securities and Exchange Commission likes to win every case that it decides to bring.

But a recent push by the agency to bring more cases before its administrative law judges rather than filing charges in federal district court is drawing increased attacks from defense lawyers claiming that the entire process is not just unfair, but also unconstitutional. Those criticisms could call into question the legality of the process used by a number of federal agencies that have in-house judges who decide whether laws were violated.

Welcome to COSO and the World of Internal Controls – Part I and Part II by Tom Fox in the FCPA Compliance and Ethics Blog

[T]here is one area of FCPA enforcement, which I think underwent a sea change in 2014 and has significant implications for the Chief Compliance Officer (CCO) and compliance practitioner in 2015 and far beyond. That change will be in the enforcement by the Securities and Exchange Commission (SEC) of the internal controls provisions of the FCPA. Last fall we saw three SEC enforcement actions, where there was no corresponding Department of Justice (DOJ) enforcement action yet there was a SEC enforcement action around either the lack or failure of internal controls. Those enforcement actions were Smith & Wesson, Layne Christensen and Bio-Rad.

What’s in your Wallet? Insider Trading

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It’s clearly insider when a company’s high-level executive trades on pending earnings data not yet released to the public. It’s clearly not insider trading when you count cars in a retailer’s parking lot to get insight to sales. A recent SEC case falls somewhere in the middle.

The Securities and Exchange Commission brought charges against two men who worked at a credit card company. The two crafty traders tracked credit card use to determine revenue trends for retailers and then traded based on that data.

Their plan was solid. They made over $2.8 million on a $147,300 investment, a return of 1,819%, according to the complaint. Those returns are too good. I would bet that their brokerage accounts were flagged by compliance.

The credit card company was not disclosed in the complaint, but Capital One has acknowledged that they’ve “been working closely with the SEC on this investigation, which involves two former employees.”

This case reminds me of the Railroad Insider Trading case where an employee noticed a bunch of “suits” walking around the railroad and some unusual activity in the office. He surmised that the railroad was getting sold, traded on that assumption, and made some money on the trade. The SEC thought he was engaged in illegal insider trading. A jury thought otherwise.

In this current case, the two men were subject to the credit card company’s rules on protection of this information. According to the SEC, they broke those rules.

They “knew or were reckless in not knowing that they owed their employer a fiduciary duty, or an obligation arising from a relationship of trust and confidence, to maintain the confidentiality” of the data.

In looking at the portions of Capital One’s insider trading policy, it probably should have addressed this particular topic. The portion of the code excerpted in the SEC complaint is a rather standard ban on illegal insider trading. It seems to fail to address the use of data at the company.

What the two traders did is certainly enough to get them fired. It was enough to get them charged by the SEC. It may be harder to get a jury to agree. Unlike some other recent insider trading cases, this one was filed in federal court. So it will be up to a jury, not one of the SEC’s administrative judges, to determine guilt.

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Compliance Bricks and Mortar for January 23

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

Equity Crowdfunding: A Market for Lemons? by Darian M. Ibrahim in the CLS Blue Sky Blog

Before reaching the more difficult Title III, I reveal that the less-radical Title II, which allows general solicitation of accredited investors, seems to have proven successful for entrepreneurs and investors in its first year of operation. Online platforms such as AngelList, FundersClub, and CircleUp have successfully matched entrepreneurs and accredited investors and raised significant cash for startups. This is somewhat surprising, at least on first analysis, considering: 1) that moving operations online would appear to weaken the close networks and geographic locality that explain traditional angel/VC success; and 2) that the first Internet matching service for startups and accredited investors, ACE-Net, failed miserably over a decade ago.

SEC Gets Busy With Accounting Investigations by Jean Eaglesham And
Michael Rapoport in the Wall Street Journal

But the new cases are on a smaller scale and typically involve conduct that is far less egregious than the accounting scandals of the early 2000s, such as the implosion of energy giant Enron Corp.

In addition, the agency’s computerized system for sniffing out accounting fraud has so far proved to be less revolutionary than many expected when it was unveiled in 2012.

’123456′ Again: The Most Popular Passwords Aren’t Changing by Rani Molla in the Wall Street Journal

Despite the high-profile hacking attacks last year, people are still using passwords that security analysts say should have been in the dustbin years ago. Both “123456″ and “password” have been the top two passwords since security-app provider SplashData began measuring the most frequently used passwords in 2011.

KKR

Refunds Some Fees to Investors by Mark Maremont in the Wall Street Journal
KKR & Co. refunded money to investors in some of its buyout funds after regulators found it overcharged them, marking one of the highest-profile results yet of regulators’ increased scrutiny of the private-equity business.

Meet The 80 People Who Are As Rich As Half The World by Mona Chalabi in FiveThirtyEight.com

Eighty people hold the same amount of wealth as the world’s 3.6 billion poorest people, according to an analysis just released from Oxfam. The report from the global anti-poverty organization finds that since 2009, the wealth of those 80 richest has doubled in nominal terms — while the wealth of the poorest 50 percent of the world’s population has fallen.

11 of the wealthiest people on the planet were simply born into their money (19 others inherited their wealth and then made it grow). The remaining 50 names on the list, according to Forbes, are self-made billionaires.

Massachusetts Adopts Crowdfunding

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Add Massachusetts to the growing list of states that are sidestepping the unusable federal crowdfunding alternative.

“The Crowdfunding Exemption is designed to foster job creation by helping small and early-stage Massachusetts companies find investors and gain greater access to capital with fewer restrictions. The exemption is also intended to provide necessary investor protections by requiring key disclosures, and by making the exemption unavailable to bad actors that have violated the securities laws or committed financial fraud.”

The federal crowdfunding provisions in the Jumpstart Our Business Startups Act of 2012 was supposed to be a panacea for crowdfunding. But the final language of the law was amended at the last minute. The Securities and Exchange Commission was vocally opposed to it, but issued proposed regulations in October 2013 to implement the exemption. The SEC received about 300 written comments to the proposed regulations, but there is no sign that the final regulations will come out any time soon. The Federal crowdfunding regime will not be effective until the SEC issues those regulations. Even then, the regime is likely to be unwieldy.

A May 1, 2014 Wall Street Journal article, entitled “Frustration Rises Over Crowdfunding Rules,” describes efforts in the U.S. Congress to amend the JOBS Act even before the federal regime takes effect. However, many states have decided that crowdfunding is worth trying and are not waiting for the SEC.

The new Massachusetts crowdfunding regime is limited to $1 million a year, which can be increased to $2 million with audited financial statements. The company must set a fundraising minimum and must keep funds in escrow at a Massachusetts bank until it reaches the target.

The investment amount limitations are a bit messy. For those with net worth and income of less than $100,000, an investment is limited to the greater of $2000 or 5% of annual income or net worth. For the wealthier, it can go up to 10% of income or net worth. The Massachusetts regulation looks to the SEC accredited investor standard for calculating those amounts (i.e. exclude the home).

There is a limitation on form. The business must be formed under Massachusetts law, have its principal place of business in Massachusetts and authorized to do business in Massachusetts. It’s too bad the regime excludes the Delaware formed organizations from crowdfunding. That limits future growth of the company. Bigger money investors will want a Delaware entity for the certainty under the Delaware corporate laws for protection of their shareholder rights.

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Preparation for SEC Examinations

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Ascendent Compliance put together a presentation on Preparation for SEC Examinations.

Last year the SEC examined 9% of advisers which represent 25% of the RAUM. Of those exams, 87% had deficiencies, 25% had significant findings, and 14% were referred to enforcement.

The SEC has implemented a new telephone assessment for offsite remote exams. The examiners do not end up in your office. Unless they find something that catches their attention.

The Never Before Examined Initiative is continuing for advisers registered before 2012.

The Presence Exam Initiative may be winding down. The SEC is still continuing its lengthy routine exams.

Enhancing Risk Monitoring and Regulatory Safeguards for the Asset Management Industry” speech by SEC Chair Mary Jo White on December 11, 2014 talks about new rule makings and possible wide reaching changes.

In the SEC Report on Objectives 2015 from the Office of Investor Advocate recommends investment advisers being examined every three years and longer than five years without a comprehensive exam.

OCIE is continuing to develop technology to help them with exams to identify fraud, manipulation, and compliance failures. If they have new tools, it’s likely that they will be using them in the exam process.

Based on the 2015 initiatives, the SEC will focus on issues affecting investors’ retirement accounts, including marketing practices and recommendations. There will likely be a focus on placing assets in a firm’s sponsored investment vehicle.

What’s New with the OCIE Document Request Lists?

  • Longer exam period for information – 2 years
  • New questions
  • Slide deck presentation on the firm, affiliated entities and services
  • List of all committees, including description, meeting frequency, membership, and keeping of written minutes
  • Summary of valuation process
  • All emails form particular individuals over a period of time

2015 Examination Initiatives

Based on the 2015 initiatives, the SEC will focus on issues affecting investors’ retirement accounts, including marketing practices and recommendations. There will likely be a focus on placing assets in a firm’s sponsored investment vehicle. OCIE announced three broad areas of priority for 2015:

Retail Investors – Retail investors are being offered products and services that were formerly characterized as alternative or institutional, including private funds, illiquid investments, and structured products.  Additionally, financial services firms are offering a broad array of information, advice, products, and services to help retail investors plan for and live in retirement. OCIE will assess risks to retail investors that can arise from these trends.

Market-Wide Risks – OCIE will examine for structural risks and trends that involve multiple firms or entire industries, including: monitoring large broker-dealers and asset managers in coordination with the SEC’s policy divisions, conducting annual examinations of clearing agencies as required by the Dodd-Frank Act, assessing cybersecurity controls across a range of industry participants, and examining broker-dealers’ compliance with best execution duties in routing equity order flow.

Data Analytics – Over the last several years, OCIE has made significant enhancements that enable exam staff to analyze large amounts of data efficiently and effectively. OCIE will use these capabilities to focus on registrants and registered representatives that appear to be potentially engaged in illegal activity.

First Impressions

  • Set a tone of cooperativeness
  • Set a tone of compliance
  • Let them know that you thought about the issues ahead of time

Exam Plan

  • What do you do after you get the call from the examiner
  • Organization of materials
  • FOIA Protection
  • Role of consultant
  • Role of counsel
  • Prepare key personnel for interviews

Improving Your Next Exam

  • Fix deficiencies from prior exam
  • Respond to deficiencies from current exam
  • Set up a training plan to fix problems
  • Implement testing and documentation

Weekend Riding – Facing the Cold

That’s me, bundled up for my first bike ride of 2015 on Saturday. I was going to ride first thing in the morning, but shied away when I saw a 9 degree reading on the thermometer. I waited for the balmy afternoon temperature of 22 degrees before enduring a 15 mile ride.

Why ride?

first ride of 2015

I’m riding the 2015 Pan-Mass Challenge this summer to raise money for the Dana-Farber Cancer Institute. (Click here to make a donation of any amount.) I would appreciate your financial support.

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Compliance Bricks and Mortar for January 16

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

RBS Loses Senior Compliance Staff, Some Poached by HSBC by Margot Patrick And Rachel Louise Ensign in the Wall Street Journal

The departures come as RBS, 80%-owned by the British government, faces a potential multibillion-dollar settlement with the Federal Housing Finance Agency over mortgage-backed debt it sold to Freddie Mac and Fannie Mae before the 2008 financial crisis.

Say Hello to the SEC’s Digital Currency Working Group (.pdf) by Marco Santori and Jeffrey Jacobi from Pillsbury

Now that enforcement agencies have determined that digital currencies are more than a passing fad, they are establishing more permanent efforts focused on the novel legal issues digital currencies present. The SEC’s formation of its multi-office Digital Currency Working Group may foreshadow an increase in the agency’s exercise of regulatory authority over entities offering interests in Bitcoin and other digital currencies

Justice Department Files First FCPA Case of 2015, Reminds Lawyers to Watch Out by David Smyth in Cady Bar The Door

Last week, the Justice Department filed the first FCPA case of 2015 when it indicted Dmitrij Harder, the former owner and president the Chestnut Consulting Group in Huntingdon Valley, Pa…

The case is interesting to me for at least four reasons. First, the European Bank for Reconstruction and Development is based in the United Kingdom, not a high-risk country for corruption issues. Second, the case doesn’t involve third party sales agents, as so many FCPA cases tend to do in one way or another. Instead, if the indictment is to be believed, here we have a company president’s single-minded determination to pay some bribes to win business, one way or the other. Third, the case invokes the “public international organization” facet of the foreign official element to establish jurisdiction over the conduct at issue. Doesn’t happen very often!

SEC Enforcement – An Analysis of Key Developments in 2014 by Bruce Carton in Compliance Week

In a webcast I moderated yesterday, a panel consisting of four former senior SEC enforcement attorneys and accountants–including former SEC Enforcement Director Bill McLucas of law firm WilmerHale–analyzed the most important developments in SEC enforcement from 2014, and looked ahead at what they expect in 2015.

Black & White Bricks is by Mike

SEC Exam Priorities for 2015

SEC National Exam Program

In 2013 the Office of Compliance Inspections and Examinations at the Securities Exchange Commission laid out their examination priorities for 2013 and did so again last year with its 2014 Examination Priorities. OCIE just released its Examination Priorities for 2015.

One item jumps out for a focus for private funds:

Fees and Expenses in Private Equity. Given the high rate of deficiencies that we have observed among advisers to private equity funds in connection with fees and expenses, we will continue to conduct examinations in this area.

Given the resources focused on this last year, it’s no surprise that this remains an initiative for the national exam program.

What is surprising is how different the priorities look from last year’s release. It is much more sparse and focused than in the past.

OCIE announced three broad areas of priority:

Retail Investors – Retail investors are being offered products and services that were formerly characterized as alternative or institutional, including private funds, illiquid investments, and structured products.  Additionally, financial services firms are offering a broad array of information, advice, products, and services to help retail investors plan for and live in retirement. OCIE will assess risks to retail investors that can arise from these trends.

Market-Wide Risks – OCIE will examine for structural risks and trends that involve multiple firms or entire industries, including: monitoring large broker-dealers and asset managers in coordination with the SEC’s policy divisions, conducting annual examinations of clearing agencies as required by the Dodd-Frank Act, assessing cybersecurity controls across a range of industry participants, and examining broker-dealers’ compliance with best execution duties in routing equity order flow.

Data Analytics – Over the last several years, OCIE has made significant enhancements that enable exam staff to analyze large amounts of data efficiently and effectively. OCIE will use these capabilities to focus on registrants and registered representatives that appear to be potentially engaged in illegal activity.

 

 

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