Month: August 2015

Proposed Anti-Money Laundering Regulations for Investment Advisers and Fund Managers

After years of talking about it, the Financial Crimes Enforcement Network (FinCEN) issued a proposed a rule requiring certain investment advisers to establish anti-money laundering programs and report suspicious activity to FinCEN. The new regulations propose to include investment advisers in the general definition of “financial institution,” which would require them to file Currency Transaction Reports and keep records relating to the transmittal of funds.

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For private funds, engaging in Know-Your-Customer and Anti-Money Laundering has become a standard practice. Now, 12 years after FinCEN first proposed a rule-making, and then withdrew it, FinCEN published a new 86-page proposal.

The proposal would apply to investment advisers that are required to be registered with the U.S. Securities and Exchange Commission, including advisers to hedge funds, private equity funds, and other private funds. FinCEN would delegate its authority to examine investment advisers for compliance with these requirements to the SEC.

Here is the main part of the proposed regulations:

(a)(1) Each investment adviser shall develop and implement a written anti-money laundering program reasonably designed to prevent the investment adviser from being used for money laundering or the financing of terrorist activities and to achieve and monitor compliance with the applicable provisions of the Bank Secrecy Act (31 U.S.C. 5311 et seq.) and the implementing regulations thereunder.

(2) Each investment adviser’s anti-money laundering program must be approved in writing by its board of directors or trustees, or if it does not have one, by its sole proprietor, general partner, trustee, or other persons that have functions similar to a board of directors. An investment adviser shall make its anti-money laundering program available for inspection by FinCEN or the SEC upon request.

(b) Minimum requirements. The anti-money laundering program shall at a minimum:

(1) Establish and implement policies, procedures, and internal controls reasonably designed to prevent the investment adviser from being used for money laundering or the financing of terrorist activities and to achieve and monitor compliance with the applicable provisions of the Bank Secrecy Act and the implementing regulations thereunder;
(2) Provide for independent testing for compliance to be conducted by the investment adviser’s personnel or by a qualified outside party;
(3) Designate a person or persons responsible for implementing and monitoring the operations and internal controls of the program; and
(4) Provide ongoing training for appropriate persons.

You would have 60 days to comment once it is published.

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Management Fee “Waiver” Tax Treatment

The Treasury and the Internal Revenue Service issued proposed regulations relating to disguised payments for services rendered by a partner to a partnership. Private fund managers have used management fee “waiver” mechanisms by reducing the management fee payable to the fund’s manager and the receipt of a corresponding profits interest by the general partner. The proposed regulations take a new look at whether that waiver mechanism would be invalid as a disguised payment for services.

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The proposed regulations focus primarily on whether the payment to the service provider lacks “significant entrepreneurial risk.” In determining whether an allocation and distribution arrangement will be treated as a disguised payment for services, the proposed regulations focus on whether the allocation and distribution are subject to this significant entrepreneurial risk. The regulations call for a determination at the time the arrangement is entered into and re-tested at the time of any later modification. An arrangement that lacks significant entrepreneurial risk would be treated as a disguised payment for services. An arrangement that has significant entrepreneurial risk generally will not be treated as a disguised payment for services, although additional factors must be considered.

The proposed regulations set up a presumption that certain circumstances lack significant entrepreneurial risk:

  1. Capped allocations of partnership income, if the cap is reasonably expected to apply in most years.
  2. An allocation for one or more years under which the service provider’s share of income is reasonably certain;
  3. Allocations of gross income;
  4. An allocation (under a formula or otherwise) that is predominantly fixed in amount, is reasonably determinable under all the facts and circumstances, or is designed to assure that sufficient net profits are highly likely to be available to make the allocation to the service provider (e.g., if the partnership agreement provides for an allocation of net profits from specific transactions or accounting periods and this allocation does not depend on the long-term future success of the enterprise);
  5. An arrangement in which a service provider waives its right to receive payment for the future performance of services in a manner that is non-binding or fails to timely notify the partnership and its partners of the waiver and its terms.

These are just proposed regulations and are still open for comment. That also means the regulations may change if adopted.

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Tax is by 401(k)2012
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Compliance Bricks and Mortar for August 21

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

red-bricks-wall-animal deer

The 5 Most Common AML Compliance Program Deficiencies by Michael Volkov in Corruption, Crime & Compliance

In my view, AML programs do not get sufficient support and exposure from top-level management. A compliance failure usually can be traced back to the lack of tone and commitment to ethics. This basic deficiency results in blatant, systemic problems that plague AML programs: poor or outdated technology; weak controls that can be overridden by business needs; and commitment to revenue at all costs. [More….]

What Is the SEC Backup Plan if It Loses the ALJ Constitutionality Issue in Court? in Straight Arrow’s Securities Diary

The saga of challenges to the constitutionality of the SEC’s administrative law proceedings — and in particular the appointments and removal protections of the administrative law judges — has played out over many months in both court and commentary.  After some early SEC victories on jurisdictional challenges, the Commission seemed content to try to fend off the court cases on such procedural grounds, and fight the merits by deciding the issue in its own favor on a petition for review of one of these proceedings (like the one now before it in the Timbervest case), with perhaps an upper hand once the case reached a federal appeals court. [More…]

Is Kim Kardashian West the New Face of Compliance? by Angela Gamalski, MHSA, CHC in SCCE’s The Compliance & Ethics Blog

About a month ago, Ms. Kardashian West posted to Instagram regarding her use of a prescription drug to control her morning sickness, including a picture of herself with said prescription drug and links to the manufacturer’s website. As Ms. Kardashian West is a celebrity with millions of followers who is often paid for her promotional ability, it was not an unusual post by any means (I assume, as I am not one of her followers). What is notable about this post is that it resurfaced this week as a hot news item after the United States Food and Drug Administration (FDA) publicized a warning letter to that drug’s manufacturer in response to said post, citing the Instagram posting for failing to contain the appropriate safety warnings. [More…]

The Justice Department Has Some Things to Tell You about Cybersecurity by David Smyth in Cady Bar the Door

In April the Justice Department’s Computer Crime and Intellectual Property Section issued its Best Practices for Victim Response and Reporting of Cyber Incidents.  It is an excellent guide for a business organization to respond to cyber attacks and, one hopes, move forward with its business intact.  The guide outlines what to do before, during, and after a data breach, and is quite detailed.  [More…]

Hiring Relatives Could Be An Illegal Bribe

In the case of BNY Mellon, it was an illegal bribe in violation of the Foreign Corrupt Practices Act. The Securities and Exchange Commission charged BNY Mellon that it violated the Foreign Corrupt Practices Act by providing internships to family members of foreign government officials affiliated with a Middle Eastern sovereign wealth fund.

compliance and bribery

The unnamed Middle Eastern sovereign wealth fund was a client of BNY Mellon for custody and asset management. Unnamed officials at the sovereign wealth fund asked BNY Mellon to provide their family members with internships. One of those officials was a “key decision maker” who could award more business to BNY Mellon.

The SEC investigation found that BNY Mellon did not evaluate or hire the family members in accordance with its hiring standards and require a minimum grade point average and multiple interviews. The family members did not meet the criteria yet were hired with the knowledge and approval of senior BNY Mellon employees in order to corruptly influence foreign officials and win or retain contracts to manage and service the assets of the sovereign wealth fund.

The SEC found smoking gun emails that it made it clear that the internships were made to influence the government official.

A Boutique account manager wrote in a February 2010 e-mail concerning the internship request for Interns A and B that BNY Mellon was “not in a position to reject the request from a commercial point of view” even though it was a “personal request” from Official X. The employee stated: “by not allowing the internships to take place, we potentially jeopardize our mandate with [the Middle Eastern Sovereign
Wealth Fund].”

In June 2010, an employee of BNY Mellon with primary responsibility for the Asset Management relationship with the Middle Eastern Sovereign Wealth Fund wrote of the internships for Interns A and B: “I want more money for this. I expect more for this. . . . We’re doing [Official X] a favor.”

In a separate e-mail to a different BNY Mellon colleague, the same employee stated “I am working on an expensive ‘favor’ for [Official X] – an internship for his son and cousin (don’t mention to him as this is not official).”

The same employee advised a colleague in human resources: “[W]e have to be careful about this. This is more of a personal request . . . [Official X] doesn’t want [the Middle Eastern Sovereign Wealth Fund] to know about it.” The same employee later directed his administrative assistant to refrain from sending e-mail correspondence concerning Official X’s internship request “because it was a personal favor.”

Hiring practices have been an area more subtle bribery. More typically we’ve seen this with government contracting where the government official will award the contract then go to work for the company.

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Weekend Reading: Rain

Rain rain go away, Come again another day.

A simple nursery rhyme for a rainy day. It also happens to be a central theme to Rain: A Natural and Cultural History by Cynthia Barnett. We need rain to survive. Too much, too little and either at the wrong time can be devastating.
rain rain go away

Ms. Barnett starts out at the solar system level and points out that Earth was not the only planet with water. Mars clearly had water. Venus had water, too.  The rest are too far away from the sun or too close to the sun for liquid water. The oceans (or whatever the bodies of water may have been) did not survive on Mars and Venus. Life on earth survived because of the rain, turning the planet blue.

And green. Rain brings plants. Plants convert sunlight to food and provides the energy for life. No rain, no plants, no life.

Rain is not a science book. It’s also not a history book. It drips in the arts with exposition on the influence of rain on music and art. It drips in religion. Ancient civilization put a profound amount of exposition and prayer into keeping the rain gods happy. Ms. Barnett even points out passages in Bible that focus on god’s influence over rain and the life it brings. (e.g. Noah’s ark)

Ms. Barnett’s background is that of an environmental journalist. Rain has large drops of global warming and climate change. She balances the past local weather cycles as experienced during the dust bowl years and settling of the western plains with the current broader trends of global climate trends.

I finished reading Rain while sitting on my front porch during a rain storm. It seemed a fitting perspective. Just last week I barely survived a bike ride in a rainstorm that had turned into the biggest hail storm Boston had seen in 50 years. Rain flooded the streets and hail stones dented car hoods. It also turned my parched lawn greener. I chanted that nursery rhyme while hiding from the pelting of the hail stones under a bridge. It didn’t work.

Rain is inevitable. Rain is unpredictable. Rain, the book, will give you some perspective.

The publisher provided me with a copy of the book in expectation of a review.

Compliance Bricks and Mortar for August 14

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

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Beware the ‘SEC Impersonator’ Scams Targeting Your Money by Bruce Carton in Compliance Week

You might not think that fraudsters impersonating the SEC would be a significant or ongoing problem but the volume of the SEC’s “Investor Alerts” on this topic would seem to suggest otherwise. On August 5, 2015, the SEC issued the latest update in a series of Investor Alerts it has released entitled, “SEC Warns of Government Impersonators Demanding Money.” [More…]

Keep it Under Your Hat by Adam Turteltaub in the SCCE’s Compliance & Ethics Blog

But there is one thing families do share with work colleagues: the unwillingness to share problems outside the group. It’s okay to talk with each other about this or that serious issue, but talk about it outside the family or the work group, and it can be seen as a betrayal. Quickly the dialogue becomes “She betrayed us,” and “He’s a traitor.” [More…]

The Difficulties Of Compliance in the FCPA Professor

In the minds of some, compliance with the Foreign Corrupt Practices Act or other similar laws is simple:  you just don’t bribe.

As highlighted in this prior post such a simplistic position is entirely off-target. Indeed what I find ironic about certain commentators who have articulated this position is that they devote their professional lives to selling compliance services and products.

Contrary to the simplistic rhetoric of some, a recent report regarding Siemens once again highlights the difficulties of compliance in a multinational business organization with tens of thousands of employees. [More…]

Government agencies turning up the heat on fees by Hazel Bradford in Pensions&Investments

While officials at the SEC are looking hard at fees and expenses charged to investors, the IRS is looking more at possible abuses by private equity general partners shifting income to more favorable tax treatment. [More…]

On line portals for fundraising

As part of the updates on private placements, the Securities and Exchange Commission granted a no-action letter to Citizen VC, an online venture capital firm. The main question was whether the firm was creating “substantive, pre-existing relationships” with prospective investors through its website. The firm wanted to avoid a result that its offers & sales under Rule 506(b) would be considered general solicitation or general advertising under Rule 502(c) of Regulation D.

citizen vc

For CitizenVC the first step is a generic online “accredited investor” questionnaire.

That moves into the “relationship establishment period.” During that period CitizensVC may

  1. Contact the prospective investor by telephone to discuss the prospective investor’s investing experience and sophistication, investment goals and strategies, financial suitability, risk awareness, and other topics designed to assist CitizenVC in understanding the investor’s sophistication
  2. Send an introductory email to the prospective investor.
  3. Contact the prospective investor online to answer questions they may have about CitizenVC, the Site, and potential investments.
  4. Utilize third party credit reporting services to confirm the prospective investor’s identity, and to gather additional financial information and credit history information to support the prospective investor’s suitability.
  5. Encourage the prospective investor to explore the Site and ask questions about the Manager’s investment strategy, philosophy, and objectives.
  6. Generally foster interactions both online and offline between the prospective investor and CitizenVC.

Maybe it’s just me, but only 1 and 3 seem particularly meaningful and substantive. But the rest don’t hurt. Apparently it is enough to create a “substantive, pre-existing relationship” once the potential member is admitted as a member. A prospective Member is not presented with any investment opportunity when being qualified to join the platform.

I found it more meaningful that the minimum capital investment requirement is not less than $50,000 per deal. That means they are not targeting small investors.

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Updates on Private Placements

One of the troubling aspects of private placements is trying to draw the line between public advertising for the business and public advertising for selling securities. This aspect is even more apparent for private equity funds and real estate funds that want to tout their deals without jeopardizing their fundraising. The Securities and Exchange Commission offered some updated guidance.

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The SEC published The 11 Securities Act Rules Compliance and Disclosure Interpretations that provide guidance on “general solicitation” under Rule 502(c)

Question 256.24 What information can an issuer widely disseminate about itself without contravening Rule 502(c)?

Answer: Information not involving an offer of securities may be disseminated widely without violating Rule 502(c). For example, factual business information that does not condition the public mind or arouse public interest in a securities offering is not an offer and may be disseminated widely. Information that involves an offer of securities through any form of general solicitation would contravene Rule 502(c). [August 6, 2015].

Which of course leads to the next question:

Question 256.25: What is factual business information?

Answer: What constitutes factual business information depends on the facts and circumstances. Factual business information typically is limited to information about the issuer, its business, financial condition, products, services, or advertisement of such products or services, provided the information is not presented in such a manner as to constitute an offer of the issuer’s securities. Factual business information generally does not include predictions, projections, forecasts or opinions with respect to valuation of a security, nor for a continuously offered fund would it include information about past performance of the fund. (Release No. 33-5180). [August 6, 2015]

Not deep guidance, but it’s still guidance.

Questions 256.26 through 256.33 offer insight into the pre-existing, substantive relationship you need to avoid general solicitation.

A “substantive” relationship is one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor. Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship.

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Upcoming Anti-Money Laundering Rules for Private Funds

The Treasury’s Financial Crimes Enforcement Network has been toying with how to impose anti-money laundering standards on private funds and investment advisers for years. There is rumbling from the White House Office of Management and Budget that it approved proposed new regulation.

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A notice of rulemaking was dropped a few years ago. The thought then was that the underlying custodian has AML standards in place to keep things in line for investment advisers.

The posting at the OMB states that a proposal is moving along. According to the entry, the rule would “prescribe minimum standards for anti-money laundering programs to be established by certain investment advisers and to require such investment advisers to report suspicious activity to FinCEN.”

A few months ago U.S. Treasury Undersecretary for Terrorism and Financial Intelligence David Cohen gave speech to to the ABA/ABA Money Laundering Enforcement Conference and said changes are underway.

It looks like changes are coming.

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Laundering Dollar Bills is by  TaxRebate.org.uk

A Win for Compliance Officers

Judy Wolf did a bad thing. During an insider trading investigation she fudged some documents. The Securities and Exchange Commission investigated the insider trading matter and Ms. Wolf’s log of her review. The fudging was discovered. She was fired and the SEC brought an enforcement against her.

There is some good news from that bad situation. An administrative law judge just dismissed the enforcement case against Ms. Wolf.

Newspaper page with eraser of erasing news, vector Eps10 image.

Last year, Wells Fargo paid $5 million to resolve the insider trading case that involved the acquisition of Burger King. Ms. Wolf was a compliance professional at Wells Fargo. She conducted an inquiry of trades related to the $3.3 billion Burger King acquisition by 3G Capital in 2010. The SEC launched its insider trading investigation in 2012. Wolf apparently was concerned that her compliance log was inadequate. She went back and added these two sentences:

“Rumors of acquisition by a private equity group had been circulating for several weeks prior to the announcement. The stock price was up 15% on 9/1/12, the day prior to the announcement.”

She fudged the log poorly and wrote “2012” instead of “2010.” Under questioning by the SEC she thought the change would not be discovered. Wells pulled up the document metadata and found the problem.

After the settlement with Wells Fargo, the SEC brought charges against Wolf.

SEC ALJ Cameron Elliott dismissed the enforcement action sanctions. The judge did not condone the action, but found that Wolf willfully aided and abetted and caused Wells Fargo’s violations of Exchange Act Section 17(a) and Rule 17a-4(j) and Advisers Act Section 204(a). Wolf should have known that it was improper to alter compliance records.

There is one additional consideration: the fact that Wolf worked in compliance. Obviously, compliance professionals are subject to the securities laws like everyone else. … In my experience, firms tend to compensate compliance personnel relatively poorly, especially compared to other associated persons possessing the supervisory securities licenses compliance personnel typically have, likely because their work does not generate profits directly. But because of their responsibilities, compliance personnel receive a great deal of attention in investigations, and every time a violation is detected there is, quite naturally, a tendency for investigators to inquire into the reasons that compliance did not detect the violation first, or prevent it from happening at all. The temptation to look to compliance for the “low hanging fruit,” however, should be resisted. There is a real risk that excessive focus on violations by compliance personnel will discourage competent persons from going into compliance, and thereby undermine the purpose of compliance programs in general. That is, “we should strive to avoid the perverse incentives that will naturally flow from targeting compliance personnel who are willing to run into the fires that so often occur at regulated entities.” Comm’r Daniel M. Gallagher, Statement on Recent SEC Settlements Charging Chief Compliance Officers With Violations of Investment Advisers Act Rule 206(4)-7 (June 18, 2015), available at http://www.sec.gov/news/statement/sec-cco-settlements-iaa-rule-206-4-7.html (last accessed July
7, 2015).

A good result for compliance professionals.

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