Month: October 2015

Compliance Bricks and Mortar for October 30

These are some of the compliance-related stories that caught my attention while getting ready for Halloween!

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The Results Are In – SCCE’s 2015 Salary Survey Report Is Now Available by Adam Turteltaub in SCCE’s Compliance & Ethics Blog

The Society of Corporate Compliance and Ethics (SCCE)® is pleased to be able to provide you with the 2015 Compliance and Ethics Officer Salary Survey report. As you will see, we have included data on compensation for both the chief compliance and ethics officer as well as for the compliance staff, giving a fuller picture of the compliance profession in one document.  [More…]

California’s Secured Promissory Note Exemption by Keith Paul Bishop in California Corporate & Securities Law

The line between real property transactions and securities transactions is not always clear. California Corporations Code Section 25100(p) provides an exemption for a promissory note secured by a lien on real property provided it is neither: (a) one of a series of notes of equal priority secured by interests in the same real property; or (b) a note in which beneficial interests are sold to more than one person or entity. However, the fact that a secured note may be exempt under Section 25100(p) will only take you so far.[More…]

“Behavioral compliance”: the will and the way by Jeff Kaplan in Conflict of Interest Blog

“Behavioral ethics” information and ideas have, to date, been used far more to identify ethical challenges than to design approaches to address such challenges. In “Behavioral Ethics, Behavioral Compliance” (which can be downloaded for free here ) Professor Donald C. Langevoort of the Georgetown University Law Center takes up this latter task, and provides a  number of practical suggestions for compliance-and-ethics (“C&E”) professionals to consider in applying this body of knowledge to their day-to-day work. [More…]

 

Are compliance officers crazy? by Richard L. Cassin in The FCPA Blog

So is it crazy to be a compliance officer?

Albert Einstein said insanity is doing the same thing over and over and expecting different results.

Expectations, then, are the key. With the verdict of history in mind, it’s crazy for a compliance officer to expect to bat a thousand against graft. Or to look for constant salutes from the C-suite. Or to think of all prosecutors, regulators, judges, and politicians as natural allies.[More…]

 

Whom Should You Suspend During an Internal Investigation? by Thomas Fox in FCPA Compliance & Ethics

Whom to suspend during any Foreign Corrupt Practices Act (FCPA) investigation is always a delicate question to answer. Unfortunately there is never an easy answer. As the Volkswagen (VW) emission-testing scandal continues to reverberate, it continues to bring up some very knotty questions, which have bedeviled the Chief Compliance Officer (CCO) or compliance practitioner in many areas. Today there is an example around internal investigations.[More…]

 

What qualities should a CCO have; here are nine. by Joshua Horn in Securities Compliance Sentinel

Andrew Donohue, SEC Chief of Staff, recently commented on what a person needs in order to be a competent CCO; he identified nine things. The overarching theme from this list is experience. According to Donahue, in no particular order, a CCO must:

  1. Have a “first hand knowledge” of the regulatory environment.
  2. Have a detailed understanding of the firm, its operations and structure.
  3. Be able to readily identify conflicts of interest, report and resolve them.
  4. Have an understanding of the firm’s business model, including knowledge of firm available products and their profitability.

[More…]

SEC Brings a Real Estate Valuation Action

Real estate is the standard for hard to value assets. But there are plenty of models to help reach a reasonable value. The Securities and Exchange Commission has apparently taken the position that it will not challenge absolute valuations, but will challenge flaws in the models that get to the value. A recent SEC case for improper valuation flaws was brought against a real estate company.

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The St. Joe Company is Florida’s second largest private landowner, holding over 500,000 acres of land in the state. The developments in question are known as Victoria Park, Southwood, and WaterColor.

The SEC order states that St. Joe deviated from GAAP and had a flaw in its impairment testing for its real estate developments. The model failed to include some necessary non-capitalized cash outflows. If St. Joe had used the correct model, those developments would have seen impairments of $55 million in Q1 2009 and $19 million in Q4 2009. The blame seems to be on the company for using two different models.

St. Joe also failed to take the pending sales price into consideration for one of the developments. The company had a development for sale at $15 million, but it fell through and went to the second place bidder at $11 million. The company failed to reflect that change in the likely realized price as an impairment. The company also told its auditors that the chance of sale was close to nil.

St. Joe’s problems came to light when David Einhorn of Greenlight Capital thought there was a problem with St. Joe’s accounting and began shorting the stock. His take: “Field of Schemes: If you Build It, They Won’t Come.” Mr. Einhorn then began releasing presentations that St. Joe was overvaluing its real estate developments.

Once the company realized there actually was a problem, it changed its models. But, it failed to go back and review prior periods. That would have resulted in a material restatement.

St. Joe also failed to disclose changes in business strategies for its Windmark II and Southwood real estate developments. The company was halting development and planned a future bulk sale of the sites. Unfortunately, St. Joe booked the value in its 2010 10-K as if it were still planning to develop both sites.

These were big issues. When finally recorded in Q4 2011 St. Joe had a 50% reduction in the value of its real estate and reduction of its total assets of more than 35%.

The order has some exact numbers which I assume are taken from St. Joe’s new valuations. The challenge by the SEC was that the company’s procedures were flawed. That lead to the improper valuations.

St. Joe is a public company so there are some differences with the private real estate fund model. However, it seems consistent with what the SEC is saying about private fund valuations.

The SEC was not fighting over small differences in valuations with St. Joe. There were big discrepancies in values. The SEC was not charging that the values were wrong, but that the way the company got to the values was wrong.

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OptOutside: REI Taking an Ethical Stance on Black Friday

I hate Black Friday. Being at a store in a sea of sleep-deprived shoppers to find bargains would likely make me lose a little faith in humanity. REI, the outdoor retailer, decided to stand behind its core value:

“We believe a life outdoors is a life well-lived.”

While the rest of the world is fighting it out in store aisles, REI hopes to see you in the great outdoors.

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REI is closing all of its stores on Black Friday and paying its employees to be outside.

We’re passionate about bringing you great gear, but we’re even more passionate about the experiences it unlocks for all of us. Perhaps John Muir said it best back in 1901: “thousands of tired, nerve-shaken, over-civilized people are beginning to find out that going to the mountains is going home.”

We think Black Friday is the perfect day to remind people of this essential truth.

Is this a move about ethics and corporate value? It sure seems that way.

OptOutside will not be cheap for REI.

It will forego sales. Black Friday is one of its top ten days for sales.

REI will pay nearly all of its 12,000+ employees for the day off. I assume there be some employees still working to keep operations running.

It may even have to pay fines or breach its leases to its landlords at shopping malls. Many retail leases in shopping centers requires stores to be open with the rest of the stores.

Other big retailers taking an ethical stance against Black Friday are merely stopping short of opening on Thanksgiving. REI is standing behind its core values.

I think I will join the stance. I’m already planning a Black Friday bike ride, far away from shopping malls.

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Another Reminder of the SEC’s Concerns About Private Funds

You have likely heard all or some of these concerns before. Securities and Exchange Commission Chair Mary Jo White spoke at a meeting of the Managed Funds Association and pointed out areas of concern.

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One thing to note is Chair White stated that the Private Funds Unit in OCIE is completing a review of private fund real estate advisers. (I assume you would call that a “sweep.”) That particular focus is related-party service providers. SEC staff is concerned that disclosure about these related-party arrangements may be non-existent or potentially misleading, particularly with regard to whether or not the related parties charge market rates.

We have heard that before from Marc Wyatt at PEI’s Private Fund Compliance Forum. It’s generally okay to use related-party service providers if the arrangement is properly disclosed. If the fund manager is going to say that it saves the fund money because the rate is at or below market rate, you need to prove that it actually is at or below market rate.

Chair White cited several other areas of interest for private fund compliance.

  • Using marketing materials that included back-tested performance numbers, portable performance numbers, and benchmark comparisons without key disclosures.
  • Disclosing conflicts related to advisers’ proprietary funds and the personal accounts of their portfolio managers, in particular allocation of profitable trades.
  • Improperly shifting expenses away from the adviser and to the funds or portfolio companies by, for example, charging a fund for the salaries of the adviser’s employees or hiring the adviser’s former employees as “consultants” paid by the funds.
  • Advisers collecting millions of dollars in accelerated monitoring fees without disclosing the practice.
  • Advisers misallocating expenses to funds;[21]
  • Failing to disclose loans from clients;[22]
  • Using funds to pay their operating expenses without authorization and disclosure;[23] and
  • Failing to disclose fees and discounts from service providers.[24]

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Compliance Bricks and Mortar for October 23

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

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Two Games about Gifts for Corporate Compliance & Ethics Week by Ricardo Pellafone in SCCE’s The Compliance & Ethics Blog

You know that your employees are competitive, so you know that a game show is more engaging than a Powerpoint lecture.

But you’ve also got other stuff to do, so spending the time to put together the mechanics and questions for a new game show isn’t going to happen.

And so you end up playing Jeopardy. Again.

Well, not this time. As we head into Corporate Compliance & Ethics Week—and towards the holiday season—here are two ideas for in-person game shows that will help your employees build their judgment on gifts and entertainment. [More…]

Inside Swiss Banks’ Tax-Cheating Machinery by Laura Saunders in the Wall Street Journal

Dozens of Swiss banks have been spilling their secrets this year as to how they encouraged U.S. clients to hide money abroad, part of a Justice Department program that lets them avoid prosecution. It is part of a broader U.S. crackdown on undeclared offshore accounts that has ensnared big Swiss banks such as UBS Group AG, but has received scant attention because it mostly involves little-known firms and relatively small fines. [More….]

DOL supports ESG fund use in 401(k) plans by Greg Iacurci in InvestmentNews

Fiduciaries had been wary of introducing ESG investments — also known by such names as economically targeted, and sustainable, responsible and impact (SRI) investing — to retirement plans due to previous guidance from the department, according to Secretary of Labor Thomas Perez. A 2008 rule said fund consideration based on factors other than risk and return, such as ESG, should be rare, which set a higher but unclear standard of fiduciary compliance, the DOL said.

That guidance “gave cooties” to impact investing and had a “chilling effect” on its use in plans governed by the Employee Retirement Income Security Act of 1974, said Mr. Perez, speaking Thursday in New York.

According to the new guidance — Interpretive Bulletin 2015-01, which is scheduled to be published in the Federal Register on Oct. 26 — “fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social or other such factors.” [More…]

Yates and Outsourcing Government Investigations by Michael Volkov in Corruption, Crime & Compliance

With the dramatic sea-change from the Yates memorandum, I predict (and fully expect) individuals who end up being prosecuted (civilly or criminally) to challenge more aspects of the corporate internal investigation. As companies conduct internal investigations under the “supervision and direction” of DOJ prosecutors, defendants will seek access to internal investigation documents, notes, and seek to portray outside counsel as agents of DOJ prosecutors.

I recognize that this will be a real stretch but I expect there to be more litigation in this area, under which defendants will claim they need access to such materials in order to adequately defend themselves. [More…]

SEC Faces New Attack on In-House Judges by Jean Eagleshem in the Wall Street Journal

Legislation to give defendants the right to opt out of the Securities and Exchange Commission’s in-house court is expected to be introduced in Congress on Thursday, ramping up pressure on the agency to further reform its controversial tribunal. [More…]

Private Fund Statistics

If you manage a private fund and are registered with the Securities and Exchange Commission, you spend a good chunk of April (and maybe more) filling out Form PF. Ever wonder what the SEC does with all that data? They publish an annual report on fund statistics, which was recently released.

Form PF

Form PF implemented Section 404 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which directed the SEC to establish reporting requirements for advisers to private funds. That reported information was to be sent on for use by the Financial Stability Oversight Council in monitoring risk to the U.S. financial system. The SEC also purports to use information obtained from Form PF in its regulatory programs and investor protection efforts relating to private fund advisers.

As of the end of 2014, there were 24,725 private fund reporting to the SEC. About 1/3 were labeled hedge funds and another 1/3 were private equity funds. There were 1,789 real estate funds.

Managing those funds were 2,694 advisers. Of those, 260 were real estate fund managers.

Gross assets for all private funds just missed the $10 trillion mark of gross value. ($9.956 trillion to be more exact). Real estate funds comprised $350 billion of that total.

One surprise is that the biggest owner of private funds is other private funds. (see Table 10) Private funds hold 20% of all private funds, with government pension plans holding 12.8% and private pension plans holding 12.5%.

There is some other interesting data in the report. It’s worth spending a few minutes flipping through it.

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The Female SEC Will be Taking on the Old Boys’ Club of Wall Street

President Obama nominated Lisa Fairfax and and Hester Peirce to fill the two vacant positions on the Securities and Exchange Commission. They will join May Jo White and Kara Stein. That leaves Michael Piwowar alone with his Y-Chromosome.

fairfax and peirce

Fairfax is a law professor and director for programs at George Washington’s Center for Law, Economics and Finance.  Fairfax is an expert on shareholder activism.

Peirce is a senior research fellow at George Mason and director of the financial markets working group at the university’s Mercatus Center. Peirce served on Senator Richard Shelby’s staff on the Senate Committee on Banking, Housing, and Urban Affairs. In that position, she worked on financial regulatory reform following the financial crisis of 2008 as well as oversight of the regulatory implementation of the Dodd-Frank Act. Peirce served at the Securities and Exchange Commission as a staff attorney and as counsel to Commissioner Paul S. Atkins

If confirmed, Fairfax would take the Democrat slot by replacing Luis Aguilar, whose term has expired. Peirce would take the Republican slot and replace Daniel Gallagher who stepped down in early October.

The President is able to placate both the right and the left with the two nominations. It will be interesting to see what direction the SEC turns to once the two new commissioners take their seats.

 

Compliance Bricks and Mortar for October 16

I have been busy and not been able to post any of my own stories this week. Here are some other compliance-related stories that recently caught my attention.

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The Right Wing’s Assault on the Post Office – Smashing the Myth That It’s in Financial Trouble by Yves Smith in Naked Capitalism

That year, the Congress passed the Postal Accountability and Enhancement Act of 2006 (PAEA). Under the terms of PAEA, the USPS was forced to “prefund its future health care benefit payments to retirees for the next 75 years in an astonishing ten-year time span” – meaning that it had to put aside billions of dollars to pay for the health benefits of employees it hasn’t even hired yet, something that “no other government or private corporation is required to do.”The problem with the Post‘s argument starts in its thesis: that the post office is in some sort of deep fiscal hole of its own making – a result of being left behind in the Internet Age and a shrinking consumer base. The truth is that almost all of the postal service’s losses can be traced back to a single change in the law made by the Republican Congress in 2006. [More…]

Compliance at the Tipping Point, Part V – Protection Afforded From a Compliance Program by Tom Fox in the FCPA Compliance Report

Finally, is the last tipping point the Schrems decision from the European Court of Justice (ECJ), which invalidated the Safe Harbor provision through which American companies brought information developed through hotlines and internal information back to the US? The decision is much more far-reaching than simply the FCPA. For instance, Sarbanes-Oxley (SOX) mandates that a company have a hotline. But similarly to the response to the whistleblower provisions of the Dodd-Frank Act, companies must now be in a stronger position to quickly and accurately assess any potential violations that might be detected, reported or arise. This means not only thoroughly training your compliance function but it also puts more pressure on the underlying internal controls to give the compliance function the underlying information, on a more real-time basis about high-FCPA risk issues. Further, if you tie the Schrems decision together with the Yates Memo which requires a company to turn over information on individuals in very short order, to receive any credit from the DOJ, you see the need for a more robust prevention system in addition to other sources of information. [More…]

Sports Organizations Need Effective Integrity and Compliance Programs by David Dodge in SCCE’s The Compliance & Ethics Blog

Scandals have become as much a part of sports as players, officials, and spectators and surely it won’t be long before today’s outrage is replaced by fresh indignation over some other antics, be they on-field or after hours. Ben Franklin once noted, “It takes many good deeds to build a good reputation and only one bad one to lose it.”

Well-designed, effective integrity and compliance programs eliminate the embarrassments that roil sports every season. Well-structured programs that have the support of top leaders in the organization would be a huge first step towards making it clear that ethical behavior is expected and there will be consequences for transgressors.[More….]

Compliance Officers Call for SEC Enforcement Guidelines by Randi Val Morrison in the CorporateCounsel.net

On the heels of recent SEC enforcement actions against Chief Compliance Officers (CCO) and associated statements by Commissioners Gallagher and Aguilar and Chair White, the National Society of Compliance Professionals, a financial services industry trade group for compliance officers, sent this letter to SEC Director of Enforcement Andrew Ceresney requesting that the Commission establish policy that permits initiation of enforcement proceedings against CCOs only if they acted intentionally or recklessly – not negligently – to facilitate the underlying primary securities law violation.

Compliance Bricks and Mortar for October 9

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

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The Unsophisticated Sophisticated: Old Age and the Accredited Investors Definition by Tao Guo, Michael S. Finke and Chris Browning in the CLS Blue Sky Blog

Using two large nationally-representative data sets that include financial literacy tests, we find that financial literacy scores decline in old age consistently among both accredited and non-accredited investors in both data sets. Average scores for accredited investors age 80 and older are significantly lower (45.7% in one data set and 57.1% in the other) than average scores for respondents age 60-64 (60.4% and 63.8%) who do not meet the accredited investor income and wealth thresholds. [More…]

DOJ Says Pursuing ‘Higher-Impact’ Bribery Cases by Stephen Dockery in the Wall Street Journal

Spokesman Peter Carr said after years of handling smaller cases coming from corporate self-reporting, the unit is now putting more at stake and going after blockbuster cases.  Initiatives to boost foreign corruption enforcement personnel and resources are being used to go after that high-profile wrongdoing, Mr. Carr said. Many of those programs began years ago.

His comments came in response to news that the Department’s anti-bribery efforts were eclipsed by the Securities and Exchange Commission in the third quarter. [More…]

The Psychology of Cheating and FCPA Compliance by Thomas Fox in the FCPA Compliance Report

In the movie Margin Call, Jeremy Irons intones that there are three ways to win in business: (1) be the smartest; (2) be the fastest; and (3) cheat. I am currently out at the SCCE 2015 Compliance and Ethics Institute and as you might guess the Volkswagen (VW) emissions-testing scandal is a major topic of conversation. One of the more interesting observations is that the VW scandal was not a failure of compliance but an intentional design to cheat emissions standards testing on a worldwide basis. [More…]

 

The image is from the Apollo 17 Archive on FLickr

Fund Managers, Legal Fees, and Fund Expenses

The Securities and Exchange Commission brought an action against Blackstone for failing to disclose fees received from portfolio companies and for discounts from legal firms that it worked with, but without passing these savings on to investors. The monitoring fee issue has been discussed in compliance circles for some time. The legal fees action is new and caught my eye.

Cash in the grass.

I had heard of an instance where the SEC gave a deficiency for charging in-house lawyers’ time to a fund and its investments without properly disclosing that practice. This is different.

According to the order, Blackstone received a larger discount on legal fees as fund manager than the funds received. Blackstone told investors that the differential reflected the different mix of work performed by the unnamed law firm for the fund manager and the fund.

Other items I noted on the issue is that the differential was in place between 2008 and 2011. Blackstone’s internal audit discovered the problem in 2011 and Blackstone changed practices. So this issue was discovered and corrected years ago. So why is the SEC bringing an action now? Maybe this is just a “pile-on” by the SEC to express its displeasure.

I’m confused about how the arrangement for legal fees worked. Blackstone said it was based on the mix of work.

Perhaps the law firm was offering a 25% discount on HR/employee work, 10% on fund formation, and 5% on M&A deals. The fund, the fund formation, and fund investments would use these legal services in different amount and so the discount would not be uniform. That would result in a disparate discount. Maybe that is what happened?

Clearly a fund manager cannot have its law firm provide discounted services for the fund manager in exchange for allowing full pricing for the fund. That’s shifting costs from the fund manager to the fund. (Of course if it’s disclosed ahead of time, a fund manager could do so.)

The frustrating thing about the order is that its not clear what Blackstone did. So other compliance professional cannot use it to figure out what the SEC wants fro mfund managers.

As to the monitoring fees:

“This SEC matter arose from the absence of express disclosure in marketing documents, 10 or more years ago, about the possible acceleration of monitoring fees,” Blackstone said, calling the practice common in the industry. Blackstone voluntarily made changes to the applicable policies before the inquiry began, according to a spokesperson.

Obviously, the SEC continues to focus on fees and expenses for private fund managers.

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