Month: January 2016

Compliance Bricks and Mortar for January 29

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

brick detail

 

U.S. Banks Cut Off Mexican Clients, as Regulatory Pressure Increases by Rachel Louise Ensign,
Emily Glazer and Amy Guthrie in the Wall Street Journal

At issue are correspondent-banking relationships that allow Mexican banks to facilitate cross-border transactions and meet their clients’ needs for dealing in dollars—in effect, giving them access to the U.S. financial system. The global firms that provide those services are increasingly wary of dealing with Mexican banks as well as their customers, according to U.S. bankers and people familiar with the matter.[More…]

Why Does The SEC Have An FCPA Unit? by the FCPA Professor

Notwithstanding the fact that the SEC played an important role (indeed a more prominent role than the DOJ) in addressing the foreign corporate payment payments problem in the 1970s’s that led to enactment of the Foreign Corrupt Practices Act, it is a historical fact that the SEC never wanted any role in enforcing the FCPA’s anti-bribery provisions. [More…]

Where To Meet? The Answer May Have Surprising Consequences by Keith Paul Bishop in California Corporate & Securities Law

In my experience, companies most often hold board and shareholder meetings at or near their principal executive offices . As a result, many corporations hold their meetings in California even though they may be incorporated in Delaware, Nevada or some other jurisdiction. Geographical convenience, however, can have unforeseen consequences. Several provisions of the California General Corporation Law apply to foreign corporations based on where they hold their board or shareholder meetings. These include: [More…]

Shareholder Engagement: How to Handle ESG Inquiries by Broc Romanek in TheCorporateCounsel.net

Investor Relations and corporate governance teams increasingly are receiving investor questions about ESG matters. What should these teams do if they receive a call or letter? [More…]

Brick detail
by Grant MacDonald
CC BY NC

A Small Step Forward in Real Estate Anti-Money Laundering

Real estate in the United States has been rumored to be an interesting place for hiding money. In particular, the US Treasury is concerned about illegal money getting filtered through US real estate. Until now, FinCEN has mostly relied on anti-money laundering protections on real estate transactions involving lending. FinCEN is now looking at vulnerabilities associated with all-cash real estate transactions.

Miami skyline

The focus is on high-end residential real estate in Miami and New York. Someone is buying those ultra-expensive condos in the new residential towers. FinCEN is worried that some of those buyers may be doing so with illicit money.

“We are seeking to understand the risk that corrupt foreign officials, or transnational criminals, may be using premium U.S. real estate to secretly invest millions in dirty money,” said FinCEN Director Jennifer Shasky Calvery.

The Director of FinCEN may issue an order that imposes certain additional recordkeeping and reporting requirements on one or more domestic financial institutions or nonfinancial trades or businesses in a geographic area. See 31 U.S.C. § 5326(a); 31 CFR § 1010.370; Treasury Order 180-01.

FinCEN issued two Geographic Targeting Orders, one for New York and one for Miami. They cover transactions that meet the following criteria:

  1. An entity is the purchaser
  2. of residential real estate in Manhattan or Miami-Dade County
  3. for a large purchase price, $3 million in Manahattan or $1 million is Miami-Dade
  4. without a bank loan or similar external financing, and
  5. is purchased with cash or check.

The big question I had is who is responsible for reporting the transaction and conducting the diligence into the beneficial owner of the purchaser entity. FinCEN put this at the foot of title companies.

FinCEN believes that title companies play a central role in the majority of real estate transactions. That is very true in the case of bank financing. Banks required title insurance on their mortgages. Homeowners may or may not pay for an owner’s policy of title insurance. It’s a good idea, but an expense when you are putting most of your free cash into the purchase.

I suppose a bad guy will just buy their high end residential real estate without title insurance to avoid a nosy investigation into who he really is and where his money comes from.

Sources:

Image is
Miami Skyline Tight Before Dawn Reflection Composite by
Matthew Paulson CC BY NC SA

The SEC’s Insider Trading Case Falls Further Apart

Five years ago, the SEC came crashing into the offices of Level Global Investors accusing it of engaging in illegal insider trading. The firm agreed to pay $21.5 million in settlement money to resolve that insider trading investigation. Now it wants its money money back.

SEC Seal 2

When it comes to insider trading, it’s not the firm doing the trading, it’s individuals. The individuals fought the charges of illegal insider trading. Anthony Chiasson, was implicated in the insider trading charges and was convicted at trial.

But the verdict was overturned and the federal appeals dismissed the charges. That ruling by the United States Court of Appeals for the Second Circuit (U.S. v. Newman and Chiasson, 773 F.3d 438 (2d Cir. 2015)), made it more difficult to pursue insider trading cases. The Newman decision changed the SEC’s view of what constitutes illegal insider trading. The government now requires the government to prove a higher level of benefit than before.

The SEC appealed to the US Supreme Court, but it decided not to hear the appeal.

With the underlying charges gone, the Level Global feels it’s entitled to get its settlement back. The SEC is not contesting and a federal judge agreed to vacate the settlement.

Although the Supreme Court decided not to hear the Newman appeal, it did agree to hear another insider trading case with a similar issue.

Sources:

The SEC Tries to Shut Down Another Failed Real Estate Investment Scheme

One of the challenges faced by the Securities and Exchange Commission when encountering a real estate scam is finding jurisdiction. The SEC is limited to securities and a real estate investment is not a security. But a real estate investments may involve securities or be a securities-like investment. That is the case the SEC is trying to make against Marquis Properties and its principals, Chad R. Deucher and Richard Clatfelter.

marquis properties

The SEC has two challenges in its case. First it needs to prove that there was fraud. Second it needs to prove that the case involves securities.

Marquis, Mr. Deucher and Mr. Clatfelter have not agreed to the charges, so I’m relying on the SEC’s side of the story to look at the real estate versus securities part of the case. It does not take much time browsing in internet search results to find a long line of disgruntled investors who feel that were ripped off by Marquis.

Marquis main strategy appears to be helping investors put money into turnkey residential rentals. Marquis promises to source the investments, buy the property and manage it for the investor. That structure would likely leave little room for the SEC to get involved. That does not mean its a good investment and not a scam. It’s just not a securities transaction.

According to the SEC complaint, Marquis offered three investment options: (1) turnkey real estate investments, (2) joint ventures, and (3) promissory notes secured by real estate. That covers the spectrum going from pure real estate to more securities-like.

The SEC in the complaint paints the turnkey real estate investments as “investment contracts.” In reading the complaint, I’m not moved by the SEC’s view. The SEC fails to lay out the key features of an investment contract: “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” (328 U.S. at 301). Or the other variation of the third prong of whether the investment was premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

The SEC does a better job of at least describing the joint ventures as “investment contracts.”

“Joint venture investors have had no participation in management or decision-making for the joint venture and have relied solely on Marquis’ efforts to locate and purchase properties, renovate, and sell the properties to earn a profit on their investments.”

However, if the investors actually have the contractual right to be involved in management, regardless of whether they actually do, the SEC may lose the argument that the joint ventures are investment contracts.

As for the promissory notes, Marquis seems clearly in the “securities” business with this option. If the note was actually the single mortgage note, there is an argument to be made. But pooled investment notes used to fund real estate investments are going to be securities.

Maybe Marquis was a legitimate business at one point. If the SEC complaint’s statements are mostly true, Marquis was very cash flow negative in 2015. The company was paying out more to investors than the properties were making. The shortfall was paid from new investor cash. The classic ponzi scheme situation.

You can get your own taste of those involved in this video:

Sources:

Weekend Reading: Lights Out

Should we worry about an attack on the Untied States’ electrical infrastructure? Ted Koppel says “very much so” in his book: Lights Out. You probably better know Mr. Koppel as the longtime anchorman on ABC News and Nightline. In Lights Out he puts on his old school journalist hat and puts together an in depth investigation of the vulnerability of the US electrical infrastructure and effects of a cyber attack on it.

lights out

The book is divided in three parts. The first part looks at the vulnerabilities of the infrastructure. It’s old. It’s connected. Hackers can get at it and cause problems. He does not dive deep into the nuts and bolts. I’m not sure if that’s because it’s too complicated, he doesn’t completely understand the vulnerabilities, or he does not want the book to be a manifesto on how to structure an attack. Personally, I think it’s a bit of all three.

The second part covers how prepared the government is to handle a prolonged loss of part of the electrical grid. No surprise; It’s not prepared.

He wraps up the book with a look at what individual citizens are doing. He spends a long time looking at the Mormon church. Part of the church’s dogma is to have its members be prepared for a long period of self-reliance. Church members are taught to stockpile food in their homes. The central church organization has a large infrastructure to stockpile and distribute food.

He spends some time with survivalists, but dismisses some of their tin-foil hat conspiracies. The truth is that cities can only survive for a few days without electricity. The lack of food stockpiles, water supply and waste disposal will quickly cause problems.

Given the compliance focus on cybersecurity, I thought this might be an interesting book to read when the publisher offered me a copy for review.lights out

In the first section on vulnerability, you guess what he says he found. It’s just a matter of “when” there is an attack on the electrical infrastructure, not “if.” In part he blames federalism, regulation, and de-regulation on the situation. There is no one regulatory body in place to impose cybersecurity standards. Ownership of the infrastructure is split into thousands of companies, with different business models and different abilities to spend the time and money needed thwart a cyber attack.

I found the second section of the book to be the better of the three. It’s also the part where Mr. Koppel is able to use his star power and connection to meet with current and former government officials who would be responsible for dealing with an attack like this.

You can buy a copy of Lights Out at your favorite bookstore or from Amazon.com

Compliance Bricks and Mortar for January 22

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

Woodberry - Snowy Brick Wall

Corporate Disclosure, Social Policy, and Dirty Pool by Matt Kelly in Radical Compliance

[L]et’s use the Conflict Minerals Rule as the flagship example of a much broader bad idea in Dodd-Frank—using federal securities law to force social policy on corporations. Because as much as the Conflict Minerals Rule is an exasperating waste of compliance officers’ time (which it is), we have a whole host of other examples, too. This business of using securities law to score political goals is getting way out of hand. [More…]

An Insider Trader Caught On Tape Tells All by Jacob Goldstein in NPR’s Planet Money

A former accountant convicted of insider trading tells his story to our “Planet Money” podcast team: what he did, how he did it and why. Though he’s still struggling with that last one. [More…]

The Debt-Equity Choice When Securities Regulations are Scaled by Equity Values: Evidence from SOX 404 by David Weber and Yanhua Sunny Yang in The CLS Blue Sky Blog

The costs of complying with SOX 404 create incentives for non-accelerated firms to avoid crossing the bright-line threshold of $75 million in public float and retain their non-accelerated filer status. Because the threshold is tied to the value of firms’ outstanding common equity, such incentives potentially affect the financing choices of smaller firms. That is, when comparing alternative sources of external financing, the regulatory threshold is likely to make additional common equity relatively more costly and additional debt relatively less costly. Thus, for non-accelerated firms looking to access external capital, we expect the scaled requirements for SOX 404 to increase the likelihood of issuing debt and decrease the likelihood of issuing common stock. [More…]

Take It Easy – Ruminations on Corruption Scandals in International Sports by Tom Fox in the FCPA Compliance and Ethics Report

As I have noted this week, the world of sports continues to provide ample lessons to be learned for the Chief Compliance Officer (CCO) or compliance practitioner. Although we no longer have the sad sack Astros to kick around, there are many other candidates out there you can draw inspiration from for your compliance regime. For today, I want recap some of these lessons. [More…]

Could Whistleblowing Be The New Short-Selling?

The Securities and Exchange Commission made an unusual announcement this week, announcing a whistleblower award to a company outsider. Could this been a new way to profit from companies engaged in fraud? Is this a new alternative to short selling?

Close-up Of Metal Sport Whistle On American Flag

Earlier this week, the SEC announced a $700,000 award to a company outsider who conducted a detailed analysis that led to a successful SEC enforcement action.

“The voluntary submission of high-quality analysis by industry experts can be every bit as valuable as first-hand knowledge of wrongdoing by company insiders,” said Andrew Ceresney, Director of the SEC’s Enforcement Division.

Whistleblowers inside a company are at risk. They risk losing promotions, bonuses, or even their jobs. Of course, they can file whistleblower retaliation claims, but even that recovery can be risky.

The traditional route for an outsider to gain from a company’s malfeasance is to short sell the stock. Of course that is risky as well. When you buy a stock, all that is at risk is the money you paid for the stock. A short position has a much bigger loss potential. If you are wrong and the stock rises, you are at loss for all of that gain. You can look at the problems Bill Ackman is having with his Herbalife short.

Now the SEC has opened the window to earning a whistleblower award for providing “high-quality analysis by industry experts” that leads to a successful SEC enforcement action. The earning potential is lower, but you don’t have capital at risk. You also don’t risk losing your job.

By law, the SEC protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity. We don’t know anymore behind the award.

I had expected that the recipient would have stepped forward to trumpet his or her success as a professional whistleblower. So far, that has not happened. I suspect there is more to the story.

The SEC order for the whistleblower award lists four people claiming an award. The preliminary determination denied three of the four. One of those contested, but still lost.  That claimant had supplied tips to the SEC, but whatever was supplied was not sufficient.  Those tips were designated for “no further action.” Upon review of the information it was not sufficient to and lacked factual connections between the tips and the enforcement action.

It sounds the ranks of professional whistleblowers are growing.

Sources:

Custody Rule Gotcha on PCAOB “Registered and Subject to Regular Inspection”

A friend in the private fund compliance community just came up with another “gotcha” under the Custody Rule. His client used an auditor that was registered with PCAOB, but had not yet been inspected. He thought it was enough to be registered, while waiting for an inspection. An SEC examiner argued that the auditor needed to be inspected.

It turns out, neither one was right.

Custody hands holding cahs in handcuffs

He and the examiner took a deep dive into the meaning of “subject to inspection” regarding the custody rule. Even thought the SEC used “subject to inspection” in the Custody Rule, it is not defined anywhere by the SEC. It turns out it was up to PCAOB to define “subject to inspection” in the PCAOB rules.

PCAOB says that you are an “inspected firm” if you have audited at least one issuer of public securities. Otherwise, PCAOB does not inspect that auditor. It is outside it’s statutory authority.

“The Sarbanes-Oxley Act authorizes the PCAOB to inspect registered firms for the purpose of assessing compliance with certain laws, rules, and professional standards in connection with a firm’s audit work for clients that are “issuers,” as that term is defined in the Act,* and (following amendments to the Act in 2010) a firm’s audit work for clients that are securities brokers or dealers. Many PCAOB-registered firms perform no such work, and the work they do perform is not within the scope of the PCAOB’s statutory responsibility and authority to assess. The PCAOB does not inspect those firms.”

The SEC takes that to mean that they are not therefore “subject to regular inspection”.

This is terrible result for private fund managers.

You can search for registered auditors on the PCAOB website. It shows the firm’s registration and which of the five categories the firm falls under. You need an “A” to see that the firm has audited at least one public company.  A “C” audit of a broker-dealer will also work. It looks like a “B”, “D”, or “E” will be a problem.

This dovetails into the other technical issue I noted in the Custody Rule regarding “independence.” That definition also refers to the public company reporting side under Regulation S-X. That standard of independence is higher than the independence standard contractually required by investors under fund documents.

Unfortunately, this is a cautionary tale for a fund manager using a smaller auditor. The firm may be registered with PCAOB, but if its practice does not include public companies or broker/dealers, the firm may not meet the standards of the Custody Rule for audited financial statements. Check the PCAOB website.

Another Pay-to-Play Case

There are few among us who think the high cost of getting elected and fundraising that it requires is good for American politics. The SEC took a moral high ground and passed Rule 206(4)-5. That rule effectively prohibits investment managers from making political contributions to politicians who control pension money, other than small token amounts. The SEC brought another pay-to-play case last week for egregious behavior. State Street was charged with funneling campaign contributions to a state treasury official.

Politician: Holding Out a Stack of Money

When I first saw this case I thought it would be a Rule 206(4)-5 case since State Street is a big money manager. In this circumstance, the relationship was a custodial relationship and outside the Advisers Act.

The deputy treasurer of a state pension fund arranged for illicit political contributions and improper payoffs through a fundraiser/lobbyist for State Street.

According to the SEC’s complaint against the fundraiser/lobbyist, Robert Crowe, he met the state official’s demand for campaign contributions by illegally filtering cash through his personal bank account and reimbursing individuals for contributions made in their own names. Crowe made additional illicit campaign contributions in response to the official’s threats that State Street would lose the business.

The State Street employee who headed it’s public funds group was also charged for participating in the pay-to-play scheme. According to the complaint against Vincent DeBaggis, he arranged for payments through a strawman as lobbying services, knowing that a large portion of that fee would be going to the state official. The lobbying agreement called for a success fee if the state pension funds became clients of State Street. DeBaggis’ conduct was in violation of State Street’s Standard of Conduct.

“Pension fund contracts cannot be obtained on the basis of illicit political contributions and improper payoffs,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division. “DeBaggis corruptly influenced the steering of pension fund custody contracts to State Street through bribes and campaign donations.”

The state official, Amer Ahmad, has already been convicted of misconduct and is currently in federal prison.

This case was more egregious than the first case the SEC brought against a Philadelphia firm for making a $2000 contribution, with no showing that it was designed to buy influence.

Sources

Saying Goodbye To An Old Friend

The world got a little less interesting now that this big, bold, brash guy has left it.

Jeff Levine

I have not posted in Compliance Building while I’ve been trying to deal with this loss.

My best friend, Jeff Levine, was diagnosed with cancer just before Thanksgiving. He lost his battle against the disease last week.

Jeff and I had been friends since high school. We grew up on the same street. Went to high school together. Went to college together. Snowboarded together. Biked together. Laughed together. Cried together.

I’ve been in Los Angeles this week saying goodbye to him, surrounded by his family and friends. There are many stories to tell and remember. His legacy will live on.

I had registered for this summer’s Pan-Mass Challenge to raise money for cancer research last week. I got the call from Jeff’s sister two days later that Jeff had taken a turn for the worse and was not going make it through the day.

One of Jeff’s legacy’s will be me riding my bike in his memory. If you are interested in supporting me you can make a donation using the links below. 100% of the donation goes to the Dana-Farber Cancer Institute.

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