Compliance Bricks and Mortar for February 26

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

brick drain


 

Protecting the Compliance Officer: A Balanced Approach by Michael W. Peregrine in Corporate Counsel

From a governance perspective, it matters not that these chief compliance officer (CCO) enforcement actions appear to be narrowly focused in particular industry sectors. Rather, what matters is the potential these actions may have to more broadly destabilize the role and function of the compliance officer. The job is hard enough as it is. Should compliance officers feel (fairly or unfairly) that they are exposed to regulatory sanction for simply errors of omission or commission, the job will become even more challenging. Interest in compliance positions–especially in heavily regulated industries–may decline. Companies will be frustrated in their attempt to maintain effective compliance programs if they are unable to attract and maintain qualified, experienced compliance officers.
[More…]


Expanding personal liability for chief compliance officers by Brett Ingerman, Michael D. Hynes, Brian H. Benjet, Christian Michael Van Buskirk of DLA Piper

The imposition of personal liability on chief compliance officers is part of the regulators’ broader interest in compliance failures at the highest levels of financial institutions. Last Thursday, the Financial Industry Regulatory Authority (FINRA) sent letters to a dozen financial firms, inquiring about the methods by which the firms establish and maintain a culture of compliance. In addition to requesting general information on the firms’ practices, FINRA specifically requested information on how the firms established a “tone from the top.” FINRA characterized the request letters as an attempt to better understand how culture affects compliance, but the focus on the “tone from the top” suggests FINRA perceives or is at least particularly concerned about deficiencies among the highest ranking executives of financial firms. [More…]


 

Outsourced Compliance Officer Trend Renews Standards Debate by Stephen Dockery is WSJ.com’s Risk & Compliance Journal

It was also eventually cited by the SEC in a detailed risk alert in November on the “growing trend” of outsourcing chief compliance officers. The deep dive by the commission mentioned cases of strong compliance work by outsourced officers, but it also said some practices by off-site CCOs were cause for concern, where outsourced CCOs’ attention was lacking, or implementation of their suggestions never occurred.  [More…]


Compliance Careers Might Get Interesting, Part II by Matt Kelly in Radical Compliance

There we were, me and a small group of compliance professionals, talking shop about where good compliance officers come from these days. One person, a recruiter for asset management firms, told the tale of how she recently placed a chief compliance officer at a hedge fund in the Midwest. This CCO was “a dream candidate,” the recruiter said: accomplished scholar, top-ranked law school, work at two major law firms, a stint in investment banking, some time on the regulatory side, “and just a friendly person people would want to talk to.” [More…]


Rob Cohen Discusses SEC’s Analysis and Detection Center by David Smyth in Cady Bar the Door

Enter the Analysis and Detection Center.  I have a friend whose job requires him to think about insider trading for, oh, probably more than half of every day.  When the SEC filed its first case referring to the Analysis and Detection Center, he emailed me asking something like, “There is one?”  We both wondered what it was.  So did Bruce Carton.  It turns out the SEC is using it, whatever it is, to generate its own insider trading cases, without relying on FINRA or CBOE or any ol’ whistleblower. [More…]

Dodd Frank and Industry Consolidation

Enhancing regulations is meant to protect consumers. The side effect is often to protect the large incumbent firms and make it more difficult for smaller firms to thrive. This theory is proving true under Dodd-Frank.

Dodd-Frank-Act

A study by Marshall Lux and Robert Greene on community banks found that since Dodd-Frank community banks have lost market share, especially small community banks.

The top 5 largest banks also lost market share.

Community banks have also suffered a significant decline in assets while the large banks have grown. Again the five biggest banks also suffered a smaller decline in assets.

However, the five biggest banks had an increase in commercial banking, while the other banks suffered declines and the community banks suffered declines.

For private equity firms, the data is unclear.

Marc Wyatt looked at the size of the funds being marketed and noted a decrease in size. He concluded that the cost of SEC registration and regulation is not stifling the formation of smaller managers. Perhaps he missed this comment from Prequin:

The stumbling block, however, has been the number of managers able to hold a final close, with this being at the lowest level since 2010. It is evident that the private equity fundraising market is still in a state of bifurcation. The largest, brand-name managers are receiving the majority of investor commitments, with smaller managers – particularly first-time funds – finding it difficult to raise capital.

This would seem to support my opening statement. Regulation is generally better for incumbent firms. Bigger firms can absorb the regulatory overhead, with the hurdle being bigger for smaller and start-up firms.

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Excessive Travel as a Bribe Under the FCPA

The recent PTC Case caught my attention for a few reasons. First, the company is based near my house and I biked past it’s headquarters this past weekend. Second, the actions stated in the headline were not good, but seemed to be at the extreme of what I thought would be considered bribery.

ptc

According to the SEC’s press release, an SEC investigation found that two Chinese subsidiaries of PTC Inc. provided non-business related travel and other improper payments to various Chinese government officials in an effort to win business. From 2006 to 2011, two PTC China-based subsidiaries provided improper travel, gifts, and entertainment totaling nearly $1.5 million to Chinese government officials who were employed by state-owned entities that were PTC customers.

The travel was sightseeing trip in the US in connection with visiting the corporate headquarters in Massachusetts.

That does not sound so bad. Not great. But not a $28 million fine bad.

There is obviously the red flag of PTC selling to a China-based company. Most would start with the assumption that the company is state owned and therefore the employees could be considered government officials. If they are government officials you have to be worried about the FCPA.

The SEC order states that the employees are government officials and does not spend any time addressing this.

Were the trips meant to generate business for PTC? The SEC order only mentions a small connection, stating that the officials who went on the trips were “often” signatories on the purchase agreements.

It’s a settlement order and not a pleading, so we have to just agree that the individuals were government officials and that the things given to them were meant to influence their purchasing decision.

I’ve said it before and I stand behind the statement:

“If your are trying to figure out whether a company is a private company or an “instrumentality” of a foreign government under the Foreign Corrupt Practices Act you are already in trouble.”

At first blush this PTC case caused me to question the statement.

Combining business activities with some pleasure activities is a common practice. The presence of government officials should not change this practice. The concern is whether the pleasure activities are excessive compared to the business activities.

The SEC and the DOJ have made it clear that bribery is not limited to cash in an envelope. Excessive gifts and travel can be considered an illicit bribe.

That was the case here.

The officials would visit the PTC office in Massachusetts for one day and then spend ten days touring the sights of New York City, Los Angeles, the Grand Canyon and Honolulu. That’s a ten to one ratio of business to pleasure.

That does sound excessive.

It sounded excessive to PTC who had a policy prohibiting excessive gifts and entertainment. PTC’s policy required pre-clearance for expenses over $500 with documentation of the business purpose.

The costs of the overseas travel were hidden in the contracts. The funds budgeted for the overseas travel were disguised as expenses related to success fees or subcontracting payments for business partners. The cover-up made the trips more illicit. If the employees involved thought the trips were legitimate there would have been no reason to hide them.

I do have a problem with the SEC order including “tours of MIT, Harvard, and Faneuil Hall” in the list of what the SEC considers excessive leisure activities. Showing prospective business partners the area, amenities and source of corporate talent should be a legitimate leisure activity connected with the business. PTC is headquartered in a suburban office park. The Charles River is lovely in that area, but it’s legitimate to show the Greater Boston.

The rest of the activities sound excessive to me. Excessive enough, that I would not expect to pay those expenses for a business partner, whether it was a private individual or a government official.

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Can Money Buy An Election?

When Jeb Bush dropped out of the Presidential race this weekend, my first thought was about all that money. Running for elected office costs too much money and all that money is seen a corrupting influence. One of the most controversial rulings was Citizens United that broadened the rights of corporations and unions when comes to political spending. This 2016 Presidential race is the first big test of the Super PAC.

Politician: Holding Out a Stack of Money

The Super PAC has lost. Or at least, they are not assuring victory.

Before I continue, I’ll let you know that I don’t like any of the current major candidates running for President. My political views don’t fit neatly into either party. (I’m liberal on social issues and conservative on economic issues.)

Jeb Bush had a huge war chest for his campaign between his own campaign and the Super PAC that had lined up behind him. He also had the Bush campaign infrastructure in place.

Hilary Clinton had  a huge war chest for her campaign, with a sweep of donations and a giant Super PAC behind her. She had the Clinton political machine in place behind her.

A year ago it seemed very likely that we would see Bush versus Clinton for President.

After three votes, it seems that money does not buy an election. Bush has dropped out after three dismal results. Clinton is in a tough fight with a Socialist Senator from the tiny state of Vermont.

Perhaps I see a bit more faith in democracy and hope that money alone will not buy an election. There is still too much money in politics.  Whether or not it has an actual corrupting influence, it certainly has the appearance of a corrupting influence.

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Compliance Bricks and Mortar for February 19

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

brick drain


Private Equity’s Unintended Dark Side by Alexander Ljungqvist, Lars Persson and Joacim Tåg in the CLS Blue Sky Law Blog

But what about more long term consequences of buyouts? In a recent paper, we explore whether private equity could, inadvertently, impose a major externality on the economy, by undermining the hard-won consensus in support of shareholder capitalism that has emerged in Anglo-Saxon economies over the past 100 years: in return for participating in the gains from corporate activity, shareholder-voters lend their support to business-friendly policies.
[More…]


The Ethics and Compliance Officer’s Many-Colored Hat by Jason L. Lunday in Compliance & Ethics Professional

Below are thirteen key disciplines that have influenced the Ethics and Compliance field and are important competences for an ECO to have or acquire through others to effectively manage an ethics and compliance program. [More…]


Mark Cuban Challenges the Referee: the Constitutionality of SEC In-House Courts in Orrick’s Securities Litigation, Investigations and Enforcement

After the repeated challenges to the SEC’s in-house courts as previously reported, Mark Cuban joined the debate by filing an amicus curiae brief in support of petitioners Raymond J. Lucia Companies, Inc. and Raymond J. Lucia (collectively “Lucia”) in Lucia v. SEC.  Cuban, describing himself as a “first-hand witness to and victim of SEC overreach” in a 2013 insider trading case brought against him in an SEC court, argued that the D.C. Circuit should grant the petitioners’ appeal because SEC in-house judges are unconstitutionally appointed. [More…]


Toward More Effective SEC and DOJ RemediesT. Gorman in SEC Actions

The thesis for the Judge Bean approach is simple and straight forward: “If a corporation has violated the law, individuals within the corporation must also have violated the law,” according to the report. Unstated is the thesis that jail for a few executives will cure what ails the world of Wall Street and big corporations as will being forced to make admissions. While these points seem intuitive their premise is at best doubtful. While admissions may satisfy a craving for retribution, the reason such a requirement will change the behavior of a large corporate entity is unclear. [More…]


Ex-Brokers Go on Trial in Test of Revised Insider Law by Patricia Hurtado in Bloomberg Business

Two former stockbrokers accused of insider trading by the U.S. Securities and Exchange Commission don’t deny making hundreds of thousands of dollars on a tip about a billion-dollar deal. They just deny they broke the law. Insider trading laws are in flux following a 2014 federal appeals court ruling in New York that, in part, says prosecutors must show a source of a leak got some kind of a concrete benefit. The trial of Daryl Payton and Benjamin Durant tests the new requirement in a civil proceeding in New York for the first time.[More…]


Volkov Law Group Partners with Charlotte School of Law to Create New Center for Compliance and Ethics

I am very happy to announce the public launch of the Center for Compliance and Ethics at the Charlotte School of Law in Charlotte, NC. The Center will be hosting many exciting events including:

  • A lunch and learn on February 24th about our compliance certificate program.
  • A webinar on March 10th where professors in the compliance certificate program speak about careers in compliance.
  • A webinar later in March on the Foreign Corrupt Practices Act, taught by leading compliance expert Mike Volkov.
  • A Symposium on compliance and ethics in June at Charlotte School of Law’s campus that will provide both a forum for discussion and will produce a white paper on important compliance issues.

 

If You Recommend It, You Have to Mean It

The Securities and Exchange Commission charged an investment bank’s research analyst with publishing a rating on a stock that was inconsistent with his own view. Charles P. Grom gave a public “buy” recommendation to the retailer Big Lots, but privately expressed his concerns about the company.

“We just had them in town so it’s not kosher to downgrade on the heels of something like that,” he said on an internal conference call, according to the S.E.C.

Stock Market Launch

Regulation Analyst Certification (Reg AC) came out of the Dot Com bubble burst. Investment banks were handing out favorable public analyst recommendations to their clients, but providing conflicting advice to their institutional clients. Sarbanes-Oxley required the SEC to adopt a rule addressing analyst conflicts.

The most famous case under Reg AC was Henry Blodget. In 2003, the former Merrill Lynch tech stock analyst paid $4 million in fines and disgorgement and was permanently barred from the industry. (Mr. Blodget neither admitted nor denied wrongdoing as part of the settlement.) Ten investment banks paid $1.4 billion in fines for publishing analyst recommendations that conflicts.

It’s been quiet under Reg AC for a decade. I assume banks took steps to correct the conflicts.

I also assume that they enforced the “Fight Club Rule.” The First Rule and Second Rule being that you do not talk about Fight Club.  Analyst should not speak about any conflicting advice.

Mr. Grom broke the rule and revealed that investment banks may not have taken Regulation AC to heart.

On March 2, 2012, Mr. Grom published a “Buy” rating on Big Lots.

On March 28, Mr. Grom and the bank hosted Big Lots executives and spent most of the day with them.

Over the course of the day Mr. Grom told a trader to sell 25,000 shares from the bank’s proprietary account.

Over the course of the same day Mr. Grom spoke with four of the bank’s top priority “Global Research Service Level 1” hedge funds. Each of those funds then sold all of their positions in Big Lots.

Then on March 29. Mr. Grom issued a research report on Big Lots entitled “Not All Is Good In Buckeye Land,” in which he reiterated his BUY rating.

On that same day he said on  a conference call with the bank’s research and sales personnel: “We just had them in town so it’s not kosher to downgrade on the heels of something like that.”

Then on April 24 he revealed that he had violated Reg AC on a call with the bank’s research and sales personnel

“[F]ortunately we told many clients a few weeks back to sell the stock.. . . I think the writing was on the wall [that] we were getting concerned about it, but I was trying to maintain, you know, my relationship with them. So, that’s why we didn’t downgrade it a couple of weeks back.”

Oops.

The question that comes to mind: how did Grom get caught? Perhaps it was internal compliance who reviewed the internal call. That would be a double face palm event for violating Fight Club Rule 1 and Rule 2. Maybe it was SEC or FINRA examiners reviewing a recording of those conference calls.  It’s an easy win for them.

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506(c) Enforcement Actions

Although I had a lot of hope that the changing of private placement advertising restrictions by the Securities and Exchange Commission would remove potential foot-faults from the fundraising process, the end result proved challenging. Now it appears that the SEC is on the brink of challenging firms that took at advantage of the loosened restrictions.

private placement

Given the enormous restrictions on being a company with publicly listed securities, private placements have been a vibrant form of raising capital. Although deemed more “risky”, to me that is a poor label without a further discussion of risk. The risk is liquidity, not risk of loss. A huge portion of the private placement market is by firms that provide no more risk than a publicly listed company. There is also capital being raised by start-ups and riskier companies. The common factor is not the risk of loss. The common factor is the investor’s limited ability to sell the security. If the investor needs liquidity, the investor will have limited options.

The main concern of the SEC in passing Rule 506(c) was be the increase in fraud. So far, we have not seen the enforcement actions to back up that fear.

However, the use of advertising under 506(c) for a private placement has been limited. From 2013, when 506(c) became effective, through 2015, there were $2,800 billion in offerings under 506(b) and only $71 billion in offerings for 506(c).

It seems like enforcement proceedings are in process for some firms that abused Rule 506(c). SEC Chair Mary Jo White stated that the SEC has some open investigations. Over the next few months perhaps those become public.

The failure of Rule 506(c) is that it was coupled with a proposed rulemaking that would dramatically change the landscape of private placements. We have not heard anything more on that rulemaking. It’s specter still haunts Rule 506(c) offerings.

I think Rule 506(c) is more than what most fund managers wanted for changes in advertising. Fund managers wanted some safe harbors for advertising to avoid foot-faults. Fund managers want to able to participate in league tables, talk to the press and talk at conferences without the fear that an inadvertent slip of the tongue would wreck havoc on a fundraising. I encountered no fund managers who were interested in media campaigns as part of a fundraising.

It looks like we may get more insight into the SEC’s view of Rule 506(c) when the enforcement actions are announced.

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Compliance and Supreme Court Nomination

One of the most important roles of the President is appointing judges to the bench, with an opening on the Supreme Court being the most important. We are set for another battle over an opening because the process lacks a set of policies and procedures.

SCOTUSbuilding_1st_Street_SE

The vast majority of Supreme Court cases are uninteresting except to the set of practitioners in that legal area. A few cases each term have broader social issues and attract the headlines. It’s those cases on abortion and marriage and gun rights that attract the most attention.

Justice Scalia took a very dogmatic approach to his view of the US Constitution. He was an originalist and textualist who believed in a static view of the Constitution. Conservatives loved this approach since it mostly aligned with their beliefs. Scalia would have been the first say that his view was not political, but a pure legal view.

He would also likely view with disdain some of the posturing coming out of Washington on how his open spot should be filled.

The Constitution grants the President the power to appoint Justices, “by and with advice and consent of the Senate.”

Scalia himself had an easy route to appointment as a Justice because the Senate opposition had focused its efforts on Rehnquist’s appointment as Chief Justice. It’s hard to fight a battle on two fronts.

The current appointment will also be about politics, and not legal theory. I’m sure the nominee will have a brilliant legal mind. He or she will likely have a short judicial record with few, if any, decisions on controversial issues. I would also guess that the nominee will not be a white male.

Leaving the Supreme Court seat open means that there are an even number of justices. Therefore, a tie is possible and impossible to reach a decision. Any governance practitioner will tell you the perils of an even numbered board.

Compliance practitioners should note that there is an insider trading case before the court. In the Salman case, the Supreme Court will try to decide if personal benefit to the insider is necessary as required in the Second Circuit’s Newman case or whether it is sufficient that there was a close family relationship as decided in this case. It would be a shame to not have a decision because of a vacancy on the bench.

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Supreme Court of the United States Building, Washington, DC, as seen from the west side of 1st St NE.
by 350z33
CC BY SA

Compliance Bricks and Mortar for February 12

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

bricks 50


CFTC Can’t Give Whistleblower Money Away by Jean Eaglesham in the Wall Street Journal

Since its Whistleblower Program was launched in 2011, the Commodity Futures Trading Commission has spent more on administrative costs than it has paid out in bounties, according to a Wall Street Journal analysis of the agency’s data. [More…]


An SEC investigation: to disclose, or not disclose? by Patrick Hunnius, Perrie Michael Weiner, Robert D. Weber, Caryn G. Schechtman of DLA Piper

In a recent decision, the Ninth Circuit addressed for a second time the question of whether an issuer’s disclosure of a Securities and Exchange Commission investigation can provide a sufficient basis for a plaintiff to plead “loss causation” in a securities class action. The court’s ruling – that disclosure of an investigation combined with “a subsequent revelation” can suffice to plead loss causation in a later civil action alleging securities fraud – should lead issuers to think more carefully about disclosure of such investigations at all.[More…]


6 Lawyers and Staff Caught in the Insider Trading Crosshairs by Casey Sullivan in Bloomberg DNA

With constant access to corporate information, lawyers can feel the urge to use it to their own financial advantage. We compiled a list of some of the lawyers and employees who have been caught in the prosecutors cross-hairs and pulled information about them from various media publications. [More…]


Compliance Across Industries

One of the puzzling aspects of compliance is that it means vastly different things across industries. What compliance means to a bank is very different from what compliance means to a drilling company.

Folder with the label Compliance

I think the reasons are obvious: regulatory requirements.

In a highly regulated industry, there will be a greater focus on complying the regulatory mandate. A broker-dealer compliance officer is going to be focused primarily on the FINRA rules for broker dealers. An investment adviser compliance officer is going to be focused on compliance with its regulatory scheme. A drilling company is going to be focused on a different set of rules.

I see the difference in the junk mail I receive each day. I get flyers on FCPA compliance, OSHA compliance, Clean Water Act compliance… Someone is clearly checking the compliance box without thought to the substance behind it.

Most compliance as a discipline starts with the Department of Justice’s Sentencing Guidelines. That is a good base framework. But in regulated industries, the regulations go into much more detail about what needs to be done. It’s not about right or wrong, but what the government says you have to do.

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