Month: March 2016

Stealing from Peter to Pay Paul

I generally think of fraudsters in two buckets. Some are trying to take the money and run. Some are using the ill-gotten money to cover up a prior loss, hoping to earn it all back. I think most ponzi schemes fall into the later category. A splashy fraud case this week highlighted this second type.

money

Andrew W.W. Caspersen had a pedigree of wealth. He graduated from Princeton University and Harvard Law School. He was a partner at a major financial advisory firm. He could do no wrong.

But according to the SEC and DOJ something did go wrong. He lost money. He was so desperate to cover up the losses he pitched a falsified investment in a legitimate private equity firm to institutional investors. He got one investor to put in $25 million.

According to the complaints, the scheme fell apart when that investor was contemplating putting in more money. The investor did some diligence, found the email addresses to be slightly different and phone numbers were incorrect. The DOJ alleges that Caspersen posed as executive at the private equity firm to answer questions from the investor and created a fake website and email addresses.

According to the complaint, Caspersen appears to have been using the money to cover an earlier loss and take a risky investment bets that did not pay off. The $25 million dwindled down to $40,000.

According to the Wall Street Journal, Caspersen was arrested Saturday evening at New York’s LaGuardia Airport. It’s not clear if he was merely heading out of town for business or vacation.

Or if he was turning into the first type of fraudster and making a run for it.

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Designated Lenders Counsel and Compliance

If you own a home, there was likely a lawyer sitting at the closing table. Who paid for the lawyer and who did the lawyer represent? You paid, but the lawyer worked for the bank. She or he was there to make sure the bank’s interests were protected. There was recent coverage of a similar situation in the context of private equity loans, starting with a story by Andrew Ross Sorkin in the New York Times.

person's female hand signing an important document

This conflict has been in place for a long, long time. Banks make the borrowers pay for the bank’s lawyers’ fees. This is true when buying a home and is true in complex private equity loans.

As the borrower, you are worried about the cost of the bank’s lawyers and the lawyers’ ability to get the deal done on time.

Since private equity firms are serial borrowers and their loans are complex, having lawyers involved who are familiar with the firm can be a big savings of time and fees. Simple things like knowing the key personnel at the private equity firm can save a great deal of time. And time is money.

The issue raised by Mr. Sorkin was “designated counsel.” Some private equity firms have lists of law firms that the lender must chose among in making the loan. The lender must use one of the designated counsel or the private equity firm may look for a different lender.

The designated counsel list is usually a list of top shelf law firms. Private equity firms don’t want unqualified firms working on their deals.

The coverage was aimed at private equity firms. But I think that is misplaced. Private equity firms should be seeking ways to lower the legal bill because the investors are the ones paying those legal bills. I don’t see a conflict or compliance issue with private equity firms using a designated counsel list, as long as those on the list are firms that a bank might otherwise use.

As for the banks, I see them as the ones who are in a potential conflict. If the bank is not comfortable with the list of law firms, then it has a problem. Compliance professionals at the lenders should be aware of the issue and make sure they are taking steps to address the risk.

Of course there is a conflict with the law firm. That too is a conflict that has been in place for decades. The bank’s lawyers know they represent the bank. They also know the borrower is paying their bill. Until banks start paying for their own lawyers, there will be no resolution to this conflict.

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Warding Off Unethical Behavior

Legend has it that if you string garlic around your house, you can ward off vampires. What if there was something similar you could do to ward off unethical behavior in the workplace? Apparently, religious symbols may keep you away from an unethical boss.

Bunches of garlic hanging on a black background

A forthcoming study in the Academy of Management Journal found that if employees displays moral symbols, it could help prevent their managers from asking them to cheat or engage in other bad behavior. Sreedhari Desai of the University of North Carolina at Chapel Hill conducted field research at Indian firms to test whether those who kept a religious symbol at their desks were treated differently by their bosses to those who did not. She found that managers were less likely to ask employees to act unethically if they displayed some indication of moral values.

The research used a broad swath of items to be considered moral symbols: quotes in email signatures, religious symbols, pictures of Martin Luther King, Jr., etc.

In one experiment, participants had to decide whether to ask one of their subordinates to tell a business lie. Only 46% of those who read the moral quote chose to issue that request, but nearly 64% of those who saw a neutral quote did. Among subjects who decided to give the unethical instruction, those who saw the moral message in the email signature from one employee were more likely to ask another employee instead.

She came up with three theories:

  • Managers may be reluctant to put seemingly moral employees in an awkward situation.
  • Managers may fear that such people are more likely to blow the whistle on any improper demands.
  • Exposure to a moral sentiment or symbol makes a manager reconsider the improper behavior and change the request.

It may that this experiment is an effect similar to what Dan Ariely saw in some experiments. Reminding people to do the right thing has a positive effect on creating more ethical behavior.

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Halloween Garlic from Graphic Leftovers

A $81 Million Dollar Hole in Anti-Money Laundering Laws

I’m vastly understating that number. We know that thieves planned to run that much through the Philippines gambling establishments. It’s a clear case of appeasing a local industry by writing loopholes in legislation.

roulette by Chris Yiu

A month ago, thieves began looting Bangladesh’s account at the New York Federal Reserve. The transfer of the money had been “fully authenticated” by an international financial messaging system, known as Swift. That means there may have been a security breach in Bangladesh. The thieves sent three dozen transfer requests. Four succeeded in moving $81 million. A fifth was stopped when the thieves misspelled the recipient’s name.

$81 million of the Bangladeshi money was sent to accounts at Rizal Commercial Banking Corp in the Philippines. According to reports, from there $29 million was directed to the account of a gambling junket operator identified as Weikang Xu at Solaire Resort & Casino, while approximately $30 million was delivered to Mr. Xu in cash. Another $21 million was transferred to a local online game company called Eastern Hawaii Leisure Co.

Casinos have always been an ideal spot for laundering money. You take cash or wires in, turn them into chips, then the chips are as good as gold. You can then cash in the chips and move money back out, looking clean and fresh.

The Philippines beefed up its anti-money laundering laws in 2013, but it decided not to add casinos to the list of covered entities. Lawmakers wanted the fledgling casino industry, and the jobs it promised to create, to flourish.

Of course, the Philippines is not alone in carving out casinos. Other countries have similar exemptions for their casinos. That makes them easier tools for money laundering.

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Roulette by Chris Yiu CC BY SA

Compliance Bricks and Mortar for March 18

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

bricks freedon trail

Five Questions for Our SEC Commissioner Nominees by Matt Kelly in Radical Compliance

How would you strike the balance between investor access to information and companies’ ability to raise capital easily?

We have already seen reduced disclosure obligations for newly public companies thanks to the JOBS Act, and the SEC is mulling other ideas such as updating and expanding the definition of accredited investors who can participate in private offerings.[More..]

How to Stay Sane as a CCO by Thomas Fox

Mindset No. 1: “Be Yourself, Everyone Else is Taken”

This quote comes from Oscar Wilde. Maslanka is worried that many lawyers look around and see someone smarter or better and they feel “Cue the scene from Wayne’s World – “I’m not worthy!” Except you are. For the CCO, I think this means there will always be someone else in your company who has more of something you might think you need to do your job well (or even better). [More…]

Crime Scene: Who Stole $100 Million From Bangladesh’s Account at the New York Fed? by SYED ZAIN AL-MAHMOOD in the Wall Street Journal

In scenes that would be right at home in Hollywood, the unknown criminals sent 35 transfer requests through the Swift interbank messaging system, a Bangladesh Bank official and an official of the Ministry of Finance have said. Whoever made the requests had the necessary codes to authorize Swift transfers and put in the payment requests on a weekend, the officials said. [More…]

Secondary Sales and An Investor Covenant You Don’t Want To Miss by Joe Wallin in the Startup Law Blog

Section 4(a)(7) is a new federal securities law that basically says, it’s OK for you to sell your investment in a private company, as long as you don’t generally advertise the securities for sale, sell to another accredited investor, and the company cooperates with certain information requirements. [More…]

Investment Advisor or Investment Adviser? by Keith Paul Bishop in California Corporate & Securities Law blog

Even though the federal statute is named the Investment Advisers Act of 1940, persons regulated by that act often refer to themselves as “advisors” and not “advisers”. Which is spelling is correct? [More…]

Compliance and St. Patrick’s Day

My office is next door to Boston’s famous Irish pub, The Black Rose. It’s hard to ignore the celebrations, with patrons going in for a pint, while I’m going into my office. So I had to find a compliance angle.

BLACK ROSE AND COMPLIANCE

One of the miracles attributed to St. Patrick as part of his sainthood was driving all the snakes out of Ireland. Legend has it that St. Patrick chased all the snakes into the ocean after snakes attacked him during a 40-day fast.

St. Patrick gets credit for the absence of a problem. No snakes, no problem.

Compliance often works in celebrating the absence of a problem. Employees are not caught doing bad things so compliance is working. Employees sit through compliance training, sign certifications, get subjected to email review. So compliance must be working. It’s a miracle!

The problem with the legend of St. Patrick is that there is no evidence that snakes were ever in Ireland. He is credited with for fixing a problem that never existing.

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The SEC’s New Office of Risk and Strategy

Whenever the Securities and Exchange Commission reorganizes you have to wonder what the impact will be on those subject to regulation by the SEC. Earlier, the SEC announced a new Office of Risk and Strategy within the Office of Compliance Inspections and Examination.

SEC Seal 2

“The Office of Risk and Strategy will lead our exam program’s risk-based, data-driven, and transparent approach to protecting investors,” said OCIE Director Marc Wyatt. According to the SEC’s press release “[t]he new office will consolidate and streamline OCIE’s risk assessment, market surveillance, and quantitative analysis teams and provide operational risk management and organizational strategy for OCIE.”

I think it’s a good thing for OCIE to increase its use of data in looking at risky firms. The amount of data coming into the SEC has increased dramatically with addition of private fund managers into SEC registration, the Form PF filings and increased trade review.

The news has been sparse as to whether the new office is a new initiative or merely a centralization of existing initiatives. OCIE has been saying for years that its exam process is risk driven. Leading up to an exam, OCIE has looked at many other firms to determine that those present fewer risks.

Hopefully, the new office will allow the SEC to better focus on firms with greater risk.

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Compliance Pie

Sometimes I’ve heard that the reward for a job is like winning a pie eating contest and finding out the prize is a pie. Is compliance like a pie eating contest?

pie pi

It seems to me that compliance only continues to get more complex and demanding. Companies will continue to do bad things. Legislators and regulators will continue to respond to those bad things by enacting new statutes and new regulations.

As compliance has become more of an accepted department within a company, more duties are being pushed to compliance. Regulators push more duties to compliance. The reward for a job well done is more of the job.

Nobody thinks that compliance is “as easy a pie.” It’s more like making a pie, rather than the much easier and enjoyable act of eating a pie.  You start with a recipe. Of course, your recipe may be different than another pie maker. You may have a different list of ingredients; you may have a different preparation method; you may have a different cooking method. Pie is never simple and is never easy to make.

Since it’s March 14 (3/14) I had to include a reference to pi today.

Image of the Pi Pumpkin Pie is by Paul Smith CC BY

Adviser is Fined For Shortchanging Himself on Fees

Anyone in compliance and anyone running a fund knows that the Securities and Exchange Commission is laser-focused on fees being charged to investors. Marco Investment Management got it wrong and was subject to an order by the SEC. But, the firm actually short-changed itself.

money

Marco’s advisory agreements with its clients called for a fee to be paid based on the “market value of all gross assets.” Some of these clients also had margin accounts. Investment proceeds were supposed to be used to repay margin loans. However, Marco believed that some of his clients wanted the proceeds to be reinvested. Marco charged a fee on the proceeds in the accounts.

The margin accounts also caused some time delays in calculating the asset value since Marco deducted the value before the liquidation was complete. That meant Marco undercharged for fees.

Given these problems, it should not be a surprise that the SEC found that Marco was mis-stating its assets under management in its Form ADV filings.

The net result of the over-charging and under-charging was a net negative to Marco according to the firm’s letter to its investor.

Even though Marco did not profit from its mistakes, it still made a mistake in calculating fees. This case shoes that the SEC expects advisory firms to be exacting when charging fees to its clients

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