TRID: The Reason I Drink

The Wall Street Journal dedicated some front page space to compliance professionals: Inside Enforcers Shake Up Bank Culture. It paints a stark picture of the regulatory pressure on banks.

private placement

There were many factors that lead to the 2008 Great Recession. Most people agree that a lack of oversight by regulators on the banks under their supervision contributed to the crash and the government bailout. The 2010 Dodd-Frank law was supposed to make the banking system safer than it was.

It has made banking harder and more complex.

Dodd-Frank was 200 pages of law that has lead to another 22,000 pages of regulatory requirements. Those requirements have spawned the fastest-growing component of the financial sector. Banks have hired tens of thousands of new compliance staff to implement and operate within in the new regulatory environment. The six largest U.S. banks spent at least $70.2 billion on regulatory compliance in 2013 which is double the $34.7 billion spent in 2007, according to a study by Federal Financial Analytics Inc.

Among the new federal banking regulations there is one that financial wonks call “TRID,” the TILA-Respa Integrated Disclosure rule.

Attendees at a recent training school here for bank compliance staff, who must learn and enforce such rules, said they deciphered TRID’s true meaning: “The reason I drink.”

According to the story, regulators sometimes struggle to decipher new rules the same way bank and their compliance professionals do. An interviewee discusses  a months long discussion between the bank and regulators over whether it should let customers pay ahead on mortgages. And if they did, would the bank consider borrowers delinquent if they later missed a month?

Another bank official noted  that it isn’t uncommon for regulators from different agencies to issue conflicting opinions. One of that bank’s regulators requested an exam.  Two weeks later, another regulatory agency requested an exam. The two regualtors came back with different results.

TRID

Sources:

Nuns With Guns: The Strange Day-to-Day Struggles Between Bankers and Regulators by Kristen Grind and Emily Glazer in the Wall Street Journal

Weekend Reading: Little Pink House

In 2005, the US Supreme Court was faced with a challenge on the “public use” provision of the Constitution’s eminent domain protection. We know the government can’t take private property without just compensation. The challenge was on the boundaries of the government’s intended use of that property. Kelo v. City of New London gave the government broad rights. It was Susette Kelo who was fighting the City of New London to save her little pink house.

kelo

Little Pink House is the story behind the Kelo. The City of New London wanted to take Ms. Kelo’s house and the rest of her neighborhood for redevelopment into an upscale hotel and retail area to complement a nearby redevelopment for Pfizer. Eighty-three property owners had agreed to sell. Ms. Kelo and six others would not sell and resisted the eminent domain action in the Fort Trumbull area.

New London was desperate for tax revenue. The city thought the renewal of Fort Trumbull could trigger a renewal not just of that small area, but the city as a whole. The redevelopment plan included residential units, a hotel and conference center, marina, offices, an expansive and public walkway along the river and most importantly, a new corporate campus for Pfizer. The governor was willing to invest state money to relocate an existing recycling business and to modernize the city’s stinky sewer plant. The government would remediate the brownfields and improve the areas infrastructure.

Little Pink House tells a one-sided view from that of Ms. Kelo. The officials of the local development agency are portrayed as evil single-minded, power-hungry schemers, willing to do anything to get their way. Even if the view is only half-correct, their actions were poor and they botched the process.

The City of New London eventually prevailed in its right to take private property for economic development. But that victory was lost in the storm of public opinion. Just because you can do something not mean that should it.

Pfizer’s buildings went up and the company stayed for 10 years. Then it left when the tax abatements expired. The buildings were valuable and General Dynamics stepped in and bought the complex for its submarine division.

As for Ms. Kelos house and her neighborhood, the re-development never came. Her lot on the corner of East St and Trumbull St is empty. The neighborhood is bulldozed waiting for development some day.

Compliance Bricks and Mortar for May 27

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

brick life determination

Up Close and Personal: Individual CCO Liability – Part I by Tom Fox in FCPA Compliance & Ethics

For when should a CCO have liability and should the regulators, whether in the financial services industry or in the broader anti-corruption world of the Foreign Corrupt Practices Act (FCPA), have such individual liability? While the financial services world is regulated by both the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) they have specific regulations requiring companies they regulate to have anti-money laundering (AML) compliance programs, the FCPA does not have any such requirements, either written directly into the statute or by interpretation therefrom. [More…]


Wall Street Crime: 7 Years, 156 Cases and Few Convictions by Jean Eaglesham and Anupreeta Das in the Wall Street Journal

The Wall Street Journal examined 156 criminal and civil cases brought by the Justice Department, Securities and Exchange Commission and Commodity Futures Trading Commission against 10 of the largest Wall Street banks since 2009. In 81% of those cases, individual employees were neither identified nor charged. A total of 47 bank employees were charged in relation to the cases. One was a boardroom-level executive, the Journal’s analysis found. [More…]


At Swinging Wall Street Parties, the Feds Are Now on the Prowl by Matt Robinson in Bloomberg

Like a skunk at a garden party, the SEC has been moving in on the fun-loving Wall Street conference circuit in hopes of getting a better handle on who’s up to no good in the world of finance. Officials scour attendee lists to spot the biggest players in advance and, properly wearing name tags, schmooze over drinks. Of course, they don’t accept any — that’s a no-no under SEC policy.
The SEC isn’t the only regulator trawling conferences for tips of suspicious conduct. The Commodity Futures Trading Commission was especially transparent about its intentions when it set up a booth in the middle of an industry gathering in March. Attendees at the opulent Boca Raton Resort & Club in Florida were greeted by smiling agency officials handing out metal whistles emblazoned with “CFTC” and mouse pads advertising their toll-free number.[More…]


GE Compliance Finds Simpler is Better By BEN DIPIETRO in the Wall Street Journal

Employees are much more likely to invest the time to read and interact with materials if they are short and simple and clearly written. In connection with our code, we dramatically reduced the length. That not only promoted readability but it helped us digitize the code, so the online version has becomes very popular with our employees, and this has been assisted by its brevity and clear messages. Simplification has allowed us to apply greater focus to how employees interact with the program. [More…]


The SEC, CCOs and Compliance Programs by T. Gorman in SEC Actions

Perhaps the final point is most important. The effective CCO must constantly be asking “What am I missing?” Stated differently, the system must, as the Guide notes, be constantly evaluated and updated. If that is done it can improve the functioning of the business. In addition, if an issue arises which comes to the attention of the SEC or another regulator, the organization will be able to follow the advise of Mr. Cohen – address the issue first by pointing to the effective compliance program of the organization; then discuss the question as an outlier rather than waiting to the remediation stage of the discussion to mention compliance as do many firms. That approach argues for a much more favorable outcome of the regulatory inquiry since compliance is a key question in any charging decision.[More…]


It’s No Accident: Advocates Want to Speak of Car ‘Crashes’ Instead By Matt Richtel in the New York Times

Roadway fatalities are soaring at a rate not seen in 50 years, resulting from crashes, collisions and other incidents caused by drivers. Just don’t call them accidents anymore.

In April, The A.P. announced a new policy. When negligence is claimed or proven in a crash, the new entry reads, reporters should “avoid accident, which can be read by some as a term exonerating the person responsible.”

[More…]


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New Anti-Money Laundering Rules

The U.S. Treasury Department’s Financial Crimes Enforcement Network’s new customer due diligence rule requires covered financial institutions to collect information on the significant beneficial owners of customers that are legal entities.

laundering dollar bills money

For a private fund manager, the rule is not explicitly applicable. The term ‘‘covered financial institution’’ refers to: (i) Banks; (ii) brokers or dealers in securities; (iii) mutual funds; and (iv) futures commission merchants and introducing brokers in commodities.

But I don’t think private fund managers should ignore the rule. FinCEN really wants to force investment advisers into an anti-money laundering regime. And it’s still illegal to do business with those people and companies on the blocked lists.

I look at the rule as a new standard or best practice.

The Final Rule requires each covered financial institution to verify the identity of each beneficial owner of an account using risk-based procedures to the extent reasonable and practicable.

There are two prongs to the definition of “beneficial ownership”:

  1. Ownership: An individual who directly or indirectly owns 25% or more of the equity interests of a legal entity customer.
  2. Control: An individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager or any other individual who regularly performs similar functions.

The first thing I noticed was the 25% threshold for ownership to trigger beneficial ownership. The release discusses this choice, noting that many comments proposed a 10% threshold.  FinCEN notes that 25% is the FATF standard.

FinCEN continues to believe that a 25 percent threshold strikes the appropriate balance between the benefit of identifying key natural persons who have substantial ownership interests in the legal entity and the costs associated with implementing this information collection requirement.

The release makes it clear that you can set a lower threshold, but the 25% is the maximum baseline.

Investment advisers and private fund managers can continue to argue that the KYC rules should not apply to them. But FinCEN’s response will be that you are supporting terrorism and drug lords by not implementing a program.

Sources:

Laundering Dollar Bills by TaxRebate.org.uk CC BY
https://www.flickr.com/photos/59937401@N07/5857345827/

Increasing the Threshold for Qualified Clients and Performance Fees

The U.S. Securities and Exchange Commission proposed to increase the net worth threshold for “Qualified Clients” from $2 million to $2.1 million.

money
Rule 205-3 currently requires “qualified clients” to have at least $1 million of assets under management with the adviser or a net worth of at least $2 million.

Under the Investment Advisers Act, an adviser can only charge a performance fee if the client is a “qualified client”. The SEC equates net worth with sophistication, so a “qualified client” had to have a level assets to prove their financial sophistication.

The Dodd-Frank Wall Street Reform and Consumer Protection Act required a change for Section 205(e) of the Advisers Act by adjusting the levels for inflation and to re-adjust the levels every five years. The SEC also tossed out the value of a person’s primary residence, just as they did with the accredited investor standards.

The last inflation adjusted increase was in 2011, so it’s time to adjust again.

Inflation has been low, so the increase is small. So small that the inflation increase for the $1 million assets under management prong is below the rounding amount specified in Rule 205-3.

So it’s time to revise you client intake / investor subscription documents.

Sources:

A Bad Bet On Insider Trading

The recent insider trading case against William “Billy” Walters of Las Vegas is fascinating for all of the players involved, including him. Plenty has been written about the charges because it implicates pro golfer Phil Mickelson and former Dean Foods board member Thomas C. Davis. All three are implicated in insider trading. How did they get caught?

roulette by Chris Yiu

It looks like the getting caught was relatively straight forward. Walters made big, obvious trades around earnings releases and major news for Dean Foods and Darden Restaurants. In June 2008, Walters bought more than 4 million shares, which represented between 29 and 37% of the daily trading volume in the company during his two day buying spree. In April 2010 Walters bought 19% to 21% of the trading volume during his short buying spree.

The SEC linked Walters to Davis. Since Davis was on the board of Dean Foods and Darden Restaurants he was the obvious source of information. According to The Wall Street Journal, Davis is cooperating with the government.

The case also implicated pro golfer Phil Mickelson. Mickelson made some big, obvious trades that would have attracted the attention of a compliance review. He bought a $2.4 million position in Dean Foods, while the rest of this trading account only had $250,000 in assets. He was not a frequent trader and had not bought Dean Foods before.

That they got caught is no surprise. Most trade monitoring programs would flag that activity.

What is a surprise is that Walters made such obvious bets on the market when he is well know for hiding his gambling bets. A story in ESPN tells all the steps he takes to hide his positions in sport betting. He uses runners to make bets so it does not look like his bets. He buys on the opposite side of a bet to better the spread. The story tells of other steps he takes to conceal his positions. According to the SEC, he failed to do so in his securities trades.

Sources:

Roulette by Chris Yiu CC BY SA

We The People

In We The People, Juan Williams tackles the history of the 20th century through the lens of some keys figures and tries to pin those societal changes back to the original thoughts of the founding fathers.

we the people

At first glance, it looks like Mr. Williams might use the ‘great man theory‘ of history. The people he picks are people who make important contributions to the United States in 20th-century America. But he does not deify them. Nor does he deify the Founding Fathers.

He uses each as a lens to elucidate some aspect of American life and how it has changed from the time of the Founding Fathers. In many respects, the US of 1900 was more like the US of the Founding Fathers than the US of 2000. In 1900, broad swaths of citizens could not vote because of the color of their skin or their gender because of the Founding Fathers’ stance on these issues. There was blatant discrimination on the basis of race, country of origin, gender, and religion. Those issues have not gone away, but are less blatant than in the past. Transportation and long distance communication were rudimentary at best. Now we can be halfway around the world in less than a day and immediately talk with anyone near a phone or internet connection.

We The People uses key figures to show the changes in particular areas of US society. In some cases, Mr. Wiliams does so brilliantly and in others, less so. Some of the up and downs of the book depend on the people selected and topic that involves them in each chapter. Given the vast number of topics Mr. Williams tries to cover, each chapter is a mere vignette. Many times it leaves you wanting more.

Juan Williams is a thoughtful journalist. There are not many who can work NPR and for Fox News.  When the publisher offered me a copy in exchange for a review, I took the offer.

Compliance Bricks and Mortar for May 20

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

Bricks and Bikes


Compliance Goes to School by Geoffrey Parsons Miller

In my view there is no one “right” answer to the question of where compliance fits in a law school’s curriculum, just as there is no “one-size-fits-all” compliance program. A good model, however, is that core concepts can be taught in a first-year or second-year class on the administrative state (a number of law schools already include a required class on the administrative state as part of their core curricula). Compliance could then be offered as a second-year or third-year class. [More…]


Check Your Use of “Check the Box” by Adam Turteltaub in SCCE’s Compliance Ethics Blog

But for all the talk about avoiding “check the box” compliance programs, I wonder how many of them there really are. I also wonder if we’re doing ourselves more harm than good by suggesting that the business world is full of “check the box” programs. Also, I’m not sure how to create a “check the box” program, given how complex some of the boxes are.[More…]


SEC $3.5 Million Mystery Whistleblower Reward by Matt Kelly in Radical Compliance

We received another glimpse into the Securities and Exchange Commission’s thinking about whistleblowers on Friday—although as usual with SEC, details are sketchy and the primary thought is “we support whistleblowers as expansively as possible.” Compliance officers, take note.

The glimpse came in the form of a $3.5 million whistleblower reward issued on Friday. To whom? We don’t know. Against what firm, or for what type of misconduct? Unclear. Apparently, the media had already reported on potential misconduct at the company (yay media!) and the SEC had already opened an investigation. That led the whistleblower to provide his own information about said misconduct.

[More…]


What’s up with Crowdfunding? So far, not much (but a fix may be coming) by Robert C. White Jr. in Securities Edge

The main problems with the new crowdfunding regulations are practical ones. First, the funding limit of $1 million each year is just too low for most companies. This is similar to the problem that we saw with Regulation A for a long time – essentially no one used it because the limit was too low in relation to the costs (although the old Regulation A limit was $5 million, substantially higher than the current crowdfunding limit). Regulation A+ has fixed this problem for Regulation A offerings, but the low limit remains a huge challenge for crowdfunding offerings. This low limit problem is made worse by the costs associated with a crowdfunding offering, which will be substantial for a small company. Legal and accounting work will be required. Companies must also use a registered funding portal in connection with the offering, and this will add to the cost burden. Finally, companies cannot “test the waters” before beginning an offering to see if the offering is even viable for them. The combination of all of these factors creates significant practical roadblocks for crowdfunding that cannot be overcome without some adjustments (as discussed below). [More…]


WHY YOUR COMPANY SHOULD HAVE ZERO TOLERANCE FOR ZERO TOLERANCE BY ROBERT ZAFFT

For corporate compliance purposes, however, “tolerance” does not mean a lack of standards or failure to impose consequences for failing to adhere to standards. Rather, “tolerance” needs to be understood in an engineering sense, meaning an essential part of businesses processes and cultures that are dedicated to continuous improvement. As these processes and cultures improve – as they become more transparent and consistent – the degree of “tolerance” will narrow. [a href=”http://corporatecomplianceinsights.com/company-zero-tolerance-zero-tolerance/”>More…]


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Cybersecurity: a growing risk imperative #CFOandCOO

I’m attending the PERE CFOs & CCOs Forum. These are my notes from the session.

PERE

On a scale of 1 to 5 the attendees created a classic bell curve on how confident we felt about our cybersecurity programs, with most choosing “3.”

The panel labeled social engineering as the upcoming threat. There were several stories of fake invoices coming from outside the firm, spoofed to look like it was coming from within the firm. The other example was malware injected into the it system by a junior person opening a malware file sent through email.

Cybersecurity should be part of the regular compliance training. Focus spoofing and phishing prevention training on those who can move funds or authorize funds to move.

Cybersecurity is now a common item on SEC exams. Be ready to answer questions.

Hackers tend to be opportunistic. They need to see a weakness or they are more likely to move on to another target. The scary problem is when our firm is specifically targeted.

The panelists seem to have some strict rules on the use of personal email. The challenge is that younger workers are used to collaborative tools and easier access to information.

For mobile devices, the standard is to be able wipe the phone remotely in case it is lost to keep information secure. Make sure everyone knows to quickly report a lost phone.

Cybersecurity is part of fundraising. It is a very common item on investors’ due diligence questionnaires. Although probing beyond the questions tends to be limited.

Cyberinsurance is becoming more common. The coverage is expanding. It covers losses. It does not necessarily cover all of the incident response.

An Update from the SEC #CFOandCOO

I’m attending the PERE CFOs & CCOs Forum. These are my notes from the session.

PERE

Bruce Karpati interviewed Igor Rozenblit, Co-head of the Private Fund Unit at OCIE, Securities and Exchange Commission. Of course, Igor’s views are his own and do not necessarily reflect the views of the SEC or the Commissioners.

Prior, when Bruce was at the SEC he interviewed Igor and hired him to join the SEC.

Igor’s group audits industry participants. A different group is responsible for making regulations and the enforcement unit is responsible for enforcement. Igor helps to train examiners so they know the difference between property management and fund management.

Real estate is a small portion of the SEC’s oversight. Hedge funds and private equity funds and managers are more numerous than real estate. They see more complexity and more conflicts with real estate managers.

They just completed a real estate initiatives focused on value-add and opportunity funds. It is still continuing. Some of the concerns.

Undisclosed related party vendors is the first. He mentioned spinoffs of managers units and then having the manager engage that unit as a fund expense.

Partially disclosed is next. The manager discloses the relationship, but not the full scope of expenses.

Market-rate. He has not had an exam where the market rate was supported. They have found managers with counter-support. The manager charges less to third-parties than to the fund. He offered no specific way to prove market rate to the satisfaction of the SEC. His recommendation was third-party market surveys.

Chargebacks should have three components. First is clarity about what is charged to the fund. The SEC views ambiguity against the fund manager. The default should be to the benefit of the investor.

In-house legal expenses charged to the fund are a noted problem. The fund documents typically provide for the fund pay legal expenses, but the manager to pay for personnel expenses. Igor’s position is that the in-house legal should be a manager expense unless explicitly provided in the fund documents.

The second is comprehesiveness of disclosure. It needs to be broader than just to the Advisory Board.

The third is timeliness. Disclosure after the fund closes is insufficient.

Valuation is a key focus. Real estate is the classic hard to value asset. The SEC is looking for a good process and not a single person controlling the valuation. Lots of review and approval is good in the eyes of the SEC.

One evolving area is fund managers controlling assets moving from fund to fund for distressed debt. It intertwines the manager on both sides of the transaction and has a valuation issue.

There are 500 SEC examiners focused on asset management. There is a variation among regions and among the different examiners. Igor’s Unit plays a key role in targeting managers for examination.

Onsite will vary depending on location and complexity. Typically it lasts a week. Then it continues back in the office with SEC likely asking follow-up questions and asking for more documents.

To prepare for an exam, Igor thinks you take a holistic approach and identify risks ahead of time. Make sure you are aware of them and are dealing with them.

Intangibles during the exam are key. Do not be combative. Be likable. Do not try to hide something, DO not look like you are trying to hide things.

He does not think the speed of document production is key, accuracy is more important.

Looking for fraud is what they do. The exam can turn investigative if the examiners finds problems.

How to avoid enforcement? Stealing money gets you in enforcement. Units may be looking to send a message to the industry and can use enforcement to do so.

Igor expects the CCO will quarterback the exam and the CFO will have a big role addressing the finance function.

There are few options for fixing SEC discovered conflicts in closed funds. One solution is approval of the advisory board if the fund documents allow the board to approve conflicts. Otherwise it requires changes to fund documents.

Igor noted that the Investment Advisors Act’s anti-fraud provisions have applied to fund managers regardless if they are registered. It’s just the post-Dodd-Frank registration that has given the SEC the ability to exam registered real estate fund managers and given the SEC more insight into the industry.

The use of joint ventures is a point of focus for the SEC. The SEC is concerned about potential conflicts in the relationship. IN particular if senior management of the fund manager has other business relationships with the joint venture partner.

Igor has found that outsourced compliance is not doing the robust job the SEC expects. He noted an outsourced CCO who did so for several dozen firms. Of course, the expense needs to be determined as to whether it is a fund expense or a manager expense.

Make sure you are treating your investors fairly.

Even a sophisticated investor can not detect that it is being charged more than bargained for if the investor does not have access to the information.

Why is valuation important when fund managers are not paid on unrealized gain. One is the use of higher valuations in marketing. The second is in taking a deal-by-deal promote based on the higher valuation.

Cyber risk is important for real estate fund managers. Don’t let hackers get at your stuff.