Compliance Bricks and Mortar for July 29

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After the picture, back to compliance…

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


The Real Value of Lawyers to Compliance by Michael Volkov in Corruption, Crime & Compliance

The most effective compliance programs usually are built around a strong partnership between a chief compliance officer and a general counsel. They are natural partners, assuming that egos do not get in the way, and should work together to advance the company’s compliance program. Lawyers have two very specific benefits that should be incorporated into an effective compliance program. [More…]


How Con Artists Manipulate Your Emotions in Genius (and Evil) Ways by Maria Konnikova in bigthink.com

The Ben Franklin effect is an oddly simple phenomenon. It was first discussed, as one could guess, by the man himself in his autobiographical writings. Benjamin Franklin used it on legislators that he was at odds with, to make them be more kind to him. [more…]


Why Your Compliance Officer Should Talk About Texting by Margaret Scavotto, JD, CHC in SCCEs The Compliance Ethics Blog

A growing number of corporations are establishing social media policies. This trend is particularly salient in the healthcare industry, where employee social media posts can violate HIPAA. The news abounds with stories of tweets, Facebook posts, and Snapchats taken in hospitals and nursing homes, many posted inadvertently, which raise both HIPAA issues and patient dignity concerns – two high priority items for any compliance officer. These social media policies can also be used to address employee texting, which can lead to similar violations. [More…]


A Ponzi Scheme Where One Investor Directly Paid Another by T. Gorman in SEC Actions

In the typical Ponzi scheme unscrupulous individuals induce investors to part with their cash based on a series of misrepresentations about the proposed investment. The investor money is then in part misappropriated and in part used to repay other investors in an effort to perpetuate the scheme. In the Commission’s latest Ponzi scheme case however, the alleged fraudster induced investors to repay other investors directly. [More…]


The Rise of the Professional Whistleblower

With the proliferation of whistleblower regimes at regulatory agencies we should not be surprised that there are professional whistleblowers.

state street

The Securities and Exchange Commission gave its blessing earlier this year when it granted a whistleblower award to a company outsider.

This week the SEC and the DOJ announced a half billion dollar settlement with State Street for overcharging its customers on foreign currency trades. As part of its custody bank line of business, State Street offered indirect foreign currency exchange trading for clients to buy and sell foreign currencies as needed to settle their transactions involving foreign securities. State Street misleading its custody clients about this service by telling them that it provided “best execution,” or charged “market rates” on the transactions. In practice, State Street set prices largely driven by predetermined, uniform markups and made no effort to obtain the best possible prices for these clients.

FX trading had been a very lucrative area because the pricing was opaque.  It seems a little obscure for the SEC to find this nugget of compliance failure.

Apparently it didn’t find it. The SEC was apparently alerted by Harry Markopolos.

That’s the same Harry who rose to fame for writing letters to the SEC about Madoff. Harry has become a professional whistleblower. Harry has been helping State Street’s clients sue the firm to recover the FX overcharges. He comes with a big name after riding on the glory of his Madoff exploits.

I would guess that we will see a growing number of firms offering services to whistleblowers.

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If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer on August 5-7. 100% of your donation goes to the fight against cancer. You can read more and donate here: http://profile.pmc.org/DC0176

Rethinking Your SEC Introductory Presentation

I was chatting with a compliance examiner from the Securities and Exchange Commission and heard that the format for private fund exams had changed.

SEC Seal 2

Given the complexity and diversity of business models for private funds, the SEC is trying to narrow the scope of its examination. Presumably to help in that effort, the SEC examiners are conducting a lengthy introductory call before they begin document requests and on-site review.

Expect an introductory call to last a few hours. The examiners will expect some members of senior management to be involved in all or a part of the call.

It sounds like the first contact from the SEC for an exam will be call to set up that introductory call. I did not hear a time frame for how far out the SEC will be willing to schedule the introductory call from the initial call.

This is a relatively new change and may not be true of all SEC offices.

I would guess that this introductory call may replace the Day One presentation for SEC examiners. I have been an advocate of having this presentation ready all the time for your firm and updating it periodically.

I expect there is still a place for that Day One presentation. It will be done on a phone call instead of in person. Perhaps the examiners will be open to the firm sending a copy of the powerpoint to help walk through the firm’s particular business plan, structure and compliance.

Even if the examiners don’t want a powerpoint during the call or toss it aside to ask questions during the call, the Day One Presentation is still a useful framework for senior management.

Cycling and the Securities and Exchange Commission

The big news in cycling over the weekend was the end of the Tour de France. Other news is a personnel change at the Securities and Exchange Commission because of cycling.

sky and froome

Chris Froome and his Team Sky dominated the General Classification of the Tour de France. He finished more that four minutes ahead of his nearest rival. He took the yellow jersey and the initial time advantage in an unusual manner. He attacked at the top of a big climb while his rivals paused. He was gone before they realized what happened. In a later stage he gained more time in an unusual attack paired with Peter Sagan, the holder of the sprinters’ green jersey, and two teammates when crosswinds fractured the peloton. In the usual manner Froome gained time on his rivals in the time trials and held off their attacks in the mountains using his incredibly strong team.

For the SEC, the Chief Accountant, James V. Schnurr, was in a serious bicycle crash. Serious enough that the SEC appointed Wesley R. Bricker as the Interim Chief Accountant.

I was disappointed that the SEC chose to use the word “accident” in the press release. Accident applies that there was no fault and perhaps was not preventable. Unfortunately, I was not able to find a news story about the crash.

As someone who regularly bikes to work, I can tell you that there are few accidents. Of course there are cyclists breaking the law. (I still don’t understand why so many run red lights.) But a bike is going to little damage if it crashes into a car. A car will do tremendous damage if it crashes into a cyclist.

I see many, many distracted drivers while on my bike commute: watching videos, texting, emailing, facebooking, catching pokemons. They seem oblivious that they are directing 3000 pounds of metal with potentially deadly force.

It’s not an “accident” when the driver has chosen to be distracted. “I didn’t see him,” is more often because the driver chose to pay attention to some other distraction instead of the other cars, cyclists and pedestrians in and around the roadway.

I hope you are not one of those distracted drivers.

On a happy note, this is one of the great watercolors by Greig Leach for sale at The Art of Cycling. This one captures the battle of sprinters at the end of stage 3. But you’ll have to pick one of the other watercolors because this one is in my living room.


If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer on August 5-7. 100% of your donation goes to the fight against cancer. You can read more and donate here: http://profile.pmc.org/DC0176


Photo Finish in Angers small

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Weekend Reading: Bluff

The mystery of the Federal Reserve leaves people wondering if it’s controlled by the mysterious Illuminati, corrupt politicians, or fat cat bankers. And it leaves people wondering what exactly it does, or not care and demand an audit. If you believe any of the foregoing then Bluff by Anjum Hoda is not the book for you.

bluff

Bluff is a deep dive into macroeconomic theory and monetary policy. It’s sharply written and easy to read, assuming you have some basic understanding of the subject.

The books focuses on the split requirements of the Federal Reserve. The primary role is monetary stability. We all want that dollar in our pocket to be worth a dollar. We want to be able to buy something tomorrow. We accept that it will cost a little bit more next year. We accept a small amount of inflation. Nobody wants high inflation. Nobody want to have to use a wheelbarrow full of dollars to do our shopping.

The other mission of the Federal Reserve is to pursue  full employment. It’s this one that causes the problems according to Ms. Hoda.

To her, the Federal Reserve’s “bluff” is to pump of asset values pre-emptively to boost economic growth by lowering interest rates. The magic formula is let assets slowly while wages move on the same path.

The problem is that the Fed gets caught in a bad place when it misses an asset bubble that develops from low interest rates. If the Fed raises rates and pops the bubble, it may burst before wages caught up and send wages back down.

The problem is that artificially lower rates are not boosting economic activity. In the first half of 1999, the Fed lowered rates dramatically after the Asian Flu. Non-financial corporations issued debt with gusto to buy back their own shares. In the years that followed, debt issuance  and stock buybacks diminished. Cheap debt is more likely to raise asset prices than to  increase employment.

The goal of the Fed is to program a small bit of inflation into the economy. Ms. Hoda’s proposal is to reduce that to a zero inflation policy.

It’s worth the price of the book. For me the price was zero since the publisher sent a copy to me for review.

 


If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer on August 5-7. 100% of your donation goes to the fight against cancer. You can read more and donate here: https://www2.pmc.org/egifts/DC0176

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Compliance Bricks and Mortar for July 22

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

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World’s 20 biggest banks rack up £252bn ‘conduct costs’ in five years by Sean Farrell in the Guardian

The cost of fines, legal bills and customer compensation racked up by the world’s 20 biggest banks over the five years to the end of 2015 amounted to £252bn, according to new research. So called “conduct costs” for the 20 banks rose 4.1%, or £10bn, compared with the previous rolling five-year period, 2010-2014. UK-based financial institutions Lloyds Banking Group, Royal Bank of Scotland and Barclays accounted for £11.3bn of extra costs while charges at five other banks fell. [More…]


Adding ‘father-son’ to the Familial Betrayal list by Bruce Carton in Compliance Week

A review of the Familial Betrayal archives here at Enforcement Action shows that we have not chronicled any father-son betrayals to date. We do, of course, have almost everything else, including husband-wife (and wife-husband), father-daughter, brother-sister,boyfriend-girlfriend, brother-in-law betraying brother-in-law, divorcee betraying divorcee.  [More…]


In Properties Targeted in 1MDB Case, a High-End House Tour by Hannah Karp and Peter Grant in the Wall Street Journal

The properties allegedly bought with funds misappropriated from a Malaysian investment fund would make for a stunning house tour of high-end real estate in New York and Los Angeles. Besides flashy real estate, the U.S. government alleges that money from the fund, known as 1Malaysia Development Bhd. or 1MDB, was used to buy a $35 million private jet and a stake in EMI Music Publishing.[More…]


Nations of the World Confront the Pokémon Menace by Karen Zraick in the New York Times

Indonesian officials also called it a national security threat that could allow its enemies to penetrate military sites and gain access to top-secret data. On Monday night, a French citizen working in Indonesia was temporarily detained after stumbling onto the grounds of a military base in West Java Province while searching, he said, for Pokémon figures. [More…]


There are two weeks to go. If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer on August 5-7. 100% of your donation goes to the fight against cancer. You can read more and donate here: http://profile.pmc.org/DC0176

I was biking all winter to stay in shape for this ride.

bike snow

Vice Presidents and the Pay to Play Rule

The Securities and Exchange Commission limits the ability of investment advisers and fund managers from contributing to certain politicians that can influence investment decisions for state pension funds. Under Rule 206(4)-5, you can contribute up to $150 to any candidate or up to $350 if you can vote for the candidate.

trump[ pence

Mike Pence is the Governor of Indiana. In that role he appoints members to the state pension boards and can influence their investment decisions. He meets the definition of “covered official” under the rule for those pension plans. Therefore, contributions to Governor Pence are subject to the SEC rule.

Since Governor Pence is running as the Republican Vice Presidential candidate, contributions to the Republican presidential campaign are limited by the SEC rule. He has not resigned as governor.

If you have an Indiana state pension fund as a client or an investor. You are not allowed to contribute more than $350 to the Republican presidential campaign. If you hope to have one as an investor or client, you should not make a contribution. The limitation applies for two years after you make the contribution.

Violating the rule means you can’t collect fees from that state pension fund for two years. It does not matter if the violation is unintentional.

The limitation applies to “covered associates” at the investment adviser or fund manager so it may not apply to all of the firm’s employees. But you need to be careful.

The Democratic Party has not yet picked a Vice-Presidential candidate. The SEC Rule may or may not apply depending on the selection.


If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer on August 5-7. 100% of your donation goes to the fight against cancer. You can read more and donate here: https://www2.pmc.org/egifts/DC0176

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SEC Exam Results

Securities and Exchange Commission Examiners are beefing up their staff and are more likely than ever to show up on your doorstep. So what are the likely outcomes?

SEC Seal 2

The SEC recently announced that it’s shifting resources from the broker-dealer side over to the investment adviser side. It’s leaving the broker dealers for FINRA and putting those examiners on investment advisers and fund managers.

As a CCO you need to prepare senior management for a poor or bad outcome. That is the most likely end result of an exam.

Only 4% of examinations will result in a “no further action” letter or “no comment” letter. These letters do not say that the firm is okay. They merely say the exam didn’t find anything that requires further action.

That means 96% of exams result in the SEC finding something wrong and requiring you to make changes.

A little over 20% of exams result in referral to enforcement. That is obviously a bad outcome and your lawyers will likely get involved.

In about half of those referrals, the enforcement staff begins an investigation. You will definitely need your lawyers in this situation.

When the exam staff come to your firm, there is 1 in 10 chance that you will have to lawyer up.

Of course, the exam staff does not come to every firm. They have a algorithm that rates the risk at each firm. The exam staff culls through the list of possible firms to examine and decides to exam those that seem higher risk or meet the criteria for a particular initiative.

Real estate fund managers were in the crosshairs of the exam staff last year and the year before. Expect to see some enforcement actions coming as those firms work through the process at the bad end of the exam results.


If you enjoy Compliance Building, please support my Pan-Mass Challenge ride to fight cancer on August 5-7. 100% of your donation goes to the fight against cancer. You can read more and donate here: https://www2.pmc.org/egifts/DC0176

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Share Class Initiative

If your firm receives revenue from the sale of funds, be sure you have procedures in place to avoid placing clients in a more expensive share class when a cheaper one is available. The SEC announced a new Share Class Initiative for 2016.

There are two main areas where an adviser will have conflict in this area.

  1. A firm where the adviser is also a broker-dealer or affiliated with a broker-dealer that receives fees from sales of certain share classes
  2. Situations where the adviser recommends that clients purchase more expensive share classes of funds for which an affiliate of the adviser receives more fees.

Those are obvious situations where the adviser has a conflict.

The alert highlights the March action against Everhart Financial Group. The firm was collecting 12b-1 fees from mutual funds that it directed its clients to buy. The firm failed to disclose that it was collecting those fees. The firm later revised its advisory agreements and stated:

EFG’s representatives “may receive 12b-1 fees from certain mutual funds… . Receiving 12(b)-1 fees represents an incentive for a registered representative to recommend funds with 12(b)-1 fees or with higher 12(b)-1 fees than funds with no fees or lower fees.”

Disclosure did not seem to be enough. EFG did not present its clients with information on funds that did not pay 12b-1 fees to the firm. It did not seem to have a good basis for when it would chose a fund with a fee and when it would not. There was no procedure for discussing cheaper class funds with clients. This was a best execution failure.

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Tesla, Self-Driving Cars and Compliance

Tesla Motors is under investigation by the Securities and Exchange Commission for failure to disclose that one if its car crashed while in self-driving mode. The question is whether whether Tesla should have disclosed the accident as a “material” event: a development a reasonable investor would consider important. That opens a bigger question about the nature of driving.

red-tesla-model-s

Take a look at the IIHS Fatal Crash data:

There were 29,989 fatal motor vehicle crashes in the United States in 2014 in which 32,675 deaths occurred. This resulted in 10.2 deaths per 100,000 people and 1.08 deaths per 100 million vehicle miles traveled. The fatality rate per 100,000 people ranged from 3.5 in the District of Columbia to 25.7 in Wyoming. The death rate per 100 million vehicle miles traveled ranged from 0.57 in Massachusetts to 1.65 in South Carolina.

Humans are far from perfect and we do a fine job of killing ourselves behind the wheel. The fatality rate has improved over the last near century of car use.

USA_annual_VMT_vs_deaths_per_VMT

The red line of deaths per mile travelled is flattening out, indicating to me that we can not eliminate fatal car crashes. Humans are not perfect.

Self-driving cars will not be perfect. There will still be crashes and there will still be fatal crashes. The big question for self-driving cars is whether they will do better than humans at keeping ourselves alive behind the wheel.

In looking at the SEC inquiry, the question is whether the fatal crash was a material event that should have been disclosed.

According to Tesla’s news release their cars have driven for 130 million miles on Autopilot and this is the first death. That’s a rate of 0.77 deaths per million miles driven.

According to that IIHS data, that rate is less than the nationwide average of 1.08 deaths and less than the Florida average of 12.5 deaths.  At least statistically, it does not seem material to investors. (It’s obviously very material to the family and friends of the crash victim.)

Google cars have driven more than 1.3 million miles since 2009. Those cars have been in at least 18 crashes, 17 of which were blamed on other drivers.

Can self-driving cars do a better job than humans?

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