Post Debate Campaign Contributions and the SEC

With the first of the presidential debates over, I thought it would be a good time to refresh myself on the SEC’s limits on political campaign donations by investment advisers. SEC Rule 206(4)-5 was put in place to limit political influence on government pension plan investment choices.

candidates

Under the rule:

1. All political campaign contributions should be reported.
2. Employees can contribute up to $150 to any candidate.
3. Employees can contribute a larger amount to certain candidates after checking make sure it does not violate the SEC rule.

Number three is the tricky part.

SEC regulations limit the ability of certain employees at an investment adviser from donating to candidates who could influence the decision-making of a state or local government retirement plans if you want that plan as a fee paying client.

You need to figure out which employees are subject to the rule. That’s what led to Goldman Sachs banning all contributions by the firm’s partners. The rule is unclear on which employees of an adviser are subject to the limitation. It’s clear that the very top and fundraisers are included. It’s clear that administrative staff are excluded. Then there are a lot employees in the grey area.

Then you need to figure out which political offices actually influence the decision-making of state or local pension funds. In most states that is the political offices appoint officers or trustees to the state fund’s board. Generally, that sweeps up the governor and treasurer. Good luck figuring out how that works with local boards.

You get really tough ones like Pennsylvania State Employees’ Retirement System. Two members are appointed by the President Pro Tempore of the Pennsylvania Senate and two members are appointed by the Speaker of the Pennsylvania House of Representatives. Those positions are voted on by the Senators and Representatives, not the general public. So I think every state Senator and Representative in Pennsylvania is affected by this rule since any of them could end up in that position.

Back to the major party presidential candidates and the Rule’s impact:

Clinton – Kaine: Neither of them are in an office that would be limited by the SEC rule.

Trump-Pence: Because Mr. Pence is the governor of Indiana, contributions to this campaign are limited by the SEC.

For those of you looking further down the ballot:

Johnson-Weld (Libertarian Party): Neither is currently in an elected office so contributions are not limited. Both were governors and would have been limited in those offices.

Stein-Baraka (Green Party): Neither is currently in an elected office so contributions are not limited.

Castle-Bradley (Constitution Party): Neither is currently in an elected office so contributions are not limited.

The effect of SEC Rule 206(4)-5 is to limit donations to the Trump campaign. CCOs across the country are telling their employees they can contribute fully to the Clinton-Kaine ticket but are limited in donating to the Trump-Pence ticket.

Personal Benefit in Insider Trading

While Mr. Cooperman was accused of making millions on insider trading. Sheren Tsai made $23,914.41 on her illegal trades. The relatively small amount of the gains caught my eye in the press release, but a particular line in the pleadings made me think it was worth highlighting.

Ms. Tsai was (is?) in a romantic relationship with Colin Whelehan.  Both worked at different investment advisory firms. Mr. Whelehan was involved in a significant corporate event. He told this material non-public information to Ms. Tsai. She bought stock in the target company and made the above-mentioned $23,914.41 in profits.

The pleading that caught my eye was the statement about personal benefit:

“25. As a result of his tip, Whelehan received a personal benefit in the form ova gift to his closest personal friend, his live-in girlfriend and romantic partner, Tsai.”

Clearly, the SEC is trying to sort the law out in the post-Newman world.

Then there is the insider trading catch.

Ms. Tsai’s compliance group noticed the trades in her account. Clearly it looked strange to have the purchase so close to the announcement and spike in price. Most insider trading platforms will flag that trade.

The compliance group also had Ms. Tsai’s emails. Mr. Whelehan had sent an email from his work email to her work email  writing in part:

“one of Apollo’s portfolio companies would be buying out ADT.”

Ms. Tsai later sent a message using her work email

“So when is it [target’s stock price] going to BOUNCE”

Both had compliance training and knew about insider trading. They are caught as about red-handed as you can get for insider trading.

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Is Cooperman The New Cuban?

The Securities and Exchange Commission brought charges against Mark Cuban for insider trading. The SEC claimed he was an insider based his status as a big shareholder in the company or that he had agreed to not trade on material non-public information disclosed to him.

The SEC brought charges against Leon Cooperman for trading on material non-public information. The SEC is alleging that Cooperman used his status as a big shareholder in Altas Pipeline Partners to obtain confidential details about an upcoming company transaction.

According to the SEC complaint, an executive at Atlas Pipeline shared confidential information with Cooperman believing he would keep in confidential and not trade on that information. That seems a lot like the Cuban facts.

The SEC alleges that the Cooperman explicitly agreed to not use the information to trade. Going back to the Cuban case, he never agreed to keep the information confidential.

The trading activity outlined in the SEC order shows Cooperman making a huge bet on Atlas Pipeline. At one point his activity was 95% of the daily volume of trading on a set of Atlas Pipeline call options.

It looks there was a parallel action of criminal charges. But the Newman case from the Second U.S. Circuit Court of Appeals sets a standard that a recipient of an inside tip must know the confidential information came from an insider and that the insider disclosed the information for a personal benefit.

The Salman case is before the Supreme Court and is looking at the Newman standard for criminal insider trading.  If that standard is upheld, it seems unlikely that Cooperman would be in an orange jumpsuit. According to reports, the DOJ has suspended its investigation into Cooperman until the Salman case is decided.

The civil charges from the SEC is based on misappropriation so it does not need to prove that the tippee received a benefit.

It seems like the case will hinge on the credibility of the Atlas Pipeline executive. That executive is not named in the complaint.

Assuming the SEC case passes the credibility standard, it will need to prove the legal standard that Cooperman’s trading should be illegal.

Given the recent history of the SEC bringing cases in front of its own administrative judges, this case was filed in federal district court.

I see two likely reasons. Cooperman demanded this venue in exchange for agreeing to the tolling of the statue of limitations. (The trading happened in 2010.) Or, the SEC is looking to set legal precedent.

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Compliance Bricks and Mortar for September 23

We have passed the Autumnal equinox and are heading into the dark nights of winter. Maybe some of these of compliance-related stories will keep you awake during the longer nights.

Bricks Boston 1


Why Don’t General Counsels Stop Corporate Crime? by Sureyya Burcu Avci and H. Nejat Seyhun in the HLS Forum on Corporate Governance and Financial Regulation

Evidence shows that in spite of these reforms enacted in SOX and explicit provisions and responsibilities given to corporate attorneys, most of the whistle-blowing in case of corporate fraud comes from employees (17%), non-financial market regulators (13%), and media (13%). [3] Clearly absent from this list are top in-house corporate counsels (GCs). In this paper, we investigate the potential reasons for the failure of corporate counsels to report and prevent corporate crime. [More…]


Ex-official at SEC says whistleblowers do crucial work by Gretchen Morgenson

McKessy said that whistleblowers under the SEC’s program had prospered because the SEC guaranteed anonymity to those who come forward. “The SEC’s devotion to maintaining the confidentiality of whistleblowers is the biggest factor in the program’s success,” he said. [More…]


SEC delivering on promise to scrutinize private equity firms by Todd Ehret, Regulatory Intelligence in Reuters

Assets under management by PE managers grew to $700 billion in 2000 thanks to the technology and dot-com boom. They have now swelled to more than $4.2 trillion according to the 2016 Preqin Private Equity Report. This tremendous growth in assets now dwarfs total hedge fund assets of approximately $2.8 trillion.

This industry largely went unregulated until the passage of the Dodd-Frank Act in 2010 which required PE and hedge fund managers to register by 2012. Two recently settled enforcement actions involving prominent PE firms added to the growing list of PE managers tripped up by the U.S. Securities and Exchange Commission’s (SEC) probe into PE firms. This, along with a handful of other expensive SEC settlements, and prominent public warnings by regulators to the industry are noteworthy and prompted our review below. We also highlight the top areas of concern and offer some suggestions. [More…]


Andrew Weissmann On The FCPA – It Is “Very Easy For The People At The DOJ And SEC To Basically Impose A Tax For Doing Business” In Certain Countries by the FCPA Professor

FCPA Professor was the first to highlight the seeming irony when vocal FCPA enforcement critic and reform advocate Andrew Weissmann was selected to head the DOJ’s fraud section in January 2015 and how Weissmann should have stayed true to his former self when unveiling the DOJ’s “FCPA Pilot Program” in April 2016.

Weissmann’s prior positions on the FCPA are nicely captured in a 2010 panel event in which he speaks at great length regarding various aspects of the FCPA. [More…]


 

Auditor Independence Enforcement Actions

The Securities and Exchange Commission announced its first enforcement actions for auditor independence failures. I expect your auditors may have a bunch of new restrictions and questionnaires when it is time for the annual audit.

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The SEC announced two separate enforcement actions, both involving Ernst & Young.

In one case, Gregory S. Bednar got too cozy with a audit client’s CFO. Bednar and the CFO stayed overnight at each other’s homes, took family trips together and they exchanged hundreds of personal messages.

In the other case, Pamela Hartford violated the auditor independence rule by having a romantic relationship with an executive at an audit client.

According to the SEC’s orders, Ernst & Young required audit engagement teams to follow certain procedures to assess their independence. They asked employees if they had family, employment, or financial relationships with audit clients that could raise independence concerns.  The SEC says that is not enough. Apparently the SEC is expecting a broader question about “non-familial close personal relationships” that could impair the audit firm’s independence.

Ernst & Young’s independence policies “recognized that a non-familial close personal relationship between an engagement team member and a client employee in an accounting or financial reporting oversight role could present an independence problem”.  But the firm had no procedures to identify those relationships and whether a relationship could jeopardize independence.

I expect that audit firms are going to broaden their independence questionnaires. I expect some of the questions and responses could be quite awkward.

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Picture of Family Travel is by  www.traveloscopy.com
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Bad Boys The SEC is Coming For You: Supervision Initiative

The SEC’s Office of Compliance Inspections and Examinations’ 2016 Examination Priorities included a focus on individuals with a history of disciplinary events. That priority has been put into action. The SEC issued a new Risk Alert on upcoming examination.

OCIE is undertaking an initiative to examine the supervision practices and compliance programs of registered investment advisers that employ individuals with a history of disciplinary events in the financial services sector. OCIE is calling the new initiative: the “Supervision Initiative.”

Okay so the name is a bit ambiguous. I suppose I may be the only one that it is looking for more interesting names:

  • Downed Hawks
  • Bad Boys
  • Operation Tiger Pit

The Supervision Initiative likely means that firms with bad boys and women are more likely to be subject to examination.

The Supervision Initiative examinations will assess such advisers’ business and compliance practices related to the firms’ supervision of higher-risk individuals in four areas:

Compliance Program “An important component of the examinations is to evaluate whether the advisers foster robust compliance cultures and tone at the top. The tone at the top is critical to setting the ethical environment of the organization and preventing misconduct.”

Disclosures. “Examiners will likely review registered advisers’ practices regarding their disclosures of regulatory, disciplinary, or other actions with a focus on assessing the accuracy, adequacy, and effectiveness of such disclosures.”

Conflicts of Interest. “Particular attention will be given to conflicts that may exist with respect to financial arrangements (e.g. unique products, services, or discounts) initiated by supervised persons with disciplinary events.”

Marketing “Examiners will review a registered adviser’s advertisements including pitch-books, website postings, and public statements to identify any conflicts of interests or risks associated with supervised persons with a history of disciplinary events.”

I would guess that the SEC is looking for firms to have taken extra steps to ensure that those who have transgressed in the past are in better supervision and in a firm that stresses good behavior.

As the SEC insists in disclosures past performance is not indicative of future results. But I think the SEC believes that those who have violated the rules in the past are likely to do so again.

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Compliance Bricks and Mortar for September 16

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

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Wells Fargo CEO Defends Bank Culture, Lays Blame With Bad Employees by Emily Glazer and Christina Rexrode in the Wall Street Journal

He later said through a spokeswoman that when the bank falls short “I feel accountable and our leadership team feels accountable—and we want all our stakeholders to know that.”

Rather, Mr. Stumpf said that some employees didn’t honor the bank’s culture. “I wish it would be zero, but if they’re not going to do the thing that we ask them to do—put customers first, honor our vision and values—I don’t want them here,” he said. “I really don’t.” [More…]


Worst Bar Exam Results Ever? Only ONE Person From This Law School Passed The Bar Exam by Staci Zaretsky in Above the Law

Indiana Tech School of Law threw open its doors in 2013, amid cries that Indiana had no need for another law schoolduring a time when jobs for law school graduates were few and far between. The administration had hoped to enroll 100 students, but only 30 students signed up to attend, and just 27 enrolled. After three years of hard work, by the time Indiana Tech’s inaugural class was set to graduate this past May, 20 students earned a degree from the state’s fifth law school. [More…]


Was This “Whiz Kid” An Investment Adviser? by Keith Paul Bishop in California Corporate & Securities Law

Earlier this week, the Securities and Exchange Commission announced that a self-styled “stock trading whiz kid” and his Los Angeles, California company have agreed to pay $1.5 million to settle a complaintfor violations of Rule 10b-5.  There is an odd disconnect between the SEC’s press release and its complaint.  The press release is headlined “stock newsletter fraud” and repeatedly refers to the defendant’s “newsletter company”.  In fact, the SEC never uses the word “newsletter” in the complaint.  Rather, the SEC alleges that the defendant and his company defrauded subscribers and potential subscribers to an on-line “chat room”, and two stock picking “alert services”. [More…]


Social and Behavioral Sciences Team 2016 Annual Report from the Executive Office of the President (the Nudge Report)

On September 15, 2015, President Obama issued Executive Order 13707, “Using Behavioral Science Insights to Better Serve the American People.” The Order directs Federal Government agencies to apply behavioral science insights—research insights about how people make decisions and act on them—to the design of their policies and programs. The Order also charges the Social and Behavioral Sciences Team (SBST), a cross-agency group of applied behavioral scientists, program officials, and policymakers, with providing policy guidance and advice to Federal agencies in pursuit of this directive

[More…]


The Free-Time Paradox in America by Derek Thompson in The Atlantic

Here is the conundrum: Writers and economists from half a century ago and longer anticipated that the future would buy more leisure time for wealthy workers in America. Instead, it just bought them more work. Meanwhile, overall leisure has increased, but it’s the less-skilled poor who are soaking up all the free time, even though they would have the most to gain from working. Why? [More…]


Trustee Charged As A Failed Gatekeeper

When a fraud is uncovered, the Securities and Exchange Commission not only wants to get the fraudsters, it also wants to get those who should have stopped the fraud: the gatekeepers. Recently, the SEC has brought charges against a fund administrator and fund auditors. The latest is a case against

Château de Crécy-la-Chapelle: Gate

The Securities and Exchange Commission announced that a subsidiary of Oklahoma-based BOK Financial Corporation agreed to pay more than $1.6 million to settle charges that it concealed numerous problems and red flags from investors in municipal bond offerings to purchase and renovate senior living facilities. According to the SEC’s order, BOK Financial failed in its gatekeeper role as indenture trustee and dissemination agent for the bond offerings.

In a case brought last year, the SEC filed charges against Christopher F. Brogdon for dozens of municipal bond and private placement offerings in which investors supposedly earn interest from revenues generated by the nursing home, assisted living facility, or other retirement community project supported by their investment. But Brogdon secretly commingled investor funds instead of using the money to finance the project described to investors in the disclosure documents for each offering and diverted investor money to other business ventures and personal expenses.

According to the SEC’s order, BOK Financial, and a former senior vice president at the bank, Marrien Neilson, became aware of numerous red flags:

  • Brogdon was withdrawing money from bond offering’s reserve funds and failing to replenish them.
  • He had failed to file annual financial statements for the bond offerings.
  • The nursing home facilities serving as collateral for one of the bond offerings had been closed for years.

But Neilson allegedly warned others that disclosing red flags could impair future business and fees from Brogdon, upset bondholders, and cause regulatory issues for bond underwriters. So Neilson and BOK Financial decided not to inform bondholders as required.

BOK Financial settled the charges. Neilson is challenging the charges, so we only have the SEC’s side of the story.

Neilson was the primary recipient of bonus compensation awarded on the basis of the fees paid to BOKF for the Brogdon Bond Offerings. She also received bonus compensation for other bond offerings that financed the sale of Brogdon-owned nursing homes and assisted living facilities to third parties. The SEC charged that she knew or recklessly disregarded that Brogdon was supposed to make disclosures to the bondholders about the red flags.

In the SEC Order, there are numerous emails showing Neilson in a poor light:

“In a March 1, 2010 email to one of Brogdon’s assistants regarding late debt service payments for an offering, Neilson states that the late payment put her “in an extremely awkward position” because “the Reserve Fund has previously been used and not replenished and I did not call a default.” In the same email, Neilson states that “[b]ondholders are going to want to know why we don’t used [sic] the Reserve Fund.” Neilson also states that “we need to disclose the other Reserve funds if they are not replenished,” asking Brogdon’s assistant “if you want a list of them and how much?”

I assume Brogdon was trying to keep his enterprise afloat and Neilson was helping him kick the can down the road. Perhaps a little more debt can buy a little more time to get cash flow positive. That didn’t happen and the debt facilities finally went into default and bankruptcy.

The gatekeeper should have stopped the fraud. Instead, it helped with a dozen more offerings expanding the scope of the fraud.

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Château de Crécy-la-Chapelle: Gate by Baishiya 白石崖
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See the Changes to Form ADV

With all the regulatory changes to Form ADV coming out, I found it tough to figure out what the changes look like on the form. The Securities and Exchange Commission published a helpful redline that highlights the changes.

The SEC is not willing to stand behind the redline, noting:

This document illustrates most of the revisions to Form ADV related to adopted rule release IA-4509. This document should not be considered a complete and comprehensive list of changes to Form ADV.

I think many will find the “separately managed account” portion to be confusing. The first being the use of this term which sounds much like the term, separate account, used in the insurance industry to invest. The borrowing and derivatives reporting will be time-intensive.

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Political Party Contributions and the SEC’s Pay-to-Play Rule

I was looking through an issue under Rule 206(4)-5. The Securities and Exchange Commission limits the ability of investment advisers and fund managers to contribute 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. I was looking at how that rule applies to political parties.

Section (a)(2) makes it unlawful for an investment adviser or any of its covered associates

(ii) To coordinate, or to solicit any person or political action committee to make, any:

(B) Payment to a political party of a state or locality where the investment
adviser is providing or seeking to provide investment advisory services to a government
entity.

So it’s not unlawful to make a contribution to the party, but it’s unlawful to solicit others to make a contribution to the party.

Just to confirm the SEC responses seems to agree with this reading of the rule.

Question V.3. Contributions to Others.

Q: If an adviser subject to the pay to play rule, or one of the adviser’s covered associates, makes a contribution to a political party, PAC or other committee or organization, but not to an official, could the adviser still be subject to a two-year time out under rule 206(4)-5(a)(1)?

A: A contribution to a political party, PAC or other committee or organization would not trigger a two-year time out under rule 206(4)-5(a)(1), unless it is a means to do indirectly what the rule prohibits if done directly (for example, the contribution is earmarked or known to be provided for the benefit of a particular political official) (see footnote 154 of the Adopting Release).

We note, however, that the pay to play rule prohibits advisers and their covered associates from coordinating or soliciting any person (including a non-natural person) or PAC to make any payment to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity (see rule 206(4)-5(a)(2)(ii)). (Posted March 22, 2011).

A covered associate at an investment adviser could attend a state political party fundraiser, but not host one.

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