“May” or “Will” is Less Important Than Completeness

The Robare case popped to my attention last year because the Securities and Exchange Commission was focused on the use of the word “may” instead of “will” as adequate disclose of a fee arrangement. My eyes rolled at such distinction. The administrative law judge felt the same way and dismissed the case. Now the Commission has heard the appeal of the case and found the adviser at fault.

Cash in the grass.

According to the SEC charging order, The Robare Group would receive a fee for client funds invested in certain mutual funds. Of course, there is nothing inherently wrong with that arrangement as long as it is disclosed to clients. Obviously, the concern is that the adviser would direct clients to invest in those funds because it is good for the adviser, not necessarily because it is good for the client.

The original decision seemed centered around the SEC raising a fuss that Robare said in the Form ADV that is “may receive compensation from some mutual funds”. The SEC thought it should say “will” to highlight the conflict. The ALJ was not moved by this argument.

He also found that Robare was not negligent because it had engaged a compliance consultant to help with the disclosures. Surely this was a boon to compliance consultants.

The Commissioners overturned the ALJ. The ruling stayed away from the distinction between “may” and “will” by pointing out that the disclosure was inadequate to explain the fee sharing arrangement and how it may influence Robare to recommend one fund over another.

The disclosure mentioned individuals getting sales commissions. That was not accurate. Robare was paid based on the assets in certain funds.

The disclosure did not let clients know which funds generated the extra fee. A client would not be able to cast a skeptical eye on the arrangement of his or her portfolio. The case notes that there was no evidence that Robare’s clients were dispoportionally invested in funds that paid an extra fee to Robare.

The SEC seems moved that Fidelity reviewed the Robare Form ADV and did not find adequate disclosure and made the firm redo it.

In a blow to compliance consultants, the Commission did not allow Robare to escape a charge of negligence merely because it used a compliance consultant.

The ALJ found that Robare was not negligent in part because Robare relied on “experience and competent compliance consultants” to help ensure that it met the disclosure requirements. The Commission acknowledged that there is defense available at times for reliance on defense counsel. But there is not necessarily such a defense available for reliance on compliance consultants. Even if there were such a defense, the Commission felt than Robare did not demonstrate that the firm had met the equivalent standards.

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Politics and Conflicts of Interest

Politicians and their staff are prone to conflicts of interest. Legislative, executive, and regualtory actions will affect the value of companies and their investors.

Hillary Clinton failed to address the conflicts between her actions as Secretary of State and the fundraising of the Clinton Foundation. One of the campaign promises of Donald Trump was to tackle these conflicts of interest and “drain the Washington swamp.” Either candidate would have to address the conflicts when taking over the presidency.

Mr. Trump won, whether you are for or against him, and now its time to figure out how to deal with the conflicts. His task is many times larger than that of any modern candidate. He has extensive business holdings, most of which are based on his name and run by his family, and extensive overseas investments.

Perhaps there is a role for a compliance program here.  It’s not just for good ethics. There is a Constitutional requirement in the Emoulments Clause and the Foreign Gifts and Decorations Act.

The standard political solution to wealth management for the president is is a blind trust. The trustees are independent of the candidate and the politician does not know what is in the trust. That would prevent the politician from achieving direct financial gain from his or her time in office.

A blind trust will not work for an active business like the Trump organization. Having it run by his children makes it even less blind. It’s hard to miss the investments made by the company when the Trump name is plastered all over the holdings. Look at his financial disclosures. He listed hundreds of companies that he owns or controls.

In addition, serving as president will not make Mr. Trump immune from private lawsuits. He could easily be dragged into court for a deal gone bad. I would expect that he will be magnet for litigation.

He has extensive holdings overseas. That is going trigger anti-corruption regimes in those countries. Some of his lenders are state controlled organizations.

Put on your compliance hat and offer some advice.

I agree with the Wall Street Journal opinion page’s advice. (I admit that this is an uncommon event for me.)

Mr. Trump needs to sell. He needs to liquidate his interest in the Trump Organization. It’s the only way. If he does not, he is just another alligator in the swamp of Washington DC.

I’m doubtful he will take the right path. To do so would put an actual valuation on the organization. I think he is happy to say he is extremely wealthy. I think he is even happier to not know what that number is.

Selling the organization would place a clear dollar value on his organization and on him. I’m sure Mr. Trump thinks that the value is many times higher than what a third party would be willing to pay, or through an IPO.

I think the chances of a sale is close to zero.

How should Mr.Trump arrange his holdings to avoid a conflict of interest or accusation of kleptocracy. One would be to prove that he not actually receiving financial gain. Unfortunately, that would require a level disclosure that gets him closer to the information he would have to provide in an IPO.

You may agree with some, all, or none of Mr. Trump’s policies, whether actual or perceived. Nobody wants the US president to have the appearance of a kleptocrat. Nobody wants the president to be using the office for overt, personal financial gain while in office.

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Compliance Bricks and Mortar for November 18

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


Four Companies to Watch for ‘Trump Risk’ by Matt Kelly in Radical Compliance

Last week two companies became the first public filers to cite the incoming Trump Administration as a risk worth disclosing in the Risk Factors section of their quarterly reports. We haven’t seen any more since then, although we will in the future.

….

Which companies are most worth watching for what they say about the Trump Administration? I have five picks, in alphabetical order. [See the picks…]


Why FCPA Compliance Makes America Great by Tom Fox in the FCPA Compliance Report

I began this week by considering the practical and legal reasons that I do not think the incoming Attorney General will lessen FCPA enforcement and President-Elect Trump would overturn the law by executive fiat. Since that time I have spoken about the compliance discipline in an attempt to demonstrate that good compliance is really good business and for that reason alone, the compliance profession is not going away under the incoming administration. Today, I want to return to the FCPA to demonstrate the effectiveness of the law in assisting American business interests outside the United States and making America great when companies are in compliance with the law. I also want to show how FCPA compliance puts forward a much wider variety of US interests to make America great again and again. [More…]


JP Morgan Pays $264 Million to Resolve ‘Sons & Daughter Program’ FCPA Offenses by Richard L. Cassin in the FCPA Blog

JPMorgan Chase and a Hong Kong subsidiary agreed Thursday to pay $264.4 million to the DOJ, SEC, and Federal Reserve to resolve FCPA offenses for awarding prestigious jobs to relatives and friends of Chinese government officials to win banking deals. [More…]


House Republicans ask White not to pass any ‘midnight rulemaking’ by Jacquelyn Lumb in Jim Hamilton’s World of Securities Regulation

In opening remarks at the House Financial Services Committee hearing to consider the SEC’s 2018 budget request, Chair Jeb Hensarling (R-Tex) strongly urged Chair Mary Jo White to resist the temptation to finalize any regulations, including Dodd-Frank Act Title VII regulations, in deference to the right of the incoming administration to set its own priorities. He said whenever there is a transfer of power from one administration to another, federal agencies are often tempted to rush pending rulemaking to implement policies of the outgoing administration. This type of “midnight rulemaking” is neither conducive to sound policy nor consistent with principles of democratic accountability, he warned. [More…]


Financial Choice Act: One Provision Could Destroy the SEC’s Rulemaking Abilities by Broc Romanek in TheCorporateCounsel.net

The “Financial Choice Act” is much more than merely repealing big chunks of Dodd-Frank. There are a handful of provisions that would render the SEC’s ability to conduct rulemaking much more difficult. But this provision in particular – infamous “Section 631” – just blows me away:

SEC. 631. CONGRESSIONAL REVIEW. If the agency classified a rule as “major,” according to specified criteria, the rule would require a joint resolution of Congress to go into effect, unless the President finds that an emergency requires that it be effective (for 90 days). Congress would also have the right to disapprove certain non-major rules.

 [More…]


LL.M.s in Corporate Compliance by Emily Cataneo in the LLM Guide

Law programs focusing on corporate compliance are growing in popularity following the financial regulatory reforms of the past decade. [More…]


The Interstate of Things: Saying Goodbye to the Mass Pike Tollbooths by Sadalit Van Buren in A Matter of Degree

On October 28, the Massachusetts Turnpike switched to an all-electronic tolling method, and immediately thereafter, began to tear out the tollbooths that had been the gateways and choke points of the Pike since its construction in the 1950s and 1960s. Unobtrusive gantries over the highway now do all the data collection for the toll-taking. It’s been very strange to drive freely through spots that have been obstructed since I was born, and I’ve been reflecting on the change. [More…]


The Downside to Advertisement Restrictions

Going back over my notes in search of guidance on when advertising for a private equity firm is advertising restricted under the Investment Advisers Act and when it is advertising for the firm’s products and services, I’m left uncertain.
half-price advertisement

I was hoping that the gun jumping interpretations would offer some meaningful guidance. So far, I have not found much hope.

My concerns arose from some second-hand rumors about what the Securities and Exchange Commission has been attacking during examinations of private equity firms and real estate firms that are registered as investment advisers. One story was about a fund manager having to take down references to a real estate industry award on the firm’s website. The award sounded like one focused on real estate operations. Using my earlier standard, the award sounded like an award for making good soup not for having good securities.

That leaves real estate fund managers registered as investment advisers at a competitive disadvantage to real estate sponsors who are not registered as investment advisers. The public real estate companies have some guidance under Rule 168 and Rule 169 as to what is advertisement.

Registered real estate fund managers may have to operate in a gray area trying to decide when an advertisement is about the real estate soup. Otherwise they risk the vagaries of an SEC examiner deciding an advertisement violates the Investment Advisers Act.

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Gun Jumping

I began exploring the difference between advertising the soup and advertising the securities in yesterday’s post. That is, I looking for distinction between a private equity firm advertising in relation to its portfolio companies or real estate holdings, and advertising its performance as an investment adviser. Portfolio company advertising is outside the legal framework under the Investment Advisers Act restrictions on advertising.

half-price advertisement

I thought the gun-jumping rules under the Securities Act might provide a useful framework to help determine whether an ad is about the soup or about the securities.

The default would seem to be that any advertising by a firm could be considered an advertisement for the firm’s securities, depending on the facts and circumstance. The SEC has explained that

“the publication of information and publicity efforts, made in advance of a proposed financing which have the effect of conditioning the public mind or arousing public interest in the issuer or in its securities constitutes an offer . . .” Guidelines for the Release of Information by Issuers Whose Securities are in Registration, Release No. 33-5180 (Aug. 16, 1971) [36 FR 16506]

In the 2005 Securities Offering Reform, the SEC created safe harbors under Rule 168 and Rule 169 for factual business information, which included advertisements or information about a firm’s products or services. These rule reinforce the ability to advertise about the portfolio company or real estate as long as its not an advertisement about the investment adviser.

It would seem that a portfolio company’s advertisements that do not mention its private equity owner are perfectly okay. Once the private equity manager is mentioned, you need to make sure the advertisement is focused on the portfolio company and not the success of the registered private equity fund manager.

It’s harder to put this in the context of a registered real estate fund manager. Tenants have a keen interest in the owner of the real estate. They want to know that the landlord has the financial resources to keep the building running and to live up to its obligations under the lease.

There is surely a distinction to be made between a real estate fund manager as an operator of real estate and as an investment adviser. I’m still looking for some guidance.

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Publicity for Private Equity Funds

While looking through the various restrictions on advertising for investment advisers, I was  struck by how they fail to address the operations of private equity funds. The Securities and Exchange Commission effectively banned advertising by investment advisers for decades. As reality came, the SEC relented, subject to strict restrictions. In this post-Dodd-Frank world with private equity funds, the advertising restrictions are tough to navigate for private equity funds and their portfolio companies.

half-price advertisement

Private equity funds are dealing with two different regulatory schemes. The restrictions under the Investment Advisers Act apply all the time, while the restrictions under the Securities Act will apply during fundraising.

The issue is drawing the line between advertising for the fund manager and advertising for the portfolio company. The same is true for private equity real estate funds, in which case the real estate asset is the portfolio company.

A soup company should be able to advertise its soup. This should be true regardless of its ownership structure, whether it is a public company, a private company, or owned by a private equity fund. The soup company can only advertise securities issued by the company in accordance with the securities laws.

I have not found much in the Investment Advisers Act to address this circumstance. That the ownership of the soup company is controlled by an firm regulated under the Investment Advisers Act should not affect its ability to advertise soup.

If the soup is real estate, the firm should be able to advertise its buildings. The ownership structure of real estate should not affect its ability to let the general public that the building is for sale, that space is available or that some new renovations have transformed the building.

The problem begins when you try to draw the line between an advertising for the soup and an advertising for the securities. It’s not a bright line. I’m sure you can imagine ads all along the line going from soup to securities.

That has lead me to look at the SEC limitations around gun-jumping. Under Section 5(c) of the Securities Act, it’s unlawful to make solicitations or offers for the sale of securities prior to the filing of a registration statement. There is a large body of law on what constitutes pre-filing publicity. This is a large body of law in which I have no expertise.

I plan to spend the next few days exploring the area of gun-jumping to see if I can find some ways to determine when a private equity firm is advertising the soup or advertising the securities.

Veterans Day Compliance Bricks and Mortar

Please remember to those who have served in the armed forces for the sacrifices they have made.

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

veterans-day-big


Donald Trump’s Transition Team: We Will ‘Dismantle’ Dodd-Frank in the Wall Street Journal

The brief note on Mr. Trump’s new website marked the first time since Tuesday’s election that the president-elect addressed financial regulatory policy. The statement was consistent with Mr. Trump’s campaign trail rhetoric, blaming the Obama administration’s signature response to the financial crisis for a tepid economy and promising to “replace it with new policies to encourage economic growth and job creation,” but providing few details. [More…]


When Compliance Counsel Speaks, CCOs Should Listen by Tom Fox in FCPA Compliance & Ethics

I was recently having breakfast with a colleague and we were discussing the Department of Justice’s (DOJ) Compliance Counsel Hui Chen and what we believe to be the positive impact she has had on the compliance community, compliance programs and the role of the Chief Compliance Officer (CCO). I told him about some of her public remarks about what constitutes an effective compliance program.  [More…]


Five Post-Election Points for CCOs to Ponder by Matt Kelly in Radical Compliance

Well, the American people, in their endless wisdom or lack thereof, elected Donald Trump to the White House and gave us a Congress even more deeply divided than before.

The post-mortems on what happened last night and what it means for the country will be many, and last for months. Compliance officers can get started with a few items that should be on your radar screen today.

Key Lawmakers are gone, or busy [More…]


Here’s How the SEC Is Using Big Data to Catch Insider Trading in Reuters

Formed in 2010, the Analysis and Detection Center of the SEC’s Market Abuse Unit culls through billions of rows of trading data going back 15 years to identify individuals who have made repeated, well-timed trades ahead of corporate news.

The new strategy is starting to show results, enabling the SEC to launch nine insider trading cases, around 7% of cases the agency brought since 2014 against people who trade on confidential corporate information.  [More…]


 

Gatekeeper Failure for a Taking Management Fees in Advance

Steven Burrill was using his venture capital fund as a persona piggy bank and the fund’s auditor failed to do anything when it saw the red flags. Now the auditor partner is subject to charges by the Securities and Exchange Commission.

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Private funds typically take management fees in advance. That is not unusual or illegal. SEC filings for registered investment advisers specifically contemplate it. Item 18 in Form ADV Part 2A requires additional disclosures that must be made if you take prepayment of more than $1200 in fees per client six months or more in advance. Most private funds take management fees quarterly in advance to “keep the lights on.”

But Burrill started taking fees earlier than allowed under the fund documents. Eventually, Burrill took more in advance fees than could be expected to earn over the life of the fund. The SEC brought charges against Burrill and he agreed to repay the fees and pay a fine.

As the SEC has done with several other cases, the SEC brought charges against a gatekeeper who failed to act.

Adrian D. Beamish was the audit partner with PricewaterhouseCoopers LLP for the Burrill engagement. According to the SEC order:

From 2009 through 2011, Burrill characterized the payments as advances on future management fees that he would earn through the provision of future management services as the fund’s manager. The payments were made many months—and even years—before the fees were to be earned. In each of these three years, Beamish failed to inquire whether Burrill had the authority to take the unusual payments, nor did he scrutinize the rationale for the payments, which Burrill needed to pay his own personal expenses and to fund his other businesses. Significantly, in conducting the yearend 2012 audit, Beamish learned that the advanced management fee payments that had been paid greatly exceeded any potential future management fee obligations the fund might owe.

The prepaid management fees were almost $5 million at the end of 2009, over $9 million in 2010 and over $13 million by the end of 2011.

“Had Beamish made appropriate inquiries as required by professional standards, his audit team would have likely discovered that the fees advanced to the General Partner had been used for the business operations of affiliated Burrill entities, such as Burrill Securities LLC, and to pay for Burrill’s own personal expenses.”

The SEC charges that Beamish failed to exercise professional care mandated by the accounting standards. According to the SEC, he failed as a gatekeeper.

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What Now? Trump Presidency and Compliance

While votes are still being counted, it’s clear that the Clinton Firewall in Michigan and Wisconsin did not hold. Get used to saying “President Trump.” The other story is that Republicans held the Senate, leaving Congress in the hands of the Mitch McConnell and Paul Ryan. That means some aspect of the Republican platform will start going through the legislative system in January. What will that mean for compliance?

trumpland

The Clinton loss was a compliance failure. Clinton failed to implement policies and procedures to address the conflict of interests between the Clinton Foundation and her role in government. There was the appearance of charitable donations being made to influence government action. (If not actual influence-peddling.) Anyone familiar with the FCPA would know that charitable donations to influence government action in a foreign country will put you in the crosshairs of enforcement for an FCPA violation.

Clinton had a cybersecurity failure, or at least the appearance of a failure. Her emails ended up on the computer of an accused pedophile.

As a result, America elected Mr. Trump.

He has clearly stated policies on isolationism, pulling away from free trade and limiting immigration. That was the bedrock of his campaign. America has its version of Brexit.

Mr. Trump has not been clear on what his plan is for domestic policy. That seems to be a more generic Republican agenda. We need to look more toward Mr. Ryan’s plans and Mr. McConnell’s plans.

Expect de-regulation. All three have made calls for repeal of Dodd-Frank. I don’t expect it will be a simple repeal. I think compliance professional can expect a wholesale reversal in some areas. Many of us will be tearing up policies and procedures and starting over.

For private funds, there have been several bills in the House to remove or lessen the registration requirements. Those died in the Senate. It’s not clear if they died because Senate leaders did not like the changes or didn’t want to bother with the legislative effort knowing they would be vetoed by the President.

I expect Mary Jo White will step down as Chair of the Securities and Exchange Commission. That will leave three vacancies to be filled by the new President. There is a chance that the current candidates are approved during the lame duck session. I would not take that bet. I’m skeptical that Mr. McConnell will let Obama implement anything during the lame duck session.

January will be busy in Congress as the old bills are dusted off and run through committee to get on the floor of the House. New bills will come together quickly. Compliance professionals will need to pay close attention. Change is coming.